With the narrowbody market so valuable, it is vital for Airbus and Boeing to be spot on with their A320 and 737 successors, both in technology and timing
Barring a major surprise, neither Airbus nor Boeing is likely to have successors to their A320 and Next Generation 737 families ready for service before 2013. Assuming both expect their narrowbody successors to demonstrate 15-20% unit cost improvements, the first appearance of a follow-on type will rely largely on the development of engine technology needed to provide the bulk of the improvement.
Airbus chief executive Gustav Humbert said as much in January, saying 2013 is the earliest he expects suitable engine technology to become available. But a sizeable body of industry opinion believes that even Boeing – seen as more likely to introduce its successor narrowbody first, if only because the A320 family outsold the 737 by 918 to 569 last year – is unlikely to bring out its 737 replacement before 2015.
One reason for that, in the eyes of economists such as Adam Pilarski, senior vice-president of aircraft technical consulting firm Avitas, is that 2013 looks likely to be the trough of the next recession. And, says Avitas vice-president of asset valuation Doug Kelly, in a market duopoly – which Airbus and Boeing have represented since Boeing bought McDonnell Douglas – neither party feels pressure to innovate without a compelling sales incentive. With A320 and 737 lines almost sold out until 2010 and delivery positions allocated up to 2016, neither family’s orderbook looks in imminent danger of expiry.
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A further argument for a later rather than earlier appearance of a A320/737NG successor is that each offering is likely to incorporate new materials and systems technology being designed into the 787 and the A350. Neither Airbus nor Boeing would feel confident cramming a new narrowbody with advanced technology adopted from the new widebody programmes until the technology has had one or two years to prove its reliability in service, says Pilarski. That implies Boeing may not finalise a narrowbody-successor design until 2010 and Airbus not until 2013. But the narrowbody market is so important in terms of aircraft numbers and dollars that as soon as one manufacturer launches its successor, the other will follow quickly, he says.
A critical issue for any airline or leasing company ordering A320-family aircraft or 737NGs today is how resale values and lease rates will be affected by the service-entry date of their replacements. Once a successor appears, their predecessors can become obsolescent and lose market value quickly. In just six years, residual values for end-of-line 1999 737-300s fell to $16 million, just half of their original purchase prices, says Jack Feir of appraisal firm Jack B Feir & Associates. Feir says residual values of the last Boeing MD-80s – produced in the late 1990s – also halved by 2005.
Customers receiving new A320-family or 737NG aircraft just as their successors are entering service may well be most at risk in terms of residual value loss. “In most cases, it’s not good to have the first and the last aircraft off a production line,” declares Pilarski.
Although later examples of a long-lived airliner, such as the A320, are more capable than early examples due to improvements introduced throughout its production life, the late-model aircraft are made just as obsolescent by a successor. Since these aircraft are new, “in terms of value they are hurt more than earlier aircraft, because they’re starting from higher values”, says John Keitz of appraisal firm BK Associates.
Appraisers take this into account in their market-value forecasts, which are predicated on “base value”, a theoretical value equivalent to the possible profit to an airline of operating the aircraft for the rest of its useful economic life. So the length of an aircraft’s expected remaining economic life at any given point is important in predicting its future market value.
Airbus is expected to study next-generation designs that clearly evolve from the A320 rather than completely replace it
In a recession, the high availability of newer, more efficient aircraft can result in even relatively young aircraft being scrapped: some late-1980s 737-300s and -400s were parted out in the recent US industry downturn. Appraisers now believe aircraft have shorter economic lives than previously thought. Where widebodies such as Boeing 747-200s and McDonnell Douglas DC-10s once were assumed to have 35-year lives, now appraisers forecast 28 years, says Keitz. Similarly, says Feir, where once it was assumed narrowbodies would stay in mainline service into their late 20s, appraisers now forecast 21-22 years.
Predicting how much the values of late-production A320-family and 737NG aircraft will decline when their successors enter service is not possible today, says Fred Bearden of appraisal firm Aircraft Information Services. Bearden says the replacements’ value impact can only be assessed when one knows how much lower their unit operating costs will be compared with their predecessors. “If it has a 20-30% trip-mile cost advantage, it’s a very big deal,” he says.
Also important is how Airbus and Boeing choose to price the final production examples of existing narrowbodies, says Pilarski. Both are aware of customers’ residual value concerns and will not want to alienate them by introducing successors in an unplanned way that will hurt balance sheets. The 737NG and the A320 families have enjoyed unprecedented production runs and their manufacturers will long have amortised their tooling costs by the time production ends. So the Airbus and Boeing will be able to price late-run aircraft incrementally, deciding whether it is better strategically to keep predecessor lines open and sell aircraft at low prices, or to stop producing them to tighten market supply and protect residual values.
Today’s pricing policies will also have an effect, says Bearden. Since Airbus and Boeing have discounted new-aircraft net prices heavily in the past five years and show little sign of ending the practice, pricing is relatively inelastic. Residual values will only fall so far since even young aircraft are cheap. If successor types are much more expensive than young A320s and 737NGs, even though they are much more efficient, it will make sense for airlines to continue to fly previous-generation aircraft.
The stage of the business cycle during which the first successor enters service will also be a factor, says Kelly. If the new aircraft enter service at the bottom of the next recession, airlines will want to keep their younger, more efficient aircraft and will use the successors to replace their oldest aircraft. These will lose value, while younger aircraft will maintain it.
Conversely, if the replacement enters service in an upswing, it could make older aircraft relatively more valuable than younger ones, particularly in terms of lease rates. Boeing 767-300ER lease rates tumbled in the 2001-4 downturn, but have doubled in recent months as airlines seek short-term widebody capacity until they receive new 787s. Narrowbody lease rates are climbing today too, says Kelly – and by 2010 (when Avitas forecasts the current airline-industry cycle will peak) it will be more economical for many airlines to lease 737 Classics, say, than new aircraft.
However, the markets for the 767-300ER and narrowbodies differ, says Pilarski. Many 767-300ER operators fly only one or two and obtaining growth capacity today is difficult, so they are prepared to pay well for it. Most A320 operators have at least 10 aircraft and the market is more liquid. But the A320 operator base is large and aircraft remain in demand, keeping lease rates and residual values stable.
CHRIS KJELGAARD / NEW YORK