Low-cost carriers are on course to take over in the European market, or so the recent stream of ambitious deals and aggressive expansion plans would seem to suggest. But just how far will they actually be able to go?
There is no stopping the low-cost revolution, or so it seems. Everywhere the talk is of the need to replace the old busted model of the traditional majors, with the fresh young approach of these low-cost, Internet-savvy pretenders. Yet as the low-cost sector builds up ever greater expectations, it is worth asking just how big the low-fares market will ultimately become, especially in Europe, and how many players will be left to contest it.
Financial markets clearly continue to expect great things from the low-fares sector. In the USA, Southwest Airlines, the king of no frills, is worth more than the rest of the majors put together. Meanwhile, the likes of United Airlines, second-largest carrier in the world, has suffered the indignity of seeing its capitalisation dodging around at less than 5% of Southwest's valuation.
In Europe the prices are no less breathtaking. Ryanair was for a brief time worth more than any other airline in Europe. Lufthansa has since nudged it from the top spot, but with a valuation at the $4 billion mark, it is still ahead of all the famous names. EasyJet has not been far behind and clearly plans to catch up. Witness its bold plans to buy up Go for over $500 million, at a stroke leapfrogging Ryanair. And thanks to the stock market's love affair with the sector, easyJet plans to fund the purchase largely through a share offering.
At these levels, the market is obviously trading heavily on future expectation, although unlike their dotcom predecessors, the low-cost carriers do actually have hard profits to show. Nevertheless, as one analyst wryly remarks, on current standing it would still take a decade of 50% annual growth for Go to earn back its asking price.
It is possible that such growth could continue to materialise. Ryanair reckons it can become the largest scheduled carrier in Europe, carrying 40 million passengers by 2010. And easyJet has painted similar pictures of the untapped potential across the continent.
Based on the latest summer schedules data, low cost has already captured 28%of flying from the UK to and from Europe. Outside of this base its penetration is almost nominal. So simple mathematics shows that if the UK experience could be repeated everywhere else, the sector could indeed grow by two- or three-fold. That remains a big assumption. The early success in the UK is precisely because it was likely to be the most receptive of the European markets.
However, low cost fleet plans, like their share prices, already anticipate such growth. Ryanair has placed a massive order for 100 Boeing 737-800s for delivery up to the end of the decade, while easyJet and Go between them could soon order some 150 Boeing or Airbus types. This would mean Ryanair and easyJet/Go trebling their fleets.
On the surface, the US experience supports such optimism. There the low cost sector has captured 20%of scheduled capacity. However, the USA also holds lessons. Over half of that share is in the hands of one carrier - Southwest. True, JetBlue is making a splash with an up-market version of the low-cost model, while AirTran and other older survivors from the mid-1990s shake-out appear to be growing steadily. If Europe is to follow this pattern then Ryanair and easyJet have a bruising battle ahead to see who becomes Europe's Southwest. Until now, low-cost carriers have rarely competed directly, but that cannot last forever and it is not clear whether cost or quality will win. Both have dangers. Ryanair is already taunting easyJet about its higher unit costs, while easyJet points to the virtues of good service and convenient airports.
Also, Europe is a different marketplace to the USA. National boundaries still matter. Family and friends have traditionally been closer to home, not in distant states, and long holidays have allowed Europeans to take extended planned vacations (with hotels and tours thrown in) rather than snatching time for weekend breaks and conventions. European habits are changing, as shown by the growth of low-cost travel itself, but it is not clear exactly how fast that change will happen.
There are also two other groups who would like a share of this new travel market. The giant leisure groups have been slow to react to the low-cost threat, but they cannot be written off. Charter carriers already fly around 20% of the scheduled seats within the region. Also there are signs of a fight back by the flag-carriers, wounded but not beaten. If and when they adopt best practice from the low-cost sector and start to consolidate into bigger and more efficient groupings, then there may be some erosion of the glaring price differential which has so far provided a free ride for the low-cost rivals. For certain, the competition can only get fiercer from here on.
The race is therefore on for the low cost carriers to build the critical mass which will make them too big to be easily picked off as the fight hots up.
Source: Airline Business
