Strategies in Enterprise Ecology: Symbiotic Models for Commercial Aviation as an Enterprise of Enterprises Sgouris Sgouridis and Prof. Joseph Sussman Engineering Systems Division Massachusetts Institute of Technology Research Presentation LAI Conference Cambridge, MD April, 19 th 2007 1
Agenda Hypotheses Background Commercial Aviation Cycles Enterprises and business cycles A framework: Enterprise of Enterprises Modeling Enterprise of Enterprises Countercyclical strategies and symbiosis i 2
Hypotheses Cyclical instability characterizes the Commercial Aviation EoE. Cyclicality is costly to the industries involved and society. There are feasible strategies that can dampen the cycles in a longterm Pareto efficient manner. 3
Business Cycles? World Airlines Operating Results and Orders 7,000.00 900 5,000.00 700 500 300000 3,000.00 300 1,000.00 100 1,000.00 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 100 3,000.00 300000 5,000.00 Airline operating results Narrow body orders Widebody orders 300 500 700 7,000.00 900 Shipbuilding in tons for Norwegian Ship Owners (18831913) [Source: Einarsen 1938] 4
Commercial Aviation Cyclicality (hi)story Global Demand for Air Travel in Billion RPKs 35% 4,000 demand in RPK 30% 3,500 3,000 25% 2,500 20% 2,000 15% 1,500 10% 1,000 5% 500 0% 0 5% global gdp Poly. (demand in RPK) Thousands 1960 1960 1961 19 1962 1963 19 1964 1965 19 1966 1967 19 1968 1969 19 1970 1971 1972 1972 1973 1974 1974 1975 1976 1976 1977 1978 1978 1979 1980 1980 1981 1982 1982 1983 1984 1984 1985 1986 1986 1987 1988 1988 1989 1990 1990 1991 1992 1992 1993 1994 1994 1995 1996 1996 1997 1998 1998 1999 2000 2002 2004 4,000 4,000.00 3,000 3,000.00 2,000 2,000.00 1,000 1,000.00 0 0.00 4,000.00 4 NetProfit 300 Seat NetProf Deliveries it 300000 Seat Seat Orders Orders 250 Narrow Delivered 250000 Wide Delivered 200 200000 1,000.00 150000 100 2,000.00 100000 3,000.00 50 150 1960 1960 1961 1961 1962 1962 1963 1963 1964 1964 1965 1965 1966 1966 1967 1967 1968 1968 1969 1969 1970 1970 1971 1971 1972 1972 1973 1973 1974 1974 1975 1975 1976 1976 1977 1977 1978 1978 1979 1979 1980 1980 1981 1981 1982 1983 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1998 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 5,000.00 5,000 6,000.00 0 6,000 50 50000 0 5
Enabling Factors for Cyclicality in CA Triggers Endogenou us Disruptive technologies Technical regulations Input shocks Demand shocks Reinvestment cycle Intertemporal substitution Bullwhip in supply chains, labor, and inventory Jets, 2pilot cockpit, fuel efficient designs, product families etc. Noise abatement, stage 2,3,4 aircraft Fuel prices, materials, interest rates Iraq war I, 9/11, SARS etc. Aircraft as large capital investment with limited but adjustable lifetime Long lead times for both labor and capital.irreversibility Industry characteristics Scale economies and large investment in upfront R&D incentivize airframe mfg. to promote their wares aggressively in short term Low marginal costs for airlines Market regulations Decisionmaking Financing volatility Deregulation combined with imperfect financing allows multiple entrants. Subsidies, bankruptcy protections, and national pride policies retain players in weak markets Bounded rationality and strategic optimism create overreaction by multiple entrants. Large number of decision makers. Debt and equity financing available in economic upturns lowers barriers to entry BUT dries quickly in downturns increasing risk of price wars. Shortterm returns can be overemphasized over longterm stability. 6
Investme ent Retur n Framework: the Commercial Aviation Enterprise of Enterprises Capital Markets Leasing Companies Revenue e Aircraft t Aircraft Flexibilit t ty Revenue e Suppliers Labor Spillovers Modules R&D Stability Revenue Airframe Integrators Labor Spillovers Defense Subsidies Price Aircraft qualities Orders Revenue Airlines Airlines Airlines Labor Defense Subsidies Regulations Fare Demand Revenue Passengers and Shippers Safety Economic Activity Government 7
Narrowbody division SDM CA EoE Demand Forecast Airframe Revenues Profits Airline industry Demand Mfg. A Demand Price? Expenses Additions Narrowbody Utilization Current Demand Forecast Widebody division Revenues Profits Economic and Demand Price? Expenses Additions external factors Narrowbody division Demand Forecast Current Utilization Widebody Airframe Mfg. B Demand Price? Revenues Utilization Expenses Profits Current Additions Widebody division Based on H.B. Weil s airline industry model (1996) Developed further in collaboration with Jijun and Josh. Using Anylogic Price Revenues Demand Expenses Profits Demand Forecast? Utilization Current Orders 8
SDM Calibration: Demand and Period: 19842025 Green: Observed (until 2005, Data source: ATA) Red: Simulated 9
Strategy Experiments 1. Identify value functions of stakeholders 2. Quantify and weight value functions. Formulate as mutliobjective optimization 3. Identify strategic alternatives and strategic bundles 4. Identify future scenarios to establish parameter values 5. Execute the model by varying the strategic bundles (inputs) across scenarios 6. Compare the results and select the strategic bundles with robust performance 7. Qualitatively study the implementability of each bundle 10
1. Value propositions and Metrics Stakeholder Values Metrics Availability of air travel Average ASK/year Passenger/ Affordability of air travel Undiscounted average fare Shipper Service of air travel Frequency, amenities (load factors as proxy) Economic/investment return Economic Value Added (EVA: Op. Profit Taxes Cost of Capital) Discounted to NPV Carriers Stability of return Standard deviation from trend Minimum time in Average time with return less than target recession Airframe Mfgs. Same as carriers Capital Combination of carriers Metrics above markets and airframe manufacturers returns maximized and stable Governments Availability of air travel Metrics above Returns of domestic champions Metrics above 11
2. Value Functions in the CA EoE as Multiobjective Optimization* Stakeholder Passenger/ Shipper Carriers Airframe Mfgs. Capital markets Governments Values Availability of air travel Affordability of air travel Service of air travel Economic/investment return Stability of return Minimum time in recession Combination of carriers and airframe manufacturers returns maximized and stable Availability of air travel Returns of domestic champions * Anylogic & OptQuest use tabu search algorithms to perform the optimization 12
3. Airline Potential Strategic Areas Strategic Area Leasing Profitsharing programs Good mix of ages in the fleet Offcyclical behavior (buy low, sell high) Steady ordering and flexible retirement Longterm profitbased planning Less aggressive revenue management Mergers Tempered expectations Desired effect Flexibility. Reduces fixed capacity costs. Flexibility. Reduces labor costs during hard times. Flexibility. Old amortized aircraft can be retired or parked without penalty on fixed costs. Bullwhip reduction. Individual airline bottom line boost. Bullwhip reduction. Bullwhip reduction. Compared to shortterm profitbased vs. marketshare based planning. Bullwhip reduction. Marginal costs of seats are not zero holding off price wars. Number of players. Consolidating capacity will increase market power and reduce excessive capacity. Decision making. Reducing irrational exuberance. 13
3. Airframe Manufacturers Strategic Areas Strategic Area Pricing Ordering Standardize aircraft.design Flybythehour aircraft services. New aircraft family release timing. i Production capacity management. delivery lead times. Production and development costs (lean improvements) Desired Effect Bullwhip reduction. Procyclical pricing vs. stable pricing. Need based delivery: Auctioning production slots. Flexibility. Allowing family orders with specification of size later in time. Order cancellation policies Order vetting. Flexibility. Stronger second hand and leasing markets. Facilitate quick postmanufacture customization (custom color schemes). Transformation from aircraft manufacturer to service provider: Flybythehour aircraft services. Cycle dampening. Follow the reinvestment cycle. Cycle dampening. Allow backlogs to build before new production facility is established. Bullwhip reduction. effects are felt faster. inflow is more stable. Flexible production. Bullwhip reduction. Lower capacity costs and higher profit margins. 14
Next Steps Formulate experiments (DOE) Run experiments Draw conclusions and consider the implementability of the bundles of strategic alternatives 15