Sustainability of Low Cost Carriers

Sustainability of Low Cost Carriers in Europe

Low Cost Carriers: Characteristics

The purpose of this study is to examine whether low cost carriers in Europe will still be profitable in the future or if upcoming new trends, laws or other restrictions will make the demand for low cost carriers decrease. The objectives of this study are to: (1) present significant literature which is related to the airline industry with an emphasis on low cost carriers in terms of performance and profitability; (2) to analyze the performance of European low cost carriers in the past and predict possible outcomes or signs which could lead to a change; and (3) to provide realistic recommendations to academia and the airline and tourism industry in order to examine whether the concept of low cost carriers still fits in the present time. There are three primary differences in low cost carriers and traditional airline carriers and by these differences the groups are divided into groups of: (1) service savings; (2) operational savings; and (3) overhead savings. (the Impact of Low Cost Carriers in Europe, 2003) the low cost airlines primarily focus on short haul routes and achieve low operating costs through having as many seats on board the aircraft possible, have those seats filled as much as they can and to fly routes as often as possible. In this realm of the low cost carrier "competitive advantage is derived from greater aircraft productivity"...achieved through "a combination of using uncongested secondary airports and not offering anything other than point-to-point services." (the Impact of Low Cost Carriers in Europe, 2003) Advantages of secondary airports include: (1) they tend to charge airlines less for their services; and (2) they are not as busy and delays due to congestion are less likely. Furthermore, the low cost airlines operate a single fleet of carriers only resulting in the pilots and crews being able to operate any carrier in the fleet. Significant cost-savings are realized by the low cost carriers due to direct and internet marketing and through electronic ticketing. This study concludes that the low-cost carrier industry in Europe has not yet realized its' full potential and that this industry is one that can expect growth and sustainability in the years to come. There is however, the issue of environmental concerns relating to jet fuel that will be addressed yet at the present there are no stated restrictions expecting to be attached to this industry in terms of restrictions or fuel taxes.

THE SUSTAINABILITY of LOW COST CARRIERS in EUROPE

CHAPTER ONE

INTRODUCTION to the STUDY

PURPOSE of STUDY

The purpose of this study is to examine whether low cost carriers in Europe will still be profitable in the future or if upcoming new trends, laws or other restrictions will make the demand for low cost carriers decrease.

OBJECTIVES of the STUDY

The objectives of this study are to: (1) present significant literature which is related to the airline industry with an emphasis on low cost carriers in terms of performance and profitability; (2) to analyze the performance of European low cost carriers in the past and predict possible outcomes or signs which could lead to a change; and (3) to provide realistic recommendations to academia and the airline and tourism industry in order to examine whether the concept of low cost carriers still fits in the present time.

BACKGROUND of the STUDY

The experience of Europe with low cost scheduled flight operators started in 1991 when "Irish carrier Ryanair transformed itself from a conventional regional airline into a carbon copy of the U.S. low cost pioneer Southwest Airlines. By focusing initially on serving the large leisure market between Ireland and the UK, the airline had a dramatic effect on services across the Irish Sea. The second phase of Ryanair's rapid growth has involved the carriers in building up a network of intra-EU routes linking London's third airport, Stansted, with over 50 under-utilized, secondary airports in a number of countries, making the second largest low-cost carrier in Europe." (the Impact of Low Cost Carriers in Europe, 2003) Following Ryanair's acquisition of British Airways Go, EasyJet in 1995, incidentally the rival of Ryanair, Ryanair is the largest low cost European carrier. There has been establishment of other low cost scheduled carriers during these development including launching of 'Buzz and bmibaby in the UK, Virgin Express in Belgium, Basiq Air in the Netherlands, and German wings and Germania in Germany.

LOW COST CARRIERS: CHARACTERISTICS

There are three primary differences in low cost carriers and traditional airline carriers and by these differences the groups are divided into groups of: (1) service savings; (2) operational savings; and (3) overhead savings. (the Impact of Low Cost Carriers in Europe, 2003) the low cost airlines primarily focus on short haul routes and achieve low operating costs through having as many seats on board the aircraft possible, have those seats filled as much as they can and to fly routes as often as possible. In this realm of the low cost carrier "competitive advantage is derived from greater aircraft productivity"...achieved through "a combination of using uncongested secondary airports and not offering anything other than point-to-point services." (the Impact of Low Cost Carriers in Europe, 2003) Advantages of secondary airports include: (1) they tend to charge airlines less for their services; and (2) they are not as busy and delays due to congestion are less likely. Furthermore, the low cost airlines operate a single fleet of carriers only resulting in the pilots and crews being able to operate any carrier in the fleet. Significant cost-savings are realized by the low cost carriers due to direct and internet marketing and through electronic ticketing. The final area of cost savings and one that is clearer to passengers using low cost carrier services is the low cost of the on-board service.

THE SUSTAINABILITY of LOW COST CARRIERS in EUROPE

CHAPTER TWO

LITERATURE REVIEW

The work entitled: "The Impact of Low Cost Carriers in Europe" published in 2003 states that in the current climate in European aviation, which is difficult in nature "one sector is performing extremely well, the so-called low cost/no-fills carriers. While the flag carriers are experiencing severe difficulties, withdrawing from routes and cutting staff, the low cost sector continues to expand at a tremendous pace. There is evidence that the low cost carriers are even becoming dominant players on a significant number of intra-European shorthaul point-to-point routes. The extent to which this expansion of the low cost carriers will affect the traditional airline hub-and-spoke networks poses interesting questions for the European industry and policy makers." (2003) Strategies of low cost carriers in Europe are comprised of two basic types of low cost business models: (1) that of EasyJet; and (2) Ryanair. Ryanair "...serves secondary airports at relatively low frequencies and focuses on new leisure markets with no direct competition. The Ryanair model has as its focus, new leisure markets with no direct competition. EasyJet serves primary high costs airports at high frequencies and focuses on existing business and leisure markets and also new markets, which "...includes strongly persuading suppliers and airports to reduce charges." (the Impact of Low Cost Carriers in Europe, 2003) the other lost cost carriers in Europe attempt to follow one or both of these models however as they are "offshoots of major carriers, so lack the cost advantages of EasyJet and Ryanair." (the Impact of Low Cost Carriers in Europe, 2003) as of the time of this report in 2003 the review states that liberalization throughout Europe has resulted in "tremendous opportunities for the low cost carriers. If they maintain the 25% year on year growth that has bee seen recently, they will possess around one third of the intra-European market in ten years time. In addition, new price sensitive markets will emerge, such as Germany, Scandinavia and the countries of Eastern Europe." (the Impact of Low Cost Carriers in Europe, 2003)

There are uncertainties expressed regarding the sustainability of the low-cost model while simplicity has been noted as the 'key' factor in the success of the low cost carriers in Europe. Consumers are stated to have benefited "from the rise of the low cost sector in terms of more competition, more destinations, greater frequencies and a greater diversity of fares." (the Impact of Low Cost Carriers in Europe, 2003) There are stated to be some issues that aviation policy makers have linked with low cost sector expansion including the mitigating environment effects, especially at hitherto secondary airports, sine the majority of the low cost sector tend to select routes between regional airports stated to be due to a great growth in traffic as well as there are different "conditions of carriage compared to traditional carriers; ensuring the maintenance of a level competitive playing field; maintaining high standards of safety in Europe's increasingly crowded skies; and organizing the allocation of ever scarcer capacity at congested Europeans airports." (the Impact of Low Cost Carriers in Europe, 2003)

Traventec, Ltd., in the work entitled: "The Inevitable Convergence of Regional and Low Cost Carriers" in relation to 'sustainability of the low cost and regional models' of low cost carriers that it has been suggested that the demand for these carriers may have peaked however, while this might be true in the business community, and even that has not been proven, this is stated to not necessarily be the case worldwide due to new entrants in Asia-Pacific and India "aiming to create demand and market share rather than compete head on with established players for existing demand." (Traventec, Ltd., 2005) Market saturation is possible according to Traventec, Ltd., due to the constant "influx of new entrants into the low cost carrier and regional space and continued expansion of existing players. When and whether market saturation is actually reached in specific regions of the world depends on how mature regional and low cost air transport is in the first place and the size of the yet under-served demographic area." (Traventec, Ltd., 2005) There is stated to be a potentially huge regional aviation market in South East Asia yet untapped with more than half of the population of the entire world within six hours flying radiuses from "Kuala Lumpur and a five hour flying radius from Bangkok." (Traventec, Ltd., 2005) the airports in this area have only recently been liberalized with the "international bilateral agreements and vested in the development of airport capacity." (Traventec, Ltd., 2005) When this is added to the low per capita levels of GDP of these countries in this radius to the "unleashed demand for low cost regional air transportation" (Traventec, Ltd., 2005) may be clearly understood.

Technology solutions are cited by Traventec research to include 25 various Internet booking engine solutions in deployment at regional and low cost carriers around the global, with 5 or 6 or these dominating the market. One of the cornerstones of the low cost model is to keep the cost of distribution as low as possible. This is achieved by aiming to sell a large proportion of flights directly to customers online..." And the merits of third party channels are also said to acknowledge by the low cost carriers as well. However as of this 2005 report only fifty percent of low cost carriers have online booking functionality even though "there are plenty of opportunities for solution providers, albeit concentrated in specific geographic sectors rather than others." (Traventec, Ltd., 2005)

Barrett (2004) writes in the work entitled: "The Sustainability of the Ryanair Model" that Ryanair is "Europe's largest new entrant airline since deregulation." Barrett examines Ryanair's product in the areas of "...acceptability to passengers, the use of secondary airports, labor productivity and use of outsourcing, corporate culture, policy environment and legal and policy obstacles." (Barrett, 2004) Barrett states the belief following the analysis of Ryanair's sustainability that Ryanair is expected to experience continued growth "...because of the popularity of low fares, the willingness of passengers to forego traditional airline services in order to avail of low fares and the ability of Ryanair to control and reduce costs." (2004)

The work of Market Research group Mintel International Group Ltd. Reports in a February 1, 2006 report entitled: "Europe's Airports" that: "Small European airports (serving less than 5 million passengers per annum) are experiencing the fastest growth rates, due to free capacity, easy accessibility and lower fees. In spite of a projected 60% increase in European airport capacity over the next 20 years, the capacity problems at the large hubs are set to worsen as European air traffic is projected to increase by a factor of 2.5 times from current levels by 2025. However, the introduction of larger aircraft, such as the Airbus 380, the shift of short-haul air travel to rail and the growth of low-cost carriers, which favor secondary airports, will relieve some of the pressure on major hubs. Most European airports are owned and managed by limited companies, with revenues currently split - about 60:40 on average - between aeronautical and non-aeronautical (retailing, property etc.) revenues. Airport fees are becoming a contentious issue in Europe, due to the disappearance of public subsidies, and the rise of low-cost airlines, for whom airport fees represent a higher percentage of total costs than for traditional carriers." (Mintel, Ltd., 2006)

The work of Fabio Domanico entitled: "The European Airline Industry: Law and Economics of Low Cost Carriers" (2007) published in the European Journal of Law and Economics states in relation to the European low cost carrier industry: "The liberalization process did not lead the entrance of competitors similar to incumbents, but a new organizational model has been developed, the one of low cost carriers. The incumbents' reaction to the liberalization process coupled with the entrance of low cost companies into the sector are hence considered. Two theories are analyzed: the contestable markets theory, to understand the theoretical vision that has influenced the liberalization process, and the core theory, a modern approach to the concept of destructive competition that, according to some authors, is a recurring problem in the sector." (Domanico, 2007) Domanico notes how there are still a plethora of barriers to entry into this market however notes the fact that this organizational model developed by the low cost carriers has assisted new entrants in overtaking these obstacles. Domanico states: "By the same token, the application of the core theory does not seem to justify strategic alliances taking place in these years. The competitive framework is definitely clearer if we analyze sector changes in a different way, from the point-of-view of low cost companies considered as new market actors." (Domanico, 2007)

The work of Whitelegg and Cambridge entitled: "Aviation and Sustainability" published in 2006 by the Stockholm Environment Institute states: "In Europe, there has been a considerable increase in scheduled no-frills airlines which operate from secondary airports such as Stanstead (UK) or Bergamo (Italy) as opposed to international hubs such as Heathrow (UK) or Malpensa (Italy). The destinations, routes and prices on offer are attractive to the individual tourist traveler and increasingly the business passenger. Whilst fewer ASK are needed per trip, the greater frequency and shorter duration of flights means that more planes with fewer seats are required. Hence, forecasts by airline manufacturers for orders for single-aisle aircraft predict future growth in all global regional markets. To increase capacity, expansion of existing airports with new terminals and runways, and the construction of new airports altogether is required." (Whitelegg and Cambridge, 2006 it is noted in this report that aviation fuel will play a key role in sustainability of all aviation carriers. The following figure shows the regional growth in market 2003 for aircraft carriers.

Regional Growth in Market

Source: Whitelegg and Cambridge (2006)

Impacts from the aviation industry in terms of aircraft emissions are shown in the following chart labeled Figure 2.

Impacts from Aircraft Emissions by Stakeholders

Source: Whitelegg and Cambridge (2006)

The work of Pieter Klaas Jagersma and Desiree van Gorp entitled: "Competing With Pirates" states that in the beginning "the low cost companies did not compete with the traditional airlines. They restricted their efforts only to creating a demand where it did not exist yet: market development instead of market penetration. This is an important recommendation for low-cost start-ups: competing with low costs is not 'suicide' provided you expand ('develop') the market as a start-up. Direct competition with existing parties for existing customers ('market penetration') with a low-cost strategy is generally doomed to fail. The triangle 'market penetration - low costs - start-up' rarely results in success. Mid-2000, the low-cost airlines in Europe had a market share of about 7 per cent, but their market share has been growing fast since then (by way of comparison: the low-cost companies had a market share of about 20 per cent in the United States mid-2001)" (2003) These authors question how long the low cost airlines can keep continually growing "without this growth being at the expense of their relatively high profitability? They also ask "What is the optimum number of low cost players and what is the size necessary for those players to maximize profitability? How much room is left on the aviation market to allow the low cost companies further growth?" (Jagersma and Gorp, 2003) the answer given is that this industry can grow a great deal more "because the low cost airlines seem to be sailing for the wind without a worry and it will still take a long time before the end of their growth comes in sight." (Jagersma and Gorp, 2003) Jagersma and Gorp additionally relate the fact that the low cost carriers hold several cost advantages over the major airline carriers in that the "business model is cheaper. The value proposition is geared towards offering one core product: offering punctual flights from a to B. without transfer. All frills have been removed from flying in their concept. Such a philosophy simplifies process management. Internal business processes are a lot simpler and therefore easier to manage. In addition, it takes less hands to bring simpler processes to a favorable conclusion. This brings us to a second cost item: labor costs. Low-cost companies employ cheaper employees and incur consequently lower labor costs, an important cost factor in the aviation industry." (2003) it is additionally stated that the low cost carriers offer what Jagersma and Gorp refer to as "an empty product" due to the often heard complaints of customers concerning the food, drinks, etc. therefore the low cost companies offer these items only by a purchase only basis. Stated as a last major cost saving factor of the low cost carriers is "...the refusal to participate in all kinds of computerized booking systems. As a rule, passengers buy their tickets directly from the low-cost companies (over the phone or via the internet) and bypass therefore the expensive intermediaries. Ergo: lower costs. The fact that low-cost airlines are constantly seeking ways to reduce their operational costs, contributes to their strong position in terms of cost. Thinking in terms of and working with low costs is a way of business life and therefore an integral part of the business culture. The low-cost companies manage to realize a first mover advantage in the field of cost management and reduction. The sustainability of this advantage in everyday practice shows that low-cost companies are experts at this 'cost management'. " (Jagersma and Gorp, 2003)

The work entitled: "AER Hearing on the Possible Impact of EU Guidelines on the Cooperation of he Regional Airports and Low-Cost Airlines: Is Regional Development at Stake?" states the main conclusion of the AER Hearing in Barcelona, April 2004 and specifically states "The recent Ryanair/Charleroi case has inspired a sudden awareness of the importance of air traffic for Regions and the impact of low-cost carriers on Regions. The AER and its working group on regional aviation therefore decided in January 2004 to launch an in-depth reflection on low-cost carriers and their impacts on regions and regional economic development." (AER, 2004) Benefits and positive impacts of low-cost carriers are stated to include: (1) Regional airports become autonomous and viable against downward economic trends and the attitude of airline monopolies and national carriers, who have deserted these airports without any further consideration: Underused airports can be used again which, in turn, leads to a reduction of air congestion (air traffic is no longer concentrated on major hubs) and an improvement of air safety; (2) Dependence on national carriers can be avoided: low-cost carriers challenge the monopolies of big national companies and competitiveness increases; (3) Peripheral regions can find solutions to their isolation: low-cost airlines contribute to the setting up of a new concept of transport that permits accessibility to many regions in Europe, including rural and peripheral areas; (4) the use of aircrafts is no longer the privilege of a few: 'normal' citizens can also fly and discover Europe. The mobility in Europe is therefore increased as well as the awareness of being part of the same entity (further integration of Europe). In addition, tourism in Europe is no longer concentrated on charter destinations but thanks to low-cost carriers, a better distribution of tourism in Europe can be achieved, which, in turn, contributes to limiting the effects of mass tourism in specific areas; and (5) the increase in passengers in regions served by low-cost carriers results in enormous economic benefits to these regions, both indirect and direct. (AER, 2004) the low cost carriers are not only undergoing steady development but also "interregional traffic exists that allows for point to point connections" instead of the general method utilized involving forcing of passengers on flights via airport hubs in capital cities. The report goes on to relate that the EU Commission is lacking in the understanding necessary relating to the emerging market "of a new innovative sector. The EU Commission states that imposition of he same rules on the low cost carriers as are imposed by airline monopolies and international hub airports would essentially limit the flexibility that is necessary "for regional airports to attract new carriers." (AER, 2004)

Political statements and proposals stated by the AER include: (1) Regions oppose against guidelines of strict regulatory measures that the European Commission will produce in the field of aviation. They call for more transparency and flexible guidelines which would take into account the diversity of Regions and the specific conditions of regional airports and give partners the possibility to negotiate while taking into account varied conditions; (2) Regions regret the persistent lack of the transfer of competences and responsibilities towards decentralized bodies in the field of aviation; (3) They commit themselves to avoid worsening the current unstable situation with competition amongst themselves, but rather to adopt an approach of solidarity. With this in mind, they express general support for forming a new strategic alliance in view of achieving long-term partnerships and sustainable development of regions and airlines alike; and (4) This Alliance will encompass the representative European organizations of low-cost carriers with EFLAA, the regions within the AER, the regional airports and their regional authorities. This Alliance, based on a public-private concept where partners share risks and responsibilities, should be regarded as a support system for joint ventures pushing regional and local development and as a solid front to prevent the EU from imposing inflexible guidelines on the field of regional aviation. (AER, 2004) the AER concludes by stating: (1) There is urgent need for non-discrimination, transparency, and equal opportunity in airport-airline negotiations as well as interregional co-operation as tools for developing regional airports; and (2) Strict guidelines would be damaging to the sector and that the EU must take into consideration the varied situations of regional airports when drafting guidelines." (AER, 2004) report entitled: "Calls to Control Low-Cost Flights" states that predictions of scientists are that "if carbon dioxide emissions continue to increase, global warming will bring higher temperatures and heavier rainfall - with all the associated problems." (BBC News, 2004) Therefore taxation of the low cost carriers became an issue with the SDC stating that policies on aviation fuel tax would require agreement on an international level. This will result in the necessity to integrate the environmental costs into the ticket prices which will impact the low cost carrier industry in Europe yet how large an impact this will be was only a projection and because there are other more pressing issues, the BBC News report predicts that the raising of ticket prices in the low cost carrier industry is highly unlikely.

The work entitled: "Flight for Survival: A New Business Model for the Airline Industry" relates that the major carriers face a future of "red ink, low-cost carriers such as Southwest Airlines, JetBlue Airways, and Ryanair are prospering by exploiting a huge cost-of-operations advantage. Low-cost carriers spend seven to eight cents per seta mil to complete a 500-to 600-mile flight...less than half of what it costs the typical hub-and-spoke carrier to fly a flight of the same duration and distance." (Hansson, Ringbeck and Franke, 2008) Hansson, Ringbeck and Franke (2008) relate that costs "mount quickly in the hub-and-spoke airlines intricate system of operations. This business model is predicted on offering consumers a larger number of destinations, significant flexibility and 'frills'. It is a model burdened by the built-in cost penalties of synchronized hub operations, with long aircraft turnaround times and slack built into schedules to increase connectivity by ensuring that there is time for passenger and baggage to make connections." (Hansson, Ringbeck and Franke, 2008) the low cost carrier industry however, by design are focused on simplicity and high productivity and is a business model constructed around "nonstop air travel to and from medium- to high-density markets at a significantly lower price point." (Hansson, Ringbeck and Franke, 2008) Hansson, Ringbeck and Franke report an analysis in the cost gap between the larger airlines and low-cost carriers and findings show that low-cost carriers are "leveraging all resources much more effectively" than the larger airlines and "the cost differential between the full -- "serve and low-cost carriers is 2 to 1 for the same stage length and aircraft, even after adjustment for differences in pay scales, fuel prices, and seat density are made." (Hansson, Ringbeck and Franke, 2008) the really surprising finding is that a mere 5% of the cost differential "can be attributed to the extra amenities the hub-and-spoke carriers offer" as a stated 65% of the low-cost carriers cost advantage "is the result of other production-model choices: (1) 15% derived from work rules and labor agreements; (2) 12% attributed to differences in balance-sheet structure and financial arrangements. (Hansson, Ringbeck and Franke, 2008)