Expert Commentary

Knowing Your Aviation Business Model

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.


Corporate Aviation
April 2008

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.

Exhibit 1:

What Lemmings Believe

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!

Exhibit 2:

Average Annual Hours Per Aircraft Graph

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 Form 10-Q - March 31, 2007 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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