Trends & Predictions for 2010: Part II

As promised, here is the second part of Airline Bulletin's discussion of trends and predictions to examine in the coming year.

Prediction #1: Industry Consolidation, Especially Abroad
While U.S. carriers have made efforts to reduce their capacity and form strategic partnerships with other carriers, it does not appear likely that we will see a full-fledged merger or buyout in the U.S. in the coming year. This is not to say that such consolidation is impossible, rather that it's simply unlikely. There aren't a lot of perennially weak airlines left to consolidate. Frontier (which has recently showed signs of strength) and Midwest have been combined, Sun Country, to my amazement, seems to be hanging on, and small LCCs like Spirit and Allegiant that have defined business models and solid market niches don't appear to be losing buckets of money either. That being said, anyone is a possible takeover target or buyer. Even Southwest, which has historically avoided growth by acquisition (with a few exceptions), has signaled of late that it is open to potential mergers.

US Airways Deals?
One carrier that still mystifies me is US Airways. The airline has been very aggressive in implementing ancillary revenue-generating programs and cutting costs/capacity. CEO Doug Parker seems to know what he's doing in this regard. But, US Airways may not be very poised for future business travel growth. It operates by far the smallest international route network of any of the 5 legacy carriers in the States, and has actually cut some of its European routes recently due to poor loads. Growth in Asia has taken something of a hiatus, as US Airways let its Philadelphia-Beijing route authority expire after the airline wanted to avoid opening the route due to the recession. And the carrier's position in Star Alliance has been weakened due to Continental's recent entry, and due to the announcement of a strengthening of reciprocity between United and Continental frequent flyer programs. The conventional wisdom has been that American would make a bid for US Airways, since American has avoided much of the consolidation activity within the past 7-8 years, and as a result, has watched its market share decline, while US Airways needs an available suitor. But American and US Airways have almost no fleet compatibility--American is mostly Boeing, US Airways is mostly Airbus. And another merger would only further complicate the labor troubles that have hampered US Airways recently, particularly with its pilots union having trouble integrating seniority between old US Airways pilots and former America West pilots. On the plus side, the route networks of American and US Airways would align somewhat, with US Airways having hubs in the Southwest, Southeast, and Northeast, all regions where American lacks hubs (American's Miami hub, mostly geared towards traffic to/from Florida or Latin America notwithstanding). However, both carriers are relatively weak in Asia and the Middle East, areas where they will need to ramp up capacity if they hope to compete in these increasingly important business markets.

What seems to be a more plausible idea, actually, is a buyout of Spirit by US Airways. US Airways as noted above has been very aggressive, perhaps the most aggressive of any legacy carrier in seeking out new ancillary revenue opportunities, and transforming itself into an LCC which can effectively compete against the likes of Southwest, JetBlue, and AirTran on the ultra-competitive routes along the eastern seaboard. A buyout of Spirit would have very strong fleet complementarities--both carriers fly A319 and A321 aircraft, as well as strong route network complementarities. US Airways tried a few years ago to open a mini-hub in Fort Lauderdale--Spirit's biggest base, with routes to Caribbean destinations, but was fended off in part due to Spirit's competition. There is clearly money to be made on these routes, but US Airways lacked the cost structure several years back to adequately compete. Now the carrier has realigned its costs, and a buyout of Spirit would make accessing such routes much easier.

It would also do something else which is pretty important. The two slot swap deals announced earlier this year, which (if approved) will strengthen legacy carriers at slot congested airports while helping to keep out low-cost competitors. US Airways, even though they are starting to act like a low-cost carrier, is not a low-fare carrier, unless it is forced to be through competition. US Airways would rather stifle demand with higher fares (and higher profits) than lower fares which stimulates demand but reduces yields, which is what Southwest tends to do. Keeping slots in the legacy carrier "family" prevents potential low-cost competition at slot-congested airports (see also Prediction #2). Spirit is one of the few LCCs to have slots at both LaGuardia and Washington National (even though it has relatively few slots in both). A buyout of Spirit would help diminish low-fare competition at these airports, and allow legacies to charge higher fares to business customers. However, I still think that this deal is somewhat improbable, only because Spirit is presumably a money-making carrier with a good market niche, while US Airways is a money-losing carrier with lots of problems that could make a merger tricky. It could be an easy buyout, or it could just be an obstacle to US Airways doing what it needs to do to revamp itself to compete against LCCs while expanding its international network.

European Consolidation
In Europe, the picture is much simpler. I don't anticipate many state carriers to go out of business, however I do imagine that governments will work even harder in the next year to privatize or revamp the following state carriers, named yesterday in Part I:
CSA Czech Airlines
Croatia Airlines
LOT Polish Airways
MALEV Hungarian Airlines
TAROM Romanian Airlines

After additional research, I also want to add the following carriers' names to this watch list:
Aer Lingus¹
Air Malta²
Bulgaria Air

Given the obligation of these governments to maintain positive images, it appears extremely unlikely that they will suddenly pull the plug on these carriers' operations, stranding passengers (voters) and angering the public, a la the recent FlyGlobespan fiasco. However, such airlines are definitely at risk of being purchased by larger airline conglomerates or of being privatized. 

Notes:
1. Aer Lingus may be at risk for another Ryanair takeover attempt in the new year. The carrier has struggled to compete against Ryanair, and has gotten push-back from its unions as management tries to contain costs. Efforts have been made to diversify the carrier away from Ireland, opening new routes from London Gatwick. While the carrier may avoid a Ryanair takeover, serious reforms are needed to make the company profitable once again, and these do not appear forthcoming.
2. Air Malta may also be in need of further reform due to the recent arrival of LCCs in Malta after the airport lowered passenger charges. Air Malta had effectively been protected from LCC competition due to these high charges, but this is no longer the case. As a result, the carrier must find ways to diversify and compete. But since the vast majority of Malta traffic is holiday-oriented, and thus, price-sensitive, it appears unlikely that unless Air Malta can turn itself into a bare-bones LCC, the carrier could face extinction. Another possibility would be a buyout, perhaps by another LCC like easyJet, which would reform the carrier, much as it did with GB Airways, while maintaining most of the its routes.

In terms of LCCs, there are simply too many out there, and too few of them have such well-defended market niches that they can't be attacked by market leaders easyJet, Ryanair, Wizz Air, and Norwegian. I believe that the following carriers are in trouble, and are at risk of potential sudden shutdown. As a traveler, I would do some research before booking with them, and then only with a credit card:
bmiBaby_³
Cimber Sterling⁴
Niki
SmartWings
Vueling⁵
Windjet⁶

3. bmiBaby is unlikely to engage in a sudden shutdown, now that the carrier is owned by Lufthansa. If bmiBaby is closed, it will likely be in a controlled fashion, or if it is sudden, passengers should anticipate far fewer inconveniences than when FlyGlobespan shut down (ie. Lufthansa will likely offer alternate flights, etc.). However, bmiBaby is under heavy competition from easyJet and Ryanair. And while the carrier is growing--it recently expanded at East Midlands which easyJet vacated due to poor yields--it is unclear whether the airline, with relatively old, inefficient planes and infrequent service on many of its international routes, will thrive in the coming years. Lufthansa may use its recent acquisition of British Midland mostly for its aircraft and slots at Heathrow, taking the airline's good routes and using British Midland to help feed into Lufthansa's long-haul routes, while scrapping much of the rest of the company. As British Midland's low-cost subsidiary, bmiBaby doesn't have very much to offer Lufthansa, and a sale or suspension of services appears likely.
4. Who knows what's going on with Cimber Sterling? The carrier seems bereft of a coherent strategy, flying both business and leisure routes with a bizarre mixture of aircraft. Most of Sterling's core routes were taken over by Norwegian and Transavia immediately after that carrier's demise, and Sterling's new namesake has been left with relatively thin routes and little room to grow. I see Cimber as extremely vulnerable to shutdown.
5. Vueling is probably not going to shut down immediately, but will be increasingly vulnerable to competition from easyJet and Ryanair in Barcelona and Madrid. It is unclear whether the combination of Vueling and Clickair has really made the company more financially stable, and due to this lack of information, I am concerned about the carrier's future. However, Vueling has potential to thrive and grow within the coming years. It has a large fleet, a relatively low cost structure, and by operating from primary airports, including Heathrow, can attract higher-yielding business travelers. Thus, it is less vulnerable than most of the other carriers named on this list, but is vulnerable nevertheless.
6. Same issue as with Cimber. It's hard to know what's going on with this carrier. It's privately owned, not discussed much in the press, and it seems hard to believe that they have a real competitive advantage in the marketplace. Now maybe they're like Spirit Air in the U.S., and have a relatively undisturbed market niche on thin routes to/from Sicily. And given Ryanair's recent announcement that it may close domestic routes within Italy, WindJet may benefit through expansion of services. But without clear evidence that WindJet is a profitable LCC with competent management, I have to place them in the same category as Cimber--extremely vulnerable to shutdown.

Prediction #2: Continued LCC Growth
As the economy continues to suffer, expect more businesses to shop around for travel, and send employees on LCCs when necessary. LCCs will try to respond to this growing demand. In the U.S. in particular, LCCs will likely make more efforts to enter or expand services at airports that are dominated by legacy carriers and which are the few remaining bastions of high fares in the U.S. While virtually every large metro area in the U.S. has low-fare airline service, many large, primary airports in these metro areas lack much low-fare service. Examples include Dallas Fort-Worth, Miami, Chicago O'Hare, Newark, Washington National, Cincinnati, Charlotte, Houston Intercontinental, and Atlanta (obviously, AirTran has a large hub here, which keeps fares lower than they otherwise would be, nevertheless, the lack of Southwest, JetBlue, or other LCCs in the Atlanta area at all is problematic and allows a Delta/AirTran duopoly to set prices). Although some of these airports are more congested and delay-prone, they are often preferable for business travelers, as they are easier to access, are located closer to where companies are situated, have better facilities and connections to other airlines, etc. In the coming year, expect expanded service from AirTran, Southwest, and JetBlue to the airports above. While new leisure-focused service will be added, particularly to/from the Caribbean, don't count out future expansions at these key airports for business travelers. Leisure demand has actually held up better than business demand, and so while LCCs will do well in leisure markets, because they are already strong in California, Florida, and the Caribbean, less of the growth in their operations is likely to be concentrated in those regions, since little added LCC capacity is needed to handle this traffic.

In Europe, while it may seem like business routes would also see expansions in service, this does not seem to be the case. Ryanair has announced minimal service of late that will be attractive to business travelers, mostly because it is concentrated in very distant and inconvenient airports. EasyJet, which has aimed to take business customers away from BA and other full-service carriers, has instead recently announced that it will add new service to a host of leisure destinations next summer, mostly in Turkey. Such moves seem to place easyJet and Ryanair in closer competition with European charter carriers such as Monarch than legacy carriers like BA. It will be interesting to see whether carriers like Wizz Air, Norwegian, and Air Berlin follow suit and concentrate growth mostly on leisure routes, but that would be somewhat counterintuitive, given the growing demand of businesses to trim travel costs.

Prediction #3: Increasing Focus on the Environment
While there are other interesting predictions to be discussed, it's getting a bit late and I need to get this out. So I'll conclude with my third prediction, which is something that will be of increasing importance not just in 2010 but in the coming decade. Expect more airlines to highlight their "green" credentials whenever possible, through marketing campaigns, press releases highlighting environmental initiatives (such as this recent announcement highlighting airline participation in a jet biofuel scheme), and programs to offset emissions. Such efforts will be reinforced as Boeing delivers the fuel-efficient 787 Dreamliner to its first customers next year, and as the U.S. Senate debates a cap-and-trade bill to combat climate change. Although we're in a recession and customers are price-sensitive, more and more consumers are going to make what they perceive to be environmentally-friendly choices, given growing awareness of environmental concerns. While airline efforts to address the issue are mostly greenwashing, since the benefits of getting customers to recycle soda cans on the plane or powering one engine with 50% biofuels aren't diddly squat compared to the effects of contrails fully-loaded commercial jets spew out at high altitudes, such efforts will likely succeed at winning customers over since most people don't know any better. What we won't see, however, are serious efforts to make the industry more environmentally-friendly through new technologies. V-shaped aircraft ("flying wings") or better yet, high-altitude airships would radically alter the airline industry as we know it, but they would also make a substantial dent in the industry's pollution levels. But because such technologies aren't compatible with current air transport infrastructure, are not seen by consumers or regulators as safe, and in some cases are slower than conventional aircraft, don't expect Boeing to announce production of such aircraft anytime in the near future. This is not to say that such technology won't be commercialized, but significant steps aren't likely to be taken within the next year due to the recent air travel slowdown and manufacturers' focus on the latest generation of fuel-efficient planes.

In 2010, as the airline industry globally continues to struggle, it will likely once again continue to make headlines as it tends to do, and Airline Bulletin will be here, whenever possible, to offer commentary on these events. Until then, have a wonderful new year!

Trends & Predictions for 2010: Part I

After the recent hiatus which was a bit longer than anticipated, Airline Bulletin is back, albeit briefly. Believe it or not, I have a life outside of Airline Bulletin, and it has prevented me from doing much on the blog of late. I will be doing some traveling over the next few months to Africa, and so once again, posting may be a bit spotty. My apologies in advance. I am using this post and the following one to highlight some trends and make predictions regarding air travel in the coming year. Part I focuses on some of the trends shaping the industry, and discusses some of the potential problems facing airlines in the coming year. Part II will make more specific predictions regarding industry consolidation, expansion, and other significant changes.

Trend #1: Continued Economic Weakness
The economy is not poised to make a significant rebound next year, and the unemployment rate may not fall below 7-8% for several years. This means that air travel demand will be commensurately affected, perhaps even more so since travel is one of the first things businesses have cut back on during this recession. However, airlines are aware of this, and have taken proactive steps to cut capacity. U.S. carriers appear to be doing better now that they've taken these steps, and are likely to fare better in the coming year. That being said, expect profits to remain relatively low, and if oil creeps up (see Trend #3), then airlines could once again wind up with buckets of red ink.

It should be noted that this crisis is hitting the traditional developed economies hardest. Europe in general is facing a severe economic situation, and the continent's demographics do not bode well for future economic recovery. The U.S. and Japan will also continue to suffer, but possibly to a lesser degree than Europe. But carriers who serve China and the Middle East are still finding relatively robust air travel demand, especially from business travelers (Dubai's debt crisis notwithstanding). These new developing markets will be increasingly important for the airline industry globally, including for U.S. carriers, and airlines like Emirates stand to benefit from relatively strong economic growth in many newly industrializing countries. Carriers that concentrate service in these markets may be a bright spot during another difficult year.

Trend #2: Capacity Cuts, Especially in Small Markets
To go along with Trend #1, airlines will continue to make capacity reductions where they appear appropriate. These reductions are likely to hit small communities in the United States the hardest, because they rely on high ASM-cost regional aircraft, which are not very attractive for carriers at $80 oil. Airlines, particularly in the U.S. will continue to press for reductions in their regional jet capacity, and especially with 50 or fewer seat planes. In Europe, small airports that rely on the business of low-cost carriers such as Ryanair will be increasingly pressured for subsidies. While these airports face a different dilemma than their counterparts in the U.S., because they can be served with mainline jets, they will be increasingly played off each other, as Ryanair and other LCCs vie for lower landing fees. 

Another concern for small airports in the U.S. is how they will address the increasing penetration of low-cost carriers into small markets, a la Ryanair. Allegiant has successfully entered many small cities and siphoned off many leisure passengers who formerly flew regional jets on legacy carriers or drove to larger cities for low-fare service, in addition to creating new demand for vacation travel. While Allegiant has been a boon for many small communities, the airline's ability to offer much lower fares than legacy carriers has put pressure on legacies that use regional jets to serve these airports. Small airports will need to work hard to keep both kinds of service, because both offer travelers in their communities a range of travel options. However, make no mistake that Allegiant is hurting legacy carriers, and by siphoning off passengers, it reduces load factors on the very 50-seat jets that need to be kept full if airlines want to avoid junking that capacity.

But there is another issue to consider here. How does the introduction of low-fare carrier service into one small regional airport affect legacy service to others? One case to examine next year: Southwest's recent announcement that it will serve the Northwest Florida International Airport starting next May, albeit with subsidies from the St. Joe Company. Such service is likely to bring lower fares to one of the nation's most expensive air travel regions. How will the airlines and airports serving Pensacola, Tallahassee, Fort Walton Beach, and Dothan respond? This remains to be seen. New low-fare service in one airport has the potential to drive away traffic in others, or it could stimulate traffic, by forcing legacy carriers to reduce fares. As U.S. low-cost carriers look for room to expand domestically, entering small markets may become increasingly attractive, but this likely means picking and choosing certain small airports in a given region to stage their operations, since LCCs need larger catchment areas to fill mainline planes as compared to legacies that need smaller catchment areas to fill 50-seat regional jets. However, if regional jets are increasingly cost-ineffective for some small markets against larger LCC aircraft, legacies could be forced to offer fewer frequencies on larger planes, or to exit these markets, which is not a desirable outcome, given that a key competitive advantage of legacies over LCCs is their wide range of destinations. LCCs have the potential to spur competition, or to squelch it, and I worry it could be the latter.

Trend #3: Problematic, But Not Devastating Oil Prices
For airlines which are relatively unhedged, the challenge of high, volatile oil prices could be a challenge in 2010. However, (and I knock on wood when I say this), I doubt that there will be major oil price spikes or falls within the next year (however, such events are quite likely to occur in future years). Here is why: oil prices are tightly connected to overall economic strength since our economy runs on oil. We are currently dependent on it for most economic activities. As the economy grows, so does demand for petroleum products. But supply is being constrained, mainly because we're running out of oil (or at least the stuff that's easy and inexpensive to access). Thus, when the economy is doing poorly, we don't use as much oil, and it isn't as expensive. But as soon as the economy starts to show signs of life, then the oil price could go much higher, because the lack of new supply is likely to result in little new oil in the market, but lots of new demand. But if there isn't oil to supply this demand, then the demand goes away and economic contraction results. Since the economy isn't showing many signs of life right now, this won't be a concern. But in the future, when the economy does rebound, then all industries, including the airline industry, will have to learn to live with less oil if economic growth will occur. And airlines will have to contend with price spikes that affect how they do business because the economy is likely to go through fits and starts. Oil prices will be something to keep an eye on, but given weak demand, it won't be as significant problem for 2010 as it was in 2008.

Trend #4: In Europe, Serious Short-haul Weakness
European LCCs are kicking butt. They are rapidly taking market share away from legacy carriers. This has resulted in a hyper-competitive intra-EU market where legacies are at a distinct disadvantage. While European carriers are looking to mergers and consolidation in order to adapt, they will nevertheless encounter resistance to doing so (see for instance, British Airways' recent difficulties with their cabin crew who nearly went on strike over Christmas due to proposed wage and personnel reductions). But unlike Ryanair and easyJet, British Airways has a long-haul operation, and when the economy picks up, this is likely to make them lots of money, since there is less competition, and such routes can command high yields in premium classes. But not all European legacy carriers have such operations--a point missed by many analysts of this market. Legacy carriers without significant long-haul operations will be strained by more efficient, cheaper, and oftentimes, more comfortable LCCs. While some of these carriers are still owned by state governments, as these companies lose money, there will be increasing pressure to privatize and get taxpayers out of this loss-making business. Whether such privatizations will be successful or not, given the competitive disadvantage of these carriers, remains to be seen. Some of these carriers could get bought out by bigger legacy carriers, and become part of European Airline conglomerates, such as Austrian Airways, which got bought out by Lufthansa. However, without such deals, carriers such as LOT, CSA Czech Airlines, Croatia Airlines, Malev, and TAROM, are likely to suffer from the likes of Wizz Air and Ryanair, the latter of which has recently signaled its intent to open new bases in Eastern Europe. All legacy European carriers will encounter problems as they battle LCCs, but those without long-haul operations that bring less competition, higher yields, and opportunities to support feeder flights to other cities will be in serious trouble.

Trend #5: Pressure for Foreign Integration
As the recent battle between American and Delta for a partnership with struggling Japanese carrier JAL illustrates, U.S. carriers will increasingly look abroad to find ways to boost their route networks. While U.S. carriers are unlikely to become owners of many carriers abroad, they may continue to deepen their partnerships with alliance partners. As business travel increasingly entails international flights to countries poorly served by American carriers, such as China, India, or Gulf states, U.S. carriers can capitalize on the route networks of their partners. Additional deals such as the loans proposed to JAL from potential U.S. suitors are likely to occur as foreign carriers, especially those in Europe and Japan, struggle with weak economies and strong competition from LCCs.

But integration will also come in other forms. U.S. carriers already have the privilege of serving intra-EU routes, and come 2010, Open Skies II should take effect, such that EU carriers can serve intra-U.S. routes. While it remains to be seen whether this provision of the treaty will be enacted by U.S. authorities (failure to do so could result in the initial phase of the deal being nullified), it will be a boon to European carriers who could enter and cooperate with their alliance partners on U.S. routes, siphoning business travelers off from carriers like JetBlue and Virgin America with the perks many foreign carriers offer, and which U.S. carriers have removed.

Finally, integration could take place through foreign carriers purchasing controlling stakes in U.S. carriers. Right now, foreign entities are prohibited from owning more than 25% of U.S. carriers. Some, such as airline consultant Mike Boyd seem to think this is a grand idea and that such restrictions ought to be maintained. As he notes in his Dec 21 "Hot Flash", "Regardless of what the deals may represent to shareholders, foreign control of US airlines means foreign strategic planning." He then proceeds to spew out some jingoistic nonsense about how such foreign ownership is anti-constitutional, and how Democrats don't give a damn about U.S. independence from dangerous dictators. Please. Foreign ownership is not necessarily a bad thing (the key word here being necessarily). It's one thing to have Richard Branson's Virgin Group take a controlling stake in Virgin America, or for Lufthansa to increase its stake in JetBlue to 51%. These companies run profitable, world-class airlines, and would bring new capital and new insights into one of the world's most dynamic aviation markets. Such connections would also help support the expansion of carriers like Lufthansa, which with its evil, anti-American strategic planning, could better time JetBlue flights at JFK to coincide with arrivals from Europe, offering Lufthansa's European passengers a convenient option when they travel to the States. A controlling stake would lead to more complete integration, and likely provide customers with a more seamless travel experience, while preventing the conflicts that sometimes occur between alliance partners. While many of the benefits of ownership can be obtained in alliances, the different interests of shareholders and managers of the partners can result in conflicts between the companies and hassles for passengers if flights aren't adequately timed and ticketing/baggage systems properly integrated. Common ownership is likely to over time alleviate such problems, increasing efficiencies and minimizing the conflicts passengers encounter when they travel between carriers.

What Boyd worries about, and rightly so, is a scenario where a Chinese conglomerate turns Delta Air Lines into The Pearl River Delta Air Line, which would not only result in minimal alliance benefits for customers (since Delta's most Western hub is in Salt Lake City which isn't really convenient for many trans-Pacific connections), but would place America's largest carrier in the hands of a country we don't really trust. Ownership rules are ostensibly in place to provide aircraft for the military in the event of a national emergency. It's implausible to me that Richard Branson would suddenly divert Virgin America's planes to help Hugo Chavez, but Chinese control of hundreds of U.S. commercial planes could leave the U.S. in a difficult situation if there ever were such a crisis. The days of restrictions on foreign ownership of U.S. carriers should not end. But their days may be numbered. Such policies need to be changed not with a bang but a whimper. Steps should be implemented to allow investors from nations trusted by the U.S. (eg. the EU, Canada, Japan, Australia, etc) to control U.S. carriers. This may require changes to bilateral or regional trade agreements that have restrictions on foreign investment, but the process should be started. Integration will result in some "foreign strategic planning", but in a world where business is increasingly global, one where airlines need to be able to transport passengers seamlessly between distant markets, big and small, such common ownership may be increasingly important to building strong, dependable transport networks.

2010 will most certainly be an interesting year for the industry, and I'll offer some more specific predictions of all the interesting things we'll see in my follow-up post.

Air Scoop Article: LCC Contrast: The trend is fuller flights, so why are some carriers flying empty planes or using fake passengers?

I recently authored this article, published in the October 2008 edition of Air Scoop, a European newsletter devoted to the low-cost airline industry. I'll have a post or two out later this week about US carriers, but in the interim, I hope you enjoy this piece.

LCC Contrast: The trend is fuller flights, so why are some carriers flying empty planes or using fake passengers?

As fuel prices rise, LCCs have an even greater incentive to fly fuller planes with passengers paying higher fares. Ryanair and easyJet operate with the highest load factors in the industry (near 90% over the summer), and are increasing yields through higher ticket prices and higher ancillary charges. However, some smaller LCCs have chosen to fly emptier planes with passengers using free tickets. Earlier this year, Flybe was implicated in a scandal when the carrier hired actors to achieve a threshold passenger count on a route, thereby receiving a subsidy from the airport. Some carriers are even operating empty flights. With all the problems LCCs face, why do some companies engage in these behaviors? Two words: airport subsidies.

Arguably, part of the problem lies with the airlines themselves. The airline business has low margins, and airlines are desperate for competitive advantage and additional revenue. In order to survive, carriers want to extract the best possible deals from airports, leading to higher-than-necessary subsidies. However, airports are mostly to blame. Many airports, and the local governments that support them, need LCCs to improve passenger levels and generate tourism. Subsidies are often needed because the barriers to receive airline service, in this era of higher costs, are increasing. However, oftentimes subsidies are handed out without sufficient assessment of a route’s viability. Therefore, airports sometimes dole out large cash amounts for relatively few passengers, especially on routes not specifically focused on generating tourist traffic. Moreover, airports all too frequently cross the line between legal and illegal aid, privately negotiating with one carrier, while refusing to offer comparable aid to other carriers.

This is not to suggest that all LCCs are created equal in terms of their attitudes towards receiving subsidies. Ryanair has been more successful than others in using subsidies to successfully launch new routes from small airports. Often, these facilities lack international service, and Ryanair is a boon for the small communities that receive an influx of valuable tourist dollars. In most situations, Ryanair will typically launch flights to London, and then if those are successful, to other bases. Many of these routes have become commercially successful for Ryanair and the airports, enabling airports to withdraw subsidies over a period of time.

But, there have been occasions when Ryanair has opened a new destination, only to find that its expansion prospects are limited, as few of its other bases outside of London can support its services. Ryanair has withdrawn flights on many routes because of low demand, or because of an unexpected increase in the airport’s costs. This strategy, while somewhat ruthless, has helped the airline minimize losses on new routes. Often, the most successful airlines are those that know when to cut their losses early, and Ryanair has learned this lesson well.

Flybe, on the other hand, has tended to use subsidies from airports not to necessarily foster creation of a long-term, sustainable route, but rather to improve the bottom line. Subsidies are more effective in markets with large potential for traffic increases, such as tourist markets that have not yet been exploited. Markets that have a higher proportion of business traffic generally see slower gains in traffic. Moreover, airports that need to offer subsidies typically lack significant demand from business travelers because they’re typically distant from major trade centers.

Airports can be seen as subsidizing airlines in two ways, through direct subsidies and inefficient slot appropriation. By offering cash to carriers that add new routes or meet specific passenger count totals, airports can spur the creation of new services. Through poorly managed subsidy programs, airports can end up in a very undesirable situation, having to pay a subsidy to a carrier that did not fly passengers benefiting the airport in any way, such as what Flybe did in Norwich. Norwich, like any airport, should consider using subsidies, but should work closely with carriers to develop targets that are meaningful and realistic, on routes that will actually produce tangible gains in passenger totals. This means airports must carefully select routes to subsidize.

Simply because a carrier is able to or interested in serving a route does not mean that it is the best use of airport dollars. If a facility is looking for significant passenger gains, targeting subsidies at carriers like Flybe, which operate smaller planes shorter distances, on routes flown mostly by business travelers, may be less attractive than working with Ryanair or easyJet to bring in more passengers from greater distances to tourist markets.

Unfortunately for airports, given the high fixed costs of the airline business, LCCs will need subsidies to take the risks associated with a new route. Until the EU more stringently regulates this practice, subsidies will continue to exist. However, more careful and conservative route analysis, along with consultation with airlines about ways to increase passenger totals, will help airports ensure their investments.

Moreover, airports can artificially limit passenger counts through antiquated slot arrangements that limit competition. While this is a non-issue at most facilities, larger airports like Heathrow are grappling with carriers such as BMI, which intends to fly empty planes this winter in order to maintain slots. The slot restrictions, which require airlines at Heathrow to use the slots at least 80% of the time in order to keep them, are inhibiting the ability of new carriers who want to fly into Heathrow (with paying passengers) and introduce competition into the market. Since the introduction of Open Skies, Heathrow has become enormously popular for foreign carriers. Few low-cost carriers have been able to obtain slots there, because of high price and scarce availability. Many foreign carriers are willing to pay much more for a slot than LCCs are, since intercontinental flights can generate more revenue with larger planes and longer sector lengths. Regulation will be needed to ensure that slots are distributed more equitably, to carriers who fly paying passengers. Governments need to work with airlines and airports to ensure that the standards for keeping a slot are very high. Not only should airlines be required to use a slot at least 90-95% of the time, but also, there should be a combination of regulations ensuring high load factors, as well as minimum plane size.

My suggestion would be for airlines that fail to achieve an average 70% load factor on a given flight over a three-month period would lose the slot for that flight. Airlines would be required to use aircraft with a minimum of 100 seats. This would force airlines to fill larger planes, more efficiently using the valuable runway space at Heathrow and airports like it. Moreover, to ensure such a high load factor, airlines might be forced to discount some seats, benefiting passengers and encouraging competition.

However, these regulations would need to be implemented in careful consultation with airlines. A 70% load factor on early-morning flights sometimes is not feasible, and some carriers should be allowed exemptions on certain flights, but a target like this would ensure efficient movement of passengers using the least number of aircraft during the vast majority of operating hours. This regulation alone does not mean that many more LCCs will be able to operate from Heathrow, but it will make fares more competitive and ensure greater efficiency.

Most LCCs are guilty of taking excessive subsidies from airports desperate to see new services. During this time of duress for carriers, airlines are under pressure to seek a competitive advantage in any way possible. This does not absolve carriers of their shortcomings, but it will require increased vigilance from governments and airports to ensure airlines don’t exploit public bodies. Airports need to do a better job of holding LCCs accountable for their investments, ensuring that routes are well chosen and are bringing in the desired passengers. Moreover, airports also need to work with governments and airlines to update outdated regulations addressing slot allocation, improving facility utilization and encouraging added competition to crowded airports like Heathrow.

Air Scoop Article: Seat Pitch Regulation: What Impact on LCCs?

The following article, concerning the potential regulation of seat pitch on European low-cost carriers, was recently published in the European low-cost airline newsletter, Air Scoop. Enjoy!

Seat Pitch Regulation: What Impact on LCCs?

As LCCs, and charter carriers in particular, have expanded across Europe, they have engaged in prolonged battles to profitably reduce fares. To do so, LCCs have had to trim costs, and one way to generate additional efficiencies is to pack more seats into an aircraft, cutting the seat pitch (the distance between any point on a seat and that same point on the seat in front).

The Civil Aviation Authority (CAA) in the UK mandates that carriers provide a minimum of 26 inches of seat pitch, and most charter carriers, including Thomas Cook, First Choice, and Monarch, offer the bare minimum or just above it. Short-haul LCCs such as easyJet and Ryanair offer slightly more, their seat pitches are around 28 inches, while legacy carriers such as British Airways and Bmi offer a minimum of around 30 inches. While a reduction in seat pitch to near the regulatory minimums has meant that LCCs can offer lower fares, some critics are raising questions that these reductions might be at the expense of passengers’ health and comfort.

The House of Lords Science and Technology Committee recently issued a report calling for the minimum seat pitch to be increased from 26 inches to 28.2 inches. The committee argues that this change will allow passengers to more easily adopt the brace position in an emergency, reduce the risk of passengers developing health problems as a result of sitting in cramped conditions, and improve their comfort. Many LCCs, and especially charter carriers that offer the legal minimum seat pitch, oppose the proposed regulations. I suggest a wiser course should be that LCCs fight for revised regulations, which take into account several aspects of passenger comfort while maintaining low fares.

One of the primary concerns of legislators is that a narrow seat pitch will cause health problems, such as deep vein thrombosis (DVT). While valid, this is a much bigger concern on long-haul flights, where customers sit in their seats for hours. On these flights, where seat pitches can be extremely tight on charter carriers in economy class, passengers are much more vulnerable to developing DVT. On short-haul flights, less than 6 hours or so, passengers run a lower risk of developing DVT, and carriers could argue that on short-haul flights, the current regulations should be kept. However, on flights over six hours, airlines should concede to the recommendations. This would affect virtually no flights from short-haul LCCs like Ryanair and easyJet, which don’t operate flights over six hours in length, but would affect charter carriers that operate long haul flights to Asia, Africa, or the States.

If regulations where seat pitch varied on flight time were contemplated, there would be several details to negotiate. The first is how flight time would be measured, as scheduled flight time is often not the same as actual flight time, and passengers’ time on the ground stuck in their seats could contribute to developing DVT. The second would be what penalties airlines would face if they were to violate the flight time requirements, since the severity of penalties can greatly affect how willing airlines are to violate the rules.

Additionally, the LCCs would have to determine how to subdivide their fleets into aircraft configured with long-haul seat pitches and short-haul seat pitches. LCCs hate subdividing their fleets, because it reduces flexibility and operating efficiencies. Although some aircraft, such as the 757 or 767, are versatile, and could be used for higher-density short-haul flights, or lower-density long-haul flights, seat pitch regulations, and the desire by airlines to pack as many seats as possible into aircraft, could encumber airlines and make it difficult for them to use those aircraft efficiently.

Another regulation that carriers should lobby for, because it is not very intrusive and could prevent regulators from imposing more burdensome requirements, would simply require cabin crew to discuss DVT and the dangers of staying in one’s seat too long in the pre-flight safety demonstration. Moreover, airlines should be required to put some sort of notice about DVT in onboard safety cards, with suggestions about how to prevent its effects during the flight. A brief announcement advising passengers to get up and walk around the cabin to avoid DVT would remind passengers of their role in maintaining their health. Granted, this would not address the safety issue of passengers being able to adopt the brace position, which regulators are also concerned with, but it would make it easier on LCCs to address some of the regulators’ concerns while maintaining the status quo in seat pitch.

If these new requirements are implemented, regulators may decide to eventually target other areas of passenger comfort. For instance, regulators may try to impose greater seat width requirements. With a narrow seat width, passengers often must squeeze into their seats, making the flight very uncomfortable and painful. Moreover, passengers can be squeezed further if a passenger of size sits next to them (though admittedly, this is a larger problem in the States, where I live). While this is an issue that cannot be rectified immediately, since it is difficult for carriers to add width to seats to existing aircraft without narrowing the aisle (a health and safety hazard), it will likely be taken under consideration by regulators in the future when Airbus and Boeing are designing new generations of aircraft. 

LCCs that already offer the proposed minimum seat pitch standard should have no problems in the future. However, charter carriers that currently offer the bare minimum will likely need to remove seats, leading to higher fares and fewer opportunities to offer loss-leading extra-low fares in order to lure customers to their planes. The regulations will also diminish the opportunities for carriers to utilize one potential revenue-generating tool, premium seating. Most charter carriers offer some form of “premium economy” seating, with similar seat widths, but slightly more legroom than regular economy. Many taller passengers who cannot comfortably sit in regular economy seats often purchase these premium economy seats, and if more legroom is given to economy passengers, fewer passengers will have a need to do this. Charter carriers could be forced to rethink the sizes of their premium economy seating sections and the potential revenue that they might generate as a result.

The House of Lords proposed regulations will, however, make charter carriers more attractive to fly on for passengers, and if these companies can keep fares substantially lower than legacy carriers, then they may be able to make the improved legroom a selling point. Many passengers currently avoid charter carriers because of uncomfortable seats, and instead fly with legacy carriers. Some of these passengers could be converted back to charter carriers if they were given more legroom. As a result, British Airways and other legacy carriers could be forced to offer more amenities to retain economy passengers. However, the regulations will change little in the short-haul market, as most LCCs already exceed the minimum seat pitch. But it will still be an important battle that LCCs and charter carriers will fight in the new year, as it affects their ability to operate economically. But whether the outcome will be successful for LCCs will depend on how much airlines fight the proposed requirements, and how much they choose to concede.

Air Scoop Article: LCC Web Sites Under Investigation

This article was recently published in the European low-cost airline newsletter Air Scoop. It discusses the recent EU investigation of airline Web sites to make them more transparent. Readers in the States should note that our government has not done anything like this yet, which means that, for better or worse, Spirit Airlines will be able to continue advertising its $1 fares without taxes and fees included for the time being. If you have questions or comments about the article, please leave them in the comments section below, or email them directly to samsellers@gmail.com.

LCC Web Sites Under Investigation

Recently, the EU Consumer Protection unit launched an investigation into improper displays on airline Web sites. After a ruling that forces airlines to advertise prices in full on their sites, airlines had to change the way prices, as well as terms and conditions are displayed. Airlines also had to ensure that customers were not being “tricked” into purchasing products they otherwise wouldn’t.

If airlines fail to comply with the EU directive, they could face fines or the closure of their sites. As Web sites are now the primary way passengers in Europe book tickets, such a closure would affect carriers dramatically. No airline has the resources to scale up call centers and airport ticketing operations quickly enough and any airline would certainly suffer if its Web site were shut down, even temporarily.

While some LCCs have recently made moves to diversify the number of booking outlets for customers (most notably easyJet’s decision to offer its fares over a GDS network), their Web sites are still the primary booking locations because they provide the lowest fares to customers, the lowest costs to carriers, and the most opportunities to generate ancillary revenue. The shutdown of the Web site of a major European LCC is very unlikely. The EU is giving carriers ample time to adjust their sites, and the EU plans on imposing fines before any site shutdown.

The Scope of the Probe

This most recent investigation by the EU occurred in late September, and focused on 447 airline and travel booking Web sites. Of the 447 sites investigated, 226 were found to be in violation of EU law. The results varied considerably depending on the country investigated. For instance, in Belgium, 46 out of 48 sites investigated were found to be in breach of the law whereas in Austria, none of the 20 sites investigated violated the law.

The investigation, conducted by consumer protection organizations in each of the 27 EU member states and Norway, cited sites with unfair pricing, hidden charges, tick boxes checked by default, luring customers to purchase unwanted items, and terms and conditions not translated properly into the language of the customer’s country of purchase or not given at all.

However, the investigation did not publicly name companies, preferring instead to comment about its overall findings, though an EU spokesperson noted that in four months, they intend to “name and shame” the companies involved. Companies that are found to have violations will be contacted by local EU enforcement authorities to either delineate their stance on the violations or to rectify their sites. The EU has stated that they initially will impose monetary penalties on violators and only close sites as a last resort.

The Rationale for Creating Violating Web sites

As fuel costs rise for LCCs, increases in fares are often not keeping up with the added costs. As a result, LCCs have increasingly sought to grow their ancillary revenue streams. Most of these Web site violations stem from pressures to grow ancillary revenues by tricking customers into purchasing services that they do not necessarily want. For example, many of the violations occurred when airlines pre-selected travel insurance for their customers, a violation of the EU’s policy that customers must select the product, not the other way around. Since travel insurance is a very profitable product for LCCs, this has helped airlines increase ancillary profits.

Another common problem was either misstated or missing terms and conditions. This is especially a problem on LCCs that have strict ticket reissuing and baggage policies, since passengers are likely to look to the airline’s terms and conditions on those two issues. For instance, buried in Ryanair’s terms and conditions is the mention that passengers who check bags will be charged an excess baggage fee if any single bag goes over the 15 kg limit, even if the pooled baggage weight among a group of passengers totals less than 15 kg per bag.

Ryanair has been very successful at charging excess baggage fees to passengers who don’t carefully read their terms and conditions, making it one of Ryanair’s leading ancillary revenue streams. Other LCCs have engaged in similar tactics. If the EU has found that Ryanair or other LCCs have improperly displayed terms and conditions, then it could expose those carriers to considerable penalties. If restricted in these ancillary product offerings, LCCs will likely see slower growth in this revenue stream, since a significant percentage of ancillary revenue is generated from customers who unwillingly purchase the product.

Moreover, as LCCs know, price is everything, and some carriers may have been deliberately slow to transition to all-inclusive pricing. With a lumbering EU bureaucracy, carriers that continue to advertise fares without taxes don’t have any immediate threat of sanctions, and so if they can make their fares appear cheaper than their competitors’ for a few more months, it helps them gain a competitive advantage.

It’s probable that LCCs that operate in more countries and which have more complex Web interfaces are more likely to be subject to penalties. Therefore, I suspect that easyJet and Ryanair are most likely to have violations. Easyjet currently automatically selects and prices a customer’s flight with a hold bag and travel insurance included. Customers must remove these items to receive the price of their ticket only, something the EU prohibits. EasyJet will need to change this practice in the near future to avoid penalties. Ryanair currently advertises flights on its home page with taxes and fees included, but when a customer goes to book that flight, he or she may see a price much lower than that, as low as .01 EUR. Ryanair then adds the taxes and charges on the following page, possibly misleading customers who thought that the flight cost .01 EUR, and a potential violation of the EU policy.

The Potential Effects on LCCs

Obviously, a Web site shutdown would have disastrous consequences for any airline, not just an LCC. Since many LCCs do not offer tickets through travel agencies, passengers would have either the option of booking via phone or booking at the airport, neither of which are very convenient or desirable for either airlines or passengers. If its Web site closed, an LCC would quickly lose market share and money, as it could not arrange bookings for enough passengers to fill its airplanes.

The effects would be immediate and dramatic, and even with a temporary site closure, the effects could last for months: A carrier could see lower load factors months after a Web site closure. Moreover, the airline’s reputation for quality would likely suffer if its site closed, leading to suspicions about other areas of the airline’s operation.

Yet the possibility of an airline’s Web site being taken down is very real, even if a rogue hacker succeeds where the EU doesn’t, and needs to be taken more seriously by carriers. As the expression goes, “Don’t put all your eggs in one basket”. LCCs put all their eggs in one basket in a number of facets of their operations, including fleet makeup (since many LCCs operate only one type of aircraft, and most operate no more than two) as well as distribution method (since many LCCs sell virtually all of their tickets through their Web sites).

Putting their eggs in one basket has led to enormous efficiencies; however, consolidating baskets also increases risks for carriers if their basket breaks, leaving carriers exposed and vulnerable. In this ultra-competitive marketplace, just a few things have to go wrong to lead to disaster. The EU probe will likely succeed in forcing LCCs to make the necessary changes to their Web sites to make their sites more transparent, easy-to-use, and consumer friendly. These changes will cost LCCs some ancillary revenue, but they will also help make LCC sites more attractive for consumers, helping to build brand loyalty and strengthening the ability of LCCs to generate repeat business.

If you enjoy reading Airline Bulletin, then why don't you consider subscribing to our free feed? You won't receive any spam, or more than one email a day, and it's the best way to stay on top of the latest Airline Bulletin posts.

 

Air Scoop Article: Safety and Security Worries Reemerge for European LCCs

I wrote the following article, which appeared in the November edition of the European low-cost airline newsletter Air Scoop. It discusses the potential safety and security concerns of many European LCCs, especially in the wake of the SAS announcement to indefinitely ground its Q400 fleet due to mounting questions about its safety.

Safety and Security Worries Reemerge for European LCC

Some Flybe cabin crew and pilots recently reported being sickened by fumes on the company’s BAE-146 aircraft. On ten flights over the past fifteen months, noxious air leaked from the engines into the cabin, causing at least one flight to be aborted. Some crewmembers are so furious that they are boycotting the aircraft. While these incidents involve an older aircraft type that is quickly being phased out of Flybe’s fleet (Flybe plans to remove all BAE-146 aircraft from its fleet by February 2008), the problems revive past questions about how much LCCs are doing to protect the safety and security of passengers.

Critics charge that the LCC business model that aims to keep costs to a minimum has led to inadequate pilot and cabin crew training, more aircraft breakdowns, and increased pilot and cabin crew fatigue. All these factors have contributed to a number of close calls over recent years. For instance, in 2002, the Number 2 engine of Ryanair flight 296 caught fire upon landing at London Stansted. While the fire was put out, and the plane evacuated within 90 seconds, confusion and chaos during the evacuation prompted an investigation by air safety authorities. Ryanair was criticized for having inexperienced cabin crew, many of whom trained in Eastern Europe with questionable quality control.

Overall, European LCCs have a very good safety record, but because LCCs want to cut costs, they are seen as more willing to sacrifice passenger safety for the bottom line. Already, public concern for the environment, anger over a swath of new baggage charges, and frustration over variable service standards has made the European public rethink LCCs. A single accident could significantly damage the reputation of an LCC and the entire sector.

If a major accident by an LCC occurs, it could lead to a tremendous amount of pressure from regulators and the public. The harshness of the reaction will likely depend on the severity of the accident, the carrier’s problems that led to the accident, and the response of the carrier to the accident. The carrier has to appear sympathetic and take responsibility for its mistakes. And if it is discovered that the carrier has preexisting problems that led to the accident, then its reputation could suffer tremendously.

For example, in the year 2000, an MD-80 aircraft owned by US LCC Alaska Airlines crashed into the Pacific Ocean, killing all on board. In subsequent investigations, it was discovered that there were serious oversight lapses in Alaska’s maintenance operations. As a result, Alaska’s reputation for safety suffered, which will likely continue until Alaska removes the MD-80 type from its fleet, which it plans to do in 2008, eight years after the tragedy.

The nuance that carriers need to remember is that the public will make assumptions about why the airline was involved in the accident. If an LCC is involved, often the first explanation will be that the root of the problem is excessive cost cutting, leading to maintenance and safety lapses. If a legacy carrier is involved, the likely explanation will be human or mechanical error. LCCs need to combat this misperception by communicating that maintenance is done in accordance with Part 145 and other EU maintenance regulations. LCCs have done a very good job of making safety and security their number one priority in the past ten years. But if LCCs start de-emphasizing safety for cost or business reasons, then the industry is at risk.

Concerns about how an accident would affect a carrier’s reputation aren’t limited to LCCs. SAS has taken dramatic action after the third gear collapse on one of its Q400 aircraft in less than two months. After a landing incident with SAS flight 2867 on October 27, SAS decided to permanently ground their entire 24-aircraft Q400 fleet. SAS’s dramatic action, while potentially very costly, emphasizes to the public that they’re not taking any chances when it comes to safety. Even if the accident were the fault of the aircraft manufacturer, it is the airline that is seen as liable in the public’s eye.

Q400 aircraft make up the bulk of Flybe’s fleet and will comprise even more once their BAE-146 planes have been removed. With a low-cost business model that necessitates high aircraft utilization, would Flybe be as willing as SAS to ground its Q400s if it discovered a technical problem with the plane?

Part of the problem LCCs have in making such a decision is that they typically only operate one or two aircraft types, whereas legacy carriers like SAS operate many. Q400s comprise almost half of Flybe’s fleet; so such a grounding could be devastating to the company. Moreover, if a grounding occurred with 737- or A320-type aircraft, low-cost carriers around the world could suffer, and legacy carriers could use their advantage to take market share.

However, other safety lapses, including pilot and crew fatigue could jeopardize a LCCs reputation. On Channel Four’s Dispatches program about Ryanair, one pilot stated that the airline flies him just under or exactly 100 hours a month, the EU maximum. Flying this way for many months straight left him exhausted. While Ryanair argues that rosters are manually set to minimize the risk of fatigue, it appears that in at least some cases, rosters are set to maximize the utility of pilots, which also maximizes the risk of fatigue. Moreover, cabin crew are not subject to such strict work limits, so they are at an even greater risk of fatigue. For example, one of the Dispatches undercover reporters discovered a cabin crew member asleep on the job, making it difficult for her to respond in an emergency.

But perhaps more pervasive throughout European LCCs have been security concerns. The Ryanair Dispatches program uncovered some serious lapses in Ryanair’s security practices and argued that these lapses were a result of cost cutting on the part of Ryanair, particularly its policy of 25-minute turnarounds.

In one instance, one of the undercover reporters was chastised by supervisors for taking too long to board passengers, because she followed procedures and verified that the name of the passenger in the passport matched that on the ticket, and that the passenger’s face matched the passport photo. Her actions prevented Ryanair from making a 25-minute turnaround on that flight. Moreover, many Ryanair employees used temporary security passes without following the stipulation that they be accompanied by a permanent pass holder, a security flaw, that if exploited could let a dangerous person on the tarmac or on the aircraft.

Fortunately for LCCs, if they are laxer in complying with these requirements, the effects of doing so aren’t as significant. Security incidents are rare and typically aren’t as dangerous as safety problems. Moreover, most security incidents don’t create the same levels of negative publicity for LCCs that accidents do. However, that doesn’t mean LCCs shouldn’t do more to improve security. It can be argued that LCCs face a greater risk than legacy carriers of a security threat, because they often operate from small, rural airports with laxer security.

If a major publicized security incident occurs involving LCCs, it could threaten not only their reputations, but it could threaten the way LCCs do business as security would be ramped up in the resulting weeks and months.

If airports or governments are unable or unwilling to pay for tighter security at airports with only a few commercial flights a day, then LCCs could be forced to move operations to other, larger facilities, adding additional costs from higher airport charges and a greater likelihood of delays. Even if LCCs don’t have to move operations, they could be inhibited from doing 25-minute turnarounds if they are forced to do stricter passport checks, leading to greater boarding delays and lower aircraft utilization.

LCCs have had a remarkable safety record over the past decade, with a very low rate of accidents. However, as the Dispatches expose demonstrates, many LCCs operate in ways that are not as safe as their legacy counterparts, and are running a significant risk of an accident. It is uncertain what the effects of a major accident would be on the European LCC sector, but suffice it to say that the failure of one LCC has the potential to damage the entire sector.

If you enjoy reading Airline Bulletin, why not subscribe to our feed? Just enter your email address under Get Posts By Email on the right side of the page, and you will receive Airline Bulletin posts soon after they are published. Don't worry, you won't receive any spam or more than one email a day.

Ryanair’s Profit Projection Motivations

I wrote the following article which was published in the European low-cost carrier newsletter, Air Scoop, regarding how Ryanair has taken advantage of some earnings projections it made earlier this year to gain an advantage in the marketplace. Enjoy!

Ryanair’s Profit Projection Motivations

Many analysts were concerned on June 5 when Ryanair, citing higher fuel costs and airport charges, projected sharply lower coming-year profit growth. Although Ryanair projected profit growth of a mere 5%, its recent results have far exceeded that figure, which poses the question: Why were Ryanair’s projections so far off, and were they deliberately off to give Ryanair a strategic advantage in the marketplace? While we will never know for sure, Ryanair has exploited its projection to further its lobbying, public relations, price-cutting, expansion, and value creation efforts. This has particularly hurt medium-size LCC competitors, including Jet2, Vueling, and SkyEurope, in the process.

Ryanair’s lowered projections created a more positive environment for the company’s lobbying efforts. Ryanair has traditionally engaged in fights against regulatory and airport authorities and the company has been known to take drastic measures to prove a point because it feels that if it loses any battles against these authorities, it will have a weaker negotiating position when it fights against future restrictions and rate increases. A lowering of projections generated media sympathy, providing Ryanair with more negotiating power.

But the lower predictions were also followed by some dramatic actions by Ryanair, perhaps partially intended to influence press coverage, which furthered the company’s lobbying and public relations efforts. Ryanair has been engaged in battles with BAA, Aer Rianta, the EU, as well as the UK Government. Ryanair’s most recent highly publicized fight was against BAA for doubling Stansted airport charges, resulting in Ryanair grounding seven Stansted-based aircraft. Instead of continuing to fly aircraft with a slightly higher cost base (keep in mind that Ryanair still has by far the lowest costs of any European carrier) the airline simply grounded the planes, enabling the media to publicize the story and the apparent victimization, generating public sympathy for Ryanair and animosity towards BAA. But Ryanair may have exploited this situation to cleverly to turn media attention away from service issues. No media outlet wants to spend too much time and effort covering one company, and the battle with BAA provides the media a Ryanair story that is positive for the company and a good story for the media since it’s new, different, and engaging—unlike many of the Ryanair traveler “horror stories” that are often covered instead. However, while the company’s public relations may have been boosted by this move, the company still isn’t winning the lobbying battles it wants to, and the company’s unilateral negotiation approach seems to be proving rather ineffective, so good press, while helpful, hasn’t done everything. 

The lower projections provided a logical explanation for Ryanair subsequently drastically cutting prices on most of its routes, including offers of 10 Euros each way including taxes and fees, as a way of stimulating lower load factors. This became a Ryanair-led price war. EasyJet was unable to match many of these fares, but trimmed fares where they could to maintain competitiveness. Air Berlin, with a higher cost structure than either Ryanair or easyJet, could not match Ryanair’s deals. (However, Air Berlin’s ongoing acquisitions will enable that airline to offer fares much closer to Ryanair’s in the future.) The carriers who really suffered were those who were unable to cut fares without hemorrhaging cash. Vueling is a prime victim of Ryanair and easyJet’s expansion into Spain. Because the company has higher costs than either carrier, it lost money when it was forced to cut fares to compete with Ryanair and easyJet. Ryanair’s price cut strategy worked brilliantly to further destabilize Vueling, and as a result, that carrier is now reconsidering its business strategy.

The lower projections also provided Ryanair with an understandable excuse to cut unprofitable routes and launch routes that compete more directly with easyJet, especially for the future. Ryanair will soon need to become more active and aggressive in higher-density city-pair markets if it hopes to meet passenger growth targets. As a result, Ryanair will continue to pressure carriers such as easyJet, Vueling, SkyEurope, and others who have high-density strategies. When Ryanair reshuffled routes this summer, the company positioned itself to compete more directly with easyJet, especially on routes to or from Spain and Italy. As Ryanair expands further there, it will compete more intensely with easyJet, which could alter easyJet’s strategy of targeting large, high-density markets as its primary growth strategy. 

As the industry leader, Ryanair sets the trend, so its poor projection hurt LCC stocks across the board. That provided Ryanair several opportunities. With its own share price lower, the company could buy back stock and likely increase the share price. Ryanair’s competitors, with their shares down, had to be more careful about their expansion plans. But most importantly, it made some of Ryanair’s smaller competitors more susceptible to takeover, which might cause them to exit markets where they compete with Ryanair. Takeover rumors have been swirling concerning Vueling and SkyEurope, in part because of the immense pressure that Ryanair has put these carriers under, and a lower share price makes them more attractive to potential suitors.

On June 5 Ryanair announced its annual results and a share buyback. Ryanair stock closed at 5,36 EUR the day before earnings were announced, while the stock headed lower in successive days and on June 26, Ryanair commenced the buyback, purchasing shares at a price of approximately 4,95 EUR. Ryanair was able to purchase its stock at a very attractive price, triggering a temporary increase in the share price. This in turn benefited Ryanair shareholders, including senior level executives. But this strategy hasn’t been too successful at creating lasting value for shareholders thus far, as Ryanair’s stock has since fallen to approximately post-earnings levels.

Ryanair’s move affected the share prices of other companies in the industry, causing pain for investors and concern for executives about future competitiveness. While easyJet’s stock took a steep dive this summer, declining from 563 pence on June 4 to as low as 453 pence on July 30, it has since regained some of its lost value. EasyJet, Vueling, Jet2, and many other Ryanair competitors have all seen declines in share performance since the June 5 announcement, raising questions about whether these companies will be able to maintain competitiveness with Ryanair in the future as they lose market value.

On most fronts, Ryanair’s strategy has been effective. The company exacerbated problems that its medium-size competitors have been facing, while enabling the company to better compete with its larger rivals. Unfortunately, this strategy hasn’t yielded all the potential benefits it could, as the company still is fighting BAA’s Stansted Airport charges, and Ryanair’s stock has had lackluster performance since the earnings announcement. But regardless of whether Ryanair’s earnings announcement was an intentional deception or a happy accident, the company has used it successfully to gain ground in a very competitive marketplace by driving down competitors’ yields and increasing competition on lucrative routes.

If you enjoy Airline Bulletin, then don't forget to subscribe to our feed under Get Posts By Email on the right side of the page. You won't receive any spam, and it's a great way to stay connected with the site.

 

What a Price War Could Look Like in Europe

Ryanair and easyJet both plan to cut prices in the coming months in order to help lure passengers to their airlines. Ryanair announced that in the second half of this year the carrier may lose money. But Ryanair's costs are also rising which worries investors, though it appears to be a temporary increase due to some operational changes as well as higher airport charges. If Ryanair's costs continue to increase, it could signal a shift in dominance in the European low-cost airline industry, since Ryanair might no longer have the lowest costs, although this is rather unlikely in the near future. But even with these cost increases, Ryanair plans to launch an all-out price war, and hopes to damage the competition which cannot afford the fight. EasyJet plans to lower fares to compete with Ryanair, though it's likely Ryanair's fares will still be lower than easyJet's. But the real victims of this price war will be the smaller LCCs which don't have the scale or the cash to withstand a prolonged fight against Ryanair. Wizz Air in Eastern Europe, Vueling in Spain, and Sterling in Scandinavia could all be hurt by this price war. While it's unlikely that any of these companies will go out of business as a result of this fare war, it will no doubt hurt these airlines. It will also hurt traditional legacy carriers, who would be unable to come close to matching Ryanair's lower fares. However, these carriers have diversified themselves enough by attracting a large share of the business traveler market that they will be less affected by a fare war than LCCs. What all these LCCs must do is to find other areas to compete, aside from price. A fare war would encourage airlines to get more creative in their marketing, which could include airlines discussing comfort (since many LCCs have a greater seat pitch than Ryanair), travel convenience (since many of the LCCs listed above use primary airports closer to city centers where Ryanair uses secondary airports more distant from city centers), and booking convenience (since LCCs can advertise their low-cost vacation packages that can be booked all at the same site as airline tickets, saving customers time and money). This last point is critical. LCCs will need to sell customers based on ancillary revenue streams, such as hotel booking, car rental, travel insurance, and other products. If customers are looking for the easiest way to book their vacation, they can find it on the Web sites of many LCCs. Ryanair will win virtually any price war. The company has the lowest costs and the largest operation. And it will hurt many LCCs. But Ryanair doesn't necessarily offer the best value for vacations through its ancillary revenue partners. As a result, if Ryanair's competitors can sell themselves on points other than price, then these airlines can garner higher fares as well as drive more passengers to use their ancillary revenue streams which could generate considerable sums.
A price war is the inevitable result of a slowdown in demand. This is due primarily to the environmental controversy in the UK that has hurt the credibility of low-cost airlines on the environment, as well as higher passenger taxes, and the continuing hassles of air travel due to long lines at security checkpoints and air traffic control delays. These issues will continue to plague low-cost airlines for the indefinite future, as they are related to issues that won't go away anytime soon, the environment, security, and overcrowding of the skies. And since airlines have little control over how the public responds to these issues, airlines are held at the mercy of government and interest groups. These groups could do considerable damage to low-cost carriers in the future, and not just in Europe. For example, if the environment becomes a larger issue in the United States, particularly after the 2008 presidential elections, low-cost airlines could be hurt enormously.

As passengers continue to view air travel negatively, the growth in discretionary trips could subside, particularly from more well-off and educated regions, such as the UK, Scandinavia, and Spain. Regions which are poorer will continue to encourage low-cost airlines to service their countries in an effort to provide their citizens with convenient and cheap access to Western Europe. Poland is the poster child for what low-cost airlines can do to a region. Ryanair offers service to nearly a dozen Polish cities and connects these markets with London and other Western European cities. It offers cheap, reliable, and convenient service for thousands of Poles who need to access work and family in Western Europe, and Ryanair has made millions in the market. Ryanair is now starting to expand its successful Eastern European model to other nations. This is where low-cost air travel is needed. Not in bringing planeload after planeload of tourists to the Balearics, but by helping people who truly need to fly get where they need to go. Low-cost air travel will come under increasing assault in the coming years, and it's imperative that LCCs find ways to diversify themselves in the long-term by elongating average stage lengths and serving destinations that support fewer discretionary trips so that their businesses won't be destroyed by external factors. People who need to fly will continue to fly. People who don't may not.

Also, if you enjoy reading posts on Airline Bulletin, consider subscribing to our feed. Enter your email address under Get Posts By Email on the right side of the page. Don't worry, you won't receive any spam or more than one email a day.

(R)evolution of Ryanair's Business Model (Part 2)

This is the second part of an article I wrote for the European low-cost airline newsletter, Air Scoop. The article concerns Ryanair's growth plans over the next five years, which requires the airline to carefully transform its business model. You can read the first part of the article here.

Ryanair is also examining the prospect of expanding into larger airports.

Ryanair, unlike its low-fare rival easyJet, has meticulously avoided many central airports due to high fees and longer turnaround times. Ryanair has avoided central airports in numerous cities where easyJet operates from them, including Barcelona, Brussels, Copenhagen, Paris, and Venice. Ryanair also has large operations in secondary airports near Dusseldorf, Frankfurt, Glasgow, Rome, Stockholm, and of course, London. While it’s unlikely Ryanair will enter Heathrow anytime soon, due to its slot restrictions and very high costs, Ryanair may enter primary airports in other cities where it already has bases at secondary airports. Ryanair will try to target travelers who prefer the convenience of a larger airport, typically closer to the city center, and who are willing to pay a price premium for that privilege. That price premium will compensate not only for the higher fees that Ryanair will pay at the airport, but also for the longer turnaround times that Ryanair may encounter.

However, Ryanair must target its new customer base carefully. Many business travelers who prefer airports closer to city centers are loyal to legacy carriers because of their frequent flyer programs and spacious seating configurations. Ryanair will probably offer neither in the coming years, and as a result, it may not attract the legions of business travelers it desires, even if it offers significantly lower fares than legacies. Therefore, Ryanair must target leisure travelers and others who prefer larger airports, not necessarily business travelers. It’s unlikely that Ryanair will significantly trim flights at secondary airports if it adds service at primary airports, because the new service will augment the old service by enabling Ryanair to target different consumer groups that currently don’t use Ryanair because of the secondary airport issue. Some service may be transferred from secondary airports to primary airports, but Ryanair will primarily grow its passenger numbers from these larger airports, not simply transfer passengers from one facility to another.

Ryanair will need to add longer routes, as well as routes to and from central airports if it wants to meet its five-year growth targets. However, Ryanair must do both carefully, in a way that modifies its business model without destroying its cost advantage over other carriers. If it can do so, it will, without a doubt, be Europe’s leading airline, catering to the majority of passengers with substantially lower costs than its competitors.

If you live in the States, you don't have Ryanair to shuttle you around for next-to-nothing. But, you can get the next best thing, an ebook that gives step-by-step instructions for how to get the cheapest ticket. Take Control of Booking a Cheap Airline Ticket, which has been recently updated, offers instructions for booking domestic and international travel, as well as information about consolidators, vacation packages, and frequent flyer programs. Take Control of Booking a Cheap Airline Ticket is a great bargain, and it can save you more than the price of the ebook with your first trip. It can be purchased here.

Also, if you like what you see, consider subscribing to our feed. It's the best way to stay on top of all the latest from Airline Bulletin, and don't worry, you won't receive any spam, or more than one email a day. Sign up on the right side of the page under Get Posts By Email.

Delta Exits Bankruptcy and Rebrands: Can the Airline Now Compete Freely?

Delta Air Lines formally exited bankruptcy today, ending its protection from creditors. But the airline exits bankruptcy when the industry is still experiencing difficulties, particularly with regard to fares that are still too low and potential overcapacity with two new competitors coming on line this year. Delta's restructuring has focused on reducing costs, and the company has done a fair job of that. Delta will continue to face uncertainty in several areas, but particularly with regard to its hubs. Right now, much of Delta's profits are being made with customers flying to or from a hub, and that will inevitably change in the future, given the expansion of low-cost carriers in this country. As a result, Delta will need to focus more on connecting traffic, especially to higher-margin international destinations for a greater share of its profits.

One of Delta's largest profit centers is in Cincinnati, where according to the Department of Transportation, the airport has the highest average fares of any major airport in the country other than Anchorage (which for geographical reasons is likely to have very high fares). Cincinnati even has higher average fares than Honolulu! And while Delta has a virtual monopoly in Cincinnati, that probably won't last. I suspect that in the next couple years an LCC, most likely AirTran or Frontier, will add service to Cincinnati (although Southwest and JetBlue are reasonable possibilities as well), and Delta will try to drive its new competitor out of town, a tactic that has worked in the past and may work in the future.

However, if an LCC can maintain an adequate foothold in Cincinnati, especially one that offers connections to many business centers across the country, then fares in that market will decrease, and the massive profits Delta is making in the city will decline sharply, which could spell more bad news for employees at Delta's regional subsidiary Comair, who have already had a tough time accepting significant pay cuts during Delta's bankruptcy. It's important to note that since Comair operates an all-regional jet fleet, its costs have skyrocketed in the past few years, since regional jets are more fuel-hungry than larger planes, and as a result, its competitiveness has decreased. Pay cuts, which have damaged employee morale, were necessary to help stabilize the company (though it's debatable whether Comair management made cuts that were too steep). Since Comair does much of Delta's flying in Cincinnati, an LCC could force employees at the subsidiary to sacrifice even more, and Delta's network at the hub may shift, since additional regional jets may get trimmed from the network in order to reduce Delta's costs. Those changes may be necessary soon if low-cost competition enters Cincinnati, and in any case will eventually be within 5-10 years in order to modernize Delta's hub there and lower its costs. These changes could make Delta's overall transformation strategy more difficult, especially if yields from Cincinnati decrease substantially.

Delta's other two hubs in Atlanta and Salt Lake City may also face changes, but not nearly as many as Cincinnati will. Atlanta and Salt Lake both have low-cost competition, and Delta has adapted nicely to the competitive climate in both markets. Both Delta and AirTran are struggling to figure out how to add capacity in an East Coast market which is oversaturated by low-cost competition. As a result, Atlanta will see mainly a boost with international flights in the next few years. The number of domestic services may increase, especially if Delta increases frequencies on routes where larger 767 aircraft are being replaced with smaller 757 or 737-800 aircraft, but the amount of capacity will not change substantially. AirTran will likely focus on building domestic operations in focus cities outside of Atlanta (as I will discuss in a post to be added within a day or two), while Delta will concentrate on adding service from Atlanta to a growing number of destinations, particularly in Latin America and the Caribbean, Europe and the Middle East, and depending on the DOT's decision in 2008 concerning China route authorities, Delta could add additional service to Asia to complement China flights.

Salt Lake City is a bit harder to analyze, because the West will become increasingly important for Delta, as the airline tries to target additional traffic to Latin America as well as in the growing Southwestern United States. Salt Lake City will be an important connection point for Delta destinations in the West, but its importance in the Delta network could diminish if Delta cuts regional services to many smaller cities due to high costs. Right now, Delta doesn't seem to be heading that direction, in fact, the airline seems to be using its massive regional jet fleet (much of which is service Delta contracts to SkyWest Airlines in Salt Lake City) to serve a growing list of destinations, including Yakima, WA and Salem, OR. However, much of Delta's future depends on the viability of regional jets as a cost-effective means for transporting passengers. If fuel costs skyrocket, then Delta's transformation plan could get derailed, and the effects in Salt Lake City and Cincinnati would be disastrous. Let's hope Gulf War III doesn't start anytime soon.

However, the future importance of Salt Lake City could also depend on how Delta's expansion in Los Angeles goes. Delta seems to be using its reoriented international focus to turn its Los Angeles focus city into a small hub, adding to the list of cities it serves from Los Angeles in both the US and Mexico, partly through a new regional jet contract with ExpressJet Airlines for ten regional jets to serve cities on both sides of the border. Delta plans on offering convenient connections between major cities in the US and destinations in Mexico. If Delta's Mexico flights don't attract sufficient yields and loads, then the entire Los Angeles operation could be downsized, and the importance of Salt Lake City could grow. However, if the Mexico operations in Los Angeles succeed, then Delta could place a renewed focus on Los Angeles, adding flights from the city to other key markets in South America, the Caribbean, and possibly Asia.

Delta's focus cities in Washington DC, New York, and Boston will continue to be important for the airline in the near future. This is especially true in New York, where Delta has a sizable presence at JFK with transcon and a growing menu of international flights as well as at LaGuardia with a profitable mix of flights popular with high-yield business travelers. Boston and New York will continue to receive point-to-point flights from major US cities in the near future, even though Delta has reduced its presence somewhat in Boston due to low-cost competition. Business travelers are very important for Delta from all three markets, and will be courted even more aggressively as Delta continues to improve its amenities and services on shuttle, transcon, and international flights. Moreover, the Delta Shuttle operation is still a very profitable enterprise, even with new competition from JetBlue, and it will continue to be profitable unless demand from business travelers slows significantly. There is no reason to believe that Delta will want to realign capacity at its hubs and engineer a pullback from its lucrative business markets in these three cities. As a result, Delta's focus city operations from the three major East Coast business centers will continue for the time being.

As part of the announcement today, Delta announced an agreement with Pinnacle to fly 16 CRJ-900 aircraft in a 76-seat two-class configuration to help feed Delta's operations. This should enable Delta to add frequencies on routes to select midsize markets while still being able to cater to their premium class customers. But in addition to this minor announcement, Delta plans other announcements throughout the week, as it celebrates its emergence from bankruptcy. These announcements may include a major new aircraft order. Delta has dozens and dozens of older 767 variants that need replacement in the next ten years, and the airline has been rumored to be considering the 787. It's entirely possible that Delta and Boeing have negotiated an agreement for new aircraft, and are waiting to announce it until after Delta's formal emergence from bankruptcy protection for legal reasons. A Delta 787 order is a rumor, but one that makes perfect sense given Delta's need to transform into a more cost-effective carrier with an international focus. Within the few years, Delta plans on transitioning from using many of its widebody aircraft from routes within the lower 48 to international routes, where they are needed more. Delta is launching service to more and more international destinations, and has been strained to use 767s on some longer routes, such as to Lagos where the aircraft needed to be retrofitted with special crew rests. Delta needs aircraft other than 777s (of which Delta may order more as well) for its longest international routes, and since some variants of the 787 can fly farther than comparable 767s, it may make the plane even more attractive to Delta as a partner for 777s on very long routes. It's also possible that Delta will order additional short-haul aircraft, most likely Boeing 737-800s, which Delta will need as it upgrades frequencies on domestic routes when additional 767s are replaced. However, Delta may wait until Boeing or Airbus release a new 737/A320 variant before making a large purchase. Even though this is pure speculation, given the opportunity Delta has right now, a major widebody aircraft order makes sense. 

But what Delta needs even more than new aircraft is a new way to target travelers through amenities and services. Delta is upgrading its amenities on transcon and international flights, but it's still not enough if Delta wants to compete with international carriers. Delta needs to invest more in upgrading its amenities in all classes of travel. One key service that Delta needs to improve is its frequent flyer program, SkyMiles. Even though the program partners with Northwest and Continental, offering its members hundreds of ways to earn or spend miles, it is still considered by many business travelers to be one of the more mediocre frequent flyer programs in the US. Delta, and all airlines for that matter, need to make a renewed effort to increase award availability for its business travelers. Because planes are fuller than ever, airlines have trimmed the number of seats that can be redeemed with the lowest number of frequent flyer miles. Delta needs to ensure that its most frequent flyers are given preferences when searching for available award seats, but Delta also must enable those who fly less frequently to still have a realistic shot at redeeming miles. With rising ticket prices, frequent flyer miles are becoming a more important source of tickets for travelers and a more important component in a traveler's decision when choosing an airline. Because of this, Delta must do what it can to maximize availability without sacrificing revenues. If Delta doesn't take the lead on this issue, then it will hurt the airline's reputation with business travelers, which will only diminish the airline's yields and the overall effectiveness of its transformation plan.

Another service Delta plans to offer is carbon offsetting, a first for a US carrier. This is a brilliant move by Delta that I believe will serve them well in courting many younger, more environmentally aware travelers, who typically flock to low-cost carriers. Carbon offsetting is gaining popularity in Europe (though not necessarily respect, as the Guardian discusses here), and it's an important service that airlines will be expected to offer their customers within the next five years. By getting a jump on the competition in this area, Delta is preparing for a long-term trend in the industry of environmental awareness and action. Delta appears to be approaching this issue, and the other pressing issues facing the company with a long-term focus, which is exactly the kind of thinking that will keep Delta out of bankruptcy long into the future. Even though Delta will continue to encounter difficulties from all sorts of pressing issues facing the airline, now that Delta has had an opportunity to restructure, the company seems to be better prepared for the challenges it will face in the future.

Also, if you like what you read here, don't forget to sign up for Airline Bulletin posts via email under Get Posts By Email on the right side of the page. You won't be spammed, and you won't receive more than one email a day.