That same day Luca and I were visiting Hollywood and the Universal Studios theme park, and yes, you can imagine which t’shirt did I dress for the occasion: “I support piracy (of my movie)”.

El Cosmonauta in Hollywood (“I support piracy”)

PD: during the whole day I only got one comment from Universal’s staff .

This was my first long run and first race just 2 weeks after completing Rome marathon. I had only run 2 days between then and today, thus I took it more as a run in the nature than as a race, no stress from the departure. I even took the photo camera as I suspected I could take some nice pics.

The race consisted of 20km from Lavelanet to the castle and back, going as much as possible through the forest and as little as possible through paved roads (basically the first and last kilometres and little else). The rain of the previous days, of that precise morning and the passing of hundreds of runners left many of the paths impracticable, completely muddy and enabling the funniest situations.

Trail des Citadelles (20km) profile.

Before having completed the 2nd kilometre my running shoes and socks were already completely soaked. Before the 3rd kilometre we had been running through some stretches in which the feet were covered up to the ankles with mud (chop, chop, splash!).

I love trails for they put you in close contact with nature, the variety of their landscapes, the absence of time pressure; even if I acknowledge that I am not particularly good with difficult descents which require some technique and equipment that I lack of.

Today I missed some mountain sticks. At the starting line I saw many people with them. I wasn’t sure if it was because they would walk instead of run. Indeed. The thing is that I would also have to walk a lot, uphill, through rocks covered with very slippery mud. Only during the race I understood why they brought them. Between the 4th and 5th kilometre we started to walk uphill more than run, and it lasted like that for almost the next 7 kilometres.

Montségur castle from afar at the top of the mountain (notice the footprints in the mud). Picture taken at about km. 5

The mostly walking uphill took a full hour to cover about 5 kilometres to the bottom of the castle stairs.

Montségur castle from below.

Inside the castle.

The views from the castle are stunning. The picture below does not make enough justice so I took a panoramic video.

Views from the castle.

From the castle to the end of the race most of the time we would be descending. In theory, this should have made it easier. But that was only the theory. That is when the fun began (to call it that way).

The way down started with the same stairs of the castle, which we descended with much care. Then some hundreds of metres of going up and down over more or less dry surface and finally the same kind of very steep descent, sometimes along and others crossed by water flows, fully covered with slippery mud.

I lost count of how many times I slid without any control on the verge of falling down. I do keep count of the 5 times that these detours ended with me, my face, arms, whatever it was… in the mud. They were not especially painful, but left you with hands and face covered of mud, having to wash yourself in the next current of brownish water. Other times the sliding left you looking uphill to the wrong side of the race hands in the ground to prevent a full-blown fall. As I was not the only one going through this, you can get an idea of the image…

Eating at ~ km. 12.

Around the kilometre 11-12 there was the only point of supply so I did a little stop to drink some Coke, eat some chocolate, etc.

After this stop, the mix of sliding / running continued for about another kilometre until we entered a forest of pine trees where the ground was a bit drier. There I was happy as I started running faster, less worried about falling and more focused on keeping the pace… until I bent my ankle… the same ankle I strained 3 times during winter. That one was painful. I had to stop and walk for some 2-3 minutes to recover from it.

It was then that I took the camera to film another short video as an update of the race so far at 13.4 km (in Spanish):

The making of the video, the self-deprecating humour of the situation lifted my morale. I tried the ankle, which responded positively, so I started running again.

During the last 5 kilometres, more or less flat, even if still going at times through water flows or mud, I tried to enjoy running a little. I think it was only at this point that I was overtaking others instead of being overtaken . I discovered then that instead of avoiding water flows and poodles, it was indeed better going through them as their bottom used to be firmer. The guys of the organization took it seriously and somehow made us literally run along the river for about 200m! That was another high moment of the trail, which I recorded here (excuse my French):

When arriving at the village, one final sprint and done. I mean, done. 

Finish line.

My performance: 2h49’16″, 201 out of 366 finishing within the time given of 3h30′ (see Garmin records).

—

PD: All this happened in the 20 km race; bear in mind that at the same time 2 other races were taking place one of 40 km and one of 73 km (the runners having departed at 6am to run… 9 hours? 12?). My admiration to all those heroes.

I am very satisfied with the way I could train towards this marathon, no injuries this time.

Since running Berlin marathon last September 30th, I only stopped for a couple of weeks and swiftly started running again. Even if I started a bit late to pick up with the number of miles run per week (from mid December instead of mid November) I have amounted almost 800km in these last months, including:

• 5 days of tough series training: 12x400m, 14x400m, 8x800m, 9x800m and 10x800m.
• 7 long runs of over 16km each, 4 of them over 20km.
• 5 races: San Silvestre Vallecana (10km), Course des Rois (10km), Le Deca d’Escalquens (10km), Trailhounet (18km) and Media Maratón de La Latina (21km).

You can see below the mileage run per week:

Maratona di Roma 2013 training season. Kilometres run per week.

A lesson learned from previous training sessions: when I noticed that some muscle or tendon was getting sore from too much training I did not hesitate in slowing down that week, instead of keeping up with the training until getting seriously injured. Let’s see today how it goes, anyway, as Jaime says, it’ll sure be a day for the epic .

I wanted to bring forward some comments and two graphics:

• “To put matters into perspective, a single C-17 can carry the equivalent of 15 C-47 loads (as well as cargo that could never fit inside a C-47) and deliver that cargo anywhere in the world within hours without requiring en-route staging bases.”
• “The average cost of a flying hour over the past decade is around $23,000 (in constant FY11 dollars), compared to about $11,000 in 1985 and roughly $4,800 in 1970.”
• “For example, a single B-2 now armed with 80 Joint Direct Attack Munitions (JDAMs) could strike as many targets as five of the 75-aircraft 1991 Gulf War era packages.”

US Air Force fleet evolution 1950-2009.

US Air Force Airlift fleet, 1950-2009.

The keyword here is capability, not numbers.

I will come back to here in following posts.

Joe Nadol (JN) of JP Morgan: Is there pricing pressure?

Ray Conner (RC): I think margin will be OK [for 737NG]. Some initial launch deals for MAX can be a little more aggressive, but we’re seeing that become more stable.

JN: MAX–I thought pressure would be more on late NGs than on the MAX.

RC: We were a little late getting into the marketplace with MAX and there was pricing pressure on NGs. We were about a year late so we were more aggressive than we would have been had we not been late.

For the last years I have been trying to estimate averages for the discounts Boeing applies to its commercial aircraft using as departing information Boeing year-end financial results, list prices, net orders, deliveries and services revenues. You can see the results for 2012, 2011, 2010 and 2009. In each of the posts you can see a detailed explanation of the methodology I followed.

Why do I comment this? Since 2009 I have noticed that the average discount has gone from ~38% (2009), 39% (2010), 41% (2011) to 45% (2012)!!

Find below the explanation I could find for that hike in the discount:

The explanation I can find for that increase shall be linked the built-in penalties for 787 (net orders for 2012 being -12 a/c) and 747 delays (1 single net order) into revenues plus the launch of a new aircraft, 737 MAX (forced by A320neo sales success in 2011).

How does it compare to Conner’s words?

The first time was when a colleague shared the following article: “Bombardier CSeries: How will Boeing/Airbus Duopoly Respond?“.

The article is interesting as long as it tries to make a strategic analysis of the possible moves that Airbus would arguably have to make because of the entry into market of a new entrant (taking Boeing 737 strategy as similar to Airbus’). That theoretical exercise is… an exercise.

I found some arguments difficult to sustain:

• “Assuming that Bombardier effectively executes its 50% market-revenue capture“.
• “Bombardier CSeries aircraft is positioned as value advantaged in the commercial airplane manufacturing market space.  Since the CSeries offerings deliver superior value to customers relative to competitors at lower list prices, Bombardier’s go-to-market pricing strategy is consistent with a penetration pricing methodology.  Bombardier’s aggressive entry tactics for the CSeries aircraft offers a credible threat to existing Boeing and Airbus revenue.”
• “With over 382 commitments for CSeries aircraft“.

I must say that I am no expert in commercial aviation market, but from my point of view, here are some rebuttals:

• To start with, I would take as commitments only firm orders, of which the CSeries hasn’t got 382 to date, but 180 a/c (less than half).
• I would say that an aircraft is positioned or perceived as “value advantaged” when the market actually responds to that statement. See in the graphic below the market response to A320, 737 and CSeries since the launch of the CSeries program:

CSeries, 737 & A320 net orders and market shares.

In the table and graphic you can see that since the CSeries launch it started piling orders in 2009. If we compare its net orders to Airbus and Boeing ones in these years, the CSeries has captured a 3.2% of the market share, in contrast to 50.5% of Airbus A320 family and Boeing 737 46.4%. I would not derive from these figures that the CSeries is perceived as value advanted product.

It is curious to note how 737 and A320 families have been alternating market share lead year by year in the recent years.

• Finally, confessing that I do not know a dime about Bombardier’s entry tactics, I once read the following statement of Bombardier’s CEO Pierre Beaudoin:

“Price will go up also when delivery dates are confirmed, and we’re flying the aircraft. Whether we like it or not there is a Boeing discount. We’re being told [by our customers]: “We want 100 [aircraft], but because you won’t be on time, we want a discount.” I say, “Listen, we will be on time. We will be performing as promised. So, if you want to wait, wait.”

If I take that statement as truthful, and having myself estimated for years Boeing Commercial discounts, I would not describe Bombardier as “aggressive”.

As I said to my friend, rather than doing this strategic analysis about CSeries versus A320, I would have done it in the past about A320neo and 737, and now about A350 vs. 777 (where there must be really going this kind of analysis), take bold assumptions and check in a few years how the strategy of each company has evolved.

The second time was after this tweet from the aerospace analyst Scott Hamilton:

Bombardier expects 20-30 CSeries production yr 1, 120 by yr 3 1/2: earnings webcast. To reveal first production CSeries March 7—
Scott Hamilton (@LeehamNews) February 21, 2013

My impression, despite of Bombardier’s earnings webcast information, is that:

• if now firm orders stand at 180 a/c,
• if the plan to deliver 20-30 a/c in the 1st year and 120 a/c after 3.5 years
• if the customer interest, in comparison to A320neo or 737MAX, stays as it has been in previous years…

… the programme is closed by 2017 (1).

****

(1) A bold statement for my forecasting career, this one to be checked with some colleagues down the road.

Saucony’s: old Triumph 8 and new Triumph 9.

Let this short post be a tribute to the Triumph 8s, which have run to date over 770km, in several cities and countries, and including 6 races, among them a marathon and a half-marathon. A similar curriculum awaits the Triumph 9 pair: several races including 2 marathons and no less than 700 km in a few months.

Triumph 8s will live side by side with the 9s, as casual sport shoes from now on, instead of running shoes.

From this year’s letter, I wanted to comment on 3 things:

• Lesson on dividends’ policy
• Books
• Running

****

Dividends’ Policy

In my opinion the great lesson from this letter starts at page 18, when Warren explains the different ways a company has to allocate earnings. He makes a comparison between dividends and what he calls the “sell-off” scenario, where a shareholder can be better off when the company is not paying dividends and instead reinvesting all earnings while the shareholder sells part of his shares to obtain some cash.

See the explanation below (bit long):

“We’ll start by assuming that you and I are the equal owners of a business with $2 million of net worth. The business earns 12% on tangible net worth – $240,000 – and can reasonably expect to earn the same 12% on reinvested earnings. Furthermore, there are outsiders who always wish to buy into our business at 125% of net worth. Therefore, the value of what we each own is now $1.25 million.

You would like to have the two of us shareholders receive one-third of our company’s annual earnings and have two-thirds be reinvested. That plan, you feel, will nicely balance your needs for both current income and capital growth. So you suggest that we pay out $80,000 of current earnings and retain $160,000 to increase the future earnings of the business. In the first year, your dividend would be $40,000, and as earnings grew and the onethird payout was maintained, so too would your dividend. In total, dividends and stock value would increase 8% each year (12% earned on net worth less 4% of net worth paid out).

After ten years our company would have a net worth of $4,317,850 (the original $2 million compounded at 8%) and your dividend in the upcoming year would be $86,357. Each of us would have shares worth $2,698,656 (125% of our half of the company’s net worth). And we would live happily ever after – with dividends and the value of our stock continuing to grow at 8% annually.

There is an alternative approach, however, that would leave us even happier. Under this scenario, we would leave all earnings in the company and each sell 3.2% of our shares annually. Since the shares would be sold at 125% of book value, this approach would produce the same $40,000 of cash initially, a sum that would grow annually. Call this option the “sell-off” approach.

Under this “sell-off” scenario, the net worth of our company increases to $6,211,696 after ten years ($2 million compounded at 12%). Because we would be selling shares each year, our percentage ownership would have declined, and, after ten years, we would each own 36.12% of the business. Even so, your share of the net worth of the company at that time would be $2,243,540. And, remember, every dollar of net worth attributable to each of us can be sold for $1.25. Therefore, the market value of your remaining shares would be $2,804,425, about 4% greater than the value of your shares if we had followed the dividend approach.

Moreover, your annual cash receipts from the sell-off policy would now be running 4% more than you would have received under the dividend scenario. Voila! – you would have both more cash to spend annually and more capital value.”

As always, I believe that the best way is to make (play with) the numbers yourself, so you get to understand it once and for all. I paste here the numbers for those not being number-crunchers:

Buffett’s sell-off case vs. dividends.

Books

Over 2 years ago, I read Buffett’s biography “The Snowball: Warren Buffett and the Business of Life“, by Alice Schroeder (of which I wrote a post); it seems that I will have to get the newest one by Carol Loomis, “Tap Dancing to Work: Warren Buffett on Practically Everything“.

There is another book that I should read, according to the following passage in the letter:

“Above all, dividend policy should always be clear, consistent and rational. A capricious policy will confuse owners and drive away would-be investors. Phil Fisher put it wonderfully 54 years ago in Chapter 7 of his Common Stocks and Uncommon Profits, a book that ranks behind only The Intelligent Investor and the 1940 edition of Security Analysis in the all-time-best list for the serious investor. Phil explained that you can successfully run a restaurant that serves hamburgers or, alternatively, one that features Chinese food. But you can’t switch capriciously between the two and retain the fans of either.”

I’ve got all three books in the shelf since 5 years ago, it’s a shame that I have not yet read or gone through the first one!

Running

I found one final surprising and hilarious passage at the end of the letter embedded in the information related to the shareholders meeting:

“On Sunday at 8 a.m., we will initiate the “Berkshire 5K,” a race starting at the CenturyLink. Full details for participating will be included in the Visitor’s Guide that you will receive with your credentials for the meeting. We will have plenty of categories for competition, including one for the media. (It will be fun to report on their performance.) Regretfully, I will forego running; someone has to man the starting gun.

I should warn you that we have a lot of home-grown talent. Ted Weschler has run the marathon in 3:01. Jim Weber, Brooks’ dynamic CEO, is another speedster with a 3:31 best. Todd Combs specializes in the triathlon, but has been clocked at 22 minutes in the 5K.
That, however, is just the beginning: Our directors are also fleet of foot (that is, some of our directors are).

Steve Burke has run an amazing 2:39 Boston marathon. (It’s a family thing; his wife, Gretchen, finished the New York marathon in 3:25.) Charlotte Guyman’s best is 3:37, and Sue Decker crossed the tape in New York in 3:36. Charlie did not return his questionnaire.”

I would have loved to take part in that race. I will probably do so in some other year .

Final confession

Luca and I went a couple of years ago to Berkshire Shareholder meeting. This year’s meeting will take place on May 4th.

This year, Luca and I will get married on May 11th, but one of the dates we considered was April 27th, and one of the drivers behind it was to be able to attend 2013 BRK meeting during the honeymoon…

“The KC-46 program 2012 estimates for cost, schedule, and performance are virtually the same as last year’s, with the contractor running very close to the planned budget and schedule”.

On the technical side it points to several challenges: flight test plan, completion of engineering drawings, relocation of personnel and facilities related to defense equipment, etc.

However, in this post I wanted to focus only on the costs and contractual sides of the program, given the amount of articles that we could read about it during the past year. Several news have reported about the cost overruns in the program and about how these were to be born by Boeing.

The last time I read about the topic, the reported overrun was of about 1.2bn$ on a 4.4bn$ contract, out of which ~500M$ would be born by USAF and the remaining 700 M$ by Boeing (see articles from Bloomberg, Aviation Week, The Seattle Times…).

But, where do these figures come from?

One of the many things I like of the USA is the transparency in making lots of information and data available to the public, for example, budgeting information of the Air Force, GAO’s assessments, hearings at the Senate and House of Representatives Committees, etc. Thus, you can find:

• FY2013 budgeting information from the US Air Force KC-46 program  here [PDF, 29 MB, from page 671].
• GAO’s assessments on selected weapon programs [PDF, 14 MB]. 
• Department of Defense (DoD) Program Acquisition Costs by Weapon System [PDF, 8 MB].

Contractual framework

From the USAF budgeting material, page 675, under the paragraph “E. Acquisition Strategy“, the explanation of the different contracts structure for the KC-X program (the name of the program prior to the contract award) can be found:

“The KC-46 program released a final Request for Proposal (RFP) on 24 Feb 2010, and entered source selection on 9 Jul 2010. The KC-46 program held a Milestone B Defense Acquisition Board (DAB) on 23 Feb 2011, received approval to enter EMD from OSD AT&L on 24 Feb 2011, and awarded the KC-46 contract to Boeing on 24 Feb 2011 to develop and procure 179 KC-46 aircraft. The KC-46 contract procurement was conducted via a full and open competition per Federal Acquisition Regulation (FAR) Part 15, and resulted in a FY 2011 EMD Fixed Price Incentive Firm (FPIF) contract. The EMD phase will develop, build, and test four KC-46 aircraft, and will qualify receiver aircraft.

Production will begin in FY 2015 with two Low-Rate Initial Production (LRIP) lots (Firm Fixed Priced (FFP)) and then Full-Rate Production (FRP) options (FFP with Not to Exceed (NTE) + Economic Price Adjustment (EPA)). The LRIP and FRP options will be exercised following successful completion of Operational Assessments (OAs) for the LRIP decisions, and a successful completion of Initial Operational Test and Evaluation (IOT&E) for the FRP decision.”

Thus, so far only the Engineering Manufacturing and Development (EMD) contract  phase has been contracted, on February 24th Feb 2011 (you can see Boeing and DoD press releases).

Cost Assessment by GAO:

From the Government Accountability Office (GAO) assessment of the program, referred above:

“The current development cost estimate of $7.2 billion as reported in October 2012 includes $4.9 billion for the aircraft development contract and 4 test aircraft, $0.3 billion for the aircrew and maintenance training systems, and $2 billion for other government costs to include program office support, government test and evaluation support, contract performance risk, and other development risks associated with the aircraft and training systems. [...]

Through December 2012, Boeing has accomplished approximately $1.4 billion (28 percent) in development work and has more than $3.5 billion (72 percent) in estimated work to go over the next 5 years. [...]

Barring any changes to KC-46 requirements by the Air Force, the contract specifies a target price of $4.4 billion and a ceiling price of $4.9 billion at which point Boeing must assume responsibility for all additional costs. [...]“

See the table below showing Air Force and Boeing contract amounts and estimates:

KC-46 EMD Contract & Estimates (Source: GAO).

The report from GAO offers the following graphic referring to what they call “management reserves“:

KC-46 EMD Management Reserves (Source: GAO)

This graphic shows well the rate at which Boeing has been supposedly burning its margins. However, it does not reflect at all the nature of the issue, related to the type of contract this “Engineering Manufacturing and Development” (EMD) contract: a Fixed Price plus Incentive Firm type of contract (FPIF).

Fixed Price Incentive Firm contracts

It is not easy to find good literature online about these types of contracts. The Wikipedia for instance does not have yet an article on FPIF contracts, but only on the calculation of the Point of Total Assumption. However, you can find a couple of good sites with explanations and examples of FPIF contracts here and here [PDF from the US Army].

Some concepts that we need to bear in mind are (definitions from the link above):

Target Cost (TC): The initially negotiated figure for estimated contract costs and the point at which profit pivots.
Target Profit (TP): The initially negotiated profit at the target cos
Target Price: Target cost-plus the target profit.
Ceiling Price (CP): Stated as a percent of the target cost, this is the maximum price the government expects to pay. Once this amount is reached, the contractor pays all remaining costs for the original work.
Share Ratio (SR): The government/contractor sharing ratio for cost savings or cost overruns that will increase or decrease the actual profit. The government percentage is listed first and the terms used are “government share” and “contractor share.” For example, on an 80/20 share ratio, the government’s share is 80 percent and the contractor’s share is 20 percent.
Point of Total Assumption (PTA): The point where cost increases that exceed the target cost are no longer shared by the government according to the share ratio. At this point, the contractor’s profit is reduced one dollar for every additional dollar of cost. The PTA is calculated with the following formula. [thus, PTA = (Ceiling Price - Target Price)/Government Share + Target Cost]

Where can we get these figures for the KC-46 EMD contract? Some of them are referred to in the different reports and budgeting materials (explicitly or implicitly) and others can be found in the following letter from US Senator John McCain to the DoD from July, 15 2011 [PDF, 400 KB].

Thus for the KC-46 EMD contract we have:

• Target Cost: 3.9 bn$.
• Target Profit: 500 M$.
• Target Price: 4.4 bn$
• Ceiling Price: 4.9 bn$
• Share Ratio: 60% / 40% (Government / Boeing).
• Point of Total Assumption (calculated): ~4.73 bn$.

With this information we can produce the typical FPIF contract curve, which is the only thing which is missing in ALL the news, budgeting materials, GAO reports, etc., that I have read and is the most illustrative graphic to understand what is going to happen if the cost overruns keep piling and who is going to bear which amount of the cost from which point:

KC-46 EMD FPIF Contract.

On average, how loaded do US Air Force transport aircraft, C-130 Hercules and C-17 Globemaster, operate? (as a percentage of their maximum payload capacity: let’s take the figures reported by the US Air Force, ~16.5 tonnes for the C-130 -”maximum normal payload”-and 77.5 tonnes for the C-17)

Before continuing reading below, take your chance in the poll below, where I offer 4 possible responses: 3 from my colleagues’ responses to the quiz plus the correct one:

Background. Before posing the quiz to my colleagues we were commenting on a piece of news of an Antonov 124 which had landed in Spain to load some equipment weighing 1,000 kg. The An-124 reported payload capacity is 150 metric tonnes. For those not being number-crunchers: that means using the one of the biggest cargo aircraft to load it up to 0.7% of its capacity.

After having read this last paragraph you may have changed your opinion as to which is the correct answer to the quiz.

I based the correct result on a news release from the US Air Force dating from the beginning of 2007. At that time I was working in Airbus Military strategy where I would like to pick up any number related to aircraft and play with it (the hobby has stayed). That release offered figures US Central Command air transport operations, including operations Enduring Freedom (Afghanistan) and Iraqi Freedom. Find the results from that short number play:

US Air Force average loads (in tonnes) for C-130 and C-17 during 2005 and 2006.

If you do the math, you will immediately get the right answer: C-130 Hercules, 22% and C-17 Globemaster, 17%.

“What a waste of resources!” you may think. A former senior colleague pointed to that result: “You buy a Mercedes to travel with the family and baggage, then on a Sunday when having to go out to get some bread or any week day when you go alone to work… when you get to the garage and find a Mercedes… Guess which car you take?”