The Low Cost Model: Is it Sustainable

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The Low Cost Model Is it Sustainable?
Aristotelean University of Thessaloniki

Professor Rigas Doganis Rigas Doganis and
Associates Visiting Professor Cranfield
University
8 May 2006
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Intra-European Traffic GrowthAnnual Growth in
Pass-Kms 2000-2004
Geographical Europe plus domestic N.B. - 2003
growth includes purchases of Go (easyJet) and
Buzz (Ryanair) - Ryanair/easyJet
traffic for Financial Years
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Operating Profit or Loss 2003 on Intra-European
Operations
After commission and interest payments
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Cost Advantage of European Low-Cost Carriers on
short-haul routes

• Cost Cost
• Reduction per Seat
• CONVENTIONAL SCHEDULED CARRIER 100
• LOW-COST CARRIER
• Operating advantages
• Higher seating density -16 84
• Higher aircraft utilisation - 2 82
• Lower flight and cabin crew costs - 3 79
• Cheaper secondary airports - 4 75
• Outsourced maintenance/Single aircraft type -
  2 73

Source Rigas Doganis Airline Business in the
21st Century, pub. Routledge, 2005
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AVERAGE DAILY UTILISATION Boeing 737 (2004 Year
Round)

• i.e. 4 easyJet aircraft do the work of 5 BA
  aircraft or 6 SAS

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Pushing the limits Ryanair's five B 737-800s
at Rome Ciampino - 2005
Average utilisation 5 aircraft 1356 hours per
day
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Short-haul pilot productivity - Europe 2002
Network average, short-haul pilots AF, BA, IB,
LH and SK Low-cost average for Buzz, DBA,
easyJet, Germania and Ryanair Source Compiled
by speaker from European Cockpit Association data
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Cost Advantage of European Low-Cost Carriers
(continued)
Cost Cost per Reduction Seat
CONVENTIONAL SCHEDULED CARRIER 100 LOW
COST CARRIER (operating advantages) -
27 73 Product/Service Features Minimal
station costs/outsourced handling - 7 66
No free in-flight catering - 6 61
Marketing differences No agents
commissions - 6 55 Reduced
sales/reservation costs - 3 52 Other
advantages Smaller administration -
3 49 Assumes 100 per cent direct sales and
none through agents

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Total Operating Costs on Intra-European Services
in 2003
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Unit Cost versus Sector Distance in
2003 Intra-European Services Selected Scheduled
Airlines
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Impact of Seat Factor on Unit Costson
Intra-European Services in 2003
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Average Yields on inter-European Services 2003
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Revenue advantages of low-cost carriers

• Simple fare structure and sales in only one or
  two currencies facilitates yield management
• All revenue in advance - if 100 direct sales
• No yield dilution from multi-sector tickets
• No refunds for cancellations
• High ancillary revenues from
• on board food sales
• ticket changes
• cross sales on website (e.g. hotel commisions)
• e.g. 2002-03 Ryanair ancillary profits 55
  million or 21 of profits

BUT no freight revenue or costs!
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easyJet's yield management London (Luton) -
Nice in January 2005
N.B. Fares did not include taxes which were
14.50 for a round trip
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Market stimulation Mature market
London to Barcelona Scheduled Traffic
(1997-2005)
Ryanair (STN-GRO, LTN-GRO, LTN-REU, STN-REU)
easyJet (LTN,LGW,STN-BCN)
Iberia
British Airways
Source UK CAA
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Market stimulation Secondary market
London to Valencia Scheduled Traffic (1997-2005)
Ryanair (STN-VLC)
easyJet (STN,LGW-VLC)
Iberia
British Airways
Source UK CAA
easyJet started STN-VLC on 3 November 2004,
LGW-VLC on 1 March 2005
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(No Transcript)
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• London to Athens Scheduled Traffic (1997-2005)

Others
Hellas Jet
Virgin
easyJet
Olympic
British Airways
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IMPACT OF "LOW COSTS" on PRICINGe.g. Return Fare
on London-Toulouse (US)(Prices requested 6
weeks before)
operated by British European
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BA and easyJet fares compared on
London-Athens(fares at 11 April 06)
includes airport taxes
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Market Shares UK-Italy 2004
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of Total Scheduled Seats to Other EU States or
on Domestic Offered by Low Cost Carriers in March
2006

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Southwest dominates its major markets

• Largest carrier in 90 of SW's top 100 OD markets
• 65 share of its top 100 OD markets (second
  largest American with 7)
• 77 share of intra-Texas traffic
• 71 share of intra-California traffic

Will Europe and Greece go same way?
Source Debbie Ackerman Geneva Aviation Forum,
February 2004
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Risks to the Low Cost Model in Europe

• ? Increasing face-to-face competition between
  low cost carriers
• ? Too rapid growth leads to over-capacity
• ? Charter airlines hit back - "dynamic
  packaging"?
• Upward pressure on costs?
• as airlines increase in size
• as labour/airport agreements unwind
• Pax become more demanding!
• need for product improvements

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What can Conventionals learn from Low-Cost
Carriers?
Product Simplify fare structure Sell direct -
mainly via internet Single class cabin No free
meals -- but sell on board Operations Higher
seat densities on short haul Reduce aircraft
types in fleet, e.g. Aer Lingus Simplify network
reduce hubbing Faster turn-rounds More
flexible labour practices Minimum cabin
crew Maximise pilot hours More out-sourcing
fewer suppliers
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Can legacy carriers reduce the unit cost
advantage of LCCs?
Network Model imposes higher costs Two-class
cabin Connecting passengers and bags More ground
staff Passenger lounges Slower turn-rounds More
expensive airports Higher Staffing
levels Out-dated work rules More expensive
distribution (e.g. agents and GDSs) Some
in-flight catering Mixed fleets
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Can legacy carriers respond to low-cost threat?

• Three choices
• Match LCC costs and/or become LCC
• i.e. Aer Lingus, US Air, Independence Air or
• America West
• Spin off a low-cost subsidiary
• Refocus on the longer-haul markets via their
  hub(s) and reduce short-haul

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Aer Lingus Cost Reductions 2001 to 2003 change

• Distribution - 56
• Aircraft hire - 51
• Misc. Direct Operating Costs - 49
• Overheads - 36
• Fuel - 31
• Airport charges - 28
• Staff costs - 21
• Depreciation - 21
• Maintenance - 12
• En route 6
• TOTAL - 30
• NB by 2004 costs cut by further 5 - 35
• BUT Aer Lingus unit costs still 30-50 higher
  than Ryanair

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A low-cost spin-off must avoid

• Carrying costs from parent
• wage rates/work practices
• low aircraft utilisation
• inappropriate aircraft
• too many in-house services
• etc.
• Interference from parent company
• spin-off carrier must have management freedom
• few do, e.g. United and 'Ted'
• Confused branding
• is it a different airline or the parent company
  in sheep's clothing?

FAILURES Buzz, Go, Snowflake, United
Shuttle SUCCESSES ?? JURY OUT Jetstar (Qantas),
Tiger (SIA), Song (Delta), Ted (United) etc
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Future Shape of European Airline Industry. Will
this be pattern elsewhere ?

• ? 3-5 Network Dominators
• ? Low-cost Service Providers
• - No Frills (2 to 3 majors)
• - Charters (2 to 3 majors in Europe)
• ? Niche Carriers
• - Regional
• - Cargo and Integrators

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For these and other current issues see new 2006
edition of The Airline Businessby Rigas
Doganis Publisher Routledge, UK, and
available throughwww.amazon.co.uk