Airline Management - Critical Review of LCC Vs Legacy Carrier ATM-II

Airline Management- Critical review of LCC Vs Legacy Carrier

By P.S.ASHWIN KUMAR Email Id: psashwin_aero05@yahoo.com Cell no: 09885326003 Center: Hyderabad (Executive PGDALATM)
ABSTRACT: The airline industry is a young industry. It has been well regulated and protected, and this was probably necessary during the establishment of operations at a satisfactory level of safety. However, like in any protected industry, the protection resulted in the airlines becoming fat and lazy, and the cost and effectiveness left a lot to be desired. World over, the airline industry is seeing turbulent times with increasing operational costs ,rising oil prices, decreasing passenger capacity and other significant factors. Recently, a number of airlines filed for bankruptcy. In an attempt to survive, airlines embarked on rapid cost cutting initiatives. But there is one airline model that defies all this and manages to bring in profit to the industry and the air travel within the reach of common people, a business practice that is turning heads towards it and forcing the conventional carriers to rethink their strategy and their pricing, a model that is now being taken up as a case study in major b-schools around the world. This is the world of the Low Cost Carriers. For the past five years, low-cost airlines have been growing at more than 40 per cent a year, while the full-service airlines are yet to recover from the crisis that hit them post 9/11. Many of these low-cost airlines, be it Southwest Airlines, EasyJet, RyanAir or even AirAsia, have had such a great run that they are taught as case studies at leading
P.S.ASHWIN KUMAR (M.Tech, Aerospace), PGDALATM, HYDERBAD, EXECUTIVE BRANCH
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business schools across the world. And the CEOs of these low-cost airlines now see themselves as a tightly-bound community of evangelists who have an avowed mission: to make air travel accessible to more and more people. THE LOW COST AIRLINE: WHAT IS IT? Let us begin our analysis by taking up a traditional airline. It has all the luxuries that money can afford viz. hot meals, frequent flyer programmes, decent legroom, and a full complement of air-hostesses. Now delete all this, and what you get, to say brusquely and simply, is the low cost carrier. The low cost carriers do not offer any extra luxury like those mentioned above, but it all comes down to making air travel more affordable. They do not issue flashy tickets, do not have a transfer connections, but operate on a point to point basis, do not have onboard meals giving additional space for more passengers, spend more time on the air than conventional carriers, have quick turnaround times in airports, do not use busy and major airports but use secondary airports with lower landing and parking charges. They maintain a uniform fleet to reduce operational and maintenance costs. The merits of low cost carriers are endless and the above mentioned features are some of the few. Let us go ahead and see how these changes represent a paradigm shift in the ailing airline and aircraft industries. WHY A LOW COST AIRLINE? Low cost carriers (LCC) satisfy a basic need of humans, the need for man to travel, to explore, to push his boundaries and to connect with people and places he had never dreamt of reaching. The rich man travels by jet; the poor man by rail, bus or foot. But these means of
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transportation are limited. Jet aircraft land only at big airports - what happens to the urban man with rural roots who wants to visit his native small town? What happens to the working woman who wants to visit her family living far away from the big cities? LCC bridge the gap and fill the need of the common man - they connect people in all walks of life to different and previously untouched sectors in the country. The low cost carrier industry is a nascent industry in India and so this paper cites examples from global carriers that include Southwest and JetBlue from the United States, RyanAir and EasyJet from Europe and other regional carriers from Australia and South East Asia NO FRILL SERVICE: The fundamental and obvious principle of a low cost carrier is that they operate a no frill service. That is to say, they do not provide onboard meals, no complementary drinks, and provide nothing more than the bare essentials. Instead of providing a menu of product choices priced within a range, these carriers offer a single type of product, coach system .This results in cutting the costs by upto 3.2%. No meals on board mean you don't need the extra space for storage. Instead, you can add seats. In the typical Jet and Indian Airlines layouts, one could increase the seat factor by as much as 20 per cent by pulling out the business class, reducing the seat pitch (how far the seat can incline), and throwing out a couple of galleys. Now, if you can put in three extra rows, then you get (6x3) 18 seats more. In a 120-seater aircraft, if you get 18 seats more, you are up by 15 per cent. Also, these airlines lack elaborate loyalty programs, which necessitate extra employees, to provide more personalized service, and expensive facilities, like airport clubs. Low-cost airlines do not provide costly services, which are only profits enhancing
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for a hub-and-spoke carrier able to extract a high level of rents from customers with a high willingness to pay, business travelers. The main advantage of the low-cost carrier is that it can compete on price, with the high-cost traditional carriers.
POINT TO POINT CONNECTIVITY:
The next major feature of the low cost carrier is that they operate on a point to point basis. That is, they do not offer connecting flights like the traditional hub-and-spoke system. In this system followed by most major carriers, the aircrafts have to wait at an airport till all the connecting flights have come in. This, added with the baggage transfer from one aircraft to another often leads to flights being delayed. The system provides customers a high level of convenience but creates operating inefficiencies In a point to point service, a passenger traveling on two different aircrafts isnt issued a single ticket. Instead, he is given two tickets for the corresponding destinations. The passenger has to carry his baggage from one aircraft to another and check in once again. The airline doesnt owe the passenger an explanation when the first flight gets delayed and he is forced to miss the second flight. The contract is to take the passenger from point A to B and if the airline doesnt do it, it returns the money.
THE DISTRIBUTION FACTOR:
Another factor on which the airlines cut costs is on distribution, which can be 11-15 per cent in a conventional airline. They do this by not going through the travel agents and the existing central reservation systems like Amadeus and Galileo. Instead, they sell through the Internet and call centers - EasyJet in Europe even has its website
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address painted on its plane. These airlines don't issue a ticket, as it costs to print mail and process tickets. What the passenger gets instead is a booking number when he makes a reservation. Passengers have to quote this number at airport check-ins, and present their photograph ID to collect their boarding pass. Air Deccan, has developed its own online booking system, which has helped it reduce the distribution cost by a major margin. LABOUR COSTS: One of the major factors in reducing the airline operation cost is in labour costs. The higher number of personal required per flight to effectively operate a traditional hub may be an important factor in the different cost structures of traditional and low-cost carriers. The two most prominent low-cost carriers, JetBlue and Southwest, both have lower labor costs than the large incumbent carriers. Analysts estimate that Lowcost carriers such as Southwest and JetBlue have labor costs 30% to 40% lower than the mainline carriers. For example, United Airlines, American Airlines, Northwest Airlines, and Continental Airlines all have costs at least 40% higher than Southwest. Although, Delta Air Lines and Alaska Airlines have the lowest costs of the majors, each of them has unit costs 30% higher than Southwests. While labor costs are the largest single cost item for airlines, there are many other costs. The cost differential between the low-cost and major carriers is not only attributable to the wage differential. Although, the primary cost for any carrier is labor related. Controlling labor costs can improve the bottom line. The operating cost distribution suggests that lowering labor costs by 10% can lower the average airlines total cost by 36.8%. LONGER FLYING HOURS
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The low cost carriers manage to bring in more revenue by being on air for a longer time than conventional carriers. This enables them to cut the fare further. While most full-service airlines like Jet take at least an hour to leave an airport after landing there, Deccan can do it in 15-20 minutes for ATRs (and about 30 minutes for its new A320 service.) So, if Deccan does six sectors a day, it can fly one additional sector a day. This allows it to fly 20-30 per cent more than a full-service airline. On an average, the conventional airlines fly their aircraft for 8-9 hours a day, while a low-cost carrier is able to keep its planes airborne for 11 hours a day. It is only by more hours of flying that you can give a lower price,. In fact, it is able to make the same revenue with fewer aircraft.
DIFFERENTIAL PRICING SYSTEM
One of the remarkable features of Air Deccan, the low cost pioneer, is a differential pricing system. This was introduced previously as Apex fares by the major players, which allowed the passengers to buy tickets at a price that was as low as 40 percent of the original fare. In the Deccan system, the price of a ticket is as low as Rs.500 for those who book there tickets 3 months prior to their journey. And it increases as the days decrease. Even then, the last day fare comes only to about 60-75% of other carriers. This is done to generate a good passenger capacity, known as the Passenger Loading Factor (PLF). Air Deccan at present has a PLF of around 75% while other carriers have only around 40-50%. This not only generates the required revenue, but reduces the operating costs too. UNIFORM FLEET: The low cost airlines usually maintain a uniform fleet of aircraft. This reduces the costs involved in training personnel, maintaining the
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fleet and allows the airline to shift its pilots and workmen between aircrafts easily. It also won't have to worry about carrying spares for three different kinds of aircraft. That generates economies of scale.
USAGE OF SECONDARY AIRPORTS:
A major factor involved in the cost reduction, not followed in India though, is the usage of secondary airports. For every major metropolitan airport there are often two to three secondary airports. Lowcost carriers can achieve fast turnarounds and pay less for leasing airport facilities at secondary airports Low airport lease rates and gate costs also contribute to the lower cost structure of low-cost carriers. Under utilized secondary airports often levy lower charges for the use of their facilities. In comparison, hubs require a large number of gates and personnel per flight, due to the banks of flights that are used at hubs. The banks of flights result in the majority of flights arriving and departing within 20-30 minutes of each other. These peak periods result in a high demand for facilities and personnel for short periods of time. For example, at its Dallas Fort Worth hub, American operates banks of flights to make connections convenient. While at neighboring Dallas Love Field Southwest spaces its flights out due to the lower emphasis it places on connecting traffic. Like other hub-and-spoke carriers, American Airlines has peak times when a considerable number of planes land at its hubs and passengers rush off to get on their next flight. The system provides customers a high level of convenience but creates operating inefficiencies. Employees stand around between peaks. Planes sit on the ground longer and get caught in line waiting to take off. The hub-andspoke structure raises an airlines costs at a hub compared to operating that same hub with a de-peaked structure. In particular, the higher number of personal required per flight to effectively operate a traditional hub may
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be an important factor in the different cost structures of traditional and low-cost carriers.
THE IMPACTS: INCREASE IN PASSENGER DENSITY:
The entry of these low-cost carriers will have several far-reaching implications for the aviation sector in India and, to a wider extent, on the mass transportation industry and domestic tourism. In a country of a billion people, the Indian aviation industry is puny. We have 12 million people who travel by air every year against 3 million passengers who fly everyday in the US, even though its population is one-fourth that of India. The number of daily flights in India averages just about 400 a day, as against 40,000 flights a day in the US. RyanAir, among the low-cost pioneers in Europe, flies 25 million people in a year and still has less than 5 per cent market share. Closer home, in Malaysia, there are 12 million people who travel by air yearly. Look at it another way: India's 200million middle-class population is equal to that of the whole of Europe. Even if we assumed that only one-fourth of that large middle-class could afford and would be willing to travel by air, it would call for at least a 56-fold increase in capacity. DEMAND FOR AIRCRAFT: The increased demand for air transportation triggered by the entry of the low cost airlines will in turn generate a demand for newer aircrafts to meet the demand. The aircraft industry which had been facing a declining trend after the September 11 attacks is now facing brighter times with the order for aircrafts. In the year 2002, RyanAirs order accounted for 54%
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of Boeing's 184 aircraft orders year to date while EasyJet order accounted for 44% of that years order at Airbus - so the terms are likely to favour the airlines. In India, the present aircraft strength of 174 of all the aircrafts put together is set to touch 307 in the next 5 years. Air Deccan has ordered 32 new aircrafts worth around 2 billion USD to expand its fleet. Another low cost carrier in the offering has ordered 30 aircrafts worth around Rs.8000 crores. All this leads to an increase in the demand and development of new aircrafts with an eye on reducing maintenance costs and increased efficiency. GROWTH DRIVERS: The growth drivers for the low cost carriers are stipulated below State of the economy Market stimulation from low-cost carriers Price cuts Increasing customer acceptance for flying THE CHALLENGES: A study by the Mercer Management consulting company finds that the yield of the low cost business model is expected to decline due to Surplus capacity Struggle for survival among carriers in poor financial straits Competition from low-cost carriers Further market entrances from new competitors The report finds the challenges faced by the LCC include: Rapid occupation of new markets (first mover advantage) Build up and safeguard dominant market position
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Strict cost management and retention of pure low-cost business design A recent study by the McKinsey & company finds that world over the low cost aircraft industry will grow at a tremendous pace till the year 2007 after which it shows a decline which is attributed to three reasons :
Increasing competition among low cost carriers in international
traffic
Strong position of national airlines on important domestic routes Dominance of the tour operators in the package tour segment for
pure tourist destinations THE FUTURE: So, what are the possible future scenarios? Over the next few years, one can expect to see a complex system of low-cost airlines. Depending on the amount of capital they are able to raise and the business plan they formulate, some will ply on the trunk routes, others on the Class A and B towns and then, some will operate purely as air taxis. In India, for the moment though, Deccan remains a small player, flying just about 1,6001,700 passengers a day and expects to achieve a turnover of Rs 450 crores by end of March 2005. Jet, on the other hand, had operating revenue of Rs 2,876 crores in 2002-03 with a fleet size of 41. So the critical question is: do the LCC have the deep pockets needed to withstand a price war? Much will depend on how traditional carriers react. One possibility is that they could begin offering more seats under the apex scheme fares than the current level of 5-10 per cent. Fortunately, a low-cost airline has the advantage of being a model that throws up cash much faster than its fullP.S.ASHWIN KUMAR (M.Tech, Aerospace), PGDALATM, HYDERBAD, EXECUTIVE BRANCH
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service counterparts. So, if Deccan can survive the price war for the first year or so and scale up, it will soon reach a size where Jet and the rest cannot undercut without losing massively in the bargain. It is always simpler to drop prices if you are trying to take on a company with just three planes. If, Air Deccan, however, scales up fast to 100 planes or so, the others cannot undercut it without maiming themselves. Even if it does scale up, there's another possibility: success will soon attract imitators. In Europe, the original pioneers, RyanAir and EasyJet, are suddenly faced with too many new competitors in the same low-price segment, sparking off an intense price war. To attract customers, they are cutting prices to unreasonable levels, impacting the profitability of the entire sector, say analysts. Some low-cost airlines also lose their bearing and begin adding frills like assigned seating, hot meals and in-flight entertainment to attract some of the more comfort-seeking customers. But that leaves them exposed to being undercut by a new competitor who focuses exclusively on price. Anything (like frills) that adds costs and reduces price competitiveness is a bad trade-off. After all, if you get them on price, you could lose them on price too. In the low-price sector, only those with the lowest costs survive in the long run, and scale does matter in delivering the lower costs. After all, it comes down to good business management in the end. CONCLUSION: World over, low-cost airlines have begun to radically change the rules of the business. In market after market - be it in the US, Europe and, now, Australia and South-east Asia - the low-cost model has expanded the market, and gained significant share. Full-service airlines have responded in one of three ways: restructure their
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operations, launch their own low-cost airline. Or simply get crippled whatever is the outcome, the customer is the winner.
SOURCES: o The New Low Cost Warriors Business World, July 5,2004
o Low-Cost
o
o
o o
o
Carriers and Low FaresCharles Najda,Department of Economics ,Stanford University Flights of Fancy The Industrial Economist Impact of Low Cost Airlines :Summary of Mercer Study Mercer Management Consulting The Emerging Airline Industry A joint study by A T Kearney ad the Society of British Aerospace Companies Budget airlines in Europe McKinsey & Company Low Cost Airlines, A revolution in Asian Airline IndustryDerek Sadubin, ALAANZ conference, Sydney
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