The Hindu Business Line : How do you price an airline seat?

RECENT REPORTS about a likely price increase across the Indian airline industry seem strange at first, given the recent flurry of discounted fares. Few businesses are as fiercely competitive, or as difficult to run profitably, as a passenger airline. Seat on an airline flight is an extremely perishable, high-value good, and poses a challenge to traditional full-cost recovery approach to pricing.

Every flight taking off with empty seats carries some profits away with it forever. Along with fuel, many costs such as airport charges are common to all rivals. Therefore, making a competitive difference is tough and often fares of competing airlines rise and fall together.

Yet, the market for airline seats presents a paradox. Low-cost airlines have emerged everywhere bringing in new travellers in huge numbers at low prices, offering a minimalist service.

Southwest Airlines, which is the grand-daddy of them all, holds the unique distinction of a 30-year unbroken record of profitability in an industry where filing for insolvency is the more common occurrence.

Meanwhile, spiralling fuel prices threaten the viability of the industry, forcing all carriers to revise fares periodically or crash. The trick is for each carrier to keep his relative distance from others about the same even at higher price levels.

Established carriers charge premiums over the budget airlines for essentially the same product. And Business Class fares have always been well above what it costs the airline to provide a larger, comfortable seat up front, better amenities and luxuries.

The ability to charge such a disproportionate differential in price — for a higher class or for the airline brand — is the essence of a successful brand-based pricing strategy.

It works as long as the customer sees that `something different' as valuable enough to pay for it. Yet, evidence shows that competition from low-cost carriers heightens the customer's price sensitivity, and undermines their ability to skim the cream off.

Everyone must then cut costs to maintain an advantage over their rivals. Cost and fares will come down all round - more so in real terms, measured by adjusting for income increases.

Eventually, all price wars tend towards consolidation.

In India, the situation is slightly different because one of the players is Government owned, an erstwhile monopoly, which is accustomed to believing that it will be bailed out when things go horribly wrong for it.

And in an era where loss-making public sector units are seen not so much as less as that such but as merely subserving a larger the socialist cause there is even less reason to respond to cost pressures.

If New Delhi takes the same view here as in pricing of cooking gas and kerosene, a fare revision may be long in coming.

Without a signal from the public sector player the others may just grit their teeth and carry on for as long as they can.

But in a truly competitive market, the weaker ones tend to be taken over or just go under.

Alternatively, as with most automotive industries, including tyres, an informal price agreement not amounting to a cartel, operates.

The consumer and the government may suffer this in silence, but only so long as the profits are not obscenely high.

Otherwise, what happened to the British oil interests in Iran in the 1950s could befall them.

S. Ramachander

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