The king-size problem

The king-size problem

Airline industry

Kingfisher Airlines (KFA) and Vijay Mallya are in the headlines for wrong reasons. Mallya’s Kingfisher Airlines is in serious financial trouble. With the benefit of hindsight, pundits are finding fault with his business model, including his takeover of loss-making Air Deccan (primarily to gain market share and start international flights in a hurry which, according to regulations, required at least 5 years of domestic operation which Air Deccan fulfilled but KFA did not) and focusing on the small premium segment in a price-sensitive Indian market by converting economy class seats to business class at huge costs. In fact, KFA made profits in only one quarter out of the past six years. 

Should his troubled airline be bailed out directly by the government with tax payers’ money or indirectly by the government asking the public sector banks to do so by providing more loans to the airline? It is clear now that with the mounting public opinion against bailout (or ‘socialising private losses while privatizing profits’), this is becoming increasingly difficult for the government, even if it showed some initial inclination to do so. The banks, too, have already burnt their fingers in early 2010 by converting their loans to KFA into equity  at high premium and then KFA’s share price tanking (as a result, banks together lost more than Rs 500 crore). Hence, they  are in no mood to  provide additional loans or softening terms (‘restructuring’) unless Mallya puts in more of his own money from his profitable liquor company UB Group.

True that Air India (with a total debt of Rs 42,000 crore and net loss of Rs 7,000 crore  as against KFA’s  debt of Rs 7,057 crore debt and net loss of Rs 1,027crore) is surviving with massive subsidies from the government. But since the government is the major owner of Air India and hence, in principle, gets a share of the profits (though that has not happened for a long time), has to share its losses too.

That argument for loss sharing by the government does not apply to privately owned companies like KFA. Further, if one private airline is bailed out, others will also ask for the same. Even for Air India, many analysts are suggesting that the government should come out of the airlines business and the chronic loss-making AI should be put up for sale to strategic investors, domestic or foreign. There is no case for subsidising with tax payers’ money an activity which can be performed more efficiently by private players. National security will not be compromised. In a national emergency (like war), even private sector planes can be commandeered by the government. 

Cut throat price competition

But we should also give the devil his due. Some of the problems are not the making of the airline companies. All the airlines in India are making losses, except only one low-cost carrier (Indigo), despite revenue and passengers increasing for all of them and even with seat occupancy rate of 80 per cent to 85 per cent. The major reasons are cut-throat price competition after the entry of so many low-cost airlines together with sharply rising costs – specially rupee cost of fuel (due to rising dollar price of ATF and declining value of rupee against $), interest cost on loans and salaries of pilots and technicians (due to shortage of trained and experienced personnel in the face of  rapidly growing demand).

Economists can find standard textbook models to explain what is happening. One model suggests that if each firm believes that its competitors will not raise price if it unilaterally raises price while the competitors will follow if it reduces price below the prevailing market price, then all the firms may find it in their interest to absorb the higher cost and not pass it on to the consumers, even when all of them are making losses. Trying to disturb the existing price unilaterally would involve even bigger loss.

Ultimately, either some of the loss-making companies would go out of business (or taken over by others)  leaving a smaller number of players to increase their market share, capacity utilisation (‘consolidation’) and make profits or there will be an explicit or implicit collusion under which all the firms together will hike the price or a combination of the two. It is to be seen how it will play out in India. It is also quite likely that now the Indian government, different political parties and the troubled domestic players would all be more amenable to allowing foreign players to enter the Indian aviation market, with some cap on the level of foreign ownership (like 24 per cent or 26 per cent). Some reduction in taxes on ATF is another possibility.

 Many people are asking: How come Indigo (net profit of rs 650 crore in 2010-11) is making profit while others are not?  It may be due to lower cost since they started late, learnt from others’ mistakes and adopted a better business model. But if that is the case, then some other player (usually a new entrant) would eventually follow this successful model and would take away the profits. In fact, this is what is happening all over the world (after deregulation, no barriers to entry and free price competition). Most of the airlines make losses while a few (more efficient ones) make money but that also does not last for ever. The successful players in the airlines business go on changing everywhere.   
(The author is a former professor of economics at IIM, Calcutta)

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