Overview
The airframe manufacturers are in a fragile state. Understanding this will allow industry participants to prepare for significant pending changes
I. High Concentration
Rarely is a global industry as concentrated as the airline industry. The term duopoly comes to mind, but with the continuing problems of Boeing, perhaps a blend of the terms duo and mono is more apt; “dumo” as in “dumopoly” has a nice ring to it. Regardless, it has taken years for the industry to devolve into the current state and probably take additional years for a resolution. We will address the impact of the current conditions later but first, it is helpful to comment on some likely next steps.
II. Next Steps
Our view is that progress is never-ending and that those which impede that progress will fail over time. The latest important example of this is the space launch industry, over which Boeing and Lockheed Martin had a lock. Three significant competitors vied for a chance to be alternatives with SpaceX winning the competition to date. The problem was that the two incumbents were able to use their dominance to secure cost-plus contracts from NASA, which reduced their business risk and their incentive for innovation.
The same occurred in the auto industry in the 1970s when the dominant US manufacturers refused to produce fuel-efficient, affordable vehicles, thereby providing an opportunity to the Japanese firms to establish a presence in the US. Likewise, in the 1920s, Henry Ford’s company dominated auto manufacturing and stated the following:
“Any color the customer wants, as long as it’s black.” Henry Ford¹
While such approach simplified manufacturing, it did not meet customer demand and provided an opening to Alfred Sloan of General Motors, which rapidly assumed leadership in the industry.
For those who are still not convinced, the dominant wagon manufacturer in the United States as of the early 1800s, Conestoga, never made the transition to self-propelled wagons or horseless carriages.²
Our thesis is simple: (1) companies that are insulated from competition become less capable of innovating and (2) the major global airplane manufacturers are insulated from competition.
An additional factor is that with the recent missteps regarding Boeing’s doors, regulators have increased scrutiny:
The Federal Aviation Administration plans to keep “boots on the ground” at Boeing until it can be sure the aircraft manufacturer’s quality control system is working. “We’ve got a lot of inspectors on the ground, visually inspecting the aircraft as it comes through,” FAA Administrator Mike Whitaker told CNBC’s Leslie Josephs. “We’re shifting from more of an audit approach to a direct inspection approach.” The agency earlier this month announced an audit of Boeing’s production lines in light of the Jan. 5 incident on an Alaska Airlines flight in which a panel blew out of a 737 Max 9 at 16,000 feet. Whitaker told CNBC the FAA has dispatched a “couple of dozen” inspectors to review the planes, which are grounded.
It is difficult to argue that such additional scrutiny will enhance innovation.
III. Innovation
There are several developments which promise to make air travel more effective (that is faster, cheaper, better):
Engines – The rotary detonation engine³ has the advantage of deriving more thrust from fuel and appears to provide up to a 25% savings on fuel costs, which is massive.(See the photo at the top of this article.) The problem of engine heat appears to have been addressed via new materials and the engine is being tested in various applications.Other power sources such as electric have potential but are likely to remain a challenge on longer journeys. The current engine manufacturers such as GE, Rolls-Royce, Pratt & Whitney, and CFM are well-positioned, but others might jump in with variants of the new technology.
Wings – new wing designs have the potential to reduce drag in increase lift with a dramatic increase in fuel efficiency.⁴
Airframes – integrating the wing and body has the potential of more efficiently moving passengers.
Speed – Memories of the 3-hour trip from London to New York are fading, but it is only a matter of time before some alternatives arise. Perhaps it is only a matter of time before a viable alternative emerges.⁵
IV. Upshot
- Increased Airplane Values - The most immediate impact is that the current supply of aircraft is likely to become more valuable as Boeing’s production problems will stem new deliveries. Demand is growing rapidly as the economy recovers.
- Airline Benefit – The major drivers of airline profitability are demand (which is likely to remain strong), competition (which will be constrained by limited new deliveries), fuel prices (which have been manageable), and labor costs. Hence, the future looks bright. For those airlines holding Boeing 737 Max9 such as Alaska Airlines⁶, the grounding of airplanes will hurt.
- Diverging Values - Share price of the two has reflected the continued troubles of BA; it might be a decade before Boeing can seriously challenge Airbus’s leadership.
- Emerging Competition – while it is hard to imagine now since there are few alternatives to Boeing and Airbus currently (with the possible exception of China-based Comac), we expect some to emerge.
Note that Tesla had to internalize parts manufacturing because it was shunned by the parts manufacturers beholden to the legacy manufacturers. A new airframe entrant will likewise have to build its own parts capabilities. SpaceX, with assistance from Tesla, has the capability, but as the opportunity becomes more obvious, expect others to enter. - Support from Major Players – watch for some of the major airlines and freight companies to search for alternatives as they seek some leverage over the legacy manufacturers.
Figure I: Stock Price (% change, 3 yrs)
Sources
[1] https://www.thejamesmadisonmuseum.net/single-post/any-color-the-customer…
[2] https://en.wikipedia.org/wiki/Conestoga_wagon
[3] https://en.wikipedia.org/wiki/Rotating_detonation_engine
https://www.google.com/search?q=rotating+detonation+engine+efficiency…
[4] https://www.aerospacetestinginternational.com/features/how-and-why-aircraft…
[5] https://www.businessinsider.com/see-the-supersonic-passenger-planes…