36541163 Analysis of Low Cost Airlines

TABLE OF CONTENTS

1. EXECUTIVE SUMMARY.........................................................................................1

2. EVOLUTION OF LOW COST AIRLINES GLOBALLY.........................................3

3. AVIATION IN INDIA..............................................................................................13

4. EMERGENCE OF LOW-COST AIRLINES IN INDIA..........................................15

5. AIRLINE OPERATORS IN INDIA (DOMESTIC).................................................19

6. MEANING: LOW-COST AIRLINES......................................................................22

7. BUSINESS MODEL: LOW COST AIRLINES........................................................24

8. MARKET SCENARIO.............................................................................................26

9. RECENT DEVELOPMENTS...................................................................................33

10. GROUND REALITY................................................................................................35

11. CHALLENGES AND CONCERNS.........................................................................38

12. THE SOLUTION: LCC INTEGRATION.................................................................41

13. FUTURE OF LCC.....................................................................................................45

14. REFERENCES..........................................................................................................49

1. 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

companies and ‘up-selling’ in-flight services. But by far, the largest proportion 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 airline industry could be described in three words, they could be “intensely

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

international services. Originally, the airline industry was either partly or 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, ranging from loose, limited bilateral partnerships to long-term, multi

faceted alliances to mergers and takeovers. Since government often restricts the

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ownership and merger between the companies in different countries, we see 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.

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2. 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

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.

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 low-

fares 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

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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.

Figure 1, Average costs US Airways Vs Southwest Airlines

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Source: www.jvdz.net

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. Low-

cost 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.

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Figure 2, Overview costs flight EasyJetFlight London (Luton) – Nice, amount is in pounds sterling. The left column displays the costs; the right column displays the income from ticket sales.

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Source: www.jvdz.net

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

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tourist areas in the South. As of 2002 the network expanded to Eastern Europe and

Scandinavia.

Figure 3, Spatial low-cost carrier network development over time

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.

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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 is 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.

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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:

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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.

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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

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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.

3. AVIATION IN INDIA

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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.

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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.

4. EMERGENCE OF LOW-COST AIRLINES IN INDIA

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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

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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 on-

time 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:

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Factors China India

Population (billion) 1.4 1.1

Air population (million) 140 15

Number of LCCs 5 1

Middle class population(million) 400 300

Longest routes(hrs) 2.5 2.5

Growth forecasts (per annum ) 17% 25%

Source: Center to Asia pacific aviation (CAPA)

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.

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5. AIRLINE OPERATORS IN INDIA (DOMESTIC)

Existing full service carriers:

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Existing LCCs:

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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:

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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

Source: business world

6. MEANING: LOW-COST AIRLINES

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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

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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.

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7. BUSINESS MODEL: LOW COST AIRLINES

The “low cost carriers” business design can be defined by three elements:

POSTIONING

LOW OPERATING COST

SIMPLE PRODUCT

(NO FRILLS)

LCC

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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.

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8. 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.

The market share of the players is as follows:

market share

Jet airw ays25.5%

Air sahara8.2%

Kingfisher Airlines10.5%

Spicejet8.0%

Paramount Airw ays1.5%

GoAir 5.0%

IndiGo4.3%

Indian16.3%

Air Deccan20.7%

Source: DNA, February 2007

It can be seen from the above diagram that the market leader is Jet Airways with 25.5%

market share. The No.2 and No.3 position are held by the Air Deccan and Indian with

20.7% and 16.3% market shares respectively.

While the new entrants have usurped market share from incumbents, low-cost airlines,

which were not around three years back, look set to dominate the sky for some time to

come.

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Understandably, the share of incumbent carriers (Indian Airlines, Jet Airways and Air

Sahara) 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%.

The biggest loser has been Jet Airways, which has lost 9.2% marketshare from 34.7% last

year.

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%.

The comparison of market share between incumbent and new entrant with respect to last

year is given below:

Incumbent vs new entrant

Jan 2006 Jan 2007 Up/down (in %)

Incumbent 72 50 ↓ 22

New entrant 28 50 ↑ 22

Source: DNA, February 2007

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The comparison of the market share between the full service carriers and low cost carriers

with respect last year (Jan 2006) is given below:

Full service vs low-cost carriers

Jan 2006 Jan 2007 Up/down (in %)

Full service carriers 79 62 ↓ 17

Low-cost carriers 21 38 ↑ 17

Source: DNA, February 2007

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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.

30

Source: Business world, Jan 2007

31

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

32

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.

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9. 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.

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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 prowl.

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 other airline in the Indian market.

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10. 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.

36

Source: Business world, Jan 2007

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 start-

up 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.

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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.

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11. 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.

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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.

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Domestic traffic:

Airports Avg. flights/day Avg. pax/day

Mumbai 273 21,776

Delhi 203 16,627

Visakhapatanam 300 10,451

Bangalore 115 7,407

Chennai 101 6,854

Kolkata 88 6,849

Hyderabad 61 4,442

Ahmedabad 30 1,984

Goa 24 1,944

Guwahati 37 1,471

Source: DGCA

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12. 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 combined, 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.

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Figure 4, Airline alliances

Alliance About Members

Since: 1999

Passengers: 343,6

million

Daily flights: 15.207

Countries: 133

Destinations: 684

AeroMexico, Air France-KLM, Alitalia,

Continental Airlines, Czech Airlines, Delta,

Korean Air, Northwest Airlines.

Since: 1998

Passengers: 242,6

million

Daily flights: 8.110

Countries: 134

Destinations: 599

Aer Lingus, American Airlines, British Airways,

Cathay Pacific, Finn Air, Iberia, LAN, Qantas.

Since: 1992

Passengers: 382,6

million

Daily flights: 15.000

Countries: 138

Destinations: 790

Air Canada, Air New Zealand, Asiana Airlines,

Austrian, BMI, LOT Polish Airlines,

Scandinavian Airlines, Singapore Airlines,

Spanair, TAP Portugal, Thai, United, US

Airways, Varig.

Source: www.jvdz.net

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:

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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:

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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.

13. FUTURE OF LCC

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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.

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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.

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There is tremendous untapped potential in Indian domestic industry.

The table below illustrates this fact:

Source: Business world

Centre for Asia Pacific Aviation (CAPA) predictions:

By 2010, the (low-cost) market share will be 50 per cent up from today.

On parameters like fuel prices and airport charges, India will be at par with

international levels.

Coupled with labor cost advantage and high quality IT infrastructure (at low

prices), India will be one of the lowest-cost aviation markets by 2010.

Unbelievable valuations for Indian aviation companies.

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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.

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14. REFERENCES

BOOKS, DAILES AND MAGAZINES

Business world

DNA

The Times Of India

The Economic Times

WEBSITES

www.jvdz.net

www.en.wikipedia.org

www.ryanair.com

www.airindia.com

http://indian-airlines.nic.in

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