“Airbus vs. Boeing in Super Jumbos: A Case of Failed Preemption”

The relevant argument involves more careful consideration of competitors’strategy spaces and was originally developed in the context of a circular model of productdifferentiation by Judd (1985). In the present, linear context, reconsider the two firms’new product decisions and assume, for the sake of simplicity, that attempts at innovationalways succeed. 32 If both firms somehow introduced a new product at location 1 by stage3, prices at that location would fall to the common marginal cost of c, and no operatingprofits would be earned on the new product by either firm. This would also put pressureon firm I’s price at location 0, which in equilibrium would fall to c + 0.5t, ensuring ittotal operating profits of t/8. In the absence of exit costs, firm I could improve its payoffsby withdrawing its product from location 1 and letting firm E monopolize it. In doing so,the incumbent could raise its price at location 0 to c + t (firm E’s equilibrium price atlocation 1 would also now be c + t), earning operating profits of t/2. By implication, inthe absence of exit costs, if both firms do end up entering at location 1, it is a dominantstrategy for firm I to withdraw from location 1 and, since it is not credible for firm I tothreaten to stay in the market, for firm E to stay. Anticipating this outcome, firm Irationally saves itself some money by refraining from innovate—even if it is certain thatfirm E will definitely enter if it does not. It is worth emphasizing that this prediction doesnot depend on the fixed costs of innovation/entry: exit costs are necessary to allow firm Ito effectively “stake out” location 1 as the first-mover (Judd, 1985).It is in this sense that game theory—or more specifically, the relatively subtleconstraint that preemption be credible—helps rationalize why Airbus, not Boeing,introduced the superjumbo. Even if Boeing had threatened to build a superjumbo, Airbuscould have called its bluff by proceeding with its own plans to launch one—at least underthe hypothesis that both firms were value-maximizers, which we will scrutinize later.What it is time to turn to here is the second key question about their interactions: whyBoeing also considered but failed in its attempts to proceed with a “stretch jumbo”intermediate to its jumbo and Airbus’ planned superjumbo in terms of capacity. Theanalysis will, once again, focus on using expected operating profits at the end of stage 3to help identify product configurations in the longer run.19