Eco Project Reprt

CHAPTER 1 INTRODUCTION

1.1 INDIAN AIRLINE INDUSTRY- A Brief History Air India was set up by J.R.D. Tata, who ran it successfully until it was nationalized in 1953. In the 1960s the “Maharaja”, as the national flag-carrier was affectionately known, was flying to 32 destinations (it now flies to 46 destinations) and making profits. For many years in India air travel was perceived to be an elitist activity. This view arose from the “Maharajah” syndrome where, due to the prohibitive cost of air travel, the only people who could afford it were the rich and powerful. In recent years, however, this image of Civil Aviation has undergone a change and aviation is now viewed in a different light - as an essential link not only for international travel and trade but also for providing connectivity to different parts of the country. Aviation is, by its very nature, a critical part of the infrastructure of the country and has important ramifications for the development of tourism and trade, the opening up of inaccessible areas of the country and for providing stimulus to business activity and economic growth. Until less than a decade ago, all aspects of aviation were firmly controlled by the Government. In the early fifties, all airlines operating in the country were merged into either Indian Airlines or Air India and, by virtue of the Air Corporations Act, 1953 this monopoly was perpetuated for the next forty years. The Directorate General of Civil Aviation controlled every aspect of flying including granting flying licenses, pilots, certifying aircrafts for flight and issuing all rules and procedures governing Indian airports and airspace. Finally, the Airports Authority of India was entrusted with the responsibility of managing all national and international airports and administering every aspect of air transport operation through the Air traffic Control. With the opening up of the Indian economy in the early Nineties, aviation saw some important changes. Most importantly, the Air Corporation Act was repealed to end the monopoly of the public sector and private airlines were reintroduced. Domestic liberalization took off in 1986, with the launch of scheduled services by new start-up carriers from 1992. A number of foreign 1

investors took an interest. Modiluft closed after failing to meet financial obligations to lessers and its technical partner, Lufthansa. In 1996-1998, Tata and SIA tried to launch a domestic carrier, but the civil aviation minister had publicly stated his opposition on numerous occasions (Airline Business 1998). The Indian government introduced the open sky policy for domestic players in 1991 and partial open sky policy for international players only in November 2004. Increasing liberalization and deregulation has led to an increase in the number of players. The industry comprises three types of players full cost carriers, low cost carriers (LCC) and many start-up airlines that are making/planning an entry. Figure 1.1 Airlines Market Share

1.2 Airline Price Discrimination Research on price discrimination in the airline industry has so far yielded two stylized facts. First, business travelers pay higher fares than do leisure travelers. Second, the degree of

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Figure 1.2 First degree Price Discrimination fare discrimination positively depends on competition. Constrained capacities with uncertain demand and price discrimination have been suspected as the main sources of such price discrimination. Yet, the question of the relative contribution of these factors remains open. It has to be stressed that constrained capacity and price discrimination need not be entirely conflicting explanations. Rather, apparent price discrimination might be carriers’ response to fixed capacity with uncertain demand. So, the issue is not whether the cause is price discrimination or constrained capacity, but rather whether capacity constraints with uncertain demand cause price discriminating behavior of airlines. In a perfectly competitive market, firms have no market power to discriminate by price. At the other extreme, a monopolist can, provided he has information about consumers’ taste differences and the transaction costs of setting multiple prices do not prevent such pricing strategies. Most real-life markets, however, fall somewhere in between the two extremes. What happens as the market becomes more competitive: Does price discrimination increase or decrease? From the above statements, it would seem that as market concentration increases, so should price discrimination. Theoretical studies contradict that intuition, however. Price discrimination may increase as the market becomes more competitive. For example, in Gale’s theoretical model there is more price discrimination under duopoly than under monopoly. This study tests the hypothesis that how various ticket restrictions affect the price discrimination policies of airlines. The existing studies of the airline market show that as market concentration increases, so does the average price level. Unlike previous studies of

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airline pricing that focused on the average fare on each flight, this study uses individual airline ticket prices and ticket restrictions. 1.3 RELEVANCE OF THE STUDY The study deals with the price discrimination in the Indian airline industry. This study will give an in-depth information about the various aspects of Price Discrimination that is prevalent in the Industry. Based on the data gathered from the analysis of this study, Business decisions like whether to increase or decrease the price, changes in the ticket booking scenario, ticket restrictions, and different prices at different timings of the Flight etc, can be made effectively. For this purpose, we have basically considered Kingfisher Airlines. 1.4 OBJECTIVE OF THE STUDY The objectives of the study are as follows •

To indicate the effect of Monopoly power v/s Imperfect competition over Price Discrimination.

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To analyze the role of Price discrimination on airline industry and its effect on the market shares of Kingfisher Airlines.

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To analyze the issue of across-airline dispersion of fares, aimed at consumers of different types (namely, business versus leisure travelers).

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To understand the changes in the consumer behavior towards airline in the industry due to Price discrimination.

1.5 LITERATURE REVIEW:For the purpose of analyzing the effect of price discrimination in Indian Airline Industry, few books and articles related to the topic were selected for study. Following are the Literature reviews of the article.

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1.

Regulation Misled by Misread Theory: Perfect Competition and Competition-Imposed Price Discrimination -

By William J. Baumol AEI Press, March 2006

The monograph Regulation Misled by Misread Theory: Perfect Competition and CompetitionImposed Price Discrimination (AEI Press, March 2006) focuses mainly on instances in which firms can charge different prices to different groups of consumers. Basic economics suggests that only monopolies can engage in such discriminatory pricing because, supposedly, in a competitive market any firm's attempt to increase prices will be undercut by a competitor. Professor Baumol counters that price discrimination is likely to be a standard feature in many markets in which firms compete vigorously. A conventional test for competitive markets, for example, might conclude that airlines have market power because of the large range of ticket prices on each flight. Baumol's theory suggests just the opposite. Because people cannot resell their tickets, airlines can find themselves in a situation where they must charge different prices to different consumers just to survive. (If people could resell their tickets easily, one would expect that the tickets might eventually go for a single price--i.e., there would be a conventional market.) Professor Baumol shows that effective competition does not necessarily impose uniform prices. More provocatively, competitive pressures can force all firms to adopt discriminatory prices if consumers cannot easily resell a product. This radically different picture of competitive markets helps explain the actual near ubiquity of discriminatory pricing and suggests that regulators should only sparingly use discriminatory pricing as a justification for market intervention. 2. Indian Aviation Industry: Opportunities and Challenges

Against this background, this book “Indian Aviation Industry: Opportunities and Challenges” provides an insight into the great opportunities awaiting the Indian Aviation Industry and also the major challenges to be faced in realizing the objectives. The book is

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divided into three sections. The first section of the book titled “Introduction” aims to provide an overall view of the current state of the Aviation Industry in India. The second section “Developments in Infrastructure” is devoted to the comprehensive study of the aviation infrastructure development scenario in India. The last section of the book “Trends and Challenges in Indian Aviation” focuses on the emerging trends and the challenges that need to be overcome by the booming aviation industry in India. The next section “Developments in Infrastructure” is focused on studying the current state of infrastructure in the aviation industry in India and the measures being taken to improve the state of affairs. The last section “Trends and Challenges in Indian Aviation” focuses on the emerging trends in the Indian aviation industry. It also talks about the new challenges being thrown continuously in the aviation sector and the need to surmount them successfully.

3. Dyanamic Pricing models for Airline Business -

By Y Narahari, C V L Raju, K Ravikumar, Sourabh Shah

This research has been focussed on Dyanamic Pricing. It says that Dyanamic Pricing includes two aspects: 1. Price Dispersion 2. Price Discrimination In Price Discrimination, different prices are charged to different consumers for the same service. It is of three types: 1. First Degree Differentiation 2. Second Degree Differentiation 3. Third Degree Differentiation 6

The example taken in this for deployment of dyanamic pricing strategies is Airline Industry. The kind of pricing policies followed here is popularly known as yield Management or Revenue management. The method taken here is to dynamically modulate prices over time by adjusting the number of seats available in each pre-defined fare class. Advantage is taken of a natural segmentation in the consumers: business travelers for whom the flight dates and timings are primary and fares are secondary; casual travelers for whom prices are important prices are important and the dates/timings are flexible; and hybrids for whom both factors are at an equal level of importance. For this study, third degree of price discrimination is followed. 4. Price Discrimination in the Airline Market: The Effect of Market Concentration -

By Joanna Stavins

In this Research article, price discrimination in airline market has been studied. Economic theory suggests that a monopolist can price discriminate more successfully than can a perfectly competitive firm. Most real life markets, however, fall somewhere in between the two extremes. What happens as the market becomes more competitive: Does price Discrimination increase or decrease? This paper examines how price discrimination changes with the market concentration in the airline market. The paper uses data on prices and ticket restrictions across various routes within the United States, controlling for distances and airport gate restrictions. Price discrimination is found to increase as the markets become more competitive.

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CHAPTER 2 METHODOLOGY

2.1 METHODOLOGY FOLLOWED The research on price discrimination involves lots of study and in depth analysis of the information. The following were the methodology adopted:1. This study used data collected from the websites such as makemytrip.com &

cleartrip.com. 2. The data include ticket information for flights on a particular route (Delhi-Mumbai) on

the same day; Monday, September 3, 2007. The date was picked to avoid summer or holiday peaks, as well as weekend travel. Selecting a single day eliminates price differences due to travel on different days of the week. The data include fares offered for sale at various times before the scheduled travel date. 3. The earliest data include fares offered 2 days prior to departure, followed by fares offered

at 4 days prior to departure. 4. The route was selected arbitrarily and range from highly concentrated to quite

competitive. 5. The data collected were finally analyzed using regression analysis.

2.2 DATA ANALYSIS The purpose of the data analysis is to compare dispersion of fares under different booking scenarios.

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A restricted model was estimated, where price discrimination is assumed not to vary with market concentration. The assumption will be relaxed below. The model is a reduced-form regression of airfare on ticket restrictions, market concentration on the route, the carrier’s market share, and other route- and ticket-specific factors:

P = a + b1 DAYS + b2 DEPTIM + b3 DUR

(1)

Where P is the airfare; DUR is the duration of the journey from DELHI-MUMBAI; DAYS is the numbers of days prior to departure booking has been done. Ticket restrictions are expected to have a negative effect on airfare, and market share to have a positive effect. 2.3 FINDINGS The regression equation comes out to be: P = 8922.81 – 1629.9 DAYS - 831.1273 DEPTIME – 26.9095 DUR •

From the above equation we can infer that with duration time, time of departure and advance purchase as zero, the price of the ticket comes out to be Rs. 8882.43. This means when the ticket is booked in case of an emergency, when ticket restrictions are not applicable, the price charged for the ticket will be the highest.

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The effect of a ticket restriction on price (price discrimination) was negative and significant, when the advance-purchase requirement was used. Increasing the advancepurchase requirement by a day resulted in Rs. 1629 decrease in the ticket price. For example, a ticket with a 4-day advance purchase requirement cost Rs. 2375 less than a similar ticket on the same without the requirement.

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If the departure time is increased by an hour, the air fare will decrease by an amount equal to Rs. 831. Anyways, it has been observed from the study that the price actually varies based on whether the departure time is odd hours or business hours. 9

If the departure time is odd hours, then the price of the airfare will be less and hence, then the effect of departure time on airfare will be negative. But if the departure time is in business hours, then the price of the airfare will be high. Hence, in that case, the effect of departure time on airfare will be positive. •

It has also been observed that the duration of the journey also affects the air fare but not that much. If the duration of journey is increased, the price of the ticket is decreased by Rs. 26. As we know the distance between Delhi-Mumbai takes around 2 hours, hence the duration can be increased by just a few minutes. This doesn’t affect the airfare much.

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The coefficient of determination or R2 comes out to be is 0.9283 . This means that if only one variable is taken, then the variation in it explains 92.83% variation in airfare. The adjusted R2 is 0.8746. This means that variation in the duration of journey and departure time and advance purchase explains 87.46% of the variation in air fare.

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While performing the t test, the value of the calculated t statistic for departure time Duration of flight and advance purchase is more than the critical t value of 3.182. This shows that the three parameters are statistically significant and shares significant relationship with the airfare. Means they have a great impact on the variation in prices.

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We have also observed that Kingfisher Airlines is an Imperfect Competitor to other airlines in Indian Airline Industry. Hence we can say that price discrimination work well not only in monopolistic competition but also in imperfect Competition.

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CHAPTER 3 CONCLUSION This study analyzes the issue of price discrimination in Indian aviation industry. We used a sample of airfares offered by Kingfisher airlines and various ticket restrictions. Using the effect of individual ticket restrictions on airfare, this study finds that price discrimination decreases with various ticket restrictions. Price discrimination has been studied in terms of restrictions like duration of journey, departure time, cancellation penalty and advance purchase. The study proved that the airfare decreases as these restrictions are increased. The study proved that not only price discrimination can work well in monopolistic competition but also in imperfect competition as here Kingfisher Airlines is an Imperfect Competitor to other airlines. Also price discrimination works well only when price elasticity of demand are different in different situations. Here we have studied for Kingfisher Airlines but with more firms in the market, price discrimination can increase or decrease. Price discrimination depends on the routes. The analysis of discrimination of fares revealed that a customer attempting to book a ticket at roughly the time of our data collection would have faced the same fares as those included into our sample and could only have a choice between purchasing at the quoted fare or attempting to purchase from a different carrier. Also, in their fare setting decisions, airlines should have a specific customer in mind. Moreover current technology allows carriers to observe and track competitor’s fares, which means that it is very likely that fares we observe in the sample have been set taking into account fares offered by competing airlines at roughly the same time. Hence we can say that there is a great scope of price discrimination in airline industry. 11

3.1 LIMITATIONS The limitations for this study are: •

Only one airline considered in this study.

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Only one route considered in the study.

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A particular day considered for the study.

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Some of the ticket restrictions have been taken.

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Only Regression model has been considered in this study.

3.2 FURTHER SCOPE •

Other airlines can be included in the Indian Airline Industry.

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Other important routes can be considered in further study.

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Different days can be taken into consideration.

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More ticket restrictions can be considered.

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Other models can be used in the further analysis.

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