Low-cost warriors

Running an airline is like having a baby: fun to conceive, but hell to deliver,” rued Collett Everman Woolman. Having founded Delta Air Lines and fathered two daughters, Woolman certainly knew what he was talking about. But his observation has not dissuaded many from either having babies or worse, venturing into the airline business. Its glamour quotient notwithstanding, the aviation business is a veritable graveyard of lost fortunes. Despite that poor record, though, there’s a new braveheart in town — AirAsia India.

In March 2013, Malaysian low-cost carrier (LCC) AirAsia announced its decision to enter the domestic market (its medium-haul arm, AirAsia X, already flies to Chennai, Trichy, Kochi, Bengaluru, Kolkata and will soon add a service to Madurai). The final approval for the first foreign airline to start operations in India are still awaited but Tony Fernandes, the maverick entrepreneur who along with Kamarudin Meranun acquired AirAsia from DRB-Hicom Berhad in 2001 for about 25 cents and $11 million in debt, is already working on his flight path for India.

Having brought on board Ratan Tata as chief advisor and S Ramadorai as chairman, he announced his head of Indian operations in typical, unconventional style. On March 4, 2013, Fernandes tweeted: “I have selected our CEO for AirAsia India. Very smart boy from the south, Madras. An amazing CV. Will impress all that meet. A real winner. That will bring new meaning to competition.” 

Hunter gets hunted

The “smart boy” is Mrithyunjay ‘Mittu’ Chandilya. When you meet the duo for the first time, the sartorial difference between the 49-year-old Fernandes and 32-year-old Chandilya is stark. Fernandes is at ease in a pair of jeans and t-shirt while Chandilya is dressed to the nines. But, then, Chandilya wasn’t handpicked by the AirAsia board for his dress sense. He was based in Singapore, heading the Asia Pacific practice for recruitment consulting firm Egon Zehnder’s services business, when he first came to AirAsia’s notice after he called for an informal pitch. 

As it happens, the cold call wouldn’t have been much use — Fernandes’ aversion to outsource any aspect of recruitment at the firm he has painstakingly grown is well-known. The story of one of AirAsia’s newest captains in Malaysia is a classic example. Fernandes routinely spends one day a month carrying bags at his airline and on one such occasion, his fellow bag carrier was a young boy “who I realised was super smart,” recalls Fernandes. “I said, ‘You should be a pilot’, to which he replied, ‘I left school at 13; I don’t stand a chance’.”When the LCC started its first cadet pilot scheme in 2003, of the first 18 cadets, 11 were from within the company and included check-in assistants, engineering cabin crew and bag carriers.

The airline’s existing pilots helped them study for the pilot exams and the boy Fernandes referred to scored the highest marks ever at the Malaysian Flying Academy. Two months ago, he became a captain. “You join the airline to carry bags and eight years later you are the captain of an A320. That changes the whole motivation of the organisation,” he emphasises. 

Similar thinking was in evidence in end-2012 when AirAsia’s India plan started to materialise and the board contacted Chandilya and introduced him to Fernandes. “We talked for about 30 minutes and where we really hit it off was probably in our discussion on vision,” says Chandilya. “He shared his vision for his organisation as a whole and what he was trying to do in India and I shared my vision on what I would be attracted to. And it was a little bit different. The difference would be surprising to most people: My vision was much bigger.” 

It surely is an interesting appointment but, based on the limited facts that they are going with, the dapper Chandilya has reservations about how the media at large has projected him. “Most people think this guy was a model before and then he became a headhunter. They totally miss out a major chunk of my experience, which was running a $2 billion P&L for Ingersoll Rand. That is far bigger than what we are projecting AirAsia India to be in three years.” 

What is also not widely known is that Chandilya was an entrepreneur when he was just 19. His company, Save-our-Syrup, held a patent that alerted restaurant managers when they were running low on syrup at the soda fountain. The invention was born out of Chandilya’s frustration as he kept getting fizz from the soda fountain he frequented off-campus. The self-funded venture even won a grant to take it to product status, but Chandilya and his partners decided to sell the patent and pay off their college loans.

On graduation, instead of joining his father’s construction business, where he may have had things handed to him on a platter, Chandilya opted for the corporate world, becoming Ingersoll Rand’s youngest-ever general manager at 24. “If everything is looking okay, I need to find something else to do,” he smiles.

Which probably makes the hotseat at AirAsia India the perfect place for Chandilya. “An aviation CEO is one of the most difficult roles. You have not only to be a CEO in the traditional sense, very focused on being a leader and manage external stakeholders, you also have to understand all the technicalities associated with flight operations,” he himself says. And, from the evidence we have around the world and in India, running a successful LCC demands extreme meticulousness.  

Potholed runway

AirAsia India wants to glide up the very same flight path that GR Gopinath of Air Deccan valiantly pioneered (see: The Air Deccan effect). Its tagline “Now everyone can fly” is a lot like Air Deccan’s “Simplifly” and Fernandes’ ambitions also echo those of Gopinath, who wanted to enable every Indian to fly at least once in his lifetime. “My dream is that the guy who picks me up from the airport will have flown. So far, the number of times I have come to India, no person who has come to pick me up has ever been on a plane,” says Fernandes. 

What does the first mover think of the newcomer? Says Gopinath, “When Air Deccan came in, only 13 million tickets were being bought. But while existing airlines were looking at the 1% who could afford flying, I was looking at the 99% of the market who could not. Even now, the number of passengers flying year-on-year is stagnant or falling. Therefore, you need a new player to galvanise the market.”

He has a point. Worldwide, LCCs, which entered the market much later, rule the stakes when it comes to number of passengers carried. In Europe, Ryanair flew about 80 million passengers in 2012, while in the US, LCC champion Southwest flew 112 million passengers. The number for India: 57 million. And this, mind you, is the figure for the entire country, not for a single airline. This potential excites everybody and Fernandes wants to bite deep and wide. “AirAsia went from 200,000 to 33 million passengers without taking anyone’s market share. We grew the market by offering low prices,” he says.

Remind him that others such as Gopinath have tried and failed, and a gentle pushback comes through. “You can do whatever you want with fares, but if you don’t have the right cost structure, you will lose money. Air Deccan had the right revenue structure but wasn’t able to match it with an equivalent cost structure.” 

That won’t be a problem with AirAsia India, Fernandes is convinced. The parent company has built its reputation by keeping an iron grip on costs and paying attention to detail. “GE is very scared of me. I know every single part of an engine. I know the cost of a HPT [high pressure turbine] blade down to the reverse thrusters. They can’t fool me. That’s the level of detail we go to,” he says.

Traditionally, LCCs have remained low cost by staying away from the traffic-intensive main airports and using secondary airports. In India, given the lack of usable infrastructure, LCCs have no option but to use main city airports along with the full-service carriers. This pushes up costs and necessitates a higher passenger load factor to break even (see: Bleeding alike). Given such operating constraints, an exasperated Vijay Mallya once remarked, “In India, there aren’t any low-cost airlines, only low-fare ones.” 

Across the world, LCCs have also kept a tight lid on costs by operating in a set geography with a single type of aircraft. Southwest Airlines, for instance, has always been partial to the Boeing 737-700, while Ryanair’s weapon of choice is the Boeing 737-800. AirAsia has worked magic with the Airbus A320 and Chandilya now hopes to replicate that efficiency in India with the same aircraft. As it happens, local leader IndiGo has already been sweating the same A320 advantage for about seven years now and in the process has become India’s largest LCC (see: Flying high). Says Marc Watkins, editor, Airline Network News and Analysis, “IndiGo is a lot like AirAsia and has been very strictly following the LCC rulebook, whereas SpiceJet has a mixed fleet. The crews are not interchangeable and it all adds to complication and costs, which could be one reason why they have not been as successful as IndiGo.” There is admiration for IndiGo even at AirAsia India. “All of them have their strategies but from what I have experienced so far, IndiGo is doing a great job, they are just eating away market share and I can’t fault them,” says Chandilya.

IndiGo already has scale (66 aircraft) and reach (28 local cities). It has also mastered quick turnaround and high asset utilisation, the cornerstone of a successful LCC strategy. A common explanation that crops up whenever talk veers towards IndiGo’s profitability is how it has extensively used sale and leaseback to keep costs low. Says Saroj Datta, aviation consultant and former executive director of Jet Airways, “As I understand, IndiGo got terms that enabled it to return the aircraft to lessors after five or six years, prior to heavy maintenance, namely D-checks that are required after seven years of operation. By returning the aircraft to the lessor/manufacturer earlier, IndiGo has been successful in achieving lower maintenance expense and has also been able to operate with a younger fleet than their competitors.” Gopinath doesn’t entirely agree. He says, “Sale and leaseback only explains part of their success. If that is the only reason, why can’t the other airlines do it? And who is not doing sale and leaseback? Everybody is.” But he adds a rider to his praise. “IndiGo runs a very efficient operation, but it has grown at the cost of Kingfisher’s demise and of Jet and Air India themselves not growing.”  

Bums on seats

Over the years, IndiGo has consistently offered the lowest fares. But with rising airport user charges, the base has inched up much higher. For instance, in 2010, if you booked about a month in advance, you could get a Mumbai-Delhi return ticket for ₹5,000. Now, even if you book a couple of months ahead, the return fare is close to ₹7,000. The very fact that despite rising capacity, fares in India’s busiest sector have gone up points to rise in input costs (mostly infrastructure related), cost-slippage at the airline end or both. 

High airport charges are the main reason that AirAsia India will not be operating flights to Mumbai and Delhi initially. It remains to be seen, however, as to how long the LCC can stay away from a sector that accounts for just over 50% of total domestic traffic. As Watkins says, “You cannot fly domestically in India and ignore those two destinations. It is like flying in the US and not flying to New York or Los Angeles, or flying in Germany and not going to Frankfurt.” Datta, too, says, “Notwithstanding AirAsia’s current plans, I cannot see the airline staying away from the north and central Indian markets for very long.”

Right now, though, the focus is on jumpstarting operations in South India, a sensible move according to Shakti Lumba, an independent airline consultant with 40 years of experience having worked with Indian Airlines, Alliance Air and IndiGo. He explains, “AirAsia has sensibly chosen the best market in the country. South India not only has three metros — Bengaluru, Hyderabad and Chennai — it also has three other major airports — Kochi, Thiruvananthapuram and Kozhikode. All it needs to do now is work with the state governments to get a concession on sales tax on aviation turbine fuel (ATF).” The cost of 1 kiloliter of ATF in Chennai is about ₹76,500 and ₹80,500 in Kolkata, compared with ₹70,200 in Delhi or ₹72,500 in Mumbai. 

Actually, that is not all. Flying into unproven markets such as tier 2 cities come with their own risks and AirAsia India may eventually find that the route is unviable or rivals may underprice it on the same route. So there’s every likelihood that even if it starts six routes, about half could see churn 12 months down the line. Even if AirAsia India pulls a few fast ones past the competition, there is no guaranteeing that IndiGo, JetKonnect or SpiceJet will not copy it move for move. Chandilya seems prepared for that. “The routes will be replicated, but can they deliver the cost savings and sustain it? That is where we can win.” 

Lumba agrees, “The airline with the lowest CASK (cost per available seat km) will achieve better RASK (revenue per available seat km) even at lower prices. AirAsia has one of the lowest CASK (see: Low-cost champion) and the Indian arm has a competitive advantage as most of its costs are not dollar denominated and it has no expatriates on its rolls.” Even Datta believes Indian airline companies can learn a lot from AirAsia. “Indian LCCs, as also the other carriers who are trying to serve both the LCC and the full-service markets, have to assess where they can benefit from AirAsia’s processes in order to compete with it more effectively. Factors that have contributed to its success include effective cost control and ground handling of flights, high aircraft utilisation and high employee productivity.”

Back in Malaysia, Fernandes has his own ways of keeping costs in check, and much depends on the culture of the organisation he has created. “You can tell your pilot a thousand things. If he doesn’t want to do it, he will not do it and then your fuel cost shoots from 40% to 50%,” he elaborates. Fernandes’ solution: walk the talk. He carries bags once a month and serves as cabin crew. There is no workers’ or pilots’ union at AirAsia and he is always available to employees: everyone in AirAsia has the CEO’s mobile number. He jests, “Pilots have an easy life. They taxi to the runway and take-off, then put the plane on auto-pilot and bitch about the company for two hours. Then they land the plane and say ‘Oh, tough job, pay me more.’ It is the engineers who are doing the hard work.” That is why Fernandes gets the pilots to cook breakfast for the engineers once a month. “It is vital that pilots and engineers talk. If they don’t talk, it costs you a lot of money,” he grins.

Chandilya is looking forward to implementing much of that culture at AirAsia India, especially the speed with which things get done. “We would rather execute and if need be, pull back if it is not working as opposed to wasting three or four months doing analysis and downside computations,” he says. That’s Fernandes’ preferred style of working as well. For instance, it took just a month to decide whether AirAsia X should start flying to Trichy, a decision that was almost universally mocked, including, says Fernandes, by Vijay Mallya. “He said, ‘What are you doing there?’ I went there because someone at a funeral told me, ‘Trichy is a great place. You should fly there’. So I sent my team out there and they said, ‘Great place’. Now we fly three times a day from KL to Trichy,” says Fernandes.

Arm all doors

While it will be flying into economic turbulence, AirAsia India seems to have its share of beginner’s luck. The grounding of Kingfisher Airlines has come as manna from heaven for the competition, which jacked up fares in FY13. That profiteering drove away budget fliers and FY13 saw a drop in passenger traffic, from 60.84 million to 57.56 million. But this is just a growth lull, says Watkins. “Though AirAsia India’s capacity growth is cautious, their entry into the market is well-timed, because they will find themselves positioned ready for the bounce-back.”

Also, the greenlight to charge for ancillary services such as excess baggage and seat selection seems to have come just in time. Right now, LCCs make less than 5% of total revenue from ancillary services, but Lumba thinks AirAsia India could target ancillary revenue in the 18-20% range. Ancillary helps separate base fares from add-on fares and Fernandes believes unbundling is the way to go if LCCs want to offer the lowest possible fare. He justifies charging extra for baggage. “If you bring more bags, I need more people to carry those bags onto the plane. If the bags are heavy, they will result in more fuel burn.” For airlines, there’s another advantage to ancillary fares — passengers may arrive at the airport early for their choice of seats, allowing airlines to maintain a quick turnaround time.  

Flap check

But, given the infrastructure constraints, is there scope for AirAsia India to cut costs and keep fares low? Lumba believes AirAsia India’s start-up costs will be lower as it does not have to incur heavy capital costs on training, maintenance, systems etc., given the world class infrastructure existing in KL. “AirAsia is paying market wage for pilots and cabin attendants, but it will use them more efficiently. The DGCA requires three sets of crew per aircraft but AirAsia India may work with 4.0-4.5 sets of crew per aircraft. Other airlines have seven to eight sets per aircraft,” he adds. After ATF, employee cost comes high on the expense list. IndiGo, for instance, spent ₹520 crore on salaries and wages in FY12, of which about ₹225 crore went towards payment of salaries to pilots and associated staff.

Chandilya also plans to use only three baggage handlers to deal with an aircraft. He says, “I am confident that on-loading and off-loading of bags can be done by three people and we can turn around within 20 to 25 minutes.” As planes get added, this optimal utilisation of staff means its ratio of 100 employees per aircraft will eventually come down to 65 employees per aircraft. 

A well spread-out distribution strategy is also crucial for AirAsia India, given that in Indonesia it initially followed an online model and found it hard to gain volume. In its home market in Malaysia, about 80% bookings happen directly through the airline’s website. In India, at least initially, it will not have that advantage and so will lose out or be on equal ground with other LCCs. Online travel agents (OTAs) bring flab into the system, the antithesis of what AirAsia stands for, but Chandilya defends the decision to go with multiple OTAs in India. “Our distribution strategy now is very open and we need to see where our volumes are coming from. At this point we are giving OTAs access to good fares as much as we normally do. And so long as volumes are going up significantly and inventory is being used, I don’t mind.” 

To the flier, it is the ticket price that matters; so, how AirAsia India will place its inventory in the market will determine its initial success. One way it can differentiate is by placing its inventory in just three buckets instead of, say, 10 as may be the case with other LCCs such as IndiGo. That simplifies fare for the flier, saying that whatever time you book, there is not much price volatility. And even as it engages initially with online and offline travel agents, it seems likely that the airline will continue to drive people to book directly on its website as that is where distribution costs are the lowest.

When Air Deccan entered there was Jet, Sahara and Air India, and all of them had high fares despite 65% occupancy. It was an unofficial cartel and the market was not growing. Air Deccan came in and grew the market. Can AirAsia India do an encore? Gopinath believes so. “Low-cost is about ruthless efficiency, sweating of assets and a cost culture that runs from top to bottom in the hierarchy. If IndiGo can do it, so can AirAsia. It has stimulated the market in South East Asia, so why not in India?” But it is not as if rivals are napping. As Gopinath cautions, “The entry of AirAsia will keep IndiGo on its toes and the moment it enters, IndiGo and the others will lower their price.” Well, it so happens that the incumbents are not waiting for the actual entry to happen; they are already playing offence. IndiGo’s recent frequency additions crisscross what AirAsia India is likely to target: Chennai-Kochi, Chennai-Thiruvananthapuram and, eventually, Mumbai-Thiruvananthapuram and Mumbai-Kochi. As for Jet, it recently completed its seven-day, 700,000 seats-for-sale campaign in order to preempt as many potential bookings that the competition could get.  

Wind shear

In the months ahead, LCCs have to deal with the double whammy of high crude prices and a weak rupee. The depreciating rupee continues to play spoilsport, since most overseas costs, including aircraft lease outgo, are billed in dollars. Also, in the current slack scenario, pricing power is non-existent. The way to get ahead, then, is to decimate the competition to the extent you can and that is what legacy carrier Jet Airways, backed by fire power from Etihad, has the power to do. But Lumba thinks AirAsia can hold its own. “AirAsia has a bigger advantage than Jetihad. Not in terms of quantum, but in terms of concept. If AirAsia gets a passenger from Thiruvananthapuram to Kuala Lumpur, it can afford to give Thiruvananthapuram to Chennai free and charge him only the Chennai-Kuala Lumpur fare.”

If AirAsia gets into a price war here, and most likely it could, there will be pressure on its profitability. For the parent, that will mean fighting multiple wars. There is already rising heat in its home market after the entry of Malindo, whose parents, Lion Air and Malaysia’s National Aerospace & Defence Industries, are engaging in a price war that may sooner or later force AirAsia to retaliate. The folks at Malindo are so charged up that they are planning to fly to Delhi and Mumbai as well. If it were a weaker brand, AirAsia wouldn’t have been bothered about it. But, explains Watkins, “Malindo is backed by LionAir, which has been very successful in Indonesia and is looking to emulate what AirAsia has done. Malindo will be making them scratch their heads a little bit more.”

As an LCC cannot indefinitely pursue loads at the expense of yields, AirAsia might also list its Indonesian arm later this year to shore up its staying power. AirAsia X, the medium-haul carrier, also recently raised $310 million through an IPO. Its joint venture with ANA in Japan has run into partner trouble and those brand new jets might as well be deployed in India until it figures out how to get Japan right. New jets are more fuel efficient and Chandilya could do with all the help he gets. Watkins provides another reason why AirAsia India can play around with lower yields in the beginning. “When you are buying 200 planes, you get tremendous bulk buying efficiencies and it allows you to tinker a little with the yields and introduce lower fares in the market.” 

This is one advantage that AirAsia India would fully want to milk. Lumba points out, “Since the aircraft is owned by AirAsia, there is only a depreciation charge. Leasing cost leads to a fixed dollar outflow every month. A new A320 is available at about $400,000 a month and requires a security deposit of six to nine months lease rent. Then, you have to create maintenance reserves as well.” Depreciation cost is about 5-8% compared with the lease cost of 15-18%. So, there is a 10% saving there. 

Steady climb 

Price is where AirAsia stands out, and that could well be its selling point in a down cycle. Sustaining low fares would also be a function of how many planes AirAsia India has in the air. That is why it is looking at scaling up by adding one aircraft every month after its initial launch with two to three aircraft. But even if AirAsia India falters in its stated objective of growing the market, it will end up making a big dent in the revenues of JetKonnect and SpiceJet. IndiGo already runs a very lean operation and may not feel the heat until AirAsia India expands its network to include Mumbai and Delhi. Watkins’ prophecy: “We are predicting that SpiceJet is going to have the bloodiest nose, if you like, from the arrival of AirAsia India, if they start with the routes that we are forecasting.” (see: Southern spice)

The biggest air pocket ahead is the awaited operator’s licence. Lumba quips, “The challenges that AirAsia India will face are regulatory and dirty tricks. But Tony has a couple of tricks up his sleeve, too, no doubt.” Watkins says even in a worst-case scenario of regulatory hurdles, AirAsia will eventually step into the domestic market, even if it needs to go the acquisition route to do that. “If the current business model doesn’t work out, that is the way they would go. So what if SpiceJet operates a particular kind of aircraft? AirAsia would just get rid of the 737s and replace it with their A320s, increase their order with Airbus and get a better deal in doing so,” he adds. 

Understandably, Chandilya is playing his cards very close to his chest. He’s reluctant to share details on the kind of volumes AirAsia India is targeting in the first year or the routes that it will first start flying. Still, he says he has a rough idea of what he needs to break even on a month-by-month basis and what the AC two-tier traveller pays for his train fare. His focus is on closing the gap as much as possible. “What we are doing now is constantly pushing our cost down and seeing if we can move up their willingness to pay. If I can’t move that up, I have no option but to bring down cost as much as I can.”  That fits with Lumba’s reading: “AirAsia’s likely philosophy will be to not only corner market share but also revenue share. You can get 100% market share by selling seats at ₹100, but that won’t get you any revenue. There is a distinction between the number of passengers you fly and the revenue share that you have.”

For the moment, user fees are certainly lower in Chennai but that, too, could change as the cash-strapped government has okayed privatisation of Chennai airport. The longer that is delayed, the better it will be for AirAsia India. But if it were to happen, would AirAsia India lose the low airport charge edge? All Chandilya is willing to say is, “The hope is that it is two years away, so you have an ability to ramp up your operations between now and two years and reduce your cost by utilisation of assets. There is never going to be an ideal situation where all the costs are going to come down at one time, otherwise it wouldn’t be a fun business.”

Mittu Chandilya has always pushed the limits. Even in school, when his classmates played it safe calculating their formulas and following the instructions of their chemistry teacher, Chandilya would mix different acids just to see what happens. He is now gearing up for the challenge of bringing fares down by at least 20-30%. There is no shortage of ill-wishers and naysayers but Chandilya is building critical thrust to take-off. As he affirms with a steely resolve, “You tell me it can’t be done, it probably motivates me more. Five years from now, I not only want to be the biggest player in India, I want to be to bigger than AirAsia.”