Two Industry Veterans Discuss the Low Cost Carrier Business Model and the Challenges it Pose for Legacy Carriers
Thursday, 03 May 2012
The Low Cost Model Arrived in Nearly All Markets in the MENA Region… Is it All Bad and what can Legacy Carriers do?

By Mike Halper & Sascha Feuerherd*

Some years ago when one of the writers of this article was Group Marketing/Commercial Director of Ryanair, he was asked at an airline conference, by the director of a very large and successful European carrier, to give him advice on how to start a LCC. His answer was short “Do Not!” the Director was somewhat taken aback.

After all, this carrier already had regional subsidiary companies and therefore he was perplexed with the negative answer that was given. However it was quickly followed up by an explanation. And it is appropriate that the answer be given here in full. “You as a large and successful legacy carrier, a world airline have thought processes, regimes and methods of operation which are a total anathema to a LCC. You focus on such areas as passenger comfort, service reputation, class separation, airline reputation etc. You normally take major decisions based on a board decision, which may inevitably take some time to formulate, or needs to be in conformity to these pre requisites.”

The decisions of a LCC are fabricated on very few pre requisites, they are "How cheap can our fares be whilst still making a small profit on a large number of passengers and what else can we sell them". The writer suggested to the legacy carrier that this was exactly the opposite way that his airline formulated their policies. The Legacy carrier took the advice and did not form its own LCC but formed a quasi-independent carrier that had its own board, made its own decisions, sort its own markets and even competed with the lower end of the existing market of the legacy carrier. Only in very major decisions such as major capital expenditure, such as aircraft acquisitions was the legacy carrier consulted." This advice was taken and now the LCC subsidiary is a thriving but still independent airline which compliments the policies of the Legacy carrier.

The first low cost carrier was Southwest Airlines in Dallas, Texas with flights turning profitable as early as 1973. Legacy carriers were aghast that it only gave it passengers a packet of peanuts. It only operated 60 to 90 minutes sectors with very quick turn-around times. The first European LCC was Ryanair, which one of the writers joined in its very early years. The great advantage was that there was therefore no history of the methods, policies and thought processes of its major competitor Aer Lingus (who have now effectively become a “hybrid”- offering traditional legacy carrier service on their Trans-Atlantic, whilst competing with LCCs in Europe).

Today Ryanair is constantly one of the most profitable airlines in the world. Known for its innovative fare structure (one of the writers developed the highly regulated but well publicized 1 POUND FARE). Ryanair in its first few years operated short sectors and charged for everything. It also had the advantage of being born when the World Wide Web was making its entry and fundamentally changed the way that bookings were made and what other products could be sold on its web pages. From the US via Europe, the low cost business model went to Asia (with Air Asia probably being the best known example) and to the rest of the world.

We are now seeing the birth of “hybrid” carriers, a good example is JetBlue in the USA. It has, like RYANAIR and easyJet, extended its sector lengths from the original 60-90 minutes to 3-5 hours, this being the range of its equipment (either Airbus 320s or Boeing 737/800s). JetBlue, like RYANAIR/easyJet and other successful LCCs, follows the "KISS" principle but is now developing interline agreements in order to capture more of the business market. The business market is now a market that LCC’s are more and more targeting. A good example is easyJet which recently announced that some 20% of its traffic are business passengers, who are in ever increasing numbers looking for value for money with little or no extras.

Another business model adaption from the original low cost model are the longhaul low cost carriers like AirAsiaX or Jetstar. This business model has its own peculiarities, which still need to prove successful.

(Sample Market Liverpool/Manchester – Nice)

For years and years this route was only operated by BA/AF. Annual traffic varied from circa 30-40,000, mostly wealthy people visiting 5 star hotels and or friends on the Côte d’Azur.

EasyJet approached Manchester airport to set up its second base there (after Luton) and was told by the airport management that there is no interest. So they approached the nearby airport at Liverpool-just 35 miles away, thus in the same catchment area as Manchester airport. EasyJet in its first year at Liverpool launched services to Nice-in its first year it carried 120,000 pax on this route whilst Manchester traffic stayed the same-i.e. it produced an entirely new market. Latest CAA figures show that annual Liverpool/Nice now fluctuates around 90,000. Manchester traffic has remained static. In other words EasyJet produced a totally new market for this destination.

If you visit the French regions of Provence, Dordogne, Aquitaine you will find that almost 100% of the property purchases in the last 10 years, have been made by Brits- indeed some villages are almost totally British .There is a simple reason for this. It can be traced to the entry of RYANAIR and EasyJet into the provincial airports in these areas. They have therefore contributed billions to the economies of these regions.

Prior to EasyJet moving to Liverpool, the Airports annual passenger numbers were circa 700,000 p.a. it is now circa 5million! Nearly all of this traffic is LCC generated. 

The question is often asked" what is to become of the mega legacy carriers and those carriers which still adhere to the format and modus operandi  that pertained to the 1960s and 70s". Perfect examples are carriers that the authors are regularly advising. Let’s call one of them carrier X; it operates a mixed class configuration on its aircraft, it has several different type of aircraft in a small to medium size fleet, it boasts it's long years of operations; it has a massive board of non-executive directors; it operates from expensive city center premises, it has interline agreements with a multitude of other carriers and it is constantly losing market share to LCCs as well as losing money…. You could go on and on and many carriers will find themselves in many of the listed attributes.

The all-important question that we need to ask ourselves is: “is there any protection from LCC carriers”? And the answer is: “There is no need for protection, but a need to constantly check the business environment and to question if it might be necessary to improve / change the own business model. Any attractive market between A and B with a minimum passenger volume and supposedly weak competitors being active in this market will rather earlier then later attract competition. LCC airlines are famous of “smelling” such opportunities and take action very quickly. This can well be seen in the Eastern European markets, where for example Wizz Air is very active and bases aircrafts at various airports. These low cost market entrants “create” new passengers (see box), but also “steel” passengers from the established airlines. Since the authors of this article are convinced, that the market entrance of low cost incumbents is a trend that cannot be stopped, it is mandatory for the established legacy carriers to consider their options.

There are several options:

  • it could become a LCC or separate part of the business into a to be founded LCC
  • it could become a “hybrid carrier”
  • it could head for a performance enhancement exercise, question all cost and investment while at the same time increasing revenues wherever possible to ensure lean processes while keeping a full service concept
  •  it could carry on as it was and risk failing on single routes or in their entirety (not a real option!);

Since the typical ostrich behavior (to put the head in the sand in case of danger and thus not to do anything) is not a viable option from the point of view of the authors, there are basically only three options (again with all different shades of grey in between).

Within a short period it is probable that some existing LCC’s will become hybrid in that they will no longer just go for the cheap and cheerful but will adopt some of the policies of the legacy carriers but keeping to the "KISS" principle.

Similarly, some legacy carriers implement more and more of the lessons learned from the low cost industry. The result is, that there is no black and white anymore, but hundreds of different shades of grey. In parallel, the mega carriers / alliances will further develop (but this does not necessary mean that they grow in numbers of participants) and several carriers will simply go out of business, as was seen in the past with carriers like SpanAir or Malev.

Shareholders and Governments alike are less and less willing to support loss making legacy carriers in their constant rejection of the need to take action. Who will be next to join the carriers that recently went out of business? Who will actively approach this challenge and prepare for the future?

* Sascha Feuerherd a leading aviation industry professional with over two decades of experience specializing in airline restructuring and implementation of cost reduction programs. Feuerherd was Senior Director with Lufthansa Consulting in charge for airline restructuring, more recently headed all airline consulting projects for IATA Consulting and now runs a boutique airline consulting company.

Mike Halper, a leading airline and airport professional and entrepreneur with over three decades experience; involved in a number of successful airline start-ups, held senior and advisory positions with leading airlines and an airport authority. Halper is currently a senior management consultant focusing on developing low cost airline operations and generation of ancillary revenues

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