Boeing 'Dreamliner' - A Distant Dream

After what has been really long period of time, there appears a ray of hope for Boeing in the form of the much awaited Dreamliner. The 'Dreamliner' on which the Boeing Corp. has in a way bet on for the future, has been plagued with difficulties right from inception. First there were what can be called seemingly trivial matters like lack of availability of spares, to the problems faced in integrating the parts being manufactured across the plate. Well this brings us back to the point that most problems encountered by modern day businesses trace their origins to something considered very trivial. While the importance of sourcing raw materials (on time) and other procurement related issues is drilled into the minds of young managers all too often, but still we find the biggies of the world making those very mistakes.

Anyway, on the bright side, things being normal, the first passengers of All Nippon may step onto the 'Dreamliner' in around 9 months. But then the operative phrase here is things being normal. While everyone is pretty gung ho with the test flights starting, let's not forget that this is a project which is already running late by more than 2 years. Other than the difficulties being mentioned above there have been some technical glitches as well, like the excess stress on the fuselage at the point where the wings meet the fuselage. While Boeing has faced some flak over these issues, it would be only logical to say that such minor setbacks are to be expected while embarking on a project which makes such a huge leap in terms of 'innovation'.

While everyone has been quick to point out the innovative attributes of the 'Dreamliner', be it the composite structure or the aircraft or the innovative design of the engine blades, but what has not been so prominent is what benefit does these translate into for the customers , the airlines, and more importantly the end customer, the travellers.

Well a composite structure obviously helps to reduce the weight of the aircraft which would eventually result in lower weight of the craft and ultimately savings for the airlines with less fuel being consumed. Another major advantage with composite frames actually arises from absence of aluminum. Humidity levels in flights were kept down earlier because with higher humidity aluminum tends to corrode, so in this respect the 'Dreamliner' promises better experience for future travellers. Also the 'Dreamliner' will allow higher pressurization for flights resulting in more comfortable flight for long duration flights.

But what will really bring smiles to the faces of Airlines executives is the lower noise levels of the aircrafts. This will result in lesser opposition from neighborhoods close to airports and possible result in wider operating hours for airlines. While this issue may not be all that prominent in developing world cities, this is actually a very major concern in developed countries.

And yes, this definitely results in a more comfortable flights for travellers. And yes, there are other passenger amenities like the much talked about LED lighting, wider and longer windows, and electronically operated shades.

So while the benefits are plenty, what remains to be seen is whether there would be any other complications in the nine month long test flight schedule, and will Boeing be able to deliver the aircraft on time this time.

An interesting take on the same at http://blogs.hbr.org/cs/2009/12/is_boeings_787_dreamliner_a_tr.html

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Gracious thanks to my batchmate - Amit Tyagi for his inputs! :)

Also, Mr. Dinesh Keskar - President Boeing India for his address at FMS - Annual Convention

News to Cheer

Finally some news to cheer!

Domestic traffic is expected to reach record high this quarter. According to DGCA, the Nov-Dec traffic has passed of 4o lac barrier - which is much higher than the 2007 record figure during the same period. Incidentally, last year's figure stood around 30.48 lac

So hopefully, less red ink in balance sheets! Amen..

The Survival of 'Metrics'

Deming had once commented that you cannot improve what you cannot measure.

As one of the biggest yet one of the most vulnerable industries, airline industry is currently under one of its worst periods of bust. At these times, focus does shift on optimising and rationalizing capacity and decreasing costs. This also leads us to tackle one of the trickiest challenges in any business – identifying and choosing the right set of metrics.

With changes in the business models and dramatic shifts in the industry, the traditional and oft used metrics could turn misleading.

A case in point was presented by a BCG report on US airlines in 2006: Within the period 2001-06, the legacy and full service carriers (FSC) had favourable big numbers in almost all the commonly used metrics-

- 90% share of revenues

- 85% share of seat capacity

- 85% share of departures

Yet together the FSCs lost close to $30 bn during that period, while LCCs made a profit of $3 bn during the same period, despite their lower numbers in the metrics. This disagreement between the metrics and profitability was largely attributed to the change in the industry cost structure brought about by the low cost carriers.

In this post, we would analyze the commonly used airline operating metrics that are largely used for modelling profitability. Profitability is defined in terms of Income per ASM (Available Seat Miles) which is determined by 3 factors – yield, load factor and operating expenses. Yield is attributed to total revenues per RPM (revenue passenger miles), while load factor is the ratio of RPM and ASM. The third factor is the total operating expenses per ASM.

Thus increasing profitability would require optimizing any of these factors:

Revenues/RPM – The primary determinant of this factor is the level and intensity of the competition on the routes flown. Also, the airline’s ability to attract high paying business customers through superior customer service - could also be one of the determinants of this factor.

Load Factor – is one of the most commonly used operating benchmark metric, which is largely determined by the efficiency of route planning, the ability to foresee passenger demand to match airplane size for individual routes and the competitiveness of prices. A common industry benchmark states that an airline would require to have an at least a 80% load factor (with today’s yield) to make money.

Operating Expenses/ ASM – Operating costs largely comprise of aviation fuel, airport charges, labor costs and administrative expenses. As discussed in one of the earlier posts, almost 60-70% of the total costs is non controllable by the airline management, leaving little room for flexibility of this lever.

While traditional metrics of revenue and capacity are essential components to model profitability, alternative complementary metrics are time and again explored that track more accurately the changing industry models.

References: ‘Strategy: KSFs’ – Robert Grant

May 2009 Traffic Figures

The domestic Indian market has shrunk by 4.4% year on year as per the figures released by DGCA for May 2009. According to ACI, the passenger demand worldwide has fallen sharply in May 2009, with the world airports reporting an 8% decrease y-o-y. This sudden fall has largely been attributed to the impact of H1N1 virus which has slowed down to some extent the international traffic.

The figure shows the May 2009 market share of Indian carriers in the domestic market, with IndiGo and Go Airlines gaining strength at the behest of larger airlines. Kingfisher, with 26% market share retains its spot as the largest domestic carrier.

During the first quarter of the year, the passenger traffic has contracted by more than 12%, which has gained some semblance now. In the same period, Indigo, Go and Paramount were the ones that have gained their domestic market share.

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.