Nicolas COMBE

THE AIRLINE INDUSTRY:

The Conquest of the Sky by Low-cost Carriers

Can the new Emperors of the Sky jeopardize Traditional Airlines?

Master of Arts, European Tourism Management University of Bournemouth September 2004

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ABSTRACT

This dissertation is aimed at a thorough understanding of the current European sky. It

deals with the emergence of low-cost carriers over Europe to determine and discuss

whether the new Emperors of the Sky can jeopardize the traditional airlines. The

author of the thesis has intended to show an unstable and attractive sector, the air

industry, which suffers from continuous change and evolution.

The thesis has been carried out thanks mainly to secondary data, namely relevant and

varied documentation collected by the author during the elaboration of the piece of

work. The primary data have been used with parsimony since the structure and the

implementation of the problem have certain similarities with documentary research.

However, it is a passionate sector and the discovery of the functioning of low-cost

carriers is essential to understand the central issue and the various sub-questions of

the dissertation.

The literature review enables the assessment of the fundaments of the low-cost

carriers: the major role of Europe with the liberal approach to fares, the removal of

all restrictions on low fares and the deregulation and the liberalisation of the air

industry in general, which have facilitated the proliferation of low-cost carriers. The

explanation of the different strategies led by powerful low-cost airlines is also a good

way of assessing this sector. Hence, the data analysis provides the core of the thesis

and then the answer to the initial question. In this chapter, the author has highlighted

the importance of a successful pioneer: Southwest, which has inspired some low-

cost carriers in Europe, and has presented precisely some representative low-cost

airline.

Besides, the research seems to show that the low-cost carriers do not really endanger

the traditional airline even though they propose the same service at a low fare.

Whereas they create a new market segment and do not cannibalize the traditional

airline, they just complete the air offer. The current danger could come from the

presence of mixed models, the “middle cost” adopted by certain low-cost carriers,

which aim at the same routes as the major airlines.

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Table of contents

Abstract: ii

List of Diagrams: ix

Acknowledgements: 1

INTRODUCTION: 2

1. General Introduction to the Dissertation: 2

1.1. Purpose of the dissertation: 2

2. Overview of the European Sky and the Low-cost Issues: 3

2.1. The current situation of the European air industry: 3

2.2. The cult of cost reduction: 5

2.3. The breakthrough of the low-cost airlines: 6

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METHODOLOGY: 8

3. Introduction and Objectives: 8

4. The Pivotal Aspect of the Research Question: 8

5. Methods and Sources Used: 9

5.1. Generalities: 10

5.2. Secondary data: 11

5.3. Primary data:

6. Criticism and Limitations of the Methods Used: 11

LITERATURE REVIEW: 13

7. Introduction and Prescriptions: 13

7.1. Objectives and recommendations : 13

7.2. Explanation of the choice and description of the literature review: 14

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8. Some Relevant Readings and Theories: 15

8.1. The major role of Europe: 15

8.1.1. Introduction: a history of intergovernmental regulation: 15 8.1.2. The creation of a common European Civil Aviation policy: 17 8.1.2.1. Conditions for change: 17

8.1.2.2. The three packages: 20

8.1.3. Commission power and State aid: 21 8.1.3.1. Introduction: 21

8.1.3.2. State aid and market competition in the airline industry: 22 8.1.3.3. The Commission promotes the low cost companies and regional

Development: 24

8.2. The challenge of low-cost carriers: Thomas I. Barkin/ O. Staffan Hertzell of McKinsey: 25

8.2.1. The challenge of low-cost competitors: 25 8.2.2. Understanding the competitors’ strength: 25 8.2.3. Assessing the threat to the core business: 26 8.2.4. Strengthening the position: 26

8.2.5. Developing a tailored strategy: 27

8.3. Michael Porter’s theory: 29

8.3.1. A sectional diagnosis: 29 8.3.2. Weak entry barriers: 30 8.3.3. Competitive Intensity: 30 8.3.4. Bargaining power of suppliers: 30 8.3.5. Bargaining power of customers: 30

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8.4. The different strategies led by the two low-cost leaders: Ryanair and EasyJet: 31 8.4.1. The strategies related to product: 31 8.4.2. The competitive strategies: 31 8.4.2.1. The flying costs : 32 8.4.2.2. The maintenance cost of the aircraft: 32 8.4.2.3. The depreciation cost of the aircrafts: 32 8.4.2.4. Taxes and insurance: 32

8.4.3. The strategies of development: 33 8.4.4. The financial strategies: 34 8.4.5. The management strategies: 36 8.4.6. The corporate strategies: 37 8.4.7. The marketing strategies: 38 8.4.7.1. The target: 38 8.4.7.2. The distribution policy: 38 8.4.7.3. The communication policy: 39 8.4.7.4. The price policy: 39

DATA PRESENTATION AND ANALYSIS: 41 9. Identification and Place of the Low-cost Carriers: 41

9.1. Introduction: 41

9.2. What is a low-cost carrier? 42

9.3. Review of the low-cost companies operating in Europe: 45 9.3.1. The complete listing of European low-cost airlines: 45 9.3.2. Targeting ten representative European low-cost carriers: 47

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9.4. Defining the pioneer: Southwest: 49

9.4.1. The product: Southwest bases its offer on a still similar product: 49 9.4.2. The Trade policy: 50 9.4.3. Innovating human resource management: 50

9.5. Functioning principle of a low-cost company: 51

9.5.1.An Economic model distinct from the traditional companies: 51 9.5.2. Analysis of the low-cost companies principles: 54 9.5.2.1. Aeroplanes with optimized capacity in seats: 54 9.5.2.2. Higher utilisation rate of the airplanes: 55 9.5.2.3. Optimised fixed cost: 55 9.5.2.4. Flying costs : 56 9.5.2.5. The costs of maintenance: 56 9.5.2.6. The costs of depreciation or the loan of the aircraft: 57 9.5.2.7. The “incompressible” costs : 57 9.5.2.8. The use of secondary airports: 59 9.5.2.9. Direct selling by call centre and Internet and lack of provision of services: 60 9.5.2.10. Unique and simple pricing: 61 9.5.2.11. The implementation of a simplified yield management:. 62

10. Can the low-cost carriers endanger the traditional ones? 64 10.1. The nature of the dangers: 64

10.2. Low-cost carriers create new markets: 67

10.3. The evolution of certain low-cost companies become a direct threat for the 72

traditional companies:

10.3.1. Retaliation by traditional companies: 73

10.3.1.1. Giving up certain routes or market share: 73 10.3.1.2. Pricing: the response: 74 10.3.1.3. Must the business model be re-evaluated? 75 10.3.2. The low-cost carriers can also be in danger: 76

10.3.2.1. An obligation to grow quickly: 76 10.3.2.2. The risks of the middle-cost model: 77 10.3.2.3. The loss of advantages linked to the maturation phase: 78

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11. What future for the low-cost airlines: 80

11.1. The future of low-cost carriers: 80

11.2. The expansion towards the Eastern countries: 82

11.2.1. Low-cost carriers in Central and Eastern Europe: 82 11.2.2. Low-cost airlines aim to grow as Europe expands eastwards: 83

CONCLUSION: 86

APPENDICES: 87

BIBLIOGRAPHY: 93

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List of Diagrams List of diagrams:

§ Diagram 1: The five force of the Michael Porter’s model. 29

List of tables:

§ Table 1: Financial situation of Ryanair/EasyJet compared to Air France. 35

§ Table 2: Targeting ten representative European low-cost airlines. 47

§ Table 3: The main functioning principle of a low-cost company and a

traditional one. 53

§ Table 4: Comparison of operating costs of a Boeing 737-300 from main

American airlines in 2000. 58

§ Table 5: Synthesis of the gap of overall operating costs on intra-

European lines. 59

§ Table 6: Example of evolution of price in EasyJet. 63

List of figures:

§ Figure 1: Market share of low-cost carriers. 44

§ Figure 2: Induction of EasyJet on the “Manchester/Liverpool-Nice” flight. 68

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§ Figure 3: Induction of Ryanair on the “Paris-Dublin” flight. 68

§ Figure 4: Induction of EasyJet on the routes departing from Geneva. 69

§ Figure 5: Induction of EasyJet on the Geneva-London route. 71

§ Figure 6: The illustration of the decrease in personnel costs on maturation

of the low-cost model. 78

1

Acknowledgments

I should like to express my sincere tanks to my supervisor Mr Jörge Elbe. I met him

during my second semester in Heilbronn, where he taught Marketing for tourism. I

actually chose him for his ability to listen to my expectations and to give me precious

advice to build up my thesis. His pluridisciplinary knowledge provided useful scope

and an objective opinion as regards my subject. I also chose him as well because of

his availability, his pleasantness and his real interest in my topic.

I should like to thank Ms Arracque for his friendliness and his availability as well as

Mr Marriolle for her objective opinion on the air transport industry

I would also like as well to express my gratitude to my friends who have postponed

their dissertations to the year 2004. We motivated each other during the elaboration

of the dissertation and we have also judged each other objectively on what has been

worked out.

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INTRODUCTION

I. General Introduction to the Dissertation:

1.1.Purpose and Objectives of the Dissertation:

The purpose of this dissertation is aimed at the understanding of the emergence of

low-cost carriers in Europe, as well as the dangers and the opportunities that such a

breakthrough involves. By extension, such a work considers deeply the world of air

transport and thus the stakeholders. The major companies naturally, but the accent

will be put on “the new Emperors of the Sky” who appeared approximately twenty

years ago: the low-cost airlines or carriers.

In order to comprehend precisely what is going on in the European sky, and as

regards the air industry, the consumers have seen a conquest of the sky by the low-

cost carriers. Consequently the main issue will be first presented and then developed

in this report. In fact, from an economic point of view, can the low-cost airlines

jeopardize the traditional ones, or can these two types of structure coexist without

cannibalizing each other? Moreover, the emergence of the “new Emperors of the

Sky” could, as well, endanger new low-cost entrants in a European sky. Such a

predicament cannot be defined with a single issue. The complexity of the air industry

raises various questions:

§ What is the current situation of the air market?

§ What is considered a low cost company? (By distinguishing traditional, low

and medium cost)?

§ Is there any place for just one low-cost company in a continent? (The

European continent for instance)?

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§ What are the new stakes for the traditional companies, low or middle cost?

Basically, the dissertation will be divided into four major parts. Firstly, a general

overview will go through the situation of the European sky and point out the low cost

issues.

Next, the literature review will aim to provide the theoretical bedrock of the thesis.

Then, the accent will be put on the account of the methods required to gather the data

in the dissertation.

Finally, the last major part will deal with the presentation of data and analysis, as

well as some implications of the research findings or recommendations.

2. Overview of the European Sky and the Low-Cost Issues:

2.1. The Current Situation of the European Air Industry:

The decade spanning the second and third millennia proved a tumultuous time for

the world airline business. The globalisation of the industry, accompanied by

market deregulation in Europe and parts of Asia, encouraged a newfound vigour

in a relatively staid industry.

These dynamics prompted the emergence of a multitude of price-based

competitors, together with a fundamental restructuring of most existing airline

companies and a consolidation of the airline industry.

The consolidation was symbolised, at first, by a wave of mergers and acquisitions,

particularly in the USA; and second, by the emergence of competing global

alliance groups.

These two phenomena are interrelated, with the largest survivors of the US

industry consolidation spearheading the formation of global alliance clusters. 1

Thomas C.Lawton, Cleared for take -off

4

Thus, nowadays, the airline industry tends to consolidate by strategic divisions of

airlines, guided by American or European airline. In 2001 these strategic divisions or

alliances can be broken down into five categories:2

§ The Star Alliance counts fifteen member airlines (including United Airlines,

Air Canada, Lufthansa…) with 19% in terms of share of the world air

passenger market,

§ Oneworld Airlines owns eight members (including American Airlines,

British Airways, Quantas…) with 13%,

§ The Qualiflyer Group has eleven participants (including Air Portugal,

Swiss…) with 10%,

§ Skyteam with member like Air France, Delta Airlines or Koreanair… with

9%,

§ The final group comprises Northwest Airlines, Alitalia and initially KLM

(which joined with Air France in October 2003) with 3%.

These strategic alliances quoted above propose various benefits to the Airlines such

as cost savings or improved service for customers. The drawback of this organisation

is the impact on the competition and the customers, with the establishment of an

oligopolistic structure of the airline industry. This structure also induces a come back

to deregulation norms in Europe and in the USA.

Moreover, there is one main difference between the airlines at the moment and those

in the seventies, in the USA or in the eighties, in Europe. Although most of the major

companies are well established, there is now a growth of low-cost alternatives.

For instance, the low-cost company Southwest Airline in the USA or Ryanair in

Europe provide a coherent alternative model for air transport. Their profits and

margins are almost the highest in the industry. Thus, the traditional companies are

required to re-engineer their products because of the fare prices and cost structure of

the low-cost carriers.

European’s 2000 Annual report on the EU air travel industry

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2.2. The Cult of Cost Reduction:

For any organisation, multiple and improving methods of operational cost are

required to be able to understand this issue. Ames and Hlavacek (1990) argued that

managing costs is at the heart of every successful company and that four related cost

truisms apply universally to every business situation3:

§ The first one, over the long term, it is essential to be a lower cost supplier,

§ The second one is to maintain a competitive position, the inflation-adjusted

costs of producing and supplying any product or service must continuously

decrease,

§ The third one, the true cost and profit of each product or service and every

customer segment must always be transparent,

§ The last one, a company should focus on cash flow as much as on profit

generation.

The trend of the cult of cost reduction is due to two present factors: the market

deregulation and industry globalisation that have amplified the competitive pressure

on the firms, reducing the margin for error and making the “cult of cost reduction”

essential. This observation applies especially to the commercial air transport

business. Efficient and constant cost control is crucial for most airline companies.

SAS learned this lesson during the 1980’s when the market driven philosophy caused

their costs to escalate unchecked (Robertson 1995, p 29).

However, the profit margin of most airline companies remains very low. There is a

slight disparity between the average total cost of any flight and the number of

passengers as well as the yield per passenger needed on this flight to generate profit

(some percentage as regards the traditional full- fare airlines). Therefore most airline

companies highly depend on market fluctuations and regulation as well as any

related fall in traffic. The solution to preserve a firm against this severe market

vulnerability will be to drop the operational expenses and increase employee/aircraft

efficiency and productivity.

Cleared for take off : Thomas C.Lawton

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The key factors affecting indirect costs for an airline are fleet structure, route

network and company policies on remuneration and work rules (Seristö and

Verpsäläinen 1997, P11).

These factors establish the total cost differences between airlines and the primary

ways in which an airline company can cut its costs relative to competitors and

develop its relative competitiveness. There are therefore multiple ways to achieve

this:

§ Flexible work rules,

§ Uniform fleet structures,

§ Point-to-point service operation between lower cost and secondary airports.

These cost reduction techniques are essential elements of the low-cost airline

business model.

2.3. The Breakthrough of the Low-Cost Companies:

The European airline industry underwent a major competitive shake up during the

1990’s; with the advent of full European airline liberalisation, a wide array of new

airline start-ups emerged within the European Union, many of them competing on

price with established carriers4. Nevertheless, a real study conducted by the British

Civil Aviation Authority (CAA) in 1998 showed the appearance in the 1990’s of a

third way to fly in Europe, namely the low-cost companies which can offer,

simultaneously, fares at the charter level and the ease of a scheduled service.

The CAA asserted that the breakthrough of a third way was certainly one of the most

fundamental developments in airline competition over Europe during the second part

of the 1990’s and probably one of the most significant for the future.

Cleared for take off Thomas C.Lawton

7

Besides, the Civil Aviation Authority claimed that the introduction of the new

Emperors of the Sky tended to stimulate the new air traffic without important

handicaps to the operations of incumbents. For example, when EasyJet and Debonair

started operations on the London-Barcelona route, the number of passengers

increased by a staggering 32% in the first year alone; and this compared with growth

of 7% in the previous year.

In the same way, traffic growth on the London-Glasgow route was double the United

Kingdom average in the twelve months following the entry of Ryanair and EasyJet in

1995. And more than 2.2 million people flew between London and Glasgow in

October 1996 compared with 1.8 million the previous year.

These figures tended to prove that the introduction of the low-cost carriers onto

domestic and international routes generally led to serious market stimulation. Thus,

their goal is not to win market share from traditional scheduled airlines but to create

actually new market segments. And this is possible by attracting people away from

other means of transport (train, boat) or in other ways by encouraging people who

rarely or usually never fly.

The low price offered by the low-cost airlines brings new customers into the airline

industry and increases the travel frequency. The new entrants put pressure on the

traditional airlines in order to put down the fares and put pressure on the charter

airlines to sell “seat only tickets”.

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METHODOLOGY

3. Definitions and Objectives:

This third chapter is devoted to the methodology, which the researcher used for his

piece of work. The purpose is to define and determine the various methods used to

collect the information and data. The stake of this part is, on the one hand to, explain

and discus why the author selected one method more than another one. And on the

other hand, which method is more appropriate to comprehend and fulfil the objective

of this thesis.

Basically, the section will firstly explain the purpose of this research that can be

resumed in a simple question. However from this unique issue will follow on the

framework of the thesis and namely the argumentation.

Next, the different methods used to gain the primary and secondary data will be

referred to. As regards this research, which is a pooling of multiple literature, articles

and documentations, the description of the origin and the reason while choosing the

data will be pointed out.

Finally, the critic ism and limitations of the methods used will be developed in order

to highlight the difficulties met while accessing or to analysing the data.

4. The Pivotal Aspect of the Research Question:

Building up an object for research consists of the elaboration of a question or an

issue where the researcher will figure out and find out the reality. It is a matter of

making a question, linking, articulating or asking for theoretical, methodological or

empirical objects. In that case the research question: -can the new Emperors of the

Sky jeopardize Traditional Airlines? - has never been asked so far.

9

This question should enable the reader to understand the current situation of the

multiple actors in the European sky. Theoretical objects can be concepts (the notion

of collection representation, the change, the knowledge or collective knowledge,

cognitive schemes…), explaining or descriptive models of phenomena or theories.

Bourdieu (1980) put the accent on this theoretical dimension that the object must

take on.

5. Methods and Sources Used:

The problem of the research was tackled at a micro level; the author aimed to show

the comparison methods of the low-cost model and those of the traditional one, as

well as the dangers of coexistence of the low-cost model and the traditional one in

the European air industry.

The scope of the study covered the European market even though the pioneer of the

low-cost model came from the United States, namely with the appearance of

Southwest Airlines who launched the concept of the low-cost airline. Therefore, the

history of this “pioneer” airline will be explained in the following chapter.

The researcher will investigate what is happening in the European sky by using a

range of techniques and skills that is available and will examine the application of

concepts or theories (which will be deeply developed in the literature review), issued

in the field of the airline industry.

Basically, two major types of data will be handled to build up the thesis:

§ Primary data: collected by the author, namely information held by the

companies or interviews. These types of data can be qualitative or

quantitative,

§ Secondary data: this concerns namely the books, articles, reports and surveys

conducted by other people.

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5.1. Secondary Data:

The overall argumentation was carried out thanks to the secondary data. The core

subject and the answers to the central issue could be found with difficulty elsewhere

than in precise and detailed documentation.

Hence, meticulous research and the sorting out of the literature were made in order to

fit as closely as possible to the research question. A difference must be noticed while

approaching the review of literature and the rest of the argumentation, namely the

last part of the thesis.

The purpose of the literature review was to put the subject matter into its context and

to look through the topic in a theoretical way, (strategies led the companies,

European political background) and will be dissected deeply in the following part.

In a global and objective view, the secondary data, used in the data presentation and

analysis, will point out the place of low-cost carriers in Europe and will discuss the

potential danger that the traditional carriers have to face and stress the enlargement

of the Eastern countries and the economic consequence that such a breakthrough

involves. The argumentation is made via the compilation and sorting out of the

diverse secondary data.

Basically, the secondary data can be broken down into four categories:

§ The specialised magazines and articles (Tour Hebdo, Tourisme Express,

Journal of Air Transport Management, Elin, Harward Business Review…),

§ The books with topics referring to either low-cost/traditional carriers or

theories on strategies and economic issues (Thomas C Lawton: Cleared for

Take Off, Stephen Shaw third edition: Airline Marketing und Management,

Pitman Publishing, etc…),

§ The Internet (daily news, websites dedicated to low cost airlines…),

§ The annual reports and information held by the companies (Ryanair,

Easyjet…).

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6.1. Primary Data:

Since the structure and the general issues of the dissertation seemed to be similar to

documentary research, it was therefore evident that the primary data was used with

parsimony and was not fundamental while elaborating the piece of work.

The two interviews carried out in March 2004, intended give the author a general

overview of the peak of the low-cost carriers and the economic stake of the

traditional airlines. The interviews showed the author the possible orientation for his

piece of work. The interviewees came from the air industry sector. -Gisèle Arraque

teaches at the Saint Exupéry Airport School and has been working for many years in

various airlines (Air Lib, Air France).

-Eric Marriolle, in charge of the transfer department service in a secondary airport

(Saint Etienne de St Geoirs), has worked in Aéris, a French middle-cost airline which

went bankrupt a few months ago. Basically, both interviewees did not answer the

questions exactly and did not really respect the order of the questions, but they talked

freely on different subjects with the author.

They actually gave their objective points of view on what is going on nowadays in

the European sky. Both interviews brought general ideas and opinions on the subject

matter.

6. Criticism and Limitations of the Methods:

This dissertation, which looks deeply into the airline industry and more especially

the strategic battle between the low-cost carriers and the traditional airlines, does not

really look like most traditional dissertation models. This thesis is actually

characterized by the inexistence of a detailed questionnaire or multiple interviews.

12

The point is that it is not always compulsory to compose a questionnaire if the theme

or the issue of the piece of research does not lend itself to that.

In this context, documentary researches together with as two interviews have been

carried out to build up this thesis.

The documentary research was the basis of the thesis. The “low-cost” problem is a

current and fashionable issue. Therefore, it is quite easy to get information about this

subject, on each written support (articles, books, theories, websites, and newspapers).

However it is perhaps the major drawback of the thesis. There is too much literature

on it, the most difficult thing is to sort it out and keep up the most representative and

coherent sources.

Besides, such a subject tends to be more descriptive by its approach than analytical

and in that case, interviews and a questionnaire did not really match the object of the

thesis for many reasons:

§ It is really difficult nowadays to predict what will go on the next months or

next years concerning low-cost airlines and their future development, and

what is valid today (alliances between firms, creation or bankruptcy of

airlines, eventual monopoly…) will not be automatically valid tomorrow,

considering the fact that the air industry is an unstable sector and is coming

through a period of mutation.

§ At this time, nobody can bring answers; everyone, namely the researcher and

the readers, can build up their own opinion about the questions,

§ The researcher would have liked to meet a person in charge of the

development of Ryanair or EasyJet, the two major low-cost airlines in

Europe. Unfortunately, the offices of these airlines are located abroad and it

is really difficult to contact these people.

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LITERATURE REVIEW

7. Introduction and Prescriptions:

7.1. Objectives and Recommendations:

One of the main characteristics of the air transport industry is perhaps its abundance

in literature. The air industry field is very often represented in specialised daily

newspapers, economics books, financial or management reports, and magazines.

Therefore, the goal of this seventh chapter is to show and describe the varied

literature and explain, in an objective approach, why the author chose such resources.

Basically, the literature review must include sources, which are relevant to the

research problem; it must define the problem in terms of previous search and thus

show how the piece of work of the author is better than anything that has been done

before. The research question is totally original; it is a current issue that has never

been treated before.

This seventh chapter aims to set the work of the researcher of a specific part of an

academic subject, the airline industry in which the marketing, the management or

strategic sector is primordial to assess, to discuss and to lead to the development of

the dissertation (commentaries) on what has been found out about the general

context. The goal of the literature is not only to write the summaries, the theories and

findings of another author’s piece of works, but must make out the general themes:

low-cost/fare airlines, strategies adopted by themes, the role of the European Union

(laws, enlargement).

One of the main important aspects of this seventh chapter is to ensure the coherence

of the chosen literature whose development (the findings) must corroborate.

14

Besides, there is an overall objective, a research question that has been broken into a

number of sub questions all along the development that the researcher will try to

answer as a result of the literature review.

7.2. Explanation of the Choice and Description of the

Literature Review:

Basically, four representative and detailed documents have been used to elaborate

the literature review. The goal is to highlight two major components that will allow

the readers to understand and to assess the context that is surely as important as the

research question:

§ The foremost role of Europe,

§ The understanding of the air industry by distinguishing and discussing the

different strategies, models and concepts implemented by the low-cost

carriers.

The first resource is largely devoted to the European Union and the political context

to define the axes of regulation, its history, as well as the major instances of the

Europe, the mechanisms of aid, the power of the Commission and its influence on

promoting the activities of airlines and namely the low-cost carriers.

The second resource is dedicated to the birth and the breach of the low-cost carriers.

It deals with argumentation to assess and perpetuate the key factors of success of

low-cost carriers. The various factors keeping low-cost carriers such competitive,

and how they can maintain their competitive advantage.

The third resource deals with the explanation of Michael Porter’s Model and its five

forces. Such concepts characterize quite well the structure and the situation of the

low-cost airlines (problems of new entrants, rivalry among industries etc…).

15

The last resource involves the detailed presentation of the strategies led by the two

leaders of the low-cost carriers: Ryanair and EasyJet. This document is pivotal in

terms of the comprehension of the business and activities that the low-cost carriers

endeavour to promote. All the business levels will be explored, the diverse strategic

orientations implemented by the firms will hence be considered.

8. Some Relevant Reading and Theories:

8.1. The major role of Europe:

8.1.1. Introduction: A History of Intergovernmental Regulation:

For the initiation of the European project, the transport sector has been rationally

viewed as a key component of the integration process. The post World War Two

period announced faster and cheaper means of transport and everyone could get

access to road, rail, sea and air transport. The central aim of the European plan, “the

free movement of peoples”, seemed to hinge upon developments in the transport

sector; air transport was the most important issue of this sector since the greatest

developments were occurring. Hence, civil aviation had the potential to play a

pivotal part in the political integration of Western Europe.

The jealous guarding of national autonomy in air transport matters was not an

attitude that existed from the industry’s inception. During its formative years,

global idealism had permeated the realm of air transport. Evidence of this spirit

was visible even at the 1944 Chicago Convention, which granted governments’

supreme authority over their national aviation arenas. The United States expressed

their wish for “open skies”, not subject to any national sovereignty.

16

In this opening address to the Chicago conference, Francklin D.Roosevelt

pronounced: “let us rather, in full acknowledgement of the sovereign rights of all

nations and the legal equality for all peoples, work together in order that the skies

of the world can be exploited by man for all mankind.5

The States agreed, in Chicago, that governments will negotiate bilaterally over

airline access to their national markets. The following Anglo American Bermuda

Bargain of 1946 set a standard for air transport deals and most international

agreements during the following years (Sampson 1984, p 72). The idealism of free

and equal access to air transport was therefore replaced by hard reality, as national

governments realised the economics and political significance of the air transport

industry. A limited form of global co-operation developed in the area of price setting.

Most governments recognized the difficulties involved in fixing seat prices

unilaterally or bilaterally and accepted the creation of an international body to deal

with this matter.

As part of the 1946 Bermuda Bargain, the contentious issue, of whether and how to

fix fares, was ceded by governments to the airline firms themselves, represented by

the International Air Transport Association (IATA). IATA was based on the belief in

firm regulation and control of air transport (Sampson 1984, p73).

In spite of this limited multilateral co-operation, the central aspects of national

aviation policy – market and industry regulation, aid, traffic rights and international

market access – were jealously guarded by all the governments. This idea of pooling

authority in these areas or of transferring power to a supranational body did not

appeal to most nations.

When the council of Europe was established, talks developed within that forum as to

the possibility of establishing regional co-operation in the sphere of air transport

(Sochor 1991, p.187).

Cleared for take off, Thomas C.Lawton.

17

Efforts to create an acceptable proposal for European air transport policy continued

throughout the following decades, both at an intergovernmental and a supranational

level (Sochor, the Politics of International Aviation, 1991, P 187).

One significant achievement was the 1954 creation of the European Civil Aviation

Conference (ECAC), a permanent regional air transport consultative organisation. In

1964, the European Commission pressed for the extension of the application of the

Rome Treaty’s provision for a common transport policy to include both air and sea

transport.

8.1.2. The Creation of a Common European Civil Aviation Policy:

8.1.2.1. Conditions for Change:

Efforts to create a common European civil avia tion policy were set in motion in 1974

when the European Court of Justice ruled on the general principles of a common

transport policy.

However, a majority of European Union Member States chose to block the

legislative development and enactment of this ruling prior to its inclusion on the

Single Market agenda (Kassim 1996, p196).

During the first half of the 1980’s, a global trend emerged towards greater economic

liberalisation, championed by the United States and the United Kingdom. The United

States led the way in world airline liberalisation. Passenger services within the

United States experienced fast deregulation. This trend was transferred across the

Atlantic as the decade progressed. From the middle eighties, Europe began the

tumultuous process of liberalising its airline industry.

18

Working in parallel with national governments and in alliance with the Court of

Justice, the European Parliament, industry pressure groups and the commission acted

as a policy leader in the field of airline liberalisation (Doganis 1991, p79; Button

1991, p.114-115).

The move towards a more liberal European policy for airlines began with the 1984

British and Dutch renegotiation of their respective bilateral agreements (Button and

Swann 1989, p262). In fact, the deregulation of air services between these two

countries may be seen as a significant break with the past and one of the first major

steps towards European-wide airline deregulation. It was followed by similar

agreements between the UK and Germany (1984), Luxembourg (1985) and Ireland

(1988). The British Government clearly perceived these arguments as setting the

scene for multilateral liberalisation at a European Commission level6.

As Doganis pointed out, the commission’s Directorate General for Transport was an

early advocate of liberalisation (Doganis 1991, p.82). As early as 1972, the

Commission advanced some suggestions concerning airline deregulation; the first

significant proposals came in 1978, when the commission issued a memorandum on

civil aviation (CEC 1994, 1) with the introduction of cheaper fares which increased

possibilities for market entry and developing a policy to monitor state aid to airlines7.

The first tangible European Commission- level initiative to result from this

Commission activism was the Council Directive on Inter-Regional Air Services of

July 1983, allowing air carriers using small seventy-seat or fewer planes to freely

develop air routes between European Commission regional airports (Doganis 1991,

p.82).

This was followed in 1984 by the Commission’s own air transport objectives,

outlined in a memorandum to the Council of Ministers8. Overall, the Commission’s

objectives were double:

British Department of Transport, pack on EC aviation liberalisation (1997) The Commission’s Civil Aviation Memorandum Number 1 (1979) Communication and Proposals by the Commission to the Council, Civil Aviation Memorandum N°2

19

§ To liberalise existing intra-Community air traffic,

§ To open-up the heavily protected national air transport market.

Both of these objectives were in harmony with the liberalisation principles of the

Single Market Programme and were to deregulate the air transport sector and open

the industry up to greater competition. The deregulation and increased privatisation

of this industry could therefore be seen as a “Single Market Success Story”.

European government did not freely embark upon more liberal air transport policies.

Although their Treaty obligations committed them to promoting and enforcing

competition rules, their status as major stockholders did not dispose them towards

increased competition against their national flag carriers (Sochor 1991, p.67). There

is evidence to suggest that the concurrent national/European Union liberalisation

process was loosely co-ordinated. Van Der Polder argues that there has been a

fractious but single-minded coalition of actors actively involved in the EU legislative

process for the airline industry.

These consisted of:

§ The national ministries, parliamentary committees, and government advisory

bodies of several Member States,

§ The Council of Ministers and the Committee of Permanent Representatives

(COREPER),

§ A number of airport authorities; individual airline companies; organisations

such as the Association of European Airlines, ECAC, and IATA,

§ European consumer associations; the European Commission, particularly the

Directorates for Transport, Competition,

§ The Environment and External Relations,

§ The European Parliament, primarily through the Committee for Transport

and Tourism

20

8.1.2.2. The Three Packages: Doganis (1994 p.15) argued that controls on market access, frequencies, pricing and

capacity served to disadvantage the travelling public. In particular, such controls:

§ Limited the range and choice of service quality and airline,

§ Protected high cost inefficient carriers and resulted in higher fares,

§ Excluded start-up low price competitors or those willing to innovate,

§ Limited international services to a few gateway cities.

Liberalisation of the airline industry was therefore normally justified on the grounds

that competition encourages the efficient provision of airline services, with carriers

offering good-quality services at the lowest possible cost and price.

It was with this objective in mind that the European Commission had two objectives

for the European airline industry: deregulating existing intra-European Community

routes and liberalising national markets. This was started with the introduction of a

three-steps-to- liberalisation approach, approved by the Council of Minister in

December 1987.

The European Union introduced three legislative packages, in 1987, 1990, and 1992,

which gradually eroded Member States rights to regulate the airline industry and

consolidated the emergence of a European policy for aviation.

Despite article 84 of the Rome Treaty explicitly advocating a common European

transport policy, it was only with the introduction of these three legislative packages

that liberalisation ensued (Kassim 1995, p.196).

Consecutive cabotage 9 was subsequently established, with full cabotage in place by

early 1997. Such a principle has resulted in airlines being permitted to fly between

destinations within another member State, following or preceding a flight from their

country of origin. “Eight freedom rights” referred to the elements of the eight global

air transport principles that have evolved since the 1944 Chicago Convention.

This principle guarantees that an airline can, on the flight,

serve two airports in another state.

21

Together these symbolise the essence of airline market liberalisation and all eight are

enshrined in the three packages of the European Union airline liberalisation.

Moreover, a more liberal approach to fares has been established, with the removal of

all restrictions on low fares. These pieces of legislation have together facilitated the

proliferation of low-cost carriers, thus ensuring greater competition within the

industry and cheaper flights for the consumer.

The right of landing slots at international airports is now also an established principle

within the European Union. The final package therefore consolidates full exercise of

the freedom of the air. The British Department of Transport argued that European

Union liberalisation measures have promoted and increased competition and served

to open up an assortment of new opportunities for European Union airlines.

As for the British Civil Aviation Authority (CAA), the three packages have

contributed significantly to the increased levels of competition in Europe.

The dominance of national carriers and at the same time, the emergence of low-cost

carriers proposing a low fare alternative has transformed the European sky; price

competition is growing, and competition on international routes is increasing (CAA

1995).

8.1.3. Commission Power and State Aid:

8.1.3.1. Introduction:

The concept of state aid is much wider than the notion of “subsidy”. It is a more

inclusive term and can involve tax concessions, state guarantees and state

participation in industry, as well as simple financial assistance (Cini and McGowan

1998, p.136). Its objectives are usually driven more by social concerns than by

market forces. For instance, state aid can involve money to improve the social

redundancies resulting from corporate or industry restructuring.

22

State aid can also be employed in cases of perceived market failure. This is

particularly relevant to air transport, as airlines perform functions analogous to utility

companies.

Many European flag carriers receive government subsidies to provide services for

remote regions of their countries where passenger numbers are low but where the

government is obliged to ensure a transport link.

The logic behind this form of subsidy is often flawed as regional carriers can

frequently provide a service to such regions without public support. In general, as

with most subsidies, state aid tends to distort the market. The air industry is a very

good example of this issue. The international Chamber of Commerce argued, “State

assistance to airlines, whether direct or indirect; should be deemed to distort the

market and to be detrimental to airlines and users”10.

8.1.3.2. State Aid and Market Competition in the Airline Industry:

During the 1991/2 period, the Commission undertook an inquiry, which resulted in

an inventory of existing state aid in the air transport sector11. The report revealed that

several airlines were benefiting from state intervention, often direct operating aids or

aids aimed at improving the airline’s financial structure.

Several potential state aids in the form of exclusive rights concessions were also

revealed. In response to these findings, and complaints by various Member State

governments and airline companies, the Commission, in the summer of 1993, set up

a committee of experts, the “Comité des Sages” for air transport, for the purpose of

analysing the situation of Community civil aviation and making recommendations

for future policy initiatives; Within this study, the group devoted some attention to

the state aid issues.

10 State Aid to Airlines, Commission on Air Transport, 13 June 1995 11 Report by the commission to the Council and the European Parliament on the evaluation of aid schemes established in favour of Community air carriers, 19 March 1992

23

Its conclusions, released in a 1994 report, that the Commission were driven by

principles of competition, rather than the notion of national prestige. The “Comité”

argued that access to finance should be equal, regardless of an airline’s size or

ownership. Moreover, a state should not give preferential treatment to an airline that

it owned or partly owned.

All domestic-based airlines should be equal and none more than others. On this

point, the “Comité” argued that the surest way to avoid preferential treatment would

be to privatise national flag carriers.

This would have the added benefit of enabling these companies to compete in what

was becoming an increasingly global business (Hanlon 1996, p.25-6). Overall, the

“Comité” stressed that the Single Market must be made to work by enforcing its

rules and addressing sensitive issues such as state aid (Hanlon 1994, p.6). The

“Comité” acknowledged that many of the national carriers were not in a position to

compete unaided in a fair and open market.

Therefore, if privatisation were immediate and unconditional, a significant number

of these companies ran the risk of bankruptcy (Hanlon 1996, p.26). The solution

reached was an explanatory ‘one time, last time’ principle 12. The “Comité” conceded

that, for a brief transitionary period, some states would have to act to put airlines on

a normal commercial footing, the reasons for granting exceptions are essentially

political, (Hanlon 1996 p.21).

The principle was to provide government with a short transition period, during which

they were to launch their flag carriers on the path to market competitiveness and

private ownership.

12 Principle supported by liberal European governments as United Kingdom or Netherlands

24

8.1.3.3. The Commission Promote the Low-Cost Companies and the

Regional Development:

However, nowadays (February 2004) and with regard to the various rights and duties

of the European Commission, a major decision has been taken by the European

authorities for the future of air transport, guaranteeing full competition between the

carriers operating from regional airports. The Commission actually allocates some

aids, which have led to the absolute development of new routes, in clearly

established conditions.

On the other hand, other aids, allowed directly by the Walloon Region, are not

compatible with the good functioning of the internal market and will have to be

reimbursed. Thus, the Commission is on the road to establishing increased

competition that will lead the low-cost companies to develop in the European Union,

in accordance with equal rules of competition between companies and that the

consumers will be able to take advantage of.

Loyola De Palacio, Vice-chairwoman in charge of Energy and Transport outlined:

“This juridical decision is well balanced: it allows the instauration of better

transparency in the contractual relations between the airline companies and the

airports, particularly the regional ones”.

It also allows the development of the activities of the low cost carriers, which

respond to the consumers’ evident expectations while ensuring fair competition

conditions for all airline companies. All carriers must know the offered possibilities

and only real competition guarantees the consumers’ rights. The decision favours

regional development and will lead to an increased development of the low-cost

companies

25

8.2. The Challenge of Low-Cost Competitors:

Thomas I.Barkin/ O.Staffan Hertzell Of McKinsey

8.2.1. The Challenge of Low-Cost Competitors:

In many industries, long-established market leaders are under attack from low-cost

competitors. The banking insurance and retail sectors have all been faced with the

menace of upstarts. Despite the challenge, traditional players can deve lop a strategic

approach to combat low-cost competition, say Thomas I. Barkin, O.Staffan Hertzell

and Stéphanie J. Young, of McKinsey & Company.

Twice in the past two decades the American airline industry has been threatened with

low-cost competitors. The 1980’s saw the traditional carriers successfully beat off

almost all cute-price. “No-frills” service providers after the market were deregulated

in 1978. A decade later these carriers re-emerged, grabbing excess capacity caused

by aggressive expansion of the late 1980’s and depressed demand in the early

1990’s, when aircraft and staff became available at bargain prices. By slashing fares

and paying staff below-industry wages, low-cost airlines are now estimated to hold

15% of total air traffic in the United State of America.

The low cost systems, combined with high customer satisfaction, have produced

exceptional profit margins and growth compared with traditional carriers. In

industries where battles are being waged with low-cost competitors, traditional

suppliers should follow a five-step strategic approach to address the competitive

threat as outlined in the following sections.

8.2.2. Understanding the Strengths of the Competitors:

It is nowadays primordial to understand what drives the success of low-cost

competitors. In the airline industry these operators enjoy specific cost advantages:

26

§ Lower input costs (e.g. cheaper labour, higher productivity, use of

outsourcing),

§ Cheaper product design (such as elimination of first-class seats, seat

assignments and food),

§ Cheaper process design (e.g. simplified and quicker boarding, disembarking

and aircraft turn-rounds, improved utilization of airport, equipment and

personnel).

All aimed at a target customer segment that value a reduced-price service.

8.2.3. Assessing the Threat to the Core Business:

Low-cost competition is not necessarily a threat in itself: it is only about an

assessment of the extent of the challenge by evaluating both the sustainability of

their success and the room for expansion in the existing market. It must be

underlined that the advantages based on input costs are likely to be less sustainable

than those based on product or process design: the wage-gap difference, in particular,

will eventually narrow.

Based on their cost advantages in the short-haul, high- traffic markets, low-cost

carriers may be cautious about operating lower-traffic routes, where utilization

advantages may be difficult to exploit.

8.2.4. Strengthening The Position:

Traditional airlines have reinvented their operations to defend their position by:

§ Cutting costs (such as adopting union contracts to pay new employees less, or

voluntary bankruptcy to circumvent high-wage contracts),

§ Embarking on expansion programs,

§ Introducing more efficient planes,

§ Undertaking acquisitions to rationalize excessive costs.

27

On the revenue side, they have:

§ Built up large hub-and-spoke networks, creating economies of scale to

dominate certain regions,

§ Introduced frequent-flyer programmes to reward loyal customers,

§ Developed yield management systems to match the fares of low-costs rivals

on some seats without diminishing total revenue.

In addition, the traditional players are cutting costs more aggressively than before, so

that the cost gap with low-cost carriers has narrowed, and they have invested heavily

in their best (full- fare) passengers.

8.2.5. Developing a Tailored Strategy:

After having strengthened their overall position, the next challenge is to develop one

of four basic strategies tailored to market conditions.

The choice will depend on their own capabilities, the importance of the market, and

the characteristics of the market and the seriousness of the threat. The four strategies

are:

§ In the withdrawal strategy, certain markets are ceded to low-cost competitors

while shifting resources to more profitable routes. Taking into account the

impact on the remaining operations, the availability of other profitable

opportunities and the risk of strengthening newcomers, and also being aware

that large-scale withdrawal may reduce customer loyalty.

§ Head-on competition involves matching prices and using aggressive

marketing tactics. This may prevent a new competitor from establishing a

foothold in the market, limit the growth and encourage it to avoid future

competition. The key here is restructuring the cost base.

28

Although problems could result from union resistance, low employee morale

and customer confusion. This is not a popular strategy. An alternative is to

create a separate brand identity for a lower cost service.

§ In a coexistence strategy, the traditional players cede parts of its market to the

low-cost competitors; while avoiding losses associated with intense

competition. This option is attractive where a large premium segment exists,

although the risk is that the low-cost operator will begin chasing a larger

share of the market.

§ Joining forces involves the traditional players withdrawing from its

uncompetitive routes and entering into a marketing/service agreement with its

low-cost competitor; whereby the former operates the connecting and

premium routes and the latter serves the low-fare/leisure markets. This option

can bring attractive benefits to both sides, although the risk is again that the

low-cost carrier may grow at the expense of traditional operators.

Traditional players may also have the opportunity to go on the offensive, by seizing

any opportunities to shape the industry to their advantage. Very aggressive

competition with new entrants in the early stages may do the trick. New entrants can

be checked by steering them toward markets in which established players may

coexist or withdraw. While this is a costly strategy in the short term, it can pay off in

the longer term. Threat can also be pre-empted by introducing a low-price and low-

cost products.

This may keep new competitors out of the market by reducing fares while cutting

costs enough to maintain profits. Key resources can be cornered: some traditional

airlines have been able to take control of landing slots and gates at certain airports,

thereby limiting competitors’ ability to operate.

The airline industry is a good example of traditional market players fighting against

the serious threat of low-cost competitors. The winners will be those that understand

the competition, think market by market, and exploit any opportunity to change the

structure of the market.

29

8.3. Michael Porter’s Model:

8.3.1. The Sectional Diagnosis:

In order to evaluate the low cost situation, an external diagnosis on the Porter’s

model considers the different market actors and the pressures that they put on the

given sector.

Diagram 1: The Five Force of Michael Porter’s Model:

(Source www.quickmba.com).

Industry competitors Rivalry among existing Firms

Bargaining power of suppliers

Bargaining power of customers

New entrants entry barriers

Threat of substitute products

30

8.3.2. Weak Entry Barriers:

The model is already taking shape. It is actually simple to subscribe to it. Therefore

the low-cost model gets nearer the start-up development model. The products of

substitution: it performs the same functions for really good value for money. The air

industry saw the arrival of the Eurostar, Thalis and other means of transports: car,

boat, etc. The cost change of the means of transport is nearly worthless which does

not really develop customer loyalty. The customers think in terms of arriving at a

place with a high propensity to change

8.3.3. Competitive Intensity:

Ryanair, EasyJet, Go, Buzz and other low-cost companies namely Eastern low-cost

companies, are still announced: Air Polonia. The air landscape has become more

complex with the uninterrupted entry of new entrants: Tour operators are launching

as well into low-cost companies by using a large customer network.

8.3.4. Bargaining Power of Suppliers:

It must be underlined that the transfer cost of suppliers is high which involves certain

dependence for the firms. The aeroplanes influence the flight quality; these are

indissociable products and there are no replacement products.

8.3.5. Bargaining Power of Customers:

Internet, Leisure: the customers have complete information; there is a

democratisation of the information. They can therefore compare prices and boycott

certain airline companies. However, the customers can find replacement products.

The low-cost phenomenon is reflected in the creation of new customers (member’s

concept) with attractive prices.

31

8.4. The Different Strategies Led by the Two Low-Cost

Leaders: Ryanair and EasyJet:

8.4.1. The Strategies Related to Product:

To gain a position of leader, Ryanair has:

§ Production costs lower than the other actors of the market due to experience

effects which enable economies of scale,

§ Better known and a stronger image,

§ Powerful communication which uses an existing mark,

§ A certain ability to influence the policy and behaviour of the competitors

All these characteristics help Ryanair to establish its position as a leader on the

market.

To conquer a dominant position on a market and preserve it, the leader must:

§ Dispose of a penetration anteriority on the market,

§ Have been the first to adopt the considered product, a penetration strategy

rather than a skimming one,

§ Possess financial, technological or commercial resources superior to those of

the competitors.

8.4.2. The Competitive Strategies:

In a market where services offered by the various actors are basically similar, the

low-cost airlines chose to lead a cost dominating strategy.

This strategy position can be resumed to a primordial goal: the minimization of its

costs.

32

To keep up this competitive advantage, the firm will have to control direct costs of

fabrication, conception, marketing and distribution, as well as bureaucratic or

financial costs. Those economies of cost have the refore repercussions on prices.

Besides, it is this dominating strategy that allows the company, without increasing its

margins, to propose competitive prices. Thus, the firm is constrained to make a lot of

sales to amplify its business. There is a huge difference and it is relative to various

savings broken down into the following costs:

8.4.2.1. The Flying Costs:

The fuel costs are approximately the same as for the major airlines. However, the

low-cost companies reduce the staff on board and their services such as lunch; fo r

instance, EasyJet uses on average three people against four/five for the major

companies.

8.4.2.2. The Maintenance Costs of the Aircraft:

The business model recommends a unique type of plane. Therefore there is an

economy of scale on maintenance, staff training and the licences of flights.

8.4.2.3. The Depreciation Costs of the Aircraft:

The depreciation is very weak since the low cost companies are using quite recent

aeroplanes: Boeing 737.

8.4.2.4. Taxes and Insurance:

Concerning the insurance and the taxes of flying, the low-cost companies are not

allowed to make savings.

33

However, landing into secondary airports enables them to pay much lower airport

taxes than on big hubs. The cost per seat of low-cost companies is as a result

relatively diminished.

Using new technologies of communication also diminishes many functioning costs:

the Internet. Actually, the sale of the flight tickets is done on line: direct selling.

There is no commission to intermediaries any longer, such as travel agencies.

Moreover the low-cost companies save by respecting two rules:

§ More seats in every aeroplane : the reduction of space between the rows, the

lack of toilets and the suppression of first and business classes allow the low-

cost companies to increase the capacity of their aircraft (120% more than the

major companies). Hence the seat/kilometre cost is necessarily lower.

§ A more intensive use of aeroplanes: this particularity is directly linked to

secondary airports and to the organisation avoiding the hubs. There are fewer

take-offs and landing on the runways, as well as less waiting at the end of the

runway. The time saved is thus significant; the aeroplanes fly 20 to 30%

longer than the aeroplanes of the traditional companies.

8.4.3. The Strategies of Development:

The low-cost companies adopt a strategy of internal growth (either by integration or

by diversification). Thus they can grow in the air industry market. This strategy is

possible thanks to market penetration: the insertion into a current given market

(development of products). The low-cost companies operate on the compounds of

global demand in order to increase the size of the global market by increasing the

frequency of use or by finding out new uses.

They increase their market share by diverting the consumers from the competing

products. However, internal growth also implies a strategy of market extension:

34

Ryanair:

§ Geographical expansion

EasyJet:

§ Aims to conquer new consumer segments (namely business class),

§ Growth by integration in order to grow among the subsidiaries,

§ Strategy of horizontal integration in order to reinforce its competitive

position by neutralising certain competitors namely the buying out of Go,

(former subsidiary of British Airways).

8.4.4. The Financial Strategies:

Low-cost carriers use the market as a lever. In fact, by informing the markets that the

goals of such companies contribute to the reductions of costs and hence the increase

of their profitability, such companies ensure an induced growth of the share prices. A

high share price protects the companies from possible predators.

35

Table 1: Financial Situation of Ryanair/EasyJet Compared to Air France:

(Source www.yahoo.com).

Financial information

EasyJet

Ryanair

Air France

Date of creation 1996 1985 Capital (number of shares)

391 672 036

7555 056 018

Market valuation (millions of pounds)

981 3360

Turn over (millions of pounds)

552 624 8080

Net profits (millions of pounds)

49 151 142

Price earnings ratio (pence)

14.61 20.3

Price earning ratio/market share price

17.69 21.94

Since its introduction in the share market, the price of the Ryanair share has been

multiplied by three. The price of the EasyJet share introduced into the share market

one year after, is noticeably in regression in comparison with its introduction price.

This phenomenon is due to two factors: the “bulimia” of EasyJet and its

diversification (namely through its external growth by buying out Go, or by

exploiting more routes than its competitor), in comparison with Ryanair that does not

lead these strategies.

36

8.4.5. The Management Strategies:

The management policy of the low-cost companies aims to be innovating and young.

The companies rely on their staff in order to grow. The hierarchy is composed of the

following axes:

§ A flat structure: their structures are light and their organization is flat. Hence,

the low-cost company’s management is placed at three or four stages from

the most modest employees. If Taylorism reduced employees considerably,

the low-cost companies prefer to reduce the size of the managerial staff,

etc…

§ Selective employment of staff: “Passionate”, “enthusiastic, “the best”…are

the key words which defined the “perfect” employee. Actually, it is rather the

human qualities, the motivation and the character of the applicant, which will

be evaluated by the low-cost companies’ managers. However these

companies tend to take on very few new employees.

§ Participative management methods: the organization of the work is founded

on the versatility of the staff. Each stockholder has multiple tasks to do and

various responsibilities as a real Chief Executive Officer. They have to

manage the costs, the people, adapt and react quickly. Even the manager can

carry out banal tasks. Each stockholder in the company must give their best

but it is quite worthwhile since the companies promise very quick career

evolution. Therefore, the average age of the managerial staff is very low.

§ A policy of high participation in the company’s profits: the remuneration

system is composed of an important variable part indexed on the quality of

the service and the gross trading profit. In EasyJet, for instance, the

remuneration of each employee includes a variable part.

37

This bonus represents approximately 10% of a pilot’s income and 35% of a

flight attendant’s income. This system incites people to work more and

seems to reduce absenteeism.

§ Powerful corporate culture: the low-cost companies also attach importance to

the atmosphere at work and the integration in the company: “casual day”

every day, “grill parties” every weekend and big parties twice a year. The

relationship between staff is natural and simple too.

§ The consequences: a working day is composed of around eighteen hours to make

achieve such work. Teleworking remains essential even though structures

welcome employees. Actually, the organization is free; there is no constraining

schedule, no waste of time in transport. Information is given as quickly as

possible thanks to the suppression of useless paper and the use of the Internet.

However staff turnover is very low; they are satisfied with their jobs and consider

themselves privileged people.

8.4.6. The Corporate Strategies:

EasyJet, the King of Discount has many its “Easy components” (Easyrentacar,

Easyeverything, EasyJet, Easy.com, Easymoney and Easyvalue). Easygroup has

adapted its business methods to the new technologies (namely the Internet to gain its

productivity and to overclass its competitors).

All its companies are already broken down all over Europe and are expected to

become a worldwide name in future years.

38

8.4.7. The Marketing Strategies:

8.4.7.1. The Target:

The low-cost companies aim at customers who wish to lower their transport

expenses or at customers looking for low fares, (major competitive advantage).

Usually, this type of discount offer develops the market by 5% and draws a new type

of customer without competing directly with the traditional companies.

The low-cost companies have certainly attracted customers from their traditional

competitors, but they have created a heavy traffic of induction (creation of a new

market). Actually, a huge part of the customers (business and leisure) prefer

nowadays the plane rather than terrestrial means of transport (principally the car) to

cover short distances. Hence the low-cost companies do not compete with the

traditional airlines but with terrestrial transport.

8.4.7.2. The Distribution Policy:

There is a large use of direct selling by call-centres and the Internet. The companies

do not show their seats in the booking system. (Sabre, Amadeus, Galileo). There is

no printing of flight tickets with the introduction of the principle of the electronic

ticket (e-ticket), reducing the ticketing costs.

The low-cost companies do not number the seats, which rules out the need to edit

boarding cards. EasyJet works mainly by Internet for its bookings (10% via call

centres and 90% via the Internet).

EasyJet axes its distribution on the Internet and uses all ways (the call-centres

promise a reduction of 5€ for each online booking. This type of commercialisation

aims to suppress two kinds of costs:

§ The commission to travel agencies (8%),

§ The transaction taxes linked to the booking system (3.5 % for each booking).

39

8.4.7.3. The Communication Policy:

The marketing axe is simple and revolutionary: to let the customer have the benefit

of an attractive price, the low-cost carriers take care of the transport, but only the

transport. The lack of travel agencies that promote the products of low-cost

companies has forced them to work with a large marketing and communication

budget to promote their offer:

§ No exhibitions,

§ No customer loyalty,

§ No correspondence,

§ Aggressive marketing (free phone numbers).

Ryanair does not need any travel agencies: a unique message, it is price! Michael

O’Leary does his commercials himself.

8.4.7.4. The price policy: While offering fares far lower than the competitors (from 30 to 60% cheaper), the

low-cost companies manage to show in terms of income per seat/kilometre, high

incomes thanks to high occupancy rate between destinations which correspond to a

high demand and on which the company offers very frequent flights with excellent

punctuality. Therefore, by limiting their offer principally to the use of mono-class

shuttle from airports that are not overcrowded and by suppressing transfer

constraints, they can offer low fares without restrictions.

Their fares are based on a unique principle, favouring simplified access to the offer:

only one-way flight tickets are sold, and an exclusive fare is offered for a given flight

at T time. (At T+1 time, this fare will be re-evaluated. Such a low fare is possible

thanks to:

§ Unique fares: no customer segmentation, a unique price for a given flight at

a T time,

§ Low fares,

40

§ No fare restrictions ,

§ No compensation for the flight tickets: no reimbursement and the slightest

modification (name of passenger, date) leads to additional costs.

Hence the passengers are not encouraged to make flight ticket modifications and this

induces saving as regards after-sales service,

§ A simplified yield management: in order to optimise the optimisation rate

of the aeroplanes and maximise the profit per flight, the strategy consists in

proposing the lowest fare for the bookings on a flight and then putting the

fares up progressively as soon as the customer gets closer to the departure

date or as the company has sold the number of places for a given flight.

EasyJet uses a very simple type of pricing policy for a customer doing his booking

himself. The company proposes only one fare range, without particular conditions

(no minimum journey duration, no return tickets, no Saturday night on the spot, no

different class pricing, no typological fares).

For instance, the prices put on advertising are either introductory prices, particularly

low, or a first price (14€.90 on a Paris-Nice for EasyJet). Ryanair offers slightly

different prices between the weekend and weekdays. And this leads to unit revenue

largely higher than the basic price. The first price on a Paris/Dublin amounts to

17€.99. The commercials put introductory prices forward. In reality, the price range

is composed of multiple prices.

The review of the relevant literature gave a precise idea of the functioning, the main

characteristics and the European political context, as well as all the analogies on

strategic existing models that can be found concerning low-cost carriers.

After setting the scene through the literature review, the research question – Can the

new Emperors of the Sky jeopardize the Traditional airlines? – must be discussed

and answered in the following chapter: the analysis and the presentation of the data.

41

DATA PRESENTATION AND ANALYSIS

9. Identification and Place of the Low-Cost

Carriers:

9.1 Introduction:

Although most of the international airline companies went through heavy losses in

their last financial report, the low-cost companies, relatively new in Europe, seem to

be successful.

Their stocks and shares are equal and even sometimes better than those of the

traditional airlines. Their growth, reaching 20% a year, has been progressing since

their creation.

However, the European low-cost companies did not invent a new economic model

for air transport.

This model was invented in the United States at the beginning of the seventies by

Southwest and such a system was set up in Europe a few years ago. Launched by

Ryanair in 1991, it is only in 1995 that a real network appeared.

However, the big traditional airline companies launched their low-cost subsidiaries:

§ Go created by British and sold again in 1998, bought out finally by EasyJet,

§ Buzz created by KLM in January 2000, (bought out by Ryanair),

§ Germanwings created by Lufthansa in October 2002.

42

Nowadays, three economic models exist:

§ The first is built on the basis of a structured network around one or more

transfer points: “the hubs”. Its efficiency is based on its ability to offer a

global service to their customers and enable them to travel all over the world

with a minimum journey time. It works on the differentiated fare and

optimised ways which need the implementation of the alliances between the

traditional companies,

§ The second consists of a development of a low-cost approach: the

development of a “point-to-point “ network, structured and organised basis

and proposing low fare regular flights without complementary provisions of

services,

§ The third rests on the concept of “charter flights”: the chartering of aeroplane

on a determined date and route, with low fares.

9.2. What Is a Low-Cost Company?

The concept of a low-cost company was born in the United States with the launching

of Southwest, and three Boeing 737. This company appeared in the wake of other

companies namely People Express. After thirty years, Southwest was in 2001 the

fourth American company with a traffic of 63.7 million passengers and a turnover of

$5.6 billion Dollars for 29 274 employees.

On the European continent, Ryanair initiated the movement in Ireland and in Great

Britain in 1991 before finding stances of growth in Europe at the end of the 1990’s.

The influence of the Southwest model has become evident.

Michael O’Leary, Chief Executive Officer of Ryanair pointed out : “all the

employees from Ryanair have carefully studied the methods of Southwest.

43

That was the way to act to make Ryanair work ” (Financial Times, 1998). Ryanair

strived, just like Southwest a few years ago, to take advantage of the process of the

liberalisation of the sky in Europe.

In 2000, there were six low-cost companies in Europe:

§ Ryanair, 5.6 million passengers,

§ EasyJet, 5.6 million passengers,

§ Basiq Air, 3.8 million passengers,

§ Virigin Express, 2.9 million passengers,

§ GO, 2.8 million passengers,

§ Buzz, 1.1 million passengers.

Within 2 years, the new entrants got in this new landscape. Four new supplementary

low-cost companies were born:

§ Germania,

§ Sky Europe,

§ BMiBaby,

§ Goodjet (went bankrupt in 2003)

…

In 2002, various low-cost companies followed the trend:

§ Flyeco,

§ Ciao Fly,

§ Airvia,

§ German wings…

The complete offer of low-cost carriers will be presented in the following chapters

The tour operators are going into the low cost system as well, working on a wide

network of customers:

§ MyTravel (ex-Airtours) have announced the creation of MytravelLite with a

base in Birmingham since October 2002 and two Airbus A320,

44

§ TUI has launched Germania Charters created by Hapag Lloyd Express with a

base in Cologne-Bonn with a fleet composed of eight Boeing 737-700’s.

Whereas, the change of stockholders and the multiplicity of acquisitions must be

noticed, for instance the sale of Go by British Airways in 2001 to their managerial

staff and 3i and then the buyout by EasyJet in Summer 2002.

The low-cost offer in Europe represented 7% of the market in summer 2002 (against

3.7% in summer 2000 and 5% in summer 2001); there has been an improvement of

20% per year.

Figure 1: Market Share of the Low-Cost Companies:

(Sources: Journal of Air Transport 2003).

7%

93%

low-cost

Others

21%

79%

Low-cost

Others

2%

98%

Low-cost

Others

80%

20%

Low-cost

Others

Great Britain-Ireland Total Europe

Continent Cross Channel

45

9.3. Review of the Low-Cost Companies Operating in

Europe:

9.3.1. The Complete Listing of European Low-Cost Carriers,

Being in Business:

Germany :

Air Berlin German Wings

Germania Express Hapag-Lloyd Express

DeutscheBA V BIRD

Great Britain: Air Scotland Excel Airways MyTravelLite

Air Southwest Thomsonfly.com Jet2

Bmibaby Go Fly Virgin Express

EasyJet

Austria: Belgium: Poland:

Fly Fair fly VLM Airlines Air Polonia

Finland Hungary Norway Flyeco Wizz Air Norwegian

46

Ireland Italy Sweden AerArann AlpiEagles Flyme

FreshAer.com eVolavia.com Scandjet

Jetmagic.com Meridiana Snalskjutsen

Ryanair Volareweb.com snowflake

Skynet Airlines

Denmark: The Netherlands Czech Republic Sterling Jet Basiq Air Smart Wings

Snowflake SkyEurope

Maersk Air

47

9.3.2. Table 2: Targeting Ten Representative European Low-Cost

Airlines:

(Source: L’Express Magasine, June 2003).

Ryanair EasyJet Basiq Air BMI Baby German wings

Date

of foundation

1986 December 2002 December 2000 January 2002 October 2002

Origin

Irish low cost

carrier since 1991

European leader

(bought out Go in

2002)

Subsidiary of the

Dutch airline:

Transavia

Subsidiary of the

British airline: BMI

Subsidiary of the

German airline:

Lufthansa

Main airports

9 (Dublin, London,

Frankfort...)

London

Luton

(Great Britain )

Amsterdam

Schilphol

Netherlands

East Midlands

(Great Britain)

Cologne, Bonn

(Germany)

Number

of routes

125

(France: 19)

102

(France: 18)

39

(France: 5)

13

(France: 3)

20

(France: 2)

Fleet

Boeing 737 Boeing 737 Boeing 737 Boeing 737 Airbus A-319

A-320

Airports

Taxes

Before taxes Before taxes Before taxes After taxes After taxes

Booking fee Payment by credit

card:

+5 € 00

Payment by credit

card: +5 € 00

Phone: +6 € 50

Payment by

Phone: +6 € 00

Payment with

creditcard: +5 € 00

Phone: +6 € 00

Payment by

Phone:

+5 € 00

Additional luggage Over 15 kg: +6 €/kg Over 10 kg: +6 €/kg Over 20 kg: 5 €/kg Over than 20 kg: 7

€/kg

Over than 25kg: 4

€/kg

Change of flight 25 € 24 € 20 € 24 € 25 €

Change of

passenger name

25 € 24 € 20 € 50 € Impossible

Infants 8 € Free of charge 10 € Free of charge Free of charge

Unaccompanied

minors

Not possible,

minimum age: 12

Not possible,

minimum age: 14

Not possible,

minimum age: 12

Not possible,

minimum age: 14

Not possible,

minimum age: 16

Other information None If booking by phone:

departure within 30

days

Booking at least 4

days before

departure

Refund possible if

delay more than 2

hours

Phone- booking 0825 00 03 04 0825 08 25 08 0821 231 214 0890 710 081 01 55 21 25 10

Websites Ryanair.com Easyjet.com Basiqair.com Bmibaby.com Germanwings.co

m

48

The lack of two important companies must be noted: Go fly and Buzz respectively bought out

by EasyJet and Ryanair, both “tenors” of the low-cost air industry.

Globe Span Jet 2 My travelLite Snow

flake

Virgin

Express

Date

of foundation

November 2002 November 2002 August 2002 Summer 2003 1992-

1996

Origin

Charter airline of the tour

operator Globe span

Created by Dart

Group and Channel

Express

Charter airline of

the tour operator

Globe span

Created by the

Swedish

airline: SAS

Charter airline

turned out by the

deregulation

Main airports

Glasgow (Great Britain) Leeds, Bradford

(Great Britain)

Birmingham

(Great Britain)

Stockholm

(Sweden)

Brussels

(Belgium)

Number

of routes

8

(France: 1)

9

(France: 1)

11

(France: 1)

19

(France: 1)

18

(France: 2)

Fleet

Boeing 737 Boeing 737 Airbus A320 Boeing 737 Boeing 737

Airports

Taxes

Before taxes Before taxes Before taxes After taxes Before taxes

Booking fee Payment by phone:

+ 4 € 00

Payment by credit

card:

+ 5 € 00

Payment with

credit card:

+4 € 00

Phone: + 5 € 00

None Payment with

credit card:

+2 € 00

Phone: + 5 € 00

Additional

luggage

Over 20 kg: +6 €/kg Over 20 kg: +8 €/kg Over 20 kg: +5

€/kg

Over 20 kg: +5

€/kg

Over 20 kg: +5

€/kg

Change of flight 23 € (30 days before) 25 € 30 € 25 € 25 €

Change of

passenger name

23 € (24 hours before) 25 € 30 € 25 € 25 €

Infants 19 € Free of charge 8 € Free of charge Free of charge

Unaccompanied

minors

Not possible, minimum

age: 16

Not possible,

minimum age: 14

Not possible,

minimum age: 12

Yes from 5 to

11 years old

extra charge:

27 € 50

Yes from 5 to 12

years old extra

charge: 25 €

Other information Last minute prices on

Internet

Business prices

enabling changes of

flight

Phone- booking 0044 131 441 2700 0825 0826 022 0825 00 03 04 0825 325 325 0800 528 528

Websites Flyglobespan.com Jet2.com Mytravelite.

Com

Flysnowflake.c

om

Virginexpress.co

m

49

9.4. Defining the Pioneer: Southwest:

Southwest focused on a strategy consisting in operating on small distances by

offering low fares without restrictions, high frequencies on a “point-to-point”

network and excellent punctuality. The company got rid of services traditionally

offered by airline companies (lunch on board, reserved seats, transfer...) and have

developed a new brand image “Flying is fun”.

Such a strategy was successful enabling the company to attract a part of the

customers of their direct competitors, but especially to create a huge traffic of

induction (creation of a new market).

Actually, a large number of the customers (business or leisure) have got used to

preferring the aeroplane to terrestrial means of transports (namely the car) to travel

relatively short distances separating the different cities served by the company. The

Chief Executive Officer of Southwest, Herb Kelleher, cleverly summed up his

strategy: “we are not in competition with the other airline companies, we are in

competition with terrestrial transport (Freiberg and Freiberg 1996).

At the origin of the success of the first low-cost carrier, there was a very simple but

revolutionary marketing principle that can be expressed in this way: “if the

customers want to get an extremely low fare, Southwest have developed a model

with a logic of very low-cost”.

9.4.1. The Product: Southwest Bases its Offer on a Still Similar

Product:

Southwest proposes prices much lower than most of their competitors (60% less

expensive) but manages to bring out, in terms of income per seat/km, high income

thanks to high air passenger rates between high demand destinations. And where the

company offers a frequent service with excellent punctuality.

50

The company proposes only one-class shuttles from less busy airports and it does not

suffer from transfer constraints too. On board Southwest aeroplanes, there is just one

class, which makes the capacity in seats higher. It proposes neither lunch on board

nor alcoholic drinks.

9.4.2. The Trade Policy:

The trade policy of Southwest is based on an extreme simplification. There is great

use of direct selling, out of the traditional distribut ion network.

The company does not show its seats in the “GDS” booking system as Amadeus,

Sabre, Galileo, etc… In January 1995, it was the first company to launch the

principle of the “e-ticket”, reducing in this manner the costly procedure of

“ticketing”.

9.4.3. An Innovating Human Resource Policy:

Staff motivation has revealed itself as a pivotal factor of success. The Southwest

model could seem to be more constraining than the traditional model, in terms of

working time and required flexibility.

Southwest has preferred promoting participating management methods and a policy

of profit sharing. Thus in 1973, Southwest was the first company to offer the

employees shares in the profits. This could be used to buy shares in the firm. The

staff owns more than 10% of the capital of Southwest.

And Southwest was right, every time, the carrier went into a new market, applying

low fares; the company has systematically stimulated the demand with high air

passenger rates. Besides, when a new route has been opened on a destination not

directly served, the traffic growth rate was superior to the average rate.

51

However, the growth of Southwest took quite a long time: Southwest has waited for

twelve years to obtain a 50-aircraft fleet. New capacities have been systematically

used to put up the frequency on existing routes and then to add some lines chosen on

a flow study basis.

The financial success of the American low-cost carrier revealed it self by operating

on similar lines to the traditional competitors on a basic unit cost thirty times lower

than them.

It is actually important to stress that Southwest has always opened new routes

proposing great frequency. One of the “key” conditions to get a large share of traffic.

It is also essential to emphasize that all the other initiatives on the American market

were never successful and that Southwest remained unique. At this time, two

important issues must be considered:

Two important issues:

§ Is there any place for just one low-cost company in a continent?

§ Did Southwest create an impassable gap for a new entrant?

9.5. Functioning Principles of a Low-Cost Company:

9.5.1. An Economic Model Distinct from the Traditional

Companies:

The efficiency of the major airline model is based on its capacity to bring a global

service to its customers enabling them to travel all over the world with a minimum

journey time. Such a system requires a logical network supported in the following

ways:

52

§ A structured network around one or more transfer points, and the hubs

favouring a better density and frequency,

§ Alliances between big companies.

This model is based on a complete range of products that enables the company to

offer a service adapted to each segment of the customers. The low-cost companies

take advantage especially of regular business customers on long-distance flights

(more than two hours), a high demand for this type of service.

One of the main components of the traditional companies is the consideration of the

value of time for the passengers:

§ To be able to propose a whole journey all around the world, as quick as

possible,

§ To be able to book easily whenever travel necessary is.

Such a system implies:

§ The management of differentiated price setting (by customer segment),

§ The implementation of efficiency yield management,

§ The multiplication of services targeting the loyalty of the highly profitable

segments.

In a major airline, the long-distance flights represent the core activity and the service

remains the priority axis though the efforts are concentrated on the control of costs.

On the other hand, the “low-cost” model aims to propose to the customer, who wants

to reduce his transport expenses, a low-cost carrier offer regular short and long-term

point-to-point flights.

It requires an ability to maintain extremely low unitary costs involving the respect of

the following principles:

§ Aeroplanes with high seating capacity,

§ High utilisation rate,

§ Optimised fixed costs.

53

To limit the functioning costs, it requires:

§ The use of secondary airports,

§ Direct selling by call-centre or the Internet and no provision of services.

However, these companies must optimize their aeroplane occupancy rate. This

involve

§ The application of unique and simple price setting,

§ The implementation of a simplified yield management, (like a

date/destination model).

In a low cost company, the specialisation on short or medium journeys and the

pressure on the costs are the priority axes.

Table 3: The Main Functioning Principles of a Low-Cost Company and a

Traditional One: (source CSC)

Low-cost model Traditional model Organisation

Network

Airports

Fleet

Staff

- Point to point organised from base - A wide network - Short distances (800 km on average) - Secondary airports sometimes overcrowded - Monotype: Boeing 737 in General - High density of seats (149 on B-737) - Recent aeroplanes - High utilization rate - Motivating wages - Participations in profits, stock-options - Light structure: teleworking, subcontractor..) - Minimum staff

- Network allowing a worldwide scope - Transfers - Long distances - Main airports - Diversified fleet - Optimisation of the use of the ae roplanes (respect of the hub logic) - More traditional human resource management - More services on board - Few subcontractors - Many information systems

54

Product

9.5.2. Analysis of the Low-Cost Companies Principles:

9.5.2.1. Aeroplanes with Optimized Seating Capacity:

The suppression of a business class and the reduction of the disparity between two

ranges of seats permits an increase of 25 seats on a Boeing 737 (124 seats on a B737

of British Midland against 149 seats on the same EasyJet aeroplane). Then, if

traditional and low-cost companies have the same global operating costs, the

seat/kilometre cost of a low cost company will always be lower.

- All type of clients who look for a low price

- One-way - Single cabin - No numbered seats - No lunch on board - Paying for snacks and drinks - No newspapers on board - Low and simple fares - No restrictions on fares - Simplified yield management to optimise the air occupation rate - No lounge - No loyalty bonus - No transfer - Few sales in agencies - Direct selling (Internet or Call-centre) - Electronic ticket

- Many business travellers - One-way and return tickets - All types of transfer - A complete range of products for each customer segment. - Numbered seats - Lunch on long-distance - Free provision of services on board - Newspapers - Several fares based on origin and destination logic and on customer segmentation - Segmentation and typology of customer to differentiate the fares - Complex yield management - Lounge and services on ground - Individual loyalty program, enterprises relations - Transfers - All channels - No direct selling

Customers

Flights product

Fares

Ground product

Distribution

55

9.5.2.2. Higher Utilisation Rate of the Aeroplanes:

The utilisation time of an airplane in a low-cost company is higher than in a

traditional company due to quicker turn-round time. It is mainly for 2 reasons:

§ Firstly, the low-cost carriers are not constrained by the functioning of a

“hub”. In a traditional company, and in order to maximise the short transfer

opportunities that offer customers a minimum journey time, the timetable of

arrivals and departures are synchronized on landing and take-off slots.

Considering that the time of a flight differs from one route to another, this

implies the aeroplanes waiting for a more or less long time at the end of the

route to come back on the hub in the same slots. This phenomenon makes the

time of the aeroplane utilisation drop. Therefore the low-cost companies do

not encounter those problems.

§ However, there are other reasons explaining how the aeroplanes can turn-

round more quickly. The use of secondary airports, a minimum time for

cleaning linked to the low level of catering, to quicker boarding (no

numbered seats) and to staff that share company profits directly and a gain of

productivity.

On average, the aeroplanes from low-cost companies fly daily 30% more than those

from traditional companies. The overall costs, fixed yearly, such as equipment

depreciation or the cost of leasing, the maintenance and the insurance are actually

relatively low as regards the kilometre/seat ratio.

9.5.2.3. Optimised Fixed Costs:

The fixed operating costs traditionally cover three main expenses:

§ The flying cost (fuel and the cost of the flight crew),

§ Maintenance,

§ The depreciation of the aircraft.

56

Two types of costs must be added to these operating costs:

§ Insurance,

§ Taxes of flying.

9.5.2.4. Flying Costs:

The cost of fuel is almost the same for each company. It is actually not a way to save

for a low-cost company. It is even quite conceivable that a traditional company could

on the one hand bargain its purchase price better than a low-cost company and, on

the other hand, can optimize its fuel costs by purchasing it in airports where it is less

expensive.

However, the unit cost of the flight crew of Southwest and Ryanair is close to the

cost of traditional companies, in absolute terms. Nevertheless, considering the

utilisation rate, the duration of working is longer and productivity is therefore better.

Yet, a restricted fleet involves the reduction of expenses linked to training and to the

changing of pilots’ qualifications.

As regards the exploitation during the flights, the lack of lunch services on board

enables a reduction of staff in the cabin. Consequently, EasyJet uses three flight

attendants compared to four to five in a traditional company. Moreover, the

aeroplanes of low-cost companies come back most of the time to their base in the

evening in order to rule out the overall expenses linked the mission costs of the air

personnel.

9.5.2.5. The Costs of Maintenance:

Concerning maintenance, these companies manage to save by using a unique type of

aeroplane (the Boeing 737 in general), which reduces the costs related to the

aeroplane components stock control, to the licences and to the training of the

technical staff. Moreover, a large use of sub-contractors limits the high costs linked

to the equipment or the necessity to own hangars for instance.

57

9.5.2.6. The Costs of Depreciation or the Loan of the Aircraft:

Considering these companies use a “young” fleet, the costs of depreciation are higher

than those of a major one. However, the unit costs of depreciation or leasing are

diminished thanks to a higher utilisation rate of the aeroplanes and to their reinforced

density.

9.5.2.7. The Incompressible Costs:

As with fuel, the costs linked to insurance and to air taxes are relatively similar for

each company. The density of the cabin can only explain that the costs are lower in

comparison with those of the traditional companies (when we are referring to the

“seat/kilometre” cost).

The main saving, in comparison with the major companies concerning these

“incompressible” costs, does not depend on their unit value but on their relative costs

linked to two main factors:

§ The better daily rate of use that makes the air personnel efficiency go up,

§ The higher densification of the aeroplane that can also make the cost

“seat/kilometre” drop (maintenance and depreciation costs of the fleet). It is

the case for British Midland and EasyJet.

Southwest could actually diminish its costs by implementing these principles. And

the main European low-cost companies tend to be successful by benchmarking this

model.

The following table compares costs generated by the exp loitation of the same type of

aeroplane in Southwest and its competitors (in the USA).

58

Table 4: Comparison of Operating Costs of a Boeing 737-300 in Main

American Airline Companies in 2000:

(Source: data compiled by Rigas Doganis from the Airline Monitor, 1999).

Companies

(1)Costs per seat/miles (US cents)

(2) Costs (index)

Average distance (miles)

Daily utilisation (hours)

Number of seats per aircraft

Delta Airlines

5,54 100 708 9,8 126

United Airlines

5,20 94 668 10,3 128

US Airways

5,04 91 698 10,1 126

Continental

4,28 77 1007 10,5 129

America West

3,91 71 701 11,8 131

Southwest

3,10 56 461 11,3 137

(1): direct operating costs including fuel, the cost of the flight crew, the cost of

maintenance and the different costs of the aeroplanes (depreciation, etc…)

(2): Delta Airlines = 100.

Such a table points out the ability of Southwest on operate in relatively lower unit

costs than other companies (from 20 to 40%).

Of course, this approach of comparison by “seat/kilometre” cost can be valid only if

the occupancy rates are similar between the companies that are compared. However,

in this case, the low-cost companies seem to have an advantage since they have an

occupancy rate of 80% (82% for EasyJet), more than the traditional companies.

Besides, in low-cost companies, the unused tickets cannot be reimbursed. It is

actually possible for the physical occupancy rate to be sometimes smaller than a

number of seats paid by the customers (when a customer misses his flight).

59

Table 5: Synthesis of the Gap of Overall Operating Costs on Intra-

European Lines:

(Source: data compiled by Rigas Doganis from the Airline Monitor (1999).

(1): Direct operating costs including fuel, the cost of the flight crew, the cost of

maintenance and the different costs of the aeroplanes (depreciation, etc…)

(2): British Airways = 100

9.5.2.8. The Use of Secondary Airports:

The priority given to the use of secondary airports is a source of great saving. The

charges of these airports are actually lower. The possibility of bargaining with these

airports is far more possible than with the main airports due to the traffic generated

by the opening of lines on these stops. In some cases, the airports subsidize the

companies on their own to attract them more easily.

For the coming of Buzz (when the firm did not belong to Ryanair) in Caen for

instance, the regional council paid almost half a million euros each year for three

years, as advertising; and this is not the only example.

Company

(1) Cost per seat (Us cents)

(2) Cost (Index)

Traditional companies

15.07 126 13.86 116

Aer Lingus SAS Air France 12.85 107

11.98 100 11.58 97

British Airways British Midland Alitalia 10.05 84

Low-cost companies

6.04 50 EasyJet Ryanair 5.04 10

60

These infrastructural airport costs are even lower as these transporters do not propose

a lounge for their customers. There is therefore less ground staff due to the

simplification of booking and boarding; these airports do not own any specific

equipment and are not in charge of possible transfers, etc…

9.5.2.9. Direct Selling by Call Centres and the Internet and Lack of

Provisions of Services:

The distribution costs are greatly reduced for a low-cost company thanks to a wide

use of direct selling by call centres and the Internet. Companies like EasyJet

nowadays mainly use the Internet for their booking (10% via a call centre and 90%

via the Internet).

This mode of distribution has managed to rule out two types of cost:

§ The commission to travel agencies (almost 8%),

§ Transaction taxes linked to the use of different booking systems (GDS) such

as Sabre, Amadeus, Galileo, which represent approximately 3€50 for each

booking.

Therefore, these transporters can obtain great savings by using the electronic ticket

that rule out the process of ticket printing. A supplementary saving is made thanks to

no numbered seats ruling out the edition of a boarding pass.

However, the lack of travel agencies offering the products of the low-cost companies

forces them to have large communication and marketing budgets to promote their

offer.

The lack of catering and services on board constitute another source of savings. The

lack of lunch on board and making the passenger pay for provisions of services on

board represent a large gain. It is also important to note that this gain is just one of

the components of the economic model of the low-cost companies often

overestimated in comparison with other economies.

61

Nevertheless, proposing just “flights only” brings great savings for all functions

usually linked to a transfer service such as passenger in transit or transfer of the

luggage.

9.5.2.10. Unique and Simple Pricing:

The pricing proposed by these transporters is backed up by a unique principle,

leading to simplified access to the offer: only one-way tickets are sold at a “T” time;

a unique price is offered for a given flight (re-evaluation of the price at a “T+1” time.

In comparison, a traditional company looks for the optimisation of its profitability

per aircraft. This is therefore implemented through a pricing scale presenting a range

of different prices valid for a “T” time for a given flight as regards a chosen product

(classes) and constraints associated to this price (length of the stay, typological

prices, Apex 14 or 17, etc…).

EasyJet for example, proposes just one range of prices, without any particular

conditions; (no minimum duration of stay, no return tickets, no Saturday night on the

spot, no different class pricing, no typological prices, etc…).

Most of the low-cost companies also use this type of pricing policy, which is very

simple to use for a customer booking on his own.

The prices displayed via advertising, which are introductory price, are particularly

low.

For instance:

§ Easy jet proposes 14€90 + VAT for Paris-Nice,

§ Ryanair proposes 17€90 for Paris-Dublin,

§ Minus 5 € if using the Internet in both of cases.

62

However, the tickets of low-cost companies offer very little flexibility. Most of the

time, reimbursement is impossible and the slightest modification (name of the

passenger, date, etc…) causes a supplementary cost for the passenger (15€ in

general) and the passenger must often pay the difference in price between the

booking price at the beginning and the price applied at the time of the modification.

Therefore, the passengers are not encouraged to modify their tickets inducing

savings on after-sales.

9.5.2.11. The Implementation of Simplified Yield Management:

The advertisements of these companies stress introductory prices. In reality, the price

range is composed of at least ten prices (thirteen by EasyJet and Ryanair). Therefore,

they can reach a unit income (average profit per passenger) much higher than these

introductory prices.

The low-cost companies, like traditional companies, use the yield management

system to maximise their generated profits per flight. However, this system is

extremely simplified by the nature of the product, one-way, point-to-point and single

class).

This is all the more simple as, except for Virgin Express and Go that offer different

prices (reduced, flexible for GO; reduced, classical, flexible, business class for

Virgin Express), there is just one possible price for a given flight and a given time.

The strategy consists in proposing the lowest price at the opening of booking for a

flight and then making the prices go up progressively as soon as the time of

departure approaches or the company has sold all the tickets at a given price.

However, some introductory prices are not available at certain peak activity levels.

For instance, Ryanair proposes slightly different prices between the weekend and

during the week. This process ensures for the company a unit income far higher than

the basic price.

63

Table 6: Example of Evolution of Price in EasyJet: (Source: CSC).

Time of departure

Date of the price offer on the Internet

16th August 23rd August 30th August 06th September 13th September 20th September

Paris-Nice Friday, 20th Sept.

22.40 57.40 72.40 72.40 72.40 72.40 32.40 57.40 72.40 72.40 72.40 87.40

32.40 72.40 72.40 87.40 87.40 87.40

8.20 13.30 17.55 22.10

32.40 72.40 72.40 72.40 87.40 122.40

Nice-Paris Sunday, 22nd Sept.

32.40 57.40 57.40 47.40 47.40 57.40 57.40 72.40 72.40 72.40 72.40 72.40

57.40 87.40 72.40 87.40 87.40 87.40

7.00 11.25 16.05 20.20

87.40 122.40 122.40 122.40 122.40 122.40

The benefits of such a relatively simple system are reinforced by a lack of mixture of

income that can occur in the case of transfer or of “multi-route” tickets.

For example, on a London-Amsterdam route, EasyJet collects the total profit on each

ticket while KLM, which transports part of the passengers in transfer on othe r flights,

will get back a smaller part on its passengers in transit than those travelling from

“point-to-point”.

So can this model question the models of traditional companies?

64

10. Can the Low-Cost Carriers Endanger the

Traditional Ones?

The success of the “low-cost” model, the important growth of EasyJet or Ryanair,

the regular appearance of new companies on this segment of the market, make one

question the traditional model. Certain studies foresee such a conquest of market

shares by these transporters in the next ten years (20% of market shares in Europe in

2010) that it is relevant to ask oneself if the present big actors will still be always

successful in some years.

However:

§ Does it make any sense to oppose these two models?

§ If there is a place for both models, the nature of the dangers and the

adaptation necessary for each one must be identified.

10.1. The Nature of the Dangers:

The dangers exist for all the operators, the traditional companies (the major ones)

and the low-cost carriers. The differences between the United States and the

European continent must be considered to build up a constructive postulate. The

North-American background is fundamentally different as well as the infrastructures

linked to the socio-geographical aspects and traffic habits of the consumers.

Air Transport is the natural way to travel in the USA. Very early, a large number of

all size airports, on a very wide space, developed, offering an outstanding capacity.

For example, in United States of America, one can find many main or secondary

hubs while there are less than ten hubs in Europe and the capacities for extension are

often limited.

In consequence, in the USA, as opposed to Europe, the airlines can take advantage of

resources in diverse structures, not overcrowded (except maybe the metropolis), easy

to access in terms of slots and financial requirements.

65

The mode of consuming is very different as well. Only 20% of the traffic is

international. The international aspect has quite a different meaning in Europe; that is

why it is not that relevant to compare these two systems.

However, the number of long-distance flights exceeding two to three hours, is far

greater. In consequence, the transfer system in the USA is mainly composed of

medium-distance/medium-distance (“trivialized” market) while it is composed in

Europe of medium-distance/long-distance (market of added value service type).

The American market presents weaker entry barriers than the European market for

two main reasons:

§ Important resources (slots and infrastructures),

§ Traffic mainly national (no traffic laws between states).

And there are consequences sometimes. When the traffic start dropping (as has been

the case since September.11th 2001), Traditional American companies put down their

prices. They became therefore “low-fare” companies whilst retaining “high-costs”.

This could explain the financial crisis that they came through.

For opposite reasons, the traditional European companies seem to be better

protected. The strongest contribution comes from long-distance: international traffic

in which traffic rights remain an entry barrier and in which the functioning of the

low-cost companies is less relevant.

Moreover, the airports of big European capitals do not work to full capacity. The

rarity of slots represents namely a heavy entry barrier for the new entrants. Anyway,

to make certain of a sufficient volume on their most profitable long-distance traffic,

the traditional companies need to make medium-distance traffic converge to their

hubs.

Another important issue:

This medium-distance traffic could be jeopardized by the low costs and the

traditional companies must protect it in priority.

66

In point of fact, the massive and sudden appearance of the low-cost companies is

creating a huge perturbation, at the beginning limited to the United Kingdom and

Ireland but which is now covering the European continent.

Some locations almost belong to low-cost companies: at Stansted, there are now four

low-cost companies and almost all carriers are present in an airport from London.

From London, there are approximately ten routes with at least two low-cost

companies plus two traditional companies (Venetia, Frankfort, Amsterdam, Madrid,

Barcelona, Lyon, Geneva, etc…). Thus, the traditional companies are considering a

short or long-term response to bring, or considering the opportunity of creating their

own low-cost companies.

§ KLM created Buzz in 2000 with a fleet composed of eight Bae 146, departing

from London Standsted and hence causing the fall of Debonair with quite a

similar market.

§ British Airways created its low cost subsidiary in May 1998, Go, but this

company was finally bought out to employees and to an investment fund in

2001, before EasyJet bought it out in summer 2002. Go could have eaten into

the market share of the European customer of British Airways and could have

jeopardized its “point to point” traffic as well.

In such a system where competition is constantly growing for the low-cost

companies themselves or facing the major ones whose aim is to protect their market

shares and their routes, three central issues arise:

§ Are the dangers of the same nature?

§ How can the different actors react?

§ Who will survive?

This economic background is maybe too recent to make some hasty conclusions

about failures or success. Debonair, for instance, failed for intrinsic reasons

(criticism of the low-cost principles, the aircraft type, problems with the Bae 146).

The big companies have not fund an optimum response to low-cost attacks so far.

67

However by looking over the European market in more detail:

§ The low-cost companies have created new markets,

§ Significant evolutions are appearing in certain operators, creating new

conditions of competition,

§ If the response of the traditional companies is not homogenous, they testify

the importance of the stake that they have to face.

10.2. The Low-Cost Companies Can Create New Markets:

The presentation of the Southwest model has emphasized the fact that low-cost

companies endeavour above all to create a specific type of traffic. Two axes

translated this:

§ Firstly, the exploitation of a “niche” market in which the major companies

are not present, creating previously inexistent market. Buzz, for instance,

served a majority of secondary stops such as Bergerac, Chambéry, La

Rochelle, Poitiers or Toulon in France, departing from London Stansted. This

company proposed therefore mainly routes, which were not exploited by

traditional companies.

In this following example (Manchester-Liverpool-Nice launched by EasyJet), it is

evident that the opening of a regular route at a reduced price is sufficient to create a

new market.

68

0100000200000300000400000500000600000700000

1995 1996 1997 1998 1999 2000

Air France Aer Lingus Ryanair

Figure 2: Induction of EasyJet on the Manchester/Liverpool-Nice Flight:

(Source CSC).

Number of passengers

§ Secondly, these companies induce traffic on their existing route operating in

the secondary airports of big cities. The induction of traffic is a development

objective targeted by Ryanair, aiming at passengers who do not want to pay

much money. In this situation, the degree of competition of the low-cost

companies towards the major ones cannot be generalised but must be

analysed route by route.

In the following graph, it is possible to measure some induction examples of traffic

by low-cost companies.

Figure 3: Induction of Ryanair on the Paris-Dublin Flight: (Source CSC).

Number of passengers:

0

20000

40000

60000

80000

100000

120000

140000

1995 1996 1997 1998 1999 2000

Charters Other lines EasyJet B.A

69

0

50000

100000

150000

200000

250000

300000

350000

1998 1999 2000 2001

LX Air France EasyJet

0

20000400006000080000

100000120000

140000160000

1998 1999 2000 2001

B.A EasyJet

It must be observed that there was no real weakening of the competition. Aer Lingus

is slightly penalized while Air France went on with its progression. The explanation

of this phenomenon is that Ryanair worked in Ireland at a main airport (Dublin) and

in France, at a secondary airport.

Moreover, the control of market drives by Ryanair; (out of induction) operated

mainly on “low contribution” passengers. Therefore Air France could keep its high

contribution passengers or users of the Charles de Gaulle Hub. This example points

out an observation: in the case of low-cost companies opening a new line on a route

where there were already two traditional companies, it is systematically the company

linked to a hub, which defends its traffic best.

In fact, the induction on routes, which were already exploited, depended largely on

the maturity of the market where the low-cost company got in. In the case of one or

more actors having already been there for a long time, the induction would be

relatively limited with or without the takeover of the market by the competition.

In the following graphs, EasyJet had to face all the possibilities. If it contributed

systematically to a growth of a market where it set up, it represents as well a lesser or

greater threat for the existing competition.

Figure 4: Induction of EasyJet on the Routes Departing from Gene (Source CSC).

Geneva-Nice Geneva- liverpool Number of passengers Number of passengers

+106% +217%

70

020000400006000080000

100000120000140000160000180000200000

1998 1999 2000 2001

I.X EasyJet

0

50000

100000

150000

200000

250000

1998 1999 2000 2001

K.L EasyJet

Geneva-Barcelona Geneva-Barcelona Number of passengers Number of passengers

+296% +64%

In case of Geneva-Nice, EasyJet created a heavy induction of traffic (106%) and

took over a large part of the traffic of the more recent and weakest company on this

route, Air France. It is surely because it took place at the end of the route and it is not

linked to a hub.

However, was it a reason to give up the market more quickly?

On Geneva-Barcelona, a route with weak competition, EasyJet did not jeopardize its

competitor, Swissair and managed to create a huge induction multiplying the traffic

by four on this route.

On the other hand, on Geneva-Liverpool, EasyJet created not only a very hard

induction (+217%) but weakened its competitor, British Airways, which lost more

than half of its traffic.

Again, on Geneva-Amsterdam, EasyJet created a more limited induction (+64%),

taking a market share from its competitor.

When the market has arrived at a certain phase of maturity, the induction is generally

weaker and operates by taking market shares from the competitors.

71

0200000400000600000800000

10000001200000140000016000001800000

1996 1997 1998 1999 2000 2001

EasyJet (LGW)

EasyJet(LTN+STN)Crossair

Swissair

B.1 (LGW)

B.A (LHR)

With regard to the London-Geneva proposed by EasyJet, it is interesting to observe

that the opening of routes at secondary airports from London led to an induction on

this market, quite limited however. (+28% in four years (1998 to 2001).

Figure 5: the Induction of EasyJet on the Geneva-London Route:

(Source CSC).

72

10.3. The Evolution of Certain Low-Cost Companies

Become a Direct Threat for the Traditional Companies:

All the low-cost European companies do not inevitably apply the model of

Southwest and do not content themselves with creating new markets. They make a

head-on attack on the traditional companies.

EasyJet announce clearly a willingness to catch a business customer and get into the

competition on some of the routes with traditional companies with an aggressive

strategy on fares.

EasyJet is settling down gradually into the main airports. The carrier tries to use Orly

as a base with an objective of seven airplanes, 20 000 slots and 2.5 million

passengers. This kind of threat represents potentially about ten million euros of

turnover loss for a company like Air France.

It is the same observation for British Airways in London. Moreover, EasyJet

purchased 120 Airbus A319; that means it does not respect the principle of the unity

of its fleet and proves as well a modification orientation. In this case, is it still

possible to talk about a low-cost company?

By adopting this strategy, these companies accept to put up their costs on the ground,

the costs of maintenance, and their costs in flight that represented logically their

main source of savings.

Should they or can they pass these costs on in their prices?

Will they use a full occupancy air rate or even reach saturation?

Therefore, a new concept seems to emerge in this air environment: the middle-cost,

which represents a new threat for traditional companies on their own territory and for

their own customers.

So what are the new stakes for the traditional companies, low or middle-cost?

73

10.3.1. Retaliation by Traditional Companies:

Currently, the reactions of traditional companies are diverse, and as regards the

companies themselves their long-term efficiency is hard to evaluate. An interesting

initiative consists in the creation of low-cost subsidiaries.

However, it might be difficult to implement this type of strategy and its success

seems to be hard to prove.

Actually, two dangers must be observed:

§ The cannibalization risk of the markets and then a destruction of the value,

§ The difficulty to bring together two different corporate cultures.

The example of Go (and British Airways) can perfectly illustrate this issue. In the

same way, the creation and development of a low-cost company by a traditional

airline force it to face several accounting difficulties (different wages, working time,

etc…) and even a heavy social pressure.

Two other current reactions:

§ The renunciation of certain routes or market segments,

§ The pricing response.

10.3.1.1. Giving up Certain Routes or Market Share:

Giving up certain routes, where the traditional companies do not manage to be

profitable in the face of low-cost companies, may be a first solution. Thus, Air

France gave up its Nice-Geneva line to EasyJet.

A pivotal issue has to come up:

To what extent can the enlargement of this tactic to the whole market segments

represent a dramatic challenge to this strategy?

74

British Airways aims to restructure by focussing its activity on intercontinental

traffic, which targets more specifically the business customer (high contribution).

10.3.1.2. Pricing: the Response:

The pricing response to maintain its position in the face of this new competition is

currently the more simple reaction.

Since July 2002, British Airways has announced a drop of fares up to 80% on 37

destinations and has made some changes on the pricing scales (within the framework

of their “Size and Shape ”plan). On the Paris-London route, there are only ten prices

left compared with twenty previously. Lufthansa has brought its prices down as well,

since October 2002, by fixing them only according to the stock between capitals and

off peak.

One of the difficulties that the traditional companies must consider comes from the

multiple existing segment criteria.

A low-cost company proposes prices only in accordance with the stock while

traditional companies must carry on proposing prices that match their customer

segmentation according to:

§ Behavioural criteria involving conditions of pricing application (sale in

advance, different prices for one-way or return tickets, overnight on Saturday

or Sunday on the spot,

§ Stock criteria,

§ Customer typology (young, couple, families, senior citizens).

The pricing response cannot only depend on the following two aspects:

§ The implementation of introductory low prices like low-cost companies,

§ A modification of the pricing structure aiming to simplify some principles of

segmentation (the prices resulting from this segmentation).

75

However, it is essential for a traditional company to maintain its commercial

specificity and, in particular, its ability to identify and to target a business customer

and then keep a coherent model, which valorises its offer:

§ The density of the network (frequency, transfers, time slots),

§ The fluidity of the processing (the dedicated products (lounge for instance),

§ The management of the customer relationships (loyalty program, etc…),

§ The multiplicity of channels of distribution.

10.3.1.3. Must the Business Model Be Re-evaluated?

In order to maintain a long-term pricing response, the traditional companies must

face the necessity of bringing down the gap of the costs between them and the low-

cost companies.

The characteristics of their models (use of several types of aeroplanes, operations

from main airports, synchronisation of the hours limiting the use of the fleet)

constitute a cost barrier difficult to overcome. It can be possible however to take

advantage of levers which are successful for the low-cost model:

§ Cost of catering,

§ Gain of aeroplanes fuselage to shorten the turn-round,

§ Optimisation of the density of the aeroplanes and the flight crew,

§ Drop of the costs on the ground,

§ Drop of the structural costs.

Moreover, must the fundaments of the model be given up?

By considering the specificity of the demand in Europe causing the high rate of

short/medium or long distance transfers, two important issues come up:

76

§ Do the traditional companies have to jeopardize their advantages?

§ Do they have the choice to question the major axis of commercialization

based on the knowledge of the customer, its segmentation, and its loyalty

from the beginning to the end?

One must consider the overall economy of the system. The allocation of resource

must be likely reconsidered to ensure or to restore the profitability.

For instance, specific alliances concerning subcontracts could be carried out to “fuel”

the hubs with external help in order to maintain the necessary density which is

susceptible to offer the global service expected by the customer.

10.3.2. The Low-Cost Companies Can Also Be in Danger:

The low-cost companies must face important difficulties whether they aim to stay

alive.

10.3.2.1. An Obligation to Grow Quickly:

Growth is an absolute requirement for a low-cost carrier. Actually, the structure of

costs of these companies can persist only if it is supported by steady growth. Two

factors justify this obligation:

§ The upholding of structure with low salary costs: the ability to maintain low

salary costs depends on the promptness to maintain a relatively young staff in

the firm and then to be able to employ new collaborators in the case of heavy

growth,

§ The obligation of a hard stock value: stock capitalization is a primordial

feature for the low-cost companies. For example, since March 25th 2002, the

valorisation of Ryanair is better than that of Air France, British Airways or

Lufthansa.

77

This overvaluation finances the heavy growth mentioned above while

reducing a part of the wage bill. Actually, it is common to see these

companies giving a part of the income in the form of stock-options. This

necessity for hard value applies in a sector with low profitability (from 1 to

3% of the wages) and can represent a medium-term hurdle.

Nevertheless, uncontrolled growth might quickly cause an overcapacity. All the

companies developing on this model in Europe have growth objectives from 20 to

30%.

For instance EasyJet aims to own 49 airplanes in 2004 and have just bought out Go

(with its fleet and its orders) and have just ordered 120 Airbus A-319’s. Therefore

there is no comparison at all with the growth of Southwest. In its first years of

existence, its growth objectives were limited to 10%. It has grown to 15% recently.

Southwest took twelve years to get a fleet of 50 aeroplanes.

Are Certain Low-Cost Companies not Going too Fast?

Moreover, the European low-cost companies seem to encounter a growth limit

forcing them to explore new markets when the market share reaches 20%. So when

they reached a market share of 20% on the British market, the low-cost companies

developed as many routes to the continent and then on the continent.

It is therefore likely that the number of low-cost companies will drop significantly in

the next years if they cannot find new niches, (around the Mediterranean).

10.3.2.2. The Risks of the “middle-cost” Model:

The positioning of the companies on a “middle-cost” model drives them to adopt a

mixed mode of exploitation. Therefore, a new economic system must be looked for.

Actually, the implantation into these continental bases and on main costly

continental locations forces these companies to bring up their unit costs.

78

Figure 6: The Illustration of the Drop in Cost of Personnel at the

Maturation of the Low-Cost Model:

(Source CSC).

Ryanair takes advantage of the growth of its offer, particularly strong and more than

that of its staff and is thus seeing nowadays the beneficial effects of economies of

scale.

Will it be able to maintain this structure in a phase growth?

Conversely, will EasyJet or Virgin Express be able to take on the increase of the

cost?

10.3.2.3. The Loss of Advantages Linked to the Maturation Phase:

As soon as they grow, these companies may no longer benefit from the same

advantages as those encountered during their launching phase.

They actually cause the covetousness and could come up against pressure from

airports and staff.

Cost of Personnel (cents$)

00,2

0,40,6

0,81

1,2

1,41,6

1,82

Southwest Ryanair EasyJet ViriginExpress

79

For instance, the low-cost companies plan to create new bases in Belgium, in

Switzerland or in France. On the one hand, the social taxes are not necessarily as low

as in Great Britain or Ireland. On the other hand, these airports may try to take

advantage of the strong growth of these companies to bring down the advantages that

the other ones have proposed them so far.

On their original ground, growth can generate social pressure. EasyJet have recently

known their first strike. This phenomenon can become even more obvious in the case

of external growth, which highlights the difference of culture, or raises specific

difficulties.

However, in order to gain market share, certain pricing methods might weaken the

market by getting the customer used to very low prices.

This issue brings up a question without an answer:

Does Europe have the ability to welcome more than twenty low-cost companies

while the United States have known only one success: Southwest?

80

11. What future for the low-cost airlines:

11.1. The future of low-cost carriers: “The low-cost airline revolution has injected a dose of democracy into European

travel, but can it last?” 13. It seems to be complicated to answer such a question. The

cracks are beginning to show in the budget aviation world. Buzz agreed to a takeover

by Europe's biggest low-cost carrier, Ryanair, for a knockdown price of £15 millions.

Buzz, which first belonged to KLM and was recently bought out by EasyJet, lost

patience after 3 years of multimillion-pound losses. Critics said it had chosen the

wrong planes and destinations. Gert Zonneveld, an airlines analyst at WestLB

Panmure declared “Buzz is not the only operator finding the going tough: it sounds

very easy to say, 'let's start up a low-cost airline and make lots of money'. But in

reality it's not easy, and it takes quite a few years, if you're lucky."

The airports in Great Britain possess a wide choice of low cost carriers, with

BmiBaby, MyTravelLite or Jet2, etc...

The German companies are getting in on the act, with Hapag-Lloyd Express and

Germanwings. Few of them release detailed financial information. Besides, Mr

Zonnaveld acknowledged as well: "With the exception of EasyJet and Ryanair, I

would suspect that most of them are losing money." There have already been

victims. Ciao Fly, considered as "the low-cost airline with frills", proposed flights

from Luton to Parma airport for £46 return. An industry source described Ciao as "a

Swiss company run by a German, operating an Italian airline to Britain". Ciao lasted

6 weeks. Luton airport stepped in to guarantee services for its last seven days to

ensure all passengers were safely repatriated. Then there was Goodjet, a Swedish

discount airline launched in April last year. The visitors to Goodjet's Website are

automatically directed to the site of an accountancy firm, where a sad little note

reads: "Goodjet was declared bankrupt on 17 January 2003 by the Gothenburg

district court."

13 Andrew Clark, Transport correspondent, The Guardian (February, 2003)

81

After 5 years of exceptional growth, the low-cost carriers in Great Britain account

for 41% of seats on domestic flights and 32% on routes to continental destinations.

This compares favourably with the position of longer established players in the

United State of America such as Southwest Airlines.

It must be underlined that demand for traffic has been keeping up with supply over

the last years but it cannot go on indefinitely. Ryanair is still growing, commanding a

market value of more than £3 billion. Its profits leapt 71% to £108 millions in the six

months to September. Among the younger players is MyTravelLite, which began

flying four aircraft from Birmingham to a range of holiday destinations in October.

Its managing Director, Tim Jeans, says: "Buzz is certainly a salutary lesson to

anyone with a few million in the bank who thinks they might make a few million

more by starting a low-cost airline." He insists: “the picture is not as bleak as some

suggest. MyTravelLite, an offshoot of the struggling MyTravel holiday group,

expects to lose £5 millions in its first year but has so far met internal expectations,

selling nearly 300,000 tickets”.

Considering the current market, it looks as if there will finally be two large players in

the industry. As regards their market share and annual turnover Ryanair and EasyJet

will certainly be two of them. There will still be scope for smaller players. The new

entrants try to establish a new niche and do it well. The bigger the big players get,

the more opportunities they will leave behind. The fragment for niches is about to get

tougher. With the coming of Eastern low-cost airlines like SkyEurope or Wizzair…

Dart Group chief executive Philip Meeson declared: “the north of England is poorly

served by airlines: there is still tremendous opportunity throughout Europe”. The

potential for low-cost travel is phenomenal; the full-service airlines in Europe will

eventually be overtaken by low-cost operators. With a glut of aircraft available from

leasing companies following September 11, it has never been cheaper to get into the

industry. Mr Meeson insisted: “ the new carriers are here to stay: who has not got

competition? Supermarkets have competition, manufacturers have competition.

82

We will survive and we will expand." What is more, the European sky would seem

to be favourable to the low-cost carriers: actually they could (especially Ryanair and

EasyJet) organise one fourth of the flight in Europe by 2010, the low-cost sector

taking advantage of the new European markets. These indications are Eurocontrol’s

conclusions: the agency for air traffic safety in Europe. According to its

expectations, the number of flights will go up by 3 to 4% a year. The annual rate of

growth is estimated at 20% during these six years. Hence, the low-cost carriers might

increase their European market shares (6% in 2002) and might reach 24% by 2010.

Great Britain and Ireland represent the largest shares of this market. However “the

growth of this sector is moving from East to South” according to the study of

Eurocontrol.

11.2. The expansion towards Eastern countries:

11.2.1. Low-cost carriers in Central and Eastern Europe:

On May 1st 2004, ten new members came into the European Union. Therefore, an

expanded Europe will need greater communication links and could be served by

increased air transport links. There seems to be an outstanding opportunity for some

of Europe's established low-cost carriers to step in and develop these new markets.

But are they ready to go east? Some of them have already taken tentative steps to

serve Central and Eastern Europe. EasyJet and the Cologne-based carrier

Germanwings already operate services to the capital of Czech Republic, Prague, and

the German carrier also flies to the Hungarian capital, Budapest.

But the Irish carrier, Ryanair, had already decided that it would not venture into the

Eastern countries when the new European Union members joined in 2004. "At the

moment we have no interest in Eastern Europe, it's very fractious," said Howard

Millar, Finance Director at Ryanair in Dublin.

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"We think a lot of people will rush into Eastern Europe and lose a lot of money," he

said. Airport prices have got to come down and incomes have got to rise.

British rival, EasyJet has taken a somewhat different approach. As part of a pan-

European media exercise, the airline placed advertisements for tender in the national

media of ten European countries. Of the ten EU accession countries, EasyJet has

focused its attention on the Czech Republic, Hungary, Poland and Slovenia. But

according to a spokeswoman for the airline, EasyJet is open to propositions from any

airports in Europe. This kind of parade is nothing new for carriers, especially at a

point in the industry cycle where airports are anxious for business. Southwest, the

archetype of all low-cost carriers did exactly the same in the USA. It was being

courted by three airports within a 100-mile radius in the state of Virginia, according

to a source close to the airline.

For that reason, the carrier was able to secure the deal that it wanted. However

Ryanair may have been expecting a more animated welcome from the airports in the

region, which are renowned for inflexible pricing policies. Germanwings Deputy

Managing Director Andreas Bierwirth also highlighted that airport charge are

definitely an issue for his carrier.

11.2.2. Low-cost airlines aim to grow as Europe expands eastward:

Since the European Union is about to get larger with the coming of new members, a

price war between airlines could come about. The increase of the offer could lead to

a drop in the unit income and fierce pricing competition. But nothing is yet sure,

perhaps the offer has anticipated the demand even if it is sure in East Europe that the

market will grow the fastest.

But the flying capacity between the member states and the new entrants is going to

increase because of the low-cost companies. The low prices well suit the East

populations where Gross Net Profit per inhabitant is lower than ours.

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Thus, with Sky Europe, Air Polonia, Getjet (Poland), Wizz Air (Hungary) and Smart

Wings (Czech Republic) prepared their breakthrough in France in May 2004. And

the existing Western low-cost carriers will probably face these new entrants. These

new entrants will explode the market since the Eastern demand will be greater than

the Western one.

For instance, SkyEurope, the Slovak low-cost airline opened, on June 14th 2004, a

route between Warsaw and Paris. As Christian Mandl, Chief Executive Officer of the

Slovak carrier, declaims: “Taking advantage of the buying power of the Western

European and the costs of the Eastern European”. SkyEurope, the first Eastern low-

cost company, confirms this. Based in Slovakia, the firm can take advantage of

wages costs two to three times lower than in Western Europe, all the more as the

airline aims to take advantage of its geographical location (Bratislava is only 60

kilometres away from Vienna), to become the secondary airport of the Austrian

capital.

In order to realize its financial goals (60 millions euros in 2004 compared with 13 in

2003!), the low-cost airline, which proposes flights from Bratislava and Budapest to

Eastern destinations, recently opened a third hub in Warsaw. The target will be

European business customers who would intend to set up in Polonia.

Besides, with Hungary and Poland who have just one into the European Union, it

makes sense that they should have what other highly developed countries possessed:

a no-frills airline with a silly name. Wizz Air, a low-fare carrier, will make its initial

flight in May from Katowice, in Southern Poland, to one of the ten destinations

around Europe. It aspires to be the number one airline in Central Europe by 2005.

If it sounds a bit optimistic since Wizzair has signed leases for nine Airbus planes

(with 180 seats), a fleet that would discourage most start up airlines, at least until

they had demonstrated they could fill a single plane. Supporters of Wizz, however,

are convinced that the eastward expansion of Europe will create a vast new market

for air travel. On May 1, the European Union will phase out aviation treaties

intended to protect national carriers.

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“7 millions people will join the European Union in a couple of months”, said Jozsef

Varadi, chairman of Wizz Air, who runs the airline from a freshly painted suite in a

Budapest suburb. “If it is a huge market, with very little to serve these people right

now”.

Never mind that many of the potential customers for Wizz Air have never flown,

they will be able to choose between carriers. The Internet, which 90% of the

passengers of budget airlines use to book their flights, has only half the presence in

Central Europe that it has in the West. Mr Varadi cited as likely passengers for Wizz

the thousands of Polish immigrants who work in Paris and London. Today, they have

to endure 24-hour train trips back to Poland to visit their families. Soon, he said, they

will be able to fly home on Wizz for nearly the same cost. “Families were broken

apart decades ago because of the underdevelopment of Eastern Europe. They are

now trying to reunite, and we are providing the infrastructure for that” said Mr

Varadi.

No-frills airlines survive only if they grow large enough, quickly enough to make

their operations efficient. People will respond as enthusiastically to no-frills flying as

their Western neighbours; the hype about low-cost airlines did not stop at the borders

of the European Union.

“People have been waiting for this”, he said.

The Business traffic will develop but not that much. The business demand already

exists because investment in the East has already been made. Nevertheless the leisure

customer is going to grow heavily, linked namely to a development of the low-cost

companies. In this way, Sky Europe is ready to work with the tour operators, which

is a profitable step forward for Hélène Abraham, in charge of the transport by Club

Med. The enlargement of Europe will provide opportunities for the development of

short stays.

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CONCLUSION

Contrary to commonly held ideas, few things make one conclude that low-cost

companies represent mortal danger for the traditional companies, namely the

European ones. Their positioning is based mainly on the conquest of new customers,

more used to other means of transport. Therefore they just complete the air offer of

the major companies.

This will be the case unless if the low-cost companies evolve successfully to a mixed

model leading to competing partly with the major companies on their segment

(“middle-cost”), particularly by aiming to be present on the traditional routes from

international airports. However, this represents for them quite a risky stake as

regards the weight of real and induced costs.

The present landscape has become very as a result of the uncontrolled proliferation

of the low-cost companies. Nowadays, there is a type of “bubble” similar to that of

the Internet at the end of the years 2000 with non-dissimulated desire for quick profit

by the operators. People are aware that drastic rationalisation is going to come about

and quite a limited number of operators will survive. However, these transitory

periods are hazardous and, as long as the market is not rationalised, they can cost all

the actors a large amount of money.

The emergence of the low-cost model will have possibly large and durable effects on

the consumers’ choice, as they are now getting used to very low prices for a good

quality offer.

In this context, the stake for the major companies is the sustaining of their medium

distance traffic, necessary to ensure the transfers on their long distance traffic. Then,

they must reduce the difference in cost with the low-cost companies, while

preserving the characteristics corresponding to their economic models: importance

given to the time value and a global service.

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APPENDICES

88

APPENDIX A: Summary of the interviews

Here is the questionnaire:

§ What is the situation of Aéris nowadays? § Is there just one place for a low-cost airline in Europe? Problems with new

entrants/high entry barriers?

§ How can one explain such bankruptcy compared with certain success?

§ Who are the low-cost competitors in Europe?

§ What are finally the advantages of the low-cost /major airlines?

§ Why does Air France not create a low cost subsidiary?

§ What criticism can be formulated concerning the low-cost carriers?

§ What could still be improved?

§ Is Ryanair only profitable thanks to subsidies?

Summary of the interview with Eric Marriolle:

Some relevant characteristics of Aéris that could explain its bankruptcy in 2004:

§ The firm should not have diversified: there was a misunderstanding with the

middle and long distance model and therefore problems emerged with the

tour operator,

§ Aéris should have chosen the low cost model at the very beginning (by

delocalising for instance),

§ Appearance of frequency problems,

§ The French airline was under the control of an American holding (pension

funds).

Ryanair and EasyJet can represent nowadays a real fight between two major actors:

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EasyJet is a middle-cost model in classical airports but nobody can predict its future,

although it is the second operator in France.

Ryanair receives subsidies from airports, situated in isolated areas. It can perform

and perpetuate its activities but must operate reductions in the following areas:

§ Functioning costs,

§ Distribution costs,

§ Airport assistance costs,

§ Training costs,

§ Problems to reduce servicing costs (governed by European laws).

Factors explaining the trouble that the airlines have been faced with:

§ September 11th 2001,

§ The war in Iraq,

§ The SRAS.

The air industry is governed as well by laws of the offer/demand :

Here is the current situation in Europe:

§ Either it deals with young firms without any significant experience,

§ Or, like Ryanair, the firms can carry on their business thanks to subsidies.

Here are the reasons why Air France does not create low-cost subsidiaries:

§ The train is currently the competitor of the French company,

§ The low-cost carriers stimulate the traditional ones,

§ The existence of Cityjet, which is a type of Air France subsidiary, based in

Ireland.

Air France owns the monopoly and will be backed up by the state as long as the firm

is not privatised. Air France contracts out flights with a low cost company (Cityjet).

The low cost airlines have conquered customer using the train and the automobile.

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The low-cost model remains anyhow middle distance (point-to-point):

§ The networks are different,

§ It is nevertheless an outstanding stimulator of growth,

§ However the business customer tend to prefer the train (simplified access to

city centre).

Two solutions to diminish costs in airports:

§ The airports could propose different services (cleaning service, external

generator)?

§ The low-cost carriers would choose the expected service.

Is there just one place for low-cost airlines?

§ The airlines could join in the future, create synergies like traditional ones,

§ By creating and keeping one single low-cost carrier (grouping of airlines).

Summary of the interview with Gisèle Arracque:

There is some ambiguity with Aéris; a problem of status: there was actually a

mixture of charter flights/ regular flights and low-cost flights, which induced

financial consequences:

§ High fixed costs to open up new routes,

§ No subsidies,

§ No adapted structure,

§ The charges in France are not the same as in England.

Some relevant aspects of Ryanair:

§ Ryanair establishes only on secondary airport,

§ The low-cost airline is exploding the market,

§ The firm is well established in the west of France (Brittany, Aquitaine…),

§ Creation of new routes.

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For instance, Ryanair with Bergerac airport:

§ 17000 passengers a year,

§ There are no financial problems even though the company does not earn

money,

§ Importance of property stakes with the coming of the British,

§ Huge financial and economical spin-offs, (average amount spent by British:

one hundred euros).

As another example: Buzz with the Beauvais airport:

§ 100 000 passengers a year,

§ Buzz does not make money with this airport but from secondary services

(duty free, bus, rental, advertising…).

France is viewed as a receiving country; the country receives more passengers than it

sends. The slowdown of the air industry was due to a serious political context: 11th

September 2001, the importance of the exchange between continents had economic

consequences for the airlines:

§ Exchange Europe/USA,

§ KLM based all its flights on the North American market,

§ Alitalia or Air Iberia had only a domestic market and could not hence expand

to other continents.

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APPENDIX B: a relevant graph:

§ Interest coalition actors for European liberalisation:

(Supplement to the eighth chapter: The creation of a common European civil aviation

policy: Conditions for change).

European Commission

European Parliament

Individual firms and industry associations

Policy

Council of Ministers

and COREPER

Airport authorities

and Consumer lobbies

DGs VII, IV,XI,I Transport & Competition Cabinets

National ministries parliamentary Committees, government advisory bodies

Member States

Business

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