Turbulent Times: What's Next for the Indian Airline Industry?

Turbulent Times: What's Next for the Indian Airline Industry?: India Knowledge@Wharton
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Turbulent Times: What's Next for the Indian Airline Industry?
Published in India Knowledge@Wharton

When the owner of a private airline calls his pilots "terrorists,"
something is seriously amiss. But that is exactly what Jet Airways
chief Naresh Goyal did this month. On the third day of a mass sick
leave by his pilots, Goyal lost his cool. "They are behaving like
terrorists," he said. "They cannot hold the country, passengers and
the airline hostage. We won't tolerate such blackmail."
In trying to control the damage, Goyal brought back his public
relations agency, which earlier had been shunted to the sidelines,
to handle the media. He was advised to start talking about the "Jet                                     This is a single/personal use copy of India
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"'Terrorist' was poor PR," says Jitender Bhargava, executive
director at national carrier Air India.
Jet's tug-of-war with its pilots is just the latest among several difficult situations it has faced in recent
months, and is symptomatic of pains being felt across India's civil aviation industry, according to Wharton
management professor Saikat Chaudhuri. "All [carriers] are in trouble," he says, noting that Indian
airlines are "disproportionately disadvantaged" by high state tariffs on aviation turbine fuel (ATF), and
many operate unsustainable routes while responding to severe competition with steep price discounts.
"The recession has made all that worse," Chaudhuri adds. Kingfisher Airlines, for example, has the
highest outstanding dues to airports and oil companies, compelling it to provide bigger guarantees.
"Every week we hear the problems of some airline or the other highlighted."
At Jet, Goyal had already undermined his case a month before the latest standoff with pilots. In early
August, several private-sector airline owners -- including Goyal and Kingfisher Airlines' Vijay Mallya --
got together under the banner of the Federation of Indian Airlines (FIA) and threatened not to fly on
August 18. Their demand: concessions from the government. "This is a well-considered decision of all
members to protest against high aviation turbine fuel and airport charges," FIA secretary-general Anil
Baijal stated at the time. Mallya said that private operators would suspend operations indefinitely if the
government did not include them in relief it proposed to dole out to state-owned Air India. (See: " Labor
Pains: Is Industrial Unrest Growing or Slowing?")
The government responded by saying Air India would operate additional flights that day. Then it asked
the airlines to refund money to all passengers who had bought tickets. The airlines, which have run up
huge fuel bills and claim to have no cash even for salaries, ended their protest with a whimper. IndiGo, a
low-cost carrier (LCC) that is making money, was the first to back down. Others soon followed suit.
According to the financial daily Business Standard: "The airline owners, back-pedaling furiously because
they realize that they have overstepped the line, say now that they did not want to threaten the
government or blackmail passengers; all they wanted to do was highlight their problems."
Trouble has been brewing at Jet Airways for some time now. In October 2008, huge protests ensued when
800 cabin crew and ground staff were fired overnight. (An additional 1,000 were told they would be next
to go.) Employees learned of their dismissal when their morning pickup didn't arrive at their homes. With
politicians breathing down his neck, Goyal made a PR event out of it. In a late-evening news conference,
he announced that all terminated employees would be taken back. "They are like my family. I cannot see
them unhappy," he said. "I could not see tears in the eyes of my employees. I could not sleep when I saw
what had happened."

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Complaints in 'Epidemic' Proportions
No tears were shed for Goyal this month, however, as he grappled with pilots over several issues,
including pay and perks, alleged preferential treatment for expatriate pilots and job security. But the
immediate bone of contention was the formation of a pilots' union -- the National Aviators Guild -- in
June. Jet had fired for an unspecified breach of discipline two pilots who had joined the union;
management said it did not have to provide a reason for their termination. More dismissals followed.
On September 8, 420 pilots called in sick. Over the next four days the number grew daily, to 539, about
half of Jet's approximately 1,000 pilots. The protest took its toll: From September 8 to September 12, Jet
had to cancel 71% of its flights, including 85% of its domestic flights and 40% of its international flights.
On September 13, an accord was reached, though little seems to have been achieved. "It's time to get back
to work," Goyal told his staff. "It is now time to look to do what we know best -- fly." The agreement
between Jet Airways management, the pilots' union, and representatives of pilots who aren't union
members, called for "sick" pilots to report to work immediately, for dismissed pilots to be taken back, for
no action to be taken against any pilot for the protest, and for a consultative mechanism to be set up to
discuss similar problems in the future.
Yet several issues remain unresolved, and many pilots are still fuming. Among the issues is
management's ability to terminate them without assigning a reason. "Don't I even have the right to be
given a simple explanation as to why I lost my job?" Sam Thomas, one of the first pilots to be dismissed,
asked Jet executive director Saroj Datta on business channel CNBC TV-18. Datta's response: "We are
fully and legally permitted under contracts for anyone's services to be terminated [without explanation]."
The pilots deny they went on strike. (Thomas claimed that an epidemic struck.) Management denies that
the union's formation had anything to do with pilots' dismissals.
"These pilots have made no demands apart from their basic right to form a union," says International
Transport Workers Federation civil aviation secretary Gabriel Mocho. "Jet Airways has sacked pilots for
trying to form a union, in direct contravention of not only international freedom of association
conventions, but also Indian national law. If anyone is holding the country to ransom, it is Jet's
management. What has made several airlines disappear is mismanagement and excessive greed, not their
workers' actions."
"One cannot say that their demand for a union is not justified, because in a democratic country unions are
allowed," says Vishwas Udgirkar, executive director of PricewaterhouseCoopers India (PwC). "But
creating a forum where all representatives come together and participate in addressing the issues is a far
better way of resolving the problems."
A Business Standard editorial provided another viewpoint. "Naresh Goyal has asked how pilots earning
$8,000 a month can be equated with shop-floor workers who are entitled under the law to launch
industrial action, like striking work. His argument is that pilots get paid very well, and are in charge of
the planes they fly -- that is, they perform a vital supervisory/management role in that they command a
plane and its crew. No one, for instance, has heard of a ship's captain going on strike on a wage issue. So
how are airline pilots different?... To say that a manager has the right to strike is surely an oxymoron."
An Industry in 'Survival Mode'
What's new is the dramatic change in the environment. It's been a bad year for airlines globally. The
International Air Transport Association had forecast a loss of US$9 billion in 2009. On September 15, it
revised the number to US$11 billion. The estimate for 2008 has been increased from US$10.4 billion to
US$16.8 billion. "Expect more casualties," says the association's director general and CEO, Giovanni
Bisignani. "The world is changing. The industry is in survival mode."
The industry's fortunes have been especially bad in India. The country accounts for just 2% of the global
market, but its losses are expected to top US$2 billion. "The past one year has [presented] serious
challenges for the aviation sector," says Susnato Sen, practice head (infrastructure) for the Tata Strategic
Management Group (TSMG). "The sector was faced with a double whammy of high fuel prices and a
considerable drop in traffic due to the economic slowdown. While there seem to be indications of a
recovery in the economy, the woes of the aviation sector are far from over."

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Chaudhuri calls the current situation "a reality check" following the boom years when passengers were
willing to pay higher fares, and low-cost airlines could coexist with full-service carriers. "The industry is
behaving as if India were a fully developed country," he says. "Anything that grows too fast there will
[have] problems. But sustainability would not have been an issue if it were not for the recession."
Consider Jet's finances. According to a report by Enam Securities, in the April-June quarter, the first of
the fiscal year, Jet had operating revenue of US$470 million, down 19% from the same period last year.
(These do not include the numbers for its low-cost subsidiary, JetLite.) In the international segment, the
company has given nine aircraft on wet lease (providing the aircraft and crew) to foreign airlines. The
US$47 million lease figure "was the key driver for cash profits." The overall outlook, however, is bleak.
Enam projects a consolidated loss after tax of US$176 million in 2009-10 and US$78 million in 2010-11
(including JetLite, which has turned profitable). In 2008-09, Jet lost US$456 million.

Kingfisher isn't doing any better. In the April-June quarter, it lost US$48 million, its 10th straight
quarterly loss. Oil marketing company Bharat Petroleum has filed a petition in Karnataka High Court in
an attempt to recover more than US$60 million. The airline owes more than twice that amount to other
government-owned oil marketing companies. That may explain why Mallya, normally the most optimistic
and ebullient of businessmen, joined Goyal and the others to threaten a strike.
Air India, which has been merged with domestic carrier Indian Airlines, is in equally bad shape. Salaries
have been paid behind schedule and the organization's many unions are becoming restless. Losses last
year topped US$1 billion, which is why it has approached the government for a US$1 billion rescue
package.
Many Sources of Woe
The global slowdown's impact on India is only one reason for airline industry's troubles. The high price of
aviation turbine fuel is another. It accounts for about 40% of Indian carriers' operating costs, compared
with 25% to 30% for carriers globally. Part of the reason for the disparity is the high sales tax imposed by
state governments. "The aviation sector has been hit hard by the fluctuation in the fuel price and the
current economic slowdown," says Udgirkar of PwC. "In India, this sector is viewed as servicing the
higher economic strata and so, unlike other infrastructure sectors, it has not got government support by
way of tax reductions or other sops."
A slump in demand is another factor. In 2006, passenger volume grew by 46.4%. Growth slowed to
32.5% in 2007, and in 2008, volume retreated by 4.7%. Indian carriers had ordered numerous new aircraft
in the days of galloping growth. Now they have been left with overcapacity and a pipeline of aircraft
deliveries they don't know what to do with.
Most people blame the global slump and bad planning. But G.R. Gopinath, chairman and managing
director of Deccan Cargo & Logistics and the man who started the LCC movement in India with Air
Deccan (later sold to Kingfisher), sees it differently. One of the reasons passenger load factors have come
down, he says, is that a year ago the airlines got together and fixed fares. "If it had happened in another
country, they would have been punished for cartelization. But instead of the government taking action,
consumers punished the airlines by not flying and occupancy rates have tumbled since then.
"Airlines are themselves partially responsible for the crisis they are in today as they have failed to build a
sustainable aviation model suitable for the country," he adds. Gopinath reserves part of the blame for the
government. "For the first 50 years, policies for the country were made to suit Air India and Indian
Airlines. More recently, [the government] appeared to be biased toward Jet Airways. Now, the new
airport operators seem to be in favor." Udgirkar of PwC agrees that a consistent, level playing field is
lacking: "The government seems to be protecting the interests of the airport operators without considering
the problems of the airlines. It needs to support both segments equally."
Chaudhuri feels the government may have legitimate reasons for supporting Air India in its recent bailout
request. "It is owned by the government, and the owner is stepping in to help; they have some right to do
it. If you are a private concern, you cannot expect the government to help you out in the national interest."
Air India's supporters have pointed out that it has not always gotten the best deal from the government, as

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in the case of Emirates and other private carriers being granted supposedly more lucrative routes and
flight timings, Chaudhuri adds.
Competitive Rates?
Others blame LCCs for the mess. According to Bhargava of Air India, LCCs have made the entire
business uneconomical. "They set prices that defied all logic. They were below breakeven. For instance,
in 1998, a ticket to New York cost $800. In 2009, it has gone up by $60, though fuel prices have risen
six-fold."
A clear case exists for the government to reduce fuel tariffs to "give the airlines breathing room," says
Chaudhuri. The airlines, too, need to focus on controlling costs, especially pilots' salaries, and
rationalizing routes by operating low-cost flights in sectors and times of the day wherever it makes sense,
he adds. For example, it doesn't make sense to offer low fares on morning and evening flights between the
major metros "because you will have business executives traveling," but airlines could lower fares for
afternoon flights or smaller routes.
Some airlines are already offering distinctly different full-service and low-cost flights, Chaudhuri notes.
Examples of the latter are JetLite, Jet Konnect, Kingfisher Red and Air India Express. That trend is
visible among international airlines, too, with some offering a "premium economy" class, he adds. Air
France, British Airways and KLM have always had a premium economy class one notch below business
class; Qantas added one recently and Cathay Pacific and Lufthansa are considering the same, he says.
These premium economy offerings target business travelers who are willing to travel economy class,
especially given the recent recession.
"The industry as a whole needs to sit back and think about the pricing strategy," Udgirkar says.
"Competitive rates are fine in order to attract volumes, but they should not result in losses. The airlines
need to avoid the very unhealthy practice of a price war. The low-cost airlines which attracted an entirely
new set of customers have not been able to control their costs and have been unable to sustain their price
competitiveness. Worldwide, the low-cost airlines have many avenues to control costs. For example, they
either have separate airports or non-peak charges at the regular airports. This is not the case in India."
Adds Sen of TSMG: "The LCC model in India has never really taken off. It is more an LFC [low-fare
carrier] model."
Excess capacity and mismatched cost and revenues also plague the industry, Sen says. Based on robust
growth in recent years, most airlines had major aircraft acquisition plans. With so many aircraft scheduled
to be delivered in the next seven to 10 years, the industry faces serious overcapacity. Airlines are trying to
postpone deliveries.
Additionally, the airline industry has a high and largely fixed cost structure. Cut-throat competition has
resulted in falling average ticket prices, with increases difficult because customers in India are highly
price-sensitive. This has resulted in a misalignment of operating costs and revenues. Most of the airlines
have failed even to recover operating expenses, let alone capital expenditures.
Another issue, Sen notes, is the slow pace of infrastructure development. "Airport development has not
been aligned to growth in air traffic. Here in India, while we have had phenomenal growth of airlines,
airports continue to grow at a much slower pace. This has resulted in acute congestion at airports,
especially in metro airports. This in turn has resulted in increased operating costs."
What next? "Crisis is part of the aviation industry's genetic profile. And still it survives, more or less
intact," says the Centre for Asia Pacific Aviation Outlook 2009. "But today, the industry is at a crucial
turning point.... The industry has been historically unable to deliver returns to cover even the cost of
capital. Government protection and subsidies are going.... Airlines will in the future need to generate
revenues consistent with, and behave like, companies in other commercial industries." The report goes on
to warn that "substantial staff cuts are inevitable and some industrial turbulence [is] likely."
"It will take a couple of years for the yields to come back," Chaudhuri predicts. Revenue will not be quick
to rebound, but the industry has little choice but to focus on a combination of cheaper fuel, route
rationalizations across sectors and timings, and cost controls, he says.

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Turbulent Times: What's Next for the Indian Airline Industry?: India Knowledge@Wharton
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