Boeing: Cleared for Takeoff
By: Asad Hussain & Erik Bartos
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
In June of 2011, three men accused of stealing six cows were arrested in North Dakota. What sets this arrest apart from all others was not what they were stealing, but how they were caught. It was the first arrest in U.S. history to be carried out with the help of an Unmanned Aerial Vehicle (UAV). The UAV revolution, which started in the military sector, is starting to spill over to the civilian sector. This presents a phenomenal opportunity for aerospace companies, like Boeing, who have the capacity to embrace the relatively young and rapidly expanding UAV market.
Boeing’s Impending Crisis
Development of the civilian UAV market is occurring at an opportune time for Boeing. Simply put, Boeing’s outlook is far from positive and the company needs a project to turn around its fortunes. Boeing currently faces the prospect of losing billions of dollars in contracts from one of its main customers, the United States military. Boeing’s military manufacturing business unit –Boeing Defense, Space & Security (BDS), consistently secures a large portion of the contracts issued by the U.S. Department of Defense (DoD), which has the largest budget of any military in the world. Unfortunately for Boeing, economic conditions and the winding down of wars in Iraq and Afghanistan have prompted the U.S. government to reduce the DoD’s budget starting in 2013. With BDS reliant on U.S. military spending for 76% of revenues, these cutbacks constitute a real and potentially expensive problem. A reduction in overall DoD spending, however, does not have to result in a reduction of BDS revenues. BDS can reposition to take advantage of the DoD’s new spending priorities and strengthen revenues in other business units, namely through the use of UAV technology in civilian segments. Boeing should do its best to not let a good crisis go to waste.
Thinking Short-Term to Set Up for the Long-term
Market research projects a CAGR of 12% in the UAV market over the next five years, increasing the total value of the market to $86.5B. To understand what makes UAVs so attractive to purchasers, consider that a F-22 Raptor (manned fighter jet) costs approximately $155M, while a UAV costs approximately $4M. Also, consider the average fighter pilot is paid $98,000 annually, whereas most UAV operators earn less – between $30,000 and $80,000 a year. In 2012, the DoD outlined its spending priorities in the Defense Strategic Guidance program. The plan is to reduce spending on conventional Cold War assets like tanks and manned military aircraft while increasing expenditures on special forces, including UAVs. Cuts to manned military aircraft directly impacts many of BDS’ most profitable models including the F-22 Raptor and the Boeing P8-A Poseidon, the latter of which will absorb $5.2B of DoD cuts over four years.
Growth in the UAV market can help aerospace companies offset declining revenues from the manned military aircraft market. While volumes in the UAV market are increasing, these aircraft have much lower margins than their manned military counterparts. Focusing solely on manufacturing UAVs could help BDS maintain revenues, but at the expense of Boeing’s profits. Fortunately, UAVs require significant communications infrastructure and aftermarket support. These products and services can be procured by BDS’s Networks and Space Systems division along with BDS’s Global Systems and Support, which retain healthy profit margins of 8% and 11% respectively. Boosting revenue in all three BDS divisions will maintain profits in absolute terms.
Boeing must invest significantly to corner the growing UAV market. Given BDS has approximately $10B in liquid assets; some of this money would be well spent immediately on R&D efforts. This will require a major change in corporate strategy, as Boeing’s R&D spending has decreased 33% over the past two years. Meanwhile, competitors Northrop Grumman and EADS have continued to support R&D spending on advanced technologies in response to the DoD’s increased interest in more advanced and sophisticated weapons. Using excess cash to bolster the R&D budget is one of the best things Boeing could do to secure its position in the UAV market.
Spillover
As military demand for UAVs is satisfied in coming years, Boeing must look to alternative customers to market its products. The increased R&D spending will not have gone to waste because military technologies often have civilian applications. For example, jet engines developed for military aircraft in WWII were used on commercial airliners by 1952.
As shown by the North Dakota theft, selling military grade drones to civilian law enforcement agencies is an exciting possibility. In addition to being covert, drones are less expensive than helicopters and do not require pilots to put their lives at risk when tracking dangerous criminals.
UAVs could be used for civilian applications beyond assisting police forces. Air cargo traffic is expected to increase by 5.2% annually for the next 15 years. Long-haul freighters with larger payloads are expected to make up 60% of this traffic, indicating the importance of range and capacity in the cargo segment. While K-MAX, an unmanned cargo drone manufactured by Lockheed Martin, was used to carry supplies for the Marine Corps in Afghanistan, having been selected above Boeing’s A160T Hummingbird – a drone with lower capacity but higher endurance –the long endurance of Boeing’s cargo drone is an asset in the civilian sector. FedEx, for example, would likely be interested in buying cost efficient drones from Boeing to fly cargo; FedEx’s International Domestic operations experienced 31% revenue growth in 2012. Although an attractive alternative to conventional cargo planes from a cost perspective, Boeing’s current drone offering is not yet a perfect fit with FedEx’s needs due to limited cargo capacity. This issue will need to be addressed through innovation if BDS drones are to become truly superior to manned cargo aircraft.
To begin a transition towards civilian application of UAVs, building cargo drones will help Boeing outcompete its main rival, Airbus. Approximately one fifth of FedEx’s current fleet is made of Airbus aircraft. A low cost drone offering provides Boeing with the means to steal FedEx orders for new aircraft. This can be a remunerative strategy for Boeing, especially if also applied to companies like UPS and DHL.
If solutions to range and capacity issues are found, Boeing need not stop at manufacturing drone cargo aircraft. There are no secrets about the intense competition between Boeing and Airbus in the passenger aircraft market. Airbus, owned by the defense firm EADS, has a 30% market share in the global commercial aircraft industry and sufficient order backlog to maintain its leading position in the $150B industry for the foreseeable future. Boeing trails closely with 26% of the market, but can secure a unique advantage by manufacturing passenger drones. Airbus would be required to invest significant time and R&D in order to match Boeing’s offering.
If this technology were integrated into passenger and cargo jets, expensive pilots could be eliminated and the chances of human error could be reduced. Of course, even machines are susceptible to erratic behavior; the idea of pilot-less civilian planes, and the liabilities surrounding them, make passengers and regulators uneasy. However, the fact is that the latest generation of airplanes are already capable of performing numerous functions without input from a pilot, and it would be a relatively small step to physically remove the pilot and replace him or her with less expensive ground crews.
Opportunity Awaits
Genuine revolutions are few and far between. The last revolution in aviation took place with the development of the jet engine. While commercial airplanes have seen gradual developments since 1950’s, these have been evolutionary. With a compelling cost argument, UAVs will fundamentally alter the nature of aviation as fewer manned aircraft roam the skies. Although people may not be ready for a drone passenger jet, the UAV revolution presents opportunity in cargo freight and domestic security; opportunity Boeing cannot ignore.
