Wharton’s Saikat Chaudhuri and George Mason University’s Kenneth J. Button discuss the shutdown of India’s Jet Airways.

After 26 years in operation, India’s Jet Airways had its final flight last week, following a refusal by lenders for emergency funding. The lenders’ action came as a result of a string of missed debt-servicing payments by the airline and disagreement over whether it could be revived under the management of its founder and 51% equity owner, Naresh Goyal.

Jet Airways had also missed payments to aircraft leasing companies, which led to the grounding of about two-thirds of its 121-strong fleet in March. The airline posted a loss of Rs. 588 crores ($86 million) on revenues of Rs. 6,198 crore ($911 million) in the quarter ended December 2018, its fourth consecutive quarter in the red. Jet’s 15% share of the Indian civil aviation market is up for grabs by rivals, while the fate of its 22,000 employees remains uncertain.

Meanwhile, the Indian government has refused to bail out the airline — civil aviation minister Suresh Prabhu said such support would be construed as favoritism. A similar government stance forced the closure last month of Iceland’s WOW Air, a low-cost airline. The situation at Jet Airways is also reminiscent of the 2012 shutdown of Kingfisher Airlines, whose flamboyant founder, Vijay Mallya, helped it become India’s second-largest carrier before it was overtaken by financial problems.

Saikat Chaudhuri, executive director of the Mack Institute for Innovation Management at Wharton, listed what he sees as the main culprits behind the airline’s current turmoil: India is a price-sensitive market; many low-cost carriers such as Indigo and SpiceJet have been making inroads; and fuel prices have been rising. Jet also has faced steep central and state taxes on aviation turbine fuel and an unfavorable exchange rate for the rupee. The rupee was one of Asia’s worst performers last year; as the rupee weakens, Indian airlines have to pay more for imported fuel, and those with international operations like Jet Airways find dollar-denominated operating expenditure more challenging.

“The cost environment hasn’t been good, and the pricing hasn’t been good for Jet Airways,” said Chaudhuri, who is also adjunct management professor at Wharton. “There has been cutthroat competition, which has driven down the fares. Unfortunately, something had to happen, and we have this regrettable outcome [of Jet suspending operations].”

As more and more low-cost carriers enter the market, they drive down fares to their marginal cost, said Kenneth J. Button, a professor at the Schar School of Policy and Government at George Mason University, who is an expert on transportation policy. In that scenario, airlines aren’t able to earn enough to cover their capital expenditures, and “ultimately leave the market,” he noted. “Airlines come and go. The capacity gets absorbed [by other airlines]. We see it going on all the time with smaller airlines; occasionally, you get the bigger ones.”

“The cost environment hasn’t been good, and the pricing hasn’t been good for Jet Airways.” –Saikat Chaudhuri

Chaudhuri and Button discussed the problems facing Jet Airways and how successful airlines avoid them on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)

Untapped Market Potential

For investors in airlines like Jet, the Indian civil aviation market is one of the world’s most attractive. “India has a population of more than a billion people and a fair chunk of them has never flown before,” said Chaudhuri. “So, the low-cost market is very attractive.” The major routes tend to be busy, especially with a flying time of just about two hours between the major cities of Mumbai, New Delhi, Kolkata and Chennai.

India’s civil aviation industry grew last year at nearly 17% and is set to overtake the U.K. market by 2024, according to a report by the India Brand Equity Foundation, a government agency.

Chaudhuri said he expects consolidation within the Indian airline industry approaching the U.S. model of essentially three major airlines (American Airlines, United Airlines and Delta Airlines). That model leaves room for smaller but strong players like Southwest Airlines, JetBlue and Alaska Airlines. Similar consolidation is occurring in Europe as well, he noted. However, India’s large population and population growth ensure that the Indian market could sustain more airlines than in Europe, he added.

Button agreed, and pointed to rapid urbanization in countries like India and China as another positive factor. “Aviation is a good way of serving passengers between two large [cities] that are not huge distances apart, say 300 or 400 miles apart,” he said. Other demographic changes that are salutary for airlines include “rising incomes and younger populations that want to be more mobile,” he added.

Chaudhuri added that the growth of smart cities in countries like India would also make air travel “a very effective means of connecting,” in addition to rail. He noted that the Indian government has announced plans to connect Tier 2 and Tier 3 cities with each other in a subsidized model with incentives.

In that setting, the slots that airlines have at airports are “immensely important,” said Button. “Slots are the bottlenecks in many aviation markets – you have a limited number of slots at airports. Slots have got value and they sell in Europe for millions and millions of euros.” That should be good news for Jet Airways with its slots, and therefore any potential suitors. “Given that the population growth and probably the demand for aviation is going to grow faster than the airport capacity, [slots will] become more valuable,” Button said.

What Went Wrong

Along with those attractions in the Indian civil aviation market come hurdles, too. According to Chaudhuri, the cost base for airlines operating out of India is high because of the taxes on aviation turbine fuel that state governments assess (it varies from 5% to 30% across states). “So, even if the labor is cheaper in India, what happens is that this tax creates a higher cost base than, say, Singapore would,” he said. “That is something the government needs to look at structurally.”

“The difficulty is in mixing low-cost carriers and short-haul flights with long haul flights. They’re different businesses.” –Kenneth J. Button

Button pointed out that that those taxes would erode the competitiveness of Indian airlines operating international services. But the competition between all Indian airlines would be even since each of them would have to pay the same taxes. However, “moving the floor up” would make fares that much higher and have the effect of shrinking the market size, he said. “That will make the overall supply smaller than it would be without the tax, and without actually giving any airline an added advantage.”

The rapid growth of low-cost airlines in the Indian market was too tempting to ignore for Jet. It diversified from its full-service business model and added a low-cost service by buying Air Sahara in 2007 — which it renamed JetLite – for Rs. 1,450 crore ($213 million). Two years later it introduced another low-cost service called Jet Konnect. All that caused “a lot of brand confusion – part low cost, part full-service,” said Chaudhuri.

Furthermore, Jet failed in its bid to establish a hub in Abu Dhabi with Etihad as a partner and tap the markets in that region, Chaudhuri continued. It also faced more competition as the previous Indian government gave many Middle Eastern carriers the rights to fly into India, he noted. “Many of these airlines became feeders for Abu Dhabi instead of exploiting the markets that they have and the natural comparative advantages that they possess, such as access to the Indian market,” he explained.

The fact that Jet doesn’t own all its aircraft but leases a large part of them makes it especially vulnerable to airline leasing companies grounding aircraft if payments are not made on time. “Jet Airways stopped flying basically because they couldn’t pay the leasing fees and the aircraft were being taken away from them by the leasing companies,” Button pointed out.

Fleet deployment becomes tough for an airline that operates both full-service and discounted-fare flights. “The difficulty is in mixing low-cost carriers and short-haul flights with long haul flights,” said Button. “They’re different businesses. Successful low-cost carriers like Ryanair and Southwest Airlines keep a very basic model. They don’t really become too adventurous.”

Possibilities for Revival

SBI is currently leading discussions with potential suitors who could revive the airline, including Abu Dhabi’s Etihad Airways that already has a 24% equity stake in it, TPG Capital and India’s sovereign wealth fund, the National Investment and Infrastructure Fund. They have until May 10 to submit financial bids for an equity stake of between 32% and 75% in the airline. Last month, Goyal resigned from the airline’s board, a precondition set by the potential suitors to send in their bids. Meanwhile, slots that Jet Airways had at Indian airports are being allotted to other airlines for three months, and will be reassigned if and when a new owner and management takes over at Jet.

“Even if the labor is cheaper in India, what happens is that this tax [on aviation fuel] creates a higher cost base than, say, Singapore would.” –Saikat Chaudhuri

Chaudhuri noted that the Tata Group, Air India and Delta Airlines have looked at investing in or buying Jet Airways. “Perhaps there’s room to merge a few of these together and create one strong airline as opposed to a bunch of them that either can’t grow or are weak financially,” he suggested.

Attempts to revive Jet Airways raise several questions that don’t have easy answers. “Is the brand Jet Airways worth something?” Chaudhuri asked. He noted that the slots Jet had at various Indian airports that are being temporarily absorbed by other airlines will be difficult to get back as time passes. What’s more, because Jet’s aircraft are leased and not owned, it’s hard to transfer them to a new owner, he noted.

If Jet were to eventually close down for good, competitors would obviously welcome that, especially those on international routes. In 2018, Jet Airways accounted for about a third of the total available seat kilometers (a measure of airline capacity) of Indian carriers on scheduled international services, according to a Mint newspaper report that cited data from India’s Directorate General of Civil Aviation. “This big chunk of international capacity is at risk if Jet were to go out of the system,” it stated. It predicted that “a reasonable portion” of that international traffic will be eaten into by other carriers including Emirates, Etihad, Qatar Airways, British Airways, Singapore Airlines and Deutsche Lufthansa. It noted that other Indian low-cost carriers have also been incurring losses, such as IndiGo and SpiceJet.

Button had some advice on how Jet might position itself if it gets a second chance. “It has to think of itself as a smaller airline. It’s got to think of itself as an Indian airline and compete with the low-cost carriers in India using the short-haul routes, and it’s got to provide the lowest-cost product possible.” Or, it could become “a quasi full-cost carrier,” he added. “That involves mixing fleets, and a more complicated network structure, and it involves serving essentially two different products. Most companies are not good at that.”

Button noted that an airline domiciled in India enjoys advantages arising out of bilateral agreements with other countries. Having a large scale is important, but there could be room for well-run medium-sized players like Southwest Airlines, he said. “The crucial thing is network management to have the optimal network,” he said. “Size isn’t important. Having quick turnaround to the airport, having an appropriate fleet and having a good balance of business (including cargo traffic) is a good business model.”

However, Button is not sold on the durability of a low-cost business model for airlines. He pointed to a paper he wrote in 2012 titled Low-Cost Carriers: A Failed Business Model? “Low-cost carriers grow for a while, then they go out of business and go bust,” he said. “Or, they may grow very fast and then … morph into something different [like] a medium-type carrier, with additional revenues from add-on services and so on. If you start looking at statistics, an awful lot of low-cost carriers enter and leave the market every year. We don’t hear about them. Jet Airways is a fairly large one that went under.”

“It is difficult to do a Phoenix-style resurrection of [Jet Airways].” –Kenneth J. Button

Over the past five years, several low-cost Indian airlines have ceased operations, including Air Pegasus, Air Costa, Air Carnival, Air Deccan, Air Odisha and Zoom Air, as a report in The Hindu newspaper noted.

Fate of Employees

Perhaps the biggest casualty of Jet’s shutdown is the fate of its employees, including their unpaid salaries. Airlines including SpiceJet and Air India are offering jobs to Jet Airways staffers, while offers have been flowing in from several startups as well. Chaudhuri said that Jet’s employees will most likely find jobs at other airlines as they add capacity.

Meanwhile, Passengers would ask if they could trust the airline in the future, Button added. “It is difficult to do a Phoenix-style resurrection of the business.” However, passengers are not likely to be affected beyond the immediate cancellation of flights, Button noted. “Passengers may not even notice much a few weeks after an airline vanishes.”

Image: By Robert Underwood – VT-JEH@LHR 18AUG12, CC BY-SA 2.0, https://commons.wikimedia.org/w/index.php?curid=29617570