Let the Aviation Sector Live in PEACE!!

Blast from the Past

I believe most of our first flying experiences would date back to the times when the Indian Aviation sector was revolutionized with the introduction of Air Deccan - India's First Low Cost Carrier. That was one such time in the Indian History which threatened the normal functioning of Indian Railways - people going by First Class in Railways started taking flights, maybe by paying a little extra, but with the added advantage of reaching their destination much much earlier. The value that they derived from paying just a little extra than the First Class railway fare outweighed the marginal difference of the same from the flight fare. It was also perhaps the First time when the Railway officials would have heard about the word Strategy - how to retain their customers. This is a classic example of cross - elasticity of demand - wherein an increase in demand of a service caused a decrease in demand of the other and vice versa. This is also an important landmark where we saw the aviation sector changing from a Duopoly to Oligopoly. Before the advent of Air Deccan, there were only 2 players in the Aviation Sector - the erstwhile Air India and Jet Airways.

Present Times..

Recently, we have been hearing and reading a lot about the so called "Predatory Pricing" of the Aviation sector. The Govt. is accusing the players of the Aviation sector of forming a kind of cartel wherein they are charging exorbitant rates to the consumers during the peak season of Christmas/New Year. They have even asked all the players to fix their price bands so that the consumer knows at the time of purchasing the ticket whether he is buying the cheapest or the costliest ticket. One would say that Govt. is doing this in the interest of common people. Agreed. This would bring in more visibility for the customers, and would help them in turn to take more informed decisions. That's the kind of perfect world that we dream of living in, and that’s what the Govt. is trying to provide. Bravo!!

Airline Industry Woes.. Hear Them Out

Now, let us understand this from the point of view of the airline players. The Govt, indirectly, is trying to fix the profit margins of the players. Which kind of business would like to operate in this scenario? The Govt. doesn't come to the rescue of the airline players during the lean season and want to compensate any loss that the airline players incur at those points of time. This move of the Govt. is only trying to rationalize the profits of the players, not their losses. One needs to keep in mind that this business is seasonal in nature, and not like that of an industry where demand doesn't fluctuate much throughout the year - like FMCG. At the same time, airline players are unable to increase their flying capacity as and when they want, because the lead time between placing an order and getting a new plane delivered runs into years, and it also requires a lot of CAPEX. Hence, the players have to do a financial analysis of whether they should actually buy a plane or lease it. Having recently witnessed the financial meltdown, the players would have preferred to go with conservative forecasts and hence, would have ramped up their capacity accordingly. But the response of the consumers has been spectacular (thanks to the confidence the customers have shown in the economy). A few players had also given a statement saying that some of their aircrafts were not operational and under maintenance. Hence, due to the supply-demand mismatch, prices are bound to rise.

It’s Time to Take a Stand..

I would have loved to support this move of the Govt, but am unable to do so, because of the following couple of examples that I could think of:

• It's a known fact that during the time of Diwali, every year, year-on-year, gold and silver prices touch the peaks, and have always followed an upward trend.
• The prices of Real Estate have always been a concern of the common man (except during financial meltdown)

Everyone knows that gold is precious. If one asks why that is, there is only one answer - it is a scarce resource. I believe that it’s only a perception that has been created in the minds of the consumers that it is scarce. Same is the case with diamonds. As there is uncertainty over the fact whether additional sources of the same would be found in future, hence the high value associated with it. Without further arguing on the topic whether gold/diamond is scarce or not, let’s focus on the consumers now. At the time of Dhanteras, there are people who believe that they have to buy gold on that day, as it’s considered auspicious. Whether the price was 20K this year or whether it would be 25K next year, it’s a known fact that people would buy gold - come what may. This is because people believe that they are/would be deriving more value from the ownership compared to the price they have to pay.

In the case of Real Estate, the same theory applies. People believe that the value of their property would always appreciate - as in the case of gold. 

But there is reason for us to believe that the profit margins in both the above businesses are very high. Why doesn't the Govt try to regulate the profit margins in these cases as well? I believe it would provide greater respite to a larger population, rather than just concentrating on the aviation sector. Whether a person would like to fly or not, he/she would always want to have a house of his/her own. Any person's yearly expenditure on flight travels would surely be much less compared to his yearly outgo towards home loans. Also, Real Estate as well as Gold gives you tangible products, whose value is supposed to increase over time, unlike travelling by flight - which is a service, intangible in nature that one consumes in a very short span of time.

In the case of the peak time of aviation sector around New Year, although the prices have supposedly risen "sky-high", still there is a demand from the customers. This is because the customer believes that they would be deriving value greater than or equal to the price that they are paying for. If such is the perception, then why unnecessarily interfere with the system?

Change is NOT Always for the Better..

I know all this sounds illogical, isn't it? How can the Govt keep tracking all the sectors and fix their profit margins. It isn’t right and it isn’t feasible for the Govt. as well. After all, businesses are running for providing good returns to the shareholders. If the shareholders come to know about the profitability of each and every sector in an industry, there would be a crowding out effect wherein the all investments would rationally flow to the sector giving the highest returns to the shareholders, while other sectors would remain under-financed. To cut short the imagination, it would result in utter chaos. So, let’s not try fixing the price bands of any sector in an industry - be it a goods or a services industry. Let things take their natural path, and all would be well in the end. Amen. :)

Can THIS Cause Inflation ??

I guess inflation is the word which is equally understood by the rich and the poor, the educated and the uneducated, and whatever other combinations you can think of. As most of us know, it’s a man-made phenomenon, and generally works to the disadvantage of the commoners, or better, the consumers. Who would like to get smitten by the prices of the daily use items that burn BIG holes into your pockets? Although the inflationary pressures have been brought down a bit and is currently hovering around 10.15% (as of 25/11/2010), still one can't forget that it reached to as high as 16% in the current fiscal year itself.

What Government Says..

The Government of India has smartly given its opinion that the food inflation is not because of supply - demand factors, the Classical Supply-Demand theory of Economics known to one and all. I would like to agree with that, and I am sure (as well as hopeful) that it would be lowered further on account of good monsoons (Now even that is under scrutiny - more than expected rains is being attributed to Climate change!!)

Why are you Reading This!!

I have a different take on this topic, and a weird one too. I believe that the food inflation is because of the Supply-Demand Factors, not relating to the food supply directly, but to that related to Labour- again one of the favourite topics  of Classical Economics. I think most of us must be aware of the Government Scheme called NREGA. All the Indians are gaga over this scheme, and believe that it would be one of the prominent pillars for the upliftment of the poor. I completely agree with this, but somehow I feel that it’s doing some bad as well - like two sides of the same coin.

Some GYAN

Consider this - A farmer in the village needs some helping hand on his fields, as he can't do all work by himself. Yes.. Even the Indian farmer is implementing the world famous "Outsourcing Model" - does what is his core competency, and outsources the remaining activities. Kudos!! The labourers that work in the fields consider themselves to be very lucky if they are able to earn as much as Rs 20-40 a day, depending on the type of work. 

Next day, to the dismay of the farmer and the happiness of the unskilled/semi-skilled labourers, NREGA scheme gets launched in the same village. It promises Rs 100 per day to a worker. Now, it’s a human tendency to get attracted to higher income (all the employees would vouch for that). Hence, now the same labourers would want to leave the farmer, and go for NREGA, as it would give him at least 2.5 times his daily income. He has common sense, after all. Therefore, here we see the classic case of supply-demand factors acting on the labourers, wherein the demand has increased, but the supply would not get increased in the same proportion (or even remain constant, who knows).

Now, the farmer is facing the issue of labour crunch. He either has to increase the pay of the labourers or else look for new helping hands which is a huge task of its own (considering the rate at which young people from villages are leaving their villages for finding greener pastures in the cities). Even the labourer understands that NREGA would be there in the village only for a limited period; after that, he would again have to fall back on the same farmer. So, here come some Management concepts as well!! In order to maintain his Long Term Relationship with the farmer, he would ask the farmer for some hike in his pay. Let’s assume that under pressure, the farmer has to increase the pay of the labourers by 10%. Now comes a Supply Chain Concept :)

We all know that the price which the consumer pays for a commodity is much more than the price at which the supplier sells it. So, taking a conservative approach, let’s say the farmer simply increase his selling price by only 10%, which gets magnified as it changes hands (all the players in the distribution channel), and finally, the end consumer, that is us, have to pay 20-25% more for the same quantity of the commodity.

Government's Two-Pronged Strategy

This is quite interesting. On one hand we are paying more for our daily use products, and as we saw, the reason why this all started was the NREGA scheme - that is, the Government. On the other hand, the RBI has been increasing the base rates every now and then (a total of 5 times this year), thus making the loans costlier as well. So, the Government is impacting both our long term goals (say, a house loan) as well as short term necessities (our day to day consumption of food items).

Conclusion

To conclude, I'd like to say that this is just my perspective, and I am not sure how much impact my deductions can have on the inflation. It might be tiny or a mighty part of the pie. The purpose of this article is just to point out that NREGA scheme can be having negatives (apart from the negatives pointed out by the politicians). What Say??