By
updated 7/3/2006 12:53:04 PM ET 2006-07-03T16:53:04

John Leahy, the American-born chief salesman for Airbus, is rarely heard to utter a discouraging word. But when Leahy was asked, over coffee in his office this week, to discuss the turmoil enveloping Airbus, his response was blunt: "The facts speak for themselves. This is a major screwup. It's an embarrassment, the worst I can remember in 22 years" with the company.

Indeed, Boeing's European archrival faces an unprecedented crisis. Shares in its parent, European Aerospace Defence & Space, tumbled 26% on June 13, when the company disclosed production delays on Airbus' A380 megajet that will slash $2.5 billion in profits from 2007 to 2010.

Under fire
Stock market regulators are investigating Noel Forgeard, the EADS co-CEO who ran Airbus from 1998 until last year, because he and his family exercised millions of dollars' worth of stock options less than two months before the delays were made public. Airbus' carefully cultivated image as a pan-European company has been tarnished by nationalistic finger-pointing, with some in France blaming German factories for the A380 problems, and vice-versa.

Now, heads are rolling. EADS announced on July 2 that Forgeard and Airbus Chief Executive Gustav Humbert have stepped aside and have been replaced by executives from outside the company. Humbert’s job will be taken by Christian Streiff, an executive of Paris building materials group Saint Gobain. Forgeard will be replaced by Louis Gallois, the head of France’s national railroad company. Thomas Enders, the German who has shared CEO duties with Forgeard, will remain in his job. The shakeup, rumored for days, was engineered by Daimler Chrysler, French media group Lagardère, and the French government, EADS' three biggest shareholders.

These changes could help salve the political wounds. But Airbus's biggest problem isn't political—it's managerial. Like a child that has learned to dominate its parents, Airbus has largely functioned as an independent company, even while being 80% owned by EADS and 20% by British aerospace group BAe Systems. That's partly because Airbus has been in business for more than 30 years, while EADS was created only six years ago by stitching together a parcel of European aerospace companies under a joint Franco-German management structure.

Grave consequences
Most important, Airbus has been EADS's profit machine, generating more than 90% of the parent company's earnings as it overtook Boeing as the global No. 1 jetmaker. "EADS has become a holding company with a set of operating businesses that it doesn't really control," says Nick Cunningham, an analyst at London brokerage Panmure Gordon. "The top company doesn't know what's going on, because it isn't allowed to know."

The problems with the A380 show just how grave the consequences can be. Last summer, Airbus had warned that complications with the plane's electrical wiring would delay the expected first delivery, to Singapore Airlines, from mid-2006 until the end of this year. Airbus until recently insisted there had been no further slippage in the timetable.

But union representatives at the A380 factory in Toulouse say managers summoned them to a meeting in February to tell them that work had fallen so far behind that Airbus was suspending shipments of components from other factories to the final assembly line. The shipments only resumed recently.

Big hit
As of June 30, only one A380—Singapore's first delivery—had been fully outfitted with cabin wiring and sent on to Airbus' Hamburg factory for painting and interior finish work. Eight other planes, largely complete except for their wiring, are still being worked on in Toulouse.

That's why EADS now says it expects only nine A380s to be delivered in 2007, down from an earlier projected 25 deliveries. That's a big financial hit, because typically more than 90% of each aircraft's price is paid for on delivery.

How could the bottleneck have escaped the notice of EADS, especially co-CEO Forgeard, who maintained an office at Airbus headquarters and visited about twice a month? While EADS wasn't kept completely in the dark, the parent company seemed reluctant to press the issue with Airbus.

Tricky wiring
Minutes from a May 12 EADS board meeting, leaked to the French newspaper "Le Monde," show Humbert told the board he thought Airbus would deliver 13 A380s in 2007, far less than the original estimate but enough to allow EADS to remain within its earnings targets. Forgeard said he found some of Airbus' calculations unrealistic, and warned that the number of deliveries might be closer to Humbert's "worst-case" estimate of 8 to 10 deliveries. But board members accepted Humbert's more optimistic estimate and decided against issuing a profit warning.

Another question is why Airbus itself didn't sound the alarm sooner. Company executives say the problem arose because, even as the first planes are being built, engineers continue to tweak design details, based on data from test models already being flown. Some of those changes require modifications to wiring, especially in the cabin, where airlines have ordered customized features such as upgraded entertainment systems not used on earlier Airbus models.

To make the changes, technicians must thread their way through bundles of wires known as harnesses that run the length of the fuselage beneath the cabin floors. Each inch-thick bundle contains hundreds of wires, and the work is maddeningly slow.

Leahy says that until this spring, managers on the plant floor downplayed the problem. "If you asked any one department, they'd say, 'I'm a little bit behind, but we're going to catch up,'" he says. But Airbus executives were concerned enough to ask the consulting firm of McKinsey & Co. in April to examine the problem. It was McKinsey's report, in early June, that triggered the EADS announcement.

Fear factor
Yet others say the situation is no surprise, because Airbus's corporate culture openly discourages employees from alerting managers to potential problems. "If you tell them bad news, they simply don't listen," says Andrew Walker, a former top engineer at the factory in Broughton, Wales, where the A380's wings are built. "No one dares tell a high executive that something isn't possible, because he risks losing his job," says a local union leader at the Toulouse factory who asked for anonymity.

Video: Airbus shakeup That fear could explain why Airbus failed to grasp the severity of the problem sooner, even though the company had similar problems in the 1990s with long-range versions of its A340 aircraft. Those planes "were delayed over one year from entering service by persistent problems associated with the installation and configuration of their interiors," says Sash Tuda, a London-based analyst with Goldman Sachs. "Airbus should have learned and explicitly applied the lessons from this," Tuda says.

EADS tacitly acknowledged some of these problems in announcing the resignations of Forgeard and Humbert. In a news release, the company said its board had "resolved to closely integrate the Airbus Div. into the organizational structure of EADS," and clarify lines of management reporting, after EADS buys out BAe Systems’ 20% stake in Airbus.

Rough ride
The British company wants to unload its stake and concentrate on its defense business. Negotiations between EADS and BAe are set to begin in early July after the investment bank Rothschild completes an analysis of the value of BAe's stake. At the same time, EADS is pressed for cash because of the A380 delivery delays, and because Airbus is expected to begin development soon of a midsize widebody jet to counter Boeing's hot-selling 787 Dreamliner.

No matter how the current crisis plays out, it's clear that Airbus will face a rough ride for the next few years. Until it can get a new widebody into the air—which will probably take more than five years—it will lose out on profitable orders to the Dreamliner and Boeing 777. It will have to pay penalties to disgruntled A380 customers, and some could cancel their orders.

But for all its woes, Airbus knows how to build good airplanes. If it didn't, it wouldn't command more than half the global aircraft business. While the Dreamliner so far looks like a big winner, Boeing has already run into production hurdles on the technically complex plane.

Airbus could still steal a march on Boeing with its next plane, likely to be unveiled at the Farnborough air show in England in July. If EADS can discipline its talented but sometimes unruly child, Airbus' recent trauma will have served a good purpose.

Copyright © 2012 Bloomberg L.P. All rights reserved.

Discuss:

Discussion comments

,

Most active discussions

  1. votes comments
  2. votes comments
  3. votes comments
  4. votes comments

Data: Latest rates in the US

Home equity rates View rates in your area
Home equity type Today +/- Chart
$30K HELOC FICO 4.32%
$30K home equity loan FICO 5.05%
$75K home equity loan FICO 4.50%
Credit card rates View more rates
Card type Today +/- Last Week
Low Interest Cards 10.98%
10.96%
Cash Back Cards 16.43%
16.45%
Rewards Cards 16.00%
15.99%
Source: Bankrate.com