The airline challenge: Can’t discount fear as the pandemic continues

October 17, 2020 5:45 AM

While multiple reports hold India’s large domestic market will help insulate airlines from collapse, what they overlook is that the growth driver—that is the practice of discounting—is just not working

To understand the gravity of the situation, it is important to highlight how airlines book revenue.To understand the gravity of the situation, it is important to highlight how airlines book revenue.

By Satyendra Pandey

The exorbitant price of jet-fuel, the extreme price-sensitive behaviour of the market, currency risk, cashflow risk, the taxation policy and the lack of a united front—for India’s airlines the ride has been anything but smooth. Still, until the beginning of this year, India’s aviation sector was on a rapid ascent. Passenger volume growth of 3.2x for domestic traffic and 2.1x for international traffic over the last decade and forecast growth of double digits through 2028 was the pre-Corona aviation narrative. Day trips between metro’s were the norm, it was cheaper to fly to some international destinations compared to some domestic ones, and an increasing number of travellers were taking to the skies. Yet, what was widely accepted but glossed over was that growth could be attributed to a single factor. Namely: discounting.

On a compounded annual basis, India’s airfares have declined by 2% every year since 2010. During this time, the troika of fuel, financing and foreign exchange rates continued to show an opposite trend, while structural challenges, such as the price of jet fuel, taxation and cost of capital, remained. As passenger numbers soared, various stakeholders rushed to lay claim to success. Yet, it is not airports that led to exponential travel growth—they only partly facilitated it; neither was it opening up of new routes—that only increased options, nor was it a sudden love for flying amongst the travelling public. India’s aviation growth was driven solely by discounting. As airfares trended lower, passenger volumes soared.

Discounting reached its zenith with “rail-air parity”–railway fares were either equal to or above airfares. This should have been a cause for alarm.

Ironically, rather than forcing a rethink on the gravity of the situation, this became a talking point. The market converged to seven airlines chasing the same passenger base with similar airfare offerings built on different cost structures. At the same time, the Indian consumer became anchored to a price point that made viability a tough sell for many airlines. Even prior to the pandemic, signs of significant strain had started to reveal. But airlines continued their discount policy, aided by non-operational income streams and a promise of perpetual growth. But then the pandemic hit. And it brought with it the sentiment of fear—a sentiment that fails to segment along the lines of age, social status or vulnerability.

As the pandemic continues, fear of exposure is prevalent. Whether consciously or subconsciously, passengers continue to be apprehensive—the spread of the virus that has been traced back to aviation. And, also because if each unplanned interaction is classified as a random risk, then the overall travel experience aggregates to a significant randomised risk. As such, it is not the fear of flying; instead, the fear of infection that is holding back travellers. And as fear continues to pervade, not only have the travel volumes diminished significantly but the booking patterns have changed. Add to this, the government-mandated price-caps which have effectively alienated the most price-sensitive travellers. Passengers are now booking travel closer to the day of departure. Indeed, it is now fairly normal for some airlines to see 10% – 12% of bookings come within the last twenty-four hours of departure. Occupancy levels are hovering around 60%–an impressive number till you realise that this propped up by capacity restrictions. Once these are removed, occupancy levels will fall, prices will fall, and the already tepid cashflow will dissipate.

To be successful, a product should be exceptionally good or exceptionally cheap. Market realities forced, and continue to force, India’s airlines to focus on the latter. Yet the debt structures, cost of capital and cost of operations do not support that strategy. For most airlines, cashflow and the ability to raise funds is significantly impaired, liabilities continue to build and recourse avenues are few and far between. While the cashflow situation has improved from earlier months, cash balances for the industry continue to be alarmingly low. Banks continue to be negative on the sector, and collateral is found wanting. A government bailout is out of the question. It is quite telling that the cash situation was so dire that airlines refused to issue cash refunds for booked tickets—a matter that finally found its way to the Supreme Court. Airlines invoked a force majeure clause and cognizant of the tenuous nature of the industry the court issued an elaborate judgment and the ruling indicated that, “Strict enforcement of Civil Aviation Requirements at this moment may not yield any meaningful result for any stake holder.”

To understand the gravity of the situation, it is important to highlight how airlines book revenue. Airlines collect money for tickets upfront and service is rendered at a later date. That is, an airline sells tickets in advance and collects cash. The actual flight may be several days or weeks later and only then will the airline realise a profit or a loss. Effectively one sells for cashflow and then flies for profit or loss. Thus, offering discounts for tickets booked at a later date enables the airline not only to generate cash but also to secure a minimum amount of bookings after which prices can be adjusted—ideally upwards. Overall, this has been the revenue management strategy for the industry as a whole. But they never accounted for fear. Airlines are now staring at scenarios where the demand simply isn’t showing up—discounting doesn’t work. And, for a price-sensitive market like India that does not bode well.

As the pandemic continues, airlines are affected the world over. Challenges on both liquidity and solvency are the norm. India’s airlines are no exceptions. While multiple reports cite that India’s large domestic market will help insulate airlines from collapse, what they overlook is that the growth driver—that is the practice of discounting—is just not working. Because you simply can’t discount fear.

The author is Former head of Strategy, GoAir. The author was also with CAPA (Centre for Aviation) where he led the advisory and research teams

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