Low Cost Carriers - Business Model, Impacts of its Expansion and Challenges

Table of Contents

1. Introduction

2. Deregulation of the European Aviation Market and its Impact on the Emergence of Low Cost Airlines
2.1. Outlook of the European Aviation Industry until 1988: Three Pillars of Economic Regulation
2.1.1. Bilateral Air Service Agreements
2.1.2. Inter-Airline Pooling Agreements
2.1.3. International Air Transport Association
2.2. Commercial Aviation Industry Liberalisation
2.3. Outcomes of the Single Aviation Market
2.4. The emergence of European Low Cost Airlines

3. LCC Business Model and Characteristics
3.1. Definition of the Low Cost Aviation Model
3.2. Overview of the LCC Market
3.3. Business Model and Strategic Positioning of LCC
3.4. LCCs Cost Advantages and Their Determinants
3.4.1. Aircraft Size and Seat Density
3.4.2. Fleet Commonality
3.4.3. Sector Distance
3.4.4. Aircraft Utilization
3.4.5. Usage of Secondary Airports
3.4.6. High Labour Productivity Rates
3.4.7. Types of Routes Served by LCC
3.4.8. Distribution Costs
3.4.9. Passenger Service Costs
3.5. LCC Market segmentation
3.5.1. Business Travel Market
3.5.2. Leisure Travel Market
3.6. Differences between Full Service Carriers and Low Cost Carriers
3.6.1. Operational Differences
3.6.2. Service Structure Differences

4. Impacts of the LCCs Operations
4.1. Benefits of LCCs Operations
4.1.1. Benefits for Consumers
4.1.2. Benefits to Airports
4.1.3. Benefits to the European Community
4.2. Negative Impacts of Aviation industry on EU Community
4.2.1. Effects on the Environment
4.2.2. Limitations of the Low Cost Product

5. Long-Term Sustainability of the European Low Cost Model
5.1. Resisting Economic Downturns
5.2. Low Cost Industry’s Dynamics and Challenges
5.2.1. Overcapacity
5.2.2. Decline in yield in the Average Fare
5.2.3. Controlling Costs
5.2.4. Basic Model
5.3. Competitive Strategies for LCC
5.3.1. Adopting a Strategic Position
5.3.2. Leveraging Capabilities

6. Conclusion

List of Tables

Table 1: Traditional and New-Style European Air Service Agreements

Table 2: The Three Air Transport Liberalisation Packages

Table 3: The “National Airline” and Deregulated Airline Products Contrasted

Table 4: Business Design of Low Cost Airlines

Table 5: Comparisons of Salaries in FSCs and LCCs

Table 6: Product Features of Low Cost Carriers and Full Service Carriers

Table 7: The Largest FSCs in Europe by Scheduled RPK

Table 8: British Airways Fleet

Table 9: Ryanair fleet

Table 10: Beneficiaries of LCCs’ Development

Table 11: Employment in the European Aviation Industry for 2006

Table 12: Number of Employees in Some Leading European LCCs

Table 13: Total Employment by Low Fare Airlines (LFAs) in 2007

Table 14: European Traffic in Terms of Million Passengers – from 2002 Forecast

Table 15: Typical LCC Levers for Reducing Unit Costs

List of Figures

Figure 1: LCCs Market Share for 2006

Figure 2: Low Cost Carriers Operating to/from Major European Countries by Frequency in November 2005

Figure 3: easyJet Versus Traditional Carrier Seat Density

Figure 4: How to Generate Economies of Density

Figure 5: The Growth of the Ryanair Network (1991-2004)

Figure 6: European Airline Market Segments – Services and Customer Target Groups

Figure 7: Low Cost Carriers Segmentation

Figure 8: The 500 Busiest Business Aviation Routes in Europe (2007) Carried 28% of All Business Flights

Figure 9: Difference between Hub-and-Spoke and Point-to-Point Model

Figure 10: Point-to-Point versus Hub-and-Spoke Model

Figure 11: Number of Routes (city to city: EU 27)

Figure 12: Malev’s Fares from Budapest to Major EU Destinations

Figure 13: Traffic Growth of London Stansted Airport Following the Entry of LCCs

Figure 14: The “virtuous” Cycle Airport Model

Figure 15: Visitors Demand Versus Airport Arrivals

Figure 16: ICAO Scheduled Airline Financial Results (1988 to 2003)

Figure 17: Traffic Demand Correlates with Economic Growth

Figure 18: Ryanair Passengers Growth in Millions

List of Abbreviations

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1. Introduction

Across a wide range of industries traditional market leaders are threatened by low price competitors. These low price firms are steadily eroding the profit margins and market share of their more established rivals. A vivid example from aviation is the Low Cost Carriers. Beginning in the North America and spreading to Europe, the airline passenger market has witnessed a growing intensity in price-based competition. This intensified competition has been facilitated by policy deregulation initiatives until the emergence of the phenomenon Low Cost Airlines. European Low Cost Airlines have changed people’s leisure and travel habits, opening up direct services between city pairs that were not available before.

The present thesis aims at analysing the European Low Cost Carriers (LCCs) business model from the perspective of its rapid expansion on the air travel market. In conjunction with the liberalisation of commercial aviation the LCCs’ impacts on the European community have been identified in line with the sustainable transport concept recognized as a common goal in the two European Commission’s strategic documents: Lisbon Agenda and European Sustainable Development Strategy.

The European low cost model is examined in terms; its business model and strategic positioning; the LCCs’ positive and negative impacts after its rapid growth; the sector dynamics and its long term sustainability. This LCC multi-dimensional view imposes the main questions of the current work in search for broad analysis of the LCCs trend: “What are the essential characteristics of the LCCs business model?”;” How it affects the EU community?”; and “What driving forces stand behind the LCCs model?”.

The thesis sets itself the following sub-objectives and attempts to answer their corresponding questions:

- Overview of the European civil aviation industry prior deregulation (until 1988): How the industry was regulated and by whom?
- Tracing the European air travel industry’s liberalisation: What kind of regulatory changes have been introduced in European civil aviation after 1988?
- Consequences of the deregulation processes on the air travel market: What were the outcomes of the air transport industry’s liberalisation and prerequisites for LCCs emergence?
- Introduction of the first European LCCs: How the European LCCs emerged?
- Analysis of the LCCs competitive and cost advantages: What are the LCCs’ cost advantages and their determinants?
- Identifying the differences between LCCs and FSCs operational models
- Analysing the benefits of the LCCs development: Who are the main beneficiaries?
- Analysing the negative impacts of the LCCs development: How LCCs impose negative impacts on passengers and European Community?
- What were the historical LCCs performance indicators (RPK, RTK, market share) ?
- Analysing the main challenges LCCs face in the present economic environment: What are the main drivers of the European low cost industry’s dynamics?
- Sustainability of the LCCs model: How can the low cost model be competitive in the longer term?

2. Deregulation of the European Aviation Market and its Impact on the Emergence of Low Cost Airlines

The completion of a single market for air transport within the European Union (EU) has led to significant changes in the air transport industry of Europe. As the market in Europe became freer with lower entry barriers, it permitted the emergence of Low Cost Airlines. This chapter trace through the process of air transport liberalisation in Europe and EU aviation industry deregulation for paving way to enforce free and fair competition in European airline industry. A retrospect approach is used beginning from the origin of the first European commercial airlines; through overviewing the path of liberalising European civil aviation market as a prerequisite for the appearance of new market entrants, such as Low Cost Carriers; to clarifying the emergence of Low Cost Airlines process as such.

2.1. Outlook of the European Aviation Industry until 1988: Three Pillars of Economic Regulation

“ National airlines dominated international aviation in Europe for almost 70 years. They also dominated policy and achieved identification of the national airline interest with the national interest in the era of protectionism (Barrett, 2006, p.159).”

Hitherto the creation of a single market for aviation in the European Union in the 1990s, air transport used to be a highly regulated industry, dominated by national flag carriers and state-owned airports. The dawn of European aviation rose with the origin of privately owned, commercial airlines following World War I. The governments of Britain, France, Germany and other countries began to amalgamate the first airlines into national “flag carriers”. Predecessors of British Airways, Lufthansa and Air France, and others gradually became owned by, and subsidized by, their national governments (Rivkin, 2000), “The route structures of British, French, Dutch and Belgian flag carriers developed to serve the colonial aims of their respective governments. Services were focused on international routes from each nation’s capital to colonies, other areas of national influence (Rivkin, 2000, p.1).” Within Europe, traditional airlines served particular pairs of cities, mainly the capitals of European countries, as only one airline per county was designated on a given route. For example, on the route Paris-London, only two carriers served this route, namely British Airways and Air France. The traditional regulatory framework of international air transport originated in the aftermath of the World War II. In order to settle economic issues three interlinked pillars of international regulations emerged: the Bilateral Air Service Agreements, the Inter-Airline Commercial or Pooling Agreements, and the International Air Transport Association (IATA) (Doganis, 2006).

2.1.1. Bilateral Air Service Agreements

Bilateral Air Service Agreements are trade agreements among governments of pairs of countries, which nations sign to allow civil aviation between their territories. Bilateral Air Service Agreements were aimed at facilitating the operation of air services; regulating of access to routes; guiding tariffs; designating airlines; covering taxation issues and airport charges, in order to impose strict control over national aviation. In many cases Bilateral Air Service Agreements controlled capacity and flight frequencies. Until 1978, all Bilateral Air Service Agreements were restrictive in terms of market access (points served and traffic rights) and market entry (designation of airlines) (Doganis, 2006).

2.1.2. Inter-Airline Pooling Agreements

The Inter-Airline Pooling Agreements represent the second pillar of the international aviation regulatory regime. The main objective of the Inter-Airline Pooling Agreements was to enable airlines to share the revenues on routes served, in proportion to the seat capacity they offered in that market. Although distributing revenue among the airline pairs was the primary purpose of the Inter-Airline Pooling Agreements, seat capacity control was essential to ensure that each airline’s final revenue corresponds to the number of seats provided on a given route, which was commonly fixed at 50 per cent per airline.

2.1.3. International Air Transport Association

In the 1946 Air Services Agreements signed by United Kingdom, the United States agreed to approve tariffs fixed by IATA (Doganis, 2001). “In the early days, governments insisted on the right to oversee the prices charged by international airlines but could not, in practical terms, develop those prices for themselves.”(http://www.iata.org/about/history_2.htm) Although traditional bilateral agreements stated that passenger fares and cargo tariffs should be agreed by the designated airlines, they were encouraged to use the tariff-fixing machinery of IATA. Nevertheless, both governments must approve such fares and tariffs, forming the so-called “double approval” regime. Therefore ultimate control on tariffs rested on governments.

To examine whether markets are freely competitive, oligopolistic or monopolistic is determined by three essential criteria: new entrants’ ease of access, the degree to which output levels are controlled and the nature of price controls. The three pillars of regulation created oligopolistic or duopolistic market environments due to the strict control of governments on all of the three above-mentioned criteria. First, market access was sternly in command of governments; that is the number of airlines designated. In most traditional Bilateral Air Service Agreements only one airline was to be approved for national civil aviation purposes. Second, the output levels, capacities and flight frequencies, were often restricted by Inter-airline Pooling Agreements. Third, effective price competition was precluded because air fares were fixed by IATA. Traditional bilateral regulatory regime set aside the industry structure as rigid and inflexible. “The regulatory regime discouraged innovation and efficiency, and ensured the survival of many poorly managed and inefficient airlines (Doganis, 2006, p. 31).”

2.2. Commercial Aviation Industry Liberalisation

“Europe’s system of regulation came under growing pressure during the 1970s. National monopolistic carriers have characterized Europe’s airline industry with strong links to their national governments and strict regulations on scheduled routes (Rivkin, 2000, p.2).” These regulations largely applied to regularly scheduled services. Within Western Europe and North Atlantic charter airlines appeared and became popular, bypassing regulation charter services were offering significantly lower prices than national carriers (Rivkin, 2000). Apart from these competitive pressures, consumer dissatisfaction grew rapidly with higher prices, attacking the restrictive nature of bilateralism. It was the Commission of European Communities that requested changes to be made to the structure of regulation affecting air services between member countries of the Common Market (Doganis, 1991). The Civil Aviation Memorandum No.2 written in March 1984 by the European Commission proposed the abolition of pooling agreements, price fixing, and government subsidies (Lawton, 1999). ”In this document the Commission sought to create a debate on the contents of a Common Air Transport Policy among the institutions of the Community and to propose certain specific actions in order to improve the scope for better air transport services in Europe (Zebinsky, 1994, p.40) .”

Changes in regulatory environment were introduced in two ways:

1) Bilaterally Through the Renegotiation of Bilateral Air Service Agreements Between Pairs of Countries

The trend of a more liberal and free market attitudes towards air transport in the United Kingdom (UK), contributed to renegotiation its key European bilateral agreements during 1984 (Doganis, 2006). The first major breakthrough was in June 1984 when a new air service agreement was negotiated between UK and the Netherlands, another country with a positive attitude towards liberalisation. The key aspects of this agreement were the right of free entry of new carriers, free access given to designated airlines to any point in country, no capacity controls and a double-disapproval regime (Doganis, 2001). Following this pattern, the UK renegotiated many bilateral agreements with other European countries, in essence allowing multiple designations of airlines and Four Freedom rights of route access.^[1] Following UK’s pace many other European countries also began to renegotiate their Bilateral Air Service Agreements. The following table serves to illustrate the main difference of the old and new-style European Bilateral Air Service Agreements:

Table 1: Traditional and New-Style European Air Service Agreements

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Source: Doganis, 1991

2) Multilaterally through Introduction of Liberalisation Packages by European Commission

“In the EU, alleviation of rigid and inflexible aviation services and operations between two particular Member States built by bilateral agreements for years was realised as gradual process in three phases, each determined by implementation of single ‘Aviation Liberalisation Package’ (Graham, 1999).” The First package adopted in December 1987 allowed the airlines to increase their capacity shares; limited the right of governments to object to the introduction of new fares as well as Fifth Freedom Rights (European Communities, Flying together: EU Air Transport Policy, 2007). The Second Package was approved in June 1990. It additionally alleviated further the regimes of capacity shares and it gave all EU carriers the right to carry an unlimited number of passengers or cargo between their home country and another EU country. The Third package was the most significant towards industry liberalisation and removed most of the remaining regulatory constraints on intra-EU air transport (European Communities, Flying together: EU Air Transport Policy, 2007).

Table 2: The Three Air Transport Liberalisation Packages

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Source: Graham, 1999

The three reform packages gradually eroded Member States’ rights to regulate the airline industry and consolidated the emergence of European aviation policy, which form together a complete liberalisation of the skies of the EU members for EU carriers, including Seventh and Eight freedom rights. In this respect a more equal balance of opportunities to the airlines of each Member State has been offered as this measure implies that any European airline will ultimately be able to fly any route within EU. The liberalisation has extended to Switzerland and non-EU members of the European Economic Area (EEA, i.e. Norway, Iceland and Liechtenstein).

2.3. Outcomes of the Single Aviation Market

With the Third liberalisation package, effective in April 1997, all EU airlines had open access to virtually all routes within the 15 Member States and followed by Iceland, Norway and Switzerland in 1998. The subsequent enlargements of the Union in 2004 and 2007 have added a further 12 states, largely in Central and Eastern Europe, to the single aviation market. The competitive dynamics unleashed by market liberalisation, together with the spread of global industry alliances and consolidations have transformed the industry landscape. As a result of liberalisation in Europe there have been structural and operational changes as airlines adjusted to the changing environment.

The single market for air transport in the EU has brought vast benefits to air transport users. First, the number of airline routes within the EU has increased 170 % since the creation of the single aviation market in 1993 — more cities and also remote regions are served by air transport (European Communities, Flying together: EU Air Transport Policy, 2007). Passengers have a greater choice of destinations and the convenience of more direct flights. Between 1992 and 2006, the number of routes with more than two competitors rose by 300 % (European Communities, Flying together: EU Air Transport Policy, 2007). Second, competition within the EU has strongly increased. The European scheduled airlines saw their highly regulated and protected environment being opened up to new entrants such as other scheduled airlines and charter operators as well as new business model of Low Cost Airlines. Not only are passengers faced with fewer and fewer monopoly services but, over recent years, Low Cost Carriers entering the market have introduced completely new business models and changed the travel habits in many European countries. Third, the single market also removed all commercial restrictions for the setting of fares. The effect of the new liberal legislation framework was dramatic: where new airlines entered routes previously operated by a single carrier, fares decreased drastically. Bauer and Zlatoper 1989 (cited at Vowles, 2000) stated that as the number of carriers on a market increases, the average fare decreases. The lower fares and the new entrants in turn stimulated competition and traffic growth.

European airline deregulation, in addition to allowing new market entry, price and capacity competition, allowed the product to be redefined. Barrett (2006) summarizes the main characteristics of the new product after the deregulation in 1997.

Table 3: The “National Airline” and Deregulated Airline Products Contrasted

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Source: Barrett, 2006, p.164

2.4. The emergence of European Low Cost Airlines

In 1997 air passenger services in Europe were largely deregulated as a result of the Third Package of liberalisation reforms. “It soon became apparent that most of the denser intra-European routes continued to be operated as high-fares duopolies by the traditional flag carriers. Even where third or fourth carriers had entered such markets, as on London-Paris or London-Athens, the downward pressure on fares had been limited (Doganis, 2006, p.160).” While Europe as a whole remained dominated by state-owned carriers with government-mandated monopolies, individual countries moved to liberalize their domestic airline industries. The UK was the most insistent in doing so. The first Low Cost Airline established in Europe was the independent Irish airline Ryanair. When launched in 1985 it was not a Low Cost, but a Low Fare Airline and targeted Irish ethnic market on the London-Dublin route by offering traditional type of service with a two-class cabin at significantly lower fares (Doganis, 2006). Doganis (2006) estimates traffic growth on the London-Dublin route, which had been stagnant for years, passenger numbers doubled in the next three years after the launch of this route in response to the low fares introduced by Ryanair. In the mid-1990s the existence of many European city-pair routes still run only by conventional carriers and an awareness of the Ryanair experience clearly highlighted how low fares greatly stimulated demand and influenced several new entrants to follow the low cost model. Fourteen new companies began operations between March 1995 and September 1996 (Jones, 1996, cited at Mason, 2000). In 1995 and 1996 respectively, easyJet and Debonair launched intra-European low-fare services from the London’s fourth airport Luton. In Europe several others low cost scheduled carriers have also been established short after the liberalisation as a reaction of the recent developments, including Buzz and bmibaby in the UK, Virgin Express in Belgium, Basiq Air in Netherlands, and Germanwings in Germany.^[2] In May 1998 as a response to competitive pressure British Airways set up its own low cost subsidiary, Go, operated from London’s third airport Stansted. Doganis (2006, p.161) comments on the reasons for the United Kingdom to be the first-mover in the low cost sector: “New start-up airlines were attracted by the huge London market, the light-handed regulatory environment and the entrepreneurial culture. UK costs were lower, especially labour costs, because of substantially lower social charges than elsewhere in Europe.”

3. LCC Business Model and Characteristics

This chapter analyses the Low Cost segment, its business model and operational characteristics. In the first section introduction to the LCC phenomenon in the form of definition is presented. The second section gives overview of the dimensions of the Low Cost companies’ share in this segment as well as identification of the countries with high usage of this service. The next section deals with LCCs’ business model and strategic positioning in regard to their pricing and operations model. The following section analyses in detail European LCCs’ cost advantages and their determinants. In the fifth section of this chapter attention is paid to LCCs’ market segmentation and two essential passengers segments are recognized, namely business and leisure travellers. Finally, differences between two contrasting operation models are acknowledged, specifically dissimilarities between Full Service Carriers and LCCs.

3.1. Definition of the Low Cost Aviation Model

Fist in North America, then in Europe and now elsewhere in the world, the remarkable growth of LCCs has been the most important outcome of the liberalisation processes. The low cost model was pioneered by the US-based airline Southwest and has been widely emulated by other American and European carriers; and since 2000 the model has been adopted in Asia and Oceania, led by operators such as Malaysia’s AirAsia, India’s Air Deccan and Australia’s Virgin Blue. The Low Cost Carrier model is applicable worldwide, although deregulated markets are most suited for its rapid spread.

According to Graham and Shaw (2008) the definition of an European LCC is rather ambiguous: the sector includes airlines ranging from the Irish national carrier Aer Lingus, through former charter airlines such as Air Berlin to the dedicated low cost operators such as Ryanair and easyJet. Doganis (2006, p.149) describes the European Low Cost Airlines as a comparison with charter airlines: “In essence, the successful innovation which Ryaniar, easyJet and other carriers introduced into Europe was the provision of easily accessible scheduled short-haul services at very low unrestricted fares close to and often lower than those of charter airlines but with ‘no frills’, that is without many of the traditional product features of either scheduled or charter services.” Discount airlines, No frills airlines, Price fighters, Low Cost Airlines, or Low Cost Carriers, all are different names for the same phenomenon.

3.2. Overview of the LCC Market

The following figure represents the European LCCs market share for 2006. It can be seen that Ryanair and easyJet are the major players on the LCCs market segment. Capitalizing on their ‘‘first-mover” advantage (Ryanair and easyJet carried 42.5m and 28.0m passengers, respectively in 2006, placing both in the world’s top 20 airlines by this measure (Graham and Shaw, 2008).

Figure 1: LCCs Market Share for 2006

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Source: Official Airline Guide, European Low-Cost Carriers White Paper, 2006

At present times, the UK is the largest and most mature market for LCCs in Europe, followed by Germany and Spain, which is now seeing the fastest growth. France has no major LCC of its own, for reasons which include the dominance of Ryanair, its high-speed TGV rail network and a relatively small market for Mediterranean flights compared to the more northerly sun-seeking markets of Germany, Scandinavia and the UK (OAG, 2006).

Figure 2: Low Cost Carriers Operating to/from Major European Countries by Frequency in November 2005

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Source: OAG, European Low-Cost Carriers White Paper, 2006

3.3. Business Model and Strategic Positioning of LCC

LCCs are frequently defined as airlines that supply no-frills flights for which passengers pay low fares. ”LCCs are characterised by a different business model, based on quick, streamlined processes, and with minimal complexity in products (Alves and Barbot, 2007, p.1).” The Low Cost Airlines have adopted a new form of operational and commercial strategies (low cost strategy) by offering lower fares to the customer and an alternative form of service premised on basic services. The nature of the low cost model consists of low fares, which are made possible by reduction of the complexity of costs. Graham and Vowels (cited at Graham and Shaw, 2008, p.1441) explain the low cost model in terms of the following operational characteristics:

- “High-capacity seating
- Minimum legal crew
- Cabin service only at additional cost
- Fast turn-rounds
- On-board air stairs instead of airport air bridges
- Operating procedures to minimize take-off thrust and braking on landing, congruent with runway length
- Point-to-point traffic only
- No freight
- Advantageous rates from airport operators
- Generally sectors of less than 2 h to maximize aircraft utilization
- Online booking to eradicate travel agent commission
- Supplements for payment by credit card
- Sophisticated websites with extensive information on destinations
- One-size and type fleets (although some LCCs have compromised on this point)” (Graham and Shaw, 2008,p.1440)

LCCs are frequently compared with Full Service Carriers (FSCs). FSCs are traditional or conventional airlines, usually these are the successors of flag carriers, such as Air France, Lufthansa and British Airways. Besanko et al (2000) argues that “a firm with cost advantage creates more value than its competitors by offering products that have a lower cost C^[3], with the same, or perhaps lower, perceived benefit B. But even though a firm with a cost advantage may have a lower B than its competitors, its B disadvantage must be less than its C advantage, so that its value created, B-C, is greater than the competitors in its market”(2000, p.412) Low Cost Carriers pursue cost advantage and as a consequence of this advantage offer lower fares. Full Service Carriers offer a product-service with higher quality, and as a result charge passengers with higher fares. According to Morrison and Gillen (2003), the business model of FSCs requires a bundled strategy of service for business and leisure markets. The ‘bundle’ means that network carriers provide airport service such as check-in and lounges; in-flight services such as connections, baggage transfer and coordination of flights as well as destination service, that is, baggage handling. On the other hand, LCC “…have provided markets with an alternative bundle and allowed some market segments to move away from Full Service Carriers. The success of this new strategy has been driven by a number of factors including access to larger markets (due to usage of secondary airports); competition based on cost efficiency; and a focus on stimulating market demand rather than cannibalizing them. The ability to use cost, as the basis of a sustainable strategy is contingent on the ability to unbundled product, service and organization (Morrison and Gillen, 2003, p.17).”

The drivers of LCCs’ strategy are simplicity of product design and operational organization. By offering a cheaper product design, LCCs have a cost advantage over network carriers. The simpler product design includes no food service, fleet commonality (using only one type of aircraft), point-to-point service between secondary airports, one class (abolishment of business and first class seats) and higher density of seats in the aircraft. The differentiated no-frills product is a mere consequence of the implementation of a rigorous low-cost strategy. The success of Low Cost Airlines derives from a focused business design which is aimed at the meeting the specific needs of air travellers. LCCs target the derived demand of passengers to reach certain destinations by offering them lower fares on the expense of less flight comfort.

Mercer (2001) describes the business design of Low Cost Airlines in terms of three key elements. The first characteristic of the LCC business model is product simplicity: a simple “no frills” product, with no meals on board, no seat reservations, etc. LCCs are positioning themselves with aggressive marketing that directly targets leisure travellers and price conscious business travellers, by offering frequent, short-haul, point-to-point service between less congested secondary airports. The third characteristics of Low Cost Carriers in terms of low operating costs, that is, low wages and low airport fees, low maintenance costs and low distribution costs achieved by selling tickets online.

Table 4: Business Design of Low Cost Airlines

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Source: Mercer, 2001

Barrett (2006) adds that the production of the low cost product, in addition to the cost-reducing measures involves much higher productivity than attained by Full Service Carriers (conventional airlines).“The higher productivity is achieved by reducing the cost base, simplifying the product, using a single aircraft turnaround time at airports to 25 min compared to an hour to 75 min by traditional airlines, and outsourcing services such as passenger and baggage handling, maintenance and catering (Barrett, 2006, p.161).”

3.4. LCCs Cost Advantages and Their Determinants

In this section an analysis of the LCCs’ cost advantages over network carriers and their determinants is conducted. LCCs’ sources of competitive and cost advantage coincide with their operational model features:

3.4.1. Aircraft Size and Seat Density

Aircraft size has a profound effect on an airline’s unit cost. The larger the aircraft, the lower will be its direct operating costs per passenger (Williams, 2001). As far as the seat density in the aircraft is concerned it has major cost implications. LCCs provide narrower seating in the aircraft as compared to FSCs, that is, greater capacity in order to sell more seats. Doganis (2006) compares the number of seats in the same aircraft (Boeing 737-300) used by easyJet and British Airways. By removing business class and using lower seat pitch (71-74 cm) easyJet has a total seat capacity of 149. This contrasts with British Airways, which has 130 seats per aircraft on average and has seat pitch of 79- 81 cm. Hence, this trade-offs, that is, putting more seats in the aircraft but reduce the physical comfort contribute to lowering the operating costs per seat and thus give LCCs a cost advantage. The following diagram illustrates approximately the number of seats easyJet needs to sell, to cover each type of expense (left) in comparison with the number of seats a conventional carrier needs to sell (right). It can be seen from the following figure that if a traditional carrier offered the same fares as easyJet, they would make a loss even if they filled every seat in their aircraft.

Figure 3: easyJet Versus Traditional Carrier Seat Density

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Source: http://www.aatl.net/publications/easyjet.htm

3.4.2. Fleet Commonality

The second cost advantage of LCCs is fleet commonality, which means that they use only one type of aircraft. By having fleet commonality, typically Boeing 737 and more recently Airbus 319, LCCs are able to obtain spares and maintenance services on favourable terms, limit costs on staff training, allowing better flexibility on crew’s assignments and other flexibility in scheduling aircraft. For example, easyJet operates with modern 737 aircraft because operating costs are low (compared to older aircraft), as well as crew training is simplified (avoiding the overhead of needing crew for several different aircraft types).

3.4.3. Sector Distance

Average sector distance affects the utilization of aircraft and crew, the amount of fuel that is consumed and part of carrier’s maintenance expenses. Low Cost Airlines focus on short-haul routes, generally less than 1500 km. The OAG’s (Official Airline Guide, 2006) White paper on European Low Cost Carriers comments on LCCs’ route distance: “The most profitable routes for LCCs are of no more than two hours’ duration, allowing maximum utilisation of aircraft. A study made by Williams (2006) is reported that Ryanair has had the lowest average sector length (481 km).

LCCs operate on a point-point basis as this strategy eliminates delays in boarding connecting passengers avoiding the costs incurred from services (baggage transfer, passenger assistance) for connecting passengers. This means that these airlines may have a better on-time performance than traditional airlines since FSCs operate connecting flights.

3.4.4. Aircraft Utilization

Porter (1995, cited at Barrett 2006) argues that a firm normally develops a cost advantage by controlling cost drivers better than the competitors. He identified 10 cost drivers related to value-chain activities: one of them is capacity utilization. Low Cost Airlines operate at a utilization level that is higher than network carriers. LCCs ensure more flights a day per aircraft due to their rapid gate turnaround time. Dobruszkes (2006, p.250) explains LCCs’ utilization levels using the notion economies of density ^[4]:”LCCs achieve density economies by maximising flying time for each aeroplane, thus implying very reduced times between arrival and departure (turnaround). For the air transport sector, economies of density are essential and much more effective in reducing unit costs than economies of scale ^[5].” The average LCC takes about 25 minutes to disembark passengers, unload and loan baggage, refuel and clean the aircraft and embark new passengers. This is estimated to be as much as half time it takes a traditional airline to carry out the same activities. In the next figure Dobruszkes (2006) exemplifies the way to organize frequencies and routes per aircraft in order to generate economies of density. As certain routes do not require high frequencies, realising savings of density can mean multiplying the routes while decreasing their frequencies.

Figure 4: How to Generate Economies of Density

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Source: Dobruszkes, 2006, p. 259

LCCs’ higher utilization level than FSCs is achieved by a combination (Mason, 2000) of using uncongested secondary airports, not carrying cargo, offering no connecting flights and having no on-board catering marketing turnaround quicker. The last point means that by avoiding free food and drinks in-board, LCCs reduce the cleaning and loading time. This in turn, contributes to avoid delays in departures. Moreover, these airlines do not provide seat assignments which have the effect of forcing the timely boarding of passengers. Without a seat number, the passenger is induced to reach the departure lounge largely in advance in order to find more comfortable seats on-board. Finally, the absence of boarding cards has speed up check-in processes, which leads to quicker boarding times and increased punctuality rates.

[...]

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^[1] See Appendix A for Freedoms of Air

^[2] See Appendix B for present operating LCCs detailed list

^[3] C thus represents the average cost of production inclusive all the inputs used in the production and sale of the good. If, for example, the finished good is offering a flight, C would be the cost of capital (planes), labour (pilots, crew, ground handling, etc) and materials (fuel) used to produce and offer the flight. (planes), labour (pilots, crew, ground handling, etc) and materials (fuel) used to produce and offer the flight.

^[4] The fact of increasing the use of aeroplanes and/or their capacity within a network of a given size

^[5] The fact of extending the network and increasing the production factors