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Past Issue • Apr-Jun 2016

Low Cost Airports: Catalysts For Inclusive Growth

Low Cost Airports: Catalysts For Inclusive Growth

“The world is focused on Indian aviation – from manufacturers, tourism boards, airlines and global businesses to individual travellers, shippers and businessmen. If we can find common purpose among all stakeholders in Indian aviation, a bright future is at hand.” – Tony Tyler, Director General and CEO, International Air Transport Association (IATA).

In 2015-16, Indian domestic passenger traffic has shown an increase of 21.2% as compared to 2014-15. When compared to the global average growth of 6.7% in the same period this is highly impressive. The domestic aircraft movement too has shown an increase of 12.8% as compared to 2014-15.

While the remarkable growth figures have earned India the crown of ‘being the fastest growing aviation market in the world’, the moot question is how long can this crown be retained? The poor state of airport infrastructure is highlighted by the fact that the country has one airport to every eight million citizens, as compared to one airport to every 170,000 citizens in USA (See Table). The disparity is huge even if one gives consideration to difference in population densities of the two countries.

lca-table-1

Between now and 2039, we could add another billion people to the global middle class and consume a whopping 23% of global middle class consumption. The rising disposable income and aspirations for a better lifestyle is likely to make this set of people the primary drivers of air traffic growth.

Even the asymmetrical traffic pattern at airports is a matter of concern. In 2015-16, the ten busiest airports handled 78% of the total passenger traffic and 74% of the total aircraft movement in the country. These airports are located at the metros and Tier 1 cities, leaving vast swabs of hinterland underserved. Such unbalanced growth of traffic will soon saturate the busiest airports while smaller airports will continue to remain in a state of disuse. The lack of inclusive growth in air traffic can be a dampener to rapid aviation market growth in India. In my opinion, this is the single biggest challenge that will be faced by the Indian aviation sector in coming years.

Need for Inclusive Growth in Air Infrastructure

India has added 6.7 million adults to the middle class between 2000 and 2015. Between now and 2039, we could add another billion people to the global middle class and consume a whopping 23% of global middle class consumption. The rising disposable income and aspirations for a better lifestyle is likely to make this set of people the primary drivers of air traffic growth. Residing mostly in Tier 3 cities, this group will have economic necessity to connect with Tier 1 cities having big jobs, big businesses and international gateways. The surging demand for regional connectivity is currently being met by rail and road. For air travel to become the primary choice for such connectivity, inclusive growth in infrastructure located within easy reach of such commuters is a must.

A Practical Model for Inclusive Growth

The demand for air travel among Tier 3 cities is likely to be in two categories:

  • Type A: Connectivity with the Provincial Capital cities (Tier 2) such as Chandigarh, Nagpur, Jaipur, Bhopal, Pune and others
  • Type B: Connectivity with large Metros (Tier 1 cities) such as Delhi, Mumbai, Bengaluru and Hyderabad.

A time tested model is of a regional hub in provincial capitals with spokes in numerous Tier 3 cities; while simultaneously having a metro hub in Tier-1 cities with spokes in provincial capitals. The regional hubs would be established by regional operators like Air Pegasus and Truejet, utilising propeller aircraft that require lower maintenance and shorter runways but also with lower passenger capacity. The metro hubs would be supported by scheduled commercial airlines like Indigo, Jet and Vistara having high capacity, high maintenance aircraft.

lca-types-a-b

Achieving connectivity between Tier 3 and Tier 1 cities is an uphill task as Tier-1 Airports in India are thoroughly congested and getting more so. A traveller from say, Gaggal (Himachal) wishing to travel to Delhi will have to first come to a Tier 2 city, say Chandigarh through regional airlines like Air Pegasus or TruJet. Aggregation of travellers from various Tier 3 cities will take place at regional hub and a national airline like Indigo will ferry them to Delhi. Code sharing could be done by specific regional and national airlines to enable seamless transfers at regional hubs. While the value proposition for commuters in Metro hubs would be both facilities and fares; in regional hubs it would exclusively be rock bottom fares. Hence Tier 3 cities would be best served by Low Cost Airports (LCAs) that can have facades similar to school gymnasiums with no frills, no air-conditioning and no parking charges. Such airports will also have less manpower, use close-circuit cameras and motion detectors, and do away with X-ray machines, aerobridges, and buses for travellers. Free land, aircraft centric security and firefighting services could be provided by state governments to drive down operating costs.

To make regional hubs more cost-effective, one may consider co-locating heliports with such airports. Regulatory relaxations in National Civil Aviation Policy are likely to popularise helicopter services, and with better penetration of remote areas they will have a positive effect on commuter traffic.

Commuters will travel by air only if ‘convenience and fares’ are competitive to other modes of travel. A lesson can be drawn from the strategy utilised by ‘Uber’ to transform luxury to necessity through astute leverage of subsidies and technology.

Enabling Inclusive Growth in Aviation

Commuters will travel by air only if ‘convenience and fares’ are competitive to other modes of travel. A lesson can be drawn from the strategy utilised by ‘Uber’ to transform luxury to necessity through astute leverage of subsidies and technology. When Uber entered the Indian market in 2014, travel by cabs was considered to be ‘upscale’ and auto rickshaws were the norm. Using deep pockets, Uber provided cabs to travellers at the price point of an auto rickshaw and ensured their regular availability by incentivising cab drivers. Technology was exploited for providing ease of convenience. This strategy has made cabs an essential part of a commuter’s life and hailing a cab no more generates pangs of guilt.

It is eminently clear that at current price points, the Uber model does not have long term sustainability. The company will either have to raise fares or find other revenue streams. However, when Uber does raise fares loyalty of commuters would be retained by ‘force of habit’, and due to the overwhelming convenience they experience in comparison to other means of travel.

To enable inclusive growth in aviation, airports need to be available within commutable distance and airfare needs to be at the price point of a train ticket. This is an ambitious vision considering the complexities involved. ‘Uberification’ can be achieved by subsidising airfares and incentivising airlines (cab drivers). An additional issue beyond Uberification is that of creating infrastructure. The government will have to maintain sufficient low cost airports and suffer losses till threshold level of traffic is achieved for additional revenue streams. A few solutions to achieve sustainable operations are below:

  • Tax air travel from metros to heavily subsidise regional air travel
  • Encourage foreign investment through innovative models
  • Construct/maintain low frill airports using Foreign Direct Investment and Viable Gap Funding
  • Privatise airport management
  • Minimise fixed costs of low cost airports
  • Minimise fixed costs of regional airlines and subsidise their variable costs
  • Ease entry and exit strategies for regional airlines to encourage more players
  • Incentivise national airlines to fly to regional hubs using route dispersal guidelines
  • Promote air cargo operations for alternate revenue streams
  • Co-locate regional hubs with heliports

The government is well aware of the situation and has come out with the National Civil Aviation Policy (NCAP) 2016 to provide a solution for all stakeholders.

The policy push has set the stage for development of low cost airports and improvement of existing ones through enhanced private sector participation and modernisation drive by the combination of Airports Authority of India and state governments.

National Civil Aviation Policy 2016

The NCAP has addressed key issues by introducing guidelines for regional connectivity scheme, regional connectivity fund, viability gap funding, route dispersal guidelines, easing of entry barriers for regional airlines, code sharing and trading of available seat kilometres, easing of IRR requirements for greenfield airports, simplified cargo operations, relaxed norms for helicopters and 100% FDI norms. The Airports Authority of India (AAI), State Governments and private players have been encouraged to become partners in the aviation growth story. Such an approach will diffuse risks and promote inclusive growth.

However, the key lies in execution. The broad canvas of incentives to stakeholders is displayed in the table below.

The policy push has set the stage for development of low cost airports and improvement of existing ones through enhanced private sector participation and modernisation drive by the combination of Airports Authority of India (AAI) and state governments. The success of LCAs will depend on the durability of the business models.

Resilient Business Models for LCAs

The airfare charged by airlines is dependent on a number of variables, the most prominent being fixed costs and fuel charges. While the latter is dependent on global dynamics, fixed costs can be reduced by minimising charges levied by airports. Efficient low cost airports with resilient business models can bring in immense cost reductions that can further be passed on to airlines. Globally, governments have realised the advantages of privatisation of aviation infrastructure for efficiency and cost reduction.

Privatisation need not imply sale of property. The most practical scenario would be for a government to retain control over the type of facilities to be developed; while private operators oversee routine operations of the airport. As shown by Guislain and Kerf,( 1995), the degree of privatisation may vary from supply and civil works, to management contracts to complete transfer of property (Divestiture). The degree of risk sharing thus changes in increasing order from public to private ownership.

lca-table-2

Although a wholly privately managed airport has not yet been established in India, various models of airport infrastructure provision have been used that range from publicly held airports (with a state government stake) to those operated and managed by the government. A few examples are provided in the table below:

The above models work well in areas with established air traffic. However, private players are disinclined to invest in remote areas with static traffic growth. Till such time a minimum threshold of traffic is achieved, such investors have to be compensated by subsidies, soft loans and equity participation. Innovative models to overcome capital shortage are the order of the day.

lca-public-private

The airfare charged by airlines is dependent on a number of variables, the most prominent being fixed costs and fuel charges. While the latter is dependent on global dynamics, fixed costs can be reduced by minimising charges levied by airports.

lca-public-private

lca-public-private

Suggestions for Enabling Profitable LCAs

Aviation infrastructure projects are high capital expenditure undertakings often beyond the financial capability of private operators. The governments often have to provide support by absorbing initial losses and providing low cost funds. A few suggestions in Indian scenario are discussed below:

1. While the PPP models in five airports (Delhi, Mumbai, Bengaluru, Hyderabad and Kochi) established by AAI with private operators have overall been profit making and providing as much as 60% of the total revenues, 93% of airports wholly owned by AAI have made losses. According to the profitability statements of airports managed by AAI, eight airports registered profits in 2013-14.
Considering the demonstrated success of PPP models, privatisation of above AAI managed airports in PPP mode is recommended. Revenue generated from these airports can be utilised towards LCAs. Such LCAs can then be put under management contracts with private operators for extended durations. On achieving commercial viability, these airports could then be brought under the PPP umbrella.
2. The government has not been using financial instruments for funding LCAs. Introduction of tax-free bonds against future earnings of the airports can be a low cost source of funds.
3. AAI can have long term partnerships with individual airlines for funding of LCAs. Airlines contributing to specific LCAs can have long term exclusive rights at these airports including naming rights. These arrangements would be mutually beneficial to both stakeholders. The airline can make it a low cost hub, while airport operator would have assured traffic.
4. Airports at regional hubs like Jaipur, Chandigarh, Bhopal, Pune amongst others can also serve as ‘Fulfillment Centres’ of ecommerce companies. Cargo operations by regional airlines can generate substantial non-airside revenues to compensate for fixed costs.
5. Defence Offsets have the potential of bringing in billions of dollars from OEMs in joint ventures with Indian companies. Currently, this investment can only be utilised in defence related projects. Investment in airport infrastructure can be made an acceptable means of discharging offset obligations, thus making vast funds available for the purpose.
6. Regional airlines ought to develop deep understanding of needs of local businessmen/ commuters by adopting a customer first approach. For e.g., a local vendor carrying excess baggage in relation to metro commuters. Enabling higher baggage allowances for such commuters will provide disproportionate gains in commuter traffic.
7. Seamless and efficient inter-hub transfers should enable an international tourist to reach interiors of Tier 3 cities with relative ease. Such experiences can bring in a continuous flow of tourist traffic

Conclusion

The success story of Indian aviation will depend on two primary drivers; low fares and increased connectivity. Low fares can be sustained by alternate revenue streams and innovative utilisation of tax payer’s money. Improved connectivity can be obtained by no frill airports that connect to each other through airline hubs.

SouthWest airlines successfully identified the requirements of local commuters and designed their model around these needs. They are one of the most successful airlines in the world. A similar customer first approach by our Low cost airports and regional airlines can yield rich dividends. It is time for Indian aviation industry to compete with Indian Railways.

References

http://www.aai.aero/traffic_news/TRMar2016.pdf

http://www.hindustantimes.com/business/india-fastest-growingaviation-market-in-the-world/story-1dDZlE1AZygsPV3LUK3RAN.html

These are airports at Delhi, Mumbai, Bengaluru, Chennai, Kolkata,Hyderabad, Kochi, Ahmedabad, Goa and Pune

http://www.indiastat.com.ezproxy.exchange.isb.edu:2048/table/transport/30/totaltrafficaircraftmovementatairportofindia20022016/286831/483750/data.aspx

http://www.business-standard.com/article/current-affairs/indian-middle-class-is-24-million-not-264-million-credit-suisse-115102900181_1.html

http://siteresources.worldbank.org/EXTABCDE/Resources/7455676-1292528456380/7626791-1303141641402/7878676-1306699356046/Parallel-Sesssion-6-Homi-Kharas.pdf

https://www.linkedin.com/pulse/think-small-why-next-evolutionindian-aviation-ushered-agarwal

Guislain P, Kerf M (1995) Concessions: The way to privatize Infrastructure sector monopolies, World Bank Report.
Ohri Manuj (2009), Discussion Paper: Airport Privatization in India,Springer Science + Business Media

https://factly.in/93-government-owned-airports-are-makinglosses-collective-loss-4788-crores-last-four-years/

http://www.business-standard.com/article/economy-policy/aai-srevenue-flow-might-have-improved-with-privatisation-of-airports-115082000016_1.html

ABOUT THE AUTHORS

  • Col.-Rajiv-Bhargava

    Col. Rajiv Bhargava

    Col. Rajiv Bhargava is Associate Director at the Munjal Institute for Global Manufacturing at the Indian School of Business (ISB). His areas of interests cut across Aerospace and Defence, Renewable Energy and Product Design and automation.
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