Boeing and Airbus Turn To Model “Extensions” To Minimize Risk

Risk mitigation is in the air. 

The latest industry (after the movie industry) to think about ways to mitigate risk is the ever-wary-of-risk Airline industry (don’t blame the industry for that attitude, blame super high fixed and just high variable, costs).

Writes Christopher Drew on The New York Times, 

Boeing’s announcement last week that it had begun pitching airlines on an enhanced version of its 777 jet, rather than a whole new plane, underscores how the aerospace industry is pulling back from the risky bets that have led to costly, and humbling, delays on other planes, like Boeing’s 787 Dreamliner.

Instead of following the Dreamliner template, in which it sought to create a revolutionary plane brimming with new technology, Boeing is now seeking a safer, more incremental path. It plans to add the most crucial new technologies, like lightweight plastic composite wings and more fuel-efficient engines, to the 777, while avoiding the time and expense of designing a replacement from scratch.

To be clear, even extending existing models by upgrading various parts (the wings, the engines, other systems) iteratively is not without financial risk either. Unlike generic lego blocks that easily snap onto each other, fuselages for example are designed to support a certain set of systems and materials. So when new materials are used, some major new design work may be required – just not as much as is needed for a brand new plane though. 

PS: And these concerns are not limited to Boeing by any means. The article also includes this memorable quote:

“Risk, risk, risk,” Tom Enders, the chief of Airbus’s parent company, European Aeronautic Defense and Space, said of Boeing’s approach to the Dreamliner.

Mergers Mitigate The Airline Industry’s Wretchedness Problem

At a fundamental level, the airline business is a wretched business.

As Warren Buffett eloquently put it a few years ago:

If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in.

You’ve got huge fixed costs, you’ve got strong labor unions, and you’ve got commodity pricing.

That is not a great recipe for success. I have an 800 number now that I call if I get the urge to buy an airline stock. I call at 2 in the morning and I say: ‘My name is Warren, and I’m an aeroholic.’ And then they talk me down.

If you’re not one for folksy wisdom and hard facts are more your cup of tea, the 2nd paragraph above should satisfy you.

Now, in order to reduce the wretched nature of operating pressurized aluminum tubes in the air, airlines have been pursuing two strategies.

The second and more recent one is to break down the flying experience into its’ fundamental parts:

(more…)

Outsourcing, Technology or Bad Luck – What’s Behind Boeing’s Dreamliner Woes?

 

The Boeing Dreamliner has many good things going for it. It is lighter, can travel long distances, is cheaper to operate (by 30%?), passengers are more comfortable, etc. Part of the weight reduction comes from not just cutting-edge composites in the fuselage and the body but also a bunch of innovations with electronics and associated systems to replace legacy hydraulics and pneumatics. 

A small part of that reduction in weight comes from using lithium-ion batteries, which are unfortunately prone to overheat and catch fire – which is what happened recently and grounded the entire Dreamliner fleet the world over. Before delving into that, let us take a small detour to see why the Dreamliner is such a strategic bet by Boeing on the future of flying and aviation. 

Airbus, Boeing’s principal competitor, thinks that the future of airlines and flying is a hub-and-spoke model. Gigantic aircraft fly between major population centers and airline hubs. Those hubs then ferry passengers to their final destinations on smaller planes. Its Airbus A380 is designed to ferry passengers between these mega hubs. 

Boeing on the other hand thinks that passengers will prefer flying from point A to point B and avoid the current hub-and-spoke model. So its 787 Dreamliner is designed to carry a lot of people efficiently and comfortably from one point to another that is up to 7000 miles away:

That means it (the Dreamliner) can fly nonstop routes that larger planes can’t profitably support, such as San Francisco to Manchester, England or Boston to Athens, Greece…“It’s going to be a hub-avoiding machine,” said Ernie Arvai, partner with aviation consulting firm AirInsight. “You’d pay extra not to go to (London’s) Heathrow.”

What this means is that both Boeing and Airbus have a lot riding on (in?) the 787 and the A380, respectively.

In 2011, Boeing was quite happy when, after numerous delays, the first Dreamliner was delivered to ANA (All Nippon Airways). The first commercial flight from Tokyo to Hong Kong on Oct 26, 2011 was deemed “Spectacular“. Most maiden Dreamliner flights for different airlines around the world had been garnering similar attention and praise. Ironically it was an emergency landing for an ANA Dreamliner (because of the lithium-ion battery catching fire) that triggered the current crisis, following, as it did, a battery unit catching fire in a parked Japan Airlines Dreamliner just a few days before that.

The subsequent grounding of the 787s is not good for either Boeing or various global airlines that must now use less efficient, older and more expensive (to operate) aircraft on the Dreamliner’s routes:

a. Boeing’s reputation (and the Dreamliner’s) takes a (big?) hit. So far, it hasn’t seen any massive cancellations hitting its order book, but the longer the FAA investigation and probe goes on, the higher the probability that customers balk at taking delivery of more such planes.

b. Airlines are going to lose some money, though it is possible that they may seek compensation from Boeing:

Mann estimates that airlines flying the Dreamliner will lose $2.5 million per aircraft for every month the model is out of service. ANA, which has the largest 787 fleet, with 17 currently in service, will be more severely affected. Here’s one projection, courtesy Reuters: ”Keeping the 787s on the ground could cost ANA alone more than $1.1 million a day, Mizuho Securities calculated, noting the Dreamliner was key to the airline’s growth strategy.”

Naturally, inquisitive minds want to know how Boeing and the Dreamliner got to this point. 

The three leading theories are:

a) Technology - The lightweight lithium-ion batteries used in the Dreamliners have a tendency to overheat and catch fire. But why did they use these batteries and not, say, Nickel-Cadmiums or others? Simple. Weight.

But then again, so many technologies in use by mankind today are safe only under very specific operating conditions. So as long as Boeing took adequate measures to assure that the batteries wouldn’t overheat, it would have been in the clear. Unfortunately for Boeing, that does not seem to be the case.

The latest here is that America’s FAA and Japan’s officials are pursuing slightly divergent investigative paths (while cooperating with each other though)

One facet of the effort led by experts from Tokyo appears to concentrate heavily on potential problems with the batteries themselves, while their counterparts in the U.S. seem more centered on possible hazards stemming from the manner in which the batteries interact with the plane’s novel electric grid.

It might take a while (or not) for the investigations to conclude, for the “root cause” to be identified and fixed. What must be frustrating is that in the 1.3 million hours of test flying, Boeing did not see (page 1, last paragraph) this problem even once. 

b) Outsourcing – An important sidebar for the lithium-ion technology discussion from above is that these batteries, the systems that charge the batteries and various other parts of the Dreamliner are made by a staggering array of globally dispersed suppliers.

According a CNN article, 45 companies supply the major parts and more than 100 supply the smaller ones, including the electronics. Sliced another way, 70% of the planes parts come from American suppliers and 30% from global suppliers. Now, one such supplier, the Japanese company “GS Yuasa” is under the microscope because it made the fire-catching batteries.

And this is where the outsourcing argument comes in. Those that blame aggressive and excessive outsourcing argue that while outsourcing may result in labor-cost savings in the short-term, in the long-term, outsourcing causes cost overruns, loss of design expertise and problems with quality. 

Links to various articles blaming outsourcing here, here, here (widely quoted LA Times article) and here. 

Those arguments certainly sound plausible…but it is rather difficult to blame outsourcing (only?) as the culprit. The nature of the airline industry over the last 10 – 15 years is such that global supply chains are the rule, not the exception. Suppliers in this industry include many venerable names with deep experience and expertise. Consider GS Yuasa. The company is no greenhorn. It is a 100+ year old company that has been in the battery making business for a long time (though Lithium-Ion batteries are relatively new for it). And Japanese companies in every vertical are known the world over for their QA/QC processes. 

What we can expect for sure is Boeing conducting a rigorous and thorough investigation into the outsourcing angle – not just because of the hundreds of unfulfilled Dreamliner orders but also because its operating model is at risk here. 

c) Bad Luck - Luck of course has a lot to do with this and at the same time very little to do with this. More than anything else, the timing is bad. New planes also experience many teething issues and the Dreamliner is no different…So while it still looks like Boeing has a hit on its hands with the Dreamliner, this is the kind of publicity that lingers in the public mind long after the underlying issues have long disappeared. 

If there is one thing Boeing must be happy about today, it must be diversification. Boeing’s 737 and 777 lines are “printing money” and it can’t make these planes fast enough to meet demand. Still, with its reputation, future sales and jobs at risk, it must be waiting for Dreamliners around the world to spend more time in the air and less time in their hangars. 

 

Options on Flight Tickets – Adventures and Innovations In The Travel Industry

Most airlines in the U.S. charge $150 to change a non-refundable flight ticket 24 hours after it is bought.

For business travelers and others that buy flexible tickets (often, by paying an extra $300 to $700 or more) these change fees don’t matter. But for leisure travelers whose plans change for any number of reasons after you buy your ticket - illness, work schedule changes, annoying friends and relatives that change plans or can’t commit to the group vacation that you had all agreed to, 12 months prior - $150 is a lot of money.

For a family of 4, that’s $150 times 4 = $600 down the drain, enough to encourage such families to drive 10 hours to get to a destination – where, as an added bonus, they get to drive their own car for the duration of their trip or vacation. Then again, if you live in Washington DC and are considering a trip to Seattle, Florence or Bangkok, clearly that’s not going to work. 

There is now some relief in sight in the form of “options” or insurance – where flyers can purchase flexibility and insure themselves against such such annoyances, thanks to start-ups such as BitBend and others (note though that (a) United Airlines is one airline that already offers similar protection albeit for 3 or 7 days only, at a time, in the form of its FareLock program and (b) Most airlines offer something called “Travel Insurance” for extenuating circumstances – something I’m not a big fan of…the fine print and the conditions are a turn-off).

On the face of it, this is a no-brainer and many people might pay $10, $20, $30 or even a hundred dollars to buy that flexibility based on the cost of the ticket.

As BitBend’s co-founder (the co-founders seem to have a background in currency/futures trading) eloquently states:

“If you’ve ever coordinated one of those ski trips or golf vacations with a group of friends, you know you can be the sucker who puts down the $500 for the flight and nobody goes,” said Heidi Brown, co-founder of BitBend, a startup fare lock-in service in Chicago.

and to that end, BitBend offers the ability to lock in fares for 3, 7, 14 or 21 days for varying prices.

SteadyFare offers something similar for departures from 3 cities for now, with a more Priceline-like twist:

…Not specifying an airline or flight time gives SteadyFare more choices of flights, ensuring it can book the ticket for those who exercise their options, he (the co-founder) said.

Unlike others, SteadyFare’s option is essentially a cap on airfare for two or four weeks. You won’t pay any more than your option specifies, but if prices drop, you’ll pay the lower price when you book. Another advantage is the ability to choose a range of departure and return dates.

(Above: A snapshot from Steadyfare.com for a JFK-DEN R/T in December)

But both The Economist and the Chicago Tribune (excerpted above) argue that while a market exists for these options, their appeal may be limited and imply that the flight ticket options market may always be confined to a very small niche. 

The Economist attributes this to

…The high fixed costs endemic in the airline industry explain why carriers are reluctant to give too much flexibility to passengers…

and the fact that these options collide with airlines’ ability to dynamically price their seats.

What that means is that, as we all know, air fares start creeping up as you get closer to the travel date. So if someone is “sitting on” an option to buy the ticket the airline doesn’t know if that person is going to ultimate buy that ticket (or “exercise that option”) or let the option expire. So that could wreak havoc on their supply-demand-pricing algorithms. 

Of course, like with anything else, time answers many things and we will find out soon how well these start-ups do.

Based on that we may actually see the airlines themselves offer these programs thanks to some kind of “Black Scholes for tickets” formula (which will be bad for these start-ups…what will these startups do that the airlines won’t be able to, by themselves, other than an improved formula?). The airlines have little to lose and potentially a lot to gain by letting these start-ups test the market, with the attendant investments and risk. 

Meanwhile, in a passenger friendly move, perhaps the airlines should start tinkering with their flat $150 change fee so that the “friendly skies” are a tad friendlier?

Airplanes: Everyday Deep Discounts

 

What does an airplane cost?

Half of whatever its listed at.

So says an enlightening article in the Wall Street Journal. But there is a veil of secrecy that makes it very, very hard to determine how much airlines or leasing companies actually pay.

Why? 

One reason for the secrecy surrounding all this, say industry officials, is psychology: Less-experienced plane buyers like to think they got a bargain and don’t want to be embarrassed if they overpaid. The safest approach then is silence. More-seasoned plane buyers also know that bragging about discount specifics would anger Airbus, Boeing or other producers and hurt the chances of striking a sweetheart deal again.

Other reasons of course are a combination of complex multi-year deals that involve airplanes, service, parts, etc., that could make the purchase price very, very different from the list price.

The full article (behind a paywall) lifts the veil a little more.