High stakes in Van Miert’s merger battle with Boeing

Date: 19/06/1997

By Tim Jones

JUST what can Boeing and McDonnell Douglas do to make Karel van Miert a happy man?

The Commissioner responsible for cartel-busting in Europe has made it absolutely clear that the 10-billion-ecu merger of the world's biggest civil aircraft manufacturer and a leading defence aerospace company cannot go ahead in its present form.

The problem is that while everyone knows what he dislikes - Boeing's gigantic world market share in sales of civil aircraft, its exclusive long-term supply contracts with leading airlines and the potential for US defence subsidies to leak into non-military production - nobody can work out how to appease him.

On the face of it, the bare facts are worrying.

If the merger is given regulatory approval, Boeing, which already has a 60&percent; global market share in sales of civil aircraft, would overnight become a big player in the manufacture of fighter planes, helicopters and satellite launchers. It could take on Lockheed Martin head-to-head in the market for military equipment.

What is less obvious is how it would strengthen Boeing's hand in civil aircraft manufacturing and undermine the growing competitiive challenge posed by Airbus Industrie - the consortium made up of British Aerospace, France's Aerospatiale, Daimler-Benz Aerospace and Construcciones Aeronauticas of Spain which are the only rivals to Boeing in this sector.

Underlying this is an even greater problem for Van Miert: the consumers who should be panicking about the creation of an all-powerful aircraft-making monopoly are not.

“As long as there are two big competitors, that is enough of a guarantee for us,” says David Henderson of the Association of European Airlines.

Not only are airlines indifferent to the fact that a company which makes and sells two-thirds of all the civil aircraft in the world is consolidating, they are also queuing up to sign exclusive supply deals with it.

Only last week, Continental Airlines announced it had decided to buy all of its new jets from Boeing - a decision emulating recent moves by American Airlines and Delta Air Lines.

While Van Miert claims these very-long-term supply contracts are unacceptable to the competition authorities, the airlines and industry analysts are not so sure.

“These deals allow an airline to decide what it wants very late in the day, to be flexible about taking delivery of aircraft and to receive a better-than-usual discount,” says Sash Tusa, an aerospace analyst at UBS in London. “If Airbus had the same product range, they would be doing the same thing.”

There is no longer any room in this industry for more than two big players, with others catering for niche markets. The scale of investment demanded is astronomical and the returns on offer for the size of the risks involved are simply not enough to interest small companies.

This is precisely what happened to McDonnell Douglas. For all the talk that the merger would strengthen Boeing's position in the civil aircraft market, Douglas Aircraft is pretty well a spent force, accounting for just 4&percent; of world market share.

It is true, as the Commission has pointed out, that Douglas' share in the market for narrow-bodied planes is larger at 11&percent;, but Airbus is a tough rival in this segment. The Toulouse-based consortium has made a mint in recent years with its A320 family - the single-most successful product in the market for narrow-bodied jets at the moment.

Airlines are now looking for 'total service' suppliers. They want companies to offer them 'families' of aircraft ranging from small twin-jets to jumbos so that they can pick and choose according to their needs at any given time. Opting for a single manufacturer cuts their training costs because pilots and technicians need only be taught once to use a product range. Exclusive deals cut these costs even further.

McDonnell Douglas could not compete in this kind of market. In 1991, the company ran into severe financial difficulties after a number of fixed-price contracts it had entered into with the US government ran well over budget and fell behind schedule.

Although times have improved, Long Beach-based Douglas Aircraft has fallen so far behind Airbus and Boeing that it cannot catch up. Last year, the company considered revamping its long-standing MD11 model, to be known as the MDXX, but calculated that this would have cost as much as 13 billion ecu over a decade.

“Looking at our competitors, we realised that they were not going to be standing still during that time and we could spend all that money and still be in the same position we were in before,” says Larry McCracken, a spokesman for McDonnell Douglas in St Louis, Missouri.

“Our problem is that the airlines have decided that they want a family of aircraft and we do not have a family. We are never going to be a full family competitor with Airbus and Boeing.”

One possible solution to Van Miert's gripes would be to put Douglas Aircraft up for sale and encourage Airbus to buy it. But, to quote many analysts, why would they want it?

The California plant, which employs 8,000 staff, has a long history of poor - if improving - labour relations. Although its order book is not empty, neither is it bulging. Last year, the business received orders for 38 aircraft, including 29 twin-jets and nine MD11s mostly for the freight market. The biggest order came from Lufthansa in September for five MD-11 freighters with options for seven more - a deal worth 1.1 billion ecu if the German airline exercises all of its options.

Looking ahead, Douglas is developing an MD95 100-seat passenger aircraft in an attempt to get into a market where there is currently little competition.

It now looks as though the toughest competition will come from Airbus after the consortium announced plans to produce a 100-seat jet in China along with Italy's Alenia, and Chinese and Singaporean partners.

Airbus would be unlikely to take any interest in Douglas Aircraft. Indeed, Boeing has still not committed itself to the business given that its main interest is in McDonnell Douglas' military wing. Only 24&percent; of McDonnell Douglas' sales come from commercial aircraft sales, 57&percent; from military aircraft, 16&percent; from missiles, space and electronic systems, and 3&percent; from financial services.

Boeing wants to complement its civil aircraft strength with muscle in the defence market since cyclical swings in the two sectors tend to come at different times.

The European Commission is equally worried that Boeing would benefit from leakage of millions of dollars in subsidies paid to McDonnell Douglas to develop fighter aircraft and NASA space programmes into its civil side.

The amounts involved are huge. The biggest is a 12-billion-ecu seven-year contract with the US airforce to supply 80 C17 wide-bodied four-engine military transport carriers, but there are five other major procurement programmes on McDonnell Douglas' books.

However, short of renegotiating the 1992 EU-US bilateral agreement on aircraft subsidies, it is hard to see how the Commission could do anything about this in an anti-trust settlement.

Following hearings last week between Boeing, McDonnell Douglas, Airbus and the Commission, the firms are still little the wiser. The suspicion remains that the institution is using its competition powers to fight a trade war.

The cleverest thing the companies could do is to offer to sell the Long Beach plant to Airbus, so forcing both the consortium and the Commission to come clean.