The airline industry is one of the most controversial industries in the world. While the industry does not create much value for its shareholders it still around, and, moreover, the airlines are increasing their capacity (expending the fleet) from year to year. According to the data published by the International Air Transport Association the weighted average cost of capital (WACC) in the airline industry for the last 20 years was constantly higher than the return on invested capital (ROIC). Only in years 1988 and 1998, WACC and ROIC were at the same level. Even though the profitability of airlines in 2015 is going to increase, mainly due to the decreasing oil prices, the ROIC will remain lower than average WACC. So, why do airlines destroy shareholders` value?
To answer this question I am going to use one of the frameworks that are used to analyze attractiveness of industries – Michael Porter`s 5 forces. This framework was first introduced in the Harvard Business Review article back in 1979, but is still widely used today. The Porter`s 5 Forces framework includes the following components:
Threat of new entrants
Bargaining power of suppliers
Bargaining power of buyers
Threat of substitute products/services
Rivalry among existing competitors
Now let me analyze how each force is shaping airline industry.
- Threat of new entrants - high. Companies do not have to invest heavily in buying aircrafts, they can just lease them. It substantially decreases entering costs. Access to potential customers is also quite easy with the help of new technologies (i.e. online bookings). The hardest part can be to get landing slots at the airports (if company aims on most popular ones, i.e. Heathrow or Schiphol) but for not top airports getting access to the slots will be much easier.
- Bargaining power of suppliers - very high. There are, basically, two major aircraft producers – Boeing and Airbus. In addition, if the company wants to get access to huge passenger traffic it should fly to/from major airports, so airports also have a huge bargaining power as suppliers of the slots/infrastructure.
- Bargaining power of buyers - very high. The switching costs for customers are rather low and there is no big difference either to fly with KLM or British Airways. Basically, air travelling became a much commoditized product.
- Threat of substitute products/services - medium. For short distance travels, i.e. London-Paris, people can easily substitute airlines with train. The network of bus routes is also a substitute for the airlines, especially for low-end customers who can sacrifice their time for cheaper type of transportation. In addition, with the development of the new technologies, the need for business travel is decreasing – people can have business meetings via video conferences.
- Rivalry among existing competitors - very high. Airlines have high fixed costs for the flights (including paying pilots and fuel) but very low marginal costs for each additional passenger. Together with the fact that airlines have overcapacity it creates pressure on air fares and this decreases the profitability of the industry.
Using the Porter`s 5 forces we can conclude that the airline industry is not an attractive industry to be in. Therefore, there is no surprise that the industry does not create value for its shareholders. But, why do companies still operate in this industry? The main reason is high exit barrier because of the high fixed costs (aircrafts leasing contracts, contracts with pilots/suppliers etc.).
Now let`s take a look at the space travelling industry. Does this industry also looks as unattractive as traditional airlines?
Before I will apply the Porter`s 5 forces framework to the space travelling industry it is worth to note that these industries are in completely different stages of the lifecycle. Whereas space travelling is at the set-up stage, the airline industry is already mature. This fact alone can explain why space travelling industry will be able to make money, at least at the first stages when first movers can charge high premium for space flights and demand will exceed supply.
Now let me apply the Porter`s 5 forces framework to the space travelling industry:
- Threat of new entrants - medium. Space travelling is a new interesting industry that attracts different kinds of companies. Apart from Virgin, SpaceX and several other companies who are already working on delivering a space travelling service, potentially other companies that have a cash pill, i.e. Apple, can enter the industry. However, the level of investments, as there is no market of leasing spaceships, that company will require is quite huge and can be a hurdle. Nonetheless, companies can also obtain financing from government bodies, i.e. NASA is financing the SpaceX projects Falcon 9 and Dragon.
- Bargaining power of suppliers - medium. There are no existing producers of the commercial spaceships. At the same time, the number of producers of the main components, such as engines and controlling systems, remains rather limited.
- Bargaining power of buyers - very low. There are no existing players in the market. Customers simply do not have alternatives. At the same time the service, that the space travelling industry is going to offer, is unique and different from any existing services. Therefore, at the early stage of its development the space travelling industry is not going to face pressure from customers. While air travel is rather commoditized, space travel is currently a fairly unique product, which offers customers a completely new experience. The essence of air and space travelling is completely different. And customer`s decision making and buying process is also different.
- Threat of substitute products/services - very low. As for now, there are no direct substitute products/services. The chances that in the foreseeable future there will be alternative ways to transport people to the space are very low.
- Rivalry among existing competitors - medium. As the industry is not yet established, there are no existing competitors. At the same time, several companies are working on projects in the space travelling area – SpaceX, Virgin Galactic etc. Also, such companies as Boeing and Orbital Science Corporation are building space rockets. In my opinion, the first mover advantage will play an important role in space travelling industry, as first movers will be able to charge customers a high premium.
Summarizing my analysis I want to say that space travel industry looks much more attractive than airline industry. First, in the airline industry, there is a high threat of new entrants because it is easy and cheap to replicate the business model. Whereas in the space travel industry, a company needs to build up significant internal competencies and resources, such as develop the spacecraft, etc. which are not easily replicated. Therefore, a major threat that leads to low margins is not present in the space travel industry. Second, space travel industry will not experience a huge pressure from the suppliers and customers. It mainly explained by the uniqueness of space travelling and absence of the existing competitors. Finally, air travel became a fairly commoditized industry, whereas the space travel industry will offer a unique product and experience. All these factors allow me to conclude that space travel industry will create value for its shareholders.
But, we have to remember that high profits usually go hand in hand with high risks and the space travel industry is not an exception. The biggest risk is the feasibility of the industry itself. For example, first test launches of the Virgin Galactic and SpaceX shuttles were unsuccessful. Second major risk is a safety concern. According to the statistics 3% of astronauts die due to accidents with the spaceships. Therefore, the main challenge for companies that want to start a space travelling business is to design a reliable and reusable spacecraft.
1. International Air Transport Association (IATA) website – www.iata.com/economics
2. IATA Press Release No.: 66, December 2014
3. Porter, M.E. (1979) "How Competitive Forces Shape Strategy", Harvard Business Review
4. Luscombe R. NASA grants Boeing and SpaceX contracts for manned space flights. The Guardian, September 16, 2014
6. Margolis J. Spaceports are unlikely to get off the ground. Financial Times, April 27, 2014
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