This week, Boeing (NYSE:BA) confirmed that it plans to cut thousands of jobs in 2016 in order to become more cost-competitive with top rival Airbus (OTC:EADSY). Airbus has been very aggressive on jet pricing in recent years, and the strong dollar is giving it even more room to offer discounts.
Boeing's management has been candid in the past few months about the pricing pressure it faces across the board. This is definitely an issue that investors should keep an eye on. Fortunately, Boeing's massive order backlog gives it the luxury of remaining patient as it hunts for new orders in the next few years.
What Boeing is doing
Boeing plans to cut 4,550 jobs by June, consisting of 4,000 at its commercial airplanes division and 550 from its flight testing unit. For now, it hopes to accomplish the cuts mainly through attrition and voluntary buyouts. (However, some managers and executives may be hit with involuntary layoffs.)
These reductions are part of a broader effort across the company geared toward "taking out billions of dollars in cost by the end of 2016." In addition to shrinking its workforce, Boeing aims to cut overtime, reduce supplier costs, and slash corporate expenses like travel.
Some insiders have privately stated that Boeing could cut as many as 8,000 jobs this year. However, the company claims that it views layoffs (particularly of unionized workers) as a last resort and that it hopes to find enough non-labor cost savings to avoid further headcount reductions.
Boeing's increased emphasis on keeping costs down will give it some flexibility to offer bigger discounts without crimping its profit margin. That in turn should help it garner a fair share of future orders. Boeing doesn't necessarily need to win a market share battle over Airbus -- but it can't afford to fall too far behind.
The backlog is a big parachute
The good news for Boeing is that even if aircraft pricing is starting to deteriorate, it has already sold most of the aircraft it will produce over the next five years.
For its largest and most important aircraft program -- the 737 -- Boeing has nearly 4,400 orders in its firm backlog. This equates to about seven years of production, even with Boeing planning to boost annual 737 deliveries by more than 35% by 2019. It also has 763 firm orders for its second-largest aircraft program, the 787 Dreamliner. That would cover roughly five years of production.
The prices for these aircraft are already locked in. That will delay the impact of any increase in discounting, cushioning Boeing's earnings and cash flow over the next several years.
Boeing's healthy backlog also reduces its need to fight Airbus tooth and nail for every potential sale. In some cases, it might make sense for Boeing to accept a low profit margin to seal a deal. In other cases, Boeing should just walk away, given that it doesn't have very many open 737 and 787 production slots until 2020 and beyond.
Furthermore, Airbus has an even longer backlog than Boeing. If it continues to use discounts to grab a disproportionate share of the order volume, Boeing would gradually gain an advantage in terms of aircraft availability. A few years from now, if Airbus' A320neo is sold out for four or five years while the delay for a 737 MAX is only two years, customers with near-term aircraft needs would have to work with Boeing.
Boeing faces risks, but they are manageable
Boeing does have one key commercial aircraft program facing a shrinking backlog: the current-generation 777 widebody. In January, the company confirmed that it will cut production from 8.3 per month to 7 per month in 2017. Boeing still needs to secure another 200 orders to tide it over until the next-generation 777X becomes available in 2020.
The current pricing environment could force Boeing to offer steep discounts to get the orders it needs. In contrast to the situation with the 737 and 787, Boeing can't afford to wait for better market conditions with the 777. The one saving grace is that Airbus' main competitor in that market segment -- the A350-1000 -- isn't available yet.
Luckily, rising profits from the 737 and 787 lines should more than offset any weakness from the 777 over the next few years. The pricing pressure in the market today won't have a big impact on the 737 and 787 programs until at least 2020. That gives Boeing plenty of time to find further cost reduction opportunities.