For Rono Dutta, the Cure for Airlines’ Ills Lies in Deregulation with Oversight

The growth of Indian civil aviation in recent years and the rapidly expanding number of airlines has prompted industry watchers to wonder what is going on. Clearly, there are pointers from the aviation industries in markets like the U.S. and Europe that have gone through it all — consolidation, cost management, and the pros and cons of deregulation. Ronojoy Dutta, former CEO of Air Sahara, spent 17 years in the U.S. aviation industry where he was last CEO of United Airlines. In an interview with Knowledge@Wharton, Dutta spoke to Wharton management professor Saikat Chaudhuri about the lessons India’s airline industry could learn from the U.S. experience.

Chaudhuri: We’re starting to see U.S. airlines — the legacy carriers — stabilize again and experience very high load factors, especially this past summer. Fuel prices continue to keep them on their toes, though. What are your views on impending consolidation in this scenario? Do you expect it to happen? Is it necessary?

Dutta: It’s critical that consolidation does happen. If you go back in time, the legacy carriers of course had much higher costs than other carriers, or LCCs (low cost carriers), as they’re called. The legacy carriers were at a major disadvantage. Now, thanks to both of them going to bankruptcy practically, they’ve restructured costs. The cost gap between the two has narrowed very much, and it’s almost the same now. As a result, the playing field has been leveled, but they will all be in trouble long term. The issue really is capacity.

There has been an ongoing debate as to whether the airlines should be a regulated or a deregulated industry. Deregulation has a lot of advantages in terms of more competition and, most importantly, lower prices for the consumer, different kinds of services — and the consumer really benefits. The downside of deregulation is that there is absolutely no control on capacity [expansion]. The problem with the airline business, and why some people think it should be regulated, is that there are a lot of incentives from an individual carrier’s perspective to add capacity. That’s because the airline industry is very much a network industry, similar to pipelines or electricity or telecom. And that is the underbelly, if you will, of deregulated industries.

In the U.S., some carriers like United and Northwest are essentially east-west carriers. What they do very well is taking people from the east coast to the west coast and vice versa. On the other hand, others like Delta and U.S. Air — the old U.S. Air — take people to Florida and so forth, and this is what they’re good at.

But because of the network characteristic of carriers, if United were to carry people only east-west, well, there are a lot of customers in Boston and New York or Washington who say, “Hey, I also go to Florida — or I also go to Mississippi, or whatever — and how come you don’t have any flights there? And if you do have flights there, I won’t switch.” So United and Northwest, against better judgment in an economic sense, added a lot of capacity to Florida. U.S. Air and Delta have exactly the same problem. There is no control over this. Everyone wrings their hands in anguish … and they’re obviously stupid to do it, but they say they had to do it. And that ultimately destroyed the health of the industry.

Chaudhuri: How can the airline industry extricate itself from such messy situations?

Dutta: You don’t want regulation to figure out this problem because deregulation is a good thing for the customer. But leaving it totally unattended results in what you have just seen — too much capacity, bankruptcy. And it did cost the consumer a lot after all, just so you know. That’s why consolidation is a very critical aspect if you’re going to go down the path of regulation.

On the other hand, the European carriers are much healthier, because to some extent, they’ve gone through various phases of reconsolidation. The best example is British Airways — you remember how badly the old BOAC was doing. Air France and KLM are also great examples. Whether it was fortuitous or a coincidence, the end result is better. They also have the same advantage that, for the most part, their capacity is still regulated because it’s international capacity. All airlines do well internationally because international capacity is somewhat regulated.

So net-net for the U.S., the glue has been laid out to some extent, the restructuring was very good. But also we realized that in human terms it was very painful, [with] people losing their pensions and many people losing their jobs and the creditors taking a bath; all that restructuring has not been painless.

Knowledge@Wharton: In the U.S., the legacy carriers are facing trouble. In addition to Delta and Northwest, U.S. Airways and United have been reorganizing in bankruptcy courts. In the meanwhile, the traffic seems to be shifting to low-fare carriers like Southwest and JetBlue and AirTran. My understanding is that they now have about 25% of the U.S. airline business. Do you think that sometime in the future, the low-fare carriers are also likely to face a glut of seats and that there could be some sort of shake-out in the discount airline market?

Dutta: To some extent, the immediate advantage the low-cost carriers has disappeared. Over time, I think they are going to pay for the same problems. How do you grow without a complete network? Southwest has pretty much a complete network, but JetBlue will have to keep extending its network, and will, to some extent, run into the [capacity] issue.

There is one other factor with the legacy carriers. That’s the “old employee cost” — I can’t think of a more elegant way to put it. That issue is important and fascinating, because it’s going to be played out in several industries.

The problem that United, Delta and the others have has to do with the ratio of the number of employees who are working and those [the companies] support but are not working. And again, you look at Europe, or even Canada; they don’t have the problem, because to a large extent, pension costs and health care costs are, sort of, government issues. Society takes the burden of that; individual companies don’t. It works great if you have growth, because the ratio of working employees to non-working employees is high.

When they get into trouble, well, they’re supposed to keep growing. Even if they grow, [they have] more and more workers who are getting older, who are retired, have higher dental costs and whatever else. That really becomes a problem.

Just look at G.M. versus Toyota; I say, “This is Southwest versus United all over again.” With GM, yes, I can do so many things, but what do I do about my health care costs and what can I do about my pension costs? I looked at Canada restructuring as a consultant. Yes, they have so many issues, and they have health care and some pension costs, but the majority of that is borne by the government. The European carriers have this advantage, Toyota has this advantage, and then you say, “Okay, so what are the lessons for the rest of the U.S. industry?” Well, it’s a very painful lesson. If you don’t grow, and you can’t keep growing all the time, health care and pension costs really come back to hurt you.

Chaudhuri: When you were at United Airlines, you were pushing very early on — well before September 11, 2001 — to control costs. And at that time you met with some resistance, but it would have been very good because that forethought was there already at that time.

Dutta: But it’s not just at United. It’s United, Delta and the whole aviation industry. Unless you’re in bankruptcy, why would you accept it? Unfortunately, the auto industry is facing the same problem right now. But this cost advantage becomes such an issue that people say, “Why don’t they improve quality?” Well, guess what, guys? Quality will pay off, and of course, it’s the right thing to do, but it takes time for quality to pay off. In the meantime, the money is flowing out the door, and you are sort of scrambling to cut back on your cost, and that’s a real vicious cycle.

Chaudhuri: We can learn from other industries and gain lessons, like from the automobile industry, right?

Dutta: Looking back in history, when United and American were young — in this demographic issue — and TWA and PanAm were old, we said, “Oh, wow, we got them.” But then we got old, and then JetBlue and Southwest came in and started saying, “Oh, wow, we got them.” But JetBlue and Southwest will get old, too. The demographic issue is something where the U.S. government should realize that individual companies can’t solve this problem.

Chaudhuri: Like work force demographics, you also have demographics in terms of customers, right? In the Indian aviation industry, several low-cost carriers have emerged, and the full-service carriers that are also trying to compete with them. I’m definitely expecting to see consolidation taking place, but what are your views on that? How many carriers will survive?

Dutta: Let’s go back to the old issue of regulation and deregulation. Is there a case that can be made for regulation? I mean, you would never make that case for car companies or cereal companies, or health care companies. But again, because of the tension, because of the network nature of the airline industry, many people think regulation is a way out. I don’t believe it. It should be deregulated. But then you need a sort of oversight on the capacity issue. If you don’t even have the oversight, leave it totally up to the market, and then you must allow consolidation and create consolidation. I don’t live in that world. In the Indian scene, deregulation has been a very good thing, and the result is the country is enjoying all the benefits.

Chaudhuri: How do you see it shaping up going forward?

Dutta: I do think they [the airlines] are going overboard. They’re going overboard for a couple of reasons. On the one hand, you know the infrastructure constraints in India. There aren’t enough runways, there isn’t enough airport capacity, there aren’t enough gates and there aren’t enough counters. At the same time, there isn’t enough skilled labor. You can’t get pilots and mechanics. Yes, you can get customer agents trained fast, but it takes years to train pilots and mechanics. You cannot simply ignore all that and say, “Fine. We used to have two national carriers, now we’ll have six private carriers, and by the next year we’ll have 11 private carriers.” That is not a very good plan for foresight.

So, the Indian scene, I think, is dangerous. Unfortunately, they don’t seem to have learned from the last time they totally opened up the market about seven or eight years ago.

Chaudhuri: That was after 1991.

Dutta: Most of them went bankrupt. And because India doesn’t have the bankruptcy laws that the U.S. has to protect them, they had to shut down. I don’t think any of the Indian carriers right now are making money.

Chaudhuri: For consolidation to take place, does the recent Sahara Jet situation — the acquisition which didn’t go through — send a negative signal about the maturity of the Indian market to consolidate through M&As?

Dutta: The M&A market in India is a little different, in a sense. Some of your more mature carriers should be allowed to consolidate. India has only one carrier, so it’s a little too early to start talking consolidation. All these guys have barely gotten their feet on the ground yet.

In the Indian context, I think the situation is that they should be a little more careful about authorizing more and more carriers all at the same time. You had three airlines starting within two months of each other, including SpiceJet and Air Deccan. And now you have IndiGo, GoAir and Magic Air all starting within two or three months of each other.

No government should allow that. Of course you want to help the consumer; you want more competition, but not competition for six months. You’re looking at competition for 10 years. And you’re looking at a domestic industry that can sustain itself in foreign competition. So, all the competition is too early. It’s this authorizing of new carriers — all at once — that’s the bigger issue there.

OK, so that’s done. The horse has fled the barn to some extent. Now, what do they do about consolidation? I don’t think the government can stand in the way of that. They haven’t issued any policies, unlike the U.S. government. Of course, there is a review process. But, at the end of the day, Sahara Jet was allowed to — from a government standpoint — they did all the right things. They said, “Yes. You can keep your gates.” If they had said, for example, “If you consolidate, you lose your gates,” that would have been a huge barrier in the area of consolidation. They haven’t said that, and it seems to signal that they are okay for consolidation. I think the Jet-Sahara deal was more of a financial issue.

The answer for India is not consolidation, because Indian airlines are not mature players in a mature market. There are too many players in a growing market. This issue is more a planned entry of new carriers. That’s the real problem.

Chaudhuri: You mentioned the constraints in terms of infrastructure: the airports, air traffic control and maintenance, among others. Do you see that developing quickly enough? What do you think can be done to accelerate that improvement in infrastructure?

Dutta: Privatization is presumably one way of doing it. But they are already so far behind the curve, it will take another two or three years for them to really make a significant dent in the infrastructure issue. There is a lot of talk of new maintenance, repair, overhaul systems being set up, new pilot training and mechanic training being set up. The lead time is two or three years away.

At a minimum, they shouldn’t allow any more new carriers in place until it has matured a little. But it would have been even better if they had said two years ago, “All right, let’s have some breathing time here for a couple of years.” They should have allowed five or six carriers and then paused, instead of going to nine right away.

Chaudhuri: I don’t know how many more are in the wings, waiting to fly. Could you share your experience in trying to apply some of the practices from these markets in India and Indianizing them. As former Air Sahara CEO, what are some of the similarities and differences you observed, both strategically and operationally? For example, you made a big push to build hub-and-spoke operations and promoted this Hub Hyderabad concept. How is this progressing, as well as other initiatives that you have observed from an operational and strategic point of view?

Dutta: The fundamentals are pretty much the same. There are different forms of maturity and competitive dynamics. The biggest issue in any airline, of course, is safety, followed by reliability. Those are the basic fundamentals in the airline that you are operating. After that, you come in with cost and management and etcetera.

From a safety and reliability standpoint, India is very safe, no question. But the lack of skilled manpower and facilities is always an issue, in order to be reliable without wounding yourself on cost. Our tires used to go to Hong Kong for re-treading, our APUs (auxiliary power units) would go all the way to Texas for overhaul, and our engines would go to Germany. It’s very hard to have a cost-effective, reliable operation like that, especially if you need something in a hurry and you can’t get it.

Reliability is affected also by airport issues. The fog in Delhi is an ongoing problem. Pilot training is an ongoing problem. You send people all the way to London for pilot training. All of those are very much more difficult in a way, but the essential dynamics are not different. They are the same really. What’s important to an airline in the U.S. is what’s important to an airline in India. Along what lines is competition trying to differentiate itself? How does the customer value one thing versus the other? The fundamentals are really the same.

Chaudhuri: The Indian industry benefited from your experience in having done this for one of the world’s largest airlines, and then coming to India to help an upstart, fledgling airline trying to come to this point.

Dutta: As an airline executive — both in the U.S. and in India — the frustrating part of it continues to be that there is so much you can and should do in terms of the service and the product and the customer loyalty and so forth. And yet, I would say, a disproportionate amount of time is just spent on sheer survival issues, like cost management. That’s not healthy for the industry.

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