Capturing traffic from the small towns of India to fuel growth in topline and bottomline has always been a holy grail for domestic airlines, but the potential of the market still remains largely untapped. Some airlines such as Air Deccan and Paramount Airways tried to focus entirely on such markets, but failed spectacularly, while existing airlines expanded in a more measured manner, mostly just adhering to the existing route dispersal guidelines. But as the government gives another push to improving regional air connectivity by giving sops to airlines for flying to smaller towns, plus the imminent entry of Malaysian budget carrier AirAsia, the potential of India?s tier II and III towns is once again the buzz word in the aviation industry.

On his recent whirlwind visit to India, flamboyant AirAsia chief Tony Fernandes reiterated that AirAsia India will focus on regional routes, primarily in south India, while giving the lucrative aviation markets of Mumbai and Delhi a miss because of the high operational costs in these two cities.

?Our goal is not to steal market share from others here in India,? said Fernandes during his press conference in Delhi earlier this month. ?We are here to create a new market for aviation, and hopefully our slogan, ?Now Everyone Can Fly?, can come true in India.?

Sceptics have raised doubts whether Fernandes? ambitious plans would be successful in India. The doubts aren?t totally unjustified. In the past, Captain Gopinath tried the low-cost model with Air Deccan connecting small towns where no other airline flew. But while Gopinath?s venture gained market share, it remained an unsustainable model and ultimately went down along with its buyer, Kingfisher Airlines.

M Thiagarajan?s Paramount Airways also tried to capture the market in tier II and III towns, but it used the full-service fare model by offering business-class services for travellers in south India?s regional routes. It also could not sustain operations.

Despite being repeatedly asked for some insight into AirAsia India?s business plans during his recent trip, Fernandes kept his cards close to his chest. The only hint dropped was that the airline would need roughly 50-60% seat occupancy to break even.

The figure seems unrealistic at first, since existing domestic airlines have their break-even seat factors at above 75%. But the efforts of the civil aviation ministry to promote regional air connectivity may help airlines break even with lower seat occupancy rates on flights between smaller towns.

Stimulating regional air connectivity has also been taken up as one of the priority areas by the government. Recently, Prime Minister Manmohan Singh set up an investment target of R1.15 lakh crore in the next six months, which includes setting up of 50 new low-cost airports in small towns.

The civil aviation ministry is doing its bit by working towards removing landing and parking charges for all aircraft at tier II and III airports. Such charges are the fourth-largest cost component for airlines, amounting for nearly 10% of an airline?s costs.

The ministry has also ensured that all aircraft with seating up to 70 passengers will be provided aviation turbine fuel (ATF) at a uniform sales tax of 4% across the country. The next big change could be amendments to the archaic route dispersal guidelines, which have been in place since 1994.

Deloitte Touche Tohmatsu had been appointed earlier this year to undertake a study and recommend measures to boost regional air connectivity. The consultancy firm submitted its report in May. One of its two key recommendations are the implementation of a seat credit mechanism, which would allow larger airlines to buy seat credits from smaller air-taxi operators flying to smaller cities, and meet the requirement of flying to remote areas without risking losing money on such operations.

The other measure suggested by Deloitte is to abolish the route dispersal guidelines and use a direct subsidy method to be funded by a regional air connectivity fund that would receive both budgetary support and money collected via a cess on domestic air passengers.

?There is a requirement of establishing a regional air connectivity fund for provision of support to improve air connectivity to under-served and unserved markets,? Deloitte said in its recommendations to the civil aviation ministry. ?While a cess on domestic passengers has been proposed as a means of finance for this fund, if a certain part of the fund is contributed by the central government through budgetary support on an annual basis, it would be helpful in reducing the burden on existing passengers.?

The efforts of the civil aviation ministry have already sparked off expansion of existing domestic airlines in smaller towns. Earlier this week, Jet Airways expanded connectivity in south Indian cities of Vijaywada, Trichy and Mangalore.

?As disposable incomes increase in India and the propensity for air travel increases as a direct corollary, we are seeing strong demand emanate from tier II and III cities across India,? said Sudheer Raghavan, chief commercial officer, Jet Airways, after the launch of the new flights. ?Jet Airways is thus only too happy to introduce new services to those cities across India and enhance connectivity.?

India?s largest passenger carrier IndiGo, too, has been steadily increasing connectivity of non-metros with metro cities. ?With increased flow of tourist and business traffic to and from these cities, along with the growing demand for connectivity with metros and tier II cities, we are pleased to provide direct daily connections and additional frequencies to meet the requirement of our flyers,? said IndiGo president Aditya Ghosh, after the airline enhanced connectivity of Jammu and Srinagar with New Delhi.

IndiGo has over 200 Airbus A320s, which it will receive till 2025. The large order book and the civil aviation ministry?s move to remove landing and parking charges for all aircraft in smaller towns opens up the possibility for the airline to aggressively expand on tier II and III routes. Along with cheaper rates at the airport, IndiGo?s one type of aircraft fleet gives it an added advantage as it makes sure its maintenance costs don?t escalate. Maintenance costs are nearly 15% of an airline?s operating costs.

IndiGo?s rival SpiceJet has already reaped the benefits of the civil aviation ministry?s moves to enhance regional connectivity by providing sops for airlines in the form of reduced taxes. Media baron Kalanithi Maran-owned SpiceJet began adding the Bombardier Q400 planes since 2011. The turbo propeller planes give SpiceJet the advantage of refuelling these planes with a 4% tax on ATF.

Getting a discount on sales tax for ATF is a big fiscal incentive for airlines as sales tax normally varies anywhere from 4% to 30% across the country. Being a state subject there is little that the central government has been able to do to bring down sales taxes on ATF. However, just like smaller aircraft are allowed to get ATF with a 4% tax, some states like Maharashtra have tried to use cheaper sales tax as an incentive for attracting airlines.

?Regional connectivity has been a focus area for us,? said Neil Mills, chief executive officer of SpiceJet, at a recent industry event. ?We do 110 flights a day now on our Bombardier Q400 fleet (the airlines? fleet for non-metro operations) and we have seen that growth is a lot more in the tier II?III cities.?

SpiceJet would also be AirAsia?s biggest rival when the Malaysian carrier finally starts operations. Already, SpiceJet has managed to develop Hyderabad, Chennai and Bangalore as effective operational hubs to connect tier II

towns in south India with the metros and use the three hubs to connect to other tier II and III towns in east and north India.

While the changes that have been initiated at both the policy level and on part of the airlines, regional air connectivity still remains woefully underserved. The efforts from

the likes of IndiGo, Jet Airways and SpiceJet to connect tier II and III towns are barely scratching the surface for achieving a wide domestic network.

The Deloitte report mentioned earlier in the story had indicated 86 cities as having the economic and tourism activity that demands air connectivity. Out of these 86, barely more than a tenth of cities have air connectivity.

The state of connectivity is so weak that for years airlines have scrambled for lucrative metro routes, while using flights to regional routes just to adhere to the route dispersal guidelines.

In the past, domestic airlines have been most attracted to the Delhi-Mumbai route. In the past three years, the Delhi-Mumbai sector has seen airlines deploy more than 50% of the overall seat capacity in the country. The sector was also in the top 10 of the world?s most busiest routes in 2011 in terms of passengers carried, as per a survey conducted by Amadeus.

The Deloitte study also stated that 93% of total seat deployment during winter 2012-13 was between metro cities to smaller towns while for routes connecting tier II and III cities it was only 7%.

But with all signals pointing towards air connectivity between tier II and III cities being improved, airlines could thrive from an untapped market. If the aviation ministry is successful in bringing down the high operational costs in these small towns, soon everyone will be able to fly, especially if airfares manage to compete with rail fares.