Making money from nothing: A holistic approach to investment based on the Porter Five Force Framework in commercial space travel ventures.

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Matthew Day's picture

It is certainly well known that Warren Buffet is not a fan of investment within the airline industry, however is he correct in saying “no sector has destroyed more value than airlines”. It certainly does not take an exhaustive amount of financial research to ascertain that the above statement is correct in regards to industry profitability. The Chief Economist at the International Air Transportation Association (IATA) reported airline net profits averaged just 0.1% between 1970 and 2010 (ILO 2013, p.7).  A recent report issued by IATA shows global profit per passenger for 2014 to be USD$5.94 this is compared to the average revenue per passenger of USD$224.40 (Pearce 2013, p.20) this global profit per passenger was up from a 2012 figure of just USD$2.56 per passenger (IATA 2013, p.10). Space Travel is an extremely new industry with a large amount of capital being invested, the most recent data from the FAA (2010) reports that in 2009 just over USD$208 billion in economic activity had an impact on the commercial space industry, with over USD$53 billion in earnings reported, new data is scheduled to be released this year (2015).    

This essay does not explore the fundamentals behind airline value but rather the positive difference between space travel and airlines as a potential viable investment option. The analysis will pay particular attention to the Porter Five Forces Analysis for investment strategy in relation to competition, differences in industry business models and profitability.

 

According to Harvard Business Professor Michael E. Porter (2008) airlines are one of those “sexy” industries, yet they are by far the least profitable industries in reference to return averaging just 5.9% return on invested capital (ROIC) versus the United States average of 14.9% ROIC from 1992-2006 (Porter 2008, p.83). Porter (2008) continues to state that airlines are a perfect example of how coolness has nothing to do with industry profitability. Space travel like airlines easily fall into the same attractive category, however profitably is not necessarily driven by the “chicness” or the type of the industry but the underlying industry structure itself, and when it comes to space travel the considerable differences are substantiated.

On the outside an industry may look and appear the same, but they may have completely different underlying structures, the same applies in reverse, two different industries may have the same underlying structure, this concept paramount in determining the strategy behind profitability and competition analysis. Developing on the underlying structure concept is the Porter Five Forces Framework. This framework is extensively used in the industry to explore the competitiveness intensity resulting in an analysis of overall attractiveness or unattractiveness in context to a particular industry profitability.

The Five Forces focus on a deep analysis into the following characteristics of an industry; threat of new entrants, threat of substitute products of services, bargaining power of customers/buyers, bargaining power of suppliers, and also the threat of competitive rivalry which is considered the main determinant behind the competitiveness of an industry.  

Applying this business analysis model with a focus on comparing the airline industry to the space travel industry will provide insight to the varying degrees of financial performance driving industry profits.

 

In respect to the airline industry the threat to competitive rivalry is substantial, this is due to the airlines offering a perishable product. This is based on ticket price and sunken costs for both the aircraft, airport and flight to its destination. Most modern airline customers are no longer loyal to a particular carrier and therefore choosing an operator based on price, this forces the price down into a zero-sum competition situation driven purely by currency and potentially not based on the product.

Current space travel operators on the other hand such as Virgin Galactic, SpaceX, SpaceAdventures, World View, and XCOR (Jao 2014) offer or are developing completely different products and product attributes for their current or potential clients and therefore are developing a positive-sum competition environment. Competitive rivalry is also hinged on the threat of new competitive entrants to the industry, airlines have limited economies of scale, easy access to distribution systems and low customer switching costs, it is these factors that saw 1,300 new airlines established globally from 1970 to 2010 (IATA 2011, p.37). Space Travel in contrast to airlines have various significant barriers to prevent entry into the industry such obstacles include; Specific patents and rights to particular technology, government policy, significant initial capital requirements, absolute cost, product differentiation and brand equity. The current players in the industry have timed the presence well as it would become much more difficult for new entrants to make a move into the industry as time progresses. Airlines not only face threats of new entrants to the industry or competitive rivalry but also threats of consumer or customers to adopt product substitution.

 

Product or service substitution is defined by consumer desires and needs, for the airline industry this may be displayed by passengers opting for high speed train or even web-conferencing as a means to an end, in lieu of air travel. For the airline industry this product substitution will result in an overcapacity of available seats, thus increasing costs with significant impact on profitability. In essence product or service substitution is not possible for the space travel industry, as the customer is paying for a service, being space travel, they cannot achieve the same outcome by replacing the service or product for one in another industry. Buyers and consumers do not have to substitute products or services for one in another industry to alter the attractiveness of that industry, they also have bargaining power.

 

Buyer bargaining power for an airline is extremely price sensitive, if consumer demand for lower ticket cost is not met, consumers are able to switch between competitors relatively easily for a similar product this problem is exaggerated by highly concentrated distribution channels. If the consumer demands for higher quality or more service, this will also impact the airline through increased underlying costs. In comparison space travel buyer bargaining power is not price sensitive, the consumer chooses their preferred operator based on product, offering or potentially location as distribution channels are scarce. Space travel operators have a differential advantage based on the uniqueness of their product offering, and the lack of available substituting products or services. Another force which can alter the attractiveness of an industry is supplier bargaining power

 

Supplier bargaining power is extremely restrictive on airlines, major influences on supplier bargaining power for airlines include but are not limited to; restrictive aircraft and aircraft engine manufacturing, airport monopoly, and also airline strikes. The space travel industry cannot prevent action taken during staff strike, much the same as any industry, however the current operators have mitigated the effect of manufacturing and airport monopolies by either building their own spaceports and launch facilities to either building their own launch vehicles or having strict binding contracts with other corporations to build launch vehicles solely for that operator. The exception to this is SpaceAdventures which currently hires room on the Russian Government Soyuz Rocket system and the International Space Station for its clients.

 

Even though airline and space travel are not dissimilar in using the sky or space as a medium for their product, applying the Porter Five Force Framework model to both the airline and the space industry shows a considerable difference in the underlying operating structure and the product offering itself. The five forces of competition and industry strategy have been explored and it has been proven that the Space Travel industry shows a much higher potential for investment attractiveness in relation to probable substantial profitability compared to the airline industry. Space Travel is offering new customers an experience to pay for travel in an area where few people have been before, for the few that could afford the service it would not be about the destination but the journey. 

References: 

Federal Aviation Administration (US) 2010, Economic Impact of Commercial Space Transportation on the US Economy in 2009, viewed 5 January 2015, http://www.faa.gov/news/updates/media/Economic%20Impact%20Study%20September%202010_20101026_PS.pdf

International Air Transport Association 2011, Vision 2050, Singapore Conference 2011, viewed 10 January 2015, http://www.iata.org/pressroom/facts_figures/Documents/vision-2050.pdf

International Air Transport Association 2013, Profitability and the Air Transport Value Chain, IATA Economics Briefing no.10, viewed 15 January 2015, https://www.iata.org/whatwedo/Documents/economics/profitability-and-the-air-transport-value%20chain.pdf

 

International Labour Organisation 2013, Civil Aviation and its Changing World of Work, GDFCAI/2013, viewed 10 January 2015, http://www.ilo.org/wcmsp5/groups/public/---ed_dialogue/---sector/documents/meetingdocument/wcms_201282.pdf

Jao, C 2014, 'All systems go (cover story)', Entrepreneur, vol. 42, no. 10, pp. 40-50.

Pearce, B 2013, The Outlook for Commercial Air Transport, Information Presentation, International Air Transport Association, viewed 21 January 2015, http://www.iata.org/whatwedo/Documents/economics/IATA-outlook-for-the-airline-industry-December-2013.pdf

Porter, ME 2008, 'The Five Competitive Forces That Shape Strategy', Harvard Business Review, vol. 86, no. 1, pp. 78-93.