criscokid
Mar 16, 01, 4:03 pm
Information source: http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT33PRGJCKC&live=true&useoverridetemplate=IXLZHNNP94C
Over the last 12 months, in stock market terms, the two best performing airlines have been Ryanair and Southwest Airlines. No surprises here, perhaps. Elsewhere, the EasyJet flotation went rather better than some commentators had thought - myself included. There has also been almost constant comment about the increasing importance of the so-called low cost or no-frills segment of the short haul market, its high growth rates and alleged damage to the established carriers.
But what do we mean by the term 'low cost airline'? Is it a case of saying well we know what it is when we see it, or is it more than that? Indeed, there are a variety of different business models within the domain. These range from the pure low cost with an ability to benefit from a fare mix that is predominantly low (Ryanair) to that where, although the costs per available seat kilometre (the industry standard measure of unit costs) are markedly lower than those of a mainline airline, there appears to be an increasing need for better yield traffic.
It is worth reviewing some of the issues associated with airline economics. We have argued on many occasions that not all airline traffic is necessarily profitable. It is very easy to sell tickets at $10 a trip but if it cost $11 a trip to carry a passenger the consequences are obvious and painful. Despite the traditional view in the airline industry, I would argue that market share for its own sake is not a sufficient condition for success - even over the medium term. This is all the more the case as markets become more open and liberalised. At the same time the traditional segmentation of the market between leisure and business travellers is too simplified - the number of pricing points in an airline's yield management system is a clearer and better indication of the segmentation that actually exists in the marketplace. As the propensity to pay more increases so does the demand for more.
The real issue if we look at this from the perspective of the customer is the willingness to pay. It is blindingly obvious that an airline must have a cost base that is appropriate to the revenue stream that it is targeting. Now, of course, the real world is complicated for many airlines by issues of transfer traffic and allocation but if we focus again on point-to-point traffic the issue is clearer.
Returning to the alleged damage to the mainline airlines we would argue that this for the most part is not traffic that they should target and BA's European strategy is a very clear example of the recognition of this.
The real issue for any airline is to maximise the gap between the breakeven load factor and the achieved load factor. There are some who might just look at the achieved load factor of an airline and use that for the health check. The need is to look at both. In this respect the last reported full-year results of the three most quoted lower cost airlines show an interesting picture - we have used the standard industry method to calculate these.
The breakeven load factor is the reflection of the relationship between costs and revenues and indeed traffic mix. The greater the proportion of higher quality traffic the quicker that breakeven is reached - similarly the lower the cost. Herein lies a crucial difference in the approaches of Ryanair on one hand and Go and easyJet on the other. Both Go and EasyJet are increasing frequency to attract better quality of traffic (the business traveller) and have had some success - but where do the diminishing returns from this strategy set in?
The type of traffic attracted by an airline also reflects its catchment area and both Stansted and Luton appear limited in this respect for business travellers, compared with the main London airports. There is also the view that the lower cost airlines are more attractive to business travellers from SMEs. On the other hand, BA and others appear to have significantly increased their marketing activities in this area over the last 12 months. Against this background some research from Keith Mason at the UK's Cranfield University suggests that in an economic downturn although business travellers on 'mainline airlines' would seek to travel more cheaply than they currently do, business travellers using lower fare airlines expressed a greater propensity not to travel at all.
For all airlines we have long argued that it is structural cost reduction that is important. There was a very clear example of this when Ryanair announced its third quarter figures where the rapid take up of Ryanair.com resulted in a 66 per cent reduction in distribution costs. Furthermore here was also a very good example of profitable market stimulation. Total revenue per passenger fell by 7.7 per cent in the quarter, operating cost per passenger fell by 7.2 per cent and operating profit rose by 25.1 per cent. Ryanair's model is very simple: to use low fares to create market and having a sufficiently low cost base to do this profitably.
For other operators in this area of the market the core of the strategy appears based upon the ability to pull traffic in some instances from competing modes (within the UK) and in others - usually where it involves crossing water, competing airlines whether scheduled or chartered.
For all lower cost airlines a major concern is direct competition from within the same market (chiefly between two lower cost airlines) - even airports that are close together. The problem here is that if you are dependent upon using price to stimulate the market or pull traffic to your service then there is the risk that the point is reached when the market is effectively exhausted and what traffic remains is pulled between the airlines at ever lower fares.
What is clear also is that we are about to enter a new environment. The fundamental economic background for most of the last decade was relatively benign. For the mainline airlines we expect capacity growth to remain below the level of fundamental or GDP driven traffic. Whilst the correlation with GDP is not as evident for the lower cost airlines economic activity is bound to have an effect and as we suggested earlier it may not mean a positive traffic switch - even in a downturn business travellers will still use an airport which is most convenient for them. Even for the lower cost airlines there is the need to deploy capacity profitably and also the need to be able to structurally reduce cost.
The next 12-18 months are going to be particularly interesting and there could of course be a competitive change in the market place with British Airways close to selling Go and the future of KLM's Buzz uncertain. Ryanair acting in a different segment of this lower cost market would be unaffected - anyway as they say the only constant in this industry is change we would expect little different in the future. However, whatever the future holds, there is no getting away from our initial point - what really matters irrespective of the chosen market - is that it is necessary to have an appropriate cost base to be able to operate profitably particularly if the going gets a little tougher.
Over the last 12 months, in stock market terms, the two best performing airlines have been Ryanair and Southwest Airlines. No surprises here, perhaps. Elsewhere, the EasyJet flotation went rather better than some commentators had thought - myself included. There has also been almost constant comment about the increasing importance of the so-called low cost or no-frills segment of the short haul market, its high growth rates and alleged damage to the established carriers.
But what do we mean by the term 'low cost airline'? Is it a case of saying well we know what it is when we see it, or is it more than that? Indeed, there are a variety of different business models within the domain. These range from the pure low cost with an ability to benefit from a fare mix that is predominantly low (Ryanair) to that where, although the costs per available seat kilometre (the industry standard measure of unit costs) are markedly lower than those of a mainline airline, there appears to be an increasing need for better yield traffic.
It is worth reviewing some of the issues associated with airline economics. We have argued on many occasions that not all airline traffic is necessarily profitable. It is very easy to sell tickets at $10 a trip but if it cost $11 a trip to carry a passenger the consequences are obvious and painful. Despite the traditional view in the airline industry, I would argue that market share for its own sake is not a sufficient condition for success - even over the medium term. This is all the more the case as markets become more open and liberalised. At the same time the traditional segmentation of the market between leisure and business travellers is too simplified - the number of pricing points in an airline's yield management system is a clearer and better indication of the segmentation that actually exists in the marketplace. As the propensity to pay more increases so does the demand for more.
The real issue if we look at this from the perspective of the customer is the willingness to pay. It is blindingly obvious that an airline must have a cost base that is appropriate to the revenue stream that it is targeting. Now, of course, the real world is complicated for many airlines by issues of transfer traffic and allocation but if we focus again on point-to-point traffic the issue is clearer.
Returning to the alleged damage to the mainline airlines we would argue that this for the most part is not traffic that they should target and BA's European strategy is a very clear example of the recognition of this.
The real issue for any airline is to maximise the gap between the breakeven load factor and the achieved load factor. There are some who might just look at the achieved load factor of an airline and use that for the health check. The need is to look at both. In this respect the last reported full-year results of the three most quoted lower cost airlines show an interesting picture - we have used the standard industry method to calculate these.
The breakeven load factor is the reflection of the relationship between costs and revenues and indeed traffic mix. The greater the proportion of higher quality traffic the quicker that breakeven is reached - similarly the lower the cost. Herein lies a crucial difference in the approaches of Ryanair on one hand and Go and easyJet on the other. Both Go and EasyJet are increasing frequency to attract better quality of traffic (the business traveller) and have had some success - but where do the diminishing returns from this strategy set in?
The type of traffic attracted by an airline also reflects its catchment area and both Stansted and Luton appear limited in this respect for business travellers, compared with the main London airports. There is also the view that the lower cost airlines are more attractive to business travellers from SMEs. On the other hand, BA and others appear to have significantly increased their marketing activities in this area over the last 12 months. Against this background some research from Keith Mason at the UK's Cranfield University suggests that in an economic downturn although business travellers on 'mainline airlines' would seek to travel more cheaply than they currently do, business travellers using lower fare airlines expressed a greater propensity not to travel at all.
For all airlines we have long argued that it is structural cost reduction that is important. There was a very clear example of this when Ryanair announced its third quarter figures where the rapid take up of Ryanair.com resulted in a 66 per cent reduction in distribution costs. Furthermore here was also a very good example of profitable market stimulation. Total revenue per passenger fell by 7.7 per cent in the quarter, operating cost per passenger fell by 7.2 per cent and operating profit rose by 25.1 per cent. Ryanair's model is very simple: to use low fares to create market and having a sufficiently low cost base to do this profitably.
For other operators in this area of the market the core of the strategy appears based upon the ability to pull traffic in some instances from competing modes (within the UK) and in others - usually where it involves crossing water, competing airlines whether scheduled or chartered.
For all lower cost airlines a major concern is direct competition from within the same market (chiefly between two lower cost airlines) - even airports that are close together. The problem here is that if you are dependent upon using price to stimulate the market or pull traffic to your service then there is the risk that the point is reached when the market is effectively exhausted and what traffic remains is pulled between the airlines at ever lower fares.
What is clear also is that we are about to enter a new environment. The fundamental economic background for most of the last decade was relatively benign. For the mainline airlines we expect capacity growth to remain below the level of fundamental or GDP driven traffic. Whilst the correlation with GDP is not as evident for the lower cost airlines economic activity is bound to have an effect and as we suggested earlier it may not mean a positive traffic switch - even in a downturn business travellers will still use an airport which is most convenient for them. Even for the lower cost airlines there is the need to deploy capacity profitably and also the need to be able to structurally reduce cost.
The next 12-18 months are going to be particularly interesting and there could of course be a competitive change in the market place with British Airways close to selling Go and the future of KLM's Buzz uncertain. Ryanair acting in a different segment of this lower cost market would be unaffected - anyway as they say the only constant in this industry is change we would expect little different in the future. However, whatever the future holds, there is no getting away from our initial point - what really matters irrespective of the chosen market - is that it is necessary to have an appropriate cost base to be able to operate profitably particularly if the going gets a little tougher.