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Warren Buffet has some quote on capital intensive industries like you say. "The worst sort of business is one that grows rapidly, requires significant capital

by gen220 4y ago

Warren Buffet has some quote on capital intensive industries like you say. "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." [1] The last sentence is a sarcastic quip, for those who aren't familiar with his personality. [1]: warning, pdf link: https://www.berkshirehathaway.com/letters/2007ltr.pdf https://www.berkshirehathaway.com/letters/2007ltr.pdf

snake_doc 4y ago
I don’t think he’s particularly concerned with capital. It’s the lack of competitive advantage that is key. Insurance (the classic financial services industry that is Buffet’s life blood) is one of the most capital intensive industries. Airlines lack substantial economies of scale, customer captivity, captive supply, or regulatory protections. The airline industry is a textbook case of an industry with no durable competitive advantages, thus the only performance factor is operational efficiency. Insurance on the other hand, there are substantial economies of scale (large fixed costs and also larger insurance companies are more diversified thus less costly/risky) and high customer captivity (high switching cost, high search cost).
- gen220 4y ago
  You're right! I was lazy with my words, it's definitely the durability that he's concerned with. The word durable, from the quote, is even emphasized in the original text.
- nradov 4y ago
  Airlines have huge economies of scale due to network effects. Most customers will only buy a ticket if they can reach their final destination on a single airline with only one (or at most two) transfers. Code share agreements with partner airlines only partly mitigate this. The other major factor which prevents airlines from ever sustaining high profits is pilot unions. The pilots will demand most of the extra profits, and usually get it because a strike instantly shuts down the entire airline.
  - snake_doc 4y ago
    Having a higher route coverage is a function of size absolutely. However, it is definitely not a significant competitive advantage. Economies of scale is applicable in absolute and relative terms. Airline A can have 100% coverage everywhere in the world and be the largest airline. But if Airline B enters a specific route, there is no advantage to a customer whether they ride with A or B for that specific route. This is why there are so many entrants into the industry. The biggest factor to the lack of durable profits in the airline industry isn’t labor or unions. It’s the ease of entry into the market which puts tremendous pressure on price. There are no substantial barriers to entry, prices go down until profits are close to zero. So in classical value based investment lingo, it is an industry with no competitive advantages. The airlines industry in aggregate has never had a ROIC greater than its cost of capital over the long term (>1 yr) for the lifetime of the industry.
    - jacobr1 4y ago
      There were attempts to introduce artificial scarcity with loyalty programs. I used to be a more frequent flyer and still fly enough that I will pay a premium (up to a point) to get the benefits - upgrades and free-personal travel. Locking in business-traveler loyalty has long been a key to profitability in airlines.
      - snake_doc 4y ago
        I think our definition of profits are different. You’re referring to financial profits, ie earnings. Yes loyalty programs increase customer captivity and can enable market leaders to make marginal financial profits through some periods. However, for investors, we care about profits from capital deployment, or returns from invested capital minus cost of capital. The marginal earnings that leading airlines generate from loyalty programs and business traveler accounts do not make up for the huge demand for capital, thus insufficient to break even the cost of capital.
  - Spooky23 4y ago
    Pilot unions have gotten the shit kicked out of them for years. 1970 wants its argument back. Tickets are fungible and people will make insane choices to save a dollar. The constrained resource is gates. The network effects that make big airlines viable are expensive, so without regulation there’s always upstarts who drive the price as low as possible. That’s why Emirates is fancy. If you live near NYC, there is an airport in Newburg that attracts weird financial engineering airlines that leverage leases to fly international cheaply. When I saw Hamilton, I flew Norwegian airlines from NY to London for $24. The long term parking cost more. It’s an industry where the low barrier to entry ensures that the industry as a whole is barely profitable.
didericis 4y ago
That quip also acts as a healthy reminder that money is a tool, not an end. At the end of the day what matters is building a world that works and enables us to live meaningful lives. Money in a world where things don’t work and don’t enable us to use our time in meaningful ways means nothing.
- robertlagrant 4y ago
  Absolutely - it's just an abstraction layer over the idea of exchange. If there's nothing to exchange, there's no need for money!
- dxbydt 4y ago
  I had to take 1 semester of Accountancy. The problem sets were like - "Acme Corp had revenue of 23,000,000$, profit of 2,000,000$, cost of materials 5,000,000,$ cost of labor 12,000,000$, cost of inventory...." Ultimately the problem boiled down to plain arithmetic. Just addition, subtraction. Hard problems involved multiplication. After like the tenth problem I lost my patience & raised my hand - why don't you just do these problems with small numbers ? Like 23-(5+12+4) = 2 ? Why are you making us do 23,000,000 - (5,000,000 + 12,000,000 + 4,000,000) = 2,000,000 ? The Professor said - Accountancy is arithmetic. With Big numbers. That's money for you.
kjkjadksj 4y ago
I think thats starting to tip. I fly spirit now, because is usually a couple hundred cheaper than delta et al and offers me the same exact service short of the 30 cent biscuit and 70 cent can of coke given out on the delta flight.
- opportune 4y ago
  That is actually kind of Buffets point. Airlines are mostly undifferentiated businesses selling a commodity service, which creates a race to the bottom with low margins. In combination with being capital intensive, that makes it hard to turn a profit. You picking a cheaper airline with worse margins does not mean that airlines are a good business
- gen220 4y ago
  It's true that Spirit has competed well recently. Spirit (and other airlines) innovated and temporarily enjoyed a large market share of a second modality of commercial flight (very low budget travel). But it isn't (and wasn't, if you compare their operating margin over time [1]) a durable advantage. The reason is there's very little preventing you and I from starting Soul Airlines, and copy-pasting the Spirit playbook. Many airlines have, and more will. And this drives their prices down, which is great for you but not for long-term Spirit investors. At the end of the business cycle, the logical limit of their operating margin has proven to be functionally indistinguishable from Delta's. [1]: https://www.macrotrends.net/stocks/stock-comparison?s=operating-margin&axis=single&comp=DAL:SAVE https://www.macrotrends.net/stocks/stock-comparison?s=operat...
  - giantrobot 4y ago
    I wish an airline would copy and paste the Ted playbook. Every seat was basically business class (on the flights I took) and you had the open seating model of Southwest. I only flew on a couple Ted flights and I don't know if my experience was standard but those were comfortable flights.
    - gen220 4y ago

by gen220 4y ago

snake_doc 4y ago

I don’t think he’s particularly concerned with capital. It’s the lack of competitive advantage that is key. Insurance (the classic financial services industry that is Buffet’s life blood) is one of the most capital intensive industries. Airlines lack substantial economies of scale, customer captivity, captive supply, or regulatory protections. The airline industry is a textbook case of an industry with no durable competitive advantages, thus the only performance factor is operational efficiency. Insurance on the other hand, there are substantial economies of scale (large fixed costs and also larger insurance companies are more diversified thus less costly/risky) and high customer captivity (high switching cost, high search cost).

gen220 4y ago
You're right! I was lazy with my words, it's definitely the durability that he's concerned with. The word durable, from the quote, is even emphasized in the original text.
nradov 4y ago
Airlines have huge economies of scale due to network effects. Most customers will only buy a ticket if they can reach their final destination on a single airline with only one (or at most two) transfers. Code share agreements with partner airlines only partly mitigate this. The other major factor which prevents airlines from ever sustaining high profits is pilot unions. The pilots will demand most of the extra profits, and usually get it because a strike instantly shuts down the entire airline.
- snake_doc 4y ago
  Having a higher route coverage is a function of size absolutely. However, it is definitely not a significant competitive advantage. Economies of scale is applicable in absolute and relative terms. Airline A can have 100% coverage everywhere in the world and be the largest airline. But if Airline B enters a specific route, there is no advantage to a customer whether they ride with A or B for that specific route. This is why there are so many entrants into the industry. The biggest factor to the lack of durable profits in the airline industry isn’t labor or unions. It’s the ease of entry into the market which puts tremendous pressure on price. There are no substantial barriers to entry, prices go down until profits are close to zero. So in classical value based investment lingo, it is an industry with no competitive advantages. The airlines industry in aggregate has never had a ROIC greater than its cost of capital over the long term (>1 yr) for the lifetime of the industry.
  - jacobr1 4y ago
    There were attempts to introduce artificial scarcity with loyalty programs. I used to be a more frequent flyer and still fly enough that I will pay a premium (up to a point) to get the benefits - upgrades and free-personal travel. Locking in business-traveler loyalty has long been a key to profitability in airlines.
    - snake_doc 4y ago
      I think our definition of profits are different. You’re referring to financial profits, ie earnings. Yes loyalty programs increase customer captivity and can enable market leaders to make marginal financial profits through some periods. However, for investors, we care about profits from capital deployment, or returns from invested capital minus cost of capital. The marginal earnings that leading airlines generate from loyalty programs and business traveler accounts do not make up for the huge demand for capital, thus insufficient to break even the cost of capital.
- Spooky23 4y ago
  Pilot unions have gotten the shit kicked out of them for years. 1970 wants its argument back. Tickets are fungible and people will make insane choices to save a dollar. The constrained resource is gates. The network effects that make big airlines viable are expensive, so without regulation there’s always upstarts who drive the price as low as possible. That’s why Emirates is fancy. If you live near NYC, there is an airport in Newburg that attracts weird financial engineering airlines that leverage leases to fly international cheaply. When I saw Hamilton, I flew Norwegian airlines from NY to London for $24. The long term parking cost more. It’s an industry where the low barrier to entry ensures that the industry as a whole is barely profitable.

didericis 4y ago

That quip also acts as a healthy reminder that money is a tool, not an end. At the end of the day what matters is building a world that works and enables us to live meaningful lives. Money in a world where things don’t work and don’t enable us to use our time in meaningful ways means nothing.

robertlagrant 4y ago
Absolutely - it's just an abstraction layer over the idea of exchange. If there's nothing to exchange, there's no need for money!
dxbydt 4y ago
I had to take 1 semester of Accountancy. The problem sets were like - "Acme Corp had revenue of 23,000,000$, profit of 2,000,000$, cost of materials 5,000,000,$ cost of labor 12,000,000$, cost of inventory...." Ultimately the problem boiled down to plain arithmetic. Just addition, subtraction. Hard problems involved multiplication. After like the tenth problem I lost my patience & raised my hand - why don't you just do these problems with small numbers ? Like 23-(5+12+4) = 2 ? Why are you making us do 23,000,000 - (5,000,000 + 12,000,000 + 4,000,000) = 2,000,000 ? The Professor said - Accountancy is arithmetic. With Big numbers. That's money for you.

kjkjadksj 4y ago

I think thats starting to tip. I fly spirit now, because is usually a couple hundred cheaper than delta et al and offers me the same exact service short of the 30 cent biscuit and 70 cent can of coke given out on the delta flight.

opportune 4y ago
That is actually kind of Buffets point. Airlines are mostly undifferentiated businesses selling a commodity service, which creates a race to the bottom with low margins. In combination with being capital intensive, that makes it hard to turn a profit. You picking a cheaper airline with worse margins does not mean that airlines are a good business
gen220 4y ago
It's true that Spirit has competed well recently. Spirit (and other airlines) innovated and temporarily enjoyed a large market share of a second modality of commercial flight (very low budget travel). But it isn't (and wasn't, if you compare their operating margin over time [1]) a durable advantage. The reason is there's very little preventing you and I from starting Soul Airlines, and copy-pasting the Spirit playbook. Many airlines have, and more will. And this drives their prices down, which is great for you but not for long-term Spirit investors. At the end of the business cycle, the logical limit of their operating margin has proven to be functionally indistinguishable from Delta's. [1]: https://www.macrotrends.net/stocks/stock-comparison?s=operating-margin&axis=single&comp=DAL:SAVE https://www.macrotrends.net/stocks/stock-comparison?s=operat...
- giantrobot 4y ago
  I wish an airline would copy and paste the Ted playbook. Every seat was basically business class (on the flights I took) and you had the open seating model of Southwest. I only flew on a couple Ted flights and I don't know if my experience was standard but those were comfortable flights.
  - gen220 4y ago