From my column at Yahoo:
Is "cheap" good, when you’re making losses? In general, people like cheap. As in "inexpensive", not "shoddy". Prices can get lower for many reasons. Competition can force price cuts — either you compete or customers leave you. You can get greater productivity — producing more at the same price means you can charge lesser. You can lock in the price of your raw materials and retain customer prices at the same level.
Let’s look at a few industries where, over a long period, prices haven’t changed or have actually come down.
The most obvious is electronics. About 15 years ago, I paid Rs. 65,000 for a mid-level computer, and I’d probably pay about Rs. 25,000 today. Prices of chips fall, even as they add more computing power. Even as prices have dropped, profits of semiconductor companies have stayed high; volumes and efficiencies more than made up for increase in raw material costs or labour.
The car market has also managed to maintain prices, for the most part. A Hyundai Accent (one of the cheapest sedans in India) cost about Rs. 520,000 in 2005, and continues to cost around that much today. (Delhi prices) Again, carmakers aren’t entirely miserable; Maruti has dramatically increased profits through greater volume.
While food costs have increased, the cost of staying in a hotel in a holiday location has largely remained the same. City room prices have gone up but that’s largely due to business travel. Still, hotels have managed to retain margins for the most part. Some of the impact here is competition, but it’s also that volumes have gone up and costs are spread across more customers and room-nights.
But this hasn’t applied to a few industries which seem to be in the limelight today. Airlines have been losing money, even though their prices continue to be ridiculously low. Not that I’m complaining, having recently paid the same amount for a family of four (one infant) as I did for just one ticket 10 years ago. Airlines have almost no productivity benefits to provide — the aircraft manufacturers have so much demand they won’t cut prices, labour costs more where good staff is in demand, and fuel costs are market determined and taxed to the moon and back. Regulators, too, step into every piece of the pricing process — recently, the airline regulator barred airlines for charging for pre-assigned seating, for instance. Even if there are more flyers than ever, airlines are simply not turning a profit. The massive capital required to buy planes, or the high operational costs (parking costs, landing fees, rent etc.) are either impossible to reduce or too difficult to influence. In addition, you have the taxpayer bailed-out Air India that seems to be able to make endless losses and still continue to get aided by the taxes collected of our sweat and hard work. If they charge less, everyone must follow.
Telecom companies must pay government mandated (or auctioned) fees for spectrum and for licenses, and yet, their average revenues per user have been going down. Some carriers show user revenues as low as Rs. 100 per user per month. These customers simply don’t exist at higher price points — raise prices, and you’ll find people start migrating away or using landlines instead. The high costs of supporting voice is expected to be made up through the more high-end data charges, but the 3G auctions have driven up the price of data packages so much that they’re unaffordable except for the urban rich. With infrastructure costs mounting, from tower rents to equipment, and employee salaries rising, there’s very little room for cost cutting, other than large layoffs and silent retrenchment that the industry has been seeing in the last year.
Oil-marketing companies that have been giving us substantially cheaper fuel than the market should otherwise allow. Oil companies are losing Rs. 512 cr. per day on the under-recovery of costs in diesel, LPG and Kerosene. Fuel is not cheap — in Bangalore, we pay over Rs. 73 per litre of petrol (which is equivalent to $5.3 a gallon), a large portion of which are state and central taxes. But oil companies still make losses because the real cost to us, the consumers, needs to be higher; and in 2011-12, they have lost over 138,000 cr. (Rs. 1.38 trillion).
In other industries such as online retailing or "deals", players attempt to gain market share by selling at a loss. A restaurant might attempt to give away meal coupons at a loss in the hope that patrons will continue to visit it even when there’s no coupon. But if it turns out that most "new" customers wouldn’t have paid the higher non-coupon rate anyway, the strategy fails. Other companies lose money on one product to make profits in another; shaving razors are sold at a loss that overpriced blades will more than make up for, printers are made cheap so you’ll buy the expensive ink replacements, and newspapers are sold cheap so that you can see all those advertisements instead.
During the dot-com boom, losses were considered par for the course, and companies were valued using other metrics like eyeballs, page views or meters of cable laid. It got so bad that if you actually made profits people wondered if you weren’t trying hard enough. That situation had an unhappy ending, but it was because of those investments (and losses) that the world got cheap fiber, as the current companies bought it for fire-sale prices when the loss makers went bankrupt.
The losses in airlines, telecom and oil will see different endings, not all of them happy for the survivors. My take: Oil prices will have to go up in order to curb demand, since you have nothing great in terms of alternatives or technological progress in the field. The existing telecom setup will change as some of the current companies die and sell their infrastructure cheap to new players, who will then be profitable at the same price points. Airlines will make losses till kingdom come, because it’s that glamorous industry where no one ever seems to make money on a sustained basis anywhere in the world. The old joke goes:
"How do you become a millionaire?"
"Begin as a billionaire and buy an airline".
