According to press reports, the Prime Minister has expressed concern over the predatory pricing of airline tickets. The chairman of the Competition Commission of India has said that capping air fares will violate competition laws.

In a market-oriented economy which has recovered from strict regulation, free competition should be permitted to flourish, and controls like capping of prices should be avoided because they are antithetical to the philosophy of deregulation and market-determined prices. However, recent international experience has demonstrated that unabated and uncontrolled market forces can lead to situations where taxpayers’ money is used for bailouts. The new philosophy is that the ‘invisible hand’ has ‘visible’ implications for the markets as well as the fiscal and monetary policy of the country. Therefore, some regulation and supervision is necessary.

The Indian aviation industry has evolved over a century. Till the late 1980s, the government-owned carrier enjoyed a monopoly. The open- sky policy of 1990 and the Air Corporation Act of 1994 opened the industry to the private sector. Although many airlines entered the industry, most had to leave the market, except for Jet Airways.

Intense competition in the air Pricing competition is intense and a change in price by any player affects the prices of all airlines. The airlines are finding ways to serve effectively in order to earn a competitive return but they have generally been unsuccessful. Further, many low cost carriers are constantly entering the industry and adopting innovative ways to reduce their basic ticket fare disconnected with baggage fee and seat preferences.

Airline ticket pricing is dynamic; it changes continuously depending on variables such as date and time of travel, one way or return, load factor, in-flight services, choice of airport, season and peak period, and competition on the route from other airlines. Prices are also impacted by tax and other government regulations.

Although airline ticketing is primarily a service, it represents a fixed product inventory with several unique characteristics. Identical units will have different values because of different purchase conditions and service amenities, enabling it to be priced and sold at distinctive price points. Also, the value of an unsold product increases in the market with time, but only up to the point the aircraft departs. Accordingly, the industry in general has adopted techniques to maximise revenue. With the deregulation of ticket pricing, airlines stimulate demand at preferred price points. The process of price discrimination is to determine the price a potential passenger would pay for the services offered.

How it works Initially, the tickets were bucketed into different attributes such as cancellation option, time and date option, and amenities like food and snacks. But now, the revenue system takes various components separately into consideration. Based on different functions and the past record of air traffic and passenger behaviour, airlines develop a price movement plan across the timeline. These price movement plans are called buckets. The price of a ticket is based on probability data. If the trend in actual bookings does not follow the projected probability-based value, based on historical pattern, prices are reverted. Once the prices are cut by one airline, other airlines follow suit.

Ideally, the government should avoid interfering in commercial enterprises but given the rising NPAs in infrastructure and aviation, some evaluation of airline pricing becomes necessary. Further, the strategy of beggar-thy-competitor is also impacting the government-owned Air India; this has direct implications for the national fisc.

Thus, there is an urgent need to streamline the bucket system, and revisit wide price bands and variations, a practice unique to India. There may be a need to link minimum prices and variation with cost of capital, before topping with dynamic pricing. There is also a need to usher transparency in the pricing model . After all, cartels are not unknown in airlines, international or domestic.

The writer is RBI chair professor of economics at IIM-Bangalore. His students, KS Reddy and KS Somasundaram, contributed to the article

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