Taking flight

The latest addition to the Sichuan Airlines fleet landed in Chengdu in June 2009. The plane, a 150-seat Airbus A320, was nearly identical to the roughly 40 A320s already flying routes for the southwest China-based airline – except that it was the first A320 to be assembled in China, fresh from the French company’s new Tianjin factory.

Establishing a factory in China, the world’s second-largest aviation market, might seem like a natural next step for Airbus, one of largest global airplane manufacturers. Yet the numbers didn’t add up. By moving assembly out of Europe, Airbus was forced to sacrifice the economies of scale that come with a large, centrally-located production unit, likely making the planes more expensive.

But Airbus was not aiming to make cheaper planes in China. Rather, it was looking to gain favor with the Chinese and local Tianjin government in the hope that they would urge the largely state-owned airline industry to buy a few more Airbus planes. The company’s closest competitor, the US-based Boeing, chose a similar route: Although it has not set up a factory in China, Boeing has forged partnerships to manufacture airplane parts with Chinese companies.

Despite these tactics, the world’s two largest airplane manufacturers will soon see stiffer competition in China. When it comes to playing politics, neither company can best Commercial Aircraft Corporation of China (Comac), a state-owned enterprise which is preparing to release its own plane in the same class as the Airbus A320 and Boeing 737 in 2016. Although lagging on technology, Comac’s political importance virtually guarantees the government will find customers for the planes.

“It’s the market you have to be in, and [Airbus and Boeing] have got to maximize their market share over the next five to eight years,” said Sash Tusa, an aerospace analyst with UK-based Echelon Research & Advisory. “It’s going to be very hard to do that much post-2015 when there’s a domestic competitor coming along.”

Sky’s the limit

China’s air passenger traffic exploded over the past decade, increasing an average of 15.3% annually on the back of rising business and leisure travel. In the mid-2000s, China became the world’s second-largest aviation market behind the US, a developed market whose growth has nearly stagnated. Only India rivals China’s growth rate, but its passenger volumes are much smaller.

These trends have made China the most important growth market for Boeing and Airbus. Aviation Industry Corporation of China (AVIC), one of Comac’s major investors, estimates that China will need 4,583 new planes over the next 20 years to satisfy growing demand.

Thus far, Airbus and Boeing have kept China’s fast-growing market all to themselves – just as they do in most countries around the world. Airbus and Boeing have been the world’s only two major manufacturers of large aircraft since 1997, when Boeing completed the consolidation of US commercial airplane makers with its acquisition of McDonnell Douglas. The companies have become bitter rivals, each seeking to eke out a few extra orders that could tip the nearly 50-50 global split.

The competition is just as fierce in China. Boeing has manufactured 53.4% of the planes currently in service in the country, while Airbus has made 44.6%, according to data compiled by US-based aviation consultancy Teal Group in 2011. But Airbus is catching up, with roughly three unfilled airplane orders for every two of Boeing’s.

The close competition stems partly from the fact that Airbus and Boeing have honed their technology to the point where the differences between their products are nearly negligible.

“If margins are razor thin, salaries are what they are and fuel is a commodity, guess what it all comes down to? Minute differences in technology,” said Richard Aboulafia, vice president of analysis at Teal Group. “If you’re an airline with a good business plan, it wouldn’t matter a whole hell of a lot which one you are using.”

Local politics

But there is one difference that sets the two companies’ China strategies apart: Airbus has established a factory on the mainland, while Boeing has not.

Airbus opened its Chinese factory in spite of the higher cost of making airplanes locally. The production line in Tianjin only does final assembly, which almost surely adds to company costs, Tusa said. Apart from the additional cost to set up the assembly line, the Tianjin factory incurs substantial long-distance shipping fees for huge parts like fuselages, tails and subsystems that are made elsewhere. It would surely be more efficient to focus on existing production lines in Europe that have supplied China with planes since 1985.

“It is a marketing advantage, it is a political advantage and therefore it’s a commercial advantage, but it’s not an economic advantage in that it cuts costs,” Tusa said.

It is difficult to quantify whether the advantages of locating a factory in China outweigh the costs. The government probably influences airlines to order more from manufacturers in its good favor, likely giving a company a marginal number of extra orders, Aboulafia said. But there is no direct evidence of this happening, he added, so it is hard to gauge how much a manufacturer benefits.

Boeing has tried to garner political favor in other ways, for example by partnering with local companies. The US-based company announced in June that it would join AVIC to open a “manufacturing innovation center” in Xi’an later this year to boost technological development among Chinese airplane parts manufacturers. In September, Boeing also awarded a major parts manufacturing contract to Shanghai Aircraft Manufacturing, a subsidiary of Comac.

Chinese champion

Yet no one can play China’s political system quite as well as the Chinese. Airbus and Boeing are both likely to see their market share shrink as Beijing pushes for Comac to become a domestic and eventually an international contender.

Comac is betting that its C919, scheduled to enter service in 2016, will be able to compete directly with the A320 and 737. The Chinese company has pledged to undercut Airbus and Boeing on price, though it has not said by how much. But government influence will likely make the largest difference in orders. State support has already helped Chinese airlines to expand faster, serve more destinations and retire aircraft earlier than most purely private carriers, said Bijan Vasigh, a professor at Embry-Riddle Aeronautical University in the US.

Government intervention might also explain why Comac has already received orders for more than 150 of its unproven C919 planes, mostly from other state-owned companies. The leasing arm of the Industrial and Commercial Bank of China (ICBC) has ordered 45 planes, for example, while the Bank of Communications leasing division has ordered 30.

With such a clear political advantage, Comac could begin to steal market share from Airbus and Boeing once it ramps up production. But luckily for foreign contenders, Comac’s production capacity will remain small for years to come.

China is projected to demand 200-300 new airplanes annually. In the near term, analysts estimated that Comac could produce only about 50 of those.

No way to make a winner

That China is trying to make a national champion out of Comac makes sense politically, even if it’s not a good economic model, Aboulafia said.

“If you’re the [Communist] Party, you’re trying to take credit for an economic miracle, [and] there’s very little you can hang your hat on anymore because so much of the economy is driven by private enterprise,” he said. “Here’s something that’s perfect: It has national pride all over it, [and] it’s best executed by some gigantic entity. It should be privatized, but how could you take credit for that?”

But that
same logic is unlikely to help Comac win market share abroad. In the long run, government support will diminish Comac’s incentive to innovate, because domestic airlines will be pressed to buy its planes regardless of the value proposition. As with Chinese manufacturers of cars and trains, airplane makers seem likely to concentrate on acquiring and reverse-engineering Western technology.

The C919, for example, closely resembles Airbus’ China-made A320s, which Comac investor AVIC had access to through its joint venture, Tusa said. That makes the C919 technology about five to 10 years old.

“You have to assume that the leakage of the technologies that are available to [Comac] occurs,” an anonymous industry analyst said. “It’s up to Airbus and Boeing to stay one step ahead.”

And Airbus and Boeing have plans to do just that. Airbus will release its next generation A320 Neo in 2017 and Boeing will launch the 737 Max in 2019, which will make the Comac C919 outdated almost as soon as it launches. The C919 will not even be able to compete on fuel efficiency against Boeing and Airbus’s current models, because it is projected to weigh at least 1,500 kilograms more. Comac may still get plenty of orders domestically, but it will hardly be able to compete abroad.

There is some appetite for a challenger in the market; a duopoly such as Boeing and Airbus could get lazy when it comes to competing on price and technology, said Sebastian Hein, an aviation analyst at German bank Bankhaus Lampe. Given time, Comac could develop the resources and the ability to compete internationally.

But the company must first ramp up production and prove the C919’s reliability, he said. It must also gain access to high-quality engines – the most technologically advanced part of the aircraft – as well as establish a system to service its planes globally. This last goal will take at least a decade, Hein said.

Other analysts said it could take Comac 10 to 20 years to compete with Airbus and Boeing on technology. Teal Group’s Aboulafia, however, said it may never happen under the current system. Only intellectual property protection and privatization would give Comac that incentive, he said.

“The killer [advantage] for the West is not technology, large battleships or landing on the moon,” Aboulafia said. “It’s the less tangible things, such as free access to information, free trade or the legal protection of intellectual property that encourages innovation. It’s the rule of law.”