Warren Buffett wrote in one of his recent annual letters to Berkshire shareholders that:
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.
So curiously enough, building airplanes — unlike operating them — are a tremendous market. In fact, over the next 20 years, the portion of the market that consists of single and twin aisle jets of over 100 seats will amount to over $4 trillion dollars of revenue (so, $2oo billion a year if the revenues were smoothed out over the period). Virtually, all of this revenue is earned today by Boeing and Airbus.
Unlike airlines, drawing repeat entrepreneurs enamored with the long past glory of flying, entering the business of creating jets has proven to be almost impossible. This is despite the huge revenues and profits potentially available. Unsurprisingly, the cost of building an airplane platform is expensive, at least $10 billion. Other features of the market make that an even more unappealing investment, beyond its magnitude. First, airlines gain huge discounts by purchasing huge orders of planes a decade or two in advance, thus leaving little business for a new entrant to compete for, even if enters with a next-generation plane. Two, there is an incredible safety hurdle to overcome, and there would be a “bet the business” risk for an airline to purchase a plane from a new entrant and, consequently, suffer a crash.
The best candidate for breaking through the duopoly is Chinese state-controlled Comac. Money is no object as becoming a serious player in the industry is a further sign of validation of the Chinese state as a power, so budget and balance sheets are not a constraint. Also, growing Chinese airlines present a huge almost-captive market for Comac for beginning to gain the sales and safety record it needs to gain credibility outside China. That said, it will still be a massive risk for Western airlines to turn to Comac. The Chinese have made in-roads in other sensitive industries (see this week’s Economist article on Huawei, in telecommunications equipment, for example) in a short period of time, but airplanes are highly visible and passenger safety is an emotional issue, so this one may be different.
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