Download Airlines-a bad business - Tribune

COPY FOR ‘TRIBUNE”
“Airlines-a bad business” by S L Rao
When telecommunications was opened to private investment with the introduction of
cell phones, government sold licenses to the highest bidders. There was a scramble for
licenses. Companies paid hundreds of crores for their licenses. They had not, estimated
demand realistically, accounting for 3 principal factors-quality of the service, cost of cell
phone instruments and the cost per call-minute. At the outset a cell phone cost Rs 20000
and Rs 20 per call-minute, declining to Rs 10 or so. These costs would and did limit
demand. To recover the high fees from call earnings would take many decades at the low
level of demand at such prices. Companies paid high license fees without estimating this
equation and had poor revenues. They appealed to government to save them. So it is not
just government but many in the private sector also that do not consider demand as
related to price.
One company aggressively went after customers, dropping call charges and sourcing
low cost instruments. It led the way for the industry. India underwent a telecom
revolution led by cell phone companies from both private and public sectors. Cell phones
have overtaken fixed line phones. Operators make good profits despite charges being
among the lowest in the world. New companies with only a license are worth many times
what the license cost. With India’s low income population, volumes depend on low
prices.
Airlines in India were in a similar position but were unable to do much about reducing
costs. They were mostly outside their control. It is a cyclical business everywhere, with a
few years of rising traffic and profits and others of poor profits and even losses. The best
run airlines in the USA of past years are no longer there. New ones come up and will
probably suffer the same fate.
Mr. Ratan Tata’s executives must be happy that his passion for flying was grounded by
government obduracy. TATA’s would like the others, have lost a lot. The Group, position
would have deteriorated further after expensive and perhaps ill-timed acquisitions: of
Corus steel which is mired in declining demand and world recession; and of the three
declining but iconic car brands led by Jaguar. The fall of the Rupee in relation to the
dollar by over 20% in nine months, the much higher costs of servicing foreign debt as
well as a decline in domestic demand and prices, would have been aggravated by similar
conditions in the airline market.
Airlines and airports are notoriously cyclical industries everywhere. Yet, many
businessmen from more prosaic industries like textiles and collapsible aluminum tubes,
and profitably glamorous ones like liquor entered it. Naresh Goyal, Vijay Mallya, Jeh
Wadia, and many others were like lemmings. They started new airlines, marching behind
each other to drown in the ocean of high costs and declining traffic. They could not have
had realistic forecasts of demand and price. They bought the propaganda about India’s
continued growth, imminently in double digits, India as a Great Power and the
unstoppable India.
They also saw an opportunity as government owned airlines went steadily downhill,
helped by venal politicians and some bureaucrats as well as some airline owners. None
anticipated the extent of competition but only foresaw easy pickings. Jet and Kingfisher
even acquired Deccan and Sahara on top of heir already large commitments on airplane
fleets. Jet paid well over the top for Sahara, a weak airline with little real assets.
Kingfisher paid much less, and for new planes, but did not foresee the extent to which
Deccan was a totally unviable business.
The “Low cost” airlines were actually selling below cost, without compensating cost
savings. At these low prices many travelers switched to air travel. A huge market resulted
as airfares fell close to the level of rail fares. Unbridled price wars began. All airlines
began to lose money as the tried to retain customers by selling below cost. The big ones
were playing “chicken”, i.e., who would fold up first, leaving the market to the rest, or
who would blink first and who charge remunerative prices.
These operators had not grasped the essentials of a “budget” airline. It demands tight
cost control over all costs. Ryanair or Air Asia are profitable because they work with low
fuel costs, low operating costs, low airport charges (by using the less popular air
terminals and airports), restrict baggage, food and other services, and utilize aircraft to
the maximum. Outstanding managerial skills gave low costs, low prices and large
demand from undemanding customers who only wanted on-time safe travel.
Indian airline operators neither displayed managerial skills, nor did the operating
conditions make it possible to keep costs low. Indian aviation fuel taxes are more than
their cost. Fuel prices in most cases are 100% higher in India. Sales taxes on fuel amount
to 27 to 30%. Fuel costs are fixed, and at 35 to 40% of total costs are the largest
components of airline expenses. Many other taxes-service tax, excise and customs duties,
user development charges in new airports, add to costs. Our airport charges are said to be
62% higher than comparable tariffs abroad.
Aircraft utilization suffers because of poor airport infrastructures, with fewer runways
and hangars and no alternative cheaper airports nearby. Cost flexibility is confined to a
fraction of operating costs, namely customer services on ground and on air, service of
food and water, etc. These are inadequate to make a difference unless government
reduces fuel taxes, rationalizes airport charges, there are alternative airports close by, and
airport infrastructure improves. Hence when “low cost” airlines cut fares, they were
selling well below costs. Bigger airlines had to follow. Demand boomed but everyone
lost money.
When prices of aviation fuel rose with crude prices, so did passenger fares, leading to
precipitous decline in airline traffic. An emerging recession also reduced air travel. The
“low cost” airlines sank because of their un-viability, and disappeared. Air fares have
risen greatly and traffic has dropped. Overheads on account of high cost debt, lease
charges expensive foreign pilots, led to unbearable fixed costs. Many airlines will close
down.
Business leaders with demonstrated commercial success in other businesses went
berserk in their airlines businesses. They bought new craft, with borrowed funds. They
leased many aircraft. High interest and repayment costs, high lease rents, high priced
aviation fuel, and high airport charges, are inflexible costs. An aircraft with empty seats
is a loss of revenue. Filling it requires unviable low fares. The business model is in these
circumstances not viable.
Despite this simple economics, airlines opened new routes, and ignored the relation of
costs to prices and volumes. Airline entrepreneurs have shown a lack of foresight, poor
skills in forecasting demand at different prices, poor understanding of irreducible costs,
and sunk costs on borrowings and lease rents. (1129)