Saturday, June 16, 2007

Consolidation in Indian skies - putting the cart before the horse ?

The frenetic activity in India’s fledgling airline industry [Jet-Sahara, Kingfisher-Air Deccan, Air India-Indian] intrigues me no end. I normally am tempted to go by the general opinion of investors across the world about this industry, which in summation is that - a profitable airline is a dysfunctional one.

There’s this favorite airline industry stat, offered up by a recent Bloomberg article:

Historical profits: $18 billion
Historical losses: $32 billion

Internationally, the performance of aviation industry has been characterised by boom and bust cycles with a period of robust growth in operations and profits giving way to losses and an inevitable search towards consolidation. This is in the very nature of the cost structure of airline operations where fixed costs such as aircraft lease rentals, depreciation and staff costs could be as high as 50 per cent of sales. Even a marginal decline in traffic volume or a nominal addition to capacity arising from the entry of new players can undermine the viability of incumbent operators. The current wave of consolidation sweeping the Indian skies may appear to be in accord with the global trend, but is actually different in one respect. The consolidation is happening even before the industry has achieved a state of stable and orderly growth (and hence the title). The sector was opened to private competition, just a few years back. The period since then has witnessed one of the most exceptional record of buoyancy in national prosperity. In the event, the new entrants can perhaps be pardoned for viewing the future with an optimism that in hindsight may not only be regarded as excessive but did not prepare them to withstand the pressures of the market place.

Get this perspective from none other than legendary investor Warren Buffett:

"If I'd been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough -- I owed this to future capitalists -- to shoot him down."

Seems the airlines are in bad need of a visit from the business model doctor.

It seems Vijay Mallya and Naresh Goel have different ideas. Well, you can argue there are millions of Indians that haven’t had their maiden flight experience as yet, who would love to take to the skies if the fares are affordable. How easy a task is that - coming to think of soaring oil prices, high lease rentals, wage inflation, shortage of pilots and trained in-flight, maintenance and repair crew.

Well, who am I to say that? John M Keynes quote captures it best as he says -

“A large portion of our positive activities depend on spontaneous optimism rather than on mathematical expectation…If animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but mathematical expectation, enterprise will fade and die.”
Won't you join me in raising a toast to that ?

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