Week 1:

Overview of the Aviation Industry

PGDM (Semester 1)

1For class discussion at NDIM

Service sector in India: Key StatisticsThe service sector in India constitutes roughly 57% of our national wealth. i.e. about USD 1.1 Trillion

Key segments include:1.Banking and Financial Services2.Organized Retailing3.Education Sector4.Health Care Sector5.Hospitality Sector – accounting for 6% of India’s GDP and this includes the contribution of the airlines business estimated at USD $ 6 Billion.6.Independent Services

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Aviation sector• Duopolistic Market with Two aircraft manufacturers :

– Boeing; and – Airbus

• Aircraft engines typically supplied by – Rolls Royce– General Electric; and– Pratt & Whitney

• Outsourcing of activities leads to cost rationalization and focus on key areas

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Aviation in India and Rest of the World

In terms of Air traffic, India will be the fastest growing country for air travel for the next 10 years.

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India

2010-2018 2019-2028 20-Year Growth

World

2010-2018 2019-2028 20-Year Growth

12.2% 6.6% 7.3% 4.6% 4.8% 4.7%

Aviation sector: Profitability factorsProfitability Drivers in aviation sector

Aviation Turbine Fuel (ATF) estimated at USD 1200/ KL constitutes – 45% - 50% of total cost of operations.

(ATF prices are increasing on rupee devaluation against a basket of foreign currencies)

Government allowing import of ATF prices which are much lower than domestic prices due to low tax incidence and this would provide some breather

For class discussion at NDIM 5

ATF• ATF – Aviation Turbine Fuel• Aviation Turbine Fuel is a specialized type of

petroleum-based fuel used to power aircraft.• It is generally of a higher quality than fuels

used in less critical applications, such as heating or road transport

• ATF contains additives to reduce the risk of icing or explosion due to high temperature, among other properties.

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Aviation sector: Profitability factorsProfitability Drivers in aviation sector

Manpower and administration costs accounts for 22% of the total cost as foreign pilots and technical staff demand high salaries

Profitability hinges on seat load factor, usage of fuel efficient aircrafts, High turnaround rate, other non ticket incomes, outsourcing of key services, etc

LCCs are emphasizing on reducing manpower engagement and cutting costs to the extent possible to recover profits

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Aviation sector: Concern Areas• Highly competitive industry due to entry of private players• Leasing of aircrafts a preferred option – but need to generate

sufficient cash flows to retire debt obligations• Rising fuel costs and erratic fluctuations due to crude oil prices

being volatile and rupee depreciation adding to the woes• Outsourcing non core activities and productivity of manpower

critical for profits.• Overstaffing and operations in non viable routes for national

carriers create profit pressures• Airlines willing to invest mainly in fuel efficient aircrafts like

Boeing 737 600 (South West Airlines) A – 320 (Indigo) and B 787/ 777 by JAL and AirIndia for long overseas routes

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Low Cost Carriers: Success Factors1. Low cost implies low fares and minimum facilities and

in-flight entertainment and support services2. No Frills, ancillary revenues are important3. Hidden charges, pay extra for not being attentive

(Printing of Boarding Pass, Check in, Meals etc)4. Operation of standardized fuel efficient aircrafts5. High utilization of aircrafts – quick turn around times6. Short distances, high frequency7. Avoiding overstaffing, achieving high seat load factor8. Operate out of less busy, smaller, cheaper airports

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Southwest Airlines - Low Cost U.S. Carrier• Started operations in 1971, HQ-Dallas, Texas, USA – pioneer in low cost

air travel• Easy jet & Ryan air follow Southwest’s strategy in Europe• World’s largest low-cost carrier.• Reputed for innovative advertisements• FORTUNE listed it for the 10th year as among America’s top 10 most

admired corporations • Peculiar features:

– No Assigned Seats!– No Travel Agents, can book only on its own website, saves $50 Million (Rs

300 Crore) annually– Turn around time 15-25 mins, US industry Average 55 minutes– Only one type of aircraft, helps train better and build operational efficiencies

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Ryan Air - European Low Cost Airline• Started operations in 1985, HQ-Dublin, Ireland• CEOs maniacal focus on being the lowest cost producer

– Even encouraged staff to steal stationary from hostels & banks to save costs!– 25 Minutes turn around time, to get maximum aircraft utilisation– Often operate from smaller, less congested airports with lower costs

• Branded itself as the Bad Boy of the Aviation Industry– Often use provocative & Misleading ads that get the attention at a low cost– Enormous charges for small mistakes:

• € 70 per passenger if you forget to print your Boarding Pass in Advance• € 100 per passenger, if you want to check in luggage at the airport and not online

– Rated among the worst in customer service – almost being rude• Over 20% revenue from ancillary products (ie other than ticket sales)

example print boarding pass, inflight sales, airport baggage checkin, etc• Successful despite public opinion of being mean, uncaring & money

grabbing – offers the Lowest price tickets – 37% lower than the Easy Jet (the Second best low cost European carrier)

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Ryan Air – Lowest cost per Passenger in Europe Ryanair Easy Jet Norwegian Air Berlin Spirit Southwest

Staff 5 8 15 14 16 33

Airports & Handling 8 18 8 26 15 22

Route Charges 6 6 13 8 - -

Aircraft O’ship & Maint. 6 8 17 20 16 17

Sales & Marketing 2 6 12 31 4 2

Total 27 46 65 99 51 74

% vs Ryanair - +67% +137% +262% +86% +170%

Source: CAPA - Centre for Aviation and latest available accounts via Ryanair presentation 28 January 2013

Cost per Passenger (excluding fuel) is lower by 67% compared to the Second Low Cost European Airline

Air Asia - Malaysian Low Cost Airline• Started operations in 1996, HQ-Kuala Lumpur, Malaysia• Largest Low Cost Carrier in Asia (Both in Fleet Size & No. of Passengers)• Often Awarded as Best Asian Low Cost Carrier• Air-Asia India Launch Planned for October 2013• India JV Partners Include

– Air Asia – Tata Sons– Telstra

• Key people in Air Asia India include

• To start operations soon from Southern India and expand internationally• Innovative Fares (Free/999/1999 so on) and steep introductory discounts at the

initial stages

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Ratan Tata, Chief Advisor to the Board; Chairman Emeritus -Tata Sons

Tony Fernandes; Group CEO for Air Asia

Arun Bhatia Owner of Telstra; Son Married to LN Mittal’s only Daughter

Evolution of Aviation in India

• 1953 : 9 Airlines including IA & AI• 1953 : Nationalization of private airlines• 1994 : Private airlines allowed to operate• 1995 : Jet, Sahara, Modiluft, Damania, East West• 2003 : Air Deccan as India’s first LCC• 2005 : KF, Spicejet, IndiGo, Go Air, Paramount• 2011 : IndiGo international ; KF exits• 2012 : Govt allows ATF import, FDI -49%,

For class discussion at NDIM 14

Indian Aviation Sector – Current Scenario

Indigo has the Highest Market Share15

% Market shares of Aviation players in India (By Passenger Traffic)

Airline Estimated Net Profit (Loss) in US $ Millions (FY 2012-13)

Indigo 100-110

Go Air (15)

Spicejet (34)

Jet Konnect (53)

Jet Airways (87)

Kingfisher (510)

Air India (950)

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Indian Aviation Sector – Profitability

• Indigo – India’s Only Profitable Airline – On Time • Air India with Maximum Losses among all Indian airlines survives on Government funding• Kingfisher with almost half of Air India Losses - Perishes

The Kingfisher Story

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Established in 2003May 2005: Indian Commercial operations commence. Losses since 2005 itself

USP: Best in class, luxury airline, fancy meals, top domestic in flight entertainment, focus on quality flying experience

Sep 2008: International operations also startedNov 2010: Largely due to KF losses, UB Group shares at Rs 82 down from 52 week high of Rs 315

Mar 2011: Banks convert Rs 1300 crore of debt to equity at 61% premium, give little breather to KF, which continues to lose money

Sep 2011: KF Discloses substantial losses to the BSENov 2011: Financial results disclose the company is drowning in high interest debt and losing money

Nov-Dec 2011: Bank accounts frozen twiceSep 2012: Market share shrinks to 3% from 15% in 2009Oct 2012: Flying License suspendedFeb 2013: Government withdraws domestic & International flying entitlements

Jet – Etihad Deal• Etihad to invest Rs 2058 crores in Jet for 24% stake, premium of over

20%– Values Jet at Rs 8500 + crores – Naresh Goyal owns 51% stake in Jet

• FIPB yet to clear the proposal. Main issues to be considered– Who has Effective Control and What is the Ownership Structure

• Need to convince the regulator Eithad’s control is in line with its 24% stake

– Deal signed within 2 days after an agreement between India & Abu Dhabi assigned ~37,000 additional seats to Etihad

– Did Jet-Etihad know what the Government was planning and are the two deals linked?

• GOM initially approves the deal, PMO retracts• SEBI yet to accord final clearance• Deal being reviewed

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Current Policies in Indian Aviation

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• FDI upto 49% is allowed in Indian Airlines• In July 2013 a proposal to raise the FDI limit from 49% to 74%

was rejected• Up to 100% of NRI investment is allowed by the means of

automatic approvals pertaining to the domestic air transport services

• Proposal to allow airlines to directly import ATF • Discussion on Lifting the freeze on international expansions of

private airlines– Current you can not fly internationally unless you operate

for 5 years and have 20 aircrafts

FDI & FII• FDI is an investment that a parent company makes in a

foreign country.• FII is an investment made by an investor in the

markets of a foreign nation.• FII can enter the stock market easily and also withdraw

from it easily. • But FDI cannot enter and exit that easily.• Foreign Direct Investment targets a specific enterprise. • The FII increasing capital availability in general.• The Foreign Direct Investment is considered to be

more stable than Foreign Institutional Investor

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FIPBThe Foreign Investment Promotion Board

(FIPB) is a national agency of Government of India, with the remit to

consider and recommend FDI which does not come under the automatic route.

It provides a single window clearance for proposals on FDI in India.

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Aviation in India

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• FIPB: Foreign Investment Promotion Board to approve projects which are not under the automatic route

• FDI Automatic: This is permitted for certain categories of services in Aviation sector

• FDI requiring FIPB Nod: FDI norms specify that the FIPB nod is mandatory for certain categories of services, whereas approval of SEBI is mandatory for all Joint venture projects

Aviation in India: Benefits of FDI

• More Capital Infusion for fund starved airlines• Enhanced market access for carriers• Better consumer choice• Adding to government revenue earnings• Supporting Growth of hospitality sector• Transfer of technology and best practices • Scope for more employment

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Aviation in India: Limitations of FDI

• Heightened Competition and price wars• Industry consolidation is inevitable • Spate of mergers and acquisitions• Scope for cartelization• Severe operational challenges for airlines/ carriers• Few Survivors and consumer choice gets limited as

market is dominated by select few• Large scale lay offs and unemployment

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Aviation in India

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Aviation in India

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Aviation in IndiaRecent Govt. initiatives & Investments:• PPP mode for mega projects & operations viz

– Green field airports– Operation of some selected airports

• To invest Rs 20000 crores for– New international airports in Bhubaneswar & Imphal; and– 50 low cost domestic airports

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Indian Travel Websites

Source: Economic Times June 30-July 06, 2013 28

• Started around 2006-07 ie a time when Indian skies were buzzing with airlines, more were expected

• Airline commissions have fallen from 5% to 2% in the last 4 years, expected to decline further

– Airlines losing money are looking to cut costs & commissions– Airlines started to woo customers directly on their websites– Example: Online bookings for Southwest Airlines are only on its own website

• Future for these sites seems to be with Online Hotel Bookings– 5 Domestic Airlines Vs 45,000+ Premium Hotels in India itself– Only 500 Branded hotels, rest are fragmented, opportunity for a booking website to add

value to customers– Commissions with Hotels typically 5 times higher than airlines– Already 75% of hotel sales are online

• 60-70% of Current revenue of Yatra.com & Cleartrip.com is from Ticket sales• Ticket & Hotel sales expected to generate 50:50 revenue in 18 months

Aviation Industry: Key Takeaways• Understanding the dynamics of the aviation sector• Assessing the factors determining profitability• Assessing the global and Indian market trends• Understanding the operational/ Business Models of Low Cost carriers

Vs Full Service Carriers• Identifying success stories for select airlines abroad and in India• Examining the reasons behind failure and bankruptcy of key airlines• Awareness of new initiatives by Government of India and thrust on FDI• Identifying the benefits of FDI for all stakeholders and the implications

for the airline industry

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THANK YOU

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