Zealots drive down costs

Low-cost carriers from around the globe are unanimous about two things: cutting costs and the quest for boosting ancillary revenues

Costs, costs, costs – get them low, keep them low, then get them lower. If there were themes to emerge from the recent annual Growth Airline Conference in New York, organised by US financial consultancy Raymond James, this surely was one of them.

“Lowering costs is not a one-time event,” says Joe Leonard, chairman and chief executive of AirTran Holdings. “It’s a religion.” The carrier has been able to reduce non-fuel unit costs every year since 1999 except for 2001, even though it offers assigned seating, a business class, travel agency bookings and XM radio, he notes. Leonard cites AirTran’s productive workforce: young, fuel-efficient fleet with attractive ownership costs; high percentage of tickets booked directly with the airline; and efficient use of facilities among the factors for its low-cost advantage. “While legacy airline costs are down, the gap remains large,” he says.

A second clear theme from the conference was the increasing use by carriers of “ancillary” revenues to supplement air fares, both by charging for elements of air transport that were once thought of as part of the ticket price and through the creation of new services.

Airlines are putting such an emphasis on instituting charges to raise ancillary revenues that Jim French, chief executive of UK low-cost carrier Flybe, joked about some new potential disaggregated pricing: charging for take off and then again – but more – for landing.

Flybe has delivered strong growth in ancillary revenues, with charges for seat assignments, baggage, on-board sales and such items as car hire, hotel bookings and insurance. The carrier raised £4.08 ($7.18) per passenger in ancillary revenues in 2005, compared with Ryanair’s £4.95, and has set a £5.55 target for 2006-7.

Flybe charges economy passengers £8 to reserve seats on its flights and double that amount for emergency exit and bulkhead seats – per segment. The carrier charges £2 per bag for luggage checked, if booked ahead of time, or £4 per bag if it is checked at the airport. It recently raised both the amount of hand luggage a passenger could carry on and check (see related story on page 18).

The airline has also been pursuing policies to reduce its cost base. Since 2002, Flybe has realised a 20% cost- reduction benefit from changing its fleet strategy, replacing a variety of aircraft types with the 78-seat Bombardier Q400 turboprop and soon the 118-seat Embraer 195. With a continuing focus on other overheads, Flybe has been able to reduce costs by 12% over the year, excluding fuel. The carrier’s costs are not as low as those of Ryanair or easyJet, French says, but are “a lot lower than others in the market”, particularly those of competitor British Airways.

Flybe, which concentrates on medium and lower-density markets using regional airports such as Southampton on the UK’s south coast, expects a 34% passenger growth in its current fiscal year and is looking to expand substantially in the years ahead as it takes delivery of 195s and more Q400s.

Allegiant Air, a privately owned low-fare, leisure carrier based in Las Vegas, also has concentrated both on keeping costs low and growing its ancillary revenues. The carrier has been expanding quickly by flying to Las Vegas and Orlando Sanford from small, under-served US cities. “These small cities have been neglected over the years,” says Maurice Gallagher, Allegiant’s chief executive. “We’re the circus coming to town, but we don’t ever leave.”

Allegiant, which serves Las Vegas from 31 cities and Orlando from 13, saw its traffic grow 80% last year. The carrier, which operates low-frequency scheduled service with Boeing MD-80s, also has a huge charter programme, which contributes 20% of its revenues. Ancillary revenues account for another 20% and include charges of $10 for pre-assigned seats (which gives passengers priority boarding), charges for snacks and beverages, inflatable pillows and T-shirts and hotel and theatre bookings. In 2005, Gallagher says, Allegiant’s average fare was $94.09 and ancillary revenues added $32.45 per person. In its quest to keep costs low, it eschews global distribution systems and garners 84% of its scheduled passenger revenues via bookings on its website. Because Allegiant is bringing service to cities with little or no air service – regional jet service to hubs at best – it also gets a lot of free advertising through news stories, Gallagher adds.

Operating efficiency

Called “the lowest-cost airline in the world” at 5.8¢/km (3.6¢/mile) by James Parker, a managing partner at Raymond James, AirAsia is seeking to reduce them further, says Tony Fernandes, group chief executive. He says he expects that phasing in new Airbus A320s to replace Boeing 737-300s will reduce direct operating costs by 12%. He also anticipates significant cost savings from greater operating efficiency and lower rates when AirAsia begins operating from the new low-cost terminal at Kuala Lumpur international airport in March.

In tapping the huge Asian market, Fernandes says AirAsia also seeks out the lowest-cost airports. Instead of flying to Hong Kong, for instance, it picked cheaper Macau, he says, a 45-minute ferry ride away. It now has five flights a day there.

Howard Miller, Ryanair’s deputy chief executive and chief financial officer, says the airline’s costs, excluding fuel, have been reduced by 7% in the year to date and expects unit costs to fall 5% next year as the carrier continues to drive up load factors. Ryanair’s goal is to boost ancillary sales, which now account for 15% of total revenues, to 20% over the next three to five years, he says. With its website attracting 15 million visitors a month, the carrier is looking at new products to sell, including car parking, activity breaks and hotels. While reducing fares by 9%, Ryanair also has begun to charge for checked baggage.

Clive Beddoe, chief executive of WestJet Airlines, says the carrier is generating $125 million in revenues a year flying charters for Air Transat, which eliminated its own narrowbody aircraft. The revenues, generated when WestJet’s scheduled business is slow in Canada, have changed its profit dramatically in the first quarter of the year. The carrier’s replacement of older generation 737s by 737NGs, completed last year, also has had a substantial impact in reducing annual maintenance costs.

WestJet has steadily increased its domestic market share since 1999, when it had 8%, to last year when it achieved an estimated 33% of the market. Citing its cost advantage over competitor Air Canada, Beddoe adds: “We see no reason why we can’t continue to grow this.”

The consulting firm Roach and Sbarra, which performed a unit cost analysis for Raymond James, asks the question: “Can the ‘reformed’ legacy carriers match Southwest’s unit costs?” Its answer: “Not in your lifetime.”

Using public data for mainline aircraft operations and adjusting it for stage length and aircraft size, Roach and Sbarra found that Southwest had the lowest cost per available seat mile during the third quarter 2005 at 500-, 1,000- and 2,500-mile stage lengths. Even ascribing to other carriers the same price for fuel that Southwest paid under its advantageous fuel-hedging strategy, Southwest still remained the lowest-cost carrier at 500 miles and was the second lowest-cost airline behind AirTran at 1,000 and 2,500 miles.

Michael Roach, one of the consultancy’s two principals, says United Airlines has done well in bringing unit personnel costs down a cent and a half during bankruptcy but he does not expect that to last. He predicts that United’s pilots will at some point ask for some back. Moreover, he says, “there is more to an airline than personnel”, adding that “United’s other costs, ex-fuel, are going up. “United has traded employee costs for ‘other costs’, and there is still a huge gap between United and Southwest,” he says. His overall conclusion: “An airline is a business, and the key to success is costs, costs, costs.” ■

CAROLE SHIFRIN / NEW YORK

Source: Airline Business