By Christopher S. Tang (UCLA)
Prudent new car shoppers often worry about the uncertain trade-in value when they decide whether to buy a new car. To entice these shoppers to buy new cars, Hyundai launched the “Hyundai Buy-Back Program” in 2011 that intends to eliminate the uncertain trade-in value. At the time of purchase, Hyundai guarantees the future trade in value as long as the car is maintained at a Hyundai authorized dealer according to a certain schedule. This buy-back program can certainly boost sales, as we witness the significant increase in Hyundai’s revenue in 2011. Due to unknown reasons, Hyundai scaled back the buy-back program to two high-end models (Genesis and Equus) in 2012.
While we do not know the real reasons behind Hyundai’s change of heart, it is quite possible that the hidden cost of running this kind of buy-back programs is more costly than the company had anticipated. Airbus has learned a painful lesson over buy-back program associated with its A340.
In 2003, when Airbus and Boeing were competing for the order from Iberia in Spain, it became clear that Boeing 777 can be a dominate choice because of two underlying reasons. First, Boeing 777 could earn Iberia about $8000 more per flight than the A340 because Boeing’s 777 can hold 24 extra seats than Airbus’s 340. Second, Boeing’s 777 is cheaper to operate (Michaels (2003)). To win the order from Iberia, Airbus developed a buy-back program that can be described as follows. If Iberia wants to sell its A340, Airbus must cover the difference between the market price of the used plane and the guaranteed minimum price (specified by Airbus).
Airbus’ buy-back program helped seal the deal as Iberia ordered more A340s in 2003. To win more orders, Airbus extended the buy-back program of A340 to all other airlines ranging from Virgin Atlantic to Qatar Airways. By 2011, Airbus sold over 130 A340s, each of which is approximately $200 million.
On the surface, this has been a phenomenal success in terms of using buy-back programs to stimulate sales. However, the nightmare began when airlines discovered that Boeing 777 is truly a much better plane in terms of performance, operating cost, and revenue generation. As many airlines (Virgin, Qatar, Singapore, China Eastern, etc.) start selling their old A340s in 2013, the market price of the used A340 plummeted from $100 million to $20 million per plane. Because of the buy-back program, Airbus is committed to cover the difference between the guaranteed minimum price and the market price ($20 million) (Michaels (2013)). Knowing there are over 100 A340s under the buy-back program, the financial liability can be huge especially the market price of the used A340s is unlikely to rise soon because of the superior Boeing 787 and the brand new Airbus 350 are getting the airlines’ attention.
What do we learn from Airbus’ buy-back programs? When a company offers buy-back programs, the company should beware of the likelihood that its customers may sell the used products at the same time especially when better and cheaper products become available. When customers sell the used products at the same time, it drives down the market price of the used product and it is the company who is liable to make up the difference. When it rains, it pours.
References:
Michaels, D. “Airbus and Boeing Duke It Out to Win Lucrative Iberia Deal,” Wall Street Journal, March 10, 2003.
Michaels, D., “For Airbus and Bankers, Big 340s Pose Sizeable Risks,” Wall Street Journal, June 13, 2013.
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