Bangalore Aviation News, Reviews, Analysis and opinions of Indian Aviation
Related Articles
The following was posted as a guest post over at The Wandering Aramean, a great travel blog written by Seth Miller which also doubles as a travel tool site. Be sure to check his site out, and stay tuned, as we will have some guest content from him this week.
When India’s Jet Airways, Kingfisher Airlines, and SpiceJet all recently reported large net losses for Fiscal Year 2012 on the heels of Kingfisher’s steep downsizing in February and March, it came as a surprise to many people around the globe who considered India, and its burgeoning airline industry, one of the world’s greatest success stories. But as with India’s economic growth story (GDP growth in the first quarter of 2012 was a (relatively by Indian standards) anemic 5.3%), beneath the shiny veneer lies a tottering industry that must take drastic steps in order to ensure its future. But before one can explore the solutions to these issues, it is helpful to look at what exactly created the problems.Any attempt to assign the collective failure in the Indian airline market to one specific reason is highly disingenuous; it took a special confluence of factors to create this mess. Some of the major factors are outlined below.Lack of Capacity DisciplineThe single biggest factor in the struggles of Indian airlines is their inability to properly manage capacity. It is said that the US airline industry, once a global loss leader, returned to profitability by following the “three Cs”: capacity cuts, consolidation, and charging for everything. But in India, the second and third clauses do not apply, and airline strategy planners have essentially ignored the first one.To be sure, India’s aviation sector is growing at a robust pace. Demand measured in RPKs for domestic travel has averaged around 10% since April of last year. But India’s airlines have gone above and beyond this demand growth, adding capacity at exponential rates even as losses continued to mount. The graph below shows that for 9 out of the past 12 months, capacity growth in India far outstripped growth, a trend that has only recently begun to reverse as India’s airlines become increasingly cognizant of their dire financial situation and Air India and Kingfisher continue to shed domestic capacity.And to a large degree, the laws of supply (capacity) and demand have driven India’s losses. Standard supply/demand analysis tells you that when you increase the supply of something faster than the demand for that product is increasing, the price will then drop. What made the problem particularly acute was that this occurred right as there was a rise in fuel prices; the single largest input into the air travel product. Thus in effect, Indian carriers were driving down prices for their own products right as the price required for them to make money was appreciating. It’s not hard to see how this situation would cause an acute worsening of financial results.FuelAs was mentioned above, fuel prices were a killer for the Indian aviation market. From early 2010, fuel prices grew by more than 40%, lulled for a little bit in early 2011, before pushing back upwards again to $105/barrel (West Texas Intermediate). For India’s airlines, this rise in fuel prices was nothing short of disastrous, as it completely eroded their profitability (at India’s publicly traded carriers, the appreciation in nominal fuel costs was larger than the change in financial result – the loss could be primarily attributed to the sharp jumps in fuel costs. Domestic flying in India has razor thin margins during even low-oil periods, during a time of high fuel costs, profit margins quickly swing to loss ones.And the problem is particularly troubling for India’s airlines thanks to a peculiarity of the market. Fuel composes between 40 and 50% of operating costs at all of India’s major airlines, higher than the figures at most major world carriers (those with older fleets typically spend somewhere in the mid 30s percentage wise on fuel, while LCCs and other carriers with younger fleets typically have fuel spend in the low 30s. The underlying reason for this cost disparity is Indian government policy.Government Policy FailuresThe policies towards jet fuel of the various levels of Indian government are a huge drag on Indian fuel costs. The tax burden on aviation turbine fuel (ATF) in India is sky high, nearly 35% on average. The problem starts at the national level where there is a double digit import duty on ATF. That’s then compounded on a state level by sales tax on the ATF that ranges from 3-4% in states like Tamil Nadu, to more than 20% in Karnataka. In addition to being an exorbitant levy, the state level ATF sales tax drives scheduling distortions, because the rates in two neighboring states can be widely disparate, making it more cost efficient for airlines to fly extra sectors and load fuel at airports. This adds extra time cost, delays, and congestion to the Indian air travel system. To give a specific example, Bangalore and Hyderabad are two cities in South-Central India, 283 miles apart. However, the sales tax on ATF is more than 15 percentage points lower in Andhra Pradesh (home to Hyderabad and incidentally, my ancestral home as well) than it is in Karnataka (home to Bangalore). Now most airlines with flights that terminate in Bangalore (given the relatively short distances involved in India’s domestic air transport system) will still have some fuel left over. What these airlines do, is instead of refueling entirely in Bangalore, they’ll only refill to the bare legal minimum before flying the short hop over to Hyderabad, where they refuel the entire tank. Then the aircraft will be re-routed into the airline’s system ex-Hyderabad, or in a lot of cases, flipped right back to Bangalore with a nearly full tank where it can fly routes to another Indian destination.Beyond the problems with fuel, Indian government policy has failed the market in a broader sense, through misguided aviation regulations. The two most important are the prohibition of direct investment by foreign airlines, andThe Prohibition of Foreign Direct Investment and the 5 Year RuleWhile India’s government finally appears to have approved 49% foreign direct investment (FDI) by foreign carriers in Indian airlines, the move might be too little too late. During the past year and a half, India’s airlines, especially Kingfisher Airlines, suffered from a lack of liquidity. While a lack of profits might have scared away normal investors, airlines are usually willing to accept a somewhat lower return on investment (ROI) in other airlines. For Kingfisher especially, inadequate funds might have been their biggest problem. In a vacuum excluding all interest and finance charges last year, Kingfisher’s financial results weren’t all that bad; and could have even been sustainable in the short term. And given the growing importance of India to the global airline system (especially amongst the alliances), it is likely that pre-crisis Kingfisher could have gotten access to the funds that it needed, perhaps from its future oneworld partners. And in a general sense, more liquidity for the Indian carriers would have boosted profitability across the market as a whole.The 5 year rule meanwhile precludes Indian carriers from running international operations until they have been operating for five years (pretty self explanatory). While the explicit rationale behind this rule is ostensibly for safety reasons, the underlying driver behind the rule was to protect Air India’s lucrative near-monopoly on international routes from India. Once again, this rule played its biggest role in the downfall of Kingfisher. When Kingfisher was first started by the flamboyant, Branson-esque Vijay Mallya, a liquor baron, it was obvious that the new premium carrier had global ambitions. In a normal aviation market, such as the United States, Mallya’s airline would have simply had to pass all of the requirements to be certified as an airline. But in India, he would have had to have waited for five years. So Mallya instead decided to buy Air Deccan, a somewhat struggling low cost carrier (LCC) that had been in operation since 2003 and thus met the 5 year rule (possession of Air Deccan’s AOC would allow Kingfisher to fly abroad). This turned out to be a horrendous mistake, because Kingfisher Red (as the rebranded Air Deccan was known) had an unsustainable cost structure for an LCC and suffered from severe competition from more efficient LCCs like IndiGo and SpiceJet. Beyond the effects on Kingfisher, the 5 year rule has hurt Indian airlines in general. Because the 5 year rule was in place only for Indian carriers (while foreign carriers such as Emirates and Qatar Airways had free reign to essentially do whatever they wanted thanks to poorly negotiated bilateral between India and Dubai/UAE/Qatar – a whole different issue), carriers like Emirates managed to capture the lion’s share of lucrative traffic from India to the Gulf, Europe, and beyond.Of course these policy failures are just drops in the bucket when compared to the single biggest factor; India’s erstwhile national carrier, Air India.“The Air India Effect”Air India has a very proud industry. It was the very first non-American airline to operate an all-jet fleet of Boeing 707s, and when Singapore Airlines was just starting out, they actually asked Air India to help design their service standards (shocking I know). But we’ve come a long way since those golden days, and today Air India is essentially a misshapen amalgamation of two disparate airlines (the “old” Air India that primarily flew international routes and Indian Airlines), that is mis-managed by the Ministry of Civil Aviation (MoCA).Of course MoCA will want to protect its own business and so bilateral rights going disproportionately to Air India earlier this decade (via right of refusal) was a minor factor. But the bigger issue is the aforementioned “Air India Effect,” which is my euphemism for the blatant market manipulation practiced by the carrier. For political reasons, it is usually expedient for Air India to put out a ton of capacity, especially within India. Of course at Air India’s cost levels, the vast majority of this flying is unprofitable. If Air India were a private carrier, there would be a minimum level of prices beyond which they would not go (in microeconomic theory, this is the point where the price of an additional unit of product [capacity here] is equal to the marginal cost of producing another unit). But because Air India knows that the Government of India will not let them fail, it need not pay attention to these metrics, allowing it to dump excess capacity onto the market. If the routes are unprofitable, as almost every Air India route is, then MoCA and the GOI will be there waiting to bail out Air India. If Air India were a private carrier, they would have put out much less capacity over the past 5 years, and while I have yet to fully work out the demand elasticities, my model says that this excess capacity cost the Indian airline market billions of dollars in lost profits over the past 5 years.Conclusion – Mismanagement and Hope for the FutureEven though I’ve outlined most of the major reasons above, I’d be remiss if I didn’t point out that strategy failures at the airlines themselves were part of the fall. Every airline in some form or the other has to deal with hostile factors outside of its control, but it’s how you respond to it that makes all of the difference. In the US, airline lost a cumulative $60 billion between 2000 and 2008, but after discovering the three C’s the US airline industry is powering non East-Asian airline profits. Meanwhile in India, airline execs largely ignored the signs calling for capacity discipline, and failed to make the tough choices in terms of being realistic with employees and cutting costs, while simultaneously pursuing failed business strategies.And yet, there is hope for the future. India is troubled air market where the once largest domestic airline holds just a 5.4% market share and the national carrier is embroiled in prolonged industrial action with its most important pilot group. Yet during a time of slowing growth, a rapidly depreciating Rupee, and persistently high oil prices, it’s important to note that all of India’s airlines save Air India would have made money under the US ATF taxation system. Even in its darkest days, the Indian airline market is just a step away from profitability. Luckily, the fix for what ails India’s airlines is rather simple. Capacity (and cost) discipline is a must; and Jet Airways is a prime example. Since announcing their dismal results for fiscal year 2012, Jet Airways has begun purging their international network of unprofitable flying like Mumbai-Johannesburg in an attempt to shore up profitability; a smart idea to say the least. India’s government can make it easier on the airlines by coordinating a uniform national level sales tax on ATF, approving FDI, and abolishing the 5 year rule. And if by any miracle, Air India actually shrinks, then the recipe for reform in the Indian market is all but complete.
