No easy way

Running an airline appears simple but several ambitious companies have been grounded soon after take off

The Indian airline industry is at a critical crossroads. Mounting losses driven by high debt levels and fares that don’t recover costs have pushed the industry into a tight corner. Will it be able to recover from this position? What’s the way forward? And, what role can innovation play in getting out of this mess?

Airline losses are not a problem in India alone. According to one estimate, the US airline industry lost $54 billion on domestic routes between 2000 and 2009. In aggregate, US airlines have reported losses in two out of every three years since deregulation in 1978. No wonder, the airline industry is described as “brutal.” 

Why is the airline industry prone to financial woes? Entry barriers are low as there is little differentiation between airlines; passengers face low costs in switching from one airline to another; aircraft are available on lease, so capital costs have come down; and there are plenty of knowledgeable people in the industry who know the basics of running an airline. The only real barrier is the fact that profits are hard to come by. Further, airlines are under pressure to fill the capacity of their main capital-intensive asset—the aircraft. And since they are selling a perishable commodity, this pressure intensifies into selling each seat at a price that recovers money, even if it doesn’t cover the cost of the seat. The advent of the internet has allowed the consumer to compare prices and this information has accentuated price-based competition.

The adverse economics of the airline industry is made worse in India by government policy. Route dispersal guidelines require airlines to deploy a part of their capacity on unattractive routes. The public sector oil companies see aviation turbine fuel (ATF) as a cash cow and price ATF significantly above international benchmarks. State governments view ATF as a source of easy sales tax revenue with tariff rates as high as 24%. And, the costs of enhancing domestic airport infrastructure are being loaded onto both consumers and airlines. With the government repeatedly under-writing the losses incurred by Air India, the airline has had little incentive to run on commercial lines making the environment even worse for its competitors. 

All systems check?

What role does innovation play in the airline industry? Quite a substantial one, if we look back at the last few decades of the airline industry. It’s well known that the low-cost carrier (LCC) model in the United States was most successfully executed by Southwest Airlines, making it the only major carrier in the US to keep its head above water. Though the essential features of Southwest’s LCC model—a single aircraft type, point-to-point service,  no food service, use of less congested airports, etc.—-----are well known and well documented, legacy carriers have been unable to emulate Southwest because of high cost structures and a history of adversarial union relations  that prevents them from renegotiating employment contracts.

When the LCC model was first introduced in India, the viability of the model was questioned by full service carrier (FSC) owners Naresh Goyal and Vijay Mallya. Their argument was that the most significant cost of running an airline comes from operational expenses such as aircraft lease rentals, fuel and services provided by airports, which are the same for all airlines irrespective of whether they are operating on the LCC or FSC model. This led them to refer to the LCCs as “low fare” rather than “low cost” airlines. 

But, data released by the Director General of Civil Aviation (DGCA) shows that the LCCs do have lower costs. In FY10, IndiGo’s operating expense per available seat km (ASKM) was ₹2.32 against ₹3.48 for Jet and ₹4.18 for Kingfisher. The biggest difference between IndiGo and Jet was in the area of general administration where IndiGo’s costs were only ₹0.07 per ASKM against ₹0.55 per ASKM for Jet, reflecting the different overhead structures of the two. IndiGo’s daily utilisation of aircraft was 11.8 hours compared to 10 for Jet. 

In the wake of the success of LCC carriers, Jet experimented with hybrid models. It purchased Sahara and converted it into its LCC arm, Jetlite. It converted several of its own FSC flights into a hybrid JetKonnect that combines a small business class cabin with a large, economy class. While Jet’s hybrid innovations helped it retain market share, the airline remains vulnerable because its cost structure is still higher.

What does the experience of the Indian airline industry tell us? It points to points to the difficulties in executing a differentiation strategy in an industry that is undergoing increasing commoditisation. And, the challenges faced by Jet and Kingfisher competing with IndiGo and Spicejet in the low cost segment point to the dangers inherent in competing on price when competitors have better cost positions.

So, what’s the future of the Indian airline industry? While regulatory changes such as removal of the route dispersal guidelines and lowering of sales tax will help, they will not change the dynamics of the industry. 

What history tells us is that the most enduringly successful airlines—irrespective of their product-market strategy—are the ones that are operationally efficient. Singapore Airlines is a case in point. It regularly wins awards and has low costs. How does it combine these seemingly contradictory features? Through organisational innovation! Singapore Airlines is pragmatic in evaluating every service innovation through a cost-benefit lens. It adopts only those innovations that customers perceive as valuable, and are willing to pay for. Major innovations like “book the cook” that allow business class passengers to pre-order meals are the result of a centralised process. This may seem ironic, but the airline believes that a high degree of standardisation of services facilitates rather than inhibits personalised service. 

While Singapore Airlines is a leader in service innovation, it is conservative in implementing back-office technologies that do not give immediate value to customers. At the same time, like Toyota and Dell, it is constantly looking for small, low-risk operational changes that reduce costs. This could be as simple as removing jam jars from breakfast trays because many passengers don’t eat jam. This ambidexterity is built into the DNA of the company.

The future of the Indian airline industry is thus clear, The survivors and winners will be the ones that are successful in embracing operational excellence and differentiating to the extent that customers value. IndiGo’s emphasis on a combination of low operational costs and on-time performance is a good example of this. Michael Porter may have argued that cost leadership and differentiation don’t go together, but the winners will be the airlines that succeed in challenging this orthodoxy.