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Boeing Has a Secret Weapon for Competing With the Airbus A321

By Adam Levine-Weinberg - Oct 28, 2017 at 10:40AM

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In 2011, Airbus offered American Airlines a most-favored customer clause in order to win a massive order. Now, Airbus is having trouble matching Boeing's pricing -- at least in some cases.

When Boeing (BA -1.34%) launched the 737 MAX 10 earlier this year, many aerospace pundits panned it as a poor man's Airbus (EADSY 0.46%) A321. Nevertheless, the 737 MAX 10 won hundreds of orders and commitments at the 2017 Paris Air Show, including an important order conversion from U.S. airline giant United Continental (UAL -1.18%).

In fact, Boeing has a secret weapon that has helped it win all of United's new narrowbody aircraft orders recently: a "most-favored customer clause" granted by Airbus to American Airlines (AAL -2.76%). This clause could give Boeing a huge advantage in competing for an upcoming aircraft order from Delta Air Lines (DAL -2.62%).

The origin of this secret weapon

Back in 2011, Airbus scored a major coup when American Airlines ordered 260 A320-family jets, after years as an all-Boeing airline. Indeed, it was this impending order that forced Boeing to create the 737 MAX to hang on to a portion of American's business.

American Airlines' then-parent AMR was in financial distress at the time, which limited its bargaining power. As a result, while Airbus offered the company substantial help in financing the deal, it didn't need to provide as big a discount as would be typical for an order of that size.

An Airbus A320neo on the tarmac

American Airlines agreed to pay fairly high prices for its A320neo-family order. Image source: Airbus.

However, there was one catch: a most-favored customer clause. According to Scott Kirby -- who is currently the president of United Continental, but held the same role at American Airlines until August 2016 -- Airbus agreed that if it gave another airline more favorable pricing, it would refund the difference to American Airlines. This is limiting Airbus' ability to match the pricing that Boeing can offer to key customers.

The details are murky

At an employee meeting earlier this month, Kirby indicated that while United is interested in buying narrowbody planes from Airbus, the latter can't provide a competitive price right now. That's why United has 161 orders for the 737 MAX family and none for the A320neo family.

Some aerospace analysts were puzzled by this statement. After all, Airbus has sold thousands of A320neo family planes since announcing the American Airlines deal. It has also sold over 100 A321s to Delta Air Lines (American's other main rival) at bargain prices. Furthermore, it seems odd that Airbus would have agreed to terms that might seriously impair its sales efforts.

One possibility is that the most-favored customer clause only applies to new-engine aircraft rather than the current-generation planes that Delta has bought recently. It also could apply only to U.S. carriers -- and perhaps even just U.S. legacy carriers. The one detail that Kirby confirmed is that the most-favored customer clause expires eventually. (He didn't say when.)

This is a huge advantage for Boeing

To the extent that the most-favored customer clause is applicable, it's a big stumbling block for Airbus. Of course, Airbus could always just give another customer whatever discount is needed to close the deal and pay American the refund it would be entitled to. However, this could severely damage its profitability.

For example, suppose Boeing and Airbus are competing for a 100-plane order and Boeing offers a price that would allow it (or Airbus) to make a $5 million profit per plane. Let's also suppose that this price is $5 million less than the pricing Airbus had offered American Airlines on its outstanding deal for 100 A320neo-family planes. If Airbus were to match Boeing's price, the $5 million per-plane profit it would make from the new deal would be completely offset by having to give American an additional $5 million discount on each of the 100 planes it has on order.

A rendering of a Boeing 737 MAX 8

Boeing has offered some airlines unbeatable pricing for the 737 MAX. Image source: Boeing.

Given that the Airbus and Boeing narrowbody families are both sold out for years, there's no incentive for Airbus to sign any deal that would trigger refunds to American Airlines.

A mystery solved?

Boeing has feuded with Delta Air Lines repeatedly in recent years. In 2015, Delta's management took great pains to highlight falling resale values for Boeing 777 jets. In 2016, Delta canceled an order for 18 Dreamliners. During the past year, Boeing has been working to block a deal for Delta to acquire 75 CS100 aircraft from Bombardier. And over the past three years, Delta has orchestrated a campaign to limit the expansion of Emirates, Qatar Airways, and Etihad Airways -- three of Boeing's most valuable customers.

In light of this acrimony, many pundits have assumed that Delta has no interest in doing business with Boeing right now. This isn't just a theoretical issue: Delta hopes to order about 75 next-generation narrowbody planes within the next few months.

However, Delta's management has consistently maintained that its various disputes with Boeing don't affect the likelihood that it will order planes from the U.S. aerospace giant. Now, we may know why. Delta Air Lines has a reputation for being very savvy about getting the best deal possible. There's a good chance that Boeing will win this competition by offering a price for its 737 MAX that Airbus won't be able to match.

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Stocks Mentioned

The Boeing Company Stock Quote
The Boeing Company
BA
$136.60 (-1.34%) $-1.85
Airbus Stock Quote
Airbus
EADSY
$24.14 (0.46%) $0.11
United Airlines Holdings, Inc. Stock Quote
United Airlines Holdings, Inc.
UAL
$35.26 (-1.18%) $0.42
Delta Air Lines, Inc. Stock Quote
Delta Air Lines, Inc.
DAL
$28.86 (-2.62%) $0.78
American Airlines Group Inc. Stock Quote
American Airlines Group Inc.
AAL
$12.67 (-2.76%) $0.36

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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