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How budget airlines keep their costs low
Meenakshi Radhakrishnan-Swami |
May 31, 2005
Even two years ago, if someone had offered these prices to you, chances are you'd have asked them what banned substance they were on. Today, they all exist. You can fly SpiceJet from Delhi to Mumbai for Rs 99 or Air Deccan from Delhi to Bangalore for Re 1.
But before you rush to buy your ticket, stop to consider for a moment:
Given that these costs are fixed and the same for all airlines that fly in Indian skies -- and account for close to 40 per cent of total costs -- how do low-cost carriers earn their name?
"Perhaps it would be more fair to call them low-fare carriers," muses Faisal Wahid, director, East West Airlines. His company was India's first private sector domestic airline (between 1992 and 1997), and is now working towards a relaunch later this year.
The new version of East West was to have been a low-cost carrier (LCC), but Wahid's now keeping his options open. "It's going to become a dirty business. There will be a shakeout among Indian LCCs," he says.
That's a thought echoed by Kapil Kaul, the Indian subcontinent and Middle East CEO of the Sydney-based think tank, Centre for Asia Pacific Aviation. "By 2010, there will be just three large LCCs in India, with another three or four smaller, regional players," he predicts.
The LCC business in India really began with the Bangalore-based Air Deccan, which launched in August 2003 with a Bangalore-Hyderabad flight. Now, there are already four LCCs in operation in the country and more than 10 others are finalising their flight paths.
That's more than all the LCCs operating in West Asia and Asia Pacific. Will there be business enough for all these players? More importantly, given the constraints of the Indian aviation industry, how are they going to keep their costs down?
The defining features of an LCC are also the main reasons why its costs are lower compared to the legacy, full service or 'normal' airline.
Most LCCs offer short haul, point-to-point services on a no-frills basis; they have a single seat arrangement (all economy, no business or first class); and their fleet consists of a single aircraft model.
These, plus a few other factors, ensure that their costs are 35 to 40 per cent lower than those of legacy carriers. The stranglehold on costs and heavy passenger load also ensures that most LCCs break even by Year Two, latest by Year Three.
Did we say 'most'? SpiceJet started operations just two weeks ago but CEO Mark Winders is confident of breaking even within the next six months.
The UB group's Kingfisher Airlines, too, has been in the air for just over a month, but President and COO Alex Wilcox says the company will achieve operational break even by end-2005.
Those claims are still to be proven; meanwhile, there's Air Deccan. The airline claims a turnover of Rs 350 crore (Rs 3.5 billion) in 2004-05, having flown one million passengers.
This year, says Founder and Managing Director G R Gopinath, it will earn Rs 1,000 crore (Rs 10 billion) from 4 million passengers. But then, most industry analysts agree that the Air Deccan business model is a textbook case of how to operate an LCC, with a few significant differences.
LCC by design
According to Kaul, compared to legacy carriers, Indian LCCs can shave 15 to 20 per cent off their costs just by tinkering with their design structure.
That means ripping out the business class and -- since business class generally allows for more legroom -- using the space so freed up to squeeze in more economy seats. That's not quite as uncomfortable as it sounds: most Indian LCCs have about 189 seats on a Boeing 737-800 aircraft.
That's just 40 seats more than, say, Jet or Sahara, on the same aircraft model, but "It's an instant productivity gain of about 20 per cent," claims SpiceJet's Winders.
Even Kingfisher Airlines -- not a true LCC, it is offering what some call an "Air Deccan plus, Jet minus" service -- has single-class seating for 174 people on its Airbus A320s; legacy carriers don't take more than 122 passengers on that plane.
The type of aircraft you fly matters, too. Most Indian LCCs have begun by leasing aircraft, with plans to invest in purchases once the money starts coming in. The exception is Kingfisher, which is investing in a fleet of 11 new Airbus A320 by February 2006.
"New aircraft pay back in five or six years because they require very little maintenance," points out Wilcox.
Typically Indian LCCs -- or even international biggies like Southwest and Ryan Air, for that matter -- opt for jet engine aircraft such as the Boeing 737 series or Airbus A320. Both are old warhorses, known for their relative fuel efficiency, operational flexibility and reliability.
The exception, as usual, is Air Deccan, which began with an ATR 42-320, a 48-seater turboprop aircraft (a small aircraft that uses a turbojet engine to drive an external propellers). The present fleet comprises 13 ATRS and five Airbus, all leased.
The airline is sticking with that mix even in the future: the company has ordered 32 ATRs and 32 Airbus, taking delivery of one aircraft every month over the next five years.
Given the airline's stated objective -- "We want to penetrate deep into the bowels of the country," says Gopinath -- the choice of aircraft makes sense: Air Deccan flies to small towns such as Hoogli, Belgaum, Bhavnagar and Dibrugarh; given the passenger load, dedicating a high-capacity Airbus to these routes would be financial catastrophe.
"You need to put in capacity that reflects your demand," agrees Kaul, adding "But handling two different types of fleet is a challenge for any airline."
It also adds to your training and maintenance costs, which is why most LCCs fly a single fleet type. They gain economies of scale in terms of maintenance, spare parts, tooling, crew training and scheduling.
Uniformity in these areas translates into quicker turn times, higher aircraft utilisation and ultimately, increased revenue per seat.
Use it or lose it
Quicker turn time is critical for LCCs' cost structures -- turn times of under 20 minutes can help an aircraft reduce its costs by 10 per cent.
The sooner an aircraft flies back after a landing, the more it can be put to use, and considering the plane is an airline's most expensive asset, it needs to use it as much as possible.
That's where the other characteristic of LCCs -- little or no catering -- plays a significant role.
If an LCC doesn't provide meals on trays on board, or at best offers a packaged snack, it saves time on loading and unloading meals, waste disposal, and cleaning the aircraft. (In fact, Air Deccan doesn't distribute even newspapers given to it for free, because the attendants would have to fold them up after the flight.)
All of which translates into quicker turnarounds and, hence, more flying hours (on average, LCCs fly 11 to 13 hours a day compared to eight for legacy carriers).
The commissary savings actually accrue under various heads -- more flying hours means more revenue generated, greater asset utilisation brings down the cost per aircraft, the requirement for flight attendants and janitorial staff is reduced, and there's the cost of the meal itself.
A legacy carrier spends between Rs 300 and Rs 500 on an economy meal; Winders points out that SpiceJet's snack and bottled water doesn't cost the company more than Rs 25.
A ticket to fly
LCCs also save significantly by abandoning the traditional distribution systems of legacy carriers. Full service airlines generally subscribe to global distribution systems (GDS) and computerised reservation systems (CRS) such as Galileo and Amadeus -- none of which come cheap.
Most such services charge processing fees of anywhere from $3 to $8 a reservation. These services allow multiple reservations, which adds to an airline's costs in more ways than one: first, there's the obvious fee per reservation.
Then, if too many bookings are cancelled, the flight may end up flying at a punishingly low load factor. Or, worse, if more passengers than available seats turn up, the airline has to compensate them, perhaps also provide hotel accommodation.
An LCC can't afford any of those risks. Instead, it embraces the Internet with vigour, opting for web-based ticket distribution services and call centres.
Since the airline pays only for the cost of setting up and managing the Web site, the costs come down drastically: Gopinath estimates that Air Deccan pays just 25 to 30 cents per reservation.
Selling tickets through the Net has several benefits. The cost of physically printing, distributing and re-collecting tickets is done away with; travel agents commissions (between 7 and 10 per cent) are eliminated; and the system typically works on a cash payment basis, which takes care of the LCC's working capital needs.
There are two issues where LCCs gain -- and lose -- about equally. One relates to licensed staff. The acute shortage of trained pilots and flight engineers in India is well documented -- naturally, LCCs aren't exempt, either.
Most airlines agree that staff costs have gone up higher than they had anticipated, but add that labour cost savings are not a significant part of the LCC cost model. In the US and Europe, staff costs account for 25 to 30 per cent of total costs of LCCs; in India, it's more like 7 to 8 per cent.
The other zero-sum game is interlining arrangements with other airlines. LCCs avoid such alliances where passengers from one airline switch to aircraft of other airlines at an intermediate point of the journey.
Granted, it helps them improve utilisation by avoiding delays for connecting passengers, but it also limites opportunities to strengthen traffic flow by servicing multiple markets.
Money for jam
But it's not only about cutting costs. LCCs in India are looking at ways to increase revenues as well.
That includes advertisements during the in-flight entertainment -- "We will sell ad space on the TV screen inside the aircraft," says Kingfisher's Wilcox; and advertising on the aircraft: Air Deccan's aircraft have logos of Sun Microsystem and NDTV painted on the exterior. Then there's the sale of meals and snacks, and in-flight shopping for gifts and souvenirs. Air Deccan pays its air hostesses a 10 per cent commission on all sales and hopes to get 10 per cent of its total earnings from this source by 2007; right now it accounts for 3 to 4 per cent. "If you stand still long enough, we'll put a 'for sale' sign on you, too," laughs Gopinath.