Battle for the skies, phase II

Air Deccan's real battle will be with established players.

It's an audacious incentive scheme "" especially in the glamourous world of the airline business. The next time you find an airhostess on board the no-frills airline Air Deccan cajoling you into buying samosas, a sandwich, or even bottled water, don't be taken aback.

For the airline offers its cabin crew a 10 per cent commission on all beverages and food that they sell passengers on the flight. Captain G R Gopinath, co-promoter and managing director of Air Deccan, explains the logic.

As the airline does not offer complimentary meals, he expects the average passenger to fork out about Rs 75 to pick up a quick meal. On a margin of 30 per cent for the 1 million passengers who have flown Air Deccan over the last 12 months, that means Rs 7.5 crore in extra revenue.

That, of course, is not the only way Air Deccan is innovating revenue. It hawks advertisement space on the seats, the cabin interiors, and even on the body of the airplane.

And it will soon offer inflight entertainment "" from movies to news and music "" at a cost, naturally. Gopinath reels off some figures "" the airline is already making about Rs 20 lakh on each Airbus aircraft a month through ad revenue, and he hopes to squeeze in another Rs 5 crore by hawking inflight entertainment.

These permutations aside, what is Gopinath's secret mantra for running a low-cost airline? "My cost per kilometre per seat is only 4.3 cents," he says simply, "my competitors fly at eight-16 cents. My revenue yield is 5.1 cents. And now, by expanding the network and adding more flights, I will reduce costs even further".

That is precisely what Gopinath and his team are busy with: Air Deccan is on a major overdrive and wants to transform itself from a small regional feeder route carrier to a pan-Indian player.

Taking off rather shakily (its inaugural flight had caught fire) with only two ATR turbo-prop aircraft in September 2003, the fledging airline has targeted a fleet of over 35 aircraft by March 2006 (which will include 13 Airbus 320s).

At the moment it flies 64 flights a day, with 7 ATRs and three Airbuses, but has set itself an ambitious five-fold increase in the number of flights to about 300 by March 2006.

That's not all. By March 2005, the airline hopes to grab a 10 per cent market share (up from 3 per cent in March 2003) with a passenger load of 1.4 million.

It will add 10 new cities on the map within the next four months. The target is to have over 30 Airbuses and a similar number of ATR turbo-props in the next three years.

The cornerstone of the aggressive expansion is rock-bottom tariffs to impel users of railways to upgrade to air travel. The first salvo was shot last year when Air Deccan offered tariffs that were at least 50 per cent cheaper than scheduled airlines.

But the bigger bombshell was thrown this year when Air Deccan offered air travel at an amazing Rs 700 (on only a few seats) "" virtually half the price of a railway ticket in many destinations. By next year the airline hopes to push down tariffs by at least another 10-20 per cent.

And Gopinath is not complaining. Already, as much as 90 per cent of the 10,000 seats till March 2005 on the Bangalore-Mumbai sector are booked. On the Delhi-Mumbai sector, 65 per cent of the capacity for the same period is full. But the pygmy airline is still thirsting for dollops of cash if it is to fly into the big league.

Industry watchers say the going had been easy so far as Air Deccan mostly leased turbo-prop ATRs. But the game will change dramatically with the introduction of Airbuses and forays into metro routes where Indian Airlines and Jet Airways reign supreme.

Inevitably, this had led to speculation about Air Deccan's survival. Already, the company has slipped from its turnover target of $120 million by March 2005 because of delay in aircraft acquisition, scaling it down to $90 million.

Nor will the going be easy. Says Kapil Kaul, senior vice president of the Centre for Asia Pacific Aviation, an aviation consultancy firm, "Air Deccan will have to face intense competition from new airlines like Wadia, Kingfisher Air and Royal Air next year, all of which are looking at low-cost models. Also, the existing carriers will not keep quiet."

The three big carriers, for instance, have been quick in responding to the Air Deccan challenge on metro routes by dropping tariffs on select flights where, unlike an apex fare, you need not book earlier.

Indian Airlines has responded by bringing down tariffs on its flights that coincide with those of Air Deccan.

For instance, IA is offering Fly Select fares on three flights from Delhi to Mumbai "" at 9 am, 10 am and 6 pm "" for Rs 4,200. (Air Deccan flies at 8.55 am and 4.30 pm.)

Says an IA executive: "Passengers may pay Rs 500-1,000 more, but they get major advantages "" they don't have to book in advance or lose their money if they cancel, and will get food and beverage on the flight. The premium they pay is very little".

Even Jet (through their Check Fares) and Air Sahara (through Steal a Seat) are using the same model. IA is also planning to have at least three of its Airbus 319s which will be delivered next year to run with only economy seats and cheaper tariffs.

Competitors point out that the average tariffs for Air Deccan aren't as low as they are made out to be, and even Air Deccan admits to an average ticket yield of Rs 3,750 on its Bangalore -Delhi leg.

The hyped Rs 700 seat is booked within hours, and for many passengers seems more an advertising gimmick than reality. In most cases, the apex fares offered by the three airlines are more or less similar to what you can book on Air Deccan.

Says a senior executive of a competing airline: "If you book three months in advance, you get a cheap price, but between the seven-30 day advance booking period there are many cases where tariffs of full carriers are cheaper".

Also, these carriers are cutting costs too. Says Rono Dutta, CEO of Air Sahara: "There are smarter ways of cutting costs than by stripping down the product. In fact, today our costs are not any higher than those of Air Deccan."

Sahara has restructured its routes by creating a hub in Hyderabad. Dutta says this will improve utilisation of his fleet by over 10 per cent and save passengers travel time of over 50 per cent for those taking onward flights, as they don't have to wait long to take the next flight.  Plus, with the carrier spending US $20 million, it will save cost by having a single hub, spare parts depot and maintenance centre for its whole operation.  So where have Gopinath and his men cut costs? Gopinath suggests that his Airbus aircraft have 180 seats "" 22 per cent more than what his competitors squeeze in "" and that he flies his aircraft for over 12 hours compared to the competition's eight-nine hours.  Besides, his sales and distribution costs constitute only 8 per cent of the total cost compared to the full-service airlines that spend as much as 28 per cent.  That's because he has managed to shift bookings away from travel agents to the Net, ensuring his money upfront (you pay by credit card or cash), does not use international reservation systems (like Amadeus) which charge money for each transaction, and saves on agency commission.  There are also savings in avoiding the printing of tickets, and keeping staff on a tight leash. Besides, he only flies point to point with no onwards or connecting flights, saving on both fuel and time.  But many analysts and competitors say the cost-cutting model might not work here at all. For instance, IA says it also flies its aircraft for 11 hours, so that's not a big deal.  Adds Sahara's Dutta: "Low-cost made sense in Europe and US where labour costs constituted over 45 per cent of total cost; in India it is not more than 15 per cent. Instead, 50 per cent of the cost is fixed."  Analysts suggest that Air Deccan's ATRs did not have to pay landing fees, and forked out nominal navigation charges (government allows special rates for aircraft with less than 50 seats).  "But with Airbus, this saving (which is as high as 18 per cent of total cost) will cease to exist. Then the battle will be different." Worse, unlike in Europe, there are no no-frills airports (such as Gatwick in UK) that charge a fraction of the cost for landing and parking compared to the main airport.  Competitors also point out that the key ingredient for success of a low-cost airline is its dependance on e-ticketing. But in the case of Air Deccan, as much as 40 per cent ticket sales are through agents.  Says an airline executive: "He offers them the same 5 per cent commission we do, and is now also offering them credit lines. If they were not important, why should he do so?"  For instance, Air Deccan has recently tied up with ICICI Bank under which agents are issued a special Air Deccan credit card to buy tickets from the Net with a 40-day credit free limit. (Gopinath says he still gets his money upfront from the bank.)  The managing director of Air Deccan knows it isn't going to be a cakewalk for him. But he points out that he should be able to make a profit in the first year of operation itself.  No doubt he is also banking heavily on how successfully he can raise the funds for his next expansion phase. That could well be his acid test. And he knows the battle will only get fiercer. 

Money matters
Air Deccan has an equity capital of only Rs 30 crore and a debt component of Rs 15 crore. That might be passable when you run a small operation with turbo props, but running a pan Indian airline with Airbuses is a different kettle of fish. Company finance director Mohan Kumar agrees that the funding requirement will change dramatically ""he is scouting for $300 million to buy six Airbus aircraft next year"" by roping in fresh investors to expand the equity capital base. 

Already, Air Deccan is in the final stage of negotiations with three equity investors (ICICI Venture and Capital One among them) to raise $50-60 in fresh equity. 

Says Kumar: "We might do a deal with all three, or with one of them. An option is to issue zero-interest convertible debentures to these investors where the conversion would be tied up with the company's performance." 

The company is ready to offer up to 26 per cent to the new investors. That still leaves a yawning gap of $240 million. Air Deccan says this will be raised through debt, talks for which are on with Export Credit Agency of Europe that funds up to 85 per cent of the cost of the plane as long as companies buy European products. 

But that could overburden the company with debt and high interest costs. Kumar says the debt to equity ratio will go up from 0.5 to 2 "" beyond this would put a strain on the company's bottomline. So on an equity capital base of $67 million (after the new investors have been roped in) it will be able to raise debt to a maximum of another $130 million. 

That still leaves a gap. Kumar's answer is to get into a contract with Airbus to buy the aircraft (as the Export Credit Agency does not give loans for leasing out), then transfer the contract to a bank or a leasing company which will then buy the aircraft and lease it back to Air Deccan. Talks are already on with international banks, he says, that will ensure Air Deccan's debt burden is under control. 

He says the company might be able to buy two aircraft (the price of an Airbus 320 is around $56 million) and take the rest on lease. Analysts say the airline's future is uncertain until the financial deals are closed. 

Especially as the financial restructuring does not include the leasing of more ATRs. They also say the debt burden could put tremendous pressure on the company's bottomline, something Kumar refutes as he says that these are long term loans spread throughout the life of the aircraft.

 (Additional reporting:  Bipin Chandran )