Indeed, it can be argued that numerous low-cost carriers have been operating in Europe for years. However, few if any of these can realistically be described as true low-cost airlines of the US type. Most airlines which claim Southwest as their model have deviated significantly in one way or another from the proven US practices.
But there is a strong argument that the concept of 'no-frills' shorthaul scheduled airline operations in Europe will gradually develop along US principles, following in the path of many other innovations which have crossed the Atlantic in recent years. In time, these airlines will become effective and permanent features of the European market. They will still, of course, have to confront many of the pitfalls which the sceptics have identified as insuperable barriers to low-cost operations in Europe. If they do, there seems no reason why a European low-cost startup airline on the Southwest model cannot succeed.
There are six key strategic imperatives. The first and most important is, logically, that the carrier must institute and maintain a lower cost structure than the competition - this is the primary competitive advantage of any startup airline. Southwest's unit cost levels of roughly 7 cents per available seat mile (4.4 cents per available seat kilometre) on an average stage length of 400 miles (640km) would be hard to achieve in Europe, but a startup's costs will still be far lower than those of the incumbents, including 'low-cost' subsidiaries of major airlines.
The reasons for this are the same as in the US: greater efficiencies in the type, use and cost of labour, aircraft and distribution. Even if a European startup's unit costs are 75 per cent higher than Southwest's, the fares they would need to offer to cover costs would still be much lower than those charged by incumbents. If their yields are double those of Southwest, they would still be only half those achieved by a typical European flag carrier on similar routes. The flag carriers' high yields may decline as competition grows and draconian cost-cutting continues, but - as the US experience has shown - they could never go far or deep enough to compete profitably for every passenger.
All this assumes that the European startup can achieve satisfactory load factors. Route selection is crucial to this, but it also depends on the willingness of Europeans to sacrifice frills for a low fare. Those who say that Europeans are culturally averse to Southwest-style operations forget that every year millions fly on European charter flights, which are far less hospitable than Southwest's.
On flights of up to three hours, an aircraft seat is increasingly seen as a commodity by consumers who just want to get there cheaply and easily. The advent of scheduled low-fare services will spur the growth of travel by small businessmen and by passengers visiting friends and relatives (VFR traffic) - both markets undeniably stunted at the moment - as crossborder trade grows. Marginal pricing in the major computer reservations systems (CRS) has already reduced Europeans' price perceptions, but consumers still have to hunt for discounted fares. This would change if passengers knew about, and became used to, a consistently low-fare airline operating on routes they need.
The second strategic imperative is a growth-oriented route strategy targeting unserved or underserved city pairs. The unique conditions at Europe's slot-controlled airports, which are fortress hubs for the majors, have led to the belief that a new entrant cannot succeed without adequate slots and a significant share of these markets. However, the quickest way for a startup to run headlong into financial disaster would be to storm on to a trunk route dominated by a flag carrier. The incumbent has the resources to absorb losses resulting from matching a new entrant seat-for-seat. Any legal action resulting from accusations of predatory behaviour will be resolved long after the startup has gone under.
Fortunately, in Europe there are many underserved shorthaul city pairs with underused airports at both ends, from which a new entrant can build up a solid franchise. Each has growth potential for business and VFR traffic, and each suffers from inadequate service from other modes (road, rail, sea links) and charter services. If they are served by scheduled carriers, it is often with expensive and less comfortable turboprop aircraft.
The US industry has witnessed countless examples of how low prices and reliable services can stimulate apparently small, limited markets to levels of traffic which can support jet aircraft services. Low-fare airlines do not generally steal traffic from incumbents, but generate their own passengers by luring consumers away from rival surface modes. In Europe, this has already happened in the Ireland-UK and French domestic markets.
Some of Europe's best openings for low-cost services probably lie in unserved markets at secondary airports. For example, in Hamburg the modest, unhubbed point-to-point system operated by Lufthansa could be cut back if the airline were to concentrate on profitability rather than market share. From Gothenburg, Sweden, scheduled low-fare services would capture a large share of the existing surface (mainly ferry) traffic.
The Italian city of Turin, population 1.5 million, is a high-fare airport where new shorthaul routes would easily displace difficult surface transport. In Switzerland, Swissair increasingly hubs at Zurich, has lost key monopoly privileges, and cannot fill all the gaps with its regional subsidiary Crossair, creating openings at Geneva and Basle/Mulhouse. London/Luton airport's improving road and rail links to the city, ample slots and low user fees are attracting low-cost airlines such as EasyJet and Debonair.
The third key strategic decision involves possessing a distribution system which does not follow traditional CRS lines. Airline distribution is in the midst of an upheaval, largely driven by the Internet, which will continue for some time. As ticketless travel and direct distribution outside the traditional agent/CRS system become the norm, the need for travel agents will diminish, although their influence will remain strong in the short term.
A new entrant airline must convince its customers that it is quicker and easier to call the airline itself, and should persuade travel agents to book flights in non-traditional ways, outside the ubiquitous CRSs. Although no low-cost startup can afford entirely to alienate the travel agent, these carriers usually fly in city pairs which can generate strong origin and destination traffic, which can be targeted directly though local advertising. By using travel agents and CRSs, startups hand over up to 20 per cent of their ticket revenue for something they can easily do themselves. In the case of US example Morris Air, word-of-mouth and free press coverage about their low fares ensured that the airline hardly needed to advertise at home in Salt Lake City.
The fourth key factor is the need for a sophisticated reservations and yield management system. If direct selling and promotion is to work, an airline must have an effective information system, particularly with regard to reservations, revenue accounting and yield management. All too often a startup's choice of systems is based on funds available, which can be a false economy. It is amazing that some entrepreneurs are prepared to take a gamble on cheap, untried software which might cripple their airlines before they take off. Others go to the other extreme by selecting expensive, over-functional systems.
In yield management, small airlines commonly still rely on simplistic approaches which require hours of manual analysis: only now are some realising that there are revenue maximisation software packages available which do not cost a great deal, yet fill each flight at more than satisfactory yields. These efficient, low-maintenance systems run in real time, so a manager knows whether a flight is profitable as it departs.
Fifth, and vital, is that an airline should have a strong and knowledgable financial partner with local contacts. Money remains the biggest stumbling block for a new entrant carrier. Most business plans state that profitability will be almost immediate, in the belief that only this will ensure an investor's interest.
But the truth of the matter is that the average, competently-run, low-cost startup will lose money for between 12 and 18 months before it is truly established, and it will devour cash in the process. Total cash needs are typically understated from the outset. The turning point usually comes when frequent travellers embrace the services, which usually occurs only after a reliable operation, as well as value-for-money ticket prices, have been demonstrated. This is true worldwide, despite the success of US carrier ValuJet, which has been exceptional in every way. Historically, most airlines fail because they run out of cash before they gain a firm foothold.
The amount of cash needed varies from case to case, but raising enough capital to absorb startup costs and early losses is an issue for most fledgling carriers, even in the US. Europe's Southwest copycats have usually been launched by entrepreneurs with sufficient cash in hand. For others, venture capitalists who are not deterred by high risk, capital-intensive projects are very thin on the ground.
But investing in airlines, although it may seem foolhardy, can yield rich dividends if the right horse is backed. There are not many industries when a company can go from nothing to $100 million in revenues in a matter of months after a relatively modest investment. Since the stock market values of US low-cost airlines roughly equal their revenues, investors are bound to be interested.
So, the sixth and final strategic question is this: what do venture capitalists want to see in a startup airline company? Critically, such companies tend to invest in successful, innovative individuals and their ideas. This is by far the most important element in considering a business plan. A management team must have an impressive track record, a low-cost orientation, and the capacity to ride out hard times. The business proposal must have the potential for strong but pragmatic growth. Of course, it must also be clear that the first five strategic imperatives have been thoroughly researched and provided for.
The relative lack of entrepreneurial activity in the truly low-cost airline segment in Europe continues to be surprising. Today the total number of such aircraft operated in Europe comes to just 10 per cent of Southwest's fleet. There is clearly a great opportunity in Europe, which investors will find increasingly attractive as it becomes easier for smaller companies to access the public stock markets around the continent.
After a period of rapid consolidation in Europe, the post-deregulation environment will closely resemble the one which exists now in the US, where the second wave of startup carriers is proving more sensible and resilient than the first. Europe's industry will eventually stratify into two stable tiers, made up of large, much more efficient carriers with global networks and small, tightly-run low-cost airlines serving point-to-point niches. These two tiers will co-exist peacefully by catering to different market segments, attracting different types of passengers, both tiers doing so profitably. Where routes do overlap, fares will only be matched on a strict capacity-controlled basis.
The major full-service airlines, armed with huge marketing resources and costly frequent flyer programmes, will exploit their global alliances and CRSs to attract high-yield business travellers with complex itineraries. They will gradually restructure to their profitable cores by focusing on traditional hub-and-spoke operations from major cities which require regional feed from codeshared jet and turboprop franchise partners.
As in the US, this will increasingly free up a multitude of short-haul, point-to-point routes by-passing the hubs out of smaller but not insignificant cities. Even in some major cities there are secondary airports with no slot controls. Airline passengers, especially the leisure traveller, will be more than willing to avail themselves of these services.
With only slight adjustments to take cultural and regional idiosyncrasies into account, the strategic 'formula' for a low-cost new entrant airline outlined above can be applied all over the world. Many of the economic factors which enabled the first wave of US startups still exist. But Europe, with full deregulation looming from April next year, is of particular interest to venture capitalists.
Source: Airline Business
