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Ružica Škurla, Željko Radačić, Danko Čurepić LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET

LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET

Ružica Škurla, MSc Željko Radačić, DSc University of Zagreb Faculty of Transport and Traffic Engineering Vukelićeva 4,10000 Zagreb, Croatia [email protected], [email protected]

Danko Čurepić, MSc Hrvatski telekom, inc. Hebrangova 32-34, 10000 Zagreb, Croatia [email protected]

ABSTRACT

One of the most significant trends in the European air travel market in the last decade, has been the emergence of low-cost carriers that serve short haul markets at very low unrestricted fares and without many of the traditional product features of either scheduled or charter services. After full liberalization of air services in Europe, implemented in 1997, they have started to pick up major slices of traffic from traditional, more established carriers forcing them to review their offer. Low-cost carriers generate cost reductions by higher seat density, high aircraft utilization, using secondary cheaper airports, no in-flight catering, using the Internet to distribute tickets and using one type of aircraft. These advantages may result in cost levels that are up to 40 per cent lower than that of their conventional competitors. The strategies of the leading low-cost airlines and their impact in the European market are analyzed in the paper. The paper also describes how the European low-cost market has evolved, highlighting major trends and predicting likely future developments.

1 INTRODUCTION

The liberalization of the airline industry in Europe became fully effective in April 1997. It has brought about numerous advantages to passengers, both in terms of higher quality offered by airlines and drastic price reductions. However, one of the main aspects of the free market has been the entry in the industry of the Low Cost Airlines (LCAs) in Europe coincided with the final deregulation of the air traffic market during the 1990s. The successful innovation which these carriers introduced into Europe was the provision of easily accessible scheduled short-haul services at low unrestricted fares close to those of charter airlines but with “no frills”, that is, without many of the traditional product features of either scheduled or charter services. They have achieved a very lucrative position on several intra-Community routes forcing those carriers who were traditionally operating these routes to review their

ICTS 2003, Nova Gorica, 6-8. november 2003 Ružica Škurla, Željko Radačić, Danko Čurepić LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET offer. The increased number of routs operated, aircraft in command, passengers carried and staff employed during the last decade confirms that LCAs have definitively found their place in the liberalized EU market and seem to be promised to even more success. For the time being, most of the LCAs are based in the UK and Ireland, but some are also located in Germany, Sweden, Belgium and Netherlands.

2 THE LOW COST AIRLINE CONCEPT

No-frill carriers bring a different business model to confront the traditional full service, flag carriers that has resulted in lower unit costs for the short-haul, radial-hubbed networks that they tend to operate. This type of strategy has recently led to carriers such as Ryanair earning very high rates of return on expanding networks. Low-cost airline model is shown in Figure 1 [1].

Coherent Business Strategy Distinctive Service Structure Liberal Regulations Low fares Short Haul Simple fare structure Low cost airports Differentiated services Targeted Market Motivated culture Adhere to Business Plan Basic service High Seat Density

Streamlined operations Operationally efficient service design Sound financial management Single aircraft type Quality of management Outsourcing non-core services Limit cost of ownership Productivity-based labour agreements Maintain strong balance sheet Technology-based distribution Focus on employee motivation Ticketless booking Profit sharing No inter-lining

Figure 1: Low Cost Airline Model

The history of the first truly low-cost airline, Southwest has been marked by growth and constant profitability with following six features of its business design: 1. Short-trip service 2. Low prices 3. High point –to point frequencies 4. High punctuality 5. No frills: no meals, no seat reservation, etc. 6. Brand image: ”flying is fun” [2].

ICTS 2003, Nova Gorica, 6-8. november 2003 Ružica Škurla, Željko Radačić, Danko Čurepić LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET

Southwest Airlines has become the fourth largest major airline in America. Its success is reflected in its value performance. It has become the airline with the highest stock market value in the world and the only US airline to be consistently profitable for the last thirty years. 2.1 Cost advantages

The ”low cost” model can be defined by three key elements: 1. Simple product (no meals and drinks for free, narrow seating, no seat reservation, no frequent-flyer programs); 2. Positioning (price-conscious business passengers and leisure traffic, short-haul point-to-point traffic with high frequencies, aggressive marketing, secondary airports); 3. Low operating costs (low wages, low airport fees, low costs for maintenance, cockpit training and standby crews due to homogeneous fleet, short turnaround time, high percentage of internet sales). In order to establish how LCAs can achieve unit costs which may be as much as 60 per cent below those of conventional airlines, cost comparison of the detailed cost data between easy Jet and British Midland, small conventional scheduled European short-haul carrier whose network and operations are most similar to those of Europe'’ LCAs is undertaken (Table 1).

Table 1: Cost comparison: LCA easyJet and conventional short-haul airline British Midland easyJet British Midland Cost category (pence per seat-km) (%) (pence per seat-km) (%) Direct operating costs Cabin/flight crew salaries 0.43 10.3 0.92 9.4 Fuel 0.35 8.4 0.55 5.6 Airport charges 0.55 13.1 1.20 12.1 En-route 0.39 9.3 0.41 4.1 Maintenance 0.58 13.8 0.75 7.6 Depreciation 0.02 0.5 0.26 2.6 Aircraft rentals 0.80 19.1 1.23 12.4 Insurance - 0.02 0.2 Total direct 3.14 74.9 5.34 54.2 Indirect operating costs Station costs 0.01 0.2 1.36 13.8 Handling 0.31 0.7 0.40 4.1 Passenger services 0.04 0.9 0.63 6.4 Sales/reservations 0.18 4.3 0.47 4.7 Commission 0.01 0.2 0.78 7.9 Advertising/promotion 0.27 6.4 0.31 3.1 General and administration 0.17 4.1 0.44 4.4 Other 0.06 1.4 0.14 1.4 Total indirect 1.05 25.1 4.52 45.8 Total operating costs 4.19 100.0 9.86 100.0 Source: Doganis, R.: The Airline Business in the Twenty-first Century, Routledge, London, 2001, pp.146.

Direct operating costs are all those costs which are dependent on the type of aircraft being flown. EasyJet’s unit cost of flight and cabin crew are over 50 per cent lower because of the higher seating density, the higher aircraft utilization achieved and fewer cabin crew used. In a full service airline crew costs vary between about 10 to 12% of total costs. Less crew required due to higher crew workload, fewer required overnights and hence higher crew- utilisation can draw the assumed advantage of 3% over full service airlines. In addition, LCAs’ payments include almost always a higher variable income compared to the actual work accomplished. During times of lower market demand the LCA crew costs are reduced more than those of the full service airlines because of the higher variable crew salaries in LCAs. EasyJet’s aircraft landing fees and passenger’s-related charges are significantly lower because of very low rates negotiated as a new start-up carrier. Maintenance costs also offer substantial savings because of outsourcing maintenance requirements and single aircraft type used. There are three areas of direct costs in which LCAs do not enjoy any market advantages: fuel costs, en-route charges and insurance. Overall, easyJet direct operating costs are about 60 per cent those of British Midland. In practice, LCAs achieve their most valuable and sustainable savings in most categories of indirect operating costs (Figure 2). These are mainly handling and marketing related costs which are independent of the type of aircraft used. Huge savings can be achieved in station costs. While conventional airlines maintain significant numbers of staff and equipment and rent considerable space for business lounges and offices, especially at their base airports, LCAs outsource most of their passenger and aircraft handling and maintain minimal numbers of their own staff. The small difference between in unit handling costs between the two airlines is largely the effect of easyJet’s longer sector distances and higher seat density. While for conventional short-haul airlines passenger service costs represent 6-7 per cent of total operating costs, LCAs escape most of these costs because they do not offer any free meals or drinks on board. They have also simplified the whole process of reservation and ticketing with high percent of tickets sold via Internet. To offset the absence of travel agents as a selling tool LCAs tend to be more dependent on advertising and are unlikely to enjoy a cost advantage in this area especially as their network expand. Finally, LCAs have a smaller administration partly because they outsource many activities and do not have large numbers of planning and other staff dealing with IATA issues or bilateral air services negotiations [3]. 9,86

+135% 4,52

Indirect 4,19 Operating Costs 1,05 5,34 3,14 Direct Operating Costs

easyJet British Midland

Figure 2: British Midland’s vs. Easyjet’s Operating Costs (pence per seat-km)

Following a detailed assessment of the data on which the cost comparison of British Midland and easyJet was based as well as a review of other studies dealing with economics of LCAs, it is possible to identify where LCAs can continue to enjoy sustainable cost advantages. Figure 3 shows the cost positions where LCAs have advantages over full service airlines [4].

0% 20% 40% 60% 80% 100%

seat density 16% 16% 84%

higher a/c utilization 3% 19% 81%

lower crew costs 3% 22% 78%

cheaper airports/landing fees 6% 28% 72%

outsourcing maintenance/single a/c type 2% 30% 70%

minimal station costs/outs. handling 10% 40% 60%

no inflight catering 6% 46% 54%

no agents commission 6% 32% 48%

reduced sales/reservation costs 3% 35% 45%

smaller reservation/overhead costs 2% 57% 43%

advantage cumulative advantage low-cost

Figure 3: Low Cost Airline Advantages

Even though there are differences between the LCA’s savings in each position the graph clearly illustrates that there are accumulated saving possibilities which cannot be matched by full service carriers due to: - grown structures - the need of an integrated network and of a network serving long-range flights - the need to serve major airports - the need of offering a premium service in flight..

2.2 Revenue advantages

The cost advantages enjoyed by LCAs are reinforced by more limited advantages on the revenue side. LCAs, like other scheduled airlines need to practice revenue management to maximize the revenue generated per flight. They can apply revenue management more easily because they only sell point-to-point single sector tickets. Instead of having large number of different booking classes LCAs manage with four to six to reflect the separate fares they may offer on any individual route. Easyjet’s practice of selling only one ticket price at any one time for each flight further simplifies revenue management. Their marketing strategy is to start selling the cheapest advertised fares when bookings for flight open and then to progressively move to higher fares as departure dates approach or as sales at the lower fares pass certain pre-planned levels. The benefits of a relatively straightforward revenue

ICTS 2003, Nova Gorica, 6-8. november 2003 Ružica Škurla, Željko Radačić, Danko Čurepić LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET management system are reinforced by the absence of yield dilution from multi-sector tickets and interline passengers. The major revenue advantage enjoyed by LCAs is the fact that the passengers cannot make reservation without paying so LCAs generate their revenue before flights are made. This contrasts with their conventional competitors who selling through various agencies worldwide may not receive all the payments for individual flights until several months after the departure.

3 DEVELOPMENT OF LOW-COST AIRLINES IN EUROPE

The European airline industry has undergone significant changes over the past decade. The market within Europe has been liberalized under the ‘Three Packages’ and other, extra- European markets, most notably the North Atlantic have seen significant amounts of liberalization following signings of Open Sky and similar agreements. The profitability of the major European carriers began to decline in the late 1990s, and the impact of the attacks on the US, and then the SARS outbreak and the second Iraq conflict, pushed them into serious deficit – with carriers such as Sabena and Swiss Air going into bankruptcy. There has been some recovery in operating margins but overall the European industry is still some way from recovering its full costs. The importance of low cost carriers (no-frill carriers) in Europe has grown since the liberalization of the European market. They have spread from initially UK/European based services as international markets within Europe were liberalized, to take advantage of cabotage rights within Continental Europe – e.g., they now constitute about 7% of the French domestic market. It is estimated that the available capacity in terms of weekly seats offered by the six main no-frill carriers (Ryanair, Virgin Express, Easyjet, Go, Buzz and bmibaby) increased by 48.3% between Summer 2001 and Summer 2002 (Figure 4) [5]. Structurally, with airlines offering a significantly different business model, this has seen the traditional airlines restructuring to meet the new challenges of the less rigidly controlled market and to meet the requirements of a commercially driven environment. 1000 s t a e s

d 800 n a s u o

h 600 T

0 1995 1996 1997 1998 1999 2000 2001 2002 Summer

Ryanair Virgin Express easyJet Go Buzz bmibaby

Figure 4: Growth of LCAs in Europe

The first low-cost, no-frills European airline to have any impact was the independent Irish airline Ryanair. It stimulated a rapid growth of passenger traffic across the Irish sea by offering a more or less traditional type of service with a two class cabin but at significantly lower fares. Launched in 1985, by 1991 its accumulated losses amounted to close on £18 million and the airline was facing serious cash flow problems. In 1991 it reinforced the low- fare strategy but with no frills in order to reduce costs and it also moved its London base from Luton to Stansted airport, which was new and offered high-speed access to Central London. Traffic and profits grew steadily and in 1997 Ryanair launched new routes to continental Europe from Dublin and Stansted. EasyJet started flying in November 1995 and since then it has grown from a Luton base offering two routes from Luton to Edinburgh and Glasgow, to one that offers 111 routes from 38 European airports, operating 67 aircraft (April 2003). Today, Ryanair and easyJet are the biggest European LCA in Europe (Table 2). In May 1998, British Airways set up its own low-cost subsidiary, Go. It was followed by KLM whose own low-cost subsidiary, Buzz, started flying from Stansted in January 2000.

Table 2: General facts and performance indicators for 2002: Ryanair and easyjet Date Company Employees RPK Operating Company Fleet PLF founded headquarters number (million) Revenue (US$) Ryanair 1985 Dublin 1897 56 10,200 84,0% 843 000 000 easyJet 1995 London 3100 67 9,208 85,5% 815 000 000 Source: Airline Business, September 2003.

The major innovation in airline pricing introduced by the LCAs was not only the very low level of fares but the availability of such fares on a one-way single basis and with no or minimal restrictions. In many markets, the established flag carriers have been forced to introduce some very low fares though with restrictions and limited availability. Thus, in summer 1999 Virgin Express’s single fares on Brussels-Milan ranged from US$68 to US$132 and Alitalia’s and Sabena’s prices ranged from US$76 to US$ 474. The lowest fares offered by Alitalia and Sabena generally had more restrictive conditions and the number of seats available at these fares were limited. As in the United States, the new entrants’ low fares have stimulated demand and generated higher traffic growth than in other markets. The entry of Ryanair and easyJet on the London Glasgow route pushed traffic up by 21 per cent in the first twelve months while UK domestic traffic as a whole grew only 10 per cent in that period (CAA, 1998). Despite their relatively poor in-flight services and the use of less accessible secondary airports, the low cost carriers are attracting business as well as leisure passengers. On the London-Glasgow sector in 1996, 44 per cent of easyJet’s passengers were travelling on business, while 28 per cent of Ryanair’s traffic was for business [3]. Although all LCAs in Europe shared some characteristics, all were, equally, substantially different from each other. The degree to which the low cost concept has been implemented is shown in Table 3 using the predefined strategic success factors. Only Ryanair and to lesser extent easyJet and Go operate in Europe as genuine low-cost airlines. They do not offer any complimentary drinks or catering or in-flight entertainment and they have a single class high-density cabin. In some respects the European carriers have gone even further in simplifying their products and reducing costs than southwest Airlines in the United States. Like the latter, Go and easyJet are completely ticketless, but unlike Southwest these two airlines have cut out travel agents, that is passengers can only book directly with the airlines. All low cost airlines have focused on a single aircraft type and in all cases the seating density

ICTS 2003, Nova Gorica, 6-8. november 2003 Ružica Škurla, Željko Radačić, Danko Čurepić LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET is higher than that of traditional scheduled airlines. In order to achieve quick turnarounds and also to benefit from lower airport charges, LCAs have based themselves at secondary and less congested airports. Ryanair got very good deals at Dublin airport and at Stansted when it moved its flights from Luton. Since 1997 it persuaded IATA to redesignate the unknown airports of Beauvais, Charleroi, Hahn, Torp and Nykoking respectively under the Paris, Brussels, Frankfurt, Oslo and Stocholm city codes, despite the fact that they were some distance from these cities. On the other hand, easyJet, while based at Luton, has tended to fly to established large or regional airports such as Amsterdam, Nice, Palma, Zurich Geneva or Athens. Go has done the same from Stansted [3].

Table 3: Comparison of European Low-Cost Airlines Virgin Criteria Ryanair easyJet Go Buzz Express Simple product (“no Genuine no- frills”) Genuine no- Genuine no- Use of KLM Two-classes, frills offerings frills offerings frills offerings lounges, reser- FFP, “high vations frills” possible Low operating Sec. airports Major airports, Major airports, Major airports: Major airports, costs Homogenous hence higher hence higher higher hence higher fleet turnaround turnaround turnaround turnaround Minimum cost times and fees times and fees times and fees times and fees base 2 types of a/c Positioning Straightforward, Low-cost Low-cost Major airports Unclear aggressive position position Bulk position with low-cost except for except for customers low cost, code positioning major airports major airports Business focus share SN, charter Degree of implementation: high high-medium medium low Impact of Low Cost Airlines, Summary of Mercer Study, Mercer Management Consulting, 2002., p.14.

During the last few yeas, the sector has seen some significant structural developments. Go and Buzz have been absorbed by Easyjet and Ryanair respectively. KLM subsidiary Transavia has created a no-frills brand, Basiq Air. Eurowings, a Lufthansa affiliate, introduced the Germanwings brand with a hub at Cologne. Leisure airline Air Berlin set up a subsidiary, City Shuttle, connecting several German cities with European business destinations. Similarly, Hapag-Lloyd Express has introduced services from twin hubs at Cologne and Hannover. Another newcomer to the market is a new UK airline, MyTravelLife. Also scheduled for 2003 introduction are a no frills subsidiary of the Italian airline Volare, and possible startups in France and Ireland. SAS have set up a stand-alone low-fare operation, Snowflake, to mainly leisure destinations with – unusual for this sector – less than daily frequency. While the no-frills sector is still dominated by operations involving UK points, 2003 has seen a huge upsurge in services within Continental Europe, accounting for The German market climbed from seventh to second in importance, with a more than five-fold

ICTS 2003, Nova Gorica, 6-8. november 2003 Ružica Škurla, Željko Radačić, Danko Čurepić LOW-COST AIRLINES AND THEIR IMPACT IN THE EUROPEAN AIR TRAVEL MARKET increase in capacity. The number of seats on offer more than doubled in the Italian and Netherlands markets. European low cost airlines hold about 7 per cent of the intra-European market but the low-fare segment of the market is expected to grow at a significantly higher average annual rate than overall air transport in Europe (Figure 5) [6]. A key development in the no-frills sector has been the creation of secondary hubs. To EasyJet’s established operations at Amsterdam and Geneva have been added Ryanair networks at Frankfurt Hahn and Brussels-Charleroi, while Buzz have introduced a number of domestic routes in France. As regards airports, the two London satellites of Stansted and Luton are dominant with, between them, more than 20% of capacity in this sector. Both are hubs for major players, but also destination airports for many of the new Mainland Europe start-up carriers. Cologne, with two resident carriers, has the next largest share. Subsequent airports ranked by no-frills capacity are generally major hubs or larger regional airports.

Table 4: Top European airports for low-cost carriers Airport Daily departures* Main low-cost airlines London Stansted 222 Ryanair, easyJet Cologne/Bonn 77 Germanwings, HLX Berlin Tegel 68 Air Berlin, dba London Luton 66 easyJet Dublin 62 Ryanair Amsterdam 50 easyJet Brussels 44 Virgin Express Munich 42 Dba Belfast 41 easyJet, bmibaby London Gatwick 40 easyJet *average weekday departures for summer 2003. Source: Airline Business, October 2003.

LCAs in Europe face a number of difficulties which must be successfully overcome if they are to survive in the term: growing competition among the low-cost carriers themselves and from the conventional airlines, risk of overcapacity arising from rapid growth, controlling costs which are going to be under pressure as many contracts between low-cost operators and airports will need to be renegotiated after the start-up phase.

2 7 14 Low-cost 33 32 30 International*

25 23 Domestic* 21 17 17 16 Regional* 23 21 19 Charter 1998 2001 2007**

* traditional scheduled ** forecast Figure 5: Share of intra-European passenger traffic on airlines by type of carrier (percent)

LCAs also compete with European railways, especially on the lucrative, heavily used long-distance routes (400-700 km). The final problem that will increasingly be faced by LCAs in Europe is weather they can compete effectively in the largest low-fare short-haul markets served by the charter airlines. Charter airlines have certain additional advantages over LCAs: they use more economical aircraft, have higher daily utilization, capacity offered closely matches demand, high passenger load factors and very low sales or advertising spends.

4 CONCLUSIONS

The European air travel market is characterised by the expansion of existing LCAs (Ryanair, easyjet), new upstarts (Basq Air, bmibaby), takeovers (Go by Easy Jet) and bankruptcies (AB airlines, Debonair). LCAs stimulate market growth and capture the bulk of the growth themselves. They are forecasted to have a significant share of the European market by 2010, taking over part of the charter traffic as well as “seat only” traffic. To ensure their long- term survival LCAs in Europe must maintain a sustainable competitive advantages over their conventional competitors sticking to essential features of the low-cost product: short- haul routes, single aircraft type, high-density seating, no free on-board catering and operating from secondary airports. On most of their routes they must ensure first place in terms of market share which gives them a very powerful defensive position should new competitors attempt to enter. The success of LCAs may also depend on the implementation of pricing strategies that attract various segments of consumers and increase the carriers’ load factors, thus helping to maintain low fixed operating costs.

REFERENCES

1. New Frontier is ready for the Southwest clones, The AVMARK Aviation Economist, 19, No. 8, 2002., pp.7.

2. Impact of Low Cost Airlines, Summary of Mercer Study, Mercer Management Consulting, 2002.

3. Doganis, R.: The Airline Business in the Twenty-first Century, Routledge, London, 2001, pp.126-162.

4. Low Cost Carriers in the European Aviation Single Market, ECA Industrial Sub Group, Bruxelles 2002.

5. AEA Yearbook 2002, AEA, Brussels, 2002.

6. Binggeli U., Pompeo, L.: “Hyped Hopes for Europe’s Low Cost Airlines”, The McKinsey Quarterly, No.4, 2002., pp.1-3.

ICTS 2003, Nova Gorica, 6-8. november 2003