RISK MANAGEMENT

How Risky Is Your Company?

Ivon Oktaviani R Ronaldus Mujur Tony Shovaldo Ike Olivia P Irma R. Harriri Yulivia R. F (29107027) (29107020) (29107065) (29107035) (29107006) (29107014)

2008

MAGISTER BUSINESS AND ADMINISTRATION

AIRBUS A3XX: DEVELOPING THE WORLDS LARGEST COMMERCIAL JET (A)

Case Summary Airbus is one of the biggest players in airplane industry and planned to start super jumbo jet (A3XX) project that would seat from 550 to 990 passengers. The project will cost around $13 billion for development, which is large amount of money to spend on it, meanwhile Airbus still dont know the demand for its very large aircraft (VLA) product. So, in this case, airbus takes the risk to develop a product, out of the projection that how many of the product will be pull by the market. The only forecast that Airbus do, is just a prediction that the demand for super jumbo jets over the next 20 years will be more than 1500 aircrafts, which would generates sales in excess of $350 billion. Based on the prediction, Airbus management feel positive for its super jumbo jet project, because Airbus believed that its project would break even on an undiscounted cash flow basis with sales of 250 planes, and could sell as many as 750 over the next 20 years, which is half of the demands prediction. It is not a problem for Airbus, because in the VLA market, Airbus will be competed with Boeing only. In order to take the advantage from the VLA market that at the present had been monopolized by Boeing 747 for three decades, Airbus had been decided to move on its jumbo jet project, which initially collaborated with Boeing, but Boeing withdrew in 1995 because the project was too expensive and too risky given the uncertainty in demand. Based on the managements decision, around 1990, Airbus starts its sales to begin taking firm orders for the plane with delivery starting in 2006, so Airbus takes another risk that doing the sales meanwhile the product still in development program. If the delivery had been delay, Airbus has to pay penalty for the delayed delivery. Another uncertainty that Airbus had to faced with is how

many customers, in this case is the airlines that would be align with its VLA product. How many airlines that were still using the hub-spoke system operational, which align with the A3XX, because the A3XX will not proper with the airlines whose using direct flight system (point to point system).

Risk Identification
Market Risk
To launch A3XX, Airbus face various risks such as economic fluctuation since it needs long period to develop. Interest rate risk In order to funding the Airbus A3XX project, Airbus need large investment approximately $13 billion to launch it. Funding would come from three sources : $3.5 billion from vendors referred to as risk sharing partners (RSPs); $3.6 billion of launch aid from the partners national governments; and $5.9 billion from the Airbus partners themselves in proportion to their ownership interest. The investment must be repaid in a market rate of return. The risk occurs from the fluctuation of the interest rate especially from the increase of interest rate during the payment period. Equity Price Risk The project can impact to the stock market price. For the example, when Boeing launched the 747 and announced the initial 25-planned order, its stock price go up to 5.1%. Since the project investment was so high($13 billion), if the Airbus project failed there are high risk that the stock will be sharply declined. Foreign Exchange Risk In Airbus, the raw material price is very influenced by fluctuation in foreign exchange because the aircraft component such as engines, landing gear, and electrical system are not manufactured by Airbus but imported from vendor all over the world. Airbus sell the aircraft to global market. Fluctuation in foreign

exchange will take impact on the dollar value that Airbus will receive at the payment period. Commodity Price Risk The fluctuation in commodity price, such as steel, aluminum, oil, etc will affect operation cost of the aircraft production, the risk will be greater because the long period of the project. Liquidity Risk Based on calculating, Airbus has current ratio 0.93 (less from 1). It means that financial condition of Airbus is low liquidity because ideally current ratio of firm should be minimal 1. Working capital of Airbus is minus 2401, it means that Airbus has to lend money for paying its debt. This prove that Airbus has liquidity risk for funding its operations, large investment in the project that funding by debt lent by the consortium is also cause the risk from company liquidity . Operational Risk Operational Risk of Airbus: Lack of material supply Starting merger problem Late Delivery Human error in day to day operation

Business Risk
In order to launch A3XX, Airbus faces the uncertainty of demand. While the early response from customer have been positive, initial order were not always reliable indicator of long term demand because in early launching customer receive substantial discounts.

Strategic Risk if the A3XX launch fail, it can lead Airbus to bankruptcy, because of the large investment on this project that funding

from debt must be repaid. Legal Risk Boeing planed to challenge the launch aid by filling a complaint with WTO, because of the alleged subsidies on the use of military contract subsidies and its use of foreign sales corporation. Reputation Risk Many aspect can bring the bad influence the Airbus reputation: The late in delivery, because it can cause lost to the airlines firm that order the A3XX. If A3XX is failed to launch. The new plane is also have the risk that it contain defects.

Risk Calculator
Market Risk Interest rate risk Foreign Exchange Risk Commodity Price Risk

Point 4 4 4 12 Point 4 4 3 11 Point 2 4 3 9

Liquidity Risk unable to paid debt Unable to paid supplier Unable to operational cost

Operational Risk Lack of material supply Late Delivery Day-to-day Operation error

Business Risk Uncetainty demand High COGS Price

Point 5 4 4 13

Strategic Risk Bancruptcy Legal Risk Reputation Risk

Point 4 1 3 8 53

TOTAL

Risk Category Low Risk Medium Risk High Risk

Point 0-20 21-40 41-60

From the risk exposure calculation the Airbus A3XX is a very high-risk project.

Mitigate Boeing risks

Do hedging for keep the price of material stable Use forward contract to mitigate uncertainty demand risk Train employee to mitigate human error risk To mitigate liquidity risk, Airbus should use long term debt or issuing shares to decrease current liability Make long term contract with the supplier to ensure the availability raw material Make quality control plan of all production activities