What is the secret of low cost carriers?

Air France – KLM has recently announced, for the third time this year, that they are falling short in their earnings forecast. The French-Dutch carrier, which faced a two-week pilot strike in September, has experienced in the third quarter of 2014 a revenue decrease of about 6.7%, when compared with the same period of the previous year. The damage of the pilot strike on the revenues was initially estimated on 416 million euros but the real costs of transferring passengers to other carriers are still being calculated.

At the same time, easyJet and Ryanair have published positive financial results. EasyJet (Fig. 1) reported a 21.5% rise in annual pre-tax profits, while Ryanair announced that the net profit has rose by 32% in the first half of 2014 . The profit growth of both carriers was supported by a 6% and 4% increase in the number of passengers transported, respectively for easyJet and Ryanair. What is the secret behind these low cost carriers (LCC)? Should Air France – KLM follow their steps and also become a ‘lower’ cost airline? To answer these questions we need to understand what are LCC and how they have emerged.

EasyJet Airbus A319 - Photo: Stefano R. / Planespotters.net

Fig 1. EasyJet Airbus A319 – Photo: Stefano R. / Planespotters.net

The LCC concept was born in the USA several decades ago when the market was liberalized. Before the 70’s, airlines would have to follow ‘air service agreements’ defined between states. These agreements designate the airlines that could fly between each pair of airports, regulate airfares and establish the service frequency that can be offered. This is still the case in several regions of the globe but, since the 70’s in the USA and the 90’s in the EU, these agreements have been eliminated for local airlines. This means that the market is now liberalized and that airlines can fly between any pair of airports, as many times has they want and without suffering control of airfares. LCC proliferated under these new circumstances, offering high-frequent, cheap and connection-free flights in markets that were not so well covered by legacy carriers (e.g., by Air France – KLM, Lufthansa, British Airways or Brussels Airlines). They created new markets, transformed low-demand markets into growing leisure markets, and generated the idea that air transport is accessible to (almost) everyone.

But why are LCC called ‘low-cost’? How do they operate? The LCC business model is associated with productivity efficiencies and lower operating costs. Some of the main LCC original characteristics that guarantee this business model are:

  • LCC operate a single aircraft type. This is the case of Ryanair and Transavia with the Boeing 737’s and of easyJet and the Hungarian Wizz Air with the Airbus 320 family. The benefits of this ‘fleet commonality’ are the reduction of maintenance, crew training and acquisition costs.
  • LCC operate ‘point-to-point’ flights. As said before, LCC offer connection-free flights, competing in time and in convenience with legacy carriers that serve most of their markets via connections at hub-airport(s). This connection-free concept discharges LCC of any compensation costs related with passengers missing their connections and allows LCC to efficiently use their aircraft without having to wait on the ground for connecting passengers.
  • LCC fly to not congested airports with lower utilization costs. In fact, most LCC fly to secondary airports, with lower landing fees, lower processing times and with shorter distances between runways and passengers’ terminals.
  • LCC work under reduced ‘turn-around’ times at airports. ‘Turn-around’ time refers to the time beween an aircraft arriving at an airport and being ready to depart again. LCC choose not to have their aircraft docking at a gate, their passengers access the aircraft via the tarmac, and they do not allocate seats to passengers. These features combined improve the productivity of the process at airports and reduce costs.
  • LCC reduce ‘frills’ and seating space on board. They eliminate any free service on board, reducing costs and attracting more passengers by promoting a ‘no-frills’ airfare.
  • LCC do not have frequent-flyer programs. This type of programs are associated with administrative costs that can be avoided.
  • Last but very important, LCC have lower labor costs when compared with legacy carriers. In fact, LCC avoid labor unions keeping their employees non-unionized, achieving higher productivity by following less restrictive work rules and by promoting agile working agreements.

This last point is vital to understand the current dispute between legacy carriers and pilots. Companies as Air France and KLM have a long labour legacy. They have much more rigid agreements with their employees than LCC. Perhaps, some of these agreements involve benefits for the workers that are nowadays unendurable under the context of fearful competition from LCC.

American legacy airlines have faced this problem (together with the dramatic effect of 9/11 in air transport) in the beginning of the century. Between 2001 and 2005, the six largest US legacy carriers have either declared ‘bankruptcy protection‘ or have threatened their employees with this legal option. Under this scheme, they were able to restructure their organization, focusing on downsizing (i.e., firing people), cutting operating costs and improving productivity. In Europe the context is different and a similar option is not available. Instead, the major European airlines are looking at ways of reducing costs and achieving productivity gains in multiple steps of their operations. This includes for instance the introduction of new technology (e.g, web check in and the introduction of more efficient aircraft), the elimination of free meals on shorter routes and a more efficient utilization of their fleet. But this is not enough to compete with LCC (Fig. 2). Further measures need to be adopted to make legacy airlines ‘lower’ cost carriers. However legacy carriers cannot get rid of their hub-based structure, or of their loyalty programs or even of their multi-type fleet that is needed to operate the variated markets. They need to find other alternatives.

The solution followed by the largest European legacy carriers was to create LCC subsidiaries, partly or completely owned by the main airline but with a new organizational framework that allows the company to follow a LCC business model. This is what happened with Transavia.com and with Air France – KLM. The pilot strike in France last September was related with the fact that the company wants to further develop the LCC subsidiary – the fleet is planned to be doubled by 2017. Pilots are not happy with this fact, since moving to Transavia will mean losing their current rights and being exposed to more fragile labour agreements. This is identical to the situation in the German carrier Lufthansa. The largest European airline is also developing the GermanWings LCC subsidiary and is experiencing a similar reaction from pilots – the recent pilot strike in early December was the 10th strike since April.

Cost per available seat kilometer (CASK) for different airlines (source: CAPA - Centre for Aviation)

Fig 2. Cost per available seat kilometer (CASK) for different airlines (source: CAPA – Centre for Aviation)

The next months will be interesting to follow. The struggle between employees and legacy carriers and the clash between LCC and legacy carriers will be on. However in the long-term, one should expect that LCC will become more aggressive in their business but, at the same time, more aware of passengers needs. This will force LCC, at some points, to get closer to the service of legacy carriers. On the other hand, legacy carriers will continue to pursue more efficient operations and to reduce cost differences between them and LCC. Nevertheless, legacy carriers will continue to be ‘costly’ carriers. The direct competition with traditional LCC will be done with their LCC subsidiaries. For the mother legacy carrier the focus will be on their long-haul markets and on feeding these routes with efficient short- and medium-haul air services.

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