The recent airline business environment has been characterized by erratic swings in profits, fuel prices and traffic statistics. But even in such tough financial conditions, aircraft manufacturers can find opportunities to lay the foundation for growth in profits and market share.

The world airline industry posted a net profit in 2007, for the first year since 2000. Net profitability was achieved largely because U.S. major carriers finally joined the recovery. Previously, their financial results had been lagging behind the rest of the industry.

Unfortunately, this return to net profitability was short-lived. The airline recovery began to stall in early 2008, and conditions generally worsened over the course of the year. Air traffic growth slowed significantly. The crisis that hit the financial markets in fall 2008 only served to deepen airlines’ woes, as economic uncertainty further weakened passenger demand. Meanwhile, fuel costs began to decline with the worldwide halving of oil prices, but they remain high.

Consequently, preliminary data indicate the world airline industry fell back into red ink in 2008, posting a sizable net loss for the year. Once again, U.S. carriers were the main culprits with their big losses a direct result of the slowing U.S. economy. Early indications are that the global industry will record another net loss in 2009, although some analysts believe U.S. airlines collectively may return to profitability, thanks to lower fuel-cost forecasts as well as other factors.

At least for the next few years, it will be increasingly difficult for airlines to grow revenue. Capacity control is one of the key tools that carriers will need to navigate the difficult period ahead, as excess capacity will only lead to falling yields and other difficulties. This makes the present situation particularly worrisome, as traffic growth is slowing while airliner delivery rates remain high or are even increasing. Although a portion of deliveries will be offset by retirements of older aircraft, capacity still grows if larger aircraft are replacing smaller ones.

Complicating the situation are the strong order backlogs for Airbus and Boeing. Cancellation and deferral rates will have to be watched closely over the next year or so, as both airlines and leasing companies re-evaluate outstanding orders. Clearly, some of the backlog, perhaps 10% or more, is at risk.

Driven by the difficult operating environment, the airline industry itself is undergoing a period of attrition and consolidation. In 2008 alone, more than 25 airlines declared bankruptcy. The exit of some carriers is not necessarily a bad thing, if the result is a stronger and more robust industry.

Industry consolidation by way of merger and acquisition has become a major focus in the U.S. and Europe, with the merger of Delta Air Lines and Northwest Airlines being one of the more high-profile deals in the past year. Short of outright mergers, much consolidation activity likely will involve the expansion of code-share agreements. The rise of global airline alliances, based on code-sharing and other types of cooperation, has dramatically changed the industry and the way airlines do business.

The three main global alliances—Star, SkyTeam and Oneworld—combined represent most of the world’s airline capacity. Though there is little room for a fourth major alliance, the next several years will likely see all three expand their ranks via the addition of nonaligned airlines. Some member carriers could also shift their loyalties, further changing the competitive landscape.

In the midst of all this change and turmoil, the challenge for Airbus and Boeing is to fashion product lines that best meet customer needs. Each manufacturer is in a transitional mode, consolidating lines while scrambling to put key new mid-size airliners into service.

Boeing enjoys a bit of an advantage in the wide-body portion of the market. Production of the 777 should continue at a strong pace, with deliveries forecast at 80-plus a year for the next several years, and 747 output will increase to 20-plus a year from 2010 onward after the new 747-8 replaces the 747-400 in production. Barring further delays, service entry of the 787 mid-size airliner is now widely expected in early 2010, with production aggressively ramping up over the next several years. Even with its recent schedule delays, the 787 has a decided timetable advantage over Airbus’s new A350XWB.

The early (and continuing) sales success of the 787 forced Airbus into responding—belatedly—with the A350XWB. In a smart and ambitious move, Airbus competitively positioned the A350 against the 787 and 777, thus forcing Boeing to take a fresh look at product strategy. A Boeing response to the XWB could take the form of a stretched version of the 787 (the so-called 787-10) and/or a new member of the 777 family. The decision remains a tough one for Boeing, however, as the projected 787-10 would instantly cannibalize its 777-200ER market.

The game will change when the A350XWB enters service, which is slated for 2013. Airbus wide-body production should then accelerate rapidly. Besides A350s, the company’s wide-body output will include A330s (primarily freighters) and A380s. The A340 may be out of production.

The next major battle between all-new Airbus and Boeing products will involve narrowbodies. Neither company is in much of a hurry to launch a new narrowbody, and the current level of sales of the companies’ respective A320 and 737 families indicates the market is not yet forcing such a decision.

Meanwhile, Airbus and Boeing are attempting to reorganize their production processes. The 787 program could become a template for future Boeing production efforts, but it was a victim of ambitious scheduling combined with a business plan calling for considerable development and production responsibility to be offloaded to suppliers. Still, Boeing is unlikely to completely jettison the 787’s global supply chain model for future projects, and new Boeing programs will likely use some version of it, incorporating lessons learned from the 787 program’s growing pains.

In a more limited way, Airbus is looking to outsource an increasing proportion of work. This is at least partly driven by a need to move production into the dollar zone to protect the company from the dollar’s weakness versus the euro. EADS CEO Louis Gallois has estimated that a 10-cent rise in the value of the euro against the dollar costs Airbus €1 billion.

Regional carriers also are suffering. In the past, they often outperformed major network carriers during times of stress in the airline industry, because they find opportunities to expand as the majors contract their route structures. However, in the current industry environment, regionals are feeling pain every bit as much as the majors.

Financial pressures are once again forcing the majors to dump capacity and consolidate route networks. This time, however, they are not passing the work over to their regional partners. Capacity reductions are extending to regional allies, thus forcing them to downsize their fleets. And this is occurring while slowing passenger traffic is making the operating economics of regional jets problematic.

As some models of regional jets have become less economical to operate, regional turboprops have seen an upswing in popularity. The market for turboprops began a decided resurgence around 2004. Various factors working in combination account for this revival, including air traffic trends, high fuel prices and the need for regional airlines to cut costs and reduce fares—particularly in the face of low-cost carrier competition.

The revival in turboprop demand has been most evident in Europe and Asia, but North American carriers are starting to join the trend. Looking to take advantage of the increased market interest, ATR has announced improved, -600 versions of its ATR 42 and ATR 72, and is accelerating design studies into a family of 70-98-seat turboprops for service entry in the second half of the next decade. Bombardier has launched the Q400 NextGen airliner, an improved version of its Q400 70-seat turboprop, and is continuing studies for a 90-passenger version called the Q400X.

Demand for regional jets continues to shift upward to larger-capacity aircraft—from the once-dominant 50-seaters, to 70-seaters and now to aircraft seating 90 passengers and more.

Pilot contract scope clauses remain a significant limiting factor on sales of 90-125-seat regional jets, as such provisions prevent the regional partners of many major airlines from operating aircraft of this size. While there is not yet much of a push to remove or relax scope clause restrictions on the operation of 90-plus-seaters, competitive pressures combined with air traffic growth eventually will force such an easing. Scope clauses once prevented the operation of 70-seaters and even 50-seaters by many regional carriers. In the meantime, low-cost carriers, independent regionals and even some majors can be expected to buy 90-125-seat regional jets in quantity.

With a regional jet product line that extends to 122 seats, Embraer is well-positioned to exploit this trend in the market. The company has displayed no desire to expand seating capacities beyond 122. Meanwhile, its Canadian rival, Bombardier, has launched the 100-145-seat CSeries family.

Having reached the design limits of its existing CRJ regional jet series with the 100-seat CRJ1000 model, Bombardier had to go all-new if it wanted to compete in the market above 100 seats. Bombardier has sized the CSeries not only to take on the largest Embraer jets but also to challenge the Airbus A319 and Boeing 737.

Other products attempting to capitalize on the promise and potential of the 90-125-seat regional jet segment include the Avic I ARJ21 from China, Mitsubishi Regional Jet from Japan and Sukhoi Superjet 100 from Russia.