Battle for the Sky

By SALLY B. DONNELLY

Boeing CEO Harry Stonecipher spent last Christmas at his St. Petersburg, Fla., home. He wasn't happy about that. Angered because key airlines like AirAsia and Air Berlin were buying rival Airbus planes, all too aware that the European manufacturer would soon be rolling out its new 555-seat, double-decker A380 jumbo liner, Stonecipher had told his salespeople he would travel anywhere in the world, even on Christmas Day, if he was needed to close a deal. Yet no one called. "The whole idea is that I will go anywhere for them," he says.

Stonecipher stayed home last month too when five European leaders, 12 airline CEOs, scores of journalists and more than 5,000 invited guests gathered at Airbus headquarters in Toulouse, France, to celebrate the unveiling of the A380, which cost $12 billion to launch. The roll-out of the world's largest passenger plane is a powerful symbol of the coming of age of 35-year-old Airbus and underscores that the world's two major commercial-airplane makers--Airbus and Boeing--are at each other's throats as never before. Although the U.S. government and the European Union reached a temporary deal last month to avoid a World Trade Organization (WTO) fight over government subsidies, the two sides were sniping at each other again less than 24 hours later. When Airbus CEO Noel Forgeard said aircraft launch aid (the no- or low-risk loans that European governments have historically provided the company to help finance plane development) wasn't "part of the past," a spokesman for the U.S. trade representative fired back, "The U.S. will not agree to permit new aircraft subsidies that are illegal under WTO rules. That certainly covers launch aid." The two sides have to reach a new agreement by March, or a nasty legal battle will break out.

Competition in the commercial- airplane market--estimated to be worth $2 trillion over the next 20 years--is expected, but this feud has bigger implications. At its core is a debate about the relationship between the state and private enterprise--specifically, what sort of helping hand can a country legally give its friendly local planemaker? Because of the big money involved and the critical role that aircraft play in national security, the spat threatens already tense U.S.-E.U. relations and could hurt the huge aerospace industry and its thousands of employees on both sides of the Atlantic.

The dispute also illuminates the painful decline of Boeing, the 90-year-old aerospace company created by Bill Boeing from modest beginnings in a Seattle barn. Although its 156,000 workers produce thousands of products, from Internet equipment to satellites, the Boeing name has always meant aircraft. Yet for the second straight year, the $50 billion firm, based in Chicago, has been outsold by Airbus. In 2004 Boeing saw its market share fall to 43%, from 67% just five years ago.

The A380 is Airbus' prized 21st century showpiece. The plane, which has a list price of $285 million (though airlines rarely pay the published rate on any plane), has been ordered by major airlines around the world, including Air France, Emirates, Lufthansa, Qantas and Virgin. Last month UPS joined FedEx as the second U.S. cargo airline to buy the freighter version. "The A380 is the most significant event in aviation in 40 years--since the introduction of the Boeing 747," says Stephen Forshaw of Singapore Airlines, which will be the first airline to fly the aircraft, in the spring of 2006.

Boeing isn't impressed. Airbus has got ahead, the company contends, because of unfair advantages--those launch-aid loans, to the tune of some $15 billion over the past 30 years. Airbus' retort: it will give up its state support if Boeing--the U.S.'s second largest defense contractor--forgoes its tax breaks and R&D support. In fiscal 2003, the E.U. estimates, total U.S. government support for Boeing R&D was $2.74 billion, representing 11.9% of the company's profits. That argument has stung Boeing, especially since it is involved in investigations of illegal or unethical behavior in its relationship with the Pentagon. Boeing has already fired two executives and is cooperating with authorities. But Europeans fail to mention that Airbus' majority stakeholders (the Franco-German conglomerate European Aeronautic Defense & Space Co. and BAe Systems, based in Britain) have significant military businesses too. The Europeans also object to state governments' providing tax benefits or other subsidies to Boeing. Says Airbus' Forgeard: "We want a level playing field."

The debate over subsidies is especially heated because the aircraft business is so precarious. Launch costs for a new plane are enormous, with little guarantee that the market will reward innovation. In December 2003 Boeing announced plans for the twin- engine, highly efficient 787 (originally called the 7E7), its first new airplane in a decade and its designated aircraft of the future. In contrast to the A380, which is designed to fly lots of people to big hub airports, the smaller (about 220 passengers) 787 aims to fly longer distances to more cities. Scheduled to roll out in 2007 and fly commercially in 2008, the 787 will cost an estimated $9 billion to launch.

Boeing predicted it would have 200 orders for the $120 million 787 by the end of last year, but it was just last month that the company snagged the key order it had been waiting for: China signed up for 60 for its airline industry. The 787 has 186 orders, including some from more-obscure carriers like Italy's Blue Panorama, Britain's First Choice Airlines and Primaris Airlines from the U.S. Established carrier Japan Air Lines has ordered 50, though skeptics note that Japanese companies are building 35% of the 787's air frame.

Airbus' reaction to the 787, meanwhile, has been baffling. At first, Forgeard was quoted as dismissing Boeing's new plane as a "Chinese copy" of Airbus' similar A330. But last December, Airbus abruptly shifted and said it would build a derivative plane called the A350. Boeing spins the A350 as a sign of lost confidence in the A380. In an interview last month, Boeing's Stonecipher pointed to another European government-backed plane that never made a profit and has been grounded. "The A380 is a great engineering success, but so was the Concorde. The A380 could be a market disaster," he said. Analyst Richard Aboulafia of Virginia's Teal Group agrees: "Airbus bet wrong on the A380, and the 787 is a major competitive threat."

But Boeing has its own problems. Although its commercial-aircraft unit (which accounts for 40% of revenues) remains profitable, the company has only two types of aircraft (the 777 and the 737) that are selling well, and last month it said it would stop making its 717. "If Boeing doesn't make the 787 a success, it has no more trumps in its hand," says Ulrich Horstmann, an aerospace analyst with Bayerische Landesbank in Munich. Don't think Stonecipher isn't aware of that. He recently approved the firing of the head of Boeing's sales team. Stonecipher admits that his company has been overconfident in the past but says he sees the same trait among the Airbus troops: "Arrogance is just awful. It will kill you." So Stonecipher is hopeful, if not completely happy. And, yes, he has some travel plans in the very near future. --With reporting by James Graff/Paris

With reporting by James Graff/Paris