2/19/2014 Europe Economics | Blog - Unbundling of Airline Services in India an Economic Perspective

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Unbundling of Airline Services in India an Economic Perspective
posted by Saattvic
On April 30, Indias Ministry of Civil Aviation allowed airlines to unbundle charges
for services including drinks (except drinking water), carriage of sports equipment,
seat selection, baggage and so on. While some airlines have implemented
additional charges for some services and reduced their free baggage allowance,
base fares have not yet declined. The Air Passengers Association of India
opposed the unbundling decision and worries that the decision would merely be a
licence for airlines to indirectly raise fares. Airlines contend that base fares would
reduce once they acquire a clearer picture of the potential revenue generating
power of ancillary services.
In our article of 3 May 2011 for the Competition Law Insight analysing the
Surcharges Supercomplaint by the UK Consumer Forum Which? to the UK
Competition Commission (http://www.europe-
economics.com/publications/the_surcharges_supercomplaint.pdf), Dr Stefano
Ficco and I analysed the practice of airlines charging extra for online booking
services in the UK. The Supercomplaint contended that the charges were unfair
and anti-consumer. Our analysis at that time is very relevant to the current
situation in Indian aviation.
A package of services
In our article, we had written that the product in question was a package of
services that enabled the customer to move from one city to another. This
includes the price of the ticket as well as that of any ancillary services. There is
even 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 and
drop off with the ticket). It is the price of the complete package that the customer
takes into account while making a purchasing decision.
Unbundling and efficiency
Consumer preferences naturally vary when it comes to a bundle of airline
services. Some consumers might be flying for a short time, and would not wish to
carry too much baggage. Passengers with slight mobility issues (such as the
elderly) may place a premium on being able to sit in the first two rows. When the
entire bundle is priced at a single price point, airlines are unable to take into
account the different willingnesses to pay of different customers for different parts
of the package. Unbundling allows service providers to adjust to variations in
consumer preferences. Moreover, if certain ancillary services are priced in
proportion to cost, this could reduce or eliminate perverse incentives facing
customers. For instance, charging for baggage could incentivise passengers to
carry only as much as they require, leading to reduced weight and subsequently
savings 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, slightly
differentiated, products where earlier they could only differentiate based on limited
criteria like class of travel. The Indian aviation sector is sufficiently competitive
data from the Directorate General of Civil Aviation shows that the largest carrier
has a market share of 30 per cent and four carriers have shares of over 19 per
cent 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 package
according to their preferences, and being able to charge for ancillary services
should lead to a reduction in base fare as the price for the total package remains
the 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 long
time by low cost carriers in Europe (like easyJet and Ryanair). This has not led to
the complete elimination of airlines offering only the package rather than its
constituent parts. Two insights from behavioural economics can easily explain
this.
First, there is a known disutility associated with making too many choices a
mental transaction cost. For some customers, the extra time and mental energy
spent deciding on each of the constituent parts of the package may not be worth
the 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 to
a lower economic class, there might be a social status premium that some fliers
might attach to not flying with a low cost carrier.
These factors, specially the first, should guarantee that traditional all-inclusive
tickets 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 Civil
Aviation is likely to ask airlines to increase transparency regarding the services
they 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 issue
we raised in our article for the Competition Law Insight in May 2011 that of
search costs. The issue, in a nutshell, is that the total package price is not known
to the consumer a priori. The customer has to search for the prices of ancillary
services, which are often revealed only at the end of a lengthy booking procedure
in order to learn the final price. The time and energy invested in learning the price
entails 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 package
prices, but with costs involved in learning package prices, consumers are less
likely 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 allows
them to charge more than they would be able to in the presence of effective
competition. Naturally, the higher the search costs, the lower the willingness of
consumers to carry out an additional search, and the higher the market power
enjoyed by airlines.
The Ministry of Civil Aviation is correct to ask for greater transparency publishing
a 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 in
learning the final package price.
Conclusion
Whether or not unbundling will ultimately benefit the Indian consumer and whether
base prices do eventually come down are things that time will tell. The Ministry of
Civil Aviation can, however, increase the likelihood of this move being successful
by pre-empting attempts to sabotage the move by artificially increasing search
costs. In this regard, transparency and ease of access to information
requirements would play a major role.

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