Yet over the past two years US startup Valujet has achieved an astounding cost base of 6.69 US cents per available seat mile, an average yield of $70.55 and a 64.5 per cent load factor across its entire network. In fiscal 1995 its revenues exceeded $350 million and its income before tax was in excess of $100 million. Why can't this experience be replicated in Europe?
The reasons can be found in a comparison of the operating conditions and aviation cultures of Europe and the US. Slots, for example, are a major problem for most of Europe's cities, whereas in the US only four, New York/JFK, Chicago/O'Hare, New York/La Guardia and Washington National have slot restrictions.
In Europe runway capacity is at a premium: new terminals are being built but extreme environmental pressure is mounted to stop the construction of any new runways even though aircraft have become substantially quieter. At Düsseldorf airport a new runway has been completed which can increase the annual landings substantially over the existing 90,000 movements. However use of the new runway was blocked by a local government ruling resulting from a powerful environmental lobby. In some cases airports are being built in the wrong places: some would argue that Stansted, for example, does not assist congestion in the London market. Nor, arguably, does Luton. The Munich investment could have been made in Frankfurt or Düsseldorf, transit points for more than 60 per cent of German traffic. Europe lacks the runway freedom that characterises North America; pretty new terminals are not enough.
There is also a fundamental difference between North America and Europe as regards distribution, a vital function for any airline. In the US passengers phone airlines directly to make their reservations; already it is estimated that over 60 per cent of all US bookings are direct. In Europe the travel agent accounts for some 90 per cent of all bookings. Part of the problem is that the credit card mentality has not yet penetrated Europe to the same extent as the US.
Ticketless travel is also a rapidly growing concept in the US. PIN numbers are issued to passengers who then buy a series of discounted vouchers or points on a digital card enabling them to travel on a given number of sectors. Much of the benefit of such systems lies in the fact that they bond a passenger to a given airline which receives a substantial cash flow benefit from the early cash remittance. In Europe matters are moving much more slowly though ticketless trials are underway at Lufthansa and SAS and some startup carriers such as France's Air Jet are using smart cards. BA has announced a direct booking system which will be available in late 1996 to allow regular travellers to book from their PCs. The system, called Executive Travel Works, was developed in the US by BA's partner USAir.
Another key difference concerns airline staff. Employees in the US are service and results-oriented and have been forced into heavy pay and productivity concessions. As an example low- cost, low-fare Valujet was able to pay its employees $14 million in incentive bonuses last year, amounting to 3.9 per cent of turnover. Not so in Europe, where union resistance is still rife at many state-owned carriers including Alitalia and Air France. Flight deck pay cheques in Europe can be as high as double their US equivalent.
One of the biggest differences between the US and Europe has to be the existence of government ownership in Europe of both the national airline and the major airports. This problem lies at the root of Europe's higher en route and airport charges (see tables). It is not in the interest of private or public monopolies to open their facilities to greater supply and see their prices forced down by competitors.
And overmanning remains endemic in Europe within many airlines, airports and air traffic control authorities. One reason is that some governments see aviation as a source of revenue and appear to be less preoccupied with cost reduction to be more competitive.
The inefficiency of the European state-owned carriers has also allowed the leisure market to be attacked in a wholly different way than in the US. The major European carriers were interested in the high yield business traffic and left a large gap at the bottom end of the leisure market. As a result the second largest UK airline is a Canadian-owned charter carrier called Britannia. The UK charter business is the nearest approximation to a free market to be found anywhere in the aviation world. It is almost completely deregulated and offers competition to the scheduled carriers which are gradually coming out of their cocoon. The secret to the charter operators' success is their high levels of aircraft utilisation - up to 16 hours a day - and reliable aircraft. As a result seat-only fares comparable to those of ValuJet are possible.
However, by far the largest difference between Europe and the US is their operating costs, more specifically their overflight costs, landing fees, handling charges and fuel costs. Since President Reagan reduced the power and mystique of the US air traffic controllers in the 1980s, US air traffic control has been governed by one highly efficient authority, largely funded through an aviation fuel tax.
But flying within Europe carries a huge hidden tax burden that US carriers don't suffer. An analysis of five routes shows the dollar cost of operating those sectors and the corresponding overflight cost per km (table 1). The cost of flying a Boeing 757 from Paris to Frankfurt, a distance of just 463km, amounts to $650 or $1.40 a km. Flying within Europe is expensive but why should the tax authorities reduce such a great source of revenue? After all, they are also the major shareholders of the big carriers.
You would think that the cost of fuel would be pretty constant throughout the western world. Think again. Massive differences exist due to inefficiencies and tax differentials. The cost of fuel in Gibraltar is maintained at a high level because Shell is the only supplier allowed onto the airfield. And prices at each of the major European airports are way above those available in Atlanta, Dallas, Detroit, Washington, Orlando or Miami (table 2).
The pattern is the same as regards handling costs (table 3). It could surprise many people to know that handling an A320 at Paris/CDG costs five times more in dollar terms than in Atlanta? It shouldn't as the owner, Aéroports de Paris, is of course the French government, sole shareholder of Air France. In Athens, where many users have wished the facilities could be brought into the 20th century, the Greek government owns Olympic and the airport. Charges at Athens are over a $1,000 higher than in Washington or Dallas!
It's the same story with landing charges. A look at the charges for a DC-9 in Atlanta compared to Frankfurt charges reveals a stunning differential (table 4). At Atlanta landing costs of just $17 are charged for a DC-9. Frankfurt imposes a penalty of 100 per cent on stage 2 aircraft. But even for an A320 there is a huge gulf in price between the two.
The result of all these costs inevitably means that fares, and therefore yields, are much higher in Europe. An analysis of the lowest fares available on a selection of routes in Europe and the US on 19 February confirmed that, apart from the London/ Heathrow-Athens route on which competition between BA, Virgin and charter operators has increased capacity and reduced fare levels, European fares are much higher (table 5).
While the analysis is far from comprehensive, it lays bare the simple truth: the US gives the consumer significantly lower fares and the shareholder greater rewards. Within Europe the reverse is true. The European cost base is too high and, with the exception of the charter market, has not been compensated for by giving the customer what he or she wants.
So what can would-be startups or new entrants do in response to high infrastructure costs, the competitive weight of major players, slot congestion, the anti-competitive behaviour of governments that own their national airlines and airports and raise taxes through indirect products such as overflying, and the lack of handling competition?
UK-based British Mediterranean's initiators scrutinised the problem two years ago and ended up starting a high quality airline to Lebanon instead, a booming part of the world used to high yields. Its directors looked at the ValuJet model in 1993 but couldn't see a way to put it profitably into practice in Europe. However, there are a few examples of brave players who have spotted and acted on the opportunities.
The first is EasyJet: why do you think Luton was chosen? I am sure the decision was not driven by the wonderful train connection to London but by the availability of slots and the lower handling costs and landing fees at Luton.
EasyJet is perhaps the only start-up in Europe that is truly modelled on ValuJet. The airline currently serves Edinburgh and Glasgow three times a day and Aberdeen daily, and is considering an Amsterdam service. Even then, the minimum startup capital required by the UK Civil Aviation Authority is almost $4 million per aircraft, significantly more than in the US. EasyJet operates one-class wet-leased B737-200s and recently committed to a new B737-300. The key issue appears to be getting the product distribution right. Its most innovative commercial idea was cutting out the travel agent. The message is simple: 'All fares are one way; non-transferable and non refundable'. EasyJet aircraft's orange livery advertises its telephone reservations number.
All bookings are made directly to reservation agents in Luton and customers are issued with PIN numbers only and pay by credit card. The non-refundable aspect greatly reduces administration: the delay of collecting cash from the Bank Settlement Plan can be as long as 2.5 months after refunds are made.
EasyJet's average load factor reached 70 per cent in December and some flights have been 100 per cent full. As you would expect no financial information is in the public domain.
Italy's Air One has shown that slot decongestion can happen if a case is strong and well argued. Intensive lobbying at Milan/Linate finally resulted in an increase in slots at the airport from 22 to 32 per hour. Air One now occupies a well deserved number two position on the lucrative Rome-Milan route which it serves 13 times a day, providing Alitalia with much needed competition.
Meanwhile Virgin Atlantic is forging ahead with plans to establish Virgin Europe, a low-cost operation in Brussels, in partnership with US financier David Bonderman. At press time the carrier was finalising the purchase of a 90 per cent share in Brussels-based EuroBelgian Airlines. Given the tough operating environment in Europe it is unlikely that Virgin Europe will match the success of ValuJet.
One of the rare examples of a successful low-cost operation in Europe is the Irish carrier Ryanair which operates from Dublin into London/Stansted airport and to other UK cities. Though Ryanair has been established for several years, it has been able to supply growing demand for low-cost, low frills leisure and VFR travel to and from Ireland while rival Aer Lingus struggled with its financial difficulties.
ValuJet has prospered because of the space granted at its 26 airports, the sheer efficiency of its operation, anti-trust legislation and the acquisition price of its fleet. Compare this with the European experience: common state ownership of airports, airlines and handling agencies and a historical dominance of major airports by a handful of airlines.
Imagine EasyJet operating shuttles to 26 cities from London/Heathrow. The airline didn't choose Luton, it was forced there by lack of space. And, given freedom of choice, would Virgin's Richard Branson really have chosen Brussels as a base for a low-cost European airline?
Anybody who thinks that anything has happened to suit the consumer following deregulation in Europe should think again. Niche routes can be found but they need time to develop and focused management teams. Beyond that, the future of a low-cost airline in Europe under existing operating cost structures is to pick an airport that no one wants to fly from and operate to an airport no one wants to go to.
Source: Airline Business
