How IndiGo is backpedalling from its avowed LCC model

IndiGo has abandoned its pure low-cost carrier model

From inception through the beginning of 2019, IndiGo has been on a steady uptick. There were a few bumps on an otherwise stable ascent and on the metrics that matter the airline continued to deliver.

At the beginning of 2019, the airline was sitting on a cash balance of $2.2 billion, the lowest CASK in the industry at  US cents 5.16 and a market share of 46.9 percent in an environment where competitors had withered. Yet, few could foresee the clear air turbulence ahead, which emerged in mid 2019. This would change several things at the airline.

In May 2019, news emerged of a bitter discord between the two airline founders. The points of contention were reportedly the structure of the board and the ability to nominate the president, managing director and chairman of the board and the approval process involving related party transactions (RPT).

The timing of the rift was also important as the airline had several matters that required strategic guidance. One vital decision was the engine selection for the third batch of aircraft and also a new fleet order, which would be essential for the foray into international routes and whether to do it via narrow-body aircraft or wide-bodies.

While the promoter dispute played out publicly, the key point that emerged as far as strategic direction was concerned was that Rakesh Gangwal, until then the lead architect of the fleet plan and financing plan, was not fully participating in the discussions. An otherwise extremely hands-on figure in the monitoring of performance, he was not even taking the review meetings.

Interestingly, it later came to light that a very senior former Airbus executive was roped in to advise IndiGo and while the airline undoubtedly got a competitive deal for both the engines and the new aircraft order, these were a departure from the core tenet of the LCC model of a uniform fleet and engine type.

June 2019 saw the Paris Air Show where IndiGo announced an order worth $20 billion for aircraft engines. It was the largest engine order to date. The order was placed with CFM International for 280 Airbus A320neo and A321neo aircraft. CFM is a 50:50 joint venture between General Electric from the US and Safran from France. The order was a significant coup given that 87 percent of the IndiGo Airbus 320/21 fleet was powered by IAE and Pratt and Whitney with the IAE powered aircraft on their way out via fleet replacement cycles.

The engine order also meant that IndiGo was introducing complexity to its fleet. While the CEO in an interview indicated that beyond 70 aircraft, the induction of a second fleet type and a second engine type have no material impact, many industry insiders disagree. Interestingly, in their second quarter results, Indigo also saw higher maintenance costs per seat kilometre and a portion of this is presumably likely linked to the inability to rollover engine credits due to a switch of suppliers.

IndiGo also announced another major order for planes this year. Interestingly, this was done three months after the Paris Airshow, which caught several aviation analysts by surprise.

The order was a firm order of 300 Airbus 320NEO/321NEO aircraft. It included the extra-long-range (XLR) version, which reveals the stage lengths the airline will be targeting.

Partly, this order was necessary to continue financing the income stream that IndiGo has capitalised on. Based on current lease cycles and financing structures, the initial orders were set to have been fully absorbed by 2026 or 2028 depending on how the deliveries were brought in. As such, an additional order was needed.

But what is equally interesting is the nature and type of aircraft. The 321s give the airline 19 percent additional capacity per flight with economics that are still competitive. This enables the airline to continue to deliver on a competitive CASK, a measure of an airline’s unit cost.

The A321s and A321XLRs (extra-long range) enable more cities to come into the network enabling network expansion. Yet, what it also does is introduce varied stage lengths. And not all stage lengths are as profitable. An impact on the network CASK is all but certain.

As a side note, yet another aircraft order by IndiGo in the near term cannot be ruled out.

The year 2019 also saw rapid international expansion by IndiGo, including the addition of seven new destinations. The nature of the expansion was a further deviation from the LCC principles.

Destinations ranging from Myanmar and Malaysia to Vietnam and China were added to the network. Each had very different demand profiles and varying stage lengths. The recent announcement of flights to London is yet another step in this direction.

For IndiGo, the past, as it pertains to International expansion, may not be a predictor of the future. Because unlike some of the earlier stations where IndiGo captured a leisure and low-cost (labor) travel base, demand for cities such as Yangon, Chengu and Hanoi has to be stimulated. Seasonality also plays a key role.

Finally, the competitive landscape for the new cities IndiGo is targeting is also very different. From competing with the likes of Jazeera Airways in Kuwait (led by a seasoned team that understands the India market extremely well); FlyDubai in Dubai (with access to the broader Emirates network), Vietjet in Vietnam (a powerhouse in the region and likely to start flights to India) and AirAsia in Kuala Lumpur (a powerhouse in the South Asia region).

Its competition is not restricted to low-cost carriers because the full-service counterparts such as Singapore Airlines, British Airways, Emirates and the like can also offer fare levels that are at par or below. This challenge is partly alleviated by code-shares and alliances, which also add complexity to the mix. And indeed IndiGo has gone in this direction by entering into codeshares with Turkish Airlines and Qatar Airways. Yet, the codeshares signed are fairly restricted and geopolitics may not allow either one to deliver in terms of costs and cash flow.

Since its first flight in 2006, IndiGo has gone from strength to strength. In the domestic market, the airline is hovering just below a 50 percent marketshare. And by all indications its position here is only being strengthened via both market weakness and tactical moves. On fleet, it is well positioned with confirmed capacity through the next decade and beyond. And its network is evolving to include more international destinations.

Partly, this is inevitable. Because the airline is limited by the number of additional flights it can mount on domestic destinations before cannibalising its own traffic. And because crossing the hallway mark may also mean added challenges poses by the competition regulator and how that plays out is yet to be seen.

Yet slowly but surely, the airline has moved away from a pure LCC strategy. Complexity has been introduced to the business model and this will only grow with the introduction of long-haul routes like London. As volumes have grown, overall customer experience has declined – a view echoed by several travellers.

On the financials, the cost of delivery (CASK) has risen by 26-30 percent in the past five years depending on what metrics are grouped. Fare levels remain flat and some competitors have linked this to IndiGo’s dominant position and pricing strategy. Cashflows have remained healthy but as the international network matures, the operational cash flow will be interesting to watch.

IndiGo is no longer content with just being the dominant Indian airline but is intent on spreading its wings to the greater South Asia region. Its international expansion plans are as of now the clearest indication of grand ambitions.

Recent filings show that IndiGo has applied for slots at three airports in the London area. The buzz is that these will be serviced via wide-body aircraft. And this introduction of wide-body aircraft to serve long-haul routes will perhaps be the final deviation in Indigo’s departure from a pure low-cost model.