LCC Dogfight Over India

IndiGo and SpiceJet take on each other and the network airlines

For most of its existence sincebeginning scheduled service in August 2006, Delhi-based IndiGo kept a pretty low profile, letting high flyers like Vijay Mallya’s Kingfisher Airlines grab the spotlight. All that changed in February, however, when the low-cost carrier, which also happens to be the country’s most profitable airline over the past two difficult years, changed gears.

It began with advertisements and mailers, mostly directed against archrival SpiceJet, another LCC based in the Indian capital that commenced service in May 2005. Leading the charge was a 10-slide presentation e-mailed to frequent flyers entitled “Desperation is in the Air,” in which IndiGo systematically attacked its rival’s claims of superiority on various parameters such as punctuality, cabin occupancy, flight cancellations and passenger service.

SpiceJet responded by installing a 2-tonne concrete replica of one of its 737s, accompanied by a giant billboard touting its claim to be Delhi’s No. 1 airline, located so as to be seen easily by IndiGo passengers entering the airport.

In many ways, the sniping marks the coming of age of the two budget carriers, which began life as fringe players that everyone—particularly the incumbent airlines—said would “never work in this market.” India has notoriously high taxes on aviation fuel and no secondary airports, so key cost inputs are the same for everyone. Despite these challenges, the LCCs have shaken up the market. Over the past 4-5 years they have gone from nibbling at the network airlines’ traffic to setting the agenda for domestic fares.

Other airlines, especially the network carriers, have little option but to match their lead. The two flew into 2010 with about 27% of the domestic market under their wings, and their success and broad market presence have forced the two largest full-service airlines, Jet Airways and Kingfisher, to launch their own low-fare units in order to keep passengers from migrating en masse. If these brands, Jet Konnect and Kingfisher Red, are included, more than 70% of the tickets sold in India are at low fares. Largely owing to this stimulation, airlines carried 43.8 million passengers in 2009, the most in the country’s history.

Avoiding The Bleeding Edge

India has been a value-conscious market for many consumer products. Most low-priced goods, from sub-$2,000 cars like the Tata Nano to shampoos in sachets, usually do well. Therefore, the boom in passenger preference for budget airlines should surprise no one.

Interestingly, IndiGo and SpiceJet were not the first movers. That honor, if it can be so described, went to Bangalore-based Air Deccan, which made waves with its INR500 ($10) fares and sent out a message to a billion Indians who had never flown that “Everyone Can Fly” (ATW,5/07, p. 48). Sadly, the catchphrase did not prove to be true for the airline. Its promoter, Capt. Gopinath, had to sell it to Kingfisher when it ran out of funds.

Air Deccan’s followers, however, have survived and consolidated their operations. They now dominate the LCC space along with two smaller carriers, Go Air and JetLite (the former Air Sahara acquired by Jet in 2007). Competition is stiff, in large part because there is little differentiation among the products. IndiGo and SpiceJet both follow the textbook LCC model, offering no-frill point-to-point service countrywide. IndiGo operates a fleet of 25 A320s to 22 destinations while SpiceJet has 20 737NGs (mostly -800s and -900s) serving 18 destinations. Their fares track each other closely and distribution strategies are similar. The focus is on cutting costs and raising load factors. But beneath the surface the two are very different in terms of their promoters and operating philosophy.

SpiceJet is a publicly listed company with a wide retail shareholding and investors ranging from Indian companies like the Tata group (with 6%) to American distressed-asset specialist Wilbur Ross (32%). Nonresident Indian businessman Bhulo Kansagra, with oil interests in Africa, started the carrier in early 2005. He earlier had bought out ModiLuft, a failed airline venture between an Indian textile magnate and Lufthansa. SpiceJet was launched after a long legal tangle with previous promoters and assorted red tape.

IndiGo’s origins, on the other hand, are much simpler. Rahul Bhatia, an obsessively low-profile businessman who runs InterGlobe Enterprises, a conglomerate active in aviation services, hotels, IT and travel distribution (through partnerships with Accor and Galileo), started the closely held airline venture with Rakesh Gangwal, the former US Airways CEO and Stephen Wolf protege. IndiGo, and to a lesser extent Bhatia, only came into the limelight at the 2005 Paris Air Show when the carrier stunned attendees with an order for 100 A320s. At that point, it was still on the drawing board and Bhatia did not even attend the event.

Many industry observers questioned whether IndiGo would take delivery of the aircraft. Those in India who had watched Bhatia build InterGlobe over 20 years were far less skeptical about his plans. Gangwal had been a close friend and Bhatia depended on his understanding of the business as well as his international connections. For almost a decade he had waited for the right time to launch the LCC.

Revealing Financials

Because IndiGo is not publicly listed, its financial situation was not clear until recently when Indian Minister for Civil Aviation Praful Patel made a statement in parliament. In response to a question on the profits (mostly lack thereof) made by airlines in India, he said IndiGo posted a profit of INR820 million ($18.3 million) in the year ended March 31, 2009. This contrasts starkly with losses of $30 million for SpiceJet, $90 million for Kingfisher and a mountainous $496 million for Air India.

The situation has improved in the past three quarters as the economy emerges out of the slowdown. SpiceJet has been quick to turn around with a profit of $7.5 million in the nine months ended Dec. 31, 2009. IndiGo’s comparable numbers are not known yet, though airline management claims it has done well. The carrier has been taking delivery of aircraft throughout the downturn and plans to induct nine more this year. It is planning a fleet of 40 by 2012.

Speaking to ATWabout what keeps IndiGo ahead, CEO Aditya Ghosh says it is simply sticking to the basics of the business: “If we can get the fundamental elements right . . . fresh, clean aircraft and flying on time, we should do okay.” There is so much demand today in India that it is difficult to decide where to fly right away and where to go later, he adds. Recently the carrier launched flights to the northern state of Kashmir, connecting Srinagar and Jammu to Delhi. Its network contains an equal mix of the larger metropolises and second- and third-tier cities. Average stage length is about 90 min.

“By global standards, aircraft penetration in India is very low with just one commercial plane for three million passengers,” says Ghosh. He sees air travel doubling in the next five years if fares can be kept affordable. The airline has made a virtue of its high ontime performance, featuring it in many advertising campaigns.

Frequencies Over Routes

IndiGo’s strategy has been to increase frequencies on a route rather than opening up too many points. This is in sharp contrast to Air Deccan, which expanded rapidly to connect 70 points in India. Ghosh says IndiGo will continue on its path, expanding within India, and to neighboring countries once it completes five years of operation by the end of next year and is eligible for permission to fly overseas. “With the massive investments in new airports and infrastructure, India can take hundreds more flights,” he says. According to Boeing’s “2009 Current Market Outlook,” the Indian market will require 1,000 commercial jets worth about $100 billion in the next 20 years.

One reason for the huge growth in LCC traffic while network carriers have struggled is the former’s capital cost advantage. A research report by Citibank on the Indian airline business says capital costs per passenger have jumped several-fold over the last few years for network carriers such as Jet Airways and Kingfisher, while those of budget airlines have remained stable or moved up marginally.

SpiceJet CEO Sanjay Aggarwal is very proud of his carrier’s ability to control cost. He claims to have the lowest unit cost, with a CASK of INR2.30-2.40. Distribution expenses are only 4%-5% of SpiceJet’s total costs. About a fourth of its seat inventory is sold on its website, while another quarter is sold by travel agents but again on its website. Online travel portals account for 12% and 25%-30% comes through the airline’s call centers. Remaining sales are from walkup passengers at airports. SpiceJet uses its Boeing fleet for an average of 12.5 hr. a day with a turnaround time of about 30 min. between flights, roughly the same as IndiGo. These numbers are much higher than the network airlines.

SpiceJet’s service standards and people are a differentiator, says Aggarwal, who joined the carrier in late 2008 from Flight Options, a US private aviation and fractional ownership provider, where he was COO. “Being an LCC does not mean being cheap; we have an airline working harder to find out how to deliver value,” he says. In a move that wins hearts in India, SpiceJet, whose aircraft are named for local spices, serves up warm Kathi rolls and hot beverages that passengers prefer, rather than cold sandwiches.

The airline says the edge also comes from a higher seat density; it carries 189 passengers on its 737-800s, nine more than IndiGo gets on its A320s. On the 737-900s it can take 212 passengers with what Aggarwal claims is a lower fuel burn than rivals. It froze aircraft deliveries for about 14 months but has begun accepting planes again. It plans to add five more in the next year as it begins flying overseas.

It also is trying to raise about $75 million through a preferential issue of shares. Foreign equity in airlines in India is capped at 49% and SpiceJet has been dangerously close to that level in the past two years. Only financial investors are allowed, and although carriers like Kingfisher have been lobbying for policy reform, foreign airlines are not yet allowed to take stakes in domestic carriers. This limits funding options, particularly for cash-poor airlines that lack a good story. Dubai-based investment firm Istithmar cashed out its 13% stake in SpiceJet last month and the new partner, either a private equity player or a fund, is likely to replace it.

IndiGo, on the other hand, says it has no plans to raise capital and claims to be well funded through internal accruals for all its financial needs.

With more than two-thirds of the inventory in the market now being sold at prices dictated by them and huge unmet demand, India’s two leading LCCs look like they are just getting warmed up.