CHANGES IN THE AIR
On the back of a rising middle class, India is redefining aviation economics.
By Abe De Ramos

The two-lane highway that cuts through the Indian state of Goa crosses quiet rivers and overlooks the green tops of coconut trees and the sparkling aquamarine of the Arabian Sea. Even in the dry heat of summer, the former Portuguese colony is a beguiling destination. Thanks to the rush of new domestic airlines, what used to be a haven for foreign hippies is now being rediscovered by Indians themselves, including city-dwelling weekend warriors seeking to relax on its golden beaches.

But their Goan respite abruptly ends the moment they head home. On any given day, a flight to Bangalore could be delayed for hours by last-minute runway repair work, while flights to Mumbai or Delhi are likely to be put in a holding pattern for half an hour or longer before being allowed to land at either congested airport. Still, one may call these hassles progress, as they signal the arrival of a neglected industry that is about to explode and break business rules.

Five new carriers will take off in India over the next year, bringing to 12 the number of private players flying its skies. Three years ago, only two challenged the dominance of state-owned Indian Airlines. Radical reforms have opened a market brimming with pent-up demand. The number of Indians flying domestically had been growing at only 5% a year, reaching 14m in 2003, paltry for a population of 1.1 bn. But as new carriers offered more seats, traffic jumped 42% in two years, taking passenger numbers to 20m as of 2005. On the back of a strong economy, that should grow a further 25% a year and reach 60m by 2010, according to consultant Centre for Asia Pacific Aviation (CAPA). Naturally, each player is as bullish as the next in becoming the market leader. “We want to be the biggest private full-service carrier in India by the end of the decade,” says A Raghunathan, CFO of Kingfisher Airlines, currently the fifth largest.

The race for pole position in a rapidly growing market is giving rise to new business models. While most emerging carriers claim to be low-cost, they cannot blindly copy the playbook of European pioneers Ryanair or EasyJet. The peculiarities of the Indian market – from low credit-card penetration to higher-than-average fuel prices to a chronic shortage of pilots – are forcing aviation companies to adapt and try strategies not likely to be seen elsewhere, and require greater creativity and innovation from the CFO. They also have to deal with India’s dismal airports, with their single runways, crumbling terminals, and scarce parking spaces. The government is addressing infrastructure bottlenecks with privatization and greater funding, but labor strikes and the difficulties of doing business in what some say is a democracy gone amuck are delaying actual work – even as Indian carriers are scrambling to meet future demand, having ordered last year 430 new aircraft, double the existing fleet of the industry.

Cabin Pressure

The first challenge of identifying growth markets is easy. Indian Railways, the largest rail system in the world, shuttles 16m people a day. Of these, 700,000 travel in first class cabins, paying fares comparable to what no-frills carriers are now able to offer. Bangalore-based Air Deccan was the first to capture this potential market when it launched a low-cost carrier in August 2003, flying four 48-seater Turboprops to cities with airstrips that had not been used since the end of British rule. “Thirteen trains used to ply between Hubli and Bangalore per day,” says CFO MG Mohan Kumar, referring to a city 405 km from the outsourcing capital. “This route had 600 upper-class travelers per day, and we were pretty sure we could capture at least 45 of them.” The model worked, and in two years, Air Deccan became the third-largest domestic carrier, with a 16% market share serving 260 flights a day to 56 airports.

The second challenge of mapping out flight routes is determined by infrastructure limitations and the economic boom. Airports in the six biggest cities in India are seriously congested. Traffic between the hubs of Bombay and Delhi alone accounts for 50% of total, making parking and landing charges there expensive. While not ignoring these routes, the new carriers are focusing on cities outside of the six metros, which also include Bangalore, Hyderabad, Kolkata, and Chennai. “The real growth drivers today are the industrial second-tier cities, where the retail sector is booming and people’s attitude are changing, from saving to spending money to improve their quality of life,” says M Thiagarajan, managing director of Paramount Airways, which caters to corporate passengers. “We’re trying to eliminate the hub-and-spoke concept, and make point-to-point connectivity between these smaller cities.”

The easy part ends there. For Air Deccan, start-up funding proved a challenge. “We approached the largest banks in the country and realized there was no point in depending on them for working capital,” says Kumar. The reason: India had granted licenses to nine private players from 1991 to 1993. All but two of them went bankrupt, leaving banks mistrustful of the sector. “We had to establish a model where working capital was self-sustaining,” recalls Kumar. With only 55m rupees (US$1.2m) in capital to recruit 42 pilots, the CFO knew he needed to preserve his cash instead of using it all on training, which cost 1.4m rupees per pilot. He thus designed a scheme where the recruits would finance their own training. Kumar deposited his capital in banks, against which pilots could borrow the full cost of training, pledging their own property as security. Air Deccan reimbursed them in full after a year.

None of the new players face similar constraints. While Air Deccan was started by a retired Air Force captain, its competitors are backed by some of India’s largest conglomerates. Kingfisher was founded by the UB Group, India’s largest brewer, while GoAir is owned by the Wadia Group, which has interests in chemicals and consumer goods. Because most of them are still loss-making, what they might struggle with is raising equity to support fleet expansion. Air Deccan’s IPO last month was met with poor demand, while Jet Airways, the largest private carrier, has languished below its IPO price even before the stock market crashed in late May. Kingfisher is expected to raise equity later this year. Analysts remain skeptical of the sector. “Their success is very much dependent on the time it takes authorities to solve the infrastructure bottlenecks,” says Akshit Shah of UTI Securities.

But the long-term challenges lie in the high cost of operations due to factors unique to India. While aviation may have been opened up to all players, it is still overregulated. For one, jet fuel prices are up to two times higher than the international average, says Kapil Kaul of CAPA in Delhi, thanks to the monopoly of state-owned oil firms. On top of the marketing charges and import and customs duties that oil companies levy, state governments also slap their own sales taxes ranging from 4% to 40%. Adding insult to rising oil prices, domestic carriers are not allowed to hedge their fuel costs, while international airlines are. “There’s nothing much we can do about it; it’s a fait accompli situation,” Raghunathan laments. As such, fuel accounts for a third of airline operating costs in India, double the global average.

Manpower shortage is also an urgent concern. Due to the volume of new aircraft on order, Kaul envisions that India would need 3,000 pilots to add to the current 2,000 by 2010. Already, local carriers have had to hire 300 pilots from overseas. Air Deccan has 75 from as far away as Brazil, Nigeria, Romania, Philippines, and Australia. “Local hires have the same salary as expatriates; pilots will not accept a lower salary just because you’re a low-cost carrier,” says Kumar. Salaries of pilots at Kingfisher range from US$5,000 to US$100,000 a month, on par with international standards. “Pilot wages are nothing great in terms of total cost, but the demand-supply situation is so bad,” says Raghunathan. Engineers for repair and maintenance jobs are equally scarce, and the CFOs can only hope that the quality of new graduates in India will be up to par.

The most alarming constraint is the lack of physical space to accommodate new aircraft. Major domestic airports like Mumbai and Delhi have little to no overnight parking slots. Their single runways are also designed to turn around only 15 aircraft an hour, just a third of the global average; planes need to taxi and fly around in circles for 30 minutes before takeoff and landing. “Our airports have reached saturation point,” Raghunathan says. “The existing Bangalore airport is actually a defense airport; there is congestion, and we can’t possibly put more flights there.” As a result, landing, parking, and navigation charges are 70% more expensive in India than in Changi in Singapore, says Kaul. In most cases, even smaller airports that previously had little traffic are also raking it in, as they get their revenues mostly from aeronautical charges.

Even in metro airports, revenues from retailers make up only 20% of the total, versus 58% in Changi and 71% in Sydney, says credit-rating firm CRISIL. Using secondary airports – a crucial factor of low-cost operations in Europe and Asia – is not an option, simply because they don’t exist. While India has over 400 airports, only 89 domestic ones are operational. All of these undermine the viability of low-cost carriers. Jeh Wadia, managing director of GoAir, claims that his cost of operations is only 37% lower than that of Jet Airways, whereas the cost of operations of low-cost carriers (LCCs) globally is on average 60% lower than full-service airlines. Raghunathan of upscale Kingfisher goes as far as to say that the LCC model is simply not workable in India. “Low-cost as a concept cannot really succeed here, because all our costs are the same,” he says. “With the kind of pricing they’re doing, there’s no way they will make money.”

Who Will Survive?

But Wadia doesn’t buy it. “My 37% cost differential is more than enough for me to kill the likes of Kingfisher and Jet,” he argues. While the jury is still out on the winning business model, the blossoming sector is creating an environment for experimenting on business strategies, some of which are not known to exist elsewhere. Air Deccan, GoAir, and SpiceJet – along with the seven other potential new players – are no-frills airlines focused on transporting passengers without hot meals or in-flight entertainment. Indian Airlines, as well as the merging Jet Airways and Air Sahara, are full-service carriers that are already responding to low-cost carriers on pricing. Kingfisher is a premium full-service airline where every seat has its own television screen – rare on domestic routes even in the United States – while Paramount claims to provide first-class service for all its passengers – with wider seats, entertainment units, and exclusive airport lounges – at fares comparable to economy seats in regular carriers.

Regardless of business model, each should operate efficiently and have strong capital backing in the next three years. That’s when Wadia expects the challenges of manpower shortages, high fuel prices, and poor infrastructure to ease. “We’ve come into the business when costs are at an all-time high,” says the 31-year-old scion of the Wadia family. “Things will only get better,” Kaul of CAPA agrees. “Airlines must understand that there are constraints within the next two years, and so they need to work within those constraints as part of their business model.”

Both Air Deccan and GoAir are cutting costs and enhancing revenues through aggressive distribution, allowing bookings by internet, call centers, and travel agents – with a twist. The cheapest distribution method for any airline in the world is by far the internet, as it eliminates the cost of paper tickets as well as commissions for middlemen. But because internet penetration in India is poor, Air Deccan came up with a scheme that mixes both. The company set up an internet-based reservation system where bookings were charged against the credit-card accounts of the people generating the ticket, “so there is no time lag between the ticket sale and the money collection,” says Kumar. In short, agents book through the system on behalf of people who have neither access to the internet nor a credit card account. “Whatever ticket is sold today, the money is in my bank account the next day.”

Kumar pushed the idea to the 5,000 travel agents in India, 2,000 of whom were using the global distribution system of the International Air Transport Association (IATA). The rest were sub-agents with no IATA connection. Initially, the IATA-linked agents, who were used to keeping customer payments for 45 days before they were cleared by the system, resisted the move. Non-IATA agents, however, accepted it with gusto because they did not have to wait for Air Deccan to reconcile the payments and settle their commissions – the system allowed the agents to collect the mark-up immediately. “The IATA guys started losing business, so they changed their minds,” says Kumar. While they still resisted the credit-card system, they offered a deal that turned out to be better for Air Deccan – the agents were to deposit the cost of the tickets in advance, while keeping the mark-up. As a result, Kumar claims the company continues to enjoy negative working capital.

Inspired by this model, GoAir went a step further by tying up not just with travel agents but also retail shops around the country. This gave the company greater exposure, and helped educate consumers about the LCC model of getting a progressively bigger discount the earlier the booking. As part of the scheme, Wadia claims that GoAir gives free seats to the first 10,000 bookers in a month. “The whole sustainability of the LCC model is to have about 12 to 15 months of revenues and 12 months of operations costs,” he says. “But in India, people don’t know how to book early. We needed to push our product and come up with an alternative to travel agents, because we couldn’t rely only on the highest cost distributors to reach the consumer.”

GoAir has signed an exclusive arrangement with Tata Telecom, one of the largest mobile-phone providers in India, to have internet booking available in its 2,800 shops, and with InLot, the largest lottery-booking agent with 10,800 shops. Taking inspiration from EasyJet, GoAir also worked with mom-and-pop internet cafés to provide the same internet booking in their premises in exchange for putting up the “GoCyber Café” signs in their storefront. “We gave them a brand, and we get advertising free while pushing our product into the shops,” says Wadia. In all cases, bookings may be settled with the shopkeeper’s credit or debit cards or cash deposits. They charge 50 to 60 rupees on top of the cost of tickets that GoAir makes available to them. Now, only 29% of GoAir tickets are sold via traditional travel agents. “Distribution is how you can be innovative in this business,” says Wadia. “I believe that the war in the skies will be won on the ground.”

Adapting to India’s infrastructure limitations, most low-cost carriers in India fly at least two types of aircraft, most commonly the 180-seater Airbus 320s and the 80-seater ATR Turboprops. This goes against the practice of no-frills airlines in Europe and Southeast Asia to have just one aircraft model to minimize the cost of training pilots and engineers. For Air Deccan, the Airbuses serve the six metros and 12 other secondary cities, while the ATRs serve smaller cities and also act as feeder flights. “The ATR gives you better frequency,” says Kumar. “Instead of flying one Airbus carrying 180 people, you can fly the ATR three times to that destination and offer customers the convenience of having choices of flight times.” Air Deccan claims an average load factor of 71%.

To get around the lack of airports in some viable routes, Air Deccan has started contracting private airports. Last April, it signed an agreement with Tata Steel to use the latter’s airstrip in the steelmaking city of Jamshedpur for its services between that city and Kolkata. This is the first time that any airline has served this route; until now, travelers between the two cities needed to take a four-hour train ride. “We want to fly wherever there is business,” says Kumar. As with other low-cost operators elsewhere, Air Deccan keeps its flights to a single class. “Not having business class, having denser seating, will save you around 7% to 8% cost on lease rentals and insurance,” he adds. Likewise, the company stresses on keeping its turnaround time to a minimum – 15 to 20 minutes for the ATRs, and 40 minutes for the Airbuses.

Wadia has a slightly different take on turnaround time. Acknowledging the congestion in the metro airports, GoAir spreads out its flight schedules to make sure that its on-time performance is not compromised. “We’ve reduced the number of flights we have per aircraft per day while increasing the bunker,” he says, “because if one flight is delayed, it will have a domino effect, and I will have ruined my reputation.” And in a bid to minimize GoAir’s cost of operations, Wadia has decided to keep at least 25% of his fleet on six-month leases at any given time. The logic is to lease aircraft from European operators during the latter’s off-season months. “My high season in India, October to May, is the low season in Europe,” says Wadia. “They say ‘We’d rather lease it to you for this price, rather than let it sit on the ground or make losses.’” Wadia did not disclose how much advantage a short-term lease has to long-term leases.

To augment their revenue sources, both Air Deccan and GoAir allow advertising outside and within their aircraft. GoAir also set up in-flight shopping called GoShop, selling items such as mobile phones, pens, watches, and sunglasses at deep discounts to retail-shop prices. “We tied up with volume players who give us the price points we want,” Wadia says. He claims that the cost of flying a GoAir route and buying a Samsung mobile phone from GoShop would still turn out to be cheaper than the cost of the mobile phone alone bought from a retail outlet. The company is also exploring arrangements with consumer-goods companies – including his brother’s snack-foods business – to test their products on GoAir passengers. “Today, ancillary revenues give us 7% of total, and we hope to bring it to double digits in the next couple of months,” Wadia adds. The company expects to break even by March 2007, and turn a profit in the latter half of that year.

Boutique Brand

At Paramount, Thiagarajan claims the company has already broken even within months of its launch. The reason? Paramount – whose selling point is to offer business-class service at fares equivalent to economy tickets in other full-service carriers – uses only the Brazil-made Embraer aircraft, which he says are not only cheaper, but are also more fuel-efficient. Thiagarajan claims that in spite of high oil prices, jet fuel accounts for only 20% of his total cost, compared with 35% for the industry in India. Because the airline also retrofitted its aircraft to fit only 60 passengers – there are no middle seats, seats are 35 inches wide, and they recline to 145 degrees – it satisfies an Indian civil-aviation rule that exempts aircraft with fewer than 80 seats from paying landing charges.

Paramount also focuses on directly connecting non-metro cities, flying only to Mumbai and Delhi outside of prime time. With smaller aircraft, Thiagarajan says Paramount can also turn around its aircraft quickly, and thus raise their utilization rates. “We turn around our aircraft in 20 minutes, as opposed to 40 minutes taken by an Airbus 320,” he says. With three aircraft at present, Paramount flies 22 times a day carrying 1,600 passengers. So far, the model has worked, as it has reported a 95% load factor. The company will bring its fleet to ten by the end of the year, having already hired the needed pilots. One advantage of being the only airline in India that uses Embraer, Thiagarajan argues, is that his pilots will not be easily poached by competitors. “We’re not worried by people taking 320s and 737s, because they are not our competition,” he says. “We’re building a boutique brand.”

At Kingfisher, which runs 70 flights a day to 15 destinations, Raghunathan is insistent that the premium full-service model – such as having in-flight entertainment with five video and eight audio channels in every seat, and giving away travel kits even on one-hour flights – is the way to go. Even as the company has not joined any price war and charges more than its competitor Jet Airways, the CFO claims a load factor of 67%. “The increase in the number of middle class with higher disposable incomes means people are no longer going to be as price conscious as they used to be,” he says. Not surprisingly, Kingfisher is the most aggressive airline in terms of marketing – with billboards all over big cities and a plan to sponsor the concert of pop star Jennifer Lopez in Mumbai.

“We don’t believe in undercutting prices,” says Raghunathan. “It’s better to create a product and a brand that is distinctly superior, because customers develop a liking for that.” Instead, Kingfisher, which uses A-320s, focuses on efficiency to keep its costs low, keeping aircraft turnaround time to 40 minutes. The company has also outsourced most of its ground handling at the airports to Indian Airlines, and its repair and maintenance needs to Lufthansa Technic. “We don’t have to have the entire number of people on our payroll,” says Raghunathan. “There are risks attached to having a trade union holding you at gunpoint.” The CFO expects Kingfisher to break even by March 2007 on revenues of 6.8 bn rupees, and turn a profit by March 2008 on revenues of 16 bn rupees.

Already, the company is planning to fly international routes – starting with the tech cities of San Francisco and Bangalore – by 2008, with a plan to get around a regulation that requires domestic carriers to have been in business for five years before flying outside India. “We can make a representation with the government to get a waiver for that,” says Raghunathan. As back-up, Kingfisher has incorporated a company in the US, called Kingfisher International, which may introduce flights from US cities to India. In any case, Raghunathan has already ordered five wide-body Airbus A-340s to ply its planned overseas routes. Ambitious? No doubt. But it only means that for India’s aviation sector, there is no turning back.