The schoolchildren in ‘Deserted Village’, a poem by Oliver Goldsmith, poet-novelist of the 18th Century, were a discerning lot. One look at their village schoolmaster’s face, and they would know if they were are going to have a tough time that day or if the school hours would pass like a breeze. Would it be, for instance, a case of six of the juiciest on their posteriors for not reciting their Latin lines properly or just an indulgent shake of the head and a benevolent smile? It all depended on the school-master’s countenance. ‘Learned to trace the day’s disasters in the morning face’, is how Goldsmith describes the student’s ability at ‘face-reading’.
B-school students of this era are, of course, more fortunate than the school-children of rural England in the aftermath of the Industrial Revolution. Not much would be at stake for the former if they didn’t, for instance, complete the case analysis the professor had assigned for submission the following day, except perhaps the risk of a marginal reduction in marks awarded on internal assessment.
But the ability to size up a situation and decide whether the present moment is appropriate to bring up a subject with another person, a skill closely aligned to that of ‘face-reading’, would be desirable, if not as students, most certainly later in one’s professional career. Such sensitivity may prove quite handy while dealing with the immediate superiors in an organisation.
A chance to lock in
Imagine the following: An airline offers a special fare to fly to the Andamans, and you would like to lock into it. But there is some uncertainty about getting time off from the office. Ideally, you would like to give yourself a couple of days to catch the boss’ attention when he is in the right mood. But there is a catch. The airline has placed only a limited number of seats under offer. They might all be sold out in a day or two, if not earlier. So the situation, on the face of it, would appear to have reached an impasse.
But Jet Airways thinks it has figured out a way to help you out of the current predicament. You could lock into a trip at a specified fare right away, but need not commit fully to the travel. The airline will keep the seat reserved for a few days on payment of a small fee. In short, the much-hoped-for holiday can be firmed up, for all practical purposes, without the assurance of a go-ahead from the boss for a fortnight’s leave of absence from work.
The airline says it has introduced a booking feature called ‘Fare Lock’, that allows the traveller the flexibility of retaining a selected fare for 72 hours before confirming the actual purchase. Once a guest selects the ‘Fare Lock’ option, he/she will need to pay a nominal fee of ₹350 for a domestic ticket and ₹700 for an international ticket to lock the available fare, which would stay locked in for that duration.
Call option
In financial market terminology, the airline is writing a ‘call’ option and the would-be passenger is the holder of that option. A ‘call’ option confers on the holder the right to demand of the option writer that he sell the asset at a specified price, while simultaneously not fettering oneself with the obligation of buying the asset at that specified price. For such a privilege, the holder of an option pays a fee.
In the Jet Airways example, if the airline seat is an asset, the would-be passenger acquires a right to demand of the airline the sale of a seat (ticket) at the stipulated fare (asset price) without simultaneously committing to making the trip and thus end-up paying the cost of the ticket. For Jet Airways, then, the analogy of practices in the financial markets is thus complete with regard to its policies on pricing airline seats. But only just. Investors have a lot more choice in the financial markets, unlike prospective customers in Jet Airways.
For instance, an investor in an ‘option’ contract on an underlying financial asset could acquire the right to buy an asset at a specified price that will be valid for as long as a month and, in quite a few cases (if the market in that financial asset is deep enough), going as far into the future as three to six months. But Jet Airways is unwilling to risk freezing the price of an airline seat for anything more than three days. More importantly, investors have the option to acquire the right to buy an asset at a specified price but also the right to sell, though they might not possess the asset at the time when they enter into such a contract.
Market potential
But there is no reason why derivative products related to seats on a commercial flight between two points should not become just as vibrant as derivative contracts in underlying financial assets have become on the stock exchanges. This would be clear from an analysis of the factors that create a vibrant market in derivative contracts for an underlying financial asset.
The first and foremost requirement is that, in the perception of market players (read, investors), the value of the asset could vary from time to time. The sum total of unused passenger seats on a flight represents ‘value’, in the sense of the opportunity cost the airline loses from vacant seats. The sum total of such a loss depends on the number of seats going vacant on a flight, and that can vary from day to day.
Again, it is not the actual number of seats that go unfilled that is relevant but rather, the perception of market players as to such an outcome. In that sense, it is not very different from the perception of market players on the aggregate value of all the equity shares in a company (market capitalisation), which varies from one player to another, and from one day to the next.
The airline industry too has, over the years, moved from an era of shortages to excess capacity, leading to the phenomenon of planes flying less than full. In the beginning, the industry was highly regulated and capacity was always short of potential demand. You could buy a ticket and cancel it just hours before the flight was to take off and you would practically get your entire ticket money refunded. Since there was always someone waiting in the queue, the airlines didn’t lose anything by returning your money. But with deregulation, the situation changed.
Power of computing
From demand chasing supply, it became a case of supply chasing demand. The airlines recognised that getting some money from passengers is better than letting the plane fly empty. This led to features such as ‘dynamic’ pricing and ‘early bird’ offers. But these gimmicks wouldn’t have been possible but for the phenomenal progress in the power of computing and telecommunication. Technology cold help airlines virtually scour the entire earth for a potential customer and get paid with ease through credit cards and electronic fund transfers.
The only issue that remains to be resolved is this. Should airlines remain the sole market-makers in derivatives contracts for unsold seats, as was the case with equity markets with ‘market-makers’ offering to make a market in individual shares for prospective investors to buy and sell — a phenomenon that flourished until the 1980s and, in some cases, well into the 1990s?
Alternatively, should airlines shift to trading platforms where there is complete and transparent dissemination of information about vacant seats so that people with superior information about future movements in the underlying asset make the market, as is the case now with the equity market? The answer to that question depends on whether airlines see themselves as suppliers of a flying experience, preferring to leave it to the market to price their offerings, or pretend to play ‘god’ with regard to asset prices.