University of Cologne

“Low-Cost Carriers –
Evolution, Strategies and Performance”

by

Vanessa Blaha

CONTENTS

TABLE OF FIGURES II

1. INTRODUCTION 1

2. EVOLUTION OF THE LOW-COST CARRIERS  1

2.1. Southwest - the “role model” for all low-cost carriers  1
2.2. Other LCCs in the United States  3
2.3. Evolution of LCCs in Europe 3

3. COMPETITION THEORY BY PORTER  6

3.1. Cost Leadership 7
3.2. Differentiation 7
3.3. Focus 7

4. APPLICATION OF PORTER’S THEORY ON THE LOW-COST CARRIER BUSINESS 8

4.1. Cost Leadership 8
4.2. Differentiation 10
4.3. Focus 12

5. MARKETING STRATEGIES  14

6. PERFORMANCE OF MAJOR LOW-COST CARRIERS 15

6.1. Growth and volumes in terms of sales and passengers  16
6.2. Profitability in terms of operating and net margin  17
6.3. Shareholder value measured with stock price performance  18
6.4. Performance of low-cost carriers versus full-service carriers 19
6.5. Future outlook of the aviation sector 21

7. CONCLUSION  22

1. INTRODUCTION

In the last three decades low-cost carriers (hence forward referred to as LCCs) have captivated travellers by making the world smaller through cheap short-haul flights. Travellers in the United States have benefited from this concept since the 1970s; whereas, the development in Europe has been much more recent. Lately, LCCs have been quite a hot topic especially since the terrorist attacks on September 11, 2001. Many LCCs have amazed investors with their financial performance, as they successfully earned profits in a time when most conventional carriers reported major losses. In Europe, LCCs have entered the market in order to gain market share and to take part in the success of the business. In Germany, the LCC market has taken off with the emergence of two new carriers in the end of 2002.

To best understand the low-cost concept, the evolution of LCCs in the United States and in Europe is examined in the second chapter. Furthermore, the background of the most successful LCC Southwest, still being the role model for other LCCs, is presented. In the third chapter the competition theory of Michael Porter is discussed in order to be able to analyse the competitive strategies followed by the LCCs in the chapter four. The fifth chapter gives a brief outline on the most striving marketing strategies among LCCs. Marketing strategies are examined in the fifth chapter. The performance of LCCs is analysed in the sixth chapter, and a comparison to the performance of conventional carriers is conducted. An outlook for the future can be found in chapter seven.

2. EVOLUTION OF THE LOW-COST CARRIERS

The creation of airlines with a business profile based on low fares appears to be quite new in Europe, and especially in the German market. However, it has a longer history in the United States; therefore, it is not surprising that most of the recently founded European LCCs are following the business model from the American company Southwest Airlines.

2.1. Southwest - the “role model” for all low-cost carriers

The Air Southwest Company was founded in 1967 by Rollin W. King and Herbert D. Kelleher, and incorporated as Southwest Airlines in Texas. It commenced operations with three Boeing 737 aircraft on June 18, 1971 with flights connecting three interstate destinations - Houston, Dallas and San Antonio. After adding five more destinations to their system map in 1976 and the company’s initial public offering in 1977, they began service to New Orleans in 1979, the first city outside of Texas being served by Southwest.¹ The steady growth of the airline was also enhanced by the deregulation process in the U.S. airline industry in the late 1970s. The Airline Deregulation Act of 1978 eased the entry of new companies into the market, and gave them the freedom to set their own fares and fly whatever domestic routes they chose.² Today, Southwest Airlines is the fourth largest major airline in the Unites States, and provides primarily short-haul, high frequency, point-to-point and low-fare service, carrying more than 64 million passengers to 58 different cities in 30 states. The company’s fleet as of October 17, 2002, consists of 370 Boeing 737 jets. According to Southwest, they are the only airline making steady profits in the last 29 years of operation. Of the nine major U.S. airlines, only Southwest has posted a profit during the fourth quarter and full year of 2001, which was approximately $511 million. Furthermore, it was the only carrier that kept its capacity and staffing levels intact after the terrorist attacks on September 11th, 2001. These results could only be achieved because of Southwest’s cost advantage over other airlines, resulting in unrivalled lowfares for their customers.

Southwest has implemented several cost-effective approaches, which allow savings to be passed along to the consumer. They do not offer full cabin service, provide only “coach-class” service without free meals, and operate one type of aircraft and engine. Southwest Airlines uses a direct method of distribution, selling tickets directly to the traveller, bypassing travel agents and reducing the costs associated with commission incentives. In 2001 over 85 percent of their seats sold were ticket-less, and over 45 percent of their revenue was generated through the company’s website, eliminating significant processing costs.³ Southwest Airlines also offers point-to-point transportation by using smaller, less congested airports, and does not operate within a hub system like other major U.S. airlines. It is also a stand-alone carrier with no alliances or partnership agreements with other domestic or international airlines. Another key factor for its success is the company’s culture, which allows the employees to participate in the company’s success, thus attracting flexible and highly motivated staff creating a customer friendly environment.⁴

2.2. Other LCCs in the United States

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1 Southwest Airlines (2001a).
2 Wells (1999), pp. 68-74.
3 Southwest Airlines (2001a).
4 Doganis (2001a), p. 133.