The secret recipe: lower variable costs, differentiated services and a profitable business model
According to the International Air Transport Association:“India was the world’s fastest growing aviation market in 2015, expanding more than 20%”. The Indian aviation market is predicted to become the third largest aviation market by 2020. India overtook China to become the fastest growing economy at 7.4% in Q3, 2015. The higher economic activity combined with domestic demand and lower fuel prices has recently resulted in higher profits for the aviation companies.
This present situation of higher profits is quite contrary to that in the last five years, more specifically 2010 to 2015, when the Indian carriers lost billions of dollars. During these five years, some carriers like Kingfisher Airlines went bankrupt, and others were either acquired, merged or went through a complete change of management teams. One bright star from among these is IndiGo (InterGlobe Enterprises) which not just navigated through the turbulent times(pun intended) but also managed to capture the maximum domestic market share by 2015.
IndiGo is an LCC (low cost carrier) which is known today for its “low fares, on-time flights and a hassle-free experience”. The company went public on the Indian stock exchanges (NSE and BSE) in November, 2015. The aviation industry in India was disrupted by IndiGo in 2006 when the airline priced its tickets way lower than its competitors. This inevitably invited all competitors towards a price war. This price war lasted till about 2011, when Kingfisher started losing market share to Indigo.
While it may seem that this price war like any other, where companies post losses and still continue competing, the fact is that IndiGo posted profits all through these years. In fact its profit of INR 787 crore(117 million USD) in 2013, a year when Kingfisher shutdown and others made losses in billions, was way higher than predicted by anyone including IndiGo itself. The financial standing of IndiGo is immaculately strong in comparison to its competitors and the industry average. While the Asset Turnover(about 129-150) for IndiGo has been lower than its competitors(around 200), there are three main reasons why, on the whole, IndiGo seems to have a better financial standing. Firstly, the company has been able to reduce operating costs and post consistent profits through 2009-2015. Even in 2012-13, when the rupee value plunged and the oil prices went up, the company reported a Profit Margin of 2.52%. This resulted in positive Debt-to-Equity(D/E) ratio while for other companies, the losses started eating into the Owner’s Equity resulting in a negative D/E. The second reason is that, the overall debt for IndiGo has been among the lowest in the industry. Though it has the lowest debt, it has the largest fleet of aircraft. This is possible by leasing the aircraft instead of buying them. Overall, the company maintained a healthy Current Ratio greater than 1, while the other companies went lesser than 0.5 during these years. Meaning thereby, that the other companies faced cash crunches to pay the short-term liabilities. Thirdly, IndiGo has been posting significantly higher non-operating income (57million USD in 2015) in comparison to its competitors. This is possible due to the Sale-and-Leaseback business model adopted by IndiGo which will be delved into later. The higher non-operating income has enabled to convert operating losses into overall profits for IndiGo.
In 2015, the Net Income increased by 52.6% than last year and the Profit Margin increased by 49% in the face of the total cost increasing by 10%. The reasons for higher Profit Margin though the total costs increased are that the airfare increased by 13.1% on average and that IndiGo started newer and longer routes. The higher Profit Margin is further explained by the decrease in the cost per seat per kilometre (CASK) which decreased by 8.9%. In short, IndiGo seems to be able to exploit the Economies of Scale as it increases its operations.
IndiGo adopted a simple yet effective business model for its operations. The company owns a fleet of a single kind of aircraft (Airbus A320 87). Flying a single kind of aircraft results in lower maintenance costs, lower training costs and overall lower variable costs. At the same time IndiGo uses each aircraft for about 3.26 years which is way lower than other companies. The younger fleet consumes lesser fuel. The aircraft have sharklet wings which make these aircraft about 10% more fuel efficient. On the whole, the company substantially reduced its fuel expenses which, due to taxation etc.,makes up about 40% to 45% of the total cost in India.
The non-operating revenue at IndiGo has been accredited to its sale-and-leaseback model. Under this model, instead of buying and owning an aircraft, IndiGo places a big order to the aircraft suppliers. Placing bigger orders and other cash incentives enables IndiGo to negotiate a lower price. After buying the aircraft, IndiGo sells the aircraft to aircraft lease companies (e.g. AWAS) at a higher price. Subsequently, IndiGo leases these aircraft from the lease companies at a negotiable price. Overall, if the profit earned by reselling the aircraft is more than the price of leasing the aircraft, the company shall earn a positive cash flow and this is exactly IndiGo’s model to remain profitable even with a loss in its operations as was the case in 2012-13.
During the price war, IndiGo was successful in differentiating its services by ensuring on-time services with least delay. In fact, the company encouraged its passengers to arrive at the airport 30 mins before the check-in time. The reason was that IndiGo started flying its flights before time if the passengers had boarded the flight – a stark difference from the otherwise slow and perennially late travel services in India. The flights have no freebies and have a single economy class; the underlying principle being, keep the operations slim and fast. Overtime IndiGo earned its name as the go-to carrier for on-time travel. This resulted in an increase in the WTP of the customers. To this day, even after capturing maximum market share, IndiGo does not offer airline miles to frequent flyers. While the price war would have had market forces push IndiGo towards losses, differentiating its services enabled it to not decrease the prices and instead post profits. At the same time, IndiGo started marketing itself extensively when Kingfisher Airlines was losing grip on the market. IndiGo’s advertisements read, ‘Let the bad times roll… Fly IndiGo in good times and in bad times.’; clearly a tongue-in-cheek reply to Kingfisher’s tagline ‘Fly the good times.’
The commercial aviation industry started using analytics way before the term ‘analytics’ became popular. The dynamic pricing of air-tickets is a perfect example of using analytics to obtain data, recognize patterns and take decisions. This method has advanced further today to the extent that if the tickets are checked from the same computer twice, the price might have increased – a simple demand shift case. Analytics is being used extensively not just to obtain trends in demand and WTP of the customers but also to predict the demand. One example is predicting the average number of seats vacant on a flight on a route during a certain season from data collected from previous years.
But Mr. Pankaj Khare, Director IT at IndiGo took analytics to another level by exploiting the power of data in cost cutting measures in its operations. The IT infrastructure was expanded to include all teams – managerial, functional and operational. All operations and functions were logged and the IT infrastructure pumped out patterns and important statistics to the managers and functional heads. This data was then used to reduce operational costs. An example is the case where passengers are requested to dump their used utensils and waste in waste-bags carried by the flight crew about twenty minutes before the flight lands. This reduced the on-land time of the aircraft, which reduced the fee paid to the airport. Another example is that IndiGo’s most flights have a flight-time of not more than 2.5 hours. Though this is achieved through point-to-point routes instead of the usual hub-and-spoke routes, it results in slimmer operations – lower amount of food, beverages etc. At the same time, IndiGo uses data to obtain the busiest routes so that the aircraft fuel shall be efficiently utilized to earn most revenue. The efficiency of fuel consumption depends not only on the aircraft, but the altitude, the load, taxi-out time at airports etc. Each of these parameters is captured, logged and processed to perform analysis. The result is that IndiGo flies fewer routes than its competitors in the domestic market but still captures about 40% of the market and that too at lower costs.
To conclude, IndiGo seems to be hitting the nail on the head by using analytics to identify the right areas for cutting cost and improving the quality of services. Lowering costs enabled it to survive the price war and emerge as a clear winner with its business model. The prospects of IndiGo seem bright with the economies of scale beginning to kick-in at a time when the overall growth in the country is positive.
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