Make Space for Airlines?

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Joel Lam's picture

Introduction

It is difficult to write a fully developed research paper with limited words. As a result, I have chosen to focus primarily on the conceptual arguments involved for space travel, dealing with the key phrase in the question “there is money to be made. Space travel will be defined to include both the public sector and the private sector as customers. I will argue that the pursuit of space travel is a unique value proposition that only shares similarities on the surface with airlines. In fact, it is possible that the competitive nature of airlines is exactly why some airline companies have chosen to innovate and pursue the science of space travel despite the seemingly common problems between the two industries.

The Problem with Airlines (According to Warren Buffett)

Warren Buffett makes a very fair point[i] on why airlines destroy value, though there are exceptions to the cause[1]. In short, Buffett believes that it is hard to carve out a sustainable competitive advantage for airlines. Firstly, there is significant sunk cost and start-up capital required. Secondly, extremely low profit margins of about 1% on average; the Economist reports airlines only made $4 per passenger in 2012[ii]. Thirdly, it is difficult to differentiate yourself within the industry without affecting price. Combine high operating costs with a highly competitive environment (in terms of price) and you have a recipe for disaster – for the Airline corporations, not the consumer. Warren has not even begun to highlight the volatility in demand, there was a huge downturn after 9/11[iii] and recent disasters such as the AirAsia saga, and MH370 continue to affect the airline industry as a whole. Airlines have to sell high volumes to make a sizeable profit, and they are struggling to do so with inconsistent demand.

Setting the Context

One can see why it may be a tempting proposition to label space travel with the same problems (or worse). Research and development for space travel is extremely expensive, and it promises no potential payoff in the short term. NASA itself shut down the space shuttle program in 2011, quoting that the costs outweigh the benefits. By then, private corporations like SpaceX[iv], Boeing and Sierra Nevada have already set about conducting R&D on their own private space shuttles in a bid to win future contracts. Virgin Galactic joined in slightly later with a different value proposition – it wanted to bring the ultra-wealthy (and ultra-adventurous) to explore space on a commercial flight.

The Value Proposition for the Public Sector

Three aerospace giants (SpaceX, Boeing and Sierra Nevada) are fighting in a space race to secure a contract with NASA which has outsourced its original job in a bid to cut costs. It is a high risk venture for all three aerospace companies, with the company who provides the greatest value proposition – higher capacity in terms of how much the shuttle can carry and lower costs – to win the contract. Cost is of utmost importance in the space race, as highlighted by SpaceX’s attempts to manufacture reusable rocket parts[v] which will result in substantial savings. The failure of SpaceX’s launch is also an indicator of how refined the technology must be to constitute success, any less than perfection would result in failure. Yet, CEO Elon Musk is convinced he is on the right track.

 Losing the NASA contract would set the other two companies back significantly in a bid to differentiate themselves further, which in turn means more funds sunk into research and development. Yet, the prospect of this does not seem to deter the three companies, which continue to fight for the first mover advantage. A won contract would effectively establish a monopoly in the corporate Space Race with NASA. Boeing’s willingness to invest heavy amounts of money in space travel despite its strong airline industry presence should hint to us that there is much ‘future money[2]’ to be made from space ventures.

There is one aspect that we could consider which would help make more sense of the space race. We have established that it seems like an all-or-nothing venture but perhaps we should consider how else this technology can be used. Patents with regards to the technology could be sold for other commercial uses, after all, all three competing aerospace companies have different value propositions regarding the design of their space shuttles which may be of use to industries outside of aerospace. There is also the very slim possibility of collaboration, where two companies could theoretically pool resources and collaborate to make an even better product. But this is not likely given the highly individualistic nature of the three competing companies, this is not likely.

Is there money to be made? Definitely, but it seems to be a case where one company will come up on top whereas the other two competitors will be struggling to break even should they fail in this high risk, high reward venture.

The Value Proposition for the Private Sector

Virgin Galactic offers a product[3] – space tourism – which, on the surface does not seem to be too different than air travel. But Virgin Airlines already has a strong industry presence with regards to the airline industry; there must be strong reasons for CEO Richard Branson to decide to pursue space travel in spite of his company’s success. In my opinion, he views space travel with an entirely different business model and a golden opportunity waiting to be seized should one have the risk tolerance to do so. It is a strategic move to diversify into space travel as the industry is able to evade the pitfalls that Buffett points out due to its niche target consumer audience and the space tourism industry’s current landscape.

The first key difference between the two industries is that the pricing power for this luxury service lies in the hands of the supplier as there is little competition. This effectively removes the possibility of razor-thin profit margins as well as the need to differentiate in terms of price. Space tourism’s target consumers would be ultra-wealthy individuals who recognize that this service is a luxury rather than a necessity. This introduces a strong price inelasticity which works in Virgin’s favour. Cost is still going to be a very big factor in capturing consumers, but it have the same importance that it does with the airline industry. Would there be an Expedia or Orbitz for space? The possibility does not even exist in the near future.

The second key difference that acts as a double edged sword is whether space travel is able to capture or generate consumer demand consistently. Space travel is a niche, very new to the market and still perceived as a risky venture[vi]. But the demand is definitely there. I think the numbers speak for themselves – over 800 people have signed up in advance for Virgin Galactic’s space travel offering at a hefty fee of $250,000. In addition, over 200,000 people have volunteered[4] for the Mars One initiative to populate and colonize Mars[vii].  Even after the Virgin Galactic Crash, there are contrarians that argue that the demand for space travel, generated by the human spirit and a thirst for adventure[viii], is unlikely to change because of one accident.

Should the virgin flight (no pun intended) of space be successful, there will definitely be money to be made as Virgin Galactic will have strong control over prices while establishing a first mover advantage in space tourism. The technology required for its competitors to even catch up will put Virgin significantly ahead of the curve. That alone may be worth the heavy investment sunk into the project. While space tourism is not seen to be accessible to the masses in the medium term[ix], there seem to be enough ultra-rich clients for the market to tap on for now.

Conclusion

I believe Warren Buffett was right, airlines did destroy a lot of value and the phenomena continues today. But to erroneously superimpose his words onto space travel simply because of seemingly common traits between the two industries is to be hasty and judgemental. This essay does not attempt to defend the airline industry, rather it seeks to understand why people may perceive the similarities between the space and airline industries wrongly. Subsequently, the essay tries to argue there is money to be made from space travel both in the public and private sector should one be able to tolerate the risks and heavy investments involved. After all, Man has always had a strange fascination for what lies beyond.

1494 Words

 

[1] Companies like Southwest Airlines have been reporting consistent profits over the years.

[2] Future money is defined as money that may not necessarily materialize but is still worth trying for given the cash flow projections alone.

[3] Other companies like Sierra Nevada and Arianespace are developing this product as well.

[4] Interestingly enough, I was one of those volunteers.