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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)