In mid-may this year, G.R. Gopinath, the man who pioneered low-fare aviation in India, was a worried man. The initial public offering (IPO) of Deccan Aviation (Air Deccan is the brand) was all set for launch, but the stock market was in the vice-like grip of bear operators. Keeping its fingers crossed, Deccan went ahead with the IPO, only to find that on the day of its opening (May 18), the bse Sensex tanked 826 points. The second day, the index swung another 800 points. Faced with near-certain failure, the company slashed the issue floor price of Rs 150 to Rs 146 and extended the closing by three days. But as luck would have it, the Sensex was at its volatile best the following week and swung a record 1,111.7 points. With great difficulty, Deccan and the issue's lead managers, Enam Securities and ICICI Securities, managed to drag the IPO over the line, ensuring it was oversubscribed a measly 1.23 times by May 26.

Cut to mid-July and the mood at Air Deccan's four-storey office on Bangalore's Cunningham Road could not be more different. There's a new surge of optimism among Gopinath and his top managers, thanks largely to a 2 per cent increase in its June market share to 21.2 per cent, which puts it marginally ahead of Indian. Not bad for an airline that took wings just three years ago. (For the record, the state-owned carrier has disputed Deccan's claim.) "This is a vindication of our low-cost model," beams Gopinath, a former army captain, who raised Rs 373 crore from the sale of 24.5 million Deccan shares.

There's little doubt that low-fare airlines have transformed the domestic market, never mind that a full-service carrier, Jet Airways, still has the lion's share of 32 per cent. Three years ago, less than 14 million passengers were flying the domestic sectors every year. By the end of 2005, that figure stood at about 28 million, and is expected to more than double over the next four years. In that time, the no-frills carriers are expected to increase their market share from 26 per cent to between 35 and 40 per cent. "Low cost is the way to go in the short-haul market globally and the trend is catching up in India too," says Ajay Singh, Director, SpiceJet. Adds Jeh Wadia, Managing Director, GoAir, another no-frills airline: "More than 60 per cent of the airline traffic is concentrated in Delhi and Mumbai. As the low-cost carriers cover more cities, the options for train passengers will increase and the market will see increasing depth and width."

Low Fare, But Low Cost?

It is that promise that has drawn a number of new players to the industry (see Crowded Skies). At present, there are an estimated 17 to 18 million daily rail passengers and another 10 to 12 million who travel by bus. "If we get just 5 per cent of this, we could have 1.5 million people airborne daily," points out Gopinath. Yet, if his investors aren't rapturous over either Deccan's market share gain or the market potential-the Deccan stock is down to Rs 74 from the list price of Rs 148-it's because stiff price competition has ensured that few airlines make profits. In Deccan's case, it is expected to lose money at least uptill 2007-08.

Why? To put it simply, while Deccan is low fare, it's not quite low cost. Blame it on the nature of the industry and Deccan's own peculiar problems. Running an airline is an extremely capital-intensive proposition. It costs anywhere between $225,000-$325,000 (Rs 1.06-1.53 crore) per month to lease an Airbus A320, which is what Air Deccan flies on longer routes. Maintenance costs (including mandatory 'maintenance reserve') can be as much as $150,000 (Rs 70.5 lakh) per plane for labour charges alone, with spares being billed additionally. Employee costs (essentially pilot wages) can be as high as 11 per cent of operating revenues. Fuel costs take another third off the revenues. Do the math, and this is how Deccan's costs are expected to break up as a percentage of revenues in 2005-06: Fuel, 47 per cent; lease rentals, 15 per cent; employee and maintenance expenses about 10 per cent each; and commissions about 5 per cent.

Some of Deccan's higher expenses are due to its own mixed fleet and inefficiencies. Unlike the only other listed low-fare airline, SpiceJet, Deccan operates a fleet that comprises 14 A320s and 22 ATRs (smaller, 48- and 72-seater planes that do feeder routes). That means the airline has to maintain a duplicate set of everything: Pilots (they need to be type-certified; an A320 certified pilot cannot fly an ATR and vice versa), engines and spares, and maintenance engineers. In his quest to corner market share, Gopinath has spread the airline thin, which means some of his routes are not profitable at all. For example, early August, the airline announced it was discontinuing its service on the Delhi-Kanpur, Mumbai-Nashik and Lucknow-Kanpur routes for being unviable. Once again, Deccan's flight dispatch and passenger load factor (that is, capacity utilisation) aren't as good as SpiceJet's. Not only does SpiceJet (earlier called Royal Airways and prior to that ModiLuft) have the highest load factor of 86 per cent in the industry, but it boasts an impressive flight dispatch rate of 99.5 per cent. Consider the irony, though: SpiceJet still reported a net loss of Rs 41 crore on revenues of Rs 453.15 crore in 2005-06, its first full year of operations.

The fact that SpiceJet operates a vastly smaller, single-type fleet comprising just five Boeing 737-800s and flies to only 12 destinations in the country, compared to Deccan's 55, should have helped. If it didn't it only points to the difficulty of making profits in this business. By that argument, Deccan needs to pull up its socks even more. "Our on-time record was terrible-just 60 per cent in February-April (2006). We clearly had issues to resolve this problem if we wanted to improve the airline's perception," says Warwick Brady, hand-picked by Gopinath in end-2005 from global low-cost carrier Ryanair to be Deccan's coo. When you are an airline, quick turnarounds of the aircraft make or break your profits, since expenses are incurred by the hour, and per landing and take off. So, one of the first things Brady, 41, did was to fire 10 ground handling agents and get new ones. Since his arrival, Deccan's on-time dispatch has improved to 80 per cent, but some analysts still expect the airline to report a net loss of Rs 171 crore for 2005-06 (results are expected late September).

Staying Power

Gopinath knows only too well that market share alone does not mean much. To become a profitable low-fare airline, Deccan needs to wring cost out of its system. In fact, that was the primary idea behind the IPO. For instance, of the Rs 373 crore raised, Rs 133 crore will go towards repaying debt, saving Deccan Rs 8-9 crore in annual interest charges. Brady also says that the airline will invest about $25 million (Rs 117.50 crore) over the next couple of years in a 60,000-sq. ft hangar in Chennai, engineering facilities and a pilot training centre in Bangalore or Hyderabad. "The hangar facility is important for us to undertake routine maintenance in-house to cut costs," says Andy Daines, Vice President (Engineering).

By the end of this financial year, Deccan hopes to have a fleet of 19 A320s and 26 ATRs, and each aircraft needs to undergo 10 days of annual scheduled (and unscheduled) checks. At present, the aircraft are sent abroad for the mandatory checks at a significant cost. "It costs us Rs 30-35 lakh to fly an empty plane to Singapore and get it serviced every 4,000 km and then fly it back empty," says M.G. Mohan Kumar, Deccan's Finance Director. "Instead, we are examining the possibility of doing that in India and cutting this expense." A local maintenance facility would also allow Deccan to troubleshoot unscheduled groundings faster, thereby keeping its aircraft in the air longer.

Simultaneously, the airline, which has ordered 96 aircraft for delivery over 96 months, is trying to push its non-fare revenues. Abroad, it is not unusual for low-fare carriers to get as much as a quarter of their revenues from non-ticket sales. In Deccan's case, the figure is just 9 per cent. "Your imagination is your limit," says John Kuruvilla, Deccan's Chief Revenue Officer, on the revenue potential. On that count, the airline has been innovative. It has sold space on its aircraft body to advertisers, monogrammed logos on headrests and even painted the roof of its aircraft with the colours of an insurance company for advertising rupees.

Gopinath's strategy seems to be simple: He wants to woo an ever-increasing number of first-time flyers, fly to newer destinations (including nearby countries), and continue to give full-service airlines such as Jet Airways and Indian a run for their money. But how to do all that while keeping his costs pared to the bone is a tightrope walk he will have to perfect.