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Troubled skies

Troubled skies

The global airline industry is headed for a train-wreck.

Despite a recovering global economy, years of draconian cost-cutting, massive concessions from employees and lenders, the airline industry in the US can’t make any money over time, can’t efficiently run its operations and seems determined to abuse its customers by reducing service at every turn. Elsewhere, the only airlines that are “doing well" like Singapore Airlines, Emirates and Qatar Airlines have either implicit or explicit government support. From Chile to the US, to Europe, to India to China, airlines are bleeding red.

The global airline industry has been growing at about 5% annually over the last 10 years and is expected to continue that for the next decade. Today, the world flies about four trillion revenue passenger kilometres (RPKs), the unit of measure that refers to the number of revenue passengers multiplied by the kilometres of air travel. Mature markets like the US and Europe have been growing at a slower rate than the rest of the World. Experts believe that their market share will gradually decline over the next 10 years from approximately 60% to about 50% of RPKs. The last decade witnessed a very serious impact from two events: the 9/11 terrorist attacks and the 2008 financial crisis.

The nub of the issue though is not revenue or passenger growth but sustainable profits. The global airline industry is over-studied. It’s a common parlour game to speak about how poorly airlines are doing and to speculate about the next airline that will go bankrupt.

The US airline industry is estimated to have lost over $10 billion in cumulative terms over the last decade. India’s airlines lost about $2 billion in 2010-11 and a similar magnitude of loss is expected in 2011-12. According to the International Air Transport Association (Iata), the years 2010 and 2011 were modest profit years for the overall industry (led by airlines from the Asia-Pacific region) after losses in 2008 and 2009. Southwest Airlines in the US (current fleet 555, established 1967), Ryanair in Europe (fleet 290, established 1985) and IndiGo in India (fleet 51, established 2006) are often quoted as examples of airlines that have succeeded. After a few initial years of teething troubles, Southwest Airlines has had an unparalleled 39-year streak of continuously making profits. IndiGo, which now has the second largest market share of air traffic in India, is the country’s only profitable airline.

While there is an intense effort around quarterly and annual estimates, few seem to be asking the question about the structure of the industry and the design for long-term survival. Fuel costs, taxes and operational efficiency are often the suggested “villains".

The most important issue though is that revenue is simply not sufficient to cover the costs of operation. Downward pressure on revenue from competition and pricing visibility is unable to keep up with the upward pressure from escalating costs related to fuel, taxes, insurance and employees. Tweaking costs alone is not a long-term solution; it must be combined with a structural increase in prices.

Confronted with fierce competition, how can the industry raise prices? Is the inevitable market–forced consolidation the best approach? Or is applying the public utility model to airlines the right solution?

This would take the airlines full circle back to the late 1970s in the US or the 1990s in India, where prices were fixed and a government agency was responsible for planning growth. While the public utility model does a good job when change is small and measured, its rigidity in terms of innovation and pricing becomes obvious during periods of rapid change. The principal rationale suggested for full deregulation of the US airline industry in 1978 was “sharp rise in pricing" and “no new entrant for decades". The experience of deregulation around the world has indeed delivered new players, lower costs of travel, greater innovation and choice to customers. Deregulation is clearly the preferred alternative to the public utility model. In India, we can do a few things to make the deregulated industry more viable. The low hanging fruit is to reduce taxes on jet fuel to the international average and to deregulate pricing of airport charges.

More (small) airports in proximity of economic hubs—Faridabad or Ghaziabad near Delhi for example—will allow for lower airport charges, a premium for convenience and a revolution in lower-capacity jet aircraft seats. Bombardier and Embraer offer 45-70 seat jet aircraft that could dramatically change the revenue-cost trade-off on some segments in India. For India’s geography, these newer planes offer fuel economy over the ancient Boeing 737 and the more recent Airbus 319.

P.S. “If the Wright brothers were alive today, Wilbur would have to fire Orville to reduce costs." Herb Kelleher, legendary CEO of Southwest Airlines.

Narayan Ramachandran is an investor and entrepreneur based in Bangalore. He writes on the interaction between society, government and markets. Comments are welcome at narayan@livemint.com

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