SpiceJet in Q2: Great Performance in Testing Times

Key points

• SpiceJet's heavy market stimulation produced India's highest domestic load factors in recent history.
• Higher loads pointed to higher revenue per available seat kilometre (RASK) in a low season. Average Q2 load factor was 82.5%, 8 points above the domestic average.
• The airline changed its brand, network and service to attract passengers, added loyalty measures to keep them, and used data driven pricing to fly more of them.
• Between January and September 2014 SpiceJet transformed its service and its passenger and ancillary revenue, the fastest turnaround of its kind in Indian airline history.
• Costs fell, but both costs and revenue suffered from a lack of funds, through cancellations, merged flights and weak bargaining power with suppliers including maintenance.
• Had SpiceJet's cost per available seat kilometre (CASK) matched IndiGo's or GoAir's, it would have been the best performing low cost airline on a revenue to size basis.
• CASK was between INR 4.1 and 4.2, peak season RASK around INR 3.7 to 4.0, and low season RASK around INR 3.3 to 3.4.
• A Q3 FY15 profit was possible only with a further infusion of funds.

The setting

Through July, August and September 2014 SpiceJet had the highest domestic load factors in India, averaging 82.5%, a full 8 points above the industry. Fuller aircraft meant every seat contributed, whether through a cheap early booking or a high last minute fare. Ancillary revenue also rose on the back of more passengers and a more aggressive approach to extras.

Revenue is only half the story. Costs at the airline stayed high, largely because it lacked funds. As the Q1 press release had noted, the airline kept paying extra interest and funding costs caused by heavy losses carried forward. Raising money costs money.

A study prompted by severe SpiceJet delays at Bangalore on 30 October 2014, caused by problems inside its ground handler Globe Ground India, revealed how the cash shortage was hurting supplier relationships. With large dues outstanding, the airline could neither negotiate better terms nor switch providers, which raised costs. Cancellations were rising too, above those of the two other notable LCCs according to DGCA data: 0.36% in July, 0.6% in August and 0.95% in September. Sources said aircraft could not be released from maintenance on time for want of funds, so flights were cancelled or merged, costing revenue. GoAir and IndiGo had lower cancellation rates.

Without the funding problem, SpiceJet might have posted a very small profit or a mild loss in Q2 FY15. It had been profitable in a Q2 only once in the previous five years, in FY2010-11. In spirit and performance, SpiceJet had become the true AirAsia of India, which was no surprise given that two of the key people driving it came from AirAsia.

The acts leading to the results

Since January 2014 SpiceJet had run 28 discounted fare sales, about 2.8 a month, and The Flying Engineer counted at least 47 distinct actions by the team, a number only possible with experienced planners and executors.

• To cut costs, the network was rationalised and the fleet trimmed to 32 or 33 Boeing 737s, from 42, plus 15 Q400s, with one of each usually in maintenance. Older and non standard 737s were returned (high gross weight versus standard, dual versus single FMC, ETOPS versus non ETOPS), giving a more uniform fleet. A single type would have been ideal, but the Q400s reached Tier II and Tier III markets no one else served, giving monopolies or duopolies and the highest yields.
• The damaged brand was repaired with a cabin refresh, customer service training for cabin and ground staff, more efficient aircraft cleaning, a dedicated wash hangar at Chennai, and in flight music.
• The in flight menu improved through partnerships with TajSATS and Cafe Coffee Day. Service improved through a better network and frequencies, SpiceMAX extra legroom seats, priority check in, Bags Out First, an internet banking fee waiver and the SpiceFlex bundle.
• To win back trust, passengers had to experience the changes. Heavily discounted advance fares pulled in people to try the new SpiceJet, turning sceptics into loyalists.

The sales drives

The sales grew in frequency and intensity after Kaneswaran (Kanesh) Avili joined as Chief Commercial Officer on 1 April 2014, along with Fares Azeem Kilpady as VP and Head of Revenue Management. Kanesh had been a key member of the team that bought AirAsia from the Malaysian government and built it into Asia's leading LCC, and had worked at three other airlines including Tiger Airways. Kilpady came from AirAsia X, where he headed revenue management and pricing. A SpiceJet press release of 4 March 2014 already quoted COO Sanjiv Kapoor crediting promotions to an expert team well versed in LCC revenue and capacity management, suggesting the pair had a hand in the sales as early as January.

The sales were not desperate dumping of seats. With nine years of operating data, the airline could predict seasonal demand by route and identify the seats most likely to fly empty, flight by flight. Only those seats were sold at headline grabbing prices, and the discounted fare was usually slightly above the cost of carrying the extra passenger. So the airline made money.

Example: Bangalore to Delhi

Bangalore to Delhi was the airline's longest sector, so an extra passenger there carried the highest fuel penalty. A Boeing 737-800W on this roughly 1,000 nautical mile trip, landing near 63,000 kg, burns about 6 kg more fuel for every extra 100 kg, the industry standard passenger plus baggage weight. Six kilograms of fuel is about 7.5 litres, and at around INR 74 a litre that is INR 555.

During the Re 1 sale on 1 April 2014, The Flying Engineer bought a Bangalore to Delhi ticket for 6 October at INR 799 including fuel surcharge, taxes and fees extra. That left INR 244 above the fuel cost. Allowing INR 50 to 100 for the CUTE fee, the airline cleared roughly INR 144 to 194, about INR 170, per passenger, since the other costs of carrying one more person are close to nil.

Making money

Apart from the actual Re 1 fare, most offers made money. With around 40,000 passengers a day, giving away 1,000 promo seats, 2.5%, was modest. At INR 170 each, 1,000 tickets a day over a year adds INR 6.12 crore of profit, and most sales had higher margins than that.

Disproving the sceptics

Critics argued that discounts simply let people who would have flown anyway pay less. That would be true only if load factors had stayed flat. They did not. Q2 FY15's average load factor of 82.5% was a 15 quarter high and consistently the industry's best, reaching 85.9% in September, 14.1 points above Q2 FY14. Capacity grew and aircraft flew fuller, so more passengers and more revenue came in. The sales did not undercut regular fares either: SpiceJet did not sell its cheapest tickets close to departure, and its late fares were slightly higher than competitors, maximising yield and RASK.

This was the highest load factor Q2 in SpiceJet's history. The last quarters with loads this high, Q1 and Q3 FY11, produced net profits of INR 55 crore and INR 94 crore, and Q1 FY13 at 80.7% produced INR 56 crore, but those were peak seasons. SpiceJet had made a low season work for it, echoing AirAsia's view that seasons are what you make them.

RASK and CASK

Based on published Q1 figures, CASK stood at INR 4.1 to 4.2 while peak RASK was estimated at INR 3.7 to 4.0 and low season RASK at INR 3.3 to 3.4. Without the cash crunch, or with shareholders putting money in, Q2 might have been a small profit or a soft loss.

Cash flow, predictability and pricing power

Because most sale tickets were for travel two months to a year ahead, advance bookings rose sharply. That brought cash to keep the airline afloat, and it gave revenue management room to set higher fares close to departure, a bet that late travellers would pay more. Far out bookings also meant many cancellations without refund and no shows, both of which helped the airline.

Ancillary revenue

New products fed off the larger passenger base. The on time guarantee voucher, not redeemable for cash, gave people a reason to return. Hot meals, SpiceFlex, SpiceMAX and Bags Out First brought in money. Meal prices rose from INR 250 to INR 350 with a bundled drink and yoghurt or brownie, and the pre booking discount fell from 25% to 10%. Every INR 10 increase in meal profit yielded INR 14.6 lakh a year for each 1% of passengers (400 a day) who bought.

On 22 of the 33 Boeing 737s the first five rows (30 seats) were reset to 35 inch pitch and sold as SpiceMAX for INR 800 extra. Other window and aisle seats up to the exit row cost INR 300 and exit row seats INR 500, allowing up to INR 39,600 of seat revenue per converted aircraft per flight, or about INR 8.6 crore a year per aircraft at six flights a day. SpiceMAX launched on 7 August and included priority check in at select airports. Bags Out First cost INR 300 for two bags and INR 600 for four. An SME travel portal targeted the highest yielding last week bookers, and SpiceFlex bundled change fee waiver, a hot meal and preferred seating for business travellers. A cargo deal with DELEX guaranteed minimum revenue plus a share above a minimum weight, and cargo per ASK rose by as much as 23.6% in April year on year. Ancillaries were estimated at about 10% of revenue, with room to grow.

Performance indicators

DGCA data for domestic and international flying showed capacity shrinking in Q1 FY15 as the fleet contracted, then rising in Q2 through higher utilisation. Passengers per ASK rose year on year in every month except August, with September exceptional. Cargo per ASK beat the previous year throughout. Flight hours per departure fell, meaning shorter flights after long unprofitable international routes were dropped. Only in August did passenger and cargo growth per ASK trail capacity growth. Low season demand still limited fares, so Q2 RASK was below Q1 but well above Q2 of the previous year.

Comparison with IndiGo and GoAir

IndiGo led only on market share, with about 530 daily flights, almost 50% more than SpiceJet, and a fleet of more than 80 aircraft, double SpiceJet's. It trailed on load factor, carried fewer passengers per ASK and flew less freight. Its lower CASK kept it profitable at a lower RASK; with IndiGo's CASK, SpiceJet would have outperformed it per ASK.

GoAir, the only other profitable LCC, flew just 19 aircraft, carried fewer passengers per ASK and flew emptier aircraft, but had India's best cargo per ASK, possibly because its parent group, which owns Bombay Dyeing and Britannia Industries, used it to move its own goods. With GoAir's CASK, SpiceJet might have outperformed it as well. SpiceJet's aircraft utilisation, though rising, still lagged both, partly because its Q400s flew short sectors.

Conclusion

Sanjiv Kapoor took SpiceJet into surgery and brought in Kanesh and Fares Kilpady to operate. Despite the airline's poor finances, the commercial team flew more passengers and generated cash through advance sales in record time, lifting RASK. The Q1 FY15 report to the BSE showed how badly the previous Q3, normally the strongest quarter, had gone; fortunes changed in January 2014 when RASK began rising year on year and kept rising despite more capacity and competition.

Those best practice LCC results were being eclipsed by the cash crunch, which kept costs high and cut revenue through daily cancellations. A Q3 FY15 profit was possible, but only if shareholders quickly injected more capital. The earlier INR 300 crore infusion did not go far. A success story proven in numbers risked going to waste without timely funding.

One reader disagreed with the IndiGo comparison, arguing that IndiGo and GoAir had lower costs for reasons SpiceJet could not easily copy, and that the Q400's extra revenue was offset by its higher maintenance cost per seat.