Lessons from the KF tailspin

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Jitender Bhargava
Jitender Bhargava

The Kingfisher mess shows the Centre has to make changes to save the aviation industry

 

 

 

Desperate measures: Vijay Mallya wants the Centre to let airlines import ATF and allow FDI in the aviation sector
Desperate measures: Vijay Mallya wants the Centre to let airlines import ATF and allow FDI in the aviation sector, Photo: AFP

IS KINGFISHER Airlines in a state of crisis? Yes, if one goes by the large-scale cancellation of flights last week allegedly due to financial liquidity. No, if one takes seriously the assertions made by Vijay Mallya at his press conference on 15 November and duly supported by his CEO Sanjay Aggarwal. Both went out of their way to make people believe that everything was hunky dory with the airline and that the cancellations were a mere aberration. They claimed that neither were they facing a financial crisis nor have they sought a bailout from the government.

What we are now being told is that Kingfisher has an in-house solution to all the financial problems. Mallya said that oil firms have almost been paid off their dues — they were getting Rs 1,000 crore released from leasing firms, which are going to be substituted with a letter of credit; their decision to withdraw from the low-cost segment didn’t matter in his business plans and that the decision was well thought of and irrevocable.

The question that begs an answer is that if the solutions were in Mallya’s hands, why was the crisis allowed to erupt in the first place? His assertions can at best be attributed to an understandable desire to send a positive message to employees, customers, bankers and creditors that the airline didn’t face any threat for survival as was being portrayed by the media. It is doubtful if anybody was convinced.

However, there is no denying that Kingfisher is a great brand and Mallya offers passengers amenities more than what most airlines do. But the question for the management, and banks if they are eventually prodded into sanctioning more loans, is whether the business model being pursued by Mallya is economically viable.

It is a known fact that a big chunk of the domestic market is being catered to by low-cost airlines and they continue to be in growth mode. This is not because such airlines are offering a superior product but because our market is hugely price sensitive. If an airline offers a fare that is even Rs200-Rs300 less, the customer has no qualms about switching from one airline to another. This is apparent from the fact that low-cost airlines offering attractive fares are achieving load factors of 80 percent or more.

It is in this context that one is sceptical about Mallya’s decision to exit the low-cost business and focus entirely on a full-service carrier in the belief that competition is less fiercer in this segment. But the question is will Mallya be able to recover his costs from the truncated market that he would now serve following his decision? When you have a smaller cake from which one wishes to take a slice, howsoever huge, revenues generated may not be enough to meet your costs. After all, there are fixed costs that a company needs to disperse over a larger base than a contracted one, which Mallya will end up with once he exits the low-cost segment.

The industry runs the risk of seeing more airlines getting into bad financial health

IT IS interesting that no less a person than Prime Minister Manmohan Singh made a statement saying something needs to be done to help Kingfisher. This decision can be described as premature because as subsequent events showed that while the PM wanted to extend a helping hand, here was Mallya stating in no uncertain terms at the press conference that he had neither sought any financial support and nor does he need any. The PM ought to have been guided sensibly by his advisers.

A positive that may come out of the crisis is that even though it has been the flights cancellation and nonpayment of dues to vendors that has brought the lack of economic viability of Kingfisher in particular, and the industry in general, to the centre stage, the Centre cannot ignore the ground realities any longer as the financial condition of other airlines is also not different.

Why are airlines in a crisis? It needs to be understood that the aviation business is capital intensive and that the returns, even for a highly efficient airline, are seldom more than 3-4 percent even in a really good year. Indian carriers have been sustaining losses, notwithstanding an impressive growth in traffic, because of high fuel costs, high interest rates and depreciation of rupee visa- vis dollar on one side and the below-cost fares prevailing in the market due to competition.

While there are people who agree that the government will perhaps take a hard look at the economics of the airlines, there are also sceptics who are guessing as to whether the crisis was brought forth so as to compel the government to fasttrack FDI in the aviation sector. It is, of course, hard to believe that Mallya could have played such a gamble considering that his airline has taken a severe beating image-wise.

Another question that needs to be looked at is this: Why is the financial situation of Kingfisher more precarious than other airlines? This is because Kingfisher has a product with numerous passenger amenities that other airlines don’t offer either due to lack of vision or they realise these amenities don’t help get passengers. After all, such facilities must help airlines get higher revenues through enhanced fares, something that is not happening in the Indian market, leading to bigger losses for Kingfisher as compared to a full-service carrier such as Jet Airways.

Considering the fact that airlines operate on 3-4 percent return on turnover, how could Mallya conceive that he would make profit even when he was spending far more than warranted by market conventions? His association with the Indian Premier League or Formula 1 has certainly not gone down well with the investors.

Having said this and considering the fact that the aviation industry as a whole runs the risk of seeing more airlines getting into precarious financial health if the existing pattern of operational costs and market conditions dictating below-cost fares continue, there is a need for government to intervene — not for Kingfisher alone but for the industry as a whole. Faster the systemic corrections — reduction in ATF taxes, interest rates, navigation charges, improved infrastructure — are made, the better for the industry because the airlines have made air travel a reality even for the aam aadmi.

Mallya also made two significant points from the industry perspective. 1. Airlines should be allowed to import ATF and 2. FDI from foreign carriers be allowed in Indian carriers. Both suggestions have merit and are worthy of being considered by the government.

The import of fuel, which is a major component of the operating cost of the airlines, would help them reduce their cost platform, thereby not necessitating an increase in fare, which will have a negative impact on market growth.

Second is FDI: whether it should be 24 percent or 49 percent will have to be a subject of animated discussions. At 24 percent, it is unlikely that a foreign carrier would come and finance an Indian airline because of the market environment in which airlines are regularly losing money and of not having a say in the running of the company. After all, a foreign carrier would not only like to be part of the Indian carrier but also guide the airline’s destiny.

The question is: will Mallya, who is likely to be the first candidate for FDI, agree to someone doing backseat driving for him or being in his airline’s cockpit?

Jitender Bhargava is former executive director, Air India.
jitenderbhargava@hotmail.com

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