Sneak Peek into the Classroom

Today It was Ruksana's  first day in class at the ngo's school.She blushed and her smile couldn't be any wider as she controlled her excitement to come back to school again. I was informed that she was not able to attend school for 2 months in betwen  as her father did not have any job and they were just moving around a term for displaced unorganized workers. Most of the kids who study in the ngo are children of the migrant labourers, hence there is no certainty of their admission throughout the year as they leave the city with their parents. Recently a report was released by Kapil Sabil based on a survey by Pratham that pointed out the falling learning and reading abilities of students. This was happening when the enrollment and attendance ratio was rather improving. This made me wonder how much are the schools helping these students to enhance their knowledge? What is the advantage of spending huge amounts of money as its not translating to its require purpose ?

I thought to myself  how difficult it is for children like Ruksaana to catch up ?  As i spent a week teaching her,she needed to be taught all lessons of addition and multiplication again. How can the students be expected to have even 'decent' mathematical knowledge if they don't have access to schools because of the migrant nature of their parents job? This calls for policy making considering ground realities and not just opening up large number of schools at any location. If elementary schools can be opened near the construction sites ( like provided by this ngo) , it can surely make a big difference. 

Coming to another issue. A large number of students had come from China for a month to work in this Ngo. They mentioned about their inability to teach as the students were not comfortable in English. Given these times when English has become such an important language,  emphasis should be paid to teach English in these schools seriously so that the children are not at a disadvantage. Consequently  the Chinese cohort  could focus on physical education only! The students had a great time dancing and exercising to the tunes of  Chinese Music. However one should note that an excessive emphasis on English language should not be given. The basic concepts and lessons must be taught in their mother tongue only so that the child can comprehend. This will make sure that he doesn't have to rely on 'rote learning'. English must be taught to these children to make them competitive but as a additional language not as a medium.

One of my suggestion to ensure that how much regularity can affect in knowledge gained can be seen from this boy's story. Vinayak (see below)  the 'brightest' had  all the answers to my questions and could very well converse in English ( these kids are taught English). The reason for his great performance is regularity. His father has been working as laborer at a construction site in Delhi or at nearby places and is thus he is able to attend school.To make the students at par with any other Student in a metropolitan cities , the government should make sure to locate schools strategically  so that every child enjoys the learning process and government's efforts are not in vain.

Anna Mania BACK then

Times change dont they? This post was written when the Anna movement created a mania all over India and he was called  the Gandhi of 21st century. 

   

Corruption is believed to have been deeply embedded in the roots and soils of our country and that no amount of effort will able to uproot this monster which is voraciously eating our economy has been a widely held view. But what we saw in the past week was an exodus of people from their work , college, schools to the Ramlila grounds. The Anna movement wasn’t limited to the capital city and was  witnessed throughout India in form of protests on street, candle light marches and huge support on the social media websites. It was an event big enough to get the whole country together.People of all age groups and work strata were present to show their solidarity for the cause. The numbers at the Ramlila ground corroborated  for the popularity and support for the Team Anna’s movement.

The government finally assented with Anna’s three demands after relentless efforts and brought an end to the political impasse and the 13 day fast. It was very much against the bill initially but finally had to succumb to the demands under severe public pressure showing a flaccid stand. People celebrated in  the large numbers in India gate and  rose in exultation as the whole nation celebrated unitedly  the great victory of Team Anna.

But was it really a ‘victory’?  Firstly the demands which have been passed as a resolution include coverage of entire lower bureaucracy under Lokpal, passage of a bill on creation of Lokayuktas in states and citizens charter for redressal of grievances. However there are serious doubts on how the committee of the Lokpal will be appointed. If the committee will have people who are not elected then it poses serious threat to the functioning of a ‘representative democracy’. The whole idea of the democracy is people’s rule which will be threatened if  the same is not adhered to.Also it may just become a ‘secure’ job for retired judges and other government officials looking for stable income to cover  for  the corrupt practices of the government. This way it will just end up becoming another defunct government body and would be a retrograde step .

The means adopted by Team Anna were flawed. Holding the government at ransom to decide on nationally important policies do not signal a mature stance. The recent scams which have unfolded has led to large public dissent towards the government. But this does not justify that the parliament is forced into taking decisions which needs to be debated and passed as a resolution.Whatever has been the success of the movement and the fact that a large number of people are now conscious of the ‘prevalent corruption’ and think they can make a difference cannot be forgotten. Saying that the whole movement was a sham would be highly pessimistic and cynical, however citizens and other ‘civil ‘ society members should be wary of the ramifications of their actions .80,000 people who gathered on the grounds and the rest who actually boast of supporting Team Anna by wearing white  caps and t-shirts should not succumb to the evil of corruption. One way to combat is that citizens themselves should oppose to the practice of “corruption’. It is indeed a very utopian idea but if the people who are pressing for the Bill want an end to graft, they have to ‘be the change’ as Gandhiji says.That one man got the whole nation to its tunes for 13 days is no joke. But we should not prostrate to this as a panacea of all problems gnawing  and crippling our economy. Other serious reforms need to be brought to make sure that corruption is reduced to the minimum. Some of the measures include banning  corporate funding of  elections, judicial accountability ,speedy redressal which calls for judicial reforms and establishing transparent procedures to ensure that allocation of contracts, resources or spectrum is done in a fair manner. As Dr Manmohan Singh concludes in his speech recently in Calcutta "Corruption not only weakens the moral fibre of our country, it also promotes inefficiency and cronyism which undermine the social legitimacy of market economics. It also creates a trust deficit which ultimately weakens our ability to act unitedly."

European Conundrum

Delving into the European Crisis, trying my best to solve some puzzles! 

What is the crisis ? Why do we have this crisis?

Nations mostly spend more than their income,this is done in order to increase future economic growth through the increase in expenditure. (The increase in expenditure will increase growth if the country spends on capital expenditure,any expenditure that will feed economic activity. If the expenditure is to meet current interest payments or consumption expenditure such as short term subsidies,then the country is leading its way to a debt trap). So what really happened for the PIGS nation was ( Portugal, Ireland, Greece ,Spain )that their debt increased to very high levels and these nations were  not able to generate high enough economic growth so as to reduce the size of the debt. The reasons for the crisis therefore fall on the increasing debt. The debt has been growing and this is because some nations such as Greece have been indulging in reckless spending in the form of unemployment insurance and other benefits. These measures are successful if the world economy is growing and the animal spirits (that is the investor sentiments) show an optimistic outlook.. But once the world economy growth slowed these measures could not lead to an increase in spending and growth. Hence the problem of high spending, budget deficits and inability to control /restrain expenditure is at the heart of the European Crisis.Other Reasons for debt were also that  in many countries the property bubble was transferred to the banking system bailout which further increased the debt. The Global Financial crisis was a proximate cause which further restricted the ease of access to the capital markets for these countries. Moreover the crisis were because of high risk lending made during 2002-2008

One of the reasons of the Debt crisis come down to the Euro-a unified currency for the European Countries. Countries who are under the Euro are not a homogenous group and by bringing all countries under the same currency, many countries could access funds at cheap interest rates and indulge in reckless spending. Thus because of the Euro , these countries did not face the true borrowing costs.  Market become inefficient when the buyers/sellers do not face the true costs/prices of the product. Hence the Euro by tinkering with the borrowing costs led to excessive borrowing by some countries.

What happens if the country's DEBT increases?

Now if the debt of the country increases , all the lenders that is those people who have purchased the government bonds/securities will lose confidence in the government to return their money. As we are aware of the risk return trade off, the investors will be willing to buy the bonds of the country only if they are compensated for the high risks and are offered a high return. This is where the crisis begins to become a 'vicious circle'. The country crippling with debt and unable to meet interest payments borrows further to meet the recurring interest payment, as the investment sentiment erodes the investors demand for higher returns which leads to again high interest costs for the country.

Why should other nations be concerned?

There a close interconnection in the global financial system because if one nation defaults on its  debt it  puts some of the external private debt at risk, the banking systems of creditor nations face losses. So if Country X defaults on its debts then in this case the other country will also be affected be under pressure which would further lead to this cycle and spread of Financial Contagion. 

What can be done?

• On way is to reduce spending and bring in austerity measures! But this can again counteract! A reduction in government spending will further reduce consumption,reducing the  multiplier. So a situation where the economic growth is low bringing about austerity measures does not sound feasible. Secondly this measure may lead to political risks as we have seen the protests by Greece and Spain's citizens
•  Bailout!- The other measure that can be brought about is that The European Central Bank sanctions a bailout package for the debt stricken economies. This may seem as a good idea but this in turn leads to the problem of Moral Hazard. If the banks know that they will be bailed out , what would stop them from taking precarious steps!. Secondly the ECB can also save these economies only in a limited way. Economies such as Italy and Spain are 'too big' to be saved and hence cannot be rescued just by the bailout package.
• Increasing Competitiveness : Without economic growth these countries will never be able to get out of this situation. Depreciating the currency in order to increase exports can work to be effective.

So the inherent flaw of the Euro Currency was that it instituted a monetary union without a fiscal Union. Now through measures such as European Financial Stability Facility and European Fiscal Compact , the European Union hopes to amend its folly. So the question arises ! Will it Work? This is where the political problems creeps in and hence makes it difficult to go ahead with Fiscal union and austerity measures.

 Will  Greece exit? What will happen in case of a  Exit?

As a default seems unavoidable , Greece may sought to default and exit from the Euro Zone. This  may be the only way out ,but will be effective only in the long term. In the short term this would  lead to a financial contagion (domino effect) and as mentioned above will put the creditor nations under great pressure.  Once  Greece can exit from the Eurozone , it can devalue its currency and regain competitiveness. This will in turn help to increase its exports leading to increase in economic growth.Secondly it will be effective because Greece would be able to reduce and increase its fiscal spending depending on its areas of interest. Presently the Germans want control over its fiscal spending  in return of the bailout package. It can either go ahead with the tight fiscal measures as wanted by the Germans and get the bailout package OR exit from the Eurozone in order to start afresh and build on its competitiveness.

Rounded Rectangles

In a recent post that I read in HBR ,it was argued why a patent is not necessary for innovation . This is the exact opposite of what all of us have encountered studying about patents in monopoly . The purpose of a patent is to encourage innovation and new ideas. The premise of introducing a patent/copyright is that people or companies will take conscious efforts to innovate or spend on research and development to come up with new and creative ideas that will be beneficial for the society as a whole that can be in terms of better technology or better utilization of resources. If all firms could just copy the product/service of the other , the other firm will lose its monopoly that is helping it too earn revenues and will be alone facing the research and development. This may happen only in one period and the firm after paying high cost of research and development in one period will not continue to do so in the coming periods  and hence will be discouraged to innovate.

 Now let's look at the mobile industry. The pace of innovation in mobile phone industry is highly dynamic and it is not surprising to see a new model come up every week. Considering the dynamic and evolving nature of the mobile industry , does a 20 or 14  year patent for a mobile make sense. Is it right to consider the mobile phone or a table at par with a cancer life saving drug! So the first question is does the mobile industry need patents with a 20 year life? I think the patent life should be decided using a' case by case 'approach rather than following a 'same size fit all' approach'. As mentioned above this to ensure the patent life is decided keeping in mind the pace of changes/innovations in the industry. 

Secondly , as discussed above  the purpose of the patent is to encourage innovation. Apple has been spending a considerable amount on research and development , it is because of the ability of Apple to come up with simple yet such powerful products and technologies that makes it so successful and  'desirable'  across all  segments. Now the law suit of Apple vs Samsung , where in Apple has accused Samsung of infringement on Apple's patents, has largely been in favor of Apple as the Jury claimed 'Samsung willfully infringed Apple's patents on a wide variety of its phones'. If we were to believe that the Jury's decision is true that Samsung did use Apple's patented designs for products, then why didn't it deter Apple to cut back on its research and development expenditure. Why didn't Apple stop innovating even if its competitor was using its patented products and was coming up with almost similar products(sometimes with cheaper cost). The point here to understand is that the very purpose of the patent is that no person can illegally use a  patented product/technology/service  as it has a legal backing; a patent is supposed to be compiled by all and hence will make sure that companies/individuals innovate and have the right incentives to do so. Now even if the patents were infringed still Apple wasn't deterred to  innovate ,this highlights the competitive nature of the industry. The idea is that the nature of the market is so dynamic given the demands of the voracious consumers looking for new features and models ,that patent or no patent apple or any other mobile company has to innovate itself to survive in the market. 

I am not saying that Who should have won the case and who was right! I argue it is  important to realize  the 'nature' of industry to come up with patent laws. So its not about considering 'rounded rectangle's as ludicrous patents, it is to have a proper law that defines precisely whether a specific product is a patent , a special feature or a service and patents/licenses are given accordingly. The idea should be encourage innovation and benefit the consumer through a plethora of choice, not to grant monopoly to the mobile company for features and interface of the phone.

Agricultural Crop Insurance: How to minimize risks?

In theory, insurance is an efficient risk sharing mechanism,but the same is not always true in case of agriculture crop insurance, because of a costly risk shifting  mechanism . 

 A major role played by insurance programs is the indemnification of            risk-averse individuals who might be adversely affected by natural probabilistic phenomena. By pooling individual risks, insurance leads to Pareto-preferred states. Insurance, by offering the possibility of shifting risks enables individuals to undertake activities  which they would not otherwise undertake.

Agricultural crop insurance market may or  may not lead to Pareto preferred states. Let us first consider the case of identical farmers with perfect information.

 The case of identical farmers exposed to similar types of cases  is  a special case which leads to a risk shifting role of competitive crop insurance markets. In this case a completive equilibrium is established such that the utility of the farmer is maximized subject to the profit function of the insurance companies..If the probability p is known, then, under perfect competition, customers get full insurance at actuarially fair odd so  the outcome is efficient. EF is the fair odd line. The equilibrium policy α* maximizes the farmers utility and the insurance company just breaks even. In equilibrium each farmer buys complete insurance at actuarial odds.

J. Kurian,Ali and Ahsan have asserted that in case of identical farmers, a competitive equibrium is

Agricultural insurance market does not turn out to be like the ‘commodities’ market since it is very difficult  to assess the information of the land type, weather , risk attitude

Why a competitive market does not develop?

Imperfect Information

·      Adverse Selection

This happens if the insurer cannot distinguish the inherent riskiness of different farmers. The individual farmers may have fair knowledge about their own risk position , but the insurance agencies may  not be able to distinguish among such customers. This will eventually lead to only high risk farmers buying insurance and hence the insurance companies will run into losses.

·      Moral Hazard

It is an alteration in input use which deviates from social optimality and which occurs because of incompatible incentives and asymmetric information.Moral hazard problems occur because the insured can take action which affect the probability of losses and cannot be observed by the insurer. It is because the insured choices can affect the distribution of the losses. In crop insurance individuals have no control over the state of nature , but through dependency in the contract , the individual  can affect the amount of indemnity.

Absence of adequate information and high cost of collecting generates imperfect information in agriculture. Given there are two categories of farmers that is high risk farmers with p^h and low risk farmers with probability ^pl.   where  H> L  . Thus in the case of imperfect markets there will be either a pooling  equilibrium or a separating equibrium.The farmers knows and can ascertain his/her risk while the insurance company cannot find this out.

  There would be a  separating and pooling equlibria because of imperfect information in the market. This was given by  Micheal Rothschild & Joseph Stiligtiz

Pooling Equilibrium

A pooling equilibrium is an equilibrium in which a single insurance contract is offered to all customers. Let p’ be the average accident (loss) probability p’=λp^h+( 1-λ )p^l   where λ is the proportion  of high risk farmers.  If α is the pooling equilibrium and consider  profit of insurance firms to be Π(p’,α). Now if  Π(p’,α)  <0   implies  firms are losing money contradicting the condition of a equilibrium, Similarly if   Π(p’,α)   >0  , means there exists a contract which would offer more in both states of nature and this not the equilibrium then. Therefore we get Π(p’,α)  = 0 and α lies on the line  EF ( slope (1-p’/p’).

Competition among insurance firms implies that any equilibrium contract must break even so any pooling equilibrium must lie on the ‘pooling line’

There is a contract  β near α such that the low risk individual prefer to α, but the high risk individuals would prefer α to  β.  Since β is near α, it makes profit when the less risky buy it. The existence of β contradicts the definition of equilibrium

   

                       

 Separating Equilibrium

A separating equilibrium is the one where two separate contracts coexist. This means that the premium rate for the high risk farmers is greater than that for the low risk farmers. If the insurance companies could costlessly separate the high risk  and low risk farmers, farmers  would demand full coverage policies under the separating equlibrium.However practically insurers cannot distinguish perfectly between the risk classes. Hence there would be imperfect information in the market. Therefore the high risk farmers would realize that they can increase their utility taking the low insurance contracts. Given the opportunity to purchase the low insurance contracts they would do so.

              

The problem is that high-risk farmers impose an externality on low-risk people. The low-risk people should have cheap insurance, if only they could separate the two. But if an insurance company offers a contract  which perfectly insures low-risks, then the zero-profit condition of competitive equilibrium means that these contracts make no profit when losses occur with the low probability p. If such a contract exists, then all high-risk farmers would want to buy the low-risk contract. This would drive the insurance companies into losses as the high risk farmers would be buying the low premium rate insurance contracts and the insurance companies would be paying a higher benefit for the loss against a lower premium payment.

If you consider the above diagram EH denotes the high risk farmer’s contract with the slope (1-ph/ ph).Similarly EL denotes the low risk farmers  contract with a slope (1-pl/pl). The contract on EH most preferred by the high risk farmers gives complete insurance ( ). Low risk farmers would of all contracts on EL preferhigh contract β which also provides full insurance. However β offers more consumption than , and high risk farmers would prefer it to . The nature of imperfect information in that insurance companies are unable to distinguish between among the farmers. Profits will be negative ( ,β)will not be an equilibrium.

 An equilibrium contract for low risk farmers must not be more attractive to the high risk types,. This establishes that ( , ) may be an equilibrium . But consider the contract γ, if it is offered both low and high risk farmers would want to purchase it in preference to  or . If it makes profit/losses it will upset the potential equilibrium. EF and EF’line represents the market odds (average probably ) showing the composition of the market. EF’ is for few high risk farmers , in this case the contact γ will earn profits  and EF represents for sufficiently high risk farmers, in this case the contract γ will lose money.  Since ( , )  was the only possible equilibrium, therefore no completive equibriulm exists.

The above shows that absence of competitive markets can be largely explained by market failures due to imperfect information.

The following  explains the public crop insurance model which is cited by S.M Ahsan, AG Ali, Nj Kurian as an effective way of managing risks in agriculture.

Public Crop Insurance Model

According to Kurian, Ahsan and Ali  ,public subsidization is cited as an effective method to overcome the market failures associated with ‘imperfect information’.The insurance policy is such that it guarantees a minimum income M. The farmers is taxed at the rate for the income before applying for indemnity. The reason for including ‘s’ is that otherwise the premium rates would have been very high without such revenues given the value of M.  The value of M is exogenously determined.

In this approach the farmer chooses the optimal amount of the resource devoted to risky cultivation, so as to maximize his utility ,treating the insurance contract as given.The insurance company ,in turn, selects the optimal insurance contract so as to maximize social welfare. The insurance treats the factor utilization under risky farming as determined by the farmer in advance.

This model  asserts that the insurance agency chooses an optimal insurance program to maximize social welfare .Social welfare is assumed to be the total output of the farmer.

The results of this model show that the optimal level of s (tax rate) would be such that the expected marginal product of the resource equals the social value of the marginal revenue of the agency.In the long  rum the farmer receives  what he has put in the form of premium and tax rates ,but the basic purpose is that high premium rates inhibit risk taking. This shows that the farmers will not take high risks  and at the same time are  given a minimum income guarantee,.This will ensure a better farming output as the farmers can undertake ‘farming’ optimally under risky production at the same time have an income guarantee.

In a paper, Mark V Pauly argued that fears of market failure may be lessened by inducing farmers to signal their risk situations. He has suggested that the government could collect and make public the total insurance purchased by individual farmers.

Public provision generates a specific information and if this information is made available to firms, optimal market outcome can occur. Another argument that he raised was to  charge  premium  with quantity. Firms can increase the marginal rate of premium with respect to the quantity purchased by individuals. They will recognize, adjust to the increasing price and thus be inhibited to over insure to some extent.

Private insurance companies then could use this information to classify farmers. One difficulty is that unless all farmers have identical tastes, the above procedure would not yield useful information. Two individuals facing identical risk prospects may purchase different amounts of insurance if one is more risk averse than the other. This means that the definition of risk is different for different people ,therefore this solution will not always work.

Carl H Nelson and Edna T. Lehman argue that the cost of public subsidies may not justify the benefits and thus offer, ‘Other ‘Second Best Solution’. Information collection and application of contract design principles are possible ways of achieving the benefits of insurance at less cost than public subsidies.  The social returns from government expenditure on information collection to improve the structure of insurance contracts is likely to be significantly larger than the social returns from government subsidization of insurance.

The following give various  ‘second best’ solutions to the problem of agricultural crop  insurance

·      Self selection Mechanism

The mechanism offers a set of contracts which satisfy the break-even constraint and would cause farmers to voluntarily reveal their class to the insurer. The basic motive is that the high-risk farmer would voluntarily chooses the contract designed for him and the low-risk farmer would choose the other contract. To implement this concept, the insurer would need to determine the various "types" of farmers. The costs of determining types of farmers and designing contracts and premia accordingly would be lower than the costs of obtaining information and designing contracts for individual farmers. Types of farmers could be defined by the distribution , risk attitudes, and production possibilities. This solutions seems more practical but it depends on the magnitude of the costs required to find ‘classes/types’ of farmers. Thus, private market provision of agricultural insurance is not necessarily impossible. This implies that, without  increasing subsidies, it should be possible to increase participation by offering contracts that are more specialized to an individual's risk characteristics

·      Repeated contracts

The insurance contract covers a series of years under this arrangement. With repeated contracts, a time dimension is added to the insurance problem; both Pareto-optimal resource use and zero profits for the insurer will occur in the limit over time even though the insurer may have positive or negative profits during some particular time periods. The farmer is charged a premium based on initial expectations about the expected value of losses. If the farmer's losses are higher than expected, the premium is revised based on the new loss information and higher premiums are charged for the next year. Rubinstein and Yaari have proven that repeated insurance contracts converge to the Pareto-optimal full information equilibrium.

·      Principles of Contract Design

In applying the economic concepts the following principles are suggested

for the design of an agricultural insurance program or for a revision of the

Inputs and outputs, risk attitudes, and risk distribution functions. The self-selection type should be designed according to types of farmers. Information about realizations of stochastic events, observable input use and imperfect monitors, or inferences concerning un- observable inputs should be used to determine insurance payments. Premium rates should be readjusted over time according to the information obtained about a farmer's actions.The design or revision of an agricultural insurance program should be based on a systematic application of these principles in order to achieve the best possible risk sharing at the lowest cost in terms of resource misallocation and information collection.

According to Nelson and Loehman, the social returns from government expenditure on information collection to improve the structure of insurance contracts is likely to be significantly larger than the social returns from the government subsidization of insurance. However,the above statement is country specific.

The two equlbria that arise when there is a imperfect information in the market were discussed and found that it may not always exist ,therefore according to Rothschild and Stiglitz model that ‘imperfect information’ may not lead to a competitive equilibrium in case of agricultural crop insurance. The  public insurance model showed the government provided subsidies in agriculture can ensure a  better outcome.  Other solutions and  ways to combat the inefficiency of  the market to deliver agricultural crop insurance. were also discussed to combat the problem of imperfect information in agriculture market

Indigo vs KFA: Beyond the rise and the fall

The amazing performance of Indigo Airlines( its the only airline company to make profit since starting operations) since its inception has finally made it possible to be the top leader of the market surpassing JetAirways and now occupies 27 % market share. Under the leadership of Aditya Ghosh ,Indigo has been able to survive the otherwise 'troublesome' aviation sector. This has cleared Vijay Mallaya doubts who had commented on the veracity of Indigo's profitability.

KFA share plummeted from around 20% in July last year  to 3.5 % in August this year. No doubt that Indigo has benefited from the plummeting share of KFA but it is important to realize that this alone isn't the reason for Indigo's success. This opportunity was available to all the airline companies and it is because of its efficient way of functioning that it has been able to expand its market share.

What was  the difference between the business models of the two companies that led to such a contrasting fate for the two companies?Indigo   focused on a slow and steady approach , conducted a thorough analysis of the market to  understand that the average consumer would not be fascinated by red carpets, expensive food and entertainment facilities but rather would be more concerned about the basics of the airline industry are supposed to provide that is   clean aircrafts and punctual flights operations(hence the excessive emphasis 'on time'). I recall that the managing director Aditiya Ghosh had mentioned in an interview that he wanted to show that 'low cost' is not synonymous with  'low quality'. This has precisely been the reason for its success. Indigo understood what the customer essentially wanted from a domestic airline company. Thus it has been able to minimize the wasteful expenditure and focused on ‘no frills’ model followed by US regional airline companies.For example , doing away with 'free food' provided in the flights and instead making the food available on payment as per the choice of the customer.This in turn removes the cost of food in the ticket making it more competitive .Moreover KFA worked on the premise that luxury would sell in the airline industry. What it failed to consider was that fuel costs comprise a very prominent share of variable costs that are subject to changes in international market. In times when the price of fuel would escalate people would often cut down on luxury expenditure ( elasticity for luxury goods is greater than one)

Additionally both the companies followed different strategies to expand  to international operations. While KFA followed an aggressive and haphazard approach ,Indigo  followed a organized approach. This helped Indigo by not increasing costs immediately and gave the airline ample time to expand and stabilize.Malaya’s approach to expand to international operations is best described as aggressive. Impatient to start international operations, he chose to acquire Air Deccan – a low cost provider.This was done to meet the criteria of 5 year domestic operations to fly international routes. In this haste , KFA acquired a low cost airline with a low turnover and huge debts. The most damaging aspect of the merger was that it created a ‘brand conflict’ among the consumers. One of the most important aspects of a merger is to evaluate what would be the impact of the merger on the demand for the current product/service offering. This is exactly where KFA missed the mark and created confusion in the minds of the consumers.

As KFA's market capitalization now stands less than its debts , it now depends how well it can resume its operations back to normal. This will be possible only if the banks would be willing to lend the airline to support its daily operations. Just like an economy fighting recession has to ensure   increase in capital expenditure to drive demand and escalate GDP similarly KFA has to get back to its normal operations to prevent the dilution of its market share ( that is supposed to reach its lowest 3.5%). T

No doubt the aviation industry is not the easiest to survive( even Michael Porter believes so)  but Indigo’s management has proven that the doubts expressed by Mallaya are spurious. It is at the end what the business offers that will decide its fate.