P -2 Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements –

P -2 Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements –

Monitoring role of MoCA –

The Memorandum of Understanding (MoUs) signed between the erstwhile IAL and
AIL and MoCA were flawed. The non-financial parameters included in the MoU
included minor or insignificant parameters or gave undue weightage to such
parameters, at the cost of critical traffic and operating parameters in the airline
industry (such as those being monitored by Directorate General of Civil Aviation).
This skewed the MoU ratings of IAL and AIL unduly to present a “rosy” picture of
performance. The overall combination of financial and non-financial parameters
devised for the MoUs were such as to ensure that the MoUs became a meaningless
exercise, rarely (if ever) reflecting poor performance, and ensuring lack of effective
accountability for all parties concerned.


The issue of the MoCA order of 2010 granting additional facilities for upgradation of
tickets, subject to availability, for former Secretaries, MoCA and their immediate
family members at this time of AI's financial crisis indicates that MoCA is not acting
as a responsible stakeholder. These decisions granting freebies to retired airline
staff and officials needs to be reviewed.

Financial and operational performance of the erstwhile IAL/ AIL and AI

There was a significant deterioration in operational performance on most
parameters such as; passenger/cargo revenues, Available Seat Kilometres
(ASKM), Available Tonne Kilometres (ATKM), Revenue Passenger Kilometres
(RPKM), passenger revenue per RPKM and Passenger Load Factor (PLF) for the
two airlines (pre/ post merger) between 2005-06 and 2009-10.

As regards the erstwhile IAL: route economics revealed that most of the services
were not meeting cash costs or total costs, both in domestic and international
sectors.

The performance of IAL vis-a-vis its competitors on various parameters (PLF,
domestic market share, Passenger Revenue per RPKM) was consistently poor. IAL's
On-time Performance – a critical parameter of service – was dismally low, compared
to both full service carriers and low cost carriers. Further, the market share of IAL in
cargo operations dropped dramatically, despite conversion of five B737 aircraft into
freighter aircraft.

With regard to the erstwhile AIL: even earlier, most routes (North America, UK, SE
Asia etc.) were incurring losses, and only the Gulf/ Middle East and Far East Asia
routes made profits till 2005-06. By 2009-10, all routes were loss-making. The
single largest loss-making routes being the India/ USA route, which contributed
between 41 to 90 per cent of AIL's total operating losses during the period 2005-06 to
2009-10. This clearly revealed the grossly exaggerated nature of assumptions
relating to increased yield on account of non-stop operations (projected in the
revised fleet acquisition report). Besides this, the main reasons for low route
profitability were the liberal increase in bilateral entitlements, which benefited foreign
the carriers with large volumes of 6 freedom traffic and the failures of AIL to contain
losses, especially on the India/ USA route, through appropriate route rationalisation
and other measures etc

AIL's PLF suffered drastically vis-a-vis its competitors. In particular, the PLF of AIL
flights in first class and business class declined from already low figures of 14 per
cent and 31 per cent (2004-05) to abysmal levels of 12 per cent and 28 per cent
respectively. Considering the widely recognised view that occupancy of a single
seat in business/ first class can financially offset several vacant seats in economy
class, these abysmally low PLFs in business/ first class are unsustainable. Similarly,
AIL's On-time Performance for arrival and departure was significantly low at 62 and
52 per cent respectively during 2009-10

Market surveys of customer perception revealed that Air India was no longer a
preferred brand, and that it was not adequately oriented towards customer
satisfaction. Expenditure on publicity and sales promotion was negligible

Dedicated cargo freighter operations started in June 2007/ August – December
2008 by converting four passenger aircraft ( two owned and two leased) into
freighters at a cost of Rs.168.30 crore. This ended up incurring losses of Rs.270.62
crore and were suspended from September 2009.

The overall financial position of IAL/ AIL and the merged entity has been abysmally poor during the period from 2004-05 to 2009-10:

Revenues showed a static trend. Expenditure increased dramatically. Interest
burden, which was nominal in 2004-05, increased 36 times to Rs. 2434 crore in
2009-10. Working capital loan went up nearly 21 times from 2004-05 to Rs. 18524
crore in 2009-10;

In our opinion, the Directors on the AI Board (especially the Government Directors)
should have been aware much earlier that such enormous increases in working
capital loan limits (without a corresponding increase in operational revenues) were
indicative of a major liquidity problem.

Cash profits and marginal net profits in 2004-05 and 2005-06 turned into substantial
cash losses and net losses. The net worth of the entities, which was negative in
2004-05, was made positive in 2008-09 through a revaluation of fixed assets by Rs.
8,028 crore. Even such revaluation could not reverse the trend and it became hugely
negative in 2009-10;

As of 2009-10, the total borrowing was 2.87 times the total revenue. Even the working
capital loan was 1.38 times the total revenue. GoI's equity infusion of Rs. 325 crore in
2005-06 into the erstwhile IAL and Rs. 800 crore in 2009-10 to AI represented a mere
drop in the ocean.

We had pointed out in earlier audit reports that Productivity Linked Incentive (PLI) paid to officials amounted to rewarding employees for less than average achievement, since the base levels for incentive payment were set lower than the average performance achieved prior to introduction of the PLI scheme. During 2004-10, huge amounts continued to be paid as PLI to different categories of staff without appropriate linkage to operational and financial performance, at a time when the entity can ill afford such payments.

What do we recommend?

The current critical state of affairs of the merged entity “Air India” is a combination of a
multiplicity of factors:

risky acquisition of a large number of aircraft with the intention of vastly expanded
operations and “footprint”. In the case of the erstwhile AIL, the large acquisition was
clearly driven under the influence of the MoCA;

In a liberalised policy on bilateral entitlements for international air travel introduced by
GoI. These agreements, besides not affording adequate time to AIL/ IAL to set their
houses in order and gear up for a highly competitive environment, very evidently
worked to the detriment of the National and Indian private carriers.

an ill-timed merger undertaken strangely after separate aircraft acquisitions by AIL
and IAL were completed, driven from the top (rather than by the perceived needs of
both these airlines), with inadequate validation of the financial benefits from such a
merger and without adequate consideration of the difficulties involved in integration
(notably in terms of HR and IT, among other areas); and

chronic operational deficiencies;

a weak financial position, grossly inadequate equity capital and undue dependence
on debt funding providing little or no cushion for the financial shock when it came;
n external factors beyond the control of AI, such as high ATF prices, the 2008
economic recession etc.

However, the merged entity “Air India” has since undertaken several positive measures,
notably the following:

A considerable amount of route rationalisation has taken place, especially in terms
of loss making routes during 2008-09 and onwards;

A common code for AIL and IAL passenger reservations has finally been
implemented with effect from February 2011, although the full set of modules of the
new Passenger Service System (PSS) is yet to be implemented and operationalised.
The next critical milestone to be fulfilled is admission to the Star Alliance, which is
yet to happen. The importance of joining the Star Alliance cannot be
overemphasised, as failure to do so by this deadline could allow other competing
private carriers (e.g. Jet Airways) a window of opportunity and, thus, result in AI
losing first entry advantage to other competing private Indian carriers.

Timely development of hubs in India (e.g. at Delhi and Mumbai Airports) will help Air India in getting significant volumes of 6 freedom traffic from India.

The 43 narrow-bodied ordered by the erstwhile IAL have been received by April
2010, while of the 50 aircraft ordered by the erstwhile AIL, 20 (8 777-200LR – long 1
range, and 12 777-300ER – mid-range ) aircraft have been received. However, the
delivery of the 27 B787-8 aircraft (which is termed as the “dreamliner” aircraft in
popular parlance, and is projected to have substantially lower fuel consumption) is
delayed to the 2nd half of 2011-12.

In order to maximise the chances of a positive outlook for the merged Air India, further
measures need to be taken HR integration (viz. harmonisation of HR) below DGM level (pilots, engineers and other staff) of the erstwhile AIL and IAL has not yet taken place. This is a critical issue, whose importance and associated difficulties were not fully appreciated pre-merger, more so in view of recent strikes and HR disputes. This needs to be handled swiftly, if the merger is to become a success.

Incentive structure – In our view, the current structure of the Performance Linked
Incentive (PLI) needs to be restructured, as it does not adequately incentivise, or
disincentivise actual performance on the ground:

PLI should focus on On-time Performance (OTP), as this is the most critical
parameter in the airline industry, from a service perspective. The base level for
OTP for performance incentive should not be set at an unduly low level, based
on AIL/ IAL's past performance. It should be linked to the performance of its
competitors (Jet Airways and Kingfisher, the leading full service carriers, – in
respect of domestic operations, and Jet Airways/ Emirates/ Singapore Airlines
etc. in respect of international operations). At the very least, the OTP baseline
for performance incentive should be set close to the performance of its
competitors (say no more than 3-5 per cent below its competitors – Jet
Airways/ Kingfisher)

Impact of first flights on OTP – The impact of the first flights on On-Time
Performance throughout the day, especially for short haul flights is critical.
Consequently, the incentive/ disincentive for OTP of the first flights should be
set at a substantially higher level than for subsequent flights.

The PLI paid to various categories of employees should have distinct
components – one component linked to the overall performance of AI as a
whole and the other component linked to the specific performance of the
division/ department/ sector to the most granular level possible. This will ensure
that incentives are as closely linked as possible to performance at the
grassroots level. The structuring should be such that different categories of
employees do not get incentives merely for completing activities within their
limited sphere of work, without consideration of how such work contributes to
the overall efficiency of the organisation.

The PLI paid to various categories of employees should have distinct
components – one component linked to the overall performance of AI as a
whole and the other component linked to the specific performance of the
division/ department/ sector to the most granular level possible. This will ensure
that incentives are as closely linked as possible to performance at the
grassroots level. The structuring should be such that different categories of
employees do not get incentives merely for completing activities within their
limited sphere of work, without consideration of how such work contributes to
the overall efficiency of the organisation.

Increased proportion of web-based/ technology-based ticket sales – In order to
ensure cost rationalisation, AI must ensure a substantial increase in ticket sales
through web/ technology based channels, rather than agents/ front offices (which
result in enhanced costs). The current proportion of ticket sales through AI's website
is abysmally low. Further, anecdotal evidence of the poor speed/ response of AI's
Internet website ticketing vis-a-vis that of competing airlines/ travel sites also
abounds.

AI should also leverage IT more effectively to ensure maximum use of technology for
operations – e.g. web/ mobile check in, check-in kiosks/ scanned security checks
etc. In particular, it is not enough to set up technological solutions; it is necessary to
ensure that these are fully utilised.

Real-time revenue management – AI's record of implementing revenue
management solutions has been, at best, mixed. In addition to full scale
implementation of latest generation, revenue management systems to enable real-
time dynamic pricing, AI also needs to ensure adequate availability of skilled
analysts who could make use of such granular data, with appropriate delegation of
powers and empowerment of officials.

The airline is in a crisis situation. Salary payments and ATF obligations are becoming
difficult. If the airline has to survive, the management and employees will have to set
personal interests aside and undertake some harsh decisions, unless the health of
the airline improves. PLI, incentives, salary hikes and allowances merit major
restructuring in the long term interest of the employees and the airlines.

Maximisation of PLF in Business/ First Class – Even more than overall PLF and PLF
in economy class, AI's PLF, in terms of revenue-generating seats, for business/
first class – which is far more critical to a full service carrier's financial health than
economy class PLF - is abysmal. Rigorous controls need to be put in place to
ensure that there are no vacant seats in Business/ First class, allowing for
“upgrades on availability basis” from economy class, which is subject to
exploitation.

All free travel by AI officers, on duty or leaves in business/ first class should be
prohibited. All existing facilities offered in this regard should be withdrawn till
AI's financial conditions improve dramatically. Given the life-threatening crisis
that AI is currently facing, top and middle management in AI should set an
example in this regard.

Freeze on bilateral entitlements to countries/airlines predominantly utilising 6
freedom traffic – Most of the liberalised entitlements for bilateral rights granted to
foreign airlines, especially in Dubai, Bahrain, Qatar and other Gulf/ SE Asian
countries, has been utilised for 6th freedom traffic, typically to destinations like USA/
UK/ Europe and not for genuine traffic to the other country. AI and Indian carriers are
handicapped by the lack of adequate hub facilities and other factors from
competing effectively with other predominantly 6th freedom carriers (e.g. Emirates).
Till India has its own effective and efficient hubs and AI/ other Indian carriers are able
to exploit them effectively, entitlements for airlines/ countries predominantly
dependent on 6th freedom traffic, notably Dubai, Bahrain and other Gulf countries,
should be strictly frozen by MoCA. If possible, subject to diplomatic and other
considerations, options for rollback of excess entitlement granted beyond genuine
traffic requirements should also be considered by MoCA. MoCA has in the past five
years very obligingly bowed to ostensible pressures from Ministry of External Affairs,
Ministry of Tourism and Ministry of Commerce. Whilst these Ministries no doubt
recommended the need to liberalise international air services based on their
mandate, MoCA yielded to them ignoring the interest of the Indian carriers including
that of AI, the national carrier.

Prompt payment of Government dues – AI's services are frequently used for VVIP
and other Government duties. Reimbursement of costs incurred by AI is never done
in a timely manner. Given the financial and liquidity crisis in which it finds itself, AI
cannot afford such delays. MoCA should ensure that such dues are paid to AI in a
timely manner.

Infusion of Government Equity – Both the erstwhile AIL and IAL and the merged
entity have been unduly dependent on debt/ loan funding with a very narrow equity
basis, which has dramatically increased the financial risk/ burden on AI. GoI should
consider prompt infusion of additional Government equity in a timely fashion to
ensure that the Debt-Equity (D/E) ratio reaches levels prevalent in the Industry.
However, such infusion has to be linked to a package which the company must
accept in advance viz. restricting of incentives at all levels, reassessment of
additional aircraft acquisitions, on time performance, rationalisation of routes
with MoCA maintaining a hands off approach, critical relook at Bilateral
Agreements, especially those linked with 6th freedom traffic and cutting down on
staff/officers posted abroad in countries where the Airline does not operate.

We believe that AIL had inherent strengths. A multitude of factors which were
internal and external have rendered it in a very critical situation. There is also no
evidence of MoCA having provided it with positive support in the last few years.
If the Airline has to be nursed to commercial viability, Government has to
consciously attend to the following:

(i) The Airline has a debt liability of Rs. 38,423 Crore as on 31 March 2010.
Aircraft acquisition has contributed predominantly to it. Government must
lay down a road map for liquidating the liability within a short span after
making a realistic assessment of revenue generation capacity. Piecemeal
infusion of small amounts is merely going to at best delay the certain
closure of the Airline.

(ii) Accountability in the Airline, its Board, Government nominated Directors
and the MoCA has to be clearly established and transparently dealt with.
Grant of routes to private carriers, Bilateral Agreements (of which there
appears to be no further scope as there is saturation already) must factor
in interests of the national and other private carriers. Concluded
agreements need to be reassessed.

(iii) A critical assessment of the Airlines profitable sectors, if any, is required.
On other sectors attempt to remove infirmities including bilaterals to
support the Airlines may be made.

(iv) MoCA and Government must recognise that AI is the National Carrier. In
very many ways, it is a symbol of the State. Even if Ministers and officials in
MoCA profess not to be Ministers/Officials for AI alone, the fact remains
that it has to be given a more than level playing field now which it has not
been given. All decisions to allot routes, alter timings, provide first refusal
rights on domestic and international routes must be made taking into
account the interests of AI. This should be done in a transparent and
demonstrable manner placing it in public domain. Accountability at the
decision making level has to be established.

(v) A total hands-off approach with regard to the management of the airline is
required.
Audit is of the firm view that unless the Government takes cognisance of above
mentioned factors and decisions thereupon, the Airline does not have a future
as a vibrant Public Sector entity.http://www.blogger.com/img/blank.gif

Suggested Reading –
Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements – Part One
http://realityviews.blogspot.com/2011/09/complete-cag-report-air-india-ministry.html

Reality views by sm –
Thursday, September 08, 2011

Tag Keyword – News CAG Report AIRINDIA LOSS