Where are the Southwests of Europe? As 1997 fast approaches, Sara Guild talks to the sole example, Ryanair, and looks at the difficulties of establishing the profitable low cost, low fare European airline.

Tentative inquiries from the US are reaching the ears of would-be European airline companies. Two years away from complete liberalisation in the European Union, foreign investors are thinking that a carrier established now could grow quietly for a few years, before rocketing away to fame and fortune á la Southwest.

But the number of Southwest mimics in Europe numbers exactly one, namely Dublin-based Ryanair, with another 'low-cost' carrier in EBA Express of Brussels. Carriers with the Southwest ethos have yet to flourish in the European environment, and while it is clear only a certain number of low-cost carriers can coexist successfully, the question remains of why the Southwest concept has not crossed the Atlantic in droves.

Operating from Dallas/ Lovefield, Southwest is a high productivity, low fares, no frills airline that keeps its operations as simple as possible. It operates one aircraft type, has quick turnaround times and operates on high density, short-haul routes. Keeping costs down is the company motto, although equally important is the people culture that its chief executive Herb Kelleher has instilled in the airline. The strategy is to enter markets that will expand rapidly, allowing it to offer sizeable capacity at fares that major carriers will only offer on 5-10 per cent of their capacity.

Initially there appears little to stop European entrepreneurs from transposing the model from the US. But European consultants point to a variety of issues that make the transfer far from easy. Perhaps most importantly are the high costs of European infrastructure, such as air traffic control (ATC) and landing and groundhandling fees. In the US, ATC is paid by a tax levied directly on the passenger ticket and airports do not have handling monopolies.


Uneven competition

Despite liberalisation being a year and a half away, state aid still tips the playing field in favour of the state-owned, state-subsidised carriers like Air France, Olympic, TAP Air Portugal, Aer Lingus, Sabena and Iberia. Until market forces are allowed to take their toll, says Bertrand d'Yvoire of Paris-based Consultair, US investors should be wary of jumping into an unfair competition. 'In the US post-deregulation Pan Am and Eastern were allowed to disappear, but here the government backing is cheating us of a liberal market,' he says. 'People are reluctant to invest where they are not sure what the rules will be.'

Indeed those who have tried to start up have found capital difficult to secure. European financial institutions have had their fingers burned with the likes of Air Europe and the former (Belgian carrier) TEA, says d'Yvoire. 'Now these banks want backing from government institutions like Exim, ECDG, Coface, or they want manufacturer support [for new aircraft purchases],' he says. Buying old aircraft is another option, but with the non-addition rules of Stage 2 aircraft to European fleets, this too becomes problematic.

Aircraft absorb the bulk of the capital, though start-ups normally expect to incur losses in the early years, even if Atlanta-based ValuJet managed to make a profit of $20.7 million in its first year. Ryanair's chief executive Michael O'Leary says the Irish carrier was no exception to the general rule and 'made all the traditional airline mistakes', losing I£7 million ($4.2 million) in 1990 and consuming I£20 million of equity in the previous four years, before its owners contemplated a second life as a 'Southwest' style operator.


European expectations

A less tangible problem for the would-be low cost airline is what Stefan Beyhoff, market analyst at DLR, the German air transport research department, calls the 'soft factor'. 'In Europe flying still has to do with social status,' he says. 'People in the US are accustomed to travelling by air. That is less the case here.' This social status factor contributes to the expectations of business people who still feel that business class is a 'perk' that the company should provide. 'If you travel for business you expect your employer to give you a comfortable trip,' says André Clodong, from consultants Clodong and Partners in Brussels.

In Europe air travel has not become the commodity it is in the US, though it is only a matter of time until it does, says Alastair Pugh, at Goldman Sachs in London. 'I believe that Europe is lagging behind the US, but I am sure it is going to come and it is a problem for the [high cost], high yield carriers,' he says.

Once again the size of Europe relative to the US plays a role, with alternative modes of transport available such as the Autobahn in Germany and the TGV high speed rail network providing quick, competitively priced transport for French travellers. Additionally the population on the European continent is mainly concentrated in the relatively small area of Belgium, France, Germany and the Netherlands, says d'Yvoire. 'There is not the spread of cities that you see in the USA.'


Inevitable innovation

Despite the barriers to entry, the emergence of the innovative, low-cost carrier in Europe is widely considered as inevitable, although this may happen later rather than sooner. This attitude is echoed by San Francisco investment firm Hambrecht and Quist, the company responsible for arranging the venture capital financing for Vanguard Airlines in the US. 'We believe that it is a case of when rather than if, with these low cost carriers in Europe, and we are looking to exploit those possibilities,' says Russell Winter, who is charged with finding such opportunities.

So with US investment looming on the horizon what golden rules should would-be Herb Kellehers follow? According to Ryanair's O'Leary, the key, obviously, is to be profitable and to achieve this constant cost reduction is vital. 'Everything is driven with costs. Southwest is rapacious about costs,' he says.

Equally essential is ensuring that the route will sustain substantial growth, as the carrier is not trying to take traffic from the competitor, but to 'grow' the market.


VFR market vital

Any growth potential lies primarily in the visiting friends and relatives (VFR) traffic, says Henry Schlee at Mercer Management Consulting in London. 'If you cannot grow the market you will die. And it is the VFR market that is going to grow, not the charter market to Spain,' says Schlee. Again Europe contrasts with the US. 'In America there is a large proportion of the population which lives in a city other than where their families live,' he says. 'That is not generally the case in Europe.'

The market's sensitivity to fares or price elasticity goes hand in hand with its growth potential and is vital to the success or failure of the operation. When visiting friends or relatives the air fare is the major cost, so when this drops, customers are more likely to take more trips, hence the market growth. If travellers are not VFR the price of the trip may be three times the cost of the air fare, so even if that cost is halved the bulk of the cost will remain, explains Schlee. Consequently, if the route is primarily a business or a leisure destination, without VFR market, it is more likely to be price inelastic.

In contrast, business people have to travel and, until the European business attitude changes, they will request their business class trip with lounges, frequent flyer points and free newspapers, says Clodong.

In the case of Ryanair, growth was ensured by the presence of a large commuting population between Ireland and the UK: there has been average annual growth of 11.6 per cent on the London-Dublin routes since Ryanair first entered that market in 1986.

In 1995, the carrier estimates it will hold 37 per cent of the total market. On Dublin-Birmingham traffic will have doubled between 1993 and 1995, says O'Leary. On Dublin-Manchester there will be an estimated 57 per cent increase this year.

Schlee advises against attacking core routes that will force the majors to initiate a response. He points to Shuttle by United as the response that Southwest elicited by attacking the San Francisco hub of United. 'United could not walk away from LA-San Francisco, so attacking that corridor is inevitably going to invoke a robust response,' he says.

Ryanair's operation on Dublin-London, although not something Aer Lingus could walk away from, was not vital to British Airways, says Schlee, so it was able to leave the route without significant damage to its interests. BA does still have a hand in, however, with franchisee BAExpress operating from London/City.

Secondary airports at major cities are a must to keep costs down, especially in the European environment. Congestion for one thing is costly, and the smaller airports are unlikely to have this problem. Quick turnaround is vital for the low-cost high frequency carrier, and this too is easier to achieve at the less congested airports. Ryanair uses London/Stansted, connected to the City of London by British Rail, which O'Leary argues is more convenient for access to central London than Heathrow. EBA Express flies to Rome/ Ciampino which is 16 kms from the city as opposed to 22 kms for Fiumicino. In some cases however Europe's second hubs are further from the city centre, as is the case with Milan/ Malpensa.

Flying to the secondary airports also allows the carrier the possibility of negotiation with the airport authority for the business. At Stansted airport, managing director Terry Morgan admits that he was happy to offer Ryanair a marketing deal. Morgan says he is still willing to talk to new carriers as part of the airport's drive to reach profitability, with the proviso that the carrier will be a financial benefit to the airport, and that it would offer new destinations from Stansted.

Ryanair also reached a deal with Dublin airport authority, taking a specially built stand away from the main terminal. 'It may be remote, but it was part of the deal to keep the price down,' says a senior source close to the carrier. 'Operating this kind of carrier needs style and negotiating skills. You need to break the moulds. Ryanair has done that,' he says.


Load factors not yields

Ryanair has been profitable since 1991 and O'Leary says in 1994 the average annual profit per passenger was I£1. With an estimated 1.7 million passengers in 1994, rough calculations show the airline made I£1.7 million ($2.7 million) last year.

The carrier has load factors of 81 per cent and, against the current of drives by the BAs and Lufthansas of Europe, is driving yields down. 'We do not manage yields, we manage the load factor,' says O'Leary. 'Our budgets are based on driving costs down by x per cent next year. The 1995 yields are more than 40 per cent less than 1991, but costs have fallen by more than that so we are more profitable than in 1991.'

Although Ryanair is increasingly cited for its emulation of Southwest, Pugh points out that there is not just one answer for the low-cost carrier. 'I believe that what one should say is that there must be scope for marketing innovation in the low-cost arena,' he says.

EBA Express has only been operating since November 1994, and has yet to prove itself, but it too is trying to find a low-cost formula that works. Managing director Victor Hasson says even when the innovation and ideas are there, current practices can be inflexible.

For example Hasson wanted to have re-usable plastic boarding cards that could simply be collected once passengers had boarded. But current regulations require paper evidence of passengers on the aircraft.

EBA Express flies to Madrid, Barcelona, Vienna and Rome from Brussels. It is too early to say whether the market is growing in the proportions that Ryanair has seen, but Hasson says the carrier made an operating profit in April and is exceeding expectations.

However flag carrier Sabena is offering deals at the same fares as EBA Express. As EBA has no immediate plans to increase dramatically its low frequencies any market growth generated by the fares competition may benefit the incumbent carriers. On this basis it may be hard for the newcomer to survive.

Indeed one analyst queried whether a carrier based in Brussels could be considered 'low-cost'. Hasson says he has negotiated a deal on groundhandling services at Rome/Ciampino, but clearly it is more difficult to wrangle with primary airports such as its home base at Brussels/ Zaventem.

The carrier justifies its 'low-cost' tag on the basis it does not have sales offices at its destinations and uses toll free telephone lines for bookings. The carrier is effectively ticketless and does not belong to any of the major computer reservations systems, thereby eliminating even the basic 9 per cent booking fee that Ryanair pays.

But tollfree numbers are not without their problems, says Hasson. With customers using credit cards issued in the three countries served, guarantees of the price cannot be given to the airline by the credit card services. So the advertised price in Spain is what the customer pays, but currency fluctuations may mean the airline gets less. Hasson says he changes the prices about once every two months, far more often than the major carrier.

It is not just start-ups that are able to imitate the Southwest concept, as Shuttle by United has endeavoured to show. In Europe the majors have seen the Southwest effect and considered the options. KLM decided that a Southwest-style operator would need to operate from the UK if it were to concentrate on the densest European routes. Swissair says its low-cost concept has been shelved until Switzerland's entry to the European Union can be guaranteed, although a senior source says the carrier knows exactly what needs to be done, down to the type of aircraft needed.


No room in Germany

In Germany, Lufthansa is said to be examining a low-cost European version, possibly of its Express product. The existence of Deutsche BA, with British Airways behind it, and Lufthansa's dominance in the market are probably enough to make most would-be new entrants think carefully.

'Lufthansa has done the necessary to be prepared for a low-cost Southwest style competitor. There is not the incentive for a startup like when DBA came in three years ago, and they were correct to do so then,' says Beyhoff.

Ryanair has proved it can be done and, like Southwest, it has operated in what may be termed a niche market for the first few years, 'getting it right' according to O'Leary. But the carrier's sights are set on Europe, and services would probably be launched from Stansted. While some are sceptical that Europe is the right move, others believe that with the right routes Ryanair will succeed.

Southwest was not built in a day, and its existence prior to US deregulation means any one of Europe's lower cost carriers could metamorphose into the industry's next 'model airline'. In time certainly the low-cost carrier will arrive in Europe. But whether today's examples will continue to prosper is another question.

While it has proved itself on the Irish-UK market Ryanair must now look for new growth markets. EBA Express is still in its infancy and must prove that its low-cost innovations can succeed. Meanwhile, US investors are looking for the next pot of gold under the rainbow. Perhaps they will find it. Alternatively, maybe they will lose all to the leprechauns.

* Must operate in market where substantial growth is possible

* Needs to operate from secondary airports, where it may be possible to negotiate 'deals' with the airport authority

* Avoid attacking strong major carriers on their core routes - they will have to respond

* Costs, costs, costs are THE focus

* Be innovative; there is not just one formula for low-cost carriers

Barriers to success

* High infrastructure costs, for example air traffic control, groundhandling, landing fees

* Difficult to secure finance from European institutions

* Unrestricted cabotage rights still not possible; competition is still against some 'subsidised' majors

* Competition from TGV highspeed rail in France and the Autobahn in Germany - two of Europe's largest domestic markets

* European culture not commoditised in same way as the US - business people still expect the company 'perk' of business class

Source: Airline Business