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Much ado about prices

Right pricing mechanism coupled with effective price-setting capacity enables a competitive market benefitting both the industries and consumers

Much ado about prices

The debate around "pricing" of goods and services is of interest to the government, the private sector and consumers. When the "service" in question relates to essential ones such as transportation, electricity and water, the debate is both necessary and delicate.

The recent decision by a low-cost carrier (LCC) airline in India to charge extra for certain services has raised a storm in social media. While the specific issue regarding a fee for web check-ins is one that LCCs probably should not be charging for, this incident does bring to fore the vital question on the capacity of a service provider to shift charges as the market evolves.

Another pertinent question is: Given the freedom granted to LCCs to fix prices, what are the effective checks and balances that are required to ensure that consumers get a fair deal?

For low-cost carriers in India, one needs to analyse the "pricing mechanism" in the context of the global aviation pricing levels. An analysis titled "Flight Price Index 2017" by kiwi.com found that the average price charged by Indian airlines for short-haul flights was $3.88 per 100 kilometres. In the list that contained 80 countries, the airline charges in India are in the bottom 10.

While a large part of this competitive pricing regime is one that is applicable across industries due to the market competition and relatively low revenues per user, it nevertheless demonstrates that the prices that the Indian aviation customer is paying are highly competitive on a global scale.

When the general input prices for airline companies -- i.e., fuel prices, costs of aircraft financing as also "Maintenance, Repair & Operations" costs of aeroplanes -- are on an average similar across the globe, prices in the Indian market seem competitive. Therefore, while the decision by an LCC to charge for certain services might be debatable, the ability of the service provider to raise prices in reaction to changing market dynamics is not. The ability to adjust prices is critical for the health of any sector, and not just the airline sector.

While it is essential to ensure that service providers in an industry do not indulge in collusion, it is equally important to allow prices to adjust to the demand and other significant drivers of profits. The key is to ensure that the correct checks and balances are in place to provide a competitive market so that LCCs remain viable and the consumers get a fair deal. Effective regulations and a relatively competitive market (with an adequate number of players) is a better strategy to ensure high-quality service for consumers at competitive prices rather than impeding the price-setting capacity of market participants.

It is imperative that the market is so competitive that if a consumer did not like one aspect of a service provider, then she should be able to switch for a minimal "switching cost". The inability of service providers to adjust rates in the face of market volatilities through any price-caps leads to market failures and, in the end, a loss for the end-consumer.

Additionally, functional markets where firms can set prices given the changing dynamics are vital to attracting investments, from both global and domestic investors. To boost business sentiment, promote research and innovation, and facilitate the adoption of new business models, it is crucial to let market forces determine equilibrium prices, albeit subject to effective regulations.

The effective flow of capital into new, efficient businesses is one of the significant factors that drive capital formation, business growth and employment generation. Attractive industries where new market participants can spot business opportunities are also industries in which competition ensues to ensure a "quality and pricing regime" that benefits consumers.

Not only does impeding the pricing capacity of industry have significant ramifications on the specific sector, but it also adversely affects other sectors that have linkages with the said industry. For instance, issues that an asset-heavy industry (such as airlines) might face when not being able to raise prices in the face of rising input prices can affect cash-flow profiles negatively. Negative cash-flow profiles, in turn, can acutely reduce the capacity of firms within the industry to service their debt.

Issues around debt servicing create non-performing assets (NPAs) for banks (an endemic problem in the Indian banking system). Such NPAs, in turn, limit credit access for new attractive business opportunities, thereby setting a negative chain of events. As a country, India must ensure that it avoids "negative multipliers" that lead to such market failures.

The point above is even more vital because the government has some capacity to finance new infrastructure, but not all of it. India needs private capital to fund and run a large chunk of mission-critical businesses. Effective regulations that are consistent and "business-enabling" will be required.

A model that ensures the right pricing mechanism can reap the benefits of long-term infrastructure. However, reducing the price-setting capacity of companies is not a substitute for an effective regulatory framework that both promotes business and protects consumers.

(The author heads Development Tracks, an infrastructure advisory firm. The views expressed are strictly personal)

Taponeel Mukherjee

Taponeel Mukherjee

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