Special Report: Low-cost carriers - coming of age

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In many ways 2009 could be seen as a defining year for the low-cost carrier model. It has been as tough a 12 months as the industry has ever known. Yet low-cost carriers have largely weathered the recession better than the fuel-driven crisis of 2008, and with a good deal less pain then their network carrier counterparts.

Our financial snapshot of the segment that follows (see chart), covering results for 35 leading low-cost carriers in their last financial year, gives a clear indication that the profitability of the sector has held up relatively well. Only two of the top 20 carriers where operating results were available lost money in their financial years ending during 2009. This marks an improvement on the six that were in the red at an operating level in 2008.

At net level, the 27 carriers for which figures were available generated a combined profit of more than $1 billion in 2009. Contrast this with the small net loss they incurred in 2008 and the $9.4 billion IATA estimates its members lost collectively in 2009, and the picture of a robust performance emerges.

 

Airline  2009 Revenues  Change in $
Southwest Airlines  $10.4bn   -6.1%
Air Berlin  $4.6bn  -9.2% 
Ryanair  $4.1bn  6.9% 
EasyJet   $4.1bn  -11.8%
 JetBlue Airways $3.3bn   -3.0
 Gol  $3.1bn  -12.9%
 AirTran Airways $2.3bn  -8.3% 
 WestJet Airways $2.0bn   -15.8%
Virgin Blue Airways   $1.9bn  -10.2%
Aer Lingus   $1.7bn -15.7% 

 

Our financial listings rank airlines by revenues in US dollars for their financial year ending in 2009 and include profit figures where available. Currency fluctuations therefore mean the revenue change figures in US dollars, listed here, are different from those recorded in local currencies. In particular the strengthening of the US dollar has created quite a heavy impact in this year's listings, as generally revenue rises at non-US carriers are higher in local currency and revenue declines less sharp than they appear in US dollars. Notable examples include easyjet and Virgin Blue. EasyJet increased revenues 13% in local currency, but recorded a 12% decline in US dollars. Virgin Blue revenues grew 10% in local currency, but fell 10% in US dollars. For more details on how to purchase the full low--cost survey data, covering financial data for 35 airlines and traffic data for 70 airline, click here 

Notably, established low-cost carriers have proved resilient across the regions, despite differing economic and market dynamics. In the USA, low-cost carriers AirTran, Allegiant, JetBlue and Southwest Airlines all posted profits in 2009, with all but the latter profitable in every quarter. Latin America's largest budget operator, Brazilian carrier Gol, stormed back to profit in 2009 after losses in 2008. Meanwhile, profits stayed steady at the largest Middle East carrier Air Arabia. And, in the fast-growing Asian sector, AirAsia and Jetstar boosted profits during the last year.

In the tough European market, Norwegian enjoyed some of strongest revenue and profit growth of the year; Air Berlin significantly cut its losses; and easyJet's profits fell, but this was set against a financial year ending September 2009 which ran through the height of the crisis. And while Ryanair's profits to March 2009 were heavily down, these largely reflected fuel costs and it expects to outperform its original profit expectations in posting a net profit of around €310 million ($417 million) for its year just ended in March.

But this strong performance in the sector comes with a caveat. While the established low-cost carriers have performed robustly during the economic crisis, a glance through the airline failures over the last two years shows a relatively high number of casualties from the low-cost sector - particularly in Europe. Slovakia's SkyEurope, Flyglobespan of the UK and Italy's MyAir were all among the casualties during 2009, following on from the likes of Sterling, ATA Airlines, Oasis and Zoom in 2008.

 southwest tails, shawn byers
 Long-established US carrier Southwest Airlines continues to dwarf other low-cost carriers in terms of revenues
Similarly, while total passenger numbers in the Airline Business low-cost carrier traffic rankings (see pages 54-55) grew over 8% in 2009, revenues - reflecting lower yields and more restrained capacity growth - have generally moved the other way. This is particularly evident among the most established low-cost names in more mature markets.

Capacity discipline in the US, hugely evident among network carriers, was also adopted by their low-cost counterparts, which mostly saw flat or slightly lower capacity during 2009. Europe's two biggest airlines by passenger numbers, easyJet and Ryanair, both held capacity in check - relative to their historic high growth levels.

Mature Industry

"I think it's got every reason to consider itself a mature sector," says Conor McCarthy, managing director of Plane Consult. The former Ryanair chief operating officer, who has worked with easyJet, Mexico's VivaAeroBus, Australia's Jetstar and is currently a director or AirAsia, notes: "We are in the third generation of low-cost carriers and the number of survivors is really quite strong.

"I'm very bullish of the low-cost carriers' ability to grow and expand their market share. The crucial thing is the airlines that have made a success in the sector have done so through a low-cost focus and retaining this DNA, rather than diluting it. It's something that Ryanair and AirAsia do very well.

"I'd be more concerned about those airlines that are starting to drift, that they could be caught in the open ground between the two extremes and fall between the cracks," he adds. "It's frustrating to see it: many airlines that are starting on the right path, but start to spread themselves too thinly - start doing things like interlining and codesharing - and so they then need to develop more feed. Before they know it, they are a legacy carrier. It all sounds great on PowerPoint. But the real reason they are successful is they are giving a good reliable service at a very attractive price. Airlines that continue to focus on the key issues of cost management and delivering an on-time service will continue to grow."

Growth has always been central to the profitability of low-cost carriers, but the pull-back on capacity - especially in the more mature low-cost markets of Europe and North America - has brought finding different ways to boost revenue into sharper focus. This has been the cue for attempts to woo cost-conscious business travellers trading down, increased co-operation efforts and various measures to grow ancillary revenues.

"You've seen at the low-cost carriers there is more attention to revenues then they have had in the past," Andrew Watterson, partner at consultants Oliver Wyman, says of carriers in the well established North American low-cost market. Without the growth effect he notes these carriers have worked on other ways to improve their revenues, lifting top-fare limits, moving into the GDSs and bringing over ancillary boosting measures already evident in Europe.

Reaping The Results

He predicts US carriers will benefit from the capacity discipline of both network and low-cost carriers over the last three years and this continues to prevail. "They have aggressively moved down supply, so as the economy comes back, it is simple supply and demand and there is a natural impact on the top line. I expect when the first quarter results come out, you will see unit revenues increase." But even should the US economy recover quicker than expected, such is the maturity of the market he does

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not expect low-cost carrier growth to return to previous levels and an emphasis on revenue boosting measures to remain. "I think growth is very hard. The number of really juicy markets has disappeared. So where do you go for growth? Spirit has gone into the Caribbean, Allegiant into niches markets, JetBlue has gone to the Caribbean as well," says Watterson. "The new frontiers are smaller markets. There is still incremental growth, but there will be more niche markets, and there will be more ancillary revenues - where they are still well behind those in Europe."

This is echoed by Andrew Cowen, partner with consultancy Mango Aviation Partners, and former head of Middle East budget carriers Sama and Jazeera Airways. "As the low-cost carriers establish very significant market share positions, the question is where is some of the revenue growth going to come from?" An area pursued by some has been developing codeshare and interlining arrangements, especially with those long-haul carriers that have scaled back short-haul. "I think there is some opportunity, especially if the passenger connection can be solved in a very cost-effective and customer friendly way," he says.

North American low-cost carriers have been among the most enthusiastic to embrace new co-operation moves. JetBlue, having already started a codeshare-style arrangement with Aer Lingus and codesharing with minority-shareholder Lufthansa, has now struck a partnership deal with American Airlines. The latter's chief executive Gerard Arpey suggests several of his counterparts at other oneworld carriers have expressed interest in forging similar bilateral agreements with JetBlue, attracted by its strong presence at New York JFK. "While a lot of others have looked at it, JetBlue went out and did it," notes Watterson, adding the carrier had always been realistic about what such co-operation could bring to the bottom line given the added complexities involved. "A lot of US low-cost carriers saw it as a big new thing, they went in there thinking there would be big growth, when it is really just the icing on the cake."

 
 JetBlue has been among the low-cost carriers initiating new partnerships, most recently a deal with American Airlines
Other low-cost carriers have similarly adopted a partnership approach. Brazil's Gol has embarked on a number of codeshares, most recently announced plans to do so with SkyTeam's Delta Air Lines, following on from recent codeshares pacts with oneworld partners American Airlines and Iberia. Virgin Blue, which has never felt comfortable within the confines of the low-cost carrier handle, describing itself instead as a "new-world carrier", has begun codesharing with Delta in relation to the latter's joint venture partnership with long-haul arm V Australia. Air Berlin, which also defies the low-cost name tag with its range of long-haul routes and frequent flyer scheme, will this summer further attempt to optimise a hub structure at Berlin Airport to increase transfer options at the airport.

No One Size Fits All

Cowen believes it is only natural, especially giving the differing markets, that a diverse range of approaches in the low-cost sector have emerged. "If you look at just about any other service offering out in the market, there is no two sizes that fit all. There are multiple offerings. That segmentation is happening in aviation, as with other service offerings and this is the way it is going to go on." He points to the current experimentation by low-cost carriers, and indeed some of their network counterparts, to find out what additional ancillary and service ideas will work. But on the issue of unbundling fares, he questions if airlines have moved too far in breaking out the component parts of the fare. "The disaggregation has been useful as it has expanded the awareness of the cost of these activities and asked passengers 'do you really want to pay for this'," he says. "But with the distance between the base fare and the eventual sum, I think the pendulum has gone too far. I think we are going to see increased customer dissatisfaction, and some of that expressed through some of the regulatory bodies."

On the cost side, fuel remains a key worry for airlines, and potentially is more of a threat to low-cost carriers, where it comprises a larger proportion of their cost base. McCarthy though says: "The key thing to bear in mind is that low-cost carriers, with higher seat densities and load factors, burn less fuel per seat than legacies and with typically newer, more efficient aircraft, the cost of fuel per passenger for a low-cost carrier ends up substantially lower than for a legacy passenger."

He also points to AirAsia's experience with fuel surcharges as a possible way to de-risk fuel. He says AirAsia was able to virtually neutralise the oil cost hike with its fuel surcharge, which it moved down and eliminated as the oil price fell, as customers could see a natural link between the two. He believes dropping the surcharge is as important as implementing it, noting: "People may be sometimes slow but they ain't stupid!

"Whilst hedging worked well with backwardation [where prices for are lower for distant delivery] it has become an expensive insurance premium of late, so a surcharge can be made to work if it is more transparent to the passenger," he adds. "If you can achieve an offset of fuel/oil hikes within the quarter, when most bookings are made, it begs the question whether to hedge at all?

 IN THE ARCHIVES

 
 Check out our 2008 report and rankings from 2008 here
Cowen, meanwhile, expects network carriers to do more to challenge low-cost carriers in short-haul. "Low-cost carrier profitability has tended to be pretty resilient and that has got to be attracting the attention of the traditional carriers," he says. "Few traditional carriers are making reasonable rates of return on short-haul. So the question is, what are they going to do to address the short-haul profitability issue. They can't just close their eyes." Watterson points to a recent Oliver Wyman analysis, of which he is co-author, showing that while US low-cost airlines retain a strong a cost advantage, the cost per available seat mile gap between network and value carriers is now the smallest it has ever been.

But Cowen also expects more low-cost carriers to follow AirAsia X in challenging network carriers on long-haul. "I think we are going to see the low-cost market evolve, partly to secure the revenues, and partly because flag carriers don't seem to have learned any lessons," he says. "If you gouge the passenger on fares, that sort of pricing encourages the likes of Air Asia to think about how they can attack the mid and long-haul."

While much low-cost carrier growth potential lies in relatively untapped markets, like Asia, Latin America Africa and the Middle East, McCarthy still sees room for growth in Europe where he says plenty of city pairs are still under-served from a low-fares perspective. "There is always room for low-cost carriers to break in," says McCarthy.

 

REGIONAL VIEW: ASIA

Even in a year as tough as 2009, double-digit growth has remained the norm in the fast-growing Asia-Pacific low-cost sector. Together with Latin America, both aided by a developing market and lower exposure to the economic crisis, Asia-Pacific is the region continuing to see the fastest rates of growth. Some of the strongest progress has been in the short-haul market around Southeast Asia, India and Australia. AirAsia and its Thai and Indonesian associates, Tiger Airways and Jetstar Asia have all managed to grow their market share in Southeast Asia. Tiger's entry into the Australian market, in particular the Sydney-Melbourne route, has resulted in Qantas subsidiary Jetstar ramping up its services and taking over some of its parent's slots.

In India, a country the size of Southeast Asia, low-cost carriers SpiceJet and IndiGo continued to grow as they chipped away at the likes of Air India, Jet Airways and Kingfisher Airlines. Even Jet and Kingfisher, over the last year, have converted over 70% of their domestic operations to the low-cost model in response. In Northeast Asia, however, the indigenous low-cost airlines have still found it hard to make an impact as the local legacy carriers held on to their market share. Ironically, the likes of AirAsia, Tiger and Jetstar have been bringing the low-cost model to countries like China and Japan, and offering passengers cheaper alternatives.

AirAsia and Jetstar, meanwhile, have embarked on a partnership aimed at reducing costs, such as ground-handling services, and generating savings through co-operation on future aircraft purchases. Reflecting the continued optimism about the low-cost market, Tiger had a successful IPO earlier this year and the Philippines' Cebu Pacific is expected to follow in the coming months.

REGIONAL VIEW: AMERICAS 

The sharp traffic growth among Latin American low-cost carriers, in particular in countries like Brazil and Mexico, contrasts with the capacity curbs seen in the maturer US market. Most North American low-cost carriers cut or kept capacity growth to a minimum in 2009, though notable exceptions included the growing Virgin America and niche operator Allegiant Air.

Much attention at Southwest Airlines will be on completing development of its back end technology to handle proper codeshares. Its commitment to its largest potential codeshare partner, WestJet, appears in jeopardy as Southwest said in recent weeks WestJet has requested "material and significant changes" which it could not accept. JetBlue meanwhile concluded a surprising agreement with American Airlines that gives it key access to Washington National airport. JetBlue will get slot pairs at Washington National and transfer some of its New York JFK slots to American, while the two will also interline on non-overlapping markets from Boston and JFK.

Allegiant Air, a long-time bullish MD-80 operator, is making a bold attempt to apply its business model to Hawaii by adding a second fleet type. Six Boeing 757s will join the fleet before the end of 2011 solely to serve Hawaii. AirTran, meanwhile, is persisting in its attack on Midwest Airlines in its hometown base of Milwaukee through a marketing deal with regional carrier SkyWest Airlines. The pro-rate deal includes the independent operation of 50-seat CRJ200s by SkyWest to smaller markets from Milwaukee.

REGIONAL VIEW: EUROPE 

A more cautious capacity approach has also been evident in Europe, but consolidation has helped individual carrier growth. Vueling's merger with fellow Barcelona budget operation Clickair enabled the former to grow its share, but both carriers had markedly scaled back capacity prior to the tie-up. Elsewhere carriers have moved into gaps created by low-cost carriers casualties, for example central Europe's Wizz Air benefiting from the collapse of SkyEurope and Ryanair moving into former MyAir bases in Italy. They also continue to heap pressure on retrenching network carriers, where Association of European Airline members carried 20 million fewer passengers in 2009, expanding in key markets. By contrast, passenger numbers across European Low Fares Airline Association members were 8.7% higher at 162.5 million in 2009.

European low-cost operators continue to push the envelope on ancillary revenues, growing in a diverse range of directions. But Ryanair's ambitions to use mobile telephony as the platform for a range of additional future services have taken a hit by the recent decision of its service provider OnAir to walk away from a deal to equip its full fleet.