Europe's low-cost carriers find themselves facing a vigorous response from the network majors and an oversupply of seats. They may need to evolve the model, writes Chris Tarry of CTAIRA
If any reminder were needed of how unforgiving stockmarkets can be when companies fall short of expectations, then look no further than the recent experiences of Ryanair, easyJet and WestJet. In the case of easyJet, two profit warnings have taken the share price down by 45% since the day before it announced its interim results in May.
Against the background of some reasonably emotive language, some observers may have concluded that the new airline business model is broken. That is not the case, but it may need some attention. The catalytic effect that these airlines have had has fundamentally changed how we all view the industry and created a behavioural shift on the part of travel buyers too.
The real issue lies with the competitive response that the new model carriers have received in Europe - and perhaps a hint that it was underestimated. While in the US market the majors were slow to react to Southwest's early days in Texas, the response to Europe's new carriers has become increasingly vigorous and widespread. The new entrants began to accelerate their development, largely based on the lucrative London market, in early 2002, perhaps in the belief that the established airlines would be unable to respond. However, it was clear that easyJet, in particular, was becoming too close a substitute for the network carriers to ignore and it also helped to convince them that the market had really changed. Such factors necessitated a response.
The immediate actions of incumbent carriers such as British Airways and bmi was to reduce their glaring competitive disadvantage by offering simplified fare structures and cheaper prices. Attention then focused on the value of the other attributes of the product such as pre-assigned seats, onboard food or convenient airports.
Although price remains the key determinant, there is now a more overt recognition of what is being received in return and this results in customers making their choice on the basis of a quality-adjusted price. The key for the mainline airlines is to uncover how much the value the customer places on such product offerings and what financial return they will bring if offered.
And if the competitive battleground has moved away from fares alone, the new model carriers too need to ask what features they may need to add and how much they will cost. EasyJet has already introduced self-service check-in kiosks, which also brings a cost saving, and has aired the possibility of a loyalty scheme.
A further dimension is that the fare structures put in place by BA and bmi have also been exported to mainland Europe, resulting in a wider-spread structural downward shift in prices. Therefore, the point at which competitive advantage may be gained on the basis of price alone in markets outside the UK, is already lower.
Traffic volume alone is no sure guarantee of financial success for the new model carriers, any more than fleet growth or high load factors. The approach of some may well be to fix a target load factor and then set prices to hit that goal. All well and good if expected prices hold and there is a "pull up" to departure with fares increasing as the departure date approaches.
However, if fares do not rise and the load factor target is either not met or achieved with lower than expected fares, the natural consequence is that the breakeven load factor rises.
Many new model carriers have little scope for cost reduction other than by "growing" them down as they add new capacity, so their room for manoeuvre may be limited. If so, the consequences are likely to be direct and painful.
Of course, the extent of the pain depends on where you start from. If, like Southwest, breakeven load factors are in the low 60s and achieved factors in the higher 60s there is some headroom. That is also true if, like jetBlue, the break-even point is in the low 70s but you are achieving low 80s. But if, as for easyJet, break-even load factor is in the order of 80% and the achieved load factor is in the mid 80s, life may be less comfortable; particularly if there is excess supply in the market, putting further downward pressure on fares. The consequences in Europe are already evident: profit margins appear to have peaked and there has been a fall from grace, at least in terms of stockmarket investors.
In any case, traffic is not infinitely price-elastic and there is a point beyond which all that lower fares succeed in doing is redistributing a finite amount of traffic among competing carriers rather than expanding the market. At the same time, the web has provided the traveller with close to "perfect information" on competing prices and products, which allows for more informed buying decisions.
But the core issue is that an aggressive response by competitors, combined with an oversupply of seats has begun to change the rules of engagement. As for any other business, the new model carriers will have to be able to adapt and evolve if they are to survive.
Source: Airline Business
