indian low cost airlinesspidi2.iimb.ac.in/~networth/ccs/2005/525 indian low cost airlines.pdf ·...

I N D I A N L O W C O S T A I R L I N E S

Present Model & Strategy for an Increased Profitability

PROJECT REPORT

Submitted to Prof. Rishikesha T Krishnan

August 29th 2006

Submitted By

Madhurjya Banerjee Sandeep Kanathia 0511170 0511182

INDIAN INSTITUTE OF MANAGEMENT BANGALORE

CONTEMPORARY CONCERNS STUDY

Acknowledgements

We are extremely grateful to our guide Prof. R.T.Krishnan for constantly giving us insightful

directions during the course of this project work. Thank you Sir.

We are also indebted to Mr. Anurag Jain, Yield Manager, Air Deccan for his inputs about the

Low Cost Aviation Industry in India.

Finally, we would like to thank our friends who were constantly there for us.

Madhurjya Banerjee

Sandeep Kanathia

Table of Contents A. Global Low Cost Model ...................................................................................2

A-1 Southwest Airlines......................................................................................2

A-2 The European Model ..................................................................................4

A-3 The Common Features................................................................................5

B. Indian Low Cost Aviation.................................................................................6

B-1 Air Deccan..................................................................................................6

B-2 Cost Advantages .........................................................................................7

B-3 Profitability Scenario ................................................................................10

B-4 Operational Scenario.................................................................................15

B-5 Competition ..............................................................................................17

C. Conclusions and Recommendations..................................................................22

C-1 Increasing Profitability..............................................................................22

C-2 Applying the Global Low Cost Model ......................................................24

C-3 Key success factors for Indian LCCs.........................................................25

Appendices ..........................................................................................................26

References...........................................................................................................31

Low Cost Airlines – Contemporary Concern Study

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A. Global Low Cost Model Low-cost aviation, a recent phenomenon in India was introduced in Europe in mid-1990s. It is certainly not new to the United States where airlines adopted a low cost, no-frills strategy in as early as 1970s. Though a novel approach towards attracting passengers, very few service providers across the world have managed to operate profitably. Southwest Airlines in United States has emerged as a pioneer in operating on reduced costs. Inspired by Southwest, service providers in Europe such as Ryanair and easyJet have successfully managed low-cost operations. The success of low-cost, no frills method in Europe led to introduction of the model in other parts of world. In this section, select approaches followed by successful low-cost airlines achieving low cost have been identified and analysed. These approaches have certain common features, which would be summarized at the end of this section.

A-1 Southwest Airlines1 In the year 2002, Southwest Airlines – USA’s fourth largest air service provider, completed 31 years of incorporation and also a same number of years of continuous profit. It had a market capitalization of US$ 9 bn., more than the combined market capitalization of other major air service providers. This widely known low cost Airline was popular for a low employee turnover rate and more surprisingly of avoiding lay-offs after 9/11. The success story of Southwest is widely attributed to its low cost strategy. Southwest has been observed to operate at cost levels 28-50% below than its competitors. Early players in the airlines industry believed that wage reduction was the only way of achieving such reduced cost levels. Southwest, on the contrary believed in the following:

• Increased operational efficiency: A low turn-around-time2 (time lag between landing

and departure of an aircraft) in airports could make an aircraft spend relatively lesser time on ground thereby making possible for it to generate more revenue per day3. This increased efficiency makes it possible for Southwest to pay wages at an industry average at low priced service. Apart from turn-around-time, cycle times of most ground operations could be optimized. These levels of operational efficiency were achieved by the following:

– Point to point service: Southwest’s operational model was point-to-point connectivity with short haul flights. A Hub-Spoke model is traditionally more cost effective as a higher rush will result in scale economics. But, such a concentrated rush of passengers is not easy to manage on airports. Point-to-point reduces rush and improves control. This is a better bet than Hub-

1 Nuts – South West Airlines’ Crazy Recipe for Business and Personal Success by Kevin and Jackie Freiberg and THE SOUTHWEST AIRLINES WAY – Using the Power of Relationships to Achieve High Performance by Jody Hoffer Gittell

2 Southwest Airlines averaged a turn-around-time of 10minutes, Southwest averaged 10.5 flights a day at gate, compared to industry average of 5. 3 Each aircraft at Southwest flew 11.5 hours a day, in comparison to industry average of 8.6


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Spoke model if an excellent level of operational efficiency (low turnaround times) aided by staff coordination is present. As already described, Southwest was successful in the former. The latter was achieved through a concept of relationship coordination, successfully implemented by Southwest

– Secondary Airports: Southwest tried using secondary airports to serve major cities. Using these airports reduced average flight times by 15-20minutes due to short ground taxi times, fewer delays at aircraft gates and less circling on air while approaching. Due to these Southwest was able to attract and retain business travelers. Also these airports were situated quite close to the Central Business Districts of the towns.

– Coordination: A strong working relationship (leading to high coordination) amongst the staff (in-flight and ground) was a characteristic of Southwest. Southwest idea of coordination was guided by Shared Knowledge, Shared Goals, Mutual Respect and Frequent/Timely Communication amongst its staff. This distinctive and inimitable feature at Southwest differentiated Southwest-the organisation from its competitors. This lead to a reduction in cycle times of most operations. The costs at airport are like set-up costs/times. A lower set-up time will have a positive ripple effect on the total time an aircraft can fly during the day.

• Cost Elimination: Southwest reduced and changed some of the regular offerings to

flying passengers. They are given as follows: – No frills: Southwest provided minimal in-flight service. These included doing

away with in-flight food/beverages and a single seating class. This meant Southwest could fly with minimum cabin crew to meet safety rules. Hence, in-flight catering which represented 2-3% of most US airlines costs was reduced to 0.5% for Southwest.

– Sales & Distribution: Southwest bypassed travel agents for ticket booking by introducing direct ticket booking through its call centre and website. It saved on agents’ commissions that were around 7-10% of ticket price in US.

• Consistent Fleet: Better lease rentals and economies on maintenance costs were

achieved through a single type of fleet. Southwest used a single fleet (Boeing 737) succeeding in achieving high level of coordination (and standardization of practices) across the airport crew. Training requirements for maintenance engineers were minimized due to this move.

Hence, Southwest was able to offer low/unrestricted fares, high point-to-point frequencies and excellent on time departures. Low cost model was to be aided by a matching business strategy. Therefore, Southwest believed in the following:

• Domestic focus: At a time when major US players were targeting the international

traveler, Southwest concentrated on building densities in the national market by offering low fares. It benefited from the changing mindset of the business traveler, who was willing to compromise on frills with an efficient low cost service. At its onset of expansion it focused on a very distributed market (ranging across the coasts)


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On the operational side, they operate with single type of aircrafts with higher seating density obtained by reducing the seat pitch4. High daily utilization of aircraft is obtained by smaller turnaround times of 30 minutes or less. To achieve this, not only do they have minimum frills or on-board services but they also have done away with pre assigned seating.

A-3 The Common Features Though the LCCs modify their operations according to the needs of the market, there are a few common features in LCCs across the world. They are as follows:

• Direct Ticketing: First, a major cost saving comes from direct ticketing, completely or partially bypassing the traditional agents and booking systems. Direct sales enable the LCCs to capture revenue even before flights are undertaken. This gives a unique interest income opportunity.

• No Frills: They follow a low, unrestricted fare policy and there is a complete cut

down on in-flight services. In fact, revenue generation happens by on-board food, beverages sales. This coupled with factors like no pre assigned seats enable them to have a lower turnaround time resulting in higher aircraft utilization.

• Secondary Airports/Short Haul routes: The LCCs use the secondary airports of

developed markets to their advantage often negotiating for better terms of use and lesser airport and ground charges. This enables faster commuting, lesser delays due to decreased congestion. The LCCs also operate on point to point short haul routes. It is interesting to note that it is very rare to find more than one LCC on a single route.

• Consistent Fleet: The other factor that is common to LCCs includes their

standardized fleet which enables them to have better deals while leasing aircrafts. This also lowers the overall maintenance costs. The LCCs also negotiate with the manufacturers for increasing the seating capacity on their planes by reducing the seat pitch.

• While the crew works at similar wages compared to FSCs, they are highly motivated

due to the fact that most of the pay is performance related. In fact, in easyJet’s reservation centre, no employee receives a basic pay.

However, as the markets mature in the US and Europe there are certain sustainability concerns for a LCC. There is a continuing decline in average passenger fares coupled with rising oil fares. Most markets today face the problem of overcapacity resulting in route-wise competition. As maintaining a high yield continues to be the biggest challenge, LCCs are feeling that low cost and offering low fares might no more be a differentiator. Many LCCs are now contemplating the addition of minimal frills. 4 Distance between the seats


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B. Indian Low Cost Aviation Indian low cost aviation has occurred at a relatively earlier stage in India’s aviation industry. Aviation was termed as an ‘industry’ in year 19945, with the repeal of the Air Corporations Act, private carriers were permitted to operate scheduled services. This was in continuation to events in 1990 which allowed private sector players to operate as air taxi operators, and not permitted to schedule services. The economic growth (driven by liberalization in 1990s) lead to an increasing demand for air services and several initiatives were taken by airline majors to capture this increasing demand. One of these was the concept of Apex fares6. Some airlines were also quick to realize the importance of a low cost provider in the country. Prominent amongst these was Air Deccan, followed by Spice Jet and GoAir. The emergence of LCCs has changed the face of the Indian air travel scene. Demand is skewed towards low cost fares, and regular service providers such as Jet Airways are dedicating a share of seats at low prices to compete with the low cost airlines. On the other hand, airlines such as Kingfisher and Paramount specifically targeted at business travelers have been introduced. The creditor for this market stir -low cost airlines or more specifically Air Deccan would be discussed in this section. Profitability is an issue surrounding Air Deccan for the past few months. Various factors relevant to profitability would be introduced to discover success factors of a low cost provider in Indian scenario.

B-1 Air Deccan Air Deccan was incorporated in year 1995 as a private-helicopter and charter service provider. It started its scheduled services in year 2003 with a low-cost business model. The low cost approach of Air Deccan offered a “no-frills” air travel at cheap rates. Air travel at affordable prices stimulated market demand and passengers started to choose air travel over other means of transport. Observing such a growth, new low-cost players entered the aviation market to capture this demand.

Despite the fact that ab


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increasing capacity utilization of flights and not charging a high fare per passenger (which would be high from a business traveler).

Air Deccan operates ATR-42s, ATR-72s and A320s - a twin-fleet model. The ATRs (42 & 72) connect small towns/cities to major cities or to each other. They take advantage of low traffic between such stations and use the airstrips which are suited to smaller aircrafts. The Airbuses (A320) operate between metro cities. This fleet model at Air Deccan is just one of the factors contributing to its low cost efforts. Next, we discover where Air Deccan is cutting costs. These costs are understood and measured through a set of parameters. (Refer Appendix A for a brief on these parameters.)

B-2 Cost Advantages Air Deccan claims to be low on a set of cost components. They are as follows:

• Operating Costs

– Landing Fees is lower by 50% for smaller aircrafts (ATRs) than regular sized passenger aircrafts. Hence short haul flights are not expensive.

– Turnaround Time for Air Deccan is 40minutes (in comparison to an industry average of 55minutes) for an Airbus and 20minutes for ATRs. This leads to more number of flights per day, and lesser parking fees.

– No frills flying meant that all food/beverage options available to passengers were removed from in-flight offerings

• Administrative Costs – No frills concept was extended to the administrative set-up at Air Deccan. There

were no swanky offices or fancy airport lounges, and frequent flyer clubs were absent.

– Minimum crew members needed to follow safety rules were present in flights

• Distribution Costs – E-ticketing is a concept introduced by Air Deccan. This meant every ticket was

sourced directly from the airlines and hence travel agent commission was reduced. Air Deccan also had provision of booking tickets through its own call centre. The direct sale model meant that Air Deccan had no receivables at the time of aircraft departure, minimizing additional working capital requirements.

– Innovative Channels such as petrol pumps and ticketing vans meant fewer ticketing offices and fewer salaries.

Apart from the above, cutting unused space on aircraft for additional seating are one among the many measures Air Deccan has taken to reduce fares.

To understand the magnitude of cost advantage Air Deccan achieves, we make a comparison of its operating costs with those of a regular airline – Jet Airways


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This has been carried out as follows. The exhibit below determines the P&L components per Available seat kilometer (ASKM). In other words, the cost of flying one seat for a kilometer has been put side by side. This is an industry measure of comparing costs.

Air Deccan7 Jet Airways8

2004-05

(Rs. Cr)

Rs. Crores Per ASKM

(Rs.) Rs. Crores

Per ASKM

(Rs.)

% difference

(per ASKM)

Net Income 266.95 2.77 4338.01 4.43 -38%

Aircraft Fuel Expenses 92.98 0.96 1051.73 1.07 -10%

Aircraft/Engine repairs maintenance 49.27 0.51 287.37 0.29 74%

Aircraft/Engine Lease rentals 45.12 0.47 198.57 0.20 131%

Other direct operating expenses* 73.65 0.76 943.25 0.96 -21%

- Commissions^∧ 18.30 0.19 420.81 0.43 -56%

Employee Remuneration & Benefits 31.77 0.33 374.74 0.38 -14%

Landing, Navigation, Airport Charges^ 20.51 0.21 238.78 0.24 -13%

Adminstrative, General expenses 20.31 0.21 148.54 0.15 39%

Advertisement, Promotion 6.30 0.07 NA - -

We can observe and infer the following on the cost components.

• Aircraft Fuel Expenses: They are expected to be uniform across the industry. JA’s fuel expenses per ASKM are 10% higher than Air Deccan. This can be probably owed to a relatively old fleet for JA as it has been operating since a larger period. Also this can be due to the technical differences between Boeing 737s and Airbus A320s.

• Aircraft/engine maintenance: Air Deccan’s maintenance costs are 74% higher than JA. The major reason for this difference is the fleet composition of Air Deccan. Air Deccan operates Airbus A320 and a high percentage of ATRs. Airbus is turbine operated whereas ATR is propeller driven. The manufacturers of both are different leading to two different contracts for maintenance. Additionally, separate engineers are needed for two types of fleets.

• Aircraft lease rentals: Aircraft rentals for Air Deccan are higher as most of its aircrafts are leased in comparison to JA which has more buyouts and lesser number of leased aircrafts. Most of the lease payments for Air Deccan are in their initial

7 Offer Document, Deccan Aviation Ltd, May 31 2006 8 13th Annual Report, Jet Airways, 2004-05 * Includes airport landing, navigation, ground handling, Insurance, General crew expenses, Commissions

paid to agents ∧ As per Edeilweiss Analyst Report for Air Deccan


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stage. Air Deccan has chosen a rapid expansion in fleet and it will take some time before its lease payment expense stabilizes.

• Other direct operation expenses/Commissions: Air Deccan scores reasonably over JA on these parameters. The major contributors to this effect are: § By-passing of agents through direct ticketing approach(online and phone

booking) leads to lowering of commissions (Appendix C) § Elimination of frills (in-flight food, services etc.)

• Employee Remuneration: Air Deccan salaries are competitive, but it score in employing minimal staff as per the required optimum usage and safety norms.

• Administrative: Administrative expenses per ASKM for Air Deccan are higher. This is due to sudden expansion approach due to which Air Deccan has to establish administrative offices in major cities and also in unprofitable smaller destinations.

The above gives an understanding of Air Deccan’s low cost model and areas where it has less cost to operate. There are certain cost expenses which we thought need to be measured differently (and not per ASKM) to fully justify the cost advantage with Air Deccan.

Measure

Air

Deccan

Jet

Airways

%

difference

Aircraft/Engine repairs maintenance Per aircraft (Rs. Cr) 3.08 6.84 -55%

Aircraft/Engine Lease rentals Per aircraft (Rs. Cr) 2.82 4.73 -40%

- Commissions Per passenger travelled/day (Rs.) 186.87 525.05 -64%

Employee Remuneration & Benefits Per Employee (Rs. Lakhs) 2.69 4.75 -44%

The following points can be observed from the above:

• Maintenance costs and lease rental per aircraft are lower for Air Deccan as opposed to a contrary observation for per ASKM. This indicates that aircrafts for Air Deccan are flying more time per day leading to a higher ASKM.

• Commission paid to agents is further magnified to a cost advantage of 64% for Air Deccan. The same occurs with Remuneration per employee.

To understand the cost savings of Air Deccan under various parameters, its costs were compared with Jet Airways, a Full Service Carrier on the Delhi Bombay Route. In our discussions with Dr. Anurag Jain, Yield Manager of Air Deccan, he claimed that Air Deccan operated at 65% of the cost of Jet. In our calculations prior to meeting him, we had taken a few of the major cost components of the flight. Our initial findings showed that in these parameters, Deccan’s costs were almost half of that of Jet. There were certain inherent problems with this calculation though. Deccan’s low cost of operating its ATRs had been factored into these calculations as separate data for Airbus and ATR was not available. The calculations were then modified as explained in the previous section.


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The route wise cost comparison between Air Deccan and Jet Airways is made as follows:

Delhi to Mumbai Deccan Jet Distance 706 mi 706 mi 1135.954 kms 1135.954 kms Flight Time 2 hrs 1 hr 55 mins Type Airbus A-32 Boeing 737 -900 Seating 180 189 Aircraft/Engine repairs maintenance

84383.56 187397.26

Aircraft/Engine Lease rentals 77260.27 129589.04

Other direct operating expenses*

863.32504 1090.51584

Employee Remuneration & Benefits 736.99 1301.37

Landing, Navigation, Airport Charges^

241.40 276.89

Adminstrative, General expenses 239.05 172.25

Total Rs. 163724.60 Rs. 319827.32

B-3 Profitability Scenario The P&L statements for Air Deccan report negative profits throughout its 2+ years(FY 2004, 05, 06-upto 31 Nov05)) of its operation. Profit margins are driven by two factors- expenses and revenue. We focus on the effect revenue generation components can bring to Air Deccan’s profits latter during this discussion. Revenue dependence is shown in the following diagram.


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The first level of dependence is based on number of passengers and Yield. Number of passengers is dependent upon available seats (given by fleet size, composition -ATR/Airbus). Thus the three independents are Yield, PLF and Flights per aircraft.

• Yield : As defined previously, this is the average collection per passenger. Since we have data on 2004-05 we can calculate Yield for each year. We can observe (demonstrated later) that Yield is increasing marginally. This % increase can be an input to forecast future earnings per passenger.

• PLF: PLF for years 2005, 2006 can be calculated. It can be used to determine the breakeven value of PLF needed in present and coming years to breakeven.

• Flights per aircraft: This is observed to be increasing. Though industry findings show that flights per aircraft are limited to a certain number.

Now, we analyze the P&L statements for FY 2005, 06 (Appendix D) to determine the drivers for profitability. Once the drivers are known, we would be in a position to project profits for future years. The profit determining methodology would entail assumptions and forecasts of certain parameters as shown in the following table:

The figures in 2005 are actual, while those for 2006 are derived with the following inputs • Fleet size, Flights per day, Km per passenger per day, Yield, Employee per ASKM,

Increases in ATF rate, inflation, wages.

It should be noted that figures for fiscal 2006 are available up to 31 Nov, 2005. The profit projection methodology of ours is tested by comparing the projected P&L figures with those estimated by simple extrapolation. The basis for our projection was the figures for fiscal 2005.

The assumptions towards projecting a P&L are as follows:

% change forecast

2005 (Actual)

2006 (Projection)

Fleet Size (Nos) 16.0 29.0

Flights per day (Nos) 58.0 226.0

Flights per aircraft per day 3.6 7.8

Available Seats (annually) 1292738 3266445

Passenger Load Factor 76.4% 70.3%

Passengers Flown (annually) 987104 2296311

Kms per passenger per day -5% 698.7 663.8

ASKM (Million Kms) 903.3 2168.3

Yield (Avg. collection per passenger - Rs) 10% 2704.4 2974.8

No. of employees 1183.0 2697.7

Employees per ASKM -5% 1.3 1.2

ATF Rate Increase 10%

Inflation 8%

Wage Increase Factor 10%


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• Flights per aircraft (for all fleet types) per day are expected to be constant in the coming 3-4 years. This figure- 3.6 in 2005 and 7.8 in 2006 is assumed to stabilize at 7.9

• Kilometers per passenger per day is observed to be decreasing, and expected to decrease further because of a short haul strategy of Air Deccan. This decrease is assumed to y-o-y by 5%.

• Employee utilization rate is expected to go up, leading to a decrease in No. of employees/ASKM. This y-o-y decrease is assumed to be 5%.

• Economic growth factors such as inflation and wage increase have been suitably assumed. ATF fuel prices are expected to increase 10% every year.

The above are indicative to develop future profitability projections. They can be varied to determine the effect on the bottom line.

The following exhibit devises the profit projection model, by comparing projected and estimated (extrapolated) figures in year 2006.

P&L Projections Cost

Driver/Dependence Driver rate 2005 Actual

2006 Projected

2006 Estimated

%age error

Income

Sale of airline tickets and related income ASKM, PLF 266.95 683.11 668.85 2.1%

Helicopter charter and other services Extrapolated 38.61 48.67 48.67 0.0%

Other income Extrapolated 14.73 59.91 59.91 0.0%

Total 320.28 791.69 777.43 1.8%

Expenses

Aircraft Fuel Expenses No. of flights 1.60 92.99 398.55 323.18 18.9%

Aircraft/Engine repairs maintenance No. of aircrafts 3.08 49.28 96.46 108.10 -12.1%

Aircraft/Engine Lease rentals No. of aircrafts 2.82 45.12 81.77 121.07 -48.1%

Other direct operating expenses ASKM 0.08 73.65 190.95 195.06 -2.2%

Employee Remuneration & Benefits No. of Emplys 0.03 31.77 86.06 96.98 -12.7%

Adminstrative, General expenses ASKM 0.02 20.31 52.64 67.83 -28.9%

Advertisement, Promotion 6.30 8.47 8.47

Financing, Banking Costs No. of aircrafts 0.64 10.21 19.99 17.13 14.3%

Ammortisation No. of aircrafts 0.36 5.73 10.38 12.38 -19.3%

Depreciation No. of aircrafts 0.19 3.06 5.99 7.20 -20.3%

Total 338.40 951.25 957.40 -0.6%

PBT 18.11 159.56 179.97 -12.8%

The working of this model is as follows:

Income • Alterable variables to income are PLF and Yield increase

9 Discussion with Air Deccan officials


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• Inputs are fleet size, composition (number of ATR, Airbus etc.). If number of flights per day for each type is known, the number of available seat capacity is known. Multiplying it with PLF gives number of passengers flown.

• Number of passengers is multiplied with Yield (an input) to determine the revenue earned.

• Income from helicopter is expected to remain same. Other income is assumed to follow its normal trend.

Expenses • ASKM is determined by multiplying available seats with average distance traveled by

an airline passenger (as mentioned before, this is likely to decrease) • The cost driver for each expense is determined from 2005 figures. The ones (drivers)

which logically come close to driving an expense were selected and discussed with company officials to confirm. The %age difference between estimated and projected was a good indicator of driver selection.

Projections for 2007-09 • After confirming and verifying our approach to determine profit, we can apply the

same to project profits in 2007-09. • The fleet expansion plan of Air Deccan for these years which is the only external

input in profit projection. All other drivers and projection parameters would be replicated for these years. The only difference would come in determining the available seat capacity.

• Along with the fleet size, we can determine the total number of flights per day. To determine the available seats we need to flights for each type of aircraft. It can be observed that fleet addition to ATR-42 comes to halt after 2007, while ATR-72 and A320 keep adding to present numbers. Hence, the number of flights from ATR-42 will not grow after 2007.

• The growth in flights for A320 is assumed to follow the growth of its fleet expansion. The total number of flights per day is known, and hence number of flights by ATR-72 can be known. The workings are shown below.

Seats 48 72 180

ATR 42 ATR 72 Airbus A-320 Total

Fleet Size (2006) 14 4 11 29

Fleet Size (2007) 15 12 19 46

Fleet Size (2008) 15 19 25 59

Fleet Size (2009) 15 25 34 74

No. of flights / day (2006) 122 23 81 226

No. of flights / day (2007) 131 51 141 322

No. of flights / day (2008) 131 97 185 413

No. of flights / day (2009) 131 136 251 518

No. of seats / day (2006) 5858 1627 14645 22130

No. of seats / day (2007) 6276 3651 25296 35223

No. of seats / day (2008) 6276 7008 33284 46568


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No. of seats / day (2009) 6276 9775 45266 61317

• It should be observed that this is a theoretical figure for available seats per day. When compared with the real seats offered in 2006, a difference was observed. This factor of difference between calculated available seats and real available seats has been used for the remaining years. The results are presented below.

• We project Air Deccan to earn a profit margin of 26.5% in the year 2009 for a PLF of 80% and all other assumptions holding a minimum variation.

• The effect of PLF and Yield on profitability can be observed from the following

graphs. Three scenarios have been taken for Yield: constant, increase by 5%, increase by 10%.

• From these graphs we can observe that Yield plays a major role in achieving a higher profitability. In all three cases the slope for PBT vs. PLF curve is the maximum for

All Figures Rs. Cr

P&L Projections (PLF = 80%) 2007 2008 2009

Income Projected Projected Projected

Sale of airline tickets and related income 1361.03 1979.33 2866.86

Helicopter charter and other services 61.35 77.33 97.48

Other income 59.91 59.91 59.91

Total 1482.29 2116.58 3024.25

Expenses

Aircraft Fuel Expenses 567.85 728.33 913.50

Aircraft/Engine repairs maintenance 153.00 196.24 246.13

Aircraft/Engine Lease rentals 129.71 166.37 208.67

Other direct operating expenses* 288.72 362.63 453.61

- Commissions^

Employee Remuneration & Benefits 123.62 147.50 175.28

Landing, Navigation, Airport Charges^

Adminstrative, General expenses 79.60 99.98 125.06

Advertisement, Promotion 8.47 8.47 8.47

Financing, Banking Costs 31.71 40.68 51.02

Ammortisation 16.46 21.11 26.48

Depreciation 9.50 12.18 15.28

Total 1408.64 1783.48 2223.48

PBT 73.65 333.10 800.77

PBT / Income (%) 5.0% 15.7% 26.5%


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year 2009 which represents operation at enhanced capacity. A higher slope means that profit at low PLFs would nosedive for a low ‘Yield’ing operation. Hence, to realize high margins Yields must be high for an enhanced capacity operation.

B-4 Operational Scenario A key to continual profitability, as evident from profitability analysis are high yielding business travelers. A major requirement for all passengers and particularly business travelers is schedule adherence. With frequent delays and cancellations, operational efficiency at Air Deccan has been a talking point for the past few months. The reasons for such an operational in-efficiency are discussed by dividing various factors leading to it. Air Deccan’s performance and probable shortcomings in these factors are discussed alongside. As large number of low cost airlines across the world, Air Deccan prefer to have a high number of flights per aircraft (leading to large number of flights per day)10 to achieve a high capacity utilization. This operational strategy has a two way effect:

• Highly constrained scheduling • Concentrated traffic on certain airports and routes

Minimizing operating costs and maximizing resource allocation drives high capacity utilization which is achieved through an optimum GANTT chart based schedule. This

10 Presently 226 flights per day, Air Deccan is expected to operate around 336 flights/day in 2007, and 413 flights/day by 2008. This is evaluated through the projected fleet expansion plan and assuming flights/aircraft ~ 7


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squeezed schedule has close to little slacks or idle time which is necessary to tackle uncertainties and fluctuations11. A plan is more likely to be disrupted due to these. Tackling uncertainty under a fully utilized plan is difficult (due to ripple effect) but achievable. Hence, it is important to underline various factors contributing to disruptions to determine scope in handling them. They are:

• Aircraft Maintenance

Maintenance checks are divided into three types –A, B & C depending upon the frequency of those types of checks. (A – After every 60 flying hours, B – 300-500 flying hours, C – After every 4-5weeks) Also before every flight, the aircraft has to be checked. As per safety regulations, Airlines have to invest on aircraft maintenance as directed by the regulator. This investment and personnel for maintenance depends on fleet type. Air Deccan with a twin fleet model, requires engineers for two types of aircraft. Engineers for ATRs are scarce as Airbuses and Boeing dominate global skies. Additionally, learning curve for ATR maintenance is low as they are a recent phenomenon in India. Therefore, maintenance time for ATRs is increased. Maintenance time on a whole also suffers due to minimum deployment of engineers as part of cost cutting measure. This leads to more work for a single engineer, decreasing productivity and hence delays.

• Pilot Work Rules Pilot work rules determine the maximum amount of flying time permitted for an individual pilot in given period. The differences across service providers on it are minimal and hence affect all of them equally.

• Airport Infrastructure The shortcomings in airport infrastructure can trigger delays in various manners. They are: – Lack of parking bays, leading to increase in pre landing air time – Lesser number of aerobridges/passenger transfer facilities leading to increase in

departure time Additionally, most airports have adopted GDPs (Ground Delay Programs) at the advent of sudden constraints such as rough weather. GDP refers to delay in departing aircrafts to minimize aircrafts waiting to land. This is a collective decision by air-traffic controller and operators to maximize safety, minimize fuel costs and workload. A GDP is a special case of schedule disruption. However, in Indian airports like Delhi or Mumbai, Air Traffic congestion is a major issue due to which airports adapt to GDPs. This results not only in wastage of fuel but also results in delay propagation which sends the entire scheduling for a toss.

• Passenger

Flight delays due to passengers occur in case of connecting flights where flights wait for connecting passengers to arrive. Air Deccan and most low cost carriers do not follow hub-spoke system and hence, passenger delay does not affect them.

11 Airline Operations, Lecture 1 1.206J, MIT, 2003


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With a highly constrained optimal solution to operations, Air Deccan faces an uphill task of schedule adherence in wake of uncertainty. This uncertainty comes primarily in the form of its maintenance issues, the nascent stage of infrastructure development of Indian airports and in secondary forms of weather, emergency etc.

B-5 Competition Target Segments There are two ways in which the entire consumer market can be divided. First, it can be divided in terms of the SEC (Socio Economic Classification). The chart below shows the relative standings of the various SECs12

The Focus of the above chart is in finding the purchasing power of various segments. What it also shows are the relative attractiveness of the various segments in terms of the value generated.

Jet Airways Air Deccan SpiceJet SEC A1 Executive class,

business travelers, Leisure travel

Always the second option Not much traffic from these segment as spread is small

SEC A2 Business travelers, some leisure

Leisure, some business Business, some leisure

SEC B1 Some Business travel Business travel, leisure travel, most profitable segment

Business and leisure

12 Calibrating Purchasing Power, Rama Bijapurkar and Ashok Das, BW Marketing Workbook, 2006


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SEC B2 None Business travel, leisure travel, VFR

Business and Leisure

SEC C None Predominantly VFR and little business

None, as presence is still limited

While it can be said that SEC A1 and A2 are predominantly Jet customers, B1 and B2 are the customers Deccan and other LCCs are banking upon. The second classification is based on income per annum. All consumers are divided into 5 segments from Destitute to Rich; as shown below. As shown, the consuming class is the fastest growing segment. While the Rich offer a much better value proposition, the LCCs have always targeted the growing consuming class.

Also the focus of LCCs in India has always been the Upper Class Railway Passengers.13 They have succeeded in increasing Air Travel Traffic in India. But seeing the lucrative market, the number of LCCs starting operations in India have increased substantially.14 The figure above show a surge in the consuming class which are the main targets of the LCCs. The Air Fares today are already lower than I-AC fares offered by Indian railways on long distance routes.

The main effect of the LCC story in India so far has been to broaden the base of air traffic in India. It can not be denied that the LCCs have opened the skies for a whole new set of consumers. The question however is whether these consumers are bringing value to the 13 According to railways data, the total number of upper class passengers was about 41m in FY02 (compared to 13m air passengers in the same year), paying on an average about Rs0.87 per km per person and the average lead distance was about 680 kms (average speed of express trains in India is 49 kmph. In FY03 the number increased to 52mn 14 SSKI Research

Increase in numbers


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table. Air Deccan ahs been expanding in Tier II cities while many LCCs are planning to concentrate only on connecting several Tier II cities to one central Tier I city. For example, even though Air Deccan will surpass Indian in terms of market share soon enough; it will still continue to languish in terms of the value share. The question is therefore: “Are LCCs in India focusing on increasing a non profitable pie and having a larger share of the same?” Competitors The competition for Air Deccan will be manifold and from many players. The battle will be waged not only on the Indian skies but also on the ground. With the entry of various new players in the market, the struggle for the resources will intensify. This part of the report looks at the various competitors to Air Deccan.

The focus of LCCs in India has always been in capturing upper class railway passengers.15 And they have succeeded in increasing air travel traffic in India. Observing the emergence of such a lucrative market, competition from various dimensions has risen. These are from the regular service providers, other low cost carriers and the railways. These are discussed as follows:

• Regular Service Providers

All across the world, FSCs have responded to the threat from Low Cost airlines with severe price wars and have failed miserably as they could not match their costs to the level of LCCs. Jet Airways has not tried to fight the low cost threat with a major fare cut. Instead, it has gone for differential pricing of its tickets, which has arrested the migration of leisure travelers away from Jet Airways. The time conscious business travelers have stuck on with Jet Airways because of its superior service and reliability. Also traditionally Jet has used only Boeing for its flights, thus saving on maintenance costs. The National Carrier has been rechristened Indian and is now armed with a fresh flow of cash from the government to turn itself around. Though every analyst had almost written it off, the erstwhile Indian Airlines will prove to be a tough competitor. Though much data is not available in the public domain about Kingfisher, from popular business press and available literature, it is clear that Kingfisher is trying to the differentiated Player in the segment offering Superior Service at a lesser price. The effectiveness of this approach is yet to be tested. “While fares are 20-25% cheaper than a full service airline, the company intends to provide good in-flight service. Kingfisher Airlines has chosen a single-class seating configuration of 174 passengers. The airline also provides in-flight entertainment system that offers a personal video screen at every seat with 10 audio and five video channels.”16

• Other Low cost carriers

15 According to railways data, the total number of upper class passengers was about 41m in FY02 (compared to 13m air passengers in the same year), paying on an average about Rs0.87 per km per person and the average lead distance was about 680 kms (average speed of express trains in India is 49 kmph 16 SSKI research


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SpiceJet17 is considered to be the strongest new entrant in the LCC segment, focusing on on-time travel at almost 50% cheaper rates. Given the fact that Air Deccan has been suffering from delays and cancellation of flights, the timely flights of SpiceJet will be one major differentiator, not only for Air Deccan but also might be successful in eating into the share of Business Travelers of Jet Airways. According to Analyst reports, the major sources of cost advantage for Spice Jet are:

• Seating capacity: SpiceJet uses single seat configuration (all economy) in all its flight.

Thus, in a typical 737-800, it would have a carrying capacity of 189, compared to 154 of the existing two class configuration (126 economy & 28 business). Consequently, the per seat cost is far lower.

• Distribution: All SpiceJet tickets will be sold over the Internet. Travel Agents (TA)

will be paid a minimal commission per ticket (about Rs50 per ticket) in case the booking is done through them. On the other hand, existing FSCs pay 5% commissions to TA, in addition to 3% to the GSAs. SpiceJet expects commissions to account for about 1% of revenues (compared to 10% in the case of Jet).

• No frills: Passenger amenities typically cost about Rs250-300 per ticket that are

completely passed on. • Maintenance: Lower maintenance cost because all aircrafts are new and similar

(maintenance cost is about 10% of Jet’s revenues). • Staff cost: SpiceJet will have about 30% lower cabin crew per aircraft compared to

that of FSCs.

17 Indian Aviation – Spice Jet, 22nd July 2005, Deutsche Bank


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• The Indian Railways: No one expected the Indian Railways to be a serious threat to

LCCs. The reason Indian Railways features in this section is because it has arrested the expected shift of customers from the upper classes to the LCCs through a lot of innovative ideas and service improvements. The II-AC and the III-AC passengers have always been the ones who have subsidized the sleeper classes and brought in money for the railways. They will surely exercise all options before allowing LCCs to poach on these passengers.

• Self Created Brand Image: Often companies are slaves of the images they have created

for themselves. From the very beginning, and even today, Deccan has been constantly focusing on expanding its market base purely on the basis of cost leadership and opening up untapped markets. However, because of its low cost image and continuing hitches in its operations, Deccan is perceived to be not only a Low Cost but also a Low Quality player. The consumer perception is right now so ingrained that though Deccan will continue to increase the air traveler base, it’ll have difficulty in luring the value passengers away from Jet. Recent initiatives like giving away three lakh tickets for Rs. 3 on account of its third anniversary is not going to help the cause in any way. Finally, given its unreliable image, the time conscious business travelers will not risk traveling in a Deccan flight if possible. SpiceJet has effectively played on this parameter to gain quite a few business travelers from jet which Deccan has not succeeded in.


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C. Conclusions and Recommendations The Aviation Industry is primarily a Service Industry where the customers are paying for a transportation service. The absence of accompanying minor goods (e.g. food and drinks) are what differentiates an LCC from an FSC. The effort therefore is more on the part of the LCCs to ‘tangibilize the intangible’. Today there exists a clear perceived difference in the consumer’s mind between various service providers. This in Services Marketing terminology is called Variability. This variability is often strengthened by Word of Mouth Communication. Air Deccan’s main efforts should be towards reducing this perceived difference with respect to other service providers. Also along with the traditional 4Ps of marketing, people, physical evidence and process are important criteria for a company. The following section discusses our conclusions and recommendations based on this.

C-1 Increasing Profitability The key to long term competitiveness in the low-cost airline space would be in building up resources to mitigate threat from other low-cost and regular service providers. Taking the case for Air Deccan, its profitability in its 2+ years has been negative and other players such as Go Air and Spice Jet have entered the low-cost industry. Spice Jet broke even in its first operating month and Go Air isn’t building a negative image either. Upcoming low-cost operators such as IndiGo have ordered a fleet close to half of Air Deccan. These certainly are not positive signals given the present numbers of Air Deccan. However, it is clearly


23

ahead of its competition in innovation like the Re. 1 fare. So while it’ll be easier for Deccan to pre-empt moves by other carriers, especially the traditional ones, the reverse will be tough.

Turning around such a situation would follow strategies in two key areas

• Yield & Costs • Corporate strategy

The first two, Yield and Costs are modifications to the functional strategies followed by Air Deccan, whereas the last one would deal with policy decisions. Yield & Costs Business travelers build up Yield. At an approximate measure, it can be said that leisure travelers cover operating costs and business travelers contribute to the profit. Air Deccan has lost business travelers due to its poor schedule adherence. And, business passengers do prefer to travel by low cost provided it is punctual, as proved by Spice Jet. The loss is not only that of present fliers but a loss of goodwill and future fliers. The only solution to attracting business traffic is in improving operational efficiency. The steps to this are: • Lowering Turnaround Time: This implies more flights per day and greater

distribution of fixed costs. Compared to SWA, Deccan takes around 4 times the turnaround time. Achieving a low turnaround time is the job of the ground staff, which Air Deccan has outsourced to a third party. Being a critical member of the operating chain, the ground staff should be under the direct control of Air Deccan. A direct control would mean efforts going in to make sure the ground operating learning curve is sloped higher. This was successfully adopted by Southwest, and CEO Herb Kelleher claimed that outsourcing hampered a well coordinated organisation. Moving from outsourcing to in-house would involve costs but in our opinion it would lead to the following:

An operationally efficient airline with a high percentage of business travelers will be more profitable in the long run than an operationally inefficient airline with high percentage of leisure travelers. • Greater slack: A squeezed schedule cannot handle uncertainty. Hence, the schedule

needs to be either relaxed or spare aircrafts need to be available on high traffic. • Maintenance: Maintenance in ATR is causing a high number of delays and Air

Deccan needs to make sure that a good number of engineers are available for them. ATRs operate in small cities where delays do not affect customer as severely as it would on a high traffic. Nevertheless, delays are a cause of costs and should be reacted to.

Corporate Strategy Air Deccan has expanded too much and too soon. Lack of learning in such an explosive expansion affects operations as discussed above. Additionally, the risks of such a rapid expansion are:

• Lack of reserves to mitigate competition or economic downturn


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• More number of avenues in expansion means different competitors on different routes

It should be noted that, inspite of good performance Southwest followed a controlled growth model. It focused on building itself for handling competition and concentrating on providing a focused low cost service (around the southwest region of the US). Such a strategy helped them to undercut prices if a new competitor entered and to build capabilities. Air Deccan with a rapid expansion plan will take time to build capabilities in running a low cost airline. Hence, a controlled growth expansion plan is suggested. For example, the northern Industrial centres like Jalandhar and Ludhiana are still not well connected with the Tier I cities. We believe that connecting these smaller centres to major cities through ATRs should be the focus for the next couple of years.

C-2 Applying the Global Low Cost Model Given that every market has its unique characteristics, the Low Cost Model can not be force fitted to the Indian context. The main concerns that plague the Indian Aviation scene are lack of secondary airports and the absence of subsequent cost savings that the LCCs enjoy elsewhere. Some of the Government regulations still make Airlines adhere to some archaic rules. Infrastructure woes add on to the problem of operational efficiency which is extremely important for an airline to keep its cost low. Propagation of delay is one of the major concerns in Indian LCC scenario, especially Air Deccan.

“India has over 400 airports, of which the Airports Authority of India (AAI) manages 94 airports and 28 civil enclaves in military stations. Although the airport capacity is seemingly considerable, only 62 airports are in use with the remaining being inactive. Additionally, over 40% of the passenger traffic is concentrated on the two main international airports (Delhi and Mumbai). As a result, limited terminal capacity at these airports has led to increased congestion, bunching of flights and delays in passenger clearances. Due to congestion aircraft have to wait for as long as 10-15 minutes due to unavailability of runway or parking bays. The Mumbai Airport is currently handling 480 landings/ take-offs in 24 hours. It has about 26 parking bays at the international terminal and 42 at the domestic terminal.”18 Given the fact that the operational cost savings is the major differentiating factor between an LCC and an FSC, infrastructure issues will continue to be a major concern for LCCs.

Another issue is the parking space slots. Traditional carriers have the slots in the busy airports making the new entrants park their planes at night in shelters far away from the morning traffic. Flying back to their main hubs always poses problems for the Airlines. Costs go up and at the same time effective craft utilization is not achieved.

18 SSKI research


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C-3 Key success factors for Indian LCCs Focus: The focus should be on concentrating on fewer routes and smaller geographical segments. Expanding too fast will mean spreading the investment thin across geographies. Also expansion should be done keeping in mind the burgeoning interest in tourism in India. Value: The value from the business customer will be an important criterion for the success of the LCCs. We find it impossible to believe that by spreading thin, Air Deccan can achieve more than just a breakeven and a large market share. The shift should be from a fight for market share to a fight for value share. Staying Power: Any LCC should have the staying power to fight off immediate competition. While the numbers of Major Airlines in US have shown a minor increase, there has been a huge drop in number of LCCs and smaller Airlines. Having a deep pocket is essential for survival in this sector. Capacity: Whenever a new market opens up in the aviation industry, there should be players with enough capacity to tap into that market. In India that is yet to be a problem or a KSF given the fact that all the players in the market are in an expansion mode. The Chart in the next page shows how every player is now into the fray for ASKMs and the oligopolistic situation no longer exists.19

Image: One interesting factor we noticed is that the consumer is extremely image conscious. This has led to a mapping between the price of the tickets and the Airline’s image. For 19 SSKI Research


26

example, it becomes difficult for Deccan to earn more than a certain revenue per ASKM even though opportunities existed. Also, for the business traveler today in India, Deccan is synonymous to delays. As the LCC revolution sets on in India, the LCCs will have to differentiate themselves in their service offerings. As an immediate measure we believe that the bookings of the LCCs should be made as hassle free as possible. Finally, for any LCC to survive anywhere and not only in India optimum operating efficiency is a must as shown by the research in this paper.

Appendices

Appendix A: Commonly Used Aviation parametes

The following are some of the commonly used parameters in the aviation industry to

understand the cost structures of the industry.

• ASKM/ASM: Available seat kilometers/miles measures the seating capacity of an

aircraft between two stations. An aircraft with a seating capacity of 120 operating

between two stations 1000 km apart would offer an ASKM of 120,000 for a single

flight.

• RPK: Revenue passenger kilometers refers to the number of seats that were actually

sold to passengers paying a fare.

• PLF: = RPK/ASKM


27

• RASK/RASM: Revenue per available passenger kilometers/miles measures the

revenue earned per seat kilometer.

• CASK/CASM: Cost per available seat kilometer/mile

• Operating Revenue/RPK: Revenue generated per passenger kilometer flown

• Operating Expenses/RPK: Costs expensed per passenger kilometer flown

Appendix B: Progression of Indian Aviation Industry


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Appendix C: The Process at Air Deccan

Appendix D: P&L Statement of Air Deccan


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Appendix E: How Low Cost Compares with an FSC

Appendix F: Expansion Plans


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References

1. India Research – Jet Airways, SSKI, 15 June 2005

2. http://www.domain-b.com/industry/aviation/index.html

3. http://www.domain-b.com/companies/companies_a/air_deccan/index.html

4. Red Herring Prospectus – Air Deccan IPO offering

5. Red Herring Prospectus – Spice jet IPO Offering

6. Red Herring Prospectus – Jet Airways IPO Offering

7. Nuts – South West Airlines’ Crazy Recipe for Business and Personal Success by

Kevin and Jackie Freiberg

8. THE SOUTHWEST AIRLINES WAY – Using the Power of Relationships to

Achieve High Performance, Jody Hoffer Gittell

9. Industry Data www.dgca.nic.in

10. Annual Reports – Jet Airways, SpiceJet

11. Report of the Centre for Asia Pacific Aviation; 17th October 2005

12. Deutsche Bank Company Research – Indian Aviation –Spice Jet – 22nd July 2005

13. Perspective, Jan 2006 - Centre for Asia Pacific Aviation

14. Emerging Landscape and New Value Propositions in the Civil Aviation Sector -

In conversation with Captain G R Gopinath, Murli Patlibandla, IIMB

Management Review – March 2005

15. Deccan Aviation – Edelweiss Equity Research – May 17, 2006

16. Airline Operations -1,2,3 : 1.206J, MIT Open Courseware, April 2003

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