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Budget carriers struggle to raise yield

Rising losses have been a worry for airlines as they fast run out of cash raised from investors, reports Ranju Sarkar.

business Updated: May 02, 2007 22:44 IST

Last week, Deccan Aviation, which runs budget carrier Air Deccan, announced a loss of Rs 213 crore for the quarter ended March 2007. Rising losses have been a worry for airlines as they fast run out of cash raised from investors.

The biggest question facing airlines today is how to raise yields and sustain the cash burn? This is best reflected in the pressure on yields-almost all budget carriers have been saying that they are Rs 200-500 (yields per seat) away from beginning to make money or achieving cash break-even.

But given the operating environment-high infrastructure and fuel costs coupled with brutal price wars-and the more price-sensitive travellers who patronise them, will the budget carriers in India be ever able to increase yields?

''I have been hearing (that they are Rs 500 away from making money) this for the last two years. Budget carriers have no choice but to increase fares (to survive and attract investors). Fares must go up by 15 per cent immediately,'' said Alok Sharma, who quit as president of Sahara Airlines after Jet Airways took it over.

The low-cost warriors are more hopeful. ''The present cash burn is temporary. In the next 15-18 months, demand will exceed supply; that's when airlines will start making money,'' said Mohan Kumar, former CFO of Deccan Aviation, who still advises the airline. He says airlines business is similar to the telecom story.

On a 60 million consumer base, any increase in telecom usage by Rs 100-200 per user, straight away accrues to the bottom line. ''When people are addicted they don't mind paying a couple of hundred rupees more,'' added Mohan Kumar.

In 1965, when LPG cylinders were introduced by the oil companies, there were no takers-oil companies were begging customers to take connections. Within a decade, the situation changed, and they could not keep pace with the increase in demand. A similar trend is likely to happen in the airlines business, says Kumar.

Consider the potential. This fiscal Deccan will fly nearly 7.5 million passengers; next year, it could fly 10 million passengers. Now, if it can charge Rs 500 more on every seat, it could earn a profit of Rs 500 crore. But the big question is: are investors willing to buy this story, and what cost are they willing to put money? This will be clear when Deccan raises new money.

''If you extrapolate the way in which capacity is being absorbed (the numbers of seats-on-offer have increased from 90,000 a day in January 2006 to 150,000 a day in December 2006) there will be a stage when the growth in supply will not keep pace with the growth in demand,'' added Kumar.

To be fair, yields have been going up-but much too slowly for investors comfort. In January 2006, Air Deccan made an average yield of Rs 2450 per seat; at that time, the airline was flying 12,000 seats a day and selling 69 per cent of them. In January 2007, it achieved an average yield of Rs 2750 per seat, despite flying 36,000 seats a day and reporting a higher load factor of 83 per cent.

The chances of improving yields in the near future look bleak-the industry will induct nearly 80 planes or 12,000 seats in 2007 on top of the 150,000 seats at the end of the 2006. ''You are riding a tiger. You can't ride it nor get down from it,'' said Sahara's Sharma. But he feels budget carriers will be forced to increase fares for money to come into the business to run it.


Airlines are not doing enough to help themselves get out of the low-yield regime. Barring a few like GoAir, which returns planes during off season and leases them back during peak season, or SpiceJet, which recently deferred to take delivery of couple of jets to October, airlines are not trying to cut capacity. They could, for instance, defer taking deliveries till market absorbs existing capacities.

Similarly, they are reluctant to increase fares. ''History tells us that mostly no one wants to take the first step. No one wants to appear as the ''bad guy.'' It is ok, however, to follow and match other carriers once they increase fares first,'' said an expatriate CEO, who has served with a private airline in the country.

That's because when you are a young carrier, whatever traffic you have built is very precious, and you do not want to disappoint your customers, particularly when you are under the looking-glass, as they are probably still unsure of how you will fare in the future. ''Customer fidelity is difficult to achieve and is very fragile at best,'' said the expatriate CEO, who didn't wish to be identified.

Actually, there is another problem. When you raise fares, and no one else does, it is normal that some of your passengers will migrate to competitors. That's what Deccan discovered when it tried to raise fares on the Bangalore-Delhi sector. On an experimental basis, Deccan began selling tickets on 4 flights from a higher (Rs 3,000) price level. The result was disastrous: the flights went half-empty.

But experts say that even if you increase fares and some passenger drop out, you can still make more money per plane flight depending on the fares you can charge the remaining customers. ''The trick is to anticipate the effects a tariff change will have on the overall financial picture of the airline,'' added an expert.

Even in other markets like the US (post-deregulation in the 1970s), some low-cost carriers (LCCs) chose not to blink and play the waiting game until one or more of them fell out of the market by going bust. Once that happened, the survivors were able to breakeven faster, thanks to the additional customers gained from the fallen carriers. ''But this is a dangerous game that most of the time leaves the winners too weak to survive in the future,'' adds an expert.

In India, many LCCs have decided to go head-on with competitors on all their routes. This leaves no breathing room for strong and calculated growth. Instead of that, an LCC can carve a niche for itself in the market (say, just focus on non-metro routes) and have networks which allows for minimal or no competition. The yield on such routes can meet the costs, and support the other more competitive routes the airline operates, say experts.

Some additional quotes, if you can include them somewhere in the story:

''We are making money at operating level as our costs are lower than other airlines. We are probably short by Rs 150-200 per seat. If we make Rs 2600 and can fill our planes 80 per cent, we are fine,'' said Ajay Kumar, director, SpiceJet.

''With Jet taking over Sahara, one spoiler has exited the market. That should help in hardening the yields. But Indian and Deccan continue to drop fares even in peak travel season, and are tremendous deterrents to boost yields,'' added Singh

''in the short term it may not be easy to raise yields. Everybody is in a war chest mode. There has to be some rationality,'' said Anurag Jain, Air Deccan's head for revenue and pricing. ''If we increase fares, someone else drops fares,'' he added.

''I don't think over-capacity is an issue. The airlines are not being able to manage their yields because of higher competition. India has just 300 planes; Southwest Airlines owns more than that,'' said the chief executive with an aircraft financier.

''With a tight aircraft market, manufacturers or a leasing company will be very happy to take over the delivery slot for an airline. Airlines can defer to take the deliveries, if they wish to,'' said the chief executive with an aircraft financier