Ailing 'Indian' Airlines

The recent crisis of the state carriers ‘Air India’ and ‘Indian Airlines’ (AI-IA) has definitely brought to fore the trouble the Indian airline industry is facing. Though, the economic downturn has taken its toll on all the airlines worldwide, the impact in India has been higher due to excessive competition and higher fuel prices. Some estimates put the industry loss to be at around $1-2 bn, with industry debt pegged at more than $8 bn. The sorry state of the industry does merit some discussion on the problems it’s facing and the possible steps ahead.

Airline industry could be defined by 3 key characteristics that are relevant in the current context. First, as widely observed, the industry is highly cyclical, with marked periods of boom and bust. Just 3 years back, Indian Airline industry was riding high with huge increase in domestic demand – growth that unfurled infrastructure woes. Airlines faced acute shortage of pilots and one could recall the rapid rate at which the airhostess’ academies mushroomed. Airline companies, in order to achieve economies of scale, were quick to order new aircrafts and increase their capacities. And then came the bust – first the spiralling jet fuel that almost crippled the airlines, forcing them to increase fares and then the economic recession that put the brakes on the growth.

Next, the troubles of airline companies are further exacerbated by highly unionised staff, which is strong even in developed markets. This is largely attributed to the specialised nature of the workforce, especially with regards to pilots and engineers. Airlines, thus, must be cautious in increasing their workforce in the times of boom. ‘AI-IA’ combine, with 221 employees per aircraft (as compared to its local competitor Indigo Airlines with 140 employees per aircraft) is definitely overstaffed. Though other state carriers, such as Alitalia and Malaysian Airlines (231 employees/aircraft) have achieved high service levels, the path to recovery has not been easy at all. In either case, it looks tough that the government would allow ‘AI-IA’ to shed excess workforce, when even a private player Jet Airways was forced to revoke its decision to lay off its 1900 employees.

Lastly, the airline industry requires large capital investment, marked by high level of debt and much lower investment returns. The most commonly used aircraft in India - Airbus A320 or Boeing 737 costs around Rs 300 Cr. per plane, which is worth a small or medium sized industry in India. Michael Porter’s analysis of US industries for their ROI during the period 92-06, rated airline industry with one of the lowest returns, with the figure almost one-third of the average percentage across all the industries analysed.

So how could then, one manoeuvre out of this turbulent weather?

First option is indeed obvious – to close down and sell off the assets. Though the likelihood of this option for ‘AI-IA’ looks dim, with the government putting its weight behind, many carriers over the years have been forced to choose this option. Even established carriers could go bust, such as Belgium’s national career Sabena which liquidated its assets in 2001, after more than 8 decades of operations. Smaller Indian private carriers, such as Modiluft and East-West Airlines, closed down in mid 90’s.

The next option is to cut capacity and consolidate through mergers and acquisitions. Indian skies have already seen the first round of consolidation between Jet & Sahara, Kingfisher & Deccan and Air India & Indian Airlines. ‘AI-IA’ alone has more than 43 aircrafts under order, excess capacity that would definitely outpace the growth. Consolidation could help in seeking economies of scale by optimizing routes and sharing workforce. However, excessive consolidation could also lead to a monopolistic market such as Jet-Kingfisher combine might lead to.

The most viable option in the current context would be restructuring, tempered with fiscal concessions. Pure cash bailouts, as sought by ‘AI-IA’, usually don’t work in practice. Numerous cash injections over the years by the Italian government in its national carrier – AIitalia has failed to make it profitable. On the other hand, Malaysian Airlines, inspite of higher employee/aircraft and much older fleet, has consistently restructured its operations, to turn profitable in the recent years.

Recent reports suggest that Government intends ‘AI-IA’ combine to turn into a Low Cost carrier. While cost cutting is definitely required, it seems interesting to see whether ‘AI-IA’ would be able to sustain itself on the basis of cost/price competitiveness in this fiercely competitive market.

An analysis of the airline operating costs reveal that in India because of higher ATF prices, almost 60-70% of the total cost is non controllable by the airline management. A kilolitre of jet fuel costs almost 60% higher in Mumbai than the other airports in Asia Pacific (June’09 ATF prices). Rationalizing the taxation policy and making ATF a ‘Declared Good’ could provide some long sought respite to the industry. Further, unlike other Asia Pacific airports, such as in Singapore and Malaysia, none of the Indian airports have a ‘Low Cost Terminal’ (LCCT) (Delhi Airport Terminal 1D is slated to be the first LCCT in India). Thus, all the airlines, operating at Indian airports end up paying at the same parking or landing rate – leaving little room for an Indian LCC airline to reduce costs. A typical example of how parking rates could define an LCC’s strategy was when Air Asia decided not to fly to Singapore as its airport charge of about $25/passenger was more than the flight ticket – It used to drop its passengers to airport of Johor Baru (Malaysia) from where passengers could take a taxi to Singapore.

In the end, the path to recovery would require the combined efforts of both the airlines and the government, with the former restructuring and cutting capacity and the latter providing ambient policies and concessions.