ALEXANDER CAMPBELL & MAX KINGSLEY-JONES / LONDON
Overcapacity, job cuts, bankruptcies: amid the collapsing fortunes of Europe's airlines, one sector is soaring. We investigate the region's no-frills boom and ask: can it continue?
How are Europe's low-cost carriers bucking the trend?
In the current European airline slump, one sector is still performing extremely well - the group of airlines known as no-frills, bargain, or low-cost carriers (LCCs). While their established rivals, the full-service carriers, are cutting staff, grounding aircraft and even collapsing into bankruptcy, the LCCs continue to open new routes and order new aircraft. In this in-depth analysis of Europe's LCC market, Flight International will consider three questions: what are the keys to the low-cost business model, how did low-cost airlines start and what does the future hold for the European low-cost sector?
The table below compares the most recent full-year results of several airlines in the full-service and low-cost sectors. Not all low-fare airlines are low-cost: Buzz, for example, initially offered low fares, but inherited the high-cost base of its parent, KLM uk. The difference in cost per available seat kilometre (ASK) - a measure of the running costs of the airline - is clear: carriers such as Ryanair and EasyJet in Europe, and Southwest Airlines in the USA, are operating at almost half the cost per ASK of full-service airlines.
The carriers, understandably, are unwilling to explain exactly where and how they make their savings. But the chief differences between low-cost and full-service airlines fall into three groups: service savings, operational savings and overhead savings.
The most noticeable are in service. Many LCCs have cut cabin crew to the legal minimum - three in the case of a Boeing 737, the commonest aircraft in the no-frills fleet. This is possible largely through providing a lower-quality cabin service. They provide no premium-class service, which would demand far more staff per passenger than economy class. There is no inflight meal - this not only saves catering outlay, but also places less workload on the fewer cabin crew, and means that the cabin needs less cleaning at the end of each sector. Similarly, while snacks are offered, they are subject to an extra charge, again saving costs. In fact, this strategy makes inflight service an extra profit centre and the service at the airports is similarly cut back. No premium class passengers means no expensive lounges for their use. And, in some cases, when airports allow it, LCCs have refused to pay for the use of air bridges, instead unloading passengers down stairs and across the apron.
EasyJet's start as a "virtual airline" with very few of its own employees underlines another important tactic: many no-frills carriers outsource ground operations, making cuts and expansion easier, and reducing the number of employed and thus pensionable staff.
Short haul
Operational savings reflect the most important differences between low-cost and full-service airlines. Many of the savings here stem from the low-cost strategy of operating point-to-point services with fairly short-sector lengths. Short sectors also mean that passengers miss full service less; the benefits of first-class service, or even of free meals and drinks, are less apparent on a flight lasting only 90min.
Deciding to operate only one sort of route - the short domestic or intra-European flight - means that LCCs can survive with only one aircraft type, almost invariably the Boeing 737. This in turn cuts maintenance and training costs, compared with full-service carriers which may have fleets of eight or 10 aircraft types. Aviation consultant Michael Tretheway of Intervistas Consulting of Canada adds: "Some carriers are now re-certifying down their aircraft to lower operating weights. This gives them less range, but more seats and lower landing charges, which depend on operating weights."
The point-to-point decision has subtler benefits. There is no commitment to making connections - a passenger flying, for example, on Go from Edinburgh to Rome buys two tickets, Edinburgh-Stansted and Stansted-Rome, and Go does not guarantee that he will reach Stansted in time for his onward flight. Not only does the LCC not have to pay transfer costs - the passenger transfers himself - but a full-service airline would make such a commitment to onward connection, meaning that, to insure against delays on the Edinburgh-Stansted sector, it must build a certain amount of slack into its timetable.
A no-frills airline, by sacrificing passenger convenience, removes the need for slack, allowing its aircraft to operate to a tighter timetable. Running the aircraft for more hours a month - higher asset utilisation - is also important for the low-cost model. This means concentrating on fast turnaround at each sector end, and ensuring fast passenger loading and unloading. Aviation economist David Gillen says: "Fast throughput is a value proposition for full-service carriers, but a cost proposition for the low-cost carriers. This makes different demands [on airport and airline operations]."
This is evident in the comparison of ASKs per aircraft in the table below - this reflects 8h of revenue flight a day for British Airways' short-haul fleet, for example, against nearly 13h for EasyJet. The simpler point-to-point operation also removes the need for positioning flights - except in emergencies - which also increases the return from each aircraft in the fleet.
Buzz's commercial director Tony Comacho breaks destinations into three categories - with primary airports being the obvious and secondary airports being points near, but not at the heart of, a city.
Tertiary airports
Tertiary airports are not linked to any city, says Comacho, but provide a starting point for low-fare passengers in a region. The advantage of secondary and to a much greater extent, tertiary airports, is that they usually offer the most competitive pricing policies as they are developing and trying to capture new business.
The increased commercial muscle associated with being one of only a few customer airlines has also benefited LCCs at airports such as Frankfurt Hahn. Frankfurt Airport, which operates the primary airport, Frankfurt Main, and the secondary Hahn 60km (38 miles) away, has decided to devote Hahn exclusively to low-cost operations - and has abolished landing fees for 737-weight aircraft.
Adapting airport operations to suit no-frills airlines is a "seductive" strategy, says Lufthansa airport economist Hartmuth Posner, but can take airports heavily into the red, as the preferential conditions they offer the carriers eat into profit margins. In addition, if the airports are owned by local or national governments, as is often the case in mainland Europe, offering advantages to new LCCs may constitute illegal government subsidy.
However, adapting to suit no-frills carriers may be the only way for airport authorities to maintain the flow of passengers through the terminals on which both their aviation (landing and passenger fees) and non-aviation (for example, concession rental, parking and retail) revenues depend. Airports such as Amsterdam Schiphol, says Schiphol chief financial officer Piet Verboom, accept that they will make a loss on their aviation business to keep passenger numbers high enough to turn a profit from non-aviation sources, which often account for most airport revenue.
Resistance from airport operators continues to restrict low-cost expansion. It has two causes: political; and concern over profits. Politically, most European airports are still owned and operated by local or national governments. While many flag carrier airlines are now nominally outside state control, there are still often strong links between airline and state. Although under European law the degree of state aid is severely limited, flag carriers can also be protected by restricting the growth of competitors in the flag carrier's home market. The bitter fighting, especially in Germany, shows exactly how determined a well-established flag carrier can be to defend its quasi-monopoly on domestic traffic.
Political and profit
Even without political pressure, airport operators are often concerned that low-cost airlines will take away from full-service pasengers and replace them with low-cost passengers, who will provide less revenue for the airport - by travelling there on public transport rather than driving and parking, for example - or by spending less in the airport's shops.
As Tretheway points out, however, this perception is incorrect. LCC passengers tend to spend less, but visit the shops more frequently - chiefly for food, which is not provided by the airlines. In troubled times for full-service carriers, airports may have to revise prices to suit the low-cost carriers, which are, after all, providing most of their growth.
As for the issue of customer convenience, research comparing the US LCC Southwest and the full-service carrier Northwest indicates passengers accept that driving further to the airport is part of the penalty for flying on an LCC. Aviation economist Michael Levine says Southwest is "actually a hub [rather than a point-to-point] system, with feeder networks of people driving their cars". Passengers are content to drive 2h to board a Southwest flight, and three and a half hours for a WestJet flight in Canada, but will not drive for longer than 1h for a Northwest flight. Part of the added value in the Northwest product is the convenience of having the aircraft land closer to the passenger.
Less visible to the passenger are overhead costs. Most of the LCCs have started from scratch, rather than evolving, as most full-service carriers have, from state-owned monopolies. This means that LCCs do not have long lists of retired staff on generous pensions; they are not stuck with networks of loss-making international routes operated for reasons of politics or prestige rather than economics; their headquarters and support arms have had less time for the inevitable growth of bureaucracy unrelated to company activities and dictated by Parkinson's Law.
Also, without legacy sales and ticketing systems to impede change, LCCs have been far readier to adopt internet sales programmes. "The full-service carriers seem to be stuck at 5-10% of online ticket sales," says Carl Michel, former chief executive of Deutsche BA, who points out that LCCs are doing far better. In some cases, for example EasyJet, 90% of tickets are sold directly, either through a call centre or online, bypassing the usual channels of travel agents - and so avoiding their commissions.
While full-service carriers are trying to emulate this by setting up joint online ticket operations, they have yet to reach similar levels. Website credit card sales are both cheaper and far more easily scalable than travel agent or call-centre sales. Of course, this means dealing with consumer reluctance to buying online - and resistance to the idea of ticketless travel. But these obstacles seem to be dwindling - certainly in the UK market and, to a less extent, also in mainland Europe.
Astute network planning can also reduce maintenance costs. LCCs typically operate only one maintenance base, and never leave their aircraft abroad overnight. This avoids costly duplication of facilities, and eliminates the expense of housing crew abroad. The cost, again, is in passenger convenience - the first flight out of a foreign destination in the morning will be on a local carrier, or a full-service aircraft, which has stayed overnight, rather than on an LCC. This is likely to affect business travellers more than leisure travellers.
Lower wages
Lower wages are also common in the low-cost sector - although not for aircrew, who tend to earn much the same as they would flying short sectors for a full-service carrier - even if they are worked harder. The downturn is making it easier for LCCs to continue recruiting from the former employees of full-service carriers forced to cut back.
One key area where no-frills airlines gain is the cost base of their flightcrew, and Go made sure it did not bring any baggage with it from its high-cost parent company. "No pilots were transferred from British Airways, although we did recruit on Go contracts some ex-BA pilots who had reached the parent company's retirement age of 55," says Go chief operating officer Ed Winter.
He says that one of the airline's most important early achievements was to negotiate new employment terms with UK pilots' union BALPA and workers union AEEU. "We took a 'clean-sheet' approach, and our employees' contracts are free of individual restrictions," Winter says. This means that, for example, Go's pilots are restricted only by UK Civil Aviation Authority CAP371 regulations, rather than any employee terms and conditions.
Furthermore, at least according to some LCC chief executives such as Neil Burrows at Virgin Express and EasyJet's Ray Webster, their small size and maverick spirit has allowed them to keep morale and productivity high in the absence of more traditional incentives.
But while this is possible in the UK, more rigorous labour and pay laws in mainland Europe have caused problems for LCCs there, such as Virgin Express, which operates from Brussels. Higher taxes, wages and social costs, along with stricter limits on working hours, all make low-cost operations on the continent of Europe intrinsically more difficult. As will be discussed later, this will challenge every LCC seeking to expand by setting up hubs in continental Europe as well as in the UK.
Remarkable growth
As well as cutting costs, LCCs have also managed remarkable traffic growth, during both the 1990s boom and the present downturn.
The low-cost sector has managed to grow rapidly - in some cases, at sustained rates of 25% a year. But it is important to remember that the European low-cost airlines still have only 10% of total passenger numbers - possibly as little as 5% if measured by scheduled ASKs.
Not only overall, but even in their own areas of operation, they are still dwarfed by full-service carriers. However, analysts and airlines are confident their historic annual growth rate of 25% a year can be maintained for the next 10 years - growth which has not come exclusively at the expense of full-service intra-European airlines.
While it is difficult to determine exact proportions, the consensus is that around 50% of LCC passengers would otherwise have travelled with a full-service airline, while the rest would either not have travelled at all or would have used surface transport. Analysts and airlines both believe LCCs can compete successfully against full-service carriers within Europe.
The low-cost market is also split between leisure passengers, extremely price-sensitive, who might not otherwise have made the journey, and business passengers, less sensitive to price and more willing to pay slightly more to arrive at primary or convenient secondary airports. Adapting operations to this split and coping with continuing growth and deregulation are the challenges facing the sector in the years to come.
Source: Flight International
