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Indonesia’s price floor for airlines is misguided, a bad precedent and will be counterproductive

Regulation of Indonesia’s airline sector is becoming more stringent as the government introduces a new floor price which will force carriers to stop selling heavily discounted fares. The new measure is an unfortunate knee jerk response that will purely have a commercial impact on airlines. Ostensibly a safety related move, it can only have a counterproductive effect in that regard.

The Indonesia’s airline sector is already over-regulated with unnecessary and impractical rules governing fares and splitting airlines into categories. Indonesia should be deregulating its vibrant industry and instead focus on upgrading infrastructure to facilitate future growth and meet global standards.

Indonesia’s domestic market has nearly doubled in size over the past five years and prospects for long-term growth remain bright. But growth slowed in 2014 as most airlines became unprofitable. This is hardly the time for new regulations that meddle in commercial matters and have nothing to do with operations or safety.

Indonesia’s airline industry is already too regulated

Indonesia has a highly regulated airline sector with rules and fare levels that vary depending on an airline’s business model. The government has a ceiling price for every domestic route. Airlines classified as full-service can charge up to 100% of the ceiling price while airlines characterised as medium service can charge up to 90% and no frills airlines up to 85%.

The three categories are based on what services an airline offers. To be in the full-service category airlines need to offer at least 20kg of checked baggage as well as food and beverage. LCCs are able to charge for bags, food and beverage. (All of Indonesia’s LCCs sell food and drinks but some LCCs including Lion and Citilink at least for now still offer 15kg of free checked baggage.)

Indonesia airline categories

Of the 14 airlines currently certified for scheduled passenger services two are classified as full service – Garuda Indonesia and Lion Group full-service subsidiary Batik Air. Five are in the no frills category – Garuda budget subsidiary Citilink, Indonesia AirAsia, Lion Air, Lion regional subsidiary Wings Air and Susi Air. According to Indonesia’s DGCA, the seven airlines in the middle service category include Aviastar, Kalstar, Sriwijaya, Transnusa, Trigana, Xpress Air and Sriwijaya subsidiary Nam. (See background information for the full list of airlines in Indonesia.)

Indonesia also has a price floor which in theory prohibits airlines to charge less than 30% of the ceiling price. But in practice Indonesia has routinely provided exemptions for LCCs to offer fares well below this floor. By allowing such exemptions Indonesia seemed to recognise that offering some seats at very cheap prices was an important component of a sustainable LCC model.

But unfortunately the Indonesian Transport Ministry has recently taken a U turn and decided to stop allowing any exemptions to the floor and raise the floor from 30% to 40% of the ceiling. If enforced this means LCCs will have a much smaller range of fares. For example if the ceiling price on a certain route is USD100, LCCs will not be able to charge less than USD40 or more than USD85.

Fare flexibility is crucial for the LCC model

LCCs typically offer a wide range of fares, with very low fares offered to passengers booking well in advance and flying during off peak periods. Meanwhile much higher fares – sometimes even higher than full-service carriers – are sold for peak periods or flights which are already nearly fully booked. This is an essential part of the LCC model as it allows LCCs to stimulate demand and maintain high load factors during less popular travel periods or times. The high load factors in turn help the airlines sell more ancillaries.

The theory is that it is better to have a passenger that pays next to nothing than an empty seat. With the empty seat there are no opportunities to sell other items.

Indonesia’s Transport Ministry has stated the new policy on floor prices are designed to make sure airlines are more profitable and therefore have more to spend on safety. But the reality is floor prices have nothing to do with safety. This is a shortsighted and knee-jerk response following the 28-Dec-2014 crash of Indonesia AirAsia flight QZ8501 that will instead undermine the ability of airlines to run viable commercial businesses. Being seen to be doing something merely for its own sake has always been bad policy and this is no exception.

It is unlikely the new regulation will ensure airlines make more money. The reverse outcome is much more likely as airlines could become endangered as their commercial flexibility is restricted.

The new floors could wreak havoc with airline pricing strategies, particularly LCCs as full-service airlines generally follow a different model that does not involve discounting as steeply. Demand could be impacted as the lowest price buckets are no longer offered. Certain price sensitive passengers – the type of passengers that likely did not fly before LCCs were introduced into the market – rely on these fares. Without these passengers traffic could decline. The impact on tourism and local economies will inevitably be negative.

Indonesia has more pressing requirements - that the government itself needs to fix

The safety argument is silly because Indonesia, like all other countries, requires all its airlines – regardless of category or business model – to meet the same safety standards. Indonesia simply needs to continue making sure these standards are met rather than making ad hoc interventions in commercial matters.

Indonesia has other more pressing requirements. It should be focusing on accelerating infrastructure investments to expand airports and upgrade ATC facilities. This would enable Indonesia, which has fallen behind the growth curve in recent years, to catch up and accommodate future growth while also raising standards.

Oversight capabilities also need to be raised for Indonesia to regain a US FAA category 1 safety rating. Currently Indonesia has a Category 2 rating and several Indonesian carriers remain on the EU blacklist.

Infrastructure challenges have intensified as Indonesia’s market has roughly doubled in size over the last five years. Domestic passenger traffic increased from 43.8 million passengers in 2008 to 75.8 million passengers in 2013, according to DGCA data.

Indonesia annual domestic passenger traffic: 2008 to 2013

International passenger traffic has grown at a similar clip but from a much smaller base. There were about 22 million international passengers in Indonesia in 2013, with about half carried by Indonesian carriers and half by foreign carriers. 

Indonesia's growth slows as market conditions become more challenging

But the pace of growth has slowed significantly. Indonesia’s domestic market grew by only 7% in 2013 compared to between 16% and 19% in 2010, 2011 and 2012. Figures for 2014 will not be available for a few more months but domestic growth was about 3% in 1H2014 and was likely about 5% for the full year.

Indonesian carriers also struggled financially in 2014 as demand slowed due to a weaker economy and as the rupiah depreciated. A majority of Indonesian carrier costs are in USD while revenues are in rupiah.

The price ceiling exacerbated the situation as Indonesian carriers were unable initially to raise domestic fares to offset higher costs. Eventually the ceiling was raised - a seemingly important precedent against the new knee-jerk rule.

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Deregulation is the best solution, instead of lumpy regulation

Indonesia should be looking at deregulation rather than putting in place stricter regulations. Deregulation would benefit consumers – as it did years ago in Europe, North America and other markets. It would also give airlines more flexibility to adjust to changes in market conditions similar to those  experienced in 2014.

Indonesia could also benefit from deregulation of domestic routes. The current system is complex and antiquated, with no practical or logical support. In the aftermath of QZ8501 the DGCA uncovered about 60 violations of domestic route licenses by several carriers. The planned adoption of a simpler electronic system for route licenses should boost compliance. But again the best outcome would be deregulation.

Indonesia has a relatively liberal market and it has helped massively to improve transport and social mobility. The rise of Lion Air, which has overtaken government-owned Garuda as Indonesia’s largest airline, and the launch of other LCCs could not have happened otherwise. But the regulatory environment is less than ideal. Given the tough market conditions of the last year, now is not the time to over-regulate.

Background information: Indonesia’s airline sector

Overall there are more than 30 airlines in Indonesia, according to CAPA data. Besides the 14 active scheduled passenger carriers this includes planned start-up Indonesia AirAsia X (IAAX), cargo carriers, charter airlines and air taxi operators.

Indonesia airlines ranked by number of aircraft: as of 13-Jan-2015

Rank Airline Widebody Narrowbody Regionals Total
1 Garuda Indonesia 30 79 23 132
2 Lion Air 2 101 0 103
3 Susi Air 0 0 36 36
4 Sriwijaya Air 0 35 0 35
5 Citilink 0 32 0 32
6 Wings Air 0 0 30 30
7 Indonesia AirAsia 0 29 0 29
8 Trigana Air 0 9 11 20
9 Pelita Air Service 0 0 19 19
10 Batik Air 0 18 0 18
11 Airfast Indonesia 0 4 8 12
12 Travira Air 0 1 10 11
13 Kalstar Aviation 0 3 7 10
14 Deraya Air Taxi 0 0 10 10
15 Indonesia Air Transport 0 0 9 9
16 Xpress Air 0 6 1 7
17 Tri MG Airlines 0 4 2 6
18 Aviastar Mandiri 0 0 6 6
19 TransNusa Air Services 0 0 6 6
20 Nam Air 0 5 0 5
21 Gatari Air Service 0 0 5 5
22 Nusantara Air Charter 0 0 4 4
23 Asialink Cargo Express 0 0 3 3
24 Cardig Air 0 3 0 3
25 Sabang Merauke Raya Air Charter 0 0 2 2
26 Pegasus Air Services 0 0 2 2
27 Manunggal Air 0 0 1 1
28 Dimonim Air 0 0 1 1
29 Enggang Air Service 0 0 1 1
30 Indonesia AirAsia X 1 0 0 1
31 My Indo Airlines 0 1 0 1
32 Republic Express Airlines 0 1 0 1

IAAX received its air operator’s certificate in Sep-2014 but is not one of the 14 active airlines as it has not yet launched services. IAAX initially planned to launch services on 26-Dec-2014 with five weekly flights from Bali to Melbourne. It has postponed its launch pending final approvals from Australian authorities.

There are currently about 560 aircraft in service in Indonesia, according to the CAPA Fleet Database. Almost 60% of the fleet consists of A320 and 737 family aircraft. Almost 40% of the fleet consists of regional aircraft including large turboprops (primarily ATR 72s), smaller turboprops (including single-engine turboprops at operators such as Susi Air) and regional jets. The widebody fleet is relatively small.

Indonesia fleet breakdown by aircraft type: as of 13-Jan-2015

There are also five carriers that are still certified to operate scheduled services but are currently suspended, according to the DGCA. This includes Indonesia Air Transport, Mandala, Merpati, Pelita and Sky. All these carriers were in the middle category except Mandala, which was categorised as no frills.

Indonesia Air Transport and Pelita still operate but only on a charter basis. Mandala, Merpati and Sky suspended operations entirely in 2014. These carriers could potentially relaunch scheduled services. Merpati, Mandala and Sky have had some discussions with potential new investors.

Other airlines that have suspended services in recent years no longer have AOCs and therefore are not able to relaunch. These include Batavia, Kartika and Pacific Royale.

There has been significant consolidation in Indonesia over the last three years. In 2012 there were 20 scheduled passenger carriers in Indonesia.

More consolidation is likely and would improve the overall health of the Indonesian industry. Adding new regulations could lead to consolidation as some airlines struggle to cope but it is not the appropriate response. Deregulation can also lead to consolidation and would be more appropriate.

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