by Adam Pilarski, Ph.D., Senior Vice President, Avitas
Life is very uncertain and becoming more so all the time. Manufacturers have to worry about the airline industry since if people don’t fly there is no need for aircraft. Look at changes that occurred in last number of years. 9/11 changed a lot and the subsequent changes like TSA did a lot too (mainly negative). Oil prices hit $147 in July of 2008. Since oil prices are a big part of airline expenses such price levels raised ticket prices and reduced traffic. The much heralded $147 though is not real. It reflects the price of July 3rd (actually $146.31) with an average for the month of July 2008 being $134.88. Still, $147 a barrel was over 10 times the price of oil paid for less than a decade earlier (March 15, 1999 the price was $14.41 and actually February 17, 1999 it was $11.78). The $147 price went down to $41.50 a few months later on December 24 (ho ho ho) 2008. SARS also caused huge stoppage of traffic showing declines of 90% some months in Hong Kong. Swine flu (or calling it H1N1 so as not to insult the pigs) almost caused catastrophic problems which luckily did not materialize. Volcanic ashes from a volcano whose name nobody can pronounce did the same and is still threatening us. But manufacturers have much to worry about in addition to problems of airlines. New environmental regulations can make old equipment obsolete overnight. The success of Bombardier at Republic made the status quo strategies of Boeing/Airbus obsolete and overnight created demand for re-engining solutions.
Uncertainty does not mean that nothing is predictable. In early 1980 I was predicting oil prices had to come down from their at that time historically high number while I was at McDonnell-Douglas and we were contemplating a new airplane (the UHB) whose success depended on continuing high oil prices. Solid economic analysis told me that such prices were unsustainable in the long run and had to drop. And it came to pass. Luckily my management listened and we did not make the mistake to invest too much at that time in the UHB. Another example is the future of Chinese aviation. Today the position of China is very prominent in aviation. Thirty years ago that was definitely not the case. The Chinese government itself had plans which called for annual growth of “only” 6.7%. Using econometric analysis I was able to convince the Chinese government that the real growth will be a few times larger and for a long time. At that time my forecasts were met with ridicule by most because Chinese traffic was then miniscule. Today as China has the second largest number of passengers in the world nobody will doubt their position in aviation. Thirty years ago most people in the industry did not believe my, turns out fairly accurate, forecasts for Asia in general and China in particular. But the long term future can be successfully predicted when using proper analysis.
How is this related to swans? Many years ago British zoologists had perfect descriptions of swans with all their physical characteristics, including the fact that they were white. When Britain had too many criminals and decided to discover Australia to house them there (a few centuries after the Chinese discovered that continent but decided not to colonize it since they did not have too many criminals), British zoologists discovered black swans which were identical to those in Britain except for the color of their feathers. Hence the term BS (for black swan) is used to describe something that cannot be predicted beforehand but is perfectly logical and explainable after the fact. Like the financial meltdown we experienced during the last recession.
Even if we cannot predict unpredictable events (which by definition cannot be predicted) we can predict their consequences. So what can a business do? One is to continue to attempt to predict the future using standard forecasting tools and traditional analyses. A lot can be predicted, especially when dealing with the long term as witnessed by my two work examples above. And, two, is to be as flexible as possible. A good way to accomplish this is to employ scenario analysis. One might analyze what a business should do if unpredictable events happen. As one example, if a re-engining program of the narrow body by Airbus and Boeing were to happen. A set of specific assumptions can be developed for example when the program will commence, how many aircraft will be sold, what will happen to the Bombardier CSERIES and so on. A future can then be developed predicting product developments in the next decade or two with regard to narrow body aircraft and the possible product opportunities for said company.