B7E7 List Pricing Starts From Low Base

Residuals to Benefit from Comparable B767 Cost In announcing that pricing of the B7E7 will be comparable to the B767, Boeing [BA] is setting the stage for a tough battle with Airbus while also laying the foundation for stronger residual values. At the recent Asian Aerospace exhibition in Singapore, Boeing...

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Residuals to Benefit from Comparable B767 Cost

In announcing that pricing of the B7E7 will be comparable to the B767, Boeing [BA] is setting the stage for a tough battle with Airbus while also laying the foundation for stronger residual values.

At the recent Asian Aerospace exhibition in Singapore, Boeing revealed that pricing of the B7E7 will be similar to that of the existing B767. This matches the strategy used with the B737-700 versus the B737-300, which included only a $1 million difference in list price between the new and old, resulting in an instant emphasis on the newer model. The 2002 list price of the B767-300ER ranged between $115.5 million and $127.5 million while the B767-400ER's price ranged between $126.5 million and $138.5 million. The 2003 list price of the A330-200, comparable to the B767-400ER rather than the smaller B767-300ER, ranged between $139.6 million and $145.5 million. Assuming an annual rise of 2 percent, the average list price of the baseline B7E7, at service entry in 2008, will amount to just more than $135 million.

List pricing, however, is of little relevance to actual pricing. Widebodies continue to be discounted by about 30 percent. Actual purchase prices for small order quantities of B767-300ERs were averaging $80 million to $85 million (including engine manufacturers' discounting) in the run-up to Sept. 11, 2001. Larger orders tend to attract even greater discounting. Launch customers, who usually order a large number of aircraft and shoulder the risk of unproven performance and economics, are likely to receive significant discounts on indicated list prices. Airlines that place orders in the second wave are likely to pay higher prices. The actual price of the baseline B7E7 during the second wave of ordering is therefore likely to range between $85 million and $90 million, subject to increases due to escalation and selected specification. The stretched version, offering similar capacity but longer range compared to the Airbus A330-200, but will not be available until perhaps 2010, likely will have a net price in excess of $105 million at service entry.

The level of net pricing is heavily dependent on market conditions. An extended backlog and strong demand likely will elicit a sizeable premium. Inevitably, weak market conditions favor greater discounting. Specific orders competing with Airbus likely will cause pencils to be further sharpened. Pricing of the A330-200 has sometimes reportedly fallen below $80 million for important customers, especially when the orders compete against Boeing.

The announcement that pricing will be virtually pegged at B767-300ER levels follows speculation that Boeing would seek to charge a premium for the yet-to-be-launched B7E7. Such a premium would be in return for a 15 percent to 20 percent improvement in fuel efficiency. Usually, operators require a 12 percent to 15 percent improvement in overall operating costs to justify acquisition. While a 15 percent to 20 percent improvement in fuel consumption seems attractive, fuel accounts for only about 20 percent of direct operating costs for operators, subject to individual sector lengths. Fuel prices, however, also fluctuate. In an environment of high fuel prices, fuel efficiency is of vital importance, hence the development of the propfan in the 1980s. Sustained weakness in oil prices quickly led to the cancellation of the program later in the decade. Fuel burn may therefore variously account for 15 to 25 percent of direct operating costs depending on the price of jet fuel. As the B7E7 does not seek to reduce unit costs by offering greater capacity compared to the B767-300ER, the fuel savings are vital. A 20 percent reduction in fuel therefore represents only a 4 to 5 percent reduction in direct operating costs. Charging a 10 percent premium for such fuel efficiency would result in only a marginal improvement in overall direct operating costs. Finance levels account for around 15 percent of direct operating costs, making it difficult to impose an appreciable premium on the capital cost.

By offering competitive pricing, Boeing likely will seek to build large numbers of the B7E7, currently estimated to be 2,500 over 20 years. Nearly 1,000 B767s have been sold over nearly the same 20 year timeframe. There have also been 1,000 B757 deliveries. Manufacturers usually seek to amortize development costs over about 400 aircraft. A conservative estimate for the development of the initial two B7E7 variants approximates $7 billion, or $17.5 million for each of the first 400 aircraft. A product life cycle of 20 years will involve many enhancements, which will add hundreds of millions, if not billions, to development costs. The first 100 to 200 orders are likely to attract considerable launch-order discounting such that amortized development costs will be difficult to recoup. The subsequent 200 orders for the B7E7 will likely extract the desired premium as operators scramble to obtain increasingly scarce delivery slots. By contrast, the amortized development cost of the A330-200 is already close to being covered, giving Airbus even greater pricing flexibility.

Should lessors -- a vital ingredient in expanding the operator base beyond flag carriers and ensuring stronger residual value performance -- order large numbers, then pricing will have to be particularly attractive, particularly as lessors already appreciate that the A330-200 is an established and popular product. In contrast to Airbus, which relies heavily on lessors for the distribution of its products, Boeing is likely to ensure that Boeing Capital Corp. (BCC) will play a leading role in supporting the B7E7. BCC will offer financing for customers, although the exposure to residual value risk may be greater.

Net pricing is heavily dependent on the level of discounting offered by engine manufacturers in anticipation of future spares revenue. Boeing is keen to ensure that residual value performance will be above average and wants the selected engine to be interchangeable with other airframes. While there will be technical problems in securing common use across a number of airframes, engine manufacturers will be anxious to ensure that the maximum number of engines are sold. Greater emphasis on reliability is reducing short- to medium-term revenue from spares for the engine manufacturers. Producing a dedicated powerplant for a single airframe may require higher installed pricing, thereby driving up net pricing for Boeing. Airbus is likely to take advantage of new engine developments and will consider offering a re-engined A330-200 about the same time that the B7E7 enters service. In the meantime, Boeing is reportedly having problems in securing the first and vital order due to uncertainty over which engine supplier will be selected.

Ensuring strong residual performance for widebodies has proven difficult, particularly after 10 to 12 years of reasonable production. The B7E7 will face similar difficulties. The economic employment of widebodies is usually restricted to relatively few operators. While low-cost operators have emerged on a regional basis, longer-range and intercontinental services remain the preserve of a few carriers. Regulation, time differences, fewer frequencies and high indirect operating costs make it more difficult for low- fare operators to make money. Remarketing widebodies can be problematical, particularly during a weak economic climate. However, the capacity of the B7E7 will appeal to a considerable number of operators, allowing the depth and breadth of the operator base to emerge. More important than the estimated 20 percent reduction in fuel consumption is timing. By the time of service entry of the first B7E7 in 2008, the B767-300ER will be 20 years old and many operators will be seeking replacements. The values of aircraft that have been acquired for a premium have subsequently experienced a rapid fall. The disconnection between rising new prices and strong residuals is already all too apparent. To ensure widescale placement, low initial and ongoing pricing is vital, hence Boeing's decision to price the B7E7 comparable to the B767.