Will AirAsia and Tata-SIA succeed?

After a gap of several years, two new airlines are entering the Indian market. Their decision really intrigues me because the airline industry in India is clearly what one would call an unattractive industry, that is, an industry in which profit potential is poor. In fact, every time I discuss a case study on the Indian airline industry with my class, my students end the class by asking why anyone would want to enter this industry.

The reasons for the travails of the airline business are well known.

Greedy suppliers are the first reason. Oil companies treat aviation turbine fuel as a cash cow and pass on all cost increases plus more to the airlines. Airports, driven by huge investments in new infrastructure are constantly trying to raise airline and passenger user charges. Buyers in India allow airlines no respite — they are acutely value conscious, and demand is price sensitive. Thanks to the Internet and travel portals they have full information on fares with no search cost, resulting in price-based decision-making. And being a high fixed-cost business with the added challenges of perishability, price-sensitive demand and very low customer-perceived differentiation, this is a cut throat business on the pricing front. This is hardly the recipe for attractive returns.

This is not the story of India alone. A recent International Air Transport Association (IATA) report found that only a handful of the world’s airlines make real profits on a sustainable basis. And, if anything, India makes things worse, with high fuel prices, poor infrastructure and further debilitating policies like route dispersal guidelines that make airlines fly on unprofitable routes.

So, why are AirAsia and Singapore Airlines (SIA) both entering the Indian market?

Fork in the road

As is well known, there are two basic strategies followed by airlines globally — one is that of a ‘low-cost carrier’ (LCC) that drives costs to the bone and succeeds because of high occupancy driven by low fares; and the other that of a ‘full-service carrier’ (FSC), which offers additional services to a business traveller. Today, in most short haul markets there is only one strategy left and that is of keeping costs as low as possible. In both Europe and the US, the financial performance of LCCs has been far superior to that of FSCs.

The reasons for the entry of AirAsia into the Indian market are clear. India is likely to be a major growth market in the future (it was from 2003-2010, though it has slowed down since) and as a major LCC in this region, entry into India is a natural choice. But, there is no reason to believe, as Tony Fernandez would like us to, that AirAsia will take the Indian market by storm.

Running an LCC in India is not for the faint-hearted. While LCC pioneer Deccan’s poor performance and ultimate sell-out to Kingfisher may be attributed to the lack of experience of Captain Gopinath, Spicejet’s fortunes have also been going southwards in recent times despite having experienced LCC executives at the helm. So much so that the airline’s auditors have even asked questions regarding whether it can be treated as a going concern.

By all reports and evidence — steady expansion, high occupancy rates, on-time performance and profitability — IndiGo is the one LCC that has figured out how to succeed in the Indian market. There is nothing to suggest that AirAsia has any secret recipe to do better than IndiGo , and I would expect AirAsia to take five years or more to get anywhere near IndiGo’s operational excellence in a difficult working environment like India.

Regarding the Tata-SIA alliance, it’s clear what’s in it for SIA. Headquartered in the small city-state of Singapore, SIA is a 100 per cent international airline. The growing clout of gulf carriers like Emirates and Etihad constitutes a significant threat to SIA’s future, particularly in relation to the Indian market. Having a beachhead in India allows SIA to take on these airlines on stronger terms.

But a bigger question is how expensive will this be for SIA? The last businessman to set up a FSC in India, Vijay Mallya, perhaps never expected to make big money from the airline business. But I am sure he never expected to make such big losses either. Today, the poor performance of his airline has placed his entire group under financial stress. The other FSC operating in India, Jet Airways, has not made a profit for the last several quarters. In a value-sensitive market like India, the number of customers willing to pay for full service doesn’t appear to be adequate to make money from the FSC model.

Managing India

Will Tata-SIA be able to do better than either Kingfisher or Jet? SIA has a reputation for being very efficient on managing costs that are not visible to the customer. It is legendary for choosing only those features that are valued by customers, following a rigorous cost-benefit methodology. But, it remains to be seen whether it can replicate the same business discipline in India. Remember that many members of Jet’s senior management over the last twenty years came from SIA, but they were unable to work the same SIA magic here!

The most confusing strategy is that of the Tatas. They have a small equity stake in Spicejet, and now plan to be partners in two new airlines. The airline business is a notoriously capital intensive one, and the Tatas’ ability to raise capital at competitive costs will definitely help. But I can see no particular reason why the Tatas will be able to overcome the inherent challenges of the Indian airline industry.

Why do people still enter the Indian airline industry? Is it because every airline thinks it’s going to be the Southwest Airlines of India, and buck the trend of the rest of the industry? I really hope the new airlines’ entry plans are based on more than such naïve optimism.

(Beyond Jugaad is a monthly column.The author is the Professor of Corporate Strategy and Policy at IIM-B and author of From Jugaad to Systematic Innovation: The Challenge for India.)

COMMENT NOW