Propping up Air India

The Indian civil aviation ministry has announced a plan to save the ailing national carrier Air India, by injecting 5.7 billion dollars of tax payers' money through 2020. This will enusre that AI's commitments with boeing for 27 787s will be paid for. Also, the ministry is injecting 1.3 billion dollars now to pay for its working capital and also to pay the dues to its employees and to its suppliers. The ministry has also decided to postpone the decision on letting foregin carriers to invest on Indian airlines.

The decision is a huge blow for Kingfisher, one of the privately held airlines in India. Kingfisher is struggling to pay for its operation and is only operating less than one fourth of its normal schedule currently. It has also suspended almost all of its international operations. Kingfisher is banking on much needed foreign capital investment for survival and this news should be a huge blow for its survival. (Though it is hard to see who would invest on an airline which was losing money even during the boom years)

In a model where state owned airlines are operating alongside privately held airlines, there must be a level playing field to ensure fair competition. Air India is a less productive organisation than most of the private airlines in India. Injecting money into it without a proper roadmap to repair the structural inefficiencies is a huge mistake. Without proper structural changes, it will only be a matter of time before Air India needs another bail out.

On top of all this, the civil aviation ministry is unfair to private business by denying a bail out to Kingfisher and now bailing out Air India. The private airlines has to mandatorily serve a proportion of its flights to poorly connected patrs of the country. With the number of privately held airlines and the connectivity they provide and that too with better efficiency and productivity, Air India found it very difficult to survive. AI is an organisation that lived most of its life as a monopoly and hence letting inefficiency as a part of its business.

Air India is not too big to fail. If Air India fails, it is not going to create a major catostrophy in India. Privetely hald airlines have enough capacity and coverage to fill up the void. The civil aviation ministry should have tried to make Air India lean and efficient by cutting capacity on unprofitable routes and by cutting inefficient jobs and by outsourcing non core part of the business. Instead, the ministry is buying time by injecting more tax payers' money into a failing organisation without a proper road map. That is a mistake!

Problems facing Indian carriers

The aviation industry in India is facing a very difficult time at the moment. Air India has received government support whereas Kingfisher is struggling to even pay their day to day bills. All other airlines face some difficulty in an extremely uncertain environment due to higher oil prices, euro zone crisis and a near stall in global economic recovery.

Are the uncertain environments the only problem for the Indian aviation industry at the moment? On a closer inspection, it looks like there are few other factors that could influence the profits of the airlines. Here are a few

Fuel taxes:
If an airline purchases fuel in India, then it has to pay central and state fuel taxes. The central excise duty on aviation turbine fuel is 16% according to the Central excise website. This is significantly more than any of the developed nations. Hence, if an airline is operating an international route, they are at a competitive disadvantage with all foreign carriers on its operating cost to begin with. Hence, the Indian Government has failed to ensure a level playing field for Indian carriers.

On top of this, all domestic flights within India have to pay state fuel duties. Some states charge upto 30% tax on the fuel purchased in their state. The success of the Indian aviation is largely based on luring first class train passengers to take the air for a small premium. For this model to sustain, the higher fuel duties are not helping. It could be one of the reasons for airlines to be squeezed for profits.

When the cost of fuel is more, it implies that the airlines have to maintain a higher load factor to break even. If the load is weaker, it implies that the airline is bleeding money quickly.

Infrastructure:
India has seen a phenomenal growth in the last decade. However, the same level of growth has not happened in the airline infrastructure such as airports and runways. A new airport was constructed in Hyderabad and a new terminal in New Delhi, but this level of growth in Infrastructure is not enough to sustain the level of growth the airlines enjoyed.

The country's busiest airport in Mumbai is running on near full capacity. Also all other airports in the Metros are over utilised. It means that the aircrafts have to make a longer wait for take off and landing. This increases the fuel consumption, which adds heavily to the operating cost, and had to wait for the gates and other facilities provided by the airport. For example, the international terminal in Chennai airport (4th largest city in India) has only 6 gates. Hence, the turnaround time is naturally longer. As a result of this, the aircraft utilisation is lesser.

The Government of India should have planned airport expansions that keeps up with the pace of growth and should have thought about creating secondary airports for the low cost aviation market to flourish. In most of the airports, even the public transportation is not good enough.

Airport charges:
As a result of the squeeze on the airport infrastructure, the prices of using the facilities has gone up. Due to higher demand for the airport services such as usage of runways for take off and landing has increased over the years. These charges may not be completely transferred to the customers as the higher charges may put of millions of price savvy customers from not taking the air for travel.

Hence, the airport charges, along with higher fuel cost has put an upward pressure on the operating cost. To offset these costs, the airlines sometimes have to keep the fares artificially low to fill up the seats. With these low fares, they make losses, but without the low fares, they would have made even more losses. Again, the policies of Government of India is not helping the airline industry to thrive.

Preferential treatment:
Air India would have gone bust if not for Government's bail out every now and then. Air India should have been allowed to fail. If a state organisation is not making profits - especially due to structural deficiencies - then the organisation should be allowed to fail instead of using tax money to prop it up artificially. While Kingfisher is currently having the same problem, it does not get any help from the Government. This preferential treatment from the Government is not creating a level playing field for all the carriers. In a free market environment, all airlines must be treated the same way.

Mandatory routes:
All Indian carries must operate to the remote North Eastern states to ensure connectivity. Even though the demand is less from this part of the country, all carriers are forced to run a certain percentage of their flights to remote places in India. This is a 'Red tape' imposed on airlines that are already struggling to make any money. While the intention of the Government is correct in a way, its policies should ensure that these airlines don’t lose a lot of money by taking these unfavoured routes in its schedule.

Foreign ownership:
Foreign organisations can invest 49% in Indian airlines. However, foreign airlines are not allowed to invest in Indian airlines. Most of the Indian carries are relatively new to the business and need the in-depth knowledge of the established carries of the west. Indian carries need the IT systems that western carriers use to minimise costs. Also, foreign carriers can infuse money to expand the operations to realise the economies of scale. However, in the current climate, nobody is sure on how keen the foreign carriers would be to invest in India.

Still, the restriction on foreign ownership is blocking the Indian airlines form the technology and business experiences of the established airlines of the west.

Kingfisher airlines’ misery is partly due to the policies of the Government of India. However, when other airlines are keeping their head above water, Kingfisher's track record since the year it was founded is poor. By not making a profit for six consecutive years - which coincided with the biggest boom years in Indian aviation history - Kingfisher has let itself down.

India has a huge potential for aviation business. Statistically, on average even if Indians travel 15% of how much Americans travel, it would create a market that would be half as big as America. For that to happen, the Government of India should get its policies correct and should invest heavily on the infrastructure development. Until then, the sustainability of all Indian airlines is in danger.

The multi brand retailing story

The scene at the Indian parliament was very chaotic - even by its own standards - in the first nine days of winter session last year. The reason was to block one of the far reaching reforms; allowing 51% FDI investment in multi brand retailing. The government had to give up this proposal due to vociferous demonstration by the opposition in the parliament. It was hard to believe the same BJP led NDA government, that opposes the current reform, accelerated the pace of economic liberalisation between 1998 and 2004. It looked as though the opposition would oppose anything that comes to debate.

Some of the comments and observations were absolutely stupid. Some parties claimed that it would accelerate farmer suicide. Anna Haraze compared these international companies such as Wal-Mart and Tesco to the East India Company. He also spoke about how they would rule our country if we let them in.

To understand economic liberalisation, we must go back to 1991. Preceding this period, brands like Nike, Pepsi, and Sony etc were unheard of. On a normal weekend, an average Indian living in cities would watch a regional movie on a Doordarshan channel in a Solidaire TV sipping a bottle of gold spot purchased from local kirana shop. Maruti 800 was considered a luxury car. The richest had telephone. However, the usage is limited as not a lot had telephones at their homes.

Fast forward to current times. An average Indian living in cities goes to a mall, watches ESPN on a Sony television, sipping a Coke and talking on a Samsung mobile using Vodafone spectrum. Such is the quantum of change due to the liberalisation. Some people still say that the pace of liberalisation is too slow and more reforms need to be done to maintain or enhance the growth rate.

In the late eighties, there was a severe strain in the Indian balance of payments. India almost went bankrupt and was expecting IMF to bail out by providing soft loans. India had to pledge several tonnes of gold. IMF also enforced some economic reforms in exchange for the bail out. Indian politicians were so reluctant to make changes to the economic policies until this time. A lot of people in India believe that economic liberalisation is one of the biggest achievements of the congress government. That is not true. The changes were enforced on India in exchange for money. Indian politicians never had the will to reform in a large scale until a deep crisis hit normal life.

The fruits of liberalisation is still can be seen in India. The average GDP growth rate more than doubled and almost 300 million Indians (More than the population of USA) came out of deep poverty. However, one big problem remains. Managing food supply chain. For the most part of previous year the food inflation was well into double figures. India has a few inherent problems in terms of infrastructure and technology. More than 20% of fruits and vegetables rot before it even reaches the market, which puts a lot of pressure on the supply side of economics.

The retailers and middlemen that serve India do not have the money to invest in technologies and infrastructure to move fruits and vegetables to market before it rots. Food value chain in India is one of the worst in the world. From farmland to household, the value chain is long. In such a scenario, the farmer is unable to sell the products directly to the market and hence was paid lesser by one of the bigger middlemen who are a part of the value chain. Almost all the middlemen in the value chain do not add any value to the product. These middlemen do not have the expertise and technology to preserve the food items from rotting. Most of the food inflation in India is due to these structural inefficiencies. Without addressing these inefficiencies, manipulating supply and demand would only give temporary relief. For most of last year, RBI was using monetary policy tools to contain inflation rather than reform the food value chain structure.

This is exactly why the entry of multi brand retailer is essential. They have the money to create infrastructure and the technical expertise to preserve the food until it reaches the market. Multi brand retailers deal directly with the farmers and hence time to market reduces and structural efficiency increases. Therefore, the accessibility of food items to common man at affordable prices increase.

In rich countries, such as UK and EU, multi brand retailers play a crucial role. Also, many small retailers also co-exist. Hence the fear of Wal-Mart and Tesco trashing all small retailers is not true. Multi brand retailers increase the efficiency of food value chain, provide more jobs, provides technology and better price for farmers, and most importantly reduce the cost to end customers. The only people to lose out is the middlemen who made a lot of money without adding any value.

The government of India must decide whether they support shoppers and farmers or they support the middlemen who have served the country and its people poorly over the past decades. Or, they should wait for another deep crisis to push more reforms.

The EU and aviation emission

Aviation business was brought into the EU Emission trading scheme (EU ETS) from the New Year. This essentially puts a cap on the amount of fuel the airlines can burn in a given time and if they want to burn more fuel, then the airlines have to buy carbon credit from other companies that managed to save from their carbon emission limits. While there are certain questions still being asked about emissions allocation and carbon pricing volatility in the past years, the inclusion of aviation industry was largely debated in the courts of law and was finally given an approval.

Even though, aviation accounts for less than 2% of world carbon emission, the economics of this emission is little different to that of others. Carriers from other continents that are forced to pay for carbon emission within EU are not happy about this extra cost for their operation. But, for this writing I would like to argue for the case of EU carriers only.

Aviation business is unique in a few ways from other business as it is very high fixed cost intensive and fuel is the biggest cost for running the business. Also, the type of fuel required for running the business is one of the most expensive ones. Hence, whether EU laws are in place or not, airlines must control their fuel cost to stay competitive. A thermal power station can control the coal input to create electricity based on the forecasted demand. In other words they can convert all their fuel into money. However, in aviation, no matter whether the flight is full or almost empty, the fuel cost remains almost the same. Hence, the amount of fuel burnt is not tightly coupled with the revenue made from the flight. This may not be true in other participating industries in the EU emission trading scheme. Hence, this gives added incentives to airline industry to reduce their carbon emission naturally without any EU emission laws.

The cost of creating one ton of carbon from aviation fuel is far greater than cost of creating one ton of carbon from coal powered business. Also, the revenue earned by burning one kilo of aviation fuel is different to that of revenue earned by burning one kilo of other fossil fuels. In such a scenario, how can a single price for carbon across all industries using different fossil fuels work? Surely, the emission trading scheme would favour one industry over other.

Also, the basis of carbon allocation for industries is flawed. All emitters are given same amount of carbon emitting licenses that they emitted in the previous years. This favours large emitters and cripples small emitters from expanding. When the same is applied to the aviation industry, it would surely cripple small airlines from expanding due to high emission costs. The emission trading scheme should stop this 'Cap and Giveaway' scheme and should study the carbon reduction potential of each industry and also the carbon reduction potential of each fuel type. With a single code across the continent, the business landscape would be tilted with aviation industry in the wrong side of it.

Another flaw from the previous years was the over allocation of the carbon credits. However, EU claims that the carbon allocation problem is sorted from the 2012 period; there are two possible scenarios. If the carbon were priced lower in the market due to over allocation, then the industry would prefer paying lower for carbon emission instead of investing in carbon reduction. If the carbon were priced higher in the market due to under allocation, then the companies which wants to invest in carbon reduction would find it difficult to fund it. In either ways, the emission trading scheme is not encouraging companies to invest in carbon free technologies. Instead of paying for carbon emission, the airline industry could do better by investing in low emission aircrafts and technologies. It is inevitable for the airlines to move in that direction due to the cost of fuel and prevailing competition. EU ETS is a major distraction for the airline industry.

On top of all this, there is another severe danger. The danger of moving quickly towards bio fuel. Bio fuel emits very less carbon than the kerosene based aviation fuel. However, it has many other consequences. The population of the world has reached 7 billion last year. We do not have enough land and fresh water resources to feed all people three times a day. If Bio fuel picks up, then farmers might be forced to use their farming land to create bio fuels. This will cripple the health and safety of people, especially to those living in poor countries. The cost of malnutrition and other human costs should also be factored into, in the pricing of bio fuels. Again, EU ETS is a major distraction. It encourages the usage of bio fuels, instead of encouraging investing in genuine technologies that reduces carbon footprint.

Investment in renewable energy such as wind and solar is the way forward for most of the industries. It is a very long distant dream as far as aviation industry is concerned. Aviation industry should invest in technologies and aircrafts that reduces carbon emission. Any other laws or treaties such as EU ETS is a distraction towards that path.

The 'Mid-life' crisis

The growth of Indian software industry is phenomenal. Companies are growing at an alarming rate of more than 30% an year on average for the past ten years. The industry has provided big job opportunities as every big company on average hires around 20,000 net employees per Annam. It is not just the growth rate that looks enviable, but the profit margin is one of the biggest in the world. IT majors such as TCS and Infosys have managed to achieve more than 25% operating margin consistently. That is 25 dollars profit after all expenditures on a 100 dollar revenue.

Most of the IT companies in India focus on low end consulting or the bottom of the pyramid. If a designed architecture is provided, these companies are very good in implementing high level designed applications that fits to the architecture using the standard and existing processes. The business models adopted by the IT majors enables them to cut cost for its customers and at the same time provides a bit of value. Also, the difference in productivity by employees of Indian companies are generally more than that of their customers. This allows customers to save money on routine tasks such as maintenance of code and support of critical applications. This market is so huge that most IT companies in India fight for it at cut throat price.

Some companies are trying to break away from the bottom of the pyramid strategy. IT global majors such as IBM and Accenture are well established at the top of the pyramid as they provide high end consulting services to its customers. Although the revenue from high end consulting for TCS is only around 2.5% of its overall revenue, it is growing at around 50% per annum. As the growth was enormous at the bottom, most companies settle down comfortably there. It requires a cultural and attitude shift to move upwards in the pyramid. The cultural shift should start right at the top and proliferate till the bottom of the organisation.

The non existence of this cultural shift can be explained in terms of productivity achieved per person in an organisation. There is more money to be made as one moves up the pyramid. I have taken previous four years of financial data from TCS and Infosys (listed in BSE) and Cognizant technology solutions (listed in NASDAQ but operates from India) for the analysis. After analysing the revenue per person per financial year, it was found that TCS scores the lowest whereas Infosys was able to earn more revenue per person for the same period. As companies recruit in thousands every year, i have only counted half the new additions for the years for the productivity per person calculation to consider induction time for the employee into the company.


From the graph above, two points for discussion emerge. First, for all three companies, the productivity per person stays almost stagnant which confirms that the earnings from every employee on average remained stagnant. Secondly, how does infosys manage to extract more out of its employees than its competitors? This is an important question as the business model, employee utilization and most other parameters fairly remain the same as its competitors over a five year period.

For any company, if the productivity of an employee increases, it is equivalent to adding new employee at little or no additional cost and it in turn means earning more revenue with existing resources. In most of the big offshore development centers of IT majors in India, employees work extended hours to meet the deadline. However, the difference between touching in and touching out is not an ideal parameter for measuring the productivity of an employee. If an employee is capable of writing 100 lines of code or solving 5 tickets per day in a production system on average, then if the same employee can write 120 lines of code or solve 7 tickets on average in a day on average in the next year, that is the real definition of getting more out of an employee.

Some of the big problems with big offshore development centers are its distance from the city (which means longer hours of travel everyday), crowded atmosphere and some admin policies that eat productivity. For example, if an employee takes a tea break, say at 11 AM in the morning, one has to share the crowded infrastructure to take a meaningful break and get back to work. This takes around 30 to 45 minutes of the morning time. Most of this time can be avoided if coffee machines are installed as close as possible to the work desk and allowing employees to take coffee and snacks to the desk. Also, at least 30% of the employees smoke 3 cigarettes a day on average. In big development centers, the smokers have to get out of the building for a smoke. This again takes an hour on average from an employee's productivity. The same applies for the overcrowded canteens during lunch. If the infrastructure and admin rules are employee friendly, then it allows the employee to stay at the desk for a longer period of time thereby increasing the chance of producing more in the same amount of time as before. In a typical offshore development center where around 10,000 employees work, these simple measures could save at least 8000 person hours worth lost productivity every day. This is only a conservative estimate. It is true that these 8000 person hours are performed after working hours. But, that is an additional cost to the company in terms of additional electricity, security, transportation and mental fatigue if this persists every day.

Employees should be given more choice on how they want to work and still can completely follow the code of conduct and all security rules and guidelines. It can even go to an extent of using the time in the office bus in the morning for performing some activities that do not require network connectivity. This ensures human capital empowerment, which is the most important assets of these organisations.

The problem with productivity is not even talked about in the industry till now. This is because Indian IT majors are able to grow at mouth watering rates with an enviable operating margin. But, this operating margin is achieved due to the large addition from the elastic pool of college graduates every year, who work for less money. But, the simple fact is inflation is India is around 10% over the last few years whereas inflation in the western developed nations from where Indian IT companies get business is around 2%. There is an 8% gap in the value of what we earn every year. The productivity has to increase by 8% every year to stay where we are in real terms. This gap in real terms is adjusted partly due to the addition of low wage collage graduates in thousands every year.

At the moment, Indian IT companies are just a blip in the radar for companies like IBM and Accenture in premium consulting services market. IBM and accenture are aggressive in entering into non premium services while the Indian majors are trying to move up the ladder. When they meet, the IBMs and the Accentures will be in a better position. So, if the top line growth for Indian IT company stalls, which might happen sooner than we think due to the debt crisis in Europe which threatens to take the work economy into a double dip recession, then there will be enormous pressure on operating margin. This could lead to the organisation getting middle heavy and in worst cases, this could lead to job losses as well. To stop this from happening, the IT majors have to think about increasing productivity both by entering into premium services and by finding ways to get more out of existing resources.

Productivity increase could be the difference between sustained growth and a "Mid-life crisis" for Indian IT companies.

Is A380 ban in India justified?

The civil aviation authority in India has banned any scheduled inbound A380 aircraft to land in India by any foreign carriers. Emirates is probably the worst affected carrier as it was planning to operate its large A380 fleet to the Indian market. Lufthansa was also planning for the same, though in small scale compared to Emirates. At the moment, none of the Indian carriers operate A380 super jumbo. Fly Kingfisher will be the first Indian carrier to operate the super jumbo in 2016.

Is this ban justified? What competitive advantage does A380 give to foreign carriers, especially Fly Emirates? An A380 can typically carry more than 500 passengers in a 3-seat configuration. This is 20% more than the largest aircraft Indian carriers operate (B747). With higher demand to the Middle East and the European markets, the capacity of A380 can bring significant cost advantages to the carriers operating them. At the moment, foreign carriers enjoy these advantages due to the investment choices they have made in the past few years. Also, Emirates competes directly with Air India for the Middle East market. Middle East is the major international market for the ailing national carrier. With A380 used by Foreign carriers, Air India would loose further competitive edge.

Apart from US, India do not have an open skies program with any other country or region. Aviation industry in India is still highly regulated by the Indian Government. This red tape prevents foreign operates to fully tap the potential of the Indian market. It is true that Aviation is a strategic business unit for the government. However, too much of regulation could prevent the future growth of the industry. Foreign ownership rules by the Government can be justified but more reforms are needed to open up the Indian aviation market to foreign carriers. Even the developing economies unions such as ASEAN have developed a strong Open Skies policy that enables carriers within the union to operate any number of flights to any destination within the union without any regulatory pressures from the Governments. A similar deal was established between EU and US in the previous decade that opened up the competition between trans Atlantic airlines.

The aviation policies that protect the local carriers, especially Air India will only hurt the local consumers. Opening up the market increases competition; competition increases customer focus and reduces fares. Protecting Air India from competition can never be justified. Air India is non-performing state run airline. Indian taxpayers are paying for its losses in the past decade. Government should clearly identify bust organisations and should help private airlines to gear up for competition.

The aviation fuel tax paid by the Indian carriers are one of the highest in the world. This makes Indian carriers at a competitive disadvantage to start with. Instead of creating protectionist policies, the aviation ministry should enable a proper level playing field to help Indian carriers to fight for market share with foreign competitors. Until then, A380 ban is not justified.

Can Iberia Express take off?

International airlines group (IAG) announced today that it is launching a low cost subsidiary airline Iberia express from summer 2012. This airline is expected to complete in the short and medium haul business against well established low cost carriers such as Easy Jet and Ryan Air. The short and medium haul business of Iberia airlines is making losses for a few years in a row now. This is mainly because Iberia is not cost effective and hence was unable to compete with the price other low cost carriers offer. The solution IAG proposes is to focus on this market segment through a fully owned subsidiary making use of the existing fleet and by recruiting new pilots and crew members at the market rate which is significantly lesser than the rates offered to Iberia airlines crew. However, will this idea help IAG beat its competitors in the short haul business?

Easy Jet, Ryan Air and Iberia airlines use the same hub airport in Madrid. Iberia express will also be using the same airport. Since the budget and the full fare airlines use the same airport, the cost advantage for the low cost airline is fairly limited. Generally, low cost airlines use less congested out of the city airports. From Madrid, for a customer, the difference between flying low cost and full fare is minimal when compared to other cities such as London. Now, Iberia express will also use the same airport. What difference will it make for a normal customer between flying Iberia airlines and Iberia express? With only four A320s, all from exiting Iberia fleet, are used for Iberia express for some of the short haul routes, Iberia may be in danger of cannibalising its main business, the full fare Iberia airlines. If Iberia express takes over all of short haul network, the idea might work better. With the current idea, three airlines belonging to the same group, Iberia airlines, Iberia express and Vueling airlines ( a low cost subsidiary of Iberia airlines), compete in the market. How much ever IAG can work out on the timetable, competing with Easy Jet and Ryan Air as three different airlines may not be effective

Iberia express will fly in a two class structure. No established low cost carrier operate this structure. According to IAG, Iberia express will compete with established low cost carriers. With two class structure, achieving this goal could be difficult. Also, Easy Jet and Ryan Air fly to less congested airports from Madrid. Iberia express, however, flies to congested airports like Iberia airlines does. With this arrangement, Iberia express might not be able to achieve aircraft utilisation as much as other low cost carrier does.

The main cost advantage for IAG with Iberia express is their new recruits. They will be paid significantly lower wages and are expected to be more productive then their peers in Iberia airlines. Spain's labour laws mean that most organisations recruit contract employees who can be easily hired and fired. Spain's youth employment is one of the highest in Europe. In this situation, IAG might recruit contract employees at a very good rate. If this works out well, then they might expand this model at the expense of Iberia airlines' short haul business.

Ryan air and Easy Jet are well established from Madrid. Iberia airlines, with the current plan, will find it very difficult to compete with these low cost giants. However, not taking any action with the ailing short haul business is not a solution as well. The news of Iberia express would have made Iberia's employees more anxious than other low cost carrier's bosses. In the short term, Iberia express should compete with Iberia airlines for a better market share, than competing with other low cost carriers.