CTAIRA analyst Chris Tarry on how Ryanair's recent lowering of its profit guidances underscores the need for budget carriers to improve their traffic mix
Ryanair’s second profit warning in as many months underlines the need for low-cost carriers (LCCs) in particular to alter their focus to continue growing profitably.
When Ryanair issued its first profit warning back in September, this column raised the point that while getting costs right is important – and in the case of Ryanair its low cost base is clearly a strength – it is revenue, and particularly what might be described as revenue that is an outcome of the ‘necessary fare levels’, that is of even greater importance.
While Ryanair at the time of the September profit warning expected an outcome at, or close to, the bottom of the then forecast range, the airline added that “there could be no guarantee” that the full-year outcome might not be “at, or slightly below, the lower end of the range”.
The reality is that despite responding “aggressively with pricing promotions”, the latest results announcement was accompanied by a further cut in expectations for the full year to an outcome of €510 million ($680 million). This represents a reduction of some €60 million from the bottom end of the previous range, suggesting, at the very least, market exhaustion.
No market is infinite at the price levels that are necessary for an airline to make the required returns, which in the worst times should be sufficient to cover at least variable costs in addition to making some contribution to fixed costs, overheads and profit. Furthermore, when fares fall, instead of stimulating more traffic with a net outcome of more revenue, the consequence can be less revenue overall because the same number of people are travelling but on lower fares.
What has been clear for a long time is that markets described as “stimulated” mature relatively quickly, and there is a need to find additional markets which without, for example, financial support from airports, tend to be less profitable.
This is not a new issue for low-cost carriers. Almost four years ago Airline Business considered how changing focus and substitution effects would become increasingly important. We believed back then that we were close to “another pivotal moment in the industry” and that in Europe and the USA in particular, overall growth would be limited and, for individual airlines, a greater component of their growth would need to come from substitution effects. In other words, they would have to take traffic from other competing airlines.
We wrote about the need for low-cost carriers to increase their average fares by improving the traffic mix. At the time, EasyJet’s management said passengers travelling on business paid some 20% more that the airline’s average fare. We were also very clear that any business with an absolutely low cost base which provided a product demanded by the market would always be a winner.
Furthermore, economy class cabins and single-class airlines may offer a common product, but airlines offer a series of differently-priced commodities where the main price determinants are the timing of the flight and, where there are various options, the airports served.
Since 2010, we have seen in Europe – with the exception of Ryanair – a much greater degree of market convergence. This has not just resulted in a number of low-cost carriers in Europe becoming direct competitors on city pairs, but also changes in how they reach their customer bases.
Against this background it is interesting to examine the changes that have occurred in the London market, generally regarded as the most important market in Europe, between the onset of the downturn in 2008 and 2012.
In overall terms the number of passengers has declined from 135.7 million to 133.2 million. London’s Gatwick and Heathrow airports reported an increase in 2012 over 2008 of 400,000 (1.1%) and 2.6 million (3.9%), respectively, while passenger numbers at London Stansted declined 4.8 million to 17.4 million.
In terms of the split between leisure and business, for all airports in the region, apart from London City, business passenger numbers in 2012 were lower than in 2008. The decline at Gatwick of 7.8% was just below that at Heathrow, which fell 9%, whereas the fall in the number of business passengers at Stansted was almost 40% against a traffic decline of some 22%.
Part of the decline in passenger numbers at Stansted reflects Ryanair’s decision to redeploy aircraft to other bases during the period.Conversely, the relative strength of Gatwick reflects the strategy of EasyJet to increase its focus on the business passenger where, as the airline suggested in a recent presentation, “frequency, timing and price [were] all leading to continued profitable growth”.
While Ryanair has now agreed to a 10-year deal with Stansted to grow passenger numbers from some 13.2 million to 20 million, it is mix rather than just volume that will be important. Here, the issue may still be the airport at the other end of the Ryanair route as it is clear that passengers, particularly business passengers, want to fly to principal airports at either end.
The challenges faced by network carriers with their own short-haul businesses must not be forgotten either. Given the market convergence that has occurred, a key question for European network airlines is whether their own short-haul operations – even when using in-house low-cost subsidiaries – will ever be satisfactorily profitable.
This question has been asked many times in the past and continues to be the focus of management attention and activity. The cost of managing the necessary change, rather than what might be done, appears to be the key issue that cannot be resolved. This will, inevitably, ensure that most, if not all, European network carriers continue to have sizeable elements of their businesses which continue to underperform.