The strategies and effects of low-cost airlines

Contents
Who and what are the low cost airlines?
Who are the low cost airlines?

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What are the key characteristics of low cost airlines?

● high seating density and load factors

● uniform aircraft types (usually the 737-300)
● direct booking (internet/call centre - no sales commissions)
● no frills such as “free” food/drinks, lounges or ‘air miles’
● simple systems of yield management (pricing)
● use of secondary airports to cut charges and turnaround times
 Successful low cost airlines are very profitable

Operating margins by airline (1999)

British Airways 0.9%

Air France 3.5%
Lufthansa 5.7%
KLM 1.5%
United Airlines 11.9%
Ryanair 22.7%
Southwest 21.8%
What is the market for the low cost airlines?
 Entry spurs an increase in demand (often one-off)

260

240
Time of entry of lower cost carrier

Data is for passengers on routes to London. Source: CAA airline/airport statistics

On some routes low-costs have become the majors

● For many destinations, easyJet now offers frequencies better than British
Airways
● Higher frequencies mean low cost airlines become more attractive to
business passengers, and these are now a significant proportion of
passengers for easyJet
Some traffic is new, but some comes from other airlines

Low cost market share

46% in 2003
If ‘natural’ growth 5%

Passeng
per year:
• 62% of low cost
traffic is new or
transferred from
surface transport
(38% from other
airlines)

4000
• Traffic on other
airlines would be
32% higher now
without the low cost
operators.
How much lower cost are the low costs?
The passengers fare varies in two ways
Low cost carriers are renowned for cheap fares...

● Dublin to London €2.99 single (Ryanair)

● London to Düsseldorf (almost) £0.99 single (Ryanair)
● London to Edinburgh £9.99 single (easyJet)
● London to Barcelona £12.99 single (easyJet)
 ... excluding government tax, plus on Ryanair, airport charges and a compulsory
‘wheelchair levy’, ‘insurance levy’ and charge for your credit or debit card


This results from different systems of yield management

● Fare conditions: different degrees of flexibility, requirement to stay over a

Saturday night, usually must buy a return ticket to get any discount
(hence single fares often much more expensive than returns)
● Different classes of service: business class may be 5-10 times the price of
economy, but the service probably only costs 25% more
● Distribution: cheaper fares were offered through discounters than through
corporate travel agents
Low cost airlines use simpler, more flexible, pricing

● Seats sold first-come first-served, so passengers get cheaper fares by booking

earlier; price thus automatically responds to variations in demand
● The airline can also adjust the price bands if demand is greater or less than
expected
● All fares are one way and there is no difference in fare conditions
● No attempt to buck the market by imposing ticket conditions (return trip
required or Saturday night stay) to get the best fare
 Book in advance for cheap seats

● easyJet - almost entirely first-come, first-served, with few special offers or

sales
● Ryanair - frequent “free”, “half price” or “99p” seat sales


Prices for
peak,
shoulder
and off
peak
flights, by
advance
booking
period
 Overall costs are significantly lower:

● easyJet aircraft are in the air for 11 hours a day – BA’s equivalent aircraft fly
for less than 8 hours

Operational data for 1998 from CAA 1998 airline statistics; financial data is for FY1998 (CAA 1999 airline statistics)

 Breakdown of cost saving

Passenger services costs

Full cost short
Aircraft related costs haul airline
Commission
Low cost airline
Station costs
Advertising and promotions costs
Sales and reservations costs
Airport and ANS charges
Aircraft fuel and oil
Cabin crew
Flight crew
Other operating costs

0 5 10 15 20 25
Cost per 000 RPK (£)
Ryanair has negotiated good (illegal?) deals with airports

● Regional/local governments want Ryanair to come to their airports, perceiving

that there are economic benefits to the region from this
● Actual evidence is mixed - positive at Prestwick, negative at Blackpool
● Airports can make money on associated services (catering, retail)
● Airports may also make a profit from ground transport concessions (buses,
car hire)

● direct subsidy from the regional government; or

● cross-subsidy from other airlines

●
●
The Charleroi ruling challenges this

■ At Charleroi, Ryanair was receiving:

● Reduction in airport charges of €1-2 per passenger (illegal)
● Reduction in ground handling charges from €8-13 to €1 per passenger (illegal)
● “One-shot” flat rate incentives for starting up new routes, such as contribution to
recruitment costs, hotels etc (illegal)
● Route start-up aid - for example, shared marketing costs (legal, provided it is
proportionate, does not exceed 50% of cost, is limited in duration and competitively
available - none of which apply to Ryanair’s deal at Charleroi)
■ The Commission claims that Ryanair may be able to keep 70% of aid provided, but it
is hard to see how (pay back €10 million?)
■ Impact could be about €15 per round-trip passenger
■ EC is now investigating other Ryanair deals (eg. Pau in France)
■ Probably only has a significant effect on Ryanair - easyJet claims not to receive
equivalent subsidies and welcomes the ruling
■ Ryanair is appealing: this appears to be a delaying tactic only, but the delay could be
quite long
●
What is the impact on long-distance rail?
Traffic will be taken from long-distance rail as well

Airline costs per passenger, and rail fares, from Barcelona

l fare (€)
200
It’s not clear what rail operators can do about this

● SNCF is pioneering here - you can print your own ticket, which is scanned
on board the train; some trains (idtgv) are internet booking only
● Other rail operators are years behind airlines

●
 Rail market share will fall

100%
Rail market share

80%

60%

40%

20%

0%
00:00 02:00 04:00 06:00 08:00 10:00

Rail journey time (hours)

Adapting the yield management system is key

● not the case in the UK, but regulation of Saver and season tickets limits
potential for yield management
● 60-day booking limit (often much less in the UK, for various reasons) for
most rail fares no longer appropriate

● Passengers board en-route - systems not designed to handle this

● Rail is a network: some passengers may have to use specific trains to make
connections - if they can’t use them at the right price, won’t travel by rail
at all

What are the key strategies for success?
Despite the overall success of the sector, most fail

● recent failures include Pro Air and ValuJet

To survive, airlines need to be genuinely low cost:

● costs per 000 ASK for KLM UK were £84 in 1999-2000 (easyJet £49)
easyJet is lower cost – but only Ryanair is really cheap

● easyJet primarily uses new aircraft; Ryanair usually has not (although has
recently placed a very large order for new 737s)
● easyJet aims to build frequency, Ryanair generally just to expand its network
● easyJet usually flies to major airports – Ryanair airports may be 100km from
the cities they serve. But easyJet faces problems of congestion (Gatwick,
CDG)
● easyJet’s customer service is better (eg. limited compensation for delays)

● Business passengers help offset the fact that most leisure passengers want to
travel during weekends and peak holiday periods


Strategies may diverge further

● JetBlue is overtly pursuing an ‘intermediate’ strategy which distinguishes it

from airlines such as Southwest - new planes, leather seats, generous
legroom, live satellite TV
● Very successful and profitable
● Demonstrates that cost efficient and cheap are not the same


What is the future for the low cost sector?
Low cost airlines are planning growth but there are risks

● easyJet grew by 21% in the year to June 2004

● Ryanair grew by 44% in the year to May 2004

● greater competition, including between the low cost airlines - Ryanair issued a
profit warning last year, due to lower yields and lower load factors
● capacity constraints in Southeast England
● management/operational problems as low-cost carriers grow into very big
airlines
● direct competition with major Continental airlines

● Aviation fuel tax / higher airport charges

Traditional airlines have responded

● BMI has adopted an economy-class ticket structure quite similar to

easyJet’s
● BA has also copied elements of easyJet’s pricing system although it is much
more restrictive and absurdities remain
● Eurostar has also copied it, but incompletely (arguably, inadequately)

● Travel agent commissions have been cut, usually to zero

● Most booking now online
● Wider use of e-tickets (large surcharges for paper tickets)
● BA has standardised on two aircraft types at Gatwick
Most growth will be outside the UK

● Amsterdam, Geneva, Dortmund, Berlin and Paris (easyJet)

● Rome Ciampino, “Barcelona” Girona, Brussels Charleroi, Frankfurt Hahn and
Stockholm Skaavsta (Ryanair)

Low France
cost Netherlands
market Germany
share by Italy
country,
Spain
2003
Belgium

UK

Ireland

0% 5% 10% 15% 20% 25% 30%

Low cost market share
This is harder than expanding from the UK or Ireland

● Ryanair has recently been prevented from advertising Dusseldorf “Weeze”

airport
● easyJet has found it difficult to obtain slots at Paris airports
● Ryanair forced to withdraw from Strasbourg Airport after a French court ruling
● Charleroi ruling may significantly impact on Ryanair (but not yet)
The air travel market is more limited


Low cost airlines also compete with charter carriers

● operating costs equivalent to or below low-cost airlines, partly due to even

higher aircraft utilisation
● sales and distribution costs close to zero
● load factors of 95% or higher
● now selling seats to scheduled passengers
● zero frills (food/drink) becomes less attractive on routes of 3+ hours

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The ability to offer low fares is under pressure

● Free food, telephone calls and accommodation for cancellations/major delays

- even if the airline isn’t responsible (eg. weather)
● €250 cash compensation for most flight cancellations

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Summary