The Global Budget Airline Industry

Afzal Habib July 2009

Industry Backgrounder

Name: Budget Airline Industry, Low Cost Carriers (LCC’s), No Frills Airlines, Discount Carriers

Major Players:

North America: SouthWest, Jet Blue, AirTran, Westjet (Canada), Interjet, Volaris (Mexico)

Europe: Ryan Air, Easy Jet, Air Berlin, Virgin Airways (Subsidiaries in US + Australia)

Asia/Oceania: Jet Star, Air Asia, Tiger Airways, Cebu Pacific Air, Kiwi Air, Kingfisher Red (India)

Middle East/Africa: Air Arabia, Jazeera Airways, Fly Dubai (to begin this year), 1time, Atlas Blue

Business Model:

Airline companies that operate on a price leadership strategy, alternate model to the traditional ‘legacy carriers’.

They rely on high volume and capacity management while eliminating ancillary services to offer lower fares.

Low operating cost structure is achieved by:

o Use of exclusively online booking systems (eliminating fees to travel agencies)

o Use of single type of aircraft (eliminating costs for training, maintenance costs)

o Use of secondary airports outside of city centers (eliminating excessive landing costs and taxes)

o Multiple functions for human resources (flight attendants do bookings and check in),

o Flying during less busy times minimizing air traffic and increasing utilization (turnaround time).

o Often offer limited ‘traditional features’ like food and headsets for additional cost developing multiple

sources of revenue but cutting stocking and fuel costs.

Competitive Landscape:

- Budget Airlines compete with one another, but also with Legacy (or Traditional) carriers that offer full service flights

and classes of seating at a premium attracting the business traveler market.

- Seeing as how LCC strength lies in regional (short haul flights), in some geographic regions like South East Asia and

Europe, LCC’s also compete with high speed rail and bus services as well.

- Compete on low cost (price leadership) and efficiency/convenience in regards to schedules.

Crucial Figures:

LOAD FACTOR: Ratio of passengers to seats available [e.g. easy Jet = 81.5% vs. Ryan air= 83% (2004)]

CASM: Costs per Available Seat Mile [operating costs/(seats available x mileage flown)] in cents

RASM: Revenue per Available Seat Mile [revenues/(seats available x mileage flown)] in cents

Industry Average: CASM = 13.56¢, RASM = 12.01¢ (3rd

Q 2008)

Historical Roots:

Originated in America (Pacific Southwest Airlines) where it has now reached the maturity stage, but has rapidly

spread throughout Europe and Asia where it is still in its growth stages.

Sources Used In The Analysis:

World Low Cost Airline Congress: Annual meeting program notes- http://www.terrapinn.com/2009/wlac/programme.stm

Oliver Wyman: Growth Airline Economic Analysis Report- January 2009, Bob Hazel, Max Kownatzki et al.

Airline Business: Industry Magazine – Low-cost carriers: Ready for battle. April 24, 2009. Graham Dunn

Handbook of Low Cost Airlines- Strategies, Business Processes and Market Environment, Gross,S et al. Berlin 2007

Low Cost Airline News –Government & Regulation, Fares-Promotions-Fuel, Airports & IT. http://peanuts.aero/low_cost_airline_news/

Report on Business, Globe & Mail – 2009 airline industry losses to top $4.7-billion. June 04, 2009. David Chance

Interview with Industry Professional– July 20, 2009 – Andrew Watterson, Partner, Oliver Wyman Dallas Office

The Global Budget Airline Industry

Afzal Habib July 2009

Issues and Trends Analysis

1. Managing Ancillary Revenues: Budget airlines are working to offer some services for additional fees developing

secondary sources of income attracting business customers. This is increasingly important given the fact that those

airlines who have mastered this practice are leading the industry in profitability (e.g. EasyJet).

2. Increasingly Disruptive Government Regulations: Faced with the prospect of bailing out legacy carriers (often

state owned), Governments around the world are working with traditional carriers to curb the growth of LCC’s.

Regulations on marketing (full price not headline price), and stringent safety and maintenance regulations are

increasing costs in a low margin industry. Tourist/fuel taxes and the unavailability of landing slots for no frills airlines

has forced CEO’s to take on a larger policy and government lobbying roles for commercial freedoms.

3. Strategic Fuel Hedging: With fluctuating oil prices, developing and applying effective fuel hedging strategies has

become crucial for LCC’s. With 40% of CASM derived from fuel and tiny margins, bad predictions in either direction

could lead to the success or demise of a carrier. Fuel hedges act as an insurance policy to protect from shocks, but in

times of increasing costs firms heavily hedged are just delaying the inevitable. Need to stay nimble but protected.

4. The Changing Competitive Landscape: Threatened by LCCs and changing demand, conventional airlines are

developing low-cost subsidiaries to dip into low-cost markets. Subsidized by the parents’, these pseudo-LCC’s try to

price budget airlines out of the market squeezing them out of regional routes. Still, research shows the cost gap is

not shrinking, but prices are coming within striking distance. Some carriers are choosing to stick to their strengths

and cut costs to stay competitive, while others are adding deeply discounted premium services to steal customers

from the legacy carriers. Choosing which to pursue, is a critical competitive decision with huge financial implications.

5. Capacity Management in the Midst of Declining Demand: With looming threats like H1N1 and the financial crisis,

LCC’s are faced with the prospects of stagnant or declining demand. While well off compared to legacy’s, lower

Load Factors force LCC’s to cut capacity, preserve liquidity, and increase ancillary revenues to break even. With a

business model built on growth, capacity decisions are top. Deep discounts on capital equipment, and potential for

future growth, versus the risk of growing too quickly has rendered predicting demand is crucial to the LCC’s strategy.

6. Effective Use of Technology: A heavy reliance on online booking systems and an increasingly tech savvy customer

base, ensuring that IT and Wireless options (including cellular check in) are operational relatively quickly is key. LCC’s

seem to be lagging in technology when it comes to kiosks and check in which would decrease check in times and

labour costs. Also, security, simplicity, and most importantly cost effectiveness is a major challenge.

7. Finding A Place Called Home: Some airlines are choosing to develop low cost terminals adjacent to current city

centre terminals to improve value to customers and turn-around time (in EU & Asia). NA carriers are sticking to their

roots flying into distant airports with low or negative landing fees, while trying to build a hub to manage costs.

8. Long Haul Flights: LCC’s have begun their foray into long haul service (AirAsiaX/Virgin Blue) leading back to the

debate surrounding differentiating LCC’s from legacy carriers (as some services are required). Core features of cost

savings like Load Factor and turn-around time are difficult to improve so CEO’s are looking for growth at home first.

9. Environment and ETS: Prospects of emissions trading schemes and GHG reductions have led carriers to be proactive

and work to improve environmental efficiency which also helps their bottom lines. Needs to be managed closely as

it has future cost implications, marketing appeal for customers, and requires close management.

10. Channels: LCC’s divert up to 2% of their budget to advertising instead of traditional sales channel sales like travel

agents. Looking for new channels not dominated by traditional carriers leading to higher online presence.