Why Modi Govt Should Listen to Tycoon Warren Buffett on Air India

Air India is in trouble and the government needs to follow Warren Buffet’s logic, NOW.

Image of Air India aircraft and billionaire tycoon Warren Buffet, used for representational purposes.

(Photo: Altered by The Quint)

Dear Reader,

That was a clickbait headline to get you interested in reading this piece. Warren Buffett has never said anything about Air India, nevertheless, he has a very strong view about the idea of anyone owning an airline.

In his ‘Chairman’s Letter’ to the shareholders of Berkshire Hathaway, Buffett once wrote:

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here, a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.

Warren Buffet

Too caught up to read? Listen to it instead.

The brothers, Orville and Wilbur Wright, are generally credited with building and flying the world’s first airplane. Buffett further wrote in the same letter: “The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it”.

Long story short – what Buffett meant was that owning an airline is an expensive proposition, and to keep running it requires an endless amount of money.

In fact, a 2017 McKinsey article points out:

The airline industry in aggregate has not earned ROIC (return on invested capital) greater than its cost of capital in any year in its history, until 2015.

What does this mean in layman’s English? Every business needs money. This money is referred to as capital. There is a certain cost to any capital that is invested in a business. The return on that invested capital (which basically means the return from the business) has to be greater than the cost of that capital, for the business to be a financially viable proposition.

Why Owning an Airline is Not Viable

As the McKinsey article points out, that hasn’t happened for the airline industry as a whole. There are multiple reasons for it. According to the aforementioned article:

Long lead times for new capacity, low barriers to entry, high barriers to exit, perishable inventory… and a government regulatory framework that doesn’t always help carriers, all contribute to cutthroat pricing, excess capacity… Investors should probably just pack their bags and go home.

Keeping this scenario in mind, now let’s talk about Air India. The accumulated losses of the airline between April 2010 and December 2017 were at a massive Rs 46,256 crore. In order to keep the airline going, the government has invested money in it every year since 2011-2012. A total of Rs 26,545 crore has been invested in the airline since 2011-2012.

This investment is made as part of a plan which provides Rs 30,231 crore of equity infusion from the government into the airline, until 2021.

The interesting bit here is that other than the government investing money in it every year, the airline has also had to borrow money to keep itself going.

As of 31 March 2017, the total debt of the airline stood at Rs 48,447 crore. Of this, Rs 31,088 crore, is basically working capital loan. A working capital loan is a loan which helps finance the everyday operations of a company.

Air India’s Sky-High Losses

The total revenue earned by Air India in 2016-2017 was Rs 22,178 crore, way lesser than the working capital loans of the company. Clearly, there is a problem here. The company does not make enough money to be a viable business proposition and borrows money all the time to meet its expenditure and to keep itself going. The total expenditure of the airline in 2016-2017 stood at Rs 25,797 crore.

As mentioned earlier, the accumulated losses of Air India stand at Rs 46,256 crore between April 2010 and December 2017, with the airline never making money in any of the years.

The logical question to ask here is, why are the banks still lending money to it, when it is clear that the airline is not in a position to repay its loans. The only way it can repay its loans is by taking on newer loans.

The banks are lending to Air India because it is owned by the government. Governments, usually don’t default, and at the end of the day, have the power to print money (through the central bank).

If Air India was not a government-owned company, it would have clearly shutdown by now. As Thomas Sowell writes in Basic Economics:

Capitalist businesses can make only so many mistakes for so long before they have to either stop or get stopped – whether by an inability to get the labour and supplies they need or by bankruptcy.

But given that Air India is a government-owned company in a mixed economy, it has continued to survive. More and more of taxpayer money has been pumped into the company over the years.

High Time Indian Govt Bought Buffet’s Logic

A government company unlike a private company has much deeper pockets. As Sowell writes: “In a… socialist economy, leaders can continue to make the same mistakes indefinitely. The consequences are paid by others in the form of standard of living lower than it would be if there were greater efficiency in the use of scarce resources.”

It is time, the government buys Warren Buffet’s logic on airlines, and gets out of the ownership of Air India. While the government has put the airline on the block, the terms of the sale, the way they are currently, are unlikely to help find a buyer.

These terms need to be changed, if the government is serious about selling Air India, else it will have to keep pumping more and more money into the airline.

Every rupee that goes towards rescuing the airline is taken away from other more important areas like education, health, defence and agriculture. The citizens of India are bearing the cost of Air India. And that is something that needs to come to a stop.

(Vivek Kaul is the author of ‘India’s Big Government—The Intrusive State and How It is Hurting Us’. He can be reached @kaul_vivek ‏. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)

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