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INDIAN INSTITUTE OF MANAGEMENT

ROHTAK

Flying Too Low:

Air India 2009 & Beyond

P Rameshan

Director, IIM Rohtak

March 20, 2012

INDIAN INSTITUTE OF MANAGEMENT ROHTAK M.D University Campus, Rohtak - 124001 INDIA

Phone: 01262-274052/Fax: 01262-274051

E-mail: iimrohtak@iimrohtak.ac.in Website: www.iimrohtak.ac.in

Copyright IIM Rohtak, March 2012

IIM-R/0301/SM/2012 IIM Rohtak Case Series

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Flying Too Low:

Air India 2009 & Beyond

CASE

September 26, 2009 – the Executive Pilots of Air India (AI) began a strike protesting against a

cut in their Productivity Linked Incentives by 50%. The pilots took mass sick leave and

abstained from work. As the following days saw several AI flights getting cancelled and the

management struggling to bring the situation under control, passengers frantically looked for

other carriers to avoid disruption to their travel plans. The strike was the culmination of the

ongoing financial problems of AI arising primarily due to years of poor performance that had

forced the carrier even to delay payment of salaries to its staff in recent months. Still, matters

might not have come to such a state, had there been no global oil crisis during 2008 and

concurrently there was no onset of a global business slowdown that continued into late 2009.

There was no immediate relief in sight, and where the company was headed was everyone’s

question.

March 3, 2010 – Media reports that the losses of Air India for 2008-09 and the subsequent

financial year might total Rs.72 billion (over $1.5 billion) and that the government might support

Air India with fresh funds of Rs.12 billion to help it tide over its immediate problems. However,

Air India got a clear message that such support would not continue and that the airline needed to

generate profits and its own cash to keep it going further.

Airline Scenario 2008

International

2008 was particularly a bad year for airline industry across the world. Before this, only 2001

appeared as bad in the near past. The immediate problem of 2008 to airlines was two-fold - a

dramatic rise in the cost of operations and a steep fall in passenger traffic. Rise in the cost of

operations had its main root in the skyrocketing fuel cost - crude oil prices in the world market

increased from about US$60 per barrel in April 2007 to over $140 per barrel by July 2008. (See

Figure 1.a and 1.b for trends in international (US) crude oil prices.). Issues on the demand side

primarily emanated from the economic slowdown that followed the global financial crisis,

which, on the other hand, had its roots in the sub-prime crisis in the USA. The fare hikes

subsequent to the oil crisis aggravated the demand problem.

This case was originally prepared as basis for classroom discussion. It does not intend to

illustrate either effective or ineffective handling of a management situation. The author wishes to

thank those members of Strategic Management Forum, India, and North American Case

Research Association, USA, as well as several other scholars, who contributed to a substantial

improvement in the drafts of this case. The author also wishes to acknowledge the support of

Indian Institute of Management Kozhikode.

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Carriers, in general, struggled to stay afloat; a few of them approached bankruptcy. According to

the International Air Transport Association (IATA), two-dozen airlines had discontinued

operations in the few peak oil price months of 2008 and many more bankruptcies were expected

over the subsequent months if crude oil prices continued to soar. What happened during 2008-09

was in stark contrast to the picture till 2007. 2007 was a boom year for international airlines

industry. World-wide, IATA-affiliated airlines expected to earn over a $5 billion of profits in

total.

India

In India no airlines failed in 2008; but, all of them heavily lost money. The combined loss of

Indian carriers during December 2008 and January 2009 was projected at about US$45 million.

The total loss in 2007-08 was nearly US$1 billion and the expectation for 2008-09 was about $2

billion. There were indeed speculations of collapse of a few carriers. A timely intervention by the

government and an improvement in the fuel scenario, however, pre-empted this. Still, in early

2009 the airlines did not appear to be in a good shape.

Fuel charges accounted for a third to two-fifth of the operating cost of Indian airlines. The

strategic mistake of not hedging the fuel exposure compounded their woes. Severe cash problems

forced the Indian carriers to delay payments to oil companies. JA owed Rs.10.57 billion to Indian

Oil Corporation (IOC), Hindustan Petroleum Corporation (HPCL), and Bharat Petroleum

Corporation (BPCL), KA owed Rs.9.83 billion and AI had a due of Rs.8 billion. Kingfisher

Airlines (KA) defaulted on aircraft lease rentals, Jet Airways (JA) was struggling with large

losses, SpiceJet was looking for a breakeven at least in 2009-10 and Air India (AI) fell deeper

into red.

Cost Issues

Indian airline companies faced a peculiar cost scenario. One complaint was that the Aviation

Turbine Fuel (ATF, i.e., the airline fuel) cost in India was higher than the international rates by at

least 30% due to certain taxes. Second, both airlines and observers felt the airport charges to be

very high as compared to even South East (SE) Asian nations. Charges levied on airlines at

airports were varied and substantial. They included Route Navigation Facilities Charges (for

both landing flights and over-flying flights), landing charges, aircraft housing charges, parking

charges, and night parking charges. Airport congestion (hovering over airports for long) was also

an important cost factor. Third, ground handling charges in Indian airports were much higher

than abroad. Besides, the private carriers in India were not permitted to do their own ground

handling – this privilege was reserved for the public carriers and the Airport Authority of India

(this was soon to change though). Absence of own ground handling escalated ground handling

costs. All these added to operational costs and strained the performance of airlines.

Capacity, Competition & Fleet Structure

There were yet other constraints. According to observers, the Indian airline industry suffered

from over-capacity and intensive competition. Excess capacity was, in fact, a global problem and

innovative methods were necessary to boost revenue. There was strong competition from road

and rail services. Further, Domestic airlines were operating a fleet consisting of a variety of

aircrafts which increased their cost of operations. A fleet rationalization was required by airlines.

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Cost-Fare-Load Cycle

In 2008, to manage their spiralling fuel cost in particular, the struggling airlines had to effect

huge fare hikes. The fuel surcharge of airlines, which stood at Rs.900 per ticket in May 2007,

had surged to Rs.2900 by May 2008. In passenger response, demand fell through the bottom.

Leisure travel was reported a major victim. Air traffic was lower in November 2008 by a fifth

over November 2007. Air traffic had fallen in November 2008 to 3 million passengers from 3.8

million in November 2007, indicating a 21% fall. Many airlines had drastically reduced services

in 2008 and cut down flights on short-distance routes to reduce costs. In the tourist season

starting in end-2008, the load factor of carriers was estimated to fall to 40% for full carriers and

45% for low cost carriers (as compared to 60% in November 2008), a load factor that would

have rendered airlines bankrupt in markets like the USA. Needless to say, airline revenues

declined sharply. The falling revenues and increasing cost made the airlines struggle for survival.

All major players were slated to suffer huge losses in 2008-09.

In contrast, look at what had happened in the tourist season of 2007. In December 2007, heavy

rush was felt in the routes between India and SE Asia, and India and Europe. Load factor for SE

Asia ranged 95-100%. The load factor in the Delhi-Mumbai route was over 90%. This trend was

expected to continue till January 2008.

Slow Response

Still, later in the second half of 2008 when jet fuel prices began falling sharply, Indian airlines

showed great inertia in reducing fares. According to some media reports, due to this, a recovery

in air travel demand was not quickly forthcoming. However, with ticket prices again heading

downward in early 2009, one view was that there might be a substantial demand recovery in

2009.

Problems of Air India

Competition & Capacity Constraint

During 2008, Air India (AI) happened to be the only state-owned carrier operating in India (see

Exhibit 1 for a complete list of Indian airline carriers). (The other state-owned carrier, IA, had

been merged, by then, with AI). It was for AI that the turmoil in the airline market was most

burdensome. AI was already reeling under intense competition from private sector and facing

severe performance problems. Its market share was rapidly shrinking and it was virtually being

pushed to be a marginal player. In addition, it was in the early stages of operationalizing its

merger with IA. AI faced, apart from high fuel prices, increased interest burden of new aircraft

orders, personnel shortages, inability to cope with competition, and a worsening service image.

AI had extreme capacity constraints. Yet, reports revealed that 60% of AI’s proposed aircraft

acquisition was for replacement of old aircrafts and only 40% was available for growth (capacity

expansion). The National Aviation Company of India Limited (NACIL), the holding company of

AI, was exploring an equity infusion from government to meet its capital needs.

Struggle to Perform

AI operated both domestic and international routes. Its low cost arm Air India Express (AIX)

tried to meet the low cost needs of passengers in the Persian Gulf sector. Earlier, AI was

operating only international routes excluding the Persian Gulf sector, while IA operated the

domestic routes in addition to connecting the Persian Gulf sector. Both AI and IA did not

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historically have a consistent record of profits. Often, they struggled to survive and depended

heavily on government support. The government in the past had taken several measures to

improve their operations; but they continued to struggle.

Recurring Losses

During 1995-99, AI had accumulated losses of several billions of rupees. AI incurred losses of

Rs.55 billion in 2008-09, and Rs.33 billion in 2007-08 after settling one time wage arrears. AI’s

revenue fell in 2008-09 to Rs.134.8 billion from Rs.152.6 billion in the previous year (See

Exhibit 2 for summary financial statistics of AI during 2003-04-2008-09). Between 1996-97 and

2006-07, AI had accumulated a loss of Rs.8.30 billion, with first 5 years of profits of Rs.3.53

billion and the subsequent years of losses - losses amounted to Rs.5.4 billion in 2006-07 alone.

Performance Problems

As per reports, the major performance problem of the state carriers was the private competition

since 1990s. However, some analysts believed the real factors as (a) overstaffing, (b) aging fleet

and limited fleet size, (c) regulatory or policy constraints on outsourcing non-core activities and

on de-staffing, (d) higher cost of ATF due to higher prices, special taxes and a cross-subsidy

burden on oil products, (e) social burden of supporting loss-making routes, and (f) the burden of

supporting Haj pilgrimage and Prime Minister’s foreign visits with aircrafts. One estimate

showed that the employee to aircraft ratio of AI was over 3 times the international level! The age

of some of the aircrafts of AI was reckoned to be more than twice that of the major international

players. Of course, all these had been its problems earlier too. It was competition that finally

took the wind out of its sails.

Formation of NACIL

After trying out several measures to improve the performance, the government finally decided to

merge AI and IA in 2007. The key objective of the merger was to provide the resultant entity

scope for better efficiency and profitability by achieving larger scale of operations, greater

resources and a rationalized route structure, in addition to greater decisional autonomy. The

National Aviation Company of India Limited (NACIL) was formed as a holding company to

manage the new post-merger Air India. NACIL aimed at becoming an energy efficient,

competitive and premium international player.

In contrast to expectations, the post-merger AI experience was one of management

disorientation. Reportedly, a single entity was being operated at two headquarters, revealing

clear internal conflicts. Even after merger, AI and IA continued to have different flight

schedules. It could not meet the customer expectations any better, and the competitors continued

to wean away customers from AI. Under NACIL, AI was reckoned to incur operating losses of

Rs.21 billion (over US$450 million) during 2008-09.

Evolution of Indian Airline Industry

Formation of Air India & Indian Airlines

The airline industry in independent India began with the private sector. The most important

private airline at the time of independence was Air India International owned by the Tatas. Air

India International came into existence when Tata Airlines, set up in 1932, was made a public

company in that name in 1946.

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In the early 1950s, 8 private airlines were operating in the Indian domestic airline market. But,

the government decided to nationalize aviation industry, and in 1953 under the Air Corporations

Act, 1953, Indian Airlines (IA) was formed under government ownership by merging seven

private airlines. Subsequently, IA had dominated the domestic segment of the Indian airline

industry till early 1990s. The government incorporated Air India in June 1953 and nationalized

the air transport. Air India was given the right to run international operations as India’s flag

carrier when it took over Air-India International Limited.

Liberalization Era

The public sector grip on the industry continued until the early 1990s, when the sector was again

opened for private participation. The Air Corporations Act, 1953 was amended in 1994.

Subsequently, several new private players emerged as competitors and the market share of state-

owned carriers saw a steady decline. Some of the new private players who came into being since

the 1990s have ceased operations for various reasons. The government was not very keen on

foreign airlines entering the domestic airline market. It did not allow the Tata-SIA (Singapore

International Airlines) domestic carrier to take shape; the government also paved the way for

Kuwait Airways and Gulf Air shedding their equity stake in Jet Airways.

State-owned Carriers’ Performance

The state-owned carriers were suffering losses more often than they earned profits. A 1995

Commission set up to look into their losses favoured dilution of government equity and infusion

of new capital. A private partner was to be roped in - for both new capital and management

control. But, the attempts of Tata-SIA combine and Ashok Leyland-Hinduja combination to get

into the state-owned carriers did not work out due to resistance from various quarters within

India (most prominently, employee unions). The disinvestment plan had to be put off.1

Subsequently, the state-owned carrier AI faced network contraction as well as rapid market share

losses. According to a former senior executive of the airline, AI had earned a daily profit of

Rs.10 million during 1980s and its performance declined due to a bloated workforce and an

aging fleet. Now that it is going from bad to worse, many believed it was not yet time to

conclude privatization of AI as jettisoned for ever; for them, it might be only a matter of an

opportune moment.

Organizational Changes

To look after certain regional requirements, in 1996 IA had created a subsidiary, Alliance Air,

which had subsequently ceased to operate. Performance problems of its own and its parent had

plagued the carrier right from beginning; but, its discontinuation of services came with the

merger of AI and IA. The operations of Alliance Air were to be integrated into the Air India

Express and the Boeing fleet of the carrier was to be absorbed into the Air India Cargo services.

1 Not that privatisation or disinvestment was unpalatable to the reforming India. Several central public sector

enterprises including oil companies have already experienced varying levels of disinvestment. The improvements

in customer service achieved after privatisation in sectors like telecom and by private airline companies had

created a favourable public opinion in favour of privatisation. A major stumbling block to widespread

privatisation, though, was the influence of leftist parties on the government. In the airline context, however, the

aggressive trade unions of AI and IA were particularly hostile to privatisation efforts. And, the government lacked

the will to fight them in view of their strong political clout and bullying tactics. The AI-IA employees were

notorious for their flash strikes on even minor issues. The passengers indeed strongly resented the attitude of AI-

IA staff.

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The name of Indian Airlines (IA) was changed in 2005 to ‘Indian’ as part of a strategy for

revitalizing its services. However, it did not alter the fortunes of IA in any noteworthy manner.

Finally, the government decided to merge IA with AI and by 2008 the two airlines began joint

operations. Still, several hitches reportedly persisted. Industry analysts believed that even

NACIL would be incapable of becoming a strong international player compared to Emirates,

Singapore Airlines or Thai Airways since it faced several size and network constraints.

Rise of Private Airlines

The problems dogging the national carriers had facilitated the rapid rise of private airlines in

India ever since the industry was opened for private investment in the early 1990s. Refer Exhibit

1 for a list of private airline players in India since 1990s. Each of the major private players such

as JA and KA had a stronger market position than the old guard state-owned carrier, the post-

merger AI. Let us briefly look at the main private competitors.

Jet Airways (JA)

JA was incorporated as a private company under the Companies Act in April 1992 and became a

scheduled airline in January 1995 after operating as an air taxi since May 1993. JA became a

deemed public company in July 1996, got converted to a private company in January 2001 and

again became a public company in December 2004. Tail Winds was the largest shareholder of

the company and Naresh Goyal was owning 100% of Tail Winds. During 1994-1997 period 20%

each of the shares were owned by Gulf Air and Kuwait Airways; but a change in government

policy with respect to foreign investment in domestic carriers necessitated buying out the equity

of the foreign airlines by Naresh Goyal in October 1997. When JA commenced its operations in

1993 it had just 4 leased aircrafts whereas it increased by 2008 to 100 aircrafts that operated well

over 2000 flights a week, including to international destinations such as London. The quest for

fast expansion of market reach and secure leadership as well as for an entry into Low Cost

Carrier (LCC) market culminated in JA acquiring Air Sahara (AS) in 2007 after an earlier fizzled

out attempt. AS was re-branded as JetLite and was operated as the LCC arm of JA. JA became

the top player in the market with a market share of nearly 30% together with JetLite; but KA was

aggressively trying to occupy the top slot and was fast closing the gap.

Air Sahara (AS)

AS was established as ‘Sahara Airlines’ by the Sahara Group in 1991. It began operations in

1993. Its operations were initially focused on the northern part of India and it expanded

subsequently to major cities in other regions. Sahara Airlines was rechristened as AS in 2000. It

began international operations in 2004 (to Colombo). In 2006, JA attempted a takeover of AS –

but, despite the government approval of the same, the attempt failed (primarily due to differences

over price). After a bit of acrimony over the failed attempt, finally in 2007 JA acquired AS and

renamed it as JetLite. JA designated JetLite as its LCC arm. The AS acquisition immediately

catapulted JA to a leading position among airlines in India.

Kingfisher Airlines (KA)

KA was founded in 2005 as a full service airline by the domestic liquor baron, Vijay Mallya,

known for brand name Kingfisher. KA’s aggressive strategies have culminated in the rapid build

up of market share and the established players like JA and IA were running for their money. KA

was looking for acquisition targets both to expand services and to get a firmer footing in the

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Indian airline market. Finally, in 2007, KA succeeded in getting Air Deccan (AD) merged with

it; AD was subsequently converted into the low cost arm of KA under the new name Kingfisher

Red. The AD acquisition enabled KA to commence international operations early in 2008.

Otherwise, KA should have waited till 2010 to complete the mandatory 5 years of domestic

operation. AD qualified for it by 2008. KA enjoyed the second highest airline market share in

India and was approaching the top, presently occupied by JA, quite fast.

Air Deccan (AD)

Air Deccan, the pioneer among the low cost airlines in India, was owned by Deccan Aviation

that was incorporated as a private company in June 1995 and, then, converted to a public

company in 2005. Deccan Aviation used to provide helicopter and air chartering services. Air

Deccan itself was established in 2003. In the first few years after establishment, AD was looking

towards breaking even; but the intensifying competition in the low cost segment made its

operations difficult. The carrier needed a fresh infusion of funds to meet its expansion plans and

even routine operations. Its first public equity issue was not very successful as the expected

premium did not come forth mainly due to a difficult stock market. This and other related

developments paved the way for a merger with KA in 2007. KA was looking for strengthening

its operations and was planning to begin international operations in 2008 taking advantage of the

completion of 5 years of operations by AD that was mandatory for commencing international

operations. The fuel crisis of 2008 would have taken the wind out of AD’s sails if it was not in

the company of KA. KA quickly integrated AD into its fold by renaming AD as Kingfisher Red

(KR).

Other Airlines

A clutch of airlines surfaced in the 1990s soon after the liberalization of the sector. These

included Damania, NEPC, East West and ModiLuft. All of them failed. One major reason for

their fate, according to reports, was that the entrepreneurs had little idea of airline business. Less

than a decade later, a few other airlines emerged in full service and low cost segments. The

names included GoAir, IndiGo Air, Paramount Airways and SpiceJet. Several of those who were

associated with the failed airline ventures of 1990s were associated with some of the new airlines

such as SpiceJet and KA. With multiple players, the intensity of competition became extremely

high and only some of these players were expected to survive in the long run.

Future Reforms

Further liberalization in airline industry was felt imminent by observers. To explore the

possibilities in the bilateral agreements with foreign governments and in the open sky policies to

the fullest extent, the government contemplated to give more opportunities to private investors.

Privatization of the public carrier was another pending task of the government, according to

many critics.

Industry Performance Traffic Growth

For the first time after the year of the WTC terrorist attack, air traffic growth was projected to be

negative during 2008-09. Passengers carried by domestic airlines in India (DGCA data) were

17.65 million in January-May 2007 and 19.24 million January-May 2008. Passenger growth

(domestic plus international) of that part of 2008 was only 2-3%. During September 2008, there

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was a traffic decline of 18% and during October-December, the decline was of 8-10%. Exhibit 3

presents some data on air passenger traffic since 2001. Figure 2 shows the 25-year trend in

passenger traffic, domestic and total, in India.

International Traffic

International traffic was rising in major airports in India even as domestic traffic slowed down or

declined in the months of 2008. Exhibit 4 provides some insights. For some idea on the 5-year

growth of international traffic to and from India, see Exhibit 5. Needless to say, AI did not

receive commensurate benefits out of the growth in international traffic.

Capacity & Demand Growth

See Exhibit 6 to understand the rate of annualized growth of Available Seat Km and Revenue

Passenger Km in the Indian Airline industry during 1997-98-2006-07. Passenger growth rate

(RPKm) exceeded capacity growth (ASKm) in the 10-year period.

Figure 3 provides a better picture about the growth and behaviour of ASKm and RPKm in the

domestic private airlines during a 10-year period of 1997-98-2006-07.

Operating Performance

Between 1998 and 2007, sales and total income of Indian airline industry had grown by more

than 200%. There was a rapid increase in expenses too; still, operating profit had moved up.

Between 2004 and 2007, the post-tax profit remained positive and higher than in the preceding

years where profit was made. While assets expanded commensurate with sales growth, debt did

not expand between 1998 and 2007 in a way that should have caused concern. Accordingly,

debt-equity ratio actually declined in the more recent years. However, carried forward losses

continued to taunt the airline industry. See Exhibit 7 and 8 for details.

Other income of airlines as a proportion of total income was growing fast between December

2005 and June 2007; but it sharply declined thereafter. Profitability too declined during this

period. The interest burden posed a source of concern in the recent years. Some details in this

respect are given in Exhibit 9. The stock market performance of the 5 listed airlines was

impressive till the close of 2007; but market capitalization fell by mid-2008 to below half of the

closing levels of 2007. Exhibit 10 provides some data.

After 2004-05 there was a change in the behaviour of operating expenses per RPKm in relation

to operating revenue per RPKm. Till then, both of them increased, stagnated or declined

together. After 2004-05, the operating expenses per RPKm increased, regardless of the

stagnation or fall in operating revenue per RPKm. This could be attributed to the greater intensity

of competition since 2005 when many new airlines entered the fray and vied for revenue, but

caused in the process cost of all airlines to mount.

Productivity

Different airlines were found experiencing different efficiency or productivity levels. See Exhibit

11 for selected performance data. The private airlines JA and AS had a much lower number of

employees per aircraft in 2006-07 than IA or AI; AI had the highest ratio. Air Sahara had the

lowest employees per aircraft ratio in 2006-07 while for AI it was more than 3 times that ratio.

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IA had the highest operating revenue per passenger among the domestic carriers; but, its

operating expenses per passenger exceeded revenue by about 25%.

Growth of Private Services

Despite multiple difficulties, new private airlines increased their market share rapidly. They were

doing aggressive marketing. In May 2008, the JA-JetLite combine had a market share of 29.1%;

KA-KR combination had a market share of 28.4; and AI’s share was just 14.8.

Company Strategies The airline’s strategies consisted of multiple elements.

S-Curve

Traditionally, the S-curve concept was used in the airline industry to strengthen an airline’s

market position. An S-curve signified the phenomenon by which a carrier dominating a route or

an airport based on frequency (share) of flights got a disproportionately high share of traffic and

revenue there. The knowledge of S-curve was used by airlines to do everything to dominate the

airports and routes or to move out of sectors or routes where an airline did not enjoy an S-curve

advantage. Unfortunately, hardly any S-curve effect was left with Air India, due to reasons of

strategy and service quality, despite its and Indian Airlines’ long time dominance of the Indian

skies and airports. This had strong implications for its competitive position and market share.

LCCs & the S-Curve

Evidence from countries like the USA indicated that airlines should not look much for an S-

curve advantage in markets where low cost carriers (LCC) competed, where two established

carriers were not dominant or where other new trends were manifest. In India, in recent years the

LCCs emerged as a significant force. It was anticipating private foreign and domestic

competition in the lucrative Persian Gulf sector, and due to political pressure to reduce fares in

these sectors, that AI had created AIX. AIX’s declared mission was to provide convenient

connectivity to passengers in the short-range routes at the most affordable prices. AIX fares

ruled 25% below normal AI fare. It was reported that AIX had taken off well. Considering the

growth of LCCs in India, one could have expected very little scope for realization of an S-curve

effect. As already noted, AI was definitely not getting much out of the S-curve.

HAS & PTP Models

The hub-and-spoke (HAS) model used to be a favourite of traditional full-service carriers. In

HAS model, all destination points (spokes) around a hub were linked to the hub. The point-to-

point (PTP) model was a preferred one with LCCs because of the cost saving and operational

flexibility that offered. It was said, the competition between the full-service and low-cost carriers

was, in a way, a competition between the HAS and PTP models. Nonetheless, the airlines

appeared to practise a mix-up of the two particularly when they operated both full-cost and LCC

operations simultaneously. AI’s experience in this respect was in tune with the overall trend.

Global Airline Alliances

Joining world wide airline alliances to extend the reach of services had become an important part

of the recent strategy of airlines. After the merger with Indian Airlines, AI had sought and prima

facie obtained, with the help of other friendly airlines, membership in the Star Alliance, which

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was considered to be the largest airline alliance in the world (It is another matter that

subsequently AI ran into difficulties in operationalizing the alliance entry, due to problems in

fully integrating IA operations into AI).

International Services

On the international service front, the Indian rivals’ determination to challenge the dominance of

AI in international traffic was visible. AI took counter measures. It began a non-stop flight

between India and USA after acquiring a long range aircraft. The non-stop operations were

planned to expand in future.

Domestic Combinations

The strategy of alliances encompassed not only international operations, but also the domestic

one. In India, the mergers between IA and AI, JA and AS, and KA and AD were allegedly

affecting airline industry structure itself. However, all such alliances or mergers were not found

rewarding. In the case of IA-AI combination it was pointed out that there was very little scope

for synergy between them. For instance, observers noted that aircrafts used by the two airlines

were dissimilar. IA had defaulted on a lot of payments. Debt was huge with AI. The culture of

the two airlines was found to be different. There were two parallel power centres even after the

merger (Delhi of AI and Mumbai of IA). Synergy in facility deployment and in management was

not forthcoming. Interestingly, JA and KA later formed an operational alliance for cross-selling

seats, common ground handling and code sharing. Rs.15 billion was expected to be saved

through the alliance. Officials and analysts felt that the JA-KA alliance (with a 60% market

share), or any other such alliances, might lead to cartelisation, monopoly practices and predatory

pricing. So, it was felt, such an alliance might need regulatory scrutiny.

Fare Adjustments

To attract passengers, airlines needed to reduce fares. The sharp sustained decline in the fuel

prices in the second half of 2008 had given the airlines room for reducing fares that they had

jacked up in the first half of 2008 when oil prices were climbing steeply. Airlines subsequently

started re-entering the routes earlier vacated by them; but they did not cut prices the way they

raised it. AI was working, since mid-2008, on cutting down international fares (Delhi-London

etc) to woo back lost passengers and to increase load factor above the industry average of 60%

and to the load factor of 70-75% achieved by the foreign carriers flying out of India. The Indian

Civil Aviation Ministry had also reportedly asked AI to work for raising load factor and for

profitability.

All Inclusive Fares

For some time customers were complaining about the hidden costs of air travel in India. Often,

the quoted fares could be a misnomer since other levies formed a large proportion, some times

more than 50%, of the total fare a passenger needed to pay. Difficulty with quoting an all-

inclusive fare (fare that includes fuel surcharges, taxes and other levies) was the frequent

changes in tax rates and fuel charges across countries. Some airlines recently started addressing

this issue by quoting all-inclusive fares for marketing purpose. AI was planning to do the same.

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Zero Commission

Airlines in India were moving towards a zero-commission structure (followed abroad) for travel

agents, who numbered about 8000, with 2000 affiliated to IATA. These agents received Rs.10

billion as commission from the top 3 airlines in India. AI initiated the policy by announcing ‘no-

commission’ by October 2008. The travel agents were expected to recover their revenue as

booking charges from customers. The travel agents were not too happy about this and a forced

reversal of the policy was quite possible.

Seasonal Fares

Airlines effected seasonal variations in fares: for instance, during the monsoon season, they

lowered their fares or gave large discounts in international sectors connecting India. See Exhibit

12 for mid-2008 off-season fares in selected international routes. AI announced its seasonal fares

from time to time. It also offered round trip holiday packages at attractive rates for travel within

India and outside.

Strategic Issues There are many strategic issues to be addressed by AI. Some are discussed here.

Competition

Competitive worries formed a basic strategic issue for AI. It encompassed both domestic and

international routes. On the domestic front, private airlines steadily increased their market share

(see Exhibit 13). In international operations, although AI had near monopoly within India till a

few years ago, AI could not compete successfully with foreign companies in this segment due to

its smaller size, capacity constraints, resource problems and poor customer service record.

Customers

Satisfying existing customers and attracting new ones was the second important concern. The

need to cut operating expenses had forced AI to compromise on customer services. In the mean

time, Indian Railways came up with competitive packages to win back customers lost to LCCs in

particular. It was working. So, AI had to worry a lot on customer front. It had lost confidence of

the customers over the years and winning them back was not easy in the face of persistent

competition.

Growth

Business growth commensurate with a sustained fast growth of demand was a crucial objective

for airlines in general. The growth of an airline can be measured in terms of number of aircrafts,

passengers and cargo or revenues. The number of aircrafts had increased during better times, but

the problem was when demand was contracting. One way airlines solved this was by leasing

aircrafts. Still, buying was preferred by major airlines. AI had on order 111 aircrafts for a value

of Rs.430 billion. Most of these were yet to be delivered. Since they could be beyond AI’s means

when delivered, their delivery could be delayed on mutual consent. AI had another 60 new

aircrafts on discussion with manufacturers. Given the shadow of a recession across the world, AI

was feared not to be able to sustain itself with such capacity. It was looking for government

capital infusion, to the tune of Rs.10 billion. Funding growth and maintaining expanded

operations profitably might remain a pre-occupation of not just AI, but all carriers in India.

13

Government Actions

The government role in airlines was significant. The government policies decided the level of

foreign participation, the number of players entering the industry, foreign sectors available for

domestic players, ability of domestic carriers to fly international routes and so on.

The civil aviation policy in India had been evolving. As of early 2009, the foreign carriers or

investors were not free to have a controlling stake in domestic carriers. Although the government

was more open about a future policy, not all Indian operators were unanimous in either

supporting or opposing freer foreign investment in Indian aviation sector. For AI, foreign

investment could mean the strengthening of domestic competition from existing and new

players. Whatever the past responses, pressure was gradually building up on the government to

fully open up Indian airline industry and AI could be hard-pressed to invent new strategies. On

the other hand, if the government accelerated the process of privatization of AI as attempted in

the past, it might herald a new era for AI.

Operational Issues

Cost

Managing the operating cost was a major operational concern of AI and other airline companies.

Aircraft utilization had come down due to falling demand. AI faced more or less the same cost

structure as private players with respect to most of the major items. However, AI had a high-

wage structure while its employee efficiency was low. An advantage of AI was that it had its

own ground handling system due to which its cost of ground handling was lower.

If AI had used hedging earlier, one report indicated, it would not have faced an unprecedented

increase in jet fuel cost during the 2008 crisis. South West airlines hedged over 70% of its fuel

needs and it was getting oil at $51 a barrel when international price was $135 a barrel. AI started

hedging 4-5 years ago with a 10% of requirement. AI subsequently increased it to 15%. But, it

stopped hedging when oil prices stabilized at $40 a barrel. Incidentally, crude oil-ATF price

correlation appeared high – based on past data, it worked out to be 0.9.

There were a few difficulties with hedging. One, to hedge a million litres of ATF requirement,

several dozens of contracts of crude oil were required. Second, when hedging is done, a crude

price fall could impair the hedging airline’s ability to adjust costs. In other words, sometimes

hedging itself can be a drainer. For instance, Air New Zealand had lost huge sums in hedging

during 2008-09. Many Asia-Pacific airlines were facing similar losses in 2009. There were other

competitive implications such as the cost of hedging. In 2008 Southwest Airlines paid out $52

million as hedge premium while it hedged 70% of fuel requirement. It had saved about $350

million of its cost due to hedging (except for this saving, Southwest Airlines would have reported

an unprecedented loss during the corresponding period). Hedging premium might sometimes be

more than 10% of the fuel cost. Besides, hedging demanded sufficient cash flow and it was

weaker airlines that often failed to hedge. AI was indeed a weak one and it had no money to bet

against an uncertain event of a rapid fuel price surge. Hence, because of a combination of

factors, AI, like other Indian airline companies, refrained from hedging and lost money in the

process.

14

Insurance of aircraft constituted another important cost factor. A 100 fleet airline may have to

shell out about Rs.300-400 million per annum on this account. AI had a huge burden on this.

Mix of Aircrafts

The type of aircraft selected was an important factor adding to operating cost per passenger.

Bigger aircrafts like Boeing 737 and A320 were generally more economical, but uneconomical

in shorter routes. They needed to be deployed in sectors where there was a higher passenger load

factor. Airlines maintained an array of aircrafts of different sizes. But, variety brought up its own

problems – both cost and technical. The headache of AI in this respect was big given the

different types of aircrafts that the pre-merger AI and IA preferred.

Manpower

Another crucial issue related to the availability of adequate trained, technical manpower and the

ability to retain employees. Airlines were hiring pilots and other technical personnel from abroad

to overcome their domestic shortage. AI was training its own pilots for 5 decades. AI’s pilot

training institute, Central Training Institute, got a DGCA approval as an evaluation test centre, or

Type Rating Training Organization, for pilot training courses for A320. It was proposing to start

training other airline pilots within the next 2 years. Even then, retention problems were causing

anxiety. Poaching by other airlines was indeed an issue at AI.

Revenue

Excess capacity and intensive competition had led, till mid-2008, to an unprecedented fall in the

base fare of airlines. This had profoundly impacted their revenues and profits. When they raised

the base fare during the fuel crisis, the load factor plummeted. Again, revenue and profits

suffered. So, how to increase revenues and profits with a falling fare and a rising operating cost

was a crucial question before AI in the recent past. So would it be in the future.

Funding Growth

To meet the size objectives and the capacity needs of the carrier, AI required substantial aircraft

acquisition. But, finding resources was a major hindrance. In the aftermath of the oil crisis and

associated problems, major aircraft acquisition decisions had to be revisited. With severe

performance problems and losses, internal funding of any capacity build up was impossible.

Government financial support was also not easy to come. Given its health, whether AI would be

able to raise funds from market or get favourable credit terms from vendors is more than a

million dollar question.

Future Outlook

At the end, uncertainty shrouded the future of AI. How far the exuberance on future growth of

the industry might go in AI’s favour was anybody’s guess. Would it even survive its current poor

health and the pressure of domestic and global competition? A major distressing fact highlighted

by analysts was that a rapid growth was necessary for AI to build its size to compete

internationally with global airline giants; but growth alone was not a sufficient condition for

profitable operations as revealed in the past. Thus, growth and profitability would be two

overwhelming strategic concerns of AI in the year ahead and beyond. ‘Cash’, of course, would

be more fundamental.

15

Figure 1.a

Trends in International (US) Crude Oil Prices

Trends in Annual Average Crude Oil Prices: USA 1982-2009

0

10

20

30

40

50

60

70

80

90

100

1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

Year 1982-2009

Pri

ce i

n $

Figure 1.b

Trends in International (US) Crude Oil Prices

Trends in Average Monthly Crude Oil Prices: USA 2007-2008

0

20

40

60

80

100

120

140

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Months 2007-2008

Pric

e i

n $

16

Exhibit 1

Players in the Airline Industry in India Airline Year of

Commencement

Nature of

Service

Current Status Year of

Closure

Air India (AI)* 1946 Full Running

Air India Express (AIX)* 2005 Low Cost Running

Air Sahara 1993 Full Merged with JA 2007

Alliance Air* 1996 Full Integrated with AI 2007

Air Deccan (AD) 2003 Low Cost Merged with KA 2007

GoAir 2004 Low Cost Running

Indian Airlines (IA)* 1953 Full Merged with AI 2007

Indigo Airlines 2006 Low Cost Running

Jet Airways (JA)$ 1995 Full Running

Jet Lite 2007 Low Cost Running

Kingfisher Airlines (KA)@ 2005 Full Running

Paramount Airways 2005 Full Running

SpiceJet 2005 Low Cost Running

Damania Airways N.A Defunct

East-West Airlines 1992 Defunct

ModiLuft 1994 Defunct 1996

NEPC Airlines N.A Defunct

* Public sector carriers; Alliance Air was subsidiary of IA & integrated with AI after formation

of NACIL; AIX is subsidiary of AI

$ Operates both domestic & international routes

@ Recently commenced international operations

Source: Compiled from various sources

17

Exhibit 2

AI: Summary Financial Statistics 2003-04-2008-09

Year Revenue Fuel & Oil

Cost

Labour

Cost

Other Op.

Expenses

Profit Before

Tax (PBT)

2003-04 62.5 13.4 11.1 36.6 0.1

2004-05 77.3 21.9 11.8 42.7 0.5

2005-06 92.4 31.4 12.4 48.5 0.1

2006-07 92.2 35.3 13.4 50.0 -5.4

2007-08 152.6 62.5 32.2 83.8 -33.0

2008-09 134.8 62.0 NA NA -55.2

Note: All figures are in billions of rupees

Source: Media reports for 2008-09; AI website for other years

Exhibit 3

Air Traffic Growth

Year Traffic

(Million)

Growth

(%)

2001 12.8 -3.8

2002 13.3 4.0

2003 14.5 9.2

2004 18.2 25.0

2005 22.3 22.8

2006 32.7 46.5

2007 43.3 32.5

2008 (Till

Sept.)

31.5 -0.7

18

Figure 2

Trend in India's Airline Passenger Traffic

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

50000

1 3 5 7 9 11 13 15 17 19 21 23 25

Years (1982-2006-7)

Passen

gers

in

Th

ou

san

ds

Domestic

Total

Exhibit 4

Air Traffic: Domestic vs. International

(April-June Period)

Airports Domestic International

2007-08 2008-09 Change

(%)

2007-08 2008-09 Change

Mumbai 4,425,605 4,526,942 2.28 1,914,610 2,080,822 8.68

Delhi 4,198,954 4,452,722 6.04 1,639,696 1,770,794 8.00

Chennai 1,911,571 1,811,131 -5.24 817,613 926,894 13.36

Kochi 357,082 418,376 17.16 431,366 528,213 22.45

19

Exhibit 5

Growth in International Traffic (Airline) To & From India

Year Passengers

(Million)

% Change

2002-03 13.16 10.5

2003-04 14.63 11.2

2004-05 17.27 18.0

2005-06 20.17 16.8

2006-07 23.37 15.9

Exhibit 6

Growth Rate of Available Seat Km & Revenue Passenger Km:

Indian Airline Industry 1997-98-2006-07

Annualized Growth %

ASKm RPKm

12.81 13.65

Figure 3

Trends in Available Seat Km & Revenue Passenger

Km: Private Carriers

0

10000

20000

30000

40000

50000

1 2 3 4 5 6 7 8 9 10

Years (1997-98-2006-07)

AS

Km

& R

PK

m

(Millio

ns

)

RPKm

ASKm

20

Exhibit 7

Indian Airline Industry – Income & Expenses

(Rupees in Billion)

Item 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Total Income 93.4 100.4 127.8 142.5 147.1 161.0 183.5 218.9 269.5 293.6

Sales 84.1 96.0 123.1 138.1 140.6 155.1 176.2 212.3 254.5 277.7

Other Income 9.2 4.3 4.8 4.4 6.6 6.0 7.3 6.6 15.0 15.9

Total Expenses 78.5 84.5 107.4 123.4 125.2 139.1 153.4 185.0 232.0 263.3

Power & Fuel 15.5 14.9 20.8 27.5 26.4 31.5 35.9 52.9 78.3 90.4

Personnel 19.8 24.3 26.9 28.3 31.2 32.6 34.0 36.6 41.4 46.0

Operating Profit 14.8 15.8 20.4 19.2 21.9 22.0 30.1 33.9 37.4 30.2

Interest Payments 5.5 5.4 5.5 6.1 5.3 4.6 4.2 3.4 4.0 4.0

Depreciation 7.9 8.6 11.2 12.5 14.3 16.1 16.6 16.1 16.1 16.2

Tax 1.2 1.3 1.4 1.5 2.4 2.3 2.7 5.9 8.0 5.6

PAT 0.2 0.4 2.2 -0.9 -0.2 -1.0 6.6 8.5 9.3 4.5

Dividend 0.4 0.4 0.5 0.1 0.8 0.8 0.9 1.5 2.5 2.5

Losses CF -7.0 -8.6 -7.0 -9.3 -12.1 -15.2 -15.8 -11.4 -11.2 -13.4

Source: Compiled from various sources

21

Exhibit 8

Indian Airline Industry – Funds & Assets

(Rupees in Billion)

Item 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Total Funds 86.2 81.7 96.3 97.0 111.4 98.3 88.7 104.9 173.0 185.3

Owners’ Funds 19.3 19.2 23.6 24.8 26.6 23.1 31.4 52.2 72.9 73.7

Debt 66.9 62.4 72.7 72.3 84.8 75.1 57.3 52.7 100.1 111.6

Total Assets 86.2 81.7 96.3 97.0 111.4 98.3 88.7 104.9 173.0 185.3

Net Fixed Assets 80.2 79.9 93.1 96.8 99.5 102.2 97.8 88.7 96.0 108.4

Capital Work in

Progress

6.6 6.0 5.4 6.2 16.3 7.1 4.9 7.5 41.3 58.0

Net Current Assets -2.5 -5.9 -2.7 -6.5 -4.7 -9.0 -13.6 -4.0 36.1 19.7

Debt-Equity Ratio 3.47 3.25 3.08 2.92 3.19 3.25 1.82 1.01 1.37 1.51

Current Ratio 0.95 0.90 0.96 0.92 0.95 0.91 0.87 0.97 1.29 1.14

Exhibit 9

Financial Indicators of Airline Industry: Selected Quarters (%)

Quarter Other Income/

Total Income

PBDIT/

Net Sales

Interest/

PBDIT

PAT/

Total Income

Jun 2005 2.66 19.5 23.9 5.32

Dec 2005 1.62 13.9 29.4 2.46

Jun 2006 2.86 2.4 251.0 -2.65

Dec 2006 6.04 4.0 78.0 0.95

Jun 2007 8.31 -3.9 -87.2 -4.39

Dec 2007 3.50 -2.1 188.9 -8.30

22

Exhibit 10

Stock Market Performance of Airlines (5 Private Companies*)

Date Market Cap

(Rs. Billion)

Returns

(%)

Dec 2006 80.9 -4.1

June 2007 101.3 1.6

Dec 2007 147.6 23.5

May 2008 71.6 -9.0

* AD, AS, JA, KA & SpiceJet

Exhibit 11

Performance Indicators of Selected Indian Carriers: 2006-07

Indicator Values in Rupees*

IA** AI JA Air

Sahara

Employees per Aircraft (*Number) 253 439 176 137

Operating Revenue per Employee

(Millions)

3.40 5.49 6.37 5.30

Operating Expenses per Employee

(Millions)

4.18 6.29 6.41 6.90

Operating Revenue per Passenger 6,828 19,435 6,572 6,336

Operating Expenses per Passenger 8,404 22,261 6,620 8,085

Operating Revenue per RPKm 5.04 4.35 5.70 5.20

Operating Expenses per RPKm 6.21 4.98 5.80 6.60

** Includes Alliance Air

23

Exhibit 12

Attractive Off Season Return Fares

Route/Sector Airline Fare (Rs)

Mumbai-Singapore Jet Airways 16,400

India-Perth Singapore Airlines 35,555

India-New York Etihad 45,900

India-London Qatar 29,000

The Economic Times, 25.6.08

Exhibit 13

Structural Change in Domestic Traffic: State-owned vs. Private Carriers

Year Passengers

(Millions)

Passenger Share %

Public

Carriers

Private

Carriers

Non-

scheduled

1997-98 11.74 67.1 31.3 1.7

1998-99 12.18 61.9 36.8 1.3

1999-00 12.94 56.3 41.9 1.8

2000-01 13.96 50.8 47.4 1.8

2001-02 13.10 49.0 49.1 1.9

2002-03 14.23 43.9 54.1 2.0

2003-04 15.92 42.1 56.4 1.5

2004-05 19.74 39.7 58.7 1.5

2005-06 25.58 30.3 68.2 1.5

2006-07 36.24 21.8 76.9 1.2

Source: Compiled from various sources

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