Of Gulfstreams, NetJets, and Discounts

On the heels of this week’s Farnborough International Airshow, the Wall Street Journal published an analysis of the discounts offered by Boeing and Airbus to their customers for placing large orders. The conclusion drawn by the Journal? Discounts of 50% off the ‘list’ price are more the rule than the exception, especially for those committing early-on to sizable orders with either Boeing or Airbus.

An analysis of public data by The Wall Street Journal and interviews with numerous industry officials yielded this: Discounts seem to vary between roughly 20% and 60%, with an average around 45%. Savvy buyers don’t pay more than half the sticker price, industry veterans say.

It’s not something I’d given much thought to, since general aviation aircraft are not typically purchased in bulk numbers like airliners. Nobody needs a few hundred business aircraft; even the U.S. government doesn’t purchase in those quantities anymore, right?

Not necessarily. Fractional-ownership leader NetJets recently made news when it placed orders for up to 425 aircraft worth $9.6 billion with Cessna and Bombardier. That’s an airline-sized number, and it got me wondering about how large a discount the two manufacturers had to offer to secure NetJets’ business. The $9.6 billion figure assumes every aircraft is sold at full list price, and while 50% discounts are not common in the business jet sector, an order of that size would certainly come with significant markdowns.

The exact prices are closely guarded secrets and typically dependent on the various contingencies agreed to in the contract. The manufacturer doesn’t want the sales price to become public because it could anger other customers who are paying more. It would also encourage future buyers to drive hard for equivalent discounts. The OEMs are always in a tough spot, trying to offer a sufficient discount to earn the sale without giving away any more of their profit margin than is absolutely necessary.

Likewise, NetJets wants to protect their proprietary discount. They have a strong competitive advantage if they can purchase aircraft at a lower price that FlexJet and other fractionals. Besides, it’s more impressive to say they’re buying $9.6 billion in hardware than to reveal they’re getting it for, say, $5 billion.

In looking at the two airplanes selected by NetJets, the Citation Latitude and Challenger 300, it’s tough to say why those airplanes were chosen over offerings from Embraer, Gulfstream, and Hawker.

Well, I do understand the reticence to order from Hawker since that firm recently declared bankruptcy (and today’s latest news is that the firm will be sold to a Chinese company). But Embraer and Gulfstream have large order backlogs, a diverse product line, excellent reputations, exciting new aircraft, and in Gulfstream’s case, a long history of doing business with NetJets.

I suspect the answer may have less to do with the aircraft themselves and more to do with each manufacturer’s backlog and the discounts NetJets was seeking. When you’ve already got a decade’s worth of orders on the books (I believe the number at Gulfstream is about $10 billion), do you really need to offer your product at cut-rate pricing in order to secure more business? Perhaps not. Gulfstream might also be a bit gun shy after NetJets cancelled large orders in the wake of the 2008 economic crisis.

Some industry watchers note that large NetJets orders come with some strings and aren’t always as profitable as they may seem.

Aboulafia, however, believes NetJets’ buying habits are “extremely fickle”.

Before the current Phenom 300 order, he says “they had ordered scores of Citation jets and Hawkers”. These orders “came with much fanfare and celebration, but resulted in exactly nothing”, he adds. “NetJets’ recent purchases are an indication the company shops around for the best deal possible, meaning that large orders like these will likely come with heavy discounts and lower profit margins.”

The price for winning a NetJets order can be fairly high for the chosen airframer, according to Flightglobal Ascend.

“The Phenom 300 order left Embraer with 25 Citation Ultras, the youngest of which had 11 years of NetJets service behind it,” it says. Embraer has sold these aircraft on to a broker, it continues, “but most of them remain unplaced. Meanwhile Embraer has only delivered one Phenom 300 to NetJets”.

As part of the Global 5000/6000/7000/8000 deal, Flightglobal Ascend reveals: “Bombardier ended up as the ‘proud’ owner of over 60 aircraft – all high mileage.”

Hey, aviation is a tough business, and the current economy leaves little room for error. In such a climate, no one can fault NetJets for throwing it’s weight around. The company is a formidable entity with a fleet of nearly 600 aircraft, 7000 owners, and the financial heft of Berkshire Hathaway behind it. What’s the point of being the proverbial 800-pound gorilla if you can’t use that size to your advantage? If I was in their shoes I’d be driving a hard bargain with the airframers as well.

On the other hand, it’s also easy to see why companies like Gulfstream might not lose too much sleep over the loss of what, on the surface, would seem to be a huge boost for the company’s bottom line.

While the NetJets order will do wonders for Bombardier and Cessna’s revenue numbers — especially if the sales are shows on their books at full list price — the net profit may not be quite so rosy.

Over time, the manufacturer’s will probably continue to benefit through sales of parts, manuals, service, etc. on those aircraft as well as the side benefit of insuring their factories stay busy for years to come. That means they retain talented craftsmen, engineers, designers, and other highly-skilled workers they’ll need to bring the next generation of aircraft to fruition.

NetJets turns its aircraft over rather quickly, so much like an election, it won’t be long before the candidates are doing battle once again over another big order. As they say, “stay tuned”.