13 Feb The Airline COST Contest | Legacy vs. Low-cost

There is an prevalent and growing elephant in the industry. The Airline cost contest is becoming more and more real. The question is, “who is going to the pay the price?” – Pun intended.

Low Cost Carriers (LCCs) such as Southwest Airlines (USA), Ryanair (Europe) and AirAsia (Asia) have introduced and successfully proven that short-haul-no-frill flights are profitable. In fact, LCCs seem to be the only airlines making healthy profits, whereas the Full Service Airlines (FSCs) continue to struggle with high costs.

Why are Low Cost Carriers so successful?

The success of LCCs can be found in disciplined costs and flexible revenue structures. Over the years LCCs have successfully employed continuous costs reduction mechanisms, continuously iterating cost reduction rounds. Some of the most popular measures include fleet standardization to save on maintenance costs, using narrow-body aircraft to save fuel, having employees perform multiple roles in the boarding process, and a “point-to-point” model instead of the more common “hub-and-spoke” used by FSCs.

On the revenue side LCCs have unbundled their services. Travelers have grown accustomed to paying extra for cabin luggage, food & beverages on planes, and “premium” seats. Ryanair even went as far as introducing 3rd party advertising on their aircraft. Dynamic pricing also accounted for increasing load factors of aircrafts, reducing unit cost (CASK) and increasing the unit revenue (RASK) of aircraft.

Intense price competition on short-haul routes have sent legacy carriers into retreat. Most – if not all – legacy carriers are faced with high unit costs, and are entering slash or die territory. Although the CEOs of legacy carriers have more urgent tasks at hand – such a large scale transformations – let’s take a sneakpeek into the future of the airline industry.

What’s next – finding advantage

An ambitious entrepreneur has pitched a futuristic vision on the industry, including containerizing the loading and unloading of passengers. I want to take a look at the more short-term future.

Inflight Wi-Fi…finally.

US carriers have had in-flight WiFi since 2008, however EU carriers have chosen not to implement this. In-flight WiFi is a small improvement that has potential to give a noticeable advantage, especially since LCCs are luring business travelers by offering additional services.

Easter eggs.

The most recent booking frenzy with the United airlines error-fare has the stench of a guerilla marketing strategy. Over the past years United Airlines has experienced 6 ‘fare-gates’ stemming from struggles to integrate Continental’s booking systems after the merger.

As pricing dynamism is set to lure the price-sensitive part of the market into purchasing tickets that otherwise wouldn’t be bought, this potential guerilla strategy can generate a lot of exposure and additional revenue. This time not by openly competing with other airlines but ‘gamifying’ the booking process.

What’s Next – Cutting Costs

Economies of scale.

The low hanging fruit is to start with a long-haul-no-frills concept using economies of scale. The Airbus A380 could potentially transport 853 passengers in an economy setting. More volume to cover fixed costs and more fuel efficient aircraft results in lower unit costs. Simple. There’s still one “but”: load factors would have to be historically high in order to achieve sustainable long-haul-low-cost services.

In the EU, short-haul LCCs have attempted to crack the trans-atlantic nut with a long-haul-low costs service. As Michael O’leary commented: “The numbers don’t add up”.* Two of the most important reasons are that the increased distance doesn’t allow LCCs to capitalize on the fuel efficiency of narrow-body aircraft. Another important costs saver, airport turnarounds, can not be capitalized on with increased distance. There are simply not as many options to cut costs.

Stopovers.

Perhaps an area that has not received much attention is adding a mid-way stopover to a long-haul flight. This allows for  the use of smaller aircraft which can significantly reduce fuel costs. Icelandair and WoW air are eying more low cost transatlantic flights, with Iceland strategically positioned halfway between the EU and the USA. Smaller airplanes are easier to fill, making it easier to maintain a high load factor, driving unit costs down. Plus an extra stop-over provides an extra opportunity to cut costs.

Shortest-haul

In regions with low connectivity, ultrashort-hauls can be economically viable. EasySky, a Honduran airline, operates an 8-minute flight. The flexibility and low costs of small aircraft are necessary to compete directly with boats, trains, and other means of transport. Widerøe, a regional Norwegian airliner, has profited from the longer travel time of substitutes due to rocky terrain.

Economic viability may lie in regions where few substitutes are available and a market-segment that’s willing to pay for shorter travel time. Opportunities seems to be prevalent in emerging economies with relatively low connectedness. The DHL Global Connectedness Index may also provide some interesting insights into this.

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*Knowing Michael O’leary blurt-outs this could also be a strategy to deter competitors.

Image – Kevin