Low-cost Airlines: Is it really sustainable in Long run?

Low-cost Airlines: Is it really sustainable in Long run?

By

Dr. G Bharathi Kamath
Asst. Professor-Economics
ICFAI Business School
Nirlon Complex, Goregaon (East), Mumbai

"The Indian aviation market flies high……….." was the headline of a leading newspaper recently. The report said that India's aviation sector has become the fastest-growing in Asia in terms of flight operations and the rise in domestic air capacity presently is a whooping 46%. The report further added that the huge rise is mainly due to increasing low-cost flights that have been attracting substantial number of new customers. The low cost carriers not a new concept abroad has been showing phenomenal growth across globe. In India and China alone, demand for low-cost travel has skyrocketed, with domestic flight operations in this segment showing a remarkable jump of 466% and 254%, respectively according to the OAG report. The main question at this point that is raised is whether these low cost carriers (LCC's) (or the no-frills airlines as they are popularly known) are working on strong economic principles and business models to make them sustainable in long run too.

To answer the question, we need to probe a bit into the origin and business model of operation of LCC's. The airlines that venture into becoming LCC's have several options to cut their costs so that the savings can be passed on as benefits to the customer as lower price to fly between places as compared to normal airlines that charge relatively higher price. The model developed in US and Europe is based on cutting operating expenditures. By dispensing with expensive in-flight services such as hot meals, drinks and other frills these airlines reduce their costs; they also maintain very few crew on board and ground staff resulting in decrease in another expense on wage bills. Another important measure through which they protect their profits from unpredictable swings in jet fuel prices by entering into long-term hedging contracts. Finally, they cut down distribution costs by bypassing travel agents, and sticking entirely to online booking of tickets¹.

Thus broadly, across the world, low-cost carriers operate with three basic principles: a simple product — which means no free meals, economy seating, no seat reservations, no frequent flier programmes; positioning — targeting non-business and price-conscious passengers; and low operating costs².

In India, air fuel and not salaries & wages constitute the largest share in expenses of airlines as the airlines have to procure their Air fuel from oil companies. The under-developed commodity hedging market also puts a stumbling block on these companies to hedge against fluctuating prices of air fuel. Moreover, the internet connectivity in our country being low, the popularity of online booking has not taken off yet. The increase in air traffic is not matched with the increase in the infrastructure at the airports. The airlines prefer to halt and ply between only metros and airports which have sufficient landing and parking place, this leads to long halts and waiting of these planes at metros and also traffic congestion and delays besides loss of precious air fuel; this model is contrary to the European LCC's which ply between airports which reduce their halting and turn around time thereby reducing their costs further. So though these airlines are able to reduce their costs of pay, they are unsuccessful on the other fronts as compared to other countries LCC's.

The cost of procuring new fleet also needs consideration because; they should be able to have at least 80% occupancy of seats to be viable in long run. Now if most of the flights operate on the popular routes chosen due to aforesaid reasons, there would surely be a saturation of market sooner or later. Therefore, these airlines must think of exploring low-cost routes, less time taking routes, rather than hauling on the same popular routes, if they wish to remain viable in long run. For example the north-east region of our country completely remains outside the gamut of competition from these LCC's. Such routes can be tapped for future sustainability as the first mover advantage would always play favorable. The LCCs face a big revenue risk in their point-to-point services but they try to reduce it by offering low fares and flying full capacity at others. Besides this the time saved by operating in these areas is also used to fly at other destinations. Operating outside the country may also be beneficial in long-run. It may be noted here that the entire fight in skies started only after the changes in the policy to allow private operators, which was henceforth the dominance of two national carriers- IA and AI.

One of the real low cost carriers in India which seems to have long-run sustainability is Air Deccan, for example, follows a low-cost business model. Its aircraft fly longer number of hours by having a faster turnaround time; have an all-economy configuration to accommodate considerably more seats than a regular airline; have only e-tickets and no free catering on board. Also, airport ground handling has been outsourced and many functions automated to reduce the number of employees. This leads to major savings in administration and accounting. Therefore, the LCC can be a workable model if it is adopted in its true spirit.

On the other side of extremity of opinions on these LCC's was by Prock-Schauer who noted in one of the conference on aviation industry that 80 percent of costs are independent of the business model. "In Indian aviation, passengers prefer the full service model and the cost differential between full service carriers and LCCs is so small. In actual practice, low cost airlines don't really exist in India. Thus, another question that can be actually debated on is whether the low-cost are really low or have hidden costs attached.

The general problems encountered by passengers as well as airlines operators range from time taken by flights to reach destination due to stopovers to getting clearance to take off and land, parking space and the like. Infrastructure constraints make the night halts, night landing at smaller airports not possible and therefore, there is no connectivity to these places, passengers find their national carrier more reliable on these routes. In-flight services are virtually nil in these "no frills". Similarly abrupt cancellation without any proper notification and inconvenience to passengers a common grievance among those who travel through these airlines. Reimbursement of the money for the ticket cancelled is another big issue which is often complained about by the passengers.

The requirement for trained commanders to operate these flights also is another issue that needs urgent attention. A severe demand supply gap is emerging resulting in price hike by these commanders; this may also lead to increasing cost and defeating the entire spirit of operating a LCC. "Over 1,000 captains are required to make the plans of airlines come true. There is no way we can produce that number of commanders and there are not enough pilots even in the global market to meet the requirement of the mushrooming number of airlines,'' says a senior Boeing-737 check pilot based in Chennai.

These problems must be resolved before further expansion else may spell doom due to severe dissatisfaction among the customers and the airlines may find only new demand and not repeat demand. It is not new among foreign low-cost carriers that they have either merged or sold off their business due to long-run un-sustainability.

The regulatory authorities in India must take appropriate action and reprimand the management of the airline for their non-responsible attitude towards their customers. Therefore, a change in the present regulatory environment is also sought for.

On the infrastructure front The Civil Aviation Ministry had been making announcements about investments in airport infrastructure, but too little was being done. About 300 aeroplanes had been ordered but there was no place to park them. There was congestion in terminal buildings, and the infrastructure was saturated. A radical approach was needed to equip the airports for the projected growth³.

Another issue that needs to be factored is the competition among the increasing number of players entering the aviation market. The airlines are now offering packages and tying up with chain of hotels to make their offer attractive, in order to retain their customers and also add new ones. The competition not only is intra-industry but ranges across industry, now a LCC competes with the railways and some with the Luxury bus services. For example, when Air Deccan introduced airfares almost equaling the AC II-tier train fares, the response from the leading domestic airlines like Indian Airlines, Jet Airways and Sahara Airlines was immediate.

However, at present the rising number of passengers has been made possible by growing low cost carriers (LCCs) in India, whose market share is predicted to reach 70% by '10 from 30% at present, according to a recent analysis by Centre for Asia Pacific Aviation (CAPA). The Indian domestic aviation market is estimated at about 19 million passengers and is expected to reach 45 to 50 million by 2010. It is further estimated that five million passengers will be added per annum for the next five years.

According to the civil aviation ministry's latest data for April-June '06, number of passengers carried in the domestic sector increased 48%, while the international traffic rose by 16%. The fairy tale of low cost airline advent is still in its initial stages.

There are many opportunities for these LCC's, but challenges are no little. According to Prof. Taneja fro Ohio state university, "It is going to be a little like the dot.com boom. There will be many failures, but the few that survive are going to become global players."

References:

1. Aarati Krishnan , "Low-cost airlines: They may need more than a wing and a prayer", Hindu Business Line, Sunday, Jun 26, 2005.

2. Shaker, TS, "Taking off", The Hindu, Sunday, Apr 24, 2005.

3. "Plea for safety audit on low-cost airlines", Special Correspondent, Hindu Business Line, Wednesday, Jun 22, 2005.

Dr. G Bharathi Kamath
Asst. Professor-Economics
ICFAI Business School
Nirlon Complex, Goregaon (East), Mumbai

Source: E-mail April 25, 2007