INDIAN INDUSTRY FINAL PROJECT
8/17/2007 INDUSTRY ANALYSIS
AVIATION
OVERVIEW Aviation Industry in India is one of the fastest growing aviation industries in the world. With the liberalization of the Indian aviation sector, aviation industry in India has undergone a rapid transformation. From being primarily a government-owned industry, the Indian aviation industry is now dominated by privately owned full service airlines and low cost carriers. Private airlines account for around 75% share of the domestic aviation market. Air transportation in India is under the purview of the Department of Civil Aviation, a part of the India's Ministry of Civil Aviation and Tourism. India has an eminent position in the civil aviation sector with a large fleet of aircrafts. In all, 56 airlines are operating scheduled air services to and through India and 22 foreign airlines are over flying
Indian
Territory. There are over over E T TI M B U S
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O T
H P E S OJ .
.J
T
-
Y T L U C A F
R E G A N A M
L AI
S CI M O N O C E
450 450
airp airpor ortts -:
and 1091 registered aircrafts
in
the
count country ry.. Ther Theree are are also
41
scheduled
nonair
transport transport operators. operators. Additionally 34 applicants have been granted NOC by
E T TI M B U S
I
Y B D R A K S A H B
– E EJ R E H K U M
9 8 9 0 S B 7 0
B O N A R A K
O R E
4 8 1 S B 7 0 –
5 A Y H TI N
A N A G N A R
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9 5 6 2 S B 7 0 –
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– 7 6 0 3 S B 7 0 I
V N A VI H S
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the Ministry of Civil Aviation for setting up non scheduled air transport operation. Air Transport has a significant role to play in a vast country like India with major industrial and commercial centres located far apart. Earlier air travel was a privilege only a few could afford, but today air travel has become much cheaper and can be afforded by a large number of people. Let us have a look at the genesis of Indian Aviation Industry: HISTORY India has the distinction of organising the first flight by an aero plane in the world. That was in February 1911. This airmail flight piloted by French pilot M. Picquet flew from Allahabad to Naini. However, it took more than 20 years for the country to have its own airline. In October 15, 1932, Tata Son’s Ltd – which later become Air India International – commenced weekly airmail service with a Puss Moth aircraft between Karachi and Madras via Ahmedabad and Bombay, covering over 1,300 miles. Later two more airlines – Indian National Airways in 1933 and Air Services of Indian in 1937 came up. Following the end of World of World War II, II, regular commercial service was restored in India and Tata Airlines became a public limited company on 29 July 1946 under the name Air India. In 1948-49% of the airline was acquired by the Government of India, India, with an option to purchase an additional 2%. In return, the airline was granted status to operate international services from India as the designated flag carrier under the name Air India International. This marked the airline's first long haul international flight. The Government nationalised the airlines industry in 1953, with enactment of Air Corporation Act, and assets of nine existing air companies were transferred to the two new corporation – Air India International and the Indian Airlines. These two companies enjoyed monopoly power in the industry until 1991, when private airlines were given permission to operate charter and non scheduled services under the ‘Air Taxi’ scheme to boost tourism. After having a look at the history of the Indian Aviation Industry in brief at first we shall consider the Macroeconomic aspect in brief and then shall look into the Microeconomics. As such we will discuss the different eras through which the industry has evolved. 1. PrePre- Nati Nation onal aliz izat atio ion n
2. Post Nationalization and Pre Liberalization ( Pre 1991)
3. Liberalization (1991) 4. Post Liberalization and Privatization 5. Entry of Low Carriers (2003)
Pre Nationalization As mentioned in the history the first Indian Airway was TATA Airlines, division of TATA Sons Ltd. (Now TATA group) which was later acquired by the Government of India.
Post Nationalization and Pre liberalization Government of India changed TATA Airlines to Air India. Before 1991, the Indian skies were not open to the private p rivate players. At that time the two major airlines operating in India, bo th owned and and cont contro roll lled ed by the the Gove Govern rnme ment nt of Indi Indiaa were were – Air Air Indi Indiaa and and Indi Indian an Airl Airlin ines es.. The The Government nationalized the airlines industry in 1953, with enactment of Air Corporation Act, and assets of nine existing air companies were transferred to the two new corporations – Air India International and the Indian Airlines. A third government-owned airline, Vayudoot, which pro provi vided ded feed feeder er serv servic ices es betwe between en smal smalle lerr citi cities es,, was was merg merged ed with with IAC IAC in 1994. 1994. Thes Thesee government-owned airlines dominated Indian aviation industry till the mid-1990s.
Liberalization The liberalization in civil aviation industry began in 1986 with the introduction if Air Taxi system to boost development of tourism. Though there were several restrictions relating to seat capacity, airports, timing and fare, the scheme was liberalized over a period of time. Even the fare was totally deregulated, allowing air taxi operators to charge any fare. In April 1990, the Government adopted open-sky policy and allowed air taxi- operators to operate flights from any airport, both on a charter and a non charter basis and to decide their own flight schedules, cargo and passenger fares. With Open Sky Policy many private operators began operation in the domestic domestic sector. The carriage carriage increased from a modest 15,000 passengers passengers in 1990 to more than 0.4 million in 1992.
Post Liberalization and Privatization After the Liberalization process, as a government of India opened the sky, a number of private players including Jet Airways, Air Sahara, Modiluft, Damania Airways, NEPC airlines and East
West Airlines commenced domestic operations. The Open Skies policy allowed the foreign airline of any country or ownership to land at any port on any number of occasions and with unlimited seat capacity. There would be no restriction on the type of aircraft used, no demand for certification, no regularity of service and no need to specify at which airports they would land. In 1994, following the repeal of the Air Corporation Act, private players were permitted to operate scheduled services. Let us look that the major private players operating in the Indian skies.
Private Players
Entry of Low Cost Carriers (2003) A low-cost carrier or low-cost airline (also known as a no-frills or discount or discount carrier / airline) is an airline that offers generally low fares in exchange for eliminating many traditional passenger services.India services.India''s first low-cost airline, Air Deccan started service on August 25, 25, 2003 2003.. The success of Air Deccan has spurred the entry of more than a dozen low-cost airlines in India. Air Deccan now faces stiff competition from other low-cost Indian carriers such as SpiceJet SpiceJet,, GoAir , IndiGo and Paramount Airways. Airways. This low cost model is two-fold:
Offering connectivity between smaller cities and major metros and
Making air travel a feasible option to a new class of passengers.
Air Deccan is India’s first low-cost carrier, operating 350 flights to 64 destinations a day within India. Its main base is HAL BANGALORE International Airport, with a secondary hub at Chennai International Airport, Chennai.
The airline’s position of strength is in rock bottom rates; none of the larger airlines have figured out how to counter counter the fledgl fledgling ing airlin airline’s e’s pricin pricing g advanta advantage. ge. Virtua Virtuall lly y a monopol monopoly y in this this category of economy flights, Air Deccan can celebrate as long as it remains unchallenged.
SpiceJet is a low-cost airline based in New Delhi in India. It began its services in May 2005.
SpiceJet was earlier known as Royal Airways, a reincarnation of ModiLuft. SpiceJet marked its entry in service with Rs.99 fares for the first 99 days. There were 9000 seats available at this rate. It followed it up with a Rs. 999 promotional scheme on select routes. Their aim is to compete with the Indian Railways passengers travelling in AC coaches.
IndiGo Airlines Airlines is a private domestic low-cost airline based in Gurgaon, India. It operates
domestic services linking 14 destinations. Its main base is Indira Gandhi International Airport, Delhi. The carrier has set a target of serving about 30 Indian cities by 2010 with a fleet size of 40 A320s. ANALYSIS OF THE INDUSTRY
DEMAND & SUPPLY The passenger traffic in the Indian aviation industry is growing day by day. The growth rate of the passenger traffic is an indication of the growing demand of air services in India. This growth has evolved over a number of years broadly speaking in the last 10 years. Let us analyze how the demand as well as supply has changed. In the initial years i.e. during the 1990’s there were not many players in the market specifically because of the government restriction. As such the supply was limited during those years.
History speaks for itself that during that time the air fares were exorbitant making air travel affordable only by the rich and elite. Now the question arises whether the limited supply lead to high air fares fares or the high air fares lead to low demand. demand. It seems that that it was both the ways. The limited number of airlines was not able to cater to huge demand of India, thus leading to high prices .and these high prices subsequently lead to reduction in demand. P
D1
S1
P D2
S2
P* D1
P**
D2
S1 0
S2 Q*
Q
Q**
0
GRAPH I
Q
GRAPH II
In the above graphs along the y axis we measure the price and along x axis the quantity demanded demanded and supplied. supplied. It can be seen from graph I that when there were not too many players players in the market the supply curve was steep showing less elastic supply (S1S1). However the demand curve is relatively elastic (D1D1). As such the airline fares were quite high at P*. However with the entry of more players specially the low cost airlines the supply increased and became more elastic than before (S2S2) (S2S2) and the demand has also grown over the the years (D2D2) , as such the air fares are low represented by P**. It can also be stated otherwise that due to high prices the demand for air services was previously low (Q*), with the reduction in fares, the demand also increased (Q**). The following table shows the increase in domestic passenger traffic from 2002-03 to 2005-06. Year
Passenger Traffic
Percentage increase
2001 -02
28.8 million
-
2002-03
32 million
11.11
2003-04
40 million
25
2004-05
45 million
12.5
2005-06
51 million
13.33
This also shows that Indian Aviation Industry is price elastic in nature as with the reduction in the prices over the years, the passenger traffic has increased enormously. In 2003 when the low cost airlines were introduced the passenger traffic had increased enormously, even the railways were forced to revise their fares and come out with new schemes in order to face the stiff competition it was getting from the Airways. This also proves the price elastic nature of Airlines. Over the last 10 years passenger traffic has grown by 125% and at present the annual growth rate hovers around 12-13%.
Factor Costs Factor costs are the costs of the factor inputs which is the backbone for the functioning of the industry. Without these inputs no production can be undertaken. The production is undertaken by workers who are equipped with machines which are housed in factories which are sitting on land. The main factor input costs can be divided into four groups:1. Land 2. Labour 3. Capital 4. Entr Entrep epre rene neur ursh ship ip The main factor input costs for the Indian Aviation Industry are:1. Labour 2. Fuel 3. Passe asseng nger er Food ood 4. Adver Adverti tisi sing ng and and Prom Promot otio ion n 5. Landing Fe Fees 6. Infrastructure like aircraft lease rentals
7. License nse fee 8. Interest, Interest, Taxes, Taxes, Passenge Passengerr Traffic Traffic commi commission ssion
COST STRUCTURE OF THE INDIAN AVIATION INDUSTRY
•
Aviation Turbine Fuel is far higher than global rates, it is accounted for 35-40% of operating cost, as against global average of 20-25%
•
Labour accounts for the major cost incurred by the industry because large number of operators required and due to shortage of technical personnel.
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Interest repayments on foreign currency loans acts as a burden on the industry.
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The industry has to take huge loans in order to fund their infrastructural costs such as purchase of aircrafts, maintenance of airports etc.
•
Due Due to Inte Intens nsee comp compet etit itio ion n in the the indu indust stry ry the the airl airlin inee has has to incu incurr subs substa tant ntia iall adver adverti tise seme ment nt and and prom promot otio ional nal cost costss in orde orderr to crea create te awar awarene eness ss and and allu allure re the the consumers.
Revenue
Market Structure Changes in Market Structure – 1. Monopoly
During pre and post nationalization i.e. upto 1986, the only flights plying in the Indian sky were Air India and Indian Airlines both owned and controlled by the Government of India and as such the government enjoyed monopoly in the Indian Aviation Industry. Let us look at the basic characteristics of the Monopoly market:1. There is is a single single seller seller and many many buyers buyers of a product. product. 2. The products produced and sold by the firm is homogeneous or non-homogeneous but it
has got no close substitutes in the market. 3. Ther Theree are are barri barrier erss to ent entry ry.. 4. The The firm firm is a pric pricee make makerr i.e. i.e. it has has subs substa tant ntia iall cont contro roll over over the market market price price of the the product. 5. The supply supply of the product product by the the single single firm consti constitutes tutes the the market supply supply.. 6. The firm acts atomistically i.e. while taking its profit maximizing decisions it ignores the
reaction of other firms( potential competitors) and 7. The firm firm faces faces the market market demand curve for its its product product.. Let us analyse the Indian Aviation industry during that time on the above mentioned parameters:1. Indian Indian Airlines Airlines and Air India India both both under the same same entity entity were the the only supplie suppliers rs of civil civil air services while there were buyers for the same. 2. The product was homogeneous as the air services were similar in the two airlines and
though Railways Railways was considered considered a competitor competitor but it catered to entirely entirely different different market segment and was nowhere near nea r to the air services considering the time and cost factor. 3. Due to governme government nt regulati regulations, ons, no other other player player could could enter enter the market. market. 4. Both the airways controlled the entire demand and supply of the airline services. 5. Government was the price maker and it did not take pricing decisions strategically.
Price Discrimination
When a monopolist discriminates between consumers the practice is called Price Discrimination. He is sometimes able to charge different prices to different consumers of the same commodity. In the Airline Industry also the consumers are categorized into different classes such as Business and Economy and accordingly the prices charged also differs in the two classes.
MC
Price, Cost P*
G
C*
F
AC
E AR
0
Q*
Quantity MR
In the above graph, we measure quantity along the x-axis and price(P), average cost(AC), margin marginal al cost(M cost(MC), C), averag averagee revenu revenue(A e(AR), R), margin marginal al revenu revenue(M e(MR) R) along along the y-axis y-axis.. The monopolist faces a downward sloping demand curve and as such his MR curve is also downward sloping. The monopolist will produce at the profit maximizing level which is the point where 1. MR=MC and 2.
MC cuts MR from below.
This happens at the point E and accordingly the quantity supplied would be Q* and the price charged is P*. The AC curve intersects Q at the point F. As such his TC =C*FQ*0. His TR= P*GQ*0 and the profit earned is denoted by the area P*GFC*. The monopolist earns profit in the long run also as there is no competitor to enter the industry and take away his share of profits. The above graph applies to the Air India and Indian Airlines when they were enjoying monopoly status in the industry. 2. Oligopoly After the post privatization period i.e. the period after 1991 lot of private players entered the industry under the government policy of open sky, which repealed the Air Corporations Act of 1953 and came up with Air Corporations Act, 1994. Opening up of the Aviation industry to 41% FDI in the form of equity stake has also increased increased the competition competition in the economy. economy. By 1995, Private airlines occupied 10% of the domestic air traffic. Hence the various players broke into the monopoly of IA and AI creating a situation of Oligopoly market. The various characteristics of an oligopoly market are:-
•
Small number of sellers but it entirely depends on the size of the market.
•
Interdependence of decision making- The business strategy of each and every firm in respect of pricing, advertising, product modifications is closely watched by the rival firms.
•
There are barriers of entry due the high capital investment, economies of scale, resistance by existing firms, price cutting strategy etc.
•
Product may or may not be homogeneous.
•
The consumer is the price taker and the industry players are the price makers.
•
Stabilized prices – The prices tend to stabilize because no player is willing to bring about a change in its prices.
Out of the above mentioned characteristics of Oligopoly, the Indian Aviation Industry possesses the following:•
There are 8 major airways in the current Indian aviation industry. Each and every player has a control on the prices and influences the market prices.
•
The business strategies of pricing of tickets, advertisements, promotion schemes etc are in line with that of the competitors. A slight change in any type policy by a company will lead to the others to follow suit. Like when Air Deccan came up with a promotional scheme of Re 1 ticket, its immediate competitor Spice Jet launched a scheme of 99p/ ticket.
•
The Indian Indian Aviati Aviation on Indust Industry ry involv involves es a huge capita capitall invest investmen mentt and governm government ent regulation which acts as major reasons for any new player to enter. Not only that, the customer loyalty is attached to a particular airline and they might not be willing to switch.
•
The The prod produc uctt offe offere red d by each each and and ever every y airl airlin inee i.e. i.e. air air serv servic ices es is more more or less less homogeneous with minor differences.
•
The prices in this industry are fixed by the players according to the segment of market they want to cater to.
In Oligopoly market the profit maximization output and price is not determined by the profit maximizing criterion we saw in the monopoly market structure. Hence here lies the problem of indeterminacy. As such we can describe the Indian Aviation industry’s market structure through Sweezy’s model of Oligopoly Oligopoly which talks about price stability/rigidity stability/rigidity.. Here, a firm A believes believes that if it increases its prices then none of the firms will follow suit so firm A will face considerabl considerablee losses. losses. Hence in this context context the demand is relatively relatively inelastic. inelastic. On the other hand
when firm A reduces its prices, all other firms follow suit to protect their market share. Here the demand curve becomes relatively elastic. Same is the case with Indian aviation players like reduction in price by Air Deccan will result in reduced prices of Spice Jet and an increase in prices of Air Deccan will cause them considerable con siderable losses. This kind of asymmetrical price conjecture leads to kink in the demand curve. Due to this reason firms prefer to maintain stable prices for particular periods.
P, MR, MC MC2 D MC1 E PO
Kinked Demand Curve A
D’ B
0
QO MR
Q
In the above graph, the x-axis shows Quantity and the y-axis shows the price, MR and MC. Demand curve faced by an oligopolist has a kink point at E, the price and output corresponding to it is 0PO and 0QO respectively. DE portion is relatively elastic while ED’ is relatively inelastic. It is very unlikely that MC would pass through the discontinuous portion of MR, if QQO then MC>MR And the firm will increase its output to maximize profit. Hence, the profit of the firm is maximized when Q=QO. Here, the equilibrium price- output combination (Po, QO) is compatible with a wide range of costs. co sts. Thus, shifts in MC curve do not affect the equilibrium.
We can see from the following data that prices in airline industry are same for the players competing with each other. We take the fares charged by the major airlines plying along Delhi – Mumbai route (busiest route- 44 flights/day) High Cost Players
Prices Charged
1. Jet
Rs. 7760
2.
Sahara
Rs 8400
3. Kingfi gfisher
Rs 7400
Low Co Cost Pl Players
Prices Ch Charged
1. Air De Deccan
Rs.5398
2. Go Air
Rs. 5000
3. Spice jet
Rs. 5148
3. Oligopoly Oligopoly market market tending tending towards towards Monopolisti Monopolisticc characteri characteristics stics The future scenario of the Indian Aviation Av iation industry is tending towards monopolistic market Characteristics, some of which are as follows: •
Large number of buyers and sellers
•
Product is differentiated
•
No Barriers to entry.
It is being forecasted that around 8 – 9 new airlines would be starting their services in the next 2 years. As such we see that number of players is increasing and there would be cut throat competition. As such the market may move towards monopolistic in the coming years.
MARKET SHARE OF INDIAN AVIATION INDUSTRY
JET AIRWAYS KINGFISHER AIR DECCAN SPICE JET INDIAN GO AIR OTHERS
40.5 7.8 21.2 7 20.8 2 0.7 100
Domestic passenger growth rate of 44.6%. cargo cargo traff trafficic- 8.7% during during the year 2006-2007
