Richard Aboulafia: May 2018 Letter

Dear Fellow Horizontal Flight Admirers,

Death Spirals have threatened defense programs for decades. Death Spirals happen when a program’s unit cost rises, resulting in lawmakers punishing the program by cutting procurement numbers. Reduced numbers further raise unit costs, resulting in further procurement cuts, resulting in…programs like the B-2, with production of 21 very expensive planes.

The Unsustainable Life Spiral (ULS) is a less well-known but equally malicious beast. Here’s how it works. Someone offers a product or service with impossibly low unit costs. These low costs are predicated upon impossibly high production rates, or impossibly high utilization assumptions. These impossibly high utilization/production numbers are predicated upon…impossibly low unit costs. When executives, investors, or regulators inquire about the resulting financial carnage, the promise of much higher production or utilization is proffered as a way of making it all good. This never happens, of course, and everyone involved loses millions or billions, depending on how long they throw piles of cash into the ULS vortex.

The classic aerospace ULSs were the air taxi and Very Light Jet (VLJ) crazes of the last decade. See my March 2006, April 2007, and August 2008 letters, among others. DayJet, Eclipse, and the others cost investors dearly. But the latest ULS hydra-like heads to emerge are vertical urban air mobility vehicles (UAMs, or e-VTOLs, or whatever), and all the attendant UAM services. Case in point: the second Uber Elevate Summit, held in May. It attracted 750+ attendees, all enthused by concept drawings.

But UAM technology is decades away from readiness. The costs will be way higher than planned. Utilization, as a result, will be much lower than anticipated. But thanks to ULSs, the road there will see many billions lost. UAMs promise to be the Mother Of All ULSs (MOAUs). In addition to everyone’s fondness for goofy 1950s-type techno-utopianism, there are three reasons why this ULS will take many years and consume many billions of dollars:

1. Too much cash chasing too few good ideas. For ten years we’ve had very low interest rates, large piles of unemployed cash, and generally miserable returns wherever investors turn. A good techno-bubble or two would be guaranteed to attract investors, despite the incredibly obvious risks. Of course, high debt loads would kill many new players when interest rates rise.

2. Silicon Valley. Many UAM players, like Uber, are from there. Silicon Valley’s objective is to seize market share, and to prevent any followers from getting their foot in the door. They say they’ll move fast and break things, and Disrupt, Disrupt, Disrupt. That’s a recipe for getting investors to stay patient, which sometimes works, as with Amazon. But failure is more common. And since it was created in 2009, Uber has burned through $10.7 billion, with a $4.5 billion loss in 2017. Getting into aviation would accelerate Uber’s cash burn – our industry has always been in a class by itself when it comes to losing money – but at least they’d have another new growth story to tell investors. In short, Silicon Valley thinking is conducive to ULSs, even in manufacturing; let’s see what happens with Tesla, which may be an automotive ULS.

3. China. They have lots of money and a keen interest in newfangled transportation solutions, and drones too. As the Defense Innovation Unit Experimental (DIUx) puts it, “China is flooding Silicon Valley with cash.” Chinese money, Silicon Valley schemes…what could go wrong?

What’s a legacy aerospace company to do? Investors, boards, the media, and defense executives who don’t quite understand the commercial side of the business all want to know what legacy companies are planning for the hot new market that everyone is talking about, even when they’re talking breathless nonsense. Here are six bits of advice:

1. Play the Long Game. There will be no dedicated UAM air vehicles entering service in the next decade. Unless Uber plans to use its scheduling/hailing software with conventional helicopters, the current headlines about pilot UAM programs in Dubai, LA, and Dallas are silly.

2. Don’t Forget The Current Market Size. If Uber is talking about using the civil rotorcraft with its technology, that could serve as a market stimulant. The current market for civil rotorcraft light turbines and pistons is under $1 billion per year. Most of these are not used for UAM, so we could be talking about a ~30% stimulant for a $250 million equipment market. Maybe.

3. Don’t Pan For Gold. Sell Jeans And Buckets To The Gold Panners. Given #1 and #2, this timeless aphorism has never been more relevant. Companies providing infrastructure, avionics, training, and other systems can profit from the UAM ULS; UAM providers and builders won’t.

4. No. IRAD. Ever. See above. Do not spend more than token amounts of company R&D funds on developing those jeans and buckets. Instead, rely on government handouts (which may be copious) and of course funding from the temporarily-rich UAM pseudo-unicorns.

5. Don’t Get Distracted From Your Core Business. Bell, Embraer, and most of all Airbus have made all kinds of aspirational UAM proposals. Since engineering and marketing resources are finite, these proposals shouldn’t distract them from the markets that actually offer money. Airbus’s CityAirbus and Vahana concepts arrived just as the company’s twin aisle jetliner product strategy went off the rails. Unrelated? Probably. But when new management takes over at Airbus, let’s hope they don’t give UAM any kind of priority.

6. Do Your Due Diligence. If people or companies really want to invest in UAM, they need to…oh, wait, I’ll let the SEC explain. After the recent Theranos blood test disaster, the SEC said, “Innovators who seek to revolutionize and disrupt an industry must tell investors the truth about what their technology can do today, not just what they hope it might do someday.”

Sometime, decades away, an alchemical mix of autonomy, hyper-efficient manufacturing, battery improvements/air vehicle electrification, and the discovery of unobtanium will enable some kind of sustainable UAM market. It will be smaller than dreamt, but possibly large enough to justify dedicated air vehicles. Will that be in 2045 or 2075? 2040 is very aggressive to me, but not inconceivable. Of course, at the same time 3D Printing and Virtual Reality might greatly reduce the need for mobility. A lot can happen when you’re looking 50 years out.

Yours, ‘Til The Teal VTOL-X UAM Vehicle (with Blockchain!) Gets Its Own ULS,

Richard Aboulafia