316-0009-1

$ IÉSEG UNIVERSrrYOF CranFeld

CAMBRIDGE tmrvnsrry

ON School of Management

Principled Negotiation and Value Creation in Aircraft Deals:

Airbus — Icarus Airways

Part I — Briefing for both Parties

This case was prepared by Adrian Borbély (IESEG School of Management), Javier Marcos (Cambridge
Judge Business School) and Ian Speakman (Cranfield School of Management). We are indebted to Paul
Clark, aufior of Buying the Big Jets (2007 - 2 d Edition, Ashgate publishing), who provided expert
insights into the case.
The case is intended as a basis for class discussion rather than to illustrate effecåve or ineffective handling of an
administrative situation.

-me case js inspired by real negotiations and uses industry knowledge and expertise. It has been compiled from
published sources. However, it remains fictitious and simply aims to provide an appropriate vehicle for the
negotiation simulation. In particular, at no point was Airbus consulted and validated the format of the negotiation,
nor the numbers presented in the case. Icarus name is fictitious, thus them is no relationship with the corporate jet
organisation Icarus Aviation Group.

14 January 2016

O IESEG School of Management, Cambridge Judge Business School and Cianfipld School of Management No
part of this publication may be copied, storedi transmitted, reproduced or disfributed in any fom or medium
whatsoever without the permission of the copyright owner.
Contents
1 INTRODUCTION
1 .1 THE AVIATION MARKET
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1.2 BUYING NEIN AIRCRAFT: KEY ASSESSMENT CRITERIA

1.3 BUYING AIRCRAFT: ADDITIO?UL PARAMETERS TO CONSIDER. 2 ICARUS
AIRWAYS AND THE GREEK AVIATION MARKET
3 AIRBUS
31 THE AIRBUS
GROUP
3.2 AIRBUS
SERVICES 3.3 THE AIRBUS A320 FAMILY
4 SUMMARY OF AGREEMENT COMPONENTS
13 5 BOEING 737 VS. A320: TECHNICAL
SPECIFICATIONS 14
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DATE: For the case and simulation to work effectively, please consider that the day
when the simulation commences is Thursday, July 10, 2014

1 Introduction
1.1 The aviation market
Passenger air transportation is and will continue to be a critical sector for the
functioning of the world's economy. Increasing levels of liberalization and
globalization, market competition, and rise in disposable income enable to predict the
passenger air transport sector will expand in the coming years. In addition, relaxation
of travel restrictions, the expansion of ethnic ties and the promotion of tourism will all
bring opportunities for carriers. Furthermore, the UN World Tourism Organisation
forecasts that international tourist arrivals will grow on average by an annual 3.3
percent in the two decades bewveen 2010 and 2030. Mediterranean countries are
expected to benefit significantly from increased tourism l . According to IATA's
Airline Industry Forecast2 , passenger traffic between Europe and the Middle East is
forecast to grow significantly over the next few years. A sizeable proportion of non-
European immigrants into Europe is coming from North Africa and the Middle East
and the ex-colonial wave of immigration of the 50s and 60s has created a growing
middle-class of Middle Easterners living in the EU who travel to their

parents' countries.

These trends led to the Icarus Airways project with a view of creating a bridge
between Europe and North African / Middle Eastern cities using Greece's strategic
geographical position. Icarus Airways has an ambitious business plan that will require
the purchase of up to 15 short I medium-haul, single-aisle aircraft.
1.2 Buying new aircraft: key assessment criteria
Buying new aircraft is the most significant financial and operational commitment an
airline makes. Every aspect of the transaction has to be carefully planned and
analysede Airline operators typically have different options to source the aircraft
required to start flight operations including buying new planes from the manufacturer,
leasing from them or financial institutions and trading in an extensive second-hand
market. In our case, Icarus Airways appears to be seeking to buy new aircraft.

Advantages of new aircraft One of the advantages of buying a new aircraft is the
continuously improved efficiency of the system, as a result of new innovation in the
airframe as well as engine technologies. In addition,. increasingly demanding
passengers expect an enhanced in-flight experience, which is partly delivered
providing the latest standards of comfort on-board. New aircraft help airlines provide

FT Newslines, 17 April 2014

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this superior passenger experience. Furthermore, operating new aircraft is an excellent

marketing tool, as travellers tend to think that newer aircraft are safer and that
"second-hand airframes" means gold birds".
Qualification process: Willing customers engage in lengthy processes to source their
jets3. Buying a new aircraft is not a straightforward agreement between the airline and
the Original Equipment Manufacturer (OEM). For the airline, this is a major
investment. For the OEM, agreeing to sell aircraft to an airline operator involves a
significant level of risk. A key consideration, particularly for newly established
airlines, is their financial robustness and level of investment backing. This raises an
interesting paradox, as the survival of a newcomer is sometimes critically dependent
on getting a good deal on the purchase of new aircraft.
Financing: New operators almost always consider leasing. Around half the airlines
started with leased aircraft and then went on- to buy. Lots of well-established
operators favour leasing for all or part of their fleet, to increase flexibility. Although
OEMs also sometimes do it, leasing often means involving a third player, a
professional aircraft lessor, such as GECAS (General Electric Commercial Aviation
Services) or IL-FC (International Lease Finance Corporation). Current lease rates for
a mid-range aircraft would be around 0.5-0.6% of its value per month. However, these
rates vary on a continuous basis according to market conditions and a wide variety of
factors.
Size of the order. Theoretically, a large order of new aircraft would give the customer
more power to negotiate the terms of the transaction. The OEM will prefer to spread
the non-recurring customisation costs over a large number of units, and thus, may be
willing to pass on some of this value to the customer in the form of reduced pricing.
However, it is not always the case that an airline buying a large number of aircraft
would benefit from this. It depends upon the appetite of the OEM and strength of
market demand for the aircraft. Airbus marked a new milestone in February 2014
delivering its 6,000th single-aisle A320 family aircraft. On December 31 st, 2014, the
total orders of the single-aisle jetliner were 11 ,514 units.
Delivery slots: A delivery slot means a production number, with the attached delivery
date. Much like a car assembly line, the organization of an aircraft production line
enables to deliver any type of similar airframe upon demand. This means that an
A320 production chain is made so that it can deliver an A319 CEO one day, and an
A321 NEO a few days later. Until a few months before final assembly, the customer
may switch aircraft size or engine type, for a fee.
A new customer wanting early deliveries in a tight market may not get very far.
However, in a weak market, the OEM may have distressed inventory and be willing to
do a deal
Here, different approaches are possible. Existing airlines tend to spread their
deliveries over time, phasing out older models progressively. A new airline
looking
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for opening their entire network at once may look for condensed delivery dates.
Taking ownership of a new aircraft is a complex procedure, that usually takes at least
five days and involves a large team of experts on both the buyer's and the seller's side1.

Sizeable deals can be secured or lostdepending on the availability of delivery

slots. For instance, in 2012, the Singaporean SilkAir, historically an A320
operator, signed an agreement to purchase 68 Boeing 737s, with an option for
another 54, simply because Airbus could not deliver early enough 23 .
Find/ price: To estimate what the agreed price might be, a key question is whether the
supplier market is contested, as this can be a huge issue. It is beyond dispute that the
single major factor in a purchase decision is the financial appraisal. Arguably,
competing aircraft technologies have converged and performance and economic
capability is becoming more similar between competing types.
The following table outlines the 2014 list prices for the A320 and B737 different
variants, the two competing aircraft in the short haul category.
AIRBUS BOEING
Current 'Engine New Engine Next Generation MAX (future
O ion CEO O tion NEO current version version
A319 (124 85.8 94.4 8737-700 76 85.1
seats
126 seats
A320 (150 93.9 102.8 3737-800 90.5 103.7
seats 162 seats
A321 (185 110.1 120.5 B737-900 96.1 109,9
seats 177 seats
In the industry, final agreed prices are jealously guarded, but it is well known that
discounts are available and can be achieved. For instance, on March 19, 2013, Ryanair
announced the purchase of 175 units of the Boeing 737-800 worth $15.6bn at list
price8 . Ryanair's CEO Mr O'Leary said he had secured a "reasonable discount" with
Boeing, We leave the reader to estimate what 'reasonable' meant in this particular
context. Analysts argued that this case was exceptional and may be explained by the
sheer size of the order and the timing, just when Boeing needed a large order to
provide reassurance to the market and its shareholders following the Being 787
Dreamliner debacle.
Other well-publicised deal included Air Canada's agreement to order up to 109
Boeing 737 MAX aircraft on December 11, 2013. Air Canada was one of the first

1 http://www.airbus.com/company/aircrafi-manufacture/how-is-an-aircraft-built/delivering-to-
thecustomer/
2 http://www.flightglobal.com/news/adicles/video-slot-avaiIabilfty-behind-silkairs-switch-from-
a320-to-
3 -says-37S095/
http://wmw.airbus.com/presscentre/corporate-information/keydocuments/?el
D=36716
http://wvwhoeing.com/boeing/commercial/prices/
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airlines operating an all A320 mid-range fleet to switch to the Boeing 737. In this
particular occasion, the deal was wrapped up mostly on aircraft price. The negotiators
held the key to it.
Overall, it is always in the interest of the airline to allow OEMs to compete with each
other. In the price negotiation, this makes a powerful approach that needs to be
managed strategically. On one side, OEMs are falling over themsetves to furnish a
'best and final' offer; on the other side customers become eager to convince their
potential suppliers that they will come back for more aircraft if the price is right...
The price that can be achieved on a particular aircraft also depends to a great extent
on when a new model is in the pipeline. At the time of writing this case, the expected
entry into service of the Airbus A320 NEO and the Boeing 737 MAX, the recently-
announced modemized versions of the two competitors' bestselling models, means
that pricing for the old models of these aircraft may sink precipitously.
For simplification purposes, this case assumes that depreciation of a mid-range
aircraft is made linearly, i.e. through equal yearly amounts, over a period of 15 years.
The human factor. Lastly in new aircraft negotiations, like in any other commercial
negotiation, nothing meaningful happens unless there is a climate of trust between the
parties. Confidentiality is paramount. Good relations are expected at all levels, from
the very top to the most junior analyst involved in the campaign. A single bad egg
could ruin the entire batch!

1.3 Buying aircraft: Additional parameters to consider

In reality, deals are more complex and include different technical options, such as
exact specifications (e.g. engine type when several are offered, some systems, such as
avionics, may be sourced from different suppliers, etc). Airlines will typically choose
options from an approved options list, but may also have specific (and very peculiar)
requirements. Some of these may be 'buyer furnished equipment', such as a particular
seat that is not currently certified. This means additional investment in the aircraft
In reality, it is about structuring an Initial Provisioning Package. No airline, especially
a new one, wants the OEM to 'take the money and run'. Such a package would
typically include:

training for crews and maintenance teams; initial spares; materials and
tooling; guarantees and warranties (dispatch reliability, fuel burn and payload, parts);
credit memoranda against either the final aircraft price or other goods and services;
assistance with certification issues and remedies;
option conversion rights and fees; etc.
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2 Icarus Airways and the Greek aviation market

Born and educated in England, an heir to an industrial family and owner of the B
Group, Greek billionaire Stavros Balados, aged 32, looked at the crisis in Greece both
with sadness but also lurking for business opportunities.
Greece's recovery has been extremely slow but as the tendency is clearly upward,
smart investments placed now in Greece can only generate profit. It is therefore the
right time for Mr. Balados to put in place his project, an airline called Icarus Airways,
an idea Mr. Balados has for long toyed with. Overall, the plan is to establish an
airline, based in Greece, on the ruins of the defunct Olympic Airlines.
The Greek airline business has long been a monopoly of Olympic Airlines, a
Stateowned company since 1975. Aegean Airlines was founded in 1999 as a private
competitor, operating first on domestic routes before quickly expanding, Despite
several reorganizations, Olympic Airlines went bankrupt and disappeared in 2009. Its
domestic market was picked up by Aegean. Internationally, Aegean keeps growing to
serve today, from Athens Elefthenios-VenizeIos International Airport, most European
capitals, plus Abu Dhabi, Tbilisi, Istanbul, Moscow, Tel Aviv and Izmir.
All Greek airlines suffer from powerful competitors in neighbouring countries:
European airlines on the westward market (Europe and America) and MiddleEastern
Airlines (Emirates, Etihad, etc.) on the market eastward (Asia). Closer to them, the
rapid growth and success of Turkish Airlines, which operates from Istanbul (540kms
away), has also drained their market.
Now appears to be a good time to launch a new airline out of Greece: the country is
recovering and is desperately looking for direct investment and job creation; Turkish
Airline's growth is limited by the fact that Istanbul Atatürk airport, its main hub, is
completely saturated (a new, giant airport will be built but plans currently await
political approval and the new airport will not be ready anytime soon); Aegean,
although healthy, is currently in no position to expand significantly — or to counter a
rival on their territory. The Greek government will surely back Icarus Airways'
initiative as it will serve to stimulate the country's dragging economy.
The idea behind Icarus Airways is therefore to operate routes between Athens and, on
the one hand, Europe's main cities and business centres (Frankfort, London, Paris,
Milan, Barcelona, étc.) and, on the other hand, Middle-Eastem main and secondary
cities, located in countries like Lebanon, Jordan, Israel, Egypt, the United Arab
Emirates, etc. There is clearly a market for such an airline, since economic and
demographic relationships between these two zones are rapidly growing. Passenger
traffic between Europe and the Middle East is forecast to grow

Germany, Spain, etc. but also the significant foreign direct investment going both
ways.
Athens airport offers lots of interest as a platform. Because of Olympic Airlines'
demise, there are ample available space in terms of tarmac, terminal buildings and
hangar facilities. Also, when Olympic crashed, lots of well-trained personnel were left
unemployed (ground staff, stewards, mechanics and pilots).
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The main investment for an airline is the acquisition of airplanes to operate flights. A
new airline such as Icarus Airways aims to get a fleet of versatile, mid-range,
singleaisle airplanes, seating between 120 and 170 passengers in a classic two-class
configuration (premium and economy). Currently, there are two manufacturers able to
produce such aircraft: Airbus with its A320 family (namely the A320, the shortened
A319 and the stretched A321) and Boeing with its 737 family (the short 737-700, the
longer 737-800 and the longest 8737-900). All these aircraft have enough range to
reach all the planned destinations (see technical specs in section 5).

Typical A320 — B 737 range out of Athens

Map generated by the Great Circle Mapper - O Karl L. Swartz.

Icarus is in the process of ensuring their regulatory approval; the airline has already
completed most of the required work for this. Also, Icarus has started negotiating slot
accesses at several airports (i.e. the right to land at specific airports at a specified time
of the day). Slots are traded and for congested airports may prove extremely valuable.

3 Airbus
3.1 The Airbus group
Airbus is a leading commercial aircraft manufacturer with world-class capabilities in
customer management, commercial know-how, technology and aerospace
manufacturing. The company has its headquarters in Toulouse, France. In addition to
its commercial aircraft activities, the group is comprised of Airbus Helicopters and
Airbus Defence & Space. Airbus possesses fully-owned subsidiaries in the United
States, China, Japan, India and the Middle East, spare parts centres in Hamburg,
Frankfurt, Washington, Beijing and Singapore, training centres in Toulouse, Miami,
Hamburg and Beijing and more than 150 field service offices around the world.
Airbus has established partnerships with major companies all over the world, and has
a network of some 2,000 suppliers in 20 countries1 .

1 http://www.airbus.com/company/
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In 2013, Airbus reported revenues of 59.256 billion euro, an increase of 2.776 billion
over 2012, with profits reaching 1475 billion eur0 1 . Airbus offers a wide range of
aircraft ranging from 100 to more than 500 seats. The single-aisle A320 family is one
of the fastest-selling aircraft in aviation history. The wide body, long-range options
include the A330, the A350 XWB and the double-deck A380. The company offers
aircraft to the military as well as the freighter markets.
Airbus's main competitor is the American Boeing. Both companies are in a
raging competition, since Airbus caught up with its rival in the early 2000s.
Each year, the winner of the "order race", i.e. the company who secured the
most orders the previous year, celebrates a victory. Therefore, every order
counts and every new customer, especially a future regular client, is important.
Airbus has been ahead of Boeing in 2008 until 2011, lost in 2012 but came
ahead again in 2013, mostly because of the success of the bestselling single-
aisle A320 family.
Airbus is known for its emphasis on continuously developing product innovations to
meet its customers' needs and ensuring its aircraft achieve the highest levels of
performance. Airbus's unique approach across all its fly-by-wire aircraft families
results in the highest possible degree of commonality in airframes, on-board systems,
cockpits and handling characteristics. These are aimed to help airlines significantly
reduce their operating costs.

3.2 Airbus services

Airbus employs more than 4,000 staff to support airline operations and maximise
customer satisfaction through a versatile portfolio of services such as1 1 ,
Flight operations: support and services for safe and efficient operations
Engineering & Maintenance.

Material, logistics and suppliers.

Upgrade Services that include a wide range of modifications from cabin
appearance and layout to airframe and systems upgrades.
Flight Hour Services (FHS), tailored and tumkey solutions to optimise airlines
operations.
Airbus Consulting Services.
Training: Airbus offers a comprehensive portfolio of training programmes.
Five training centres are located worldwide in Toulouse, Miami, Beijing,
Hamburg and Bangalore.
Field offices supporting operators round-the-clock on a global scale.

3.3 The Airbus A320 family

1 http://www.airbus-group.com/airbusgroup/int/en!investor-relationsjkey-financialinformation/
FinancialStatemenfs-and-Presentations/2013. html
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In 1987, Airbus launched its single-aisle product line with the A320, which continues
to set industry standards for comfort and operating economy on short- to mediumhaul
routes. Typically seating 150 passengers in a two-class cabin — or up to 180 in a
high-density layout for low-cost and charter flights — the A320 is in widespread
service around the globe on services that vary from short commuter sectors in
Europe, Asia and elsewhere to trans-continental flights across the United States. The
family is composed of a shortened version, the A319, which seats 124 to 156
passengers, for a slightly extended range 12. A longer version, the A321 (seating up to
220 passengers for a range of 5.600kms), has also proven successful, especially since
its NEO version may prove an adequate replacement for the discontinued Boeing
757.

The A320 family's advanced technology includes the extensive use of weight-saving
composites, an optimised wing that is 20 percent more efficient than previous
designs, a centralised fault display for easier troubleshooting and lower maintenance
costs, along with Airbus's fly-by-wire flight controls.

Advantages of the fly-by-wire controls — which were pioneered on the A320 — are
many, They provide total flight envelope and airframe structural protection for
improved safety and reduced pilot workload, along with improved flight smoothness
and stability, and fewer mechanical parts.

The key competitor for the A320 family is the Boeing's 737. Section 5 outlines some
characteristics of each of the aircraft for its most popular variants.
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Actually, an even shorter version does exist, the A318. initially ordered by Air France to operate out
of London City airport and its steep approach, this very short version of the A320 was never a

The A320 famil at a lance source: Wiki edia

In 2006, Airbus announced a modernization program for its A320 family, which led to
the announcement, in 2010, of the NEO variants (New Engine Option), that is to
perform 'its first test flight on September 25, 2014. Along with the result of years of
permanent improvements (aerodynamics refinements, weight savings, updated cabin
layouts), NEO aircraft feature improved, larger engines that enable significant
reductions in noise levels and fuel burn. It also comes with shark!ets (instead of the
traditional wingtip fences) at the end of the wings, designed to reduce drag. Airbus
claims a 15% fuel bum reduction but, as usual on this market, only experience will
tell the true level of savings possible with this newer model 13
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Airbus 320neo infographic (source: Airbus14)•

4 Summary of agreement components

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The agreement to acquire new aircraft is a complex operation that needs to satisfy all
parties involved. As a summary the key components of an aircraft deal are provided
in the table below. As outlined in the briefing above ail of these components are
typically discussed and form part of an agreed package. The criticality of each of the
components depends on the individual situation of the airline.

Number and type of aircraft

Unit price

Delivery schedule

Financing scheme

Payment terms

Maintenance contract terms

Crew training contract terms

Interior design

Performance guarantees

Other
5 Boeing 737 vs. A320: technical specifications
A key element in selecting an aircraft is the availability of alternative models to be
used in the planned routes. The technical specification of the Airbus A320 and
Boeing's 737 families can be found below15 .

A319 A320 A321 737-700 737-800 737-900

Cockpit
2 2
crew
Seating (1
156 180 220 148 189 215
class dense)
Seating (2
124 150 185 128 160 174
class typical)
Cargo
27.62 m3 37.41 51.73 rn3 27.3 ma 45.1 ma 52.5 ma
capacity
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33.84 m 37.57 m 44.51 m Length 33.6 m 39.5 m 42.1 m

34.10 m (35.8 m with sharklets) Wingspan 35.7 m

Wing
25 degrees 25.02 degrees
sweepback
11.76 m Tail height 12.5 m
Maximum
3.70 m 3.54 m
cabin width
Fuselage
4.14 m 4,01 m
Height
2 Engines 2

Operating
401800 kg 42,600 kg 48,500 kg 38,147 kg 41,413 kg 44,676 kg
empty weight
Maximum
62,500 kg 66,000 kg 77,800 kg landing 58,604 kg 66,361 kg 66,361 kg
weight
Maximum
79,010
75,500 kg 78,000 kg 93,600 kg take-off 70,080 kg 85,130 kg
kg
weight
Cruising
Mach 0 78 Mach 0.785
speed
Range
6,700 km 5,700 km 5,600 km (current 6230 km 5,665 km 4,996 km
version
Range (new
7,800 km 6,900 km 6760 km 7,038 km 6,700 km km
version