CONTENTS 1) Introduction 3-4 2) Decision Analysis Buy or lease decision Aircraft configuration decision Pricing decision 4-7 3) Cost Analysis Variable cost Commission expense fuel cost Employee cost Fixed cost Aircraft leasing cost and depreciation Landing and navigation cost interest expense 7-9 4) Other Recommendation Transform into low fixed cost structure Lowering the currency related cost Practice divisional profitability analysis Join alliance Practice grid routing system 9-12 5) Reference 13-15 6) Appendix Estimation used by the relevant cost analysis Estimation used by the sales mix analysis
Forecast Operation 16-17 1. Introduction We are going to investigate Kingfisher Airlines (KFA) for in-depth analysis, which would integrate management accounting topics of cost behavior, sales mix, buy or lease decision, pricing decision making and performance measurement. Kingfisher Airlines was an Indian full-service airline established in 2003{1}. It started commercial operations, involving domestic and international flights, on 9 May 2005. On one hand, it was nominated by Skytrax as a world 5-Star Airline for the 2010 ranking period because of its excellent product and service quality{2}.
On the other hand, Kingfisher Airlines had not made profit since starting operations in 2005, so it tried to reduce cost{3}. For example, from 10 April 2012, Kingfisher Airlines had suspended all international journeys. A partial lock-out happened on 1 October in the same year because of the delay payment of salaries, which eventually led to labour strike. On 20 October 2012, Directorate General of Civil Aviation (DGCA) prohibited Kingfisher Airlines from flying on the grounds of potential inconvenience to the travelling public.
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Bangalore International Airport Limited also sued Kingfisher Airlines for the user development fee and passenger service fee not collected from 2008 to 2012{4}. Up to September in 2013, Kingfisher Airlines had Rs 7,000 crore in debts and more than Rs 16,000 crore in accumulated losses{5}. Kingfisher Airlines can renew air operator’s permit within two years once it convinces DGCA that it has a concrete business plan for the revival of operations. For the year ended March 31, 2013, its net operating income is Rs. -43011. 2 million, compared with the year ended March 31, 2012, which was Rs.
-23280. 08 million, showing an increase loss of around 20000 million due to the cease of flight operations on 20 October 2012{6}. We are now proposing a restart and revival plan to the DGCA, subject to the investment by a foreign investor. In September 2012, Foreign Direct Investment policy in India allowing foreign airlines to buy up to 49% stake in Indian carriers facilitated investment. However, there are barriers that discourage investment, including uncertainty of politics and constant negative statement made by the media.
Kingfisher Airlines still has opportunity to promote investment as India is one of the fastest growing aviation markets in the world and Airports Authority of India is expected to invest $9 million to improve airline infrastructure. Kingfisher Airlines Chairman, Vijay Mallya, had enthusiastically tried to find foreign investors to invest in the airline {7}. Foreseeing the opportunity in the development of airline industry in India, high-networth individuals raised their share to 20. 3 per cent at the end of the September 2013 quarter, compared with 19.
52 per cent in the preceding three months {8}. This trend indicated the increase in investment in Kingfisher Airlines. In the following paragraphs, we will analyze Kingfisher Airline’s problems and suggest possible solutions in details. 2. Decision analysis 2. 1 – Buy or lease decision Revival plan first starts with operating the limited fleet of 7 aircrafts currently on hand while more aircrafts should be added to the fleet in the future. {6} One critical decision relating significant cost of airline operation is to purchase brand new aircraft from manufacturer or to lease from other airlines.
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... and staff members. The aircraft lease rental has been subsidized as the fleet of Kingfisher airlines has decreased. If we ... to capture the under penetrated air-cargo delivery service. Cost Reduction inventiveness Streamlining distribution channels. Renegotiating vendor agreements ... Background: Kingfisher airlines started out as a UB group subsidy, a USD 2 billion diversified conglomerate, which holds ...
The motives for Kingfisher airline to lease aircraft include relieving their financial burden and providing temporary increase in capacity. To justify the buy or lease decision, relevant cost analysis is carried out as shown below. Airport charges have been incurred for using the airport before the manager making buy or lease decision while insurance, fuel and other operating costs will be the same regardless of whether the plane is leased or bought. Sunk cost : Airport charges Unavoidable cost : Insurance cost Fuel and other operating costs Relevant cost of buying : (M) Interest expense{9} 5.
49 USD P. P. &Custom duty 2. 64 USD Depreciation 2. 03 USD Maintenance 0. 000426 USD {10,11,12} 10. 160426 USD Relevant cost of leasing : (M) Rental expense{13} 2. 08 USD Custom duty (20%) 0. 41 USD Maintenance 0. 01279 USD {10,11,12} 2. 95279 USD Interest expense is incurred as purchasing aircraft though acquiring loan is a common practice in the industry. From a financial standpoint, leasing aircraft is preferred to buying as the annual relevant cost of leasing an aircraft is much lower, however, long term leases (> 12 years) are not recommended and fleet diversity is not encouraged.
2. 2 – Aircraft configuration decision Kingfisher airline provides two classes of services, the Kingfisher First and Kingfisher Class. The cessation of the low-cost class Kingfisher Red provided on domestic services at September 2011 have proved the failure of low cost operation. {14} Supported by the third largest economy with 300 million strong middle class{15}, it provides a propensity of concentration on developing the high paying group market in the future.
Different classes of services have different selling prices, cost structure and contribution margin, and it is better to do a sales mix analysis to determine in which proportion each class should be sold in order to achieve a high profitability. FY13 – (Rs. )Million Kingfisher First Kingfisher Class Total Passenger income Excess Baggage Rebooking charge/ cancellation Total Sales Employee’s costs Operating and other expenses Total Variable expenses Contribution margin 674. 13 1. 85 8. 49 684. 47 582 371. 46 953. 46 (268. 99) 100% 139% (39%) 3755. 87 36 165. 51 3957. 38 2908 7243. 54 10153. 54 (6196. 16) 100% 257% (157%) 4430 38 174 4642 3492
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7615 11107 (6465) 100% 239% (139%) As an aircraft’s size is fixed, changing the configuration by installing more Kingfisher First seat will means to sacrifice some Kingfisher Class seat and therefore a sales mix is a necessary tool for allocating the scare resources in airline industry. The kingfisher First class can achieve a higher contribution margin than Kingfisher Class, indicating that it has a higher profitability. Shifting the sales mix from the Kingfisher Class to Kingfisher First Class can cause the overall contribution margin ratio increase, even though total sales (in dollars) are less, the net operating income can still increase.
However, the sales mix is done on an assumption that there is a demand in the market that can wholly absorb the increase in Kingfisher First seats, otherwise, the profitability may be lower due to the decrease contribution margin and constant fixed cost. 2. 3 – Pricing decision With the growing Indian economy that generates more business activities within India, installing more Kingfisher First class seat is expected to capture the needs. As business travelers are less price-sensitive, price discrimination pricing policy should be adopted that offer a variety type of fares to different market.
We will expect to reserve more Kingfisher First class seats in advance for those high-pay last minute passengers and increase the charge of fares by (1)10% and (2)20% for the tickets that is (1) reserved more than 14 days in advance and (2) sold up to the time of departure respectively to further increase our revenue in the future. For those price-sensitive leisure travelers, promotional fares with restriction, for instance, restricting their departure and returning day will be offered to them.
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In general, competition in the market is a key factors that can affect the price, in the future, Kingfisher airline should open more routes that depart and arrive in secondary airports, it is believed that it can helps to reduce the airport charges, explores a new market demand of metropolitan center’s secondary airport that requires less travelling time to and from airport and the lack of competition can enable us to charge a higher fares by price skimming policy. For other routes operating on primary
airports, since Kingfisher airline can have less control over the price and the market really determines price, therefore, target costing is adopted and the anticipated market price is taken. Kingfisher airline is pressing ahead to approach the target of 10% return on investment. Assume that the sales remains at Rs. 6835, we deduct it by the desired profit based on our return on investment to set out the target cost, the target cost should be attained in the production stage and we will break the target cost into various functions: procurement , distribution, services.
Each functional area would be responsible for keeping its actual cost within the target, and the following part will illustrate the policies to reduce both the fixed and variable costs under these functional areas. 3. Cost Behavior Analysis To simplify the case, we assume that there are only variable costs and fixed cost. Variable costs are the cost that can be flexible change when the activities change. It is directly related to the sales and output of the company’s products had sold.
Since Kingfisher airline suspend its operation on 1 October 2012 and only operated for a period of 6 months in FY13, we could easily recognized how it affects the expenditure, those variable cost will be significantly be affected and have a great drop by 60-80%. Fixed costs are the costs remain unchanged no matter the activities or the production has change. It directly relates to the company’s sales and productions and is less affected by the suspension of operation that only have a little drop of around 10-30% compared to that of FY12. Expenditure 2012 (Rs million) 2013 (Rs million) % different
Employees’ Cost [VC] 6,735 3,492 48 Aircraft fuel expenses [VC] 29,459 4,021 86 Operating and other expense [VC] 7,615 22,305 66 Aircraft/engine lease rentals [FC] 10,585 7,101 33 Depreciation/ Amortization [FC] 3,419 2,388 30 Interest & Finance charges [FC] 12,763 14,362 15 3. 1 – Variable cost: Commission expense According to other Indian airline financial information, booking agency commission can account for 3% of their total expenditure {16} which means eliminating the commission expense can help Kingfisher to reduce their expenditure by Rs2781 and Rs1495 in FY12 and FY13 respectively.
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Commission expenses could be minimized by Kingfisher airline selling their air tickets directly instead of using several thousand IATA travel agents in India. Although it will limits the distribution reach to customers, especially the high paying last minute corporate clients, it can saves the commission cost of hiring travel agents. IATA report has suggested that airline website will produce 59% of booking volume by 2017, up from 35% of 2012.
{17} To maintain the distribution channel, Kingfisher airline should fill prime development in telephone, Internet and smartphone apps for booking and simplified the booking procedure. 3. 2 – Variable cost: Employees’ Cost For the employee Cost, Firstly, Kingfisher airline can lay off some employees due to curtailed routes. The staffs that still on their payroll include the senior and mid-level managers and sufficient number of pilots, engineers, and dispatcher those are enough to operate up to 20 aircrafts.
We plan to restart operation with a limited fleet of 7 aircrafts, so there are rooms for further reducing the number of employees. Secondly, Kingfisher airline restarts the operation that focusing on domestic market in initial stage, this increases the flexibility in staff roistering, lacking overnight stay at non-base locations, and round way trip is made for every flight, it has a better utilization of staff and will requires less pilots and flight attendants.
Thirdly, The remuneration method should also be changes by paying sales commission to staff based on the contribution margin rather than the sales price, it might encourage the salespersons to emphasize the flight tickets with greatest contribution to the profits of the airline and less administrative staffs are required. Finally, Kingfisher airline should outsource some airline department such as ground staffs and it expects to reduce overhead cost by 11-15 %. 3. 3 – Variable cost: Fuel cost
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High fuel cost that create the main reason for significant loss, fuel cost remains high due to increasing crude oil price and the depreciation of Indian Rupee that weaken the Rupee against US dollar. Kingfisher airline should deploy more fuel-efficient aircraft, for instance, using airbus A320 instead of Boeing B737 with similar seat capacity and range. {18} Kingfisher airline can also cooperate with other low cost carrier to purchases the fuel jointly to enjoy bulk discount. 3.
4 – Fixed cost: Depreciation As mentioned before, Kingfisher airline should raise fleets by leasing aircrafts instead of purchasing aircrafts. This can greatly reduce the depreciation expense. 3. 5 – Fixed cost: Landing and navigation cost For the landing and navigation cost, our flight should be land on secondary airports or airports of those 2-tier cities which has a lower landing charges. Its effects have been discussed in the pricing section. 3. 6 – Fixed cost: Interest expense
Interest expense accounts for 29% and 14% of the company expenditure in FY13 and FY12 respectively, the high interest expense is due to high interest rate Rupee loans provided by the local banks, the new foreign direct investment policy incorporated by Indian government allows foreign borrowings that provide a lower interest rate loan. 4. Other Recommendation To resolve the problem in Kingfisher brought by the above reasons, we are going to suggest some possible ways. 4. 1 – Transform into low fixed cost structure For the Kingfisher, it should be transforming into lowed fixed cost structure.
Cost structure means the relative proportion of fixed and variable costs in an organization are referred to. Since Kingfisher has a high fixed cost structure during the suspension period, a lower income will occur for such bad years of Kingfisher airline compared to companies with lower proportion of fixed costs. Generally, companies in the airline industry have high fixed costs like advertisement, and fuel cost depreciation, lease payment. Although fixed costs are hard to change, some possible ways may solve the problem tremendously. a) Adopting smaller aircraft
One of the possible ways to transform into lower fixed cost is deploying a smaller aircraft. Kingfisher can dispose the existing aircraft and purchase some smaller aircrafts which are more environmental friendly. Although it takes capital to do so, the long-term effect on cost saving will be observable and significant enough for Kingfisher to have a larger profit margin even with their present revenue unchanged. When Kingfisher try to adopt a smaller aircraft, it can also reduce the probability of empty seat as there are fewer airline tickets.
Kingfisher can increases the frequency of flight to attract time-conscious business passengers. Moreover, adopting a small size aircraft can also reduce the consumption of fuel. As we all know, restricting cost is vital for a company’s profitable margin. In this moment, Kingfisher is baring a high fuel cost because of high consumption of fuel. Therefore, such fuel-save with environmental friendly aircraft models can further minimize the use of fuel. It is obviously that the consumption of fuel depends on the weighting and the emission rate of aircraft.
If fuel-save aircraft is adopted, a smaller proportion of the fuel will be used relatively. Thus, Kingfisher can reduce fixed fuel cost for each financial period. Finally, deploying a smaller aircraft can also shorten turnaround time. It can charge on the airport apron with less time. The mobility and rotation will increase tremendously. Therefore, fewer b) Less advertisement cost Since Kingfisher is one of the five star airline nominated by Skytrax, it has been developing an excellent image through advertisement especially for adopting television as a platform.
However, Kingfisher is facing a suspension in the external flight recently. Therefore, cutting the fixed cost like advertisement expense is unavoidable. One of the possible solutions to develop excellent image is through invaluable philosophy. The kingfisher brand can be built up by developing an invaluable philosophy like delivering Indian hospitality to customers and maintain high on time rate by better time scheduling. This strategy can also maintain the image with reducing advertisement expenses. 4. 2 – Lowering the currency-related cost
According to the annual report, there is approximately 75% of operating cost tied to US dollars. Kingfisher should relentlessly make effort with outside the box approaches to establish a cost structure that stands airline in the face of a volatile external operating environment influenced by such factors as currency fluctuations. We take fuel cost as an example; Basically, Kingfisher should establish a fuel efficiency program in the long run. In this program, there are some rules to guide the Kingfisher. A.
The airline has to be controlled in intake of water and even the weight of the food trolleys and magazines inside the plane in order to reduce the weight of the aircraft. B. The flight should be flying on a straight flight path at an optimum height and speed as the height and speed are positively related to the fuel cost. If the path are not straight, the excessive fuel cost will be consumed. C. When the passengers board, the air-conditioning and other systems are being powered from ground power sources and not the aircraft’s auxiliary power unit in most of the airports. And it should be avoided excessive use of engines.
Using a single engine instead of using both, thereby saving considerable amount of fuel. 4. 3 – Practice divisional profitability system As different routes will have different markets, the operating condition of each route can be better analyzed through creating segmented income statement. By knowing each route margin, the loss of one route can be compensated by the profit of another route that generate a whole gain of the company. Japan airline has been very successful in its revival by improving the productivity and raising cost awareness through the divisional profitability management system.
{19} Therefore, we believe that it could put a stop to their profit slumping and solve the problem. 4. 4 – Join alliance In long term, Kingfisher should join the international alliances that can help to increase the cost efficiency, as different airlines’ member in the alliance can share their airport facilities, do cooperative advertising and promotional campaign and practice joint procurement of fuel and amenities that can facilitate unit cost reduction by enabling the partner carriers to take the advantage of economies of scale. 4. 5 – Practice grid routing system
As now kingfisher airline is radiating most of their routes from the Delhi and Mumbai hubs, those primary airport is dominated by the network airline, Kingfisher airline with less domestic network is hard to compete with them in term of the convenience bring to the customer. Shifting to a grid network without backtracking of route can increase the traffic flow and also lower the time cost on passengers. 5. Reference 1 Kingfisher Airlines. (n. d. ).
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Kingfisher airlines receive the prestigious 5-star airline ranking. Skytrax. Retrieved November 10, 2013, from http://www. airlinequality. com/news/kingfisher_5str2010. htm 3 Kingfisher Airlines: HNIs hike stake, small investors exit (2013, October 28).
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com/business/india-business/FIR-filed-against-Kingfisher-Airlines-over-dues/articleshow/24726863. cms 5 Kingfisher Airlines shares surge 10% (2013, September 25).
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Kingfisher Airlines Limited. Annual Report. Retrieved November 10, 2013, from http://www. flykingfisher. com/pdf/KFA%20Annual%20Report%20-%202012-13. pdf 7 Kingfisher airlines stock extends rally, surges 5%. (2013).
Retrieved November 10, 2013,, from http://in. gocmenizm. com/news2013/kingfisher-airlines-stock-extends-rally-surges-5_6964. html 8 HNIs hike stake in Kingfisher to over 20% in September quarter (2013, October 28).
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docID=14849&eID=dam_frontend_push 10 Leeham. (2013, June 18).
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com/en/investor/library/report/pdf/index_2013. pdf 6. Appendix 6. 1 – Estimation used by the relevant cost analysis Sunk cost : Airport charges Unavoidable cost : Insurance cost Fuel and other operating costs Relevant cost of buying : (M) Interest expense 5. 49USD P. P. & Custom duty 2. 64USD Depreciation 2. 03USD Maintenance 0. 000426 USD 10. 160426USD Relevant cost of leasing : (M) Rental expense 2. 08 USD Custom duty (20%) 0. 41 USD Maintenance 0. 01279 USD 2. 95279USD a) 6% interest rate is used for computing the loan interest b) Purchase payment is distributed according to the aircraft’s useful life.
c) The average list price for a A320 in 2013 is 91. 5 million USD {9} d) Depreciation is computed on straight-line basis, assuming no residual value and the useful life is 45 years e) The age of a brand new aircraft is 0. The total maintenance cost per seat for a A320 aircraft is around 6. 5USD {10} and Kingfisher airline has 164 seats in their A320, including 8 Kingfisher First seats and 156 Kingfisher Class seat. {11} The relative maintenance cost index for zero age aircraft is 0. 4 {12} f) The average lease rate for a A320 in 2012 Jun is 173,000 USD {13} g) The age of a leased aircraft is 8-12, assume 10 years is used.
The total maintenance cost per seat for a A320 aircraft is around 6. 5USD {10} and Kingfisher airline has 164 seats in their A320, including 8 Kingfisher First seats and 156 Kingfisher Class seat. {11}The relative maintenance cost index for 10 age aircraft is 1. 2 {12} 6. 2 – Estimation used by the sales mix analysis FY13 – (Rs. )Million Kingfisher First Kingfisher Class Total Passenger income Excess Baggage Rebooking charge/ cancellation Total Sales Employee’s costs Operating and other expenses Total Variable expenses Contribution margin 674. 13 1. 85 8. 49 684. 47 582 371. 46 953. 46 (268. 99)
100% 139% (39%) 3755. 87 36 165. 51 3957. 38 2910 7243. 54 10153. 54 (6196. 16) 100% 257% (157%) 4430 38 174 4642 3492 7615 11107 (6465) 100% 239% (139%) a) The fare of Kingfisher First is 3. 5 time about the fare of Kingfisher Class in average. For each Kingfisher airline A320, there are 8 Kingfisher First seats and 156 Kingfisher Class seat. Therefore, the revenue from ticket sale should be in a proportion of (8×3. 5/184): (156×1/184), ie. 15: 85 for Kingfisher First sales to Kingfisher Class sales b) Excess Baggage and rebooking charge are distributed according to the seat proportion, ie.
approximately 5:95 c) The employee ratio for Kingfisher First to Kingfisher Class is 1:5, Employee’s cost is distributed on approximately 17:83 basis. d) Operating and other expenses are distributed according to the seat proportion, ie. approximately 5:95 6. 3 – Forecast Operation Forecast % Diff. from FY13 FY13 % Diff. from FY12 FY12 Income Passenger 17720 75% 4430 (91%) 49102 Cargo 1488 75% 372 (91%) 4356 Excess Baggage 152 75% 38 (88%) 327 Rebooking charges/ cancellation 696 75% 174 (85%) 1150 other income 7284 75% 1821 (45%) 3305 Total income 27340 75% 6835 (88%) 58240 Expenditure Employees’ cost 2619 25% 3492 48% 6735
Aircraft/ engine lease rentals 4142 41% 7101 33% 10585 Aircraft fuel expenses 6032 (50%) 4021 86% 29459 Operating and other expense 4284 44% 7615 66% 22305 Depreciation/ Amortization 796 67% 2388 30% 3419 Interest & finance charges 7181 50% 14362 (13%) 12763 Total expenditure (exc. Exceptional item) 25054 36% 38979 54% 92700 Net Profit/Loss 2286 (32144) (34460) a) Total income is increased by 75% as more Kingfisher First seat is installed and FY13 only has operated for only half of the year. b) About ? employees is laid off as the staff now is enough to operate for 20 aircrafts while we plan to operate only 7 aircraft in the early stage.
c) Aircraft leasing cost is reduce as Kingfisher has 12 aircrafts before suspension, and we now only operate 7 aircrafts, fews aircrafts can be returned to the lessor. d) Operating and other expense has decrease by Rs1495 due to the elimination of commission expense. On top of it, we are expecting to reduce the operating expense by 30%. e) Deprecation has reduced as we has sold some aircrafts. f) Interest charge is reduced by half as Kingfisher has change to borrow loan from foreign bank and the recapitalization of UB group has used to repay some of the loan.
