After being rejected by the Star Alliance only three years ago, Air India is now nearly ready for admission to the largest branded global alliance, according to an informal announcement by Star Alliance CEO Mark Schwab on 29-Apr-2014. Air India is expected to join the Alliance formally in Jul-2014.
This is partly a reward for the airline's substantial improvement, but mostly a barometer of the global industry, as the three Gulf carriers have come to dominate the international long-haul Indian market. For Star leader Lufthansa, the Indian market was for many years the jewel in its crown as, in a highly protected marketplace, the German flag dominated India's connecting traffic over its Frankfurt hub.
The recent rise of Emirates, Etihad (now with Jet Airways) and Qatar Airways in carrying Indian traffic over their highly effective hubs and across their diverse global networks has completely changed the shape of the Indian long-haul market, as it has in many other markets.
Lufthansa, the only one of Europe's big three to remain aloof from entwinement with a Gulf carrier, will be anxious to bring India's languishing but still powerful flag carrier into the Star fold; not quite at any cost, but still recognising that Air India has a long way to go before it regains its position as a serious competitor on the world stage. In the process, Lufthansa looks set to reinvigorate its anti-Gulf carrier rhetoric, putting any thought of an Emirates partnership behind it.
Air India is to be admitted to Star in Jul-2014
When Air India first attempted to join Star the carrier was going through a period of significant instability: the carrier had five Managing Directors in the space of just over three years; labour unrest was at its peak; the integration of the networks of Air India and Indian Airlines was still incomplete following their merger in 2007; and delivery of the Dreamliners continued to be delayed. Political sensitivity about Air India was at its peak at the time as airline's fleet orders and the decision to merge with Indian Airlines were the subject of an investigation by the Comptroller and Auditor General of India.
Against this backdrop the carrier repeatedly missed deadlines for meeting membership requirements. In Aug-2011, more than three and a half years after Air India was first invited to join the alliance, Star members lost patience and Air India's application was placed "on hold". However, Air India's management kept the dialogue open and in Dec-13 Star announced that the process of integrating Air India into the alliance would recommence. This time round the process appears to be proceeding more smoothly.
According to Air India chairman and managing director, Rohit Nandan quoted in the Economic Times on 2-May-2014, "Air India has completed 45 of the 64 requirements already (for Star admission) and the remaining will be completed in May." And Star Alliance CEO, Mark Schwab announced that - assuming completion of the requirements - Star members would hold a CEO meeting in London on 23-Jun-2014 to formalise the approval. Actual membership is to be completed unusually quickly, with Air India becoming a member in the following month.
Mr Schwab confirmed that the outstanding issues for Air India mainly related to the airline ensuring its IT systems were made compatible with the Alliance's systems. He also noted, undoubtedly with a degree of understatement, that "there are also a few commercial agreements that need to be signed".
Lufthansa last year explored a partnership with Emirates and decided against it
Despite Lufthansa's often extreme rhetoric directed at Emirates and its regional neighbours, pragmatism dictated potentially joining forces. In late 2013, following some warm conciliatory noises from Emirates, Lufthansa entered into detailed discussions with the biggest of the Gulf carriers with a view to partnership. Had that deal gone ahead, Air India would presumably have been a dot on the horizon. But, having excluded Air India from the Star Alliance reckoning in 2011, Lufthansa meanwhile left the Indian option open, probably feeling that the prospect of a deal with Emirates was a long shot.
At the time, then-CEO Christoph Franz said on 23-Sep-2013, "we have investigated this (Gulf airline) question several times. The Lufthansa group has done our homework and we developed business plans, potential forms of joint ventures, etc, with the different Gulf carriers. So far we've come to the conclusion that it is not beneficial for us. But in our industry never say never. So if things and the environment are changing, maybe we come to new solutions..."
The eventual rejection of such a proposition was in large part due to the fact that Lufthansa, as uncontested head of Star and vociferously opposed to liberalisation that allowed further access for the Gulf carriers, was concerned to protect its own longstanding sixth freedom hub role.
(A much earlier approach from Etihad to Lufthansa had all but succeeded, having gained agreement all the way up Lufthansa's long chain of management to the very top, where caution finally dictated a rejection. Etihad, as a much smaller airline than Emirates and therefore less threatening, would have been an easier partner, but even so, relatively difficult to contain. Presumably Emirates would have been a very long bridge too far.)
Lufthansa has had a bumpy ride recently, with staff discontent, coming off a pilot strike in early Apr-2014 which cost it EUR45 million and as its lower cost European short-haul operation Germanwings struggles to reduce costs. The airline's SCORE cost reduction programme did show some results however in 2013. Adjusting for one-offs, underlying profitability during the 12 months improved for the first time since 2010, mainly due to lower unit costs. But while Lufthansa is not in the same difficult circumstances as Air France, it is a long way from establishing a safely sustainable operation, either in Europe or in Asia or Latin America (a closed partnership with other Star members on the North Atlantic creates a more hospitable climate there).
CAPA's comprehensive 300-page India Aviation Outlook Report will be released on 15-Jun-2014. The Outlook includes CAPA's projections for traffic, capacity, yields and earnings and presents fleet induction plans, detailed operating and financial analysis, risk assessment of each Indian airlines and a review of prospective new entrants. The Outlook also outlines domestic and international plans, including expected bilateral developments.
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For Air India it has been a long and winding road to membership - from rags to Princess
Star, and Lufthansa in particular, have long had a considerable interest in the lucrative Indian market, but as the global alliance structure evolved, Air India became an inevitable focus of attention. But it continued to be a woeful shadow of its once considerable entity, losing around a billion dollars a year until recently and constantly in turmoil, digesting a succession of MDs and subjected to constant meddling by government.
Given Air India's circumstances and with little sign of future improvement, Star had also sought to add privately owned Jet Airways to its membership. Jet was seriously courting the Alliance at that time. The Indian government was on paper not opposed to a second Indian member but, keen to promote the interests of its costly offspring due to heightened political sensitivity, it insisted that Star first admit Air India and that it would take a decision on Jet later. In practice, agreeing to allow India's largest private airline into the same alliance as the national carrier would have been difficult to sell politically and was unlikely to happen. Such a dubious proposition, coupled with heavily indebted Jet's demands for an accompanying equity injection, proved too much of an ask for the would-be partners.
As time passed however, the bigger picture moved on. First Etihad began its progressive relationship with the competing Air France-KLM/SkyTeam grouping; then it acquired a share in Jet Airways (all regulatory hurdles to the acquisition of its 24% stake have in theory been cleared but further challenges cannot be ruled out). That took Jet out of play and greatly enhanced the Abu Dhabi flag carrier's Indian position. As a consequence, Star rapidly reversed its earlier stance and transformed into an ardent suitor of Air India.
In 2013, there was also a seemingly good prospect that Qatar Airways - which had been in discussions with Air India, but baulked at investment suggestions - might even bring the airline into oneworld. Suddenly Air India appeared much more attractive to Star. If not yet a beautiful Princess, Air India was now at least something too risky to allow to fall into another's arms.
Lufthansa has been the key driver of Star's renewed interest in Air India. The German carrier had been cultivating a framework of cooperation with Air India for many years, with a view to developing long term strategic opportunities. Those ambitions frayed between 2008 and 2011 as Air India's performance deteriorated following its merger and as the carrier became increasingly consumed by its own internal challenges. But the changing environment left no option but to resume those earlier plans.
Also helping the situation was a distinct aura of improvement in Air India's performance. Its long-overdue 787s finally arrived in late 2012 and have been generally well received; it now has 13 in its fleet with 14 more to come, according to CAPA's Fleet Database. Most of the routes on which the 787s have been deployed have turned cash positive, as a result of which international losses have reduced substantially.
The carrier now operates an integrated domestic and international network with increasing volumes of transfer traffic, while a new operations control centre has seen on-time performance improve. Service standards have also been lifted although there is still considerable room for further enhancement. And industrial relations are now more stable following a firm stance taken by management during the last pilots' strike which saw most international operations grounded for close to two months.
Despite these improvements the airline is far from being a sustainable entity. CAPA estimates that the airline lost USD720-750 million in FY2014. That is down almost 40% from two years ago but this may be as good as it gets as competition in both the domestic and international arenas is set to intensify.
The domestic market is expected to see the entry of two new strong operators this year, AirAsia India and Tata-SIA. Meanwhile Jet Airways and Etihad will ramp up the integration of their international networks and Emirates will also expand capacity and introduce A380s to having recently been granted additional entitlements. The Gulf carriers are expected to be particularly aggressive on routes between India and North America where Air India is already incurring significant losses.
But there are other events in train which may offer some encouragement to Lufthansa and Star.
CAPA's India Aviation Outlook Report will present a detailed review of Jet Airways' financial performance, its Etihad partnership and expected developments in international traffic flows for the year ahead.
A new government in India may not be so willing to underwrite Air India's massive losses; this would suit Star very well indeed
Based on current indications India's 800 million voters are likely to have returned a new government when the general election results are announced on 16-May-2014. The incoming Prime Minister is unlikely to be keen to continue raiding the national treasury to fund a flag carrier that shows few signs of ever becoming profitable, especially when the competing demands for public funds for social infrastructure are so great. But with new developments on the horizon, there may also be new options emerging. The situation in India is nothing if not dynamic.
After successive governments have failed to bite the bullet and either moved to force a genuine restructuring or shut the airline down, the arrival of the Star Alliance may well offer a solution that is equally palatable to Star and, perhaps, to the Indian government alike.
Among the "commercial agreements" that Mr Schwab says are still to be negotiated will surely be what routes the new member is welcome to operate. The experience of Jet Airways in its earlier negotiations to join SkyTeam offers a pointer to the dynamics in this equation. While Jet harboured aspirations to create a hub at Paris if accepted into SkyTeam and use that to service a spread of North American routes, nothing was further from the minds of Air France and KLM. They wanted to use the Indian access to leverage traffic over their own hubs; Jet would be little use to them if it were to set up in competition on long-haul trans-Atlantic routes.
Likewise, Lufthansa - or Air Canada and United for that matter - is hardly going to support a revitalised Air India to set up in competition to expand service to its UK or North American Indian diaspora. Air India's value lies in feeding the Star hubs, not operating long-haul itself.
(Insofar as the US market is concerned, the Federal Aviation Administration (FAA) has greatly aided the cause of restricting Indian airline access to that country. The decision by the FAA on 31-Jan-2014 to downgrade India to Category 2 under its International Aviation Safety Assessment (IASA) program was a major embarrassment for India and did no good for Air India or Jet. The Category 2 rating signifies an assessment that India’s safety oversight regime does not meet international safety standards. For Indian carriers the direct implication was to prevent them from launching any new service to the US or from carrying the code of a US airline - Indian carriers can however continue to place their code on services operated by US carriers.)
Here is the fertile ground where a new Indian government may offer a meeting of minds with the new foreign partners. If Air India - despite its recent 787-based revival - were to be constrained more to domestic, regional and medium-haul operations, its losses could be further reduced, creating a foundation for further restructuring. This would avoid competing with Lufthansa, Air Canada and United (and some other Star operators) and everyone is made happy.
In such a scenario it is possible to see Air India withdraw from North America entirely, and instead serve this region in conjunction with its Star partners. Its non-stop European network would also likely be limited to a few key destinations such as London, Birmingham and Paris, with most other point served via Star hubs. This would require a restructuring of its fleet to better align with the commercial realities of the market and its role as a regional arm. The recent sale of five of its eight 777-200LRs is a step in the right direction, but even the carrier's 12 777-300ERs seating 342 passengers are too large for its long haul operations.
Despite recent improvements in performance Air India continues to incur significant losses on its three US routes. With Gulf carriers rapidly expanding capacity into North America competition is set to increase, and given Air India's inability to generate significant premium traffic the carrier may no longer have a viable business case for its US operations. A fleet of a dozen 777-300ERs, with three more on order, is difficult to justify to support a service to London and three heavily loss-making routes to the US. and Over time Air India may be best to transition the 15 777-300ERs to 787-9s, to provide greater strategic flexibility. These could still be used to operate selected routes to the US if required at some stage. Combined with the 787-8s currently in the fleet and on order, this would eventually see Air India operate an all-Dreamliner wide body fleet of just over 40 aircraft that would deliver a fleet and network platform that would support restructuring.
Delhi could become - at last - a valuable hub to access eastern routes
That scenario would not however necessarily mean an end to Air India's international aspirations. To the east, there is the prospect that Air India could even become a valuable addition to Lufthansa's Asian expansion.
Lufthansa has expressed concerns in the past about its ability to service Asia, talking of establishing or partnering with a long-haul LCC to generate the necessary economics in this often low-yielding growth market.
This need to find a solution to service Asia could potentially be good news for Delhi Airport in particular - thus offering a win-win-win, with Star, the government and India's largest airport. Mumbai also has strong traffic potential but capacity constraints and the fact that a second airport remains several years away, limit its hub potential in the short to medium term.
Lufthansa is clearly searching for a solution to its long-haul cost issue. On 2-May-2014 it was reported in Spiegel.de as planning to convert nine A340-300s, otherwise due to be grounded, to service long-haul low cost routes, including to "India, Thailand and Taiwan". This sounds similar in design to Air Canada's rouge, where lower salary scales were negotiated and a lower cost profile seeks to cater efficiently to a lower yielding market.
Yet reintroducing the fuel-hungry and ageing A340s has to be seen an unlikely long term solution on Lufthansa's Asian routes, even one that smacks of desperation; a much more cost-conscious AirAsia X was forced to withdraw its London-Kuala Lumpur service with A340s as fuel prices rose into the USD100 range.
But serving an Indian point as a connecting hub and using Air India's 787s beyond to destinations like Australia (where its early performance has been encouraging), and to several other southeast Asian points, could be just the solution that all parties are looking for.
There would have to be a real sweetener politically for a new government to survive a likely wave of opposition if any suggestion were made of cuts at Air India - however needed they may be. An understanding that enhanced eastbound services for Air India were likely could offer just that reassurance. The airline currently has only a limited eastbound network, preferring to focus more on its European and North American diaspora, so new routes, supported by feed from Star carriers could be a mutual win.
The pursuit of such an approach would involve the creation of a new Air India with a fresh business plan. This would only be possible if the new government takes a comprehensive, long term view of the national carrier.
Star has an extensive presence in Asia, so not all members would be enthused by an added role of this kind for Air India, least of all Singapore Airlines. But, as outlined below, there might be a happy outcome for SIA as well.
An injection of equity into Air India would go down well in India
In Sep-2012, after years of protectionist-related procrastination, the Indian government finally enabled foreign airline direct investment in Indian airlines, up to 49%. In a gesture of continued nationalism, Air India was however excluded from the new rule.
But, assuming Air India can be slimmed down through deep financial restructuring and offered a future role, a minority equity investment would go down well in the current environment. It might even one day become a useful investment, although for the meantime it would mostly offer little more than the right to help top up Air India's losses. Etihad's initial experience in Jet Airways is not that dissimilar with Jet's losses in FY2014 burning through close to all of the funds received from the sale of 24% to Etihad one year earlier.
The next administration will have to take some hard decisions and could see an equity investment as a handy way of soliciting the help of the flag carrier's new partners to encourage Air India to take the medicine it so badly needs.
CAPA's India Aviation Outlook Report will outline options for the future of Air India under different administrations and scenarios, and possible fleet and network strategies.
Privatisation of Air India would be a challenging step for the incumbent Congress Party to take should they be returned to power, although this appears unlikely. After failing to take decisive action on Air India over the last decade it would be difficult for Congress to accept private investment at a valuation that is likely to be much less than the billions of dollars the government has committed to pump into the airline in recent times.
The opposition BJP, which is leading in the polls, does not have a strong privatisation agenda per se - in fact its position is that public sector performance can be improved by according them greater autonomy under government ownership. However, Air India may be past this point - by at least a decade. Most of India's public sector units operate in monopoly environments.
India's aviation sector is in contrast highly competitive and will become even more so. There is realistically no prospect whatever of Air India returning to profitability in its current form, so it comes down to a question of how long the state can continue to support the airline, diverting public funds only to allow Air India to compete with more efficient private players. A new government, without the baggage of the incumbent administration's handling of Air India, may be better placed to take a decisive step towards the carrier's inevitable privatisation.
A slimmer international Air India would open the door to other Indian airlines - and multiple ironies
Only Air India and Jet Airways are considered full service airlines in India, so effectively taking them out of play can leave the way open for other "national" airlines. If Jet is to become a feeder for Etihad and Air India for Star/Lufthansa, opportunities exist for a resourceful indigenous carrier.
That could leave the door nicely open for - no less than Singapore Airlines (SIA) as an Indian flag carrier. The high quality Singapore airline holds a 49% stake in a joint venture partnership with massive Indian conglomerate, the Tata Group, the distinguished company which in fact established Air India 82 years ago. Tata-SIA recently completed an important regulatory step with the granting of its No-Objection Certificate, and has submitted its application for an Air Operating Certificate. The carrier plans to operate a full service model on domestic and international (subject to the 5 year/20 aircraft rule being lifted) routes and hopes to launch in late 2014.
If it were to expand quickly into the new vacuum, Singapore Airlines, as a Star member, might experience some minor conflicts if it were to compete with its alliance partners, but that would be nothing new. The potential for a significant role is extensive.
There also exists great potential for a long haul low cost carrier based in India. The country's geographic location means that most of Europe and Asia is within an ideal 8-9 hour flight time. India's largest and most successful LCC, IndiGo, operates a fleet of 78 A320 family aircraft and has another 182 on order, according to CAPA's Fleet Database.
In light of the changing market dynamics IndiGo may be evaluating the potential to launch long haul services and could exercise its options for A330 wide body aircraft. And up to 20 of its A320neo orders have been converted to A321s. The enhanced range, economics and capacity of this type will enable IndiGo to compete on a much wider range of international destinations up to 6-6.5 hours away. AirAsia India is also understood to be interested in establishing long haul services from India subject to the appropriate regulatory reforms.
The Air India move marks an important milestone for an increasingly isolated Lufthansa
Given the importance of the Indian market and Lufthansa's experience in negotiating with the Gulf carriers, Lufthansa looks sure in future to harden its longstanding defensive attitude towards further market liberalisation now that it is committed to Air India. Not only has it apparently foresaken for good any prospect of working with Emirates, Etihad or Qatar Airways, it has also had an irreparable falling out with the "fourth Gulf carrier" and former close partner, Turkish Airlines. Although Turkish too is a major Star member, its influence in Germany's domestic market had become too powerful to be palatable and the two are effectively at loggerheads now.
This leaves Lufthansa in an unenviable position in long term alliance terms.
IAG has a very workable combination at European and global level and beyond that has Qatar as a Gulf oneworld partner; Air France-KLM, while still shaky within Europe, is moving to leverage the value of an Etihad partnership across the SkyTeam network. Even Lufthansa's fellow conservative alliance partner Air Canada has formed a relationship of convenience with Etihad. And meanwhile Lufthansa's main US Star partner, United, is struggling to achieve the success of its fellow majors in the US market, as persistent merger issues remain unresolved.
While not quite isolated, Lufthansa must be far from feeling comfortable about its global strategy. But there are few options remaining. In the short term this will translate into the need to rely on leveraging selected Star Alliance partners like Air India; it will presumably also default to its defensive position of fighting against liberalisation.
In this Lufthansa will certainly find comfort - and active support - in the reactionary posturing of some of the larger US airlines, notably Delta.
Lufthansa is now set return to its default position of vigorous resistance to the Gulf airlines
Incoming Lufthansa CEO Carsten Spohr has quickly moved to show he is no peacemaker, making crystal clear his future strategy as head of the airline, again invoking that mystical beast the "level playing field" as an iconic weapon to fend off the Gulf carriers. Having burned all bridges in cooperating with them apparently the battle will now be rejoined in earnest.
On 30-Apr- 2014 Mr Spohr was quoted in Bloomberg as saying the "the likes of Emirates and Qatar Airways are not operating on a "level playing field"".
While Lufthansa "can handle" the likes of "the short-haul discount operators" because "they are on a level playing field...With the Gulf carriers, it's different."
Although Lufthansa has yet to prove that it can actually handle the likes of Ryanair and easyJet, using the political card in the Gulf is a much more attractive target.
Much of the sporting metaphor is actually aimed at the European hosts of Europe's airlines, and rightly so. Europe is swathed in useless and unhelpful constraints on economic airline operation.
Europe's fragmented air traffic control regime comes straight out of Alice in Wonderland, perpetuated only to generate incomes for highly paid air traffic controllers and their governments, at massive cost to the industry; ugly taxes burden air travellers for no other reason than that they cannot fight back; Eurocrats spend long evenings dreaming up ways of gaining notoriety by adding new punitive regulations; environmentalists make life as difficult as possible on noise and emission issues; absence of recognition of the enormous underlying value of aviation socially and economically inhibits support for the industry; and the enormous complexity of building or expanding airports makes congestion inevitable.
To "level the playing field" with the Gulf carriers in those circumstances is not just fanciful, it would require acts of government lunacy by the Gulf countries beyond anything experienced in a 100 years of history. They are most unlikely to undermine their aviation systems in the comprehensive way that European governments delight in doing. By contrast, the Gulf governments are receptive to the value of aviation and do all they can to support its growth - whether by home grown or foreign airlines.
But that is probably not what Mr Spohr is talking about. The usual vague accusations of government support for Gulf airlines are what are on the line (although singling out only Qatar and Emirates, perhaps a casual slip, does little to lend credibility to his theme. On any terms, Emirates is massively profitable and highly efficient; even allowing for (arguable) advantages in aircraft financing, the airline can hardly be said to rely on external protection, operating in a completely open skies marketplace. Qatar, at a different stage in its evolution, is increasingly efficient and heading towards sustainable profitability. And in neither case do they benefit from the highly valuable but unaccountable effects of protection from competition that Lufthansa seeks to restore.)
So, despite its previous pariah status, Air India not only now has the prospect of being in the spotlight, becoming not only a highly useful partner for Lufthansa and some of its Star partners, but also of marking a significant escalation in the backwash against global liberalisation.
How effective a renewed onslaught on the new liberalisation can be is yet to be seen.
For Lufthansa, even slowing down the pace of change will be an achievement while it works out a viable long term global partnership strategy. It is still a way from doing that, at least as far as the voluptuous growth markets of Asia are concerned.
CAPA's India Aviation Outlook Report will outline the prospects for long haul LCC services to/from India identifying key prospective markets and operators; assess the future roles of the various existing and proposed Indian airlines and assess the likely winners and losers.
Please contact Vishal Bhadola on firstname.lastname@example.org to order or for more information.