Why bigger isn’t always better

Why bigger isn’t always better

Analysts quick to attribute last year’s unprecedented spike in oil prices and the miscalculations of ilitimed fuel hedging contracts as reasons for the dismal financial performance of many of the world’s airlines. The subsequent slump in market demand from the global economic downturn certainly didn’t help the situation.

To counter the downward slide, carriers took immediate steps to stop the haemorrhage by cutting capacity, furloughing staff, increasing fleet utilisation and even parking airplanes. Not onlydid airlines look for ways to minimise the cost half of the profit equation, they looked for new ways to maximise revenue by extracting more money from already beleaguered consumers for premium seat assignments, checked baggage and onboard catering. Fare increases were cleverly renamed “fuel surcharges.

Just how much blood can airlines extract from a stone? Analysing what components of the profit formula air carriers can and can not control shows how critical a role aircraft type plays in today’s environment, especially in India.

MAINTAINING CONTROL

Today, few carriers have the financial strength to play and win the fuel hedging game. At one point last year, fuel accounted for some 40 per cent of an aircraft’s direct operating trip cost (DOC) but the dramatic price decline has brought this figure down considerably. Depending on the world region, fuel now represents about 25 to 30 per cent of DOC. According to IATA’s Jet Fuel Price Monitor, the global average cost has dropped nearly 58 per cent compared to April last year. Airline accountants have about as much control over the price of fuel as they do with landing fees, taxation, air navigation charges and insurance rates.

Since fuel expense represents such a big portion of DOC, it demands that every available aircraft seat generates sufficient revenue to help offset that expenditure. Flying empty seats and heavily discounting fares to fill excess capa-v city doesn’t maximise operating margin. One company that saw an opportunity to offer airlines an alternative to the empty seat syndrome was Brazil’s Embraer, manufacturer of a new family of four 70 to 120- seat jets. “We conceived them specifically to reduce the performance, aerodynamic and economic inefficiencies associated with flying airplanes that are either too big or too small for many of the world’s markets,” according to Luiz Chiessi, Embraer’s Vice President of Market Intelligence. “Our E-Jets product line lets airlines derive cost benefits using airplanes designed to minimise those inefficiencies while delivering a high quality passenger experience that’s normally associated with large aircraft.

A CHANGE IN BUSINESS STRATEGY

Flying empty seats has a real cost. Notwithstanding the opportunity cost of lost capacity, it’s a waste of fuel to carry non revenue- generating aircraft structure. Moreover, offering heavily discounted airfares polarises the ticket prices paid by business and leisure travellers and puts downward pressure on yields.

The explosive growth in nonstop capacity in the last two years between New Delhi, Mumbai, Chennai and Bangalore saw intense competition by almost every major airline with market fares reflecting a classic case of over capacity. “Our internal analysis showed that while everyone was eager for a piece of the domestic pie in India, no one was making margins to sustain their operations,” says Alexandre Glock, Managing Director for Embraer Asia Pacific in Singapore. “From a pure business perspective, what’s more important: losing money with high market share, or making a profit? What good is market share if you can’t cover your costs?”.

The 70 to 120-seat aircraft segment offers an opportunity to earn potentially higher margins with a business strategy that better matches capacity to market demand. Instead of fighting for market share on metro markets, primary to secondary city pairs represent a new frontier.  “There is tremendous, untapped potential in this country that I’m convinced can be profitably served by E-Jet type capacity aircraft,” claims Glock about the domestic Indian market. “And with the recent regulatory changes governing market access and taxation for smaller aircraft, I think it’s only a matter a time before airlines understand the magnitude of the opportunity.

Embraer knows a lot about opportunity. It has been successful in marketing its vision of the 70 to 120-seat segment to more than 50 carriers including Japan Airlines, Australia’s Virgin Blue, Lufthansa, Air Canada, Air France and British Airways. In India, Star Aviation will soon join Chennai-based Paramount Airways as airlines in India that recognise the power of the new business strategy by flying to secondary markets.

“Paramount faced a huge challenge as a start-up company inaugurating service in a fiercely competitive environment with an unknown airplane from a manufacturer that wasn’t a household name,” says Glock. “The airline took a completely different approach by operating to underserved city pairs with capacity that was right-sized for those markets. Its business model is ideal for India.”

The key to success is offering a flight schedule that allows higher fare paying business travellers to depart in the morning and return at night. “It’s all about getting the mix of capacity, frequecy and schedule right.  In lower-demand secondary markets, a 70 to 120-seat airplane lets you do that with greater efficiency and often with a higher margin,” says Glock. “You simply can’t fly between every city in the country with a 150-seat jet, offer the frequency that consumers want and expect to make a profit.

A MARKET-ORIENTED APPROACH

In India’s intensely competitive domestic network, lower-demand secondary markets are not as well-developed as the high- volume metro routes flown by large aircraft. After serving the peak morning departure demand, airlines need to deploy their big jets on a round-trip somewhere before returning to pick up the peak evening return demand. Historically, this often resulted in a single, mid-day flight to a smaller city with a departure time that wasn’t conducive to business travel. Fare discounting was needed to stimulate price- sensitive travellers to fill the excess capacity.

“All that is changing,” says Glock. “What you were seeing was pure operational scheduling. The airline was telling passengers when it wanted them to fly. Secondary markets were treated as an after thought.” A glance at the Chennai-Coimbatore route, one of the first to be flown by Embraer E-Jets, shows the dramatic shift from the limited frequencies of just a few years ago.

Today, Paramount Airways offers morning, mid-day and evening flights in each direction giving consumers more freedom to go when they want to go. Glock adds, “Paramount introduced a market-oriented schedule with a new- generation jet, not a turboprop, which is the right size for that city pair. For travel on these kinds of secondary routes, the consumer is back in control of his time.”

If the Paramount business strategy is repeated throughout the country, then 70 to 120-seat aircraft could be the key to helping domestic Indian aviation grow profitably. Glock believes right-sized capacity jets can help steer the industry back to health. “We’ve seen success all over the world with this strategy. Get the right size airplane, fly a customer-oriented schedule, price tickets accordingly, and the passengers will come. That’s good for consumers. And it’s good for airlines, too.”

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