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

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 lowcost 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:

INTRODUCTION:

1. General Introduction to the Dissertation:

1.1. Purpose of the dissertation:

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

2.1. The current situation of the European air industry: 2.2. The cult of cost reduction: 2.3. The breakthrough of the low-cost airlines:

3 3 5 6

iii

METHODOLOGY:

3. Introduction and Objectives:

4. The Pivotal Aspect of the Research Question:

5. Methods and Sources Used:

5.1. Generalities: 5.2. Secondary data: 5.3. Primary data:

9 10 11

6. Criticism and Limitations of the Methods Used:

11

LITERATURE REVIEW:

13

7. Introduction and Prescriptions:

7.1. Objectives and recommendations : 7.2. Explanatio n of the choice and description of the literature review:

13 13 14

iv

8. Some Relevant Readings and Theories:

8.1. The major role of Europe:
8.1.1. Introduction: a history of intergovernmental regulation: 8.1.2. The creation of a common European Civil Aviation policy:
8.1.2.1. Conditions for change: 8.1.2.2. The three packages:

15 15
15

17 17 20 21 21 22 24

8.1.3. Commission power and State aid:

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

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: 8.2.2. Understanding the competitors strength: 8.2.3. Assessing the threat to the core business: 8.2.4. Strengthening the position: 8.2.5. Developing a tailored strategy:

25 25 26 26 27

8.3. Michael Porters theory: 8.3.1. A sectional diagnosis: 8.3.2. Weak entry barriers: 8.3.3. Competitive Intensity: 8.3.4. Bargaining power of suppliers: 8.3.5. Bargaining power of customers:

29 29 30 30 30 30

8.4. The different strategies led by the two low-cost leaders: Ryanair and EasyJet:

31

8.4.1. The strate gies related to product: 8.4.2. The competitive strategies:
8.4.2.1. The flying costs : 8.4.2.2. The maintenance cost of the aircraft: 8.4.2.3. The depreciation cost of the aircrafts: 8.4.2.4. Taxes and insurance:

31 31 32 32 32 32

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

33 34
36

37 38 38 38 39 39

DATA PRESENTATION AND ANALYSIS:

41

9. Identification and Place of the Low-cost Carriers:

9.1. Introduction: 9.2. What is a low-cost carrier? 9.3. Review of the low-cost companies operating in Europe:
9.3.1. The complete listing of European low-cost airlines: 9.3.2. Targeting ten representative European low-cost carriers:

41 41 42 45 45 47

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9.4. Defining the pioneer: Southwest:

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

49 49 50 50 51 51 54 54 55 55 56 56 57 57 59 60 61 62

9.5. Functioning principle of a low-cost company:

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

10. Can the low-cost carriers endanger the traditional ones?

10.1. The nature of the dangers: 10.2. Low-cost carriers create new markets: 10.3. The evolution of certain low-cost companies become a direct threat for the traditional companies:
10.3.1. Retaliation by traditional companies:
10.3.1.1. Giving up certain routes or market share: 10.3.1.2. Pricing: the response: 10.3.1.3. Must the business model be re-evaluated?

64

64 67 72

73 73 74 75
76

10.3.2. The low-cost carriers can also be in danger:

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

76 77 78

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11. What future for the low-cost airlines:

11.1. The future of low-cost carriers: 11.2. The expansion towards the Eastern countries:
11.2.1. Low-cost carriers in Central and Eastern Europe: 11.2.2. Low-cost airlines aim to grow as Europe expands eastwards:

80

80 82
82

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 Porters 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 intraEuropean 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

Acknowledgments

I should like to express my sincere tanks to my supervisor Mr Jrge 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.

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 involve s. 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 lowcost 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)?

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

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. Altho ugh most of the major companies are well established, there is now a growth of low-cost alternatives.

For instance, the lo w-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.

Europeans 2000 Annual report on the EU air travel industry

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 reductio n 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 1980s 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

The key factors affecting indirect costs for an airline are fleet structure, route network and company policies on remuneration and work rules (Serist and Verpslinen 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 1990s; 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 carriers 4 . Nevertheless, a real study conducted by the British Civil Aviation Authority (CAA) in 1998 showed the appearance in the 1990s 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 1990s and probably one of the most significant for the future.

Cleared for take off Thomas C.Lawton

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 m eans 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.

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.

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.

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. -Gisle Arraque teaches at the Saint Exupry 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 Aris, 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.

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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 authors 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.

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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 Porters 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).

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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 industrys 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.

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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.

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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 Treatys 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 1980s, 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.

17

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 commissions 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 airlines 7 .

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 Commissions own air transport objectives, outlined in a memorandum to the Council of Ministers 8 . Overall, the Commissions objectives were double:

British Department of Transport, pack on EC aviation liberalisation (1997) The Commissions Civil Aviation Memorandum Number 1 (1979) Communication and Proposals by the Commission to the Council, Civil Aviation Memorandum N2

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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

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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.

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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 fa re 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.

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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 users10 .

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 sector 11 . The report revealed that several airlines were benefiting from state intervention, often direct operating aids or aids aimed at improving the airlines financial structure.

Several potential state aids in the form of exclusive rights concessions were also revealed. In response to these f indings, and complaints by various Member State governments and airline companies, the Commission, in the summer of 1993, set up a committee of experts, the Comit 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 issue s.

10 11

State Aid to Airlines, Commission on Air Transport, 13 June 1995 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

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Its conclusio ns, released in a 1994 report, that the Commission were driven by principles of competition, rather than the notion of national prestige. The Comit argued that access to finance should be equal, regardless of an airlines 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 Comit 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 Comit stressed that the Single Market must be made to work by enforcing its rules and addressing sensitive issue s such as state aid (Hanlon 1994, p.6). The Comit 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 Comit conceded that, for a brief transitionary period, some states would have to act to put airlines on a normal commercial footing, the reasons f or 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

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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 T ransport 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 i ncreased development of the low-cost companies

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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 Stphanie J. Young, of McKinsey & Company.

Twice in the past two decades the American airline industry has been threatened with low-cost competitors. The 1980s 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 1980s and depressed demand in the early 1990s, 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:

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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 ha ve 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.

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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 manage ment 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 the y 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.

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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 lowcost 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.

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8.3. Michael Porters Model:

8.3.1. The Sectional Diagnosis:

In order to evaluate the low cost situation, an external diagnosis on the Porters model considers the different market actors and the pressures that they put on the given sector.

Diagram 1: The Five Force of Michael Porters Model: (Source www.quickmba.com).

New entrants entry barriers

Bargaining power of suppliers

Industry competitors Rivalry among existing Firms

Bargaining power of customers

Threat of substitute products

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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 (members concept) with attractive prices.

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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 experienc e 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.

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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.

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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 lowcost 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:

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Ryanair: Geographical expansion

EasyJet: Aims to conquer new consume r 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.

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Table 1: Financial Situation of Ryanair/EasyJet Compared to Air France: (Source www.yahoo.com).

Financial information Date of creation Capital (number of shares) Market valuation (millions of pounds) Turn over (millions of pounds) Net profits (millions of pounds) Price earnings ratio (pence) Price earning ratio/market share price

EasyJet 1996 391 672 036 981 552 49 14.61 17.69

Ryanair 1985 7555 056 018 3360 624 151 20.3 21.94

Air France

8080 142

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.

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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 companys 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 bestare 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 emplo yees.

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 companys 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.

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This bonus represents approximately 10% of a pilots income and 35% of a flight attendants 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.

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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).

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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 OLeary 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,

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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.

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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 tho se 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 seve nties 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.

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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 1990s. The influence of the Southwest model has become evident. Michael OLeary, Chief Executive Officer of Ryanair pointed out : all the employees from Ryanair have carefully studied the methods of Southwest.

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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,

43

TUI has launched Germania Charters created by Hapag Lloyd Express with a base in Cologne-Bonn with a fleet composed of eight Boeing 737-700s.

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 improve ment of 20% per year.

Figure 1: Market Share of the Low-Cost Companies: (Sources: Journal of Air Transport 2003).

Total Europe
7%
low-cost Others

Great BritainIreland

20% Low-cost Others 80%

93%

Continent

Cross Channel

2% Low-cost Others 98%

79%

21% Low-cost Others

44

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 Germania Express DeutscheBA German Wings Hapag-Lloyd Express V BIRD

Great Britain: Air Scotland Air Southwest Bmibaby EasyJet Excel Airways Thomsonfly.com Go Fly MyTravelLite Jet2 Virgin Express

Austria: Fly Fair

Belgium: fly VLM Airlines

Poland: Air Polonia

Finland Flyeco

Hungary Wizz Air

Norway Norwegian

45

Ireland AerArann FreshAer.com Jetmagic.com Ryanair Skynet Airlines

Italy AlpiEagles eVolavia.com Meridiana Volareweb.com

Sweden Flyme Scandjet Snalskjutsen snowflake

Denmark: Sterling Jet Snowflake Maersk Air

The Netherlands Basiq Air

Czech Republic Smart Wings SkyEurope

46

9.3.2. Table 2: Targeting Ten Representative European Low-Cost Airlines: (Source: LExpress Magasine, June 2003).
Ryanair Date of foundation Origin
Irish low cost carrier since 1991 European leader Subsidiary Dutch Transavia Amsterdam Schilphol Netherlands 39 (France: 5) Boeing 737 13 (France: 3) Boeing 737 20 (France: 2) Airbus A-319 A-320 East Midlands of the Subsidiary of the British airline: BMI Subsidiary of the German Lufthansa Cologne, Bonn (Germany) airline: (bought out Go in 2002) airline: 1986

EasyJet
December 2002

Basiq Air
December 2000

BMI Baby
January 2002

German wings
October 2002

Main airports

9 (Dublin, London, Frankfort...)

London Luton (Great Britain )

(Great Britain)

Number of routes Fleet

125 (France: 19) Boeing 737

102 (France: 18) Boeing 737

Airports Taxes Booking fee

Before taxes

Before taxes

Before taxes

After taxes

After taxes

Payment by credit card: +5 00

Payment

by

credit

Payment by Phone: +6 00

Payment

with

Payment by Phone: +5 00 Over than 25kg: 4 /kg 25 Impossible

card: +5 00 Phone: +6 50 Over 10 kg: +6 /kg

creditcard: +5 00 Phone: +6 00

Additional luggage Change of flight Change passenger name Infants Unaccompanied minors Other information of

Over 15 kg: +6 /kg

Over 20 kg: 5 /kg

Over than 20 kg: 7 /kg

25 25

24 24

20 20

24 50

8 Not possible,

Free of charge Not possible,

10 Not possible,

Free of charge Not possible,

Free of charge Not possible,

minimum age: 12 None

minimum age: 14 If booking by phone: departure within 30 days

minimum age: 12 Booking at least 4 days departure 0821 231 214 Basiqair.com before

minimum age: 14

minimum age: 16 Refund possible if delay more than 2 hours

Phone- booking Websites

0825 00 03 04 Ryanair.com

0825 08 25 08 Easyjet.com

0890 710 081 Bmibaby.com

01 55 21 25 10 Germanwings.co m

47

Globe Span

Jet 2

My travelLite

Snow flake

Virgin Express
19921996

Date of foundation Origin

November 2002

November 2002

August 2002

Summer 2003

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 Stockholm (Sweden) 19 (France: 1) Boeing 737

Charter

airline

turned out by the deregulation Brussels (Belgium) 18 (France: 2) Boeing 737

Main airports

Glasgow (Great Britain)

Leeds,

Bradford

Birmingham (Great Britain) 11 (France: 1) Airbus A320

(Great Britain)

Number of routes Fleet

8 (France: 1) Boeing 737

9 (France: 1) Boeing 737

Airports Taxes Booking fee

Before taxes

Before taxes

Before taxes

After taxes

Before taxes

Payment by phone: + 4 00

Payment by credit card: + 5 00

Payment credit card: +4 00

with

None

Payment credit card: +2 00

with

Phone: + 5 00

Phone: + 5 00 Over 20 kg: +5 /kg 25 25 Over 20 kg: +5 /kg 25 25

Additional luggage Change of flight Change of

Over 20 kg: +6 /kg

Over 20 kg: +8 /kg

Over 20 kg: +5 /kg

23 (30 days before) 23 (24 hours before)

25 25

30 30

passenger name Infants Unaccompanied minors

19 Not possible, minimum Free of charge Not possible, 8 Not possible, Free of charge Yes from 5 to 11 years old Free of charge Yes from 5 to 12 years old extra charge: 25

age: 16

minimum age: 14

minimum age: 12

extra 27 50

charge:

Other information

Last minute prices on Internet

Business prices enabling changes of flight

Phone- booking Websites

0044 131 441 2700 Flyglobespan.com

0825 0826 022 Jet2.com

0825 00 03 04 Mytravelite. Com

0825 325 325 Flysnowflake.c om

0800 528 528 Virginexpress.co m

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.

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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 s ervices t raditionally 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 c ompetitors, 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 mana ges 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.

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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.

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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 issue s: 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 Companies:

Model Distinct from the Traditional

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:

51

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 companie s 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.

52

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 Organisation Network - Point to point organised from base

- A wide network - Short distances (800 km on average)

Traditional model

- Network allowing a worldwide scope - Transfers - Long distances

Airports
- Secondary airports sometimes overcrowded

- Main airports

Fleet

- Monotype: Boeing 737 in General - High density of seats (149 on B-737) - Recent aeroplanes - High utilization rate

- Diversified fleet - Optimisation of the use of the ae roplanes (respect of the hub logic)

Staff

- Motivating wages - Participations in profits, stock-options - Light structure: teleworking, subcontractor..) - Minimum staff

- More traditional human resource management - More services on board - Few subcontractors - Many information systems

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Product - 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

Customers

- All type of clients who look for a low price

Flights product

- One-way - Single cabin - No numbered seats - No lunch on board - Paying for snacks and drinks - No newspapers on board

Fares

- Low and simple fares - No restrictions on fares - Simplified yield management to optimise the air occupation rate

Ground product

- No lounge - No loyalty bonus - No transfer

- Lounge and services on ground - Individual loyalty program, enterprises relations - Transfers

Distribution

- Few sales in agencies - Direct selling (Internet or Call-centre) - Electronic ticket

- All channels - No direct selling

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.

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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 turnround 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 maintena nce 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.

55

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 i n 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 ge neral), 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.

56

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).

57

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).

(1) Costs

Companies Delta Airlines United Airlines US Airways Continental America West Southwest

per seat/miles (US cents) 5,54 5,20 5,04 4,28 3,91 3,10

Costs (index)
(2)

100 94 91 77 71 56

Average distance (miles) 708 668 698 1007 701 461

Daily utilisation (hours) 9,8 10,3 10,1 10,5 11,8 11,3

Number of seats per aircraft 126 128 126 129 131 137

(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).

58

Table 5: Synthesis of the Gap of Overall Operating Costs on IntraEuropean Lines: (Source: data compiled by Rigas Doganis from the Airline Monitor (1999).

Company

Cost per seat (Us cents)

(1)

(2)

Cost (Index)

Traditional companies
Aer Lingus SAS Air France British Airways British Midland Alitalia 15.07 13.86 12.85 11.98 11.58 10.05 126 116 107 100 97 84

Low-cost companies
EasyJet Ryanair 6.04 5.04 50 10

(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 adve rtising; and this is not the only example.

59

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 350 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.

60

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 1490 + VAT for Paris-Nice, Ryanair proposes 1790 for Paris-Dublin, Minus 5 if using the Internet in both of cases.

61

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 advertiseme nts 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.

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Table 6: Example of Evolution of Price in EasyJet: (Source: CSC).

Time of departure
16th August

Date of the price offer on the Internet

23rd August 30th August 06th September 13th September 20th September

Paris-Nice Friday, 20th Sept.

8.20 13.30 17.55 22.10

Nice -Paris Sunday, 22nd Sept.

22.40 32.40 32.40 32.40

57.40 57.40 72.40 72.40

72.40 72.40 72.40 72.40

72.40 72.40 87.40 72.40

72.40 72.40 87.40 87.40

72.40 87.40 87.40 122.40

7.00 11.25 16.05 20.20

32.40 57.40 57.40 87.40

57.40 72.40 87.40 122.40

57.40 72.40 72.40 122.40

47.40 72.40 87.40 122.40

47.40 72.40 87.40 122.40

57.40 72.40 87.40 122.40

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?

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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.

64

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.

65

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 Stand sted 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.

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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, Chambry, 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.

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Figure 2: Induction of EasyJet on the Manchester/Liverpool-Nice Flight: (Source CSC). Number of passengers
140000 120000 100000 80000 60000 40000 20000 0 1995 1996 Charters 1997 1998 1999 2000 B.A

Other lines

EasyJet

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 Rya nair, 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:
700000 600000 500000 400000 300000 200000 100000 0 1995

1996

1997

1998

1999

2000

Air France

Aer Lingus

Ryanair

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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
Number of passengers
350000 300000 250000 200000 150000 100000 50000 0 1998 LX 1999 Air France 2000 EasyJet 2001

Geneva- liverpool
Number of passengers

160000 140000 120000 100000 80000 60000 40000 20000 0 1998 1999 B.A
+106%

2000 EasyJet

2001

+217%

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Geneva-Barcelona
Number of passengers

Geneva-Barcelona
Number of passengers

200000 180000 160000 140000 120000 100000 80000 60000 40000 20000 0 1998

250000 200000 150000 100000 50000 0 1998

1999 I.X
+296%

2000 EasyJet

2001

1999 K.L

2000 EasyJet

2001

+64%

In case of Geneva-Nice, EasyJet created a heavy i nduction 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.

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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).

EasyJet (LGW) EasyJet (LTN+STN) Crossair Swissair B.1 (LGW) B.A (LHR)

1800000 1600000 1400000 1200000 1000000 800000 600000 400000 200000 0 1996 1997 1998 1999 2000 2001

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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 the se costs on in their prices? Will the y 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?

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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?

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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).

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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 lowcost companies.

The characteristics of their models (use of several types of aeroplanes, operations from main airports, synchronisation of the ho urs 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 suc cessful 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:

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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 ens ure 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.

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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-319s. 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 whe n 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.

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Figure 6: The Illustration of the Drop in Cost of Personnel at the Maturation of the Low-Cost Model: (Source CSC).

2 1,8
Cost of Personnel (cents$)

1,6 1,4 1,2 1 0,8 0,6 0,4 0,2 0 Southwest Ryanair EasyJet ViriginExpress

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.

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For instance, the low-cost companies plan to create new bases in Belgium, in Switzerla nd 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?

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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)

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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 n ot got competition? Supermarkets have competition, manufacturers have competition.

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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 Eurocontrols 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, i t's very f ractious," 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 panEuropean 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 lowcost 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 f or 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 leisur e 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 Hlne 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 comp lete 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

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APPENDIX A: Summary of the interviews

Here is the questionnaire:

What is the situation of Aris 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 Aris 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, Aris 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 Gisle Arracque:

There is some ambiguity with Aris; 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) .

Business

European Commission

Member States
National ministries parliamentary Committees, government advisory bodies

Individual firms and industry associations

DGs VII, IV,XI,I Transport & Competition Cabinets

Policy

European Parliament

Council of Ministers and COREPER

Airport authorities and Consumer lobbies

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BIBLIOGRAPHY

a) Books:
Bourdieu, P., (1980) Le Mtier de Sociologue . Paris, Mouton. Button, K., (1991) Airline Deregulation. David Fulton Publishers. Cini, M., and Mc Gowan, L., (1998) Competing Policy in the European Union. Basingstoke, Macmillan. Commission of the European Communities (CEC)., (1994) The Way forward for Civil Aviation in Europe . COM (94) 218 final. Doganis, R., (1991) Flying Off Course. London, Harper Collins Academic, 2nd edition. Freiberg, K., and Freiberg, J., (2001), NUTS! Southwest Airlines Craze Recipe for Business and Personal Success . Textere Publishing, New York, London. Hanlon, P., (1996) Global Airlines: Competition in a Transnational Industry . Oxford, Butterworth, Heinemann. Kassim, H., (1995) Air Transport Champions: Still Carrying the Flag. In J. Hayward, edition. Lawton, T., (2002) Cleared for Take-Off: Structure and Strategy in the Low-Fare Airline Business . Ashgate, Publishing Limited. Ott, J., and Neidl, R., (1997) The Airline Industry, Turbulent Flight into the Future , Oxford, 2nd edition. Sampson, A., (1984) Empire of the Sky (the Politics, Contests and Cartels of World Airlines). London, Hodder and Stoughton. Sochor, E., (1991) The Politics of International Aviation. London, Macmillan. Thivard, R-A., (1995) Mthodes de Recherche en Management . 2nd edition, Dunod.

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a) Articles:
Ames, B.C., and Hlavacek, J.D., (1990) Vital Truths about Managing your Costs. Harvard Business Review, 140-7. Barkin, I., Hertzell, S., and Young, S., (1996) The Challenge of Low-Cost Competition. Prcis based on a Mc Kinsey & Companys report , 59-60. Bogrow, Sophie., (2003) Les Low-Cost au Banc dEssai. Lexpress magazine , 42-46. Button, K., and Swann D., (1989) European Community Airlines Deregulation and its Problems. Journal of Common Market Studies, XXVII, 259-82. Doganis, R., (1994) The Impact of Liberalization on European Airline Strategies and Operations. Journal of Air Transport Management , 15-25. Estival, L., (2004) Europe de lEst et Transport Arien: la Guerre des LowCost sAnnonce. Courrier Hebdo Cadres, n1541, 13. FG., (2004) Guerre des Prix dans le Ciel de lEurope de lEst. Le Quotidien du Tourisme , n2345, 10. Hguy, J-B., (2004) Quatre Sites Internet de Compagnies bas Prix. LEcho Touristique , Flash Press n8. Robertson, D.L., (1995) Corporate Graffiti. Business Strategy Review, vol.1, 22-44. Seuret, F., (2003) le Discount Social des Casseurs de Prix. Alternatives Economiques, n 214, 56-60. Serist, H., and Verpslinen, A.P.J., (1997) Airlines Cost Drivers: Cost Implications of Fleet, Routes, and Personnel Policies. Journal of Air Transport Management , vol.3, 11-22.

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f) Technical reports:
Aubriot Christine., (2002) Bulletin de lObservatoire des Politiques et des Stratgies de Transport en Europe, Report held by the Conseil National des transports . N7 December 2002. Conseil en Management et Technologies de l Information., (2002) La Rvolution Low -Cost . Report of CSC Peat Marwick, November, 2002. Laszlo, P., (1999) Southwest Airlines: Living Total Quality in a Service Organisation. Case studies, Managing Service Quality, Volume 9, Number 2.

g) Websites:
www.quotidiendutourisme.com www.ryanair.com www.easyjet.com www.springer.de www.airinfos.com www.senat.fr www.sudaerien.fr www.yahoo.com

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