Continued from Page 1

Sruthi, a young consultant, is a frequent flier. She watches the turbulence in the airline industry with dismay and is worried about how it will affect her. “Will it mean higher ticket prices? Will I have to plan my travel in advance so that I'm assured of a seat? And what happens to the mileage points accumulated on frequent flier programmes?” are some of her concerns.

Sruthi is not alone. Millions of passengers like her will be affected by the troubles in the airline industry. Average ticket prices are bound to increase, capacity on some routes will fall, leading to lower seats availability. And mileage points accumulated by those like Sruthi may well turn worthless if a carrier shuts down.

What brought India's airline industry to the current pass? Will it take-off again?

Excess capacity, a high cost structure and a flawed pricing strategy, in that order, are responsible for the present mess. Let us examine each separately.

Excess capacity

India's growth in air passenger traffic is one of the highest in the world at 16.4 per cent. The problem is that capacity is growing even faster at 18.6 per cent. In comparison, capacity growth in China, at 7.8 per cent, is much lower than the 10.9 per cent growth rate in demand.

Thanks to the excess capacity available on most routes, average occupancy rates on aircraft, or load factor, is just 75 per cent on Indian carriers compared to the impressive 88 per on Chinese airlines. Simply put, airlines in India fly planes with a quarter of their seats empty!

This statistic may appear contradictory to frequent travellers piqued by the congestion in most major airports across the country. How can planes not be full when check-in counters and security checks in most airports have long queues or middle seats are the only ones left when you check-in?

The airline business is a complex one to understand. Airlines might be flying the wrong aircraft or flying wrong routes. A high-capacity plane on a route that is very competitive might mean either a large discount on tickets or several empty seats. The trick is to get the equipment (aircraft), time-slot and the routing right, which airlines, often in their urge to expand, fail to do.

For instance, the Delhi-Mumbai route is one of the busiest with more than 62 daily flights operated by different airlines. Yet, the income for different airlines on this route vary based on their time-slots and the aircraft that they deploy. Thanks to a higher demand, there is usually a premium on prime time tickets, that is departures and arrivals that get the passenger into the city in time for the opening of the business day or get her out soon after the end of the day.

Morover, air traffic congestion or crowded airports are a feature in only the top eight metros. Airlines also fly to other destinations across the country with less traffic. Finally, even on the prime routes, the number of seats on offer is higher than the number of passengers.

“India witnessed stronger growth in passenger traffic compared to China in 2010-11, however the Indian carriers are bleeding due to high cost structures, excess capacity and unviable pricing strategies adopted by the carriers,” says Kapil Arora, Partner-Infrastructure Practice, Ernst & Young.

High cost structure

Fuel accounts for 40 per cent of airline costs in India, considerably more than in other countries. Aviation fuel doesn't enjoy subsidies as petrol and diesel do. To top it, government duties and taxes are inordinately high, leaving airlines with little elbow room to manage the most important component of their cost.

Oil companies price aviation fuel based on the landed cost of imports including freight from the Gulf, to which are added domestic freight, margin and various taxes and duties that add up to 28 per cent in all. Since these taxes are calculated as a percentage of the basic price, when the latter rises, so do the taxes. According to some estimates, airlines in India pay at least 40 per cent more for fuel than their counterparts abroad.

The government recently allowed airlines to import their own fuel, but this may not help them much. For one, airlines need infrastructure in terms of tanks and pipelines at ports for importing fuel as well as storage facilities at various airports.

These are currently owned by the oil companies. Even if they are willing to share the infrastructure and compromise their own business, this would be at a cost that will be unviable for the airlines. Assuming this matter is handled with some ‘support' from the government that owns the oil companies, the airlines would still need to contend with other practical difficulties. It is impossible to secure and ship small quantities of fuel. Besides, payments in foreign exchange have to be made upfront and there will be no credit period. Fuel imports are, thus, a non-option.

Staff costs come next , and here the airlines have only themselves to blame. Not only are the major airlines, starting with the state-owned carrier Air India, overstaffed, but the staff is also over-paid. Capt. G. R. Gopinath, the founder of the now-defunct low-cost carrier, Air Deccan, pointed out in a recent article in Business Line that his airline had 65 people per aircraft compared to 500 for Air India and 280 for Kingfisher.

The rapid growth of the industry also put a premium on talent, leading to wage bills rising for most carriers. Airlines routinely poach pilots from each other with the promise of higher salaries. Maintenance and repair costs are also high in India with the government again imposing high taxes and duties on spares and also on fees paid to technical personnel on deputation from the aircraft manufacturers.

In a competitive environment where fare increases can only be made at the cost of lower occupancy, the airlines have little choice but to absorb the costs. And that brings us to the flawed pricing model of the industry.

Competing on price

With excess capacity on most routes, airlines have banked on a strategy of dropping prices to fill every available seat; none practices this better than Air India. The balance-sheets of airline companies, spattered in red, testify to the damage that this strategy has caused.

Kingfisher, for instance, has never reported a profit in the six years of its existence. Over the last six to eight quarters, no airline except Indigo has managed to avoid a loss. Some of these airlines have been borrowing liberally to keep flying, with the result that interest costs have ballooned to unmanageable levels. Margins in the airline industry are under five per cent globally but for our domestic carriers, interest costs alone account for as much as 10-15 per cent of turnover! So, how can they be profitable?

The state-owned carrier, plagued by operational losses, has been consistently undercutting prices on the routes it flies, according to an aviation analyst who preferred not to be named. With the government acting as backstop, the airline has been pushing the frontiers on pricing, forcing others to join the game to survive.

The strategy is obviously to push volumes to make up for the wafer-thin margins. But the problem is that either the volumes are not enough to compensate for the ultra-low price or many a time the ticket is priced below cost. The result is that the airline companies are in a race to the bottom or as Neil Mills, CEO of SpiceJet, told this writer a few months ago, they are playing a dangerous game of last-man-standing.

We are now beginning to see the results of this game as, one by one, the weakest of the lot are beginning to fall by the wayside. The combination of a high-cost structure and price-based competition can be deadly as the industry is now discovering.

Will they take-off again?

“The aviation sector is likely to experience continued financial stress and uncertainty, at least in the foreseeable future,” warns Ernst & Young's Arora. He points out that the problem is systemic and would need the coming together of all the stakeholders (i.e. the government, airline companies and airport operators) to co-develop a viable and sustainable solution.

The Government needs to recognise that the aviations sector needs immediate favourable policy support to ensure the viability of the carriers. Over the long term, India's aviation sector has the potential of being amongst the Top 3 in the world, by 2020, says Arora. The industry estimates a 12-15 per cent compounded annual growth rate over the next five years.

The government has to ease foreign direct investment in airlines. Though it is difficult to see how any foreign airline will invest now given the weak balance sheets of most Indian airline companies, it might help in the long term, according to Arora.

A reduction in fuel duties is imperative to help the airline companies. But again, given the big hole in government finances it is difficult to envisage this happening.

And yes, the government should also further liberalise rules that will enable private airlines to fly on international routes. It recently ended Air India's first right of refusal to utilise bilateral rights to fly into destinations in other countries. Some destinations such as Dubai and Singapore are lucrative ones and private carriers can offset some of the losses they incur on domestic routes by flying to these destinations.

The airline companies need to take a serious look at their routing, aircraft deployment and most important of all, pricing. Given how badly their balance-sheets are bleeding now, it is time that airline companies restore sanity in pricing.

Of course, it all depends on how the Maharaja works, but it is about time that the government stopped bankrolling the airline using public money, say analysts tracking the industry. Unless that happens, there is very little hope for rationalisation of fares.

Passengers, on their part, need to get used to paying for what they use. If the industry is to survive and grow, passengers should be prepared to pay fares that are higher; these fares will obviously bear some relation to the actual cost of operating an airline. Flying at the cost of a train ticket is neither desirable nor healthy in the long term interests of both passengers and airlines.

Frequent fliers such as Sruthi need to understand this.