Blurring the model: Low cost airlines and regional carriers swap tactics

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Low-cost chief executives have often said that there is no single low-cost business model, and the way the sector has developed seems to have proved them right

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In Europe the tendency is to keep sector lengths short

When Southwest Airlines started out in 1971, and even when Ryanair took the Southwest concept to Europe in the mid-1990s, everyone was pretty clear about the difference between a low-cost and a major or mainline carrier.

Low-cost carriers served secondary airports on point-to-point, single-class short-haul routes; offered little or nothing in the way of frills; and had single aircraft types that, to start with at least, centred on the Boeing 737 family. And, of course, they were generally cheaper.

Network carriers, in contrast, operated, as the name suggests, hub-and-spoke systems, with a mix of long- and short-haul services and aircraft types. They offered free food and a distinctly higher-class product.

Fast forward to the middle of the first decade of the 21st century, and this distinction has blurred. True, Ryanair continues its relentless focus on the classic low-cost model, but is now more the exception than the rule. Most low-cost carriers offer at least some frills. “For these carriers, the question they have to ask themselves is, am I really a low-cost carrier, or am I a lower-cost carrier?” says Mark Darby, vice-president and managing partner at Unisys. “Some are showing tendencies to become full service carriers.”

Darby predicts that the tendency for the likes of Air Berlin and easyJet to move towards a middle market, hybrid model could open up a gap at the bottom of the market for someone in Europe to come in with a pure model.

The USA has also seen low-cost carriers moving away from the pure low-cost model – to the extent that the product offering is often an improvement on that of the majors. This is, of course, driven as much by the financial woes of the majors as anything else. As New York-based airline consultant Bob Mann says: “In the process of restructuring, [US] network carriers have eliminated the positive points of differentiation.”

Mann notes that US low-cost carriers have taken advantage of the situation. “It’s easier when you are starting fresh and the major airlines are in a financial mess. They are a soft target.” Looking at Denver-based Frontier Airlines, for instance, he says: “It is the anti-United and anti-Delta airline. It has cultivated a strong customer following.”

It is JetBlue Airways, with its live TV that has perhaps provided the most noted example of the new breed of US low-cost carriers. Again, Mann points out that JetBlue started up when passenger dissatisfaction with major carrier pricing policies was at its height.

Looking at Southwest, Mann notes: “To a large degree customer satisfaction is influenced by front-row employees who interact with passengers. Southwest attracts and retains individuals who have a unique view of customer service.” He estimates that the Texas-based carrier has 20 applicants for every job. “This allows them to select the best based on their corporate criteria.”

JetBlue has also followed the pattern of using its staff as a key selling point. Mann warns, however, that the carrier will have to stay focused on this aspect of the business model as it expands. “JetBlue is likely to find it easier to hire the first 1,000 who think like David Neeleman than the next 16,000,” he says, adding the carrier is going to need to find the best part of 10,000 new employees over the next five years. Despite the fact that JetBlue has run into some financial headwinds of its own recently, Mann notes: “The customer focus is still there.”

Another challenge facing US low-cost carriers is the fact that the sector is fast maturing. “The traditional low-cost model of short flights and high frequency is reaching a point of saturation in the USA. The law of diminishing returns is setting in,” warns David Treitel, chairman of consultancy SH&E.

This is forcing carriers to operate at airports that would not normally be associated with the low-cost model. Southwest, for instance, has starting operating out of Denver, where it is going head-to-head with Frontier and United. It is also planning to operate out of Washington Dulles, where again it will come up against United.

The market saturation is also changing the model in other ways. “Low-cost carriers are responding by flying longer sectors, and some are operating hub-and-spoke systems,” notes Treitel. In fact, dealing with transfer traffic has become pretty much the norm in the US low-cost market – although they tend to do it differently to the majors. “If you have a traditional hub, you wait around for passengers. If you are a point-to-point operator, the passengers wait around for the aircraft,” says Mann, noting: “Southwest operates the latter model.” He adds: “The key is to operate enough frequencies. It is an unwoven network of services as opposed to a very structured hub-and-spoke system.”

A few European carriers have already gone down the connecting road. The UK’s flybe offers connections on a single ticket for certain routes, but in general, transfers have essentially been a case of the passenger taking the initiative – and the risk. Even Flybe makes passengers take responsibility for their own bags.

European low-cost carriers seem to be moving closer to the US model, however. In February, Germany’s DBA took a controlling interest in leisure carrier LTU with the aim of combining its short-haul routes with LTU’s long-haul product. DBA owner, Hans Rudolf Woehrl, argues that there is room in the market for this innovation. “There are only two domestic network carriers in Germany, Lufthansa and us,” he states.

As with the US low-cost hub model, the traditional theory of banks of flights arriving to feed the mother airline seems like a different world. “Our aircraft do not wait,” Woehrl explains bluntly. “If luggage is lost outside of our own, German, network, the other airline takes care of this.” He adds that this system suits business customers, who make up 70% of DBA’s customers.

Darby at Unisys says that there may be some sense in DBA’s strategy. “The structural problem in the German charter market is that there are too many hubs,” he says, noting that both LTU and TUI have suffered from this. “Crews have to be shuttled around. It is a messy, expensive operation.” Against this background, he argues that if DBA can reduce the number of LTU bases, then this will help simplify operations. Darby adds, however, that carriers need to really justify moves towards a network model with increased revenue because “you are starting to build costs and complexity into the business model”.

Air Berlin has been the European pioneer when it comes to low-cost connecting traffic, with the development of a hub at Palma de Mallorca. The carrier’s Euro Shuttle manager, Marc Heinicke, says that the concept has been a great success, with 4.5 million passengers last year. “The hub is still growing and developing from an outgoing leisure hub to a traditional hub with many business passengers from places such as Porto, Bilbao and Valencia.” He adds that the number of international city pairs is increasing with flights to Amsterdam, London, Vienna and Zurich.

Air Berlin is attempting to bring the Palma model to London Stansted, where it launched a hub in December last year, offering connections from Glasgow and Manchester to Germany. The move was met with some scepticism from observers, but Heinicke claims that the move has worked well. “It has been a great success,” he says. “It has worked so well that we have decided to add Belfast, so we are already extending the system.” He insists the likes of Air Berlin can compete successfully against mainline network carriers. “If a low-cost airline is offering a hub, the cost structure is lower than the hub of a traditional carrier,” he argues.

Others in Europe are also looking at the hub concept, including Denmark’s Sterling. The carrier already offers connections, but is looking to go one step further. In May, Sterling will launch a service on its website enabling passengers to book tickets on other low-cost and mainline carriers to build up their own itinerary. The system, supplied by Icelandic company dohop, is already used by Sterling’s sister carrier Iceland Express.

Sterling has also teamed up with an insurance company that will allow travellers to buy insurance for around €8 ($9.6) that will enable them to be put on the next available flight by any carrier. Minimum connecting times will be around one-and-a-half to two hours. “We need to give people time to collect their luggage and check-in again – but at least their luggage won’t be lost in transit,” says commercial manager Stefan Vilner. He notes that dohop is talking to a number of US and European carriers.

In short, transferring between low-cost flights, between low-cost carriers, and even between low-cost and mainline carriers, is set to become easier. “Technological developments are making it easier to accommodate transfer passengers. There are constraints, but they are going to go away over time,” notes Treitel at SH&E.

An example of this can be seen with the move towards charging for baggage handling – effectively encouraging passengers to minimise their baggage handling requirements – which may help those seeking connecting traffic. Mann comments: “There is lot of discussion on this. People who drop bags with Skycaps [airport baggage porters] are generally offering them remuneration anyway. If airlines charge $2 per bag, there is not really very much difference.”

Those with mainline parents have seen the effects of this already. Virgin Atlantic Airways has launched a system with low-cost distribution system provider Navitaire that will enable the carrier to codeshare with Virgin Blue. Jetstar and Qantas are doing the same, again focusing on the inbound tourism market. European travel group TUI is also known to be looking at closer co-operation between its various airlines.

In North America, carriers such as JetBlue and Southwest have moved away from the idea that low-cost carriers should focus on short legs in order to maximise rotations. Both offer coast-to-coast services. In Asia-Pacific, the greater distances between major cities more-or-less forces budget carriers to look to what might be considered medium-haul destinations, at the very least.

In Europe, the tendency has been for low-cost carriers to keep sector lengths short and try and squeeze in three sectors a day. A combination of crowded markets, large aircraft orders coming on stream and increased liberalisation are changing this. “This is the next stage of the evolution,” notes Darby at Unisys.

Low-cost travel in the Asia-Pacific region is, in general, a much more recent concept than in Europe and the USA. But even so, Darby points to Malaysia’s decision to shut down most of the domestic network of flag carrier Malaysia Airlines, with low-cost carrier AirAsia coming in as a replacement, as a sign of things to come. “I can see this being repeated in a number of countries in the region,” he says.

The low-cost revolution may not be as advanced in Africa and Latin America as other parts of the world, but the sector is clearly making its presence felt. In Brazil, GOL has already stamped its mark in a country with an ailing national carrier – Varig. Currently, the carrier operates in 49 airports, mainly in Brazil, but taking in some of its South America neighbours as well. GOL is not having everything its own way, however. São Paulo-based BRA, which has reinvented itself from a charter carrier into a low-cost player, has already eaten into GOL’s market share despite the fact that its first flights only took off in March.

Mexico is another vibrant Latin low-cost market, with a rash of start-ups this year. The country is particularly ready for this revolution as air travel is becoming affordable to those who travel by bus. “There is huge potential to stimulate the Mexican market with low-cost carriers,” says Mexicana chief Emilio Romano. His carrier was among the first with its low-fare subsidiary Click.

Low-cost travel is still something of a rarity in Africa, but is starting to make an impact. In South Africa, Comair’s Kulula has operated for nearly five years, while South African Airways is looking at launching its own budget subsidiary to meet the challenge – a strategy that has already been put in place at the other end of the continent. Royal Air Maroc, which is facing the prospect of competing against the likes of easyJet and Ryanair, launched its own budget subsidiary, Atlas Blue, in 2004.

Other challenges are emerging. In the USA, Mann points out that the on-time performance advantage of the low-cost carriers is being eroded. “Between the two ends of the spectrum, network carriers have trimmed off a little time, while pure point-to-point operators have been punished by structural delays, such as air traffic management.” He adds that some new taxes, such as federal air traffic charges, “fall on low-cost carriers in a fairly regressive pattern”.

In Europe, there are some fears that the proposed emissions trading scheme could hit low-cost carriers harder than mainline carriers. The scheme could effectively penalise airlines that already have modern aircraft, if Brussels decides to set up a system that focuses on rewards for fleet upgrades.

Chief executives have often said that there is no single low-cost business model, and the way the sector has developed seems to have proved them right. As Treitel says: “At the end of the day it is all about flying schedules that people want to fly at prices they are willing to pay.” ■

COLIN BAKER / EDINBURGH