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Airline fare caps - Why airline rates are capped on both sides?

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In early May we had covered a post on the future of aviation post-Covid 19. In the post we had covered two aspects on the pricing front, one some firms astronomically rising prices to stay in business, and second the well-placed competitors significantly undercutting the competition to hurt the already distressed firms.

If the firms have clarity that the social distancing in planes will have to run for a longer period of time, there is likely to be a sharp jump in prices across the board, as firms move their financials towards more stable levels. If evidence suggests that this may last just a few months however, the reaction from the aviation firms could be starkly different. With a few firms financially better positioned than their peers, they might want to use the period to sharply undercut the competition, either gaining share or forcing the peer to underprice, pushing them further towards the brink of bankruptcy.

The government seems to share our concern, and has taken remedial measures with temporary price floors and ceilings to avoid the problem at hand. In today's post we understand the regulation in detail, the rationale behind it, and the impact it is likely to have on the industry.

Understanding the caps

It helps to understand that the caps that the government has brought in are temporary and will be in force for a period of 3 months, meaning that barring an extension, the impact of the move on long term competitive intensity will be limited. The caps, as we discussed are on both the upper and lower ends, on the upper end to prevent firms charging usurious rates to people desperate to get home, and a price floor to prevent well-placed firms who have a sufficient cash balance from charging an extremely low rate, putting weaker competition out of business. The market-based pricing system will continue from August 25th. An incremental rule here is that airline firms will have to make 40% of total seats at an aircraft available at less than the midpoint of the two caps.

Implications for the sector

The demand for the sector is likely to have a very sharp spike in the initial week or two, as the first wave of people heading home, make the journey, followed by a sharp prolonged lull, as folks then choose the comfort of their home over the risk of travel. Pricing in the first two weeks therefore will be critical, not only to make money for the period, and the lossed in the months gone by, but also to build some sort of buffer to wade through the rest of the period. With demand far exceeding supply in the initial period, it would be fair to assume the pricing limits being stretched a bit.

Within the players, the regulation is incrementally beneficial to the players who had a weak cash position going in, as it prevents loss of too much share from the stronger players in the field. For market leaders, it should be incrementally less positive. The restart in the sector however is likely to bring cheer across the board.

Implications for other sectors

The government's interference in market prices, albeit temporary is something to take note of, and could have implications for other sectors as well. While the government is unlikely to implement a blanket price floor in telecom, given the impact of millions of poor people who are already suffering from the problems of reverse migration, a price floor on postpaid connections couldn't be ruled out. This again, could end up helping the most beaten down amongst the three telco players.

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