Competitive Strategy for Low Cost Airlines

Abstract

The aim of this paper is to identify challenge faced to Low-Cost Carriers (LCCs) or Low-Cost Airlines and provide new insights into the development and competitive strategy for LCCs. LCCs are still a relatively new phenomenon in Australia since Virgin Blue and Jetstar came to the market. There are over 30 LCCs have been launched since 2002 worldwide. In fact, LCCs have been very successful in the USA and Europe since 1990s.

For example, in 1994 less than 3 million passengers flew on LCCs. In 1999, five years later, this figure had risen to about 17. 5 million. Five years further on, in 2004, 100 million or so European passengers use LCCs. For example, Ryanair’s passenger-Kilometres grew on average about 45 percent per annum from 1998 to 2003. The emergence and growth of no frills, low-cost carriers have radically altered the nature of competition within the industry. Those major low-cost carriers have exploited different operation methods to lower their cost and provide lower average fares.

However, not all LCCs are profitable, only the market-leading operators are able to produce a consistent level returns above their cost of capital. With the disappearance of two major LCCs: Go (subsidiary of British Airways) and Buss (subsidiary of KLM Airlines) and others in the US (80%-85%) and Europe (60%) (Taneja, 2003), many issues have been identified for the failure of LCCs. The question at this point is what the future of LCCs and what competitive strategy could help LCCs to survive? Porter’s Competitive Strategy Model and case studies will be used in this paper.

The expected outcomes of this paper are to evaluate cost and market share issues for LCCs and find long-term sustainable strategies and solutions for LCCs. Keywords: Low-Cost carriers; LCCs; Low-Cost airlines; Competitive strategy 1. Introduction One of the most striking features of aviation industry in the beginning of this century was the availability for consumers of a new concept of flying. LCCs open a totally new product: no frills, no food, no drinks, no spacious seats, no travel agencies bookings, but a very low price (Barbot, 2004).

This “low-cost revolution” (Doganis, 2001) has then forced the traditional network full-services carriers to respond this phenomenon progressively. Therefore, the competition between LCCs and full-services carriers has become a significant issue of widespread interest regarding the airlines industry. The emergence and growth of no frills, low-cost carriers have radically altered the nature of competition within the industry. Those major LCCs have exploited different operation methods to lower their cost base and provide lower average fares.

In terms of strategic positioning, in order to provide low-fares the LCC business model focuses on its distinct low cost strategy. However, not all LCCs carriers are profitable, only the market-leading operators are able to produce a consistent level returns above their cost of capital. This paper starts with introduction of Airline Business Models, followed by feathers and challenges of LCCs, Porter’s strategic competitive model and case studies are used to analyse issues for LCCs and find long-term sustainable strategies and solutions for LCCs. Figure 1. Industry Environment Challenges (Source: Boeing, 2005) . Airline Business Models Boeing Company described Airline business models as shown in the following diagram (Figure 1). As this paper aims to focus on the business model of LCCs, the origins and key features of LCCs business model are introduced in this section. The Origins of LCCs The term “low-cost airline” is for the first time used in the United States in 1949. The first successful low-cost 431 Proceedings of the 13th Asia Pacific Management Conference, Melbourne, Australia, 2007, 431-436 carrier was Pacific Southwest Airlines, which pioneered the concept.

Often, this credit has been incorrectly given to Southwest Airlines, which began service in 1971, and is the only one airline to have been consistently profitable in every year of operations since 1973 (Grotte, 2005). Today, Southwest Airlines operates more than 3,100 daily flights to 62 cities across the United States, and registers yearly more than 80 million passengers. What began as a small Texas airline, Southwest now has grown to become one of the largest airlines in the United States1. European history of low-cost airlines is much younger, but those airlines are for sure trendsetters of the 1990s.

The expansion of LCCs in Europe coincided with the final deregulation of the market during the 1990s. Genuine lowcost operations began in Great Britain in the 1990s with the Irish company Ryanair (founded in 1985 and started operating flights in 1986), which was patterned on American Southwest Airlines. Following Great Britain, LCCs have successfully developed on the Continent (Grotte, 2005). In the year 2005, there are 60 low-cost airlines operating in Europe2. Prior to 2002, there were no significant low cost scheduled carriers operating in the Asia Pacific rim.

The initial slow development was in part due to the perception that the low cost model adopted in the United States and Europe could not be replicated in Asia, because of the longer aircraft stage lengths, lack of secondary airports and regulatory restrictions preventing access to international markets. The latter being particularly relevant given that the bulk of traffic and revenues are drawn from international markets in Asia. Thus, the low cost experience is a relatively new phenomenon in the Asia Pacific rim with much of the necessary management experience brought in from outside the region, for example, from Ryanair.

Asian LCCs accordingly are in the initial growth phase of their development, while many of their American and European counterparts are approaching or have reached maturity (O’Connell and Williams, 2005). The Key Features of LCCs Business Model According to the Statistics and Forecast (STATFOR) Service of Eurocontrol, there is no single best definition of low-cost carrier (Eurocontrol, 2006). However, it is general accepted that a low-cost airline, also known as nofrills or discount airline, is such carrier, which offers generally low fares but eliminate most traditional passenger services.

The “low-cost carrier” business design could be defined by the following three key elements (MERCER Management Consulting, 2002, See Figure 2). 1 Simple Product: Catering on demand for extra payment; planes with narrow seating (but bigger capacity) and only a single class; no seat assignment; and no frequentflyer programmes. Positioning. Non-business passengers, esp. leisure traffic and price-conscious business passengers; short-haul point-to-point traffic with high frequencies; aggressive marketing; secondary airports; and competition with all transport carriers.

Low Operating Costs. Low wages; low airport fees; low costs for maintenance, cockpit training and standby crews due to homogeneous fleet; high resource productivity: short ground waits due to simple boarding processes, no air freight, no hub services, short cleaning times; and high percentage of online sales. Figure 2. LCCs Business Design (Source: MERCER Management Consulting, 2002) There are two LCCs models: 1. 2. Independent Airlines (e. g. Southwest, Jetblue, Ryanair, and Easyjet) Subsidiary of a legacy airline (e. g. Go, Buzz, Jetstar, Jetstar Asia, Valuair, and Tiger)

In summary, the LCC model comprises: 

1. low fares;
2. high frequency flights;
3. point-to-point service;
4. no free meals or drinks on board;
5. no seat pre-assignment;
6. short flights; and
7. flights using secondary airports.

Challenge for LCCs In a climate of continual change and uncertainty, airlines in the coming years will face critical problems and http://www. southwest. com/about_swa/airborne. html [Access on 22/08 2007]. 2 http://www. etn. nl/lcosteur. htm [Access on 22/08/2007]. 432 Proceedings of the 13th Asia Pacific Management Conference, Melbourne, Australia, 2007, 431-436 erious challenges (Doganis, 2006). He identified four main challenges for LCCs.

The first major problem that the low-cost sector had to face in the period after 2004 was the dramatic surge in new capacity which was creating substantial overcapacity in the market. As mentioned earlier, There are over 30 LCCs have been launched since 2002 worldwide. The second challenge being faced by low-cost operators after 2004 was the continued decline in yield or average fare. This was an inevitable consequence of over-capacity on an increasing number of routes.

But it was also due to the new pricing policies of most of the conventional airlines as they fought back to hold on to their market share. Airlines such as British Airways introduced some very low aggressive fares in 2003-4, especially on routes or markets where they competed with low-cost carriers. This forced the latter to maintain lower fares than would otherwise have been the case. Price competition became most acute in markets where new-entrant lowcost carriers tried to compete head-on with the established low-cost operators such as Ryanair or Easyjet.

The result was that yields on the larger low-cost airlines declined steadily after 2000. Ryanair’s average fare per passenger dropped from around €60 in that year to €46. 50 in 2003, a decline of 22. 5 per cent. Controlling costs is the third problem area faced by low-cost airlines. Rapid growth places an airline’s management and organisation under strain, and controlling costs becomes more difficult. The fourth challenge, which also has cost implications, is whether and how low-cost carriers should develop their bask model.

While increasing competition between low-cost carriers will be creating downward pressure on costs, such competition will also push airlines to try to differentiate their product. This may well mean higher costs. With so many players in the European low-cost market and with aggressive pricing strategies by conventional carriers, low fares may no longer be a sufficient differentiator. Low-cost operators will increasingly try to brand themselves and differentiate their product as they have done in the United States.

Figure 3. Porter’s Generic Strategies (Porter, 1980) scope and strategic strength. Strategic scope is a demandside dimension and looks at the size and composition of the market you intend to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm. In particular he identified two competencies that he felt were most important: product differentiation and product cost (Figure 3). Competitive Strategies for LCCs In view of the above challenges, low-cost airlines must do three things to ensure their long-term survival. Firstly, Cost Leadership. LCCs must maintain a sustainable low-cost advantage over their fullservice competitors.

LCCs must ensure that their costs per passenger-km continue to be 50 per cent or more below those of full-service airlines and continuing to reduce their own costs too. Secondly, Differentiation Strategy. LCCs must focus on differentiation of their product, that mean they must also offer a product with some frills, which is very highly rated by passengers in terms of value for money. For examples Virgin Blue in Australia and JetBlue in the USA. Virgin Blue was the first carrier outside North America to introduce multi-channel real-time satellite TV to its flights called Live2Air.

The strategies of most LCCs are twofold to take on the legacy carriers and attract higher-yield passengers, and to add points of difference from other LCCs (Thomas, 2005). Thirdly, Market Share and Market Segmentation Strategy. LCCs must ensure that on most of their routes they become the number one or number two carrier in terms of market share. This dominance, combined with their low fares, gives them a very powerful defensive position should. Porter’s Competitive Strategy Model Porter (1980) has described a category scheme consisting of three general types of strategies that are commonly used by businesses.

These three generic strategies are defined along two dimensions: strategic 433 Proceedings of the 13th Asia Pacific Management Conference, Melbourne, Australia, 2007, 431-436 new competitors attempt to enter, while also ensuring a strong cash-flow base on which to mount further expansion. Southwest’s survival and success is due in no small measure to its growth strategy, which has focused on becoming dominant in most of its markets. It is the largest carrier in over 90 of its top 100 markets (Doganis, 2006). Cost Leadership Cost category Aircraft Ownership Costs

• Cost item Levers for reducing costs
• Ownership Structure
• Anti-cyclical purchasing
• Fleet Structure
• Aircraft Utilisation
• Optimise owned / leased mix
• Fleet harmonisation
• Optimise mix of older and new aircraft
• Reduce turnaround times
• Reduce maintenance downtime Fuel Costs
• Route Efficiency
• Purchasing Costs
• Weight Reduction
• Shorter en-route and approach times
• Reduce delays, use smaller airports
• Reduction in service fees
• Use of fuel hedging strategy
• Calculation of “no show” passengers
• Through product innovation e. g. seats

As mentioned earlier, the chief difference between low cost carriers and traditional airlines fall into three groups: service savings, operational savings and overhead savings. Low cost airlines tend to focus on short haul route. To achieve the low operating costs per passenger, this type of carriers need to have as many seats on board its aircraft as possible, to fill them as much as possible, and to fly the aircraft as often as possible. Low cost carriers will affect the traditional airline hub-and-spoke networks poses interesting questions for the airlines industry and policy makers.

Low cost positioning means choosing to perform a system of activities differently from that of traditional rivals and providing a coherent set of key activities that reinforce each other to achieve such position in a sustainable manner (Porter, 1996). Despite the challenges faced, the low-cost model appears to be sustainable in Europe as it has been in the United States and elsewhere. It has a different and substantially lower cost structure than the conventional network model, because the latter imposes higher costs on those who operate network systems.

While network airlines can reduce their unit costs further, they cannot match those of the low-cost airlines on short-haul routes. The charter airlines will compete for a part of their own traditional markets with low-cost carriers, but will increasingly generate most of their business from the denser, short-haul, inclusivetour markets and from long-haul routes. Within Europe, in North America and in time most major regions, low-cost airlines will become the dominant carriers in domestic and short-haul markets. They are not a passing phase. They are here to stay and they will dominate most of the markets they enter.

In 2002, JetBlue acquired LiveTV, LLC for $41 million in cash and the retirement of $39 million of LiveTV debt. LiveTV equips JetBlue with 36 channels of live DirecTV satellite TV programming at The impact of low cost carriers in Europe, Feb, 2003. 434 Proceedings of the 13th Asia Pacific Management Conference, Melbourne, Australia, 2007, 431-436 very seat. Two years later, JetBlue announced it would add 100 channels of XM Satellite Radio, Fox TV programs and 20th Century Fox movies to its in-flight entertainment. The movies are free on flights outside of the US mainland (as DirecTV service is not available), and are available for a small fee on other flights4. Market Share and Market Segmentation Strategy Case Study-Air Asia AirAsia is a low-cost airline based in Kuala Lumpur, Malaysia. It operates scheduled domestic and international flights and is Asia’s leading low fare, no frills airline.

It is also the first airline in the region to implement fully ticketless travel and unassigned seats. With the Philosophy ‘Now everyone can fly’, AirAsia’s philosophy of low fares is aimed to make flying affordable for everyone. AirAsia also aims at making travel easy, convenient and fun for its guests. Its promotion airfare started from 1 Malaysian Ringgit (A$0. 34). Most of their prices are cheaper than bus and train. They compete with road transportation Market Segmentation not just legend airline’s market.

AirAsia’s operations are based on the following key strategies5: Low fare, no frills AirAsia’s fares are significantly lower than those of other operators. This service targets the guests who will do without the frills of meals, frequent flyer miles or airport lounges in exchange for fares up to 80% lower than those currently offered with equivalent convenience. No complimentary drinks or meals are offered. Instead, AirAsia recently introduced ‘Snack Attack’, a range of delicious snacks and drinks available on board at very affordable prices and prepared exclusively for AirAsia’s guests.

Guests now have the choice of purchasing food and drinks on board. Frequent flights AirAsia’s high frequency service ensures guest convenience is met. The airline practices a quick turnaround of 25 minutes, which is the fastest in the region, resulting in high aircraft utilization, lower costs and greater airline and staff productivity. Guest Convenience AirAsia believes in providing convenient service to make traveling easier and more affordable for its guests. Guests can make bookings through a combination of the following:

• Safety first

Internet booking Reservations and sales offices Authorised travel agents Improving customer service AirAsia’s cost optimisation philosophy is in no way at the expense of the airline’s safety. The airline’s fleet of 30 Boeing 737-300 fully complies with the conditions of the International Aviation Safety and are regulated by the internationally reputed Malaysian Department of Civil Aviation. In July 2002, AirAsia signed a US$20 million agreement with GE Engineering Services for engine maintenance and later in the month, a US$3million aircraft engine and aircraft frame parts leasing agreement with VolvoAero.

AirAsia also signed a US$7 million agreement with ST Aero, covering the airline’s engineering components support for seven years. Cost optimization operations AirAsia strives to maximize profit and provide low fares at quality service. The airline has optimised costs by operating a faster turnaround time, improving aircraft utilization and crew efficiency, providing a ‘no frills’ service, using one type of aircraft to save training costs, all of which result in savings which are passed back to consumers in the form of low fares. 7.

SWOT Analysis of LCCs SWOT Analysis is a tool to figure out those internal factors such as strengths and weakness and external opportunities and threats to objectives. The following table lists respective area from selected Low cost carriers as followings: Strengths Low cost operations Fewer management level could do effective, focused and aggressive management Simple proven business model that consistently delivers the lowest fares in the industry Penetrate & stimulate to potential market Multi-skilled staffs means efficient and incentives workforce Single minded focus on cost reduction positions the Group as ndustry’s lowest cost producer Strong balance sheet and strong cash generation gives it resources to weather short-term difficulties Single type fleet minimize maintenance fee and easy for pilots dispatch Weakness Service resource is limited by lower costs Limit human recourse could not handle irregular situation Exposed to regulatory interference on airport deals and passenger compensation Government interference and subsides have undermined industry profitability on a structural basis and delayed the much-needed consolidation of the industry.

Non-Central location of secondary airports Brand is vital for market position and developing it is always a challenge Heavy reliance on outsourcing leaves it exposed to 3rd party delivery Market remains hugely price sensitive, as service has become commoditized and open to new entrants Nationwide call centre Ticketless service Easy payment channels http://en. wikipedia. org/wiki/Jetblue [Assess date: 22/08/2007] http://www. airasia. com/site/my/en/home. jsp

Proceedings of the 13th Asia Pacific Management Conference, Melbourne, Australia, 2007, 431-436 Point to point model is lower unit cost and uplifts aircrafts utilization Distinctive corporate culture Opportunities Long haul flight is an trial to get undeveloped market share Differentiation from old LCC models by adding customer service or operation as full service airline with low fare Ongoing industry consolidation has opened up prospects for new routes and airport deals Different industry mutual cooperation provide related service and uplift extra sales profits Demand is price driven and should grow irrespective of economic cycles Dominant/monopoly position in many routes will offer some pricing power (albeit seasonal) High fuel prices will squeeze out unprofitable competitors Lack of contingency plan Doganis, R. 2006.

LCCs Some major airlines have attempted to reposition themselves as low cost carriers with varying degrees of success High fuel price decreases yield A serious accident could undermine confidence in low cost carriers As subsidiary of legacy airline could be risky due to ambiguous market Heavily reliance on the internet as sales channel exposes them to risks associated with system disruption Environmental taxes could disrupt the cost equation Accident, terrorist attack and disaster Aviation regulation and government policy

From no frills to limit frills will increase operation cost Summary of Mercer Study.

1. O’Connell J. F. and Williams G. 2005.
2. Passengers’ perceptions of low cost airlines and full service carriers: a case study involving Ryanair, Aer Lingus, AirAsia and Malaysia Airlines, Journal of Air Transport Management, 11, 259-272. Porter, M. E. 1980.
3. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York, Free Press. Porter, M. E. 1996.
4. What is strategy? Harvard Business Review, November–December, 61-78 Taneja, N, K. 2003.
5. Airline survival kit: breaking out of the zero profit game. Ashgate. Thomas, G. 2005. ber, 34.
6. To Frill or Not to Frill. Air Transport World, Octo- http://www. airasia. com [Assess date: 22/08/2007]
7. http://en. wikipedia. rg/wiki/Jetblue [Assess date: 22/08/2007]
8. http://www. southwest. com/about_swa/airborne. html [Assess date: 22/08/2007]
9. http://www. etn. nl/lcosteur. htm [Assess date: 22/08/2007]

Conclusion

The low-cost airline revolution has injected a dose of democracy into the travel world – but can it last? The price of a return flight ticket can be cheaper even than a train. It seems too good to be true in the past, but the cracks are showing in the budget aviation world really. Low-cost airlines have succeeded in taking over a large part of the market. With targeted markets and networks, low-cost carriers nearly halve turnaround times, increase aircraft utilisation, reduce congestion, and ignificantly improve their productivity; and still are in compliance with safety regulations. Moreover, low-cost carriers get ready to take off more quickly; enabling them as competitive airlines to schedule more flights and provide more attractive schedules for passengers.

Reference

1. Barbot, C. , 2004. Price Competition amongst LCCs, CETE – Centro de Estudos de Economia Industrial, do Trabalho e da Empresa (Research Center on Industrial, Labour and managerial Economics).
2. Boeing, 2005. Industry Environment Challenges. Doganis, R. , 2001, The Airlines Business in the Twenty-first Century, Routledge, London. Doganis, R. 2005.
3. Airline Business. New York: Routledge. 436