When IndiGo starts operations on August 2 on the Delhi-Guwahati leg it will probably unleash India's bitterest airfare bloodbath, for its tickets will be priced at least 60 per cent lower than the competition.

Those rock-bottom prices might be available only for a short period, but with six aircraft by the end of the year, the airline hopes to pick up 7,000 passengers every day.

Says Bruce Ashby, president & CEO of IndiGO: "We have budgeted for a loss of Rs 100 crore (Rs 1 billion) in the first year of operation. But that is nothing unusual as low-cost carriers take 18-24 months to break-even".

Three years ago, Air Deccan had started the trend with discount pricing that had established players like Indian Airlines, Jet Airways [Get Quote] and Air Sahara forced to introduce discounted fares and flexi-priced options.

Pretty soon, newer airlines joined the grand rush for the skies, and low fares became the norm, as passengers looked around for the most attractive fares rather than preferred airlines.

And it wasn't long before the aviation industry was split into two - full service "scheduled" carriers where you expected service and enjoyed a premium, and low-cost carriers where the debate was whether you could even buy a meal on board.

All of which is pretty good for the air traveller, but how will the airlines sustain themselves? It's a question many airline officials were already asking before IndiGo dealt them a blow in the solar plexus.

Clearly, at such low fares, airlines won't be able to survive accumulating losses. And thanks to IndiGo, raising already low fares is no longer a consideration. Is the party in the sky over even before it's started?

Take the case of Air Deccan. With accumulated losses of Rs 165 crore (Rs 1.65 billion), Captain G R Gopinath knows he is flying into increasingly turbulent space.

The Air Deccan promoter and CEO admits, "Yes, yields are under tremendous pressure. There is sudden panic and insecurity among existing players. And everyone has dropped prices."

Gopinath admits it could take two years to bring the company out of the red. "Till then, the challenge is to keep your head above water," says the king of India's low-cost carriers. But the market is no longer patient.

Air Deccan's maiden public issue scraped through - and then only after it reduced the issue price - and has faced a severe beating in the market with its Rs 148 share being traded at slightly over half the issue price.

Even passengers can see that airline companies are haemorrhaging as cut-throat competition forces tariff cuts in the face of escalating fuel prices.

Says Kapil Kaul, who heads aviation consultancy firm Centre for Asia Pacific Aviation, "What you will see is profitless growth, so the key is to survive by financing your losses and, at the same time, expand."

Industry experts reckon that private airlines lost $250 million last year, and are losing a whopping Rs 200 crore (Rs 2 billion) in cash every month just to stay afloat. And given IndiGo's entry now, and two more airlines to start service (Jagson Airlines this fall, and Easy Air next year), margins will bleed further like a sieve.

With the exception of Kingfisher Airlines, all entrants have chosen to go the low-cost route where the price of the ticket is the only draw. But the airline has made a loss of Rs 200 crore (Rs 2 billion) in 11 months of its operation in 2005-6. However, executives in the company hope to bring it down to Rs 100 crore (Rs 1 billion) this year.

Surely the new low-cost carriers will play the pricing game, at least when they begin. Agrees U K Bose, CEO of Jagson Airlines, "We will follow the low-cost carrier model and compete with existing players on price."

IndiGo also points out that it hopes to increase average revenue per passenger from Rs 2,000 to Rs 3,000 as it adds more routes into the network. Adding to the pressure on passenger yields is the problem of non-peak seasons when tariffs fall "by over 20 per cent", worries Ajay Singh, director, SpiceJet.

Already, investment bankers are ringing warning bells. DSP Merril Lynch in its June report warns investors to stay away from the aviation sector.

Even worse, it predicts that the only profitable airline in the private sector, Jet Airways might make modest losses in the coming quarter because of a sharp decline in yields and an increase in fuel costs.

And HSBC Global Research has forecast that Jet Airways could see its domestic yield fall by 12 per cent in the financial year 2007 as it is forced to surrender more tickets to the discount market.

Yet, to survive, airlines must spend more while they earn less. They need cash to sustain their losses and expand their fleets. Spice Jet needs four additional aircraft this year, Air Deccan is in the market for 16 planes - but the cash to fund those expansions might no longer be that easy to come by.

Many airline companies had hoped to cash in on the stock market boom, but that dream is over. Kingfisher Airlines has been forced to postpone its $200 million IPO issue indefinitely. The reason? The poor response to aviation stocks in the market. The alternative is private placement or raising debt from the market.

Says Kaul, "Capital is available, but at a realistic value." But Mohan Kumar, Air Deccan's financial director, warns, "It's getting difficult for low-cost carriers to get capital because everyone knows they have a high cash burn, and there are more viable opportunities like real estate and power."

Clearly, over the last few years something has gone wrong. Is it the low-cost model? Or are low tariffs simply not sustainable?

While there has been an unprecedented growth of 25 per cent more air travellers every year - Indian carriers now transport 25 million air passengers, and CAPA estimates this will likely grow to 60 million by 2010 - the critical issue appears to be the cut-throat price competition that has thrown plans out of gear as no one is able to increase fares.

Nor could the low-cost carriers have anticipated that scheduled airlines would fight back so aggressively, discounting fares sharply at the cost of adversely scaling down bottomlines to maintain market share.

Admits a senior executive at an equity fund that has invested money in Air Deccan, "What we did not anticipate was the intensity of the competition, though we were aware of everyone's plans."

But it isn't simply low tariffs that are hurting airlines. Gopinath says that unprecedented expansion has also led to an overcapacity of 15-20 per cent, resulting in a 15 per cent gap between average passenger revenue and average cost incurred per passenger. But to increase tariffs at the cost of losing passengers is simply not an option.

Others say there is no overcapacity at all - of course, at a certain price. GoAir boss Jeh Wadia is contrarily confident those seats will fill up some time soon.

"The market for low fares is greater than the capacity. It just takes time to convert rail travellers to air passengers and educate them on the lowest fares."

He may have a point - for now. But the reality is that with new players joining rank and existing players opting for expansion, more seats will probably be added before they can be filled up. If all current plans are taken into consideration, 20 million more seats could be added annually, to grow at a compounded 40 per cent at existing industry passenger loadfactors - far higher than the prevalent 25 per cent growth in the marketplace.

Even as low-cost carriers open up new air routes, they have no option but to price tickets lower in order to build up the market (60 per cent of Air Deccan's flights are on new routes). And now that the Jet-Sahara deal has been aborted, there are apprehensions that Sahara could again aggressively price tariffs to regain its lost market share.

Finally, as infrastructure constraints force more low-cost carriers to operate during off-peak times, any attempt to raise cheap tariffs to peak time rates will be met with opposition.

Scheduled airlines aren't helping the case of low-cost carriers with their aggressive pricing. Says Ajay Singh of SpiceJet, "On the Mumbai-Delhi route, the difference between low-cost carriers and scheduled carriers is no more than 10-20 per cent."

Air Deccan points out that on many routes Jet Airways has introduced flights in the same time band as theirs, offering low fares, ensuring lower load factor for low-cost carriers.

Analysts point out that in April-June 2006, Jet Airways sold only 40 per cent of its tickets at full fare, the rest being discounted to compete with low-cost airlines.

The pressure to expand routes has forced these carriers to move away from the classic low-cost model.

Says the CEO of an airline, "Typically, low-cost carriers use only one kind of aircraft, but Air Deccan has both ATRs and Boeings, which increases cost as you need two sets of inventories, spare parts, and even pilots. Other carriers have one kind of plane, but different engines, so again costs go up."

Air Deccan's Kumar argues that they have used two types of aircraft to build a new market, since it could not risk large-bodied aircraft on new routes till the numbers stabilised.

But there are other costs against which carriers have no control. The depreciation of the rupee against the dollar has made spare parts more expensive, particularly for low-cost carriers where the percentage of foreign travellers (and therefore dollar earnings) is low.

They've also been held hostage by the cost of aviation fuel that has gone up by as much as 30 per cent in the last year (15 per cent in the last three months alone). The option is to pass on the increased cost by increasing the surcharge for fuel on the ticket.

Says SpiceJet's Singh, "We have passed on most of the fuel hike, but if you ask me if it will dent growth, my answer is it could." Air Deccan has absorbed half the cost of the fuel increase, which has had an impact on its margins.

Ashby says they have built in the fuel cost hike in their tariff but if it goes up sharply, they may have to re-look at how they'll cope with the challenge.

Airport infrastructure is another burden on costs. Singh says that an hour of fuel burned because aircraft have to wait in a queue to get landing permission at airports, could make them poorer by Rs 80,000.

Adds Kaul, "Airlines are being forced to keep 2-3 parking slots in various cities where there is a shortage, as a result they pay 70 per cent more than international rates for this infrastructure, but are unable to utilise these assets efficiently." A shortage of trained manpower and pilots has led to increases on the salary front.

Who will blink first - the airline that will have to increase tariffs to survive, or the passenger who will not fly unless it's cheap?

Analysts are suggesting that, in spite of the Jet-Sahara merger falling through, what we are likely to see is consolidation within the industry: yes, expect some buyouts.

Tariffs too could move up, but not immediately. Wadia is sure fuel prices won't go up further. And once the government permits more, he says the "cost of engineering, ground operations and security will go down by 20 per cent under the new aviation policy".

Other carriers are looking at innovative ways to reduce cash burn and finance their expansion. Gopinath, for instance, is using a sale-and-lease method as a potent weapon to book profits - he earned $7 million selling aircraft he had booked earlier, but leasing them back for use by his airline.

Air Deccan is also part-financing its losses through infusion of equity and revenues earned in advance from ticket sales.

Says Gopinath, "It needs a huge societal change for the 200 million strong middle class to travel by air, but that inflection point will happen soon. Till then, you have to manage your growth and your cash."

Famous last words?

Will you have to shell out more for your low-cost airfare? Opinions are deeply divided for now, but Air Deccan's Mohan Kumar says a correction is already happening.

"Compared to last year, passenger yields have gone up by 20 per cent." But so have costs. GoAir's Jeh Wadia, whose average yield per passenger is at Rs 3,000, says, "Over a period of time yields will increase as prices get more realistic."

Private carriers point out that average ticket prices are likely to go up by 15-20 per cent because they can no longer sustain cash losses. With average ticket price yields at Rs 2,700-3,100, you should expect to fork out another Rs 500 on your ticket.

Says a senior airline executive, "Even Pepsi and Coke went on an all-out price war in the market to increase volumes. But when losses mounted and logic prevailed, they ended the price war and raised prices."

CAPA boss Kapil Kaul has a different take on the fare war. He says that with new competition coming up, any tariff increase can be ruled out for the next 12-24 months.

"There has been some correction and fares have gone up by 5-7 per cent," he says, "but I do not see them increasing further with new players and new capacity coming in."

That's two more years of cheap flying, if Kaul knows his business.

What you will see is profitless growth. the key is to survive by financing your losses and, at the same time, expand
Kapil Kaul, CAPA

On the Mumbai-Delhi route, the difference between low-cost carriers and scheduled carriers is no more than 10-20 per cent
Ajay Singh, SpiceJet

The market for low fares is greater than the capacity. It takes time to convert rail travellers to air passengers
Jeh Wadia, GoAir

It needs a huge societal change for the 200 million-strong middle class to travel by air, but that inflection point will happen soon
G R Gopinath, Air Deccan

We have budgeted a loss of Rs 100 crore in the first year. low-cost carriers take 18-24 months to break-even
Bruce Ashby, IndiGo

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