Analysis: Kingfisher’s LCC withdrawal may be a precursor to fleet downsizing

Last week Kingfisher Airlines Chief Executive Officer Sanjay Aggarwal issued some clarifications about the airline’s decision to withdraw its Kingfisher Red LCC service. Below is our author and analyst Vinay Bhaskara’s analysis of those clarifications.

Operating costs of so called low cost carriers and full service carriers in terms of fuel, airport charges, engineering and maintenance and crew costs are similar. Full service carriers incur additional costs on global distribution, in-flight catering, ground amenities and the frequent flyer programme. These additional costs are more than recovered through higher yields.

This is a very good point, as the incremental cost of bringing the rest of Kingfisher’s operation as one would assume. Beyond the physical cost of retrofitting the aircraft in the new configuration, the only new operational costs are related to distribution and amenities.

Line up of Kingfisher Airline aircraft at Bangalore airport
The difference in cost per available seat kilometer (CASK) between the Red and mainline Kingfisher class was not very large. This may explain Red’s unprofitability and the decision to close.

Kingfisher has traditionally offered products that are superior to their competitors’ but at similar or lower prices. As an example, the Kingfisher First cabin product has a seat pitch of more than 47 inches while Jet Airways and Air India offer a business class with a pitch of 42~44 inches, yet the Kingfisher product is available at the same or lower price than Jet Airways. If the revenue gains are truly realised, and in the quantum as large as Mr. Aggarwal has stated, then the move can improve profitability significantly, otherwise, the downward spiral will only escalate.

In addition to large aircraft orders placed at time of start up in 2004/2005, the Indian LCCs in the recent months have placed orders for over 250 aircraft. In the last two years, capacity induction of the LCCs has outpaced the demand growth in the domestic market. The induction of so many additional aircraft in the low cost / low fare segment will potentially lead to substantial over capacity and a price war with declining yields.

Both SpiceJet and Jet in their comments for Q1 of fiscal 2012 noted that capacity growth exceeded demand growth (domestically) by about 5%. IndiGo has really been the only carrier to see the benefits of this growth, but the declining yields have not only hit the low cost sector, but full service economy class travel as well. Simply converting the entire network to full service will not automatically insulate Kingfisher from low cost competition.

With continuing economic growth, business related travel is increasing significantly. Businessmen and executives prefer to fly with full service carriers because of ease of buying tickets, frequent flyer program and convenience offered. They are willing to pay extra and this segment is not as price sensitive as the classic low cost / low fare segment where there is a lot of discretionary travel involved.

However, one has to consider the volume of business travellers relative to the number of leisure travellers. Currently, the second group represents more than 60% of Kingfisher’s revenue, much of it via Red, and Kingfisher may struggle to fill its planes. Moreover, growth in the Indian market as a whole is very much driven by low cost flying; we feel Kingfisher is limiting its future growth potential with this move.

A detailed study over the last six months during the high oil price regime has clearly demonstrated that Kingfisher’s full service product has generated higher yields and load factors which is consistent with the assessment that the business travel segment is more sustainable than the extremely price sensitive low fare segment. The analysis also showed that of the incremental yield, only 25% is spent on providing the extra services associated with a full service carrier. The remaining 75% is net contribution to the bottom line.

The figure of only 25% of the additional yield being wiped out by higher costs is consistent with the first bullet point. By adding more capacity to the full service segment will have a lowering effect on fares, meaning that the benefit will likely not be as large as 75% of higher fares.

While there are currently five airlines participating in the low cost / low fare segment, there are only three full service carriers namely Air India. Jet Airways and Kingfisher Airlines. While competition certainly exists in this full service segment, such competition is tempered because of the frequent flyer loyalty programmes that are offered by each one. In short, we believe that the competition will be far more intense in the low fare space than in the full service space.

While the competition for full service passengers can be characterized as less fierce than in the low-cost sphere; one has to consider the effects of Air India on the pricing environment for full service carriers. Recent statements by the Aviation Ministry give indications that Air India will be looking to re-capture its “lost” market share. If Air India is pricing with an eye towards re-capturing market share in the full service sector, then it is likely that Kingfisher will find the competition to be just as difficult.

Kingfisher Airline is widely recognised as a premium carrier and is the recipient of 38 national and international awards. The brand and service quality image is well established. This is evidenced by the higher yields and higher load factors generated on Kingfisher’s dual cabin aircraft. For the first five months of this fiscal year, based on DGCA published data, Kingfisher Airlines has delivered highest load factors of any airline in India.

Kingfisher’s reputation amongst passengers, especially business travellers, is perhaps its greatest asset. This reputation though, has taken a significant beating due to poor maintenance, shoddy aircraft, IFE that has been switched off due to a lack of payment to the content providers, large scale groundings and cancelled flights. Re-building this reputation will be imperative to Kingfisher’s ability to succeed as a full-service carrier.

A shabby Kingfisher Airlines ATR-72-500 VT-KANWith peeling paint, this Kingfisher ATR-72-500 looks shabby

In a way Kingfisher is returning to its roots – offering a premium economy product for the price of economy. Eliminating Red will also allow Kingfisher to offer a consistent product across its network; no more connecting from luxurious Kingfisher First to low-cost single cabin flights.

Kingfisher currently operates airbus aircraft with two cabin configurations – Dual cabin full service and Single cabin no frills. This also means the Kingfisher does not offer its premium Business Class or full service economy class product on all its routes. As a result Kingfisher is losing a certain amount of business class traffic on many routes.

On the metro routes especially ex-Mumbai and ex-Delhi, where there is heavy senior corporate executive travel, Kingfisher can and will fill business class seats (especially if the configuration is reduced to 8~12 seats), but most of Kingfisher’s revenue is coming from Red’s current traffic of junior business travellers and low fare leisure travel. Kingfisher should be able to replace some of Red’s flying with 2-class service, but it is doubtful they will enjoy a higher revenue.

Kingfisher’s integration into the oneworld alliance is on track. oneworld is supportive of Kingfisher’s move to focus its energy and resources on a full service and premium product which is in line with the philosophy of oneworld and its member airlines.

The shift towards full service is consistent with the oneworld branding, AirBerlin notwithstanding, and ending Red flights means that all oneworld customers connecting onto Kingfisher flights can remain in business class for the duration of their flight, unless they connect onto ATR operated flights.

Over the next 4 months Kingfisher will reconfigure all its airbus aircraft including its single cabin aircraft into dual cabin aircraft with a reduced premium business class cabin and an increased number of full service economy class seats leading to a capacity increase of approximately 10%.

A very smart and long overdue move. With most seats empty, the over-extravagant Kingfisher First class, is a drain on the effective utilisation of aircraft. With an average flight during of 1.5 hours, not too many domestic passengers are inclined to spend the five figure fares of premium classes. Increasing the number of seats per aircraft is one way for Kingfisher to reduce the seat-kilometre costs of its aircraft. However, it remains to be seen whether they will be able to fill all of those seats at profitable fares.

The economy class will offer the same comfort as it does today. The space requirement for additional economy seats will be made available by reducing the number of business class seats.

Once the aircraft are re-configured, Bangalore Aviation will assess the validity of this statement.

The reconfigured aircraft will have the seat equivalency of a low fare carrier but an opportunity to generate much higher revenue as demonstrated by current yields. Kingfisher will achieve incremental business class revenue as a result of wider and uniform availability and the airline will also generate incremental revenue through its increased full service economy class capacity.

Increased capacity tends to place downward pressure on fares, so for Kingfisher to assume that current yields will hold even with more capacity might be presumptuous. There should be certain incremental gains for having a consistent product with business class on most flights, especially with regards to passengers connecting onto Kingfisher from domestic flights.

There will be no reduction in Kingfisher’s fleet size or its network. Our guests will continue to enjoy the benefits of Kingfisher’s network that provides connectivity to 60 domestic and 8 international destinations.

It remains to be seen whether or not the entire network will stay intact. The majority of air travellers in India choose low-cost carriers. Given such an environment, Kingfisher may see fit to reduce flights, even if it does not cut destinations. Perhaps they end up with a fleet of 40-45 aircraft that is more in line with market demand for full service flights?

Kingfisher was the only publically listed Indian airline to show an operating EBIDTAR profit in the first quarter of fiscal 2011~12. Globally airlines struggle to generate 6%~8% EBIDTAR profit. Yet, Kingfisher spends an unheard of 16% of its total revenue towards debt servicing. Despite all its positives, unless debt levels are reduced, something extremely difficult in today’s bear market conditions, the future is bleak. Ulike another red and white liveried airline, Kingfisher does not have access to the tax-payer funds of the Government of India.

With the growth in aircraft demand and and the diminishing returns on A320 classic family aircraft as we get closer to the launch of the A320neo, it is very plausible that Kingfisher will have some of its fleet re-possessed by lessors, as the aircraft leases expire. As revenue falls with a smaller fleet, and debt levels remain the same, fiscal pressures will put the carrier’s very survival at risk.

About Devesh Agarwal

A electronics and automotive product management, marketing and branding expert, he was awarded a silver medal at the Lockheed Martin innovation competition 2010. He is ranked 6th on Mashable's list of aviation pros on Twitter and in addition to Bangalore Aviation, he has contributed to leading publications like Aviation Week, Conde Nast Traveller India, The Economic Times, and The Mint (a Wall Street Journal content partner). He remains a frequent flier and shares the good, the bad, and the ugly about the Indian aviation industry without fear or favour.

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