Knowing Your Aviation Business Model
April 2008
The private aviation space is exciting, if
only perhaps due to the lack of sober business models. We don't know why this
is and won't purport to pretend that we can find the answer—it is just one of
those things that remain an elusive and mysterious enigma, like how French people
seem to stay so thin on a diet of wonderful food and wine.
by Adam
Webster and Scott Russell
Marcil Technology
Group, Inc.
Private aviation is tough. It requires a ton of money, lots of specialists
for the regulations and skill sets, and to top it all off, is fraught with risk.
Simply put, the weak don't survive long due to the risk they won't have any
bookings/sales tomorrow or the risk that one of their pilots is deciding not
to cross the T's and dot the I's today, which could lead to an accident.
Airlines (mostly) have managed to conquer the latter. The fact that Air Mozambique
doesn't crash more is a testament to the redundancy and safety built into the
engineering side of the house alone.1
The biz model side of the house
ain't so lucky.
When it comes to planning, financing, and implementing, entrepreneurs tend
to race toward the cliff like
lemmings. Since none of their wise, rich friends know much about airplanes,
most investment decisions play heavily to the emotional hooks that are required
to extract money from people for airplane matters.
For this reason, NetJets makes a great analytical case: seemingly a business
that is not only on the mend, but set for global domination. Yet, when you lift
off the hood of NetJets, you see the same pattern that is visible at all other
fractional programs: red ink on a bad day and treading water on a good day.
NetJets' Berkshire pedigree is a fantastic example of the superstar/rock star
effect on marketing too. If Warren Buffet bet on this company big, what could
possibly be wrong? By default, many assume, it must not only be sane, but perhaps
the next big thing in aviation.
Let's be fair; Warren Buffet is a smart man. Very smart, very patient, and
with enough street credit to pull throngs of the wealthy to Omaha to look at
all the wise moves he continues to make. It is no secret that
Warren Buffet likes the moats more than the castle. For this reason Coca
Cola is a natural choice for him as an investor. When you capture that much
attention, market share, and brand recognition, you write your own ticket and
print money. Similarly, NetJets (the pioneer of private business jet fractional
ownership) is well on its way to moat creation with its size, brand, and ubiquity.
It has become synonymous with the appeal of buying your "own jet," yet with
Buffet-esque modesty and logic. You didn't spring for an entire airplane (or
flight department) like your flashy cousin's company did. Bravo!
But let's be clear—airplanes, after all, are time machines that save time
(money) and allow Masters of the Universe
to float effortlessly to multiple board meetings in one day. And heck, let's
be honest, once you start using little airplanes on a whim, it is very hard
candy to give up.
Rule #1: Never Forget the Curse of Airplanes
This is what makes "knowing when you are wrong" so interesting. KPMG's Peter
Fuchs said it in a simple yet eloquent white paper,
Fractional Aircraft Ownership Programs: A Deeper Look into Why Operators Aren't
Profitable—Yet, that brings the failure of fractional ownership model down
to an almost kindergarten level of comprehension. Amazingly, even Buffet himself
has grazed on the subject,2 though naturally not
in the context of referring to one of Berkshire's holdings.
Now that Berkshire is the owner of the largest airline in the world (if NetJets
were measured in fleet size), one has to wonder where the profits are and when
they will come. Coca Cola didn't start with a $700 million investment and years
of horrific losses, and then make it. This is our first clue that some business
models just don't succeed.
But that is where the problem lies. Even though we don't make money with
them, crazy money continues to flow into the space, at first with fractional
ownership and now with one crazy air taxi scheme after another.
The key to this curse is simple: You can't reinvest your earnings if you
don't have any. Even worse, when you do, they are a drop in the bucket compared
to what you actually need to make a dent in the debt.
Rule #2: It Is Hard To Scale the Wealthy
The birth of charter, corporate flight departments, and fractional ownership
can be attributed directly to the fact that those who can afford to do otherwise
don't like to travel with the same constraints of the unwashed masses. Can't
afford it? That's ok. accept your fate that there will be lines and delays,
orange days, yellow days, TSA buffoonery, FAA problems, and the possibility
of parting with an item you didn't realize was illegal to carry.
Not so for NetJets owners. Not only is the FBO3
an easy place to park, but it takes all of 4.2 minutes to get from your car
into the plane without security. Good candy
indeed.
The point we are trying to make is this: When your entire business model
is built around catering to the passenger in ways that keep the plane waiting
most of the time (or positioning empty 40 percent of the time racing to pick
up passengers at the last minute), it is impossible to get any type of utilization
on the aircraft.
The proof in this statement is this
simple chart depicting average annual hours per aircraft. While fractional
operators are atypical of private aviation, they still peak out at about 1,200
hours per year. The curse? If the planes did (magically) break the 1,500 or
2,000 hour mark, they would suffer at the hands of their owners who bought into
a program that projects 800 hours per year utilization per aircraft. (For example,
if you buy one-quarter of an aircraft, you are effectively buying 200 hours).
Program managers are already suffering at the hands of ornery customers who
seek an
explanation as to where all the value in the aircraft goes when it is time
to trade it in. This "guaranteed limitation" of sorts cements the reality of
higher prices. And higher (much higher) prices lead to a small market!
Rule #3: Charge More than Your Costs
NetJets is the best example, since despite making some money in 2007 (and
a loss in 2006),4 the fact is that NetJets does
not earn anywhere nearly enough to plow its earnings back into brand development
and getting some money back from (or "to"?) the investor in the form of a dividend.
Ostensibly, the profit from jet sales should zoom them over the top, but reality
dictates that operationally, they barely make it (or bleed like crazy, depending
on how you choose to measure), and the precious earnings from the jet share
sales are the salient earner for any fractional company.
With over $1 billion in turnover, you'd expect a fat margin. After all, everyone
else (but the operators/program managers) seems to make a fat margin: Business
jets and their parts, services, etc., all seem to be in the 20 to 30 percent
neighborhood.5 But not so. And this highlights another
aviation risk management nightmare—the inability to charge significantly above
your cost. While NetJets is the most expensive solution for fractional ownership,
they are unable to convert the winning brand loyalty into the type of numbers
that will, long term, show the hallmarks of a winning Berkshire play.
Rule #3 is tough because the wealthy are small in number, very fickle, and
difficult to herd and scale. Wal-Mart, Coke, and (to keep it relevant) Southwest
and JetBlue don't have such problems. They can't, since there are simply too
many customers, which is the ultimate risk mitigation sweet spot—an infinite
pool.
Conclusion: Play Baseball
When looking at aviation business plans from a risk mitigation perspective,
there are endless snippets of wisdom from entrepreneurs. Experienced pilots
joke about playing baseball. If there are three things that really unnerve them
about a given day, flight, or situation, they'll take a pass. Here are three
red flags for an aviation business.
Strike One: Big sunk costs, lots of regulations,
huge crowds willing to dive in and copy you, and landscape littered with corpses
of failed dreams. The truly crazy will compete with you, and do it on the basis
that "they can do it for less." They'll
survive off subsidies,
Ponzi schemes, and other madness that doesn't spell business. It's very
hard to even be on the same playing field of such folks, even if you were first
to the market with the idea.6
Strike Two: Your costs are so high that
you can't stomach (nor will the market bear) what you need to actually charge.
You limp along somewhere in no man's land, hoping—and hope is not a strategy.
You struggle to charge 2x your costs only because they are already obscene.
(Quick reality check at
Money.CNN.com for those who want an idea of how limited this market is.)7
Strike Three: Beware the small market—a/k/a
the uber-wealthy. The allure of monetizing them is so easy to fall victim to,
since there is so much money to be made playing concierge. One problem: The
concierge doesn't scale. That is why each decent hotel has at least one on duty
all the time and not a concierge "bot" in the lobby. And it is always a human
who specializes in pandering to a request that is hard to predict.
The biggest problem with private jets, of any flavor, is that they cut their
teeth by sitting still. Sitting and waiting for the boss is an automatic "no-go"
item for a business that is going to leverage all of its assets. It is, in effect
a loss leader—a department whose only purpose is to figure out how to keep the
boss working around the clock, and if he's lucky, going to Aspen in style.
While NetJets will continue to survive, most likely as a non-stellar investment,
the silver lining for Berkshire may be that NetJets buys a lot of training services
from Flightsafety and insurance from USAIG (both Berkshire holdings). Whether
these gains will someday erase the historical investment and operating losses
in NetJets is unknown. But, as is the case with seemingly all current private
jet businesses, it's not a business model that will warm the hearts and minds
of those looking to truly make aviation and business history.
1One of the authors of this article actually took
a flight from Harare to Maputo in an aging 737 that had nonoperational landing
gear. What did the Captain do? Nothing—flew the trip anyway ... with the gear
down the whole time.
2"The worst sort of business is one that grows
rapidly, requires significant capital to engender the growth, and then earns
little or no money. Think airlines. Here a durable competitive advantage has
proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted
capitalist had been present at Kitty Hawk, he would have done his successors
a huge favor by shooting Orville down."—Warren Buffet
3FBO is an aviation acronym for Fixed Base Operator—the
place where the plane parks, gets gas and some maintenance if required.
4See page 22 of the
March 31, 2007 Form 10-Q from Berkshire Hathaway.
5The
Teal Group
is one of the most trusted analysts of aviation businesses and they are particularly
bullish on all aspects of business jet manufacturing.
6NetJets is the undisputed pioneer of the space.
Regrettably, however, there is no moat and no differentiator that prevents the
competition from ramping up very quickly to copy essentially the same "special
sauce." At least Coke could keep its recipe in a vault and profitable aviation
service businesses focused on markets that were unstoppable in all economic
climates. The fickle nature of big spenders, however, has private jets at the
mercy of economic times, peak and valley schedules, and overpriced services,
parts and aircraft.
7This is a good reality check, since many sane
uber wealthy folks remember when they didn't have money and they make this simple
calculation: I can suffer a lot in coach in order to save $4,000 / hr. for the
smallest airplane in their fleet which doesn't have the range to do this trip
that I am doing now anyway in a big plane now with a stand up lav.
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