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LPEM-FEBUI Working Paper - 041 ISSN 2356-4008 December 2019 THE SKY IN BLUES: ON THE RECENT DEVELOPMENT OF INDONESIAN AIRLINES INDUSTRY Chaikal Nuryakin Regi Kusumaatmadja Natanael Waraney Gerald Massie Alvin Ulido Lumbanraja Sean Hambali Devina Anindita LPEM-FEB UI Working Paper 041 Chief Editor : Riatu M. Qibthiyyah Editors : Kiki Verico Setting : Rini Budiastuti © 2019, December Institute for Economic and Social Research Faculty of Economics and Business Universitas Indonesia (LPEM-FEB UI) Salemba Raya 4, Salemba UI Campus Jakarta, Indonesia 10430 Phone : +62-21-3143177 Fax : +62-21-31934310 Email : [email protected] Web : www.lpem.org LPEM-FEB UI Working Paper 041, December 2019 ISSN 2356-4008 The Sky in Blues: On the Recent Development of Indonesian Airlines Industry Chaikal Nuryakin1,F, Regi Kusumaatmadja1, Natanael Waraney Gerald Massie1, Alvin Ulido Lumbanraja1, Sean Hambali1, & Devina Anindita1 Abstract As the ASEAN put forward aviation industry liberalization measures in 2010, the Indonesian aviation industry has been moving towards the other side of spectrum of late. Two market ventures driving the change was in late 2018, where one of the leading airlines group, Garuda Group, through Citilink agreed to form cooperation with Sriwijaya Air. Second, January 2019 further marked the period in which Lion Air started charging ‘baggage fees’ and Garuda Indonesia stopped offering sub class ticket. Amid the presence of such changes in the industry, this study aims to discuss the current state, challenges, and potential of the Indonesian aviation market; comprehensively discuss the economic implications of such state of the industry; as well as how the government may act to help address the possible market failures. The study utilizes multiple data sources, i.e., data from CAPA, INFARE, as well as official governmental transportation database. We first describe the potential of airlines industry in Indonesia. We identify the periodical breaks in the industry’s growth; that is, during which periods significant changes are happening. What follows is a complete breakdown of the market concentration and landscape. We proceed to show the impacts of the generalized price hike. Our findings suggest that loss of passengers is immense. Further, we find an intriguingly similar capacity drop in the period following the Citilink – Sriwijaya deal conducted by virtually all the members of Garuda Group and Lion Air Group – all against the year-on-year trend. We specifically decompose the changes that follow the late 2018 trend. Further implications are discussed. We conclude the study with relevant policy recommendations. JEL Classification: L93; L98; D43 Keywords airlines industry — imperfect competition — Indonesia — liberalization — consumer welfare 1Institute for Economic and Social Research, Faculty of Economics and Business, Universitas Indonesia (LPEM FEB UI) FCorresponding author: Jl. Salemba Raya No. 4, Jakarta, 10430, Indonesia. Email: [email protected]. 1. Introduction scape has posed a significant barrier in realizing the in- dustry’s potentials. In January 2019, LCCs of the largest How does the Indonesian aviation industry fare in terms domestic airline groups – Garuda and Lion groups – ceased of efficiency and competition? In this paper, we aim to to implement free baggage facilities, which contributed to explore such issue. For a period of time, this issue had re- upward movement in ticket prices. We further document ceived widespread attention, particularly amid the intensive the immensely negative impact of such phenomenon on news coverage surrounding recent baggage fees’ hike of the domestic airline industry in terms of passenger loss. The largest domestic airline groups (Garuda and Lion groups) passenger drop also poses negative externalities to other in January 2019 and subsequently, the removal of one mi- sectors as well, particularly tourism sector – one of the nor airline player – that is, AirAsia’s tickets from several government’s most prioritized sectors. prominent online travel agent platforms. However, despite Furthermore, in this paper, we also argue that such phe- the importance of such issues, to date we find that little to nomenon is indicative of deeper issues within the industry. no empirical study has been done on competition within The first and most important issue that will be explored in Indonesia’s aviation industry, much less the aforementioned this paper are issues related to competition within the indus- price hike phenomenon. try. After operational agreement between Citilink–Sriwijaya Such lack of study thereof is troubling, particularly if was implemented in late 2018, the current landscape of do- one considers the growing relevance of aviation transporta- mestic airline industry is a near-duopoly one in which Lion tion within Indonesia’s context as an archipelagic state. We and Garuda virtually control 96% of all market shares in document that Indonesia’s aviation market is a potential the industry. We argue that such lack of competition incen- one, as reflected by the booming passengers’ growth rate – tivizes incumbent players to engage in a rather coordinated particularly in the 2005–2012 period. Since then, however, price harmonization policy, as strongly indicated by our data. growth has been relatively modest. We argue that this is not In addition, in this paper we will also delve into greater de- indicative of an exhausted market; rather, it reflects the po- tails about current players’ state of efficiency – in terms tential of uncaptured segment. As people’s income increase of cost structures – by scrutinizing the financial reports of and flying become more bearable, arguably the number of these airlines. passengers will also grow commensurately. The figures for passenger losses presented in this paper However, recent development in domestic aviation land- should provide policy-makers with enough information on 1 The Sky in Blues: On the Recent Development of Indonesian Airlines Industry — 2/21 the severity of the issue, and the need to implement quick ister of Transport’s (hereafter named as MoT) Decree No. reforms on the industry. Specifically, we argue that liberal- 25/1997, which delegated the rights to set the (floor) prices ization policies are indeed crucial for Indonesia’s current of scheduled flights to the airline association, Indonesian aviation industry. However, not all liberalization policies are National Air Carrier Association (INACA). politically feasible – and as such, we propose several policy Following the Asian Financial Crisis that hit the Indone- alternative forms of liberalization that are aimed at bringing sian economy during 1998, Indonesia was pressured by the efficiency and competition within the aviation industry. IMF to implement several major reform packages within The rest of the paper is organized as follows. The next many sectors of its economy, including the aviation sec- section will specifically provide a brief historical account tor. Such reform is manifested in the implementation of on the Indonesian aviation market while also discussing 1999 Antitrust Act, which grants the competition committee relevant extant literature, particularly focusing on liberal- (KPPU) the monitoring authority to ensure that efficiency ization and competition within aviation industry. The third and competition within the industry are achieved and main- section will explore the methodology employed in this study. tained. Indeed, one of KPPU’s first major act of reform was In the fourth section, we will present our findings on the to pressure the MoT to revoke its previous decree which current state of competition within aviation industry, and its grants INACA the power to fix ticket prices. As a result, relevance in understanding the recent phenomenon of fare provisions on floor prices were abolished – leaving ceiling hikes between the largest players within the industry. We prices alone to be regulated. Another major milestone for will also discuss in greater details about such phenomenon’s the deregulation process was the implementation of Decree immensely adverse impact on national aviation industry. No. 11/2001 by the MoT, which further allowed private The fifth section concludes. airlines to attain the license to operate by operating only two aircraft, compared to its former requirement of five 2. Literature Review aircrafts. The enactment of such regulation propelled the abrupt growth of players within the industry; the number of 2.1 Developments in the Indonesian Aviation airline players amounted to 27 players in 2004, as compared Market to only 7 in 2000. These new players arguably undermined To date, there have been limited works of literature specif- the market shares of the once-dominant incumbent players, ically discussing the development of Indonesian aviation that is, Garuda Indonesia and Merpati Airlines. market. As such, this section will attempt to synthesize rel- However, the rapid growth was rather short-lived. In the evant extant literature and provide a brief account of the following years, several consolidations took place within market’s history. Arguably, one of the earliest monumen- the industry, and many infant players were driven out of tal events in the history of Indonesian aviation industry the industry, an example of which include Adam, Celebes, is KLM’s first intercontinental flight from Amsterdam to Batavia, and Indonesian Airlines. In addition, the aforemen- Batavia in 1924, which was then operated by a Fokker F-VII. tioned rapid growth in the industry