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2/19/2014 Europe Economics | Blog - Unbundling of Airline Services in India – an Economic Perspective
http://www.europe-economics.com/blog_post/26/unbundling-of-airline-services-in-india-%E2%80%93-an-economic-perspective.htm 1/3
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Thursday, May 23rd, 2013
Unbundling of Airline Services in India – an Economic Perspective
posted by Saattvic
On April 30, India’s Ministry of Civil Aviation allowed airlines to unbundle chargesfor services including drinks (except drinking water), carriage of sports equipment,seat selection, baggage and so on. While some airlines have implementedadditional charges for some services and reduced their free baggage allowance,base fares have not yet declined. The Air Passengers’ Association of Indiaopposed the unbundling decision and worries that the decision would merely be alicence for airlines to indirectly raise fares. Airlines contend that base fares wouldreduce once they acquire a clearer picture of the potential revenue generatingpower of ancillary services.
In our article of 3 May 2011 for the Competition Law Insight analysing theSurcharges Supercomplaint by the UK Consumer Forum Which? to the UKCompetition Commission (http://www.europe-economics.com/publications/the_surcharges_supercomplaint.pdf), Dr StefanoFicco and I analysed the practice of airlines charging extra for online bookingservices in the UK. The Supercomplaint contended that the charges were unfairand anti-consumer. Our analysis at that time is very relevant to the currentsituation in Indian aviation.
A package of services
In our article, we had written that the product in question was a package ofservices that enabled the customer to move from one city to another. Thisincludes the price of the ticket as well as that of any ancillary services. There iseven an argument to include transport to and from the airport within the package(as evidenced by many airline booking sites offering to book a taxi pick up anddrop off with the ticket). It is the price of the complete package that the customertakes into account while making a purchasing decision.
Unbundling and efficiency
Consumer preferences naturally vary when it comes to a bundle of airlineservices. Some consumers might be flying for a short time, and would not wish tocarry too much baggage. Passengers with slight mobility issues (such as theelderly) may place a premium on being able to sit in the first two rows. When theentire bundle is priced at a single price point, airlines are unable to take intoaccount the different willingnesses to pay of different customers for different partsof the package. Unbundling allows service providers to adjust to variations inconsumer preferences. Moreover, if certain ancillary services are priced inproportion to cost, this could reduce or eliminate perverse incentives facingcustomers. For instance, charging for baggage could incentivise passengers tocarry only as much as they require, leading to reduced weight and subsequentlysavings on fuel.
Since the price of the complete package is taken into account by the customer,unbundling would have the effect of allowing providers to provide several, slightlydifferentiated, products where earlier they could only differentiate based on limitedcriteria like class of travel. The Indian aviation sector is sufficiently competitive –data from the Directorate General of Civil Aviation shows that the largest carrierhas a market share of 30 per cent and four carriers have shares of over 19 percent – and this would limit the ability of airlines to use pricing of ancillary services
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2/19/2014 Europe Economics | Blog - Unbundling of Airline Services in India – an Economic Perspective
http://www.europe-economics.com/blog_post/26/unbundling-of-airline-services-in-india-%E2%80%93-an-economic-perspective.htm 2/3
to extract any more surplus from customers than they are currently doing.
Theoretically, at least, unbundling should lead to an efficiency gain. Consumers,faced with an incentive structure for every service can calibrate their packageaccording to their preferences, and being able to charge for ancillary servicesshould lead to a reduction in base fare as the price for the total package remainsthe same, or reduces due to properly incentivised consumer choices.
The death of traditional aviation in India?
Of course, the model described above has been adopted consistently for a longtime by low cost carriers in Europe (like easyJet and Ryanair). This has not led tothe complete elimination of airlines offering only the package rather than itsconstituent parts. Two insights from behavioural economics can easily explainthis.
First, there is a known disutility associated with making too many choices – amental transaction cost. For some customers, the extra time and mental energyspent deciding on each of the constituent parts of the package may not be worththe monetary savings in relation to deciding on a package price.
Second, since flying with low cost carriers may be seen as a signal of belonging toa lower economic class, there might be a ‘social status’ premium that some fliersmight attach to not flying with a low cost carrier.
These factors, specially the first, should guarantee that traditional all-inclusivetickets will remain a part of Indian aviation.
Potential pitfalls – search costs
There have been recent media reports to the effect that the Indian Ministry of CivilAviation is likely to ask airlines to increase transparency regarding the servicesthey would charge extra for and is considering capping the number of ‘privileged’seats that may be reserved on payment of a fee. This is closely related to an issuewe raised in our article for the Competition Law Insight in May 2011 – that ofsearch costs. The issue, in a nutshell, is that the total package price is not knownto the consumer a priori. The customer has to search for the prices of ancillaryservices, which are often revealed only at the end of a lengthy booking procedurein order to learn the final price. The time and energy invested in learning the priceentails a cost. I quote from our 2011 article:
“In economics, search costs are known to detract from competitive forces –effective competition relies on consumers being able to compare all packageprices, but with costs involved in learning package prices, consumers are lesslikely to want to search for information on all package prices from all airlines,hindering their ability to compare. This gives airlines market power as it allowsthem to charge more than they would be able to in the presence of effectivecompetition. Naturally, the higher the search costs, the lower the willingness ofconsumers to carry out an additional search, and the higher the market powerenjoyed by airlines.”
The Ministry of Civil Aviation is correct to ask for greater transparency – publishinga list of ancillary services along with their prices on the home pages of websites(for example) would significantly reduce the costs faced by potential customers inlearning the final package price.
Conclusion
Whether or not unbundling will ultimately benefit the Indian consumer and whetherbase prices do eventually come down are things that time will tell. The Ministry ofCivil Aviation can, however, increase the likelihood of this move being successfulby pre-empting attempts to sabotage the move by artificially increasing searchcosts. In this regard, transparency and ease of access to informationrequirements would play a major role.
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