Jet Lag

Jet’s tug-of-war with its pilots is just the latest among several difficult situations it has faced in recent months, and is symptomatic of pains being felt across India’s civil aviation industry, according to Wharton management professor Saikat Chaudhuri. “All (carriers) are in trouble,” he says, noting that Indian airlines are “disproportionately disadvantaged” by high state tariffs on aviation turbine fuel (ATF), and many operate unsustainable routes while responding to severe competition with steep price discounts.

“The recession has made all that worse,” Chaudhuri adds. Kingfisher Airlines, for example, has the highest outstanding dues to airports and oil companies, compelling it to provide bigger guarantees. “Every week we hear the problems of some airline or the other highlighted.”

Trouble has been brewing at Jet Airways for some time now. In October 2008, huge protests ensued when 800 cabin crew and ground staff were fired overnight. (An additional 1,000 were told they would be next to go.) Employees learned of their dismissal when their morning pickup didn’t arrive at their homes. With politicians breathing down his neck, Goyal made a PR event out of it. In a late-evening news conference, he announced that all terminated employees would be taken back. “They are like my family. I cannot see them unhappy,” he said. “I could not see tears in the eyes of my employees. I could not sleep when I saw what had happened.”

No tears were shed for Goyal this year, however, as he grappled with pilots over several issues, including pay and perks, alleged preferential treatment for expatriate pilots and job security. But the immediate bone of contention was the formation of a pilots’ union — the National Aviators Guild — in June. Jet had fired for an unspecified breach of discipline two pilots who had joined the union; management said it did not have to provide a reason for their termination. More dismissals followed.

On Sept. 8, 420 pilots called in sick. Over the next four days the number grew daily, to 539, about half of Jet’s approximately 1,000 pilots. The protest took its toll: From Sept. 8 to Sept. 12, Jet had to cancel 71% of its flights, including 85% of its domestic flights and 40% of its international flights.

On Sept. 13, an accord was reached, though little seems to have been achieved. “It’s time to get back to work,” Goyal told his staff. “It is now time to look to do what we know best — fly.”

An Industry in ‘Survival Mode’

What’s new is the dramatic change in the environment. It’s been a bad year for airlines globally. The International Air Transport Association had forecast a loss of $9 billion in 2009. On Sept. 15, it revised the number to $11 billion. The estimate for 2008 has been increased from $10.4 billion to $16.8 billion. “Expect more casualties,” says the association’s director general and CEO, Giovanni Bisignani. “The world is changing. The industry is in survival mode.”

The industry’s fortunes have been especially bad in India. The country accounts for just 2% of the global market, but its losses are expected to top $2 billion. “The past one year has (presented) serious challenges for the aviation sector,” says Susnato Sen, practice head (infrastructure) for the Tata Strategic Management Group (TSMG). “The sector was faced with a double whammy of high fuel prices and a considerable drop in traffic due to the economic slowdown. While there seem to be indications of a recovery in the economy, the woes of the aviation sector are far from over.”

Chaudhuri calls the current situation “a reality check” following the boom years when passengers were willing to pay higher fares, and low-cost airlines could coexist with full-service carriers. “The industry is behaving as if India were a fully developed country,” he says. “Anything that grows too fast there will (have) problems. But sustainability would not have been an issue if it were not for the recession.”

Consider Jet’s finances. According to a report by Enam Securities, in the April-June quarter, the first of the fiscal year, Jet had operating revenue of $470 million, down 19% from the same period last year. (These do not include the numbers for its low-cost subsidiary, JetLite.) In the international segment, the company has given nine aircraft on wet lease (providing the aircraft and crew) to foreign airlines. The $47 million lease figure “was the key driver for cash profits.” The overall outlook, however, is bleak. Enam projects a consolidated loss after tax of $176 million in 2009-10 and $78 million in 2010-11 (including JetLite, which has turned profitable). In 2008-09, Jet lost $456 million.

Kingfisher isn’t doing any better. In the April-June quarter, it lost $48 million, its 10th straight quarterly loss. Oil marketing company Bharat Petroleum has filed a petition in Karnataka High Court in an attempt to recover more than $60 million. The airline owes more than twice that amount to other government-owned oil marketing companies.

Air India, which has been merged with domestic carrier Indian Airlines, is in equally bad shape. Salaries have been paid behind schedule and the organization’s many unions are becoming restless. Losses last year topped $1 billion, which is why it has approached the government for a $1 billion rescue package.

Many Sources of Woe

The global slowdown’s impact on India is only one reason for airline industry’s troubles. The high price of aviation turbine fuel is another. It accounts for about 40% of Indian carriers’ operating costs, compared with 25% to 30% for carriers globally. Part of the reason for the disparity is the high sales tax imposed by state governments. “The aviation sector has been hit hard by the fluctuation in the fuel price and the current economic slowdown,” says Udgirkar of PwC. “In India, this sector is viewed as servicing the higher economic strata and so, unlike other infrastructure sectors, it has not got government support by way of tax reductions or other sops.”

A slump in demand is another factor. In 2006, passenger volume grew by 46.4%. Growth slowed to 32.5% in 2007, and in 2008, volume retreated by 4.7%. Indian carriers had ordered numerous new aircraft in the days of galloping growth. Now they have been left with overcapacity and a pipeline of aircraft deliveries they don’t know what to do with.

Most people blame the global slump and bad planning. But G.R. Gopinath, chairman and managing director of Deccan Cargo & Logistics and the man who started the low cost carrier (LCC) movement in India with Air Deccan (later sold to Kingfisher), sees it differently. One of the reasons passenger load factors have come down, he says, is that a year ago the airlines got together and fixed fares. “If it had happened in another country, they would have been punished for cartelization. But instead of the government taking action, consumers punished the airlines by not flying and occupancy rates have tumbled since then.”

“Airlines are themselves partially responsible for the crisis they are in today as they have failed to build a sustainable aviation model suitable for the country,” he adds.

Competitive Rates?

According to Jitender Bhargava, executive director of Air India, LCCs have made the entire business uneconomical. “They set prices that defied all logic. They were below breakeven. For instance, in 1998, a ticket to New York cost $800. In 2009, it has gone up by $60, though fuel prices have risen six-fold.”

A clear case exists for the government to reduce fuel tariffs to “give the airlines breathing room,” says Chaudhuri. The airlines, too, need to focus on controlling costs, especially pilots’ salaries, and rationalizing routes by operating low-cost flights in sectors and times of the day wherever it makes sense, he adds. For example, it doesn’t make sense to offer low fares on morning and evening flights between the major metros “because you will have business executives traveling,” but airlines could lower fares for afternoon flights or smaller routes.

Some airlines are already offering distinctly different full-service and low-cost flights, Chaudhuri notes. Examples of the latter are JetLite, Jet Konnect, Kingfisher Red and Air India Express. That trend is visible among international airlines, too, with some offering a “premium economy” class, he adds. Air France, British Airways and KLM have always had a premium economy class one notch below business class; Qantas added one recently and Cathay Pacific and Lufthansa are considering the same, he says. These premium economy offerings target business travelers who are willing to travel economy class, especially given the recent recession.

“The industry as a whole needs to sit back and think about the pricing strategy,” Udgirkar says. “Competitive rates are fine in order to attract volumes, but they should not result in losses. The airlines need to avoid the very unhealthy practice of a price war. The low-cost airlines which attracted an entirely new set of customers have not been able to control their costs and have been unable to sustain their price competitiveness. Worldwide, the low-cost airlines have many avenues to control costs. For example, they either have separate airports or non-peak charges at the regular airports. This is not the case in India.” Adds Sen of TSMG: “The LCC model in India has never really taken off. It is more an LFC (low-fare carrier) model.”

Excess capacity and mismatched cost and revenues also plague the industry, Sen says. Based on robust growth in recent years, most airlines had major aircraft acquisition plans. With so many aircraft scheduled to be delivered in the next seven to 10 years, the industry faces serious overcapacity. Airlines are trying to postpone deliveries.

Additionally, the airline industry has a high and largely fixed cost structure. Cut-throat competition has resulted in falling average ticket prices, with increases difficult because customers in India are highly price-sensitive. This has resulted in a misalignment of operating costs and revenues. Most of the airlines have failed even to recover operating expenses, let alone capital expenditures.

Another issue, Sen notes, is the slow pace of infrastructure development. “Airport development has not been aligned to growth in air traffic. Here in India, while we have had phenomenal growth of airlines, airports continue to grow at a much slower pace. This has resulted in acute congestion at airports, especially in metro airports. This in turn has resulted in increased operating costs.”

What next?

“Crisis is part of the aviation industry’s genetic profile. And still it survives, more or less intact,” says the Centre for Asia Pacific Aviation Outlook 2009. “But today, the industry is at a crucial turning point…. The industry has been historically unable to deliver returns to cover even the cost of capital. Government protection and subsidies are going…. Airlines will in the future need to generate revenues consistent with, and behave like, companies in other commercial industries.” The report goes on to warn that “substantial staff cuts are inevitable and some industrial turbulence (is) likely.”

Revenue will not be quick to rebound, but the industry has little choice but to focus on a combination of cheaper fuel, route rationalizations across sectors and timings, and cost controls. “It will take a couple of years for the yields to come back,” Chaudhuri predicts.