The art of announcing aircraft orders at air shows
Commercial aircraft manufacturers have never had it so good. Buoyed by constantly increasing demand for air travel and an insatiable appetite from airline customers and lessors for more capacity, the order books are full to bursting. At the end of 2017, a conservative estimate of the value of all civil aircraft on order amounted to an eye-watering $955 billion. And that takes into consideration customary discounts, rather than ‘list prices’. To put that into perspective, if the value of the backlog of commercial aircraft orders were a country, it would be the 16th largest when measured against nations’ Gross Domestic Product. So, the value of the order books is greater than the economies of Turkey, the Netherlands, or Switzerland. You might think that with so much business already signed up and sitting on the books, aircraft sales directors could relax. But you would be wrong…
Although air travel demand rises at a virtually constant rate, the patterns of aircraft orders and deliveries do not. The figure below (‘That Synching Feeling”) shows the history of airline net profitability, aircraft orders and aircraft deliveries over a 15-year period. Eyeballing the black dotted line, representing airline operating results, against the yellow bars, representing aircraft orders, suggests a plausible synchronisation between making money and spending money. The erratic order pattern is in stark contrast to the blue bars, showing a more stable delivery pattern. Manufacturers strive to achieve a book-to-bill ratio of at least 1 every year.
Spikes of aircraft orders may be explained. From 2011 to 2014, for example, high oil prices, coupled with the launch of the next wave of single-aisle aircraft from Airbus and Boeing, saw a flurry of orders as buyers rushed to secure favourable deals and early delivery positions. What is less evident from the order pattern is the effect of air shows.
The air show effect
Big commercial aircraft trade shows, such as Farnborough, Le Bourget, Dubai, Singapore and Zhuhai, are a glitzy stage upon which to announce big orders. These events attract more than just the die-hard airline enthusiast community. Airline CEOs, the world’s press, politicians and supply chain executives clear their agendas, so they can be pampered by the manufacturers. Who can blame them? Those with the best credentials are feted in luxurious custom-built chalets. Not for them the traffic jams, remote parking, shuttle buses, tiresome security checks, long entry queues and outrageously priced catering. But I digress.
Air shows are the best excuse all year for aircraft manufacturer public relations departments to deliver their sunniest smiles and spend the budget. Yet there is sophisticated power-play at work. What drives the headline-grabbing announcements of new orders?
Order bonanza, or business as usual?
It certainly appears as though Airbus and Boeing stockpile orders in advance of air shows to make a splash when everyone is watching. However, deals are not coincidentally concluded at show time. Deals are usually booked, and announced, as they are concluded, but if the deal has been brokered in the run-up to an air show, then the customer may be listed as ‘unannounced’ in the interim period. Both Airbus and Boeing are inclined to save major announcements for air shows to ensure a bigger impact, and a level of exposure obviously beneficial for the customer as well as the manufacturer. Even if the deal is all but signed sometime before an air show, the flourish of the pen on the final contract will take place in the full glare of welcome publicity.
Another aspect of keeping a collection of signed deals confidential until an air show is that it allows the manufacturers to engage in tit-for-tat announcements of eye-catching deals. Tactical play is important as everyone wants to appear successful when it really counts. It is usual for signing ceremonies to be precisely choreographed. Surprisingly, given the high stakes involved, the unexpected can happen. At the Dubai Air Show in 2017, it had been widely anticipated that Emirates Airline would announce a follow-on order for A380s at a media event. Indeed, Airbus was so confident of a sales boost for its beleaguered large jet that the press release had been printed and dignitaries invited. To the astonishment of many, including Airbus, it was Boeing who were invited to the stage for a surprise announcement of an Emirates 787 deal.
It can also happen that a decision is accelerated to enable an air show announcement. This could be considered a dangerous tactic for the buyer, as the pressure to conclude a quick deal might be at the expense of cutting corners in the analysis.
Even if air show announcements have the hallmarks of spontaneity, aircraft evaluation is a highly complex and long-drawn-out process that should move at its own speed, rather than be curtailed to fit the agendas of a PR machine.
At the end of the Farnborough Air Show 2018, Boeing announced a total of 673 overall ‘orders and commitments’ valued at $98.4 billion. Airbus trumpeted new business comprising 431 ‘commitments’. The Airbus press release did not specify a value for this tally, but it has been reported that the aircraft would be valued at $62.1 billion ‘at list prices’ [i].
These simple numbers raise important questions. What, precisely, are ‘commitments’, and how relevant are ‘list prices’? Do manufacturer press releases tell the whole story? We need to look at terminology.
Smoke and mirrors
A ‘firm order’ is unequivocally a signed purchase agreement, or contract, for a specified number of a defined aircraft type. It embraces everything from the precise specification to delivery dates, payment schedules, support issues, guarantees and, of course, pricing.
Buyers of aircraft need flexibility, so one way of achieving this is to divide an order into contractually firm aircraft and ‘optioned’ aircraft. Optioned aircraft are allocated delivery positions that may run concurrently with the ‘firm’ aircraft. Usually, a fee would be required to secure delivery positions of optioned aircraft. This fee would be credited against pre-delivery payments should firm contracts be finalised for these aircraft. Optioned aircraft are usually subject to the same basic price and terms and conditions as the firm aircraft. It is not a certainty that options are always transformed into firm orders.
Another way of building in flexibility to a deal is to negotiate ‘purchase rights’ for additional aircraft. These involve no commitment from the buyer but, in contrast to the certainty of terms for the firm and optioned aircraft, commercial terms for the ‘purchase rights’ aircraft would only be determined at the time such rights are exercised.
In addition, ‘conversion rights’ may exist between aircraft of the same family, where practical. It is useful for airlines that have, for example, ordered A320s, to retain the flexibility to convert some deliveries to larger A321s.
The expressions ‘memorandum of understanding’ and ‘letter of intent’ are interchangeable descriptions of documents considered to be important milestones along the path toward a fully negotiated contract. A MoU, or LoI, are usually signed after tacit decisions to acquire aircraft have been made by the buyer, but before the serious negotiation work has begun. MoUs and LoIs are far from irrelevant as they lay out the structure of a future agreement, but there is a huge temptation to announce them at air shows.
Signature of these documents may be accompanied by a refundable deposit, and delivery positions may also be mentioned. Importantly, neither a MoU or LoI has legal standing, and it is by no means certain that a contract will be signed. For example, in 2014 the Indian low-cost carrier Indigo signed a memorandum of understanding for 250 A320neo aircraft. This was the largest ever commitment that Airbus had ever received, measured by the number of aircraft. However, one year later the commitment lapsed.
There are other confusing announcements made at air shows. ‘Customer reveals’ occur when the manufacturer announces the buyer of a previously unidentified customer. ‘Conversions’ are no more than a rebalancing of orders between one type or sub-type and another. In such a case the value of the order may change, but not the absolute number of aircraft in the deal. Another form of conversion is where airlines agree to convert aircraft from passenger to cargo use. In this case, the manufacturer cannot claim any value through increased production.
At the end of the day the only thing that matters is the number of firm orders. Uncertainty surrounds everything else. To illustrate the impact of smoke and mirrors accounting, let’s look at the Farnborough Air Show order book for 2018.
Do the numbers ever add up?
The only answer to that question is, ‘no’. Boeing’s Farnborough highlights video boasted ‘total airplane orders and commitments’ of 673 units, whereas an Airbus press release more conservatively claimed 431 aircraft as ‘new business’.
The expression ‘commitment’, incidentally, crops up in manufacturer as well as general press releases. It is usual for a commitment to refer to a mix of both firm and optioned aircraft, including those covered by MoUs and LoIs.
How inflated are these headline numbers? Airbus is closer to the mark, having honed their numbers by excluding conversions (52 aircraft) and customer reveals (10 aircraft). That leaves a final tally of 93 firmly ordered aircraft and another 338 included in letters of intent.
Boeing had greater success in terms of absolute number of orders although the headline number of 673 aircraft quoted in their highlights video seems heavily loaded. Analysing the day-by-day announcements suggests that there were also conversions (30 aircraft) and customer reveals (144 aircraft). In addition, the Boeing numbers appear to include some unclear optioned aircraft as well as freighter conversions. A number closer to reality would be 429 aircraft according to one seasoned commentator [ii].
Another point of contention is the value of orders. Historically, it has been customary to quote published ‘list prices’. The problem is that these prices are, of course, totally unrepresentative of actual pricing, which is subject to significant discounting by the manufacturers. Airbus have not placed a value on Farnborough orders, although Boeing have stated that their orders and commitments amount to $98.4 billion. The Financial Times estimated the total value of Airbus and Boeing orders to be $160 billion [iii]. Once the padding has been removed, and a reasonable estimate made for discounts, a closer value estimate would be $31 billion for Boeing and $27.7 billion for Airbus [iv].
Does it matter that so much confusion reigns over air show orders? Not one jot. Everyone knows how the ‘sporty game’ is played. The duopoly is alive and well and the regular jostling for bragging rights shows no sign of diminishing. If anything, the world of aircraft manufacturing has never been so interesting. Airbus is riding a fresh wave having embraced the A220-300 into its product line. Boeing are on the cusp of a major decision concerning the so-called middle of the market. Should they take the plunge and develop a new aircraft to plug the gap between the largest of the single-aisles and the smallest of the twin-aisles, or should they step back and watch Airbus claim the space with a further development of the A320 family? Either way, the orders will continue to pile up and the regular tussle for market supremacy will again be played out at the major air shows.
As a final curiosity in the numbers game, consider this. Airbus are certainly confident they will convert their various options, MoUs and LoIs into firm contracts soon. However, the fact remains that, according to a downloadable spreadsheet on the Airbus web site, the official increment in aircraft orders between 1 July and 31 July 2018 was precisely eight A350-900s for a single unannounced customer. This is hardly very much to brag about, but that’s not the point. Who needs boring spreadsheet details when we can be so easily seduced by those fancy press announcements?
[i] The Narrow Win For Boeing, Seeking Alpha, 26th July 2018
[iii] Financial Times, 19th July 2018
[iv] Seeking Alpha, ibid.