Fill it, shut it and forget it, read an advertisement in 1980s by India?s largest two-wheeler maker Hero Honda ? now Hero MotoCorp ? to entice its buyers. The slogan worked well and the company sold more bikes year after year. Many Indian passenger carriers seem to have caught up with the slogan, but at the cost of yields as they sell tickets below their costs to fill up seats. ?In aviation sector, the focus is often on filling up the plane seats even if yields are compromised. However, it is a completely unsustainable situation that has led to many airlines in the US going bankrupt,? says Professor Severin Borenstein, who teaches business administration and public policy at Haas School of Business, University of California, Berkeley.
Cash-starved Kingfisher Airlines, which is seeking a lifeline from its lenders to stay afloat, lost money on every seat it sold in the third quarter ended December.
The airline?s revenue available seat kilometre (RASKM), a revenue indicator of every seat sold, was R4.02, roughly 10% below cost per available seat kilometre, the cost incurred to offer that seat, at R4.42. Liquor baron Vijay Mallya-owned airline, with piled up losses of more than R6,000 crore, is yet to make a net profit since its inception in 2005.
Jet Airways, India?s largest passenger carrier by revenue and share, managed to sell tickets 11% more than its costs, roughly 35% lower than what it offered in the same quarter previous year, indicating the rush to fill up seats at the cost of yields.
?I find it odd that there is such a pricing pressure in India despite the pace of growth in the market,? says Borenstein. ?In the US, demand was weak which led to an environment of lower fares.? The aviation market in India has grown at an average of over 20% in last decade. In 2011, the market grew at 18%.
The fight for share started in 2005 with Air Deccan, a low-cost passenger carrier took the skies offering tickets as low R1. As more new passengers chose air travel, fare war intensified, shrinking full service carriers margin. A Mumbai to Delhi return ticket, sold for R15,000 in 2000, can now bought for less than R5,000 even as fuel price, which is 40% of the costs of running an airline, spiked to R65,000 a kilo litre from R14,500.
?What has made the situation worse for the Indian carriers has been the market environment that the players have regrettably created over the last few years,? Saroj Datta, former executive director, Jet Airways told FE in an earlier interaction. ?Following the emergence of the low-fare carriers since 2005, encouraged by the buoyancy in the Indian market, all the carriers have been pursuing a policy of chasing market shares without paying adequate attention to the impact on the bottom line.?
Until December 2011, four low-cost carriers commanded 50.8% share of the Indian skies. The fare wars are unsustainable for Indian carriers where roughly 60% of their fixed cost for fuel and airport charges are beyond their control.
?Fare wars aren?t sustainable in long-term unless the instability causes a competitor to exit or significantly scale back capacity,? says Vikram Krishnan, partner, aviation at the Dubai office of the global management consultancy firm Oliver Wyman.
?For any industry, market price of a product has to be more than cost of production, the aviation industry often gets it wrong and lands up in losses,? says Borenstein of Haas Business School.
Plane makers say fare prices are inevitable to stem losses. ?Indian carriers need to raise fares by at least 15% to overcome losses,? Dinesh Keskar, senior vice-president-sales of Asia Pacific and India for Boeing said in February. A full-service and low-cost carriers cannot compete on same routes for market share. In the west, low-cost carriers connect smaller cities while full service ones fly passengers long destinations.
?By definition, cost of operations for low-cost carriers is much lower, as is reflected in the nomenclature,? says Borenstein. ?Legacy carriers have their own historical costs like customer loyalty programmes, service costs and corporate discount programmes. Their cost of operations is, therefore, always going to be higher than low-cost carriers, thus, a fare war between the two will only result in losses for legacy carriers.?
A fight between the two carriers benefit passengers to travel for less. ?In the Indian market, passengers have always chosen price over product quality,? says Krishnan of Oliver Wyman. ?The definition of ?product quality? in short-haul markets like India is typically ?fly me safely, on-time, and don?t lose my bags.? The champagne and lie-flat beds are fine for longer-haul flights,? he added.
Price war is now turning to a blame game between carriers.
Air India?s pricing tactics has also been blamed for fares being kept low. ?Air India is discounting fares and that?s absolutely a problem,? said M Shiv Kumar, senior vice president ? finance, Jet Airways on November 17, 2011 after the company announced the fiscal second quarter results. ?Ideally, fares should go up when oil-import costs go up. That?s not happening and that?s why airlines are in this situation.?
The loss making national carrier sells tickets roughly 15% below its costs to gain share after its pilots went to strike on May 2011. Air India reported a loss of Rs 6,994 crore in fiscal 2010-11. Price wars, rising fuel and airport charges, higher interest rates, less avenues to raise capital in a volatile stock market and a slowing economy makes revenue management tricky. ?Airline revenue management is very tricky,? said Professor Peter S Morrell, director of research at Cranfield University, UK and author of the book Airline Finance. ?Performance is judged not just on yields but also on seat occupancy.?
But, a nascent market like India will differentiate a full service passenger carrier from a low cost one as more airports are build and more passengers fly.
?My reading of the aviation industry in India is that the industry is at a nascent stage when you look at low-cost carriers,? says Morrell of Cranfield University. ?In a few years as the market matures, you will see airlines differentiating and the fare wars ending, this is assuming the airline managements mature in a way similar to airlines in the West.? ?The largest carriers in the world are not often the most profitable,? says Morrell. ?Alaska Air is a prime example of an airline focusing on profitability rather than passengers carried. ?Such maturity will take time to come into India, but airline managements will eventually find the right business model.?