4
Future Trends

MARKETS

Over the next several decades, demand for air transport, and the aircraft necessary to carry it, should continue to grow at a relatively high rate. Boeing's forecast, for example, envisions an annual average growth in world airline passenger traffic of 5.4 percent from 1992 through 2010.1 Such rates are somewhat lower than those prevailing over the past two decades (6.8 percent), but are still substantial. Similar trends are expected for the global air-freight market (with a 6.5 percent growth to 2010 in the Boeing forecast, compared to 8.0 percent from 1970 to 1992).

This overall growth will produce a continued increase in demand for new commercial aircraft. Boeing anticipates a global market for aircraft of $815 billion in constant 1992 dollars from 1992 to 2010 (including $204 billion in replacements and $611 billion in additional capacity). 2 McDonnell Douglas envisions a somewhat higher $1.0 trillion global market for aircraft over the same time period, representing a total of 14,072 units.3

1  

Boeing Commercial Airplane Group, Current Market Outlook: World Market Demand and Airplane Supply Requirements (1993), p. 25.

2  

Boeing, ibid., p. 34.

3  

Estimates provided by McDonnell Douglas, May 1993.



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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft 4 Future Trends MARKETS Over the next several decades, demand for air transport, and the aircraft necessary to carry it, should continue to grow at a relatively high rate. Boeing's forecast, for example, envisions an annual average growth in world airline passenger traffic of 5.4 percent from 1992 through 2010.1 Such rates are somewhat lower than those prevailing over the past two decades (6.8 percent), but are still substantial. Similar trends are expected for the global air-freight market (with a 6.5 percent growth to 2010 in the Boeing forecast, compared to 8.0 percent from 1970 to 1992). This overall growth will produce a continued increase in demand for new commercial aircraft. Boeing anticipates a global market for aircraft of $815 billion in constant 1992 dollars from 1992 to 2010 (including $204 billion in replacements and $611 billion in additional capacity). 2 McDonnell Douglas envisions a somewhat higher $1.0 trillion global market for aircraft over the same time period, representing a total of 14,072 units.3 1   Boeing Commercial Airplane Group, Current Market Outlook: World Market Demand and Airplane Supply Requirements (1993), p. 25. 2   Boeing, ibid., p. 34. 3   Estimates provided by McDonnell Douglas, May 1993.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft Within this overall picture of growth of traffic and aircraft demand, important market shifts will take place, with the nations of the Asia-Pacific region experiencing higher economic and air traffic growth than other regions of the world. This region has had some of the most rapidly growing economies in the world, and most forecasts anticipate that this pattern will continue. Furthermore, integration of China, and now possibly Indochina, into the regional and global marketplace is continuing to lead to expanded international travel associated with it. Although the region faces some uncertainty on the security front in the post-Cold War era, even these potential problems seem less serious than in most other parts of the world. Boeing foresees that intra-Asian travel will grow at an annual rate of 8.4 percent to 2010, and transpacific travel at 7.8 percent, substantially above the global average. Some of the Asian and Asia-Pacific international traffic will move on U.S.-owned airlines, but the market shift will also involve an increased role for non-U.S. airlines. McDonnell Douglas, for example, anticipates that the dollar value of aircraft deliveries to the Asia-Pacific countries will account for 39 percent of the global total. Whereas only Japan and Australia are among the top 10 countries in terms of the dollar value of aircraft deliveries through 1992, Asia-Pacific countries will account for 5 of the top 10 from 1993 through 2010 in the Boeing forecast (with Japan and Australia joined by China, South Korea, and Singapore). Japan alone is anticipated to account for $60.5 billion of the overall market for new planes through 2010 (7.4 percent of global demand). This long-term optimism about the market for new commercial aircraft contrasts with considerable pessimism concerning the next several years. Most observers believe that sales will continue to decline from their 1992 peak for several more years, perhaps through 1996. Airframe and engine makers are counting on a surge in new orders from U.S. airlines for delivery later in the decade (aided by requirements to meet more stringent noise regulations). Although we can be reasonably certain that growth in the demand for air travel and environmental regulation will lead to more aircraft sales over the coming decade and beyond, continuing financial pressure and structural change in the U.S. and global airline businesses may permanently affect traditional purchasing criteria. Airline deregulation, both in the United States and internationally, implies a continuation of strong price competition among airlines leading to average profit levels over the next several decades that will remain lower than in the past. In this more stringent competitive environment, airlines will put increased pressure on the manufacturers to cut prices. This situation is exacerbated by the longevity of aircraft. Even with improved performance characteristics, airlines demand that the anticipated ownership and operating cost of the new aircraft represent a significant savings over existing aircraft. This represents a change from the past when higher profits gave the airlines more financial leeway to introduce new models. Such a shift in airline demand will lead the aircraft industry toward increased price competition; the most successful participants in all aspects of the

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft industry will be those companies that can reduce manufacturing costs in order to maintain profitability at lower prices. Even with cost reductions, however, price competition is also likely to result in lower profit levels within the industry relative to the past, which could affect the funds available for research and development on next-generation products. The boom-bust cycle of the airline business since deregulation in the United States is a reminder that the market outlook can change very quickly. Faster than anticipated economic growth could reopen the financial spigots and contribute to partly rebuilding the long queues for aircraft that existed several years ago. Yet even under the most optimistic assumptions, competition is likely to be fierce in most segments of the large commercial transport market. Trends in military demand will have an indirect but significant impact on the commercial industry. Because of the steep projected declines in U.S. aircraft procurement, overall U.S. aerospace industry restructuring is likely to further accelerate and build toward a climax over the next several years. Foreign demand for U.S. military aircraft has also declined recently, and there appear to be few signs that it will pick up enough to offset much of the U.S. procurement decline. Although the political factors that influence military aircraft demand are even more difficult to foresee than commercial trends, the important point is that restructuring strategies for diversification, acquisition, and divestment are now being formulated on the basis of the current outlook. Although military and commercial businesses (including manufacturing and design) are often separated in U.S. companies—more so in airframes and structures than in engines and some component areas—many of the significant aircraft defense contractors are players in at least some aspect of the commercial business. Therefore, military restructuring has the potential to spur significant shifts in the U.S. commercial transport business. Since a number of the commercial businesses are not as visible or sensitive as prime military work and could easily be spun off, even some global consolidation through foreign investment in given industry segments should not be ruled out. Overall, this mixed scenario for short-and long-term market trends holds the danger that some firms with good long-term prospects, mostly at the components level, will fall by the wayside. For all firms at all levels of the industry that do survive the short-term problems, success will be increasingly dependent on an ability to cut costs while maintaining or enhancing quality. NEW PROGRAMS A number of new products are in the advanced stages of development and will enter service within the next few years.4 At the airframe and engine prime levels, new programs are currently difficult to finance. The traditional methods 4   In aircraft, the Boeing 777; the McDonnell Douglas MD-90; the Airbus A321, A340, and A330; and the Ilyushin IL-96M; in engines the General Electric GE90, the Pratt & Whitney PW4087, and the Rolls Royce Trent.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft (advances and downpayments from airlines, and commercial adaptation of engines developed for the military) have become all but unavailable over the past decade. The resulting need to raise risk-sharing capital has been one of the driving forces behind the growth in international alliances in this industry. Much attention is focused on the possible development of a new generation of very large transports that could carry from 400 to more than 600 or even 800 passengers. McDonnell Douglas's preliminary design for the MD-12 would be at the lower end of that capacity range, but the company is reluctant to launch the program without a major equity or risk-sharing partner. A planned partnership with Taiwan Aerospace fell through in 1992. Both Boeing and Airbus are conducting feasibility studies and holding preliminary discussions with potential partners concerning even larger airplanes. Japan is considered central to these discussions. Most experts believe that there is a market for one of these very large planes, and the bulk of that market is in either transpacific or domestic Japanese routes.5 The relatively limited size of the global market, in terms of the total number of such planes that would be produced, leads industry experts to believe that efficiency in production implies only a single producer. Furthermore, the high development costs associated with a very large aircraft suggest that firms will have difficulty convincing capital markets or governments to supply the necessary capital. Both efficiency and capital access considerations point toward an international consortium. For example, as a result of the U.S.-European Community subsidy agreement of 1992, Airbus may no longer have easy access to member government funding for program launch. The consortium has been actively courting the Japanese ''heavies.'' In other range/passenger categories, it will likely be difficult to launch all-new programs even if business improves. Boeing has, for example, recently decided to develop an advanced version of its 737 rather than a completely new airplane in the 100 to 150-seat segment. Since this was the projected capacity of the 7J7-YXX, the Boeing decision appears to have dealt a blow to Japan's immediate prospect for taking a more significant partnership role in a new program. Apart from the 80 to 100-seat and the more than 400-seat categories, as well as the supersonic arena, which is discussed below, there are no obvious unaddressed market needs within the current market framework. ADVANCED TECHNOLOGY One focus of advanced technology development for aircraft is enabling technology for a second-generation supersonic transport. The major issues are environmental (noise and emissions), and the keys to resolving them are in the propulsion and propulsion-airframe integration areas. Even if significant progress is made on the technical front over the next several years, an actual High 5   747s are used much less on transatlantic than transpacific routes. Japan is the only country that uses 747s on domestic routes.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft Speed Civil Transport (HSCT) development program will be very difficult to launch. Airframers will not commit to development unless they are certain that the environmental impact will be acceptable. Also, as in the case of a very large transport, the nearer-term projected market (to about 2015) appears to allow room for only one program (although the HSCT market is expected to grow considerably in the long term). Since the bulk of the market is global and transoceanic, most observers anticipate a global program of some sort, but structuring such a program will be a complicated and difficult undertaking. Finally, extensive international government involvement, in areas such as environmental and safety certification, and infrastructure (if not program financing), will likely be necessary. Although it is possible that an HSCT will be flying at some point during the first decade of the next century, substantial technical and business-related obstacles remain.6 Although maintaining leadership in HSCT-related technologies is critical for the U.S. aircraft industry in the long term, a more immediate concern is the development of technologies that can be incorporated into advanced subsonic aircraft. The major issues are those affecting cost and quality, including process and manufacturing technologies. Airlines will demand the superior performance made possible by new technology but will not be in a position to pay premium prices. Therefore, the incorporation of new technology must not only "pay for itself" in terms of lower operating costs over the life of the aircraft, but also avoid increasing the initial unit cost. Process technology developments with the potential for raising quality while lowering the unit cost of aircraft could also affect the competitive landscape during the coming decade. IMPACT OF BROAD INDUSTRY FORCES The committee has identified several broad trends for the aircraft industry during the coming decade—growing but price-sensitive markets, global restructuring, and few new programs launched by the established players. What do these trends and specific regional factors imply? Over the coming decade, one of the keys to survival and growth in the global aircraft market will be manufacturing performance in terms of low cost, high quality, and prompt delivery. Companies at the prime level through almost all parts of the supply chain will feel continuing pressure to achieve higher quality at lower cost. Japanese aircraft companies are currently investing heavily in manufacturing technology. Although a few U.S. companies are making the necessary long-term investments, many are not.7 Japanese industry is likely to tighten its hold in current areas of excellence (structures, composite materials, engine 6   In the event of significant continuing distress in the global aircraft industry, political pressure may mount in producing countries to launch an HSCT as an industrial policy measure. 7   U.S. Census Bureau data showed a 25 percent drop in capital spending by aircraft manufacturers for the first half of 1993 compared to the previous year.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft components, flat panel displays, other electronic components, and other component systems such as primary actuation). While consolidation of the Japanese position at various supplier levels will ensure that the trend toward increasing Japanese value added in commercial aircraft continues, competitive and financial pressures on U.S. primes and on suppliers outside the current scope of Japanese activities will also continue. It is now close to impossible to predict where this might lead and what opportunities (expanded partnerships or direct investment) might be available to U.S. and Japanese companies as a result. In addition to its advantages as a manufacturer, if Japanese industry can retain its traditional access to long-term capital, it will likely gain more leverage in partnership negotiations for new programs. The strong economic expansion, accompanied by extremely low interest rates and financial asset inflation, gave all Japanese manufacturing a temporary advantage in raising capital in the late 1980s. Although this so-called bubble is over in Japan, the aircraft industry remains high on the government agenda for industrial promotion, meaning that access to policy lending from the Japan Development Bank and other sources should continue. Identification by the government in this manner should give these firms an advantage in obtaining access to commercial loans as well. Overall, this Japanese industry is likely to continue its pattern of easier access to capital than the American industry. Barriers to Japanese entry into the systems integration of airframes, engines, and avionics remain. The cost of maintaining and extending systems integration capabilities through new programs has increased for U.S. companies, but the price of entry—through acquisition or accumulating expertise—is likely to fall, driven by excess industry capacity. An industry increasingly characterized by global partnerships and programs will allow the Japanese to continue building a revenue and technology base to make the jump to systems integration at an opportune time after the turn of the century. Perhaps the most significant barriers to this jump are related not to inherent capabilities, but to the perception of risks in the market for a "Rising Sun" jet and potential impacts on U.S.-Japan relations. It is also important to remember that the Japanese aircraft industry currently faces its own problems and challenges. The rapid appreciation of the yen during 1993 and the aircraft slump have dealt a double blow to the aircraft divisions of the heavies. Japanese government and industry are currently contemplating how to redeploy resources to build the industry in the future. In addition, countries such as South Korea and Taiwan have formulated national strategies to build aircraft industries through international alliances in the same manner that Japan has. In order to remain a force in the global industry, it will probably not suffice for Japan to stand in place, and vision will be required to move ahead.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft POSSIBLE SCENARIOS AND IMPLICATIONS FOR S.S.-JAPAN TECHNOLOGY LINKAGES All of the possible scenarios outlined here assume that the Japanese industry will be a source both of valuable technological ties for American firms and potential or actual competitors. Rough Continuation of Current Trends Even under the most optimistic circumstances, the global aircraft industry will be depressed for several more years. The U.S. industry will shrink further and consolidate. In coming years it will be increasingly necessary for U.S. aircraft manufacturers to continue to develop and invest in high-quality, low-cost manufacturing capability, as well as access Japanese manufacturing technology and stay ahead in product and design technology. Maintaining a broad-based supplier network is also critical. The danger during the current restructuring is that U.S. companies in some areas of Japanese strength will completely exit the industry. Japanese direct investment in some of these areas (materials) is already occurring and would not raise the national security concerns comparable to the acquisition of a prime contractor. Japanese companies are not awash in cash right now, but they could probably come up with sufficient funds for strategic acquisitions that make business sense (especially since the yen rate makes it attractive to move some manufacturing out of Japan anyway). U.S. acquisitions could also occur in areas where Japanese companies are beginning to establish a higher profile (engine components). In the case of complete U.S. exit from certain key areas of the aircraft supply chain in which Japanese companies are strong, there would perhaps be no U.S. companies with an incentive to obtain Japanese technologies in those fields (except the primes in some cases). In areas where restructuring leaves one or more U.S. companies in a position to compete with Japanese firms, the ability to make adequate long-term investments in equipment and R&D will become a critical imperative. One particular concern is whether U.S. aircraft primes and suppliers will be able to maintain control over their crown technological jewels in this harsh environment. It is possible that in order to survive, some companies will be tempted to make large-scale technology transfers that enable foreign industries (including, possibly, the Japanese industry) to compete more effectively with the United States. The future of the Committee on Foreign Investment in the United States (CFIUS) process (which reviews foreign acquisitions and provides a mechanism for blocking them when they endanger national security) is unclear, and the recent trend has been toward a relaxation of export controls. Therefore, barriers to the outflow of significant U.S. aircraft technologies may be lowered in coming years.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft Asian Airbus Some analysts discuss the possibility of an Asian Airbus, particularly if one of the existing airframe primes exits the business. Some believe that this possibility has been enhanced in recent years by Japan's industrial cooperation and aid policies in Asia. Although possible, a Japanese-led Asian aircraft consortium would be very difficult to put together. The Japanese have shown reluctance to make the large, risky investment needed to enter the market as a prime integrator, and this strategy would appear to be the most expensive and risky of them all. Japan would be the logical country to lead a viable Asian aircraft consortium, but it is hard to conceive of China, Korea, and Taiwan (countries with large aircraft markets) rushing to sign up. This would leave a Japan-led consortium vulnerable to a number of counterstrategies. In fact, Japanese press reports have speculated about an Asian aircraft consortium that would exclude Japan.8 Asia/Japan Cooperation with Airbus Still another possibility would be an alliance involving Airbus and Asian aircraft industries. Airbus has been courting Japan in recent months, and newly industrializing countries in Asia are anxious to promote domestic industries. Although it seems unlikely that all of these countries would team with Airbus (and jeopardize linkages with U.S. companies and traditional relationships with the United States), a group of them might be stimulated to do so. The issue of reallocating Airbus work share to make room for the Asian partners could also prove to be a stumbling block to such an alliance. Japan Squeezed Especially if Japan makes aggressive moves to increase its global presence (by making a major acquisition at the integrator level, launching an independent program, aggressively playing both sides against the middle in its international alliances, or other circumstances), it is possible that the Japanese heavies in particular could be squeezed by companies from other nations following a similar strategy. The Japanese have moved quite far down the experience curve in making aircraft structures, but the main requirements necessary to do that sort of work are general manufacturing excellence and lots of patient capital. It would not be impossible for Korea or Taiwan (or others who have made it known they are available) to emulate Japan, particularly if one of the major airframe manufacturers has a strong incentive to put one of these countries in business. However, this scenario is less likely to affect some materials and 8   See "YSX Keikaku in fuan no tane" (Seeds of Doubt for YSX Plan), Nihon Keizai Shimbun, October 14, 1993, p. 11.

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High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft components manufacturers (such as Toray and Hosiden) because of their existing strong global market positions. Russian Wildcard The Russian aircraft design bureaus possess considerable design capabilities. Although it appears that the Russians have been quicker to team with U.S. companies than with firms from Japan, over the long term the combination of Russian integration and design skills with Japanese capital and manufacturing know-how would seem to represent a potentially powerful combination. While the two industries have agreed to launch some small-scale collaborative activities, considerable obstacles remain to a smooth Russian-Japanese working alliance in aircraft design and manufacturing. Resurgent U.S. Industry Even in the current tough business climate, some U.S. companies are making the long-term investments in technology and R&D necessary to retain leadership in this industry. The concern is that if current trends continue, many U.S. companies will not make these investments and large segments of the U.S. industry will face severe challenges to their survival. However, the opportunity now exists to take steps—at the corporate and national levels—that can change these trends and enable the United States to retain its technological strength, maintain a full-scale manufacturing base, and compete strongly in world markets on the basis of superior technology, design, and manufacturing performance. By introducing advanced technologies into new aircraft while lowering manufacturing costs, U.S. companies can take advantage of continuing up-heavals in the global industry to reenergize their leadership. The keys to creating conditions in which a resurgence of U.S. leadership in aircraft manufacturing can take place are outlined in the following chapter.