Sunrisr in Kharadi

Sandy

Before Selfie

 
Selfie had not been 'discovered' at that time. I did not even own a mobile phone those days and more importantly we were still years away from first from camera phone and then smart phone. So this actually a photograph clicked sometime in the prehistoric era.  Looking at the photograph I can make a few guesses. First, I am in the front yard looking at my laptop. What was I doing in the front yard with my laptop? No idea. As a rule I preferred working on my desk even if I were on my laptop. Something must have happened to cause this exception to the rule, but I remember nothing. Second, now this is a tough one, the year ummmm 2009? 2010? I have to base my guess on the cloth I am wearing and my beard. The beard acquired this shade of gray when sixtyish or nearing it. So 2011 it must be.

Why Do Investors Remain Invested in Airline Business

In an earlier paper we had discussed why airlines do not make a decent return on their investment. In that paper with the help of core theory it was explained how the inherent unstable nature of airline market made it impossible for airlines to post a healthy profit consistently over a period of time. The paper, however, did not answer the next logical question that if airline was such a profit challenged business then why the investors did not get out of it at the earliest. We attempt to do this in the present paper.

Economic theory is based on the assumption that human behaviour is rational and therefore any economic decision would be based on cause and effect rationality. In reality, however, humans do not always behave rationally while making their decision. Take the case of an investors who business interest in several industry including airline. Ever since he has invested in airlines he has found that the return from airline business has abysmal compared to his other businesses. As rational investor he aught to move his investment out airlines and put it one his other existing business to maximise his gains, but he does not do so. Traditional economics would label such behaviour as irrational.

Let us take another example, a non aviation one. A year ago during IPL 1 the match between Delhi Dare Devils and Kolkata Knight Riders was abandoned due to rain without a ball being bowled. Cricket matches often get abandoned due to rain therefore was nothing unusual in the present case. In fact it was a day of inclement weather, it had been raining incessantly since morning and well before it was time for the match to start it was fair knowledge that no play would be possible as the playground, which had no drainage system worth the name was sure to be water logged. Yet, 25000 spectators turned up at the ground several hours before the scheduled start and stayed on till the scheduled time for the match to end. Traditional theory would call the behaviour of the spectators as irrational. In a rational world the spectator who already knew that no play would be possible would have been better off in spending the time in some other pursuit that had the possibility of bringing positive return rather than drenching in the rain under the open sky of the uncovered stadium. But such was the behaviour of not one or two odd spectators, 25000 people behaved in this irrational manner. Clearly there must have been some logic behind this apparent illogical behaviour. To understand such behaviour we need to go beyond traditional economics; we need to look into the psychology of sunk cost.

Psychology of Sunk Cost

Psycho economics[1], which is also known as behavioural economics, is the youngest branch of economics. It came into prominence in the 1990s although work had been going on much earlier. It received the stamp of recognition when one of the pioneers Daniel Khaneman was awarded the Nobel Prize in Economics in 2002 "for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty".[2] Philosophy of sunk cost is one among the many new concepts that this branch of economics has developed to explain many issues that traditional theory has not been able to explain adequately. However, before describing the philosophy we need to know what is meant by sunk cost and it relevance in decision making.

What is Sunk Cost

Sunk cost is the cost already incurred which cannot be recovered regardless of future events.

In economics and business decision-making, sunk costs are costs that cannot be recovered once they have been incurred. Sunk costs are sometimes contrasted with variable costs, which are the costs that will change due to the proposed course of action, and prospective costs which are costs that will be incurred if an action is taken.

In traditional microeconomic theory, only variable costs are relevant to a decision. Traditional economics proposes that an economic actor does not let sunk costs influence one's decisions, because doing so would not be rationally assessing a decision exclusively on its own merits. The decision-maker may make rational decisions according to their own incentives; these incentives may dictate different decisions than would be dictated by efficiency or profitability, and this is considered an incentive problem and distinct from a sunk cost problem.

Behavioral economics proposes the opposite: that sunk costs greatly affect actors' decisions, because humans are inherently loss aversive and thus normally act irrationally when making economic decisions.

For example, when we have put effort into something, we are often reluctant to pull out because of the loss that we will make, even if continued refusal to jump ship will lead to even more loss. The potential dissonance of accepting that we made a mistake acts to keep us in blind hope. It is common for people who have invested in company shares to hold on tight to them as the market slumps, in the desperate hope that the shares will rise in price again.

The Sunk Cost Effect

Traditional economics predicts that people will consider the present and future costs and benefits when determining a course of action. Past costs should not be a factor. Contrary to these predictions, people routinely consider historic, nonrecoverable costs when mak­ing decisions about the future. This behaviour is called the sunk-cost effect.4 The sunk-cost effect is an escalation of commitment and has been defined as the "greater tendency to continue an endeavour once an investment in money, time or effect has been made."

In their seminal paper[3] Hal R. Arkes and Catherine Blumer explain the concept of sunk cost philosophy with the example of a contest winner of a radio programme who has been rewarded with a ticket to a football game. Since he does not want to go to the game alone he persuades a friend to purchase a ticket. When they are about to leave for the game a terrible blizzard begins and the contest winner does not want to go. His friend insists on going to the match since he did not, ‘want to waste the money that he has already paid for the ticket.’ According to traditional theory the friend is not behaving rationally; he should go to the game only if the pleasure of watching the game is more than the agony of sitting in blinding snowstorm. After all the price of the ticket has already been paid for by the friend and his decision to go or not to go will not bring the money back to him, that money is gone; it is a sunk cost. Past investments that are irrecoverable should not be allowed to influence present decision. But, as 25000 spectators at the cricket ground on a rainy night demonstrated, people do.[4]

Something similar happens in the airline business. Individual and companies invest in airlines for a variety of reasons; since this paper is about why people remain invested and not why they invest in airline business we will not discuss the issue in too much detail. In terms of behavioural economics the broad reasons for investing in airlines can be summed as

(a) It will not happen to me: This is a syndrome that we are familiar with. Individuals routinely assume that ordinary misfortunes like road accidents, a loss in business, attack of an epidemic and so on will not happen to them. The confidence comes from two sources, first, about which one is generally unaware, is the statistical probability of such events occurring are extremely low and therefore for most part misfortunes do not strike a person too often. The second, about which the individual is well aware off, is an inherent belief in themselves that they are smarter than the rest. So, billionaires, otherwise familiar with the apocryphal story about the shortest way of becoming a millionaire is to start an airline does precisely that viz. invests in airline business. They carry with them the self-belief that they would be able to run the business much better than others ahead of them have been able to.

(b) Prior experience: It is generally true that those investing in airlines have some prior experience, say, as a pilot, a tour operator or travel agent, experience of running airlines etc. This provides them a confidence that they can do better than others.

(c) Glamour: Traditionally flying has enjoyed a very high glamour quotient primarily because it is a task that human beings can never perform. Another factor that earns respect for those manoeuvring a flying machine is the high risk factor. Mankind has always accorded great value to those who dare to put their life at risk to achieve the improbable. Airline business basks in the reflected glory of this glamour. In the pecking order of the Chamber of Commerce the owner of an airline enjoys a higher ranking than the owner of a hosiery firm though the business of the later may be earning higher profit.

After a point of time investors having made their investment confront situations that we have discussed in the earlier part of the paper. After facing several years of low profitability or outright losses when it seems that it would be best to get out of the business they walk into the fallacy of sunk cost. Having spent so much money and time on an investment it appears to the investors that all their efforts would go to waste if they wind up the airline. Their dilemma can be explained with the aid of the following diagram that contains prospect theory’s^[5] value function. The function defines the relationship between objectively defined gains and losses and subjectively

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[1] Behavioural economics and behavioural finance are closely related fields that have evolved to be a separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by consumers, borrowers, investors, and how they affect market prices, returns and the allocation of resources.

The field is primarily concerned with the bounds of rationality (selfishness, self-control) of economic agents. Behavioural models typically integrate insights from psychology with neo-classical economic theory. Behavioural Finance has become the theoretical basis for technical analysis.

Behavioural analysts are mostly concerned with the effects of market decisions, but also those of public choice, another source of economic decisions with some similar biases towards promoting self-interest.

[2] "Nobel Laureates 2002"; Nobelprize.org

[3] The Psychology of Sunk Cost, Hal R. Arkes and Catherine Blumer; Organisational Behaviour and Human Decision Process, 1985, 35, 124-140, reproduced in Judgement and Decision Making, Terry Connolly, Hal R. Arkes, Kenneth R. Hammond, p 97-113, accessed at http://books.google.com/books?id=Uo34qW1wi_YC&printsec=frontcover&source=gbs_navlinks_s. Various dates.

[4] Nearly six months after that IPL match I was talking to a group of friend of my daughter when the discussion turned to that match and I commented that how foolish it was for all those people to turn up for the match when the whole of Delhi knew that no match would be possible. At this one of her friend remarked that he was one among the ‘foolish’ people. Whereupon I asked why did he have to go, his reply was, “But Uncle, I had saved my pocket money to buy the ticket.”

[5] Daniel Kahneman, professor at Princeton University’s Department of Psychology, and Amos Tversky developed prospect theory in 1979 as a psychologically realistic alternative to expected utility theory. It allows one to describe how people make choices in situations where they have to decide between alternatives that involve risk, e.g. in financial decisions. Starting from empirical evidence, the theory describes how individuals evaluate potential losses and gains.

Prospect theory contends that people value gains and losses differently, and, as such, will base decisions on perceived gains rather than perceived losses. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people would choose the former - even when they achieve the same economic end result. According to prospect theory, losses have more emotional impact than an equivalent amount of gains.

Why Do Airlines Not Make Money

Seemingly since the beginning of aviation history there has been discussion and speculation on the remarkable inability of the industry to generate profits. This is even more so the case now, when a number of the world's airlines are bankrupt. The failure of aviation, or at least of airlines, to produce a reasonable rate of return on investments has been a fact pondered by many at great length but never satisfactorily understood. Somehow the industry seems to violate the most basic principles of economics and business.

Complaints about the lack of profitability in the airline industry surface during periodic downturns, but the problem has been there since the industry started. Statistics shows a long history of losses for airline industry and yet at the same a phenomenal growth in traffic. The airline industry is a complex one and the apparently contradictory statistics only underscores this fact.

Airlines Profits in Perspective

Profits by definition are surplus of income over expenditure; i.e.; the difference between revenue and expenditure. The table at Annexure 1 shows operating profits for the airlines industry from 1947 to 2007 a period long enough to qualify as the ‘long run’ of the Marshallian economics. The table throws up some interesting results. The industry made operating profits in 45 of the 61 years. From 1962 to 1979 it had a long period of uninterrupted operating profit. Though operating profit during this period remained positive they nevertheless, exhibit severe slowdowns. Besides, the magnitude of profit has been modest for most of the years. The period of losses is more frequent from 1980 onwards; since then for every three consecutive years of losses there are seven or eight consecutive years of profit. If we look more closely at the table then it would be seen that the long period of uninterrupted operating profits coincided with the period of regulation of the industry in force almost in all the countries of the world during the period. The USA, which at that time accounted for more than 50% of world traffic

deregulated its airline industry in 1978 and since then the trend in operating profit, has changed altogether. Furthermore, the period of losses coincide with periods of recession. Another thing that is not as obvious in the table but comes out quite clearly in the graph is the volatile and cyclic nature of the industry; post 1978 in particular.

The picture seen in operating profit as a percent of revenues shows disturbing trend. Since 1947 the airlines have managed to clock a return of more than 5% only on 13 occasions and have not been able to achieve double digit return even once. It may surprise many at our choice of 5% as the benchmark, after all while evaluating a project we generally use discount factor of 12%, that is an investment is considered worthwhile unless it brings in a return of

12%. To lessen the surprise let us point out that the average returns that the airlines have realized in these 61 years is 2.30%; our benchmark that is double the average is therefore reasonable. The remarkable thing is that the average does not change much with change in policy; during the regulation period it was 2.25% after deregulation it improved marginally to 2.34%. Also, to be noted here is that we are talking here of gross margin that does not include the cost of borrowings. The highest return achieved during the regulation period was 9.5% (1965, 1966) and 6.1% (1988) after deregulation.

We now turn our attention to net profit and net margin. Here the picture is even more dismal. In 31 out of 61 years the industry made losses. Even the profit making years are not great ones their magnitude is usually fairly low. In fact, if we add up all the losses and set it off against all the profits then the net figure comes to $17,000 million or 278 million a year. Hence the remark made in the early 1990s by former CEO of American Airlines Robert Crandall that the colossal losses made by the industry negated all the profit made since 1903.

As for net profit as percent of revenue, the best that the industry could achieve was 6.1% in 1966 apart from that only on one occasion margin has been more than 5%. The 61 year average is a miserable 0.12%.

The analysis above shows that the airlines industry has not been a profitable one. And this appears to be so almost since the beginning of the industry. The evidence points towards a very depressing state of financial health of the airlines.

Where Does the Problem Lie

The above analysis raises the issue of what causes this intriguing behaviour of the airline industry. The answer lies in the nature of the industry. One of the widely accepted theories of economics holds that unfettered competition does not work very well in certain industries commonly known as natural monopoly. Natural monopolies often result in infrastructure and capital-intensive industry; examples are water supply, electricity, public transport and the like. An utility is often created because it is the only way to ensure crucial infrastructure investments are made; if multiple firms operate they may not be able to afford to upgrade their systems overtime. Economists have for long argued that natural monopolies whose activities fall within the ambit of public utilities should be provided protection by allowing them to function as monopolies but within a regulated market.

Indeed many of the elements of the infrastructure of the airline industry are natural monopolies. For example, it would not be more efficient to have multiple air-traffic control firms competing against one another. By disallowing construction of a second airport within a radius of 150 kilometres of an existing airport, airports in India are allowed to function as natural monopoly in a limited sense. But airlines themselves are never thought of as a utility and this in our opinion is a myopic view. There are a number of reasons why airlines should be treated as a public utility. Civil aviation like other transport industries generates important external benefits. The returns from air transport are not restricted to the industry itself, but encompass wider effects on the economy at large. Airlines are often used to serve important national, social and economic objectives of the government. The national airline of a country is seen purely as a symbol pf prestige; or as a means of encouraging trade and investment; or as a way of stimulating the development of tourism; or as an important source of foreign exchange; or as a vehicle for supporting the development of a domestic aero space industry; or as a way of guaranteeing the availability of standby fleet with fully trained personnel in case of emergency. The importance that governments give to some of these nationalist and mercantile objectives may be declining over the years but they are still highly significant.

The consequence of refusal to accept airline industry, as a public utility infrastructure while granting some of its constituents the benefits of monopoly has been that on the supply side airlines have to pay monopoly price for the services consumed and on the demand side it has to live by the market determined price. Living by the market price would not have been such a bad thing had the market itself been a rational place like any other competitive marketplace. Sadly this is not the case. As the Fortune magazine once observed, ‘for all its ineffable allure, though, the airline industry is like the banana business.’[1] Airplane seats are a commodity - despite heroic attempts at product differentiation, passengers think one airline's seat is pretty much like another's - and when a plane takes off with empty seats, the commodity is spoiled. It is better by far, from an airline's point of view, to lure passengers from competitors at deep discounts than not to sell seats at all. Airlines sell a perishable product, and it's like the last banana in the store; one can either get a penny for it or one can get nothing for it, so airlines sell it for a penny.

Combine these characteristics and what do you get? Vicious, endless fare wars that in most businesses would quickly thin out the players but that in airlines have helped produce a record of chaos and wreckage rare in any industry and almost incredible in one so important to the nation's and world's economy.

The commonly accepted view so far has been that pricing madness and mammoth losses have resulted from bad policy, bad management, and bad luck - problems that have masked progress toward an eventual, conventional settling down of the industry. However, a small but growing group of industry experts believe the conventional explanation of chronic airline turmoil is wrong. The new view says the trouble isn't bad luck; it's the very nature of the business. Loosely associated with Lester Telser,[2] a prominent economist at the University of Chicago, they argue that the airline industry is an economic machine programmed for self-destruction or something close to it.

The argument, at its simplest, goes like this: No matter how many employees are laid off or labour concessions gained, the fixed costs of aviation - planes, fuel, facilities - are destined to remain relatively high. The marginal costs of adding passengers on a partly filled flight are negligible. So the airlines need not charge much to make that perishable seat worth selling. The result is now a days’ roughly 90% of airline passengers buy their tickets at a discount, paying on average just a third of the full fare. Thus in an industry with high fixed costs and low marginal costs, competition produces a market that never settles down. Economists say such a market has an "empty core."[3]

The essence of neo classical demand theory is built on the premise that through a process of bidding and counter bidding between the seller and the buyer the parties arrive at a price at which neither the seller makes an excess profit nor the buyer makes an excess gain. With both the buyer and the seller satisfied with the transaction the market will attain a state of equilibrium such a market guarantees that no one in the market is worse off than before and at least one person is better off than before. This is known as Pareto the position where social welfare is at the optimum. The attainment of equilibrium is made possible due to the presence of large number of buyers and sellers.

Without challenging the central proposition of the neo classical demand theory the core theory makes the additional proposition that it is not always necessary for a competitive market to attain an equilibrium price. According to core theory a market can perpetually remain in disequilibria if certain conditions are fulfilled. Telser describes these conditions using the word ‘Chaos”. According to Telser, there is chaos when "price cutting is extreme, most firms in the industry are losing money, and yet it is plain that buyers want the product and are willing to pay higher prices than those currently prevailing."[4]

If we look at the airline industry we find it meets all the requirements of a competitive market; it has large number of buyers and sellers, there is no restriction to firm’s entry or exit nor is there any restraint on price. Theoretically therefore, the industry should at some stage reach the equilibrium state yet experience shows that it never happens. The relentless pressure to sell seats and at least recover the short run marginal cost makes airlines to resort to extreme price cutting and offering seats at ridiculous fares (e.g. for Rs. 99) even when the passengers are willing to pay much higher fare, thus fulfilling Telser’’s criteria of an industry with an empty core. The chaos so created never settles down, airlines are known to sell seats even when the aircraft is on the verge of takeoff! In the process the gap between the marginal and average cost gets so large that airlines generally are not able to recover their long run average cost and thus fail to make any money.

The above discussions highlight that the unrestricted ability to contract and re-contract among buyers and sellers within an industry allows fares to be bid down to non-profitable levels. To the extent that one or more airlines have excess operating capacity, attracting additional customers by lowering price (provided such price is above marginal cost) creates additional operating profit (or reduces operating loss) for the individual airline. The important feature is the effect of excess capacity, not necessarily the cause of that excess capacity.

Another condition that must be fulfilled for an empty core to exist is the presence of avoidable cost[5]. The presence of avoidable cost lends another peculiarity to the airline industry and contributes towards the industry’s poor profitability. Once an airline has incurred the sunk cost[6] and created operating capacity the actual operation of the aircraft requires the incurrence of large avoidable cost irrespective of level of utilisation. This results in what economists call a U shaped cost curve. Once however, an airline has committed to particular fleet and schedule it cannot change output without incurring substantial adjustment cost. The airlines get caught in a no win situation – not flying saves avoidable cost but incurs adjustment cost; flying on the other hand results in higher expenditure but lower revenue.

On the supply side the cost conditions of an airline are such that cost per mile flown falls as the number of miles flown increases. However, technological constraints imply that, only reducing aircraft capacity can increase distance flown. Further, cost per passenger falls as the number of seats filled on an aircraft rises up to full capacity. Taken together this implies that marginal cost starts increasing well before the payload at maximum range is reached. The airline industry has generally operated with excess productive capacity. Further airlines tend to cut prices to short-run marginal cost in the face of excess capacity that occur due to variations in demand, which pushes prices below that required to operate an efficient set of schedules.

On the demand side an airline faces seasonal and cyclical demand. Thus, matching capacity to demand in the airline industry moves it toward an empty core, or an unstable equilibrium.

Policy Implications

The study was undertaken with the objective to examine and explain why airlines do not make money. Examination of historical data on both gross and net profit established the fact that over the long run airline industry does not indeed make any money, it at best breaks even. The reasons for this intriguing state of the industry can be found in the nature or peculiarities of the industry. Since individual airlines deal with a commodity that is perishable they are always under pressure to sell their stock of available seats. Presence of excess capacity in the industry compounds the situation further. This leads to fierce price war among airlines that results in seats being sold at a price much below what the market can bear. What is worse, in their effort to maximise their short run revenue the airlines end up with fares that are below the long run average cost. Poor financial return then puts even more pressure on the airlines to maximise capacity utilisation that once again starts the cycle of under pricing and the resultant consequences.

Analysing the behaviour of the airline industry and noting its unique features economists like Telser, Button, Nyshadham, Raghavan, Pirrong, Sjostrom and others have found an explanation in the core theory. Their theory states that a competitive market through a process of coalition among its members arrives at a price that establishes equilibrium in the market, which lends stability to the market; this stability forms the core of the market. However, they also found that there are certain industries that due to their special characteristics perpetually remain unstable, i.e.; at no point the industry attains an equilibrium price. Typically firms in such industry often have to sell their products at below cost so as to survive at least in the short run; a strategy that far from solving the problem further accentuates as well as perpetuates the problem.

The issues that emerges from the above is that though the airline industry is a competitive market it does not produce an equilibrium price and therefore is inefficient and incapable of optimising social welfare. Economists have for long advocated in favour of intervention by the government where market based solution is not efficient. Thus the policy implications are the following:

1. Should the airline industry in India be treated as natural monopoly and allowed the concomitant benefits?

2. Should there be direct intervention by the government to neutralise the instability, which is inherent in the nature of the airline industry?

3. Should airlines be allowed ‘fare agreement’ in the line of Conferences in the shipping industry?

References

Antoniou, Andreas, The Status of the Core in the Airline Industry: The Case of the European Market. Managerial and Decision Economics. 19(1), 1998, 43-54

Button, Kenneth, Liberalising European Aviation: Is there an Empty Core Problem? Journal of Air Transport Economics, 30(3), 1996, 275-291.

Nyshadham, Easwar A., and Raghavan, Sunder, The Failure of Electronic Markets in the Air Cargo Industry: A Core Theory Explanation. Electronic Markets, 11(4), 2001, 246-249

Pirrong, Stephen C., An Application of Core Theory to the Analysis of Ocean Shipping Markets. Journal of Law & Economics XXXV, 1992, 89-131

Sjostrom, William, Collusion in Ocean Shipping: A test of Monopoly and Empty Core Models. Journal of Political Economy, 97(5), 1989, 1160-1179

Telser, Lester G., The Usefulness of Core Theory in Economics. Journal of Economic Perspectives, 8(2), 1994, 151-164

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[1] Why Air Travel Does’nt Work, Fortune, April 3, 1995

[2] The Usefulness of Core Theory in Economics, Lester G. Telser; Journal of Economic Perspectives, 8(2), 1994. (http://docs.google.com/fileview?id=F.c37ca0ec-e410-49bb-9afe-8b8d9696768c&hl=en; accessed on 22.02.09)

[3] See Annexure 5 for a detailed exposition

[4] Telser; opcit

[5] Avoidable cost is defined as the cost that a firm has the option to avoid. For example, in the airline industry an airline has the option not to fly an aircraft and avoid fuel and other costs associated with flying. Also see Annexure 5.

[6] Sunk cost is expenditure that cannot be recovered. For example, the cost of purchase of an aircraft. Also see Annexure 5

Recession in Indian Aviation - What Caused It

What Caused The Recession

Airlines in India have gone through five phases of development. The first phase was the pioneering years, which started in the pre-independence period and lasted till the early years of post independence era. The second phase started sometimes in the late fifties and continued till the early nineties of the last century. The third phase has been the shortest phase so far that started with the repeal of the Air Corporation Act and ended in 2003. The current phase started with the emergence of low cost airlines and is now in the midst of a recession.

The First Phase – the Pioneering Years

The journey of civil aviation in India began in December 1912. It coincided with the opening of the first domestic air route between Karachi and Delhi by the Indian state Air services in collaboration with the imperial Airways, UK, though it was a mere extension of London-Karachi flight of the latter airline. However, before this the first commercial flight in India was made on February 18, 1911, when a French pilot Monseigneur Piguet flew airmails from Allahabad to Naini, covering a distance of about 10 km in as many minutes.

On October 15, 1932, a light single-engine Puss Moth took off from Karachi on its flight to Mumbai (then known as Bombay) via Ahmedabad. At the controls of the tiny plane was Mr. J.R.D. Tata, operating the first scheduled air service in the country. He landed with his precious load of mail on a grass strip at Juhu. Life was simple then. There were no runways, no radio facilities in the aircraft or on the ground. There were no pretty hostesses, no aerodrome officers and no airport buildings. At Mumbai, Mr Nevill Vintcent took over from Mr. Tata and flew the Puss Moth to Chennai (then known as Madras) via Bellary. Thus was born Tata Airlines, which later became Air India. In 1933, the first full year of its operations, Tata Airlines flew 160,000 miles, carried 155 passengers and 10.71 tonnes of mail.

The Second Phase – Public Sector Era

At the time of independence, the number of air transport companies, which were operating within and beyond the frontiers of the country, carrying both air cargo and passengers, was nine. It was reduced to eight, with Orient Airways shifting to Pakistan.

In early 1948, a joint sector company, Air India International Ltd., was established by the Government of India and Air India (earlier Tata Airline) with a capital of Rs 2 crore and a fleet of three Lockheed constellation aircraft. Its first flight took off on June 8, 1948 on the Mumbai (Bombay)-London air route. At the time of its nationalization in 1953, it was operating four weekly services between Mumbai-London and two weekly services between Mumbai and Nairobi. J.R.D.Tata headed the joint venture.

The soaring prices of aviation fuel, mounting salary bills and disproportionately large fleets took a heavy toll of the then airlines. The financial health of companies declined despite liberal Government patronage, particularly from 1949, and an upward trend in air cargo and passenger traffic. The trend, however, was not in keeping with the expectations of these airlines that had gone on an expansion spree during the post-World War II period, acquiring aircraft and spares.

The Government set up the Air Traffic Enquiry Committee in 1950 to look into the problems of the airline. Though the Committee found no justification for nationalization of airlines, it favoured their voluntary merger. Such a merger, however, was not welcomed by the airlines and the Government had to ultimately nationalize the sector in 1953 and accordingly, two autonomous corporations were created on August 1, 1953. Indian Airlines was formed with the merger of eight domestic airlines to operate domestic services, while Air India International was to operate the overseas services (the word 'International' was dropped in 1962. Effective March 1, 1994, the airline was renamed Air India Limited). At the time of nationalization, Indian Airlines inherited a fleet of 99 aircraft consisting of various types of aircraft.

The third Phase – the Liberalisation Era

Until a decade ago, all aspects of aviation were firmly controlled by the Government. In the early fifties, all airlines operating in the country were merged into either Indian Airlines or Air India and, by virtue of the Air Corporations Act, 1953; this monopoly was perpetuated for the next forty years. The Directorate General of Civil Aviation controlled every aspect of flying including granting flying licenses, pilots, certifying aircrafts for flight and issuing all rules and procedures governing Indian airports and airspace. Finally, the Airports Authority of India was entrusted with the responsibility of managing all national and international airports and administering every aspect of air transport operation through the Air Traffic Control. While nationalization of air transport sector solved quite a few problems during the course of time it also created a few problems. The usual ills associated with monopoly, like rising operating cost due to low productivity, falling standard of service and quality of infrastructure, disregard for passenger amenities, etc.; started to surface. With the general opening up of the economy theses characteristics of civil aviation was rendering the sector out of sync with the rest of the economy and therefore finally the Air Corporation Act was repealed to end the monopoly of the public sector and private airlines were reintroduced.

As was to be expected, liberalisation of air services led to launching of several private sector airlines. East West, Damania Airways, Air Sahara, NEPC Airways, Jet Airways, ModiLuft were some of the prominent airlines set up during that period. Of these, only Jet Airways survives today. The airlines that started operating showed lots of promise in the beginning and many at that time thought that Indian aviation was well on the way to gain maturity. Almost every area of airline business showed improvement. Capacity increased manifold, in 1996 the airlines collectively offered 70,000 seats, there were visible improvement in efficiency in the matter of ground handling, cabin crew, punctuality and on board catering.⁶ It is unfortunate though that what started with so much fan fare soon began to flounder. Within a few years of their operation most of the airlines either closed down or, as it happened in the case of Damania, merged with other airline.

Not much material or analysis is available on the probable cause(s) of the failure of the airlines in establishing themselves as viable operators. However, based on our own analysis we would like to put forward the following:

The pace at which the industry developed was too fast for the national economy to handle. The economy was still growing at 5-6 percent per annum and personal disposable income for a large majority of middle class (i.e.; the potential ‘flying’ class) had not reached the critical mass at which point one could look beyond the daily grind and seek for some luxury. The industry either did not understand or preferred to ignore the income elasticity of demand of its client base and ended up with an incomplete profile of the market.

The industry created capacity that was far in excess of actual demand. In 1996 when air traffic stood at around 27,000 to 32,000 passengers per day, the airlines together offered around 70,000 seats. It would, however, be wrong to blame the airlines for the excess capacity. Since aircrafts come in standard sizes it is in the nature of the airline industry to perpetually operate in environment of demand-supply mismatch. It is one of the inflexibilities that we have already discussed while talking about special characteristics of airline business. It is one of the ironies of airline business that the airlines’ have to bear the consequences of actions of which they are not responsible; in this case the outcome associated with over capacity.

The private sector airline underestimated the strength of the public sector airline. The unspoken belief among the private airlines was that in the onslaught of competition the public sector would soon wither away. That the public sector could (and would) adapt itself to the dictates market demands and improve its efficiency to the extent of successfully retaining a major part of its client base was way beyond the expectations of private airlines, thus the easy pickings of passengers that they were hoping for never materialised.

All the airlines, including the ones that survived, failed to demonstrate entrepreneurial courage and a boldness to experiment with a new idea. The concept of low cost carriers (which in theory at least, is most suited for a country like India) that was taking off at the same period in the West was completely ignored by all the airlines.

The country was not ready for an aviation makeover. Running an airline does not only involve buying an aircraft and flying it also needs the presence of supporting industry aviation finance, for example. The airlines were operating in a void.

Most of the airlines were under capitalised. We have earlier spoken about easy entry as on of the unique characteristics of airline business. In Indian context entry in those were even easier than they are now. Anybody could set up an airline with just one aircraft provided he promised to upgrade to three aircrafts within three years and invested a minimum of rupees one crore. As soon as Air Corporation Act was repealed all the Air Taxi Operators of the time converted themselves into airline companies without any adequate homework. Business economics was the last thing on their mind, if it was there at all. Though airlines like Damania, East West had experienced men running the company yet nothing in the way they ran their airline indicated they were seriously aware how capital intensive the business was. Jet Airways was the only airline to start operation with adequate preparation, it had equity tie up with Gulf Air and Kuwait Airways. It is perhaps because of this tie up and their professionalism that we see Jet’s aircraft in the skies today. The other airline that survived was Air Sahara, which could be ascribed to deep pockets and also the fact that they had not spread their resources too thin.

For all the defunct airlines finance remained the single biggest problem throughout their existence and which ultimately led to their downfall. While Damania sold out to NEPC Airways, NEPC’s own finance kept going from bad to worse to the extent that they kept defaulting on paying taxes and the government had to ultimately confiscate it licences. East West’s died along with the violent death of its MD. ModiLuft’s partnership had to end when Lufthansa called off the deal presumably due to non receipt of dues.

The Fourth Phase – The Era of Growth and . . .

2003 is a watershed year for Indian aviation industry for two significant reasons. First, with re-launch of new private sector airline it finally signalled the end of the shock that followed from the failure of airlines in the earlier phase. Secondly, India entered the era of low cost airlines. Launch of low cost airline (LCA) radically altered the nature of competition within the airline industry, especially on short-haul routes. LCAs exploited different operational methods, fewer service offerings (e.g. charges for in-flight catering) and distribution efficiencies (e.g. internet-only bookings) to lower their cost base and to lower the average fares paid by customers. Strong competition from LCAs forced the full cost airlines (FCAs) to respond or to fail.

India's first low-cost airline, Air Deccan started service on August 25, 2003. The airline's fares for the Delhi-Bangalore route were 30% less than those offered by its rivals such as Indian Airlines, Air Sahara and Jet Airways on the same route. The success of Air Deccan spurred the entry of nearly a dozen low-cost airlines in India. Within a few years setting up its operation Air Deccan had to face stiff competition from other low-cost Indian carriers such as Jetlite, SpiceJet, GoAir, IndiGo Airlines and Paramount Airways. After a year of operation, in 2006, Kingfisher Airlines changed its business model from low-cost to value airlines.

The LCAs made the years 2005 and 2006 the most eventful years for Indian aviation. The two years were characterised by a rapid growth in the size of the passenger market and a fiercely fought price war in which the full service carriers too joined in. Fares kept plunging beyond anybody’s expectation and as fare fell the number of air travellers increased manifold, a significant majority of which were first time travellers. Growth in passengers induced a growth in number of aircrafts as well. There were several other factors as well that contributed to the spurt in growth of the aviation sector. On the demand side were factors like GDP growth, under penetrated market, rising disposable income, growth in tourism. On the supply side were factors like improved infrastructure and a more mature market.

Unlike the past, present day Indian aviation is clearly got divided into two categories that of full service carriers and low cost carriers. The advent of low cost carriers resulted in making significant changes in the nature and development of the industry. As price competition strengthened the pressure on airlines to contain cost increased and as a result quality of service suffered, most noticeable in delays/cancellation of flights and poor in flight catering.

It also had a few downside, the revenue model of LCAs was based on a heavily discounted fare structure and an absolutely stripped down passenger amenities. While the business model of low cost was bringing in the passenger it also meant that margin had to necessarily remain small, significantly this implied that even if an airline was to earn a profit the volume of profit was likely to be low unless the volume of passenger carried was very large. However, increasing the number of passengers might have required increasing the number of destinations, number of aircrafts and so on, which would have implied added overheads and added costs. Thus the success of LCA depended much on the skill of the airline in successfully managing its yield, optimising its route planning and efficient designing of its scheduling.

….. Recession

Fare Setting, Fare War and their Consequences

Though low fares resulted in higher traffic it also led to lower yield, which combined with higher input cost put severe strain on airlines finances. Most of the newly launched airlines were running in losses, even the more established airlines were finding it hard to make profit regularly. Towards the end of 2006, mounting price war, financial losses and rapidly expanding capacity created a situation where an imminent catastrophe of closure of several airlines looked real enough.

If Indian aviation in 2007 has to be described in a single word then ‘consolidation’ would be the right term to use. After a fiercely fought price war in 2006, that saw several airlines coming dangerously close to bankruptcy and thus raising the spectre of a repeat of the 1990s, 2007 saw saner elements prevail. Airlines realized that the price war that they were waging could only result in pyrrhic victory. The most significant gain of 2007 thus was return to realistic pricing of airfare. 2007 witnessed completion of one major merger, setting in motion of the process of merger in another case and in a third case conclusion of a merger the process for which had started in earlier years. Analysts expected that the impact of these consolidations would be felt in 2008; while in the case of Air India-Indian Airlines merger infusion of new funds was not expected, in the case of Deccan-Kingfisher merger a significant infusion of funds was thought to be inevitable in the light of the poor financial health of Air Deccan.

Passenger traffic continued to grow at a healthy rate in 2007. This prompted nearly all the airlines to place orders for buying new aircraft, undeterred by the fact that they posted combined losses of about Rs 2,000 crore largely on account of rising fuel costs.

While yields slid, operation costs mounted. Airline CFOs were reported to claim that more than 80 percent of the cost had become "uncontrollable". These included wage and fuel costs (60 percent of all expenses) and higher depreciation and interest charges. These were taking a toll on the financial health of all airlines.

The sub prime crisis in the US had its impact on the Indian aviation as well. Augmenting funding from international banks became difficult as most major lenders were grappling with the sub prime crisis gripping the US market; they reduced their exposure towards funding airlines.

From the brief description of developments between 2005 and 2007 in the Indian aviation, it can be observed that the genesis of a recession had been shown way back in 2005 and continued in the subsequent year in the form of price war. The industry in general was selling a severely under priced product. Airlines, including full service carriers, were following similar business strategies. The primary aim of airlines at the time was to gain market share. In order to fulfil their objective of obtaining market share the airlines went about offering discounted fare, at times, at ridiculously low rate. For example, as recently as in late 2007 in order to gain market share GoAir positioned its fares around 30 per cent lower than most airlines and on a clogged sector like Mumbai-Delhi, where a Kingfisher ticket cost Rs 2,000 as basic fare a GoAir ticket went as low as Rs 500.

The airlines seemed to believe that if they could garner a fair share of the market then profit would automatically follow. This was obviously based on an inadequate understanding of basic economics. In a competitive market an enterprise can become a price setter if and only if it establishes a dominant position (thumb rule - a market share of over 50%), failing that the enterprise has to remain a price taker. It was over optimistic for any airline to hope to reach the dominant position in the short run in a market that had nearly a dozen competitors. In the long run, through a process of mergers and acquisitions as also demise of a few enterprises, the market may reach a position of oligopoly providing the survivors the power to dictate price and perhaps recoup the earlier losses. The problem is the market never guarantees how long the process would take and who would be the survivors.

In the previous section on economics of airline business we discussed at length the intricacies of rate setting in airline business. It was pointed out rate fixing a combination of cost of service and the value of service. Cost of service is defined as the amount of money needed for a utility to operate and maintain facilities, cover capital expenses, and provide an opportunity to earn a profit. It is obvious that airlines that were deliberately under cutting fares were not aiming at covering even the cost of service, thus an element of loss was inbuilt in their business strategy. Primarily the issue boiled down to the length of time a airline was willing and financially capable of waiting to ultimately acquire the status of a monopolist or a oligopolist. Clearly, alongside price war the airlines were also involved in a battle of attrition, each waiting for the other to blink first.

As for value of service, since under pricing was the order of the day apparently no airline was interested in realising the fare that the traffic was willing to bear. This disinterest of airlines to charge a fair fare had disastrous consequences as demonstrated in the experience of Air Deccan. In a bid to attract passengers Deccan often launched, and much fanfare, schemes like one rupee, three-rupee fare. The airline in its publicity materials never made it clear that it was not offering all its seats at Re. 1 and the numbers of seats under the scheme were very limited. That the whole purpose of the scheme was to attract eyeballs was also never clearly conceded by the airline. Anecdotal evidence suggests that the schemes were successful fulfilling its primary objective of creating a buzz. It was said that usually on the opening day of the scheme would be passengers were logging onto the airline website at the stroke of midnight to grab a ticket. The unfortunate part was that every the schemes were on offer those not getting a ticket far outnumbered those who got one. The disappointments led to negative publicity for the airline as the people were, perhaps without much justification, quick to conclude that the airline was not offering any seat at the promised fare and making a fool of them. Sensing the loss in trust and its negative impact the airline ultimately had to offer many more seats than it originally planned so that there would be a visible number of haves than have nots.

While other airlines did not replicate Deccan’s one rupee scheme they tried counteracting Deccan’s advantage by offering ultra cheap fares. This strategy too had unwelcome consequences. It resulted in airlines getting stuck in ‘sticky price point syndrome’⁷. The syndrome refers to that price of a product which even if marginally breached leads to a severe fall in demand. For some reason, which economists are yet not able to explain properly, the consumer develops a preference for a particular price point of a product. At this price point she is always willing to buy the product, however, the moment the price goes beyond the preferred price point (even by a small degree) she stops her purchase. The funniest thing is that the consumer may still continue to buy the same product but differently positioned by the company. Companies whose products get afflicted by this syndrome find themselves in a peculiar situation. It is not that there is no demand for the product; it is just that at a price beyond the preferred price point the demand dries up. The dilemma faced by the company is whether to retain the price point or abandon it. In the case of airline the passengers got so used to ultra cheap fares that beyond a certain point the efforts of airlines to raise fares often led to passenger deserting air travel and switching back to train travel. Observed data suggests that the preferred price point happens to be Rs. 1000 i.e.; the moment the difference between air and train fare goes beyond this point the reverse movement from air to train starts.

Thus, due to an inadequate understanding of economics of airline business, from 2005 onwards airlines had been a perusing a fare strategy that was tailor made for paving the way towards financial disaster. The airlines made too literal an interpretation of demand theory according to which when price falls demand goes up; yes it does but provided a host of other factors also stand up. In this case the two most important factors that the airlines missed out were price elasticity and income elasticity. In 2007 when airlines started the exercise of fare correction through levy of fuel surcharge, initially the growth in passenger traffic did not suffer. After a point continuous rise in airfares started to become a barrier for low-cost fliers. As fuel surcharges crossed the actual fares in several sectors, several leisure travellers and relatively new flyers started shifting to the railways and long distance buses. Airlines aught to not have ignored them, as this was the segment that had fuelled rapid growth in the sector and which had prompted airlines to add capacity.

Over Capacity

As in 1990s this time too there were far more seats on offer than actual demand. For example, while the passenger traffic in 2006 increased at around 25%, the past year saw a capacity addition of 48%. As on the previous occasion the airlines were not altogether to be blamed for this. Periodic over capacity is a characteristic in an industry where capacity can only be created in manufacturer-determined sizes. Airline shares this characteristic with other modes of transport, notably shipping. An element of cyclic behaviour is, in inbuilt in airline business.

In matured markets commercial aviation business cycles have a period of 7-10 years. In this type of cycles, economic growth as a driver of demand, the ordering and retirement of equipment, and the entry and exit of firms in the different markets are the key variables that influence the length and severity of the cycle.

In the period following the second round of liberalisation effect the following dynamics could be seen as driving the industry. The first effect was advent of a number of new airlines. These new entrants had lower operating costs than incumbent airlines as they operated younger fleets and their employees had low seniority and commensurate salaries. What they lacked was network size – a key parameter for attracting passengers. Therefore, a race began to gain market share and utilise capacity at a disregard for short profitability. This behaviour, although rational in the short-term for a single player, created the illusion that even more capacity is needed as the lowered prices boosted demand; this was exacerbated by a growing economy. Airframe manufacturers and, later, leasing firms were happy to oblige in providing the capacity that was being ordered, despite the mismatch between demand growth and the much higher capacity growth, as that also helped them reduce their unit costs faster and compete for market share in an oligopolistic market.

Overcapacity inevitably led to price wars and substantial losses and even when carriers failed, their aircraft was re-circulated as leased or sold to new entrants willing to try their chances. Investors willing to finance these ventures facilitated this effect.

Two other factors dictated the retention of capacity by airlines: high midterm fixed costs and the sophisticated pricing capability offered by revenue management systems to maximise flight passenger revenue. The significant medium-term fixed costs faced by airlines included the need to “hoard” or retain highly trained employees if the airline was to remain competitive at the next market upturn while the costs for long-term leases, owned equipment and gate leases were also fixed in the medium-term. The high fixed costs made the prospect of price wars more palatable to airline managers as at least these would ensure a source of badly needed short-term liquidity even at the expense of profitability and long-term viability. The modern revenue management software also provide a way of filling up the aircraft at ever higher load factors but at prices that sometimes did not cover the costs of the operation; the belief that the marginal cost of a seat is zero obscured the fact that in some cases the prices charged meant that the break-even load factor exceeded one.

In the description above, the key factor is the repeated mismatch between available capacity and demand in the industry with tight capacity matched by increased demand and high returns and vice versa. Airlines have flexibility in reducing available capacity; depending on the time horizon of the decision maker, schedules can be cut back in the short term and aircraft can be parked, returned to the lessor, sold, or scrapped in the medium and long term while airlines can go out of business. Yet, this flexibility is limited by several factors: firstly, an airline’s frequency and network coverage is a key competitive advantage which is only reluctantly forfeited; secondly, aircraft are expensive assets that do not produce if underutilised while their lease or interest and capital payments continue; thirdly, even when an aircraft is returned to the lessor or sold it will return in the market sooner rather than later.

Conclusion

Rising fuel cost has generally been called responsible for the current recession in the aviation sector. Our analysis, however, point to other factors that were directly responsible than fuel cost. The airline industry had been following a business strategy that bound to lead to recession at some point of time. Though in recent times airlines tried to ward off the inevitable by abandoning price war and attempting to restore a more viable fare structure but their earlier deed had reduced fares to such a low level that bringing that up to a realistic level involved raising fares manifold which the airline were unable to do due to elastic demand that triggered off consumer resistance beyond a certain level of fare. Any steep increase in fare was going to affect passenger demand seriously was likely to jeopardise the financial position of the airlines even further. In nutshell, by following policies that were counter productive to profitable growth airlines had pushed themselves so far into a corner a calamity was waiting to happen; rising fuel only acted as a trigger.

Fuel Crisis – How Airlines are managing

The airline industry is facing a multifaceted economic crisis: rapidly rising fuel costs, the U.S. economic slowdown, and difficulty raising capital for operations. Major airlines have responded by reducing service on some routes, abandoning service on others, idling planes, raising fares and other charges, and laying off personnel. As a result, consumers face higher travel costs and fewer options.

Oil is becoming scarcer and harder to produce. Several former big areas of oil production are in decline while other top oil-producing countries, including Nigeria, Russia, Saudi Arabia, Iran and Venezuela, are either unwilling or unable to lift production. Chinese demand is expected to more than double by 2030. Hedge funds and investment banks have been placing big bets that oil prices will continue to rise, amplifying the volatility in prices. The head of Opec and Goldman Sachs have said that prices could rise to $200 per barrel but other industry players have said that they are baffled by current prices because, despite the pressures in the market, there is still sufficient oil to meet global demand. High prices are also stimulating a frenzy of investment in new fields previously considered too small, expensive or geologically challenging to extract commercially. This could have a dampening impact on oil prices when more of these enter production. But production simply cannot continue to grow indefinitely. By 2035 the world will use more than twice as much energy as it does today and demand for oil could rise from 85 million barrels a day to more than 120 million barrels.

According to the Air Transport Association major carriers are expected to spend more than $61 billion on jet fuel in 2008, compared with $41 billion in 2007. That difference is enough to bankroll 267,000 airline jobs or 286 new narrow-body jets. As a result, airlines are expected to lose a combined $7 billion to $13 billion in 2008, or $10.89 per passenger. As recently as in June this year, US Airways said that its fuel expense for each round trip passenger averages USD 299 that was USD 151 in 2007. An average one-way ticket on American Airlines these days runs USD 221, compared with USD 206 in 2007, but the cost of oil per fare has risen to USD 107 from USD 32 in the same period. Delta Airlines projects its 2008 fuel cost to accelerate by USD 4 billion, it expects that its own operations will cover just 75% of that increase. The airline is in the midst of merger agreement with Northwest Airlines that may help it in stemming some of these expenses. British Airways, which is one of only 14 airlines in the world with a profit margin of more than 10%, has admitted it could move from a profit of £883m to a loss over the next two years despite its robust cost base and balance sheet. Fuel now accounts for 35 percent of British Airway's overall costs - compared to just 10 percent 12 months ago. The rest of the British airlines industry is less resilient and operates on an average profit margin of just over 1%, underlining the threat posed by a sudden spike in fuel costs.

Survival Strategies

#1 Fare Hikes

According to study by Airline Forecast, a consulting firm, all of the major US airlines could be in bankruptcy by early next year if oil prices remain where they are. The study found that if fuel prices remain high the top 25 airlines would spend over USD 25 billion more for fuel this year. And the major airlines could lose up to USD 9 billion over next 12 months. The study found that fares would have to increase 20% across the board to compensate for the higher costs. Raising fare is precisely what the airlines have been doing ever since fuel crisis overtook the industry. US airlines have raised fares 14 times this year; whereas, the Australian airlines Qantas in May 2008 raised its fare for the second time in less than a month. According to the latest data released by the Bureau of Transportation Statistics average US domestic air fares in the first quarter of 2008 were up 4.4 percent from the first quarter of 2007 being the largest year-to-year increase since second quarter 2006. The average domestic itinerary fare in the first quarter of 2008 of $332 was the highest average fare since the second quarter of 2006.

US Airfare Hikes 2008 - Timeline

Year	Airfare Hike Attempts	Airfare Hike “Successes”	Attempted Base Airfare Hike Attempts	Attempted Fuel Surcharge Hike Attempts	Initiated Most Hikes
2008	21	15	10	11	United (10)
2007	23	17			United (7)

Lufthansa, the German flag carrier and the largest airline in Europe in terms of overall passengers carried, has raised fuel surcharge on all its flights as a means of coping with the soaring costs of crude oil and kerosene, the recent increase was on 16^th July. Singapore Airlines, the national airline of Singapore, has so far on five occasions increased the fuel surcharge on all its flights owing to rising fuel costs. On several international routes, the fuel surcharge compared to last summer has more than doubled. Listed below is a comparison chart of fuel surcharges in summer 2007, spring 2008 and the current fuel surcharges by most major airlines that offer international service from the United States.

Destination	Summer 2007 Fuel Surcharge (Roundtrip)	Spring 2008 Fuel Surcharge (Roundtrip)	Summer 2008 Fuel Surcharge (Roundtrip)
Most European cities including Amsterdam, Athens, Madrid, Moscow, Paris, Prague and Rome	$150	$270	$330
United Kingdom (London, Manchester and Glasgow) from most Eastern U.S. cities	$130	$242	$302
United Kingdom (London, Manchester and Glasgow) from most Western U.S. cities	$130	$306	$426
Beijing, Manila and Tokyo	$180	$270	$340
Most German cities including Berlin, Frankfurt and Munich	$150	$210	$180
Hong Kong	$180	$270	$340
Honolulu	$18	$130	$260
Most Mexico cities including Mexico City, Acapulco, Los Cabos and Puerto Vallarta	$80	$120	$140
Rio de Janeiro	$56	$170	$210
San Jose, Costa Rica	$130	$250	$290
Santiago, Chile	$130	$310	$390
Sydney	$70	$230	$220

In May this year Air Canada introduced fuel surcharge on its domestic flights for the first time in four years. The surcharges were in addition to ones already in place for international flights. The price hikes were:

• $40 for return flights of less than 480 kilometres

• $80 for return flights between 480 and 1,600 kilometers

• $120 for return flights longer than 1,600 kilometers

Air New Zealand raised domestic and short haul international fares by an average 3% in May this year. It also decided to replace Boeing 747 planes on its service to London through Los Angeles with more fuel efficient Boeing 777s. Emirates Airlines has announced that its tickets would rise by 10 percent for first and business class, and five percent for economy class from August 1.

# 2 Schedule/Flight/Route Rationalisation

This is the second most frequent step being taken by the airlines to fight fuel crisis. Airlines have taken to grounding of aircraft rather than fly on uneconomic routes. The US airlines were the first to take the lead in this direction and they have been followed by airlines elsewhere in the world. In the face of a 21% rise in its fuel costs this year budget carrier Virgin Blue has cut some domestic routes and raised fares by an average $5 across more than half its routes. Virgin also decided to take four jets from the domestic market; cuttings planned capacity growth for the next fiscal year by 6%, and redeploy some planes out of loss-making services into new or more attractive markets. Qantas has blamed the relentless rise in fuel prices for the first major cut in its services since the SARS crisis hit the airline industry five years ago, after announcing plans to retire and ground some of its domestic aircraft from July. Qantas has also announced its plans to exit several low-yielding routes, including the Sydney-Gold Coast route in order to cut costs. According to Qantas the domestic cuts equate to the grounding of six jets. American Airlines, the world’s largest carrier, plans to cut domestic capacity by 12 percent in the fourth quarter of this year. United Airlines will cut domestic capacity by 15 percent in the fourth quarter, slash 1,500 jobs and jettison its low-fare unit Ted. The airline plans to cut mainline domestic capacity by 17 to 18 percent in 2009, while also scaling back international capacity by 4 to 5 percent. Continental Airlines plans to cut domestic capacity by 11 percent in the fourth quarter and retire 67 of its older and least-fuel-efficient planes through 2009. Recently budget carrier Ryanair announced that it planned to cut its number of weekly flights from more than 1850 to just under 1600 this winter. Similar trend is observed in the Asian region as well. At least seven major Asia-Pacific airlines have announced plans to cut flights in the past two weeks. China Airlines and EVA Airways Corp., Taiwan's largest carriers, plan to cut as much as 10 percent of flights. Cathay Pacific Airways has indicated that it might cut some routes, particularly on longhaul North American services, and accelerate aircraft retirement. Thai Airwyas has responded to the fuel crisis by grounding an entire fleet of fuel-guzzling four-engine jets and axing Bangkok-New York flights. Thai also intends to trim its Los Angeles service and will re-route others via Japan using fuel-efficient twin-engine aicraft. SriLankan Airlines has decided that it will be temporarily reducing the number of flights on some routes in its network of 41 destinations in 22 countries in Europe, the Middle East and Asia in response to rocketing oil prices. In India, Air India has withdrawn at least 20 services from different routes from July 1 while Jet Airways, the country's largest private airline, has withdrawn its low-cost subsidiary JetLite from 25 routes. Spice Jet, a Delhi-based low-cost carrier, has cancelled about 10 flights. Kingfisher Airlines has deferred the launch of its international operations from next month to September. Simplifly Deccan, Kingfisher's low-cost unit, has struck off about 48 flights on its short-haul routes. GoAir has cut its flights from 1,000 to about 800 a month. China Southern may cut services on at least 21 international routes, including flights to Hanoi, Paris and Los Angeles. China Eastern, the nation's third-biggest carrier, may trim some long-haul routes.

# 3 Baggage Fees

Baggage fees are fast becoming an unavoidable part of flying. Three of the largest US carriers now charge $15 for a first checked bag. Most U.S. carriers already have instituted a $25 charge for checking a second bag. As of July 1, Southwest Airlines is the only U.S. carrier that permits two checked bags for free.

Now, some carriers charge passengers for all checked luggage, and many have raised their overweight and oversize fees. Even bags that are allowed free of charge must, in most cases, weigh 50 pounds or less, and the sum of a bag's length, width and height must be 62 inches or less. To prevent passengers from dragging big bags into the cabin, some airlines are becoming more vigilant about carry-ons as well. Below are the fees that some major US carriers charge for oversize and overweight baggage, as well as new checked-bag fees and size limits for carry-ons. AirTran

Checked bag fees: First, free; second, $10 online, $20 at airport; third, $50. Overweight bag fees: 51-70 pounds, $29; 71-100 pounds, $69. Oversize bag fees: 62-70 inches, $29; 71-80 inches, $69. Carry-on limit: 55 inches. American Checked bag fees: First, $15; second, $25; third to fifth, $100 each; sixth, $200. Overweight bag fees: 51-70 pounds, $50. 71-100 pounds, $100. Oversize bag fees: 63-115 inches, $150. Carry-on limit: 45 inches and 40 pounds. Continental Checked bag fees: First, free; second, $25; third, $100. Overweight bag fees: 51-70 pounds, $50. Oversize bag fees: 63-115 inches, $100. Carry-on limit: 51 inches and 40 pounds. Delta Checked bag fees: (Domestic) First, free; second, $25; third to 10th, $80 to $180 each. Overweight bag fees: 51-70 pounds, $80; 71-100 pounds, $150. Oversize bag fees: 62-80 inches, $150. Carry-on limit: 45 inches and 40 pounds.

JetBlue

Checked bag fees: First, free; second, $10; third, $75. Overweight bag fees: 51-70 pounds, $50. 71-99 pounds, $100. Oversize bag fees: 63-80 inches, $75. Carry-on limit: 50 inches for Embraer 190 planes, 56 inches for Airbus A320s. Northwest Checked bag fees: First, $15; second, $25; third, $100. Overweight bag fees: 51-70 pounds, $50. Oversize bag fees: (Domestic) 63-80 inches, $100. Carry-on limit: 45 inches. Southwest Checked bag fees: First and second, free; third, $25; fourth and additional, $50 to $110 each. Overweight bag fees: 51-70 pounds, $25; 71-100 pounds, $50. Oversize bag fees: 63-80 inches, $50. Carry-on limit: 50 inches. United (fees effective from Aug. 18) Checked bag fees: (Domestic) First, $15; second, $25; third and additional, $125 to $250 each. Overweight bag fees: 51-100 pounds, $125. Oversize bag fees: 63-115 inches, $125. Carry-on limit: 45 inches. US Airways Checked bag fees: First, $15; second, $25; third and additional, $100 each. Overweight bag fees: 51-70 pounds, $50 to $150; 71- 100 pounds, $100 to $200 (based on number of bags). Oversize bag fees: 62-80 inches: $100. Carry-on limit: 51 inches.

# 4 The Unusual - Things Airlines Are Doing to Reduce Weight (and Save Fuel)

Airlines are doing all sorts of imaginative things to drop pounds off a plane, to save fuel. Some airlines are finding new and novel ways to conserve fuel and face the crisis.

Alaska Airlines plans to replace 16 MD-80 planes with 737-800s, which use 18 percent less fuel. The carrier also began using lighter catering carts last year and is using satellites to fly more direct routes.

American, the largest U.S. carrier, is modifying the tail cones on its MD-80 planes to be more aerodynamic and using beverage carts that are lighter than older models.

For the past few years, American has also used less paint on the outside of planes to lighten the load. Not only can paint weigh down an aircraft (paint can weigh 440 lbs on a 747), it can create drag if chipped, and that consumes more fuel. Cathay Pacific has joined American in peeling paints off its aircrafts.

US Airways is carrying less extra fuel on flights and ordering new aircraft to replace the more fuel-hungry planes. It also is changing speeds while flying to take advantage of strong tail winds or other conditions.

Some airlines, including Delta, are retrofitting planes with "winglets," vertical extensions of wingtips that improve an aircraft's fuel efficiency by roughly 3 percent.

And to avoid wasting fuel by flying half-empty planes, some airlines are flying fewer or smaller jets. Delta, for instance, ended leases on 13 domestic aircraft in the fourth quarter and canceled orders for some aircraft next year.

Southwest figures that, since it began washing some of its jet engines on a nightly basis last April (to reduce “drag” caused by dirt), its saved $1.6 million in fuel costs.

Cathay's fleet is using luggage containers made of Twintex. The new containers are about 50 pounds lighter than the older ones made of aluminum.

Airlines also are trying to cut fuel consumption at the airport. Most now run their planes' electrical systems at the gate by plugging them into outlets, rather than running the engines.

Many jets now taxi out to the runway on one engine, saving full power until in position for takeoff.

Some airlines are changing their landing patterns for certain flights. On red-eye trips into Cincinnati and Atlanta, some Delta jets descend steadily to the airport, rather than following the usual step pattern, which uses more fuel, when airports are busiest

Airlines including Delta are swapping heavier seats for models weighing about five pounds less.

American is replacing its bulky drink carts with ones that are 17 pounds lighter. The airline said that move would help save 1.9 million gallons of fuel a year, on top of the 96 million gallons it is saving through other means.

Japan Airlines is reducing the number of newspapers and magazines on international flights, which achieve a 50-pound reduction in aircraft weight. The Japanese carrier is also using smaller cutlery used on international flights, cutting the weight of each piece an average of 0.07 ounces.

The Ones’ Who Have Escaped the Wrath

While the rest of the world’s aviation prepares for economic storms, Russia’s aviation industry and Gulf carriers seems oblivious to the weather forecast. Aeroflot, still the largest Russian airline and the predominant flag carrier, continues to predict 30% growth this year while sitting on cash reserves of around USD3 billion. And the largest domestic operator, Siberia Airlines passenger numbers were up 26% in the first half of 2008, due first and foremost to the general positive growth trend in air travel on the Russian market, which also grew by 23% overall. Russia’s GDP grew at 8% in the first half, benefiting from high oil prices. Russian carriers handled 22.5 million passengers in the first half of 2008, up 19.9%, including 5 million passengers in Jun-08, up 8.7% and recording growth rate above 20% in the first five months of the year. Aeroflot’s Jun-08 passenger numbers rose 13.7%. In the January to May period (for which detailed data is currently available), total international passenger numbers to/from Russia rose 24% to 7.9 million (or 45.2% of the total), including a 24.8% increase in traffic between Russia and foreign countries outside the CIS and a 20% increase in traffic between Russia and CIS states. Domestic passenger numbers rose 23.7% in the first five months of 2008 to 9.6 million (or 54.8% of the total); the average increase in 2007 was only 18.6 percent.

Middle East carriers grew by some 18% in 2007, nearly more than double than any other carrier. Revenues for the region's carriers in 2007 rose by a quarter, Emirates saw its revenues break the $10 billion mark. It is now among just 16 carriers in the world with revenues at this high water level. Qatar Airways saw its revenues climb a staggering 40% to $2.7 billion last year, while youngster ­Etihad nearly doubled its revenues to $1.5 billion. Furthermore, the gulf airlines are mining fast-growing routes. Passenger traffic between the Middle East and Africa rose 19.8 percent in the five months to June this year, and 14 percent between the Middle East and Far East. That compares with average growth of 4.5 percent for all international routes.

The Middle Eastern carriers are also running a tight ship. During the five months to May, the load factor, or percentage of available seats sold, on the region’s airlines was 74.6, according to association figures, in line with a “high” global average of 75.2. The level means that Middle Eastern airlines are flying as full as their rivals and suggests that they are not emptying their competitors’ planes. But over the longer run, aviation experts feel, airlines like Emirates, which compete on price for the mass market and on service for business travelers, should make some inroads against competitors.

Furthermore, the gulf airlines are mining fast-growing routes. Passenger traffic between the Middle East and Africa rose 19.8 percent in the five months to June this year, and 14 percent between the Middle East and Far East, though from a low base, the association said. That compares with average growth of 4.5 percent for all international routes.

The Middle Eastern carriers are also running a tight ship. During the five months to May, the load factor, or percentage of available seats sold, on the region’s airlines was 74.6, according to association figures, in line with a “high” global average of 75.2.

The level means that Middle Eastern airlines are flying as full as their rivals and suggests that they are not emptying their competitors’ planes.

But over the longer run, aviation experts said, airlines like Emirates, which compete on price for the mass market and on service for business travelers, should make some inroads against competitors.

Emirates recent decision to cancel its service to Alexandria, Egypt and deferment of its plan to have direct flights to Durban, South Africa from Dubai in December because of high fuel costs are perhaps the first sign that Middle East airlines are beginning to take a hit from high oil prices. Until now, no carrier had announced cut-backs on flights or destinations. In fact, many carriers in the region have added one or more routes during the first half of this year.

Gulf carriers have been somewhat immune to high fuel prices largely due to the fact that Gulf region is buoyant economically. People in the region are the ones who are benefiting from the fuel price surge, so they have extra money in their pockets to spend on travel. Gulf airlines are also benefiting from the fact that they are increasingly serving as hubs for travellers across Asia and Europe. Another key factor in Gulf carriers favour is that they tend to have young, modern fleets which are more fuel efficient than older aircraft

Gulf low-cost carriers under pressure

In the Gulf, low-cost carriers have had success in providing services to a price-sensitive customer base made up largely of workers who are travelling home to high population areas. However, the smaller low-cost carriers are under increasing pressure because they don't have the cash reserves to keep their prices low as fuel prices continue to rise. The first low-cost carrier in the region that has begun to feel the pinch of high fuel prices is Sama Airlines. The carrier has had to introduce a fuel surcharge on international and domestic flights to offset some of the cost of the increase in fuel. It has also deferred some aircraft additions to its fleet until the direction in oil prices becomes clear, To help offset high oil costs, the airline has implemented a programme to reduce fuel burn by optimising flight paths and reducing unnecessary weight on the aircraft. So far the airline has not been forced to cut any destinations, but it is taking a close look at its routes.