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IIM Rohtak Case Series

IIM Rohtak Case Series IIM-R/0301/SM/2012 INDIAN INSTITUTE OF MANAGEMENT ROHTAK Flying Too Low: Air India 2009

IIM-R/0301/SM/2012

INDIAN INSTITUTE OF MANAGEMENT ROHTAK

Flying Too Low:

Air India 2009 & Beyond

P Rameshan Director, IIM Rohtak

March 20, 2012

INDIAN INSTITUTE OF MANAGEMENT ROHTAK

M.D University Campus, Rohtak - 124001 INDIA Phone: 01262-274052/Fax: 01262-274051 E-mail: iimrohtak@iimrohtak.ac.in Website: www.iimrohtak.ac.in

Copyright

IIM Rohtak , March 2012

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Flying Too Low:

Air India 2009 & Beyond

INSTRUCTOR’S MANUAL (IM)

Case Synopsis

The Indian airline industry on the eve of the global fuel crisis of 2008 had one of the fastest growing air traffic trends across the world. Intensive competition and an excess capacity build up were facilitating growth until the fuel crisis erupted. Yet, the second year in a sequence, in 2008, carriers incurred huge losses. For the public carrier Air India (AI), which had been facing poor performance and serious financial problems for years both alone and after the merger with Indian Airlines (IA), the problems were much more complex. It was reeling under intense competition from the private sector. Its market share was rapidly shrinking and it was virtually being pushed to be a marginal player. AI faced, apart from high fuel prices, increased interest burden of new aircraft orders, personnel shortages, inability to cope with competition, and a worsening service image. AI faced several size and network related constraints. Hardly any S-curve effect was left with it due to reasons of strategy and service quality. To contain the effect of competition, AI made several strategic moves. It tried to operate both full-cost and low cost services. It decided to join the Star Alliance. It offered lower fares. However, performance continued to deteriorate. On September 26, 2009, the Executive Pilots of Air India (AI) began a strike protesting against a cut in their Productivity Linked Incentives by 50%. The purpose of the cut was to control costs and, thus, losses. The strike forced AI management to cancel several flights. It struggled to bring the situation under control. Media reports in early March 2010 indicated Air India’s total losses in the past two financial years to be Rs.72 billion (over $1.5 billion). The Government of India tried to extricate it from the difficult situation by extending financial support; but the message from Government was loud and clear: the airline needed to generate profits and its own cash to keep it going further. Thus, its future strategy needed to focus on profitability and growth as its overwhelming concerns. While there was much promise for the future in the Indian airline industry, how the year ahead and beyond might turn out for AI was a moot question.

Intended Courses & Levels

This case is intended to be used in Post-Graduate level programmes in Business Administration or Management or in executive education programmes. The case is of specific use in courses related to Strategic Management covering topics of Industry Analysis and Competitive Strategy. The company, Air India, in this case is struggling to improve performance to move from losses to profits, arrest the fall of market share and to internally fund its essential growth. The issue of strategy comes to limelight both from AI’s internal perspective and from the point of view of the intensive competition in the Indian airline industry. The crucial question should be: ‘How can AI get out of its current mess?’ Finding a solution to this vexed issue should normally involve developing a Strategic Revival Plan for AI.

Teaching Objectives

Multiple objectives are met by analyzing this case. These include:

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To understand the industry environment in which a company operated (How strong was the impact of industry environment in the Indian airline industry?).

2. To understand the impact of competitive forces on a company’s strategy and performance (How strongly did competition affect the strategies and performance of AI?).

3. To analyze both the constraints that a company faced in formulating appropriate strategies and the factors that contributed to failure of strategies (Why was the strategic response of AI to its business problems inadequate and why did AI’s strategies fail to produce required results?).

4. To identify effective strategies for addressing a company’s performance problems (What should one do to solve AI’s strategic problems and revive its performance?).

Theory Application

The cornerstone of most performance or profitability improvement programmes would be of cost management. For AI too, cost management was a very crucial requirement. Cost management involved application of the Theory of Cost discussed in the economics and management literature. Further, human motivation (and productivity) was another key factor in performance improvement. As manifested in the event of pilot strike, human motivation was a major issue in AI. Motivational issues are part of well-documented motivation theories. From strategy point of view, the concepts involved in the analysis included the industry analysis, competencies and Strategic Plan. The following analytical models can be of use partially or fully: PESTLE analysis, Porter’s Five Forces Model (or an expanded 7-8 forces model) and SWOT analysis. While preparing a Strategic Plan for AI, the issues of organizational restructuring (merger with IA and forming the holding company NACIL) and change and transformation come to surface. Strategy implementation issues too will receive focus in the case discussion.

Research Methods

1. Data Sources: The case is based on secondary publications, government data and the author’s observations. Unstructured discussions with other researchers, airline service users and industry analysts have provided additional insights.

2. Extent of Disguise: Since the case used largely materials from secondary sources, not much disguise was required. However, information of sensitive or controversial nature did not find inclusion in the case. Similarly, the case does not make a mention of any personnel related or unrelated to AI relevant in the context of the case.

3. Author’s Relationship: The author is an independent academic researcher and has no connection with AI or with any important personality related to AI or other airlines.

Teaching Approaches

Ideally, this case should be analysed in about 3 hours. The students need to thoroughly read and understand the case before coming to class. The students can be divided into 4-5 member groups. Discussion questions can be distributed to the groups in advance. Alternatively, it can be given in the class before discussion begins. Each group will first discuss the case questions within itself before an open discussion is initiated. Adequate time is given for discussion within the groups. This will give the case discussion needed focus and purpose. The student groups can be allowed to make presentations on the case facts and issues. This can be followed by open discussion. Open discussion can be led by student groups with teacher intervention at appropriate times. Or, it can be led by the teacher him/herself.

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The case can be discussed with a solution orientation or a model orientation. The discussion questions need to be framed accordingly. The solution orientation comes when the case is used for addressing strategic management decision situations. In this case, the case analysis should lead to development of a strategic solution or decision (the author does this in the Strategic

Management course). The model orientation is relevant when the case is used for illustrating the application of strategic management tools such as industry analysis and SWOT analysis. In this case, the case facts, issues and contexts are used to develop a model (e.g., SWOT matrix), with

or without numerical scores (e.g., score of strength or weakness), that can be instrumental in

making strategic decisions (the author does this in the course Models & Frameworks of Strategic

Analysis).

To ensure maximum benefit from this case discussion, the students are advised to do some background reading in both strategy and case analysis. In strategy they need to look at the approaches to industry analysis, SWOT analysis etc. For industry analysis, the author recommends the works of Michael E Porter. On method of case analysis, Strategic Management textbooks generally have a section on case analysis.

Discussion Questions & Answers

Two types of questions can be used in this case analysis: discussion questions that cover the case facts and issues (e.g., what are the strategic circumstances of AI’s current poor performance?) and provoking questions that involves a decision situation and forces the students to take a position on yes side or no side, or this side or that side (e.g., should AI be privatized to run profitably again?). Questions can be asked either in a probing way (e.g., what should AI do to become profitable again?) or in a grouping way (e.g., can AI become profitable again? If yes how and if no why?). The following questions, among others, can be used for discussion from an industry analysis point of view.

1. What was the structure of Indian airline industry in 2009?

2. How did industry forces contribute to AI’s financial problems?

3. What was the role of strategies in the shape of Indian airline industry in 2008-09?

4. Why did AI face strategic performance problems?

5. What should AI do to revive its profitability and to finance its growth?

Additional questions can be:

1. Does the solution to AI’s problems lie in privatization? Why?

2. Can AI become a competitor of global scale? How or why?

Structure of Indian Airline Industry 2009: Applying Porter’s Five Forces (PFF) Model, several

parameters could be identified to explain the different forces constituting the industry structure.

A student might highlight the existing competition among two leading private players, JA and

KA, the state-owned carrier AI and other smaller players; and the concentration of 75% of market share among three players, JA, KA and AI, with the first two claiming over 60%. A lot of consolidation was happening in the industry and more could happen. Students may point out the potential of new entry since airline industry world-wide is a fatal attraction for entrepreneurs

tasting success in other areas and having huge financial resources and since in India already a lot

of entry activity had occurred in the airline industry in the past. Competition among carriers

ensured that the customers had choice despite their disorganized nature, even as carriers were

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able to charge higher from customers in times of fuel price escalations. Price and income elasticities were working on airline revenues. With regard to substitutes, the students may be arguing that the resurgent Indian Railways and the rapidly expanding passenger car industry posed serious threats particularly on shorter howls. The suppliers commanded a strong bargaining position vis-a-vis the Indian airline players, as might be pointed out, because the public sector oil majors monopolized ATF sales to them. For private players, airport services and ground handling were other supply areas of concern. Aircraft vendors and lease services too could extract their pound of flesh. Depending on the severity of the various structural forces, numerical scores on an appropriate scale could be awarded to develop force-wise and overall structural scores (the author generally prefers a 0-10 or -5-+5 scale, with scores closer to 0 on a 0-10 scale and to -5 on a -5-+5 scale showing a highly unfavourable position).

Contribution of Industry Forces to AI’s Financial Problems: AI faced a lot of difficulty due to competition. It lost a huge part of its market share (taking into account the market shares of pre- merger AI and IA) and became almost a small player. It faced competitive pressure on both the domestic and international front. AI did not have the size of many leading international airlines. AI’s woes were only likely to increase with further entry into the industry and with its domestic competitors determined to capture further market shares from both its domestic and international routes. Over the years AI lost lots of customers due to service deficiencies. Customers had choice on most of the routes due to private competitors. Customers also shifted to Indian Railways and road. AI did not have any control over the fuel prices. It had also failed to hedge its oil exposure. While it had advantage of own ground handling, on other cost fronts the burden of being a public sector enterprise was badly pinching. Overall, revenues were falling or stagnant and the costs were rising profits and financial health were destined to suffer. Thus, the industry forces posed serious threat to the existence and performance of AI.

Role of Strategies in the Shape of Indian Airline Industry in 2008-2009: Private airlines were serious about expansion and growth. They invested heavily in capacity. New airlines entered the industry. The state-owned carriers and at the end AI acted more defensively. All players were buying new aircrafts and adding capacity, which resulted in excess capacity build up. There was consolidation through mergers, acquisitions and alignments. Private airlines started their international services. Although fuel cost hedging was attempted in small measures by some of the players, generally ATF hedging was avoided by them. This exposed them to vagaries of international oil price movements. Some of the new players competed on low cost services and to protect market share, the full-service carriers too started such services either through acquisition or merger or through new arms. So, every player competed on price which led to erosion of profitability. Excess capacity also contributed to this. AI considered joining a global airline alliance as one measure to strengthen its international operations. Airlines lobbied with the government for protection or support at difficult times.

Causes of AI’s Strategic Performance Problems: One obvious immediate cause for the performance problems of AI was the escalation of fuel prices in the world market and the consequent cost increase and erosion of margins. Inability and unwillingness to hedge the fuel exposure can be blamed for the severity of its impact on AI. However, this does not explain all the problems. Exhibit IM-1 corroborates this. In 2007-08 even as revenues rose by 65.5% and fuel and oil costs went up by 77%, losses increased by 511% also because labour cost went up by

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140% and other operating expenses increased by 67.6%. Again, in 2008-09 when fuel and oil cost remained more or less the same, losses increased by 66.7% because other cost components could not adjust downward as revenues fell by 11.7%. Inefficiency and the managerial or organizational issues arising out of state ownership could have contributed to a high cost structure. Work culture and employee motivation were areas of concern. A rigid work force that did not accept a cut in incentives during bad times definitely rendered crisis management difficult. The social obligations of being a state-owned company led to cost escalating obligations and non-commercial activities. However, the basic factors of poor performance of AI were more strategic than operational. Intensive competition had left little leg room for AI. Competitors were much more agile and efficient than AI. The two leading private competitors were also aggressive. There were compulsions for operating low cost services; but, low cost services eroded the margins further. Over the years the quality of service of AI was perceived unsatisfactory particularly when the consumers had better private services to compare. Thus, loss of customer loyalty was inevitable. An aging fleet added to the service woes as well as caused high cost of operations and maintenance. Capacity constraints limited the ability to exploit commercial opportunities. Given the relative small size of AI and the lack of sustained profitability in the past, it was difficult to find resources for growth and expansion.

Reviving AI’s Profitability & Strengthening Its Financial Resources: Since profitability was dependent on cost and price, the two essential aspects of increasing profitability were reducing cost and increasing price recovery. In view of the intensive competition and excess capacity in the airline industry and the price sensitivity, raising price was not an easy option for the leisure travel customers. One possibility was to raise the value proposition to customers to achieve better recovery. This applied especially to the business travellers. Even the business travellers’ recession-period sensitivity needed to be considered. AI had constraints on cost reduction due to employee issues and social obligations. Still, there was no alternative to the requirement of sharp reduction in cost. In view of the excess workforce, large scale lay off was essential. Attitudinal and motivational re-orientation of employees, cabin crew in particular, was required. Commercial considerations in operations were necessary and one way of achieving commercial orientation was to privatize the airline. Privatization also could have paved the way for listing the shares on the stock market. This would have given AI access to a huge source of funding, more in times of improved performance. AI was not able to exploit lucrative international opportunities due to limited fleet size. So, AI was obliged to augment the fleet capacity.

Does the Solution to AI’s Problems Lie in Privatization? Why?: Some might answer no and some yes. No because solving a strategic problem did not require an ownership change. It required a revisit to strategies and a rectification if the existing strategies had a problem. If rectification was not possible, then one needed to ask why. If the answer was that the ownership was constraining the management in taking prudential decisions as required for improving performance, then an ownership change, or privatization in AI’s case, was required. Some might say no also because of the public good properties of infrastructural services including airline services. Ardent supporters of state-owned sector might even argue that the government could support the state- owned carrier to some extent due to the social services it renders. Those who would say yes to the privatization issue might believe that prudential (commercially oriented) decisions could not be taken with state-owned ownership due to acute agency problems. They might point out the better performance of private carriers JA and KA to illustrate this. Those might also discount the

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public good nature of airline services characterizing it as elite services. Those who answer yes might have also done so because of their contempt for state-owned sector presence in business and the belief that only private sector could operate business efficiently. In the case of AI, given the account of strategic and operational problems it faced and the experience of other airlines, the argument that it should be privatized could be strong.

Can AI Become a Competitor of Global Scale? How or Why?: Here too some might answer no and some yes. Those who say no might believe that under state ownership it could not have taken decisions keeping its commercial interests in mind. When it was forced to operate in unviable routes, carry the baggage of unproductive excess workforce and foot the bills of government requirements, it could not operate profitably. They might also say since AI did not have financial resources to expand the fleet size to global proportions, there was no way AI could compete with global majors. Those who argue yes might suggest that if AI was privatised it could be run with focus on its strategic interests. Once its costs were reduced, efficiency was improved by cutting down excess work force and other flabs, and was run like any other commercial enterprise, its profits and internal resources might emerge. With stock listing, resources could be raised from financial markets to expand the fleet size. According to them, over a period of time, definitely it might be a global player. Nonetheless, from the available facts of the case, a more plausible position could be that AI might not be able to be a global player in the short to medium run.

References The sources of information used for this case include the following.

1. Company websites: AI, JA, KA and others

2. Media reports: Newspapers and internet during 2007-2010

3. Wikipedia: en.wikipedia.org/wiki/Air_India

Exhibit IM-1 AI Performance Change 2007-08-2008-09

Item

Change Between 2006-07 & 2007-08

Change Between 2007-08 & 2008-09

Revenue

65.5%

-11.7%

PBT

-511.1%

-66.7%

Fuel & Oil

77.1%

-0.8%

Labour Cost

140.3%

NA

Other Op. Exp.

67.6%

NA

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