Preface

PREFACE

As a part of MBA curriculum we have to prepare a research project that is called as

MANAGEMENT RESEARCH PROJECT-I. During the third and fourth semester we

have to prepare this project in each of the semester. The main objective of the project is

to have the good analytical skills get developed and to have contemplation of the various

subjects towards the whole industry selected. We have to prepare and submit a report on

a specific industry in the third semester.

We have selected “INDIAN AVIATION INDUSTRY” with the special focus on Civil

Aviation Sector. The Indian Aviation Industry is one of the most important and basic

industry for a countries infrastructure and growth.

This report attempts to find out the possible reasons for growth, the futuristic position of

the industry and the set of variables making the industry lucrative in the whole economy.

We have also covered Low Cost Air line Model, Merger and Acquisitions and Current

scenario of Indian Civil Aviation.

ACKNOWLEDGMENT

We take this opportunity to genially express our thankfulness to all those concerned with

this project entitled: A COMPREHENSIVE STUDY OF INDIAN AVIATION

INDUSTRY with the special focus on Civil Aviation Sector.

We express our sincere thanks to Dr. Mahendra Sharma, Director of V. M. Patel

Institute Of Management for providing us an opportunity to do analysis on the topic of

our interest. We have learnt about the various variables affecting and designing the

industry and also the analytical view point development styles.

We would like to thank our project coordinator Dr. Rohit Trivedi, Assistant Professor,

V. M. Patel Institute of Management for providing his valuable guidance in fulfillment of

our project.

Lastly we would like to thank all those who were concerned and helped us out to

complete our project.

Airlines

PEST Analysis: The Indian Airline Industry

A PEST analysis is an analysis of the external macro-environment that affects all

firms. P.E.S.T. is an acronym for the Political, Economic, Social, and Technological

factors of the external macro-environment. Such external factors usually are beyond

the firm's control and sometimes present themselves as threats. For this reason,

some say that "pest" is an appropriate term for these factors. Let us look at the

PEST analysis of the Indian aviation sector:

Political Factors

In India, one can never over-look the political factors which influence each

and every industry existing in the country. Like it or not, the political interference

has to be present everywhere. Given below are a few of the political factors with

respect to the airline industry:

o The airline industry is very susceptible to changes in the political

environment as it has a great bearing on the travel habits of its customers. An

unstable political environment causes uncertainty in the minds of the air travellers,

regarding travelling to a particular country.

o Overall India’s recent political environment has been largely unstable due to

international events & continued tension with Pakistan.

o The recent Gujarat riots & the government’s inability to control the situation

have also led to an increase in the instability of the political arena.

o The most significant political event however has been September 11. The

events occurring on September had special significance for the airline industry since

airplanes were involved. The immediate results were a huge drop in air traffic due

to safety & security concerns of the people.

o International airlines are greatly affected by trade relations that their

country has with others. Unless governments of the two countries trade with each

other, there could be restrictions of flying into particular area leading to a loss of

potential air traffic (e.g. Pakistan & India)

o Another aspect is that in countries with high corruption levels like India,

bribes have to be paid for every permit & license required. Therefore constant

liasoning with the minister & other government official is necessary.

The state owned airlines suffer the maximum from this problem. These airlines have

to make several special considerations with respect to selection of routes, free seats

to ministers, etc which a privately owned airline need not do. The state owned

airlines also suffers from archaic laws applying only to them such as the retirement

age of the pursers & hostesses, the labour regulations which make the management

less flexible in taking decision due to the presence of a strong union, & the heavy

control &interference of the government. This affects the quality of the service

delivery & therefore these airlines shave to think of innovative service marketing

ideas to circumvent their problems & compete with the private operators.

Economic Factors

Business cycles have a wide reaching impact on the airline industry. During

recession, airline is considered a luxury & therefore spending on air travel is cut

which leads to reduce prices. During prosperity phase people indulge themselves in

travel & prices increase.

After the September 11 incidents, the world economy plunged into global recession

due to the depressed sentiment of consumers. In India, even a company like

Citibank was forced to cut costs to increase profits for which even the top level

managers were given first class railway tickets instead of plane tickets.

The loss of income for airlines led to higher operational costs not only due to low

demand but also due to higher insurance costs, which increased after the WTC

bombing. This prompted the industry to lay off employees, which further fuelled the

recession as spending decreased due to the rise in unemployment.

Even the SARS outbreak in the Far East was a major cause for slump in the airline

industry. Even the Indian carriers like Air India was deeply affected as many flights

were cancelled due to internal (employee relations) as well as external problems,

which has been discussed later.

Social Factors

The changing travel habits of people have very wide implications for the airline

industry. In a country like India, there are people from varied income groups. The

airlines have to recognize these individuals and should serve them accordingly. Air

India needs to focus on their clientele which are mostly low income clients & their

habits in order to keep them satisfied. The destination, kind of food etc all has to be

chosen carefully in accordance with the tastes of their major clientele.

Especially, since India is a land of extremes there are people from various religions

and castes and every individual travelling by the airline would expect customization

to the greatest possible extent. For e.g. A Jain would be satisfied with the service

only if he is served jain food and it should be kept in mind that the customers next

to him are also jain or at least vegetarian.

Another good example would be the case of South West Airlines which occupies a

solid position in the minds of the US air travelers as a reliable and convenient, fun,

low fare, and no frills airline. The major element of its success was the augmented

marketing mix which it used very effectively. What South West did was it made the

environment inside the plane very consumer friendly. The crew neither has any

uniform nor does it serve any lavish foods, which indirectly reduces the costs and

makes the consumers feel comfortable.

Technological Factors

The increasing use of the Internet has provided many opportunities to airlines. For

e.g. Air Sahara has introduced a service through the internet, wherein the

unoccupied seats are auctioned one week prior to the departure.

Air India also provides many internet based services to its customer such as online

ticket booking, updated flight information & handling of customer complaints.

USTDA (US trade & development association) is funding a feasibility study and

workshops for the Airports Authority of India as part of a long-term effort to

promote Indian aviation infrastructure. The Authority is developing modern

communication, navigation, surveillance, and air traffic management systems for

India's aviation sector that will help the country meet the expected growth and

demand for air passenger and cargo service over the next decade.

A proposal for restructuring the existing airports at Delhi, Mumbai, Chennai and

Kolkata through long-term lease to make them world class is under consideration.

This will help in attracting investments in improving the infrastructure and services

at these airports. Setting up of new international airports at Bangalore, Hyderabad

and Goa with private sector participation is also envisaged.

A good example of the impact of technology would be that of AAI, wherein with the

help of technology it has converted its obsolete and unused hangars into profit

centers. AAI is now leasing these hangars to international airlines and is earning

huge profits out of it. AAI has also tried to utilize space that was previously wasted

installing a lamination machine to laminate the luggage of travelers. This activity

earns AAI a lot of revenue.

These technological changes in the environment have an impact on Air India as

well. Better airport infrastructure, means better handling of airplanes, which can

help reduce maintenance cost. It also facilitates more flights to such destinations.

FIVE PRODUCT LEVELS

The Core Service

The core service of the airlines industry is to transport goods and services to various

destinations. As the needs of the people increased the entire system became more

organized and formal. After this stage comes the various supplementary services.

The Supplementary Services

The airline industry has many players they had a brand name like ‘Air India’,’ Jet

Airways’,’ British Airways’. All of them had some common services to offer like

connecting flights, through check-in, tele check in, food on board, and

complementary gifts etc.

Different classes like economy class, business class were introduced. Air concessions

are given to school students, old people etc. Singapore airlines was the first to

introduce small 8”television screen for every passenger. The freebies are actually

win-win deals between airlines and other services.

Sahara, for example, offers its passengers a ‘business-plan’ on two-way economy

class ticket, which includes a night’s stay with breakfast, STD facility for 3 minutes

and boardroom facility at the Park Hotel, New Delhi. To Delhi based fliers to

Mumbai, it offers a night’s stay with breakfast, airport transfers and VIP amenities

at The Orchid, Mumbai. For business class, the plan includes a stay at The Leela,

with buffet breakfast and late checkout.

All these added service helps the customer to decide upon which airlines he wants to

travel. As competition increased and the customers wanted more the next phase

evolved and that is the augmented service.

The Augmented Service

This phase is where the customer’s expectations are met; the service providers kept

working on new methods to meet the ever-changing customers’ demands. The

players introduced online booking, which was very convenient for the service users.

British Airways business class has showers; it’s more spacious and comfortable.

Sahara airlines offer its passengers six different types of cuisine like vegetarian, fat

free, diabetic etc. They also have auction going on board. Virgin airlines have

gambling on board, they also have body massage to offer to their passengers. Air

Emirates has something called cab service, they have customized pick up and drop

cab service.

This phase is the most crucial one; with increased competition service will become

the final differentiation.

Future Service

As mentioned above the customer needs keep changing, the future is unknown. The

customers may be looking in for more frequent inexpensive air travel, something

like air taxis, super sonic speed. This decreases the time thus reducing the cost.

Pricing Strategies

Premium Pricing:

The airlines may set prices above the market price either to reflect the image of

quality or the unique status of the product. The product features are not shared by

its competitors or the company itself may enjoy a strong reputation that the 'brand

image' alone is sufficient to merit a premium price.¬

Value for Money Pricing:

The intention here is to charge the average price for the product and emphasize

that it represents excellent value for money at this price. This enables the airline to

achieve good levels of profit on the basis of established reputation.

Cheap Value Pricing:

The objective here is to undercut the competition and price is used to trigger the

purchase immediately. Unit profits are low, but overall profits are achieved. Air

India and Indian Airlines have slashed their prices to meet the competition of

private airlines so that they can consolidate their position in the market.

Airlines usually practice differential pricing. There are three classes: The First

Class, The Executive or Business Class and The Economy Class. Fares for each class

are different since the facilities provided and the comfort and luxury level is

different in each class. Seasonal fares are also fixed, fares rise during the peak

holiday times.

Low-cost Pricing:

With the advent of the low-cost airlines in the Indian aviation industry, a

different low-cost flying concept has come up. Since these low-cost airlines are

trying to woo the customers by providing air travel in exceptionally low prices, a

price-band kind of pricing has to be designed.

In low-pricing strategies, the airlines provide very low prices for the flight

tickets. Also, they prices are made cheaper by booking the tickets long before the

flight date.

APEX Fares:

In this scheme, people are given very cheap rates only if tickets are booked

atleast before the specified time period. But the draw-back here is that if the

booking is cancelled, a substantial amount of money is not returned.

Aviation Industry

Overview

The history of civil aviation in India began in December 1912. At the time of

independence, the number of air transport companies, which were operating within

and beyond the frontiers of the company, carrying both air cargo and passengers,

was nine.

In early 1948, a joint sector company, Air India International Ltd., was established

by the Government of India and Air India (earlier Tata Airline) with a capital of Rs

2 crore and a fleet of three Lockheed constellation aircraft. Its first flight took off on

June 8, 1948 on the Mumbai (Bombay)-London air route. At the time of its

nationalization in 1953, it was operating four weekly services between Mumbai-

London and two weekly services between Mumbai and Nairobi. The joint venture

was headed by J.R.D. Tata, a visionary who had founded the first India airline in

1932 and had himself piloted its inaugural flight.

Current Trend in Civil Aviation Industry in India

It is a phase of rapid growth in the industry due to huge build-up of capacity in the

LCC space, with capacity growing at approximately 45% annually. This has

induced a phase of intense price competition with the incumbent full service carriers

(Jet, Indian, Air Sahara) dis-counting to 60-70% for certain routes to match the new

entrants ticket prices. This, coupled with costs pressures (a key cost element, ATF

price, went up approximately 35% in recent months, while staff costs are also rising

on the back of shortage of trained personnel), is exerting bottom-line pressure.

The growth in supply is overshadowed by the extremely strong demand growth, led

primarily by the conversion of train/bus passengers to air travel, as well as by the

fact that low fares have allowed passengers to fly more frequently. There has,

therefore, been an increase in both the width and depth of consumption. However,

the regulatory environment, infrastructure and tax policy have not kept pace with

the industry's growth.

Enactment of the open sky policy between India and Saarc countries, increase in

bilateral entitlements with the EU and the US, and aggressive promotion of India as

an attractive tourism spot helped India attract 3.2 million tourists in 2004-05. This

market is growing at 15% per annum and India is expected to attract 6 million

tourists by 2010. Also, increasing per capita income has led to an increase in

disposable incomes, leading to greater spend on leisure and holidays and business

travel has risen sharply with increasing MNC presence. Smaller cities are also well

connected now. Passenger traffic has increased and over 21 million seats have been

sold, resulting in a growth of over 50%. The Indian travel market is expected to

triple to $51 billion by 2011 from $16.3 billion in 2005-06. India's aviation sector is

in for a further shake – up as its dozen-odd airlines move towards consolidation.

The coming together of the kingfisher and air deccan is only the latest confirmation

of the trend.

Role of Technology in Aviation Industry

Intense competition in Indian Aviation Industry has made the role of technology

very important for domestic airline companies. Technology can help in making

travel comfortable, allow easy access to tickets and reduce time to check-in. A

considerable amount of money is also saved by automation. Following points

highlight the increasing use of Technology by different Airlines:

• Vijay Mallya-promoted Kingfisher Airlines is planning to install a landscape

camera at the bottom of the aircraft that will enable passengers get a view of the

take-off and landing of their airplane when flying on domestic routes. They are also

going to allow GSM phones to be used on board for the first time. They are already

providing live TV as part of our high-end In-Flight Entertainment (IFE) initiatives.

• Public sector airline Air-India is exploring the possibility of launching an

information technology (IT) subsidiary to handle its automation activities.

• Jet Airways has launched an Interactive Voice Response (IVR)-based

payment and ticketing services. The service will allow passengers to complete their

reservation with credit cards through a secure gateway and instantly receive their e-

tickets via email.

• Low-cost carriers such as Air Deccan, SpiceJet, GoAir and IndiGo are

currently allowing a web-check apart from online booking.

Major Players in the Industry

• Air-India is the national flag carrier airline of India with a network of

passenger and cargo services worldwide. Air India has 44 world-wide destinations.

It has been growing at a consistent rate of 10 to 15% each year.

• Indian is India's state owned primarily domestic airline, under the federal

Union Ministry of Civil Aviation The Company was formerly known as Indian

Airlines.

This year, Air India and Indian merged into one giant airline consisting of 130-140

aircraft.

• Air Sahara is a private airline operating scheduled services connecting all

metropolitan centres in India. Sahara Airlines was rebranded as Air Sahara on 2

October 2000.

• Jet Airways is a "regular" airline which offers normal economy and business

class seats. The airline operates over 300 flights to 43 destinations across the

country.

Jet & Sahara has also merged recently to form a new entity which will consolidate

their market share.

There are some other players in the industry involved with providing no-frill

services. These include SpiceJet, Air Deccan, GoAir, Kingfisher, IndiGo Airlines etc.

Competiton to the Aviation Industry

Competiton to this industry includes Railways and Buses, Cabs (for shorter

distances). Railway is giving stiff competition to the aviation industry. Recently, it

has reduced its fare for AC I Class and AC II Class and has been introducing newer

provisions to attract new customer segments such as it has brought online ticket

booking recently which was till now only being provided by Airliners.

Tangibility Spectrum

Unique Challenges to the Industry

Though India Aviation Industry has been increasing at the fast pace, many airlines

industry incurred losses in last year. There are many reasons responsible for it:

• High aviation turbine fuel (ATF) prices

• Rising labor costs and shortage of skilled labor

• Rapid fleet expansion and

• Intense price competition

• Inadequate airport infrastructure

• Lack of trained manpower pushing up personnel costs

TABLE OF CONTENTS

1. Break Even Analysis…................................................................04

Objectives …………………………………………………………….05

Assumptions………………………………………………………....05

Fixed, Variable and Semi Variable Costs…………………….…05

Methods used for calculating break-even costs………………07

Advantages and Limitations……………………………………...09

Contribution Margin………………………………………………..11

2. OVERVIEW OF THE INDUSTRY……………………………....12

Low Cost Carriers…………………………………………………..12

History of Indian Aviation…………………………………………13

The Current Scenario……………………………………………...14

3. SPICEJET………………………………………………………………...18

4. CALCULATION AND ANALYSIS OF BREAKEVEN ………………26

5. CONSIDERATIONS AND RECOMMENDATIONS………………….31

6. REFERENCES…………………………………………………………..32

BREAK EVEN ANALYSIS – AN INTRODUCTION

One of the most common tools used in evaluating the economic feasibility of a new

enterprise or product is the break-even analysis. The break-even point is the point

at which revenue is exactly equal to costs. At this point, no profit is made and no

losses are incurred. The break-even point can be expressed in terms of unit sales or

dollar sales. That is, the break-even units indicate the level of sales that are required

to cover costs. Sales above that number result in profit and sales below that number

result in a loss. The break-even sales indicates the dollars of gross sales required to

break-even.

It is important to realize that a company will not necessarily produce a product just

because it is expected to breakeven. Many times, a certain level of profitability or

return on investment is desired. If this objective cannot be reached, which may

mean selling a substantial number of units above break-even, the product may not

be produced. However, the break-even is an excellent tool to help quantify the level

of production needed for a new business or a new product.

The basic equation for determining the break-even units is:

Average Annual Fixed Cost

(Average Per Unit Sales Price - Average Per Unit Variable Cost)

The basic equation for determining the break-even sales:

Annual Fixed Cost

1 - (Average Per Unit Variable Cost ÷ Average Per Unit Sales Price)

OBJECTIVES:

• Break-even analysis can be very helpful in the evaluation of a new venture.

In most instances, success takes time. Many new enterprises and products actually

operate at a loss (at a point below break-even) in the early stages of development.

• Knowing the price or volume necessary to break-even is critical to

evaluating the time-frame in which losses are permissible.

• The break-even is also an excellent benchmark by which a company's short-

term goals can be measured/tracked.

• Break-even analysis mandates that costs be analyzed. It also keeps a focus on

the connection between production and marketing.

• Should one make , buy or lease capital investment

• What happens to revenues and costs if the price of one of a company's

product is hanged.

ASSUMPTIONS:

• All costs are either perfectly variable or absolutely fixed over the entire

period of Production but this assumption does not hold good in practice.

• The volume of production and the volume of sales are equal but in reality

they differ.

• The revenue is perfectly variable with the physical volume of production and

this assumption is not valid.

• The assumption of stable product mix is realistic.

Break-even analysis is based on two types of costs: fixed costs and variable costs.

FIXED COSTS:

Fixed costs are those business costs that are not directly related to the level of

production or output. In other words, even if the business has a zero output or high

output, the level of fixed costs will remain broadly the same. In the long term fixed

costs can alter - perhaps as a result of investment in production capacity (e.g.

adding a new factory unit) or through the growth in overheads required to support

a larger, more complex business.

VARIABLE COSTS:

Variable costs are those costs which vary directly with the level of output. They

represent payment output-related inputs such as raw materials, direct labour, fuel

and revenue-related costs such as commission.

A distinction is often made between "Direct" variable costs and "Indirect" variable

costs.

Direct variable costs are those which can be directly attributable to the production

of a particular product or service and allocated to a particular cost centre. Raw

materials and the wages those working on the production line are good examples.

Indirect variable costs cannot be directly attributable to production but they do

vary with output. These include depreciation (where it is calculated related to

output - e.g. machine hours), maintenance and certain labour costs.

SEMI-VARIABLE COSTS:

Whilst the distinction between fixed and variable costs is a convenient way of

categorising business costs, in reality there are some costs which are fixed in nature

but which increase when output reaches certain levels. These are largely related to

the overall "scale" and/or complexity of the business. For example, when a business

has relatively low levels of output or sales, it may not require costs associated with

functions such as human resource management or a fully-resourced finance

department. However, as the scale of the business grows (e.g. output, number people

employed, number and complexity of transactions) then more resources are

required. If production rises suddenly then some short-term increase in

warehousing and/or transport may be required. In these circumstances, we say that

part of the cost is variable and part fixed

Total variable and fixed costs are compared with sales revenue in order to

determine the level of sales volume, sales value or production at which the business

makes neither a profit nor a loss (the "break-even point").

METHODS USED FOR CALCULATING BREAK EVEN POINT:

1. The Break Even Chart: It may be defined as an analysis in graphic form of

the relationship of production and sales to profit. It shows the extent of profit or loss

to the firm at different levels of production.

Π= TR-TC

Where π= profit, TR= Total Revenue , TC= Total cost

The difference between price and average variable cost (P-AVC) is defined as profit�

contribution'. Revenue on the sale of a unit of output after variable costs are

covered represents a contribution toward profit.

A manager may want to know the output rate necessary to cover all fixed costs and

to earn a "required" profit R. Profit is equal to total revenue (P.Q) less than the

sum of total variable costs (Q.QVC) and fixed costs.

Π = P.Q [(Q.AVC) + FC]�In its simplest form, the break-even chart is a graphical representation of costs at

various levels of activity shown on the same chart as the variation of income (or

sales, revenue) with the same variation in activity. The point at which neither profit

nor loss is made is known as the "break-even point" and is represented on the chart

below by the intersection of the two lines:

In the diagram above, the line OA represents the variation of income at varying

levels of production activity ("output"). OB represents the total fixed costs in the

business. As output increases, variable costs are incurred, meaning that total costs

(fixed + variable) also increase. At low levels of output, Costs are greater than

Income. At the point of intersection, P, costs are exactly equal to income, and hence

neither profit nor loss is made.

2. Algebraic Method : Here total revenue (TR= P.Q) is equated to total cost

(TC= TFC+TVC) where (TVC=AVC.Q)

TR = TC

P.Qb = TFC + AVC. Qb

TFC = P. Qb – AVC. Qb

Qb = (TFC) / (P-AVC)

The denominator of the above equation is called the contribution margin per unit

because it represents the portion of the selling price that can be applied to cover the

fixed costs of the firm and to provide for the profits.

And the break even point Q is arrived at TFC/(P-AVC)

Once the break-even point is met, assuming no change in selling price, fixed and

variable cost, a profit in the amount of the difference in the selling price and the

variable costs will be recognized. One important aspect of break-even analysis is

that it is normally not this simple. In many instances, the selling price, fixed costs or

variable costs will not remain constant resulting in a change in the break-even.. And

these changes will change the

break-even. So, a break-even cannot be calculated only once. It should be calculated

on a regular basis to reflect changes in costs and prices and in order to maintain

profitability or make adjustments in the product line.

ADVANTAGES:

The main advantages of using break even analysis in managerial decision making

can be the following:

• It helps in determining the optimum level of output below which it would not

be profitable for a firm to produce.

• It helps in determining the target capacity for a firm to get the benefit of

minimum unit cost of production.

• With the help of the break even analysis , the firm can determine minimum

cost for a given level of output

• It helps the firm in deciding which products are to be produced and which

are to be bought by the firm.

• Plant expansion or contraction decisions are often based on the break even

analysis of the perceived situation

• Impact of changes in prices and costs on profit of the firm can also be

analysed with the help of break even technique.

• Sometimes a management has to take decisions regarding dropping or

adding a product to the product line. The break even analysis comes very handy

under such situation.

• It evaluates the percentage financial yield from a project and thereby helps

in choice between various alternative projects.

• The break even analysis can be used in finding the selling price which would

prove most profitable for the firm.

• By finding out the break even point , the break even analysis helps in

establishing the point wherefrom the firm can start payment of dividend to its

shareholders.

LIMITATIONS:

1. Break-even analysis is only a supply side (ie.: costs only) analysis, as it tells you

nothing about what sales are actually likely to be for the product at these various

prices.

2. It assumes that fixed costs (FC) are constant

3. It assumes average variable costs are constant per unit of output, at least in the

range of likely quantities of sales.

4. It assumes that the quantity of goods produced is equal to the quantity of goods

sold (i.e., there is no change in the quantity of goods held in inventory at the

beginning of the period and the quantity of goods held in inventory at the end of the

period.

5. In multi-product companies, it assumes that the relative proportions of each

product sold and produced are constant (i.e., the sales mix is constant).

CONTRIBUTION MARGIN:

In the short run where many of the firms's costs are fixed , business man are often

interested in determining the contribution additional sales make towards fixed costs

and profits. Total Contribution Profit is defined as the difference between total

revenues and total variable costs , which equals price less average variable cost on a

per unit basis. Total contribution profit is also equal to total net Profit plus total

fixed costs.

Contribution profit analysis provides a useful format for examining a variety of

price and output decisions.

TCP = Total revenue – Total variable cost

= Total net profit(TNP) + Total Fixed Costs(TFC)

Therefore if TNP=0 then , TCP=TFC . This occurs at break even point.

From the above equation it is clear that

TR= TCP + TVC

= (TNP + TFC) + TVC

Total Contribution Profit = Total Revenue – Total Variable Cost

= Net Profit + Fixed Costs

OVERVIEW OF THE INDUSTRY

LOW COST CARRIERS

An airline that offers generally low fares in exchange for many traditional passenger

services is called a low-cost carrier or low-cost airline (also known as a no-frills or

discount carrier airline). It was in the US that the concept originated. From there it

spread to UK and subsequently to the rest of the world. Initially, in the airlines

industry, it was the lower operating cost structure that differentiated a low cost

airline from the others. However, nowadays, primarily because of the media, any

carrier with low ticket prices and limited services, regardless of its operating costs,

is classified as a low-cost carrier.

Typical low-cost carrier business model practices include:

• Only one passenger class

• A single type of aircraft (this helps in reducing maintenance costs)

• A fare scheme that is uncomplicated, and provides benefits to passengers

who book their tickets early

• Unreserved seating

• Flying to secondary airports which reduces costs; flying either late at night

or early in the morning which again helps in bringing down costs as these are non

peak hours

• Ensuring maximum utilization of the aircraft by bringing down turnaround

times

• Simplified routes

• Direct sales of tickets, including over the Internet

• Employees multi-tasking

• Eliminating the concept of free in-flight catering services.

HISTORY OF INDIAN AVIATION

Aviation is a critical part of the infrastructure of the country and has important

ramifications for the development of tourism and trade, the opening up of

inaccessible areas of the country and for providing stimulus to business activity and

economic growth. Until less than a decade ago, the Government firmly controlled all

aspects of aviation.

J.R.D. Tata set up Air India and ran it successfully until it was nationalized in 1953

All airlines operating in the country, in the early fifties were merged into either

Indian Airlines or Air India and, by virtue of the Air Corporations Act, 1953 this

monopoly continued for the next forty years. Aviation saw some important changes

with the opening up of the Indian economy in the early Nineties. Most importantly,

the repealed Air Corporation Act ended the monopoly of the public sector that had

continued so long, and private airlines were reintroduced. In 1986, domestic

liberalisation took off with the launch of scheduled services by new start-up

carriers. Foreign investors started taking an active interest. The open sky policy for

domestic players was introduced by the Indian government in 1991, and it was only

in November 2004 that the partial open sky policy for international players was

introduced.

It took some time for the budget airline industry to catch on in India, but eventually

it did happen. The credit for bringing the budget airline concept to the Indian skies

can be claimed by Air Deccan, the Bangalore-based subsidiary of Deccan Aviation.

Air Deccan let loose cut-throat competition in the aviation scene with fares as low as

train fares. Leading domestic airlines like Indian Airlines, Jet Air and Sahara

Airlines had no choice but to slash rates and unveil Advanced Purchase schemes

(Apex) to take on the competition. As always it was the customer who benefited

because of the competition.

But competition for Air Deccan was not far behind. News of Vijay Mallya's

Kingfisher Airline hit the industry barely a year after the launch of Air Deccan.

Kingfisher captured the Indian budget airline market with the twin engines of

‘special flying experience' and ‘value for money'. Kingfisher Airline charged higher

than Air Deccan's, but substantially less than of the big players. However, after a

year of operation, in 2006, Kingfisher Airlines changed its business model from low-

cost to value airlines. The success of Air Deccan in the budget airline segment

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.

THE CURRENT SCENARIO

Consolidation in the aviation industry has marked the first half of 2007 with three

M&A deals happening during the period. Air India - Indian merger (March 2007),

Jet airways buying out Air Sahara 100% stake for 14.5bn (April 2007) and the latest

being UB group picking up 26% stake in Air Deccan for Rs5.5bn (May 2007), all of

them bringing the much needed boost to this loss making industry. Prior to 2003,

there were only three players operating in the Indian aviation industry but after the

entry of Air Deccan into the scene there have been seen a host of new players

starting scheduled services along with many others like Magic Air, East West, Air

One Feeder etc. are waiting for approval from the aviation ministry. At the start of

2007, there were ten players operating scheduled services in the country with none

of them holding substantial market share. However, post consolidation, the number

of players has come down to seven with top three players holding more than 80%

market share.

Exhibit 1: Market Share

Due to continuous reduction in fares by the new entrants and booming economy, the

aviation industry saw an unprecedented growth rate of around 40% during 2006.

Due to fragmented market there was no price leader and therefore no price

discipline and as a result of this all the companies were running into losses.

Consolidation will ease competition and give pricing power to the dominant players

and as a result of higher fares even smaller players like SpiceJet stand to benefit.

The air fares for SpiceJet are expected to increase by 7.4% and 3.6% during FY08E

and FY09E respectively.

Due to booming economy, it is believed that the growth in the aviation industry will

continue in the scenario of increased airfares. Generally it is believed that the

aviation sector in any country grows at twice the growth rate of its GDP. In India,

the GDP is growing at more than 7-8% per annum, which makes the growth rate in

the aviation sector to be in excess of 15%. Aviation industry in India is expected to

grow at a much better rate than this because the industry is at a nascent stage with

lower base and low penetration.

Strong passenger growth to boost top-line and profit:

Strong passenger growth would lead to 86% CAGR growth in revenues for the next

two years. Increased passenger volume would also help in spreading fixed cost over

larger passenger base there by bringing down per unit cost.

Exhibit 3: Domestic Passengers

In the last three years, the number of passengers traveling by air has more than

doubled with industry carrying 34mn passenger during FY07. On back of

conversion of upper class rail passengers to air travel and the surging tourism

industry we expect the number of people traveling by air to increase at a CAGR of

25% to 67mn by FY10E. We expect the revenue passengers for SpiceJet to increase

from 2.8mn in FY07 (12 months) to 6.8mn in FY09E, a CAGR of 58%. The expected

growth in revenue passenger is on account of aggressive increase in fleet size from

11 aircrafts in FY07 to 23 aircrafts by FY09E.

SPICEJET

AN INTRODUCTION

SpiceJet is a low-cost airline based in New Delhi, India. SpiceJet airlines is

promoted by Ajay Singh, the Kansangra family and Sanjay Malhotra. Spice Jet

airways began its operations in May 2005 when Royal Airways Limited announced

the launch of its new low-fares, no-frills, brand - SpiceJet. Royal Airways is the

reincarnation of Modiluft, which was among the first private companies that

stepped into the Indian aviation sector. It was the market leader until 1996, when it

ceased its operations. Royal Airways Ltd announced that its name changed to

SpiceJet Ltd on 4 May, 2005..

SpiceJet's mission is to become India's preferred low-cost airline, delivering the

lowest air fares with the highest consumer value to price sensitive consumers. Day

by day, the number of Indians flying is increasing. This is aided all the more by the

booming Indian economy. SpiceJet's vision is to answer the need of the Indians

travelling for both business and pleasure, and who need to save both time and

money. SpiceJet's new generation fleet of aircraft is backed by cutting edge

technology and infrastructure to ensure the highest standards in operating

efficiency. Maintenance support is provided by KLM, and state of the art

technology has been obtained from world leaders like Star Navigation, Russell

Adams and Tech Log. The major forms of booking tickets are E-booking, e-

ticketing facilities and tele-booking. A lot of stress is put on safety, impeccable

maintenance and a high level of expertise.

SPICEJET TO BREAK EVEN IN FY09E

Due to superior operational efficiencies expected improvement in average fares and

strong passenger volume growth, we expect SpiceJet to turn profitable by FY09E.

Even in the scenario where majority of the cost are fixed in nature, SpiceJet has

been able to achieve lowest cost in the industry with CASKM of Rs2.62 as compared

to Rs2.96 for Air Deccan. SpiceJet has been able to achieve this feat on back of

judicious cost cutting in areas of employee costs, lower inventory, selling and

distribution cost and other operating cost. Due to intense competition the players in

the airline business do not have any control over revenues which makes cost control

even more important. Since SpiceJet has proved its mettle in reduction of costs, now

the focus would be more towards increasing the fares. With consolidation

happening in the industry, fares are expected to steadily move upwards across the

industry which along with further cost cuts would be sufficient enough for SpiceJet

to turn profitable.

Due to its better route strategy, Spice Jet enjoys superior load factor in the industry.

Majority of its fleet fly on metro routes where passenger volumes are high but at the

same time the competition on these routes are also high. Despite flying on the

competitive routes Spice jet has been able to achieve respectable load factor on its

routes. High load factor helps spread the cost over a larger base and thereby help

bringing down the cost per passenger. SpiceJet registered load factor of 76.2% in

FY07 and moving forward due to aggressive capacity expansion we expect the load

factors to fall to 73.0% and 70.8% in FY08E and FY09E respectively. Any revenues

from increased load factor would add to the bottom line. SpiceJet's current fleet size

of 11 would almost double to 23 by FY09E. The company would be making net

additions of 6 aircrafts each year during FY08E and FY09E of which 4 will be B737-

900ER that can carry 215 passengers as compared to 189 passengers carried by the

existing B737-800 type aircraft. Due to lower fuel consumption and additional seats

B737-900ER offers around 7-9% savings in operating cost.

SpiceJet reported strong 53% growth in topline during FY07 (10 month period) and

is expected to grow its revenues at 86% CAGR over FY07-FY09E. During FY07 the

company reported negative EBITDAR, but on back of expected increase in yields

due to increase in fares and reduction in costs, we expect SpiceJet to report positive

EBITDAR of Rs1,270mn and 4,059mn for FY08E and FY09E respectively. However

the EBITDAR in FY08E would be insufficient to cover up the high lease rentals and

thereby end the year with losses. During FY09E we expect the company to

turnaround and post net profits of Rs759mn.

INCREASED FOCUS ON ANCILLARY REVENUE STREAM

In order to break even, Spice jet is focusing on income coming from ancillary

services like in-flight catering, selling insurance, excess baggage, promotional offers,

providing hotels and car on rent, etc. In a move to increase ancillary revenues, Spice

jet have started selling food on-board from May 2007 onwards. Spice jet has

recently tied-up with TATA AIG insurance to provide insurance to air travellers for

Rs129 which would cover accidental death, dismemberment, accidental medical

emergency, trip cancellation, baggage loss and flight delays during travel. The

company through its website provides online booking for budget hotels at various

destinations where it flies. The company is also focusing on revenues from couriers

and excess baggage.

During FY07, SpiceJet earned Rs348mn as ancillary revenues which were 5.4% of

the total operating revenues. We expect the share of ancillary revenues to increase

to 6.9% and 7.7% for FY08E and FY09E respectively. SpiceJet is also looking at

roping in players for advertising on hand baggage tags, boarding pass and head

rests.

RATIONAL FLEET UTILIZATION

With entry into the lean season many Indian carriers have sub-leased their aircraft

to foreign carriers as this is the peak season for other countries. In India July to

September quarter is a lean period for the airline industry whereas the same

quarter is good season for the European counterparts. Spice jet has sub-leased 2 of

its 12 aircraft to a European player for a 3 month period (July-September). By

leasing out its aircraft during lean season, Spice Jet would be able to reduce its fixed

cost such as lease rentals and would be able to utilize its current fleet size of 9

aircrafts in a more efficient manner by flying them on profitable routes.

SALE AND LEASE BACK AGREEMENT

SpiceJet has entered into sale and lease back agreement with Babcock & Brown

Aircraft Management (BBAM), along with its long-term strategic partner Nomura

Babcock & Brown (NBB), for sixteen brand-new Boeing 737-800/-900ER aircraft

valued at over $1.1 billion. SpiceJet has until now entered into sale and lease back

agreement for first 20 of its B737-800/900 which is expected to be delivered till

FY09E. Out of this the company has already received delivery of 12 B737-800. The

company's entry into sale and lease back agreement shows the company's intention

of running business on leased aircrafts rather then on owned aircrafts which makes

sense at least in the current scenario where all the airlines are running into losses.

We expect that SpiceJet will start buying aircraft once the industry stabilizes and

the company start making profits.

ADHERING TO THE CLASSICAL LCC MODEL

SpiceJet is one of the few LCC's in India who is strictly adhering to the proven LCC

model. SpiceJet flies a single aircraft type (B737-800) with single class configuration,

a must for any successful LCC in order to keep its inventory and maintenance cost

under control. SpiceJet enjoys one of the highest load factors in the industry- an

important factor for any LCC. SpiceJet achieved load factor of 76.2% during FY07

as compared to 74.8% for Air Deccan which is largest LCC in India. SpiceJet like

any other successful LCC player is focusing on income from ancillary services like

in-flight catering, selling insurance, excess baggage, promotional offers, providing

hotels and car on rent. During FY07 SpiceJet earned 5.4% of its revenues from

ancillary business as compared to 2.8% by Air Deccan. SpiceJet has one of the

highest aircraft utilization in the industry which effectively leads to increase in top

line and helps in spreading cost over larger revenue base. SpiceJet's does an average

block hour of 12.2 hours per aircraft as compared to 11.0 hours for Air Deccan.

RISK AND CONCERNS

1. Infrastructure constraints

India's poor aviation infrastructure is a major matter of concern and in the long

run can dampen the growth rate for the aviation sector. However, major steps are

been taken towards addressing these issues which includes expansion and

modernization of Mumbai and Delhi airport along with setting up of green-field

airport at Hyderabad and Bangalore. We expect the aviation industry to grow by

25% over the next five years.

2. Entry of new players

Entry of new players in the industry could pose serious threat to the established

players as these new players could resort to heavy discounting of the airline tickets

there by prolonging break-even to the already bleeding aviation industry. The civil

aviation ministry is tightening the required norms for new entrants making their

entry difficult. Magic Air, East West, Air One Feeder are few players seeking entry

into the industry.

3. Lower then expected improvements in fares

Due to consolidation happening in the industry we expect the air fares for SpiceJet

to increase by 7.4% and 3.6% during FY08E and FY09E respectively. Lower then

expected improvement in fares will directly impact the profitability of SpiceJet.

Consolidation will ease competition and give pricing power to the dominant players

and as a result of higher fares even smaller players like SpiceJet stand to benefit.

4. Increase in ATF prices

Fuel cost is the single major cost for the airline companies in India which ranges

from 50-55% of sales for an LCC. We have factored ATF prices at Rs42,000/kl for

the next two years. Any increase in ATF prices beyond this will directly impact the

profitability of the company. However, with RBI allowing hedging of ATF by the

aviation companies on their domestic purchases will help them to a certain extent in

keeping the ATF prices under control.

CALCULATION & ANALYSIS OF BREAK-EVEN

There are 2 general ways of calculating break even point of a company

1. Calculating the Break Even Units

2. Calculating the Break Even Sales

Since we are considering the aviation industry it is not possible to calculate the

break even units in this case. So we would be considering the Break even sales and

would be calculating as to when the Spice Jet Airlines would Break Even in terms of

sales

The formula as mentioned before would be :

The basic equation for determining the break-even sales:

Annual Fixed Cost

1 - (Average Per Unit Variable Cost ÷ Average Per Unit Sales Price)

Now according to the financial data available for spice jet airlines we have classified

different costs as fixed costs and variable costs in accordance with the convention

attached in the annexure:

FIXED COSTS in case of Aviation Industry are:

1. Employee Cost

2. Administrative Cost

3. Interest

4. Depreciation

5. Tax

6. Miscellaneous Expenses

VARIABLE COSTS in case of Aviation Industry are:

1. Power and Fuel

2. Other Manufacturing Expenses

We have analysed the company's financial data from the year 2003-2007 and also

the expected data of the year 2008 and 2009. After analysing the data the results

were as shown:

Thus from the calculations we see that when the company's sales would reach

4732.393 crores. The sales as depicted from the figure are 4901 crores till the end of

financial year 2009. Now analysing the various statements graphically we would do

the analysis of year by year data available to us

CALCULATION OF VARIOUS COSTS:

Relationship between Total Revenue and Total cost:

Thus we see from the above Graph we see that Total revenue of spice jet airlines

would surpass the total cost curve somewhere in the end of financial year 2008 and

in the initial phase of Financial Year 2009. Thus from the break even chart we

conclude that Spice jet Airlines would Break even in Financial year 2009.

Relationship between Total Revenue, Fixed Costs and Total Costs:

From the above graph we infer that the fixed costs incurred by the spice jet airlines

have remained constant over the years relatively with respect to total revenue and

total cost. It has increased over the years owing to the expansion of the airlines in

various parts of the country, rising airplanes and fleet sizes and also due to inflation.

From the above figure we see that the total contribution margin becomes equal to

the fixed cost at the end of financial year 2008. Hence this reconfirms the earlier

findings showing that Spice jet airlines would break even in early 2009. The

contribution margins calculated for various years are as shown below:

Financial year 2003 2004 2005 2006 2007 2008 2009

Total Contribution Margin 14.47 4.04 -4.79 165.55 250.99 522.5 1014.6

VARIOUS RATIOS FOR SPICEJET:

CONSIDERATIONS & RECOMMENDATIONS

1. Currently, as per industry sources, the employee:aircraft ratio for SpiceJet is

around 200. This ought to fall. SpiceJet has to "think low cost" in all aspects.

2. Many customers complain that SpiceJet is understaffed, leading to poor

quality of service. If not increase its staff, SpiceJet must look to train its current

airport staff better.

3. SpiceJet's call centre, many complain, falls apart in times of crisis, and its

website crashes regularly. SpiceJet must consider these issues seriously or it might

start losing customers.

4. Very low fares offered by SpiceJet may lead to "loss leadership pricing",

where the airline's fares are so low to undercut rivals that it makes little or no

money. SpiceJet must take care of this aspect.

ANNEXURES

ATTACHMENT B

Circular No. A-126

Standard Aircraft Program Cost Element Definitions

VARIABLE COSTS

The variable costs of operating aircraft are those costs that vary depending on how

much the aircraft are used. The specific variable cost elements include:

Crew costs - variable - The crew costs which vary according to aircraft usage consist

of travel expenses (particularly reimbursement of subsistence (i.e., per diem and

miscellaneous expenses), overtime charges, and wages of crew members hired on an

hourly or part-time basis.

Maintenance costs - variable - Unscheduled maintenance and maintenance

scheduled on the basis of flying time vary with aircraft usage and, therefore, the

associated costs are considered variable costs. In addition to the costs of normal

maintenance activities, variable maintenance costs shall include aircraft

refurbishment, such as painting and interior restora-tion, and costs of or allowances

for performing overhauls and modifications required by service bulletins and

airworthiness directives. If they wish, agencies may consider all of their

maintenance costs as variable costs and account for them accordingly. Otherwise,

certain maintenance costs will be considered fixed as described in a subsequent

paragraph. Variable maintenance costs include the costs of:

Maintenance labor - variable - This includes all labor (i.e., salaries and wages,

benefits, travel, and training) expended by mechanics, technicians, and inspectors,

exclusive of labor for engine overhaul, aircraft refurbishment, and/or repair of

major components.

Maintenance parts - variable - This includes cost of materials and parts consumed

in aircraft maintenance and inspections, exclusive of materials and parts for engine

overhaul, aircraft refurbishment, and/or repair of major components.

Maintenance contracts - variable - This includes all contracted costs for

unscheduled maintenance and for maintenance scheduled on a flying hour basis or

based on the condition of the part or component.

Engine overhaul, aircraft refurbishment, and major component repairs - These are

the materials and labor costs of overhauling engines, refurbishing aircraft, and/or

repairing major aircraft components.

NOTE 1: In general, the flight hour cost is computed by dividing the costs for a

period by the projected hours flown during the period. However, when computing

the flight hour cost factor for this cost category, divide the total estimated cost for

the activities in this category (e.g., overhaul, refurbishment and major repairs) by

the number of flight hours between these activities.

NOTE 2: Separate cost or reserve accounts for engine overhaul, aircraft

refurbishment, major component repairs, and other maintenance cost elements,

may, at the agency's discretion, be identified and quantified separately for mission-

pertinent information purposes. Reserve accounts are generally used when the

aircraft program is funded through a working capital or revolving fund.

Fuel and other fluids - The costs of the aviation gasoline, jet fuel, and other fluids

(eg. engine oil, hydraulic fluids and water-methanol) consumed by aircraft.

Lease costs - variable - When the cost of leasing an aircraft is based on flight hours ,

the associated lease or rental costs are considered variable costs.

Landing and tie down fees - Landing fees and tie down fees associated with aircraft

usage are considered variable costs. Tie down fees for storing an aircraft at its base

of operations should be considered part of operations overhead, a fixed cost.

FIXED COSTS

The fixed costs of operating aircraft are those that result from owning and support

the aircraft and that do not vary according to aircraft usage. The specific fixed cost

elements include:

Crew costs - fixed - The crew costs which do not vary according to aircraft usage

consist of salaries, benefits, and training costs. This includes the salaries, benefits,

and training costs of crew members who also perform minimal aircraft

maintenance. Also included in fixed crew costs are the costs of their charts, personal

protective equipment, uniforms, and other personal equipment.

Maintenance costs - fixed - This cost category includes certain maintenance and

inspection activities which are scheduled on a calendar interval basis and take place

regardless of whether or how much the aircraft are flown. Agencies are encouraged

to simplify their accounting systems and account for all maintenance costs as

variable costs. However, if they wish, agencies may account for the following costs as

fixed costs:

Maintenance labor - fixed - This includes all projected labor expended by mechanics

and inspectors associated with maintenance scheduled on a calendar interval basis.

This does not include variable maintenance labor or work on items having a TBO or

retirement life.

This category also includes costs associated with unallocated maintenance labor

expenses, i.e., associated salaries, benefits, travel expenses and training costs. These

costs should be evenly allocated over the number of the aircraft in the fleet.

Maintenance parts - fixed - This includes all parts and consumables used for

maintenance scheduled on a calendar basis.

Maintenance contracts - fixed - This includes all contracted costs for maintenance or

inspections scheduled on a calendar basis.

Lease costs - fixed - When the cost of leasing an aircraft is based on a length of time

(e.g., days, weeks, months, or years) and does not vary according to aircraft usage,

the associated leased costs are considered fixed costs.

Operations overhead - These include all costs, not accounted for elsewhere,

associated with direct management and support of the aircraft program. Examples

of such costs include: personnel costs (salaries, benefits, travel, uniform allowances,

training, etc.) for management and administrative personnel directly responsible for

the aircraft program; building and ground maintenance; janitorial services; lease or

rent costs for hangers and administrative buildings and office space;

communications and utilities costs; office supplies and equipment; maintenance and

depreciation of support equipment; tie down fees for aircraft located on base; and

miscellaneous operational support costs.

Administrative overhead - These costs represent a pro-rated share of salaries, office

supplies and other expenses of fiscal, accounting, personnel, management, and

similar common services performed outside and the aircraft program but which

support this program. For purposes of recovering the costs of operations, agencies

should exercise their own judgement as to the extent to which aircraft users should

bear the administrative overhead costs. Agencies may, for example, decide to charge

non-agency users a higher proportion of administrative overhead than agency users.

For purposes of A-76 cost comparisons, agencies should compute the actual

administrative costs that would be avoided if a decision is made to contract out the

operation under study.

Self-insurance costs - Aviation activity involves risks and potential casualty losses

and liability claims. Theses risks are normally covered in the private sector by

purchasing and insurance policy. The government is self insuring; the Treasury's

General Fund is charged for casualty losses and/or liability claims resulting from

accidents. For the purposes of analyses, government managers will recognize a cost

for "self-insurance" by developing a cost based on rates published in OMB Circular

No. A-76.

Depreciation - Depreciation represents the cost or value of ownership. Aircraft have

a finite useful economic or service life. Depreciation is the method used to spread the

cost of the purchase price, less residual value, over an asset's useful life. A-76

provides guidance on computing depreciation charges to be used in computing the

fixed costs of an aircraft or aircraft program. Although these costs are not direct

outlays in the sense of most other aircraft costs, it is important to recognize them for

A-76 cost comparison purposes and when replenishing a working capital fund by

recovering the full cost of aircraft operations. Depreciation costs depend on aircraft

acquisition or replacement costs, useful life, and residual or salvage value. To

calculate the cost of depreciation that shall be allocated to each year, subtract the

residual value from the total of the acquisition cost plus any capital improvements

and, then, divide by the estimated useful life of the asset.

OTHER COSTS

There are certain other costs of the aircraft program which should be recorded but

are not appropriate for inclusion in either the variable or fixed cost categories for

the purposes of justifying aircraft use or recovering the cost of aircraft operations.

These costs include:

Accident repair costs - These costs include all parts, materials, equipment and

maintenance labor related to repairing accidental damage to airframes or aircraft

equipment. Also included are all accident investigation costs.

Aircraft costs - This is the basic aircraft inventory or asset account used as the basis

for determining aircraft depreciation charges. These costs include the cost of

acquiring aircraft and accessories, including transportation and initial installation.

Also included are all costs required to bring aircraft and capitalized accessories up

to fleet standards.

Cost of Capital - The cost of capital is the cost to the Government of acquiring the

funds necessary for capital investments. The agency shall use the borrowing rate

announced by the Department of Treasury for bonds or notes whose maturities

correspond to the useful life of the asset.

Return to Circular A-126

Return to Top

Financial Statements

Predicted Balance Sheet(Karvy Report)

REFERENCES

• Managerial Economics By Prof. Atmanand

• Managerial Economics By Peterson , Lewis

• http://www.spicejet.com

• http://en.wikipedia.org/wiki/SpiceJet

• http://en.wikipedia.org/wiki/Break_even_analysis

• www.tutor2u.net/business/gcse/finance_breakeven.htm

• www.iimcal.ac.in/community/consclub/reports/airlines.doc

• http://cpa.utk.edu/pdffiles/adc3.pdf

• http://www.businessworld.in/content/view/541/592

• http://www.tcil.com/ca.asp

• Karvy report's Analysis On SpiceJet

Company Profile

Kingfisher Airlines Limited is an airline based in Bangalore, India. It is a major

Indian airline operating 218 flights a day and has an extensive network to 37

destinations, with plans for regional and long-haul international services. Its main

bases are Bangalore International Airport, Bangalore, Chhatrapati Shivaji

International Airport, Mumbai and Indira Gandhi International Airport, Delhi.

Kingfisher Airlines, through one of its holding companies United Breweries Group,

has acquired 26% stake in the budget airline Air Deccan and has option to buy

further of 20% stake from the secondary market.

Kingfisher is one of only 6 airlines in the world to have a 5 star rating from Skytrax,

along with Asiana Airlines, Malaysia Airlines, Qatar Airways, Singapore Airlines

and Cathay Pacific Airways.

History

The airline started operations on 9 May 2005, following the lease of 4 Airbus A320

aircraft. As of July 2007, Kingfisher operates only on domestic routes, however it

has announced plans to start flights to the USA with Airbus A340 and Airbus A380

aircraft. The airline is owned by the United Breweries Group. The airline promises

to suit the needs of air travellers and to provide reasonable air fares. Kingfisher

Airlines' main "luxury" component is its In-Flight Entertainment System.

The airline was the first in India to initially, and to continue, to operate with all new

aircraft. On June 15, 2005 it became the first (and only) Indian airline to order the

Airbus A380. It placed orders for 5 A380s, 5 Airbus A350-800 aircraft and 5 Airbus

A330-200 aircraft in a deal valued at over $3 billion. An A380 arrived on 6th May

2007 in New Delhi and in Mumbai on 8th May as part of Kingfisher's second

anniversary celebrations

PEST ANALYSIS

PEST Analysis An Introduction

A PEST analysis looks at the external business environment. PEST stands for

Political, Economic, Socio cultural and Technological. The analysis examines the

impact of each of these factors (and their interplay with each other) on the business.

The results can then be used to take advantage of opportunities and to make

contingency plans for threats.

Political

• ecological/environmental issues

• current legislation home market

• future legislation

• European/international legislation

• regulatory bodies and processes

• government policies

• government term and change

• trading policies

• funding, grants and initiatives

• home market lobbying/pressure groups

• international pressure groups Economic

• home economy situation

• home economy trends

• overseas economies and trends

• general taxation issues

• taxation specific to product/services

• seasonality/weather issues

• market and trade cycles

• specific industry factors

• market routes and distribution trends

• customer/end-user drivers

• interest and exchange rates

Social

• lifestyle trends

• demographics

• consumer attitudes and opinions

• media views

• law changes affecting social factors

• brand, company, technology image

• consumer buying patterns

• fashion and role models

• major events and influences

• buying access and trends

• ethnic/religious factors

• advertising and publicity Technological

• competing technology development

• research funding

• associated/dependent technologies

• replacement technology/solutions

• maturity of technology

• manufacturing maturity and capacity

• information and communications

• consumer buying mechanisms/technology

• technology legislation

• innovation potential

• technology access, licensing, patents

• intellectual property issues

AVIATION SECTOR POLITICAL FACTORS

KINGFISHER AIRLINES and CURRENT POLITICAL FACTORS :

The airline, that is now not allowed to operate in the international skies, has

committed to purchase more than 20 Airbus wide body aircraft, including five

Airbus A-380, five A-330 and five A-330, which would start arriving later next year.

At present, the Indian Government has stipulated that only those airlines that have

completed five years of operations in the domestic skies are allowed to fly on

international routes. Kingfisher Airlines took to the Indian skies in May 2005.

Faced with policy constraints here of not being allowed to fly out of India, the

Chairman of Kingfisher Airline, Mr Vijay Mallya, has mandated Kingfisher

International Airlines — the new company floated by him in the US — to begin the

process to get clearances to start operating regular flights to India. The law firm

would be contacting the Department of Transport and other US Government

Departments so as to initiate the process of getting clearance for the airline.

After all, the wide body aircraft that have been ordered by the airline cannot sit on

the ground. So a non-stop operation will be started and will utilise the Airbus A-

340-500 aircraft to fly on this route.

In India, one can never over-look the political factors which influence each and

every industry existing in the country. Like it or not, the political interference has to

be present everywhere. Given below are a few of the political factors with respect to

the Airlines:

Airline is very susceptible to changes in the political environment as it has a

great bearing on the travel habits of its customers. An unstable political

environment causes uncertainty in the minds of the air travellers, regarding

travelling to a particular country.

Overall India’s political environment has been sometimes unstable due to

international events & continued tension with Pakistan.

The most significant political event however has been September 11. The

events occurring on September had special significance for the airline industry since

airplanes were involved. The immediate results were a huge drop in air traffic due

to safety & security concerns of the people.

International airlines are greatly affected by trade relations that their

country has with others. Unless governments of the two countries trade with each

other, there could be restrictions of flying into particular area leading to a loss of

potential air traffic (e.g. Pakistan & India)

Another aspect is that in countries with high corruption levels like India,

bribes have to be paid for every permit & license required. Therefore constant

liasoning with the minister & other government official is necessary.

The New Policy

The liberalization in civil aviation industry began in 1986 with the

introduction if Air Taxi system to boost development of tourism. Though

there were several restrictions relating to seat capacity, airports, timing and

fare, the scheme was liberalized over a period of time. Even the fare was

totally deregulated, allowing air taxi operators to charge any fare. With Open Sky

Policy many private operators began operation in the domestic sector. The

carriage increased from a modest 15,000 passengers in 1990 to more than 0.4

Million in 1992. Of the total of 12.23 million passengers carried on domestic

sector, private carriers carried about 5.7 million passengers.

The civil aviation industry got a major boost with the announcement of Airport

Infrastructure Policy in November, 1997 which envisages development of

international hubs and regional hubs to provide a hub and spoke arrangement

connecting all airports. Under the policy, infrastructure development of airport

has been opened up for public and private participation. It allows 74%

foreign equity participation in the airport infrastructure with automatic

approval and 100 % equity on case-to-case basis.

A new policy on domestic air transport has also been evolved. Salient features

are:-

40% foreign equity participation in domestic airlines.

100% equity participation for NRIs/Overseas Corporate Bodies.

Foreign airline equity, either directly or indirectly is not permissible.

Operators to have freedom to determine fares for each sector.

Domestic carriers to be allowed to fly international routes.

Changing Pattern of Government Regulations

The steps taken by the government are as follows:

1. Investments Opportunities Foreign Equity

Foreign Equity upto 40% and NRI investment upto 100% is permitted in domestic

air transport services. Equity from foreign airlines is not permitted

directly or indirectly.

2. Disinvestment of the Government Equity in airlines

Government of India decided to disinvest partly its shareholding in both Air India

and Indian Airlines, presently wholly owned companies of the Government. But

with general elections round the corner this issue has been put on the backburner

with constant opposition from various sections of the society.

3. Entry-Exit barriers removed

Barriers to entry and exit from this sector have been removed. Only pre-entry

scrutiny to verify financial soundness, maintenance, security and safety aspects

of operations and human resource development proposals is done. Choice of

aircraft type and size left to the operator.

4. Private participation in Airports

Foreign equity participation is allowed in ventures for airports, upto 74% automatic

approvals and upto 100% with special permission. Participation is also open to

foreign airport authorities.

5. Bilaterals for operation of international air services

The Government has been more liberal in granting additional

entitlements to foreign airlines both in terms of capacity as well as in terms of points

of call. The existing air services agreement with United States of America is an

extremely liberal one as it allows any number of US airlines to operate services

from/to India. US airlines are also allowed to decide the size of aircraft and their

frequencies.

6. Taxes and Tariffs

In order to facilitate acquisition of aircraft Government of India has reduced

tariffs for import of aircraft from 8% to Nil. Even aircraft taken on lease do

not attract customs duties. India also has a liberal Corporate Tax/Income

Tax regime for airlines and encourages investment by allowance of high

depreciation rates.

7. Civil Aviation Policy

Having drawn up a successful growth model for the civil aviation sector, the

Government is now engaged in evolving a comprehensive and integrated new civil

aviation policy, some of the major highlights of which are:

All players and stakeholders are assured of a level playing field.

Private participation is encouraged and opportunities are created

for investors to realize adequate returns on their investments.

Rapid up gradation of airport infrastructure to world class is

encouraged with priority to the busiest airports and those handling

international flights.

International cooperation in aviation and development in tune with

international trends and best practices, consistent with airspace sovereignty is

promoted.

After four decades of control, Civil Aviation sector has been liberalized with a

view to draw benefits of efficiency, safety and quality in service. Government

has also opened doors to foreign participation in investment in this sector.

Kingfisher Airlines and Economic factors

Business cycles have a wide reaching impact on the airline industry. During

recession, airline is considered a luxury & therefore spending on air travel is cut

which leads to reduce prices. During prosperity phase people indulge themselves in

travel & prices increase. After the September 11 incidents, the world economy

plunged into global recession due to the depressed sentiment of consumers. The loss

of income for airlines led to higher operational costs not only due to low demand but

also due to higher insurance costs, which increased after the WTC bombing. This

prompted the industry to lay off employees, which further fuelled the recession as

spending decreased due to the rise in unemployment. Even the SARS outbreak in

the Far East was a major cause for slump in the airline industry.

ECONOMIC FACTORS :

Growth: Estimated domestic passenger segment growth is at 12% per annum.

Anticipated growth for International passenger segment is 7% while the growth for

International Cargo is likely to grow at a healthy rate of 12%.

Passenger Traffic: International and Domestic passenger traffic handled has

increased by 15.4 percent and 6.7 percent leading to an overall increase of 9.4

percent. The total passenger increased by 9.2 percent, 7.6 percent, 8.9 percent and

17.0 percent respectively at five international airports six developing international

airports, eight custom airports and 26 Domestic airports.

Factor Inputs

Comparison of Kingfisher [full service airline] and low cost airline

Airfares in India are among the highest in the world. For instance, a typical Delhi-

Bangalore round trip costs Rs 18,000 - the same as it would from Delhi to

Singapore.

Fuel Prices

ATF [Aviation Turbine Fuel] is the major cost for Kingfisher accounting for 30% of

the total operating costs in India, which is much higher than around 10-15% for

airlines worldwide. The exorbitant sales tax on the ATF, which increases the price

of ATF, is the major reason for this higher share in operating cost.

Operating Costs

The regulatory system affects where, how and when airlines can fly. Thus it affects

airlines’ ability to operate efficient networks and their revenue. To the extent that

airlines cannot use the least cost combinations of aircraft types to carry passengers

and freight, the costs of operating existing networks are higher than they otherwise

might be (technical inefficiency). Further, they may be prevented from flying the

optimum sized and configured network (allocative inefficiency). Thus, costs may be

reduced as airlines are able to operate the right aircraft at the right frequencies on

an existing route.

Airlines, by changing the design of a network and increasing its size, may also be

able to decrease costs through economies of scale and scope.

Ownership and control

As airlines strive for greater efficiencies, they consider the benefits of consolidation.

However, the normal commercial process of acquisition and/or merger is not

available due to restrictions contained in bilateral agreements that are designed to

ensure that ownership and control of airlines remain with nationals of the countries

where they are based.

Growth through merger or acquisition enables airlines to achieve economies scale

and scope by consolidating airline functions. The merger of two airlines, for

example, may allow them to consolidate their ground handling, maintenance,

information technology and various managerial functions.

Capital

The relatively capital-intensive nature of the airline industry, combined with the

fact that airlines are generally regarded as being inherently risky investments,

means that access to large, well-functioning capital markets is an important issue

for all airlines. The effects of these restrictions may vary from country to country,

but are likely to be greater for countries with small domestic capital markets.

Airline Acquisition/Leasing Cost

Taking aircraft on lease is one of the preferred modes among the Indian carriers.

However, this has suddenly become costlier affair due to changes proposed in Union

Budget 2004-05. The budget proposes withdrawal of tax exemption granted to

acquire aircraft or an aircraft engine on lease prospectively from September 1,

2004. This has resulted in imposition of withholding tax of 42% on leasing of

aircraft. Impediment of this kind at a juncture when almost all, Indian carriers are

firming up their expansion plans especially through leasing of aircraft is a setback.

But after hard lobbying by the industry the deadline was deferred until April 1,

2005, and would now be withdrawn for lease agreements entered into after April 1,

2004.

As tax exemption will not be available for lease agreements entered on or after

April 1, 2005 the Indian carriers who have plans to take aircraft on lease have to

sign agreement either on or before the expiry date or they will have to bear

additional cost burden. Alternatively, taking aircraft on lease from a country with

which India has double taxation treaty or getting lease agreement signed in a third

country could help avoid the tax on lease rental. This may not be much helpful to

state carriers and to some extent the private players also due to auditing/ accounting

procedures.

As leasing route is the most preferred one for a new entrant, the Budget initiatives

will prove be a heavy deterrent as they will escalate the effective lease rental cost by

almost 42%.

Market Structure and Implications

The aviation industry in India, especially with regard to passenger airlines, follows a

strictly oligopoly-type structure with the characteristics:

(1) An industry dominated by a small number of large firms

(2) Firms sell either identical or differentiated products (the only differentiation

here being in service quality and frills offered)

(3) The industry has significant barriers to entry (which holds true both with

respect to regulations and huge capital investment required).

One sees the following characteristics with respect to the Indian passenger airlines

market –

1. Few number of firms contributing to majority of the market share

2. Products are differentiated in terms of service quality and offerings

3. MR=MC

4. p>MC

5. Entry Barriers

6. Firm is a price-setter

7. Long run profit >= 0

8. Strategy dependent on individual rival firm’s behaviour

Indian Aviation Market – A differentiated Oligopoly

Pricing Mechanisms

Price and quantity are determined by the interaction of demand and supply in the

market. However, given the large number of buyers, firms can decide prices at

which they will sell tickets. In fact, in the airlines sector, firms go in for third degree

price discrimination and segment the market, charging a higher price to the market

with a relatively inelastic demand (such as fares between business and economy

class travellers, or between emergency travel and leisure travel by providing apex

fares). The low cost airlines follow this different pricing strategy. Customers

booking early with carriers such as Air Deccan will normally find much lower

prices if they are prepared to commit themselves to a flight by booking early, on the

justification that consumer’s demand for a particular flight becomes more inelastic

the nearer to the time of the service.

The term ‘‘revenue management’’ is commonly used to describe most aspects of

airlines’ pricing and seat-inventory control decisions; but in reality, revenue

managers primarily practice seat-inventory control. Formally, revenue management

describes a process of setting fares for each route (origin and destination pair) and

each set of restrictions (nonstop, time-of-day, day-of-week, refundable, advance

purchase, first class or coach, and Saturday-night stay over) and limiting the

number of seats available at each fare. In the language of economics, revenue

management increases airlines’ profits in three ways –

Implements peak-load pricing.

Implements third-degree price discrimination. That is, fare restrictions

screen customers and segment them by their sensitivity to price and potentially by

their demand uncertainty. For instance, Indian Airlines apex fares (for booking one

week or three weeks in advance).

Implements an inventory control system for coping with uncertain demand.

Kingfisher Pricing :

The market leader in terms of pricing in the Indian flights is without doubt Air

Deccan. Kingfisher Airlines has chosen an interesting pricing policy. On some of the

more popular routes the prices are very competitive and close to Air Deccan and

definitely much less than Jet Airways.

Pricing Strategies

Premium Pricing: KINGFISHER FIRST

Kingfisher airlines set prices above the market price to reflect the image of quality

or the unique status of the product. The product features are not shared by its

competitors or the company itself may enjoy a strong reputation that the 'brand

image' alone is sufficient to merit a premium price.¬

Value for Money Pricing: KINGFISHER ECONOMY

The intention here is to charge the average price for the product and emphasize

that it represents excellent value for money at this price. This enables the airline to

achieve good levels of profit on the basis of established reputation.

Cheap Value Pricing: Initial Pricing and Pricing on Popular Routes

The objective here is to undercut the competition and price is used to trigger the

purchase immediately. Unit profits are low, but overall profits are achieved.

Kingfisher Airlines initially slashed their prices to meet the competition of private

airlines so that they can consolidate their position in the market.

Airlines usually practice differential pricing. There are three classes: The First

Class, The Executive or Business Class and The Economy Class. Fares for each class

are different since the facilities provided and the comfort and luxury level is

different in each class. Seasonal fares are also fixed, fares rise during the peak

holiday times.

Low-cost Pricing: Kingfisher Acquisition of Air Deccan

With the advent of the low-cost airlines in the Indian aviation industry, a

different low-cost flying concept has come up. Since these low-cost airlines are

trying to woo the customers by providing air travel in exceptionally low prices, a

price-band kind of pricing has to be designed.

In low-pricing strategies, the airlines provide very low prices for the flight

tickets. Also, they prices are made cheaper by booking the tickets long before the

flight date.

APEX Fares : Air Deccan

In this scheme, people are given very cheap rates only if tickets are booked atleast

before the specified time period. But the draw-back here is that if the booking is

cancelled, a substantial amount of money is not returned.

The Potential Market

While formulating the national strategy one must remember a few aspects of Indian

Passenger Aviation Market -

a. Potentially, India is a very large corporate and luxury travel market.

b. Potentially, it is also a very large low-fare market.

c. India also has largely blocked but significant markets in the north in China.

d. India, unlike other major travel hubs in the region, is an original market both for

originating and turnaround traffic.

e. India is also a potential transit hub in more than one direction.

In Aviation circles India has become Asia's hot growth market and in the words of

SIA CEO it is, along with China, one of the two "locomotives" for growth in the

continent. Thus to enter in to an open skies agreement when India has nothing more

to offer than land for airports and the so called cheap blue and white collar labour

will tantamount to accepting a second class economic citizenship in the comity of

nations.

Kingfisher airlines and Technological factors

TECHNOLOGICAL FACTORS

Kingfisher Airlines has announced the launch of two world-class technological

innovations to enhance guest convenience. The first cutting-edge innovation is the

introduction of the ‘Roving Agent’ at the airport. Now guests with hand baggage

need not have to wait at the check-in counter to collect their boarding pass, instead

they can directly approach the Kingfisher Airline’s Roving Agents deployed outside

the security check-in area who will book them on their choice of seats.

Also launched is the facility of ‘Web Check-in’. Now Kingfisher Airlines' guests can

sit in the comfort of their homes or offices and print their boarding passes. All a

guest has to do is log on to the official website of Kingfisher Airlines,

www.flykingfisher.com, and click on the link - web check-in. Fill-in your reservation

details and the screen will display the choice of seats available onboard that

particular flight. Once booked, the guest can conveniently print out the boarding

pass and carry it along with him/her on the day of the flight and proceed straight to

the security check counter at the airport. Kingfisher Airlines is also among the first

in India to offer the latest range of check-in options for its guests, including “Web

check-in” facilities and “Roving agents” that use mobile devices to check in guests to

help alleviate check-in queues at airports.

The Airbus A380, the world`s largest and most advanced passenger airplane, which

is widely regarded as the future of aviation, marks a momentous milestone in the

history of civil aviation in India.

Kingfisher Airlines, India’s fastest-growing airline, has engaged Sabre Airline

Solutions, the global leader of software and services for the airline industry from

planning to execution, to provide a full suite of more than 20 enterprise applications

to enhance its guest processing functions, as the airline continues its rapid expansion

of its operations.

Kingfisher Airlines is also leveraging other technology from Sabre Airline Solutions

to help analyze the market and determine the best approaches to maximize revenue,

including Sabre AirMax Revenue Manager, the Quasar passenger revenue

accounting system and the Sabre Loyalty Suite.

Kingfisher Airlines Ltd and Dish TV have joined hands to provide live in-flight

entertainment on Kingfisher aircraft. The inflight entertainment system is one of the

best in the world.

The increasing use of the Internet has provided many opportunities to airlines. For

e.g. Kingfisher has introduced a service through the internet, wherein the

unoccupied seats are auctioned one week prior to the departure.

Kiingfisher Airlines also provides many internet based services to its customer such

as online ticket booking, updated flight information & handling of customer

complaints.

USTDA (US trade & development association) is funding a feasibility study and

workshops for the Airports Authority of India as part of a long-term effort to

promote Indian aviation infrastructure. The Authority is developing modern

communication, navigation, surveillance, and air traffic management systems for

India's aviation sector that will help the country meet the expected growth and

demand for air passenger and cargo service over the next decade.

A good example of the impact of technology would be that of AAI, wherein with the

help of technology it has converted its obsolete and unused hangars into profit

centers. AAI is now leasing these hangars to international airlines and is earning

huge profits out of it. AAI has also tried to utilize space that was previously wasted

installing a lamination machine to laminate the luggage of travelers. This activity

earns AAI a lot of revenue.

These technological changes in the environment have an impact on Kingfisher as

well. Better airport infrastructure, means better handling of airplanes, which can

help reduce maintenance cost. It also facilitates more flights to such destinations.

Conclusion

The King of good times am I

Roaring engines, the bird ready to fly

Cheerful spirit, takes off to the sky

Like a majestic bird, soaring high

The King of good times am I

Vibrant colours and soothing ambience

Truly a relaxing experience

Good food, pleasing hostess, everything high-fi

What a way to fly !

Up and up into the clouds

A feeling that makes you proud

It`s the Pegasus with wings

Kingfisher takes you to a new high

Discover good times aboard

The essence of flying is here

Travel in comfort all the while

Kingfisher connects you in style