Month: December 2012

Airliner’s Dilemma

It is no secret that sustained profitability remains a dream for most, if not all Indian carriers. Barring a few sporadic quarters or profit, airlines have mostly suffered losses over the past few years.  The well publicized Kingfisher lock-down and Air India bailout highlighted the consequences of accumulating sustained losses.  The Indian aviation market is in such a tough state that airlines are more focused on surviving let alone return to profits.

So, where does the problem lie? Surely, it cannot be empty seats since passengers traffic continues to increase. In fact Kingfisher was among the top in terms of passenger traffic, when it locked down its operations. Can it be oil prices? But then airlines can increase ticket prices to accommodate the effects of oil prices.

The problem lies in the very approach of trying to survive and not build profits. A classic case of the popular Prisoners Dilemma problem.

Let me quickly brief you about it. PD explains why two people/competitors might not co-operate, even if it appears that it is in their best interests to do so. Let’s say 2 murderers are caught by the police but without sufficient evidence to charge them and are questioned separately. They are promised that they would receive a lighter sentence(1 year) if they co-operate(admit guilt) and a harsher one(3 years) if they don’t. But if one cooperates and the other refuses to accept guilt then the co operative person will face the maximum term(15 years) while the other is let free.

Ideally, both would like to co-operate and get the minimum sentence of one year. But this very thinking would give a greater leverage for one of the persons to deny their murder so that he could go free while the other co-operative guy languishes in prison. Hence, both should rationally refuse to co-operate as this ensures that each doesn’t receive the maximum punishment.

In the current market heavily dominated by low-cost carriers and middle class passengers, ticket prices play an important role in luring people. So, if one airline cuts their ticket prices, naturally other airlines will follow suit lest they would lose their customers. Clearly, this would lead to an ideal solution in terms of passenger traffic for all the airlines since they are similarly priced.

For a better understanding consider the following example.

Airline/ its ticket price A/same A /cut
B/same 50-50 70-30
B/cut 30-70 50-50

(The numbers a-b represent the market share of A and B respectively)

Ideally, the best solution for both A and B would be to maintain their airfares for optimum market share and sufficient revenues. However, the prisoner’s dilemma advises not to increase their airfares though it is in their best interests to do so. This is because; if any one airline increases its fares and the other doesn’t then the passengers would flock to the one offering the better price.

This is what has happened in India all these years. With the presence of low-cost carriers there is immense competition to cut prices even if it is below profitable level. Airlines are looking at every minor opportunity to squeeze their costs to stay in the price race in fear of losing out on passenger traffic.  Add to this the fluctuating oil prices and airport taxes where every minor change can significantly their balance sheets, it becomes clear why the airlines are on turbulent weather. With FDI being introduced, fares are likely to drop further and perhaps it would be the airline with the deepest pockets which shall survive this race to the bottom.