Air India Outlook: a business model beleaguered on all fronts


In this second extract from the CAPA India Aviation Outlook 2013/14 we look at the growing challenges to flag carrier Air India's business model.

A combination of stronger Indian competitors as a result of foreign airline investment, the growth of LCCs, the opening up of the international market in the form of bilateral liberalisation and the changing nature of global alliances, will impact each of the three key areas of Air India's operations - long-haul international, regional international and domestic - each of which we will consider in turn below.

  • Etihad's investment in Jet Airways is expected to accelerate the latter's international expansion, posing a challenge to Air India's long-haul operations.
  • The Indian government is expected to liberalize bilateral agreements, benefiting foreign carriers like Emirates, flydubai, and Air Arabia, and increasing competition for Air India's key routes.
  • Air India's long-haul operations are further compromised by issues with its widebody fleet, which is spread across five different aircraft types, adding complexity and cost.
  • Air India Express, the low-cost international subsidiary of Air India, will face increased competition from Indian LCCs and foreign carriers due to the opening up of bilaterals.
  • Air India's regional domestic operations are at a disadvantage as it lacks a clear strategy and has not launched a domestic low-cost subsidiary, unlike its competitors.
  • Air India is expected to face a severe capacity crunch in the domestic market as its competitors have a significant number of narrowbody aircraft on order, while Air India has no current or impending orders.

1. Key issues for Air India's long-haul operations

Etihad investment expected to accelerate Jet Airways' international expansion

Despite the unfortunate complexity of entering equity transactions in India, there remains a strong likelihood that Etihad will acquire a substantial minority share in Jet Airways, to accompany the increasingly close working relationship the two are developing. The potential infusion of cash would be a major positive for Jet and will likely accelerate its domestic and international expansion plans. Jet Airways currently has a widebody fleet of 23 aircraft (13 A330s and 10 777-300ERs) of which five 777s have been sub-leased to Thai Airways, leaving an operational fleet of 18 aircraft.

Jet Airways current and projected 2014/15 widebody fleet size

Over the next 12-18 months the widebody fleet is expected to increase from 18 operational aircraft to at least 30 aircraft - although this is largely dependent upon the new network plan to be developed once the Etihad transaction is completed.

This growth will be achieved as a result of:

  • retaining at least two of the five sub-leased aircraft when they are returned at the end of their lease term later this year, with the remaining three possibly to be re-leased;
  • taking delivery of six new A330-300s (out of a total of 10 to be taken on lease, of which four have already been inducted);
  • introduction of five or six 777-300ERs in 2014/15.

Meanwhile Jet is likely to defer its order for 10 787-8s (with 10 options) until after 2016 and possibly switch to the -9 variant. Jet Airways is also expected to evaluate the A350 as an option. The carrier will likely review its long-haul fleet strategy after developing a coordinated network plan in conjunction with Etihad.

Jet's international operations have stabilised financially; however the route network continues to evolve. In 2012 for example the carrier exited loss-making routes e.g. services to Johannesburg, Milan, New York JFK and Kuala Lumpur. Further changes can be expected in the short-term and a new network will emerge as the deal with Etihad evolves, especially as the two carriers compete on westbound routes from India.

For Etihad, a key rationale of the proposed investment is to provide greater feed from the Indian market to support its intercontinental services to Europe and the Americas, which involves the development of Abu Dhabi as a hub. Jet Airways may in turn be used to develop Canada and other markets where Etihad faces challenges to securing bilateral entitlements.

Indian government expected to liberalise bilateral agreements with key markets

The Government of India's stance on bilaterals has lacked consistency, clarity or transparency, making it virtually impossible for Indian carriers to plan their international strategy.

The rationale of India's bilateral strategy and the allocation of precious rights (which are treated as national assets) are ideally based on serving clearly defined national objectives - rather than the interests of any individual Indian or foreign carrier - to provide the necessary connectivity to support business, tourism, trade and social ties.

From 2004 the market was opened up rapidly, only for bilateral access to be frozen again from 2008 with a view to protecting Air India. In response to growing pressure from private carriers and Air India's inability to utilise the available bilaterals, several pending route applications were finally approved in early 2012 after significant delays.

One of the critical impacts of the Jet-Etihad deal is likely to be a liberalisation of the India-UAE bilateral. This will benefit not only these two carriers, but also Emirates, flydubai and Air Arabia. Meanwhile Qatar Airways, Turkish Airlines and Singapore Airlines are all waiting in the wings, seeking an expansion of bilateral access, as they have exhausted their current entitlements.

Most of the airlines seeking additional rights are sixth freedom carriers. Further liberalisation will place further competitive pressure on Air India's key routes. The historical weakness of international services by Indian carriers - largely the result of incoherent Indian policies - means that close to 40% of Indian international traffic travels to its final destination via an intermediate offshore airport, with Middle East hubs capturing just over half of such flows.

Location of offshore hubs for sixth freedom Indian traffic, 12 months to Nov-12

Air India's long-haul operations are further compromised by widebody fleet issues

Air India is currently the largest international operator to/from India, but will face increasing competition on international routes.
The airline is poorly equipped to meet this challenge in terms of its fleet composition. Air India has a widebody fleet of 33 aircraft, with a further 21 (all B787s) on order. This relatively small fleet is spread across five different aircraft types, adding complexity and cost.

And two of these types - representing 13 aircraft (eight 777-200LRs and five 747-400s) - do not have a good strategic fit with Air India's operations. The airline has not been able to generate the necessary traffic volumes and yields - particularly in premium cabins - to support the high trip costs of these large aircraft.

As a result, aircraft which are ideally suited to long-haul missions are instead being sub-optimally deployed on medium-haul routes, with relatively low utilisation. The airline has been trying to sell at least five of its 777-200LRs - and possibly all eight - but has not been successful to date. The 747-400s may be reconfigured for VIP operations and sold to the Government of India.

Until recently this left Air India with just the 12 777-300ERs, supplemented by a couple of A330s, as the only widebody aircraft suited to its mission requirements.

For this reason the right-sized 787 with its superior seat mile costs was eagerly awaited and the aircraft was a cornerstone of Air India's turnaround plan. The strategy was proving effective with routes such as Delhi-Frankfurt turning to an operating profit within just a few weeks of deploying 787s.

But with the grounding of the Dreamliner and no clear timeline for the resumption of services, Air India will have to increasingly deploy its 777-200LRs which are poorly matched with the demand profile on its key long-haul routes.

Air India current widebody fleet size

As noted, Air India has a further 21 787s on order, all of which were due to be delivered by 2015, although the schedule is now uncertain. And with B787 pilots sitting idle Air India may be forced to incur re-training costs on other types if the grounding is extended. At the same time B777 pilots - along with other skilled, licensed staff - are being poached by Gulf carriers and a continuing exodus is likely.

Membership of an alliance might strengthen Air India's commercial reach and feed, and with Jet Airways now set to partner with Etihad, there is a (remote) possibility that Star Alliance could resume discussions with Air India.

Beyond 2015 Air India has no committed fleet expansion. Together with its commercial weakness, the opening up of bilaterals and the strengthened competition it will face from Indian and foreign carriers, LCCs and sixth freedom behemoths, this imposes a structural limitation on its long term business plan.

Air India is already bleeding badly on international routes which account for 80-90% of its total losses, and these developments will significantly weaken the business case.

2. Key issues for Air India's regional international operations

Air India's low-cost international subsidiary, Air India Express, which operates primarily on routes to the Gulf and Southeast Asia, will also face increased competition. Firstly, Indian LCCs are expanding on short-haul international routes. Secondly with the opening up of bilaterals, foreign carriers such as the UAE's flydubai and Air Arabia are also keen to increase their presence in India.

Air India Express has a fleet of 21 737-800s, of which 17 are owned and the balance leased. The carrier was earlier planning to increase its fleet size to 35 aircraft by 2015 and launch domestic operations. A combined domestic and international network would enable the carrier to increase its aircraft utilisation with a more flexible combination of sector lengths. However, with the airline facing a pilot shortage and under-utilising its current fleet, such a rate of expansion appears unlikely at this stage.

In addition to this, Air India Express does not operate at genuine arm's length from Air India and lacks a dedicated corporate structure. Air India's senior management is preoccupied with the myriad challenges at the core business and have neglected the subsidiary.

As a result, Air India Express has also seen its financial performance deteriorate since FY2008.

Air India Express net profit/loss FY2008 to FY2012

Air India Express is preparing to strengthen its base in the state of Kerala. However, this would appear to be a politically rather than commercially driven decision. Although the state accounts for the majority of the carrier's capacity today this may not always be the case going forward. If Air India Express truly wishes to be one of India's leading international LCCs there are route opportunities from airports right across the country, not just from Kerala.

Investing in developing a new base in a location which might not be the primary focus of the airline in future could result in an unnecessary duplication of resources. It would appear to be a strategic mistake to neglect other important markets and leave them open for Indian or foreign LCCs to develop their own fortresses.

And despite Air India Express making a commitment to Kerala, it is still not seen as being sufficient or in line with requirements by the state government, which is preparing to launch a competing low-cost airline, Air Kerala. It is unfortunate - to say the least - that the one market which is receiving Air India Express' attention is seeking to undermine it.

With the central government considering removing the regulation which requires domestic carriers to operate for at least five years and have a fleet of 20 aircraft before being granted permission to launch international routes, any new start-ups could in future also potentially compete with Air India Express on its key routes.

3. Key issues for Air India's regional domestic operations; failure to introduce a domestic LCC leaves it at a disadvantage

Air India currently operates a domestic fleet of approximately 40 aircraft, with no further equipment on order. However, around 60% of the fleet comprises A319s which have limitations in that they are not competitive against larger narrowbodies such as A320s and 737NGs as used by most Indian carriers, but are too large for regional routes. The airline has been seeking permission to lease up to 12 A320s to augment its domestic capacity however this continues to be held up.

There does not appear to be a clear domestic strategy and Air India has hesitated in launching a domestic low-cost subsidiary to complement Air India Express internally. This is largely for fear of cannibalising its parent operations. However, as a consequence, it is the only airline group not participating in the fastest growing segment of the market.

And it has only a small regional fleet comprising a mix of regional jets and turboprops - several of which are dedicated to operations in the northeast of the country - with no clear market proposition. Against this backdrop of capacity stagnation, Air India's competitors are set to expand aggressively.

Indian carrier narrowbody current and expected orders

Jet Airways is expected to place an order in the coming months for up to 100 narrowbodies, which may consist of a mix of 737 MAXs for the full service operation and A320neos for JetKonnect. Meanwhile 46 B737-800s from an earlier order are still to be delivered. Following the conclusion of the Etihad transaction, Jet Airways is also expected to have the capital to implement a clearer market segmentation strategy, in particular the establishment of a strong hybrid model under the JetKonnect brand.

IndiGo has around 30 A320s from its 2005 order still to be delivered of which some will be used for replacement. However, from 2016/17 it will start to take delivery of the first of its 150 A320neos, as well as a further 30 A320s. As a launch customer placing what was at the time the largest civilian order by number of aircraft, IndiGo will have obtained very attractive pricing on its aircraft (as it did when it placed its original 100 aircraft order in 2005) providing it with a competitive cost base. IndiGo is also evaluating the possibility of placing an ATR order to establish a regional subsidiary.

SpiceJet has 30 737-800s on order with deliveries set to commence from next year. A further narrowbody order may be finalised by early Apr-2013 after a new investor comes on board. The 737 MAX is the most likely equipment, particularly as there are no available A320neo delivery slots within the required timeframe. SpiceJet remains undecided on whether to exercise its options for a further 15 Q400s, however CAPA expects that the carrier will increase its regional fleet in due course.

GoAir, with its more cautious, but basically profitable strategy, will see its fleet size increase from 13 to around 20 aircraft over the next couple of years, to be followed by the first of its 72 A320neos on order from 2017. The airline is also considering inducting turboprops to serve Tier 2 and Tier 3 cities.

In sum, beetween them, Air India's competitors could have 500 narrowbodies on order by the end of this year (over 360 narrowbodies currently on order, with up to a further 140 aircraft to possibly be ordered in the coming months).

And this is just the incumbents.

There is no certainty at present regarding the approval of new licence applications for pan-India operators, but as and when the government decides to open up market access again there are two or three serious joint ventures in the pipeline. Although the Ministry may hold off granting permission to start-up national carriers for now, they will eventually launch. Meanwhile, regional airline licences will be approved and while new start-ups are likely to be small, these new carriers will nibble away at Air India's operations in Tier 2 and Tier 3 cities.

Air India meanwhile has no current or impending orders and is expected to face a severe capacity crunch which will leave it unable to participate in domestic market growth.

Its government owner is not prepared to inject capital to place Air India in a position to compete effectively, nor does it have the policy commitment to restructure the heavily loss-making company. In this policy vacuum, the only area likely to flourish at Air India is the level of annual subsidy paid to it.

CAPA India Aviation Outlook Report 2013/14

This analysis is an extract from the keenly anticipated 2013/14 edition of the annual CAPA India Aviation Outlook Report to be released on 31-Mar-2013.

The coming year will be a defining period for the long-term prospects of the Indian aviation market. In this complex environment, having access to up-to-date research and insights into the direction of the market is critical for any business with exposure to Indian aviation.

For more information about CAPA India's research reports click here or contact bs@centreforaviation.com.

CAPA has a strong and established track record in accurately identifying key trends and developments in the Indian market. We operate India's leading dedicated aviation advisory and research practice offering unrivalled analysis and data across the value chain.

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