October 30, 2020

Price wars in aviation, telecom

Date : Oct 27

Sources : mumbaimirror.indiatimes.com

Players in the two sectors have been keeping tariffs low by pouring precious equity capital in their pursuit of higher market share.

One very bright spot in the economy is aviation. Domestic passenger traffic has been growing every month for over four years. Annual growth rates have been in double digits, often above 20 per cent, the fastest in the world. Last year, both domestic and international traffic of the Indian aviation industry grew at 17 per cent.

Of course, the number of airports, or their capacity, has not increased that much. So most airports look like bus depots, overcrowded with passengers, with no place to sit and inadequate facilities. But even though the airports seem to be bursting at the seams, the efficiency of air traffic control and the optimisation of space and facilities is unbelievable. The bulk of air traffic is still between metros, with the Mumbai-Delhi sector taking the lion’s share.

Low oil prices and a stable exchange rate were the main reasons for the airline boom of these past four years. Since over 80 per cent of the variable cost of running a flight is fuel, and that fuel is mostly imported (i.e. crude oil, which gets converted to aviation turbine fuel, or ATF), airfares were kept low. The competition was so intense that the Mumbai-Delhi airfare for a non-refundable ticket booked in advance was often cheaper than an AC train ticket.

As a result of the boom, airlines like Jet, Vistara (owned by Tatas and Singapore Airlines) and IndiGo together ordered over 1,000 new aircrafts, which will be delivered over the next eight years. But the estimated demand in the next 20 years is at least 2,000 more aircrafts. India will also double the number of airports in the next 15 years.

All this good news started souring earlier this year when oil prices started to climb. Oil went from 40 to 80, and the exchange rate became expensive by 20 per cent (i.e. 64 to 75). This double whammy has hit airlines very hard and profits have plummeted. Actually, both Jet and SpiceJet have reported losses running into thousands of crores. IndiGo is still profitable, but only just. As for Air India’s losses, the less said the better (although it has turned around from deeply negative to merely negative). Surprisingly, airfares haven’t increased sharply, despite huge increase in fuel costs. Why is that? IndiGo’s rivals allege that it has huge surplus capacity and can afford to keep prices low.

Imagine, you are operating a flight from Mumbai to Delhi. The flight is only half full a day before its scheduled departure. Does it make sense for the airline to offer 50 per cent discount? What if there are empty seats one hour before departure? Should it then offer 75 per cent discount? Because any revenue (even Rs 100) is better than flying with empty seats. This is the principle of “standby fares” quite popular in Europe and elsewhere. But instead of playing this dynamic pricing game, from day to day, or hour to hour, an airline with plenty of excess capacity of seats simply offers low fares. Because it can. That keeps fares low for everyone, as nobody can dare increase.

IndiGo’s market share is already 42 per cent (Jet is around 16, SpiceJet 12, and the remaining with Air India and GoAir). Airlines like IndiGo that want to keep airfares (and costs) low don’t actually buy aircrafts from Boeing or Airbus. They lease them, which means they only pay rent. This saves them huge capital, which is then used to keep airfares low despite higher fuel costs. The ticket prices allow the airline to maintain or increase its market share. What can rivals do? Match low fares and hope that fuel costs come down or traffic picks up further and prices eventually go up. The consumer is the main gainer. But if airlines make losses, does it eventually jeopardise safety? Do they start cutting costs on maintenance and safety?

Now let’s switch to another industry —telecom. Here too fares (i.e. tariffs) are very low. Voice is almost free and data prices are cheaper than even those offered in Bangladesh. How so? Because one big player has a huge amount of capital to sustain low fares (tariffs), and thereby increase market share. What can rivals do? Well, match low fares, keep investing, and hope that prices will eventually rise above costs. Till then, continue to make losses and fund those losses by infusing capital (i.e. equity). The consumer, in the meantime, enjoys cheap telephony. But for how long? Will investments suffer? Will we face more call drops because of inadequate number of towers? What will happen to India’s foray into 5G and beyond? Will the progress of digital India slow down because of capital shortage and losses?

Telecom enjoyed a golden period of huge growth and low prices, but things have changed drastically and prices may need some revision. Sooner or later, airlines will also have to look at prices and profits for sustainable growth.

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