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Europe's LCCs: Evolutionary surge Jan/Feb 2014 Download PDF

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Michael O’Leary’s pronouncement last Autumn that Ryanair would start cuddling up to customers and increasingly operate from prime airports closer to where passengers actually want to go seems to have been seen as a radical change of strategic direction for the Irish ultra low cost carrier.

The move may more be an acceptance that Ryanair underestimated the success of other LCCs’ (and in particular easyJet’s) entry into mainstream markets and is a sign that the low cost model in Europe is maturing (or at least that the passenger base is becoming more sophisticated at determining product differences at the low end of the price/demand curve); it is becoming increasingly difficult for the LCCs in Europe to stimulate demand efficiently purely by low prices.

Hitherto the Ryanair philosophy was to operate at the lowest possible cost base, between airports offering the lowest possible handling cost per passenger, with flight timings organised to maximise schedule efficiency rather than demand convenience. It has used the pricing of unbundled “ancillaries” to change customer behaviour and help reduce costs further. In essence, the company operates a bus service in a commodity market; and held to the mantra that the lowest cost provider in a commodity market would always win.

In September last year, the UK’s consumer organisation magazine Which? published a survey damning Ryanair as the worst brand in the country (out of the top 100) for customer satisfaction. Naturally Ryanair rebuffed the criticism by emphasising that it has the best on-time performance, punctuality, reliability, lost-bag statistics and fewest official customer complaints of any European airline, but it then set out determinedly to improve its image.

The change of attitude appears pronounced. In October 2013, Ryanair announced a series of strategic initiatives to improve customer service, experience and satisfaction (the first step being to open a twitter account). In November it launched a significant redesign of its website. The old design was tired, garish and hardly seemed to have changed since first introduced in the 1990s (designed for a couple of thousand punts by a Dublin student). The redesign reduces the number of “clicks” required to complete a booking from 17 to five, while the annoying “recaptcha” security code was removed for individual bookings. It introduced a 24 hour “grace period” for minor alterations to website bookings (previously charged for), and a “My Ryanair” customer registration profile. At the same time, the company introduced a free mobile “app”, and plans to offer mobile boarding passes and a new fare finder website in the Spring of this year. It has also opened its tariff inventory to Google Flight Search and is in negotiation with the GDSs to enable its fares to be shown on their distribution channels.

Penalty fees have been significantly reduced (eg from €70 to €15 for the reissue of a boarding card at the airport), bag fees cut from €60 to €30, and passengers are now allowed a second small carry-on bag (which might please the airports’ duty-free operations). It has also introduced “quiet flights” (for those departing before 8am or after 9pm). Fully allocated seating was introduced in February. It launched a groups and corporate travel service in January with plans to introduce a new business product — with reserved seating, flexible tickets and fast-track access through selected airports.

There have been important innovations in the Ryanair network in recent months. It has announced new bases at primary airports in Europe: Rome Fiumicino (attacking Alitalia, easyJet and Vueling which had just started operations there); Athens (one of the most expensive airports in Europe for landing charges) and Thessalonica (attacking Aegean and easyJet); Lisbon (albeit at the low cost terminal); and Brussels Zaventem (taking on easyJet, SN Brussels and Vueling which again had just opened a base there).

In each of these cases it seems that it has accepted that it will not be able to do a special discount deal with the airport and that it will have to pay a per passenger handling charge well above its €5 target — and that this is worth doing. No doubt more primary airports are to come.

In any case there is a new EU regulatory framework on state aid to airports (and consequently covering state-aided airports providing support to airlines to encourage traffic) which may undermine some of the deals that Ryanair has in the past been able to negotiate with smaller regional airports.

What does this all portend for the LCCs in Europe? Ryanair and easyJet had first mover advantages: they each managed to secure favourable aircraft acquisition deals in the early 2000s respectively with Boeing and Airbus to allow them to grow into the vacuum of despair at the time and develop pan-European brands and networks. Since then other LCCs have started and failed, but a new generation with high growth plans have developed — each trying to find their own market position — and are starting to pose a real threat to the perceived LCC duopoly.

Moving up-market — the hybrid model

An airline is an airline — providing a pure commodity product of transporting a passenger (and with luck his baggage) from where he doesn’t want to be to where he wants to go to (and possibly back again). The original LCC model in Europe was based on the Southwest KISS principles:

  • high seating density,
  • high aircraft utilisation,
  • single aircraft type,
  • low fares including exceptionally low promotional fares,
  • single class configuration,
  • point-to-point services, no (free) frills,
  • short-/medium-haul services,
  • frequent use of secondary and tertiary airports,
  • quick turnaround.

Increasingly, the new entrant LCCs have been trying to find a sense of differentiation — leading to the “hybrid” model (see table opposite). One of the first elements of this is to eye the potential of yield uplift by providing a service targeted at “business” passengers. This leads to a traditional offer of at least three flights a day on a route to be attractive — a minimum of a morning and evening flight (with a mid-day infill) — while the origin and destination airport need to be relatively mainstream. In addition there is seen to be a requirement to have presence in the global distribution systems (to gain access to corporate bookings and travel agent distribution), and create a marketing team to develop relationships with corporate accounts. All this of course adds to complexity and cost.

Once you have the idea that you need to attract corporate business accounts you start to get the idea that you need to retain them through some form of loyalty programme — if only because the legacy competitors do. Most of the European LCCs have created an opt-in charged-for programme with defined benefits. Some have even been offering uncharged-for frills for those willing to pay higher “flexible” fares, effectively providing an on-board class differentiation in a single class cabin.

Some of these aspects of the departure from the KISS principle have limited or no impact on costs. These we might describe as “soft” complexities and may include items such as paid for special seat assignment, full-plane seat allocation, priority boarding, branded credit cards — all of which can be either cost neutral or self financing.

Others — which we might call “hard” complexities — are those items that impose a cost penalty against best in class if not absolutely; and here the operator’s hope is that there will be a sufficient improvement in yield to offset the effective increase in costs required to provide or use the service. These will include the use of primary airports, different aircraft types/sizes, access to global distribution services, provision of intra-line (or transfer) services, frequent flyer or loyalty plans, inter-line or code share agreements, membership of global branded alliances, class differentiation, and operation of long haul services.

Vueling (now a part of IAG) positions itself as a high quality low cost Catalonian “flag carrier” targeting SME business travel and mixing the traditional simple low cost model with elements of the legacy operation — transfer traffic at Barcelona, GDS access, quasi “business class”, code shares. As shown in the chart on page 3, Vueling has the highest proportion of capacity flown on “business friendly” routes among the LCCs with around 45% of its seats on routes with more than three daily frequencies. Norwegian is pushing boundaries in developing long haul low cost while trying to replace SAS as the Scandinavian flag. germanwings and transavia are increasingly being used by their parent companies to replace under-performing intra-European routes. Wizz quietly (because it remains privately owned) is trying to survive and grow as an Eastern European VLCC.

Quantifying the real net benefit of this hybrid model is not easy: from public information (where available) it is difficult to compare operating costs on a like for like basis to see where real difference lies. The long term net benefit if any should be seen in the airline’s operating margins; but there are many elements outside the control of the carrier that can affect any one year’s returns. In the charts on this page we show the per passenger data for Ryanair and easyJet on a rolling 12 month basis. Without allowing for currency differences, the performance in easyJet’s per passenger operating profit has shown consistent strong performance since introducing the more business friendly orientation — whereas that of Ryanair has remained fairly steady in the past four years. The stock markets have liked it too — and the out-performance of the easyJet share price has been gratification enough for the hybrid model (see chart on page 3).

From Ryanair’s perspective, the move “up-market” is fairly low risk: its new bases at primary and expensive airports form only a handful of its 65 bases and 1,600 routes throughout Europe, and it is obviously confident enough that its own cost base is still the lowest. Even paying rack rates at its new bases, the rest of its cost structure affords it a 30% advantage over its closest competitor.

Ryanair Wizzair easyJet norwegian airBerlin Vueling flybe Aer Lingus
Secondary/tertiary airports X X X X
Single aircraft type X X X X X
Primary / congested airports ? X X X X X
Corporate accounts ? X X X X X X
GDS/Travel Agent distribution ? X X X X X X
Transfer traffic X X X X
Code share X X X X
Class/Seat differentiation X X
Long haul X X X
Loyalty card (paid for) X X X X
Special seat allocation (paid for) X X X X X X X X
Full plane seat allocation ? X X X X X X
Priority boarding ? X X
Credit card X X X X X X X X
In house bank X
Business Friendly Frequencies (% of seat capacity by route/frequency)
Business Friendly Frequencies (% of seat capacity by route/frequency) Produced by GNUPLOT 4.6 patchlevel 3 0 10 20 30 40 50 60 LHAG Ryanair Air France-KLM IAG easyJet Air Berlin norwegian Vueling Airlines Wizz Air Flybe germanwings Pct intra European seats gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 3-5 daily 5-10 daily >10 daily
Ryanair per seat data
Ryanair per seat data Produced by GNUPLOT 4.6 patchlevel 3 0 10 20 30 40 50 60 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0 5 10 15 20 25 30 EUR/seat (12 month rolling average) Profit per seat gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 Revenue per seat Cost per seat Cost ex fuel Profit per seat
Share Prices
Share Prices Produced by GNUPLOT 4.6 patchlevel 3 50 100 150 200 250 300 350 400 450 500 550 600 Jan 2012 Apr 2012 Jul 2012 Oct 2012 Jan 2013 Apr 2013 Jul 2013 Oct 2013 Jan 2014 Apr 2014 Index (Jan 2012=100) gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 Air Berlin easyJet Ryanair Norwegian Air Shuttle
easyJet per seat data
easyJet per seat data Produced by GNUPLOT 4.6 patchlevel 3 0 10 20 30 40 50 60 70 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0 5 10 GBP per seat GBP profit per seat gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 Revenue per seat Costs per seat Cost ex fuel per seat Operating profit

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