The competitive gap between network and low-cost carriers has shown a few early signs of narrowing of late, raising questions over the premium that full service can command and indeed of market convergence as budget airlines seek it out too

Could the network carriers finally be making up ground on their low-cost rivals?First in Europe and now in the USA there are the faintest whispers that while the budget airlines are coming under pressure, the majors are, just perhaps, narrowing the competitive gap. There should be no illusions that a yawning gap still exists on cost and will continue to do so, but progress is being made, fuel price permitting.

At the same time, the decline in yields looks as though it may have bottomed out after the years of freefall. That raises the tantalising prospect that network carriers may be finding a new market level for the premium they can charge for their full-service offering. That in turn raises the questions of exactly what that premium is; what service levels are required to win it; and whether it can be delivered profitably.

Whatever the premium does turn out to be, and no-one truly claims to knows as yet, all are agreed that it will be substantially lower than before the crisis. Most, if not all, also agree that it is highly unlikely to rise again even as the market recovers and that network costs will therefore have further to come down and will have to stay down. The experience in the USdomestic market would seem to support the point.

Back in 1998 the USnetwork majors were achieving 34% higher yields per seat mile than their low-cost domestic rivals, according to analysis from Stephen Still, managing director with Seabury Airline Planning Group. By the end of last year that premium was down to 20%. He calculates, however, that over the five years the majors saw their unit cost disadvantage soar 10 points to 44%.The financial result of such shifts hardly needs spelling out.

In Europe too the gap is clearly visible. On a rough calculation, the network majors have been trading at a yield premium of perhaps 40% against easyJet on their intra-European routes and more than twice that against Ryanair. But that looks almost certain to decline. Those like Aer Lingus and British Airways that have found themselves in the front line of the low-cost assault have sought to narrow the premium gap to 10-20%, at least against the mid-range easyJet.

To sustain life at such fare levels requires swingeing cuts to the cost base. Since 2001 Aer Lingus has shed 30%of its costs and a third of its workforce, with still more to come. The plan is now to cut another staff by a third again as it strips out more of the legacy, including losing the remaining short-haul business class seats by April next year.

The USmajors have slashed nearly $13 billion over the past couple of years according to the General Accounting Office. It adds that the goal was closer to $20 billion, but encouraging nevertheless that they are closing on their target. That is driving some budding optimism on Wall Street - the current fuel crisis apart. Jamie Baker of JPMorgan reckons that the network cost disadvantage relative to low-cost carriers has closed to around a third over the last year, thanks to lower labour rates and rising aircraft utilisation. The gap could be down to 20-25%by 2005. However, he also suggests that the the underlying premium on unit yields may be no more than 10%.

Some even argue that the revenue premium is a myth or at least deceptive. The case is argued by Kevin Mitchell, of the Business Travel Coalition, the USlobby group set up by corporate travel buyers in the 1990s as the majors cranked up their fares. He argues that business travellers may be willing to pay something extra, but it is hard to measure. "It is perhaps in the 5% to 10% range, but it is not going to be there for ever," adds Mitchell, pointing out that as the network majors come down in price so the low-fare carriers are coming up in terms of service.

Such talk of convergence is growing and examples abound. In the USA, for example, AirTran already has a premium cabin and others are following. AirTran also has a full loyalty programme that will even provide reward flights aboard other airlines on routes that it does not serve. JetBlue too has packed its aircraft with more sophisticated in-flight entertainment than any of its major rivals.

In Europe, easyJet has clearly marked out its territory above the bare-bones service offered by lowest-cost Ryanair. EasyJet flies to more convenient, if more expensive airports, including a base at London's second hub at Gatwick. It also offers some ticket flexibility at a price, although not yet a loyalty programme.

The game appears to be on to find out what passengers really want and are willing to pay for:lounges, loyalty schemes, in-flight service, convenient airports? As the premium becomes clearer, so too will the challenge on costs. And although the story so far has been played out in short-haul markets, it is surely only a matter of time before the same lessons translate onto long-haul routes too.


Source: Airline Business