Exactly three years ago, in the month of February 2015, SriLankan Airlines had just received a new Board of Directors. The airline’s ambitious expansion plans were in jeopardy. The rapidity with which the Gulf carriers could add capacity to Colombo had not been anticipated. Fuel prices were still at near-record levels. The brand-new Airbus A330-300 aircraft, with best-in-class on board product, were being delivered but at an ownership cost that was too high for them to be profitable. A legacy route structure over-reliant on European tourist arrivals, which has remained largely unchanged since the early 1980s, was resulting in heavy losses.
The airline has since made several major decisions in an effort to realign the business with the realities of today’s marketplace, some of which have been nothing short of controversial. We caught up with the airline’s Chief Executive Officer Captain Suren Ratwatte to hear his views on the changes that have taken place at the airline.
Q: Can you give us a brief overview of the changes that have taken place at the airline under your management?
A: The airline had prepared a preliminary turnaround plan which had been approved by the Cabinet. The immediate priority for me was to see the successful implementation of this plan. Accordingly, we swiftly took steps to withdraw from routes that were resulting in the highest losses. Leases for the aircraft that were no longer suitable to our plan were cancelled. We identified that the aircraft which we were operating were too costly for the market conditions that we were facing and took steps to renegotiate and lower the aircraft lease costs. Initiatives were taken to address the high costs across some functions. Operational performance was improved, which has seen SriLankan receive several accolades over the recent months as one of the world’s most punctual airlines. We successfully integrated the operations of Mihin Lanka, in the process creating the largest airline in Sri Lanka’s history. The performance of our subsidiary and business units too have improved, with them recording the highest levels of revenue since the establishment of the airline group. The airline itself will carry over 5 million passengers and record a billion dollars in revenue in the current financial year.
Q: Your cancellation of A350 aircraft has come under spotlight. What led to this decision?
A: The changes in our route network strategy meant that we now needed an aircraft fleet that was more focused on short-haul operations than long-haul. Not taking delivery of these aircraft was already part of the new business plan approved by the Cabinet. As a result, we re-evaluated the feasibility of operating the brand-new Airbus A350 aircraft which the airline had already committed for, albeit under very different market conditions. Internal analysis, verified by two independent external industry consultants, made it clear that operation of A350 aircraft would not be a viable option for us, even at very high fuel prices.
As a result, following lengthy discussions that were carried out in consultation with the Government of Sri Lanka, we decided to terminate the lease contracts for these aircraft by a negotiated settlement with the lessor. While this decision carried a one-time cost (which was in fact spread over a period), our decision was supported by the fact that it would result in a long-term benefit to the company when considering the Net Present Value of the lease contracts.
Hindsight has shown that the A350, capable as it is, would have been an operational and cost burden to the airline. The fact that the three A350s built for SriLankan are still not in airline service shows that the market conditions for this type of aircraft remain soft.
Q: You mentioned of a reduction in aircraft lease costs. Could you explain a little about this?
A: Sri Lanka is one of the countries in the world with the cheapest airfares, where the ticket price paid by a passenger per kilometre is one of the lowest anywhere. We have seen a further deterioration in these conditions particularly as more competitors have entered our small market, increasing capacity beyond demand. We identified early on that making profits in this revenue environment with the new and high cost aircraft fleet which we had, would be quite impossible. Thus, we took steps to renegotiate the lease agreements on some of our aircraft with a holistic 360° view.
Now, what I mean by a 360° view is that there is a lot more to the lease of an aircraft than just the monthly rent. A large part of the costs are the periodic payments an airline makes to the lessor/owner for aircraft maintenance and the end of lease ‘return conditions’ of the aircraft, which are agreed upon at the outset of the lease period. In the past, when we returned aircraft at the end of their lease, we had to do certain major refurbishments to bring them up to the agreed standards. At times, the cost was more than $5 million, which in one case was about half the value of the aircraft! In the new negotiations, led by our technical team, we not only negotiated the lease rental to below-market levels but also have waived the return conditions to be almost nil. Therefore, we save a significant amount of money over the life of the aircraft and avoid the balloon payment at the end of the lease period.
Q: Did your network reshuffle bring the expected results?
A: It certainly did. Pulling out of Europe was a difficult and painful decision but it had to be done. It certainly was prestigious to be flying to cities such as Paris, Rome and Frankfurt but the returns in doing so were very poor, as our financial results show. In business, you cannot have emotional attachments.
We have since expanded our services to the Asia Pacific and Indian Subcontinent and these routes are delivering very positive returns. Our new route to Melbourne, Australia, was launched following several detailed market studies and demand forecasts into future years. It has been a success and recorded its first profit within three months of its launch – a significant achievement for a new long-haul route. Just as importantly, it shows there is untapped demand to Australia, something we intend to exploit in the near future.
Change is swift in the airline industry and we must be always one step ahead of the competition to remain viable. To this end, we are always reviewing the performance of our network and evaluating new opportunities. Should a market’s conditions change, we must be willing to redeploy capacity elsewhere quickly in order to protect our financial performance. I believe that building this agility and nimbleness was one of the most important parts of our recent network adjustments. As part of the next phase of our restructuring program, we have, together with the consultants selected by the shareholder, identified further network related initiatives – which we plan to implement over the next several months. This would include capacity enhancements to some leadership markets, seasonal capacity adjustments to some long-haul markets as well as reducing or withdrawing from markets which have low potential.
Q: What are these leadership markets and other markets with potential?
A: One of the largest markets where we see a high potential – and where we hold a leadership position – is India. Sri Lanka’s recently revised bilateral air service agreement with India has enabled us to access more metro cities in India. In line with this, we added new routes to Coimbatore, Hyderabad and Visakhapatnam in India and added additional frequencies to Delhi and Mumbai.
Another core market for us is the Maldives. In December 2016, SriLankan became the only airline in the world to offer international routes to two destinations in the Maldives with the addition of services to Gan Island.
The SAARC region as a whole, is an under-served market. But it is a very price-sensitive one that needs to be carefully nurtured and grown. To do this we must be very focused on our costs, low-yield markets are unforgiving of inefficiency.
We are also seeing a lot of opportunity in China and the Asia Pacific – as well as the Oceania region. But this is a nascent market, with leisure travel being a new luxury, albeit one with huge potential. To be at the birth of such a market is a huge opportunity but it is one fraught with pitfalls. Possibly the biggest obstacle is, again, price sensitivity. Stringent and relentless cost discipline is a requirement if we are to succeed.
Q: You “wet leased” an aircraft to Pakistan International Airlines some time back. Was this project a success? If so, why has it not been repeated since?
A: The wet lease project with Pakistan International Airlines was a major success. A wet lease operation always guarantees you a certain level of income while taking away the risk of market conditions that impact your passenger revenue. The PIA wet-lease was not only a financial success but also a huge operational achievement. Our crew and maintenance teams proved themselves to be world-class; achieving 100% dispatch reliability for the entire period of the lease.
One reason why we have not been able to repeat it since is because such projects are few and far between. However, as part of our restructuring plan, we are currently in discussions with some interested parties who would be willing to wet lease some aircraft from us during the off-peak season and return those aircraft to us for operation during the winter tourism season. This would be a win-win relationship for both parties and is set to further improve our financial performance.
Q: We have seen a lot of criticism about the airline in media over recent months and different points of view being expressed by some Ministers at times. How is your working relationship with the Government as at now?
A: We have a very good working relationship with the government and in particular with the Ministry of Public Enterprise Development, under whose purview SriLankan falls. I must state that the Government has been very supportive of all our endeavours and has allowed us to carry out business affairs with minimal interference.
Q: There have been reports of SriLankan adding a large number of employees under your management. Is this true?
A: We have added only a limited number of employees during this period, most of whom were employees that we absorbed from Mihin Lanka.
We have also expanded the fleet and the destinations. This will obviously require more people to fly, crew and maintain the aircraft we have added.
The airline industry is quite different to a regular company in Sri Lanka. For example, we need to pay our pilots and engineers world-class salaries, simply because they are in a global market and we need to compensate them accordingly to retain their talents. The airline business has a mobile workforce. If we do not compensate our people adequately, they will vote with their feet and move away.
The key concern for us is not the number of staff but rather the cost of those people. Compared to our key full-service competitors, we have been able to maintain a competitive cost base. However, we need to become leaner in order to be profitable. The primary competition we face today are the Low Cost Carriers (LCCs) such as Indigo, Air Asia, Fly Dubai and Air Arabia. These companies have a relentless focus on their cost-base, which enables them to operate profitably in a low-yield environment. They are known as Low Cost and not ‘low-fare’ carriers for a reason. The market dictates the fares, the airlines themselves must control the costs.
Q: There was an earlier search for a Partner in 2017. Why did that fail?
A: I wouldn’t go so far as to say that it failed. The process was very good, it got to the level of the final due diligence exploration and at that stage, the investors decided the returns did not meet their ROI profile. They felt that it would take too long to return the company to profitability and that they had other investment options that could give a better return in a shorter time.
I must say that I fully appreciate that position. There is much work to be done before the airline is an investment worthy entity. That is exactly what we are working on now, with an internationally reputed team of consultants who have done similar work with many airlines, assisting us in drawing up a fundamental restructuring plan that addresses every aspect of our business. Once this process is complete and implementation begins, we will be able to attract investors who can bring in the capital the business needs to grow and be competitive.
Q: Why do you need more capital? Don’t you have a viable business now?
A: The airline business is brutally competitive. Air fares have become cheaper, while consumers are demanding more from the product. The pillars the modern industry is built on, other than price, are the network (the number of destinations and the ease of getting there via the hub) and the consistency of the product. These are areas that we need to work on. Having inherited many ‘used’ aircraft in the past, we continue to have different cabin products even across the same type of aircraft. We need to modify them to offer product consistency and gain greater economies of scale. This requires considerable investment, which is not easy under our current structure.
The industry is moving increasingly towards digital platforms. The “millennials” prefer making purchases in this medium and they are going to be our largest share of customers in a few years’ time. We must acquire and implement state-of-the-art systems that allow us to attract them. These too are expensive items and a delay between the requirement being specified and delivered could well mean it is obsolete when it arrives. Time is a luxury that is in short supply in the airline world.
Colombo is becoming a player in the air-cargo space as well. Several foreign airlines schedule freighter aircraft through BIA on a weekly basis. This is a market that we should be exploiting. In the short term, we need to invest in equipping our ground handling unit with modern cargo handling equipment. These investments are costly but deliver immediate returns. Our cargo business has performed exceptionally well this year and in the medium-term, we should be looking at having our own freighter aircraft. These require a substantial initial investment.
As a state enterprise, we are now strictly following the National Procurement Committee’s guidelines. These are very thorough and detailed procedures that need to be adhered to when taxpayer’s funds are being spent. Whilst SriLankan has been reliant on commercial borrowings for funding during recent years and not direct treasury grants, this is absolutely as it should be – state funds must be spent wisely and well. However, conducting activities in adherence to this process – which was not developed with the airline business in mind – takes time. This has made it challenging for us to compete with our fast-moving competitors, particularly as the airline business involves transactions of large sums and at times we need to obtain Cabinet approval for such items.
I strongly believe that an airline, even if it is the national carrier, should be attracting private capital and be run as a business. Some state involvement is a good thing, but just as the Indian government has realised in the case of mighty Air India, airlines are best run as businesses that can attract private investment. This helps them compete more effectively, forces them to be more efficient and stops them from becoming a drain on the state’s resources.
Q: What does the future hold for the airline?
A: The airline industry is a fast-paced environment that is rapidly changing. Recent years have seen the evolvement of LCCs and in particular, Low Cost Long-Haul Carriers. These have brought about many challenges to traditional Full-Service Carriers, who must adapt to survive.
Another key challenge is the rising fuel price, which has not been met with adequate fare increases in most markets.
However, we have many strengths. We have a strong brand and a very good product. Our operational record is excellent and safety standards are exemplary. We need to build on these assets for the future.
It will not be easy. Airlines in the region, particularly from India and ASEAN, have large aircraft order books and ambitious expansion plans. If we are going to get our fair market share, we need to be innovative and cannot afford to procrastinate. Time is a luxury we cannot afford in this business – did I say that before?
Our plan is to optimise our costs further while selectively expanding to relevant markets. Jet fuel prices in Colombo continue to be high in comparison to other major airports in the region and we have established a dialogue with the Ceylon Petroleum Corporation to seek ways to minimise this, the single largest cost item on our balance sheet. We need to be able to make fast decisions and respond to changes in the market environment.
We have proven that Colombo is a viable regional hub. Now we need to expand and build this hub into a fortress. Doing so requires significant infrastructure investments, both at the airport and the airline. The current terminal is at capacity, the construction of a second terminal must be a national priority. Several other infrastructure issues at the airport, such as ground handling equipment and hangar space are within the control of the airline but will need significant capital investment very soon. A second runway is not an immediate need, but this sort of project has a gestation time of around ten years, so we must embark on it as soon as we can.
Aviation is a capital-intensive business. But it is one that produces high-value employment and is an integral part of a country’s transport infrastructure, especially for an island nation. But the required investment is not something that a middle-income country such as ours can afford. The taxpayer cannot and should not supply capital to a business such as an airline.
Attracting external investment to the airline is very possible, once the environment in which we operate and the structure of the company are in the correct place. We in Sri Lanka have shown we are quite capable of running a competitive business and holding our own against global competition. The airline has the capacity to do the same - give us the resources and the freedom to be competitive so we can prove it.