Boeing versus Airbus: Two Decades of Trade Disputes1

INTRODUCTION

For decades the commercial aircraft industry has been

an American success story. Until 1980, U.S. manufacturers
held a virtual monopoly in the field. Despite the
rise of the European-based Airbus Industrie, this
dominance persisted to the mid-1990s, when two U.S.
firms, Boeing and McDonnell Douglas, accounted for
over two-thirds of world market share. In late 1996,
many analysts thought that U.S. dominance in this
industry would be further strengthened when Boeing
announced a decision to acquire McDonnell Douglas
for $13.3 billion, creating an aerospace behemoth
nearly twice the size of its nearest competitor.
The following PBS video is recommended to accompany this case: http://
pbs-newshour.virage.com/cgi-bin/visearch?squery=_ClipID:5__VideoAsset:pbsnh053105&query_Trade&user_pbs-newshour&tid_email
1

Hill: International
Business: Competing in the
Global Marketplace,
Seventh Edition
III. The Global Trade and
Investment Environment
Case: Boeing versus
Airbus: Two Decades of
Trade Disputes
The McGrawHill
Companies, 2009

310 Part 3 Cases

The industry is routinely the largest net contributor

to the U.S. balance of trade, and Boeing is the largest
U.S. exporter. The U.S. commercial aircraft industry
has regularly run a substantial positive trade balance
with the rest of the world of $12 to $15 billion per
year. The impact of the industry on U.S. employment is
also enormous. Boeing directly employs some 57,000 people
in the Seattle area alone, and another 100,000
elsewhere in the nation. The company also indirectly
supported a further 600,000 jobs nationwide in related
industries (e.g., subcontractors) and through the
impact of Boeing wages on the general level of economic
activity.
Despite Boeings formidable reach, since the mid1980s U.S. dominance in the commercial aerospace
industry has been threatened by the rise of Airbus
Industrie. Founded in 1970, Airbus began as a consortium
of four European aircraft manufacturers: one
British (20.0 percent ownership stake), one French
(37.9 percent ownership), one German (37.9 percent
ownership), and one Spanish (4.2 percent ownership).
Airbus was initially a marginal competitor and was
regarded as unlikely to challenge U.S. dominance.
Since 1981, however, Airbus has confounded its critics
by progressively gaining market share. By the early
2000s Airbus was consistently gaining a larger share of
new orders than Boeing, and in 2003 it surpassed Boeing
for the first time in deliveries of aircraft, with 305
deliveries against Boeings 281. Also, in the early 2000s
Airbus made the transition from a consortium to a fully
functioning private entity, and it is now a division of the
European Aeronautic Defense and Space Company

(EADS).
Over the years, many in the United States have responded
to the success of Airbus by crying foul. U.S
critics repeatedly claim that the governments of Great
Britain, France, Germany, and Spain heavily subsidize
Airbus. Airbus has responded by pointing out that
both Boeing and McDonnell Douglas have benefited
for years from hidden U.S. government subsidies. In
1992, the two sides appeared to reach an agreement
that put to rest their long-standing trade dispute. The
agreement allowed Airbus to receive some launch aid
from EU governments and Boeing to benefit from government
R&D contracts. However, the dispute broke out
again in 1997, when the European Union decided to
challenge the merger between Boeing and McDonnell
Douglas on the grounds that it limited competition.
Although that dispute was settled, trade tensions
erupted yet again in 2004 when the United States
charged that given Airbuss success in the marketplace,
the launch aid that was allowed under the 1992
agreement was no longer appropriate. Airbus responded
with accusations that Boeing was still benefiting
from subsidies. When negotiations between the
United States and EU over this dispute broke down in
early 2005, Boeing referred the dispute to the World
Trade Organization. This case reviews the history of
these trade disputes.

INDUSTRY COMPETITIVE
DYNAMICS

Competitive dynamics in the commercial aircraft

industry are driven by a number of key factors. Perhaps
foremost among these is that the costs of developing a
new airliner are enormous. Boeing spent a reported
$5 billion developing and tooling up to produce the
777 wide-bodied jetliner that it introduced in 1994.
The development costs for Airbuss most recent aircraft,
the 555-seat A380 super-jumbo, which is
scheduled to enter service in 2006, are estimated to be
anywhere between $10 billion and $15 billion. (The
A380 is a direct competitor to Boeings profitable
747 model line.) Similarly, development costs for Boeings
newest offering, the super efficient 787 that
will enter service in 2008, are estimated to be in the
$7 to $8 billion range.
Given such enormous development costs, a company
must capture a significant share of world demand
to break even. In the case of the 777, for example,
Boeing needed to sell more than 200 aircraft to break
even, a figure that represented about 15 percent of
predicted industry sales for this class of aircraft between
1994 and 2004. Given the volume of sales required
to break even, it can take up to 10 to 14 years
of production for an aircraft model to turn a profit and
this on top of the 5 to 6 years of negative cash flows
during development.
On the manufacturing side, a significant experience
curve exists in aircraft production. Due to learning
effects, on average, unit cost falls by about 20 percent

with each doubling of accumulated output. A company

that fails to move along the experience curve
faces a significant unit-cost disadvantage. A company
that achieves only half of the market share required
to break even will suffer a 20 percent unit-cost
dis advantage.
Another feature of the industry is that demand for
aircraft is highly volatile. This makes long-run planning
difficult and raises the risks involved in producing
aircraft. The commercial airline business is prone to
boom-and-bust cycles. During the early 1990s, and
then again in the early 2000s, the major airlines suffered
from falling demand and high fuel costs, and many
major carriers entered bankruptcy. Orders for aircraft
tend to follow these cycles, with order volumes in strong
years frequently being two to three times as large as in
weak years.
Hill: International
Business: Competing in the
Global Marketplace,
Seventh Edition
III. The Global Trade and
Investment Environment
Case: Boeing versus
Airbus: Two Decades of
Trade Disputes
The McGrawHill
Companies, 2009

Cases 311

The combination of high development costs, breakeven

levels that constitute a significant percentage of
world demand, substantial experience curve levels, and
volatile demand makes for an industry that can support
only a few major players. Analysts seem to agree that the
large jet commercial aircraft market can profitably
support only two, or possibly three, major producers. By
the early 2000s there were only two major players in the
industry, McDonnell Douglas having been absorbed by
Boeing. This, combined with the strong production and
order levels reached that year, should have boded well
for productivity. However, Boeings profits were poor
during the late 1990s and early 2000s as it struggled to
cope with a poorly managed ramp-up of its aircraft production
rates, the effects of unexpectedly high manufacturing
costs, and intense price competition from an
increasingly aggressive Airbus.

TRADE FRICTIONS BEFORE 1992

In the 1980s and early 1990s, both Boeing and

McDonnell Douglas argued that Airbus had an unfair
competitive advantage due to the level of subsidy it
received from the governments of Great Britain,
France, Germany, and Spain. They argued that the
subsidies allow Airbus to set unrealistically low prices,
offer concessions and attractive financing terms to airlines,
write off development costs, and use state-owned
airlines to obtain orders. In making these claims, Boeing
and McDonnell Douglas had the support of the U.S.
government. According to a study by the Department
of Commerce, Airbus received more than $13.5 billion
in government subsidies between 1970 and 1990
($25.9 billion if commercial interest rates are applied).

Most of these subsidies were in the form of loans at

below-market interest rates and tax breaks. The subsidies
financed research and development and provided
attractive financing terms for Airbuss customers. For
most of its customers, Airbus is believed to have
financed 80 percent of the cost of aircraft for a term of
8 to 10 years at an annual interest rate of approximately
7 percent. In contrast, the U.S. ExportImport Bank
required 20 percent down payments from Boeing and
McDonnell Douglas customers, financed only 40 percent
of the cost of an aircraft directly, and guaranteed the
financing of the remaining 40 percent by private banks
at an average interest rate of 8.4 percent to 8.5 percent
for a period of 10 years.
Airbuss response to these charges was to point out
that its success was not due to subsidies but to a good
product and a good strategy. Most observers agree that
Airbuss aircraft incorporate state-of-the-art technology,
particularly in materials applications, systems for flight
control and safety, and aerodynamics. Airbus gained
ground initially by targeting market segments not served
by new aircraft or not served at all. Thus, Airbus took
the initiative in targeting two segments of the market
with wide-bodied twin-engine aircraft, then in developing
a new generation of aircraft for the 150-seat market,
and next, going after the market below the 747 for a
250- to 300-seat airliner with its A330 and A340 models
(to which Boeings 777 was a belated but apparently successful
competitive response).
Airbus also argued that both Boeing and McDonnell
Douglas benefited from U.S. government aid for a long
time and that the aid it has received has merely leveled
the playing field. In the United States, planes were built
under government contract during World War I, and the
construction of mail planes was subsidized between the
world wars. Almost all production was subsidized during
World War II, and subsidies continued at a high level
after the war. The Boeing 707, for example, is a derivative
of a military transport program that was subsidized
by the U.S. government. Boeings subsidized programs
include the B-17, B-29, B-47, B-52, and K-135, just to
name a few. Its nonairline programs have included the
Minuteman missile, ApolloSaturn, and space station
programs.
A 1991 European Commission study attempted
to estimate the amount of subsidies the U.S. industry
received. The study contended that Boeing and
McDonnell Douglas received $18 billion to $22 billion
in indirect government aid between 1976 and 1990. The
report claimed that commercial aircraft operations
benefited through Defense Department contracts by as
much as $6.34 billion during the 19761990 period. In
addition, the report claims that NASA has pumped at
least $8 billion into commercial aircraft production
over the same period, and that tax exemptions gave an
additional $1.7 billion to Boeing and $1.4 billion to
McDonnell Douglas.
Boeing rejected the claims of the European

Commission report. The company pointed out that the

reports assumption that Boeing receives direct
government grants in the form of an additional 5 percent
for commercial work with every military or space
contract it receives was false. Moreover, the company
argued that during the 1980s only 3 percent of Boeings
R&D spending came from Department of Defense
funding and only 4 percent from NASA funding.
Boeing also argued that since the four companies in
the Airbus consortium do twice as much military and
space work as Boeing, they must receive much larger
indirect subsidies.

THE 1992 AGREEMENT

In mid-1992, the United States and the four European

governments involved agreed to a pact that many
thought would end the long-standing dispute. The
Hill: International
Business: Competing in the
Global Marketplace,
Seventh Edition
III. The Global Trade and
Investment Environment
Case: Boeing versus
Airbus: Two Decades of
Trade Disputes
The McGrawHill
Companies, 2009

312 Part 3 Cases

1992 pact, which was negotiated by the European

Union on behalf of the four member states, limited
direct government subsidies to 33 percent of the total
costs of developing a new aircraft and specified that
such subsidies had to be repaid with interest within
17 years. The agreement also limited indirect subsidies,
such as government-supported military research
that has applications to commercial aircraft, to 3 percent
of a countrys annual total commercial aerospace
revenues, or 4 percent of commercial aircraft
revenues of any single company in that country.
Although Airbus officials stated that the controversy
had now been resolved, Boeing officials argued that
they would still be competing for years against subsidized
products.
In February 1993, it looked as if the trade dispute
was about to reemerge. The newly elected President
Clinton repeatedly blasted the European Union for
allowing subsidies of Airbus to continue, blamed
job losses in the U.S. aerospace industry on the
sub sidies, and called for the EU to renegotiate the
1992 deal.
To the surprise of the administration, however, this
renewed attack on Airbus subsidies was greeted with
conspicuous silence from the U.S. industry. Many
analysts theorized that this was because a renewed
dispute could prompt damaging retaliation from Europe.
For one thing, Airbus equips its aircraft with engines
made by two U.S. companiesPratt & Whitney and
General Electricand with avionics made by U.S.
companies. In addition, many state-owned airlines in
Europe purchase aircraft from Boeing and McDonnell
Douglas. Many in the U.S. industry apparently felt that

this lucrative business would be put at risk if the

government reopened the trade dispute so soon after the
1992 agreement.
A similar cool response from the U.S. industry
greeted attempts by two U.S. senators, John C. Danforth
of Missouri and Max Baucus of Montana, to reopen
the trade dispute with Airbus. In early 1993, Danforth
and Baucus cosponsored legislation requiring the U.S.
government to launch a trade case against Airbus on
charges of unfair subsidies. They also sponsored a bill
to create an aerospace industry consortium called
Aerotech that would finance aerospace research, with
half of the funds coming from industry and half from
the U.S. government. Vice President Al Gore called
the establishment of Aerotech an administration
priority, but a Boeing spokesman said the company
was very guarded about Aerotech because it could
violate the 1992 accord. Both Danforth/Baucus bills
died in committee hearings, and the Clinton administration
quietly dropped all talk of reopening the
trade dispute.