Kingfisher Airlines, with its tagline, ‘King of Good Times’ — as that of a popular brand of beer — is no longer around. Unfortunately, the near universal recognition of the brand and the equally popular jingle Oola la la le lo did not avail the airline much at the marketplace.
But is Jet Airways humming Happy Days Are Here Again , the first line of another popular jingle from a bygone era, for the promotion of a less intoxicating beverage, Thums Up? The airline just reported an all-time high figure of net profits for the quarter ending December 2015 — no mean achievement, considering the company went public with an IPO more than a decade ago.
Certainly, the company’s retail investors could do with the happy times lasting a lot longer, what with the share price still some distance behind its issue price of ₹1,100 when the shares were offered to the public, back in 2005.
From the red to the black
On the subject of future prospects for the airline company’s financial performance, it has to be said, the jury is still out although they have never had the going as good as they have experienced in the last year or so. Airline after airline is reporting bumper profits across the world. American Airlines, the largest airline in the US, for instance, had reported profits for 2014 after being in the red during the four successive previous years.
In India, both Jet Airways and SpiceJet have been in the black during the last four quarters. As to what lies ahead is however a matter for equity research analysts to fathom. That said, there are many aspects about the aviation industry that are deserving of the attention of a student of management.
Leasing business
In most industries, businesses tend to have complete ownership control over productive assets. But airlines, rather than buying outright, tend to hire aircraft from leasing companies. It is not uncommon to find a large airline operating a fleet of aircraft made up entirely of leased planes. What distinguishes the airline industry from other businesses is easily explained.
The assets in question are highly mobile. You can ship it from one place to another in a day or two. An aircraft in Mongolia, whose lease has expired, can be shipped to an airline operating in India in the same time it takes to fly between these two destinations. Also, aircraft are highly standard pieces of machinery with a handful of manufacturers.
The customers (airlines) are spread out through the length and breadth of the globe. If businesses are all about managing risk, why would an entrepreneur assume ‘ownership’ risk if he can, by suitable contractual arrangement, have unfettered access to the use of the very same asset without actually having to own it? Or so the argument goes, in the aviation industry.
Balancing segments
While most industries can be categorised as operating in an industrial or a consumer product market, airlines straddle both, the industrial segment (with cargo movement) and consumer segment (by providing passenger air travel service), at the same time. This distinction is significant from a competition perspective.
On the passenger transportation side of the business, airlines tend to compete aggressively, with price wars and ‘early bird’ offers of tickets at throwaway prices being prominent features of such competition. On the cargo segment however, there is prima facie evidence that they tend to collaborate with one another on setting prices.
Competitive collaboration
The Competition Commission in India recently charged leading airline companies with collusive behaviour with regard to setting prices for cargo movement. Of course, the companies are contesting the charge, but the indictment could be regarded as evidence of the proposition that where enterprises operate in two distinct market segments, there is a potential for them to come together or act in concert with one another in the segment that brings in relatively smaller proportion of the total revenues.
Cargo more profitable?
Moving people by air seems a far less profitable proposition than moving cargo from one place to another. Again, looking at the US market, FedEx, the number one cargo carrier in the US, is a lot more profitable business and commands a much higher price earnings multiple (an indication of market expectations about the future rate of growth in per share earnings) in the stock market than its passenger counterpart, American Airlines.
In India too, Blue Dart Express, the listed parent company of Blue Dart Aviation which is into air cargo business, has generated profits consistently and commands a far superior PE ratio than its counterparts in passenger transportation such as Jet Airways and SpiceJet.
That leads one logically to the question: Why should flying people from one place to another be less profitable than moving goods?
Criticality vs. leisure
The answer perhaps lies in the fact that the value proposition for the customer in both these markets is completely different. For an automobile manufacturer who swears by just-in-time inventory management principles or a manufacturer who urgently needs a spare part for a machine that has broken down, speed of movement of goods is absolutely critical. He is, therefore, willing to pay a premium for it.
In contrast, a vast majority of passengers travelling by air can be labelled as falling under the ‘leisure’ category. For this category of consumers, time is not as much of essence as price is.
Another structural factor that differentiates the two markets is that in the case of air cargo, the industrial customers are located in few select locations. In the US, there was a time you didn’t have to look beyond Detroit if you were delivering components for the automobile industry. Things have changed with a more diffused manufacturing base. But the larger point still remains valid even today.
On the other hand if you are moving people, the choice destination could be as diverse as the whole of the United States.
Hub and spoke model
What this has meant in terms of logistics and delivery infrastructure is a complex web of hub and spokes at the countries of origin and destination for aircraft operations. If we are looking at passenger movement between points in India and the United States, it could be a hub in Delhi or Mumbai and spokes fanning out to various parts of the hinterland for picking up passengers and bringing them to Delhi or Mumbai.
A similar design would operate in the US, where passengers would be unloaded at a hub airport and then bundled into other aircraft going to different smaller destinations. The aircraft doing the hub-hub flight will be heavier, fly longer distances and be a lot more expensive.
Such an architecture imposes a premium on filling up the long-haul flight to its full capacity or as close to it as possible. That may be fine during periods of boom in the global economy, but economies do not always follow a straight upward sloping path. There are booms followed by busts.
Then there are also extended periods of secular stagnation. But interest and amortisation costs on a long-haul plane remain the same irrespective of whether the airline company is able to fill up the seats.
The hub and spoke model of business was driven largely by the West, which had a 50-year-long period of prosperity. The affluent middle-class would holiday in the tropics thousands of miles away from their homeland. But the situation has changed. Both population and prosperity is stagnating in the affluent West.
The airline industry needs a new business model for making money.