Business Today

Plush makes way for cheap

With a tight rein on costs, low cost airlines IndiGo and SpiceJet show their full service rivals how to make money in the airline business. Is this model sustainable?

Kushan Mitra and twitter-logoJosey Puliyenthuruthel         Print Edition: July 11, 2010

Late in 2008, aviation fuel prices in India had started scaling down from the peaks of Rs 70,000 a kilolitre that August. But the mood at Jet Airways, the country's oldest private airline, was sombre. Its planes had begun to empty out, as the slowdown in the economy settled in and thrifty passengers opted to fly on Jet's cheaper rivals and turn to rail, or, even, road transport.

Average load factors on planes, or the number of seats with passengers, had started to sink. Airlines such as Jet, which were still clearing dues on past fuel purchases, needed their planes seven-tenths full to break even on each flight. Depressingly, Jet's load factor was hovering around 60 per cent in March 2009. Sudheer Raghavan, Chief Commercial Officer at the Mumbai-based airline, and his lieutenants needed to come up with a solution. And fast. The airline was losing Rs 2.5 crore a day.

Raghavan found the answer within the Jet fold, at subsidiary JetLite. The unit, the erstwhile Air Sahara, which Jet had bought in April 2007, was recording load factors 5-10 percentage points higher that its parent. JetLite, which ran an all-economy service and had done away with hot meals, had lower costs that, in turn, allowed it to peg its fares at least 15-20 per cent cheaper than Jet's plush, full-service model.

If Jet needed any more convincing, it came from this fact: while JetLite was making losses even with its lower costs, two of its main rivals, IndiGo and SpiceJet, were doing relatively well. The two had, by early 2009, not just garnered over 25 per cent of the air passenger market between themselves with a combined six years in the business, they were making small operating profits, too.

Jet moved quickly. Starting with eight Boeing 737 planes, it removed business-class seats and added a few more rows of economy, converting its 140-odd seat aircraft to 175-seaters-an increase of 25 per cent capacity. It cut down on its meal offerings (charging for them at times), which allowed the airline to fly with four cabin crew instead of the earlier six. All that changed was the flight number on its ticketing system and a small "Konnect" logo on the exterior of the plane at the front door.

The "Konnect" fleet today has increased to over 18 Boeing 737 and six ATR aircraft. Of the 290 daily domestic departures that Jet makes every day, 180 are "Konnect" flights. Adding departures for JetLite, over 72 per cent of the departures made by the Jet Group are on low cost services.

It is not just Jet, even Kingfisher Airlines, whose flamboyant Chairman Vijay Mallya swore by his five-star airline offering, has changed tack. Instead of adapting the planes of Air Deccan, the low cost competitor it acquired in June 2007, Kingfisher found itself starting to drift away from its gourmet meals and inflight entertainment to taking the low-fare route. Like Jet, an estimated 70 per cent of Kingfisher's daily departures are on its lowfare service, Kingfisher Red.

Kapil Kaul, India analyst with the Centre for Asia Pacific Aviation, or CAPA, says it was clear to him as early as 2005 that given India's demographics-the value-conscious business traveller and an increasingly mobile young population- low cost airlines were the models best suited for the country. "Today, 75 per cent of passengers fly low cost," he says- a huge, 180-degree turn from 2003, when the only planes flying the skies were Indian Airlines, Jet and Air Sahara.

Morph in the Skies
How did this come about? At one level, the answer is simple: Because Indians, like people all over the world, care about prices. But, the question that really begs the big answer is how is it that companies like SpiceJet and InterGlobe Enterprises, which runs IndiGo, have been able to keep costs down while running an airline service. And, why is it that others have not been able to copy this model successfully? First, the handicaps that IndiGo and SpiceJet have to contend with every day. Unlike Europe and America, where low cost carriers such as Ryanair and Southwest Airlines operate into cheaper secondary airports, in India, there were no such options.

As Sanjay Aggarwal, SpiceJet's CEO, points out, the several options for airports and landing strips around New York keeps costs competitive. "The costs an airport offers is a function of competition; that is missing in India." So, while landing charges at the Indira Gandhi International Airport in New Delhi are not very different from, say, Heathrow, what makes for pain in India is that there are no other airports in the capital. Gatwick or Stansted, on the outskirts of London, are 10 to 35 per cent cheaper than Heathrow, to encourage airlines, particularly low cost carriers such as Ryanair and easyJet, to use these less congested airports.

Crowded Indian airports and bunching of flight movements at peak hours put stress on flight timings. Southwest Airlines' famed 20-minute turnaround remains a dream in India, unless it is at an airport at a small city and everything goes like clockwork. SpiceJet and IndiGo record 30-minute average turnaround times but that is a little misleading because in India the definition of the metric is "chocks on, chocks off ", which means the time between a plane coming to a halt after landing and starting to taxi for take-off. Next, aviation fuel prices, driven up by taxes of up to 34 per cent in India, are among the highest in the world.

Aviation industry insiders say, depending on how well other costs are under control, fuel costs work out to around 40 per cent of an airline's total operating costs-as much as double elsewhere in the world such as Dubai and Singapore. The high taxation levels in India can really hurt as Indian carriers found out when aviation fuel prices peaked in August 2008. Kingfisher and Jet were losing Rs 5 crore a day and quickly had to cut down on the flights they ran to survive.

Inside the planes, leaner service may mean handsome savings to be made for cabin staff when compared with the West, but salaries for hard-to-find aircraft commanders and pilots remain high-as much as Rs 500,000 a month for expat pilots. And low cost airlines have to pay cockpit crew as much as their full-service rivals do.

Sweat the Asset
But countering all these are several cost advantages that IndiGo and SpiceJet have leveraged to their benefit. IndiGo, for instance, counts its large order book for planes as a big differentiator among airlines in India. It has on order 100 Airbus A320 planes for delivery until 2015, some 27 of which have been delivered. By the end of this year, that would have gone up to 34.

Such a large order- second only to Air India's 111-plane order on Airbus-gives the airline not just big leverage while negotiating purchases (10-15 per cent discounts are normal in such deals) but also sweetheart arrangements on spares supplies and maintenance. "The order book gave (IndiGo) the collective power of arbitrage over asset costs," says a person with close knowledge of the purchase decision, declining to be named. IndiGo has received government permission recently to buy 150 more planes starting 2015.

The airline's first CEO, Bruce Ashby, told this magazine in 2008 that one way IndiGo did well was by expanding in a measured fashion. It chose routes that were underserved and built capacity to have 50-60 per cent market share on the routes. Patna to Mumbai, for instance. "You launch one destination and consolidate over there. Each destination has an associated 'launch' cost and you need to employ staff over there. Simply put, you launch a destination with at least twothree-four flights a day," said Ashby, who is now CEO at Sama Airlines in Saudi Arabia.

Both IndiGo and SpiceJet (and indeed others such as GoAir, an airline with the Wadias of Bombay Dyeing as promoters) pack in more seats on each all-economy flight and squeeze the most out of their planes with more flights a day. "We have a high seat density on our aircraft, therefore even if we fill 70 per cent of the plane we can make money," says SpiceJet's Aggarwal. "We also utilise our planes a lot better than the full-service carriers... our aircraft spend on average 12.5 hours in the air everyday and work a total of about 17 hours."

He reckons that these two factors alone result in a 20 per cent saving on costs. Not serving food free on planes has a twin effect: they get not just to save money on it but also the weight of food carts and galley structures. This accounts for a 3-4 per cent saving on overall costs. Monetising revenues is also gathering pace. Aggarwal estimates that over a quarter of passengers buy meals when they book tickets and 45 per cent buy a beverage on board. An online distribution model accounts for another 4-5 per cent shaved off costs.

And then there is the way the pilots fly. "It is like driving a car, you can drive safely but in a fuel-inefficient way but equally safely in a fuel-efficient way as well," says the SpiceJet CEO. Pilots are encouraged to climb slowly after takeoff, request air traffic control for ideal cruising altitudes, and start their descent earlier so that gravity helps save fuel. Result: a two per cent saving on cost or Rs 20 crore on a Rs 1,000 crore annual fuel bill at SpiceJet.

IndiGo and SpiceJet tank up fuel at airports in states where the tax rates are as low as four per cent: Hyderabad in Andhra Pradesh, Jaipur in Rajasthan or Nagpur in Maharashtra. Sure, this is an option with full-service carriers too but the low cost duo gets discounts from oil marketing firms, who have had a bad experience with the likes of Kingfisher, Jet and Air India over unpaid fuel dues.

The results are showing. At IndiGo, says the person quoted earlier, revenues for fiscal 2010 closed at around Rs 2,500 crore with "net profitability in the 15 to 20 per cent range"-Rs 375-500 crore, which puts it ahead of even SpiceJet by a yard. "IndiGo is a debt-free company and has, on a cumulative basis, returned the money of shareholders," the person said without elaborating. IndiGo numbers cannot be independently verified as the company is unlisted. But in the year to March 31, 2009, it had reported profits of Rs 82.6 crore, according to filings with the Civil Aviation ministry. The airline is said to be preparing for an initial public offering later this year.

SpiceJet declared a Rs 61 crore profit for the year ended March 2010 on revenues of Rs 2,242 crore-a considerable improvement over the results the company had been posting in the two preceding years. In fiscal 2009, the airline had a net loss of Rs 352.5 crore and lost Rs 133.4 crore in the year prior to that. (It is important to note that SpiceJet and IndiGo, as also Jet, all improved revenues on the back of sale-leaseback revenues, a common practice among airlines that sell aircraft to boost revenues and then lease them back.)

The Flight Plan
The future for SpiceJet and IndiGo appears bright, if aviation fuel prices remain steady. They are at about Rs 42,000 a kilolitre today and with crude oil prices rising, the price of jet fuel, which tends to track crude prices with a three-month lag, could be a challenge.

The control of SpiceJet has just been bought by Kalanithi Maran, Chairman of the Sun TV Group, and though the media baron has not announced his plans for the airline yet, analysts do not expect much change in operations strategy and management at the carrier. Maran has not ruled out a name and brand change or a shift of its Gurgaon headquarters.

The airline plans to start international operations with a Dhaka flight in August, to be followed by a September start to Kathmandu, and expects to connect Colombo this winter. IndiGo, too, is clear that it will fly to West Asia and South Asian countries when it completes five years of flying in India, which is a minimum requirement for an airline before it can apply for government permission to fly overseas.

But, it does not see itself doing what Tony Fernandes-who founded AirAsia X-is doing: flying low cost services on long-haul routes such as, say, Kuala Lumpur-London. "We don't want to complicate the model; India offers enough and more of a market," says the person familiar with IndiGo's operations. (See Indian Air Travel: Headroom Aplenty for Growth.)

But, there is a looming challenge- Jet and Kingfisher are quick studies and are scrambling to adapt and adopt from their low cost competitors. The introduction of the Konnect service has seen load factors climb to close to 80 per cent for Jet, and the airline is now pioneering a "hybrid" model by introducing eight business class seats at the front of the plane. "We are seeing demand by some passengers for bigger seats, lounge access and on-board food," argues Raghavan, Jet's Chief Commercial Officer.

Hybrid or pure-play low cost, what is becoming increasingly important is what the airline industry calls revenue management. Shorn of jargon, it is the ability to predict the prices at which to sell different sets of tickets on a flight at what time. Typically, airlines sell them in "buckets" that sell at higher and higher prices closer to the flight date.

The right call can rake in the moolah for an airline. Last summer, in the middle of a price war, when tickets were being sold for Rs 2,500 on an average, SpiceJet took a calculated risk in not selling Delhi-Ahmedabad tickets for November-December until the last moment. It ended up selling its last few tickets for around Rs 15,000 each as tickets sold out for all rival carriers on that route.

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