I. Market Economics
An “A” candidate should seek to understand market size, growth and profitability, as well as conduct an indirect structural assessment of the industry, e.g., suppliers, customers. Information to be provided to student if asked, although some may require prompting:
Market Size: In 1999, the U.S. jet engine, 100 seat or less aircraft market was ~$5 billion.
Competitors: There is no dominant competitor in the jet engine, 100 seat or less market. The market leader has 20% market share. There are 4 other competitors with market share from 12% to 18%. Regional Jet Corporation has ~16% share.
Market Growth: The market has been growing ~5% (in units delivered) each year for the past 5 years and is expected to continue to grow 5% over the next decade. In 1999, a total of 625 jet engine regional aircraft were delivered to customers.
Market Profitability: Ask the student whether he/she thinks the market is profitable, and how he/she would go about assessing market profitability. (Answer to be provided post discussion on structural forces below):
○ Supplier Power: The supplier base for regional aircraft parts is highly fragmented and Regional Jet uses approximately 50% proprietary parts in its jet engine aircraft. Hence, supplier power is low.
○ Intensity of Direct Competition: Fairly concentrated market with only 6 jet engine regional aircraft manufacturers. Hence, intensity of direct competition is low-to-moderate.
○ Customer Power: In 1999, there were 225 customers. Types of customers include airlines, aircraft lessors, local and national governments, businesses and private individuals. Hence, customer power varies by segment.
▪ Only if the student asks about customer power, share with him/her the following facts: Aircraft lessors (i.e., Regional Jet’s aircraft customers who lease jets to airlines, governments, businesses and individuals) make large purchases (often 20 or more aircraft) during a buying cycle and hence exploit their negotiating leverage over manufacturers, such as Regional Jet. Hence, aircraft lessors have high customer power. All other customers have low-to-moderate buying power, depending on their credit worthiness.
○ Intensity of Indirect Competition: Larger commercial jets (100 seats or greater) with longer range manufactured by large commercial aerospace and aircraft manufacturers can be used on regional routes. However, these larger aircraft are expensive for customers to operate solely on a regional basis. Hence, intensity of indirect competition is low.
○ Barriers to Entry: Jet engine regional aircraft manufacturing requires significant capital investment in production facilities and equipment, as well as strong relationships with various labor unions. Hence, barriers to entry are high.
○ Based on the information provided thus far, ask the student if he/she thinks the market is profitable or unprofitable. The market is profitable with the average competitor generating 4% economic profit margins over the past 5 years.
II. Competitive Position
An “A” candidate should seek to understand competitors and Regional Jet’s offering, pricing and operating position.
Information to be provided to student if asked, although some may require prompting:
Offering position: Overall, the company’s offering position is at parity.
○ Commonality: The company’s jet engine aircraft has a cockpit that is similar to the industry standard and results in low switching costs for new customers (pilots and flight crew do not need extensive re-training).
○ Performance: The company’s aircraft offers a range of 500 miles, which is similar to the market average.
○ Maintenance and Asset Life: The majority of the fragmented jet engine aircraft maintenance companies have the capabilities and parts to service Regional Jet’s aircraft. For the aircraft customer, maintenance costs over the life of the asset is in line with regional jets of the company’s competitors. On average, the life of the aircraft is 20 years.
Pricing Position: Question for the student: Based on the discussion thus far, what does he/she think that the company’s pricing position is relative to competitors? Answer: Regional Jet is pricing below the market average, since it is gaining market share (unit volume is growing at 10% vs. market growth of 5%) with a parity offering. Hence, Regional Jet is pricing for share, i.e., in 1999 it had a disadvantaged pricing position.
Operating Position: Regional Jet’s operating cost per aircraft is at parity with the industry. Every jet engine aircraft the company delivered in 1999 cost approximately the same to produce. The student should recognize that achieving scale is critical to the spreading of fixed costs, and hence, the lowering of per unit costs.
III. Regional Jets Customers
Customer Segments: Regional Jet serves 3 types of jet engine aircraft customers:
○ Customers who purchase only 1 aircraft in a buying cycle (approximately every 5 to 15 years, depending on the customer)
○ Customers who purchase 3 aircraft, and
○ Customers who purchase 20 aircraft
At this juncture, the student should inquire about customer segment profitability. Provide the student with the handout: “Jet Engine Regional Aircraft Business - Profitability by Customer Segment”
Description of Segments:
○ Customers who buy only 1 aircraft during a buying cycle are comprised mostly of small aircraft customers with moderate-to-high credit risk.
○ Customers who buy 3 aircraft are comprised mostly of medium aircraft customers with moderate credit risk.
○ Customers who buy 20 aircraft are comprised of creditworthy aircraft lessors.
Key Driver of Segment Profitability: If the student has not discussed it already, at this point in the case, he/she should recognize that the 3 aircraft lessors (i.e., Regional Jet’s aircraft customers who lease jets to airlines, governments, businesses and individuals) in making large purchases (often 20 or more aircraft) during a buying cycle exploit their negotiating leverage over Regional Jet. The data to support this can be quickly calculated by the student by referencing the “Profitability by Customer Segment” handout: $408M/60 airreal sales dollars per aircraft from aircraft lessors, compared to $8.4M small aircraft customers and $8.0M from medium aircraft customers. [Ask the student to compute average price by customer segment, if he/she has not done so without being prompted.] Of course, the student should be able to conclude that the main driver of profitability between segments is solely price without doing any math, since operating cost per aircraft produced and delivered is the same regardless of the intended customer.
IV. Overall Competitive Position
Question for the student: Does he/she think that the company’s overall competitive position is advantaged, disadvantaged or at parity?
Answer: Regional Jet is competitively disadvantaged overall with negative profits (compared to a profitable market) driven by a disadvantaged pricing position, particularly to the large lessor customer segment.