Private & Commercial Space Prof. Henry R. Hertzfeld George Washington University Washington, DC SPACE TRANSPORTATION POLICY AND MARKET RISK SYMPOSIUM 16 November 2011

2 Definitions H. Hertzfeld, George Washington University Privatization  Privatization is the process of applying a market-oriented approach to government programs with the objective of moving the program’s activities and assets out of direct government management, control, and ultimately ownership. Commercialization  The term “commercial,” for the purposes of this policy, refers to space goods, services, or activities provided by private sector enterprises that bear a reasonable portion of the investment risk and responsibility for the activity, operate in accordance with typical market-based incentives for controlling cost and optimizing return on investment, and have the legal capacity to offer these goods or services to existing or potential nongovernmental customers. (U.S. Space Policy, June 2010)  A government providing incentives for private sector companies to provide (sell, cooperate, use) goods and services to the government as a customer that is as similar to any end-user customer as possible. This can involve either financial or in-kind exchanges.

3 Risk H. Hertzfeld, George Washington University In the end, it all comes down to who bears what risks. For space programs, who ultimately bears the risk: government or industry? There are many types of risk:  Technical  Market  Economic  Political  Personal

4 Tests of Privatization H. Hertzfeld, George Washington University Ownership of assets  If depreciable under tax code, then private ownership  If not, then government owned Assumption of risk  Will the Government let the firm go out of business?  How will market, economic, uninsurable losses be handled?  Are personal funds, equity interests, and/or loan repayments at risk? Other Risks Do Not Distinguish Ownership  Significant uninsurable risks (but common to both government and industry)  Political; general economic conditions  Insurable risks are passed on to customer through price charged  Technical risks (may be shared)

5 Why Privatize? H. Hertzfeld, George Washington University Inadequate budget—lack of funds available to do what Agency wants to do Overall government policy to stimulate commercial development A belief that the private sector can do things more efficiently The emergence of new technologies or new users  May create a market environment for current government services where one did not previously exist

6 Reasons the Government Interferes with the Private Market System H. Hertzfeld, George Washington University When private market mechanisms may fail to:  Provide public goods  National security  Insuring safety and health  Provide incentives for research and innovation (particularly basic research)  Market may be focused on short-term returns (e.g. when interest rates are very high)  Breaking down monopolies (antitrust) to stimulate competition;  Or, for aerospace in the 1990s, the opposite: mergers & consolidation  Is this policy now changing for space launch systems?  Protect infant industries  Particularly if they are of critical concern to other public interests such as defense and security.

7 Using Large Government Resources for Privatization H. Hertzfeld, George Washington University Raises questions of unfair treatment of one firm or sector over others; Raises questions of unfair international trade; May prolong government involvement in the process of privatization May continue inefficient financial and technical practices  By the absence of adequate market incentives, even after the private sector assumes management control and even asset ownership

8 Commercialization and Privatization may fail: Lessons learned from early TDRSS Program*  Concept: leasing services from private owner  Contractor to design, develop, implement and operate its own system for 10 years, providing services to the government  Advantage to NASA: defer payments to company until system in orbit and actual service would begin.  Financing: Company resources and loans  Cost recovery to company: amortized payments by NASA during 10 year operating period  At end of 10 year services contract period, system would transfer ownership to the government Prof. H. Hertzfeld, Space Policy Institute, George Washington University * The following are excerpts from an August 1988 NASA GC Report

9 Lessons NASA Learned (or did they?) The original concept was rational:  Combine an established government need for better communications between satellites and between satellites and the Earth with an existing commercial communications market. The TDRSS technology and operational concept were fully validated and the support system was an advancement of technology  R&D program as well, which is a NASA mission objective What went wrong?  NASA made technological and system design changes  The government decided the service to be provided was of a critical nature  Significant delays in providing both government and commercial services Prof. H. Hertzfeld, Space Policy Institute, George Washington University

10 Lessons Learned (2) Shared (public-private) systems offer possible big cost savings  To make it work, a good contract should be specific in advance on:  Rights of the parties (payments, penalties, termination, etc.)  Operational needs of both parties  Availability (time) of services A fixed-price contract is not appropriate for critical government R&D development  Particularly if significant new systems development is required or  Where substantial changes to the design requirements may occur In a fixed-price contract, delays can be a major problem  Litigation may occur  Services will be late—of critical concern to the government. Prof. H. Hertzfeld, Space Policy Institute, George Washington University

11 Lessons Learned (3) Private financing through loans:  The private contractor would not commit equity funds  Financial Institutions would not provide private loans without the “full faith and credit” of the U.S. Government End Result: the Government had to guarantee the payment on the private loans. Prof. H. Hertzfeld, Space Policy Institute, George Washington University

12 Other Issues Prof. H. Hertzfeld, Space Policy Institute, George Washington University NASA would have to learn to accept possible loss of control over the assets NASA would have to accept the risk of system failures Penalties in the contract were not effective enough to control the quality of the contractor’s manufactured product.  NASA should have written a better contract to avoid this issue A clear structure for the management team is essential to work with the private sector to develop access and control of key services  Contractual arrangements needed to share the accumulated technical and management improvements (both can move along the “learning curve”). Government interfaces during construction and operation should be minimized in a leased-services contract arrangement.

13 Beware of Promises of Market Demand H. Hertzfeld, George Washington University 1960’s and 1970’s  Factories in space—drugs, gallium-arsenide crystals, materials 1980’s  Space Power Satellites  Direct TV (10 year delay) 1990’s  LEO Telecommunications  Remote sensing 2000’s  Space Tourism (suborbital)  Colonization of the Moon; mining of Moon’s resources 2010’s  Fuel Depots  Demand from foreign governments

14 Beware of Misleading Diagrams H. Hertzfeld, George Washington University Demand curves  Always downward sloping  Reflect relationship of price customers willing to pay and quantity they demand at a given point in time—a snapshot  Predictions of future demand are guesses Supply curves  Reflect the costs of production  A long-run cost curve may also be downward sloping  But reflects decreasing costs of production with larger scale plants Price Quantity Normal Demand Curve $ (Cost) Quantity PastPresentFuture

15 Applicability Today H. Hertzfeld, George Washington University Recent privatization efforts  Space Act Agreements—COTS and Commercial Crew Cargo  Private launch companies depend on government contracts as an “anchor tenant” (e.g. Space X)  Private offerings for R&D facilities on the ISS  Potential private operations on the Moon or other celestial bodies Can we learn from the past? How can we make this work today?