LCAs Must Rethink Their Business Strategy

Deccan Airways and Spicejet have both announced their fourth quarter results recently. Both airlines have declared net loss for the quarter. This more or less confirms that the two airlines will end the year under loss. This is bad news for the airlines because both of them are planning to raise funds from the market. Deccan’s net loss is of the order of Rs. 213 crore while that for Spicejet it is Rs. 21.4 crore. The more significant fact is that loss has increased meaningfully in the fourth quarter in comparison to the third quarter. Deccan had made a profit of Rs 96 lakh in the previous quarter while Spicejet made a loss of Rs. 18.5 crore in the same quarter. For Deccan the financial result is doubly bad because it is going to further worsen its already negative net worth.

In the case of Deccan there appears to have been an all round decline in performance in the fourth quarter as compared to the previous quarter; net sales has gone down by 7% and a big decline in other income (from Rs. 161.9 crore to 19.6 crore) has resulted in total income falling by 28%, as a result operating profit which was positive in the previous quarter has turned negative in the present quarter. Decline in net sales should be a cause of worry for Deccan because like other airlines Deccan too, in order to cover some of its losses, had increased fares by imposition of surcharges; it is quite likely that this has affected its sales. Incidentally Deccan has withdrawn congestion surcharge with effect from 29th March 2007.

On comparing itemwise expenditure (shown in Rs. crore) for the current and previous quarter one notices that except for a 5% fall in aircraft fuel expenses there is very little change in the distribution of expenditure. From this one may make the apparent conclusion that Deccan has not been successful so far in controlling its cost in any meaningful way. But this would not be correct, a look at the items of expenditure shows that expenses on three of the seven items, namely, lease rentals, airport charges and repairs

Item of Expenditure	4th Quarter	% of Tot Exp	3rd Quarter	% of Tot Exp
Employee Remuneration and Benefits	66.38	10.35	59.63	9.95
Aircraft Fuel Expenses	229.69	35.82	243.86	40.69
Aircraft/Engine Lease Rentals	109.22	17.03	101.57	16.95
Aircraft/Engines Repairs & Maintenance	64.76	10.10	53.24	8.88
Airport Related Charges	88.48	13.80	70.32	11.73
Other Direct Operation Expenses	51.44	8.02	34.71	5.79
Selling and General Administrative Expenses	31.26	4.87	35.85	5.98
Total Expenditure	641.23		599.18

and maintenance is pretty much fixed and expenditure on a fourth item, employee remuneration too remains fixed in the short run. Thus there is very little elbowroom left for the airline to control cost.

Spicejet has not provided break up of their operating expenditure, however it has remained at the same level as in the previous quarter. They have been successful in marginally bringing down staff cost while expenditure on miscellaneous item remains very high, there is probably some scope for saving on cost here.

				(Rs crore)
Item of Expenditure	4th Quarter	% of Tot Exp	3rd Quarter	% of Tot Exp
Operating Expenditure	232.50	79.19	172.71	78.18
Staff Cost	22.30	7.60	18.26	8.27
Rent	1.30	0.44	1.11	0.50
Legal Professional & Consultancy	1.99	0.68	2.22	1.01
Others	35.50	12.09	26.61	12.04
Total Expenditure	293.59		220.91

The disappointing financial results of the two budget airlines raise some serious issues. Perhaps a time has come for airlines in this category to take a hard look at the business model of low cost airlines (LCA). LCAs had started operation based on the strategy of attracting AC class train passengers to air travel by keeping airfare close to AC class train fare. This strategy worked wonderfully and there was significant movement of rail passengers to air travel resulting in overall increase in airline passenger traffic. The airlines, however, could not keep up the momentum for long, while the Railways fought back by successive reduction in rail fare of the AC class the airlines were forced to increase airfare primarily due to substantial increase in fuel price. As a result the difference between airfare and rail fare has gone beyond Rs. 1000. The figure of is crucial because it is at this point that elasticity of substitution (that is, passengers’ willingness to migrate to air travel from rail travel) nears zero. When the difference in fare is Rs. 500 or less, passengers are most willing to give up rail in favour of air travel; once the difference crosses the 500 mark resistance to migration starts to build up and it gradually keeps rising with every increase in fare difference. The thousand barrier is a product of economic and psychological factors. Even for a AC class passenger the marginal utility of a thousand rupees is high, that is, he values his thousand rupees and believes the alternate uses that he can he can make of that money can bring in greater satisfaction than air travel. At the same time thousand rupees exists as a benchmark figure in the mind of the passenger. It is unfortunate that the ministry of Finance and the State governments refuse to appreciate the crucial importance of fuel price and continue to tax it at

unreasonably high rate thereby affecting the very survival of the airline industry. The only available alternative is to reduce airport charges which presently account for 10 -15 percent of an airlines’ operating cost. Looking at it from purely aviation industry perspective this, in fact, may be a good thing to do. A significant proportion of the surplus income of the airports goes into the general revenue of the government and in return the government has been investing only a small amount for the development of the airports. Lower profits may mean lower dividend but would result in better growth.