Innovating Long-Haul Low-Cost operations
Combining innovation in technology and innovation in business models: creating opportunities for long-haul low-cost operations
Master Thesis Business Studies
Arjan Vermeij Student Number: 6177492 Supervisor: Prof. Drs. J.G. de Wit Second Reader: Drs. E. Dirksen
15 August 2014
Abstract Abstract
Low-cost carriers have been a great success story in the aviation industry. The low-cost concept has proven to create a strong competitive advantage in the short- and medium-haul markets. But so far there have not been many successful ventures into long-haul operations. The objective of this thesis is to find out if innovation can help create a long-haul low-cost business model that will provide a competitive advantage. The results show opportunities for airlines that are willing to innovate their business models and establish new non-stop intercontinental routes to smaller destinations. This is made possible by using the latest commercial jet airliner available: the Boeing 787. Its innovative design has proven to be very efficient and made it able for airlines to compete against larger airplanes on long-haul routes. A case study into the long-haul low-cost airline Norwegian has proven that this combination of an innovative business model and an innovative airplane is able to create a strong competitive advantage.
Front cover picture by Jorge Guerra as found on www.airliners.net
2 Table of Contents
1. Introduction ...... 5 1.1 Method ...... 6 2. Innovation Framework ...... 7 2.1 Innovation as a competitive advantage ...... 7 2.2 The airline industry and innovation ...... 9 2.2.1 Dynamic Marketplace ...... 10 2.2.2 Disequilibrium ...... 13 3. Innovation of Business Models ...... 14 3.1 Low-cost airline business model ...... 15 3.1.1 Situation today ...... 16 3.1.2 How to achieve a cost advantage ...... 19 3.1.3 Cost advantage in numbers ...... 24 3.1.4 Ancillary revenues ...... 26 3.2 Recent developments of the low cost model ...... 27 3.2.1 Response FSCs ...... 30 3.2.2 LCCs network expansion...... 32 3.2.3 Different low-cost business models ...... 32 3.2.4 Future of the low-cost model ...... 35 3.3 Long-haul low-cost business model ...... 37 3.3.1 Long-haul low-cost business models ...... 38 3.3.2 Advantages of the low-cost business model for long-haul ...... 39 3.3.3 Disadvantages of the low-cost business model for long-haul ...... 41 3.3.4 How to make it work? ...... 43 4. Long-haul low-cost: Norwegian ...... 46 4.1 History ...... 46 4.2 Network ...... 47 4.3 Norwegian’s 787s ...... 48 4.4 Norwegians LHLC business model...... 49 4.4.1 Flag of convenience ...... 51
3 4.5 Price comparison ...... 53 4.5.1 Conditions and limitations of this research ...... 53 4.5.2 Summary ...... 55 5. Conclusion ...... 57 5.1 Contribution of the thesis and directions for further research ...... 59 References ...... 60 Appendices ...... 68 Appendix A. Hub vs point-to-point ...... 68 A-1 Point-to-point...... 70 Appendix B. Major players ...... 71 B-1 Southwest Airlines ...... 71 B-2 Ryanair...... 75 Appendix C. Innovation of technology: the Boeing 787 Dreamliner ...... 78 C-1 Technological innovations of the 787 that benefit its passengers ...... 78 C-2 Technological innovations improving the performance ...... 79 C-3 Competition with other aircraft ...... 80 C-4 Analysis of the 787s in use at the moment ...... 84 C-5 Problems with the 787 ...... 85 C-6 Problems with Norwegian’s 787s ...... 85 Appendix D. Routes to New York ...... 87 Appendix E. Routes to Los Angeles ...... 93 Appendix F. Routes to Florida ...... 99 Appendix G. Routes to Oakland/San Francisco ...... 106 Appendix H. Routes to Bangkok...... 109
4 1. Introduction
Innovation has always played a major role in the world of aviation. From the first flight of the Wright Brothers at the beginning of the last century, to the first flight of the Airbus A380 a few years ago: aviation has come a long way. In the early days it was all about technological innovation, as planes became more powerful, larger and safer. This created opportunities for entrepreneurs, and the first airlines were started. The business models of airlines have since evolved to keep up with all the latest developments. And they need to keep adapting to the ever changing aviation market. The low cost carrier (LCC) business model has proven to be very successful in the aviation market. Airlines such as Southwest in the United States and Ryanair and easyJet in Europe introduced low fares on many routes. Their new business model was able to generate 40- 60 percent lower costs on short-haul routes in comparison with the full service network carriers (Wensveen & Leick, 2009). By offering low fares they were able to increase demand. Today LCCs have earned a strong foothold in the European market, where they were responsible for 36,1 percent of the total intra-European capacity in 2013 (see figure 3.6). Even as early as the 1970’s entrepreneurs have been thinking about the possibility of creating a LCC concept for long-haul routes (Morell, 2008). But many of them failed to create a sustainable competitive advantage, and most of them disappeared after a few years trying (Wensveen & Leick, 2009). Long-haul flying creates many different challenges compared to short-haul flying, which means that the successful business concept of LCC on the short-haul cannot be easily transferred to the long-haul market. To create a successful long-haul low-cost (LHLC) business model requires developing a new business model which capitalizes on opportunities and accounts for the limitations of the long-haul market (Wensveen et al, 2009). At the moment multiple airlines are actively using the LHLC business model, and it is becoming well established in Asia with airlines such as AirAsia (CAPA, 2014b). But also in Europe LHLC has taken a foothold in the form of Norwegian, which has started operating with its brand new 787 Dreamliner airplanes. As the competition for long-haul passengers is increasing in Europe even legacy airlines are now openly considering using the LHLC business model, as is the case of Lufthansa (Ibid.). They want to establish their own LHLC unit next to their core full service product.
5 The start of a new LHLC airline in Europe that is using an airplane that is seen as very innovative provides the perfect background to perform a case study into the LHLC business model and its opportunities. The focus of this thesis will be on innovation. What will happen when innovation in business models is combined with the innovation of technology, which in this case is the introduction of the 787 Dreamliner? This thesis will try to answer the following question:
Will a combination of technological innovation and innovation in business models provide new opportunities for long-haul low-cost airlines?
1.1 Method To be able to answer the main research question above both a theoretical and a practical research are required. Theory from various types of sources will be used as academic journals are often lagging behind current developments as the industry is changing rapidly. This is why a combination of academic journals and reports/analyses from independent research institutions will be used to combine the latest developments with a strong theoretical background. The practical part of this research consist of a case study into the LHLC airline Norwegian. This company can provide an opportunity to conduct research into what can happen when the combination of innovations described in the theoretical part is applied in the airline industry. Fare analyses will be done comparing Norwegian to its long-haul competitors. As they have been flying long-haul routes for more than a year now and have opened many new routes with the arrival of more 787s their performance can provide some insight in how the LHLC business model is actually holding up in regards to the ticket prices. This research will be done with the use of an independent website where flights can be compared and booked.
6 2. Innovation Framework
Innovation has been at the forefront of aviation since the beginning. In fact it was through innovation that aviation became possible at all. As will be discussed later both aviation technology and airline business models have changed dramatically in response to new innovations. But first this chapter will elaborate more on the meaning of innovation in economics and in aviation when it is perceived as an industry sector.
2.1 Innovation as a competitive advantage During the last decades many economic schools of thought have developed (Conner, 1991). These have brought along many theories which are still used today. Different theories focus on different parts in the economic process in an attempt to be able to generalize and predict economic behavior of a firm. There are theories focusing on process efficiencies, market power, costly to copy resources, etc. (Ibid.). Although many of them can have an important influence on the economic performance of a firm, only innovation will be highlighted and discussed here. Innovation has no value in itself. It needs to be a solution to a problem or create a competitive advantage in order to be of value to a company. And it needs to be professionally developed and implemented as well. But before an innovation has been born and developed there must be underlying motivations for a company or the market to invest in creating these innovations. In the Austrian school of economics innovation has taken on a very prominent role. The Austrian way of thinking can mostly be understood by looking at the way they see the market process. Austrian economics view markets as processes of discovery, and firms will earn their profits through entrepreneurial discovery (Jacobson, 1992). In their view the marketplace is always changing, which means it is in a constant state of disequilibrium. There cannot be a state of equilibrium because that means innovations must be discontinuous, and Austrians argue that innovation is a continuous process (Ibid.). The way to be successful in this environment is by always searching for opportunities. Innovation plays an important role here. As competitors will always try to imitate a successful innovation or strategy it will be a matter of time before the competition will eliminate the above normal returns that these opportunities tend to provide. Joseph Schumpeter was a student of two economists teaching Austrian economics. He went as far as to argue that entrepreneurship and innovation are fundamental to any business
7 success (Jacobson, 1992). In contrast to the Austrian view Schumpeter believes the market can be in a state of equilibrium. The entrepreneur will disrupt the market with his innovation, which will cause the market to move into a state of disequilibrium. When the innovations are completed and the products have entered the market the innovator will be able to outcompete the competition, with economic profits as a result. These supranormal profits are a good motivator for innovators, but these profits are often short lived as those innovations are imitated by the competition. This will cause the market to return to a state of equilibrium. Another new innovation can replace the older innovation, and this process is called “creative destruction” (Ibid.). As said these innovations can create huge profits for the companies, which in turn they can use to develop the next innovation. With a competition that is so dynamic in nature companies and entrepreneurs should never try to just maintain their position in the market but always be trying to look ahead to the next innovation. Schumpeter also stated that large firms are necessary to promote innovation (Teece, 1992). Firm size was important for three reason according to him. The first was that only large companies can afford the costs associated with research and development programs needed to come up with the innovation. Second reason was that large en diversified firms are able to absorb failures because they can innovate across multiple technological fronts. The last reason was that a firm needs some form of control over the market to be able to reap some of the rewards of the innovation. Today some of these claims do not hold up anymore (Ibid.), as cooperative relationships have become more important and smaller companies have seen many successes with new innovations, especially in the information technology sector. Even when a company comes up with a new innovation it might not be the one who profits the most from it. Teece (1987) argues that often imitators end up profiting more from an innovation than the firm who came up with the innovation. Research from Mansfield, Schwartz and Wagner (1981) shows that about 60 percent of patented successful innovations were imitated within four years. Their study also showed that these imitators had approximately 35 percent lower development costs than the original developers. Patents do not always have the ability to protect against imitators, and lead time is often seen as more effective in providing a competitive advantage (Levin, Klevorik, Nelson, & Winter, 1987). Another way to make it harder for competitors to imitate an innovation is when knowledge available to them about this innovation is ambiguous. When it is not clear what exactly has caused this innovation to work or even how
8 to implement it, it will be more difficult to successfully imitate. This scenario of imperfect information can lead to longer lasting advantages for companies which introduced the innovation. Innovation is often seen as an innovation of a product or a business model innovation. But there is more, which Kim & Mauborgne (1997) call creating a blue ocean strategy. This basically means creating a uncontested market space. This can be done by innovation, although this does not always have to be the case. A new industry can be created or the boundaries of an existing industry can be altered. In case of the latter a good example is Southwest Airlines, who altered the boundaries of the airline industry by creating the first low cost carrier after earlier pioneers did not succeed, which in turn created a uncontested market space. Many people were now for the first time willing to travel by airplane because of these much cheaper fares. As Southwest created a new uncontested market, many companies followed in pursuit of economic profits. Today there is a situation of a few strategic groups within the airline industry, such as the full service carriers and the low cost carriers. Competition not only takes place within these strategic groups, but also between them. In order to create economic profits an airline company needs to innovate to stay ahead of the competition. This situation is being discussed next.
2.2 The airline industry and innovation In aviation innovation can come from different areas in the aviation value chain. When Boeing or Airbus develops a new airplane with new innovations it will be an innovator. At the same time the first airline to fly the new jet will also be an innovator (Nelson & Winter, 1977), since it will need to establish new procedures to fly the jet and gain knowledge of its full potential. The new jet can also make new innovations possible in a business model. For example the introduction of the Boeing 747 in the 1970’s created new possibilities to transport a very large number of passengers at once over a long distance. The first version of the 747 (747-100) could carry as much as 550 people, compared to the 180 people the 707 could carry, which was the common large intercontinental aircraft of the 1960’s. As airlines never flew airplanes that could transport so many passengers at once, they needed to find a way to attract enough people to fill the 747 so a route could become profitable. This led to the creation of the hub and spoke system (Doganis, 2006). Although the airplane itself was already very innovative, the airlines that created new routes and found profitable markets to serve were also innovating.
9 2.2.1 Dynamic Marketplace The airline industry has become a highly dynamic and contested marketplace. Even though deregulation has been popular in Europe and the United States over the past decades, the industry is still not as free of regulations and protective measures by governments as many other industries (Doganis, 2006). This makes it possible that some airlines have been kept alive by help from governments in the past when they were not making any profits and were not economically viable. Others gain unfair competitive advantage because of certain government regulations. But deregulation has caused the airline industry to become highly competitive, and the many bankruptcies of sometimes renowned airlines over the past decades has proven that the competition has intensified. With new and more advanced business models airlines need to make decisions about their networks. But in this industry business strategies are necessarily tied to network choices (Gillen, 2006). With many successful low cost carriers in the market it is no longer possible for the legacy/full service carriers to cover all the customer and market segments with just one network model. These carriers need to make decisions regarding their business model and try to preserve their core business with their intercontinental connections and their feeder platform. New business models will form, such as intercontinental low-yield/budget traffic which will mainly operate on a point to point basis (Franke, 2007). If any airline wants to be successful in the highly contested market of today it needs to be fully competitive on a stand-alone basis concerning costs and quality of their service. Cross-subsidizing will no longer work in this environment, as many full service carriers still subsidize their short-haul feeder flights with profits made by their long-haul flights (Ibid.). As will be seen in the next chapter the market for short- and medium-haul has evolved tremendously in Europa after the introduction of the low- cost carriers. This has forced both full service carriers and low-cost carriers to adapt their business model as the market has become more contested than ever. Customer segmentation is very closely linked to the airlines business models. It provides a more detailed look at their strategies. Porter (1980) writes about three generic strategies: cost leadership, differentiation and focus. When pursuing a cost leadership strategy a company will focus on having an advantage in their production costs by reducing them to a level lower than the competition. Differentiation is when a company can ask for a premium price because of a superior product in a specific market segment. When a company has a strategy of focus, it will
10 look for a certain part of the market and it will try to create the best product for this part of the market. For a company it is important to follow one of these strategies (Ibid.). This has not always been the reality in the airline industry, as recently as the 1980’s some flag carriers regarded their primary function to be the fulfillment of some public need such as employment, which has little to do with their actual business (Kangis & O’Reilly, 2003). This could lead to a strategy that will not provide any economic profits for the company. Today the worst situation an airline can be in is to be ‘stuck in the middle’ between these three strategies. Bieger and Wittmer (2011) call these three strategies the ‘quality leadership strategy’, the ‘cost leadership strategy’ and the ‘niche carrier strategy’. An airline needs to follow one of these three strategies in order to build competitive advantages. To pursue a quality leadership strategy airlines need to focus on their worldwide network, creating a dominant position in a geographical market (Ibid.). They will need to fully exploit the hub-and-spoke system by utilizing the hub-and-spoke economies, which create economies of scale, scope and density. More about hub-and-spoke can be found in the next chapter. It is hard for competitors to imitate such a network and its hub management which makes it a valuable competitive advantage. Airlines also need to differentiate with their service level, which can partially reduce the need to compete on costs and price. In order to provide better service to their customers these airlines need to have a clear understanding of their customers’ needs. If an airline can meet those needs and offer an unique service, customers will have a higher willingness to pay and an increased loyalty (Ibid.). A cost leadership strategy calls for an airline to outperform their competitors by having lower costs. This means a pursuit of efficient-scale facilities, tight control of overheads, and effectiveness in all functional areas (Porter, 1980). Many airlines use ‘standardization’ to achieve this, such as using a fleet of airplanes consisting of only one model (Bieger & Wittmer, 2011). These low cost airlines have reduced service levels compared to the ‘quality leadership strategy’ airlines and also do not possess a sophisticated customer relationship management. A more extensive description of this business model can be found in the next chapter. The niche carrier strategy are often airlines who have found a need regarding service, are geographically defined or are confined for cost advantages (Bieger & Wittmer, 2011). They are able to create a competitive advantage by better serving the needs of a chosen segment and will concentrate all their efforts and activities in pursuit of this.
11 When an airline is trying to adhere to the needs of two of these strategies at the same time it often leads to negative economic results. With the success of the low cost carriers a few legacy and full service carriers tried to create their own low-cost carrier subsidiaries as well, while maintaining some of the requirements of a quality leadership strategy. Kangis and O’Reilly (2003) did research to the way Aer Lingus in Ireland was coping with the success of the low cost carrier Ryanair. They found that “little or no migration from the ‘no frills’ to the ‘full quality’ sector exists and if the resource related values between servicing one or both markets do not overlap significantly, then the two sectors should be viewed as distinct business units and their performance assessed accordingly.” (Kangis & O’Reilly, 2003, p. 110). Aer Lingus is currently seen as a low cost carrier. The research showed that passengers will not move up to more profitable flights when they fly on low-cost subsidiaries, and those subsidiaries will not be able to achieve the same cost leadership advantages that low-cost carriers can achieve, which leads to a situation of a competitive advantage for these low-cost carriers. Porter (1996) explains it as well by talking about ‘fit’. In his example another low-cost airline, Southwest Airlines, is made of all types of activities that create a cost leadership. Southwest Airlines’ competitive advantage grows out of its entire system of activities. The fit among all these activities increases the differentiation of the whole and reduces the costs. But these individual activities cannot be decoupled from the system or the strategy, so it will be hard for another company to just copy a few successful activities and expect the same results. Appendix B provides more information about Southwest Airlines and describes the transformation it has made from its startup as a pure low-cost carrier to its current form. To transform an airline into a new strategy might be very hard and costly. To achieve a premium strategy requires a lot of expertise, and to achieve a low-cost strategy requires a new company culture (Franke, 2007). This company culture has proven to be the hardest area to replicate (Gillen, 2006). In every situation it is very important for an airline to examine very carefully which services they will provide to which customers, and to know what these passengers are willing to pay for these services. New technologies is one of the three types of innovations mentioned by Franke (2007) as important for the future of aviation. These consist of three technological innovations, and one of them is the introduction of next generation aircraft. These aircraft consists of the Airbus A380 and A350 and the Boeing 787. These airplanes will bring new efficiencies such as reduced cost
12 per available seat kilometer because of lower fuel burn, but might also intensify the struggle between intercontinental point-to-point services and hub-and-spoke services. More about the technological innovations that the 787 will bring can be found in appendix C.
2.2.2 Disequilibrium Not all of the changes in the airline industry have been caused by innovations. As mentioned before, deregulation, which involves legal and institutional aspects, has changed the market structure. Schie (2009) is arguing that deregulation has caused a disruption of the circular flow in the aviation market. The market used to consist of only full service carriers competing in the market for intercontinental and continental flights, freight, economy and business class passengers. This disruption created an opportunity for low cost-carriers to enter, as discussed earlier. They disturbed the market for continental economy class passengers at first, and are now looking into ways to succeed into the intercontinental market as well. The theory of Schumpeter seems to be applicable here. The process of deregulation however was not initiated by entrepreneurs, but by governments. Entrepreneurs established these low-cost carriers as they were exploiting opportunities that arose with the new disequilibrium in the market. The combination of deregulation and inflexible business models of the full service carriers created a profitable environment for the new low-cost carriers. The market was getting back to a state of equilibrium, although it can be hard to tell if this equilibrium has been reached yet. As will be discussed in the next chapter, the business models of low-cost carriers are ever evolving to the needs of the environment, and the market share of low-cost carriers in Europe is still growing, although much slower than it used to (figure 3.6). Schie (2009) goes as far as to predict an equilibrium in the future marketplace, which will show a split between the full service network carriers who will only be offering intercontinental flights and low-cost carriers who will offer cheap continental flights.
13 3. Innovation of Business Models
Ever since the first flight of man, people have been looking towards aviation for ways to make money. In fact this year marks the 100th year anniversary of the first commercial flight, which took place in Florida in the United States on the first of January 1914. It was a short trip of 23 minutes between St. Petersburg and Tampa with only one paying passenger on board, but it set the precedent of things to come. The first business model in aviation was created. Today many different business models exist and all are competing to create economic profit. Over the years and with the introduction of new airplanes and deregulation, new business models have been introduced in the marketplace and other business models have evolved. This evolution is necessary to survive, as the airline industry is often unstable and unpredictable (Wensveen & Leick, 2009). Restructuring and flexible strategies are needed to respond to changes in the external operating environment. While many other industries reach a point of maturation at a certain time, the airline industry seems to keep on evolving (Ibid.). A variety of internal and external forces created new business opportunities that require a strategy which can turn these opportunities into economic profit. As more markets became liberalized and deregulated, airline strategy is now mostly driven by consumer demand, forcing airlines to pay more attention to the needs and demands of their passengers (Ibid.). At the same time innovative technologies have increased the availability of information for passengers, resulting in less homogenous customer segments which created more opportunities for airline business models to evolve (Ibid.). As will be discussed in this chapter many business models are starting to blend, and it might not always be as easy as it used to be to assign an airline to a specific business model. The focus will be on the low-cost carrier (LCC) business model. This business model has seen great success and has proven to be the main driver of airline expansion after the year 2000 in Europe (Dobruszkes, 2013). Even during the global economic crisis of 2008 the low-cost sector was the only sector not losing volumes, which has led to a situation today where the LCCs represent 31 percent of the intra-European market (Ibid.). This number should be even higher considering the fact that several short-haul flights which are operated by the full service network carriers (FSC) only exist to feed passengers to their long haul flights (Ibid.).
14 The LCCs are behind most of the growth in passenger numbers in Europe, with 70 percent of the increase in the number of intra-European flights or seats during 1995-2012 being created by these LCCs (Dobruszkes, 2013). Some say it is only protectionist regulations and long distance (Francis, Humphreys, Ison, & Aicken, 2006), together with market saturation on the European continent (Wit & Zuidberg, 2012) that remain barriers to even greater growth of these LCCs. It is clear that LCCs play a large role today in the European aviation market, and this chapter aims to explain the rise of the low-cost business model and to look at the opportunities for this business model in the future, with a focus on the possibility of long-haul low-cost. This thesis and this chapter is being written with a goal to enhance further insight into the recent challenges and opportunities of the last decade in order to provide some focus on this subject of low cost aviation by narrowing the timeframe.
3.1 Low-cost airline business model In the airline industry there are basically only two ways to make money (Doganis, 2006). The first is through a network approach based on hub-and-spoke operations (for more information about hub-and-spoke see appendix A). This network approach is even exemplified in the current market because many airlines are forming alliances such as Oneworld, Star Alliance and SkyTeam, which links their hubs together with their alliance partners to increase the strength of their network. The second is through a low-cost approach. This can lead to two different low- cost models: charter/non-scheduled airliner and the point-to-point, low-cost, no-frills scheduled airline. The latter of these two low-cost models will be the focus of this chapter. As chapter two has shown, having a lower cost base than the competition is the most important aspect of achieving a competitive advantage as an LCC. A low cost business model should focus on cost reductions and cost structure in order to create economic profit. Especially in recent years cost reductions have been very important for all airlines. (CAPA, 2013k). When North America is taken in consideration, both consolidation and a revamping of airline business have resulted in capacity reductions and have also created three distinct business models in this region: full service network carriers, hybrids and ultra low-cost airlines (Ibid.). In this new market scenario strong contesters have been established in all three categories, and the remaining carriers need to adapt or find a niche. Note that in this scenario there is no room anymore for the ‘traditional’ low-cost business model.
15 In Europe the marketplace is undergoing some challenges as well. Europe is forecasted to be the least profitable major region for airlines in 2014 by IATA (CAPA, 2014d). All the different carriers are trying to survive a weak global economy and high fuel prices (CAPA, 2013a). The FSCs have experienced great competition from the LCCs on their short haul routes which feed their hubs. But on the other hand these FSCs are also experiencing a growing threat from the Gulf Carriers and Turkish Airlines on their long haul routes (CAPA, 2014d; The Economist, 2014).
3.1.1 Situation today The margins for most airlines will remain slim in 2014, even though margins are improving (CAPA, 2014d). The accounting profits will be unevenly divided, as in Europe a few LCCs are making decent returns while the majority of FSCs make little or no profit. In North America the market is benefiting from consolidation, but in Europe the market is held back by legacy carrier cost issues, a weak economy and government imposed taxes and regulation (Ibid.). This environment remains challenging for most airlines. But a structural improvement of profitability is forecasted with the latest IATA numbers showing a growth in revenues per passenger in 2014 (Ibid.). The net profit per passenger will increase from 2,94 USD to 5,94 USD, which still remains a very low margin. To illustrate this low margin figure 3.1 shows the seat lay-out of a Boeing 737-800 used by KLM. This plane is also being used by many LCCs such as Southwest, Ryanair and Norwegian. KLM uses this plane for its European feeder network flying people from different cities to its main hub in Amsterdam. As can be seen of these 180 seats available on average only one sold seat will contribute to the profit of the airline. This creates a situation where even small setbacks in the operations can evaporate the profit for the airline. These low margins have been one of the industry’s problems for a while (The Economist, 2014), with cost of capital being higher than the return on investment that most airlines are creating (see figure 3.2 below). This creates a situation where no economic profit is being made for the shareholders, since they would theoretically have made more money if they invested in something else. Even though airlines can still make a profit, this will be the accounting profit. If the levels of profitability will stay inadequate it will be harder to attract new investments. In order to create an economic profit for the shareholders more will have to be done to control costs and capacity (CAPA, 2013c).
16 Figure 3.1: Profit margin of a KLM Boeing 787-800
Source: KLM (2014)
Besides an abysmal record of achieved return on capital, there is another reason the entire airline industry needs to focus more on cost control. There is a downward pressure on air fares (Doganis, 2006), which has been initiated by a widespread availability of air fare information made possible by the internet, increased competition created by liberalized and deregulated markets and the entrance of LCCs. Customers today have many means available to check and compare different air fares, which leads to a more transparent level playing field. The airlines themselves have a much better way to compare their fares with the competitors as well, and this tends to drive prices downward because of a tendency to create a short term pricing advantage (Ibid.). This can lead to a situation where the market becomes very competitive and airlines lose control over their pricing. It can even become more uncontrollable when a situation of excess capacity exists, this can lead to airlines losing all pricing power which will make them unable to pass
17 along cost increases to their customers. While overcapacity is something that can be influenced, albeit hard to achieve if not acted on an industry wide scale, a more transparent level playing field is here to stay. This means that cost cutting cannot be seen as only a short term solution to deal with short term economic downturns anymore, but instead the necessity of cost reduction has become continuous and is now a long term requirement for financial success for all airlines, both FSCs and LCCs (Ibid.).
Figure 3.2: Return on capital invested in airlines and their cost of capital
Source: IATA
Carriers with a low-cost business model have been outperforming many of their FSC competitors. Even when there was a strong economic downturn, such as in 2000-2001 and after the global economic crisis of 2008, many LCCs have stayed profitable. The best example would be Southwest Airlines, which has had 41 years of consecutive profits and remains profitable to this day (Southwest Airlines, 2014). This seems to indicate that in periods of crisis the low-cost business model is more robust than the network model of the FSC carriers (Doganis, 2006). How are these LCCs able to maintain profitable when others cannot, and how can they maintain their cost advantages?
18 3.1.2 How to achieve a cost advantage For any airline that wants to achieve a low-cost advantage it will have to use a business model that will provide the lowest cost per available seat kilometer (CASK) possible so that it can offer the lowest ticket prices. Using these numbers a comparison can be made between different airlines, as can be seen below in figure 3.3, showing the CASK numbers of 2012 for many airlines in Europe. Most of the LCCs are at the bottom of the figure, with Ryanair being the lowest. The CASK of Ryanair is about a third of the CASK number of the Lufthansa group, which basically means that Lufthansa’s costs are on average three times as high for the same flight and this also means Lufthansa must charge higher ticket prices in order to create a profit for this same flight.
Figure 3.3: Unit costs (cost per available seat kilometer) and average sector length for selected European full service and low-cost carriers in 2012
Source: CAPA analysis of company accounts and traffic data
Something else this figure 3.3 shows is the average sector length of all these carriers. Sector distance is an important cost determinant, as direct operation costs will decline when sector lengths increases because costs can be spread over more kilometers (Doganis, 2006). All of the LCCs stay below the 2500 km, with the biggest carriers Ryanair and easyJet having an average
19 sector length of around 1200 km. This is much lower than most FSCs, as most of them also maintain an extensive long-haul network. Air France-KLM sector length is around 3000 km, which shows a situation where costs are divided between short- and long-haul flights. Virgin Atlantic shows a relative low CASK compared to other FSCs, but Virgin Atlantic is a long-haul carrier only, so these numbers cannot be easily compared. What it does show is that a long-haul only FSC operation is able to achieve a relatively low CASK. When comparing these CASK numbers it also shows that many LCCs achieve a much lower CASK than most FSCs while having a lower average sector length. So if all the airlines in this figure would have the same average sector distance the difference between FSCs and the LCCs would in many cases even increase.
Table 3.1: Load factors Dec- Jan- Feb- Mar- Apr- May- 2013 2014 2014 2014 2014 2014 Ryanair 81.0% 71.0% 78.0% 80.0% 84.0% 85.0% LCCs easyJet 87.9% 85.4% 90.7% 91.5% 89.8% 89.4% Norwegian 78.0% 74.8% 79.3% 77.8% 79.8% 77.0% Air France/KLM* 74.5% 71.2% 72.1% 75.8% 79.1% 78.5% FSCs Lufthansa 70.3% 65.6% 67.0% 71.5% 76.0% 75.5% (intra-Europe only) Aer Lingus 68.3% 63.5% 68.7% 73.9% 74.2% 74.6% IAG 73.4% 68.3% 72.8% 77.4% 78.7% 76.3% * Air France/KLM traffic is for medium haul operations (exluding Cityjet) from Jan-2014 Source: Centre for Asia Pacific Aviation & company reports, as found in peanut$, the low cost airline weekly, issue 518.
Besides CASK numbers another number is very important in aviation: load factors. This is the percentage of seats that have been sold to customers by the airlines. Selling more seats means that revenue will increase. As was show in figure 3.1, a certain amount of seats will need to be sold to cover all the costs made by operating that flight. So it is important for airlines to keep these costs down by achieving a low CASK, and on the other side to sell as many seats as possible in order to increase the amount of seats that will be profitable for the airline. LCCs often achieve higher passenger load factors than FSCs (Doganis, 2006). A comparison of recently achieved load factors can be seen in table 3.1. The LCCs are all achieving numbers of around 80 percent, with easyJet even reaching load factors of more than 90 percent. This is a significant
20 difference with many of the load factors achieved by the FSCs, who are showing scores that are more in the 70 percent range. This creates a competitive advantage for the LCCs when they sell significantly more seats. In order to get to such a low CASK level an LCC needs to have the lowest costs in many areas of its business. Southwest airlines was the first to come up with a low-cost business model. They invented and implemented this very innovative business model. Alamdari and Fagan (2005) describe this very first low-cost business model of Southwest airlines as it was when Southwest commenced flight operations in 1971, which can be seen below in figure 3.4. The focus was on point to point flights from cheaper secondary airports, which made it possible to achieve turn- around times of 20 to 30 minutes. They started flying only to destinations in the state of Texas, and afterwards they expanded to the rest of the United States. So their sector length was shorter at the start of the company.
Figure 3.4: Low-cost features Southwest Airlines at the start of operations
Source: Alamdari & Fagan (2005)
Over the years the airline and the business model changed to adapt to internal and external influences (Alamdari & Fagan, 2005). Many low-cost airlines are using similar features in their own business model, although differences exists between airlines. These characteristics that enable a low-cost airline to achieve a low operating cost will be explained in more detail next.
Fares With regards to airline pricing, “the major innovation of European low-cost operators was to offer one-way fares with minimal restrictions.” (Doganis, 2006, p. 165). LCCs are offering one way trips without all the restrictions that the FSC used to have, such as the need to stay a Saturday night.
21 Distribution By trying to stimulate their customers to buy their tickets online or by a call center, LCCs have been saving money on the commission they otherwise had to pay to travel agents. This commission can be up to 5 percent of a ticket (Doganis, 2006). The downside is that these LCCs need to spend more on advertising to generate their sales, since they will have to do all the promoting themselves.
In flight LCCs usually have a single class seat configuration in their airplanes, which means no first or business class. Seat density is high to be able to transport the maximum amount of passengers that the airplane can transport. This is achieved by using a low seat pitch, which is normally between 71-74 cm for many LCCs. As the LCCs continue to order more airplanes they have become a really important customer segment to airplane manufactures, who are now actively trying to offer a product that better suits the needs of LCCs (Ostrower, 2014a). This has led Boeing to offer more seats in its 737 airplanes, for example some 10 extra seats can be added to its 189 seat 737-8 model that is used by many LCCs such as Ryanair and Norwegian. This increase in seats will mean a decrease of the seat pitch with about 5 cm, and now more people can fit into the same airplane which result in more tickets sold for the same airplane. During the flight most LCCs offer no frills such as free food and beverages or complementary in-flight services, and most LCCs do not offer any frequent flyer benefits.
Airplanes and Airports By using only a single type of airplane LCCs can save maintenance and crew related costs. Maintenance facilities and spare costs can be kept to a minimum by using just one type. The crew only needs to be qualified on one type of airplane, which makes all crew available for all their routes and increases their productivity. Most LCCs have chosen either an aircraft from the Boeing 737 series or from the Airbus A320 series. The larger companies, such as Ryanair and easyJet, also have great bargaining power with Boeing and Airbus. This has already led to several occasions where airplanes were acquired with great discounts (Doganis, 2006). In 2005 Ryanair bought 70 Boeing 737 next generation jets with a discount of at least 53 percent, and in 2013 another 200 of these planes were ordered after Boeing offered a major discount that would
22 made Ryanair pay less than $9 billion for planes that have a list price of $17,8 billion (Gates, 2013). LCCs normally have a high aircraft utilization. This is made possible by a couple of factors in their daily operations. Because they fly to secondary airports, which are usually less congested, they will experience less taxiing time and fewer air traffic control delays. Besides advantages in turn-around time, secondary airports also offer lower airport charges and suitable slots are more readily available. Often LCCs fly at more inconvenient hours when other FSCs might not be flying, thereby increasing the number of hours the plane can be used for operations each day. Since there is no free catering offered during the flight this results in less food and drinks to replenish, cleaning time can be reduced and the cabin crew will clean the cabin, rather than airport staff. With no seat assignment passengers can speed up embarking and disembarking, saving some more time. All these factors and no freight to load or unload mean LCCs can achieve fast turn-around times, which will lead to higher aircraft utilization. A by-product of all this is high punctuality.
Sectors LCCs fly only point-to-point, which saves them from costs associated with using a hub system. This hub system is much more complex to run and more costly, as is explained in appendix A. Passengers can still connect to other flights, but they have to do this themselves, which means exiting and entering customs whenever they have luggage and no guarantee the plane will wait when the first flight is delayed.
Staff Many European LCCs offer productivity based wage incentives which can account for all or a large part of the salary of some employees. This can increase labor productivity and decrease costs, but there can be negative effects on the company culture (Doganis, 2006). This company culture can have great influence on the cost savings, but it also proves to be the hardest part in the attempts to replicate the low-cost business model as many low-cost start-ups have tried to copy Southwest Airlines culture along with their business model (Gillen, 2006). LCCs also fly with minimum cabin crew required since they do not need to spend as much time serving food and beverages, since people will need to pay for it. The rate of unionization among employees is
23 lower, which decreases the bargaining position of employees and can lead to lower wages (Francis, Humphreys, Ison, & Aicken, 2006). Another way LCCs save money on staff is by outsourcing many tasks, such as maintenance. Outsourcing leads to flexibility of which supplier of service to choose, which can create a stronger bargaining position for the LCC which might result in lower costs (Berrittella, Franca, & Zito, 2009). Something else LCCs has started to explore and use in the last couple years is to hire employees in other countries when they open a base, using cheaper contracts or forcing a cheaper contract by using contracts from another country with lower social charges. Recently Norwegian is trying this method with its employees in the United States and Asia, but this has caused some backlash (CAPA, 2013j). More about this in chapter four. Labor costs are very important to control for an LCC, since they represent the largest single input costs of which management has some control. So differences in productivity and wages can become a major factor in creating a lower cost base and achieving a competitive advantage.
All these features of the low-cost business model have enabled LCCs to reduce their costs compared to FSCs. Adopting all these features can lead to unit operating costs which are 40 to 60 percent lower than those of FSCs flying the same route with the same aircraft (Doganis, 2010). LCCs have also turned some costs into revenues using unbundling, this will be explained in section 3.1.4. The strength of the low-cost business model and how it can achieve its low costs have become clear. In order to get a more comprehensive view these costs advantages will be shown for each feature.
3.1.3 Cost advantage in numbers For every company it is important to keep track of all the costs associated with creating a product. Some costs are directly associated with output, while others will remain the same regardless of the output achieved. For airlines this is not different. As described the low-cost business model introduces some features that can bring costs down. There are the direct operating costs. These consists mainly of flying costs, maintenance and aircraft depreciation. Flying costs are crew and fuel. Fuel costs are basically the same for many airlines, although some advantages can be achieved with fuel hedging, but these are always short term advantages. Over the last decade a trend can be seen regarding fuel: the prices have gone up and have remained high. Today on
24 average 30 percent of all costs consist of fuel costs as can be seen in figure 3.5 below. What this basically means is that airlines have little to no influence on around 30 percent of all their costs, so when they want to save costs this will have to come from the other 70 percent. These fuel costs used to be less, giving airlines a higher percentage of the total costs to work with when trying to bring costs down.
Figure 3.5: World airline industry fuel costs and non fuel costs as a percentage of revenues 2003 to 2012 and IATA forecast* 2013 to 2014
*Forecast as of Dec-2013. Source: CAPA – Centre for Aviation, IATA
Crew costs are depending on the union contract if applicable and the base country, which can differ between airlines. Pilot salaries will roughly consists of 12 percent of airplane costs (Berrittella, Franca, & Zito, 2009), and cabin crew consist of around 10 percent of operating costs (Ibid.). Doganis (2006) claims that total labor costs consist of 25-30 percent of total costs, making it the single largest factor management has some influence on. This makes labor a prime target when a company wants to cut costs. Maintenance in general only consists of around 13 percent of the operating costs (Berrittella, Franca, & Zito, 2009). Another advantage of LCCs high aircraft daily utilization is that its deprecation costs, which are fixed annual costs, are spread out over more hours (Doganis, 2006). Table 3.3 below shows all the cost advantages of LCCs compared to a typical FSC, which provides an overview of the features that achieve the biggest differences in costs. With a cost reduction of -16 percent compared to FSCs, higher seating density creates the highest
25 percentage of cost reduction per seat for the LCCs. All the other factors have a relatively low cost advantage, with the exception of minimal station costs, which is a made possible by using a point-to-point network, and no agent fees, which is made possible by customers booking their tickets on the internet. This table shows a typical LCC will have a 51 percent cost advantage per seat over a FSC, creating a strong competitive advantage.
Table 3.3: Cost advantage of LCCs on short-haul routes Cost reduction % Cost per seat Conventional scheduled carrier 100 Low-cost carrier Operating advantages: Higher seating density -16 84 Higher aircraft utilization -2 82 Lower flight and cabin crew costs -3 79 Use cheaper secondary airports -4 75 Outsourcing maintenance/single aircraft type -2 73 Product/service features: Minimal station costs and outsourced handling -7 66 No free in-flight catering, fewer passenger services -5 61 Differences in distribution: No agents* or global distribution system commissions -6 55 Reduced sales/reservation costs -3 52 Other advantages: Smaller administration and fewer staff/offices -3 49 Low-cost compared to network carrier 49 Note * Assumes 100% direct sales and non through agents. Source: Doganis (2006, p. 171)
3.1.4 Ancillary revenues The competitive advantage of a LCC is mainly achieved by having lower costs than its competitors. Besides these cost advantages there have also been advantages on the revenue side, mainly regarding the ancillary revenues of LCCs. These non-ticket revenues can be divided into traditional products such as hotel and car rental partnerships, and from the ever-growing product unbundling (CAPA, 2013i). This product unbundling has been embraced by both LCCs and FSCs. Even legacy airlines such as Air France and Iberia are now letting their customers pay for food or have reduced food to a minimum on certain routes (Francis, Humphreys, Ison, & Aicken, 2006). This all comes from a standpoint where airlines argue that unbundling is a benefit to their customers, because now they only have to pay for the services they desire and are not paying to subsidize other services they do not want. Spirit Airlines (a ultra-low cost carrier) was the first
26 airline in the United States to introduce a charge for checked baggage in 2008 after multiple airlines already introduced it in Europe (CAPA, 2013k). Over the next few years it kept introducing new ways to unbundle the product. Between 2007 and the first quarter of 2013 its non-ticket revenue per passenger segment grew from 10 US Dollar to 54,75 US Dollar, a huge increase. This aggressive product unbundling was part of the reason Spirit airlines has recorded some of the best financial results among all US carriers in 2012 (Ibid.), showing the importance of ancillary revenues. LCCs dominate the top 10 list of airlines showing growth of ancillary revenue shares (Wit & Zuidberg, 2012). The unbundling of the product creates lower prices and can attract more customers, especially for LCCs who serve more price-sensitive customers. Besides creating more revenues, this unbundling can also lead to cost reductions (Wit & Zuidberg, 2012). For example, when customers have to pay for their checked baggage it will reduce the amount of baggage these customers will bring with them. This reduces the burden on the logistics of getting baggage on and off the airplane and will save weight as well, which can lead to less fuel being used. A downside of all this unbundling is less transparency for the consumer. Since consumers normally compare base ticket fares when deciding what flight to purchase it becomes less transparent when add-on fees and optional services cannot be easily compared. This is caused by the fact that some airlines only provide information about these optional services on their own website (Ibid.). Recently the Transportation Department in the US has addressed this issue of sharing information about ancillary services, but there is no near term solution in sight to make everything more transparent for consumers (Poling, 2014). While many LCCs have now adopted all these unbundling practices, Southwest Airlines remains strong in its opposition towards introducing add-on fees and optional options. It even advertises to its customers about this now unique position, trying to turn its no-fees policy into a competitive advantage.
3.2 Recent developments of the low cost model The market place in which airlines compete in is ever changing. The low cost business model is constantly evolving to keep up, as the examples of Southwest and Ryanair have already shown. The airline industry as a whole, not only the LCCs, has shown a lot of new innovations in their business models in order to maintain or gain competitive advantage. The focus of this chapter will be on Europe, but some say the market in the United States is a microcosm of what is to
27 come in Europe as well (Gillen, 2006). In the US the two main divergent business models, the FSC and the LCC, are now evolving together rather than apart (Ibid.). This is caused by the cost pressure the FSCs have been feeling from the LCCs, which made lowering their entire cost structure a key issue for many FSCs, and has resulted in lowering the cost difference in CASK numbers between FSCs and LCCs from 60 percent to 40 percent (Ibid.). Doganis (2006) claims LCCs should be able to maintain 45-50 percent lower CASK levels when operating on the same or parallel routes as FSCs. Even though the cost difference between FSCs and LCCs have decreased, between 2006 and 2009 it remained stable (Doganis, 2010). The CASK numbers of 2012 from figure 3.3 show that there is still a large gap between the average LCC CASK and the FSC CASK. There are some FSCs who are giving up domestic routes while increasing their international long-haul flying (Gillen, 2006). In Europe we also see FSCs hand over certain routes to their LCC subsidiaries, which will be discussed in section 3.2.1. While FSCs are reducing their short- to medium-haul routes, LCCs are expanding their services. They are increasing frequencies, providing connections and moving into primary airports (Ibid.). Some LCCs are even negotiating codeshares and strategic relationships with FSCs (Ibid.). Six years after the global economic recession in 2008 the aviation market has still not recovered in all its segments. One segment that is still underperforming is premium flyers (CAPA, 2013f). Before the recession about 9,5 percent of total passengers were premium passengers, in 2013 this number was still only 8 percent. This amounts to a 16 percent decrease in the number of premium passenger that would have been flying today if this segment was still at 9,5 percent, which in turn leads to a loss in total revenues of about 4 percent since premium fares are more expensive than economy fares. This is a very important revenue reduction for many FSCs because many operate with very slim margins. Most of these premium flyers are people flying for business, and this segment is getting targeted more and more by LCCs as well. In the United States the LCC JetBlue offers a product that can almost be described as business class, since they offer leather seats, 81,3 cm (32-inch) seat pitch and complementary drinks and snacks (Alamdari & Fagan, 2005). Former LCC Air Tran was offering business class service next to its economy class service on all its flights before it got acquired by Southwest. In Europe airlines such as Ryanair are now increasingly looking for ways to appeal to the business traveler, as a shift to operations from primary airports show (see appendix B). Vueling’s CEO said that 39 percent of his passengers are travelling for business, and they provide a full
28 connecting service for these travelers at their Barcelona base (CAPA, 2013d). The latest numbers from easyJet show a growth of 8,5 percent of their business passenger numbers over the 12 months up to March 2014 compared to year before, a much stronger growth that the 4 percent growth they achieved in overall passenger numbers (Rankin & Topham, 2014). Today around 20 percent of their passengers are business travelers, and they are attracted by the allocated seating that easyJet has introduced. As business travelers will pay more for extra legroom and book later increasing business passenger numbers have also positively affected revenues per seat (Ibid.).
Figure 3.6: Low-cost carrier share of total capacity (% of seats) within Europe for 2001-2014
Source: CAPA – Centre for Aviation with data provided by OAG
As both FSCs and LCCs are now competing for business travelers, competition is bound to increase in this segment as well. FSCs in Europa have seen the LCCs grow steadily, as figure 3.6 shows. In 2013 36,1 percent of all available seats in Europe were provided by LCCs (CAPA, 2013e). As lines between business models may be blurring (CAPA, 2013d), it becomes increasingly more important to maintain a competitive advantage. The main hubs in Europe have held out quite well against the LCC competition (CAPA, 2013e), which can explain why some of the major FSCs in Europe have not acted quickly and more decisively in the past decade. But
29 LCCs are now seeking to undermine the FSCs product positioning by adding product features and re-bundling them into the fare, while FSCs are mostly unbundling in order to provide lower fares (CAPA, 2013d). As customers are adapting to the new product offerings and working out a new value proposition between LCCs and FSCs (Ibid.) some major FSCs in Europe are now trying to regain the upper ground.
3.2.1 Response FSCs After acknowledging the success of the LCCs in the marketplace, FSCs have shown different responses in attempts to regain competitive advantage. But it has proven difficult to achieve this for many FSCs, as their business models differ greatly from LCCs. Most LCCs are newly formed airlines, while most FSC were established decades ago and often have the obligation to serve international markets which have not been deregulated (Pels, 2008). There are roughly four different responses by FSCs to the challenges posed by the LCCs and the uncertainty and instability of the aviation market recently, according to Rigas Doganis (CAPA, 2013a). The first is consolidation and concentration, which include market exit, merger/acquisition, joining alliances and bilateral alliances. This can also been seen in the model of Francis et al (2006), shown in figure 3.7 and discussed later in this chapter. The second is operational change and restructuring, which focusses on non-fuel cost. This includes labor, restructuring networks (cutting short-haul routes), overall capacity reduction, establishing LCCs subsidiaries and increasing links between FSCs and LCCs. The third is new marketing concepts. This includes learning from LCCs, which shows itself in simplifying and unbundling, use of direct sales channels and developing ancillaries. The last form of response is the scramble for new business models. One of these new business models is called the ‘Noah’s Ark’ by Doganis (Ibid.). This model operates in all different segments, including a FSC for both short- and long haul, and LCCs serving both short- and long-haul. Singapore Airlines Group is an example, this includes Singapore Airlines (long-haul FSC), Silk Air (short-haul FSC), Scoot (long-haul LCC) and Tiger (short-haul LCC). Some FSCs have tried to copy elements of the low cost business model in order to lower costs and become more competitive with the LCCs (Gillen, 2006), such as to adopt no-frill features (Francis, Dennis, Ison, & Humphreys, 2007). But the complexity of the hub-and-spoke network system does not allow many cost savings without losing important assets of the system
30 (Gillen, 2006; also see appendix A). And contracts with suppliers and employees are not easily changed (Pels, 2008). Other FSCs have started their own LCCs subsidiaries or acquired LCCs (Doganis, 2006; Francis, Dennis, Ison, & Humphreys, 2007) But it has proven difficult to make these subsidiaries successful because it requires a complete new way of thinking (Pels, 2008). Something else that has been initiated by some major FSCs in Europe has been the transferring of routes. One example has been Lufthansa and Germanwings. Germanwings is part of the Lufthansa group, and Lufthansa has decided to transfer all its non-hub European point-to-point traffic to Germanwings in order to counter the group’s short/medium-haul losses (CAPA, 2013b). The main reason for this transfer is an attempt to lower the costs. But this might still be a challenge, as Germanwings CEO acknowledges they have the disadvantage of being based in a high labor cost country. Therefore he is trying to become a “quality leader because you cannot be a cost leader” (Ibid.). This might be a problem when it comes down to lowering costs. While Germanwings as Lufthansa’s subsidiary is straight out substituting some of Lufthansa’s routes, other major FSCs are trying a different strategy with their LCC subsidiaries. International Airlines Group (IAG), which consists of British Airways, Iberia and Vueling, is using its LCC Vueling to operate on a stand-alone basis (CAPA, 2014n). Both Vueling and Germanwings operate on point-to-point and leisure markets, and they occupy broadly the same position for their respective groups. This is different for the Air France-KLM group, which uses both Transavia and the Air France regional network for this (CAPA, 2014n). Air France-KLM is using its LCC subsidiary Transavia mainly to open new routes, and not to take over leisure routes from Air France. Meanwhile Air France is reducing its hub feed and French regional point-to-point activities (CAPA, 2014n). But now it seems Air France-KLM might be changing this strategy (CAPA, 2014e; Rothman, 2014), and the CEO of KLM recently discussed a strategy of growth for its subsidiary Transavia in order to compete better with the LCCs that are now competing for the same business travelers and using the same primary airports (Luchtvaartniews, 2014). The CEO of the Air France-KLM group has indicated that closing some regional bases in France might be necessary to restore competitiveness to its short-haul business and wants to use Transavia as a ‘quality low-cost’ airline (Rothman, 2014). For now it seems that of all three major airline groups in Europe, Air France-KLM strategic vision for its use of their LCC subsidiary is the most limited, and this might create some competitive disadvantages in their short/medium-haul network when competing with LCCs.
31 3.2.2 LCCs network expansion LCCs have been expanding and growing their business in two different ways (Dobruszkes, 2013). The first is by creating larger networks with more routes, which has led to more services to low- density niche markets. The second is by entering or expanding the market by competing with incumbent airlines, often FSCs, on existing routes and entering new markets. As a consequence of pursuing the niche market strategy there are many monopolies on LCC routes. Because these are low-density routes the market demand is often low enough to justify only one airline serving the route, even with low frequencies. 61 percent of all LCC routes in 2012 are monopolies like this (Ibid.). But because their frequency is low, these routes do not amount into large seat numbers. Only 35 percent of all LCCs seats in 2012 represent monopolistic routes. 59 percent of all LCCs seats in 2012 are directly competing on routes that are also served by FSCs. Europe has some 4900 routes flown by LCCs in 2013 (Berster, 2014). Around 4400 of these routes are being served by only one LCC, 404 are served by two LCCs and just 23 routes are being served by more than three LCCs. This shows that direct competition between LCCs is still relatively low in Europe. Research has shown that LCCs not only stimulate traffic in the direct market of an airport but in a much larger passenger catchment area than their FSC competitors (Gillen, 2006). They are sometimes creating a new market where there was previously none due to higher FSC costs resulting in higher fares. Yet after three or so years of very rapid growth in some of these markets fueled by low fares, growth rates tend to fall sharply (Doganis, 2006). Another issue that has come up more recently as many LCCs are expanding from an already very large network, is problems regarding the density of airports served in an area (Wit & Zuidberg, 2012). The likelihood that the catching areas of these airports will overlap is increasing as more airports are being added to the network in the same areas. This can lead to a situation where common destinations served at these airports will cannibalize each other and will make future growth very difficult.
3.2.3 Different low-cost business models The low-cost business model has evolved over the years, and different LCCs have taken it into different directions (Gillen, 2006). Some decided to stick to their original cost focus, while others are focusing on creating more customer value. In order to get a better picture of what has
32 happened with these low-cost models, some have done research into the differences between the business models of different LCCs (Klophaus, Conrady, & Fichert, 2012; Alamdari & Fagan, 2005). To compare the different airlines and their business models there need to be a set of criteria. These can be found in table 3.4 (Klophaus, Conrady, & Fichert, 2012). The criteria here represent the original low-cost business model. As can be seen all of them have been discussed in this chapter. Some of these criteria, such as code sharing and frills, are being used by some LCCs in order to differentiate and attract more passengers. It becomes interesting to see what these choices will mean for the classification of the business model. This research classifies the business models by establishing an index after counting how many of the 13 dichotomous criteria are fulfilled by an airline. The maximum value is 13 for a business model that stays true to the original low-cost business model, and the lowest score is 1 which basically represents a full-service carrier business model.
Table 3.4: Criteria for the LCC business model Business model practice Criterion Value Single aircraft type Fleet homogeneity index >0.75 Predominant use of secondary airports Secondary airport index >0.5 Point-to-point traffic Point-to-point services only Yes No code sharing No code sharing Yes Only one one-way fare per flight available at One-way fares only Yes each point in time No more than one fare at Yes any time No more than two fares at Yes any time Single class cabin Single class cabin Yes No frills No complimentary in-flight Yes service with lowest fare category No complimentary in-flight Yes service with highest fare category No free checked baggage Yes with lowest fare category No free checked baggage Yes with highest fare category No frequent flyer program Yes Source: Klophaus, Conrady, & Fichert (2012)
Table 3.5 shows the result for most of the LCCs in Europe. Only Ryanair scores the highest amount of 13, indicating it is the only LCC in Europe who stayed true to the original low-cost model. Although this might change, as Ryanair is now implementing some changes in its strategy (see appendix B). The majority of the airlines fall into the hybrid category, with either dominating LCC characteristics or dominating FSC characteristics. This shows that many of the
33 new initiatives have caused most LCCs to alter their business model and basically become a hybrid carrier. Airlines such as Norwegian, which will be discussed later as a case study, and Germanwings, show many evolutions in their business models. Coming back on Lufthansa’s strategy for Germanwings to use it as a subsidiary LCC, it is interesting to see how Germanwings has more features of a FSC than a LCC, which might question the chance of success for the strategy taken by Lufthansa here. Overall, what this index shows is that many of the European LCCs have modified their business model. Most of them have adopted a hybrid market strategy in order to better compete with the FSCs, after many FSCs have changed or enhanced their business strategy in order to be more attractive to cost-conscious customers (Klophaus, Conrady, & Fichert, 2012).
Table 3.5: Simple LCC index Type Airline Value I Pure LCC Ryanair 13 Wizz Air 12 Blu Express 12 Bmibaby 11 Blue Air 11 II Hybrid carrier with dominating LCC characteristics EasyJet 10 Jet2 10 Corendon 10 Transavia 9 Vueling 8 Aer Lingus 8 Wind Jet 8 III Hybrid carrier with dominating full service airline characteristics Norwegian 7 Flybe 6 Germanwings 5 IV Full Service Airline Air Berlin 3 Air Baltic 3 Niki 3 Meridiana fly 2 Air Italy 2 Source: Klophaus, Conrady, & Fichert (2012)
Another study done by (Alamdari & Fagan, 2005) showed the same kind of results for the US and European market in 2005. Only Southwest and Ryanair were following the original model in its entirety back then, while the other US LCCs were scoring lower, even lower than the other European LCCs, showing the US marketplace was leading this movement towards hybrid
34 carriers. The study also found that there is “no clear evidence suggesting that higher yields could be achieved by LCCs through provision of product extras.” (Alamdari & Fagan, 2005, p. 15) This suggest that the more an LCC adheres to the original low-cost model, the greater the operation margin that can be achieved. So by adopting more changes in their business model to become more of a hybrid carrier these airlines might decrease their maximum profitability. The competitive advantage of hybrid carriers compared to LCCs following the original low-cost model is low according to these findings, but it seems more and more LCCs are modifying their low-cost business model in a search for higher economic profits and a better competitive advantage.
3.2.4 Future of the low-cost model As many LCCs are moving away from the original low-cost model principles the future of the low-cost model will involve many changes and adaptions. But some trends are visible that will influence the complete aviation industry and the LCCs in particular. Francis et al (2006) performed research into market developments of LCCs back in 2006. They came up with six steps along the process to market maturity (figure 3.7), which is the final step. During their research they found that the US market was already in a mature stage, and the European market was still only in the consolidation stage. Today it seems the European marketplace has moved up a few stages, although it might not yet have reached the maturity stage.
Figure 3.7: Market developments, situation of 2006
Source: Francis et al (2006)
35 There are four developments in the airline industry (Doganis, 2010) at the moment that show a stage of market maturity in Europe might be reached in the future. First is the continued expansion of the existing larger LCCs such as Ryanair and easyJet. This will lead to increasingly more competition between the two of them as they will have to face each other on many more routes. This competition between LCCs will increase even more as more LCCs are moving into primary airports. Second is that in the European market there are too many new LCCs entering (Ibid.). The capacity they bring with them will adversely affect the yields for all the other LCCs, and this will create market instability. This instability will only disappear when some of these airlines merge or collapse. Most of the smaller and newer LCCs are unlikely to become financially successful (Ibid.). The large LCCs benefit from economies of scale and of route density (Doganis, 2006). The larger and older LCCs also enjoy ‘first mover’ advantage and have widespread brand recognition within Europe and have cash reserves. The market place will eventually consolidate around the big players as it has already done so in the US, with for example the merger between Southwest and AirTran. More consolidation will also take place in the airline industry, where there are two parallel developments (Ibid.): growing consolidation into larger airlines and at the same time growing concentration of these and other airlines into multinational alliances. The third development is the increasing competition between LCCs and FSCs, as the FSCs are using a more effective pricing strategy. This has induced some LCCs to differentiate their products and become hybrid carriers. These changes might prove costly and erode some of the cost advantages LCCs traditionally had. This in turn can decrease their price competitiveness. Finally, many LCCs have grown ancillary revenues from different charges very rapidly. The additional income this generated has enabled the LCCs to maintain low fares, even when fuel prices increased. But in the future it might become more difficult to generate additional revenue this way, and the LCCs might once again become more dependent on ticket revenue and on their low fare pricing strategy. As these developments might reduce the cost gap between LCCs and FSC, a marked gap will always remain (Doganis, 2010). In the end the LCCs will always have 15-25 percent lower costs (Doganis, 2006, p. 181). This cost difference combined with aggressive low-fare pricing will ensure that LCCs will continue to grow and capture a growing share of the short- and medium-haul domestic and international markets at the expense of FSCs. The future might see
36 more FSCs outsourcing their short- and medium-haul routes to LCC subsidiaries. Or even to LCC rivals, as the cooperation between Emirates and JetBlue is a good example of a two way code sharing agreement between a long-haul FSC and a LCC (CAPA, 2014c). And the next step for European LCCs could even be a fully fledged LCC hub system (Wit & Zuidberg, 2012).
3.3 Long-haul low-cost business model It has become clear that the LCC business model has proven very successful for many airlines. But this success has so far been largely confined to the short-haul market (Francis, Dennis, Ison, & Humphreys, 2007). As the LCC market in Europe is becoming more saturated and growth opportunities are less easily available (Wit & Zuidberg, 2012), the long-haul market can become an interesting way to assure future growth for these LCCs and to diversify (Francis, Dennis, Ison, & Humphreys, 2007). There have been many attempts already of airlines trying to become successful with offering a low-cost product on long-haul routes (Ibid.). The first was Skytrain, offering services across the North Atlantic in the 1970’s. But this endeavor ended in failure a few years later. Most airlines trying to introduce the low-cost concept in long-haul have either failed before flight operations even started or went bankrupt within three to five years after services started (Daft & Albers, 2012). But in the last few years there have been new airlines trying to create a successful low cost business model for the long-haul. Even an established FSC as Lufthansa is now openly talking about starting their own long-haul low-cost airline (CAPA, 2014f). In Europe long-haul LCCs account for seven wide-body orders (data of February 20, 2014) and in Asia 99 wide-body orders have been placed (CAPA, 2014j). This shows that the long-haul LCC is not going to disappear anytime soon. It would seem that the best airlines to start a new LCC for the long-haul should be the current LCCs, who have built up experience and skills in the short-haul market and can use this knowledge when they adapt these business models for the long-haul market (Francis, Dennis, Ison, & Humphreys, 2007). The long-haul market has no common definition, it can be seen as segments with a length of more than 3000km (Daft & Albers, 2012), or flight which last more than 6 hours (Francis, Dennis, Ison, & Humphreys, 2007; Morell, 2008). Basically all flights that cannot be operated by narrow-body aircraft such as the Boeing 737 and the Airbus A320 used by most LCCs (Morell, 2008). Almost all long-haul flights are being operated by either FSCs or charter airlines. In Europe most long-haul routes are concentrated at primary hubs such as
37 Amsterdam-Schiphol, Paris-Charles de Gaulle, London-Heathrow and Frankfurt (Maertens, 2010). At these hubs the FSCs are feeding their long-haul flights from their short- and medium- haul flights. Many FSCs still offer premium cabins on their long-haul flights after disbanding most of them on their short-haul network (Wensveen & Leick, 2009), and they use the revenue from these premium cabins to cross-subsidize the cost of the economy cabin (CAPA, 2013f; Wensveen & Leick, 2009). This can lead to highly discounted economy seats, which makes it very difficult for a LCC to achieve a price advantage with an all economy seating configuration in long-haul markets (Wensveen & Leick, 2009). This situation is acknowledged by many of the LCCs, and even the Michael O’Leary (CEO of Ryanair) talked about the need to attract high yield premium passengers in his plans for a trans-Atlantic operation by offering a business class for these flights (CAPA, 2013f). One of the advantages that most of the LCCs have is the use of a single type fleet structure (Doganis, 2006). In order to cover most of the high demand long-haul destinations in North America, China, Thailand, India and Africa when flying from Europe, the preferred airplane needs to have a range covering 5000 km (Amsterdam-Dubai) to 9500 km (Amsterdam- Hong Kong/Los Angeles) (Daft & Albers, 2012). The only aircraft that can serve these routes is a wide-body aircraft. There are two categories of wide-body aircraft that can be used (Daft & Albers, 2012; Morell, 2008). The first consist of very large, high capacity aircraft such as the Boeing 747 and the Airbus A380, which offer more than 500 seats in an all economy configuration. But these airplanes need high volume routes (Morell, 2008) and tend to be oversized given the probable demand for point-to-point flights, which do not have the same number of passengers a hub-and-spoke network can offer (Daft & Albers, 2012). The second category are smaller aircraft with a seat capacity between 340 and 450, such as the 767 and 787 from Boeing and the A330 and A350 from Airbus. These aircraft offer a reasonable tradeoff between capacity and low variable operation costs (Ibid.).
3.3.1 Long-haul low-cost business models Three different long-haul business models have entered the market according to Wensveen & Leick (2009). The first is the network specialist. This business model mainly targets business travelers and executives on high-yield routes. It can be described as a corporate shuttle service for long-haul routes and they often have contracts with major companies or other airlines. The
38 second is the product specialist, and this is an all-business class/first-class airline offering scheduled service on routes with high load factors and premium fares. Their main differentiator is the ability to offer low fares with flexible tickets in a premium cabin. But this business model has not yet been mastered, as most of the airlines that used it are now bankrupt or acquired by their competitors (Ibid.). The final category is the price specialist. This business model uses low- cost strategies to be able to compete on price, which makes it the LCC for the long-haul market. The key differentiator for this model is to use high-density cabins in high demand markets which enables low fares. This model also offers more flexibility than the other two models and more opportunity to expand into new markets (Ibid.). The previously mentioned Skytrain was the first to use this model, and many more have followed. For a more detailed description about some of these airlines such as AirAsia X and Jetstar, see van der Bruggen (2008). The price specialist business model has so far shown the most potential to create economic profits and its advantages and disadvantages compared to the FSCs long-haul business model will be examined next.
3.3.2 Advantages of the low-cost business model for long-haul For a low-cost business model to be successful it needs to have lower costs than the competition to be able to offer lower prices. Previous research by van der Bruggen (2008) expected the cost- advantage for these long-haul low-cost (LHLC) airlines to be 20-40% compared to their FSC competitors. But other research claims only a 10% cost-advantage can be created using the LCC business model (Moreira, O’Connell, & Williams, 2011). In a presentation in 2007 Boeing estimated that a transatlantic LHLC airline would have 4% lower costs per flight and 43% lower unit costs compared to a FSC over the same sector, and 36% of the difference is coming just from using higher seat density (Morell, 2008). The traditional LCC provides several cost-saving opportunities for the long-haul (Wensveen & Leick, 2009). Airlines can avoid using expensive computer reservation systems by only using internet based direct distribution, save fuel by using newer more fuel efficient aircraft such as the 787 and the A350 and hiring young flight staff. When suitable secondary airports are available for long-haul flights they can also be used instead of the primary airports that most of the long-haul flights originate from today (Morell, 2008).This can lower handling and passenger fees. If an aircraft type can be found that can serve markets with a wide set of ranges and payload mixes a homogenous fleet of aircraft can be used, just as short-haul LCCs are doing at the moment. Appendix C will go into the features of the new
39 Boeing 787 type of family and its opportunities it might bring for the LHLC business model. To better compare the features of this LHLC business model with the LCC model and the FSC model, information from multiple articles has been collected into table 3.6 below.
Table 3.6: Features of the LCC, FSC and LHLC business models compared Cost efficiency areas Low-cost model FSC Model Long-Haul Low-Cost Model Aircraft - Utilization High Moderate to high High, achieved by longer sector lengths - Fleet Young, singly type Multiple types Young, simple type which can be suitable for all routes if possible
- Load Factor High Low on short-haul, higher High for long-haul Service - Seating Small pitch Generous pitch Smaller pitch, but enough for longer flights - Class Single class Multiple classes Multiple classes might be segmentation needed - No-Frills Unbundled services Many ‘frills’ included Need to offer additional generate ancillary within the ticket services because of longer revenues flights, ancillary revenues still possible - Distribution Online, direct booking Online, direct booking, Online, direct booking travel agent - Frequent flier No Yes Maybe valuable program - Cargo No Yes No, but might offer opportunities Network - Airport Secondary (mainly) Primary Primary and secondary - Connection Point-to-point, no Use of hubs, transferring Point-to-point, no baggage baggage transfer baggage transfer, self connecting - Frequency High Moderate Low to moderate - Turnaround time 25 minutes Higher because Higher, but less important as congestion, hub aircraft spends more time in the air Direct fixed costs - Crew costs Minimized due to Higher cost due to Younger and less expensive homogenous fleet and unionized crew and larger crew (no previous pension reduced cabin crew cabin crew requirements) but larger cabin crew required - Maintenance Lower due to young and Higher due to older fleet Lower due to young and costs homogenous fleet consisting of different potentially homogenous fleet types of aircraft Source: Combination of: Francis et al, 2007; Daft & Albers, 2012; Wensveen & Leick, 2009; Morell, 2008.
40 Ancillary revenues might prove to be another advantage for LHLC, as demand for many of these services is likely to be higher on long-haul flights because of the longer flight times and destinations that are located in different socio-cultural areas (Daft & Albers, 2012). Figure 3.8 shows all the possible amenities that can be unbundled and sold separately by the LCC. Most of the FSCs will have all these services included in their bundle and will not be able to create extra revenues here. Another area where ancillary revenues will be important is cargo, or the lack of carrying cargo. Cargo can be a valuable contribution to gain more revenues (Morell, 2008). But using an all-economy configuration will increase the number of bags which decreases the cargo capacity. This loss of revenue can be offset with a charge for checked baggage.
Figure 3.8: Possible ancillary revenues for LHLC
Source: Daft & Albers (2012)
3.3.3 Disadvantages of the low-cost business model for long-haul Not all features of the low-cost business model that many of the LCCs use will provide a competitive advantage when transferred for long-haul flights. As distance increases, operating costs will rise while unit costs will decrease (Wensveen & Leick, 2009). Fuel burn per passenger will be much higher and will be a larger part of the overall costs compared to short-haul flights (Morell, 2008). This means that a larger part of the costs will be fixed, and there is less scope for large reductions in fuel costs. Other operating costs that will increase are crew costs, maintenance costs and passenger service costs (Wensveen & Leick, 2009). Higher aircraft
41 utilization will be difficult, as in most cases schedules will have to be compatible with traffic waves at origin and destination airports, and time zones might also place a limit on departure and arrival times (Moreira, O’Connell, & Williams, 2011). This is especially important when passengers are connecting to other flights at one of both ends, as is the case with many of the FSCs. It will require high frequency connectivity to short-haul markets to make it work (Wensveen & Leick, 2009). Although this might be less of an issue when no feeder traffic is needed to achieve the desired load factor. Flights will need to be scheduled at such hours that there is enough demand, even without feeder traffic (Pels, 2008). This basically means a 6 am to 11 pm operating day (Morell, 2008). Higher aircraft utilization will also prove difficult because of the longer turn-around times required with the larger wide-body airplanes that are needed to refuel and service the airplane, leading to lower aircraft usage on long-haul flights (Pels, 2008). FSCs already get up to 15 hours a day of aircraft utilization, and an increase will be hard to achieve, as in long-haul time zones, night curfews and flying time will limit the number of daily rotations (Morell, 2008). Other aspects will also become more complex because of the distance involved with long-haul, such as crew scheduling and in-flight catering (Ibid.). Crew will need some time off to rest at the end of the route, so they cannot be home every night at their base. Since flights take much longer passengers will require more drinks and food, which will require catering to be able to offer this. Most of the productivity gains a LHLC model can achieve will come from using high seat densities, but some of this will be lost if a two class seating configuration will be used (Ibid.). It is very important for a LHLC airline to offer ticket prices considerably lower than its FSC competition. When the price difference is slim many potential customers will not choose for the LHLC option as its disadvantages such as higher density seating, poor ground handling and no-in flight service do not offset the small discount (Francis, Dennis, Ison, & Humphreys, 2007). As these low prices can only be achieved when a cost difference exists between LHLC airlines and FSCs, the amount of this difference will be important as well. The cost gap should be enough to dissuade FSCs from matching the prices of the LHLC airline, otherwise the LHLC airlines might not prevail over time (Moreira, O’Connell, & Williams, 2011).
42 3.3.4 How to make it work? As the transformation from the LCC business model into a successful LHLC business model is clearly not as simple, the question about the viability of the LHLC model remains. One of the most important issues is the cost difference between the LCC and its FSC competitors. The competitive advantage of the LCCs on long-haul flights can only become sustainable when the cost gap is enough to dissuade the FSC from matching the fares charged by the LCC (Moreira, O’Connell, & Williams, 2011). When the cost advantage is no greater than 10 percent as Moreira, O’Connell, & Williams (2011) demonstrated in their research, it will be very difficult to maintain a competitive advantage. Especially when FSC use cross subsidizing to lower their prices for their economy seats or use profits generated in other markets to subsidize prices of flights in direct competition with LCCs (Ibid.). But other studies show that LHLC can be profitable (Daft & Albers, 2012). A few issues will be addressed that might be important to create a profitable and sustainable LHLC business model. Apart from low costs, revenue generation will need to be a very important aspect of the business model (Daft & Albers, 2012). Especially because the cost advantage will not be as high compared to short-haul low cost market situation, which leaves revenues as the only way to increase profits when cutting costs is not really an option anymore. Another issue is the choice of aircraft for the LHLC operation. Without a strong feeder network it seems that very large aircraft are not viable, even though they can offer the lowest seat kilometer costs. A smaller aircraft which still offers low costs might be the better option, and here new aircraft such as the Boeing 787 or the Airbus A350 might prove to be the best option for LHLC operations in the future. Decisions concerning network strategies will play an important role in attracting enough customers to become and remain profitable. As airport costs are only a small proportion of the total costs with long-haul flights, a strong argument can be made to use major hub airports where there is more demand and potential feeder traffic (Francis, Dennis, Ison, & Humphreys, 2007). Another option could be to use airports where low-cost short-haul networks are concentrated which can offer ‘do-it-yourself’ feeder services. An existing LCC can operate long-haul from its major bases, but this may not be sufficient and the sum of the sector fares may limit their cost effectiveness (Morell, 2008). Interactive market agreements among LCCs could attract the necessary amount of passengers and create flexible alliances between LCCs (Wensveen & Leick, 2009). Short- and medium-haul LCCs can create code sharing agreements with their long-haul
43 competitors to increase passenger numbers for the long-haul flights, as some of the LCCs are already doing with their FSC competitors (for example Jet Blue with Emirates (CAPA, 2014c)). Besides airlines, airports can play a role here as well. A good example is the airport of Milan Malpensa, which has launched a website1 where customers can combine tickets from different airlines to plan their trip. This can lead to a trip that consists of one leg using a FSC and another leg using a LCC. In addition they also offer an insurance that will provide the customer with a new airline ticket if the first flight is late and the connecting flight is missed. By providing this service the airport itself is taking the role of the ‘hub’, as it provided an easy way for passengers to plan trips from A to B with a layover at this airport. With more passengers having a layover at the airport more money will be made at the stores at the airport or even in the nearby city itself. This pro-active way of offering easy self-connecting options can be very interesting for LHLC airlines as well, as they may use services from airports instead of airline competitors to fill their airplanes. The original LCCs attracted many new customers with their low prices, making them choose air travel over other forms of transportation when going on a trip (Doganis, 2006). This works well for short trips, as flights are relatively short and it is easy to just leave for a weekend or so. With long-haul travel this becomes a different issue, as the limited availability of leisure time means most people can only make a maximum of one long-haul trip a year (Francis, Dennis, Ison, & Humphreys, 2007). When flights take six hours or more and the destination is at a different time zone, most people will not just leave for a weekend but rather spend more time at their destination. The main area of passenger growth here will likely be passengers who trade up from short-haul to long-haul for their main holiday (Ibid.). Since the price of the ticket is only a small portion of all the costs involved when travelling (hotel, food, etc.), visiting friends and relatives markets will probably show the most stimulus (Ibid.). This is important for the LHLC business model, because leisure markets with high ‘visiting friends and relatives’ traffic can be run at a low frequency and often have no business traffic, which makes it less attractive for the FSCs (Ibid.). In fact the FSC will lose their key advantage in a situation of low business traffic and will be dependent on high fares in peak season to make a profit on these routes, rather than being able to cross-subsidize with higher yield business class seats. With no need for high
1 http://www.flyviamilano.eu/en/
44 frequencies, smaller markets can be served with one or two flights a week. A high density long- haul service will have to offer at least 300 seats per flight and will need to offer five to seven weekly frequencies, which requires a market share of at least 175,000 passengers a year (Morell, 2008). LHLC airlines can look to smaller markets if they want to generate new markets with their point-to-point service. Besides generating new markets, LHLC airlines can always try to compete with the FSCs for customers on existing markets. But this might require higher frequencies as to accommodate some of the business travelers. The LHLC business model has yet to prove itself to be a sustainable and profitable business model, but recent LHLC airlines might prove this in the future. What has become clear is that the transition from a short-haul LCC to a long-haul LCC has proven difficult in some areas, as not all of the competitive advantages of the low-cost business model can be easily transferred to a long-haul operation. But a combination of new more efficient wide-body aircraft and smaller point-to-point markets might prove to be successful. It remains very important for all the LCCs that will start long-haul operations to continually look for ways to innovate in order to achieve and maintain their cost advantages (Francis, Dennis, Ison, & Humphreys, 2007; Wensveen & Leick, 2009). This might be the most important feature for their survival in a market where the cost difference between their main competitors is less than in short-haul and they have less room to implement changes as the fixed costs are higher.
45 4. Long-haul low-cost: Norwegian
Norwegian Air Shuttle (NAS) has been a Scandinavian short-haul LCC for over a decade, but has recently started long-haul operations under a subsidiary called Norwegian Air International (NAI). They aim to provide low cost tickets, in what they call “the long distance revolution” (Norwegian, 2014). For its long-haul operation it started using the Boeing 787 Dreamliner. Norwegian will be used as a case study to conduct research into the performance of a LHLC model in combination with the use of the 787.
4.1 History Today Norwegian is the second largest airline in Scandinavia and third largest LCC in Europe (Norwegian, 2014). It employs around 3500 employees, and more than 20 million passengers flew with the airline in 2013. But the company started out as a regional airline in 1993 (Norwegian, 2014), and became a LCC in 2002. It offered only short- and medium-haul destinations and their main focus was the Scandinavian countries, where Norwegian has the most bases and destinations. Norwegian entered into an agreement with Boeing in 2011 to purchase three 787-8 Dreamliners for the long-haul operation they planned to start in 2013. This order was later expanded in 2012, 2013 and 2014 with new orders for 787-8s and 787-9s, showing a total of eight 787-8s and six 787-9s (as of April 2014). Some of these airplanes will be leased to them. As of August 2014, seven 787-8s have entered service with NAI. Besides increasing their orders for 787s, Norwegian signed the largest ever purchase agreement in European aviation history in 2012 when it ordered 122 aircraft from Boeing and 100 from Airbus. 200 of these aircraft are the two newest models that are still in development with both aircraft manufactures, the Boeing 737 MAX8 and the Airbus 320neo. This indicates a departure from the single fleet that Norwegian is now operating on its short-haul network, where they only use 737s. NAI first long-haul flights started in May 2013 with flights from Oslo to New York and from Oslo to Bangkok. The long-haul network was expanded in November of that year with flights to Fort Lauderdale in Florida from Copenhagen, Oslo and Stockholm. NAI has plans to expand to more destinations, but has recently (April 2014) suspended talks to buy 20 more 787s because of a delay in receiving approval for its long-haul plans from the U.S. Department of Transportation (Reuters, 2014). But there are plans to start services to Asia, Africa and South
46 America starting in 2016 according to Norwegians CEO, but they will depend on the delivery of the 787s (CAPA, 2014i).
4.2 Network Norwegian operates 416 routes to 126 destinations in Europe, North Africa, the Middle East, Thailand and the US (Norwegian, 2014). There are five bases in Europe that will be used for long-haul flights, as London was added in July of 2014 (Norwegian, 2014). Figure 4.1 shows all the long-haul routes in one map. For some destinations the frequencies will increase as more deliveries of the 787 take place. As of August 2014 there is no information about new destinations in the future or any specifics of the routes that Norwegians 787-9s will be flying.
Figure 4.1: Norwegian’s long-haul network destinations
Source: own creation
47 Table 4.1 Norwegian long-haul destinations showing frequency and lowest one-way ticket price* Destinations LAX JFK FLL OAK MCO BKK Copenhagen 3 (€192) 4 (€163) 3 (€192) Stockholm 3 (€189) 4 (€164) 2 (€194) 2 (€189) 3 (€179) Oslo 1 (€202) 4 (€153) 2 (€177) 3 (€177) 2 (€177) 2 (€177) London 2 (€230) 3 (€192) 2 (€230) Bergen 1 (€139) Source: prices taken from Norwegian website * It is the lowest price that was available in the period of April 2014 to April 2015, and are not representative for the average prices.
Table 4.1 shows a summary of all the long-haul network data. Most routes have a scheduled service offering two to four flights a week, with two routes receiving only one flight a week. There is no destination receiving five flights a week or a daily flight, which can make it less attractive for business travelers. Flights to New York show the highest frequencies as well as the lowest prices, which might indicate a large market and strong competition. Flights originating in London (Gatwick) show higher prices, possibly indicating higher airports costs are a higher yield market.
4.3 Norwegian’s 787s The Boeing 787 is a highly innovative airplane, and the first of its kinds that combines an ability to fly long distances with high fuel efficiency, while carrying a smaller amount of passengers than all of its wide-body competitors. This can create opportunities for airlines who can use the features of the 787 to innovate their business model. More about the innovation behind the 787 and the possibilities it is currently providing to airlines can be found in appendix C. The choice for the 787 was a strategic one for Norwegian. Its CEO Bjørn Kjos indicated it was a risky bet on their part, but it should result in a five year head start on long-haul routes over Norwegian’s LCC competitor Ryanair (The Local, 2014). In May of 2014 Ryanair CEO Michael O’Leary once again discussed moving to long-haul. But because of the huge backlog of aircraft orders that both Boeing and Airbus are now experiencing he expects Ryanair will not be able to start flying transatlantic before 2019 (Wall Street Journal, 2014). By ordering the aircraft early, Norwegian was able to receive its 787s as one of the first airlines in Europe and well ahead of all its (potential) LHLC rivals in Europe. Kjos stated that Norwegian’s reasoning behind this
48 was to achieve a situation of competitive advantage in the future, and the 787 was the means to reaching this goal, adding that other airlines flying with airplanes which are seven to eight year old might have a hard time in the marketplace competing against the 787 (The Local, 2014). Besides the standard advantages the 787 brings in terms of passenger comfort as described in appendix C, Norwegian decided to add more features to make their product more attractive to customers. Innovation plays a big role here. In collaboration with Panasonic they created the first Android powered entertainment system (Garcia, 2014). By using innovation in the technological side of the passenger experience they can offer a service some of their leading FSCs competitors cannot match. Norwegian also introduced a new form of inflight catering as they allow passengers to purchase drinks and snacks from their in-flight entertainment screens (Ibid.). This has been an innovation created by Virgin America, but has not been applied in long- haul flights before Norwegian introduced it. This shows Norwegian is actively using innovation to enhance their product and service. They market these innovations directly to their customers. When a customer is booking a flight on their website it shows very prominently that the flight includes the “787 Dreamliner experience” and “Touchscreen Snack Ordering”. So Norwegian is actively trying to differentiate itself from other airlines with its airplane and its innovations and is using this next to its cheap prices to attract customers. There are some downsides to the 787 for Norwegian. The introduction of innovation as a first mover can involve taking some risks. In this case there were technical issues with the new and complex 787, resulting in problems for Norwegian. This can undermine its advantage as a first mover, and more about these problems can be found in appendix C-6.
4.4 Norwegians LHLC business model Norwegian is not the first airline to start with a LHLC business model, and where many have failed to make LHLC successful, Norwegian is claiming their business model will be profitable. Norwegians CEO Kjos described the two main pillars on which future success will be built upon: using the 787 and the emerging middle class of China and India that will become a new group of customers (Leonard, 2014). He predicts 500 million new passengers in the next decade, which he wants to attract with low fares. Kjos is very important for Norwegian and has played a very important role in creating its success. He is being seen as the Norwegian Richard Branson
49 (founder of e.g. Virgin Atlantic) using innovation and entrepreneurship to create a successful company, which in this case introduced low prices to Scandinavia (Ibid.).
Figure 4.2: Labor costs comparison
Source: Leonard (2014)(original picture edited to omit non-relevant data)
In order to offer low prices, Norwegian needs to maintain low costs. To achieve this Norwegian is introducing new features to the LHLC model. First is the choice of the 787, which Kjos called the first airplane that can deliver the required performance for a LHLC business model (Leonard, 2014). Norwegian is the first airline to use the 787 in a LHLC setting. Second is the manner Norwegian is trying to lower is labor costs. Section 4.4.1 will explain this use of a ‘flag of convenience’ and some of the troubles that have come up because of this. Mr. Kjos claims that the ability to hire crews at lower wage countries is a decisive factor for his business model, as keeping Scandinavian cost levels would mean doom for the airline (The Local, 2014). Figure 4.2 above shows that Norwegian has the highest percentage of labor costs as a portion of its operating expenses compared to Ryanair and easyJet, showing the competitive advantage both
50 Ryanair and easyJet have in their labor costs. Table 6.1 in appendix B also shows high costs per passenger for staff compared to both Ryanair and easyJet. Here Norwegian is on par with Air Berlin, but is still spending less than half of what Southwest Airlines is spending per passenger on its employees. For NAI lower labor costs might be even more important, as some of its long- haul competitors will be from Asia, where labor costs are lower than in Europe. But hiring these new crews creates tension with the current employees, as a strike by 600 of Norwegian’s pilots was narrowly averted in November 2013 (Leonard, 2014). Union rules will now only apply to Norwegian’s European routes, and not to the intercontinental routes that the 787s will be flying (Ibid.), lowering costs. Third is its network and frequency, as for now Norwegian is flying to a mix of larger and smaller destinations. Some routes are offered only seasonal service (Garcia, 2014), and frequencies offered are limited to a maximum of four times a week (table 4.1). This means Norwegian is able to fly to smaller cities and introduce new destinations, creating a new market without any direct competition. This is the case for their routes to Fort Lauderdale, Orlando, Los Angeles and San Francisco from their bases in Scandinavia, as no other airline is offering non- stop service. But offering low frequencies can also mean that Norwegian becomes less attractive for business travelers compared to its FSC competition. As Norwegian is awaiting the delivery of the rest of its ordered 787s, it does not have sufficient airplanes that they would need to support an aggressive move into the United States (Garcia, 2014). As other airlines are still waiting on their new airplanes, Norwegian’s first mover advantage would have been even greater if they had more airplanes. Airport slots will be a limiting factor to expansion as well, as will the outcome of the regulatory and political battle over Norwegian’s methods to cut labor costs (Ibid.).
4.4.1 Flag of convenience An issue that has come up recently and can be very important for the future of long-haul low- cost is the so called “flag of convenience” strategy of Norwegian concerning their long-haul business model (ECA, 2014). This strategy aims to minimize the costs of the long-haul operation, especially the labor costs (CAPA, 2014g). Norwegian has set up an Irish operating subsidiary with an Irish Air Operators Certificate (AOC) for its long-haul Boeing 787 wide body fleet. These aircraft will also be registered in Ireland. The crew will be based at Norwegian’s different
51 destinations such as Thailand and the United States and will be paid according to local wage standards as the crew will be employed by intermediaries in these countries. The purpose of the Irish operating subsidiary is that this will secure traffic rights between the United States and Europe in accordance with the US-EU Open Skies agreement. Since Norway is part of the European Economic Area, but not part of the European Union, Open Skies would not apply to Norway. But in reality the United States treats Norway as if it is part of the European Union in this regard (Flottau, Buyck, & Broderick, 2014). The EU AOC however is also very valuable in acquiring traffic rights to Asia, where Norway is not being treated as a part of the European Union. According to Norwegian’s CEO Bjørn Kjos they need an EU AOC to fly to the Far East, South Africa and South America from their bases in Europe (Lundgren, 2014). The only other option according to Kjos would be to split their fleet between two jurisdictions with a Norwegian AOC flying West to the United States and an EU AOC flying to other destinations, but this would increase costs (Ibid.). With an Irish AOC and Irish base Norwegian also becomes eligible for export credit agency and export-import bank financing for both Boeing and Airbus aircraft (Flottau, Buyck, & Broderick, 2014). Since Ireland has signed the Cape Town Convention this gives Norwegian access to cheaper financing, and on top of that the corporate tax levels in Ireland are low. Norwegian plans to operate its 787 fleet from multiple bases in Europe, although not from Ireland (Ibid.). It is basically the first LCC to try to use the basing strategy that other LCCs have introduced successfully with their short- and medium-haul network in Europe for their long-haul network operations. The Irish Aviation Authority granted Norwegian Air International (NAI), as the operating subsidiary is called, the approval in February of 2014, and its AOC has also been received from the Commission for Aviation Regulation on the 19th of February 2014 (Flottau, Buyck, & Broderick, 2014). All this movement has caught the attention of some fierce critics, who argue against the practices of Norwegian in this case. Pilot unions in the United States and Europe have alerted policy makers and aviation authorities about social and safety implications of this new business model of Norwegian (ECA, 2014). They argue that such an ambiguous structure will distort the level playing field in the industry which will lead to air crews being more vulnerable and forced into an unclear social position. In December of 2013 all three major US airlines (American, Delta and United) have backed challenges filed with the US Department of Transportation in order to question whether NAI should be granted a permit to expand its service
52 to the United States. They claim that Norwegian just wants to “set up a shell company in Ireland to operate its aircraft using imported labor” (Reed, 2014). Labor unions in Scandinavia are also complaining, in this case about the situation of employing crews at foreign bases and paying them local wages, which almost led to a strike in October of 2013 (CAPA, 2014g). It seems there is much to gain for Norwegian in pursuing this ‘Irish’ option. Norway is a very high wage economy, and it has higher social charges than most other European countries. But the large amount of backlash might prove to be difficult to overcome, at least from a public relations standpoint.
4.5 Price comparison As Norwegian is the first LHLC airline in Europe using the 787 it has become interesting to see how their fares hold up against the competition. Is Norwegian able to offer (much) lower prices and how much is the difference? For this thesis research has been done to 17 of the 18 long-haul routes Norwegian is currently serving. Only the route Bergen - New York has not been researched as the route will be suspended after September of 2014, giving a timeframe that is too short to provide a meaningful fare comparison.
4.5.1 Conditions and limitations of this research This research uses only roundtrip fares, and they are all economy class. A departure day has been chosen on which Norwegian is flying and the return is exactly a week later if Norwegian flies back on that day, otherwise a different day has sometimes been chosen. All fares have been found by using the website www.momondo.com, which provides advanced search options. The research has been done on July 17 and 18, and August 10, 11, 12 and 13 of 2014. For every route all days of the week have been researched for potential non-stop competitors to make sure the best day of the week was picked to compare fares. Some of the routes have no competitors who serve non-stop flights. Here prices are compared with airlines who offer flights using their hubs, which means an extra stop is included in both the outward flight and the return flight. The maximum is set on one stop, as using multiple stops during a flight will increase the flight time substantially. The difference between a non-stop flight or a flight with more than 1 stop would have become too large. Overall the maximum flight time to reach the destination has been set on 30 hours. The average flight durations of the routes are
53 provided in the tables with the prices. They represent the best option available regarding flight times, and can be used to compare non-stop flights with flights using a layover. But these best flight times can offer greatly for different dates, and often the lowest fares also have long layovers which can increase the total duration dramatically. If there are no competitors offering non-stop flights, prices are compared to either hubs or alliances. As layovers are much more excepted in long-haul flights, it becomes interesting to see how Norwegian’s fares are holding up against flights offered by the main FSCs in Europe. On some routes research has been done to compare Norwegian’s fares with fares using a layover at one of the three main hubs of the three alliances which include London Heathrow for OneWorld, Frankfurt for Star Alliance and Paris Charles De Gaulle for SkyTeam. The tables show which airline was offering the fare, formal International Air Transport Association codes have been used to indicate this airline and these can be found between the brackets behind the price of the fare. In some occasions the main hubs in Europe were not offering enough flight options to compare to Norwegian’s flights. In this case the flights have been compared to the fares offered by the three different alliances, and the best offering from each alliance are shown. This means that a larger choice of layover airports is used here, with many options provided by the partner airlines in the United States. There are some limitations to this research. Non-stop service is different than a flight that requires a layover at a different airport. For customers a non-stop service will probably be preferable to a flight with a layover when both are the same price. But when the price is attractive, some customers might option for a flight with a layover to save money on their tickets. That is why these alternatives are included in the research. For some customers the actual flight time might be important in order to compare tickets, but this research is not showing individual flight times but only average flight times of the route, which is a limitation of this research. The exact product offered by the airlines is neither shown, such as the seat pitch and the offering of food and beverages. This research is only looking at the difference in fares. The use of the website is also a limitation, as price comparison sites all show slightly different prices. But by using only one website and doing the complete research for one route in one day this research tried to get the best price overview as possible. For every route great care was taken to include the alternatives offering the lowest fares, even when they were not from one of the main hubs or an airline that is not part of one of the three alliances.
54 4.5.2 Summary The fare comparisons including the tables and figures can be found in appendix D to H. All these fare comparisons have given a good insight to the current market situation on Norwegians long- haul routes. As Norwegian is a LHLC airline competing with only FSCs in all these comparisons, it is supposed to offer lower prices than its FSC competitors as low prices is their main strength in attracting customers. What made it difficult is that on many routes there are no competitors offering non-stop service, so one can only compare Norwegians non-stop service to flights using a layover offered by the competition. One can argue that there needs to be a certain price difference between non-stop flights and flights with a layover for the customer to pick the flight with the lay-over. So when an airline is the only one offering non-stop service it does not necessarily have to offer lower prices than its competitors to attract customers, as long as the price difference is not larger than what customers are willing to pay in order to avoid a flight with a layover. On the routes to New York the competition was adding about six to seven hours of flight duration when using a hub. This might be little enough for many to consider it as an alternative for the non-stop service from Norwegian if the price is much lower. On the routes to other destinations the time difference was often much greater. This could mean that Norwegian’s position is much stronger, as their competitors need to offer much lower prices to attract customers away from Norwegian’s non-stop flights. Norwegian is entering a very competitive market in its flights to New York, and in all four routes it is not offering the lowest prices for most dates. But as it the only airline offering non-stop service from Copenhagen, Stockholm and Oslo it is still in a very strong competitive position as the price differences with the competition is mostly not more than 100 euro and often much less. But in London there are non-stop competitors operating from Heathrow offering lower prices, and it is not clear what Norwegian has added to this market by entering, as it is clearly not able to offer the lowest fares. It is the only one offering these non-stop flights from Gatwick, but Heathrow can offer much more connecting services and is seen as the main airport for London. On this route Norwegian is not able to live up to its LHLC credentials. With Los Angeles Norwegian has added a new non-stop destination for Copenhagen, Stockholm and Oslo. Except for Oslo Norwegian is offering the lowest prices in all the routes, even when competing with non-stop services from Heathrow. Only on the Oslo route United Airlines is offering significantly lower prices, which might attract customers to their flights that
55 have a layover. Overall Norwegian is strong on these routes because of a superior non-stop product for a lower price than what the FSCs using their hubs can offer. More non-stop destinations have been added with the introduction of flights to Fort Lauderdale and Orlando. Norwegian is performing strong on all these routes, and is often the airline offering the lowest fares. When compared to a competing non-stop service from Heathrow it is offering lower fares. These comparisons seem to indicate that Norwegian has a very strong competitive advantage on all these routes. FSCs have not been able to offer significant lower prices for their flights using their hubs. Norwegians routes to Oakland show again that low prices are being offered, and they are again matching the competition or slightly above some fares offered United Airlines in the case of Oslo. As the only airline offering non-stop service to the San Francisco area they are again in a strong position. The last two routes were to Bangkok, which is also a very competitive market where Norwegian has to compete with Emirates, Qatar Airways and Turkish Airlines which are proving to be strong competitors to the FSCs operating out of Western Europe. Both routes show that Norwegian is clearly able to offer lower prices than all of its competition. Compared with the only other airline that is offering non-stop service the price difference is often large, showing that Norwegian can indeed be called a LHLC airline when compared to a FSC offering the same product on the same route. Price differences of 50 percent or more can be seen between Norwegian and Thai Airways. When all the fares of all the dates are taken into consideration, Norwegian is on average 25 percent cheaper than Thai Airways on its flights from Oslo and 36 percent on its flights from Stockholm. All this while Thai Airways is using a much larger Boeing 777-300 on both routes. The differences are much lower between the fares offered by Emirates and Qatar Airways, but those airlines do not offer a non-stop product. Overall Norwegian is in a very strong competitive position on the market to Bangkok, offering much lower prices than its closest rival and often beating the prices of Emirates and Qatar Airways as well.
56 5. Conclusion
The main purpose of this thesis was to answer the question Will a combination of technological innovation and innovation in business models provide new opportunities for long-haul low-cost airlines? To be able to answer this research was done at both types of innovation and a case study was conducted. Previous research indicated that LHLC can only be successful on high density routes which offer a large number of passengers. Most of the FSCs are creating strong demand for these routes by using a hub-and-spoke system. They are able to fly large efficient airplanes between the main hubs. Without a hub-and-spoke system it becomes much harder to create sufficient demand to fill large airplanes. But with an smaller airplane which is as efficient as the larger airplanes currently used there can be new opportunities for a point-to-point low-cost service. Routes which serve a leisure market are especially interesting because these markets with high ‘visiting friends and relatives’ traffic can be run at a low frequency and often have no business traffic, which makes it less attractive for the FSCs. By being able to serve low frequencies the market does not have to be really large and a point-to-point network might be sufficient to provide enough demand. When demand is not enough there can be opportunities in combining the short-haul network of the LCC with its long-haul network and offering connecting flights. But also ‘self-connecting’ is an option used by many passengers today. Even airports are now looking into possibilities to support ‘self-connecting’, and this can be very interesting for LHLC airlines as well, as they may use services from airports instead of airline competitors to fill their airplanes. Besides opening new routes to thin markets, LHLC airlines can try to compete with the FSCs as well on existing markets. But this might require higher frequencies as to accommodate some of the business travelers while they need to offer significantly lower fares to attract customers away from the FSCs. This means they need to have a lower cost base than these FSCs so they can offer lower prices. To keep costs low they will need an very efficient airplane that has a sufficient range to cover most long-haul destinations with a small capacity. The Boeing 787 might just be the right plane for this job. Its innovative design features made it a highly efficient airplane, and it is able to serve long-haul routes. In fact it can fly as far as many other significantly larger wide-body airplanes while carrying less passengers. With
57 fewer seats to fill, mid-sized European, American and Asian cities can now be offered long-haul routes. Airlines that are using the 787 have acknowledged this feature, and 20 percent of the routes currently flown by all the 787s are new routes. It is up to the airlines to use these new capabilities and show innovation in the way they use the full potential of the 787. Norwegian is doing just that by opening many new long-haul routes for its 787s. Its management is actively using the 787 as a strong competitive advantage, and they are combining the opportunities of the 787 with innovations in their business model. They attracted the 787 early to make sure to have a first-mover advantage, and they are currently the only LHLC airline in Europe using the 787. Their business model leans very heavy on the 787, which has caused some problems because of technical issues. But as the reliability of the airplanes improves Norwegian should be able to offer a strong product. The fare analysis showed that Norwegian is mostly offering lower fares than its competition. In many of the routes it is the only airline offering non-stop service. They have to compete with FSCs who are offering flights with a layover at their main hubs. On many routes the fares for these flights with a layover are close to the fares Norwegian is offering, but Norwegian is offering a superior non-stop product. When there is no large difference in price non-stop flights will probably attract more passengers. There are a few routes that do offer competitors offering non-stop flights. Norwegians entry into London Gatwick is not as strong on all of its routes, and some FSCs are offering lower prices operating from Heathrow. Norwegian position is the strongest on routes were it is the only airline offering non-stop service. This is the case in most of its routes serving a leisure market. On its routes to Bangkok a good comparison could be made between a FSC offering exactly the same product. Here Norwegian is showing of its LHLC credentials, offering on average 25 and 36 percent lower fares compared to its FSC rival, who is flying a much larger Boeing 777-300. This larger airplane is considered very efficient. The fact that Norwegian is able to offer substantially lower fares on this route against a larger airplane shows that the LHLC model can work when the right airplane is being used. It seems Norwegian is able to provide a positive answer to the main question. There are opportunities, and Norwegian is showing that a LHLC business model can be used to create a strong competitive advantage. If this will stay like this remains to be seen, as many airlines have ordered the 787. When competing against a FSC operating a 787 some of the competitive advantages of the LHLC might disappear. Norwegian is combining both routes to leisure markets
58 and routes that also service business travelers (New York). As it is adding new non-stop service to leisure destinations from Scandinavia Norwegian is innovating. It has a first mover advantage, and it might profit greatly from opening these new markets. It will be interesting to see what other routes will be offered in the future, and if they will maintain their focus on mainly leisure markets that can be offered a low frequency service. How Norwegian will deal with its labor costs might set the precedent of things to come for other LHLC competitors. Norwegian might run into trouble with the Department of Transportation in the United States, which could lead to higher costs. It does show that national regulations can still limit the full potential of a business model, and these restrictions might limit available cost reductions and can decrease competitive advantage. That is why Norwegian and other LHLC airlines should use innovation in their network and business models to stay one step ahead of the competition, as innovation is one of the key drivers behind achieving a competitive advantage and maintaining it.
5.1 Contribution of the thesis and directions for further research Many of the developments described in this thesis are very recent and they have not been extensively described in other literature. The case of Norwegian offered an opportunity for research that could not have been done until recently. With the 787 in service for only a few years details are still emerging about its performance. And Norwegian is the first LHLC airline in Europe that is actually using this airplane, so it was only now that a fare analysis like this could be made.
As Norwegian has been flying its long-haul routes for a year, it will be interesting to see how the fare comparison holds up in a few years. With more 787 deliveries in the next years Norwegian will open new routes, and the reaction of the competition on these routes will be interesting. Also the intent to start a new LHLC subsidiary by Lufthansa might prove a good topic for further research. Finally another topic for further research is the case of LHLC in Asia. Here multiple LHLC airlines are now competing, and with often much greater distances to be flown the 787 might even be of more value in this market.
59 References
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67 Appendices
Appendix A. Hub vs point-to-point
Airlines basically all use one of two main network structures: hub-and-spoke and point-to-point (See figure 6.1 below). Hub-and–spoke is preferred by many of the FSCs, while LCCs have been very successful using a point-to-point network structure. Both structures have different advantages, but the hub-and-spoke has been the preferred structure for many decades. After deregulation was introduced and airlines gained the freedom to adapt their strategies to meet market demand, hub-and-spoke became the dominant choice of network structure (Gillen, 2006). With a hub-and-spoke system everything revolves around a main base airport, such as London Heathrow for British Airlines or Schiphol for KLM. This main airport is being fed passengers from many different routes by smaller airplanes. Most of these passengers will not have the main base airport as their destination, but will use this airport to connect to a different flight. By feeding the hub with these passengers, the airline can provide a multitude of destinations that are made profitable by having created enough demand. Take KLM for example, a Dutch airline with a main base from Amsterdam-Schiphol. If it would only serve the people living in the Amsterdam area, or even the Netherlands, it would not give enough demand to sustain the more than 130 destinations it is serving today. Because they use their fleet of narrow body airplanes to feed passengers from all over Europe to Schiphol, they create a much larger demand and are able to serve many destinations. The hub-and-spoke structure adds value to both the demand and cost side (Gillen, 2006). On the demand side it offers customers a larger number of destinations which creates a broader geographic and service coverage. Higher levels of service and the creation of a large service bundle including ancillary services is seen by many FSCs as a way to maximize the revenue yields from business and long-haul travel (Ibid.). An important aspect for many business travelers is high flight frequencies, which can be achieved using smaller feed aircraft on spoke routes. The hub which is being fed traffic from many spokes allows more flights for a given traffic density and cost level. Another important aspect for business travelers is the ability to easily change flights. This leads to airlines keeping a high inventory of seats available to accommodate last minute changes (Ibid.).
68 Figure 6.1: Point-to-Point vs Hub-and-Spoke
Source: Rodrigue, Comtois & Slack (2006, p. 48)
The FSC business model favors these high service levels, which helped build the market in the beginning of air transportation. By expanding its network, the airline can increase connectivity and improve aircraft utilization. Today many expansions are in the form of joining an alliance, in which one airline can feed another airline traffic which utilizes the capacity of both, which can increase service and pricing. On the cost side the hub-and-spoke structure has no economies of scale, only economies of density (Gillen, 2006). As explained creating more demand by feeding enables more routes, but it also enables airlines to operate larger aircraft between major destinations with high passenger volumes. This can lower the cost per available seat since larger aircraft are often more efficient. A full service business model using a hub-and-spoke structure is normally aiming to “provide an array of destinations with flexibility and capacity to accommodate different routings, no-shows and flight changes” (Gillen, 2006, p. 4). To be able to achieve this requires that the airline uses a variety of aircraft with differing capacities and performance characteristics. Using a variety of aircraft increases capital, labor and operating costs compared to using only one type of aircraft, as many LCCs do. Using a main hub creates cost penalties and lower productivity due to longer aircraft turn-around times, connection slack, and personnel and baggage connections. In order to provide short connection times many airlines have their airplanes arriving and leaving in waves, leading to self-induced congestion. To offer all the advantages of a hub-and-spoke
69 structure to its customers, an airline cannot easily avoid the expenses regarding the time, resources and labor needed to achieve all of this. The product is complex and expensive, but this complexity is only demanded by 20 percent of all customers (Ibid.), and the operation is complex and susceptible to higher costs due to variance in operations.
A-1 Point-to-point Less complex in its operation is the point-to-point network structure. Here all destinations are being served in a direct flight, without using any layovers or change of flights. This means there is no need for many of the very expensive and complex features of the hub-and-spoke structure. This comes with some trade-offs, such as less frequency, no interlining or code-sharing and no attempt of the airline to connect its network. Customers can still self-connect by searching and booking their own connecting flights, but this means they will have to check-out and check-in their luggage and missing a flight due to delays on their first segment of the trip is at their own risk. Another cost advantage of using the point-to-point structure is higher aircraft utilization, which features have been described in chapter three. With the rising market share of LCCs the point-to-point network structure has become a very strong competitor to the hub-and-spoke structure used by many FSCs. The FSC business model strategy is mostly linked to the hub-and-spoke structure, and can only be sustainable as long as no subgroup of customers can defect from the rest. To achieve this FSCs introduced loyalty programs to protect each airline’s coalition of different customer groups, in particular frequent travelers (Gillen, 2006), who are often business travelers. This created a situation where many FSCs were only competing on prices for some economy fares, but not on business travel fares which deliver far higher yields. But this model became vulnerable with the introduction of the LCC business model and their point-to-point structure. LCCs were only picking profitable routes, targeted price sensitive customers and provided a simplified fare structure. This lead to many leisure travelers and other infrequent fliers moving away from the FSCs towards the lower fares provided by the LCCs. Business travelers were more hesitant to move since they value high frequency, loyalty programs and good service, although this might be changing as is described in chapter three. But the effects of losing market share to LCCs has already resulted in some changes made by the FSCs. Regarding their network, European FSCs have been trimming large numbers of point-to-point services that they operate from other places than their major hub or are
70 transferring point-to-point routes to their own LCC subsidiaries (see section 3.2.1). At their hub, the number of intercontinental destinations receiving a direct service is diminishing as a shift to more high-frequency links to key overseas hubs is being made (Dennis, 2009). Partner airlines are used to connect to secondary cities from the overseas hub instead of offering a direct service. As the FSCs are reacting to the new market realities, many LCCs keep expanding their network.
Appendix B. Major players
B-1 Southwest Airlines There are two major players that have been at the forefront of LCCs developments over the years. In order to get a more comprehensive overview of the situation today and recent developments it is useful to look at these two airlines as they provide insights that can be shared for the situation of most LCCs. First is Southwest Airlines, which has been the first airline to be successful using the innovative low-cost business model. More about the start and the performance in the first decades after the start of Southwest Airlines can be found in Doganis (2006, pp. 150-156). The CEO of Southwest, Gary Keller, has recently declared that his airline has been “a disruptive force for five decades” (CAPA, 2014m). But its business model is under pressure from FSCs who have changed their business models, and from ultra-low-cost airlines and hybrid carriers who are operating with an evolved low-cost business model based on the one Southwest once introduced and used to start the low-cost revolution. Southwest has been dealing with an increasingly tough marketplace since 2007/2008, when all the easy growth opportunities had been extinguished as the majority of secondary US airports were receiving airline service and were becoming saturated (Aspire Aviation, 2012c). This trend was also visible in the declining average weekly frequencies that LCCs in the US were offering, showing a focus on thinner markets which can only support lower frequencies indicating saturation and route density problems (Wit & Zuidberg, 2012). At the same time Southwest’s very favorable fuel hedges began to run out, which led to a situation where their fuel costs are on par with the competition. And Southwest employee-driven unit costs continued to rise, as management settled for increased wage and benefit costs in order to maintain peaceful labor relations (Ibid.). The workforce slowly began to age as well. The culture of Southwest has been the foundation of its prolonged success (CAPA, 2013i), so it is understandable that
71 management wanted to keep it this way by giving in to some of its employees demands. Although all these efforts have not lead to satisfying results, as ten unions have expressed concern over morale dropping to an all-time low in June of 2014 and have called on the CEO to restore employee morale (Maxon, 2014). While many Southwest employees are clearly not happy, they are among the highest paid in the industry (CAPA, 2013i). One traditional advantage of Southwest’s labor costs, the pension plans that burdened its FSC competitors, disappeared when Chapter 11 bankruptcy reorganizations wiped out these burdens for some of the major FSCs such as American Airlines in 2011 (Aspire Aviation, 2012c). Chapter 11 restructuring also created opportunities for many FSCs to rework their labor contracts to decrease labor costs (CAPA, 2013i). In 2013 CAPA estimated that 29% of Southwest’s cost structure consists of salaries, wages and benefits (Ibid.). In the meantime many new low-cost competitors emerged during the early to mid-2000s (CAPA, 2014m). Airlines such as Allegiant, Spirit Airlines, JetBlue and Frontier Airlines all entered the market using a low-cost business model, although many of them evolved their business model into either a hybrid or a ultra-low-cost business model. Southwest now has to deal with legacy costs such as its labor contracts, while offering fewer frills than FSCs and even some hybrid carriers, and its costs are higher than any of the ultra-low-cost carriers (CAPA, 2013i). This leaves Southwest’s business model increasingly harder to define in a US market space that is evolving to just three large network carriers/FSCs, multiple hybrid airlines and no- frills ultra-low-cost carriers (CAPA, 2014m). Southwest publicly calls their position a benefit, but it seems that their once-competitive advantages might decrease as the new realities on the US market place set in. It was inevitable that Southwest’s business model would have to evolve with these rising external pressures. (Aspire Aviation, 2012c). In 2007 Southwest decided to take action, and it rebuilt its entire business model to cater more to business travelers instead of only focusing on leisure travelers (Aspire Aviation, 2012c). The greatest priority became revenue generation. In order to achieve this some changes occurred in their network strategy. Southwest had always avoided many of the larger airports in the Northeast of the US and instead served smaller secondary airports. But these major airports in the Northeast are among the most important business destinations, which led Southwest to change its policy and it began to actively expand to these larger and congested airports. It even moved into legacy airline strongholds, where it is in direct competition with the FSCs that are
72 using these airports as their hubs. But flying to these airports has caused a significant drop in Southwest’s productivity, with productivity in a variety of measures dropping 6-8 percent between 2007 and 2011 (Ibid.). Delays created by using these congested airports also caused the on-time performance to suffer, and Southwest finished last amongst major US carriers in 2011 regarding on-time performance (Ibid.). Along with all these changes, Southwest decided to offer more connections. It used to only offer point-to-point flights, as most LCCs do, but now it is offering connecting flights at its larger airports such as Chicago Midway (Aspire Aviation, 2012c). At this location 43,2 percent of their passengers were connecting. According to Southwest, about 25-30 percent of all its passengers are using connections. Southwest’s commitment to this change in their business model was further validated by the merger with AirTran Airways, which had a central hub in Atlanta that Southwest can now use (Ibid.). Southwest’s goal is to optimize the combined network with AirTran further, which should lead to more opportunities to drive unit revenue (CAPA, 2013i). Cost cutting will be done by the elimination of underperforming routes and careful capacity management. Southwest CEO Gary Keller even went as far as to say: “That is the number one opportunity that will dwarf any ancillary fee idea” (Ibid.), showing that Southwest is not yet ready to embrace the ancillary fees widely introduced by its competition. Even though Southwest is changing parts of their business model with all these initiatives in their network and service, some say it is not enough to maintain a competitive advantage. CAPA (2013i) claims that the downside of Southwest maintaining a pioneering image are the constraints this can create in attempting to alter outdated elements of their business. For example most of their hybrid competitors are offering extra legroom or a dedicated business class. Southwest is offering neither, even as most passengers are willing to pay extra for these services (CAPA, 2014m). The conservative approach of Southwest has resulted in showing resistance to embrace new changes that might be necessary to remain successful. The situation today already shows Southwest not being able to keep up with the cost savings of some ultra-low-cost competitors, and Southwest has admitted it can no longer brandish the low-cost banner (CAPA, 2013i). As can be seen below in figure 6.2, Southwest cost available seat miles (CASM) in 2012 was much higher than those of Allegiant and Spirit.
73 Figure 6.2: US carrier 2012 stage length adjusted unit costs excluding fuel
Source: Alaska Air Group
As the ever growing product unbundling is being adopted by many of its FSC and low-cost competition, Southwest is moving along under its own terms. While it remains dedicated to unassigned seating, it has introduced ways to gain preferred seats through a charge (CAPA, 2013i). It has also introduces some fare classes, which can be seen in figure 6.3 below. With the more expensive business select ticket, a customer can get priority boarding and gets a complimentary drink, a product which is aimed at business travelers. So instead of completely unbundling all services, Southwest choose to create three different fare structures to aim at different target groups. This has been a change from the original business model which offered the same product to every customer. For now Southwest is still doing well, as it recorded a strong financial performance for fiscal year 2013 and has a positive outlook for the US economy (CAPA, 2014m). Southwest will be the fourth largest airline in the US once all the consolidation among the major airlines is complete. But competition will become ever more fierce, as its network is touching all the major markets served by full service, hybrid and ultra-low-cost carriers with varying product offerings and similar schedules (CAPA, 2013i). Currently Southwest has opted out of creating partnerships with other airlines that can lead to adding interline and codeshare partners, as many of its hybrid competition has been doing successfully (CAPA, 2013h). Southwest has been cautious and conservative in its approach to innovating, which has paradoxically been instituted to preserve its renegade image (CAPA, 2013i). But Southwest now runs the risk of “not having a passenger
74 base to identify with as ultra-low-cost carriers aggressively target price-sensitive travelers, while legacies and hybrids devise strategies to compete fiercely for higher-yielding corporate customers” (CAPA, 2014m). It is a very interesting time indeed for the future of Southwest, and it shows how much the low-cost industry has changed since the beginning of the 21st century.
Figure 6.3: Southwest Fare Benefits
Source: http://www.southwest.com/flight/pop_fareCompare.html
B-2 Ryanair Ryanair is the second major LCC that will be discussed here, as it is the biggest LCC in Europe and has played an important role in the evolution of LCCs in Europe. More information about its history and development can be found in other literature such as Doganis (2006). A detailed
75 description of Ryanair’s business model from an economic point of view can be found in Casadesus-Masanell & Ricart (2011). Ryanair’s business model was originally based on the business model of Southwest but has since pushed the low-cost business model even further towards achieving lower costs by introducing new innovations (CAPA, 2013g). Some of these innovations have been setting up bases across Europe; relying only on internet sales; installing non-reclining seats; putting advertising on boarding passes and overhead bins; persuading its passengers not to check in hold baggage. While other LCCs were also pioneering in some of these areas, Ryanair has gone further than all its competition in commoditizing and popularizing short-haul European air travel (Ibid.). By not following many of its competitors into hybridizing in search of higher yields and wider markets, Ryanair has adapted a form of innovation. But even though Ryanair seems to stick as close to the original no-frills low-cost business model, things have been changing recently. At the end of 2013 Ryanair introduced a host of customer service initiatives and product enhancements, and it will return to allocated seating. (CAPA, 2014l; CAPA, 2013h). The decision to return to allocated seating is a response to customer demand (CAPA, 2013h). Until now Ryanair had always resisted allocated seating because of fear that it would slow down boarding times which would in turn slow down turnaround times. A more surprising move is Ryanair’s decision to start negotiations with multiple Global Distribution Services (GDS) (CAPA, 2014l). Ever since its transformation into a LCC business model, Ryanair has not used these GDS channels or travel agents. But this change is driven by a need to attract business travelers, a target group that Ryanair is now also trying to accommodate. Ryanair will spent 35 million Pound on changing its business model to become more corporate friendly (Newcombe, 2014). In September of 2014 Ryanair will launch its business traveler service, which will include allowing flight changes, increased bag allowances, premium seat allocation and fast track security (CAPA, 2014k). According to Ryanair’s Chief Executive Michael O’Leary, Ryanair’s strategy is to segment the market between ‘people who want the cheapest seat’ and those looking for something more (CAPA, 2014l). These new additional product enhancements, service initiatives and wider distribution all seem to target the second segment. Another radical move Ryanair is making is establishing bases at primary airports, for example Brussels, Lisbon, and Athens in the spring of 2014 (CAPA, 2014l). Ryanair used to only fly to secondary airports. Ryanair still operates an extensive, mostly low frequency, ultra-
76 low yield point-to-point network (Wit & Zuidberg, 2012). But Ryanair is facing some of the same problems as Southwest had to face: a saturation of the market (Ibid.). It becomes increasingly more difficult to keep growing by adding only more secondary airports to its network. A move to a higher yield and higher density system using the higher demand of larger primary airports seems to make further growth a more realistic proposition. Therefore they expect a substantial portion of their target growth to come from these primary airports. Ryanair expects to grow from 79 million customers today (fiscal year 2013) to 110 million in five years (CAPA, 2014l). They see an opportunity at primary airports where the mostly high fare (FSC) incumbents are financially weak and restructuring. At the same time many primary airports are now prepared to offer much more attractive airport charges in order to gain LCC traffic (CAPA, 2014l; CAPA, 2014k). Ryanair’s business model creates a ‘load factor active, yield passive’ situation, according to Michael O’Leary (CAPA, 2013h). This basically means that any weakness in demand will show up in lower fares, rather than in lower passenger numbers. But as long as Ryanair’s costs are lower than its competitors it can continue its aggressive pricing strategy. This is still possible because Ryanair’s cost per passenger is still the lowest in Europe by some margin (CAPA, 2013g). Table 6.1 below shows Ryanair in comparison with its main LCC competitors in Europe. It shows that Ryanair has much lower costs than all other competitors, with its closest rival EasyJet having a cost per passenger 67 percent above that of Ryanair. But even a successful airline as Ryanair which stayed as close to the no-frills low-cost model as possible is now implementing some major changes. Both Southwest and Ryanair are adapting their business model to changes in the market place.
Table 6.1: Costs per passenger (in Euro, excluding fuel)
Ryanair easyJet Norwegian Air Berlin Spirit Southwest Staff 5 8 15 14 16 33 Airports & Handling 8 18 8 26 15 22 Route Charges 6 6 13 8 - - Aircraft Ownership & 6 8 17 20 16 17 Maintenance Sales & Marketing 2 6 12 31 4 2 Total 27 46 65 99 51 74
% vs Ryanair - +67% +137% +262% +86% +170% Source: CAPA and latest available accounts via Ryanair presentation 28 January 2013
77 Appendix C. Innovation of technology: the Boeing 787 Dreamliner
The 787 Dreamliner is the latest aircraft in a long line of Boeing commercial airplanes. It is a twin engine jet airliner build for medium- to long-haul routes. During its development many new risky technological innovations have been introduced in its design (George, 2012). The use of new innovations was necessary as the 787 was to set a new standard regarding its fuel burn, its achieved range and its passenger comfort. In its market segment the 787 is the direct descendant of the Boeing 707, which was one of the first successful commercial jet airplanes in the 1950’s (Flightglobal, 2011). But the 787 has been built as a direct replacement of the Boeing 767, which was introduced in the early 1980’s. Part of all the technological advances that have been made in the past decades can be seen in the decrease of the aircrafts fuel burn, as the 787 is 70 percent more fuel efficient than the 707 and is supposed to use 20 percent less fuel compared to the 767 (Ibid.). Other goals include 30 percent lower maintenance costs than the 767 and a boost of the cruise speed by nearly 30 knots. (George, 2012). All Nippon Airlines was the first airline to receive the 787 in 2011, and Boeing has been delivering 787s to its customers ever since. Many airlines are eager to start using the 787, which is the only available aircraft catered for long-haul thin routes that can offer high fuel efficiency (Aspire Aviation, 2013), and this might be a very interesting aircraft for the LHLC business model.
C-1 Technological innovations of the 787 that benefit its passengers One feature that can influence passenger comfort is the cabin pressure inside an airplane (Flynn, 2011). Most passenger jets have a cabin pressure of around 7.500 to 8.000 feet above sea level. So while flying at cruising altitude, which is often around 40.000 feet, the human body feels like it is at a lower altitude. To achieve this lower cabin altitude the plane’s fuselage has to endure great stress. The amount of stress a fuselage can handle is limited by the material it is built of. The use of carbon-fibre composite materials on the 787’s fuselage allows for more stress and lower cabin altitude levels, as 6.000 feet can be achieved with the 787 (Ibid.). This will lead to less fatigue for both crews and passengers (George, 2012). The 787 also uses a two-stage filtration system which removes gaseous molecules and has a higher humidity inside the cabin which is also benefiting passenger comfort (Flynn, 2011). Because the 787 has a more aerodynamic nose and windscreens there is less ambient noise in the
78 cockpit, which will benefit the pilots (George, 2012). Other innovations are used for a better flying experience, such as the larger windows the 787 offers and the ability to control the tint of the individual windows. The color and strength of the overhead lighting can also be controlled, which should lead to better rested passengers according to Boeing (Terdiman, 2012). Overall innovations in the design of the aircraft and the materials that the 787 is built of in combination with smaller innovations in features for passengers create more comfort for both passengers and crew. This new level of comfort can also enables airlines to offer a better product and attract new customers.
C-2 Technological innovations improving the performance As discussed in the previous section the 787 uses composite materials in its fuselage, in fact it is the first commercial jetliner to have a primarily composite airframe (George, 2012). 50 percent of all the materials used in the 787 are composites (Terdiman, 2012). These materials are light weight and therefore offer weight reductions compared to older airplanes. This aircraft also has a higher aspect ratio wing which gives it a 5 percent better lift-to-drag ratio compared to the Boeing 777 (George, 2012), its larger brother. The 777 and the 787 share a common pilot type rating, which can create savings for airlines using both types of airplanes. Another important technological innovation has been the engines from both Rolls Royce and General Electric, which “represent nearly a two generation jump in technology” according to Boeing (Terdiman, 2012). These higher bypass-ratio engines do not have to suffer from efficiency losses because there is no constant extraction of bleed air as the 787 relies heavily on electrical power rather than compressed air or hydraulics for most of its systems (George, 2012). Another innovation is the use of lithium-ion main batteries, as the 787 is the first commercial jetliner to use these kind of batteries. The 787 has been in commercial service since 2011 when All Nippon Airways (ANA) commenced flying operations with it in Japan. A lot of attention has been giving to its actual fuel burn, as the use of many of these technological innovations were driven by a goal to increase efficiency and lower the fuel consumption. So far the results have been very positive and operators are seeing better-than-expected fuel burn (Norris, 2012). ANA has stated that the 787- 800’s fuel burn was 21 percent lower than their 767-300ER planes on international flights and 15-20 percent lower on domestic flights (Norris, 2012). This was achieved with early production
79 models that are 3 to 4 tonnes overweight and equipped with Rolls-Royce Trent 1000 engines which were not performing up to their original target. Later production models are now meeting the weight targets set by Boeing, and even better performance can be expected of the models that are now being delivered. The 787 in operation of Jetstar has outperformed its fuel burn specification by as much as 3 percent, showing greater fuel burn gains are actually being achieved (Aspire Aviation, 2014b). Technical innovation can sometimes introduce problems, especially in the beginning of a new product. This was no different with the 787, and more information about its problems can be found in appendix C.
C-3 Competition with other aircraft
Figure 6.4: Payload/Range for long-range cruise, 787-8 with typical engines
Source: Boeing sheets, can be found at: www.boeing.com/assets/pdf/commercial/airports/acaps/787sec3.pdf
80 The introduction of the 787 has brought a new long range small capacity airplane to the market of wide-body aircraft. To better understand why the 787 is so innovative, it is important to compare it with its competition. In order to do this more information about the performance of the 787 is required. Figure 6.4 shows a payload/range diagram for the 787-8 created by Boeing. This diagram can be used by pilots to manually determine what the range of their airplane will be with a certain payload and fuel load. The diagram shows that the 787 can carry its maximum payload over 5.500 nautical miles (nm) (10.186 km), it will be at its maximum gross weight here. If it wants to fly further than this, it needs to exchange payload for fuel while maintaining maximum gross weight. At 9.500 nm (17.594 km) it has reached full fuel tanks with reduced payload, and after this distance the payload needs to be increasingly reduced to reach a maximum range of 10.000 nm (18.520 km). The diagram clearly shows that the payload decreases significantly after 5,500 nm. Boeing2 states that the 787-8 design range has been 7.650-8.200 nm for an 787-8 at its maximum take-off weight with full passenger payload in a three class seating (242 passengers). According to this diagram at that range about half of its maximum payload is available. For airlines it is always important to consider both payload and range. Can they still make a profit if the distance of the route is such that only a reduced payload, and thus a reduced amount of passengers, can be transported? This diagram shows that the 787-8 can offer very long distances with a full passenger load. The payload/range data can be used to compare it with other wide-body airplanes. Because only one number will be used for each airplane, it is important to understand the limitations of this comparison. Airlines can have many cabin arrangement options for each airplane, which creates differences in the number of passengers it can carry which makes it harder to compare airplanes. The range of the airplane will be influenced by the fuel capacity and the payload, as sub-optimal loading in terms of weight can result in additional range capability, as was discussed above. With these limitations in mind figure 6.5 shows most of the current wide-body airplanes and some of the future wide-body airplanes in one diagram. It shows the 787-8 at a range of about 7900 nm carrying 270 passengers. This range is about the same as both the 747-400 and the new 747-8I, both larger airplanes with four engines.
2 As found in Boeing presentation online: http://www.boeing.com/assets/pdf/commercial/startup/pdf/787_perf.pdf
81 The 787-8 has one of the lowest passenger capacity in this diagram, but has a greater range than all of its current two engine Airbus competitors (A350 is not in operation yet). All the other airplanes that have the same range or greater are much bigger and carry more passengers. Most of these larger aircraft are efficient because they can carry a large number of passengers over a large distance. When this same efficiency can be achieved flying less passengers but over the same great distance, this can truly be called a new innovation as no other airplane has achieved this before. For the first time an airline with a relatively small airplane, the 787-8, can compete with other airlines using much larger airplanes over long distances. This diagram acknowledges that the 787-8 (and 787-9) can be used on the same routes as many of its long range competitors.
Figure 6.5: Wide-body Payload/Range, dual class cabin configuration
Source: Leeuwen et al (2014)
The only thing missing in this diagram are the costs for operating the airplanes. The potential of the 787 to become a great competitor and provide new opportunities for LCCs depends on its operating cost advantage compared to current generation mid-sized wide body aircraft and its unique combination of size and range. With the data now available, Aspire Aviation (2012b)
82 claims a 6 to 10 percent CASK advantage over the Airbus A330-200, one of its other direct competitors. This advantage should hold up for the common operating range. More recently (2013) 787’s flown by United Continental have proven to be 6 percent more cost-efficient per seat to operate compared to the equivalent-sized A330s flown by other U.S. Airlines (Ostrower, 2014b). An Airbus A330-200 can hold a maximum of 380 persons over a distance of 7.500 nm. With this cost advantage a route can become 4.5 to 8.5 percent more economically viable when switching to a 787-800 from an A330-200 (Aspire Aviation, 2012b). This can create opportunities for airlines to compete. Even when comparing the 787-8 to the Boeing 777-200 the 787 should approach the same CASK. And it will do so with 100 fewer seats (depending on the configurations of both airplanes). What all of this means is that the 787 can deliver a much lower CASK than the 767 and A330. It does this while requiring fewer seats to fill since it is a smaller aircraft. There will be more options for the airlines with the introduction of the 787-9 this year (290 seats) and the 787- 10 in 2018 (around 320 seats). The 787-9 is supposed to have a 8 percent lower fuel consumption compared to the 787-8 and will also increase the range with 300 nm. The first 787-9’s are now being delivered, and launch customer is Air New Zealand (Cohen, 2014). The 787-9 is the most wanted version of the 787, as 39 percent of all 787 orders are for the -9 version (Ibid.). With its long range the 787 offers a multitude of routes which can be made profitable with fewer people. The 787 is able to fly as far as the biggest commercial planes such as the 747 and the A380. It is the first airplane of this size that can fly non-stop Europe-Asia and US-Asia flights, creating many opportunities. With fewer seats to fill, mid-sized European and American cities can be offered long-haul routes. Most of the bigger cities already have access to non-stop long-haul flights offered by full service network carriers. Often these big cities are a hub as well for one of these airlines. The 787 provides the option to create more non-stop routes without using a hub to feed enough people to make the route profitable. With only 210 seats to fill at a time and having a lower CASK than its direct competitors it can open new routes and compete with the bigger airplanes that fly from the hubs. These bigger airplanes get costs down by offering a large amount of seats, while the 787 gets costs down by being efficient.
83 C-4 Analysis of the 787s in use at the moment The 787 can have the power to break up the hegemony of some current transpacific hubs as it already showed in the case of ANA. ANA showed that previously unsustainable routes such as Boston - Tokyo Narita and Denver - Tokyo Narita can now be profitable with the 787. This can happen in Europe as well with some of the large transatlantic and transpacific hubs. Low-cost carriers might be able to attract passengers who want non-stop direct connections and are therefore willing to fly without using hubs. If companies can attract many of these passengers, it can undermine the position of some of these mega hubs, who might lose some routes or they will need to switch to smaller planes as well to keep the routes profitable. It seems the 787 is the first plane to offer this kind of economics over long distances. The 787 is approaching three years of service and CAPA (2014a) conducted a research into the 787 network so far with all the airlines. From the beginning the 787 was introduced as a ‘hub-buster’ because of its ability to open new routes serving thinner markets directly rather than via a hub. With the winter schedule of 2013/2014 included, 20 percent of all the routes that the 787 is flying or will be flying are new routes opened by the 787 (or with an interim aircraft because of 787 delays) (Ibid.). Airlines state that the 787’s lower cost and smaller capacity enable the opening of these new routes. United clearly stated that some of these new routes to China to cities with 6 to 10 million people are only now becoming an option for a direct flight because of the 787 (Ibid.). 41 new (or with delay) routes have been opened so far by the 787, and fourteen of these were opened by Norwegian. This airline is responsible for opening the most new routes with the 787, and in chapter four Norwegian was used as a case study to look further into the combination of the 787 and a LHLC business model. Besides opening new routes the 787 is also used to replace older aircraft in the fleet. With the efficiency of the 787 airlines can create a competitive advantage over their competitors which are using older airplanes. But replacing older airplanes is not the most innovative way to use the 787, and in the search for new routes airlines can show innovation and create a first mover advantage when they add new non-stop destinations and are the first to offer non-stop services on new routes. With a smaller capacity and high efficiency many new cities might now be attractive destinations to offer non-stop service to with the 787. It is up to the airlines to use these new capabilities and show innovation in the way they use the full potential of the 787.
84 C-5 Problems with the 787 The development and production of the 787 has seen many delays and setbacks, which led to increased scrutiny on everything 787 related in the media. The use of many new innovative technological features as well as other reasons caused a delay in the delivery of the first 787 to ANA in 2011, 40 months after its original delivery date of May 2008 (Flightglobal, 2011). And then there was a grounding of the entire 787 fleet that lasted three months in the beginning of 2013 (Aspire Aviation, 2013). This grounding was caused by its new lithium-ion batteries that caught fire, and this forced Boeing to re-design the battery and put it in a steel containment box. In January of 2014 Boeing admitted that the performance of the 787 is still not satisfactory (The Sydney Morning Herald, 2014). The reliability rate in the beginning of 2014 was around 98 percent, which means two out of every hundred flights are delayed because of mechanical problems. The benchmark is 99,4 percent, which is the dispatch reliability of the Boeing 777. Boeing hopes to achieve a 99 percent reliability rate at the end of 2014. But there are great differences in the reliability inside the 787 fleet. About 45 percent of the fleet is operating above the 98,5 percent reliability rate, but other airplanes of the fleet are not achieving this standard (Aspire Aviation, 2014a). This as well as carrier-by-carrier variances in reliability rate help explain some of the troubles airlines are having with their 787s such as Norwegian, who is having chronic issues with some of its 787s (Ibid.) (for more on the 787 and Norwegian see chapter four).
C-6 Problems with Norwegian’s 787s The entry into service of the 787 has not been very smooth for Norwegian. Because of problems with its lithium-ion batteries, Boeing had to delay Norwegian’s first deliveries as the entire fleet of 787s was grounded at the beginning of 2013 (Lundgren, 2013). To start flying as scheduled, two A340-300 were leased to fly the routes until the 787s arrived. Boeing had some troubles achieving the targeted aircraft’s original manufacturer’s empty weight and airline specific operating weight. All the planes manufactured before serial number LN 103 were overweight, including LN 102 which was the first 787 Norwegian received (Aspire Aviation, 2013). Norwegians 787s are equipped with the Rolls Royce Trent 1000 engines and the first airplanes were equipped with the Package B standard, which exceeds the original engine specific fuel consumption target by two percent, causing them to be less fuel efficient than was promised
85 (Aspire Aviation, 2012a). In February of 2014 hairline cracks were found in the wings of 787s ordered by Norwegian, causing delays in deliveries once again (Åsberg & Sandelson, 2014). In January of 2014 Norwegian stated that they spent an extra 101 million Norwegian Krone (12 million Euro) because of the delays of its 787 deliveries and technical problems of its 787 fleet (CAPA, 2014h). This money was spent on leasing replacement aircraft that burn more fuel and to provide accommodation, food and drinks for delayed passenger (Ostrower, 2014b). After introduction into service of the 787 with Norwegian more problems followed. It has suffered regular maintenance issues on its 787s, consisting of problems ranging from the brakes to the cockpit to hydraulic pumps (Bachman, 2014). Because the number of problems were much higher than expected, Norwegian’s CEO made some harsh public comments about the 787 in the second half of 2013 (Leonard, 2014). For Norwegian any problems with its 787s has a much greater impact compared to larger airlines as Norwegian can rely on only its 787s for all the long-haul routes, with no other wide-body aircraft available. Any disruption to Norwegian’s small long-haul fleet has an out-sized effect, which can lead to lengthy delays and stranded passengers (Bachman, 2014; Aspire Aviation, 2014a). Norwegians LHLC strategy depends on a reliable airplane to make a profit, so the success of Norwegians business model will be inextricably linked to the performance of the 787 in the future.
86 Appendix D. Routes to New York
The first flights that will be analyzed are the routes to New York. Norwegian offers services to New York from Copenhagen, Stockholm, Oslo, London and Bergen. The first four of these have been researched. Norwegian is flying to John F. Kennedy International Airport (JFK), but LaGuardia (LGA) and Newark Liberty International Airport (EWR) are also options for the competition as all three airports serve the city of New York. On all flights to New York there is difference of around 6 to 7 hours between non-stop and direct, which means that the layovers are adding about 3 hours each way to the flight. SAS is the only other airline offering non-stop service from Copenhagen to New York. As can be seen in both table 6.2 and figure 6.6, Norwegian is offering much lower prices than SAS. The average fare offered by Norwegian is 36 percent lower than the one offered by SAS during this timeframe. Norwegian will be indicated with a red line in all following figures. Price differences of 200 to 300 euro can be seen frequently. But when compared to the main hubs of Europe, Norwegian is more expensive than flights with British Airways from London most of the time, although the difference is often slim. Both Paris and Amsterdam are also offering flights in the same price range, but flights from Frankfurt are clearly more expensive. On this route Norwegian is offering much lower prices than its direct competitor SAS, and only London can offer lower prices, but will this price difference be big enough for customers to go for an inferior product offered by British Airways because of a layover that adds at least six hours of flight duration? For the route London – New York all airports in London have been used as a possible departure or destination airport for the competition. Norwegian flies from London Gatwick Airport and is currently the only airline offering non-stop flights from Gatwick to New York. Table 6.3 and figure 6.7 show the details of this route, and all flights originating in London Heathrow have been non-stop flights to New York, offering direct competition to Norwegians non-stop flights. As can be seen Norwegian is not offering the lowest prices. It beats the fares offered by Amsterdam, Paris and Frankfurt most of time but London Heathrow is clearly offering lower prices. Especially in the first half of the timeframe the price difference between Norwegian and Heathrow is 100 to 200 euros, which is substantial. This is interesting as Heathrow is seen as a more expensive airport, so the difference in fares cannot be easily
87 explained by costs differences regarding the use of the airport. It might be explained by yield management of the airlines, as they might only offer a small amount of seats at low prices. Stockholm – New York can be found in table 6.4 and figure 6.8. They show Norwegian offering much lower prices than its non-stop competitor SAS, on average this difference is 42 percent. Its prices are mostly in the same range as the fares offered by Amsterdam, Paris and London. Only at the end of the timeframe is Norwegian offering substantially lower prices than all its competitors. Oslo – New York in table 6.5 and figure 6.9 shows a very competitive market, both Lufthansa and United Airlines are offering non-stop flights. On average Norwegians fares are 19 percent lower than Lufthansa’s and 11 percent lower than United Airlines’. On October 30 both airlines are showing much higher prices, but no explanation has been found for that. Again SAS is offering much higher fares, and London and Amsterdam are often offering slightly lower prices compared to Norwegian.
88 Table 6.2: Fares on route Copenhagen (CPH) - New York (JFK, LGA, EWR) Norwegian SAS AMS CDG FRA LHR CPH-JFK Flight duration 16h 16h 22h 23h 22h 22h Date Non-stop Non-stop 1 stop 1 stop 1 stop 1 stop 22/08/2014 666 1288 630 (KL) 577 (AF) 874 (LH) 791 (BA) 05/09/2014 505 723 540 (KL) 527 (AF) 717 (LH) 379 (BA) 19/09/2014 505 629 362 (AF) 362 (AF) 658 (LH) 378 (BA) 03/10/2014 505 709 494 (KL) 514 (AF) 642 (LH) 378 (BA) 17/10/2014 465 629 372 (KL) 676 (AF) 735 (LH) 378 (BA) 31/10/2014 438 723 358 (KL) 351 (AF) 599 (LH) 378 (BA) 14/11/2014 344 615 334 (KL) 332 (AF) 401 (LH) 354 (BA) 28/11/2014 344 615 333 (KL) 332 (AF) 402 (LH) 354 (BA) 12/12/2014 411 689 537 (KL) 438 (AF) 553 (LH) 394 (BA) 26/12/2014 693 883 801 (KL) 812 (AF) 1129 (LH) 538 (BA) 09/01/2015 331 615 333 (KL) 332 (AF) 402 (LH) 354 (BA) 23/01/2015 304 615 333 (KL) 332 (AF) 402 (LH) 354 (BA) 06/02/2015 478 615 334 (KL) 338 (AF) 402 (LH) 354 (BA) 20/02/2015 398 629 334 (KL) 338 (AF) 402 (LH) 356 (BA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Friday - Friday Search date: August 10, 2014
Figure 6.6: Fares Copenhagen – New York Copenhagen - New York 1400
1200
1000
800
600
400
200
Norwegian SAS AMS CDG FRA LHR
89 Table 6.3: Fares on route London (LCY, LGW, LHR, STN) – New York (JFK, LGA, EWR) Norwegian AMS CDG FRA LHR LGW-JFK Flight duration 14,5h 20h 22h 21h 15h Date Non-stop 1 stop 1 stop 1 stop Non-stop 24/07/2014 1113 968 (KL) 961 (AF) 1057 (LH) 965 (AF) 07/08/2014 1049 956 (KL) 973 (AF) 1021 (LH) 965 (KL) 21/08/2014 971 730 (KL) 755 (AF) 969 (LH) 688 (BA) 04/09/2014 700 709 (KL) 715 (AF) 789 (LH) 520 (UA) 18/09/2014 683 709 (KL) 736 (AF) 789 (LH) 515 (UA) 02/10/2014 639 709 (KL) 714 (AF) 773 (LH) 515 (UA) 16/10/2014 602 709 (KL) 715 (AF) 768 (LH) 515 (UA) 30/10/2014 564 561 (DL) 551 (AF) 785 (LH) 476 (UA) 13/11/2014 451 549 (KL) 551 (AF) 609 (LH) 476 (UA) 27/11/2014 462 545 (KL) 551 (AF) 609 (LH) 470 (UA) 11/12/2014 526 556 (KL) 549 (AF) 599 (LH) 476 (UA) 25/12/2014 602 522 (KL) 550 (AF) 645 (LH) 476 (UA) 08/01/2015 451 545 (KL) 551 (AF) 577 (LH) 470 (UA) 22/01/2015 413 545 (KL) 551 (AF) 577 (LH) 470 (UA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Thursday – Thursday Search date: July 18, 2014
Figure 6.7: Fares London – New York London - New York 1200 1100 1000 900 800 700 600 500 400
Norwegian AMS CDG FRA LHR
90 Table 6.4: Fares on route Stockholm (ARN) – New York (JFK, LGA, EWR) Norwegian United SAS AMS CDG FRA LHR ARN-JFK Airlines Flight duration 16h 17h 17h 22,5h 23h 23,5h 22,5h Date Non-stop Non-stop Non-stop 1 stop 1 stop 1 stop 1 stop 20/08/2014 612 728 1730 677 (KL) 352 (AF) 853 (LH) 604 (BA) 03/09/2014 418 589 685 363 (KL) 349 (AF) 632 (LH) 367 (BA) 17/09/2014 386 413 523 346 (KL) 345 (AF) 503 (LH) 367 (BA) 01/10/2014 386 511 642 346 (KL) 408 (AF) 481 (LH) 367 (BA) 15/10/2014 386 380 523 346 (KL) 345 (AF) 481 (LH) 367 (BA) 29/10/2014 418 n.a. 752 346 (KL) 361 (AF) 496 (UA) 367 (BA) 12/11/2014 321 n.a. 468 323 (KL) 323 (AF) n.a. 348 (BA) 26/11/2014 321 n.a. 468 323 (KL) 322 (AF) 396 (LH) 350 (BA) 10/12/2014 353 n.a. 468 370 (KL) 431 (AF) 385 (LH) 351 (BA) 24/12/2014 450 n.a. n.a. 346 (KL) 345 (AF) 594 (LH) 368 (BA) 07/01/2015 324 n.a. 468 326 (KL) 322 (AF) 385 (LH) 348 (BA) 21/01/2015 222 n.a. 468 323 (KL) 322 (AF) 386 (LH) 348 (BA) 04/02/2015 252 n.a. 468 323 (KL) 322 (AF) 386 (LH) 349 (BA) 18/02/2015 287 n.a. 468 323 (KL) 322 (AF) 382 (LH) 349 (BA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Wednesday - Wednesday Search date: August 11, 2014
Figure 6.8: Fares Stockholm – New York Stockholm – New York 1000 900 800 700 600 500 400 300 200
Norwegian SAS AMS CDG FRA LHR
91 Table 6.5: Fares on route Oslo (OSL) – New York (JFK, LGA, EWR) Norwegian Lufthansa United SAS AMS LHR Airlines (KLM) (British OSL-JFK Airways) Flight duration 15h 16,5h 16,5h 15,5h 22h 22h Date Non-stop Non-stop Non-stop Non-stop 1 stop 1 stop 21/08/2014 722 798 691 941 577 586 04/09/2014 421 326 326 644 332 350 18/09/2014 457 505 356 696 324 350 02/10/2014 457 455 455 644 398 350 16/10/2014 361 356 356 596 324 350 30/10/2014 397 735 735 644 324 350 13/11/2014 337 474 336 464 304 330 27/11/2014 337 n.a. n.a. 464 304 330 11/12/2014 373 647 547 464 451 360 25/12/2014 566 n.a. n.a. n.a. 526 n.a. 08/01/2015 313 516 516 464 331 330 22/01/2015 256 306 306 464 304 343 05/02/2015 277 306 306 464 304 343 19/02/2015 301 366 366 464 304 330 Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Thursday – Thursday Search date: August 13, 2014
Figure 6.9: Fares Oslo – New York Oslo – New York 800
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Norwegian Lufthansa United Airlines SAS AMS LHR
92 Appendix E. Routes to Los Angeles
Norwegian is flying to Los Angeles from four different cities: Copenhagen, Stockholm, Oslo and London. At the moment Norwegian suspends its flights from Oslo and Stockholm after October, so the research was only able to compare prices until that time. London – Los Angeles is the only route where Norwegian has any non-stop competitors. The flight duration differences are larger here, they include differences of six hours to more than ten hours. It seems for this route flight duration might be more of an advantage for Norwegian, as these layovers add many hours each way. This can indicate that the completion cannot provide fast and efficient layovers for this destination. For every date the best and cheapest non-stop option from London Heathrow has been picked to compare to Norwegians non-stop flight from London Gatwick. Norwegian is the only airline that offers non-stop flights to Los Angeles from Gatwick. As can be seen in figure 6.10 Norwegian is offering the lowest prices on all dates except the starting date. It is often around 100 euros cheaper than the non-stop flights offered from Heathrow, and the average difference is 9 percent. The gap between the fares offered by the airlines flying from the other three European hubs is much larger, with price differences of around 200 euros for flights from Paris and Amsterdam and up to 300 euros for flights from Frankfurt. On this Route Norwegian is clearly offering the cheapest prices. The route Oslo – Los Angeles in table 6.7 and figure 6.11 shows Norwegian closely on par with offerings from SkyTeam, who mostly fly from their main hubs in Amsterdam and Paris. Star Alliance member United Airlines is offering much lower prices than Norwegian here using its North American hub. United Airlines on three out of five dates is offering prices 200 to 300 euros lower than Norwegian. Even though Norwegian is the only one offering non-stop service, with these kind of price differences customers might be tempted to fly using a layover. Stockholm – Los Angeles in table 6.8 and figure 6.12 shows Norwegian and British Airways, using its Heathrow hub, closely matching each other’s fares. Especially on the first three dates they are substantially cheaper than flight from the other three hubs. As Norwegian is again the only one offering non-stop service, it is in a good position here as the competition is not offering significantly lower prices.
93 On the route Copenhagen – Los Angeles in table 6.9 and figure 6.13 Norwegian is again in fierce competition with British Airways. This time Norwegian is offering lower prices more often, but again the differences are slim. The price difference between Norwegian and offers from Amsterdam and Paris are much higher, showing differences of as much as 1000 euro on 21st of August between Norwegian and Air France. On most of the routes to Los Angeles only British Airways using their Heathrow hub is able to compete against Norwegian, and United Airlines is the only one offering much lower prices. This might be possible because of their bigger presence in the United States as they are a North American company, which means they should have a better competitive advantage in the United States compared to their European counterparts.
94 Table 6.6: Fares on route London (LCY, LGW, LHR, STN) – Los Angeles (LAX) Norwegian AMS CDG FRA LHR LGW-LAX Flight duration 22h 28h 27h 33h 22h Date Non-stop 1 stop 1 stop 1 stop Non-stop 20/08/2014 1137 1116 (KL) 1037 (AF) 1220 (LH) 908 (BA) 03/09/2014 749 956 (KL) 940 (DL) 1131 (LH) 817 (UA) 17/09/2014 712 839 (DL) 958 (AF) 1016 (LH) 763 (NZ) 01/10/2014 712 839 (DL) 830 (AF) 869 (LH) 817 (UA) 15/10/2014 636 818 (KL) 818 (AF) 852 (LH) 738 (NZ) 29/10/2014 599 705 (KL) 676 (AF) 705 (LH) 594 (NZ) 12/11/2014 474 667 (KL) 674 (AF) 794 (LH) 599 (NZ) 26/11/2014 474 672 (KL) 674 (AF) 747 (LH) 599 (NZ) 10/12/2014 586 672 (KL) 676 (AF) 765 (LH) 644 (NZ) 24/12/2014 636 838 (KL) 863 (AF) n.a. 648 (NZ) 07/01/2015 561 713 (DL) 683 (DL) 773 (LH) 619 (NZ) 21/01/2015 474 672 (KL) 674 (AF) 689 (UA) 599 (NZ) 04/02/2015 474 674 (KL) 674 (AF) 689 (UA) 599 (NZ) 18/02/2015 474 674 (KL) 674 (AF) 764 (LH) 594 (NZ) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Wednesday – Wednesday Search date: August 10, 2014
Figure 6.10: Fares London – Los Angeles
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Norwegian AMS CDG FRA LHR
95 Table 6.7: Fares on route Oslo (OSL) – Los Angeles (LAX) Norwegian One World Sky Team Star Alliance
Flight duration 21h 32h 30h 31h Date Non-stop 1 stop 1 stop 1 stop 24/08/2014 926 762 (BA) 886 (KL) 614 (UA) 07/09/2014 542 707 (BA) 594 (KL) 345 (UA) 21/09/2014 375 526 (BA) 370 (DL) 363 (UA) 05/10/2014 542 401 (BA) 584 (KL) 349 (UA) 12/10/2014 445 479 (BA) 344 (DL) 363 (UA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Sunday – Sunday Search date: August 12, 2014
Figure 6.11: Fares Oslo – Los Angeles Oslo - Los Angeles 1000
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Norwegian One World Sky Team Star Alliance
96 Table 6.8: Fares on route Stockholm (ARN) – Los Angeles (LAX) Norwegian AMS CDG FRA LHR
Flight duration 22h 28h 31h 29h 30h Date Non-stop 1 stop 1 stop 1 stop 1 stop 20/08/2014 871 1210 (KL) 1192 (AF) 1228 (LH) 782 (BA) 03/09/2014 537 954 (KL) 1043 (AF) 1002 (LH) 465 (BA) 17/09/2014 418 627 (KL) 742 (AF) 773 (UA) 478 (BA) 01/10/2014 537 459 (KL) 506 (AF) 516 (LH) 493 (BA) 15/10/2014 450 461 (KL) 411 (AF) 516 (LH) 481 (BA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Wednesday – Wednesday Search date: August 10, 2014
Figure 6.12: Fares Stockholm – Los Angeles Stockholm - Los Angeles 1300
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Norwegian AMS CDG FRA LHR
97 Table 6.9: Fares on route Copenhagen (CPH) – Los Angeles (LAX) Norwegian AMS CDG FRA LHR
Flight duration 22h 30h 29h 29h 28h Date Non-stop 1 stop 1 stop 1 stop 1 stop 24/07/2014 1403 1488 (KL) 2037 (AF) 1837 (LH) 1604 (BA) 07/08/2014 1162 1517 (DL) 1669 (AF) 1011 (US) 1089 (UA) 21/08/2014 719 1240 (KL) 1756 (AF) 897 (UA) 769 (BA) 04/09/2014 559 852 (KL) 1173 (AF) 699 (LH) 614 (BA) 18/09/2014 625 942 (KL) 828 (AF) 909 (LH) 614 (BA) 02/10/2014 599 875 (KL) 1012 (AF) 931 (LH) 594 (BA) 16/10/2014 531 808 (KL) 677 (AF) 668 (LH) 594 (BA) 28/10/2014 599 744 (KL) 660 (AF) 837 (LH) 527 (BA) 11/11/2014 411 610 (KL) 442 (AF) 541 (LH) 527 (BA) 25/11/2014 438 601 (KL) 442 (AF) 540 (LH) 527 (BA) 09/12/2014 505 688 (KL) 776 (AF) 571 (LH) 527 (BA) 23/12/2014 625 805 (KL) 975 (AF) n.a. 576 (BA) 06/01/2015 491 783 (KL) 764 (AF) 628 (LH) 533 (BA) 20/01/2015 371 449 (KL) 447 (AF) 581 (LH) 527 (BA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Thursday – Thursday until the end of October, afterwards Tuesday – Tuesday Search date: July 17, 2014
Figure 6.13: Fares London – Los Angeles Copenhagen - Los Angeles 2100 1900 1700 1500 1300 1100 900 700 500 300
Norwegian AMS CDG FRA LHR
98 Appendix F. Routes to Florida
Norwegian is offering services to two destinations in Florida. It is flying to Fort Lauderdale, which is located north of Miami and to Orlando, which is located in the middle of Florida. Flights are offered to Fort Lauderdale from Copenhagen, Oslo, Stockholm and London. Orlando is only served on one route, which departs from Oslo. On all the routes to Fort Lauderdale there is no other competitor offering non-stop flights to this destination. For all these routes research has also included flights to Miami (MIA), as this city is located near Fort Lauderdale. Norwegian has a very strong position regarding the flight duration on most of these routes, as the difference can be more than 15 hours on some routes using a layover. And this is often the best case scenario for these flights using a layover, so the difference will be even larger in many cases. Figure 6.14 shows Norwegian has the lowest fares on Oslo – Fort Lauderdale. Only United Airlines is offering flights to Fort Lauderdale using a layover, all the other offers are flights to Miami using a layover. United Airlines is also offering most of the flights to Miami, and these prices are very similar to what United Airlines is asking for flights to Fort Lauderdale. Two peaks can be seen in the offers from United Airlines on the 27th of October and the 24th of November, where both flights to Fort Lauderdale and Miami are around 200 euros more expensive than Norwegians fares. Overall Norwegian is offering the lowest prices most of the time, and being the only one offering non-stop flights this can be seen as a very good competitive position on this route. Fares for Stockholm – Fort Lauderdale can be seen in table 6.11 and figure 6.15. There were no competitors offering any non-stop flight to both Fort Lauderdale or Miami. All three alliances fly to Miami, and Norwegian is offering competitive prices. Especially in the first half of the timeframe Norwegian is clearly offering the lowest fares, but in the second half differences of around 100 euro can be seen compared with offers from Sky Team and Star Alliance. On the route Copenhagen – Fort Lauderdale there were again no other competitors offering non-stop flights. The only other airline that offered flights to Fort Lauderdale from their hub was Air Canada. But their fares are overall higher than Norwegians fares, except for the final two dates. The alternative to Miami is only offered frequently from London Heathrow by British Airways, and their prices match Norwegians prices. Flights with layovers in Paris or Frankfurt
99 are not offered as frequently, so they are not included in figure 6.16. This route shows Norwegian in a strong competitive position with their low prices. London – Fort Lauderdale is offering some non-stop competition for Norwegian, as non- stop flight are offered to both Fort Lauderdale and Miami from London Heathrow. But the non- stop flights offered by Condor Flugdienst and Delta were only available on a few dates, making it impossible to offer a good comparison. There were no good cheap alternatives offering services to Fort Lauderdale using a layover, so these have not been included in the research. Only non-stop flights to Miami can be used to compare, and Norwegian is offering lower fares for almost all dates available, and on average Norwegian is offering 9 percent lower fares. US Airways is very competitive on this route with a constant ticket price of 555 euro. The final route to Florida is Oslo – Orlando. There were no competitors offering non-stop flights to Orlando or Tampa, which is also located in the center of Florida. Figure 6.18 shows Norwegian is offering the lowest fares on almost all dates. United Airlines is offering somewhat higher prices, and Lufthansa is offering much higher prices. Overall Norwegian is providing the lowest prices on most of the routes, although the price differences between its closest competitor is often slim. But except from London, Norwegian has a very good competitive advantage on the other routes as it is the only one offering non-stop service.
100 Table 6.10: Fares on route Oslo (OSL) – Fort Lauderdale (FLL) Norwegian United Airlines One World Sky Team Star Alliance OLS-FLL to FLL to MIA to MIA to MIA Flight duration 19h 34h 25h 30h 29h Date Non-stop 1 stop 1 stop 1 stop 1 stop 19/08/2014 446 763 797 (BA) 679 (DL) 671 (LH) 02/09/2014 348 356 387 (BA) 374 (AF) 356 (UA) 16/09/2014 271 356 386 (AB) 574 (AF) 356 (UA) 30/09/2014 361 356 386 (AB) 361 (AF) 356 (UA) 14/10/2014 398 354 387 (BA) 492 (AF) 356 (UA) 27/10/2014 422 604 593 (BA) 428 (AF) 594 (UA) 10/11/2014 374 371 410 (AB) 580 (AF) 371 (UA) 24/11/2014 374 n.a. 419 (BA) 379 (AF) 606 (UA) 08/12/2014 361 578 369 (AB) 379 (AF) 399 (UA) 22/12/2014 806 791 854 (BA) 800 (AF) 675 (UA) 05/01/2015 482 625 530 (AB) 557 (AF) 561 (UA) 19/01/2015 337 356 369 (AB) 379 (AF) 371 (UA) 02/02/2015 337 335 424 (BA) 378 (AF) 335 (UA) 16/02/2015 542 577 369 (AB) 379 (AF) 362 (LX) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Tuesday – Monday until the end of October, afterwards Monday – Monday Search date: August 13, 2014
Figure 6.14: Fares Oslo – Fort Lauderdale Oslo - Fort Lauderdale 900
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Norwegian United Airlines One World Sky Team Star Alliance
101 Table 6.11: Fares on route Stockholm (ARN) – Fort Lauderdale (FLL) Norwegian One World Sky Team Star Alliance ARN-FLL to MIA to MIA To MIA Flight duration 19h 25h 33h 33h Date Non-stop 1 stop 1 stop 1 stop 21/08/2014 418 1520 (BA) 669 (AF) 696 (UA) 04/09/2014 332 451 (BA) 434 (AF) 651 (UA) 18/09/2014 278 446 (BA) 424 (AF) 750 (LH) 02/10/2014 332 451 (BA) 607 (AF) 632 (UA) 16/10/2014 440 n.a. n.a. 641 (UA) 30/10/2014 570 451 (BA) n.a. 696 (SK) 13/11/2014 505 410 (BA) 378 (AF) 450 (UA) 27/11/2014 473 580 (US) 385 (AF) 421 (LX) 11/12/2014 473 461 (BA) 367 (AF) 401 (LX) 25/12/2014 1078 1101 (IB) n.a. 964 (TP) 08/01/2015 570 687 (AB) 391 (AF) 416 (LX) 22/01/2015 419 474 (BA) 378 (AF) 416 (LX) 05/02/2015 473 506 (BA) n.a. 400 (UA) 19/02/2015 635 515 (AY) n.a. 432 (UA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Wednesday – Wednesday until the end of October, afterwards Thursday – Thursday Search date: August 11, 2014
Figure 6.15: Fares Stockholm – Fort Lauderdale Stockholm - Fort Lauderdale 1200 1100 1000 900 800 700 600 500 400 300 200
Norwegian One World Sky Team Star Alliance
102 Table 6.12: Fares on route Copenhagen (CPH) – Fort Lauderdale (FLL) Norwegian Air Canada CDG FRA LHR CPH-FLL to FLL to MIA to MIA to MIA Flight duration 20h 27h 26h 26h 29h Date Non-stop 1 stop 1 stop 1 stop 1 stop 20/08/2014 404 1740 1257 (AF) 916 (LH) 1288 (BA) 03/09/2014 297 n.a. n.a. n.a. n.a. 17/09/2014 297 649 n.a. n.a. 449 (BA) 01/10/2014 398 732 427 (AF) n.a. 449 (BA) 15/10/2014 398 649 n.a. 765 (LH) 449 (BA) 29/10/2014 559 649 n.a. n.a. 449 (BA) 12/11/2014 398 404 n.a. n.a. 425 (BA) 26/11/2014 398 404 437 (AF) n.a. 425 (BA) 10/12/2014 438 642 508 (AF) 512 (LH) 518 (BA) 24/12/2014 840 1175 793 (AF) n.a. n.a. 07/01/2015 505 610 n.a. 472 (LH) 499 (BA) 21/01/2015 398 404 n.a. n.a. n.a. 04/02/2015 465 404 n.a. n.a. n.a. 18/02/2015 492 404 n.a. n.a. n.a. Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Wednesday – Wednesday until the end of October, afterwards Wednesday – Thursday Search date: August 10, 2014
Figure 6.16: Fares Copenhagen – Fort Lauderdale Copenhagen - Fort Lauderdale 1200 1100 1000 900 800 700 600 500 400 300 200
Norwegian Air Canada LHR
103 Table 6.13: Fares on route London (LGW and LHR) – Fort Lauderdale (FLL) Norwegian Condor Flugdienst Delta LHR LGW-FLL LHR-FLL LHR-FLL to MIA Flight duration 17h 18h Date Non-stop Non-stop Non-stop Non-stop 22/08/2014 928 1163 1324 1114 (BA) 05/09/2014 514 934 n.a. 555 (US) 19/09/2014 526 n.a. n.a. 555 (US) 03/10/2014 564 n.a. 991 555 (US) 17/10/2014 602 n.a. 1110 555 (US) 31/10/2014 489 n.a. n.a. 555 (US) 14/11/2014 514 n.a. n.a. 555 (US) 28/11/2014 476 n.a. n.a. 555 (US) 12/12/2014 677 n.a. n.a. 555 (US) 26/12/2014 971 n.a. n.a. 1126 (DL) 09/01/2015 493 n.a. n.a. 555 (US) 23/01/2015 451 n.a. n.a. 555 (US) 06/02/2015 467 n.a. n.a. 555 (US) 20/02/2015 451 n.a. n.a. 559 (VS) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Friday – Friday Search date: August 10, 2014
Figure 6.17: Fares London – Fort Lauderdale London - Fort Lauderdale 1200 1100 1000 900 800 700 600 500 400
Norwegian LHR
104 Table 6.14: Fares on route Oslo (OSL) – Orlando (MCO) Norwegian United Airlines British Airways Lufthansa
Flight duration 19h 31h 28h 26h Date Non-stop 1 stop 1 stop LHR 1 stop FRA 23/08/2014 424 879 1650 1930 06/09/2014 328 444 1650 1097 20/09/2014 328 523 1118 1769 04/10/2014 545 674 n.a. 1420 18/10/2014 424 643 n.a. 1330 01/11/2014 521 758 n.a. 918 15/11/2014 437 451 858 887 29/11/2014 340 480 848 781 13/12/2014 509 797 858 1076 27/12/2014 1042 1219 n.a. 1773 10/01/2015 364 465 858 787 24/01/2015 364 439 858 787 07/02/2015 485 476 848 787 21/02/2015 594 535 n.a. 787 Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Saturday – Saturday Search date: August 13, 2014
Figure 6.18: Fares Oslo - Orlando Oslo - Orlando
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Norwegian United Airlines Lufthansa
105 Appendix G. Routes to Oakland/San Francisco
Norwegian is offering flights from Stockholm and Oslo to Oakland International Airport. Oakland is located east of San Francisco on the other side of the San Francisco Bay, so this is a cheaper alternative to flights to San Francisco International Airport (SFO). On both routes there are no competitors offering non-stop flights to either Oakland or San Francisco. The differences in flight duration are also great, with often ten hours difference. This would increase the total flight time with 50 percent compared to Norwegian’s 20 hour flights. Using a layover to San Francisco will mean a strong increase of the flight duration, which only makes Norwegian’s product more attractive. Table 6.15 and figure 6.19 show the fares for Stockholm – Oakland. Most of the FSCs are offering flight to San Francisco with a layover at their main hubs, and these have been compared to Norwegians non-stop flights. Norwegian is offering low prices compared to all its competition, and there is no clear hub that is offering similar fares as Norwegian on all the dates. Fares for Oslo – Oakland are shown in table 6.16 and figure 6.20. This route is only scheduled until the end of October. On this route United Airlines from Star Alliance is offering lower prices than Norwegian, and the combination of Delta and KLM from SkyTeam is also offering prices either slightly higher or lower than Norwegians prices. Although differences are small, Delta is offering prices of around 100 euro lower on some dates which makes this route very competitive for Norwegian.
106 Table 6.15: Fares on route Stockholm (ARN) – Oakland/San Francisco (OAK) Norwegian AMS CDG FRA LHR to SFO to SFO to SFO to SFO Flight duration 20,5h 29h 33h 30h 31h Date Non-stop 1 stop 1 stop 1 stop 1 stop 19/08/2014 898 1286 (KL) 531 (AF) 928 (LH) 1471 (BA) 02/09/2014 518 776 (KL) 636 (AF) 745 (LH) 637 (BA) 16/09/2014 475 408 (KL) 413 (AF) 588 (LH) 502 (UA) 30/09/2014 475 424 (KL) 416 (AF) 636 (LH) 765 (BA) 14/10/2014 345 408 (KL) 412 (AF) 464 (LH) 435 (BA) 27/10/2014 540 541 (KL) 1016 (DL) 465 (LH) 550 (BA) 10/11/2014 345 373 (KL) 378 (AF) 445 (LH) 415 (US) 24/11/2014 345 373 (KL) 378 (AF) 445 (UA) 415 (US) 08/12/2014 399 373 (KL) 661 (AF) 445 (LH) 568 (BA) 22/12/2014 635 699 (KL) 863 (AF) 628 (LH) 650 (BA) 05/01/2015 420 669 (KL) 590 (AF) 515 (LH) 616 (BA) 19/01/2015 323 373 (KL) 378 (AF) 445 (LH) 473 (BA) 02/02/2015 399 373 (KL) 382 (AF) 451 (LH) 415 (US) 16/02/2015 540 373 (KL) 382 (AF) 445 (LH) 416 (US) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Tuesday – Tuesday until the end of October, afterwards Monday – Monday Search date: August 12, 2014
Figure 6.19: Fares Stockholm - Oakland Stockholm - Oakland 1100 1000 900 800 700 600 500 400 300
Norwegian AMS CDG FRA LHR
107 Table 6.16: Fares on route Oslo (OSL) – Oakland –San Francisco (OAK) Norwegian One World Sky Team Star Alliance to SFO to SFO to SFO Flight duration 20h 30h 29h 29h Date Non-stop 1 stop 1 stop 1 stop 20/08/2014 902 2164 (BA) 1037 (KL) 628 (UA) 03/09/2014 482 1531 (BA) 616 (KL) 373 (UA) 17/09/2014 458 994 (BA) 374 (KL) 373 (UA) 01/10/2014 361 903 (BA) 452 (DL) 442 (UA) 15/10/2014 398 505 (BA) 373 (DL) 373 (UA) Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a week trip, Wednesday – Wednesday Search date: August 13, 2014
Figure 6.20: Fares Oslo - Oakland Oslo - Oakland 2300 2100 1900 1700 1500 1300 1100 900 700 500 300 20/08/2014 3/9/2014 17/09/2014 1/10/2014 15/10/2014
Norwegian One World Sky Team Star Alliance
108 Appendix H. Routes to Bangkok
Besides all the routes to the United States, Norwegian is also offering flights to Asia. They offer two routes to Bangkok, flying from Stockholm and Oslo. Bangkok is also served by the two main carriers from the Gulf, so they have been included in this research as well. Dubai with Emirates, Doha with Qatar Airways and Istanbul with Turkish Airlines are shown next to Amsterdam, Frankfurt and London. On both routes there was also competition offering non-stop service. On both routes the competition that is using layovers is adding about ten hours to the flight duration, and all the hubs are offering flight durations of around 30 hours. Table 6.17 and figure 6.21 show the fares for Stockholm – Bangkok. Both SAS and Thai Airways are offering non-stop flights, but as flights from SAS were not available after October, only Thai Airways is taken into consideration here. Norwegian is clearly offering lower prices than Thai Airways, with average price differences 36 percent. For the time period before Christmas Norwegian is clearly offering the lowest prices compared to all the competition, after the holiday period Norwegian fares are slightly higher than fares offered by Emirates and Qatar Airways. Both Emirates and Qatar Airways are offering lower prices than the airlines flying from the other hubs, and they are Norwegians biggest competitors on this route. Appendix E also shows the fares for Oslo – Bangkok in table 6.18 and figure 6.22. On this route only Thai Airways was offering non-stop service during these times of the week. Again Norwegian is offering the lowest fares up until the Christmas period, and afterwards it is again offering prices slightly higher than Emirates and Qatar Airways. Thai Airways fares are much higher than Norwegians, with Norwegian fares being 25 percent lower on average. Norwegian is offering much lower prices compared to its non-stop rival on both Bangkok routes, and at both routes Emirates and Qatar Airways are proving to be its biggest rivals with their low prices.
109 Table 6.17: Fares on route Stockholm (ARN) – Bangkok (BKK) Norwegian SAS Thai AMS DOH DXB FRA IST LHR Airways Flight duration 22h 21,5h 21,5h 31h 31h 32h 30h 32h 33h Date Non-stop Non-stop Non-stop 1 stop 1 stop 1 stop 1 stop 1 stop 1stop 21/08/2014 531 605 629 1121 718 747 1029 776 1009 04/09/2014 379 605 627 575 504 534 644 736 633 18/09/2014 368 703 722 614 531 534 644 798 546 02/10/2014 401 607 629 689 533 716 820 1173 546 16/10/2014 433 607 627 817 506 534 944 1247 666 30/10/2014 531 n.a. 629 724 506 999 928 699 699 13/11/2014 444 n.a. 640 687 506 534 804 610 579 27/11/2014 466 n.a. 652 620 506 534 804 964 546 11/12/2014 661 n.a. 1531 862 629 901 977 953 945 25/12/2014 1171 n.a. 2333 1384 1126 1277 1501 1253 2103 08/01/2015 726 n.a. 1064 810 669 837 780 669 851 22/01/2015 596 n.a. 865 759 504 534 670 646 665 05/02/2015 661 n.a. 865 759 504 540 662 521 578 19/02/2015 737 n.a. 865 857 669 566 1055 521 781 Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a Thursday departure and next week Friday arrival Search date: August 12, 2014
Figure 6.21: Fares Stockholm - Bangkok Stockholm - Bangkok
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Norwegian Thai Airways AMS DOH DXB FRA IST LHR
110 Table 6.18: Fares on route Oslo (OSL) – Bangkok (BKK) Norwegian Thai AMS DOH DXB FRA IST LHR Airways Flight duration 23h 23h 30h 37h 32h 32h 32h 32h Date Non-stop Non-stop 1 stop 1 stop 1 stop 1 stop 1 stop 1stop 22/08/2014 604 n.a. 1058 953 941 1068 1093 03/09/2014 399 n.a. 665 540 503 682 509 581 17/09/2014 411 n.a. 665 504 503 694 509 581 01/10/2014 435 n.a. 665 625 517 742 1322 581 15/10/2014 411 n.a. 665 504 504 682 1119 669 29/10/2014 423 630 697 504 504 688 967 581 12/11/2014 423 630 665 504 503 705 736 581 26/11/2014 459 630 665 504 503 682 804 581 10/12/2014 567 800 730 504 513 753 733 669 24/12/2014 892 832 1320 922 849 1648 937 1195 07/01/2015 687 885 844 582 672 742 630 759 21/01/2015 591 885 796 554 503 682 630 639 04/02/2015 591 885 796 554 504 682 509 581 18/02/2015 633 885 869 582 503 1121 675 609 Fares are based on the best available fares, including taxes and are indicated in Euros Flights are based on a Wednesday departure and next week Thursday arrival Search date: August 12, 2014
Figure 6.22: Fares Oslo - Bangkok Oslo - Bangkok 1700
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Norwegian Thai Airways AMS DOH DXB FRA IST LHR
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