How Rahul Bhatia Found His Escape Velocity
They say you can’t make money in India’s airline business. IndiGo is proving them wrong
Rahul Bhatia and his IndiGo Airlines like to keep a low profile, yet other domestic airlines in India look at them with deep mistrust. Some of it has to do with what happened in mid-August last year, when Bhatia broke ranks with the rest. All the private airlines had decided to take on the government on high fuel taxes with a decision to stop flying for a day, and a threat of an indefinite suspension if demands were not met. Full service airline chiefs Naresh Goyal and Vijay Mallya led the move, saying that the airline business was becoming unviable in India.
Less than 24 hours after the stormy meeting, IndiGo backed out and started accepting bookings for the day of the strike. SpiceJet followed a day later, and the others were left with little option. The strike fizzled out and taxes remain unchanged. A year later, it’s clear why IndiGo was reluctant to ground its fleet.
In August 2009, while the other airlines were bleeding from mile-high debts and declining number of passengers, IndiGo was making money. Its results for 2009-2010, posted with the Directorate General of Civil Aviation (DGCA) and audited by KPMG, show a profit before tax of Rs. 550 crore on a turnover of Rs. 2,664 crore. For comparison, Jet Airways and Kingfisher, the two biggest private airlines, turned up a combined loss of Rs. 2,114 crore in the same period. Of those in the group that day, SpiceJet was the only carrier that ended the year in the black, with a profit of Rs. 61 crore.
IndiGo, an unlisted company, is on course to raise about Rs. 2,500 crore in the next six months, most likely through an IPO. However, the competition is treating the results with much scepticism. They point out that net profit margins are rarely above 4 percent for the best of airlines around the world. Numbers, they say, can be distorted by one-time incomes such as sale and lease back. IndiGo did two such deals in the period. “The results are to be taken with a big pinch of salt,” says the head of one rival carrier who would not go on record for obvious reasons.
Whether rivals believe the numbers or not, the newest of six airlines in the Indian skies is showing signs of breaking away from the pack. IndiGo had a shade over 16 percent of the market at the end of August, and is now within striking distance of Air-India domestic that has 18 percent of the market. It is also easily the most meticulous of the domestic airlines in terms of fleet and network planning with aircraft induction plans already in place for the next decade.
Consider this: Over the next five years, 70 more Airbus A320 planes, which were ordered before the airline even began its first flight, will join its fleet. For beyond that (2015-2025), IndiGo has government permission to induct 150 planes.
Airline fleet planning is typically done a decade ahead, but not many start-up carriers have the vision or resources to do it. Senior sources in the DGCA say IndiGo is gearing up to roll out international operations by this time next year. It is, in fact, poised to become a point-to-point operator connecting multiple destinations in Asia-Pacific and the Middle East by the time the new batch of 150 enters service. “If not for the government rule restricting airlines that are less than five years old from flying overseas, 6E [the IndiGo callsign], would already be doing it,” he said.
Over the next six months, IndiGo’s fleet will go up to 35 planes. The increased capacity will almost certainly catapult it to the third position, behind Jet Airways (27 percent market share) and Kingfisher (20 percent). But that is neither here nor there. Built as they are on a low fare-high load factor model, low-cost carriers (LCCs) do not find it too difficult to rapidly grab a chunk of any market. Capt. Gopinath’s Air Deccan opened new stations and grew rapidly, managing to overtake Indian Airlines for a brief period. But Deccan’s eventual inability to survive proved that a huge network and large number of passengers do not necessarily mean profits. Deccan connected 74 cities with 43 planes, while IndiGo is at 22 cities with 28 planes.
Two Men and an LCC
At its simplest, IndiGo is a story of how two extremely low-profile men, sitting 7,000 miles apart, are building an airline with a cost structure and profit margins that few have achieved. The two, Rahul Bhatia and Rakesh Gangwal, own 50 percent each of InterGlobe Aviation, the company that runs IndiGo.
As managing director of InterGlobe Enterprises, a $2 billion (revenue) group, with subsidiaries in the hotel, airline and travel technology business, Bhatia is the one in charge of operations. He has used almost two decades of experience of the travel business as well as, some say, his contacts in the government, to set up and run IndiGo.
The Kolkata-born Gangwal, an engineer from IIT Kanpur, had a long career in aviation with Air France, United Airlines and as President and CEO of US Airways. They met almost accidentally in the corridors of the United Airlines headquarters in Chicago in 1985, while Bhatia was doing IT work for the airline. The acquaintance grew into a friendship over the next decade and a half, before the airline was planned and launched.
In the US, Gangwal is remembered for bailing out of US Airways in 2002 with retirement benefits of $15 million, leaving the airline deep in the red in the aftermath of September 11. To be fair to him, old timers in the US airline industry say the airline had problems that preceded him and continued well after his departure. He left to join the private equity business and is currently advisor at Teachers’ Private Capital, which has a portfolio of $10 billion. Gangwal did not speak with Forbes India for this story.
Bharat Bhise, CEO and founder of Bravia Capital, a New York-based transportation advisory and investment company, has worked with Gangwal. “Gangwal brings in the global networking and the expertise that comes from running global airlines. He has made the mistakes and knows how to avoid them,” he says. Bravia’s affiliate company, Hong Kong Aviation capital (HKAC), has 10 aircraft on lease to IndiGo.
“The idea for us was to set up a certain kind of an airline… the kind that is on-time, clean and delivery is well executed,” Bhatia recalls. “This is our DNA and we intend to hang on to it. It has worked for us, and we have no desire to change, even when we have 100 more planes,” he says.
For the roughly 30,000 passengers it carries daily, the focus on basics, like a fresh clean product and high on-time performance, defines IndiGo.
Not every rival is sceptical of everything IndiGo does. The higher aircraft utilisation (an average of 11.5 hours per plane everyday) and quicker turnaround time (about 30 minutes) has impressed industry veterans like Saroj Datta, executive director of Jet Airways. “The LCC concept became acceptable because of the better service. Competition was much stiffer for IndiGo when it launched compared to when Jet started,” he says.
In fact, Kingfisher and Jet were forced to start their own LCC operations in response to Indigo’s success.
Low Costs: Myth or Reality?
There is more to the IndiGo story than clean planes and its most recent distraction, air-hostesses wearing bobbed wigs and blue hats. The airline is on its way to demolish some myths about the Indian airline industry. The most common of these is that you can’t make money in the airline business. High taxes on fuel, absence of cheaper secondary airports and crowded metro-airports make profits impossible. Both LCCs that made profits last fiscal (IndiGo and SpiceJet) have proved this wrong.
For the three largest airlines, Air-India, Jet Airways and Kingfisher, that have posted the highest losses, it is not operating costs but the high interest costs arising from the huge debt acquired over the last few years that has proved to be a killer.
So can an airline without these problems, with minimal debt on its books and a level-headed induction of capacity make it work? Of course, says Bhatia, who has bet the farm on more Indians flying every year. “The key to growing the market is to continue to attract more passengers with lowest fares. It is our religion to be the cheapest,” he says. Though many passengers say IndiGo is not cheap enough, Bhatia disagrees. He says that at an average of Rs. 3,000, IndiGo’s fares are among the cheapest.
What about the operating costs? Legacy carriers say with similar planes and labour costs, the costs cannot be very different for anyone. But a look at what happened in July this year, illustrates how costs can vary significantly for airlines. Kingfisher Airlines, which operates A320 aircraft, was forced to ground nine of its planes because of engines overheating. International Aero Engine’s (IAE)V2500-A5 engines power the planes. The problem was unique to the Indian skies, though the engine is used all over the world. It was traced to the high chlorine content around the Indian airports that corroded the silver nuts in the high pressure drums. Kingfisher had no option but to pull out the planes from service for repairs. Though there is no official confirmation of this, media reports say that the airline has sought compensation of Rs. 1,000 crore for losses due to the engine troubles.
IndiGo too operates A320s with the same engines in the same conditions and has had to deal with similar problems. Yet, it hasn’t taken a hit on its books. This is because of a full-suite ‘Power by the hour’ contract with IAE that put the onus of performance delivery on the manufacturer. IndiGo has similar agreements with the airframe maker (Airbus), as well as for the vendors for other critical components. “The agreement is like an insurance. It is not that they had anticipated the engine problems when they signed it four years ago. They were simply providing for any such problem,” says an official from the engine company who did not want to go on record.
Kingfisher sources say they too had an engine maintenance agreement, but it was without (the more expensive) full guarantees. Though more expensive, fixing reliability of aircraft is essential for an LCC operation because success depends on how the airline can milk the flying machines. Airline sources say the airplane usage is likely to go up further when IndiGo starts international services. “Many of the seven to eight hour operations in the subcontinent and neighbourhood will surely be at night, when the aircraft are not being used,” they said.
Not a Dollar More
Bhatia explains his basic philosophy on costs as “thinking before spending a single dollar, ‘Do I need to spend it? Can I get away without it?’”.
One visible difference between IndiGo and other airlines including SpiceJet, which operates in the same space, is the very low marketing and advertising spend. Bhatia is a firm believer in the word of mouth and IndiGo has a much lower visibility than other airlines. “How many passengers come in after seeing a hoarding? It is not about putting your name on the tail,” he says. The airline did start a campaign earlier this year after a spat with SpiceJet on on-time performance claims.
Not everyone agrees with this philosophy. Kapil Kaul, India head of CAPA (Center for Asia-Pacific Aviation) who has been studying the growth of LCCs very closely, thinks IndiGo is underinvested in branding. However, Kaul is full of praise for the way Bhatia and Gangwal have put in the systems and people and supported their business in the tough times. “IndiGo’s 100 airplane deal itself was the game changer,” he says. They had a great deal and suppliers credits that allowed them to operate with very low capital, till revenues slowly grew to present levels.
To structure the lease and financing structures, Bhatia hired CFO Riyaz Peermohammed, an old Emirates hand who handled treasury and corporate finance at his earlier job. IndiGo has six-year sale and lease back agreements for most of its planes. The leaser takes the planes back after this and the airline can induct a brand new one in its place. Though at a cost, this is effectively like a perpetual elixir of youth. The most important financial implication is that it never has to undertake the ‘D’ check, where the aircraft is completely stripped down and airlines often discover the need to spend on major repairs. This check is usually done when the plane is about eight years old.
On daily operations, IndiGo’s operations head, Capt. Saleem Zaheer, runs a tight ship. Flight performance is monitored through devices like the digital flight data recorder, which some airlines use only for compliance with the regulators. IndiGo was among the first airlines to have the aircraft taxi to the terminal with one engine, shutting down the second engine to save fuel. Another example is of pilots flying at higher speeds (and burning more fuel) to reach Mumbai quickly, only to spend the next half-hour circling the airport. This was curtailed and fuel burn reduced.
Airline costs are measured in terms of CASK or cost per available seat kilometre, designed to give an idea of how much it costs the airline to fly each seat (which may or may not have a passenger in it) for a kilometre. IndiGo, which claims to be the lowest in the industry, declined to reveal its CASK numbers. In a report, Citibank’s airline industry analysts Jamshed Dadabhoy and Arvind Sharma say the capital costs per passenger for full service airlines have jumped several fold over the last few years, while those of budget airlines have remained stable or moved up very little. SpiceJet for instance has a CASK of between Rs. 2.30 to Rs. 2.40 while the number for Jet Airways is around Rs. 3.60.
For LCCs, cost can be cut everywhere, and they may well be indirect ways. While taking delivery of a new plane, Airbus customers in India, including Air India and Kingfisher, send their pilots, crew and engineers to Toulouse to the plant. But IndiGo prefers to have the planes delivered in Delhi. “This comes at a marginally higher cost, the advantage is that two sets of pilots and crew are not out of the system for the 10-15 days,” says an airline official.
Scaling Up
The real test for IndiGo starts now,” says Nawal Taneja, professor and chairman, department of aviation at Ohio State University. SpiceJet has a very similar model and is now much better capitalised than before after Kalanithi Maran’s entry. The kind of margins that IndiGo has shown will be very tough to sustain, he says. He also points out that there is little to differentiate between the two Indian LCCs — both operate high-density seating and have similar network strategies. The models are very close to that of Southwest airlines in the US, which has a single aircraft type and a network that is a combination of two-three city hubs and many focus cities, with lots of flights but little connecting traffic between them and a very simple fare structure. IndiGo’s latest profits seem abnormally high relative to its revenue, he says.
Commenting on the low-cost model globally, Taneja says many of the older operators like Southwest and RyanAir are reaching saturation. By comparison, the industry is still very nascent in India, where hardly 5 percent of the population uses air transport. While conceptually the market is huge, infrastructure is the big limiting factor.
On the network, IndiGo is sticking to routes with an average stage length of 1 hour, 30 minutes. It has daily flights on all its routes, and is the largest operator on a third of these routes. It aligns flight timings to match connections from Mumbai and Delhi. It has no loyalty programmes, yet half of those flying are repeat customers. It is looking to increase connections to cities like Patna and Dibrugarh, where prosperity is growing.
Scalability for IndiGo is unlikely to be a problem, says Kiran Rao, Airbus vice president, sales and marketing. The airline has been able to plan its operations to the last detail over the past four years, he says. Days before an aircraft is delivered they are well-planned about where to operate it and usually have begun selling tickets. Other Asian airlines such as AirAsia have proved that it is possible to grow and keep your margins high.
(This story appears in the 05 November, 2010 issue of Forbes India. To visit our Archives, click here.)
