Sole-supplier deals could stifle competition and reduce the impetus to innovate.

When a company with the size and influence of Boeing flexes its muscles, everybody had better sit up and take notice.

Recently, there's been plenty of muscle-flexing in Seattle. Boeing has signed sole-supplier deals with American Airlines and Delta Air Lines, tying up all these carriers' business for at least 20 years. It agreed to take over McDonnell Douglas, leaving it with only one rival in the commercial aviation business. It continues to manoeuvre to discourage that rival from launching a new large aircraft. It even signalled an intention to enter the airframe maintenance business, placing it in direct competition with some of its largest customers.

Boeing should not be criticised for taking any of these actions, which merely reflect what any responsible business should do - consolidate market position, cement long-term relationships with customers, make life as difficult as possible for competitors, and seek growth opportunities in related businesses which offer profit potential. However, Boeing's overall dominance in the supply of airframes means that its recent moves deserve serious attention.

Take the sole-supplier deals. On the face of it, they make a great deal of sense. The airline obtains rock-bottom, predictable prices, guaranteed production-line slots, and fleet commonality. The manufacturer enjoys an ability to plan production with a greater certainty than has been possible in the past. But if one manufacturer obtains too many deals like this, will the industry as a whole lose out?

Suppose the top 20 airlines, which account for more than half of all airline revenues, all sign a sole-supplier deal with either Boeing or Airbus. This is not unreasonable: the airline business is so competitive that if your peers have obtained a special deal which gives a cost advantage, you need the same deal. Surely such a development would stifle competition for airframe orders and reduce the impetus to develop new models.

With a substantial amount of business already 'in the bag', the focus of the manufacturers could change radically. Nowadays, tough competition for every order forces plane-makers to improve their product lines continuously, and to offer the keenest prices and the best support. Once most major customers have made a long-term fleet choice and the possibility of shifting away from a particular manufacturer has effectively disappeared, manufacturers can cut back on development, merely concentrating on meeting performance targets and cutting costs. Worse, smaller airlines will have to pay higher prices; with the bulk of production line slots guaranteed to a few carriers, remaining slots can effectively be auctioned off.

Airlines and competition authorities need to consider these issues carefully. Airlines used to place orders strategically to ensure that a particular manufacturer remained in the business. Now, only two competitors dominate the jet aircraft market, which is worth $40-50 billion a year.

Boeing's growing strength ought to be adding further impetus to the restructuring of Airbus, but instead this process seems to be faltering. This is no time for Aérospatiale to make awkward noises about keeping its manufacturing and development activities separate, or about waiting until defence activities can be included to produce a European aerospace leviathan. Rather, the Airbus partners need to act quickly to turn the venture into an independent entity which is fully equipped to take on Boeing.

Recent suggestions that Boeing might move in on the maintenance market, perhaps by purchasing British Airways Engineering, have led to howls of abuse from Boeing customers with substantial third-party engineering revenues - notably Lufthansa chairman Jürgen Weber, who has threatened to stop buying Boeing aircraft in retaliation. It now seems that Boeing will have to tread very carefully in this area, and BAhas defused the situation by putting off the conversion of BA Engineering into a limited company for at least five years.

A bigger concern lies with the engine maintenance business. Through an aggressive acquisition strategy culminating in the purchase of US engine overhaul company Greenwich, General Electric has assumed a dominant role in engine maintenance, a capital intensive business with massive barriers to entry. Pratt & Whitney is planning to follow by offering airlines lifetime support contracts, and Rolls-Royce cannot be far behind.

There are benefits for airlines in that manufacturers can offer economies of scale, technical strength, and predictable costs through long-term support contracts. However, as with any business, concentration of supply into the hands of a very small number of companies must lead to concerns about potential long-term cost increases.

Source: Airline Business