Essays24.com - Term Papers and Free Essays
Search

The Microeconomics of the Boeing 787

Essay by   •  April 13, 2017  •  Research Paper  •  1,952 Words (8 Pages)  •  1,437 Views

Essay Preview: The Microeconomics of the Boeing 787

Report this essay
Page 1 of 8

The Microeconomics of the Boeing 787

Boeing launched the 787 Dreamliner in 2004 with the idea that airlines would seek more efficient but smaller aircraft instead of larger aircraft capable of carrying more passengers.  Apparently, this gamble paid off as the Dreamliner became the fastest selling wide body aircraft ever (Johnston, 2012).  This record may lead some to speculate that the 787 monopolizes the wide body aircraft market.  But is it truly a monopoly?  Does it have competition from any other manufacturer of wide body twin aisle aircraft?  If there are substitutes for the 787 Dreamliner, how would it affect the cross elasticity for its demand?  

Literature Review

The production of the Dreamliner was a departure from Boeings traditions (Peterson, 2011).  Boeing chose to outsource a major percentage of the engineering and manufacturing of the Dreamliner.  The intention was to reduce development cost from $10 billion to $6 billion and reduce development time from six to four years.  Boeing was attempting to duplicate the supply chain of Toyota.  But they did not maintain the same tight control over their suppliers as does Toyota.  Boeing found that some of their suppliers did not have the expertise or the ability to manage their subcontractors.  The end result of this was that Boeing had to step in and provide the engineering anyway.  Boeing even had to purchase one of their major tier one suppliers to regain control.   This action increased costs tremendously and delayed the first deliveries by 3 years (Denning, 2013).  The delays have added to Boeings costs in the form of cash compensation for losses incurred by buyers (Kelly & Sugiyama, 2013).

Boeing doesn’t publish sales or cost data for specific planes, but in an article written by Ostrower (2014), Joseph Nadol, (an analyst at J.P. Morgan Chase & Co) stated that “Boeing's unit costs for delivering each 787 exceeded the plane's estimated $115 million average selling price by $45 million in the third quarter, down from $73 million in the first quarter” of 2013.  

Methodology

To understand if Boeing has a monopoly on the wide body twin engine passenger aircraft market, we will examine the market structure for the 787.  Arnold (2012 p. 556) discusses four market structures that have certain characteristics and consequences.  First, there is perfect competition.  This structure has many sellers of a homogeneous product.  There are no barriers to entry into the market and firms have zero economic profits.  The second market structure is monopoly.  A monopoly has only one seller of a unique product.  It has very high barriers to entry and it earns positive economic profits.  The third market structure is monopolistic competition.  This structure has many sellers and the product is very similar but does have some differentiation.  There are no barriers to entry and the sellers earn zero economic profits.  The fourth structure is an oligopoly.  The oligopoly has few sellers of a homogeneous or differentiated product.  It has barriers to entry and usually earns positive economic profits.  

A high barrier to entry is another factor that will determine the market structure for the Boeing 787 Dreamliner.  Obstacles that prevent companies from entering new markets are known as barriers to entry.  These barriers can be natural barriers, such as network effects, ownership of a key resource, high set up costs or high development costs.  Or, they can be artificial barriers such as predatory pricing, exclusive contracts or patents, strong brand loyalty or limit pricing (Economics Online, n.d.).  We will examine if any of these barriers can be applied to the Dreamliner’s market.

To answer the question of whether there are substitutes for the Dreamliner, we will test the cross elasticity of demand between it and the Airbus a330neo which has also been categorized as a twin engine, wide body passenger aircraft.  Wilhelm (2014) said Airbus believes that the a330neo will compete directly with the Dreamliner.  The Airbus a330neo is an aluminum aircraft that has new engines and a redesigned wing.  Although this aircraft also fits the twin aisle wide body category, there is significant differentiation from the Dreamliner.  To test cross elasticity of demand we will use the following equation.

[pic 1]

Results

The first step in determining the market structure of the Boeing 787 Dreamliner is to examine if there is a significant barrier to entry in the market.  Fischer, Anderson, & Ram (2012) speculated that it would require $19 billion to develop a “large commercial wide-body aircraft.”  They went on to say that developing new programs present extreme risks to the company that makes it “a bet-the-company move, even for the likes of Boeing and Airbus.”  The 787 Dreamliner fits into this category of aircraft.  Therefore, it can be determined that a high cost barrier exists and that this alone basically eliminates the perfect competition and monopolistic competition market structures.  

Wilhelm (2014) states that, “Every A330neo sold by Airbus will essentially be one fewer 787 sold by Boeing.”  Zacks Equity Research (2014) reported that Air Lease Corp will buy 25 A330-900neos.  The list price for the A330-900neo is 275 million while the 787-10 Dreamliner is 288.7 Million (Zacks, 2014).  If we assume Wilhelm’s (2014) statement is accurate, then we can calculate the cross elasticity of demand between the a330-900neo and the 787-10 with this equation.

[pic 2]

[pic 3]

The result of the equation is a positive number for the cross elasticity of demand.  When the cross elasticity of demand is positive, then the two products are substitutes.  One of the determining factors of a monopoly is that the product is unique, with no substitutes.  Therefore, the Dreamliner is not a monopoly.

Discussion

The market structure for the Dreamliner more closely fits Arnold’s (2012) assumptions for an oligopoly.  There are few sellers with many buyers of a differentiated product and a high barrier to entry in the market.  In this case, there are two sellers, Airbus and Boeing.  The Airbus has more than 750 orders from 39 customers (Airbus, 2014) while Boeing has delivered 69 787’s to 22 different customers this year (Boeing 2014b).  With this type of market, it might be expected that Boeing and Airbus might become a cartel.  But this has not happened.  These two firms are fiercely competitive with one another.  No doubt, it is a prisoner’s dilemma.

If we stick to the assumption that Boeing 787 represents an oligopoly, then it is a price searcher (Arnold, 2012 pg. 548).  But this is an area where things get a bit sketchy.  It seems that Boeing (and Airbus) never sells their aircraft at the list price (Ausick, 2014b).  “The 787-9 has a list price of $249.5 million, compared with $211.8 million for the 787-8 and the 787-10, which has a current list price of $288.7 million…”(Ausick, 2014a).  For this paper, I’ll use the figures given by Ostrower (2014) of $160 million average cost and $115 million average selling price.  This information leads you to believe that Boeing is more of a price taker.  At any rate, we can safely assume that Boeing uses price discrimination.  

...

...

Download as:   txt (12.9 Kb)   pdf (183.7 Kb)   docx (63.7 Kb)  
Continue for 7 more pages »
Only available on Essays24.com
Citation Generator

(2017, 04). The Microeconomics of the Boeing 787. Essays24.com. Retrieved 04, 2017, from https://www.essays24.com/essay/The-Microeconomics-of-the-Boeing-787/75938.html

"The Microeconomics of the Boeing 787" Essays24.com. 04 2017. 2017. 04 2017 <https://www.essays24.com/essay/The-Microeconomics-of-the-Boeing-787/75938.html>.

"The Microeconomics of the Boeing 787." Essays24.com. Essays24.com, 04 2017. Web. 04 2017. <https://www.essays24.com/essay/The-Microeconomics-of-the-Boeing-787/75938.html>.

"The Microeconomics of the Boeing 787." Essays24.com. 04, 2017. Accessed 04, 2017. https://www.essays24.com/essay/The-Microeconomics-of-the-Boeing-787/75938.html.