The two pitfalls that led to SpiceJet's financial debacle

The airline dropped fares to gain customer load, but failed to cover the cost of its flights

Two mistakes in SpiceJet’s strategy brought the airline to its present financial crisis.

One happened two years ago when SpiceJet under chief executive officer Neil Mills decided to change the airline’s business model. It wanted to cash in on a first-mover advantage by flying to smaller cities. As a result, it was forced to change its single aircraft configuration of Boeings and added the 78- seat Bombardiers, something most budget airlines avoid to keep costs low.

The second is its aggressive turnaround strategy based on discount fares in the hope that it will be more than made up by the increase in the passenger load. This did not happen.

Mills wanted to be the first to go to uncharted markets like Hubli, Tirupati and Amritsar, and leverage the benefits of being the first mover for six to eight months. His strategy also included connecting smaller cities with the metros.

And by getting smaller aircraft Mills could fly to over 96 airports across the country and expand the market. SpiceJet also expected its key competitor, IndiGo, would not be able to fly into these cities because it did not have the appropriate aircraft.

SpiceJet didn’t anticipate that by handling two kinds of aircraft, for which it had to keep separate spare parts, maintenance personnel and pilots, it was increasing costs. Budget airlines like Air Asia or EasyJet prefer a single-aircraft configuration, as does IndiGo. The second problem was as SpiceJet went on opening new stations in smaller cities it did not assess if these could handle a number of flights each day so that costs could be amortised.

Airlines have two ways to drum up business. They can keep fares stable even if it means low passenger loads. That is what IndiGo does. The alternative SpiceJet chose was to drop fares and improve revenue through higher passenger loads. There is nothing wrong in this as long the cost of the flight is covered.

If it is not, the downside of this strategy is far more severe. “Higher passenger load means you have to load more fuel, the staff will be under pressure because it has to handle more passengers, the chance of delay will be enhanced and if you are on cash and carry for oil you have to fork out more,” said  a senior executive with an airline.

It still works if an airline makes the revenue on a flight to match costs. Though SpiceJet’s revenue per available seat kilometre did improve, it did not meet the cost of available seat kilometer. So operational losses continued. SpiceJet’s financial results for the second quarter of 2014-15 reveal the airline’s revenue per available seat km went up by 12 per cent to Rs 3.35 but its cost of available seat km was much higher at Rs 4.07.

This is despite the passenger load factor climbing from 69 per cent in the second quarter of 2013-14 to 82 per cent in the same quarter a year later. And while its losses fell, they were still at Rs 310.4 crore (Rs 3.1 billion) for the quarter.

UK travel advisory

SpiceJet’s flight disruptions have found a mention in UK government’s travel advisory to its citizens. The advisory issued by the Foreign & Commonwealth Office refers to the cancellation of 400 flights in recent days and cautioned citizens of further disruptions and cancellations. The advisory asks the citizens to refer to airline website for updates.