When the two leading airlines in the country?Jet and Kingfisher?are losing around Rs 8 crore a day, it is fair to say that the airline industry is in deep trouble. Early estimates suggest that losses for the industry could add up to around Rs 8,000 crore for this year. Still, this doesn?t in any way excuse the shoddy manner in which Jet tried to cut costs by dismissing 1900 employees, only to rescind the decision after a huge backlash. But the sorry state of the industry, does merit a brief analysis of how it got into trouble and how might it survive. In a geographically large country like India, the need for efficient and affordable airline industry cannot be under-estimated.
There are three key features of the airline industry worldwide which make merit a note. First, the airline industry is highly cyclical, prone to periods of boom and sharp bust. Just think back two years and recall the stories about the acute shortage of pilots in a booming Indian aviation industry?we were importing pilots from as far as South America. Think of the multiple airhostess academies which came up all over India, to keep pace with the jobs being created by new airlines, including budget airlines. How quickly things have moved to bust, sparked off by the surge in global oil prices and exacerbated now by an overall economic gloom scenario. Also, perverse government policy which charges high prices (and high taxes) for aviation turbine fuel (to cross subsidise consumers of petrol and diesel), makes India one of the most expensive places in the world to buy jet fuel. The economic downturn means that all the major airlines are operating at around 50% of their total seat capacity.
If this isn?t tough enough, things get worse for airlines because of highly unionised staff. Airline staff unions tend to be particularly strong, even in the US, because of the specialised nature of the work of some members, mostly pilots and engineers. It is thus never easy to downsize in a downturn or force staff to accept pay cuts. But airlines do commit the error of over staffing during a boom, particularly in India where employee-to-aircraft ratios are amongst the highest in the world.
Airlines also tend to have high levels of debt because of the high cost of purchasing aircraft. A bottom of the line Airbus A-320 or Boeing 737?these are the two aircraft most commonly employed by airlines in India?cost close to Rs 250 crore per plane. That?s worth more than a lot of medium-sized industries in India.
Having got into this uncomfortable air pocket, what?s the way out?
The first is the most obvious: close down and liquidate assets. This option isn?t as impossible or unrealistic as one may think, and is in fact very much a part of capitalism?s creative destruction process. In India, a number of start-up private airlines in the mid 1990s, like East-West and ModiLuft, folded up in quick time. Even established airlines close down. PanAm shut down completely after almost 60 years of operation as America?s premier airline in 1991. Belgium?s flagship carrier Sabena went bankrupt and closed down after more than 80 years of operations in 2001.
The second option is to consolidate through mergers and acquisitions. Excessive competition which comes up during a boom becomes unsustainable in a bust?there just isn?t a market for multiple players. Consolidation can help reap economies of scale (in the use of staff and aircraft), and prevent wasteful duplication of routes. One round of consolidation has already happened in India after the first surge in oil prices?Jet bought Sahara and Kingfisher bought Deccan. However, too much consolidation may not be a good thing if it leads towards a monopoly or a market dominance situation. Any Jet-Kingfisher alliance must be scrutinised in this light as the two together control about 60% of the market with only state-owned NACIL as a serious rival. This puts them in a position to hike fares beyond reasonable levels and to act arbitrarily in any restructuring process as was evident in Jet?s crass firing of nearly 2000 of its employees.
The third option, which the airlines industry is clamouring for is a government cash bailout. This is arguably the worst option as it helps airlines avoid taking difficult decisions to restructure and survive. Also, there is no reason for taxpayers to bailout airlines in trouble, since they get no extra taxes in times of boom. There is also the moral hazard argument?if loss-making airlines know they?ll get a cash bailout when in trouble, they will lean towards excess in good times. Theory aside, cash bailouts don?t usually work out well in practice. Alitalia is the ideal example?despite numerous cash injections, it has only ever made a profit in one year (1998), in its long history.
The best and most reasonable option would be for each airline to restructure its operations. Obviously this has to be an exercise in cutting costs, including in the wage bill. However, as Jet found out, this can?t be done in a hurry. Ideally, a company needs legal protection from its creditors (and even troublesome unions) while it restructures. India?s laws don?t provide for this. America?s Chapter 11 bankruptcy law is one of the finest laws when it comes to allowing stricken companies an opportunity to restructure. In the aftermath of 9/11, and a terrible downturn in US airline industry, airlines like United and American used bankruptcy protection for periods of more than a year to cut costs and emerge renewed. Unions are also forced to compromise with a company which has filed for bankruptcy and they are more likely to accept lay-offs and pay cuts. It?s time that India examined a change in its bankruptcy laws?as capitalism matures and we experience more cycles of boom and bust, we need a law that can help the orderly restructuring of companies in trouble.
For the moment though, Chapter 11 doesn?t exist in India. There is, of course, one last option for Naresh Goyal and Vijay Mallya?dilution of promoters? equity. Promoters own 80% of Jet Airways and 75% of Kingfisher Airlines, which is above the 70% average for listed companies as a whole?for BSE 500 companies the promoters share is about 60%. So, there is plenty of room for the sale of equity, perhaps even to a private equity investor. At this point of the cycle, they may even get buyers looking for a bargain. Of course, promoters will lose, but in a good capitalist system the entrepreneur must take some blows when the going gets tough. Then, perhaps, there will be more sympathy when staff does need to be laid off next.
dhiraj.nayyar@expressindia.com