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How to survive the air-wars

Surajeet Das Gupta | April 14, 2005

With some domestic carriers like Air Sahara announcing inaugural fares on their Delhi-Singapore-Delhi flights as low as Rs 10,000 (for 50 seats per flight), the question bothering everyone except the tourists naturally is whether we're in for another round of air wars and whether the airlines will survive it.

The answer, surprisingly, is yes, but with a proviso: the airlines need to have the appropriate mix of aircraft, and right now it would appear the domestic Indian airlines do not have this mix.

The survival mantra lies in the number of seats you have to offer, and while foreign airlines have wide-bodied aircraft that can take in more passengers (more than just passengers, it is more first class and business travellers that make the difference), most domestic airlines fly narrow-bodied aircraft that can take a lot less passengers.

While no airline will divulge their operational numbers, aviation experts say margins for foreign carriers operating out of India are among the highest they have anywhere in the world. What this also means is that, once the inaugural rush is over, it is unlikely Indian carriers will carry on with the discount war as it is they who will get wiped out while the foreign carriers will still survive.

How do foreign carriers make money even at cut-throat tariffs while domestic carriers get burnt? Let's look at just one example -- the Delhi-Singapore route. Foreign carriers typically flying Boeing 777 wide-bodied aircraft offer over 288 seats on board with 12 first class (with a ticket price of Rs 78,000 for a return) and 42 business class seats (ticket price of Rs 62,000). The rest, the economy seats fetch an average price of around Rs 20,000.

If the flight is full, the airlines make Rs 82.2 lakh (Rs 8.2 million) as revenue. But if they decide to follow Air Sahara's example and slash return fares on the economy segment by half, they will still make around Rs 59 lakh (Rs 5.9 million).

The numbers of course change if the flight is not full, but experts say the average load factor on this busy route is as high as 75 to 80 per cent (even hitting 100 per cent in the peak season).

Taking that into consideration the revenues from passenger tickets is between Rs 57.4 lakh (Rs 5.7 million) and Rs 65.6 lakh (Rs 6.56 million) if the normal rates are charged -- if economy rates are dropped to Rs 10,000 for a return flight, the revenue ranges from Rs 44 lakh (Rs 4.4 million) to Rs 47 lakh (Rs 4.7 million).

What of the costs? These can be divided into three key components -- the main component, of course, is the cost of flying which includes fuel, on board staff and, of course, food. And fuel costs are directly related to the kind of aircraft you fly -- the larger the aircraft, the lower the per seat kilometre cost of fuel.

The second component is the cost of leasing the aircraft (you could, of course, also buy the aircraft outright) -- this is usually done with the assumption that the aircraft will be flying 14 hours a day and every day of the month. The lease rentals themselves would depend on the age and size of the aircraft with costs going up for both new and large aircraft.

The third component is administrative costs, which include ground support, marketing, distribution and other such costs. Experts reckon this at around 30 per cent of what is spent on flying the aircraft and the lease costs put together.

Once you have this formula it is easy to work out costs. For instance, on a Boeing 777, prevailing lease rentals are about just under $1 million a month, which means you roughly fork out under Rs 500,000 (assuming the aircraft flies for 14 hours a day) as lease rental for a five hour flight between Delhi and Singapore And the cost of flying at $ 5,500 an hour works out to Rs 11.55 lakh (Rs 1.15 million).

That is, the operating cost of flying between Delhi and Singapore is around Rs 16.5 lakh (Rs 1.6 million). So the cost of operating a return flight is around Rs 33 lakh (Rs 3.3 million). Add in the 30 per cent overhead costs and you get Rs 43 lakh (Rs 4.3 million).

This is lower than the revenues earned from a wide-bodied craft even when economy tickets are sold at rock-bottom prices. The lesson is very clear: foreign carriers recover a large part of the cost of flying from the economy class passengers, and make profits from selling the relatively price-inelastic business and first class tickets.

So if they want to kill competition, they can cut prices in the economy segment to a very large extent without really affecting their bottom line in any significant manner.

Domestic carriers who are going to be flying their narrow-bodied aircraft like the 737-800, which has 168 seats (of which only 12 are business), on international routes like the Delhi-Singapore one, however, don't have the same luxury. And, of course, running smaller aircraft is a costly business.

Which is, of course, why carriers like Air Sahara have kept their promotional offers to the minimum -- the airline which saw its introductory offer being sold out in minutes has only earmarked about 50 seats at the Rs 10,000 tag. The rest will be sold at varying prices.

Since Sahara's business class seats cost a maximum of Rs 28,000 on the Delhi-Singapore-Delhi flight, domestic carriers will only earn Rs 19 lakh (Rs 1.9 million) if they price their economy at Rs 10,000 and this goes up to around Rs 26.8 lakh (Rs 2.68 million) if the economy ticket is sold at Rs 15,000 or so, based on a full passenger load. On an 80 per cent load, revenues fall to between Rs 15.2 lakh (Rs 1.5 million) and Rs 21.6 lakh (Rs 2.16 million).

This is not enough to take care of the costs. Per hour running costs of these aircraft are $3,500 an hour while lease rentals are at around $240,000 a month for an aircraft which is four to five years old and around $350,000 for a new aircraft.

Taking overhead costs into consideration, that's an overall cost of between Rs 22 lakh (Rs 2.2 million) and Rs 24 lakh (Rs 2.4 million), leaving a gap between revenues and expenses. The gap, though smaller, persists even if business fares are raised to near those charged by foreign airlines.

The answer is pretty clear -- foreign carriers, used to large operating margins in India have enough cushion to drop prices without losing their shirt. But domestic carriers need to move on quickly to large-bodied aircraft if they want to play the international game. Or go for an entire new model like the no-frills one perhaps which will bring down their costs substantially.

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Number of User Comments: 1

Sub: How to survive the air wars

Hello! Ryan Air, Virgin Express fly narrow bodied 737s and A-320s and they are doing quite well thank you. Also freight is another important component. ...

Posted by Raj Khalid


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