Why Fly? Private Jet Aviation
A couple of blog posts ago, the question came up: is flying fractional a luxury for those who can afford it? It matters because NetJets furloughed 482 pilots effective January 15. This move was announced on November 5th.
Okay, you are a pilot. Just before NetJets' busiest weekend of the year (Thanksgiving), you are told that, two weeks into 2010, you will have no job. How will you react? You're not going to be quite so obsequious to the passengers when you load their luggage into the cargo hold. You are going to use every sick day you've got. The best time to be sick will be during Thanksgiving weekend or over the Christmas-New Year's week, so you can spend holiday time with your family and avoid the hassle of flying during the worst travel periods of the year. Hence the letter from Buffett to owners denying that service has gotten worse, and stories that Christmas week turned into chaos with angry owners delayed for hours because of lack of pilots.
In fairness, there is no good time to furlough hundreds of pilots. Wait a couple of months, and they will call in sick and ruin the customers' winter and spring trips to Vail and Deer Valley. Another couple of months, school is out, the pilots call in sick, and people end up arriving late for the weekend in the Vineyard and Montauk. Right after New Years', though, may have been less ideal than some other times the company could have chosen.
Under the circumstances, it's not surprising that, instead of convenience and luxury, Berkshire Hathaway is now stressing security as the selling point for NetJets. You should expect to see this continue, and who could blame them? The Christmas Day Underwear Bomber on Flight 253 from Amsterdam is a great sales hook for fractional jet shares. The expectations for service may also be lower now. These days, merely getting on a plane without being hassled, finding something on board that will sustain your blood sugar, and being allowed to go to the lavatory whenever you want sounds like a luxury compared to shuffling through the security gates of hell in order to spend hours aboard a bus with wings.
NetJets, though, is not competing with commercial aviation, but with Bombardier, air charter carriers, and other fractional operators. It is expensive and has to provide noticeably better service than peers. My prediction is that the company will start working hard to get the service back on track.
Over the longer term, is still an open question how much you can tighten margins while charging a premium in this business. The comparison in my mind is to Chubb insurance. People know they are paying more, but the service is flawless, and being Chubb policyholders makes them feel good. They are at a cocktail party, someone says, I just bought on Jupiter Island. Who insures your Palm Beach house?, they say, Chubb, and get an approving nod.
It's a delicate thing, this sort of luxury branding. Berkshire doesn't have a lot of businesses like NetJets (I can't think of any others - if you can please nominate them). This is not a story that will unfold over a couple of months, I think it will take several years to play out.
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It sounds like NetJets still
It sounds like NetJets still hasn't found, or is still developing, their target market yet.
There's plenty of those niche customers out there, all they have to do is get their foot in the door.
However, the older I get, the more Warren bothers me.
BTW Alice, I loved your book.
BTW Alice, I loved your book. I've read enough of the Buffett fanboyz crying about it not being more investment oriented. As if Buffett has some secrets to basic arithmetic the rest of us haven't mastered. You chose to focus on the complete man and I'm guessing that's the only way to begin to understand him as the greatest investor ever.
Best book on Buffett bar none. Wonderful when paired with Poor Charlie.
Erin
thank you
The Buffett fanboyz want a book that answers the unending questions "what discount rate does Buffett use for discounting cash flows" and how does he value Berkshire. Charlie Munger has said that he's never seen Warren do a discounted cash flow analysis. From what I've seen that's the truth. Warren values Berkshire in his head but it does not involve a complicated formula. People want this to be more elaborate than it is. Case material on the various investments would be worthwhile for the following reason, it would illustrate how Buffett thinks about a business. Whether the business is good, how much it can earn, and what its assets are worth. This might be worth learning more about. What is a good business. Valuation formulas, you are not going to get. They don't exist.
They should make Chubb
They should make Chubb designer jeans. "What are you wearing?" "Chubb."
That's how I hooked my husband. Dropping the name of my property insurance company. Works every time.
But seriously, I have a place on Singer Island, Cavuto has a place in my building. My place is nicer, but maybe he's with Chubb. I had an aunt that worked for Chubb. When I was younger I thought they were a military contractor. Chubb that is. Turns out that was Northrop Grumman. Seriously, I thought Chubb was Northrop. I wonder what I thought Northrop was. Oh well.
Erin
Chubb designer jeans
hahaha
It's not as far-fetched from government contracting as it sounds. There is another Chubb -- the Chubb security and protection company that makes fire extinguishers, safes, security systems and so forth."Chubb, PLC is among the world's five largest providers of security services to businesses and governments."
The question of "materiality"
I was wondering about the matter of "materiality" with respect to NetJets. Do you know what the "all-in" before depreciation and amortization investment is that BRK has in NetJets? Clearly, the purchase price now seems to be trivial compared to the additonal capital investment. Is there any way to know what the total investment in NetJets is? Necessarily I exclude "opportunity costs," other than noting they could be huge. But are we talking about $5 billion? $10 billion? I should know but I don't.
all-in including capex
This would be a great thing to know. I wish that Berkshire disclosed more of this type of information. $4 billion does sound high to me.
I think it's easily run into
I think it's easily run into the billions. From the latest 10-K:
"Several of Berkshire’s subsidiaries have made long-term commitments to purchase goods and services used in their businesses. The most significant of these relate to NetJets’ commitments to purchase up to 556 aircraft through 2018 and MidAmerican’s commitments to purchase coal, electricity and natural gas. As of December 31, 2008, commitments under all such subsidiary arrangements were approximately $6.6 billion in 2009, $4.0 billion in 2010, $2.9 billion in 2011, $2.5 billion in 2012, $2.1 billion in 2013 and $7.2 billion after 2013."
I don't know what NetJets's fleet profile looks like, but a new Gulfstream 250 is $23m (the 600 model is $57m). I just Googled these prices so not sure how accurate but you get an order of magnitude estimate that easily puts you into the several billions of dollars.
Not only do I wish BRK would disclose more of this information, but I also wish they had at least one investor relations person on staff to answer questions. Good luck getting to Marc Hamburg if you're trying to understand the nuance of this or that number from the Ks and Qs.
NetJet Pricing
Let me just share a few thoughts on NetJets.
1. A brand name is worth something, and maybe a lot. Everyone knows General Aviation isn't the safest mode of travel. In order to provide a comfort level regarding safety, someone either has to know what they are doing or hire someone with a credible record. NetJets adds value by reducing the amount of time one needs to spend worrying about safety.
2. There has to be some sort of network effect regarding fractional ownership. The more participants, the more utilization per plane. If demand were purely random from a uniform distribution, then the marginal cost per additional participant would decrease fairly steeply. On the other hand, if everyone wanted to fly the Wednesday before Thanksgiving, then there would be no savings at all.
3. There is a geographical aspect to this also. The first owner in a city will cost more than the next, etc.
My understanding is that NetJets has a fairly simple pricing scheme based on a fixed cost and a variable charge per mile. It seems like this was based on the idea of having the users pay as much of the capital costs as possible and also to try to align revenues with expenses.
In fact, however they priced the service, it had to be wrong, since they lost a lot of money. I suspect that the network effects (savings) of the system were never as great as anticipated.
The real luxury of the service is time. Thats what they are selling. People want their flight when they want their flight. I suspect that a more rational costing system would annoy the hell out of users. They don't want to think about time/money tradeoffs, since they thought they had solved this problem when they bought in the first place.
Timeshares tend to have pricing based on seasonal peaks. Once again, the NetJet customers aren't likely to want "off season". Once they start getting blackout dates, Commercial First Class becomes a reasonable alternative.
NetJets has enough data to be able to figure this stuff out. I suspect that a simple "one price" model simply won't work at a price people are willing to pay. If Berkshire can't figure this out, I can't imagine who could.
It is possible that the only solution is to spin the business off to the fractional owners to run as a cooperative or mutual type of enterprise. This is a total mess. The reputational risk is much greater than it seems.
network effect
Yes, the network effect is huge, this is why the business has high scalability. NetJets has to acquire a "core fleet" of its own planes to serve the customers who want to fly all at once on Thanksgiving. And yes, you cannot upcharge for holiday peaks the way an airline would do. The plane costs what it costs and then customers pay a monthly service charge for fuel, flight attendants etc. This is the razor/blades model.
NetJets trains its pilots through FlightSafety. It has a "zero crash" philosophy and sells safety. With that said, part of what it is selling is glamour == from being associated with Warren Buffett, who appears in an ad, to being associated with other NetJets customers who appear in ads, to getting invited to the famous Las Vegas poker tournament.
According to various sources, expenses at NetJets needed to be pared. The question is how much you can pare them while still giving the customer that feeling of security and glamour that is the basis for the premium price that NetJets commands. It is a delicate balance. I assume that margins can be widened, but by how much?
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