Timor-Leste aviation industry – everyone is better off with two truly independent providers

Timor-Leste aviation industry – everyone is better off with two truly independent providers

*Cosme da Costa Araújo

January 2017

In a small market economy such as Timor-Leste aviation industry, no competition allows a single provider to monopolize the market and do whatever it wants, charging higher price for low quality service. But too many competitors could fuel collusion, or a price war, which ultimately lead to deterring and driving out competitors, and retaking of monopoly position. For now, everyone would be better off with two truly independent providers.

Not everyone is as lucky as Marvi

Our journey into the New Year begins with a jubilant welcoming of Maria Vitoria, the third runner up of the 2^nd Asia Dangdut Academy. A record crowd turn-out for a previously unknown Timorese teenage girl nearly brought Dili to a standstill. Marvi, as she is now known, epitomizes the Chinese prophecy for 2017 – the year of the Rooster – the year of dawn and awakening, triumph and success for those who work hard.

But not everyone is as lucky as Marvi. Air Timor, for example, a company that is dear to many proud Timorese for flying with “Timor” name and run by many Timorese businessmen, decided to terminate its Denpasar flights and reduce the frequency of its Singapore flights. The inconsistent application of the regulations by the Government and overcapacity are the main reasons leading to the reduction of its route network, significant layoffs and the surrender of any Timor-Leste airline opportunities to Indonesian carriers. The Government dismissed Air Timor’s claims and responded that “Timor-Leste is a free market, whereby Government’s role is merely to do with regulations”. The Government went further to blame the company to bring the disaster into itself for lacking managerial capacity and inability to resolve its internal affairs.

A market too small for many competitors

Accessing to Timor-Leste from other countries is predominantly by air. Air connections are limited to three entry points: Singapore, Denpasar and Darwin. Dili-Denpasar route was first serviced by the Merpati Nusantara Airlines. The monopoly position it enjoyed allowed it to charge an exuberant one-way price above $300. The entry of Batavia Air in 2010 offered an alternate transportation for the Dili-Denpasar route and the price fell accordingly by 30%. Sadly bankruptcies took toll on both companies forcing them to cease their operations in 2014 and 2013 respectively. Sriwijaya Air, another Indonesian private airline, began flying to Dili in 2013. A year later with the entry of Air Timor, in partnership with Citilink, the price for a single trip fell considerably to around $100 or less. Sriwijaya apparently colluded with Nam Air, one of its subsidiaries, waged a price war and dumped the price to $70, far below the market price. Air Timor succumbed and left the route in early 2017. Consumers’ enjoyment of low airfares was short-lived with one company again dominating the market, and the price is skyrocketing, back to its previous record high.

With a small market of about 100,000 passengers flying in a year, there are so many seats available compared to market demand that the three airlines could only achieve 50% or less Load Factor. Too much competition actually results in everyone worse off situation. When a small market is shared among a larger number of firms, the unit cost rises as few economies of scales are realized. The higher unit cost necessitates higher price being charged. In a market where airlines usually need 70% to break-even, competition forces companies to run at margin loss which leads to a price war and the subsequent failure and return to monopoly ultimately does not benefit consumers.

Australian airline market with approximately 60 million passengers flies domestically, only two providers service the market – Qantas and Virgin. Its international airline industry remains quietly regulated and is subject to detailed capacity controls. More competition should be encouraged for the Dili-Darwin route, which is still dominated by Air North.

An indication of an apparent colluded “duopoly”

Timor-Leste has seven slots available to fly from Dili to Indonesia. The Government of Timor-Leste issues licenses to both Sriwijaya Air and Nam Air, each as a separate independent company. In fact, Nam Air is a subsidiary of Sriwijaya. With a different cost structure and economies of scales leveraged from its wider operation in the other Indonesian market, and the transfers of Nam Air passengers on low-capacity days, Sriwijaya enjoys the competitive advantage over Air Timor. The deep pocket it has enabled it and its subsidiary to wage a price war that Air Timor is not able to match. The actions of the both airlines indicate an apparent collusion to force rivals out and to maintain its monopoly position. All of us would have felt the impacts as price is skyrocketing immediately after Air Timor’s decision to terminate its Dili-Denpasar route.

Government failures exacerbate market failures

The Government is right that in a free market economy, the Government’s role is to set and enforce regulations. Therefore, Government has been intervened to correct market failures through regulations. However, in many instances, Government intervention can also fail to achieve an efficient allocation of resources.

To ensure aviation safety, the Government enacted legislation that stipulates aircraft must be no more than 20 years old. There is no ambiguity in the legislation. Air Timor was asked to replace its 18-year-old aircraft with a new A320 Airbus. But Sriwijaya and NAM are allowed to operate its 22 year old aircrafts.  The Government argues that both airlines are technically assessed to still be suitable for operation regardless of its 22 year old aircraft, which contradicts the clear stipulation of the law.

The Government’s inconsistent and discriminatory enforcement of the legislation violates the provision and the intention of the law itself. And by allowing both airlines which were ranked last year among the 10 least safe airlines in the world and banned from flying in Europe and by relying the assessment carried out by other countries on the safety of the aircrafts, the Government puts the safety of its own citizens at risk. The very people they vow to protect when they come to office. This type of legal uncertainties may set a bad precedent that could deter future potential investments.

Towards the end of 2016, the Government introduced a price support regulation which set a minimum price the airlines can charge. However, the regulation was repealed in the Council of Ministers. How the minimum price came about is still unknown. A price floor is fine, as long as it is set fairly close to the equilibrium price. The Government needs to do further study to determine what the equilibrium price is. It is clearly above the low price that forced Air Timor out of the market.

After the termination of Air Timor operation, the price is skyrocketing. A return ticket for Dili-Denpasar is now close to $300 or more. The Government has to swallow its pride to intervene by monitoring and controling the price charged by now a single provider. How the Government is going to do this remains unclear. If it is trying, the current price suggests it is not doing a good job. These are few examples of government failures which exacerbate market failures. The Government can be sued for breach duties and violation of the law.

Everyone is better off with some competition

Timor-Leste aviation industry is a market too small for too many competitors. We have seen and experienced that a monopoly provider is able to charge a higher price at will, reaping the benefits at the expense of the customers. The two truly independent providers offer us alternate and affordable options. But more than two providers will either fuel collusion, or a price war, driving out competitors which ultimately lead to the charging of high price. For now, everyone would be better off with two truly independent providers.

What the Government can do is to set a minimum price to stop future price wars and encourage Air Timor or other low carrier to enter the market. If the market is not big enough, the Government needs to put a price ceiling so that traveling is affordable for as many consumers as possible. An alternative option would be, in Timor-Leste case, flying could be considered as public goods. Therefore, a national commercial airline can be introduced, jointly financed and run by the Government in partnership with the private sectors – a typical Public Private Partnership  (PPP) arrangement.   

Support “Rai-Nain” – Timor owned, Timor led

Timor-Leste is in need for foreign direct investments (FDIs) to help create jobs, reduce unemployment, improve living standards and create revenues for the government. These byproducts are secondary to the main objective of FDIs, which is to maximize profits whenever and wherever opportunities exist. But FDIs will leave the country without notice when such opportunities no longer exist. Let’s see what these investors would do when Petroleum Fund runs out.

Only domestic Timorese investors, the “rai-nain”, will stay put to help out their country and their people. During the dark hours of our struggle, we vowed to unshackle ourselves from any form of dependence. And we will never “kaer kuda talin rasik”, if we halfheartedly support the likes of Jape Konsu, Jackson Lay, Clarissa Lay, shareholders of Air Timor, and many other Timorese who are not dependent on the government’s handouts. They help create jobs, pay taxes, and more importantly keep the money circulating in our economy, instead of repatriating it overseas. Surely such local businessmen warrant our support rather than the companies that squander public money on precarious projects. When other countries forbid foreign airlines to compete in their domestic market, bail out their ailing national carriers, and force their public servants to fly their national carriers, why can’t we support ours.

A free market economy sounds good in theory. But not many countries, who preach it, practice it. It reminds me of a wise Timorese man once told his confidant “every theory is good; but the only one that is useful, is the one that fits the reality of our country”.

* The opinions expressed in this article are the author’s own and do not reflect the view of any entity or person that author works or associates with.

References

ABC News, (2017), Air Timor: Government policy, suspected corruption ‘destroying’ East Timor’s only airline.

ADB, (2015), Growing the non-oil economy: a private sector assessment for Timor-Leste.

Air Timor, (2017), Press Release

Ch-Aviation, (2017), Air Timor closes Bali route, blames government policy, dumping, www.ch-aviation.com

Investopedia, (2017), What is an ‘Imperfect Market’

Lusa, (2017), Companhia aérea timorense culpa política do Governo por perdas de 3 milhões de dólares

Lusa, (2017), Governo timorense espera que indonésia Citilink continue voos entre Díli e Bali

Ross, D., (2015), Aviation safety vs commercial profits, www.policyforum.net

The Economist, (2002), Fair play, free markets

The Economist, (2013), Spot the difference: legacy vs low-cost carriers

The Economist, (2015), The collusion delusion: Airline competition