MGT 6753 Industry Analysis

Low-Cost Carriers in Europe

Julian Geiger, Michael Schlottke, Marcus Schrade

MGT 6753

Industry Analysis

Low-cost carriers in Europe

Industry Overview
The market for low-cost carriers first emerged in the US with Pacific Southwest Airlines, pioneering the concept in 1949. The European market did not really develop until aviation deregulation came into effect in the 1990s, making flights affordable for a wider range of customers. Building on the inclining demand for cheap flights mainly by private individuals (average annual growth of 9.4% for leisure travelers between 1996 and 2003 [11], Figure 2), the industry has experienced rapid growth since then. Most notably, Irish airline Ryanair, formed in 1990, and British company EasyJet, formed in 1995, were able to shape the European market (Figure 3). Germanwings and Air Berlin are additional major players in the low-cost carriers (LCC) market throughout Europe.

PEST Analysis
The evolvement of the LCC industry in Europe was only possible through one major political decision in 1997 the deregulation of the European flight market. Before, the market for flights was largely controlled by the governments of European countries, trying to secure their respective national carriers market share. This led to high prices for European flights airfares were roughly twice as much as those for comparable distances in the U.S. [1]. After lifting most restrictions and enabling European carriers to offer routes between any points in the European Union, fierce market competition developed, leading to a sharp drop in prices. The outreach of cheap airlines is extending continuously. Initially providing competition for traditional, often overpriced and government-subsidized carriers, they are now competing with other forms of ground transportation like busses and trains. In many cases it is cheaper to take a flight as opposed to taking the train, especially for longer distances. Ryanairs average ticket price is about $63 [3], whilea ticket for a high speed train connection between for example Munich and Berlin is often way above $100 [17]. These days increasing fuel prices are affecting the whole airline industry and LCCs in particular. Fuel markets are volatile and influenced by geopolitical factors. Therefore efficient financial management of fuel reserves including trading with options and futures is getting more and more important to keep cost down and be competitive in the market place. Another factor promoting the rapid growth of the airline industry in general is the ever increasing demand for mobility. Being limited to business travelers in the past, a great majority of private persons now travels frequently via airplane to holiday destinations or weekend trips. For the majority of private travelers, price is the primary decision factor. This spurs on the tough competition in the LCC market since loyalty to a particular carrier is no longer found in most travelers the cheapest price wins. There also were numerous technological advances in the past few years that facilitate low-cost air transportation. For example the turn-around time, the time required for a plane from arrival to next departure at an airport was reduced from roughly one hour in the past to less than half an hour. This is made possible through advanced methods like aircraft fueling simultaneously with passengers boarding. Since low turn-around times are essential for higher margins, this is a crucial factor for LCCs capability to offer lower fares. As the number of passengers increases steadily and more people can afford flights for leisure activities, environmental groups warn that the impact on the environment will be severe [3]. Comparing the CO2 2

MGT 6753

Industry Analysis

Low-cost carriers in Europe

emission of a traditional driving vacation inside England with todays increasingly common vacation via plane for example to Murcia, Spain, shows the tremendous difference: for two persons, 20kg of CO 2 are emitted on the car trip as opposed to 1.4 tons of CO 2 emitted on the air plane trip [3]. Easyjet recently started the initiative of carbon offsetting, offering customers the opportunity to contribute to UN certified emission reduction projects in proportion to the CO 2 emission caused by their individual air travel [4].

Porters Five Forces

Bargaining Power of Suppliers
The market for airplanes is very restricted worldwide. Only two suppliers can satisfy the average requirements of todays commercial airliners, Airbus and Boeing. These two suppliers control the market for planes with a capacity of more than 130 seats and stand in high competition to each other. This allows LCCs to get lower prices and good services when purchasing new aircraft. However, once a LCC has made the decision for a certain model, the costs of switching to another model of the same supplier are very high and are even higher when switching to a different supplier. Pilots and mechanics would need to be retrained and the whole supply chain for spare parts and maintenance has to be reorganized. Another important group of suppliers are the airports. Some LCCs (e.g. Ryanair) try avoiding large airports with high fees, limited space and extensive infrastructure. Instead they use regional airports with little bargaining power that are located close to metropolitan areas. This advantage may reduce in the future as the contracts with low fees are running out and many small airports do not depend on just one LCC anymore. Other airlines like EasyJet rely on larger airports and major hubs, tryingto reduce their costs by flying at off-peak times instead [7].

Bargaining Power of Customers

The most important purchasing argument for a LCCs customer is the ticket price. Customers are looking for transportation from point A to B within an acceptable amount of time and in the cheapest possible way. Thus LCCs mostly sell their services through inexpensive web-based platforms and not through costly travel agencies. Without customer service or other differentiating factors besides the ticket prices, there is no close relationship between customers and LCCs. Moreover, switching from one LCC to another is simple and creates no additional cost for the traveler. In conclusion, one can say that the price bargaining power of customers is the dominant force on LCCs. Therefore it is vital for them to always offer the cheapest flight on any route in order to remain competitive.

Threats of New Entrants

The airline industry traditionally requires high upfront capital investments. A sufficient number of aircrafts has to be commissioned and maintenance facilities acquired. In order to remain competitive, a high level of efficiency has to be reached as soon as possible. Aside from the financial factors, the European sky is already very congested and thus there is severe competition on airport slots and flight permissions from the authorities. If a new competitor chooses to serve an already existing route, usually an immediate price war sets in that puts a heavy burden on profitability [8]. However, since the advent of leasing schemes for aircrafts, MRO (maintenance, repair, overhaul) facilities and even aircraft parts (e.g. 3

MGT 6753

Industry Analysis

Low-cost carriers in Europe

Power-by-the-hour, a time-based jet engine rental program from Rolls-Royce [9]) it becomes more viable for new entrants to start with a small financial footprint. Furthermore, several of the established airlines (e.g. Lufthansa with Germanwings [5] or KLM-Air France with Transavia France [6]) have already started to push onto the market of discount prices with their own low-cost brands.

Threats of Substitutes
Since the unique selling point of low-cost airlines is speedy travel for little money, any mode of transportation that can compete either on price or time requirements is a threat to the business model. Almost all of Europe is covered with an extensive, internationally well-connected train system that provides fast transportation at relatively low cost. For domestic or short-distance travel the train is often the quicker alternative due to lower overhead times (e.g. no check-in procedures, no security checks, and no reservations necessary) while offering a higher level of comfort. A good example for this is the highspeed train connection between Stuttgart, Germany and Paris, France, where the travel time of 3 hours is lower than most flight options on that route. Similar arguments can be made for travelling by car. If it comes to long-distance trips, however, the advantage of higher travel speed usually still outweighs the limitations travel by plane creates

Rivalry among Competitors

As mentioned before, LCCs need to have the lowest price to be successful and thus the competition among LCCs is extremely strong. Joining forces with customers bargaining power, this constitutes the prevalent force leveling down profits and margins. Only a limited number of large LCCs in Europe offer European-wide flights and are in direct competition with each other. Additionally there are a lot of regional LCCs that only have to compete in their local market segment. Cost advantages or new ideas for improved operations can often easily be copied by competitors. Since a low ticket price is the driving force for sales, not much momentum has yet been generated through positive differentiation on service quality, reservation procedures or other soft factors. Especially on the high-volume routes between Europes major cities the market for low-cost carriers is very mature and competition for flight slots fierce.

Key Success Factors and Future Trends

Low Fares
The ticket price can be considered as the major key success factor in the LCC industry. Customers using LCCs primarily value the low fares and are willing to compromise on service and amenities. Basically, the trend in air transport goes towards air travel as a commodity, comparable to taking a bus. There are several key factors with great impact on the price for the customers. Identifying these possibilities to save costs and passing on these savings to the customers is a crucial component of successful operation in this industry. 1. A high sales volume combined with maximum load factor (seats sold vs. seats available) of high volume aircrafts helps to keep down the cost per passenger. 2. Short turn-around times, facilitated by efficient processes at the airport, further contribute to a high utilization of aircraft and therefore increase the profit. 4

MGT 6753

Industry Analysis

Low-cost carriers in Europe

3. Efficient internal processes in back office and overall organizational efficiency help to keep the company structure lean and overhead costs low. 4. The relationship with employees through labor contracts and personnel leasing has to be managed carefully. In many cases LCCs do not have labor unions and have a high proportion of leased personnel, increasing their bargaining power with them.

Network
The second key success factor of European low cost carriers is quality and size of the network and the processes of setting up new routes. In general, there are two main types of network models found with European LCCs. On the one hand there is the model used by Ryanair, and on the other hand the model of EasyJet. Both have in common that the network is based on a point-to-point system in contrast to the hub-and-spoke system of most traditional airlines [12]. Ryanair primarily uses secondary, low-frequented airports in its network (Figure 4). It focuses on leisure markets with little competition by other airliners. For setting up a new route, Ryanair requires airport fees to be low. Looking primarily for opportunities to generate customer demand, Ryanair does not focus on current customer needs as much as other airlines [13]. Generating high volume and high efficiency routes with a good profit margin is of primary importance [14]. In contrast to that, EasyJet serves mostly major, highly frequented airports, focusing on existing customer demand and business markets and thereby entering direct competition with existing airlines (Figure 5). In order to generate the cheapest prices within the two models, both of them use the same strategy: For efficiency reasons all routes that do not generate a certain level of profits will be shut down immediately. Existing routes are evaluated frequently, leading to a fast adapting network.

Future Trends
The visible trend of converging ticket prices among the industry will require new methods of differentiation among the carriers to set their brand apart from others while keeping the price low. Increasing demand from business travelers makes it necessary to cater to their specific needs flexibility and an environment supporting productivity. Additionally the airports used will be of increasing importance travelers willingness to drive to remote locations for a low ticket price is decreasing steadily. Especially in the case of business travelers, the use of major airports and hubs is a valuable asset, since it gives customers a direct and comparable alternative to traditional carriers. Taking these thoughts into account, EasyJet seems to be the best prepared LCC in the market. It has a focus on major airports and already started to offer business lounges [18] in many locations. Being one of the biggest players in the market today, EasyJet is well-placed for success in the future, drawing upon its long experience and higher customer satisfaction ratings [19]. Compared to that, Ryanair still seems to be stuck in the traditional LCC method, failing to explore new concepts which can provide future differentiation from competitors. Therefore it appears justified to believe that EasyJet will be the number one market shaping company in the near future.

MGT 6753

Industry Analysis

Low-cost carriers in Europe

References
[1] http://en.wikipedia.org/wiki/Airline_deregulation#Benefits [2] http://wikitravel.org/en/Discount_airlines_in_Europe [3] http://www.stopglobalwarming.org/sgw_read.asp?id=1148066222008 [4] http://www.easyjet.com/en/Environment/carbon_offsetting.html [5] http://en.wikipedia.org/wiki/Germanwings [6] http://en.wikipedia.org/wiki/Air_France-KLM [7] http://www.aerlines.nl/issue_24/low_cost_engends.pdf [8] http://www.telegraph.co.uk/travel/4015854/Low-cost-airliners-in-price-war.html [9] http://en.wikipedia.org/wiki/Power_by_the_Hour [10] http://www.mckinsey.de/downloads/presse/2005/sb_050623_bb_airlines.pdf [11] EU network carriers, low cost carriers and consumer behaviour: A Delphi study of future trends [12] http://www.icao.int/icao/en/atb/ecp/CaseStudies/Europe_LowCost_Fr.pdf [13] http://robertoigarza.files.wordpress.com/2008/10/art-eu-network-carriers-low-cost-carriers-andconsumer-behaviour-a-delphi-study-of-future-trends-ma.pdf [14] http://www.dbresearch.de/PROD/DBR_INTERNET_DE-PROD/PROD0000000000078753.PDF [15] http://www.ryanair.com/site/about/invest/docs/present/Full_Year_Results_2009.pdf [16] http://www.metman66.com/images/map%20easyjet.JPG [17] http://reiseauskunft.bahn.de [18] http://www.easyjet.com/EN/Planning/Travel/airportlounges.html [19] http://www.thetravelmagazine.net/i-2786--easyjet-beats-ryanair.html

MGT 6753

Industry Analysis

Low-cost carriers in Europe

Appendix

27% 31% Ryanair EasyJet AirBerlin Fly BE Germanwings DBA 4% 4% 5% 6%

Figure 1: Market share of European LCC as percentage of available seats [10]

Others 23%

Figure 2: Growth of market share [11]

MGT 6753

Industry Analysis
200 160 120 80 40 0 0 200 400 600 Distance (km) 800

Low-cost carriers in Europe

One-way airline cost / rail fare ()

1000

1200

Traditional airlines

Low cost airlines

2002 rail fares

Figure 3: Airline costs per passenger, and rail fares, from Barcelona [11]

Figure 4: Ryanairs Network [15]

MGT 6753

Industry Analysis

Low-cost carriers in Europe

Figure 5: EasyJets Network [16]