Reasons why Airline industries are always struggling

23 Mar 2021  Read 961 Views

"If you want to be a Millionaire, start with a billion dollars and launch a new airline."
This quote by Sir Richard Branson, founder of Virgin group that operates Virgin Atlantic, an airline company, helps us understand how the Airline Industry is.
Indian Airline Industry posted huge losses during FY 2020-2021. And if you ever travelled on a flight, you might be thinking.. how is this even possible? Airline tickets are so expensive; then, how is the industry amidst heavy losses?

Well, before getting into the technicalities, let us start from the beginning and look at all the questions that might be popping up in your minds right now. To understand why airlines in India are not making money, we have to first know how they earn money and the cost they have to incur.

Keep this chart handy for a better understanding of concepts.

So, let's begin.

How does Airline Industry earn money?

Knowing the business model is very important to understand why the company is failing. Although there may be many sources of income for the airline industry, there are three significant revenues sources. They are Passenger tickets, Cargo, and Food & Beverages. There might also be additional revenue streams like tours and packages, in-flight sales, etc. (here; we'll focus only on the significant revenue sources. Let us understand these streams one by one.

1. Passenger revenue

This segment involves the primary business that is selling tickets to customers. Whenever you travel on a plane, you obviously buy tickets from them. This is called Passenger revenue. But how do they calculate these revenues?

Have a look at the chart; the passenger revenues are dependent on the number of passengers and the average ticket price. Revenue, in this case, is directly proportional to both the number of passengers and the ticket price.

But interestingly, the story begins here, as the number of passengers is dependent on several different factors such as the number of aircrafts an airline has (supply), the number of departures or the number of routes that are covered, the average number of seats in the plane that the company has and lastly the load or the utilization that the airline can garner. When you combine all these factors and account for them, you get the number of people present on the flight on any given day. You get that, right?

After calculating the number of passengers, we multiply that by the average ticket price and get the total passenger revenue.

2. Cargo

Calculating the revenue from the Cargo is very simple. You have to take three factors into account: number of aircraft, number of departures and average tonnage per departure. Multiply these, and you will get the total cargo revenue of an airline on any given day.

3. Food and Beverages 

Very few of us love the food served in the Indian airlines, right? But guess what, it makes airlines a considerable amount of money. It is dependent only on two factors: number of passengers and the average F&B spent by a customer. Both of these are directly proportional to the food and beverage revenue earned by the airline.

Now, let us move on to the cost that an airline has to incur, as, in the airline industry, managing costs is more important than earning income.

Major cost for Airline Industry  

Costs are a big reason why most airlines in India do not make any money. To survive, all the airline companies have to ensure that they manage their cost-effectively and reduce them to the extent possible. Let us understand the costs one by one.

1. Fuel cost

Fuel is the airline industry's primary cost, or in layman's terms, we can say that it is the raw material for the industry and is the major expense for any airline company.

Fuel costs are dependent on three factors: the number of departures, average fuel price in the market and the amount of fuel used in every departure. Considering these, we can get the total fuel cost that an airline has to bear every day on average.

2. Leasing cost

Airlines, nowadays, lease aircraft rather than buying, as it costs a lot to buy one. They rent aircraft for an extended period, for which, in return, they have to pay lease rentals which is also a major chunk of the total cost that an airline bears. The leasing cost is very simple to calculate as the more the number of aircrafts a company has, the greater its leasing cost.

3. Other costs

Other than the above two mentioned costs, there are also some significant costs that a company can't ignore. For example, salary, purchase of stock in trade, finance costs, depreciation of the aircraft, etc. These costs may not look that significant, but in reality, they are! 

Employee costs, for example, amount to huge costs; an aircraft's depreciation and maintenance costs are also huge.

These were the major costs that the airline industry has to incur. Now that we have seen how the airline makes money and the cost they have to bear let's move to the most crucial topic: "Why Indian Airlines Don't Make Money?" 

Why Airlines in India don't make Money? 

Just so you know… only one Indian airline is profitable! This statement alone tells us how bad the situation is. There are a lot of challenges that this industry faces, which are not under their control. Let us have a look at the major challenges.

1. High dependence on oil prices 

While discussing the airlines' costs, we saw that fuel accounts for the airline industry's significant cost. But that is not the real problem; the problem is airlines are price takers, i.e. they have to buy fuels at whatever cost it is available. The airline turbine fuel is also unregulated, so the prices move in response to the global crude oil prices. The problem does not end here; these fuels are heavily taxed in India, making airlines' life more difficult. The problem is airlines cannot transfer these costs to the consumer. Well, don't worry; we will elaborate on this later in this blog.

2. Security concerns

The airline industry is always under the radar of the DCGA and the security departments. Huge costs and operational headaches are spent to ensure safety before every departure. This makes operations for airlines very difficult as they have to fulfil all the compliance requirements.

3. High fixed costs

This is the biggest challenge that an airline faces as all the major costs have already been incurred. As we know, there are two costs; fixed costs and variable costs. The survival of this business depends on covering both these costs. Indian airlines can hardly cover their variable costs ( employee costs, fuel costs etc.), let alone the fixed expenses. 

In airlines, huge fixed costs are already incurred much before the flight sails on the air, for example leasing costs, parking costs, etc. So now, they have to ensure proper utilization of the departures. In this industry, Inventory for them is the number of seats they have in every departure, which is perishable. In layman's terms, once a flight has taken off, the empty seats are of no use to the industry as they cannot make money off it now. This is a big challenge for the airline as every seat that goes empty decreases its earnings per seat.

No matter how many seats are sold or unsold, the fixed cost remains the same for the airline. Also, in the case of weather cancellations or some other issues, when the departure is cancelled, the airline is losing money while the aircraft is grounded as the fixed costs will be incurred, no matter what. This becomes a massive problem for them as even though these factors are not in control of the airlines, they have to bear the costs.

4. Competition 

People switch from Swiggy to Zomato for just 20 Rs; this fact is enough to describe the (swaying) brand loyalty that people have; it might sound funny, but this is what the reality is!

The same is the case of airlines. When the service duration is short, people don't put so much emphasis on the services. They are ready to switch to an inexpensive airline that provides them with fewer services than expensive luxury services. Brand loyalty is not a thing that we can expect in the case of Indian airline industries. So, to acquire customers and fight competition, every airline starts cutting down their prices, which decreases the revenue per ticket for all the airlines.

These were the primary reasons why making money is very difficult in the airline industry in India. You might be pondering over the future of the airlines' industry after looking at all these challenges.

                                

The Future of Airline Industry 

Nobody can tell what the future holds for this industry, but there is one thing that we can be sure of, the aviation industry in India has enormous growth potential in the coming years. Even though the industry is competitive and bugged with struggles, it has shown growth in double digits. The road ahead is very complex, but the government is working to increase connectivity and is building airports in many cities.

Only time will tell what it holds for the aviation industry in India. We can just hope that it takes off in the future!

About the Author: Ishan Goyal | 5 Post(s)

Ishan Goyal has pursued BBA from ITM University, Raipur, with a finance & marketing specialisation. He was also Founder & Director of a start-up "Tac Cabs". Apart from being a financial enthusiast, he likes to explore new subject areas and has also got a certification in Digital Marketing & is aiming to be a Financial Analyst.

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