Thursday, 23 October 2008

India's airline industry- Nose diving in perfect formation!

An interesting topic addresses by Mr. BV Krishnamurthy on the state of the aviation industry.

The airline industry in India is losing money everyday and by some estimates expected to lose 1.5-1.7 billion USD this year (second only to the US airline industry).

The airline companies in India are upset and asking for the govt. to help them out. They blame fuel costs and the economic downturn.

I don’t believe them.

Take fuel costs. Even two years back when the airlines industry was taking off, the pricing of tickets was not allowing recovery of all costs. They were losing money at the beginning and they are losing money now. In fact, with falling oil prices they should feel happier than 4 months ago.

Take the economic downturn. What has everyone worried is that fill rates are declining. Economic slowdown seems to have everyone cutting costs. Non essential expenses are going out of the window. A downturn is indeed a good time to judge the fundamentals of a business model. Every airline company is suffering and this is unusual. Usually, in a downturn, there is “down-trading” within a category. People go for cheaper alternatives of the same product. Then, if the downturn is longer, they shift to different substitution categories.

Eg: to fight higher fuel costs- you buy a smaller car. (But if you’re already stuck with a big car, you switch categories and use public transport.)

In a downturn, you avoid a Gillette and go for a Wilkinson. Or avoid a Heinz and take a WalMart ketchup. If the downturn is too steep, you avoid ketchups!

In the airline example, you would, in a downturn, move from business class to economy class or from full service to budget airlines. But for travelers to shift from air travel to road transport en-mass means that for them the value proposition of the entire industry has been found wanting. (See- traffic declined by a whopping 19% in September 2008-

In today’s environment then, in India, low cost airlines should be gaining market share. But in India, they are closing down.

What happened?

When budget airlines took off, their ticket prices were indeed low (one fifth regular prices in some cases). But they were never making money. Always below break-even point. As the fuel prices increased, all companies were forced to reflect this into the ticket price as a ”surcharge”. These surcharges are now 80% of the price of the ticket such that the price of a low cost ticket is not much different from a full fare ticket.

These low cost airlines (Deccan airlines being the pack leader) drove first time user growth in the industry. But, fundamentally the “low cost” carriers were a myth. With a cost structure so heavily skewed to fuel prices, managing all other costs is not sufficient to create a truly low cost business model.

Sure, when less than 5% of the Indian population flies with any regularity, setting artificially low prices is a good way to drive growth. But for long term sustainability, the usage of air travel must become regular. What’s the use of market penetrating pricing if the consumer does fundamentally have the income to get hooked onto the category at some stage?

But the low cost airlines were not alone in their enthusiasm. The 30% passenger traffic growths were extrapolated by all airline companies that went on to add more aircrafts and routes....and hence more costs.

In the case of air travel, the consumer is also aware that his purchase is an indulgence. Unlike a TV/ fridge or washing machine which is purchased once in 6 years, and only when seen to be a necessity for which the purchase is planned months in advance.

When a return ticket for a 600 km journey costs Rs 6000 or USD 133 per person, does not the income of a family need to cross a significant level before such purchases become regular? (We estimate this threshold to be Rs. 15L (USD 35K approximately), before they take to flying regularly.)

Then the key questions:
How many households/ consumers in India make this cut? How many planes and airline companies are then really needed to satisfy this demand?

In the last 2-3 years, how many consumers actually flew because the ticket price was artificially low and unsustainable for the airline company?

What kind of government watches and encourages this kind of industry growth?

And now the airline industry is asking the govt. to hand out sops…and keep it afloat!

Why should the tax payer pay for the shortcomings of an incompetent business idea?


PS: on 14th Nov, came across this in the papers:

It seems, the budget airlines are indeed cutting down price to create a differentiation and hence become more attractive to consumers.
On a side note: A good parallel is the car industry. While auto manufacturers have entered the Indian market, they have refused to sell at a loss. The industry had identified new products (low cost car) that makes it more affordable for families to buy and has hence increased penetration. Isn't that a more responsible business model?

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