He Power of Partnering

A MAGAZINE FOR AIRLINE EXECUTIVES 2007 Issue No. 2 T a k i n g y o u r a i r l i n e t o n e w h e i g h t s TThehe PowerPower ofof PartnePartnerriinngg A CoConversationversation wiwitth AbduAbdull Wahahabb Tefefffahaaha, Secrecretataryry Generaeral Arab Air Carriers Organization. Special Section I NSID E Airline Mergers and Consolidation Carriers can quickly recover 21 from irregular operations Singapore Airlines makes 46 aviation history High-speed trains impact 74 Europe’s airlines © 2009 Sabre Inc. All rights reserved. [email protected] industry Low Cost for the Long Haul Low-cost carriers have transformed the original model by adding ancillary sales and full-service amenities, but can they really make a profit on long-haul flights? By David Li | Ascend Contributor here’s no question the low-cost car- caught the attention of industry professionals lines could only compete through product dif- rier business model has left a sizeable and airline passengers, it’s the way the model ferentiation: safety, comfort and schedules. Timprint on the world’s air transport has evolved over the years. From ancillary Southwest Airlines was the exception industry. More than three decades ago, U.S.- sales to long-haul flights, low-cost carriers are when in 1971, the small Texas-based car- based Southwest Airlines started the low- consistently pushing the envelope and chal- rier was bound to fly within the confines of fares phenomenon with a basic desire to get lenging the norm. the state. However, because of this inhibi- passengers to their destinations on time and Two or three decades ago, the experi- tion, it was free to set its own pricing. at the lowest possible prices. Since then, the ence of flying on an airplane was part of Hence, the company became very disciplined LCC pioneer and largest airline in the United the vacation itself. Much like cruise ships, and creative at managing costs, generat- States (based on passengers carried) has passengers expected quality service from ing ancillary revenue and increasing traffic. paved the way for others to follow suit. But airlines. The U.S. regulatory environment prior The low-cost carrier’s perspective was that it’s not just the LCC business model that has to 1978 standardized airline pricing. Thus, air- airline travel was a highly elastic commodity, sold with minimal product differentiation. For Southwest Airlines, its competition was not The Southwest Way with other airlines, but with ground transportation in Texas. Simple Product As a result, Southwest Airlines became efficient in an area that network airlines had • No meals difficulty with — making money on routes • Narrow seating (greater capacity) that had short stage lengths. Network car- • No seat reservations, one cabin-class configuration, free choice of seats (fewer passenger delays) riers operated short-haul routes at a loss • No lounges to feed traffic into their networks and used oversized fleets in doing so. Their network Market Positioning structures meant that many short-haul pas- • Private passengers, holiday travelers, price-sensitive business passengers sengers had to fly an additional four to five hours versus if they were to fly point to point. • Short-distance point-to-point connections with high frequency Southwest Airlines flew passengers nonstop • Aggressive marketing (”flying for fun!”) between their origin and destination at fares • Secondary airports significantly lower than traditional carriers. It • Competition with all transportation modes (air, rail, automobile) used smaller capacity and homogenous fleet, thereby driving efficiency and cost savings. Low Operating Costs In recent years, LCCs such as Ryanair • Low airport fees and less congestion by flying into secondary airports have been innovative in driving ancillary • Low costs for maintenance, cockpit training and standby crews owing to homogenous fleet revenue by eliminating the standard airline • High resource productivity: Short waits on ground due to simple boarding processes, short amenities such as food, beverages, blankets and in-flight entertainment and selling them cleaning periods, versatile and motivated staff to customers during the flight. Traditionally, • Lean sales (higher percentage of direct sales: Internet, call centers) these onboard amenities caused wastage • E-ticketing and check in and presented an operation burden for cabin crew. By charging for these items, LCCs were Southwest Airlines’ three-pronged business model is relatively straight forward, not only able to recover the inherent costs with a simple product that is reasonably priced, a strategic marketing plan and minimal but also create an additional revenue stream. operating costs. And while Southwest Airlines doesn’t allow advanced seat reservations, encouraging pas- ascend 27 industry sengers to arrive early at the gate to mitigate on-time departure delays, some LCCs have Revenue and Costs: LCC Versus Network Carrier offered advanced seat reservations for a fee. In addition to onboard sales, LCCs have been bold about selling their “in-flight Operating Costs: real estate” to advertising agencies. Large 2006, U.S. cents per seat mile advertisements can be seen on the fuselage of their airplanes, on the headrests of seats 11.69 and on tray rests. There are other revenue streams that +31% LCCs have found that cater to their exist- Revenue: ing customer base such as tour sales and 5.15 Labor phone cards. Regardless, ancillary revenue 2006, U.S. cents per seat mile 8.92 has increased in its importance and, in some cases, has accounted for up to 20 percent 3.29 0.85 Landing of certain LCCs’ annual turnover. As historic +6% Maintenance yields and profit margins continue to depreci- 0.93 0.53 ate, it’s likely that the industry will become 12.49 0.10 A/C Rental 11.80 Advertising dependent and more innovative in developing 0.51 0.32 0.12 Onboard sales ancillary products and services. In fact, some 0.17 0.05 2.40 Fuel carriers may opt to provide free airline seats 2.17 2.31 as incentives to gain the opportunity for a 10.76 Ticket sales sales pitch, much like the hotel and resort 0.84 0.74 Depreciation industries. 0.3 0.68 Cargo 0.44 1.52 Others Long-Haul, Low-Cost Flights 1.3 0.43 Others 1.43 Conventional thought was that the LCC LCC Network LCC Network model was applicable only on short-haul sec- Source: IBM analysis tors because medium- and long-haul seg- ments, with the use of wide-body aircraft, had Though revenue from ticket sales for low-cost carriers is lower than higher available seat miles that drove down that of network carriers, other revenue channels such as advertising or ancillary unit costs. Although Southwest Airlines found sales enables LCCs to have an overall unit revenue to be at least 6 percent higher a solution to a profitless operation (short-haul than network carriers. routes), network airlines had long been operat- Unit Costs Versus Stage Lengths for U.S. Network ing longer hauls and, therefore, dominated the niche. Furthermore, frequencies on long-haul and Low-Cost Carriers sectors were constricted by bilateral agreements, and the routes were reserved for large CASM vs. Stage Length 2005 flag carriers. Hence, the barriers to entry into 0.160 those international markets were much higher NW and more difficult for LCCs to penetrate. US However, many regions across the 0.140 globe have now adapted an open-skies policy, DL CO which has increased competition tenfold. Now UA 0.120 AA there’s an emergence of LCCs encroaching HP into new sectors by leveraging their low-cost TZ bases to international destinations. 0.100 F9 Low-cost carriers have also acknowl- FL NK edged that while customers may be willing 0.080 WN to put up with a barebones product for one to three hours, anything beyond might require B6 M ($ per available seat mile) a higher level of comfort. Thus, carriers have S 0.060 now started to appeal to the “value-focused” A C customer, an individual who would seek a 0.040 product at a level between barebones and 400 600 800 1,000 1,200 1,400 full service. This new push to appeal to value-focused customers is evident at several Stage length (miles) Source: Massachusetts Institute of Technology carriers, including jetBlue, which offers free snacks and live television to its passengers; At nearly all stage lengths, low-cost carriers have a cost advantage over traditional Eos and MAXjet’s all-business class, low-fare network airlines. trans-Atlantic flights; and Oasis Hong Kong Airlines’ London, England, and soon to be, Vancouver, Canada, flights with both busi- 28 ascend industry ness and economy cabins that offer a product AirAsia Flies Long-Haul Routes slightly lower than that of its key competitors, but at almost half the fare. However, it is difficult to quantify how the marketplace perceives the new value- Short haul (1-6 hours) Ryanair Kingfisher United focused carrier business model. While jetBlue has shown success on the short-haul sector, others have yet to prove profitable on long- AirAsia jetBlue haul sectors. Additionally, some low-cost carriers have experienced difficulties generat- ing profits on medium- and long-haul routes Medium haul (6-10 hours) Jetstar Eos because: These routes require a much larger catch- Cathay Pacific ment area. In some cases, carriers had not Airways made a concentrated effort to generate interline agreements and, instead, relied on local traffic. Value-focused carriers offer limited fre- Long haul Oasis Hong Kong Emirates quency on their routes. For example, Oasis (10+ hours) Hong Kong Airlines offers a single daily Non-quality conscious Price sensitive and Price insensitive and flight into London Gatwick while British quality conscious quality conscious Airways and Cathay Pacific Airways offer three to four daily flights.

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