TABLE OF CONTENTS

EXECUTIVE SUMMARY

This report is attempt to understand how does the airline industry function and take a
look at the emerging trends ,especially the growing significance of low cost carriers and
how this trend affect the industry dynamics and the India’s traveling pattern.
Air industry remains a large and growing industry. Good air connectivity facilitates
economic growth, world trade, international investment and tourism and is therefore
central to globalization.
Airlines also earn revenue from transporting cargo, selling frequent flier miles to other
companies and ‘up-selling’ in-flight services. But by far, the largest proportion of
revenue is derived from regular and business passengers. For this reason, its important
that we take consumer and business confidence into account on top of regular factors that
one should consider like earning growth ,debt load etc.
A final key area to keep a close eye on is costs. As we all know the airline business is
extremely sensitive to costs such as fuel, labour, and borrowing costs. Some of the major
players in the airline attribute 30-40% of their costs to jet fuel. It is also important to look
at the geographic areas that an airline targets.
If the airline industry could be described in three words, they could be “intensely
competitive market”. In the recent years there has been an industry-wide shakedown that
will have far reaching effects on the industry’s trend towards expanding domestic and
international services. Originally, the airline industry was either partly or wholly
government owned. This is still true in many countries, but now in India, private players
are gaining importance due to their excellent and value added services. The general
pattern of ownership has gone from government owned or supported to independent, for
profit public companies.
As in many mature industries, consolidation is a trend, as airlines form new business
combinations, ranging from loose, limited bilateral partnerships to long-term, multi
faceted alliances to mergers and takeovers. Since government often restricts the
ownership and merger between the companies in different countries, we see most
consolidation taking place within a country. The report highlights the various aspects of
the domestic aviation industry, role of government and throws some light on the future of
the low cost carriers.

EVOLUTION OF LOW COST AIRLINES GLOBALLY

A low-cost carrier or low-cost airline (also known as a no-frills or discount carrier /

airline) is an airline that offers generally low fares in exchange for eliminating many
traditional passenger services. The concept originated in the United States before
spreading to Europe in the early 1990s and subsequently to much of the rest of the world.
The term originated within the airline industry referring to airlines with a low - or lower -
operating cost structure than their competitors. Through popular media the term has since
come to define any carrier with low ticket prices and limited services regardless of their
operating costs.
The American airline 'Southwest Airlines' is seen by most as the first low-cost carrier and
stood example for the current low-cost model. Southwest originated in the USA after
deregulation of the airline industry. It began its service in 1971 and has been profitable
every year since 1973. With the advent of aviation deregulation the model spread to
Europe as well, the most notable successes being Ireland's Ryan air, which began low-
fares operations in 1991, and easy Jet, formed in 1995. Low cost carriers developed in
Asia and Oceania from 2000 led by operators such as Malaysia's Air Asia, and Australia's
Virgin Blue. The low-cost carrier model is applicable worldwide, although deregulated
markets are most suited for its rapid spread.
At the core of the low-cost model are the cost-reductions, which partly end up in cheaper
tickets for passengers. To obtain these cost-reductions, Southwest operates according to
two important principles which separate the low-cost model with other operating models.
First, instead of flying according to a hub-and-spoke system, Southwest focuses on short
distance point-to-point flights. Second, they only fly with one class, which a reduced
service.

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By operating according to these two points, different cost-reductions can be made.
Characteristic for Southwest are the different parts on which they save money. The figure
below compares Southwest airlines with US Airways and gives an overview of the
different costs of an average flight. Apparently there are large differences in respectively
the salary, the operating costs of a carrier, and the remaining costs. Reductions on the
salary costs consist next to a lower wage, also of a more productive staff. Southwest also
has relatively a higher flight frequency compared to others airlines like for example US
Airways. That way, airplanes are more productive. They also have a higher productivity
because they operate with only one fleet consisting of the same equipment, and have
shorter turn-around times. Cost reductions related to the maintenance and managing costs
of the fleet are obtained by operating with smaller aircrafts. Overall low-cost carriers also
operate with newer aircraft types, which are more economical and require less
maintenance. They offer only one service class with no seat reservation. On flights there
are no meals offered. By choosing smaller regional airports turnaround times are shorter,
and costs are saved because the landing and gate costs are lower. In conclusion,
Southwest Airlines is a success because of the predictability, and the straightforwardness
of the operating model. Their success became clear at the end of 2002 when airlines in
the USA had the last couple of years considerable loses, whereas Southwest still gained
profit.

The first low-cost carriers in Europe started in the ‘90s, when the deregulation of the
airspace continued throughout the European Union. The British Ryan air and Easy Jet
continued building on the Southwest low-cost model. They copied their efficient
operating model, only instead of offering reduced services; they offered no service at all.
During a flight one needs to pay for food and beverages, there is no money back
guarantee, no reservation option et cetera. In short: no service. They also started to sell
tickets directly over internet. In 2001 both Ryan air and Easy Jet sold over 80% of their
tickets through the internet, the other part was sold mainly through call-centers. The
figure below gives an overview of the amount of cost reductions on different parts in the
operating process on a flight between London and Nice. Total costs of the flight are
£5.591, profits from ticket sales are £6.136. Remarkable are credit cards as a separate

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expense. This is because most tickets sold over the internet are paid by credit card. Low-
cost carriers expanded aggressively and profited from first-mover benefits when
negotiating with different airports. In the beginning they also avoided competition with
other carriers resulting in almost no overlap of their flight networks.
Spatially low-cost carriers developed in Europe as is represented in figure 3. Low-cost
carriers first arise in England and Ireland in 1995, and started expanding to the rest of
Western Europe. From 1997 the European low-cost network developed itself more to the
tourist areas in the South. As of 2002 the network expanded to Eastern Europe and
Scandinavia.
After deregulation of the airport industry the full-service model was the dominant
strategy of most established carriers. Full-service carriers in comparison with low-cost
carrier offer three important benefits to their passengers. The first benefit is the extended
service network which is available on many different places and is easy approachable by
their costumers. Secondly they offer high quality services related to luggage processing
and their seating system. There is a low risk in baggage loss and different flights are
better connected to each other, reducing waiting times. Finally the frequent flyer
programme is improved. Another unmentioned important characteristic can be added.
Full-service carriers operate according to a hub-and-spoke system, offering a large
amount of destinations to their customers.
The first and the most successful low cost airline in US is the southwest airlines and the
most successful airline in Europe is Ryan air. It is important to look in detail of the origin
and the background of these airlines.

Southwest Airlines, Inc

South west airlines are a low fare airline based in Dallas, Texas. It is the largest airline in
the United States by number of passengers carried domestically for any one year and the
third largest airline in the world by number of passengers carried. Southwest Airlines
carried more customers than any other U.S. airline in August 2006, marking it the first
time that Southwest Airlines has topped the monthly list for combined domestic and
international passengers, according to the U.S. Department of Transportation’s Bureau of

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Transportation Statistics.Southwest Airlines is one of the world's most profitable airlines
and in January 2007, posted a profit for the 34th consecutive year. Its reputation for low
prices and a laid-back atmosphere have made it an icon of pop culture.
Southwest Airlines was originally incorporated to serve three cities in Texas as Air
Southwest on March 15, 1967, by Rollin King and Herb Kelleher. According to
frequently cited legend, Mr. King described the concept to Mr. Kelleher over dinner by
drawing on a paper napkin a triangle symbolizing the routes.
Some of the incumbent airlines of the time (Braniff, Trans-Texas, and Continental
Airlines) initiated legal action, and thus began a 3 year legal battle to keep Air Southwest
on the ground. Air Southwest eventually prevailed in the Texas Supreme Court, which
ultimately upheld Air Southwest's right to fly in Texas.The decision became final on
December 7, 1970, when the United States Supreme Court declined to review the case
without comment.That date is considered by many to be the de facto beginning of
deregulation in the airline industry.
In early 1971, Air Southwest changed its name to Southwest Airlines, and the first flight
was on June 18, 1971. short hops with no-frills service and a simple fare structure,
features that became the basis for Southwest's popularity and rapid growth in the coming
years.
Southwest turned its first annual profit in 1973, and has done so every year since — a
record unmatched in commercial airline industry history. Southwest has used financial
techniques to bolster its profitability and counteract many of the fiscal disadvantages of
operating an airline.

Ryanair:

Ryanair is an Irish airline headquartered in Dublin. Ryanair was founded in 1985 by

Christy Ryan (after whom the company is named), Liam Lonergan (owner of an Irish
tour operator named Club Travel), and noted Irish businessman Tony Ryan, founder of
Guinness Peat Aviation.
Its biggest operational base, however, is at London Stansted Airport. It is Europe's largest
low-cost carrier and one of the world's largest and most successful airlines (whether in

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terms of profits, number of flights, number of passengers flown). Ryanair operates - at
one count - on 362 routes to 22 countries. Ryanair has been characterised by rapid
expansion, a result of the deregulation of the air industry in Europe in 1997. Over the
years, it has evolved into one of the world's most profitable airlines, running at
remarkable margins by passing its costs directly to its customers.
Ryanair is also one of Europe's most controversial companies, praised and criticised in
equal measure. Its supporters praise its commitment to low fares, radical management,
and its willingness to challenge what it calls the 'establishment' within the airline industry
(similar to its American counterpart, Southwest Airlines). Critics, meanwhile, have
attacked its trade union policies, hidden "taxes" and fees, and limited customer services,
and charged that it practises deceptive advertising.
Ryanair has grown massively since its establishment in 1985, from a small airline flying
a short hop from Waterford to London, into one of Europe's largest carriers. After taking
the rapidly growing airline public in 1997 the money raised was used to expand the
airline into a pan-European carrier. In an industry where the survival rate is 1 in 10 and
where even the giants such as American Airlines and Delta struggle to keep in the black,
Ryanair's success has confounded many industry analysts
Low-cost carriers pose a serious threat to traditional "full service" airlines, since the high
cost structure of full-service carriers prevents them from competing effectively on price -
the most important factor among most consumers when selecting a carrier. From 2001 to
2003, when the aviation industry was rocked by terrorism, war and SARS, the large
majority of traditional airlines suffered heavy losses while low-cost carriers generally
stayed profitable.
Many carriers opted to launch their own no-frills airlines, such as KLM's Buzz, British
Airways' Go, Air India's Air India-Express and United's Ted, but have found it difficult to
avoid cannibalizing their core business. Exceptions to this have been bmi's bmibaby,
Germanwings which is controlled 49% by Lufthansa and Qantas's Jetstar all of which
successfully operate alongside their full-service counterparts.
For holiday destinations, low cost airlines also compete with seat-only charter sales.
However, the inflexibility of charters (particularly as regards length of stay) makes them
unpopular with many travelers.

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The entry of new nations into the European Union from Eastern Europe and moves
towards compliance with EU legislation by those who have not yet joined, has led to an
extension of open skies arrangements.
India's first low-cost airline, Air Deccan started service on August 25, 2003. The airline's
fares for the Delhi-Bangalore route were 30% less than those offered by its rivals such as
Indian Airlines, Air Sahara and Jet Airways on the same route. The success of Air
Deccan has spurred the entry of more than a dozen low-cost airlines in India. Air Deccan
now faces stiff competition from other low-cost Indian carriers such as SpiceJet, GoAir
and Paramount Airways. IndiGo Airlines recently placed an order for 100 Airbus A320s
worth 6 billion USD during the Paris Air Show, the highest by any Asian domestic
carrier. After a year of operation, in 2006, Kingfisher Airlines changed its business model
from low-cost to value airlines.

AVIATION IN INDIA

For many years in India air travel was perceived to be an elitist activity. This view arose
from the “maharajah” syndrome where, due to the prohibitive cost of air travel, the only
people who could afford it were the rich and powerful. In recent years, however this
image of civil aviation has undergone a change and aviation is now viewed in a different
light- as an essential link not only for international travel and trade but also for providing
connectivity to different parts of the country. Until less than a decade ago, all aspects of
aviation were firmly controlled by the government. In the early fifties, all airlines
operating in the country were merged into either Indian Airlines or Air India and, by the
virtue of the Air Corporations Act, 1953; this monopoly was perpetuated for the next
forty years. The directorate general of civil aviation controlled every aspect of flying
licenses, pilots and issuing all rules and procedures governing Indian airports and
airspace. Finally the Airports Authority of India was entrusted with the responsibility of
managing all national and international airports and administering every aspect of air
transport operation through the air traffic control.

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Open skies
A recurring demand often voiced by interested parties is that, in order to promote travel
and tourism, India should adopt an open skies policy. It is argued that the current policy
restricts the access of foreign airlines. As a result potential tourists are not offered a
choice of airlines or seats when traveling to India.
This problem is exacerbated during holiday season when it is difficult, if not impossible,
to get a seat either into the country or out of it. It is argued that, therefore that India
should adopt an Open Skies approach to any foreign carrier wanting to fly into India,
which literally means allowing them unlimited service, capacity and points of call.
The government owned airlines had their monopoly for almost four decades and on
march 1,1994, the government threw open the gates for private entrants satisfying the
requirements of the scheduled services. Sensing a huge lucrative opportunity in this
sector a large number of players jumped into the fray. The prominent among them were
Jet Airways, Sahara, East West, NEPC, Modiluft, and Damania.

Winds of change
The new trend of low-cost aviation has been picking up immensely in the recent past.
This new emerging trend has put the existing traditional airline agencies, both
government owned and private, all over the globe to rethink their strategies and
restructure their airfares.
A low cost carrier (also known as a no-frills or discount carrier) is an airline that offers
low fares but eliminates all unnecessary services. Low cost carriers (LCCs) pose a serious
threat to traditional ‘full service’ airlines, since full service carriers cannot compete on
the price and, when given a choice, most consumers will opt for low price over other
amenities

EMERGENCE OF LOW-COST AIRLINES IN INDIA

For the first 15 years of deregulation the demand for scheduled passenger air
transportation was driven by the constraints and confines of its providers - principally, the
network carriers. Network carriers were able to avoid cost-side pressures by focusing on

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revenue side strategies – largely centered on the high - yield business traveler. The focus
led to innovations like sophisticated global distribution system, revenue management, and
frequent flyer programs that helped the airlines segment demand. You are – or we were –
the linchpin in that strategy, as business and other time–sensitive travelers accounted for
only 20% of the airline traffic, but for 80% of network airline. This strategy worked
because the business traveler grew accustomed to paying high fares and often did not
have an attractive alternative to the high fare, and also because the airlines enjoyed a
greater ability to control the number of seats available to discretionary travelers. In short,
in the post-regulation world travelers – particularly business traveler – did have the
greater option than before, but, even with the impact of the occasional low-fare carrier,
they were often at the mercy of major carriers when it came to price. In effect, demand
for passenger service was driven, even controlled, by the supply that network carriers
were willing to deploy in the market.
The above reasons and the price transparency that the internet has created for all types of
passengers have led to the emergence of a new breed of low-cost carriers. These
developments have seriously compromised the ability of legacy carriers to charge higher
prices to travelers on the routes where they overlap with the low-cost carriers. At the end
of 2000 the demand for the business class and other high-end products fell dramatically,
as the corporate travel managers became more cost-conscious.
Customers continue to fall into segments with regard to demand for products on offer.
Not every airline will be able to satisfy every customer but the entrance of low cost
airlines has pushed customer segmentation. There is a sharper focus for the shorter routes
and the target is the price conscious and quality conscious customer. This has led to
stiffer competition for the non–business passenger and price conscious business
passenger.

Target market
The entry of these low cost carriers has several far reaching implications on the aviation
sector in India. Now low cost airlines have proliferated and offer real, lasting competition
to their network rivals. This generation of low cost carriers has newer fleets, a better on-
time performance and completion factors than the first wave of post-deregulation start-

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ups. The fare transparency delivered by the internet and the expansion of low cost
carriers has increased the price-sensitivity even of business passenger. The demand for
more affordable air travel is quite robust. Increasing numbers of business travelers use
low fare airlines as a matter of corporate travel policy whichever country they have been
launched in. It has to a very large extent influenced the mass transportation and domestic
tourism .E.g. in a country of a billion people, the Indian aviation industry is puny. In the
US around 12 million people who fly everyday, even though the population is one fourth
that of India. The number of daily flight averages around 400 a day, as against 40,000
flights a day in the US. Ryan Air amongst the low cost pioneer in Europe flies 25 million
people in a year and still has less than 5% market share. In Malaysia, there are 12 million
people who travel air yearly, thus here is a nice big fat juicy market of around 200 million
people which is equal to that of entire Europe. Now if the LCA’s are able to tap even
one-fourth of that large middle class and would persuade them to travel by air, there
could be a rise by 5% to 6% in their capacity.
Comparing the Indian scenario with that of China we see that china leads India by huge
margins in terms of the number of air passengers. This can be seen from the table shown
below:
Initially, low cost carriers (LCCs) were geared more towards holiday trips than toward
business holidays, due to the location of the airports, among other reasons. Based on
research conducted by TQ3, business travelers are clearly starting to use the LCCs more
often as time goes by. There are a variety of reasons for the shift. Quite often, passengers
will book a private holiday with an LCC to acquire experience. If satisfied, they may
decide to book LCC for their next trip. Other important reasons include the lower prices
and improved schedules (several flights per day). In addition, it is also attracting to its
fold many of the rail travelers who save hugely on time and don’t mind paying premium
for the time thus saved.
Potential of air travel in India
A total of 390 to 400 commercial flights operate in a day in India. The US, which has one
fourth of India’s population, has 40,000 flights a day.
Thus if US were to have India’s population nearly 1, 60,000 flights would be needed. If
the airline in India were to tap just 1% of its potential, we would still need 1,600 flights a

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day and that would mean a jump in the number of commercial flights by four times. Also
in India, about 12 million people fly every year. Malaysia also boasts of a similar figure,
but on a population of 24 million. If a low cost airline can offer fares at the half the price
of regular airlines, at least one-fourth of India’s middle class population of 200 million
will travel.

AIRLINE OPERATORS IN INDIA (DOMESTIC)

Existing full service carriers:

Existing LCCs:

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New entrants:
Every other month a new cost airline or value carrier is taking to the skies. A detail of the
carriers lined up to reach out to Indian skies is given here below:
 Indus airways: value carrier, had announced plans to launch in may 2005 but
is yet to import its first aircraft.
 Airone : regional airline, had announced plans to launch regional services in
2005
 Magicair :no frills airline, announced plans to launch in 2005 but is yet to get
a no objection certificate (NoC)
 Eastwest Airlines : value carrier , had plans to launch in the year 2005
 Interglobe: low-cost , has a NoC to start the operations but is yet to announce
any plans of launch
 Crystal air: regional ,the Coimbatore based airline has plans to launch regional
services with Embraer 170/175 series
 Visa air: low cost ,has NoC but in the process of raising funds

MEANING: LOW-COST AIRLINES

A low-cost carrier or low-cost airline (also known as a no-frills or discount carrier /

airline) is an airline that offers generally low fares in exchange for eliminating many
traditional passenger services. The concept originated in the United States before
spreading to Europe in the early 1990s and subsequently to much of the rest of the world.
The term originated within the airline industry referring to airlines with a low - or lower -

12
operating cost structure than their competitors. Through popular media the term has since
come to define any carrier with low ticket prices and limited services regardless of their
operating costs

Typical low-cost carrier business model practices include:

1. A single passenger class
2. A single type of airplane (commonly the Airbus A320 or Boeing 737), reducing
training and servicing costs).
3. A simple fare scheme (typically fares increase as the plane fills up, which rewards
early reservations)
4. Unreserved seating (encouraging passengers to board early and quickly)
5. Flying to cheaper, less congested secondary airports and flying early in the
morning or late in the evening to avoid air traffic delays and take advantage of
lower landing fees
6. Short flights and fast turnaround times (allowing maximum utilization of aircraft)
7. Simplified routes, emphasizing point-to-point transit instead of transfers at hubs
(again enhancing aircraft utilization and eliminating disruption due to delayed
passengers or luggage missing connecting flights)
8. Emphasis on direct sales of tickets, especially over the Internet (avoiding fees and
commissions paid to travel agents and Computer Reservations Systems)
9. Encouraged use and issuance of the electronic ticket
10. Employees working in multiple roles, for instance flight attendants also cleaning
the aircraft or working as gate agents (limiting personnel costs)
11. "Free" in-flight catering and other "complimentary" services are eliminated, and
replaced by optional paid-for in-flight food and drink (which represent an
additional profit source for the airline).
12. Aggressive fuel hedging programs.
13. "Unbundling" of ancillary charges (showing airport fees, taxes as separate charges
rather than as part of the advertised fare) to make the "headline fare" appear
lower.

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BUSINESS MODEL: LOW COST AIRLINES

The “low cost carriers” business design can be defined by three elements:

SIMPLE LOW
PRODUCT OPERATING
(NO FRILLS) COST

LCC

POSTIONING

Key elements of an LCC

Simple product
 No meals ,drinks and snacks for free
 Narrow seating (greater capacity)
 No seat reservation (free seating)

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  No frequent flier programs
Positioning
 Non business class passengers , leisure traffic, price conscious
 Short haul point-to-point traffic with high frequencies
 Aggressive marketing
 Secondary airports
 Competition with all transportation carriers

Operating costs
 Low wages, low airport fees
 Low cost of maintenance , cockpit training and standby crews due to
homogeneous fleet
 High resource productivity ;short ground waits due to simple boarding processes,
no air freight , no hub services, short cleaning time
 Lean sales; high percentage of online sales
 They generally operate with only one kind of aircraft in their fleet, such as Airbus
320s or Boeing 737s, to lower maintenance costs.
 There is no business class just economy class; this increases the number of seats
per flight.

MARKET SCENARIO

Today’s airline industry is undergoing more transformation than ever before. The
combination of ongoing global economic events, “wired” passengers and growth of low
cost carriers makes this market more competitive on price, cost and yield.
While the new entrants have usurped market share from incumbents, low-cost airlines,
which were not around some time back, look set to dominate the sky for some time to
come.

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Understandably, the share of incumbent carriers (Indian Airlines, Jet Airways) has been
dwindling, even as full service carriers (FSCs), which had for long dominated the sky, are
trying hard to preserve their market.
Except for Kingfisher Airlines (a new player), which has increased its market share to
10.5% in January this year from 7.6% last January, all other FSCs have lost market share,
even as the overall share of FSCs has shriveled to 62% from 79% last January.
The share of low-cost carriers (LCCs), on the other hand, has swelled to 38% from 21%.
Likewise, challenger carriers (Air Deccan, Kingfisher Airlines, SpiceJet, GoAir,
Paramount and IndiGo) have hammered down the share of incumbents to 50% from 72%
to take their own share up from 28% to 50%.
Another incumbent facing the brunt of the new entrants is the state-owned Indian, whose
share has been eroded by 8.7 percentage points to 16.30%.
The state-owned carrier, which has been overtaken by budget carrier Air Deccan in the
race for the second position, is only slipping further. From being ahead of it by just 0.2
percentage points in November, Air Deccan has extended the lead to 4.4 percentage
points in January with a market share of 20.70%.
Another FSC struggling to keep its market from eroding is Air Sahara, whose market
share is down to 8.2% from 11.6%. All the new players have added marketshare over the
last one year — Air Deccan 7.4%, Kingfisher Airlines 2.8%, SpiceJet 2%, GoAir 5%,
Paramount 1.5% and IndiGo 4.3%.

That Indian industry suffers from the ‘herd mentality’ is quite evident by the trends in
telecommunications, information technology, BPO... the list is long. Aviation has been
no different. Everyone worth his salt has jumped into it at the same time, so there is too
much capacity. Traffic is growing but capacity is growing faster. The traffic increases are
heavily concentrated at the lower end of fare categories. So, to break even, airlines have
to achieve higher load factors than before. That means severe competition and very low
fares. The legacy carriers need to raise average fares by around Rs 400-700 per seat to
reach any kind of breakeven or turn in a small profit; the LCCs need to raise fares by
around Rs 500 per seat. Load factors for the LCCs should ideally be in the mid or high
80s and for the legacy carriers around low or mid 70s (see ‘Viable Fares and Load

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Factors’). The external environment is not helping, what with little uniformity in fuel
taxes within states and no stability in global oil prices.
But making matters a lot worse is the obsession with one or two routes. Take a look at
Delhi-Mumbai, which has close to 44 flights operating one way, making it among the top
10 busiest routes in the world. Airlines such as Jet and Kingfisher, who are more heavily
focused on metro connectivity and frequencies, are likely to see larger losses for the time
being, as most of the money is being lost on metro routes. In case of Deccan, its ATR
operations are close to break even but losses on Airbus routes are high enough to wipe
out the gains made on many of its mature ATR routes, which are often monopolized
regional routes (26 per cent of its capacity is on metro routes).
Far too much of the total capacity is deployed on just metro routes and the airlines should
break out of this. Many airlines are making a profit on their regional far-flung routes by
charging a small premium, as there isn’t much competition on those routes. Ministry
sources point out that internationally, many of the large LCCs have survived by keeping
out of each other’s way. In the UK, very few routes or even airports of Ryanair and
easyJet coincide. JetBlue and SouthWest, both in the US, rarely cross paths.

It’s happened before:

The last memory of the wave of failures following the first wave of liberalization in India
in the early 1990s is all too fresh in everyone’s minds. At that time too, there was a flood
of new operators when the Indian government allowed entry. A lot of new capacity was
created. Just a few years later, many of the newbies shut shop.
But there’s plenty of difference in the two rounds of liberalization. Then, capacity grew
but traffic growth was not as high. Moreover, all the players entered in the full service
space — there were no LCCs or, rather, low fare airlines. So, at that time fares remained
quite high and yields were much higher. But the public’s ability to afford those fares
remained quite low. This time around, fares are more affordable and with growing levels
of income in the economy, more reachable.
Secondly, this time around the environment is much freer. People then used to say that
the aviation policy is ‘open in the air, closed on the ground’. Airlines were not even free

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to advertise their schedules. Today, when Kingfisher launched, it took on competitor Jet
Airways by directly targeting the latter’s frequent fliers through its advertising campaign.
This time, the reforms are more comprehensive — touching airports, maintenance, repair
and overhaul (MROs), and general issues. This will help make the aviation business more
viable. In the 1990s, most good things were reserved for Indian and Air India, till Naresh
Goyal began to spin his magic.
But there’s more. Airlines then did not have the deep pockets, the ability to raise money
from the markets, the investors queuing up happy to lend or the professional management
that airlines today have. Even in that rather adverse environment, at least two airlines
survived — Jet Airways and Air Sahara, the former going on to become the country’s
largest domestic airline So, there is no reason why many of today’s new carriers won’t
make it.
The airline business the world over is not known for its ability to churn out huge profits.
Airlines going bankrupt are more the rule than the exception. Take the US, where more
than 350 filings for bankruptcy have been recorded since the sector was opened up in the
late 1970s. In Europe, over 60-65 carriers have shut shop in the past 4-5 years, especially
after the advent of low-cost carriers. So what is happening in India is hardly unique. All
over the world, both legacy and low-cost carriers have lost humungous amounts of
money and have closed down with unerring regularity.

Investors’ story:
Though the markets are not too gung-ho on the airlines sector, big investors seem quite
happy to jump in. Deccan’s IPO barely scraped through and Jet has been trading below
par ever since it listed big investors seem quite happy to jump in. SpiceJet recently
managed to get the Tatas to pick up a 7 per cent stake. It has a pretty impressive list of
investors it claims are in the queue. Air Deccan has raised money through private
placements (it is expecting its second tranche of investment of $36 million). GoAir is
soon hoping to do so too. “Barring IndiGo — which is in its honeymoon period of losses
— most airlines are looking at ways to raise money to tide over this phase. So, if IPOs
and foreign currency convertible bonds are looking less attractive, companies are finding
alternative funds through private placements. Airlines and investors are hanging in there

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because the end is so juicy. Everyone thinks he will be there in the end. There is a very
bright light at the end of this tunnel. Some industry analysts are convinced that Deccan’s
valuation will exceed Jet’s or Kingfisher’s in the way Ryan air and EasyJet’s did British
Airways.

RECENT DEVELOPMENTS

Air India and Indian merger:

The government has cleared the proposal that was first mooted 20 years to merge the Air
India and Indian to take on the onslaught from private airlines and large international
carriers. The merger will create a new entity which will have a fleet of about 120 aircrafts
to start with. As new planes join fleet, some existing ones will be phased out and those on
lease will be returned. The new national carrier will have more than 125 new generation
aircraft by 2010.
The new public sector entity will enter list of top 30 airlines globally (in terms of the fleet
size) and will break into the top 10 in Asia. The merged company will be the only airline
in the world with at least 7 types of aircraft, including Boeing and Airbus in its fleet.
Jet Airways which has the fleet of about 44 aircraft at present and Vijay Mallaya’s
Kingfisher has about 23 aircrafts, which will be the closest rivals to the merged new
entity of Indian and AI. Jet intends to induct 20 more aircrafts by 2009, while kingfisher
has ordered 109 planes.
Along with the size, the new entity is expected to create considerable amount synergy for
the state-owned airlines since the two can feed traffic to each other. Besides, it could
result in redeployment of aircraft since Air India and Indian are flying on the some
common routes like Singapore and Dubai.
The government is aiming to create a mega merger with the precision and reliability of
Lufthansa and the in-flight service of Singapore airlines.
The merger is expected to cost the government about Rs. 200 crore.
This Air India-Indian merger is expected to spur consolidation in the aviation market.
The government had decided to merge the two companies to take on competition more

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effectively, but the private players, who already have a bigger pie of the sky, are only
going to be spurred to consolidate to take on the merged public sector entity.
According to some analysts, low cost carriers will have a firm grip on their passengers
and will account for nearly 70% of the market in the next three years.
The merger is expected to encourage the private players, some of whom are already
allowed to fly overseas, to consolidate. Jet Airways, which earlier tried to acquire Air
Sahara, is expected to start hunting once again the arbitration proceedings are over.
Similarly, the Vijay Mallaya’s Kingfisher and Spicejet would also be on prowl.
The traffic in India is growing at nearly 40 % a year when compared to the global pace
which is 15-20%. Thus one can expect the private equity funds to help the private players
finance their expansion.
As compared to the other players in the market, the merged airline has the advantage of
economies of scale. The combined turnover of the two airlines is over Rs. 15000 crore
and it is having the countries largest fleet of aircraft. In addition to this, the merged
airline is operating to more destinations than any other airline in the Indian market.

GROUND REALITY

The Indian aviation industry’s appetite for making losses is huge. For every passenger
flying today in India, airlines are losing on an average roughly $15 (gap between revenue
and costs; some airlines are losing less than others and some routes are losing less than
others). At 32 million passengers expected to fly in 2006-07, that works out to $480
million or Rs 2,200 crore. A back-of-the-envelope calculation of each carrier’s losses
combined is around Rs 2,100 crore. Nobody in the industry expects the combined losses
to be lower than Rs 2,000 crore in 2006-07 (that, mind you, is the number with the sale
and lease back profits excluded, financial jugglery each airline has been doing to keep its
balance sheet looking, somewhat, respectable).
Normally, November is a peak month when most carriers begin to expect to fly the good
times. Contrary to yearly trends, November 2006 showed a dip in terms of load factors.

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But that may be a trifle alarmist (in fact, December numbers are better, despite the fog).
What has really happened is that huge capacity was added in November and that has
shown up in the drop in load factors. Many airline chiefs firmly believe that Sahara alone
is contributing close to half the industry’s total losses this year, with guess estimates
ranging between Rs 800 crore to a more bizarre Rs 1,200 crore. In September 2006, a
total of 100,000 seats were available per day. By December that went up to 120,000.
Since April 2005, the industry has added 120 aircraft. Airlines are buying planes like they
were peanuts and adding capacity at a frenetic pace.
Whatever we may or may not expect, industry players certainly did not expect this kind
of bloodbath. Sure, they had all expected and accounted for some losses in the initial
phases, but the preliminary estimates are far exceeding the worst doomsday predictions.
IndiGo, brave enough to launch during this grim period, claims that its initial equity
infusion of $50 million will see them through the initial 18 months or so (the time start-
up airlines typically take to break even) — but few are willing to believe it. But industry
players estimate that IndiGo’s first year’s losses alone will be no less than $50 million.
Since the company is private, there is no way of confirming this. Deccan stunned most
analysts and its investors when it announced its Rs 340-crore loss for 15 months (1 April
2005 till 30 June 2006). Industry leader Jet Airways has clocked a loss of over Rs 100
crore in the first half, in sharp contrast to the promises made at the time of its IPO.
Kingfisher Airlines chairman Vijay Mallya has, on more than one occasion, tried to urge
his rivals to bring some sanity into their pricing, emphasizing that he is not in this
business to lose money. But his pleas have so far fallen on deaf ears.

To add to the Indian industry’s woes, it is also a time when the global aviation industry
seems to be getting its act together. The International Air Transport Association (IATA)
expects far lower losses — $500 million this year than its own estimates of $1.7 billion
made in September. Without the $6-billion restructuring costs incurred by US carriers,
2006 would have been profitable. And they expect 2007 will see the first profit — close
to $2.5 billion — since 2000. Europe is likely to have the biggest profit of $1.5 billion
followed by Asia at $1.2 billion.

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What is making it even less palatable is that it is happening at a time when most other
sectors in the Indian economy are booming and aviation itself is growing at its fastest
ever. Traffic is growing by leaps and bounds, the Indian economy is on a roll, yet
aviation is defying the trend. Every airline expects industry fundamentals to improve. But
there are no signs of that happening as yet.

CHALLENGES AND CONCERNS

Today, operating conditions present severe challenges. Airport charges are 62 per cent
higher than international levels and fuel prices are also higher. Distribution costs are
high, as Internet penetration, the main ticketing medium for budget carriers, is poor.
Aircraft utilization and turnaround times are lower due to poor infrastructure (few
runways and hangars, among other things) at Indian airports. Also, many carriers are
buying or leasing new-generation aircraft at high prices. Then, there are regulations like
all airlines have to fly to some unprofitable routes (the North-east, for example). All these
add up to throw their budgets out of gear.
Fuel costs now are the single largest cost element for the airline industry- and due to
market forces fares have not kept pace. Unit cost compression to a competitive level is
constrained by the limited size, network scale and flexibility of the individual airlines of
the sub continent –small size means lower purchasing power and higher costs across the
board – network scale restricts aircraft utilization to uneconomic levels.
If we compare these conditions with that of Europe it is quite different. In Europe, the
number (of passengers) is far lower, journeys are short, and traveling by train is a nice
experience. Yet, the low-cost airline model has worked very well. Hence one can begin to
imagine the size of the market in India. However unlike in Europe, there are no reliable
train connections between large cities in India, and the journeys are hardly comfortable.
And while many Indians traveling by train are not headed for the big cities but to smaller
towns in between, nothing prevents them from doing the larger chunk of the journey by
air and the rest by road, if prices permit.

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Concerns in future:

Pilots:
All planes need pilots, which currently are numbered about 1500 in India. Training
schools which are losing instructors produce few commercial pilots. If the expected
number of commercial aircraft grows by about 200 by the year 2010, an estimated 2400
additional pilots will be required. Pilots need 1500 hours of flying experience for the first
officer to be eligible for an airline transport pilot’s license, followed by 4000 hours and
five years of experience as a first officer to be a captain. Until current training facilities
are expanded and revamped, the airlines expect substantial use of expatriate pilots. The
scarcity of the pilots will be felt as more and more LCCs enter the domestic aviation
market.

Airport congestion and bottlenecks:

Peak hour congestion is the main concern. In Mumbai airport, for example, the peak
times for the scheduled aircraft movements, both domestic and international, are between
0500-1000 and 1700-2200 hrs. With all the airlines competing for the best slots, there
does not seem to be any way of sorting this out, especially at one runway airports.
The following table shows the concentration of international and domestic traffic at the
key metropolitan city airports, which put them under severe infrastructure pressure in
terms of both passenger and aircraft handling.

THE SOLUTION: LCC INTEGRATION

There is however a solution: the operational integration of the low cost carriers into an
effective Indian regional airline group. The operational integration of the airlines will
create an airline network that will have the scale and flexibility of significantly increasing
traffic and revenue through improved traffic flow across the network and the scale to
permit the reduction of unit costs to a sustainable competitive level. The cost benefits are

23
 apparent: one head office, one operation per city, one reservation system common to all,
one marketing organization for all. Common scheduling will overlap and increase
connectivity and the larger network scale will permit increased aircraft productivity.
Further cost savings and efficiencies will flow as the integrated structure matures. A
common frequent flyers program will reinforce strong current brand loyalty. The
combined effect will be an improved network and sustainable profitability.

About airline alliances:

An important development in the aviation sector is the arrival of the worldwide airline
alliances. An airline alliance is an agreement between two or more airlines to cooperate
for the foreseeable future on a substantial level. The degree of cooperation differs
between alliances. The three largest alliances are the Star Alliance, SkyTeam and
oneworld. With the help of alliances, airline companies can extend their individual reach
by cooperating with other airline companies. By participating in an alliance, the number
of destinations will increase; flight schedules can be combined, as well as frequent flyer
programs. The benefits can consist of an extended and optimised network: This is often
realised through code sharing agreements. Many alliances started as only a code sharing
network. Also, it is possible to buy jointly and share the costs of different services and
infrastructure. An overview of the different alliances in international context is given in
figure 4.

Figure 4, Airline alliances

Alliance About Members
Since: 1999 AeroMexico, Air France-KLM, Alitalia,
Passengers: 343,6 Continental Airlines, Czech Airlines, Delta,
million Korean Air, Northwest Airlines.
Daily flights: 15.207
Countries: 133

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 Destinations: 684

Since: 1998
Passengers: 242,6
million Aer Lingus, American Airlines, British Airways,
Daily flights: 8.110 Cathay Pacific, Finn Air, Iberia, LAN, Qantas.
Countries: 134
Destinations: 599

Since: 1992
Air Canada, Air New Zealand, Asiana Airlines,
Passengers: 382,6
Austrian, BMI, LOT Polish Airlines,
million
Scandinavian Airlines, Singapore Airlines,
Daily flights: 15.000
Spanair, TAP Portugal, Thai, United, US
Countries: 138
Airways, Varig.
Destinations: 790
Source: www.jvdz.net

This international alliance model has been successfully adopted by all major international
carriers. This can also be adopted by the domestic operators while operating within India.
This has been discussed further in details.

The network:
The Indian air travel market is complex and multi segmented. What is envisaged is an
Indian hybrid- series of major points along the linear network into which ‘clusters’ of
connecting flights will feed to and take from the main line network traffic destined to
smaller markets at the transfer times through the day e.g. Gwalior, Ranchi, Tripura,
Amristsar, and Tiruvananthapuram. Direct service between regional markets will
continue and will be improved. This system will require seamless connections at the

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cluster stations to minimize passenger connection times and shorten aircraft turnaround/
transit times.

Operations:
The integrated Airlines network will be operated by the existing airlines: Deccan airlines,
Spicejet, Go air, and IndiGo airlines operating on a common schedule. With an increased
aircraft utisisation will permit route expansion and/or limited fleet reduction. In the
medium term fleet, rationalization will bring further cost reductions through
standardization. It will be required for the profitable development of new markets within
India, and improved service on the current and new intra-regional longer low-density
routes. Access to the entire Indian market will permit the development of an efficient and
profitable cargo service. Dedicated cargo aircraft operation is envisaged in addition to the
cargo capability of the passenger operation.

The benefits:
The integrated airlines network will be profitable, delivering improved reliability,
expanded flight schedules and lower fares, region wide. Profitability will permit
expansion of the route structure thus allowing the integrated airlines to better support the
tourism industry and regional trade and economic development. It will further support the
objective of the civil aviation.
Benefits to stake holders:
1. The consumer will benefit from the lower fares, increased flight schedules and the
ability to earn and use frequent flyer points over a broader network.
2. The taxpayer will benefit in a way because it has to no longer have to subside the
airlines (government owned) losses.
3. The successful integration of airlines will be a potent regional symbol.
4. The economic and service benefits of the proposed network integration have been
extensively analyzed over many years and can be clearly demonstrated.

The integration of the airlines with proper capitalization, private sector ownership and
professional management will be operated as a business – to generate optimum returns

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for its stakeholders over a long term investment horizon through reliable, efficient, price
competitive, market responsive flight schedules and service quality – a world class airline
network.

FUTURE OF LCC

Revolutionized by liberalization, the aviation sector in India has been marked by fast-
paced change in the past few years. From being a service that few could afford, the sector
has now graduated to being a fiercely competitive industry with the presence of a number
of private and public airlines and several consumer-oriented offerings.
The market was galvanized a couple of years ago by the introduction of lower price tags
which ensured that people could travel at the fraction of the original price of air travel. It
was spurred further by the entry of Air Deccan, India's first budget airline, which offered
hard-to-believe tariffs.
This was the trigger point for the sector to move from having simple economy, business
and first class fares, to multiple slab tariffs such as apex fares, internet auctions, special
discounts, bulk purchases and last day fares. Some of the tariffs offered are so low that
they have brought airline fares neck-to-neck with upper class railway fares. Little wonder
then that the consumer prefers air travel to the railways.
The increase in passenger traffic calls for upgraded infrastructure facilities. The
international airport in Delhi and Mumbai are being modernised and upgraded through
private sector participation. In the joint venture (JV), the Airports Authority of India
(AAI) and other Government PSUs will hold 26 per cent equity. The balance 74 per cent
will be held by the strategic partner. Foreign direct investment (FDI) in this transaction
has been capped at 49 per cent.
In addition to these 10 non-metro airports, AAI has identified 15 more non-metro
airports, namely, Agatti, Aurangabad, Bhopal, Bhubaneswar, Coimbatore, Indore,
Khajuraho, Nagpur, Patna, Port Blair, Rajkot, Trichy, Vadodra, Varanasi and Vizag, for
development.
The airports have a direct bearing on the foreign direct investment and the developed
countries must augment their gateway airports.

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Investors’ interest will remain alive as they have an eye on the long term. Centre for Asia
Pacific Aviation (CAPA), the industry’s watchdog in the Asia Pacific region, estimates
that at least 2-3 large LCCs commanding a market share of around 70 per cent by 2010
will survive along with 2-3 full-service carriers, who will have a 30 per cent market share
between them. He also says that the passengers flying will go up to 60 million by then.
The legacy carriers will get almost half their revenues from international operations (Jet,
for one, is already heading that way, claiming that by March 2009, half its revenues will
be from international operations).The market appetite may be low as there is little chance
of short-term gains but investors are well aware most Indian aviation companies are
heavily undervalued, if you compare globally.
Most agree that India will be a 1,000 aircraft market by 2010. The question is: whose
aeroplanes they will be and that is the ‘billion dollar’ question. Analysts, industry players
and investors expect the valuation of any of the survivors to be no less than that. It is
really a matter of who blinks first.
It is time the government woke up. A single step by the government — making fuel a
declared good — will make the industry profitable overnight. That may be a little
simplistic but certainly there are many issues that the government needs to address, and it
is indeed trying hard to resolve them. The birth of the Federation of Indian airlines (FIA)
may be a first step in that direction.
But there is only so much an industry association can get done. The onus to wake up and
actually smell the coffee lies with the industry players themselves. There will be a limit to
the extent of losses companies can absorb.
Whichever way you look at it, capacity additions are now slowing down. That mad
scramble to add planes is over. But in case of Jet Airways one should make a note that its
new capacity is for its international routes.
In this kind of uncertain market, company’s ability to ramp up and ramp down will
determine its success.
Although many are happy with the low-cost carriers, especially because of the low prices
they offer, people want to see some improvement in customer service. The budget
airlines' staff at airports appears semi-literate. All relevant employees and points of
contact must have the same and most current status information and the on-site personnel

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should be authorized to take decisions like putting passengers on other airlines in case of
delay. Many endorse the view that the budget carriers seem unable to exploit India's IT
expertise to their advantage. For instance, the flight departure time for the same flight on
the voice helpline, SMS and website can vary by several hours.
But the good news for consumer is that the party on fares is unlikely to get over, at least
in 2007. Airlines will have to find ways to cut costs and look for non-operating revenues
to shore up bottom lines. The focus will be less on killing the competitor and more on
making the business efficient. That will, hopefully, bring a silver lining to these dark
clouds.

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