Interim Report On

Strategy in

Aviation Industry

Economics of Business strategy

Submitted to: Prof. Yogesh Doshit

Submitted by: Kaushal Vaidya 101320

Aviation Industry
Aviation industry is a kind of Oligopolistic industry. The firms in such an industry are essentially interdependent in that each is, to a greater or lesser degree, influenced by as well as influencethe actions of its competitors. Although each firm would like to maximize its profit, revenue or market share, it cannot afford to ignore the actions as well as the likely actions of its competitors. This makes the analysis of such firms and markets much more challenging than that of other market forms.

The players and respective market share are given as follows under.

Sales
6.60% 20% 14.20% Kingfisher Indigo jet Airways JetLite 13.20% 19.90% 7.60% 18.50% Air India SpiceJet GoAir

It is well known in economic theory that in oligopolistic markets, at equilibrium each competitor operates at a fraction of its capacity and so the industry capacity is more than the total demand . The extent of this excess capacity is more pronounced where the output is a service and so is non-inventoriable and where the capacity addition is in relatively large discrete units. The unused capacity adds to the cost of production and the resulting inefficiency brings down the producers margins as well as the consumers benefit/cost ratio. That is why in those sectors, where capacity addition is very expensivee.g. air travel, telecom and ISP (Internet service providers)the industry

is subject to a high degree of regulation the world over.

The interaction among oligopolists can be described very well in the language of games Game theory, which explicitly considers the strategies (possible actions) of the various players (competing firms) and the consequent payoffs (the effects of their actions on profits, revenues and market shares of various players) can be effectively used to analyze the behavior of firms in oligopolistic markets.

To understand the game there are at least four approaches to analyze the game.

1) By using the concept of dominance. According to the dominance criterion, no rational player will play a dominated strategyone which does not have a single better payoff vis-Pa-vis a dominating one, for each possible move by the opponent(s)and so can be eliminated from further consideration. The application of the dominance criterion successively can reduce the size of the game in most cases and may lead to a single prescription of action for all players in some games.

2) By identifying the Nash equilibrium if a game has Nash equilibrium. At Nash equilibrium all players are doing the best they cangiven the other players decisions; that is, all are playing their best responses. If conversely, the game is not played at a Nash equilibrium, then at least one of the players could have done better by acting differently. If a game has only one Nash equilibrium having an outcome which is efficient, it is very likely to be played at that pointhowever, many games do not have any Nash equilibrium and some games have more than one.

3) By identifying a focal point in a game, which is a course of action that seems reasonable to all players. For example, in a game with two Nash equilibrium, if one of these has higher payoffs to all the players than the other Nash equilibrium, then the best Nash equilibrium may become the focal pointthat is, it seems likely that each player will implicitly understand, without communication, that the other is likely to play at the focal point. Even narrow self-interest of individual players point uniquely in this direction.

4) By repeated interactions of the same sort in repeated or multi-stage games, the players observe the actions of their fellow players and might develop some rational expectations regarding what each will do. In some games, those rational expectations may settle down to a stationary state, and if no one has an interest in deviating, then, the game will be played at Nash equilibrium. However, the very fact that interactions are repeated will bring into equilibriumstrategy prescriptions that are not equilibrium in any single interaction. Also, the role of signaling without formal communication between players can be a very important determinant in how these games are played.

Here It is assumed that it is highly feasible for airlines to increase or decrease their number of daily departures on this route. Obviously, such a change might bring some responses from the competitors and this way the game assumes all the characteristics of a repeated game.

Oligopolistic markets behave more competitively than suggested by the Cournot model but less competitively than by the Bertrand based on empirical investigation. Estimates of airline conduct are reasonably close to Cournot behavior. According to the Cournot model, each firm decides independently how much output to produce (how many flights to operate), treating the other firms output as fixed and the resulting equilibrium is then referred to as the Cournot equilibrium, which is equivalent to the Nash equilibrium where no firm can improve its payoff by a unilateral change in its strategy. Use of Nash equilibrium to analyze the airline industry, therefore appears to be empirically justified as well.

Scenario
To understand the game properly Ahmedabad Mumbai route is taken. Fare is taken Rs 4500 for one way route which assumed to be constant for all airlines.

The airlines currently compete for market share using the number of scheduled daily departures they offer as a major competitive weapon. Each airline must decide on its number of daily departures in a situation where its decision is dependent on similar decisions made by its competitors as much as the competitors decisions are based on the decision of the airline.

Assumptions: The size of the passenger market is stable and is independent of the number of departures offered. At the prices mentioned viz. Rs 4500 for a one-way ticket, an estimated 600 passenger fly from Ahmedabad to Mumbai each day and a similar number travel from Mumbai to Ahmedabad.

The airlines fly identical planes and have identical operating costs. Each plane has the capacity to carry a maximum of 100 passengers. Regardless of the actual number of passengers in a plane (0100), each one-way trip on this route costs the airline Rs 200, 000 to operate.

Each airlines share of the total passengers equals its share of the total flights offered by the airlines as long as the industry capacity exceeds the demand. For example, if Indian Airlines offers twice as many flights as each of its rivals, it claims half of all passengers and the other two will get one-fourth each in case if there are only 3 players.

In estimation of costs, the variable cost per passenger is ignored. This cost is actually very small and, if required, can be offset from the fare collected per passenger. The assumption regarding market shares being equal to the share of total flights seems reasonable. As described above, the competitive situation can be conceptualized as a 3-person non-zero sum game where each of the seven competing airlines is a player.

Each player has a number of finite pure strategies to choose fromeach of these corresponds to the number of flights it chooses to operate on the Ahmedabad-Mumbai route.

Analyzing a 3-person game is much more difficult than analyzing a two-person game. Since each players strategies correspond to the number of flights operated and the cost and revenue functions for each airline is the same, it is possible to represent the payoff table as a two-dimensional matrix with the rows representing the row players possible actions and the columns representing the possible actions of both the competitors combined.

Let A be the number of daily departures operated by the row player and B be the number of daily departures operated by the competitors. Then the daily operating profit of the row player (in thousands of rupees) can be expressed as

own (A

,B, C) = Min ( 1 , (A+B+C) / 30 ) * [ 13500 * A / ( A+B+C) ] [ 200 * A ]

Here A denote the own firm and B and C denote the competitors. So 3 players game has been reduced to 2 player game to understand the game theory. Where the term = Min (1, (A+B) / 30) is introduced to take care of the size of the total market if less than 30 daily departures are scheduled on this route by all the seven airlines together. Each one-way ticket carries a fare tag of Rs 4500 and since the size of the total market is estimated to be 3000 passengers per day, the seven airlines are competing for a share of market having total daily revenue of Rs 45003000, i.e Rs 1, 35, 00,000. The cost of operating each daily flight to any airline is estimated to be Rs 200, 000. Similarly, the daily operating profit in thousands of rupees of the competitors (i.e. the column player) can be expressed as

others (A,B,C)

= Min ( 1 , (A+B+C) / 30 ) * [ 13500 * (B+C) / ( A+B+C) ] [ 200 * (B+C) ]

The payoff table so constructed is shown in Table 1 and each player faces the same payoff table.

0 0 1 2 3 0 0 250 0 500 0 750 0

1 0 250 250 250 500 250 750 250

2 0 500 250 500 500 500 750 500 0 250 500 750

3 750 750 750 750 750 750 600 480 382 300 231

4 0 1000

5 0 1250

6 0 1500

7 0 1750

250 1000 250 1250 250 1500 250 1750 500 1000 500 1250 500 1500 400 1400 750 1000 750 1250 600 1200 480 1120 1000 1000 800 1000 640 1000 960 891 800 692 571 800 800 640 764 509 700 400 615 308 514 229 400 800 636 636 600 500 538 385 457 286 360 200 250 960 509 764 500 600 462 462 400 343 320 240 225 150 118 891 700 538 400 280 175 82

4 1000 0 5 1250 0 6 1500 0 7 1750 0 8 2000 0 9 1800 0 10 1600 0

1000 250 1000 500 1000 1250 250 1250 500 1250 1500 250 1500 500 1200 1750 250 1400 400 1120 1600 200 1280 320 1018 1440 160 1145 255 1273 127 1000 200 900 769

8 0 0 2000

9 0 1800 160 1440 255 1145 300 308 286 240 175 94 0 -105 900 692 514 360 225 106 0 -95

10 0 1600 127 1273 200 1000 231 229 200 150 82 0 -95 -200 769 571 400 250 118 0 -105 -200

11 0 1400 100 1100 154 171 160 125 71 0 -84 -180 -286 846 629 440 275 129 0 -116 -220 -314

12 0 1200 77 114 120 100 59 0 -74 -160 -257 -364 923 686 480 300 141 0 -126 -240 -343 -436

13 0 57 80 75 47 0 -63 -140 -229 -327 -435 1000 743 520 325 153 0 -137 -260 -371 -473 -565

14 0 40 50 35 0 -53 -120 -200 -291 -391 -500 800 560 350 165 0 -147 -280 -400 -509 -609 -700

1 200 1600 2 320 1280 3 382 1018 4 400 5 385 6 343 7 280 8 200 9 106 10 0 800 615 457 320 200 94 0

The table can be interpreted as follows: if Player 1 operates 3 flights a day, Player 2 operates 4 flights a day and Player 3 operates 5 flights a day, then treating Player 1 as the row player with 3 own fights and 9 competitors flights a day, we find from Table 1 that Player 1 will have a daily payoff of 300 and the competitors will have a daily payoff of 900 (thousand rupees).

Similarly for player 2, with 4 daily flights per day and 8 competitors flights per day, its daily payoff would be 400 whereas its competitors would have a daily payoff of 800. Finally, with 5 own flights and 7 competitors flights a day, Player 3 would have a daily payoff of 500 and its competitors would have a daily payoff of 700.

This simplification of using a two-dimensional payoff matrix to represent the payoffs in a game with more than two players can be used wherever the strategies of the players represent numbers which are commensurate (like number of flights operated in this game) and so can be added to represent a combined strategy of a notional second player (like competitors in this game) and the total payoff of all players (i.e. the total daily operating profit on this route in the whole industry) depends only on the total of the strategies of all individual players and not on how this total is allocated to individual players (like the total payoff of all players in this game is 3600 as long as a total of 12 fights are operated by all three airlines combined). For example, in another situation, if the total sales of a product in the market depends only on the total number of advertisements released by all players and not on how these are distributed among individual players, then it is possible to have a unique representation of individual payoffs by using only a two-dimensional payoff matrix, even if there are more than two firms selling the product.

Referring to the payoff matrix in Table 1 it obvious that t rows representing 0 and 1 own flights per day are dominated by the row representing 2 flights a day. Similarly, rows representing 9 and 10 flights a day are dominated by the row representing 8 flights a day. We can therefore conclude that as rational persons, no player would operate 0, 1, 9 or 10 flights a day. This also implies that none of the players would face a situation where the competitors would be operating less than 4 flights a day. The effective payoff

table, therefore, reduces from tables leaving row 0, 1,9,10 and columns 1, 2 and 3 which is shown in the table by rectangles made by lines.

A close look at the area bounded by thick lines in Table 1 reveals that for the row player, rows representing 6, 7 or 8 flights a day are dominated by the row representing 5 flights a day. Also, as none of the players would operate more than 5 flights a day, the number of flights operated by the competitors would never exceed 10. Eliminating the dominated strategies, the payoff table now effectively reduces to the area shaded light grey in Table 1.

Identification of dominated rows in the light-grey-shaded area in Table 1 eliminates rows representing 2 or 3 own flights a day which are dominated by the row representing 4 flights a day. Each row player may operate either 4 or 5 flights a day and consequently will face 8, 9 or 10 competitors flights a day.

Faced with the payoff shown as the grey-shaded area in Table 1, any rational row player would choose to operate only 4 flights a day, as the daily operating profits are then higher compared to the option of operating 5 flights a day, irrespective of the number of flights operated by the competitors. Thus, by using the concept of dominance Successively, we can conclude that each airline is likely to operate 4 flights a day giving rise to a total of 12 flights a day on this route.

With each airline choosing to operate 4 flights a day, the total number of competitors flights will be 8 for any airline and each airline will end up earning a daily operating profit of Rs 400,000. This point is also Nash equilibriumin fact this is the only Nash equilibrium for this gamebecause no unilateral shift by any airline can be profitable for itself. If an airline has to operate A flights a day at the Nash equilibrium, then
own (A-1,

A, A)

own (A,

A, A)

own (A+1,

A, A)

As the total number of flights a day is expected to be at least 8 at the Nash equilibriumso as to clear the market of passengers,

3600 * (A-1) / (3A 1) 200 (A-1) 3600 * (A / 3A) 200 A 3600 * (A+1) / (3A + 1) 200 (A + 1)

Or 3600 * ((3A-1)-2) / (3A 1) 200 (A-1) 3600 * / 3 200 A 3600/3 * ((3A+1) +2) / (3A + 1) 200 (A + 1)

Or

1200 200 (A-1) 2400 / (3A-1) 1200 200 A 1200 200 (A+1) 2400 / (3A+1)

200 2400 / (3A-1) 0 200 + 2400 / (3A+1) 200 (3A-1) 2400 0 200 (3A+1) + 2400 2600 600A 2200 4.33 A 3.66

As A should be integer for Nash Equilibrium it has to be 4 flights. That is, the Nash equilibrium exists when each airline operates 4 flights a day.

Focal Point

Although the above solution appears reasonable, as it is the only Nash equilibrium available to any of the competing airlines, this may not be acceptable to the airlines as a stable long-term solution. The payoff matrix in Table 1 also reveals that if each airline were to operate one fewer flight, i.e. only 3 flights a day and not 4, each of them will be better off by Rs 200,000 as the daily operating profit will rise from Rs 400,000 to Rs 600,000. This point may be seen as a desirable state and so as a focal point by each

airline. This is because of the saving from operating 1 flight less a day without having any reduction in either the share of the market or the market itself. Each of the three airlines would therefore want to operate only three flights a daybut how is an airline to persuade its competitors to reduce their number of flights without using any pre-play negotiation or any unfair or restrictive trade practice?

It can be notice from the detailed payoff matrix in Table 1 that a unilateral reduction from 4 flights a day to 3 by any one airline results in a decrease in daily operating profit for this airline (from Rs 400,000 to Rs 382,000) and a larger increase in daily operating profits for each of its competitors (from Rs 400,000 to Rs 509,000). It is very unlikely that any airline would experiment with reducing its daily departures in such a scenario hoping that the competitors would follow suit so that everyone is better off at the end. Even if one of them does take the lead, there is no motivation or guarantee that a second airline to follow suit. Because such an action would reduce the daily operating profit for the second airline from Rs 509,000 to Rs 480,000simultaneously raising the same for the first airline from Rs 382,000 to Rs 480,000 and for the third airline from Rs 509,000 to Rs 640,000.

Just as by reducing its number of daily departures unilaterally, an airline only harms itself and benefits the competitorsthe reverse is also true. By unilaterally increasing the number of daily departures from 4 to 5, an airline experiences a marginal drop in its daily operating profit from Rs 400,000 to Rs 385,000 while inflicting serious erosion in the daily operating profits of each of its competitors from Rs 400,000 to Rs 307,500 each. This could arguably be used as a threat to the competitors. However, each of the three airlines is in an identical position to use this threat and consequently none of them actually faces threat vulnerability.

Each airline, therefore, finds itself stuck with operating 4 flights daily although it would like to operate one less provided the others also operated 1 flight less a day. All the airlines face a situation where there is a better solution for everybody but there is nothing in their control to move the industry equilibrium to that point.

Pre-play negotiation is not feasible among competitors and even informal understanding may tantamount to collusion. Even if the airlines informally agree to co-operate with each other and operate only 3 flights a day each, such an agreement would turn out to be very fragile because in the absence of an enforcing mechanism, each airline would find strong incentives to cheat. By introducing a fourth flight an individual airline can hope to increase its daily operating profit from Rs 600,000 to Rs 640,000 simultaneously reducing the daily operating profit of each of its competitors from Rs 600,000 to Rs 480,000. So each airline finds itself in a situation where formal agreements are illegal and informal agreements are not self-enforcing.

Regulation

Airlines all over the world have had a long history of economical regulation of their operationsboth domestic and international. Unlike telecom and insurance, where the Government of India has already set up separate regulatory authorities, the regulation of civil aviation is still performed by the Ministry of Civil Aviation along with the office of the Directorate General of Civil Aviationbut a statutory CAA is planned to be constituted soon according to the Draft Civil Aviation Policy framed by the Ministry of Civil Aviation.

Aircraft are highly capital-intensive equipment and a better utilization of the aircraft is in the interest of the consumers and so is usually an objective to be pursued by the regulating authority. For instance, in place of 4 flights a day at the Nash equilibrium, if the regulating body can ensure that each airline operates only 3 flights a day on the Ahmedabad Mumbai route, the 3 flights a day that are saved can be operated on some other less lucrative routes. The regulating body can achieve this by direct licensing of flights or better still, by indirectly affecting the location of the Nash equilibrium. For instance, if the regulating body charged a fee per flight from each of the airline, the payoff table would get modified and the Nash equilibrium may also change. This fee may involve a direct monetary payment or an indirect paymente.g. if private operators prefer only profitable routes, agreements should be framed to make them

contribute towards the cost of providing services on other uneconomical routes as suggested in the context of urban transport, but is equally valid for other modes of transportation. Another alternative could be levying a license fee on some profitable routes, while giving an incentive on some other less-profitable routes.

Two types of interventions from the regulating body are regulating the fares on different routes and the use of a license fee per flight to affect any desirable shifts in the Nash equilibrium.

Regulating the fare

If the fare per flight were set by the regulating body at p (in thousand rupees) per passenger, the payoff table would undergo change depending on the value of p. The payoff to an airline would then become (in thousands of rupees):

own (A

,B,C) = Min ( 1 , (A+B+C) / 30 ) * [ 800P * A / ( A+B+C) ] [ 200 * A ]

However, for the Nash equilibrium to be at A flights a day for each airline,
own (A-1

, A, A )

own (A

, A, A )

own (A+1

, A, A )

As the total number of flights a day is expected to be at least 8 at the Nash equilibrium, 800P * (A-1) / (3A 1) 200 (A-1) 800P * (A / 3A) 200 A 800P * (A+1) / (3A + 1) 200 (A + 1)

Or 800P/3 * ((3A-1)-2) / (3A 1) 200 (A-1) 800P * / 3 200 A 800P/3 * ((3A+1) +2) / (3A + 1) 200 (A + 1)

Or 200 1600P / 3(3A-1) 0 -200 + 1600P / 3(3A+1)

600(3A-1) 1600P 0 -600(3A+1) + 1600P Or 600 1800A 1600P -600

The shift in the Nash equilibrium with change in the fare per passenger is highlighted in Table 2 and as expected a higher fare also shifts the Nash equilibrium to points where each airline would like to operate more flights per day.

Table 2 Sensitivity of A to the fare per passenger

If the fare per passenger is in the range Minimum fare (Rs) Maximum fare (Rs)

At Nash Equilibrium

Own flights per Minimum day (A)

Maximum

operating profit operating profit per day per day 400 500 600 700

3000 4125 5250 6375

3750 4875 6000 7125

3 4 5 6

200 300 400 500

Thus, if the regulated fare per passenger were brought down to anything between Rs 3000 and Rs 3750, then the Nash equilibrium would shift to the focal point.

Table 3 shows the payoffs with the fare set at Rs 3600 per passenger. As can be seen from Table 4, with a fare of Rs 3600 per passenger, each operator finds that operating 3 flights a day is the best for itself. However, the operating profit per day also reduces to Rs 360,000 from the earlier level of Rs 400,000 per day.

Table 3 The payoff when fare is 3600 Rs

Total no of competitors flights 0 1 2 3 4 5 6 7 8 160 320 480 640 800 960 1120 1280 1 160 320 480 640 800 960 1120 960 2 160 320 480 640 800 960 840 704 3 160 320 480 640 800 720 616 495 4 160 320 480 640 600 528 433 320 5 160 320 480 480 440 371 280 172 6 160 320 360 352 309 240 151 46 7 160 240 264 247 200 129 40 -64 8 120 176 185 160 108 34 -56 -160 9 88 124 120 86 29 -48 -140 -245 10 62 80 65 23 -40 -120 -214 -320

Use of License fee

With a license fee of X (in thousand rupees) per flight for each airline, the payoff to an airline would become
own (A

,B, C) = Min ( 1 , (A+B+C) / 30 ) * [ 13500 * A / ( A+B+C) ] [ (200+X) * A ]

For the Nash equilibrium to be at _ 9ights a day for each airline,

own (A-1

, A, A )

own (A

, A, A )

own (A+1

, A, A )

3600 * (A-1) / (3A 1) (200+X) (A-1) 3600 * (A / 3A) (200+X) A 3600 * (A+1) / (3A + 1) (200+X) (A + 1)

Or 3600 * ((3A-1)-2) / (3A 1) (200+X) (A-1) 3600 * / 3 (200+X) A 3600/3 * ((3A+1) +2) / (3A + 1) (200+X) (A + 1)

Or

1200 (200+X) (A-1) 2400 / (3A-1) 1200 (200+X) A 1200 (200+X) (A+1) + 2400 / (3A+1)

Or (200+X) 2400 / (3A-1) 0 (200+X) + 2400 / (3A+1) (200+X) (3A-1) 2400 0 (200+X) (3A+1) + 2400 2600+X (200+X) 3A 2200 X

So for the no of own flights equal to 3 2600+X 1800+9X 2200-X 100 X 40

With a license fee per flight, the Nash equilibrium shifts as summarized in Table 3 and as expected a higher license fee also shifts the Nash equilibrium to where each airline would like to operate less flights per day. It could also be shown from table that negative License fee, or an incentive payment per flight, could increase the number of flights operated by each airline at the Nash equilibrium.

Table 4 Sensitivity of A to the license fee If the license is in the range At Nash Equilibrium

Minimum license fee (Rs 000) 40 -15.38 -50 -73.68

Maximum license (Rs 000) 100 18.18 -28.57 -58.83

Own

flights Minimum operating

Maximum profit operating profit

fees per day (A)

per day(Rs 000) 3 4 5 6 300 327.27 342.85 352.97

per day (Rs 000) 480 461.51 450 442.07

If the regulating body charged a fee of Rs 60,000 per flight from each of the airline, the payoff table would get modified as shown in Table 4 and now each airline would prefer to operate only 3 flights a day.

Table 5 Payoff when licensing fees is Rs 60,000

1 2 3 4 5 6 7 8

0 190 380 570 760 950 1140 1330 1520

1 2 190 190 380 380 570 570 760 760 950 950 1140 1140 1330 980 1120 800

3 190 380 570 760 950 840 700 538

4 190 380 570 760 700 600 471 320

5 190 380 570 560 500 404 280 135

6 190 380 420 400 336 240 118 -23

7 190 280 300 269 200 102 -20 -160

8 140 200 202 160 85 -17 -140 -280

9 100 135 120 68 -14 -120 -245 -386

10 67 80 51 -11 -100 -210 -338 -480

This would be the new and the only Nash equilibrium and to that extent the solution would be self-enforcing. Also, each airline would be better off since the daily operating profit would go up from Rs 400,000 to Rs 4200,000 even after paying a total fee of Rs180,000 for three flights. This would lead to a typical WinWin situation for all the airlines as well as for the Government and the customers. This would also be a longterm stable equilibrium as there is no solution which gives higher payoff to each of the three airlinese.g. if each airline were to operate 4 flights each, the respective payoff would fall to Rs 160,000 and if each were to operate only 2 flights each, the respective payoff would fall to Rs 380,000.

More flights for major player

Of the three competing airlines operating on this route, Indian Airlines (IA) is the national domestic carrier and is much bigger than the other two in all respectsnumber of aircraft operated, number of daily flights, number of cities served, the infrastructure available and so on. It is also true that IA operates many more flights on the relatively less lucrative routes as compared to the two private airlines. The regulating body might like to give weightage to this factor while regulating the flights on this route, and therefore may like IA to operate more flights a day on this route than the other two airlines.

If the license fee is hiked from Rs 60,000 per flight to Rs120, 000 per flight so that the payoffs are as shown in Table 6, we find that there is no simple Nash equilibrium as existed earlier. Thus, the airlines would not gravitate towards industry equilibrium by themselves. However, a gentle persuasion or a pre-play negotiation can have a very significant effect. If the regulating body favors the operation of 4 flights a day by IA, the other two would choose to operate only 2 flights a day each. The payoff for IA would be Rs 520,000 per day corresponding to the point (4, 4) [i.e.4 flights by IA and 4flights by its competitors], whereas for each of the other two airlines it would be Rs 260,000 per day corresponding to the point (2, 6) [i.e. 2 flights by the airline and 6 flights by its competitors including IA]. This would again be Nash equilibrium and no unilateral move by any of the airline would be beneficial to the airline. To that extent, the equilibrium would be self-enforcing.

Table 6 Payoff when licensing fees is Rs 120,000

1 2 3 4 5 6 7 8

0 130 260 390 520 650 780 910 1040

1 130 260 390 520 650 780 910 640

2 130 260 390 520 650 780 560 320

3 130 260 390 520 650 480 280 58

4 130 260 390 520 400 240 51 -160

5 130 260 390 320 200 44 -140 -345

6 130 260 240 160 36 -120 -302 -503

7 130 160 120 29 -100 -258 -440 -640

8 80 80 22 -80 -215 -377 -560 -760

9 40 15 -60 -172 -314 -480 -665 -866

10 7 -40 -129 -251 -400 -570 -758 -960

This would also be a long-term stable equilibrium, as the industry payoffs are the highest when only 8 flights are operated. Also, the daily operating profit per flight on this route will increase from Rs 100,000 without regulation (i.e. Rs 400,000/4) to Rs 130,000 (i.e. Rs 520,000 4) for IA and Rs 145,000 (290,000/ 2) for its competitors even after paying the hefty license fee of Rs120,000 per flight.

So the regulating body could use either passenger fare regulation or the levy of a license fee to shift the Nash equilibrium to more desirable positions on the payoff table.

General Problem for n operators

(n-1) d * p

(n-1) d * p

------------------ + --------- A ------------------- - ---------n^2 * ( c + x ) n n^2 * ( c + x ) n

n = no. of operators d = demand per day (Passengers) c = operating cost per flight X = license fee per flight

If want to measure sensitivity of A to the no of passengers per day than

(n^2 * (c+x) / (n-1) * p) * (A+1/n) d (n^2 * (c+x) / (n-1) * p) * (A - 1/n)

Table 4 Sensitivity of A to the no of passenger per day

If the no of passenger per day is in the range

At Nash Equilibrium

Minimum no of Maximum no of Own

flights Minimum operating

Maximum profit operating profit

passenger per passenger per per day (A) day 533 733 933 1133 day 667 867 1067 1267 3 4 5 6

per day(Rs 000) 200 300 400 500

per day (Rs 000) 400 500 600 700

n=3, c=200 (thousand), x=0, p= 4.5(thousand)

If A(bep) is the maximum number of flights that can be operated by each airline to break even, then A(bep) = d*p/ n * (c + x) and as long as A is less than A(bep) each airline will end up making a positive operating profit from flights on this route.

If A(bep) denotes the number of flights operated by each airline at the focal point, then A(bep) = int [int [d/k]/n] and if A =A(bep), then there will be a long-term stable

equilibrium and so the regulating body may try to move the Nash equilibrium to the focal point by using all possible regulatory interventions at its command.

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3. P.K. Bhaumik : Regulating the domestic air travel in India: an umpires game , Omega 30(2002) 33-44

4. Karl Isler and Henrik Imhof : A game theoretic model for airline revenue management and competitive pricing