Monthly Archives: July 2010

Monkey Investors

Just a few weeks ago I wrote a post about the Wall Street Monkey. Remember that the story was based on Burton G. Malkiel’s book, “A Random Walk Down Wall Street”, where he suggested that a blindfolded monkey throwing darts to select stocks wouldn’t do worse than professional fund managers.

I watched yesterday TED Talk by Laurie Santos, “A monkey economy as irrational as ours”, where she explains how she studied whether our mistakes were due to a badly designed environment or badly designed minds.

She made several studies with apes, introducing the use of money to them… and she found that apes show the same irrational behaviours regarding risk taking as we humans do…

I loved especially the following passage around minute 16:30…

“… we can actually give the monkeys a financial currency and they do very similar things we do. They do some of the smart things we do, some of the kind of not so nice things we do like stealing and so on… but they also do some of the irrational things we do; they systematically get things wrong and in the same ways that we do.

This is the first take-on message of the top… if you saw the beginning of this and you thought: “…oh! until I go home and hire and put a monkey as financial advisor … they were cuter than ours…”, don’t do that: they’re probably gonna be just as dumb as the human one you already have!

At least, apes would charge us less… just a couple of grapes.

“A monkey economy as irrational as ours”, by Laurie Santos.

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Nimrod: endless development, never delivering

Aerospace and Defence programmes are formidable undertakings full of complex developments, new technologies, changing requirements that make them difficult to manage and keep in control. This is not new and lead Norman Augustine to write his famous “Augustine’s Laws” of which I already wrote a post in this blog.

Few months ago I was having lunch with my colleagues while we were discussing about some current defence programmes with sound cost overruns and delays. One of us challenged the rest with the question of what was the programme in the direst situation. Among the answers came the British Nimrod Maritime, Reconnaissance and Attack (MRA) Mk 4 aircraft programme.

The programme called for the upgrade of existing Mk 2 aircraft. The upgrade involves extensive (80%) reconstruction of the airframe, plus incorporation of many new components, including engines, wings, landing gear and general systems, as well as new flight deck and detection systems. The contract was awarded in January 1997. The original order was for 21 aircraft.

Nimrod modifications.

One of my colleagues jokingly said “that programme is just the perfection of the British A&D business model: charging money to the tax payers without delivering a single aircraft, being paid simply for developing”. We all laughed at the comment, sure.

In 2002 the contract was reduced to 18 aircraft. In 2004 the in-service fleet requirement was reduced to 12 aircraft, including the 3 prototypes. By 2008 BAE had only been contracted to for 9 aircraft in addition to the development contract. In 2009 the Defence Equipment Minister announced that it was not necessary to upgrade the 3 development aircraft.

When first ordered the programme had an estimated cost of 2 billion pounds; by 2006 the estimation was of ~3.8 billion pounds (+90%). When ordered the first delivery to the Royal Air Force (RAF) was scheduled for 2001, with the Initial Operational Capability (IOC) in 2003, on the delivery of the 7th aircraft.

BAE Nimrod.

Last week we could read in the British press that the air force chiefs to the Strategic Defence and Security Review had proposed to cancel the Nimrod programme in order save money under current budgetary pressures. The measure would “only” save now 200 million pounds, as most of the development and acquisition costs (~95%) have already been paid. The savings would come in the longer term, due to the saving of operation and support costs related to that fleet.

If this cancellation becomes effective, that would be consummation of that model: being paid (180% of initially estimated costs) for developing of a fleet of aircraft (along a period twice as long as initially expected) to end up not having to deliver those aircraft (not 21, not 18, not 12, not 9… not a single one).

Aside from this humorous note, that would be a very sad happening for BAE engineers, managers and technicians.

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World War III

Beginning of June I bought at Schiphol airport the book “The Next 100 Years; A Forecast for the 21st Century”, by George Friedman (author of “America’s Secret War”). I receive sometimes at the job reports and articles by Stratfor, the intelligence and forecasting firm that George Friedman founded. This was one of the reasons that raised my attention, the other were the headlines that could be read in the front page “2020: China Fragments”, “2050: Global war”…

Cover of "The Next 100 Years".

Friedman’s book tells us that when thinking about geopolitics we should be aware of:

  • Experience tells us that we should expect the unexpected.
  • We should not be confused by passing chaos and cyclical crisis.
  • Humans and countries are not that free when taking decisions, but they see limited their options by several constrains. He goes looking for such constrains.

If he had written the book in 1900 he would have pinpointed the following three things as defining for the century:

  • Collapse of European Imperial System
  • Quadrupling of World’s population
  • Revolution in transportation & communications.

Now, at the beginning of the XXI century he guesses the three defining issues will be:

  • The rise of American power
  • The end of the population explosion
  • The development of technologies to deal with a declining population.

You may wonder “the rise of American power?”, yes he makes the case that North American power has just started and it’s here to last: technology, economic power, control of the World’s seas (US Navy), military power, access to both Atlantic and Pacific oceans…

As he says, the USA “had the ultimate aim of preventing any major power in Eurasia. The paradox, however, is as follows: the goal of these interventions was never to achieve something –whatever the political rhetoric might have said- but to prevent something. […] Its goal was not to stabilize but to destabilize. […] The USA has no interest in winning a war outright.”

With this in mind, he explores what may happen in the next hundred years: Russia trying to reassert  itself, China fragmenting, Poland, Turkey & Japan as rising powers, some of them starting a global war, space-based power generation, Mexico challenging the US…

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Boeing forecast for A380

The last two issues of Boeing’s Current Market Outlook, included a slide in which Boeing wanted to prove that their forecasts have been more accurate in the last 10 years. They compare actual aircraft demand versus both Airbus and Boeing forecasts in the year 2000.

Boeing Current Market Outlook, different views.

I find it interesting that all segments are described as such, segments: “Single-aisle”, “Twin-aisle”, “Large”… except for Airbus forecast in which Boeing introduces the model “A380”. As if wanting to point that Airbus was wrong in its A380 forecast… as if wanting to steer demand.

Let’s see the numbers:

  • Actual demand (2000-09): ~300 aircraft.
  • Boeing forecast (2000-19): ~700 aircraft, assuming equal split (among the 2 decades): ~350 a/c in 2000-09.
  • Airbus forecast (2000-19): ~1,300 aircraft, assuming equal split: ~650 a/c in 2000-09 (although A380 first flight took place only in April 2005).

As of today, Airbus has sold 234 A380s, including the latest 32 from Emirates. The prospects for the aircraft seem brighter as operators started operating it, on the other hand Boeing 747-8 orders have stalled since 2007.

A bit of history.

Yesterday, I was digging into back materials and I found two interesting pieces. Both from Boeing’s website in the year 1996 (using the way back machine). The first one is from a webpage about delivering value it could be read:

“In an industry defined by continual change, customers expect Boeing to help them prepare for the challenges ahead. That’s why we work closely with customers to understand their long-term requirements.

Customers have expressed interest in many potential airplanes, including:

  • An airplane smaller than the 737-600, seating 80 to 100 passengers.
  • An airplane larger than today’s 747-400.
  • A capable and cost-effective supersonic jetliner.
  • Derivatives of current models.”

Of those potential airplanes: we have seen the Embraer 190, the Airbus A380, derivatives and the only one that never came true was the supersonic jetliner

Artist image of Boeing Sonic Cruiser.

The other piece is from a news release on the occasion of the Farnborough air show of 1996 (2010 edition is taking place right now). There, Boeing stated:

Most major aerospace companies agree that airlines will require 500 to 700 airplanes capable of carrying more than 500 passengers. Boeing forecasts 500 airplanes will be needed by the year 2015.

Much of the demand for these very large airplanes will be generated by steady growth in air travel to and from Asia, and by capacity constraints at some of the world’s largest airports.

The 747-600X, with its ability to carry 548 passengers on routes up to 7,750 nautical miles (8,900 statute miles or 14,350 km), is designed to fill this market need. It will allow airlines to accommodate traffic growth without increasing the number of departures scheduled for busy airports.

During the next 20 years, airlines also will need approximately 600 airplanes capable of carrying between 400 and 500 passengers.

The Boeing 747-400 and 747-500X are designed to fill this market need.”

At this point it is useful to remember that in 1993 Boeing together with Airbus consortium companies started the feasibility study for the Very Large Commercial Transport (VLCT). Boeing left the joint study two years later. Nevertheless, still in 1996 it stated in its website that demand of aircraft carrying above 400 seats (747 and A380 of today) in the following 20 years would be between 1,100-1,300 planes, very close to Airbus forecast of the year 2000. The reasons behind that demand were the same Airbus argues nowadays: growth in Asia, constrains in largest hubs…

Later on, Boeing changed its forecast down to 700 aircraft.

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The Best Advice I Ever Received…

Although probably the best pieces of advice I have ever received came from my parents and they were many, I am going to quote two others:

The one that changed viewpoint the most: “Within the work in a company, 70% of it is human relationships” (given by a teacher of an MBA I took at EOI in Seville).

The one I like to quote often: “The pats on the back, rather in cash” (given by a colleague, former teacher in the same MBA).

Side note: “Plinky” is a service I found one day proposed by WordPress. They suggest daily topics to write about in your blog, in case you lack ideas. I find some of the suggestions interesting and this is why you will see this kind of posts from time to time.

Powered by Plinky

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Aircraft discounts and new entrants

Boeing has recently unveiled its latest Current Market Outlook (CMO): a commercial aviation market forecast for the next 20 years. It calls for 30,900 new aircraft deliveries worth 3.6 trillion dollars. Today, I wanted to write about aircraft discounts and the possibility of having new entrants.

Boeing Current Market Outlook.

Both Boeing and Airbus give their market forecast and backlog figures in what they call as list prices. If you take figures from CMO, you will reach average list prices for regional jets (31M$), single-aisle (79M$), twin-aisle (230M$) and large aircraft (306M$). These figures are in accordance to the prices published in their website (dating from 2008).

However, if you take their published numbers of deliveries each year and use the same prices, you would come to much higher revenues figures than the ones they publish in the year-end results: this is because aircraft makers actually sell the planes at a much lower price. How much lower?

Discounts

I took the figures of revenues, orders and deliveries of the last three years and tried to reach what would be the corresponding discount Boeing’s customers manage to get on average.

I assumed that new orders come with a 3% down payment in the year of the booking, while the remaining cost I assumed that was paid on the year of delivery (for simplicity I didn’t consider more intermediate payments, the 3% figure was taken from the AIAA paper “A Hierarchical Aircraft Life Cycle Cost Analysis Model” by William J. Marx et al.). I also used estimated figures for Boeing Commercial Aviation Services ranging from 2.2bn$ to 3.3bn$.

With these assumptions, I concluded that the average discount that would best replicate revenues figures for Boeing Commercial Airplanes with a minimum error was: 38%! (being the errors in revenues of: 0.05% for 2009, 3.2% for 2008 and 0.5% for 2007).

Thus, when figuring out the value of those 30,900 aircraft we could rather estimate it at 2.2 trillion dollars (instead of 3.6 trn$).

New entrants?

Randy Tinseth, BCA’s VP Marketing, was quoted in Flight Global saying that he expected at least one more competitor in the single-aisle segment. If there are more competitors, competition is going to be tight.

Today Boeing Commercial Airplanes and Airbus Commercial yearly revenues together approximately account for 70bn$. If their revenues are to grow with Boeing’s forecasted world airplane fleet growth of 3.3%, along the next 20 years the revenues of both companies combined would amount to 1.94 trillion dollars.

Considering that the whole market, factoring in discounted prices, was going to be 2.2 trn$, this leaves the rest of competitors a share of the pie of about 250bn$ for the next 20 years (excluding regional jets), this is just 11.4% of the market.

If we look at it on a per year basis: 12.5bn$ a year for all new entrants (CSeries, Embraer, MS-21, SSJ, C919, Koreans, Japanese…) would mean about 250 aircraft a year (compared to the ~380-400 single-aisle that each Boeing and Airbus are delivering per year).

There is room for one commercial success comparable to the 737 or A320 family, but there is not room for two… maybe this is why Randy says “one or two of those guys into the mix” (despite of the many more new possible players).

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Project managers and Pencils

Today I was attending a project management course at Airbus. After some introductions, the teacher came to the always controversial (within such a technological company) comment that “the project leader needs to have experience in project management not in the technical issues related to the project”… she then cited aircraft as an example: “nobody within Airbus may know every technical detail of an aircraft which counts with hundreds of thousands parts, yet there is someone managing its development…”

That example seems very clear. Tonight, while listening to a TED Talk on the exchange of ideas, by Matt Ridley, I got the thread to a way better example: that is the essay “I, Pencil: My Family Tree as told to Leonard E. Read” by Leonard E. Read, which can be found at the Library of Economics and Liberty.

I believe this a much better example because of exactly the same reasons Mr. Pencil gives:

“[…] I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

[…] Simple? Yet, not a single person on the face of this earth knows how to make me.”

Then, the pencil goes explaining where all its components are coming from…

“[…] My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern California and Oregon. Now contemplate all the saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors…”

If it’s clear that nobody knows how to make simple pencil, clearer will be for any other case of a more complex product.

There is indeed a Mr. President of the pencil company, there may even be a Pencil Programme Manager, but as Pencil says: “There is a fact still more astounding: the absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being.”

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