Revival of a Sick Airline57

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					 Project Assignment (Air Transport Management-II)

    “Revival      of a Sick Airline”
                       By

                  LAVA KUMAR

                  TELUKUNTLA



POST GRADUATION DIPLOMA IN AVIATION LAW AND

         AIR TRANSPORT MANAGEMENT

                  (PGDALATM)




          NALSAR UNIVERSITY OF LAW

                  HYDERABAD




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                             INDEX




Serial No.                   Particulars             Page No.

      1      Introduction                             3

      2      Recent Industry Evolution                4

     3       Industry Challenges                      6

     4       Challenges and Strategies to Meet The    7
             Challenges

     5       Conclusion                               10

     6       References and Bibliography              11




                                                                2
Introduction
Since the deregulation of US airlines in 1978, the pressure on governments to reduce their
involvement in the economics of airline competition has spread to most of the rest of the world.
The US experience with airline deregulation is perceived to be a success by other countries, as
the overall benefits to the vast majority of air travelers have been clearly demonstrated. While US
domestic air travel grew at rates significantly greater than prior to deregulation, average real fares
declined since deregulation and today remain at less than half of 1978 levels [2]. Several
successful new entrant and low-fare airlines had a great impact both on airline pricing practices
and on the public’s expectations of low-priced air travel. And, despite worries at the time of
deregulation that competitive cost pressures might lead to reduced maintenance standards, there
is no statistical evidence that airline safety deteriorated.

At the same time, the US deregulation experience had some potentially more negative impacts.
The pressure to cut costs, combined with increased profit volatility, mergers and bankruptcies of
several airlines led to periodic job losses, reduced wages and airline labor unions with less power
than they previously enjoyed. Furthermore, the benefits of deregulation were not enjoyed equally
by all travelers. Residents of small US cities saw changes in the pattern of air service to their
communities, as smaller regional airlines replaced previously subsidized jet services. And,
despite a substantial decrease in the average real fare paid for air travel in US domestic markets,
the disparity between the lowest and highest fares offered by airlines increased, aggravating
business travelers forced to pay the higher fares. The development of large connecting hubs by
virtually all US major airlines also raised concerns about the pricing power of dominant airlines at
their hub cities.

The management strategies and practices of airlines were fundamentally changed by
deregulation, liberalization and, very simply, competition. Cost management and productivity
improvement became a major focus of US airlines for much of the past twenty years, and non-US
airlines have more recently been forced by competitive realities to face up to this challenge as
well. A by-product of the quest for lower costs and increased productivity has been the pursuit of
economies of scale by both US and non-US airlines. In the past, internal growth and/or mergers
were the primary ways in which airlines hoped to take advantage of scale economies. With
growing government concerns about industry consolidation, further mergers have become less
likely. The response of airlines has been to expand their networks and to achieve at least some
economies of scale through partnerships and “global alliances” designed to offer a standardized
set of products and to project a unified marketing image to consumers.

The analyses and the causes for the sickness of airlines is based on the control and viability and
this also suggests remedies. Wind of change is blowing with liberalization and globalization, but
these airlines have learnt nothing. Their top-heavy managements have failed to anticipate
problems and suggest timely remedies or are it possible that the political bosses have shot down
all suggestions for the revival of the airline? While some public sector undertakings, such as the
other companies, have proved profitable and able to stand on their own feet, HIND AIRLINE has
been in the red and limping for years. It is the time civil aviation management, which is no
fountain head of airline management expertise, took its hand off the airline. There is no
alternative to disinvestment and participation of private parties who can provide the management
skills to run the airline. As a temporary measure, international airline management consultants



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can be hired. The government can provide long-term loans to help the airline tide over the
financial crunch and phase out the ageing aircraft and purchase state of the art ones.


The airlines industry is categorized as being intercontinental, intra-continental, domestic or
international. Main services are long-haul flights, short-haul flights and cargo services. Airlines
lease or own their aircraft with which to supply these services and may form partnerships or
alliances with other airlines for mutual benefit. The airline industry has been through a lot of
turbulence over the past few years. In the wake of 9/2001, passengers stopped flying, most
airlines started making huge losses and several went into bankruptcy protection, from the United
States Code.


Especially in the US, the airline sector became a byword for poor financial returns. As price
discounting and increased security helped to build passenger numbers, a new range of leaders
emerged in the sector. The old guard of primarily national flag carriers such as British Airways, Air
France and American Airlines were quickly eclipsed in terms of financial performance by a raft of
new low-cost airlines that soon came to dominate short-haul routes. SouthWest Airlines in the
US, EasyJet and RyanAir in Europe and AirAsia in Malaysia are just some of the stars of the low-
cost flight fraternity that have changed the way many of us now fly. Through opening up air travel
to previously under-served consumers, millions now pay bottom prices to get basic services as
they are often flown to small, remote regional airports. It may not be the same service as we
would get from the established airlines on the traditional routes, but with discounts up to 90% on
schedules            prices           nobody             has           been             complaining.


With RyanAir consistently worth more than AirFrance, low-cost airlines are now firmly established
as part of the airline sector. The emergence of low-cost airline companies and their financial
performance is probably astonishing as it this new business model was unexpected and has
completely modified the structure of the airlines industry.



            2) Recent Industry Evolution 2000-2005
On a global scale and especially in the United States, the airline industry has been in a financial
crisis for much of this new century. The problems that began with the economic downturn at the
beginning of 2001 reached almost catastrophic proportions after the terror attacks of September
11, 2001. In the United States alone, the industry posted cumulative net losses of over $40 billion
from 2001 to 2005, and only in 2006 was it able to return to the black with a total net profit of just
over $3 billion [2].

The industry crisis was most certainly exacerbated by the events of 9/11, which resulted in
immediate layoffs and cutbacks of almost 20% in total system capacity, in anticipation of the
inevitable decline in passenger traffic due to concerns about the safety of air travel. However, the


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airlines were in serious trouble well before 9/11, as the start of an economic downturn already
had negatively affected the volume of business travel and average fares. At the same time, airline
labor costs and fuel prices were increasing yearly. To make matters worse, airlines were faced
with deteriorating labor/management relations, aviation infrastructure constraints that led to
increasing congestion and flight delays, and dissatisfied customers due to perceptions of poor
service in general.

Thus, we cannot attribute the recent poor performance of the airline industry solely to the impacts
of 9/11. In fact, the events of 9/11 actually provided a temporary reprieve from some of the
industry's fundamental problems: Reductions in flight schedules alleviated some of the pressure
on the aviation infrastructure, resulting in fewer flight delays; faced with massive layoffs and
tremendous uncertainty about the financial futures of the airlines, labor unions moved towards a
more conciliatory position, and passengers became more willing to lower their service
expectations in exchange for improved security. In the period after 9/11, passenger traffic made a
slow recovery, and returned to pre-9/11 levels by mid-2004. With total US domestic airline
capacity substantially lower than before 9/11, average load factors soared to historical record
levels. Yet, despite operating flights that were quite full, the large network airlines were still losing
money.

The ability of the network airlines to generate adequate revenues to cover their operating costs
was severely impacted by major shifts in passenger choice behavior, particularly on the part of
business travelers. The overall volume of business air travel demand decreased in early 2001
due to the overall economic downturn. Business air travel was further affected by the increased
“hassle factor” and greater uncertainty in passenger processing times caused by increased
security requirements. The combination of reduced business travel budgets and substantial
cutbacks in airline passenger service quality led more business travelers to look for alternatives to
paying premium air fares – teleconferencing and other travel substitutes, alternative travel modes,
and especially, low-fare airlines for business travel. As a result, total US airline industry
passenger revenues dropped by over 20% between 2000 and 2002, and were still 10% below
2000 levels in 2004, as shown in Figure.

FIGURE 2: US AIRLINE INDUSTRY PASSENGER REVENUES 1999-2004




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           3) Looking Ahead: Industry Challenges
The airline industry is in the midst of a dramatic restructuring that involves even more
fundamental changes than those experienced following its deregulation in 1978. Yet, nearly three
decades after deregulation – and after multiple cycles of financial successes and failures – the
industry remains fragile. Competitive pressure from low-cost carriers, the loss of consumer
confidence in the air transportation system’s reliability and operating performance, and the
transparency of pricing facilitated by the internet and online travel distribution channels have all
contributed to a precipitous decline in average fares and a significant impact on airline revenues.

And since 2006, fuel has emerged as the single largest industry expense, surpassing labor costs
for the first time [4]. The industry still is recovering from its latest cycle of financial struggles, but
faces substantial challenges. The belief that a few quarters of profits equate to full recovery is
more wishful thinking than reality.

The next round of labor negotiations may be the most important milestone in the US airline
industry since deregulation. The recent round of labor negotiations and restructurings – many
under Chapter 11 – led to significant changes in labor costs and productivity. With those changes,
airline employees helped contribute to the short-term recovery of the industry. Finding a new
model for compensation that is durable and works to address the cyclicality of the industry will be
critical. Just as important will be the efforts of management to identify non-labor cost savings that
can be sustained as networks and operating models are reconfigured.

While there has been much progress on issues of aviation safety and security since 9/11, with the
“federalization” of airport passenger screeners and movement towards explosives screening for
all checked baggage, the questions “are we doing enough?” and “are we doing the right things?”
remain unanswered. Demand for air travel, particularly in short-haul markets, has been
suppressed by passenger perception of the “hassle factor” of increased security and the
uncertainty of passenger processing times at the airport. For the airlines, the new security
procedures have increased operating costs and induced more security-related flight disruptions
and delays. The Director-General of IATA, the world-wide airline industry trade association, has
said “our passengers have been hassled for 6 years…that’s far too much” [7]. Some experts,
however, have expressed concern that cutbacks in existing security measures could increase the
risk of future terrorist acts that could devastate the industry.

The temporary reprieve from congestion and flight delays experienced immediately after 9/11 has
effectively ended at the nation's busiest airports. The number of delayed flights reached record
levels in July 2007, and media reports of chronic and excessive airline passenger delays have
again become commonplace. Several factors, including the lack of coordination of airline flight
schedules at some of the most congested airports; an outdated air traffic control system; finely-
tuned airline flight schedules with little slack to dampen delay propagation; and record-high load
factors preventing timely re-accommodation of passengers who misconnect or whose flights are
canceled, all combine to create passenger disruptions and lengthy passenger delays that exceed
even the record-high levels of flight delays. Solutions to the problem will require a mix of
improved management of airspace and airport demand, and an increase in airport capacity
brought about primarily by improved management and utilization of existing capacity.

The lack of adequate infrastructure capacity – airports and airspace – and the rapidly growing
costs of maintaining and expanding this infrastructure are two of the most critical problems for the
future of air transportation, nationally and internationally. The prospects for substantial relief on
the capacity front are not good – at least in the medium term (next 10 years). While the FAA and
other air navigation service providers around the world have been working, with some success,
toward increasing the capacity of the en route airspace, the real bottlenecks of the air
transportation system are the runway systems of the major commercial airports in North America,

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Europe and Asia and the terminal airspace around them. The only clear way to increase the
runway system capacity at these airports substantially, i.e., at rates similar to those at which
demand is growing, is through the construction of new runways at existing airports or additional
airports in the same metropolitan areas. But obtaining approval for and eventually opening
additional runways and new airports is an extremely difficult and time-consuming proposition in
most developed countries. Barring these, airports and national civil aviation authorities may have
to resort to increasingly stringent “demand management” measures, such as slot restrictions,
congestion pricing, and even the auctioning of access to major airports.

On the cost side, the enormous investments required in order to expand and maintain the
capacity of existing airports or to build new ones has been one of the main reasons for the airport
privatization trend that has been in evidence in much of the world (but, for statutory reasons, not
in the United States) since the late 1980s. A growing tendency to tax directly airline passengers
and cargo is another consequence of the rapidly increasing costs of aviation infrastructure
(airports and air traffic control). Various taxes and fees for infrastructure support and security
currently increase the cost of the average domestic airline ticket in the United States by about
16%. The situation in the European Union is roughly the same.

These important challenges – sustaining airline profitability, ensuring safety and security, and
developing adequate air transportation infrastructure – are not limited to the United States or to
US airlines. Airlines around the world are encountering a growing wave of liberalization if not
outright deregulation, and as a result are facing competitive pressures, both from new entrant
low-cost airlines and re-structured legacy carriers. The rapid growth of the global airline industry
and the continued threat of terrorist attacks make safety and security issues critical to every
airline, and every airline passenger. And, the need for expanded aviation infrastructure, both
airports and air traffic control, is of particular importance to emerging economies of the world such
as India, China, Africa and the Middle East, where much greater rates of demand growth are
forecast for both passenger and cargo air transportation.




   4) Challenges and Strategies to meet challenges
The Air Hind has now lost it all - it is no longer able to serve caviar garnished with crumbled,
hard-boiled egg and chopped onion on lightly buttered toasts and vodka or Blue Label to his
'preferred guests', their families and office clerks who travel in his first-class home by paying only
the 'full fare' economy class fare through a very highly secretive but effective process called 'up
gradation'. The government has been busy of late (actually pretty late) to repair the Air Hind's
clothes and, if possible, buy him some new ones.

As expected the government's belated response has been three-fold - the first one is the
traditional stereotyped response of the Government called 'find the scapegoats'. Like the queen in
Alice in Wonderland, who held the croquet mallet and screamed 'off with his head', it has been
determined now that 'some heads will have to roll'.

The only difficulty with that approach in the case of Air Hind is that if not done selectively, there
may not be many spare heads left to roll. The second response is that the management must
come out with its own restructuring plan and the financing involved. But this again may prove to


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be difficult, because the management has been outsourcing this activity to the administrative
ministry for decades.

The third and the most sensible response have been to induct professional managers and
business leaders to the board of Air Hind. This should be effective provided, of course, the board
is allowed to function without interference (as was the case with Satyam Computers) and no
further committees are appointed to study the recommendations of the board.

The implication of this measure could be far-reaching, as it will enable the transition of Air Hind
from an 'administrative ministry-managed company' to a 'board-managed company'. It will require
a Himalayan change in mindset on the part of the administrative ministry, to curb its natural
proclivity to pick up the phone.

The main problem with Air Hind is not its poor financial health. The real cause is the singular
failure of leadership and governance. Any attempt to resuscitate Air Hind through financial
restructuring without a deeper organizational restructuring (going beyond a few knee-jerk
punishment transfers) will result in Air Hind sliding down the slippery slope and good money
chasing bad. A transformational change is necessary. Nothing short of it will work. Is the
government ready for it.

A combination of factors such as deregulation of air fares in US, increased competition from US
airlines and tremendous price competition had lowered the yields of all European airlines. But
Lufthansa had all along labored under the belief that, being a national airline, it was programmed
for success; so it could grow stronger merely by increasing assets and employment would rise in
any case as people would seek 'secure' jobs in a state-owned enterprise.

"We are the German Airline Company, state-owned and a prestige organization. They will never
let us die" was the refrain, according to Jochen Hoffman, Lufthansa's senior vice-president at the
time. As a state-owned enterprise, its immortality was assured.

This delusion underpinned Lufthansa's strategy to pursue higher growth, by increasing the
number of aircraft from 120 to 275 between 1987 and 1991, with its revenue growing only from
11 billion Deutsche Marks to 16 billion Deutsche Marks. The Gulf war brought in a steep fall in air
traffic.

The passenger load factor (the ratio of passenger kilometers flown as a percentage of seat
kilometers available), which measures how much of an airline's carrying capacity is used and
tests the efficiency of asset utilization, declined rapidly. Lufthansa reported an after-tax loss of
444 million deutsche Marks, followed by worse results in the second half of 1991 and 1992. In
1992, Lufthansa had cash to meet only a fortnight's operational expenses and no cash to pay




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salaries. No bank in Germany was prepared to advance money. Lufthansa's response to the
looming crisis was characteristic of a state-owned, monolithic and unprofitable enterprise.

Sounds familiar? Between 1996-97 and 2005-06 (not to take into account the latest figures), Air
Hind's operating ratio was close to 100 per cent or more, signifying that the airline was hardly
earning any profit or was in the red. The PLF was around 65 per cent, far below the international
average; it was losing on the revenue hours flown, the average revenue tonne kilometer per
employee was erratic, the service standard was declining, and there was no staff rationalization.
But all this was not motivation enough to stir up either the board or the management of Air Hind
or the administrative ministry.

Lufthansa's turnaround from near bankruptcy in 1991 to sound financial health by the end of the
1990s was orchestrated by Jurgen Weber, who was appointed the chairman in May 1991. In
June 1999, Lufthansa announced the best results in its 70-year history.

Simultaneously, with the restructuring plan Jurgen Weber persuaded the government to step up
its efforts to privatize Lufthansa. By 2000 Lufthansa was a privately-owned, profitable company -
and a core element of the strongest worldwide alliance in the airline industry.

Jurgen Weber's main strategy plank was the commitment of the people. It began with his
weekend meeting in June 1992, with some 20 senior managers at the training centre at Seeheim.
The title of the meeting was changed from 'Mental Change' to 'Crisis Management Meeting'
shortly before it began. The Seeheim meetings produced a set of 131 projects or key actions,
known as 'Program 93'.

These projects involved financial restructuring, cutting costs and redundancy, renegotiating
landing slots, route restructuring, and cooperation with other airlines by creating 'Star Alliance'.
But the reason why these projects worked was because there was enough


       space for reflection, open communication and feedback loop,
       involvement of people in strategic business processes,
       keenness on the part of top management to hear and learn,
       identification of the willing game changers within the organization,
       emotional mobilization and bonding of these change actors,
       creation of action learning networks which emphasized being leaders and not followers,
       Maintaining some slack in Lufthansa's strategy to allow for innovations, service initiatives
        for customer satisfaction and frequent-flyer developments and building sustainable
        relationships with various internal and external stakeholder groups.




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Air Hind is different from Lufthansa, and Cape is different from Germany. So what worked for
Lufthansa may not work for Cape. But the short lesson that emerges is that the inflow of
resources is a necessary but not sufficient condition for transformational change in an
organization. We have to drive for hard success through soft processes.

Air Hind is a great national asset, too precious to be frittered away and gave the country its first
national airline.




                                     5) Conclusion
The recent growth of low-fare air travel options combined with a reduced willingness on the part
of business travelers to pay the higher air fares charged by network carriers played a major role
in contributing to the poor financial performance of traditional network airlines, both in the US and
in many other countries. In the US, low-fare airlines (also known as Low Cost Carriers or “LCCs”)
exhibited slow but steady growth since deregulation, but low-fare carriers accounted for less than
7% of US domestic air passengers in 1991. As shown in Figure 3, LCCs grew more rapidly in the
US since the mid-1990s, to the point that they carried 25% of all US domestic traffic as a group in
2005 [4]. The largest low-fare airlines in the US industry include Southwest, JetBlue, AirTran, and
Frontier.

The national carrier has already tumbled from its No 1 position. It’s currently No 4 with 15%
market share and struggling to stay there. Most analysts believe that SpiceJet, which is No 5 with
14% share, will soon overtake it. The passenger load is under 60%, lowest in the industry. Others
average 75 to 80%. But then Air Hind has the largest fleet size because, even as it was sinking
into insolvency under the dead weight of its accumulated losses of Rs 15,000 crore and huge
annual losses that kept increasing, the ministry kept arm twisting it to buy more and more planes.
Finally it reached a stage where interest payment on loans became nearly equal to the revenue of
the airlines. And why were so many planes bought? No one has an answer.
   But this report is not about Air Hind’s problems. It’s about solutions. The national carrier has
lived with misfortune for decades. Manipulative ministers, effete bureaucrats posturing as
professional managers, and a third rate management at the top, that crawled when asked to bend
have been its persistent tragedy. Everyone treated it as a fiefdom to loot. Nobody wanted it to
become one of the world’s finest airlines which it could have easily been. It’s much abused
unions, overweight hostesses, middle aged pursers, overpaid pilots and pampered staff has been
the targets of every critical assessment. But the fact is, despite all this, Air Hind could have
stayed No 1 in the Cape skies if it had honest, capable, committed leadership. That’s where the
real deficit is.
      Even now, one quick shot of capital and long term debt, an overhaul of its top management,



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some accommodation by the employees, which will easily happen if someone persuades the
unions instead of trying to bully them, and with support from the banks and oil companies (all of
which is easily possible since Air Hind is still a State owned enterprise) the national carrier can be
up and running within two years. What it needs is a clear mandate for change, reversal of some
recent decisions regarding landing rights, a more aggressive marketing and pricing policy, and a
free hand to go and slaughter the local rivals. In six months Air Hind can bring them to their
knees, begging for mercy. Including those rivals plotting and planning its demise.
  It’s entirely a game of logistics management, aggressive pricing and effective aircraft utilisation,
on all three of which Air Hind has been fighting its rivals with its hands tied behind its back. The
problem is that its rivals have the support of those who actually run Air Hind and take all the
crucial decisions. So how can it compete? At below 60% passenger load, Air Hind can afford to
take any pricing decision that’s required to run its rivals out of business. But will it be allowed to
do so? Will it be allowed to restart its most profit making routes which were deliberately stopped
and handed over to other airlines? Will it be allowed to fly wherever it finds profitable instead of
where the Government wants it to fly? It needs nothing apart from one serious injection of funds
and the freedom to take its own business decisions without interference.




6) References
    1. www.flightglobal.com

    2. www.thehindu.com

    3. www.thetimesofindia.com

    4. Airline Industry review article in webpage.

    5. International Air Transport Association (IATA), Fact Sheet: World Industry Statistics,
        www.iata.org.
    6. Air Transport Association of America (ATA), 2007 Economic Report, www.airlines.org.
    7. Air Transport Association of America (ATA), Statement on the State of the Airline
        Industry, Statement for the Record of the Sub-committee on Aviation, Transportation and
        Infrastructure Committee, US House of Representatives, June 2004.
    8. US Department of Transportation Bureau of Transportation Statistics, Form 41 Airline
        Traffic and Financial Reports.
    9. G. Tsoukalas, “Convergence in the US Airline Industry: A Unit Cost and Productivity
        Analysis”, MIT Master’s Thesis, Department of Aeronautics and Astronautics, August
        2007.
    10. J. Heimlich, “Outlook: Reaching for the Skies?”, Air Transport Association of America,
        www.airlines.org. January 2007
    11. G. Bisignani, “State of the Air Transport Industry”, Address to the Annual General
        Meeting, International Air Transport Association, Vancouver, June 2006, www.iata.org.

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