MGCP Final Exam-Sandeep Taterway:61310057 Map Model ? Memo to AAI The advent of Public Private Partnership (PPP) model in infrastructure sector especially in airport development presents a tremendous opportunity for AAI to develop a sustainable, profitable and forward looking approach to solving myriad of problems plaguing the Indian airline industry. The genesis of the solution lies in the ability of AAI to attract private capital.
The shift from state owned airport model to PPP model though has been slow and is currently limited to a few major airports in the country but it has infused the much needed capital in the industry, which in turn reduces the AAI’s dependence on Government’s grants. My model emphasises on proliferation of this PPP model which will ensure consistent cash flows to the industry and will also help in improving efficiencies within the system. The interest of private players in this industry is driven by two perspectives.
Firstly by fast growing passenger and freight traffic and also by upside potential in non-aeronautical revenue. Thus in our quest to improve AAI’s sustainable profitability we need to address both these requirements of the private players. In my opinion we can approach them in the trailing manner. Generating passenger and freight traffic Due to requirement of high upfront investments in developing and operating an airport, it becomes pertinent that such investments are offset by revenues from passenger and freight traffic. AAI should take adequate measures to generate growth in demand for airports.
It is important to mention that airline industry is under constant threat from high speed rails and developing road network, especially for short haul flights. A price sensitive consumer, typically a middle class leisure traveller, which comprises almost 50% of the industry, is likely to switch to a cheaper mode of travel if prices of airlines are very high, thus reducing demand for airports. Thus for airlines to be able to generate demand, the prices should be low enough to remain competitive with other modes of transportation. Thus
AAI’s efforts should be concentrated on reducing prices for air travel. Apart from high fixed costs, airlines also pay fees to airport developers that have a direct correlation to the price to the end consumer. Thus we need to ensure that these fees are brought down without affecting the return on investment of the developer which would entail reducing the development cost. Infrastructure development projects of such magnitude are often marred by delays in land acquisition and subsequent hurdles in compensation and rehabilitation of those displaced by the project.
More often than not, the developers are engaged in long litigation processes to gain access to encumbrance free land, this leads to cost escalations and delays to the project. Therefore there is a need to have stringent and concise land acquisition and rehabilitation policies, which will directly reduce the cost of development. Reduction in development cost will lead to reduction in fees that are charged to the airline which in turn would increase the demand for air travel. As a result, airlines will run on capacity generating revenues to offset their high fixed cost and will be able to pay airport charges without default.
In turn AAI can use this revenue to develop newer airports taking into account social obligations. If there are still gaps in funding the development and maintenance of an airport, AAI should allow for charging of User development fee (UDF) to bridge the gaps. This will enable the operator to achieve fair rate of return on its investments and incentivise him to expand the infrastructure as per requirements which will further help in catering to a greater demand. Generating non-aeronautical revenue
Less that 20% of the revenue at airports is generated by non-aeronautical services compared with around 50% or more being achieved by airports around the world. The key determinant of non-aeronautical revenue is retail and duty free, both of which are still miniscule in the country. It thus represents a great opportunity for the aviation industry as Indians are travelling and they are doing so more often. They also have more money to spend and recent FDI approval in retail stands witness to this hypothesis.
The Wal-Marts of the world are beginning to line up to get a share of the great Indian retail pie. AAI is well positioned to take advantage of this advent. By expanding retail beyond the metro and Tier-1 city airports, we can generate sustainable revenues even from the loss making airports. In cases the airport in managed by a PPP driven Special Purpose Vehicle (SPV), the operator can generate revenue which will further help him to reduce fees to the airlines which have the spiral effect on reducing the fares of air travel and thus generating more demand.
On the fare regulation front for airlines, it is recommended that we adopt the rate of return method as it provides incentives for investing in capacity expansion as the focus of this method is to set a tariff that provides a certain return rate . Also cost cutting at the cost of compromised services doesn’t bring any extra gain in this method, thus there are no distorted incentives to do so. Capacity expansion on the other hand would lead to these airlines serving the newly developed airports across the country.
It is also recommended that for fixing airport fees, a dual till model is used at major airports where the assets, costs and revenues of an airport are allocated between two heads of aeronautical and non-aeronautical. For following this model, we would be able to utilise non-traffic revenues at these airports not just to further enhance the development of the airport but also to develop and maintain loss making airports which serve the social obligation of achieving nationwide connectivity.
We are today at inflection point in the airline industry, though profits have remained elusive, we need to take action to put the industry on a right case footing. Learning This case illustrates how integrating solutions for various stakeholders can guide strategic decisions which in turn can help solve even the most complex issues. I can summarize these principles into learning which can serve as a method for structured thought process in my everyday life.
The critical learning from this case lies in the complex interlinking of issues and how collaboration between various stakeholders can help mitigate even the most complex issues. For example, it is fascinating to note that land acquisition and rehabilitation policies of AAI are closely linked to what I pay for my travel. The spiral effects of one action on end consumer even though involving different stakeholders can be humongous. Thus it is imperative that no lax attitude at any juncture is acceptable in a complex project.
I could also directly relate to these issues as my prior experience with road construction involved budgeting for land compensation and rehabilitation. I always wondered why there is so much fuss about the amount of compensation that we need to pay to the rehabilitees. But this case helped me understand that if we paid excess for compensation for land acquisition, the total cost of the project would go up which in turn could only be recouped by charging a higher toll, the net effect is that passengers are more likely to switch to other non-toll roads to avoid paying these extra charges.
Another important learning from this case is the need of leadership skills when we want to bring about a change in perilous businesses like the airline industry. It is fair to assume since we, as Indians, didn’t develop the airline technology, we didn’t face the initial technological hiccups and one would assume that learning curve is much steeper in India and therefore progress should have achieved much faster. On the contrary India is plagued with deep rooted issues which have slowed if not stalled the progress of aviation industry.
The problem lies in the leadership as India does not have the ready reserve of airline industry people who have grown with the industry. Rather, the leadership has been derived from other sectors and is stuffed with entrepreneurs who are attracted to the industry but have little or no real airline experience. The Indian consumer too is not well versed coupled with the intensely bureaucratic government processes which have had a vice like grip on the industry.
In such complex scenarios, we needed some industry leaders who have both the knowledge and the tenacity to bring about a sweeping change in the industry. It could have been some top official at AAI or a seasoned aviation entrepreneur who is willing to place his bet on the Indian aviation industry. I believe the ability to lead in such conditions is a true test of leadership abilities and I would personally strive to lead my company and my industry in these settings.