10/24/2009

Boeing's Billion Dollar Costs

I have been reading many articles regarding the airline industry as a whole and about the airplane manufacturers, and the entire topic of airlines has economic topics written all over it.

With demand sinking and costs rising what's next for Boeing? I was shocked at the enormous costs that are encountered both fixed and variable. Boeing is writing off $1billion in costs due to higher costs of its 747-8 program and the current market conditions. Most of this is from higher fixed costs to produce the airplane. A firm like Boeing needs to be fairly good at predicting future demand when it comes up with a concept for a new plane. Creating, engineering, and testing new planes can take a few years. And for the 747-8 engineering plans came later then expected which raises costs of re-work and adds disruption to the process.

The remainder of the $1 billion cost come from market conditions and lower production rate due from a decrease in demand.

Boeing is also working on a new fuel efficient 787 that was suppose to have its first test flight in 2007, it is now more then 2 years behind schedule with an expected first test flight in 2010. Boeing will book another $2.5 billion in costs for 3 test planes that have no commercial value.

"Boeing is grappling with dwindling orders during the global recession, which has undercut demand for air travel and cargo services. Some airlines have been forced to cancel or delay plans to buy new planes."

"Boeing has cut costs, including plans to slash 10,000 jobs and scale back production of some planes."

Fun Fact for ya'...Boeing held a monopoly for a long time in commercial aircraft, up until Airbus started gaining market share. Also when Boeing merged with Lockheed Martin, the government granted the company monopoly rights to the production of military aircraft.

Boeing to record $1B charge due to 747-8 costs

2 comments:

Michael said...

i think this article is related to the economies of scope. Book give more clear idea about this Boeing case on page 179. "by designing the A350 as a derivative of the A330, Airbus could realize economies of scope across the two planes, and reduce its cost of developing the new A350. Boeing did not plan on similar economies of scope, hence the cost of developing the Dream liner was much higher." if Boeing can not forecast its cumulative production accurately then it can not compete with Airbus. i think if Boeing is going to use same strategy then in near future Boeing will loss its market share.

Dr. Tufte said...

-1 on Connor for a spelling error.

-2 on Michael for multiple spelling errors.

The big picture here is that we really have a duopoly in airframe production in the developed world. One of those firms is directly subsidized (Airbus) and the other one is indirectly subsidized with top dollar military contracts (Boeing). Neither has a bright outlook.

This is a business that his highly operationally leveraged (i.e., fixed costs are high compared to variable costs). The only way to manage that is by keeping variable cost volatility from bankrupting you. This suggests that airframe manufacturing is going to follow other heavy industries to developing countries.
I like Michael's point about economies of scope.