TABLE OF CONTENTS
EXECUTIVE SUMMARY
This report is attempt to understand how does the airline industry function and take a look at the emerging trends ,especially the growing significance of low cost carriers and how this trend affect the industry dynamics and the India’s traveling pattern. Air industry remains a large and growing industry. Good air connectivity facilitates economic growth, world trade, international investment and tourism and is therefore central to globalization. Airlines also earn revenue from transporting cargo, selling frequent flier miles to other compani companies es and ‘up-se ‘up-selli lling’ ng’ in-fli in-flight ght servic services. es. But by far, far, the larges largestt propor proporti tion on of revenue is derived from regular and business passengers. For this reason, its important that we take consumer and business confidence into account on top of regular factors that one should consider like earning growth ,debt load etc. A final key area to keep a close eye on is costs. As we all know the airline business is extremely sensitive to costs such as fuel, labour, and borrowing costs. Some of the major players in the airline attribute 30-40% of their costs to jet fuel. It is also important to look at the geographic areas that an airline targets. If the airlin airlinee indust industry ry could could be descri described bed in three three words, words, they could could be “inte “intense nsely ly competitive market”. In the recent years there has been an industry-wide shakedown that will have far reaching effects on the industry’s trend towards expanding domestic and intern internati ationa onall servic services. es. Origin Originall ally, y, the airli airline ne indust industry ry was either either partly partly or wholly wholly government owned. This is still true in many countries, but now in India, private players are gaining importance due to their excellent and value added services. The general pattern of ownership has gone from government owned or supported to independent, for profit public companies. As in many mature industries, consolidation is a trend, as airlines form new business combinations combinations,, ranging ranging from loose, limited limited bilateral bilateral partnershi partnerships ps to long-term, long-term, multi face facete ted d alli allian ances ces to merg merger erss and and take takeove overs rs.. Sinc Sincee gover governm nmen entt ofte often n rest restri rict ctss the the
ownersh ownership ip and merger merger betwee between n the compani companies es in differ different ent countr countries ies,, we see most most consolidation taking place within a country. The report highlights the various aspects of the domestic aviation industry, role of government and throws some light on the future of the low cost carriers.
EVOLUTION OF LOW COST AIRLINES GLOBALLY
A low-cost carrier or low-cost airline (also known as a no-frills or discount carrier / airline) is an airline that offers generally low fares in exchange for eliminating many tradit traditiona ionall passen passenger ger servic services. es. The concept concept origin originate ated d in the United United States States before before spreading to Europe in the early 1990s and subsequently to much of the rest of the world. The term originated within the airline industry referring to airlines with a low - or lower operating cost structure than their competitors. Through popular media the term has since come to define any carrier with low ticket prices and limited services regardless of their operating costs. The American airline 'Southwest Airlines' is seen by most as the first low-cost carrier and stood example for the current low-cost model. Southwest originated in the USA after deregulation of the airline industry. It began its service in 1971 and has been profitable every year since 1973. With the advent of aviation deregulation the model spread to Europe as well, the most notable successes being Ireland's Ryan air, which began lowfares operations in 1991, and easy Jet, formed in 1995. Low cost carriers developed in Asia and Oceania from 2000 led by operators such as Malaysia's Air Asia, and Australia's Virgin Blue. The low-cost carrier model is applicable worldwide, although deregulated markets are most suited for its rapid spread. At the core of the low-cost model are the cost-reductions, which partly end up in cheaper tickets for passengers. To obtain these cost-reductions, Southwest operates according to two important principles which separate the low-cost model with other operating models. First, instead of flying according to a hub-and-spoke system, Southwest focuses on short distance point-to-point flights. Second, they only fly with one class, which a reduced service.
By operating according to these two points, different cost-reductions can be made. Characteristic for Southwest are the different parts on which they save money. The figure below compares Southwest airlines with US Airways and gives an overview of the different costs of an average flight. Apparently there are large differences in respectively the salary, the operating costs of a carrier, and the remaining costs. Reductions on the salary costs consist next to a lower wage, also of a more productive staff. Southwest also has relatively a higher flight frequency compared to others airlines like for example US Airways. That way, airplanes are more productive. They also have a higher productivity because they operate with only one fleet consisting of the same equipment, and have shorter turn-around times. Cost reductions related to the maintenance and managing costs of the fleet are obtained by operating with smaller aircrafts. Overall low-cost carriers also operate with newer aircraft types, which are more economical and require less maintenance. They offer only one service class with no seat reservation. On flights there are no meals offered. By choosing smaller regional airports turnaround times are shorter, and costs are saved because the landing and gate costs are lower. In conclusion, Southwest Airlines is a success because of the predictability, and the straightforwardness of the operating model. Their success became clear at the end of 2002 when airlines in the USA had the last couple of years considerable loses, whereas Southwest still gained profit.
The first low-cost carriers in Europe started in the ‘90s, when the deregulation of the airspace continued throughout the European Union. The British Ryan air and Easy Jet continued building on the Southwest low-cost model. They copied their efficient operating model, only instead of offering reduced services; they offered no service at all. During a flight one needs to pay for food and beverages, there is no money back guarantee, no reservation option et cetera. In short: no service. They also started to sell tickets directly over internet. In 2001 both Ryan air and Easy Jet sold over 80% of their tickets through the internet, the other part was sold mainly through call-centers. The figure below gives an overview of the amount of cost reductions on different parts in the operating process on a flight between London and Nice. Total costs of the flight are £5.591, profits from ticket sales are £6.136. Remarkable are credit cards as a separate
expense. This is because most tickets sold over the internet are paid by credit card. Lowcost carriers expanded aggressively and profited from first-mover benefits when negotiating with different airports. In the beginning they also avoided competition with other carriers resulting in almost no overlap of their flight networks. Spatially low-cost carriers developed in Europe as is represented in figure 3. Low-cost carriers first arise in England and Ireland in 1995, and started expanding to the rest of Western Europe. From 1997 the European low-cost network developed itself more to the tourist areas in the South. As of 2002 the network expanded to Eastern Europe and Scandinavia. After deregulation of the airport industry the full-service model was the dominant strategy of most established carriers. Full-service carriers in comparison with low-cost carrier offer three important benefits to their passengers. The first benefit is the extended service network which is available on many different places and is easy approachable by their costumers. Secondly they offer high quality services related to luggage processing and their seating system. There is a low risk in baggage loss and different flights are better connected to each other, reducing waiting times. Finally the frequent flyer programme is improved. Another unmentioned important characteristic can be added. Full-service carriers operate according to a hub-and-spoke system, offering a large amount of destinations to their customers. The first and the most successful low cost airline in US is the southwest airlines and the most successful airline in Europe is Ryan air. It is important to look in detail of the origin and the background of these airlines.
Southwest Airlines, Inc
South west airlines are a low fare airline based in Dallas, Texas. It is the largest airline in the United States by number of passengers carried domestically for any one year and the third largest airline in the world by number of passengers carried. Southwest Airlines carried more customers than any other U.S. airline in August 2006, marking it the first time that Southwest Airlines has topped the monthly list for combined domestic and international passengers, according to the U.S. Department of Transportation’s Bureau of
Transportation Statistics.Southwest Airlines is one of the world's most profitable airlines and in January 2007, posted a profit for the 34th consecutive year. Its reputation for low prices and a laid-back atmosphere have made it an icon of pop culture. Southwest Airlines was originally incorporated to serve three cities in Texas as Air Southwest on March 15, 1967, by Rollin King and Herb Kelleher. According to frequently cited legend, Mr. King described the concept to Mr. Kelleher over dinner by drawing on a paper napkin a triangle symbolizing the routes. Some of the incumbent airlines of the time (Braniff, Trans-Texas, and Continental Airlines) initiated legal action, and thus began a 3 year legal battle to keep Air Southwest on the ground. Air Southwest eventually prevailed in the Texas Supreme Court, which ultimately upheld Air Southwest's right to fly in Texas.The decision became final on December 7, 1970, when the United States Supreme Court declined to review the case without comment.That date is considered by many to be the de facto beginning of deregulation in the airline industry. In early 1971, Air Southwest changed its name to Southwest Airlines, and the first flight was on June 18, 1971. short hops with no-frills service and a simple fare structure, features that became the basis for Southwest's popularity and rapid growth in the coming years. Southwest turned its first annual profit in 1973, and has done so every year since — a record unmatched in commercial airline industry history. Southwest has used financial techniques to bolster its profitability and counteract many of the fiscal disadvantages of operating an airline.
Ryanair:
Ryanair is an Irish airline headquartered in Dublin. Ryanair was founded in 1985 by
Christy Ryan (after whom the company is named), Liam Lonergan (owner of an Irish tour operator named Club Travel), and noted Irish businessman Tony Ryan, founder of Guinness Peat Aviation. Its biggest operational base, however, is at London Stansted Airport. It is Europe's largest low-cost carrier and one of the world's largest and most successful airlines (whether in
terms of profits, number of flights, number of passengers flown). Ryanair operates - at one count - on 362 routes to 22 countries. Ryanair has been characterised by rapid expansion, a result of the deregulation of the air industry in Europe in 1997. Over the years, it has evolved into one of the world's most profitable airlines, running at remarkable margins by passing its costs directly to its customers. Ryanair is also one of Europe's most controversial companies, praised and criticised in equal measure. Its supporters praise its commitment to low fares, radical management, and its willingness to challenge what it calls the 'establishment' within the airline industry (similar to its American counterpart, Southwest Airlines). Critics, meanwhile, have attacked its trade union policies, hidden "taxes" and fees, and limited customer services, and charged that it practises deceptive advertising. Ryanair has grown massively since its establishment in 1985, from a small airline flying a short hop from Waterford to London, into one of Europe's largest carriers. After taking the rapidly growing airline public in 1997 the money raised was used to expand the airline into a pan-European carrier. In an industry where the survival rate is 1 in 10 and where even the giants such as American Airlines and Delta struggle to keep in the black, Ryanair's success has confounded many industry analysts Low-cost carriers pose a serious threat to traditional "full service" airlines, since the high cost structure of full-service carriers prevents them from competing effectively on price the most important factor among most consumers when selecting a carrier. From 2001 to 2003, when the aviation industry was rocked by terrorism, war and SARS, the large majority of traditional airlines suffered heavy losses while low-cost carriers generally stayed profitable. Many carriers opted to launch their own no-frills airlines, such as KLM's Buzz, British Airways' Go, Air India's Air India-Express and United's Ted, but have found it difficult to avoid cannibalizing their core business. Exceptions to this have been bmi's bmibaby, Germanwings which is controlled 49% by Lufthansa and Qantas's Jetstar all of which successfully operate alongside their full-service counterparts. For holiday destinations, low cost airlines also compete with seat-only charter sales. However, the inflexibility of charters (particularly as regards length of stay) makes them unpopular with many travelers.
The entry of new nations into the European Union from Eastern Europe and moves towards compliance with EU legislation by those who have not yet joined, has led to an extension of open skies arrangements. India's first low-cost airline, Air Deccan started service on August 25, 2003. The airline's fares for the Delhi-Bangalore route were 30% less than those offered by its rivals such as Indian Airlines, Air Sahara and Jet Airways on the same route. The success of Air Deccan has spurred the entry of more than a dozen low-cost airlines in India. Air Deccan now faces stiff competition from other low-cost Indian carriers such as SpiceJet, GoAir and Paramount Airways. IndiGo Airlines recently placed an order for 100 Airbus A320s worth 6 billion USD during the Paris Air Show, the highest by any Asian domestic carrier. After a year of operation, in 2006, Kingfisher Airlines changed its business model from low-cost to value airlines.
AVIATION IN INDIA
For many years in India air travel was perceived to be an elitist activity. This view arose from the “maharajah” syndrome where, due to the prohibitive cost of air travel, the only people who could afford it were the rich and powerful. In recent years, however this image of civil aviation has undergone a change and aviation is now viewed in a different light- as an essential link not only for international travel and trade but also for providing connectivity to different parts of the country. Until less than a decade ago, all aspects of aviation were firmly controlled by the government. In the early fifties, all airlines operating in the country were merged into either Indian Airlines or Air India and, by the virtue of the Air Corporations Act, 1953; this monopoly was perpetuated for the next forty years. The directorate general of civil aviation controlled every aspect of flying licenses, pilots and issuing all rules and procedures governing Indian airports and airspace. Finally the Airports Authority of India was entrusted with the responsibility of managing all national and international airports and administering every aspect of air transport operation through the air traffic control.
Open skies
A recurring demand often voiced by interested parties is that, in order to promote travel and tourism, India should adopt an open skies policy. It is argued that the current policy restricts the access of foreign airlines. As a result potential tourists are not offered a choice of airlines or seats when traveling to India. This problem is exacerbated during holiday season when it is difficult, if not impossible, to get a seat either into the country or out of it. It is argued that, therefore that India should adopt an Open Skies approach to any foreign carrier wanting to fly into India, which literally means allowing them unlimited service, capacity and points of call. The government owned airlines had their monopoly for almost four decades and on march 1,1994, the government threw open the gates for private entrants satisfying the requirements of the scheduled services. Sensing a huge lucrative opportunity in this sector a large number of players jumped into the fray. The prominent among them were Jet Airways, Sahara, East West, NEPC, Modiluft, and Damania.
Winds of change
The new trend of low-cost aviation has been picking up immensely in the recent past. This new emerging trend has put the existing traditional airline agencies, both government owned and private, all over the globe to rethink their strategies and restructure their airfares. A low cost carrier (also known as a no-frills or discount carrier) is an airline that offers low fares but eliminates all unnecessary services. Low cost carriers (LCCs) pose a serious threat to traditional ‘full service’ airlines, since full service carriers cannot compete on the price and, when given a choice, most consumers will opt for low price over other amenities
EMERGENCE OF LOW-COST AIRLINES IN INDIA
For the first 15 years of deregulation the demand for scheduled passenger air transportation was driven by the constraints and confines of its providers - principally, the network carriers. Network carriers were able to avoid cost-side pressures by focusing on
revenue side strategies – largely centered on the high - yield business traveler. The focus led to innovations like sophisticated global distribution system, revenue management, and frequent flyer programs that helped the airlines segment demand. You are – or we were – the linchpin in that strategy, as business and other time–sensitive travelers accounted for only 20% of the airline traffic, but for 80% of network airline. This strategy worked because the business traveler grew accustomed to paying high fares and often did not have an attractive alternative to the high fare, and also because the airlines enjoyed a greater ability to control the number of seats available to discretionary travelers. In short, in the post-regulation world travelers – particularly business traveler – did have the greater option than before, but, even with the impact of the occasional low-fare carrier, they were often at the mercy of major carriers when it came to price. In effect, demand for passenger service was driven, even controlled, by the supply that network carriers were willing to deploy in the market. The above reasons and the price transparency that the internet has created for all types of passengers have led to the emergence of a new breed of low-cost carriers. These developments have seriously compromised the ability of legacy carriers to charge higher prices to travelers on the routes where they overlap with the low-cost carriers. At the end of 2000 the demand for the business class and other high-end products fell dramatically, as the corporate travel managers became more cost-conscious. Customers continue to fall into segments with regard to demand for products on offer. Not every airline will be able to satisfy every customer but the entrance of low cost airlines has pushed customer segmentation. There is a sharper focus for the shorter routes and the target is the price conscious and quality conscious customer. This has led to stiffer competition for the non–business passenger and price conscious business passenger.
Target market
The entry of these low cost carriers has several far reaching implications on the aviation sector in India. Now low cost airlines have proliferated and offer real, lasting competition to their network rivals. This generation of low cost carriers has newer fleets, a better ontime performance and completion factors than the first wave of post-deregulation start-
ups. The fare transparency delivered by the internet and the expansion of low cost carriers has increased the price-sensitivity even of business passenger. The demand for more affordable air travel is quite robust. Increasing numbers of business travelers use low fare airlines as a matter of corporate travel policy whichever country they have been launched in. It has to a very large extent influenced the mass transportation and domestic tourism .E.g. in a country of a billion people, the Indian aviation industry is puny. In the US around 12 million people who fly everyday, even though the population is one fourth that of India. The number of daily flight averages around 400 a day, as against 40,000 flights a day in the US. Ryan Air amongst the low cost pioneer in Europe flies 25 million people in a year and still has less than 5% market share. In Malaysia, there are 12 million people who travel air yearly, thus here is a nice big fat juicy market of around 200 million people which is equal to that of entire Europe. Now if the LCA’s are able to tap even one-fourth of that large middle class and would persuade them to travel by air, there could be a rise by 5% to 6% in their capacity. Comparing the Indian scenario with that of China we see that china leads India by huge margins in terms of the number of air passengers. This can be seen from the table shown below: Initially, low cost carriers (LCCs) were geared more towards holiday trips than toward business holidays, due to the location of the airports, among other reasons. Based on research conducted by TQ3, business travelers are clearly starting to use the LCCs more often as time goes by. There are a variety of reasons for the shift. Quite often, passengers will book a private holiday with an LCC to acquire experience. If satisfied, they may decide to book LCC for their next trip. Other important reasons include the lower prices and improved schedules (several flights per day). In addition, it is also attracting to its fold many of the rail travelers who save hugely on time and don’t mind paying premium for the time thus saved. Potential of air travel in India
A total of 390 to 400 commercial flights operate in a day in India. The US, which has one fourth of India’s population, has 40,000 flights a day. Thus if US were to have India’s population nearly 1, 60,000 flights would be needed. If the airline in India were to tap just 1% of its potential, we would still need 1,600 flights a
day and that would mean a jump in the number of commercial flights by four times. Also in India, about 12 million people fly every year. Malaysia also boasts of a similar figure, but on a population of 24 million. If a low cost airline can offer fares at the half the price of regular airlines, at least one-fourth of India’s middle class population of 200 million will travel.
AIRLINE OPERATORS IN INDIA (DOMESTIC)
Existing full service carriers:
Existing LCCs:
New entrants:
Every other month a new cost airline or value carrier is taking to the skies. A detail of the carriers lined up to reach out to Indian skies is given here below:
Indus airways: value carrier, had announced plans to launch in may 2005 but is yet to import its first aircraft.
Airone : regional airline, had announced plans to launch regional services in 2005
Magicair :no frills airline, announced plans to launch in 2005 but is yet to get a no objection certificate (NoC)
Eastwest Airlines : value carrier , had plans to launch in the year 2005
Interglobe: low-cost , has a NoC to start the operations but is yet to announce any plans of launch
Crystal air: regional ,the Coimbatore based airline has plans to launch regional services with Embraer 170/175 series
Visa air: low cost ,has NoC but in the process of raising funds
MEANING: LOW-COST AIRLINES
A low-cost carrier or low-cost airline (also known as a no-frills or discount carrier / airline) is an airline that offers generally low fares in exchange for eliminating many traditional passenger services. The concept originated in the United States before spreading to Europe in the early 1990s and subsequently to much of the rest of the world. The term originated within the airline industry referring to airlines with a low - or lower -
operating cost structure than their competitors. Through popular media the term has since come to define any carrier with low ticket prices and limited services regardless of their operating costs
Typical low-cost carrier business model practices include: 1. A single passenger class 2. A single type of airplane (commonly the Airbus A320 or Boeing 737), reducing training and servicing costs). 3. A simple fare scheme (typically fares increase as the plane fills up, which rewards early reservations) 4. Unreserved seating (encouraging passengers to board early and quickly) 5. Flying to cheaper, less congested secondary airports and flying early in the morning or late in the evening to avoid air traffic delays and take advantage of lower landing fees 6. Short flights and fast turnaround times (allowing maximum utilization of aircraft) 7. Simplified routes, emphasizing point-to-point transit instead of transfers at hubs (again enhancing aircraft utilization and eliminating disruption due to delayed passengers or luggage missing connecting flights) 8. Emphasis on direct sales of tickets, especially over the Internet (avoiding fees and commissions paid to travel agents and Computer Reservations Systems) 9. Encouraged use and issuance of the electronic ticket 10. Employees working in multiple roles, for instance flight attendants also cleaning the aircraft or working as gate agents (limiting personnel costs) 11. "Free" in-flight catering and other "complimentary" services are eliminated, and replaced by optional paid-for in-flight food and drink (which represent an additional profit source for the airline). 12. Aggressive fuel hedging programs. 13. "Unbundling" of ancillary charges (showing airport fees, taxes as separate charges rather than as part of the advertised fare) to make the "headline fare" appear lower.
BUSINESS MODEL: LOW COST AIRLINES
The “low cost carriers” business design can be defined by three elements:
SIMPLE PRODUCT (NO FRILLS)
LOW OPERATING COST LCC
POSTIONING
Key elements of an LCC Simple product
No meals ,drinks and snacks for free
Narrow seating (greater capacity)
No seat reservation (free seating)
No frequent flier programs
Positioning
Non business class passengers , leisure traffic, price conscious
Short haul point-to-point traffic with high frequencies
Aggressive marketing
Secondary airports
Competition with all transportation carriers
Operating costs
Low wages, low airport fees
Low cost of maintenance , cockpit training and standby crews due to homogeneous fleet
High resource productivity ;short ground waits due to simple boarding processes, no air freight , no hub services, short cleaning time
Lean sales; high percentage of online sales
They generally operate with only one kind of aircraft in their fleet, such as Airbus 320s or Boeing 737s, to lower maintenance costs.
There is no business class just economy class; this increases the number of seats per flight.
MARKET SCENARIO
Today’s airline industry is undergoing more transformation than ever before. The combination of ongoing global economic events, “wired” passengers and growth of low cost carriers makes this market more competitive on price, cost and yield. While the new entrants have usurped market share from incumbents, low-cost airlines, which were not around some time back, look set to dominate the sky for some time to come.
Understandably, the share of incumbent carriers (Indian Airlines, Jet Airways) has been dwindling, even as full service carriers (FSCs), which had for long dominated the sky, are trying hard to preserve their market. Except for Kingfisher Airlines (a new player), which has increased its market share to 10.5% in January this year from 7.6% last January, all other FSCs have lost market share, even as the overall share of FSCs has shriveled to 62% from 79% last January. The share of low-cost carriers (LCCs), on the other hand, has swelled to 38% from 21%. Likewise, challenger carriers (Air Deccan, Kingfisher Airlines, SpiceJet, GoAir, Paramount and IndiGo) have hammered down the share of incumbents to 50% from 72% to take their own share up from 28% to 50%. Another incumbent facing the brunt of the new entrants is the state-owned Indian, whose share has been eroded by 8.7 percentage points to 16.30%. The state-owned carrier, which has been overtaken by budget carrier Air Deccan in the race for the second position, is only slipping further. From being ahead of it by just 0.2 percentage points in November, Air Deccan has extended the lead to 4.4 percentage points in January with a market share of 20.70%. Another FSC struggling to keep its market from eroding is Air Sahara, whose market share is down to 8.2% from 11.6%. All the new players have added marketshare over the last one year — Air Deccan 7.4%, Kingfisher Airlines 2.8%, SpiceJet 2%, GoAir 5%, Paramount 1.5% and IndiGo 4.3%.
That Indian industry suffers from the ‘herd mentality’ is quite evident by the trends in telecommunications, information technology, BPO... the list is long. Aviation has been no different. Everyone worth his salt has jumped into it at the same time, so there is too much capacity. Traffic is growing but capacity is growing faster. The traffic increases are heavily concentrated at the lower end of fare categories. So, to break even, airlines have to achieve higher load factors than before. That means severe competition and very low fares. The legacy carriers need to raise average fares by around Rs 400-700 per seat to reach any kind of breakeven or turn in a small profit; the LCCs need to raise fares by around Rs 500 per seat. Load factors for the LCCs should ideally be in the mid or high 80s and for the legacy carriers around low or mid 70s (see ‘Viable Fares and Load
Factors’). The external environment is not helping, what with little uniformity in fuel taxes within states and no stability in global oil prices. But making matters a lot worse is the obsession with one or two routes. Take a look at Delhi-Mumbai, which has close to 44 flights operating one way, making it among the top 10 busiest routes in the world. Airlines such as Jet and Kingfisher, who are more heavily focused on metro connectivity and frequencies, are likely to see larger losses for the time being, as most of the money is being lost on metro routes. In case of Deccan, its ATR operations are close to break even but losses on Airbus routes are high enough to wipe out the gains made on many of its mature ATR routes, which are often monopolized regional routes (26 per cent of its capacity is on metro routes). Far too much of the total capacity is deployed on just metro routes and the airlines should break out of this. Many airlines are making a profit on their regional far-flung routes by charging a small premium, as there isn’t much competition on those routes. Ministry sources point out that internationally, many of the large LCCs have survived by keeping out of each other’s way. In the UK, very few routes or even airports of Ryanair and easyJet coincide. JetBlue and SouthWest, both in the US, rarely cross paths.
It’s happened before:
The last memory of the wave of failures following the first wave of liberalization in India in the early 1990s is all too fresh in everyone’s minds. At that time too, there was a flood of new operators when the Indian government allowed entry. A lot of new capacity was created. Just a few years later, many of the newbies shut shop. But there’s plenty of difference in the two rounds of liberalization. Then, capacity grew but traffic growth was not as high. Moreover, all the players entered in the full service space — there were no LCCs or, rather, low fare airlines. So, at that time fares remained quite high and yields were much higher. But the public’s ability to afford those fares remained quite low. This time around, fares are more affordable and with growing levels of income in the economy, more reachable. Secondly, this time around the environment is much freer. People then used to say that the aviation policy is ‘open in the air, closed on the ground’. Airlines were not even free
to advertise their schedules. Today, when Kingfisher launched, it took on competitor Jet Airways by directly targeting the latter’s frequent fliers through its advertising campaign. This time, the reforms are more comprehensive — touching airports, maintenance, repair and overhaul (MROs), and general issues. This will help make the aviation business more viable. In the 1990s, most good things were reserved for Indian and Air India, till Naresh Goyal began to spin his magic. But there’s more. Airlines then did not have the deep pockets, the ability to raise money from the markets, the investors queuing up happy to lend or the professional management that airlines today have. Even in that rather adverse environment, at least two airlines survived — Jet Airways and Air Sahara, the former going on to become the country’s largest domestic airline So, there is no reason why many of today’s new carriers won’t make it. The airline business the world over is not known for its ability to churn out huge profits. Airlines going bankrupt are more the rule than the exception. Take the US, where more than 350 filings for bankruptcy have been recorded since the sector was opened up in the late 1970s. In Europe, over 60-65 carriers have shut shop in the past 4-5 years, especially after the advent of low-cost carriers. So what is happening in India is hardly unique. All over the world, both legacy and low-cost carriers have lost humungous amounts of money and have closed down with unerring regularity.
Investors’ story:
Though the markets are not too gung-ho on the airlines sector, big investors seem quite happy to jump in. Deccan’s IPO barely scraped through and Jet has been trading below par ever since it listed big investors seem quite happy to jump in. SpiceJet recently managed to get the Tatas to pick up a 7 per cent stake. It has a pretty impressive list of investors it claims are in the queue. Air Deccan has raised money through private placements (it is expecting its second tranche of investment of $36 million). GoAir is soon hoping to do so too. “Barring IndiGo — which is in its honeymoon period of losses — most airlines are looking at ways to raise money to tide over this phase. So, if IPOs and foreign currency convertible bonds are looking less attractive, companies are finding alternative funds through private placements. Airlines and investors are hanging in there
because the end is so juicy. Everyone thinks he will be there in the end. There is a very bright light at the end of this tunnel. Some industry analysts are convinced that Deccan’s valuation will exceed Jet’s or Kingfisher’s in the way Ryan air and EasyJet’s did British Airways.
RECENT DEVELOPMENTS
Air India and Indian merger:
The government has cleared the proposal that was first mooted 20 years to merge the Air India and Indian to take on the onslaught from private airlines and large international carriers. The merger will create a new entity which will have a fleet of about 120 aircrafts to start with. As new planes join fleet, some existing ones will be phased out and those on lease will be returned. The new national carrier will have more than 125 new generation aircraft by 2010. The new public sector entity will enter list of top 30 airlines globally (in terms of the fleet size) and will break into the top 10 in Asia. The merged company will be the only airline in the world with at least 7 types of aircraft, including Boeing and Airbus in its fleet. Jet Airways which has the fleet of about 44 aircraft at present and Vijay Mallaya’s Kingfisher has about 23 aircrafts, which will be the closest rivals to the merged new entity of Indian and AI. Jet intends to induct 20 more aircrafts by 2009, while kingfisher has ordered 109 planes. Along with the size, the new entity is expected to create considerable amount synergy for the state-owned airlines since the two can feed traffic to each other. Besides, it could result in redeployment of aircraft since Air India and Indian are flying on the some common routes like Singapore and Dubai. The government is aiming to create a mega merger with the precision and reliability of Lufthansa and the in-flight service of Singapore airlines. The merger is expected to cost the government about Rs. 200 crore. This Air India-Indian merger is expected to spur consolidation in the aviation market. The government had decided to merge the two companies to take on competition more
effectively, but the private players, who already have a bigger pie of the sky, are only going to be spurred to consolidate to take on the merged public sector entity. According to some analysts, low cost carriers will have a firm grip on their passengers and will account for nearly 70% of the market in the next three years. The merger is expected to encourage the private players, some of whom are already allowed to fly overseas, to consolidate. Jet Airways, which earlier tried to acquire Air Sahara, is expected to start hunting once again the arbitration proceedings are over. Similarly, the Vijay Mallaya’s Kingfisher and Spicejet would also be on p rowl. The traffic in India is growing at nearly 40 % a year when compared to the global pace which is 15-20%. Thus one can expect the private equity funds to help the private players finance their expansion. As compared to the other players in the market, the merged airline has the advantage of economies of scale. The combined turnover of the two airlines is over Rs. 15000 crore and it is having the countries largest fleet of aircraft. In addition to this, the merged airline is operating to more destinations than any o ther airline in the Indian market.
GROUND REALITY
The Indian aviation industry’s appetite for making losses is huge. For every passenger flying today in India, airlines are losing on an average roughly $15 (gap between revenue and costs; some airlines are losing less than others and some routes are losing less than others). At 32 million passengers expected to fly in 2006-07, that works out to $480 million or Rs 2,200 crore. A back-of-the-envelope calculation of each carrier’s losses combined is around Rs 2,100 crore. Nobody in the industry expects the combined losses to be lower than Rs 2,000 crore in 2006-07 (that, mind you, is the number with the sale and lease back profits excluded, financial jugglery each airline has been doing to keep its balance sheet looking, somewhat, respectable). Normally, November is a peak month when most carriers begin to expect to fly the good times. Contrary to yearly trends, November 2006 showed a dip in terms of load factors.
But that may be a trifle alarmist (in fact, December numbers are better, despite the fog). What has really happened is that huge capacity was added in November and that has shown up in the drop in load factors. Many airline chiefs firmly believe that Sahara alone is contributing close to half the industry’s total losses this year, with guess estimates ranging between Rs 800 crore to a more bizarre Rs 1,200 crore. In September 2006, a total of 100,000 seats were available per day. By December that went up to 120,000. Since April 2005, the industry has added 120 aircraft. Airlines are buying planes like they were peanuts and adding capacity at a frenetic pace. Whatever we may or may not expect, industry players certainly did not expect this kind of bloodbath. Sure, they had all expected and accounted for some losses in the initial phases, but the preliminary estimates are far exceeding the worst doomsday predictions. IndiGo, brave enough to launch during this grim period, claims that its initial equity infusion of $50 million will see them through the initial 18 months or so (the time startup airlines typically take to break even) — but few are willing to believe it. But industry players estimate that IndiGo’s first year’s losses alone will be no less than $50 million. Since the company is private, there is no way of confirming this. Deccan stunned most analysts and its investors when it announced its Rs 340-crore loss for 15 months (1 April 2005 till 30 June 2006). Industry leader Jet Airways has clocked a loss of over Rs 100 crore in the first half, in sharp contrast to the promises made at the time of its IPO. Kingfisher Airlines chairman Vijay Mallya has, on more than one occasion, tried to urge his rivals to bring some sanity into their pricing, emphasizing that he is not in this business to lose money. But his pleas have so far fallen on deaf ears.
To add to the Indian industry’s woes, it is also a time when the global aviation industry seems to be getting its act together. The International Air Transport Association (IATA) expects far lower losses — $500 million this year than its own estimates of $1.7 billion made in September. Without the $6-billion restructuring costs incurred by US carriers, 2006 would have been profitable. And they expect 2007 will see the first profit — close to $2.5 billion — since 2000. Europe is likely to have the biggest profit of $1.5 billion followed by Asia at $1.2 billion.
What is making it even less palatable is that it is happening at a time when most other sectors in the Indian economy are booming and aviation itself is growing at its fastest ever. Traffic is growing by leaps and bounds, the Indian economy is on a roll, yet aviation is defying the trend. Every airline expects industry fundamentals to improve. But there are no signs of that happening as yet.
CHALLENGES AND CONCERNS
Today, operating conditions present severe challenges. Airport charges are 62 per cent higher than international levels and fuel prices are also higher. Distribution costs are high, as Internet penetration, the main ticketing medium for budget carriers, is poor. Aircraft utilization and turnaround times are lower due to poor infrastructure (few runways and hangars, among other things) at Indian airports. Also, many carriers are buying or leasing new-generation aircraft at high prices. Then, there are regulations like all airlines have to fly to some unprofitable routes (the North-east, for example). All these add up to throw their budgets out of gear. Fuel costs now are the single largest cost element for the airline industry- and due to market forces fares have not kept pace. Unit cost compression to a competitive level is constrained by the limited size, network scale and flexibility of the individual airlines of the sub continent –small size means lower purchasing power and higher costs across the board – network scale restricts aircraft utilization to uneconomic levels. If we compare these conditions with that of Europe it is quite different. In Europe, the number (of passengers) is far lower, journeys are short, and traveling by train is a nice experience. Yet, the low-cost airline model has worked very well. Hence one can begin to imagine the size of the market in India. However unlike in Europe, there are no reliable train connections between large cities in India, and the journeys are hardly comfortable. And while many Indians traveling by train are not headed for the big cities but to smaller towns in between, nothing prevents them from doing the larger chunk of the journey by air and the rest by road, if prices permit.
Concerns in future: Pilots:
All planes need pilots, which currently are numbered about 1500 in India. Training schools which are losing instructors produce few commercial pilots. If the expected number of commercial aircraft grows by about 200 by the year 2010, an estimated 2400 additional pilots will be required. Pilots need 1500 hours of flying experience for the first officer to be eligible for an airline transport pilot’s license, followed by 4000 hours and five years of experience as a first officer to be a captain. Until current training facilities are expanded and revamped, the airlines expect substantial use of expatriate pilots. The scarcity of the pilots will be felt as more and more LCCs enter the domestic aviation market.
Airport congestion and bottlenecks:
Peak hour congestion is the main concern. In Mumbai airport, for example, the peak times for the scheduled aircraft movements, both domestic and international, are between 0500-1000 and 1700-2200 hrs. With all the airlines competing for the best slots, there does not seem to be any way of sorting this out, especially at one runway airports. The following table shows the concentration of international and domestic traffic at the key metropolitan city airports, which put them under severe infrastructure pressure in terms of both passenger and aircraft handling.
THE SOLUTION: LCC INTEGRATION
There is however a solution: the operational integration of the low cost carriers into an effective Indian regional airline group. The operational integration of the airlines will create an airline network that will have the scale and flexibility of significantly increasing traffic and revenue through improved traffic flow across the network and the scale to permit the reduction of unit costs to a sustainable competitive level. The cost benefits are
apparent: one head office, one operation per city, one reservation system common to all, one marketing organization for all. Common scheduling will overlap and increase connectivity and the larger network scale will permit increased aircraft productivity. Further cost savings and efficiencies will flow as the integrated structure matures. A common frequent flyers program will reinforce strong current brand loyalty. The combined effect will be an improved network and sustainable profitability.
About airline alliances:
An important development in the aviation sector is the arrival of the worldwide airline alliances. An airline alliance is an agreement between two or more airlines to cooperate for the foreseeable future on a substantial level. The degree of cooperation differs between alliances. The three largest alliances are the Star Alliance, SkyTeam and oneworld. With the help of alliances, airline companies can extend their individual reach by cooperating with other airline companies. By participating in an alliance, the number of destinations will increase; flight schedules can be co mbined, as well as frequent flyer programs. The benefits can consist of an extended and optimised network: This is often realised through code sharing agreements. Many alliances started as only a code sharing network. Also, it is possible to buy jointly and share the costs of different services and infrastructure. An overview of the different alliances in international context is given in figure 4.
Figure 4, Airline alliances Alliance About Since: 1999
Members AeroMexico, Air France-KLM, Alitalia,
Passengers: 343,6
Continental Airlines, Czech Airlines, Delta,
million
Korean Air, Northwest Airlines.
Daily flights: 15.207 Countries: 133
Destinations: 684
Since: 1998 Passengers: 242,6 million
Aer Lingus, American Airlines, British Airways,
Daily flights: 8.110
Cathay Pacific, Finn Air, Iberia, LAN, Qantas.
Countries: 134 Destinations: 599 Since: 1992 Passengers: 382,6 million Daily flights: 15.000 Countries: 138 Destinations: 790 Source: www.jvdz.net
Air Canada, Air New Zealand, Asiana Airlines, Austrian, BMI, LOT Polish Airlines, Scandinavian Airlines, Singapore Airlines, Spanair, TAP Portugal, Thai, United, US Airways, Varig.
This international alliance model has been successfully adopted by all major international carriers. This can also be adopted by the domestic operators while operating within India. This has been discussed further in details.
The network:
The Indian air travel market is complex and multi segmented. What is envisaged is an Indian hybrid- series of major points along the linear network into which ‘clusters’ of connecting flights will feed to and take from the main line network traffic destined to smaller markets at the transfer times through the day e.g. Gwalior, Ranchi, Tripura, Amristsar, and Tiruvananthapuram. Direct service between regional markets will continue and will be improved. This system will require seamless connections at the
cluster stations to minimize passenger connection times and shorten aircraft turnaround/ transit times.
Operations:
The integrated Airlines network will be operated by the existing airlines: Deccan airlines, Spicejet, Go air, and IndiGo airlines operating on a common schedule. With an increased aircraft utisisation will permit route expansion and/or limited fleet reduction. In the medium term fleet, rationalization will bring further cost reductions through standardization. It will be required for the profitable development of new markets within India, and improved service on the current and new intra-regional longer low-density routes. Access to the entire Indian market will permit the development of an efficient and profitable cargo service. Dedicated cargo aircraft operation is envisaged in addition to the cargo capability of the passenger operation.
The benefits:
The integrated airlines network will be profitable, delivering improved reliability, expanded flight schedules and lower fares, region wide. Profitability will permit expansion of the route structure thus allowing the integrated airlines to better support the tourism industry and regional trade and economic development. It will further support the objective of the civil aviation. Benefits to stake holders:
1. The consumer will benefit from the lower fares, increased flight schedules and the ability to earn and use frequent flyer points over a broader network. 2. The taxpayer will benefit in a way because it has to no longer have to subside the airlines (government owned) losses. 3. The successful integration of airlines will be a potent regional symbol. 4. The economic and service benefits of the proposed network integration have been extensively analyzed over many years and can be clearly demonstrated.
The integration of the airlines with proper capitalization, private sector ownership and professional management will be operated as a business – to generate optimum returns
for its stakeholders over a long term investment horizon through reliable, efficient, price competitive, market responsive flight schedules and service quality – a world class airline network.
FUTURE OF LCC
Revolutionized by liberalization, the aviation sector in India has been marked by fast paced change in the past few years. From being a service that few could afford, the sector has now graduated to being a fiercely competitive industry with the presence of a number of private and public airlines and several consumer-oriented offerings. The market was galvanized a couple of years ago by the introduction of lower price tags which ensured that people could travel at the fraction of the original price of air travel. It was spurred further by the entry of Air Deccan, India's first budget airline, which offered hard-to-believe tariffs. This was the trigger point for the sector to move from having simple economy, business and first class fares, to multiple slab tariffs such as apex fares, internet auctions, special discounts, bulk purchases and last day fares. Some of the tariffs offered are so low that they have brought airline fares neck-to-neck with upper class railway fares. Little wonder then that the consumer prefers air travel to the railways. The increase in passenger traffic calls for upgraded infrastructure facilities. The international airport in Delhi and Mumbai are being modernised and upgraded through private sector participation. In the joint venture (JV), the Airports Authority of India (AAI) and other Government PSUs will hold 26 per cent equity. The balance 74 per cent will be held by the strategic partner. Foreign direct investment (FDI) in this transaction has been capped at 49 per cent. In addition to these 10 non-metro airports, AAI has identified 15 more non-metro airports, namely, Agatti, Aurangabad, Bhopal, Bhubaneswar, Coimbatore, Indore, Khajuraho, Nagpur, Patna, Port Blair, Rajkot, Trichy, Vadodra, Varanasi and Vizag, for development. The airports have a direct bearing on the foreign direct investment and the developed countries must augment their gateway airports.
Investors’ interest will remain alive as they have an eye on the long term. Centre for Asia Pacific Aviation (CAPA), the industry’s watchdog in the Asia Pacific region, estimates that at least 2-3 large LCCs commanding a market share of around 70 per cent by 2010 will survive along with 2-3 full-service carriers, who will have a 30 per cent market share between them. He also says that the passengers flying will go up to 60 million by then. The legacy carriers will get almost half their revenues from international operations (Jet, for one, is already heading that way, claiming that by March 2009, half its revenues will be from international operations).The market appetite may be low as there is little chance of short-term gains but investors are well aware most Indian aviation companies are heavily undervalued, if you compare globally. Most agree that India will be a 1,000 aircraft market by 2010. The question is: whose aeroplanes they will be and that is the ‘billion dollar’ question. Analysts, industry players and investors expect the valuation of any of the survivors to be no less than that. It is really a matter of who blinks first. It is time the government woke up. A single step by the government — making fuel a declared good — will make the industry profitable overnight. That may be a little simplistic but certainly there are many issues that the government needs to address, and it is indeed trying hard to resolve them. The birth of the Federation of Indian airlines (FIA) may be a first step in that direction. But there is only so much an industry association can get done. The onus to wake up and actually smell the coffee lies with the industry players themselves. There will be a limit to the extent of losses companies can absorb. Whichever way you look at it, capacity additions are now slowing down. That mad scramble to add planes is over. But in case of Jet Airways one should make a note that its new capacity is for its international routes. In this kind of uncertain market, company’s ability to ramp up and ramp down will determine its success. Although many are happy with the low-cost carriers, especially because of the low prices they offer, people want to see some improvement in customer service. The budget airlines' staff at airports appears semi-literate. All relevant employees and points of contact must have the same and most current status information and the on-site personnel
should be authorized to take decisions like putting passengers on other airlines in case of delay. Many endorse the view that the budget carriers seem unable to exploit India's IT expertise to their advantage. For instance, the flight departure time for the same flight on the voice helpline, SMS and website can vary by several hours. But the good news for consumer is that the party on fares is unlikely to get over, at least in 2007. Airlines will have to find ways to cut costs and look for non-operating revenues to shore up bottom lines. The focus will be less on killing the competitor and more on making the business efficient. That will, hopefully, bring a silver lining to these dark clouds.
