INDIAN AVIATION INDUSTRYFINAL PROJECT

8/17/2007

INDUSTRY ANALYSIS

SUBMITTED BY:-

BHASKAR MUKHERJEE – 07BS0989 KARAN OBEROI – 07BS1845NITHYA RANGANATHAN – 07BS2659PUJA JALAN – 07BS3067SHIVANI VIJ – 07BS4055

SUBMITTED TO:-

T.J.JOSEPHFACULTY- MANAGERIAL ECONOMICS

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 450 airports and 1091 registered aircrafts in the country.

There are also 41 non-scheduled air transport operators. Additionally 34 applicants have been

granted NOC by 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 War 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, 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. Pre- Nationalization

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 players. At that time the two major airlines operating in India, both owned

and controlled by the Government of India were – Air India and Indian Airlines. 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

provided feeder services between smaller cities, was merged with IAC in 1994. These

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 sector. The carriage increased from a modest 15,000 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 carrier / airline) is an

airline that offers generally low fares in exchange for eliminating many traditional passenger

services.India's first low-cost airline, Air Deccan started service on August 25, 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, GoAir, IndiGo

and Paramount 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 the fledgling airline’s pricing advantage. Virtually a monopoly in 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 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 or the high air fares lead to low demand. It seems 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 S2

0 Q* Q 0 Q** Q

GRAPH I GRAPH II

In the above graphs along the y axis we measure the price and along x axis the quantity

demanded and supplied. It can be seen from graph I that when there were not too many 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) and the demand has also grown over 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. Entrepreneurship

The main factor input costs for the Indian Aviation Industry are:-

1. Labour

2. Fuel

3. Passenger Food

4. Advertising and Promotion

5. Landing Fees

6. Infrastructure like aircraft lease rentals

7. License fee

8. Interest, Taxes, Passenger Traffic commission

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.

Interest repayments on foreign currency loans acts as a burden on the industry.

The industry has to take huge loans in order to fund their infrastructural costs such as

purchase of aircrafts, maintenance of airports etc.

Due to Intense competition in the industry the airline has to incur substantial

advertisement and promotional costs in order to create awareness and allure 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 a single seller and many buyers of a 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. There are barriers to entry.

4. The firm is a price maker i.e. it has substantial control over the market price of the

product.

5. The supply of the product by the single firm constitutes the market 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 faces the market demand curve for its product.

Let us analyse the Indian Aviation industry during that time on the above mentioned parameters:-

1. Indian Airlines and Air India both under the same entity were the only suppliers of 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 was considered a competitor but it catered to entirely different market

segment and was nowhere near to the air services considering the time and cost factor.

3. Due to government regulations, no other player could enter the 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),

marginal cost(MC), average revenue(AR), marginal revenue(MR) along the 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 the competition in the 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 Aviation Industry involves a huge capital investment and government

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 product offered by each and every airline i.e. air services is more or 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 which talks about price stability/rigidity. Here, a firm A believes

that if it increases its prices then none of the firms will follow suit so firm A will face

considerable losses. Hence in this context the demand is relatively 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 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 Q<QO, then

MC<MR, and the firm will increase its output to maximize profit. Again if Q>QO 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. 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)

3.

3. Oligopoly market tending towards Monopolistic characteristics

The future scenario of the Indian Aviation 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.

Low Cost Players Prices Charged

1. Air Deccan

2. Go Air

3. Spice jet

Rs.5398

Rs. 5000

Rs. 5148

High Cost Players Prices Charged

1. Jet

2. Sahara

3. Kingfisher

Rs. 7760

Rs 8400

Rs 7400

MARKET SHARE OF INDIAN AVIATION INDUSTRY

JET AIRWAYS 40.5KINGFISHER 7.8AIR DECCAN 21.2SPICE JET 7INDIAN 20.8GO AIR 2OTHERS 0.7

100

Domestic passenger growth rate of 44.6%.

cargo traffic- 8.7% during

the year 2006-2007