The entry of SAS into the low-cost sector is just the latest response by north European carriers to the no-frills threat
Ever since the emergence in Europe of the low-cost sector in the late 1990s, the continent's full service carriers have been trying to fathom out how to respond to this new challenge. In the UK - the first major market to be exposed to low-cost competition - flag carrier British Airways launched a low-cost subsidiary, Go, in 1997, only to bail out five years later as the new entity was cannibalising mainline traffic.
KLM followed BA in launching a low-cost offering, Buzz, as its KLM uk regional subsidiary struggled against the likes of Ryanair and easyJet. Unlike BA, KLM has stayed with Buzz, although it is looking for an investment partner for the operation. It also launched Basiq Air in its home market. Lufthansa also put its foot in the low-cost door through its minority-owned German regional subsidiary Eurowings. The latter launched germanwings last year.
The latest to go down this route is SAS, which announced its plans to set up a low-cost unit shortly before Christmas, given the working title Scandinavian Lite. As with all mainline forays into this market, there is no shortage of sceptics as to the merits of this strategy. "It is so much easier to establish a small carrier and gain efficiencies as you grow," says Captain Otto Lagarhaus, president of Lagarhaus Aviation Consulting and a former senior vice-president of SAS production division. "The other way is nearly impossible." He notes, however, that SAS is devoting a relatively small amount of its resources to this project. "There is not much risk involved. SAS is doing the right thing in treating this as a pilot project," he says. "The problem I have with this is that you are removing four-to-five aircraft from the fleet. This normally detracts from operational efficiency of an airline. The existing operations will have to shrink." He contrasts this with the strategy undertaken by the likes of Ryanair, where growth leads to an increase in operating efficiencies.
Growing threat
It was no secret that SAS was considering setting up a low-cost unit. In the UK, Europe's most mature low-cost market, around 30% of domestic and European services are now in the hands of low-cost competitors, putting them virtually level with British Airways. Low-cost penetration in Germany remains under 20%, despite significant activity over the last year or so, including the arrival of a Ryanair base and the entry of a host of new local players. In Scandinavia, the low cost share is still a paltry 6%, but SAS Scandinavian Airlines is well aware that this could quickly change.
Ryanair has made major inroads into Scandinavia, and has looked closely at setting up a base in Stockholm. In January last year, start-up GoodJet became the first dedicated low-cost carrier in the region, operating a Boeing 737-300 out of Gothenburg Landvetter to Paris Beauvais and Nice. Shortly afterwards regional carrier Norwegian Air Shuttle began operating 737s on domestic services under the brand name of Norwegian. Meanwhile, sources close to MyTravel, the UK travel group, have made no secret of the fact that its Danish arm, MyTravel A/S, could be used to enter the Scandinavian low-cost sector. Last year the group launched low-cost subsidiary, MyTravelLite, in the UK.
The likes of Norwegian are yet relatively small operations, and Goodjet quickly ran into financial difficulties, suspending flights in January. Nevertheless, Lagarhaus points out that they represent a foothold in the market and could be taken over by larger low-cost operators looking to expand onto SAS territory. Norwegian's managing director, Stig Willassen, does little to calm such fears: "It could be a possibility, yes. Size is of critical importance in this market, although we would prefer to eat rather than be eaten."
Against this background, SAS has decided it must act. Scandinavian Lite will initially operate out of Stockholm Arlanda and Copenhagen International with a total of four Boeing 737-800s leased from the SAS fleet. After the summer season, they will be reconfigured from 150 to 184 seats. The operation will be headed by Eva-Karin Dahl, who spent 10 years at SAS before heading off to San Francisco to join a dot.com company two years ago, and it is due to begin operating at the end of March.
Dahl says that the carrier will be following the pure low-cost Ryanair/Southwest model rather than the mixed leisure/business model espoused by the likes of easyJet and JetBlue - although unlike Ryanair it will be operating out of major airports. The destinations are mainly of the leisure/weekend break variety and Dahl says the new carrier will be aimed purely at the independent traveller. "If we happen to get business travellers, that is fine, but we are not aiming for this market."
Although it will initially operate out of Copenhagen and Stockholm, SAS said when it announced the new launch that "in the future, Oslo may be included in the new concept, and plans are already under way". Some have hinted that this was no more than a political move, designed not to leave the Norwegian public feeling left out. Oslo-based 737 operator Braathens, purchased by SAS last year, serves a broadly similar set of destinations to those chosen by SAS for its low-cost product, including Nice and Alicante, Barcelona, Malaga in Spain.
However, it appears that SAS may be willing to see both carriers flying from Oslo. Dahl says that Scandinavian Lite "will also be operating out of Oslo", although she adds that it is too early to provide any details. She says that the Braathens product is slightly different to the strictly no-frills offering of Scandinavian Lite, and that it is more than likely that the latter will operate to different destinations than the incumbent carrier.
Labour levels
Questions remain over the extent to which Scandinavian Lite can improve costs and, in particular, productivity, compared with SAS - especially in the field of labour. "I don't see the unions responding to this," says Lagarhaus. He estimates that productivity levels among SAS pilots are around the 140h a month mark, while Ryanair manages 180-200h. While not going into specifics, Dahl claims that Scandinavian Lite "is heading in the direction" of Ryanair on this issue, and says that the airline will manage utilisation levels of around 12h a day.
The fact that Scandinavia lies on the periphery of Europe means that getting three rotations a day - usually seen as a benchmark for low-cost operations - will not always be possible, but Dahl sees some advantages from the region's geographical position. "Today, if you travel from Scandinavia to southern Europe, it is likely that you will have to transfer somewhere as there are few direct flights," she says. "We will be offering direct services - something different for the consumer."
Another clear challenge will be differentiating the new product from the existing SAS operation and avoid it cannibalising mainline traffic. "I can't deny that this problem exists," says Dahl. She is adamant, however, that this is an issue that can be overcome. "When we announce the brand in March, it will be very obvious how different it is." She reiterates the fact that nearly all Scandinavian Lite passengers will be independent travellers, adding that SAS is more geared towards business traffic. "SAS is a full service network. We are offering a no-frills service."
In contrast to Scandinavian Lite, Norwegian will be closer to the easyJet model than that of Ryanair, going for a mix of business and leisure traffic. Indeed, until very recently, the carrier had a background in commuter traffic within Norway.
A year ago, most of the carrier's business was regional work carried out on behalf of Braathens and it operated a fleet of six Fokker 50 turboprops on domestic routes. The SAS takeover of Braathens last year put an end to this relationship, leaving the carrier to transform itself into a budget operation. Regional services are being phased out and Norwegian now has a fleet of six 737s on domestic shuttle routes.
Willassen sees room for a second player in a monopoly market, and contrasts this with the experience of Color Air, a Norwegian low-cost pioneer that folded in 1999. He says that the carrier struggled because it was taking on two established players, SAS and Braathens, and that both responded by heavily discounting ticket prices. Since the demise of Color Air, he estimates that ticket prices in Norway have risen by 50%, driving away passengers.
Lagarhaus says that while Norwegian has made a big impression on the market, he questions the carrier's strategy of going head to head with SAS on a number of routes. Willassen says that while Norwegian tries to avoid this where possible, the thinness of many domestic routes makes this inevitable. However, the carrier is scouting out for international destinations.
It is still only early days in the Scandinavian low-cost battle, but there are some clues to future developments from the battles currently shaping up in the neighbouring German market. The low-cost sector has a slightly longer history here than in Scandinavia, with Ryanair setting up a base at Frankfurt Hahn in 2001. That has forced established market players in both the mainline and holiday charter sectors to respond. Lufthansa has been involved in the launch of germanwings through regional affiliate Eurowings. Travel giant TUI has launched Hapag-Lloyd Express, while charter operators Air Berlin and Aero Lloyd have both moved into the low-cost sector. DBA, the former Deutsche BA, is in the process of reinventing itself as a low-cost player.
Dr Thomas Tomkos of Cell Consulting in Germany says a pattern is already emerging. "It is clear that no one will hit Ryanair in terms of price." As a result he says there is a fierce battle for the middle ground, with the various players battling to differentiate themselves. Tomkos says that UK-based KLM subsidiary Buzz and DBA are both battling for the corporate travellers, especially in the small business market.
EasyJet has an option to buy DBA from current owner BA, which it may exercise as early as March this year. However, easyJet chief executive Ray Webster has made it clear that this will require acceptance by the labour force of the easyJet business model, which would mean a significant rise in productivity.
The fiercest battle is between germanwings and Hapag-Lloyd Express, both of which have a main base at Cologne/Bonn and are operating to European city destinations. Despite the fact that the two have powerful backers, Tomkos predicts that only one of these will survive in the long term. As is the case with SAS, Tomkos believes that Lufthansa had to respond to the emergence of the low-cost threat, adding that this also gives the German flag carrier added leverage for dealing with its own unions.
Pressure points
As an example of the pressures already being felt in the sector, he gives the example of Air Berlin, which operates city shuttle-type services within Germany. Having studied the carrier's performance over December and January, Tomkos estimates that on a number of routes it is operating with load factors of around 40%. Low-cost carriers traditionally rely on high break-even load factors.
The Scandinavian market is likely to prove just as tough, and, as in Germany, most observers see a period of consolidation as inevitable at some stage. If Scandinavian Lite is successful, and Dahl says an operating profit in 2004 is the target, then an initial public offering at some stage is a possibility. "It is too soon to say, but I wouldn't rule it out," she says. As the German market shows, however, it is very difficult to compete with Ryanair on price. Scandinavian Lite is clearly an ambitious project, and is perhaps the opening, rather than the final shot in the region's low-cost battle.
REPORT BY COLIN BAKER IN LONDON
Source: Airline Business
