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Air India : In Troubled Skies

The Indian national carrier is in a serious crisis and banking heavily on government-sponsored
revival packages. But it may not be an easy flight ahead for Air India, as it is in the midst of
violent cross winds.

Air India (AI), the only domestic carrier that had retained domestic monopoly for a long time,
has lost its dominant position in recent years—its losses mounted and market share
plummeted precipitously in the last two years. A string of problems starting from the botched
merger with Indian Airlines, total management failure, lack of vision to develop responsive
strategies, a change in the long-term strategic situation, current market pressures and, not
the least, the high wage bill in the form of salary and incentives have placed the national
carrier in a spot of bother. Now it is crashing down in almost all areas. All the vital signs—
productivity of technical personnel (two-fifth of international standard), employee-to-plane
ratio of about 210 employees, compared to an industry average of about 150, number of
working hours per week of cabin crew (50-55 hours, compared with 70 in other airlines), to
cite just a few—are indicating that the airline is suffering from chronic sickness. Now, AI is
contributing around 10% of global airline losses, with just 0.35% of global traffic, and virtually
is in abyss.

"In the short-term, AI will retain a privileged position as long as the

national pride in seeing it as the nation's flag carrier remains. Over time,
as competition on international and domestic routes increases, the basis
for government favoring one carrier over another will diminish. In the end,
AI will simply be an Indian airline, indistinguishable from the other

Air India (AI), the only national carrier in India, is now in the red. What
has led to the crisis at AI?

Craig Lawrence: The crisis at AI has been fueled by three factors: a change in the
long-term strategic situation, a failure to develop a responsive strategy, and
current market pressures.

AI's privileged position in Indian aviation stands eroded in the new emerging
strategic situation. It had operated as the national carrier in a highly restricted
environment and thus, for a long time, retained its domestic monopoly. However, it
has been too slow in responding to competitive pressure from domestic players
such as Kingfisher and Jet. On international routes, it has struggled against more
service-oriented foreign rivals, especially from the Gulf states.

The absence of a responsive strategy is highlighted by a cost structure that has

remained bloated. For example, it has an employee-to-plane ratio of about 210
employees, compared to an industry average of about 150. Also, the current
overhang of a significant fleet purchasing/leasing program needs to be reviewed
when there is a decline in passenger numbers.

However, current market pressures associated with the wider crisis in India's
aviation industry over the past year have pushed the carrier close to breaking
point. Plunging passenger numbers and soaring fuel prices led to crushing
accumulated losses in the past financial year.

Hans Huber: There is nothing new about the chronic lack of competitiveness of AI
or substandard value to the customer. What is new, indeed, is the financial abyss
into which the carrier has been led by an apparent ineffectiveness in governance
and total lack of accountability.

I don't think that the term `national carrier' bears much meaning in today's Indian
aviation: the behavior of all three major airlines in India has become pretty much
the same, at the least as far as the strategic directions of the firms are concerned.
What is different with AI is the fact that it never returned any dividends to its
owner, the MoCA (Ministry of Civil Aviation). On the other hand, it repeatedly has
received significant cash infusions, credit guarantees, etc. These practices have
been criticized by the Auditor General/ Chief Comptroller of India before, but, as we
see today, with no learning consequences for MoCA. Also, IPOs of AI had been
promised by MoCA back in 2000, with renewed promises for autumn 2008, but
never materialized. Why should an IPO of AI in the coming years be any more
realistic, given that the situation both in AI and the financial markets has worsened
significantly since then? If, by comparison, private airlines such as Jet Airways or
Kingfisher burn their (or their shareholders') money, sooner or later the question of
accountability will be raised. We can already see how previously flamboyant owners
of airlines now are downscaling their public profile. In the case of MoCA, ever-
increasing infusions of money do not seem to present any problem. I don't know
any private airline (particularly if it is as poorly run as AI) that could ask for Rs
8,000 from a private investor and stand a chance of obtaining it!

How do you see the merger of AI and Indian Airlines?

Craig Lawrence: The merger between AI and Indian Airlines has not been
immediately successful. The marriage of an internationally-oriented carrier with a
domestically-oriented one poses significant challenges. The key thing will be
whether the successful aspects of each carrier can be reflected in the other one. In
hindsight, it might have been better for AI to be taken over by a very
commercially-oriented carrier to allow that commercial focus to be rolled into the
DNA of the nation's flag carrier.

Hans Huber: As my grandmother said, "Putting two sick people into the same bed
doesn't make them healthy." The same reasoning may be applied to the ill-fated
merger of Kingfisher/Air Deccan and, to a lesser extent, Jet Airways/Air Sahara. All
these mergers were not done independently from each other, but needed important
backing from the MoCA to go through. MoCA gave the green signal to all these
mergers within a couple of weeks (spring/early summer 2008), while applicants for
new operating licenses had been kept at bay for years. This fact alone speaks
volumes about the attitude of MoCA towards competition and equitable market
access to Indian aviation.

Management consultants and `industry experts', many of them with links to trade
associations or the industry/political nexus itself, wholeheartedly endorsed these
mergers. Synergies worth hundreds of crore rupees per year had been promised for
the merged AI/Indian entity. Barely a year thereafter, the consultants were gone,
and the same `experts' remain silent. Integration of operations of both airlines has
barely started, in spite of reduced demand for their respective services (which
should make the integration exercise easier, including the layoffs of unproductive
staff, etc.) What the involved stakeholders (including unions) did agree on very
quickly was to buy brand new aircraft through apparently inflexible contracts to the
tune of Rs 44,000 cr.

This happened in an industry that usually acknowledges its cyclicality through

dealings in options prior to passing final orders. Any student of Econ 101
understands the advantages of buying flexible tickets rather than betting the farm
on a purchase worth thousands of tickets that would cover all your air travel for the
next 25 years, but without being able to exchange them! The easy part of the
merger, i.e., some new marketing (including a code-share agreement with
Lufthansa), some rebranding, and new menus and cutlery can to a large extent be
considered as window dressing. In particular, these measures did not provide any
cost savings to the company and were not effective in making the passenger forget
the higher prices he/she had to pay after the merger. AI's market share, which had
already dropped to an all-time low of 15.1% by April-June 2008, is reckoned to
have decreased even further since then.

Since `merger mania' in aviation is still considered a panacea by vested interests,

but rarely by consumers or those without access to air traffic in the first place, why
not go all the way? How about merging Jet Airways with Kingfisher and AI? If the
previously identified synergies had existed, the potential for cost savings among
these carriers would be truly phenomenal: all three airlines have in the past been
remarkably unimaginative by mimicking each other's moves and present huge
overlaps in their respective route structures. Anyone serious about improving both
the competitiveness and welfare gains of India's air traffic system should give this
potentiality some thought.

The government has gone all out to revive this ailing airline. How do you
see the government's efforts to reinvigorate AI?

Craig Lawrence: The government appears to have a twofold strategy. On the one
side, provide financial assistance to sustain operations, on the other, use the
financial assistance to leverage change. I think this will only be successful if there is
a root and branch change at the airline. This will involve several things: more
independent directors with real, commercial expertise; a management team that is
financially-savvy and recognizes that it is competing in an open marketplace rather
than seeking government assistance; a unionized workforce that seeks to take
more commercial responsibility for the operation of the airline; an improved fleet
that reaps efficiencies from improved plane type commonality; more effective
planning of route structures; and, most importantly, a clear and distinctive value
proposition to offer to the international and domestic markets. It is not clear
whether the government's actions will actually drive all of these.

Hans Huber: As said before, government aid to AI (be it direct or indirect) has
been around for a long time. It may be worthwhile to compare the situation with
that of Indian Railways. Foreign scholars and consultants are trying to learn about
the remarkable transformation that has been achieved from within Indian Railways.
This is unlikely to happen with AI under the tutelage of MoCA, which takes pride in
hiring foreign consultancies to rehash old recipes from the US and elsewhere that
have not worked in their country of origin either. There are no plans from within AI
or MoCA that could provide a blueprint for a fundamental transformation. All we
know is that AI will soon be hiring a new CEO (this time from the private sector)
and recompose its Board of Directors with highly distinguished personalities. What
a revolution! What a courageous and ingenious move! If MoCA indeed had a plan
for the future of AI, which I doubt, let's agree that floating the airline through an
IPO type of procedure seems a very remote option. No need to keep fooling the
public with this fairy tale. Also, foreign ownership of AI does not seem likely, given
the current regulation on FDI, etc.

How do you foresee the future of AI?

Craig Lawrence: In the short-term, AI will retain a privileged position as long as

the national pride in seeing it as the nation's flag carrier remains. Over time, as
competition on international and domestic routes increases, the basis for
government favoring one carrier over another will diminish. In the end, AI will
simply be an Indian airline, indistinguishable from the other airlines, in much the
same way as in the US market where there is no apparent `national carrier'.

Hans Huber: We have arrived at a point where market mechanisms in aviation

have become disabled, maybe in part through the negligence of MoCA. I just
returned from a conference in Hong Kong where the Commissioner of Transport
was very explicit when she said: "Competition brings improvement. But the
government has to provide a level playing field." There are some 100 scheduled
airlines operating in China today. Rather than facilitating market entry for the
much-needed low-cost and regional operators, India has privileged market
concentration among a few high cost carriers and stressed the development of a
few Taj Mahal style, highly expensive, prestige airports through consortia.

Even the more acute among the remaining oligopoly airlines concede that their
business models (i.e., post-merger) have become inadequate, largely due to their
cost-structures which remain too high. It is clear to any observer that transforming
a full-service airline into a true low-cost carrier is extremely difficult, probably
impossible. AI is certainly the least well prepared to accomplish such a task, given
its history and productivity track record. New entry from innovative and agile firms
seems to stand a much better chance to face this challenge. Their pace of growth
would be organic and much more decentralized. But for this to happen, old
incumbents would need to give way and MoCA would need to revise its industrial

*Economic Consultant,
Economic Advisory Services - Connell Wagner Pty Ltd., Manly Qld, Australia

**Associate Professor,
Shailesh J Mehta School of Management,
Indian Institute of Technology (IIT), Mumbai, India

A problem peculiar to AI

In fact, airline business in the entire world is now bleeding profusely due to a variety of
reasons, starting from rising oil prices to a slowing world economy. But in India, the problem
is more acute. Last year, in India, the aviation industry lost more than $2.5 bn—almost one-
fourth of total global airline losses—despite accounting for merely 2% of the global traffic.
Kingfisher Airlines, India's largest airline in terms of market share, which reported a net loss of
Rs 2.43 bn ($51 mn) in the quarter to June, owes more than $199 mn in unpaid fuel bills and
is surviving on bank loans. Jet Airways recorded a net loss of $47 mn in the same period. The
rising aviation fuel prices, burdensome taxes and overcapacity should be blamed for why
India's private airlines are suffering heavily. In order to raise the market share at any cost,
the airlines priced tickets well below cost. Moreover, according to some estimates, they
purchased twice as many aeroplanes as the market could support. In addition, as competing
airlines poached pilots and mechanics, staff costs escalated, adding to the industry's woes.
But the problems faced by government-sponsored AI are different from the problems faced by
the other players in the industry. Though, AI has been battered by ballooning fuel bills and
falling demand, its crisis is largely its own making and management-related. Now, the
government has decided that it would do whatever it could to turn AI around, and plans are on
the anvil to infuse equity and soft loan into the airline. But it may not be an easy task.

In royal mess

AI, which is the offshoot of Tata Airlines founded by legendary JRD Tata in 1932, has for long
adorned the number one position among the Indian carriers. Even in the 1980s, AI was touted
as the biggest and the brightest aviation prospect in Asia. Nevertheless, things began to
deteriorate for AI since the mid-2000s, and in 2006-07, it reached serious proportions. In
2006-07, AI made a loss of Rs 541 cr and Indian Airline's loss was Rs 230 cr. In about two
years, from March 31, 2007 to March 31, 2009, when AI and Indian Airlines merged, the
losses rocketed to a mind-boggling Rs 7,200 cr. Aviation experts opine that the staggering
eightfold increase in its losses in two years can be attributed to the manner in which aircrafts
were leased, capacity was allocated to foreign carriers under bilateral agreements, ground-
handling in important airports was given to a proposed joint venture, flights were withdrawn
from profitable routes and pilots weren't sent for proper training, and not the least how AI and
Indian Airlines were merged.
The losses really began from 2006 onwards when a decision to aggressively lease aircraft was
taken to augment market share without conducting proper route study, marketing or pricing
strategy. The upshot—in the last two years, from 2007 to 2009, AI kept five Boeing 777s and
five Boeing 737s on ground at a loss of Rs 840 cr. Luckily for AI, Boeing could not meet the
delivery schedules for its new B787 Dreamliners. If these aircraft had arrived on time, all of
them would have been on the ground. Adding to the crisis, the merger between AI and Indian
Airlines proved to be disastrous. Instead of resuscitating AI, the government has diverted
funds to the next-to-impossible task of resolving the staggering mismatch between the two
airlines in respect of the nature of operations, functions, roles, structures, cultures, pay scales,
perks, and so on, with no synergy and economies of scale in sight. Sadly, even two years after
the merger, the two parts of the merged airline do not have an integrated IT system.

Besides these, the blame for the mess the airline finds itself in also rests squarely with the
government. Constant bureaucratic interference in its functioning, a huge and unacceptable
level of workforce, gross indecision in allowing fleet acquisition, growing inefficiencies, and
competition from domestic private and foreign airlines ate into AI's market share. Aviation is a
capital-intensive and high fixed cost business, which makes it much more vulnerable to
business cycles; and it has also been severely battered by the current slowdown. The problem
is clearly beyond cosmetic surgery such as forcing government employees to fly AI.

In search of clear sky

The problems encountered by the national carrier are deep-rooted and hence a radical and
sweeping approach is needed for its resuscitation. The steep spurt in losses is partly due to
depreciation on the aircraft bought in recent years. Hence, the government should ensure that
the airline should not take fresh approval for new purchases in case it cancels existing orders.
Keeping long-term perspective in mind, the issue of bloated workforce needs to be sorted out
at the earliest. The government should cooperate with the airline, politically and financially, to
shed workers and alter the generous salary and incentive terms enjoyed by the workers. The
government must also decide urgently on the bailout package sought by the airline. Lastly, the
airline needs to be given the freedom to be run on commercial lines. An important element of
that would be, bringing in professionals at the top instead of novices who may lack the domain
knowledge to run a large airline. A stock exchange listing would also be of huge help to infuse
more funds to the airline. In fact, the new board has already begun initiating bold steps to
reinvigorate the ailing airline, though turning it actually around would prove to be a huge task.