The strategies and effects of low-cost airlines Simon Smith Contents ■ Who and what are the low cost airlines? ■ What is the market for the low cost airlines? ■ How much ‘lower cost’ are they, and why? ■ What is the impact on long-distance rail? ■ What are the key strategies for success? ■ What is the future for the low cost sector? Who and what are the low cost airlines? Who are the low cost airlines? ■ The main low cost airlines operating to/from the UK are: ■ Globally, the largest and most successful low cost airline is Southwest in the US What are the key characteristics of low cost airlines? ■ The low-cost model was pioneered by Southwest Airlines in the US, and European low-cost carriers have all followed this to an extent: ● 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 ■ The successful low cost airlines are more profitable than established carriers ■ Ryanair has a market capitalisation of about £3 billion 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 Time of entry240 of lower cost carrier Data is for passengers on routes to London. Source: CAA airline/airport statistics 220 Belfast ) 200 0 0 1 = 1 180 9 Glasgow / 9 1 Prestwick ( c 160 i f f a r T 140 Edinburgh 120 100 Dublin (Ryanair) 80 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 On some routes low-costs have become the majors ■ Growth averages 10.5% in the first two years after entry of a low cost carrier ■ At other times and on other routes, growth averages 4.4% ■ Evidence of saturation on some routes after 5-10 years ■ Low cost airlines are now the major operators on some routes: ● 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% per year: • 62% of low cost traffic Passengersis new or transferred between London and Glasgow (including Prestwick) from surface transport (38% from other airlines) • Traffic on other airlines would be 32% higher now without the low cost 4000 operators. 3500 3000 ) s 0 0 2500 0 ( s r e 2000 g n e s 1500 s a P 1000 500 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2002 Other carriers Easyjet and Go Ryanair (Prestwick) How much lower cost are the low costs? The passengers fare varies in two ways ■ Different fare structures ■ Different overall costs Low cost carriers are renowned for cheap fares... ■ Cheap fare offers are heavily publicised. Current available offers include: ● 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 ■ However, in reality most fares are higher than this: Ryanair’s average fare is around €40 per passenger and easyJet’s around €60 (excluding taxes and charges). This results from different systems of yield management ■ Traditionally, airlines tried to design fares to charge each passenger as much as they were willing to pay, using: ● 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 ■ The availability of discount fares could be adjusted in response to variation in demand, but was generally on a flight-by-flight basis ■ Yield management still works (roughly) in this way for some long haul flights, especially on routes where bilateral air service agreements (ASAs) are relatively restrictive. Low cost airlines use simpler, more flexible, pricing ■ Low cost airlines offered much simpler fares: ● 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 ■ To an extent, British Airways and other full-service carriers have copied this, but their fares are still more inflexible than those the low-cost airlines offer. Rail operators have hardly responded at all. ■ Key issue: yield management through ticket restrictions only works if all competitors apply the same restrictions - so is unlikely to work in a very competitive market, where airlines have little or no market power and product differentiation is limited Book in advance for cheap seats ■ The basic principle is that the cheapest seats are sold first - but the approaches to yield management do vary between the airlines: ● 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 160 advance booking period 140 120 100 ) Peak £ ( e 80 c Shoulder i r P 60 Off peak 40 20 0 -150 -125 -100 -75 -50 -25 0 Days before flight Overall costs are significantly lower: ■ Higher seating density and no business class reduces per seat costs by 16% (easyJet relative to BMI) ■ Aircraft utilisation is also higher: ● easyJet aircraft are in the air for 11 hours a day – BA’s equivalent aircraft fly for less than 8 hours ■ Costs per available seat kilometre for easyJet are 64% lower than for BMI ■ Costs per seat are 52% lower ■ The low cost airlines operate with higher load factors (fewer empty seats) so their costs per revenue passenger kilometre are even lower 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 ■ Airport charges are typically in total £10-15 per passenger ■ Ryanair has reversed this and it is, in effect, paid to land at some airports. Airports may do this because: ● 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) ■ However, in some cases this is funded either through ● direct subsidy from the regional government; or ● cross-subsidy from other airlines ■ Newquay airport has been driven into losses as a result of the Ryanair deal it signed, and the local MP has called for the deal to be scrapped 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? Airlinecosts per passenger, and rail fares,from Barcelona Traffic Traffic will be fromtaken long-distance rail as well One-way airline cost / rail fare (€) 120 160 200 40 80 0 0 Traditional airlines Traditional 200 400 Distance (km) Distance Low cost airlines cost Low 600 800 2002 rail fares rail 2002 1000 1200 It’s not clear what rail operators can do about this ■ For short journeys (less than 3 hours) rail is likely to remain dominant: air journey times longer, particularly if (inconvenient) secondary airports used