CAN THE LOW-COST MODEL BE ADAPTED TO LONG-HAUL CARRIERS ? CLARIFICATION OF DIFFERENT MODELS AND TRENDS

With the groundbreaking arrival of low-budget , French Blue, on (Orly)-Punta Cana flights and the increased number of offers in the Long-Haul Low-Cost (LHLC) carrier segment (notably Eurowings which CONTACTS offers bargain-basement prices on flights from Cologne to Dubai, Cuba and ), the question of LHLC carriers is again at the forefront of airline sector news, especially after the announcement of Air ’s strategic plan, Trust Together.

Jean-Baptiste naU, senior Manager [email protected]

Morgane thUret, senior Consultant [email protected] this study was drafted with the help of consultants from the “air & Beyond by Wavestone” community. the LhLC formula draws on the same proposition for long-haul carriers gives rise Can the low-cost model simply be ingredients that made the traditional to a number of questions. transposed to long-haul carriers ? low-cost model a success and adapts the LhLC model is based on the ive key to underline the respective positioning of these to take account of the specific factors that have underpinned the success the airline companies under review from constraints of long-haul carriers; a stra- of low-cost carriers, and which have a comparative perspective, the following tegy that certainly seems to be paying enabled them to capture an increasing graph shows the positioning of certain of for several players, such as air asia X share of the market and generate high relative to two axes: the market and . Despite the returns. For example, the operating for airline companies in the short to long implications of the generic “low-cost” margins of ryanair, airasia and southwest carrier segments and their positioning by term, the LhLC model is by no means a airlines were two to three times higher service ofered. ixed low-cost concept. indeed, signiicant than the sector average in 20141. changes taking place in this segment are considerably modifying the original low- Key success factors of the standard low cost budget model. an in-depth analysis of model these trends indicates a global resha- Matrix of the positioning and markets ping of the airline landscape and the of the airline companies under review Enhanced operational eiciency harmonization of ofers. a new trend is emerging, focused on diferent customer- • Maximization of lying time and reduction in stop-over times experience concepts, with personalized TRADITIONAL • Procurement rationalization • Fleet standardization – optimization of maintenance expendi- services, a more or less lexible ofering ture and training costs for cabin crew members and perceived value that ranges from the Silk Air KLM (technical and sales staf) quest for “status”, proposed by the long- Hop ! Air Caraïbes standing sector leaders, and the «good Optimized costs deal» implied by the low-cost model. Long-Haul Low-Cost • Annual number of working hours of crew members higher,

POSITIONING light time only taken into account Air Asia Norwegian Air Asia X • Return to base every night avoids overnight crew costs and Southwest Wow other premiums (away from home per diems, meals, etc.) ADAPTING THE LOW-COST MODEL Ryanair Jetstar • Distribution costs limited (no computer reservation system, French Blue EasyJet Eurowings such as GDS), lack of, or simpliied, loyalty programs TO LONG-HAUL CARRIERS • Latest generation leet (consumes less fuel and requires less LOW COST maintenance) as illustrated below, several players have REGIONAL MARKET LONG-HAUL Leaner structure ventured into the LhLC segment and are © Wavestone (analysis of the activities of the airline companies beginning to produce promising results, under review) • Numerous activities outsourced (passenger handling, even though adapting the low-cost value management, airplane maintenance, etc.) • Decision-making process simpliied 1- Market analysis – 2015-2018 trends – Corporate strategies • Less binding corporate agreements for the airline

Simpliication of oferings and ancillary services

• One class only, cabin “densiication”, additional services and options billed

Targeted marketing strategy

• Essentially a point-to-point transit strategy • Choice of most proitable routes • Choice of competitive , etc.

2

2 CAN THE LOW COSTMODEL BE ADAPTED TO LONG-HAUL CARRIERS ?

the rigorous implementation of these Despite these difficulties, some airlines While all of these models are underpinned levers has caused a radical reshuling in are generating promising operating and by the same fundamentals, they do the airline market for short and medium- inancial results. this has given rise to four not necessarily benefit from the same haul carriers, especially since the trend Long-haul Low-Cost company models. advantages in the ongoing market reshule, in attractive air fares has triggered latent notably vis-à-vis the sector majors. demand for short trips in europe.

Expansion of certain LHLC companies Four Long-Haul Low-Cost models While the medium-haul low-cost carrier segment has expanded by offering cheaper fares than traditional airline « PURE » « NATIVE » companies, this price differential is LHLC airlines with a low-cost parent Airline companies created as LHLCs considerably more difficult to achieve company No notable examples when this report was drafted but on long-haul carriers given their specific Air Asia et Air Asia X some may emerge in the future constraints : « PURE » « NATIVE »

Operational-optimization potential limited « DAUGHTER » « MUTANT » Long haul carriers already spend most of their time in the LHLC airlines with a traditional parent Some airline companies have become LHLCs air with short stop-over periods that are diicult to reduce company Norwegian Air Shuttle became an LC airline in 2002 then due to the nature of the operations (cleaning, refueling) Lufthansa (Eurowings) created Norwegian Long Haul and NAI LATAM (currently undergoing transformation) Air Caraïbe (French Blue) « DAUGHTER » « MUTANT » Greater importance placed on comfort Singapore Airlines (Scoot) Passenger expectations are generally greater on long haul lights (more leg room, catering services, inlight entertainment, etc.) Advantages of Long-Haul Low-Cost airline companies Importance of premium revenues

Cabin “densiication” may therefore limit premium oferings, which nevertheless are strong revenue contributors on long haul lights « MAJOR »

Plane size « PURE » « NATIVE » « DAUGHTER » « MUTANT »

Long-haul planes carry more passengers and are more diicult Optimized occupancy rates to ill than medium-haul carriers, particularly when taking of Network/ Alliances from less attractive secondary airports (notably in the business Hub strategy + – – + + – + + + class segment) Distribution capacity Services (e.g.: lounge

Process optimization Low cost mindset* Innovation/ adaptation + + + + + + –– Synergies

Cost structure Payroll Outsourcing Possible + + + + + + + + – synergies © Wavestone (analysis of the activities of the airline companies under review) indi- under review) of the activities airline companies (analysis © Wavestone etc.) labor laws, regulations, (e.g. in local considerations does not factor rating cative

*Quest for permanent gains, rapid decision-making circuit, process simpliication

3 against this backdrop, air France has this could see the emergence of a new those of norwegian air shuttle3. Long- launched a newCo spin-off (a separate type of hub allowing medium-haul low- haul low-cost carriers are boosting this entity as yet unnamed). this parallel cost carriers to feed low-cost long haul major growth driver by differentiating company, whose offer is relatively less lights; a trend which could have an impact their oferings: expensive than that of its parent without on current models in terms of being low-cost, is targeting a different airline assignment, handling and / Densiication of seats, which, when combined with category of clientele and is envisaged as light connecting paths, etc. premium-class services, generate an innovation laboratory for the group. additional revenues (e.g. Frenchblue in this context, the Daughter model and, ofers upgraded services on 28 of the to a lesser extent, the pure model stand to 378 passenger seats in its a330-300) AN EVER- EVOLVING BUSINESS beneit from the fact that they can draw MODEL on the alliances, network and hub of their / Low cost Daughter airlines enhance parent company to optimize occupation their brand appeal, either by using the loyalty programs of their pa- since its launch, the low-cost model has rates. rent company (e.g. Jetstar/Qantas undergone several changes that are now Frequent Flyers, air asia X/Big of being adopted by the diferent long-haul Diferentiation and additional ser- air asia), or by developing their own low-cost models. vices and options (e.g. Westjet rewards). additional paying options are key to the Steady shift towards major airports Likewise, the shift towards major airports low-cost business model. For example, and other hubs could also beneit players who can rely these options account for 25% of on parent-company backing. While the irst low-cost models tended to ryanair’s revenues (~ €15 on average per operate through secondary airports for passenger in 2015)2, and 15% of inancial reasons, recent trends show that more and more players are refocusing on major airports, particularly since LhLC airlines have to ill higher capacity planes.

2- ryanair, 2015 annual report 3- norwegian air shuttle, 2015 annual report CAN THE LOW-COST MODEL BE ADAPTED TO LONG-HAUL CARRIERS ?

Forging alliances Figure 1. Creation of low-cost alliances: the new trend in an increasingly competitive environ- ment, traditional airline companies began Traditional airlines forging alliances in the 1990s in a bid to offer their customers access to a more extensive network and to optimize occu- Thai Singapore ANA Airlines pancy rates in large capacity planes. the major alliances, such as , and , are vying fier- cely to ofer customers the most advan- Vanilla Cebu Low-cost Alliance Scoot Paciic tageous loyalty programs possible with Air (Value Alliance Partnership) regard to flight miles and services. in Nokscoot terms of competitive edge, low-budget Independent low cost Low-cost subsidiaries (selection) airlines airlines benefit from a different kind of advantage in that they did not invest in Low-cost airlines alliances or costly loyalty programs at the outset. however, the reshuffling of the airline landscape could now incite them to do so. as such, 2016 saw the emergence Figure 2. Emergence of hybrid models of two low-cost alliances in asia; U-FLY, in January, comprising hong Kong express, , and , and notably, Value alliance partnership in May, Legacy carriers or traditional airlines Low-cost airlines which mainly covers low-cost subsidiaries of major asian airlines, as illustrated in the Increased search for operational eiciency chart opposite (igure 1). Cost reduction

Migration towards state-of-the-art airports as such, low budget airlines are also trying Passenger segmentation to cash in on network complementarity and code sharing in a bid to enhance their geographic coverage and optimize occu- pancy rates.

5 HEADING FOR THE BEST OF / the development of air routes to given the digitalization of cities, airports airport hubs and the creation of BOTH WORLDS: FROM MODEL- and other -related venues, we believe alliances that the services linked to digital behavior HYBRIDIZATION TO CUSTOMER- patterns will rapidly become commodities / Dynamic trends in sector consoli- and that digital amenities, such as onboard EXPERIENCE SEGMENTATION dation and partnership agreements WiFi access, should be included in the could further blur the dividing lines Emergence of low-cost hybrid between low-cost (short, medium basic packages ofered by airline compa- models: budget airlines taking on and long-haul) and legacy models, nies. the current dividing lines between legacy-carrier proile and legacy and allow airlines exposure to all airline services oferings will thus be modi- carriers ofering low-cost models segments (leisure/business/VFr4). ied and the overall challenge for compa- the development of hybrid models is now nies will lie in their ability to capitalize on under way: as illustrated in igure 2 above, this convergence of offers could lead digitalization to ofer new, paying services low-budget airlines are beginning to adopt to the convergence of prices for equiva- (inlight retail, inlight entertainment) as a a legacy-carrier proile and legacy carriers lent services in the medium term, a trend means to ofset the reduction in air fares are now ofering low-cost models. which has more or less been triggered and inance investments made. by the wide-spread practices of Yield this trend, already apparent in the low- Management and the virtually real-time the ability of a company to create a veri- cost medium-haul segment, is paving the adjustment of prices to demand and table brand environment that meets the way for sector reshaping in several key competitive trends. For example, when diverse expectations of its customers is areas: confronted with the aggressive tariff also key to corporate expansion: while policy of French Blue on lights to punta travelers seeking eiciency can choose a / increased eforts of traditional Cana, air France immediately came back standard, simple and smooth passenger airlines to achieve operational ei- with a counter proposition: in this case, light, those looking for a more memorable ciency, an issue which takes on the issue is how long these players will be trip, can opt for personalized and innova- greater importance when oil prices tive services. this certainly augurs well rise. these players model their able to hold out without causing any long- for the air-travel business and provides eiciency optimization strategies on term margin deterioration. a tremendous opportunity for airlines low-cost methods The customer-experience: a diferen- to come up with new dream themes for / Low-cost airlines ofering perso- tiating factor travelers ! nalized services fall into the «value carrier» category. given the subtle the act of purchasing has always involved segmentation of services, this ofer a psychological process speciic to each 4- Visiting Friends and relatives difers from the pure low-cost model individual; some may seek the fairest price in that it proposes customized ser- while others prioritize service or company vices and, in some instances, loyalty programs. status. as such, beyond the convergence of models and prices, companies can tap / a new premium access segment pro- into the signiicant potential arising from posed by independent players, such the differentiation of their products or as La Compagnie and low-cost air- services by adopting a more persona- lines including JetBlue (with its Mint lized, client-centered approach based on Class ofering) and Frenchblue (pre- mium Class). customer perception and experience.

6 7 www.wavestone.com

Wavestone is a consulting irm, created out of the merger of solucom and Kurt salmon’s european activities (excluding retail & Consumer goods Consulting) and one of the leading independent consultancy groups in europe. Wavestone draws on its operational, sector-speciic and technological expertise to enlighten and partner business leaders in their most critical decisions

8 2016 i © WaVestone