Airlines make money by reducing competition and capacity. The entry of a fourth airline in the domestic market will increase both, upsetting the balance between demand and supply.
In their famous book Airline Operations and Management, Gerald N Cook and Bruce G Billing state, “Airlines are notorious for lack of profitability.”
Another line in the book says, “By several measures, the airline industry has historically been a low-margin, low-profit business... The profits and losses closely track business cycle, fluctuations in economic activity over irregular periods of time.”
A new airline in Pakistan must operate on domestic routes for one year, with a fleet of at least three aircraft, before it can be allowed to operate on international routes, with a minimum of five aircraft.
The peculiar aspect of the airline business is that operating an empty aircraft costs almost the same as the one full of passengers. For example, the sum of variable operating costs — fuel, maintenance, lease, labour and ground handling on the Karachi-Islamabad sector — is over Rs1 million for a 175-seater aircraft. Other costs — ground handling, air navigation, landing/housing and parking etc — are rather negligible on domestic routes and, therefore, not included in the total.
The exit of Shaheen Air International from the market in July 2018 gave Serene Air a new lease of life and returned Airblue to profitable operations
When divided on all 175 seats, it would cost an airline about Rs6,000 per seat. Therefore, to recover the full variable cost of operations, all 175 seats must be sold at a minimum price of Rs6,000 each, or around Rs10,000 when taxes and related fees are added. The passenger-specific government tax rate is Rs2,500 and the CAA fee is Rs600 per passenger. A travel booking agency charges around Rs700-1,000 per passenger.
The airline business lacks scalability and capacity. Therefore, it cannot be adjusted to market demand on a day-to-day basis. In fact, capacity comes in bulk (175-seater aircraft) whereas passengers come in ones and twos. Booking for a flight usually begins six months before it is set to take off, with airlines selling a bulk of available seats in the last 30 days, targeting for an 80 per cent fill rate.
Empty seats are perishable. Airlines use specialised software to calculate the vacant seats and the time left to sell them to fix ticket price. The prices, therefore, keep changing from day to day, hour to hour and even minute to minute.
Airlines operate around the breakeven seat factor, which is around 80pc. Hence, the average ticket price for the Islamabad-Karachi route ought to be about Rs12,500 at a gross level and around Rs15,000 at an operating level.
The cheapest seats are sold to passengers who buy tickets three to four weeks in advance. The most expensive ones are sold at the end usually to businessmen or the affluent class for whom saving time is more important than money. Seasonality also makes an impact. In low seasons, tickets are a lot cheaper.
This business is oligopolistic ie very few airlines fiercely compete for a breakeven seat-factor. In turn, they set themselves up for a minute potential for profit, if any.
The new airline would increase both capacity and competition. The prices of tickets would fall below operating costs on domestic routes, hurting all competitors. It will have to sell tickets 10-20pc below the operating cost to snatch its market share from the current players, triggering a cutthroat competition albeit to the benefit of the passengers.
It is said that the airline business is for the people with deep pockets and large hearts. Richard Branson once famously said, “If you want to be a millionaire, start with a billion dollars and launch a new airline.”
The fourth airline, in all its probability, will expend Rs500 million of initial investment within the first six months of operations. In fact, it would need about Rs1bn each year to continue operations until it runs out of funds or one of its competitors quits the market.
The exit of Shaheen Air International from the market in July 2018 gave Serene Air a new lease of life and returned Airblue to profitable operations.
PIA is a perpetually loss-making government entity due to its unique situation. Therefore, no change in the market condition will ever make it profitable. PIA’s accumulated losses have reached Rs414bn. Its estimated losses for 2018 are over Rs60bn. Indeed, many state-owned airlines in the world are not efficient or profitable. But that is not to say that the present government will stop throwing public funds in this bottomless pit.
Privately owned airlines cannot rely on government funds. The investment market is mostly concerned with the promise of future profits. Thus, airlines that are recurrently beset by poor profits are unable to obtain funding from private financial institutions and individual investors.
The airline business is capital-, labour- and technology-intensive. It is also one of the riskiest businesses in the world where revenues are closely tracked by high costs, resulting in either large losses or insufficient profits.
India is the fastest-growing domestic aviation market in the world. But airlines have struggled to stay profitable despite filling nearly 90pc of seats and doubling the domestic passenger numbers over the last four years, according to Reuters. The combined losses for the last financial year were expected to be $1.9bn, led by India’s three full service carriers and five low-cost carriers, driven by rising costs and low air fares. That brings the Indian airline industry’s accumulated losses to over $12bn since 2009.
The prospects of a fourth airline’s success in Pakistan would depend on its ability to create a new market space by making the competition irrelevant (blue ocean strategy). However, following the same business model as the other three may turn into a recipe for creating yet another loss-attracting venture.
The writer is an air navigation services expert
Published in Dawn, The Business and Finance Weekly, February 25th, 2019