Method to the Madness

As I write this, the media is rife with news about the dire straits the Indian airline industry finds itself in. Black ink spent in discussing the predicament appears to be competing with the spreading red ink at every airline, casting a pall across an industry that sported abundant cheer not a few months ago. There is increasing clamor from the industry for government support of some form. The scene is not very different in the US or Europe, though the auto industry, for a change, has taken center stage in the former. Airlines have sought to address some fundamental problems by setting up new entitities to target specific customer segments. Thus we have JetLite as a fully owned entity, a reincarnate of the old full-service Sahara, now in the avatar of a "low-cost" airline. Kingfisher, likewise, has re-branded Deccan as Kingfisher Red. Jet even attempted to lay off several hundreds of people and had to beat a hasty retreat at the resulting political storm. The dizzying pace of change in India is matched abroad as well: British Airways, too, has now come up with a fully-owned branded carrier called OpenSkies while Delta is merging with Nortwest.

Will these work? What really ails the airline industry and do these measures address the real problems? Are the the several airlines making short-term tactical decisions, operational fixes, or working out longer-term ideas? In other words, are they pursuing a strategy or making use of a situation to bring their house in order? A singular feature of the airline industry throughout the world is its total fixation with current problems and an inability to learn from what has happened in the past to its own fortunes from specific sets of circumstances. A study of the industry is an excellent reference to understand strategy.

Strategy, Simply Put

Strategy, according to Porter, is all about creating a difference one can preserve. It lies, in his thinking, in doing the same activities differently from others or in undertaking entirely new activities. This is what has been referred to as a "positional" point of view which holds that competitive advantage arises from the ability of a firm to create a unique differentiation in the market in which it competes. The competitive advantage is sustained when a firm benefits from natural or given barriers or those it erects itself to make it difficult for other firms to replicate the unique position. These barriers include industry-specific ones that make customers captive (such as spectrum a telecom firm has bid for and won, the right to manage an important port or utility, ownership of a large coal or oilfield, etc); economies of scale and scope (cable or satellite television, undersea optic fiber cable); proprietary technology (DNA chips) or process complexity that create a unique set of activities for the advantaged firm (such as Amazon's online retailing with backend sophistication, Sabre's ownership of the travel agent's desktop, or McKesson's overwhelming presence across hundreds of US hospitals). The positional viewpoint is a product-market orientation - ie, advantage through the creation, domination, and preservation of the product market, where a "product" can be either a physical one or a service.

An alternative is the resource-based view of the firm that posits that competitive advantage comes from ownership of unique resources that include assets such as brand, distribution channels, intellectual property, corporate culture, competencies, etc. Thus, other much-touted strategy formulations such as core competence are subsumed within this viewpoint. The practical importance of whether a firm has a positional or resource advantage is possibly only academic: one may argue on both sides, for example, with respect to Southwest Airlines where its arguably unique combination of culture, staff, and systems has created a valuable competitive advantage which owes its position to the resources, but the resources themselves are unique only because of an ability and focus to deploy them in a manner that has created advantages.

The Crux of the Matter

It is easy enough, with this in mind, to see if the various airlines in India have pursued any strategic intent by seeking a competitive advantage. About four or five years ago, Captain Gopinath burst forth on the Indian skies with Air Deccan and quickly garnered market share. The so-called "low cost" airline concept took hold and was instantly - if only interminably - profitable; attracted more players, and the concept became an industry mantra. The skies soon became crowded with Air Deccan, Go, IndiGo, Spice, and Kingfisher jostling with the so-called "full service" airlines - Jet, Sahara, and Indian Airlines.

Thanks to a fast growing economy, the airline pie became larger and all the airlines grew as a result. The incumbent ones, however, saw falling market share as the new ones gained. Increasing market share of some airlines, however, only tells upon the top line, not the bottom line, and this holds important clues to the tragedy that followed. The airlines cumulatively created value that largely accrued to customers and not to the providers of such value. Today's bleeding industry is evidence of the fact that most of these players did not succeed in capturing the value they created and are now scrambling to find ways to do so.

A point that seems to have currency in recent discussions is that our low cost carriers were never that; instead they were merely low fare carriers. Where could low cost arise in the case of airlines? Listen to Herb Kelleher of Southwest Airlines: "If you take all of Southwest's compensation together - wage rates, profit sharing, the full 401(K) match, the stock options that our people have - Southwest employees are the most highly compensated people in the airline industry". So how does SWA still manage to be a low cost airline despite ostensibly having the highest visible costs? There are the usual variables that have been much discussed as characteristics of a true low cost airline: one type of aircraft that saves capex and training; direct intercity routing in place of hub-and-spoke; rapid, 20-minute, turnarounds at the gate; greater frequency; one class with no assigned seating; higher load factors; cheaper, secondary, airports; no interline baggage check; no costly booking systems; absence of costly air mile administration; vastly higher productivity of their assets, both human and material; futures contracts for fuel; and so on.

Not by Costs Alone

The cost per seat mile of such a LCA for a 500 mile flight, a Booz Allen study estimated, was about Rs.3.50, or less than half that of a full service, hub-and-spoke carrier. Their study further showed cost differences across the board between the two types of carriers: pilots, onboard services, sales and reservations, maintenance, aircraft ownership, ground handling. In general, LCAs were seen to be using all resources much more effectively and the cost difference between the two were 2-to-1 for the same stage length and aircraft after adjustments. Specifically, 65% of the cost advantage resulted from production model choices (slower pace of full service airlines owing to slack built into schedules, process complexity, and ticket distribution), 15% to labor agreements, and 12% to capital structure. Only 5% was attributable to savings from not offering amenities.

In India, none of these seem to matter. Here, a Jet flies directly from Ahmedabad to New Delhi and a Kingfisher from Mumbai to Kolkata, notwithstanding the fact that the respective bases of each are located in Mumbai and Bangalore. In effect, there is no hub to speak of, all airlines have similar capex and staff compensations, they all fly the same aircraft of like vintage for the most part, from and to the same cities, the same airports, at the same times, often enough the same passenger segments, have implemented Internet ticketing, and onward booked passengers are a small percentage of total compared to point-to-point - important because these passengers contribute about 40% lower revenue per mile than domestic passengers and are an issue with full service carriers in the US. They even have the same, long, turnarounds due to airport congestion! The differences only exist in terms of classes and on-board meals offered.

What we notice is a lack of differentiation and, therefore, an absence of competitive advantage. Differentiation comes from offering value - not to be confused with the new fangled airline industry jargon about "value carriers" - and value is simply the old fashioned difference between a customer's desire to pay for service and the cost of providing such service. With no clear benefits, or when value is replicable there is tendency to reduce price, with the benefits transferred to customers. But this works so long as there is an extractable surplus - ie, costs are within its control or controllable. In the Indian skies, as airlines have discovered, they do not have too many options with costs and simply lowering price gets them deeper into the hole.

If you thought strategy was what our airlines are practicing think again. SWA has higher staff costs and lower ticket price compared to the airlines it competes with, but still makes money because it has a competitive advantage that others find impossible to replicate.