India's untapped aviation bonanza December 2003

The Indian government’s on/off privatisation programme for the two state airlines, Air India and Indian Airlines, may be back on, depending on the impending report of a government–appointed committee. There is no doubt that there is massive untapped potential in the Indian market.

Although there are more than 1bn Indians, just 14m passengers are carried on domestic flights each year — and of that, more than 10m are either foreign or business passengers. Daily passenger traffic on the railways is also 14m. But while the majority of India’s population lives in abject poverty, there is an estimated "middle–class" of 120m people who could travel by air, yet currently only provide some 3m domestic journeys on aircraft per year — a figure that remains stubbornly flat.

Some in the industry blame high taxes, such as a 15% "inland air travel" tax and a 16% excise duty on fuel, but while fares do need to come down, the tax issue is misleading since most of the country’s middle classes can afford air travel if they want to.

More importantly, what is holding domestic air travel back is poor service standards at the state airlines, little competition from private carriers (though this is changing) and poor infrastructure, particularly at airports. In addition, Indian airlines are forced to allocate their capacity by a bureaucratic formula. Capacity equivalent to 10% of that deployed on trunk routes (Category 1 routes) has to be allocated to points in the northeast of India (category 2 routes), with 1% dedicated to intra- Category 2 services. Then, the equivalent of 50% of Category 1 capacity has to be dedicated to Category 3 routes, which are basically all other routes within India. Capacity is measured in ASKs.

This untapped domestic demand has long been something that Indian governments have tried to unleash. There was partial deregulation in the 1990s, which lead to the emergence of private carriers such as Sahara Airlines, but today only a handful of private carriers offer any real competition to the state airlines. And their profitability is questionable anyway as they face the same infrastructure constraints as their state competitors, though private airlines are keen to expand and put greater pressure on Air India and Indian Airlines.

The latest push to liberalise the aviation industry came in 2000/01, with measures such as the abolition of state–regulated fuel prices in April 2001.

However, the government’s most important step — the attempted privatisation of the state airlines in 2001 — was a failure. The government intended to sell 60% of Air India and 51% of Indian, but the effort collapsed after various bidders were either disqualified or withdrew their interest.

In April 2003, the Indian government officially declared that there were no immediate plans for the privatisation of the two state airlines, thus freeing them — theoretically at least — to make substantial aircraft orders. However, almost immediately — in July — the government set up a committee to prepare a roadmap for the aviation industry, including the possible privatisation of Indian and Air India.

The five–man committee comprises civil aviation and finance experts, and at the time the Indian government said it would report within three months. As yet, there is no sign of its recommendations. However, some analysts are confident that when it does report, a timetable for another privatisation attempt will be laid out.

Other than privatisation (or perhaps before privatisation) the main option for Air Indian and Indian Airlines is a merger, or at least much closer cooperation. However, any move to rationalise routes and/or operations will face huge opposition from unions and politicians, afraid (with much justification) than this will lead to many redundancies.

The government insists a merger is not on the agenda, but the government’s hiring of a western consulting company — AT Kearney — in 2002 to advise it on the future of the two airlines, has increased the unease at unions worried about mass redundancies.

Speculation was fuelled further in August when the Indian government announced that Sunil Arora, chairman and MD of Indian Airlines, was also to become the MD of Air India.

The on/off privatisation saga does the industry no favours, though it must be recognised that there are a lot of impediments to a successful sell–off, not least of which is the relatively poor performance of the state airlines in the last few years. The government may want to wait until their profits pick up before selling stakes in them, though some in the airlines argue that they will never be profitable in a sustainable manner until aging fleets are replaced with new aircraft — orders that may not be approved (and therefore financed) by the government prior to a privatisation. It’s a Catch 22 situation.

Also looming is the next general election in India, due in October 2004, which may discourage the current government from making a controversial decision over privatisation before then.

Meanwhile, Air India and Indian Airlines stagnate, allowing the few private carriers in India to pick away at the state airlines' market share.

Air India

Air India has been operating since 1932 and is India’s international flag carrier, flying to 44 destinations in Asia, Europe, Africa and North America and carrying 3.4 million passengers in the year to March 31 2003. Nationalised in 1953, the airline is still 100% owned by the Indian government and has more than 16,000 employees.

Air India reported a net profit of Rs 1.4bn ($30m) for the financial year ending March 31 2003, compared with a $3m profit in 2001/02.

Operating profit figures were not released however (the airline has made an operating profit only once since the mid–1990s), and much of the net profit was due to lower finance costs and sales of aircraft and property.

For the current financial year, Air India expects to post a net loss of at least Rs 0.5bn ($11m), due primarily to the impact of the Gulf War, SARS and industrial action by pilots. SARS forced Air India to cut services and suspend its route to Hong Kong in April. The airline also suffered a damaging dispute with cockpit crew in April and May after de–recognising the pilots union — the Indian Pilots' Guild — following a union decision to stop its members flying to Kuwait during the Gulf War and Hong Kong during the SARS crisis. Air India has a fleet of 29 aircraft — 12 737s and 17 A310s, of which 10 aircraft are leased. Two 747–400s and two A310–300s will join in December 2003 on dry leases, to be used on existing services to Chicago via Frankfurt and a new route to Shanghai.

Air India was planning to acquire up to 35 new aircraft in the period to 2007/08 in a complete overhaul of the fleet and to replace leased aircraft.

Some reports suggested this may have been postponed or cancelled due to the inability to get government approval for the order, and one local report said that an internal Air India analysis found that the new aircraft would be unprofitable for the airline (although Air India denied this was the case). Air India had been evaluating A340–300s and 777–200ERs on long–haul and A320s and 737- 800s on short–haul, and in November 2003 Air India formally decided to buy 10 A340–300s and 18 737–800s, slightly fewer than the order it was expected to make. Air India is now seeking government approval to firm up deals with the manufacturers — although it may take months, if not years, for permission to be given (see Indian Airlines, below).

Former managing director J N Gogoi previously stated that: "It’s a life and death question for Air India. We have survived a couple of years purely by taking dry–leased aircraft, but that has its own limitations and its own constraints. We need to grow. If we remain static we will not survive."

Air India is particularly keen to expand capacity to North America. In the last year Air India has doubled services to the US, which now total 20 flights a week, though these are all to eastern US destination.

For the west coast, Air India relies on code–sharing.

It began code–sharing with Asiana in November on services between Korea and Los Angeles, San Francisco and Seattle, and already code–shares on other routes to the western US with Singapore Airlines and Malaysia Airlines.

In 2002, the Indian government appointed management consultants to examine Air India (and Indian Airlines), and they recommended that Air India partially sell its IT, ground handling and engineering subsidiaries so that it can reduce the number of directly employed staff and concentrate on core airline activities. Among the subsidiaries that are now up for (partial) sale are ground–handling — which handles up to half of all ground handling in the Indian market and has revenues of $75m per year — and its hotel and catering subsidiary, the Hotel Corporation of India. And, in August 2003, Air India signed an MoU for a co–operation pact with Lufthansa, which will cover commercial, engineering and IT areas. Although neither airline specified what this exactly meant, it may involve Lufthansa Technik becoming a joint–venture partner.

Air India also launched a voluntary retirement scheme in February as part of an effort to cut employees by up to 1,500. Staff numbers have already fallen by 2,000 over the last few years through natural wastage and reducing the retirement age, but government rules do not allow Air India to make redundancies.

Indian Airlines

Indian Airlines is the country’s domestic flag carrier. Launched in 1953, the airline employs almost 20,000 and carried 5.5m passengers in 2002. It operates throughout India via hubs in Delhi, Mumbai, Calcutta and Chennai, and also provides services to selected Asia and Middle East destinations.

Indian operates a fleet of 45 aircraft, including 40 A320s and three A300s, although it hasn’t ordered any new aircraft for more than 10 years.

Back in 2002, Indian selected the A320 family to upgrade its ageing fleet, and requested permission from the government to buy 43 of the aircraft — 20 A321s, 19 A319s and four A320s — in a deal worth more than $2bn. The aircraft would be delivered over five years and some of them would replace 737s at subsidiary Alliance Air, which operates feeder routes throughout the sub–continent.

However, government bureaucracy or a lack of funds appears to have stalled a government decision and today — almost two years after Indian made its decision — the airline is still waiting for formal state approval. There may even be some nervousness about a Delhi court ruling in 2000 that the Indian government should not buy aircraft from Airbus until Indian police complete a longstanding investigation into alleged kickbacks from Airbus to Indian officials for an Indian Airlines’ order back in the 1980s (for further details see The Economist, June 14 2003).

Some reports suggest the government would prefer the airline to lease the aircraft, not purchase them, but in any event the lack of approval has forced Indian to seek temporary solutions, and in September the airline even placed newspaper adverts in an appeal to find five A320s to lease for three–year periods. Indian is also believed to be considering a purchase of ATR 42 aircraft for regional feeder routes, a deal that ATR is keen to encourage through the promise of assembly work in India. The need for new aircraft at Indian is critical, the airline believes, as it is coming under increasing pressure from new entrants on high density trunk routes. Indian accounts for approximately 40% of the domestic market, but this is falling fast and the state airline has been overtaken as domestic market leader by Jet Airways.

Although turnover has risen steadily over the last few years, Indian has not released any P&L figures since 2000/01, when it posted an operating loss of $5m and a net loss of $39m. However, Indian is trying to cut costs where possible. In August 2003, Indian extended a voluntary retirement scheme in a further attempt to trim 1,000 employees (though not pilots) from its workforce — around 5% of the total. Like Air India, Indian Airlines is restricted by labour laws from making redundancies.

Jet Airways

Jet Airways was launched in 1993 and is the largest privately owned airline in the country.

Based in Mumbai, Jet does not consider itself a LCC, but instead targets business travellers. The airline has 6,500 employees and operates more than 250 flights a day to 40 destinations in the Indian sub–continent.

Today the airline is wholly–owned by the Indian entrepreneur Naresh Goyal, but up to 1997 Kuwait Airways and Gulf Air each held a 20% stake, until forced to sell after the Indian government declared that overseas companies could not hold equity in Indian airlines.

On its launch Jet had a fleet of four 737–300s, but today the airline operates 41 aircraft, 33 of which are 737s and the remainder ATR 72–500s.

The ATRs carry passengers from feeder routes onto the main 737 services. Of the 737s, 27 are 7/8/900 models, and Jet has an average fleet age of just 3.4 years. However, Jet is slowing down its fleet expansion plan and has postponed an earlier plan to acquire another four new generation 737s in 2003/04. It currently has no new aircraft on order, although it will acquire a 737–400 on a dry lease in December 2003, which will be used to increase services on existing routes.

Jet also signed a LoI in 2002 to become the launch customer for the Embraer 175, an 86–seat derivative of the Embraer 170. Ten 175s were to be delivered from June 2004 onwards, partially as replacements for Jet’s ATRs.

This prospective order has also been delayed, and the first aircraft will not arrive until mid–2005 at the very earliest, assuming the order is confirmed at all. In August Jet also leased out two of its 737–400s to Japan’s Skynet Asia Airways on three–year contracts.

All these moves suggest that Jet has overcapacity, or at least is worried about the effect of competition from low cost carrier Air Deccan (see below).

The postponements may also be due to financial considerations, although it is difficult to assess the company’s profitability since it only releases revenue information. However, it is believed that Jet made a loss for the first time in its history in the 2001/02 financial year ending on March 31st, and recorded another loss in 2002/03. Thanks to the Gulf War and SARS, it is unlikely that Jet will make a profit in the current financial year either, and that may have been the spark for a management reshuffle in mid–year. In June 2003, Jet appointed Wolfgang Prock–Schauer as its CEO.

Prock- Schauer was previously executive VP for alliances/long–term planning at Austrian, and he joined Jet just a month after a new COO — Peter Luethi, who was previously COO and executive VP external relations at Swiss.

If this team is responsible for the new cautiousness on capacity, it may have to reverse that decision now that the government has just allowed private airlines to operate to foreign destinations, an opportunity that Jet can’t ignore. Jet claims to have a domestic market share of more than 46%, just ahead of Indian Airlines, but the market appears to be flattening out. After double–digit passenger growth at Jet every year from its launch through the 1990s, September 11 and a slowdown in the Indian economy has caused passenger growth to tail off.

Unless the new breed of LCCs expand the total market, traffic growth is more likely to come internationally.

Sri Lanka would be an obvious first such destination for Jet, and it will be interesting to see how long it will take Jet to launch services out of India. Expansion internationally would also provide a good story for a major fundraising effort. Jet has been contemplating an IPO or private placement of equity for a while, but has so far put off a positive decision.

Others

In August 2003, Air Deccan became India’s first new airline for many years. Launched by Deccan Aviation, an Indian helicopter charter operator, Bangalore–based Air Deccan is an LCC that operates 30 flights a day to seven southern Indian destinations using four leased ATR–42s. It plans to expand services to other cities through the addition of three more ATR–42s.

The airline has a no–frills, one–class policy, and is targeting the vast majority of the Indian population that can’t afford current fares and who currently travel by train or bus. Its prices are up to one–third lower than Indian Airlines' fares. Certain LCC operating policies are difficult in India however; for example, although Air Deccan sells via the internet, the penetration of this technology is very low and so most sales come from travel agents.

Nevertheless, the airline expects to break–even in its first year of operation on revenue of more than $50m, and if the LCC business model is successful then others are sure to copy the formula.

Air Sahara is an older airline, having been established in 1993 as Sahara Airlines. Owned by the Sahara Banking Group, the renamed Air Sahara has been expanding it operations and currently operates 19 737s and CRJ200s — many of them leased — to 20 domestic destinations, offering more than 11,000 seats each day.

The airline operates feeder routes from smaller Indian cities in the morning, which funnel passengers onto main trunk routes between cities such as Calcutta, Mumbai, Bangalore and New Delhi in the afternoon. Air Sahara says it plans to add larger CRJ700s in the future as it increases its challenge to Jet and Indian. Like Jet Airways, Air Sahara is keen to take advantage of the Indian government’s declaration that it will allow private airlines to operate internationally, and the airline intends to launch services from Mumbai and Delhi to Colombo as soon as possible.

There is also increasing and serious competition from overseas. For example, AirAsia, a Malaysian LCC, is keen to operate routes to southern India to cater for ethnic Indians in Malaysia that want to visit friends and relatives in the sub–continent.

Ethnic Indians comprise around 10% of the Malaysian population and AirAsia claims that at present flight choice between the two countries is limited and fares are high. AirAsia aims to launch services with 737–300s in 2004 or 2005.

Overall, it’s clear that competition from private Indian airlines and foreign carriers is increasing, and the longer the Indian government delays making a decision on the privatisation of Air India and Indian Airlines, the tougher it will become for them to survive long–term.