The European Low-Cost Airline Industry
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Executive Summary
A number of strategic issues affect the European low-cost airline industry but the issues affecting the industry in the short to medium term is the rising oil prices and protectionist response of flag carriers that made the competition and the competitive environment fierce. The competition operates two-fold with low-cost airlines competing with large flag carriers and among themselves. Ryanair is a leader in the low-cost airline industry in Europe. However, these issues may require the company to improve its competitive strategy. Changes in the low-cost airline industry affect the tourism industry in terms of tourist traffic. This means the need to establish collaborative strategies to ensure mutual benefit for the low-cost airline firm and the tourism industry.
Contents Page
Executive Summary
Contents Page
Introduction
Strategic Issues in the European Low-Cost Airline Industry
Competitive Environment of the Low-Cost Airline Industry
Competitive Strategy of Ryanair
Conclusion
Bibliography
Introduction
The airline industry comprises a sustainable economic sector even with constant bouts with the industry’s business cycle. This is because air transportation has become an important part of the global economy supporting other industries such as tourism and trade (Kuller 2007). The resilience of the industry depended on its experience with a number of challenges resulting to changes in the strategies of individual airline companies and the competitive environment. Factors that significantly affect the airline industry include economic factors, new market structures, marketing strategies, human resource management, and technological innovation. The sustainability of the aviation industry does not mean it is free from difficulties since aviation is one dynamic industry. The most recent change experienced by the aviation industry is the rise of low-cost airlines applying mass-marketing strategy to draw the largest market segment and support entry into the aviation industry dominated by large firms. Low-cost airlines operate through three factors such as no frills, low operations cost, and mass market positioning.
Source: (Mercer Managing Group 2002)
The emergence of low-cost airlines had a two-fold impact. One is on the business model employed by industry players and the other is on the aviation market. Prior to low-cost airlines, the business model of existing players focused on quality-based differentiation so that airlines developed first class luxury airplane amenities but at higher costs (Morrell 2005) but with the entry of low-cost airlines the business model is cost-leadership by offering basic and convenient air transportation services at lower costs. (Doganis 2001; Iyer & Muncy 2005) This caused existing large airline companies to introduce low-cost airline services alongside their existing services that increased the number of players. The effect on the market is the provision of consumer choice because of the different service values as well as many airline companies from which to choose. As such, the number of travellers for business or tourism increased in many regions such as Europe.
Strategic Issues in the European Low-Cost Airline Industry
The competitive environment of the European low-cost airline industry is again changing as the industry experience competition from more players as well as difficulties in stringent and protective regulation in different European countries. Since 2004, there are now more than fifty low-cost airlines serving the European market. (Rowe 2008) The ease in market entry resulting in many players made cost as the basis of competitive advantage for low cost airlines. The ability to draw consumers depends on the delivery of basic air transportation services at the lowest cost and least inconvenience to passengers. Profit earning at low service costs depended on the ability to draw the greatest number of regular passengers or frequent flyers. (Kuller 2007) For a time, the low-cost industry experienced growth with Ryanair, easy Jet, and Virgin Express emerging as the top players in the cost-based competition. As much as growth meant profit for low cost airlines, this also implied the saturation of the European market. This means that the industry needed to focus on maintaining loyal customers to prevent brand shifting and expansion into new routes and destinations. However, low cost airlines also needed to expand to other markets requiring the need to establish new routes to reach new markets.
In addition, strategic issues also arise within the characteristics of the low-cost industry. First characteristic of the low-cost industry is deregulation. This is a process, which refers to the elimination of airline restrictions particularly the limitation of carriers in serving specific routes. (Dempsey & Goetz 1992) Deregulation has a number of implications. One is the ease in entering the international market resulting to the internationalisation of competition. Another is the greater integration of industry players in order to pool market and resources as well as ensure competitiveness. However, the intensified competition among low-cost airlines resulted to the need to devise a more effective strategy still based on cost leadership but augmented by other value offering to ensure customer loyalty and retention. The business model of low-cost airlines is similar so that flyers can shift from one airline to another depending on their routes and available destinations. Although Ryanair augmented its low cost strategy with functionalities while other airlines augmented their low cost service with emotional values, there is still need to establish these differences in order to draw consumers. In addition, the widespread operation of low-cost airlines posed a challenge to the different large airlines.
Recently, a challenge to low-cost airlines is the stricter regulation of Italy in allowing other airlines to enter Italy as part of its route or destination. Italy has a flag carrier that controls most of the routes in its territory. The stricter regulation in allowing entry to other airlines meant that the government is trying to protect its flag carrier from the expected impact of unfettered entry into the market. Ryanair is fighting back by appealing to the European Low Fares Airline Association to make a move to address this anti-deregulation practice. (Gesar 2007) Other countries especially those with flag carrier airlines also have the tendency to act in a similar manner especially with the entry of low-cost airlines sharing in the market or even pulling customers away from the traditional flag carrier airlines.
Second characteristic of low-cost airlines is the heavy reliance on strategic alliances (Dempsey & Goetz 1992; Kuller 2007). This is necessary to facilitate entry into the international market as well as share routes. Not all airlines gain access to routes so that alliances for connecting trips are necessary to gain access to more customers and market segments. An example is a low cost airline wanting to service customers coming from Europe and going to Asia. However, the low-cost airline is unable to gain permission in the Asian country considered as the destination. The low-cost airline has the option to seek alliances with other airlines with destination routes in Asia to provide a connecting flight from the limit of the route of the airline and bring passengers to Asia. As such, the low-cost airline is able to gain customers going to Asia.
The strategic issue is determining significant alliances and sustainable trade routes (Domanico 2007). Although low-cost airlines follow a mass-marketing business model so that they experience the need to reach the widest possible market, they also need to identify sustainable routes and strategic partners to maintain cost effectiveness. Entering new markets involve costs and the inability to establish a market would mean losses that would affect the cost structure and eventually the price of service. Losses mean the possibility of raising prices or incurring additional cost for marketing and promotional activities to draw more consumers to gain revenue to augment the losses. Strategic partners are also crucial to successful market entry. Low-cost airlines highly depend on cost-cutting activities so that effective partners are airlines that allow the airline to cutback on cost in terms of routes and marketing activities requiring alignment between the business goals of the airline and its partners.
Third characterisation is dependence on cost effectiveness (Dempsey & Goetz 1992). This makes low-cost airline sensitive to factors affecting cost. In Asia, the SARS outbreak led to a slowdown in passenger traffic resulting to the failure of many airlines to meet basic operating costs leading to the decrease in the number of fleet. In Africa, political and civil unrest also affect the cost structure of many airlines. In all regions, the threat of terrorism affected operations because of fear and security concerns among passengers. Recently, the continuous increase in fuel prices also affected the cost structure of low-cost airlines. These factors challenge the cost-based marketing strategy of low-cost airlines especially since these factors comprising the external business environment of low-cost airlines does not afford them control. Low-cost airlines need to rethink the low-cost strategy and determine ways of decreasing cost as well as establishing means of justifying increases in cost in case this becomes inevitable.
Fourth characterisation is access to Internet technology in reaching out to consumers (Kuller 2007). Technological innovation can contribute to cost-effectiveness by providing a widely accessible and cheaper means of communicating with actual and potential consumers as well as linking business partners in arranging the itinerary for passengers. While many low-cost airlines including Ryanair have fully embraced the Internet as a tool, the possible benefits of the Internet have yet to be exhausted.
In the short to medium term, low-cost airline industry in Europe needs to contend with two strategic issues. One is the challenges to its low-cost structure especially low price hikes. Another is the heightened protectionist stand of countries towards the entry of low-cost airlines in favour of their flag carriers.
Competitive Environment of the Low-Cost Airline Industry
Low-cost airlines compete with each other as well as with large airlines, particularly with national carriers likely to respond defensively to the entry of low-cost airlines. Competition is due to the growing number of business players because of the limited barriers to for the low-cost industry so that there are now more than 50 airlines operating in Europe. The current competitive environment reflects the response of current players to the threat posed by the new market entrants.
As mentioned earlier, the case of Italy expresses the intensified competitive environment in Europe because of the growing number of players and the saturation of the market. The response of the aviation department of Italy is to protect its flag carrier by enforcing restrictions in granting route access to low-cost airlines. (Gesar 2007) Low-cost airlines pose a threat to traditional or full service airlines, especially flag carriers because of the differences in business model and strategies as shown below. One difference is the low-cost model of low-cost airlines that allows these competitors to reach a wider market segments. By operating on a business model of high cost, national carriers limit their market segment. With rising prices of fuel and recession in major economies such as the United States that also affected Europe to a certain degree, the middle-income groups or even the lower rung of the upper income group are likely to sway towards low-cost airlines resulting to decline in their markets.
National Carriers
Low-Cost Carriers
Business Model
High Cost
Low Cost
Network
Global alliance
Point-to-point alliance
Fleet
Different planes
Standard planes
Product
Full service
Self-service
Sales Policy
Sales departments, global distribution system (GDS)
Direct sales (customer service & online)
Source: (Keller 2002)
Another difference is the purpose and scope of networks. National carriers establish global alliances to reach different destinations worldwide while low-cost carriers slowly spread their routes outward depending on perceived demand and performance by establishing point-to-point alliances to bring passengers to these destinations. This means that national carriers are likely to concentrate on destinations with the highest traffic while low-cost carriers concentrate on areas that could create high traffic. This provides low-cost airlines with a promising potential for market expansion that threatens the market of national carriers.
Still another difference is the manner of reaching out to consumers and handling the point of sales. National carriers operate through sales departments as well the global distribution systems (GDS). As such, flag carriers only have contact with passengers during actual transit resulting to the reliance of these large airlines on activities to ensure satisfaction. Low-cost airlines communicate to passengers directly through its customer service as well as direct booking system. There are more points of contact between low-cost airlines and passengers so that even if these airlines only offer basic services, these airlines are able to draw sufficient information to know the no frills services that consumers are likely to demand.
Due to the perception of large firms and national carriers towards low-cost carriers as threats, these apply aggressive strategies making it difficult for low-cost firms to continue making market breakthroughs. In effect, the competitive environment involving large firms and national carriers with low-cost carriers is fierce. The map below shows the extent of penetration of Europe by low-cost airlines.
The highest percentage of penetration of low-cost airlines is in the United Kingdom followed by other Western European Countries such as France, Germany and Switzerland. Thee extent of penetration also reflects the strategy of low-cost firms of expanding inside out and since the leading low-cost airlines were established in the United Kingdom, the spread outwards is towards other Western European countries and then towards Eastern European countries. In addition, the penetration of Western European countries is also due to the privatization of the flag carriers resulting to lesser regulation for new entrants. In most Eastern European countries, flag carriers remain government owned and controlled resulting to protectionist policies towards new entrants.
Competition within the low-cost airline industry has also intensified for a number because of a number of reasons. One is the entry of many low-cost airlines in Europe including the American low-cost airlines Southwest Airlines that is one of the first to operate within the low-cost framework. Another is the need for the top performing low-cost airlines in Europe to enhance market distinction from the other leading low-cost airlines. This is necessary to ensure clear communication of service or brand value and build brand equity in the market. Otherwise, the market can just select one low-cost airline over the other without considering brand equity and service value in consumer decision-making.
Currently there are 63 low-cost airlines (Kuller 2007). There could have been more but many airlines have closed because of the inability to penetrate markets as well as to maintain low costs to support lower prices. As the fuel prices reach record level highs in 2008, many low-cost airlines may no longer be able to sustain low cost resulting to the possible decrease in the number of low-cost business firm through mergers or closures.
The rising fuel prices and the increasing pressures of competition (Gesar 2007) seem to have affected the performance of the stocks of two of the leading low-cost airlines in Europe, Ryanair and easyJet. The graph shows the performance of the two airlines in the last year and the shares of both companies are at a downward trend. This means that the performance of these companies have dwindled in the past year and expected to remain so until the end of 2008. If the two leading low-cost firms are experiencing declines in performance, so would the other low-cost airlines because the greater challenge in maintaining the low-cost business model amidst rising operating costs.
Source: (London Stock Exchange 2008)
Competitive Strategy of Ryanair
Ryanair is the leading low-cost airline in Europe. It reached this position because of the aggressive leadership practice of O’Leary in identifying profitable routes and defending these from regulatory challenges and competition. The business strategy of Ryanair revolved around simplicity, efficiency, optimisation and performance. As a result, Ryanair has multiplied its number of passengers from 700,000 in 1991, to 9 million in 2001, and 42.5 million in 2006. The number of passengers should reach 70 million by 2012. (Ryanair 2008) By 2005, Ryanair adopted a ticket-less system so that all reservations or sales are made over the Internet. Ryanair expanded into other markets and locations by banking on the responses of different local communities in subsidizing the airline in exchange for bringing people into the these regions. This strategy linked the air transportation and tourism industries.
Ryanair has changed its competitive strategy moving from a purely low-cost strategy to an integrated strategy to adjust to the changing competitive environment. The table below compares the initial strategy of Ryanair with three other leading low-cost airlines in Europe, which are easyJet, Virgin Express, and Buzz that also applied the low-cost structure in an attempt to establish a point of distinction to establish a regular or even loyal customer base.
Ryanair
easyJet
Virgin Express
Buzz
SIMPLE PRODUCT/NO ‘FRILLS’
HIGH
• Genuine no-frills offering
HIGH
• Genuine no frills offering
LOW
• Hybrid operating
design (low cost wet lease and
charter)
HIGH/MEDIUM
• Use of KLM lounge, provision of reservation services
LOW OPERATING COSTS
HIGH
• Services secondary airports
•homogeneous fleet
• Minimum cost base
HIGH/MEDIUM
• Services major
airports resulting to higher turnaround cycles and fees
MEDIUM
• Services major
airports resulting to higher turnaround cycles and fees
MEDIUM
• Services major airports resulting to higher turnaround cycles and fees
• 2 kinds of planes
POSITIONING
HIGH
•Straight-forward, aggressive low-cost positioning
HIGH/MEDIUM
• Low-cost position,
except for major airports
LOW
• Unclear position:
low cost, code
share SN, charter
MEDIUM
• Major airports
• Bulk customers
• Business focus
Source: (Mercer Management Consulting 2002)
The low-cost business model involves three operating considerations, which are the simplicity of product, low operating cost, and clear positioning in the market as a low-cost carrier. Of the four leading low-cost airlines, only Ryanair was able to receive high ratings for all these three factors. This means that it was able to implement fully the low-cost business model by offering a no frills service to consumers in a cost effective manner and has been able to establish and sustain its operations by living-up to the low-cost model. The other players implement the low-cost strategy in part or by developing hybrid versions.
Full adherence to the low-cost business model enabled Ryanair to gain an edge over its competitors. One, it was able to provide the lowest cost for the no frills services similar to its competitors and the ability to drive down cost is one measure of a successful low-cost competitive strategy. Another, Ryanair was able to establish to consumers the company as a low-cost airlines as part of its marketing strategy. As such, it experiences the benefit of having to claim the ability to offer the lowest cost relative to its competitors. The aggressive competitive strategy and widespread market reach of the company resulted to its reaching a leadership status.
However, with the entry of new players, cost leadership strategy alone was not sufficient to support competitive sustainability. New entrants provide options to consumers making it more difficult to offer low cost value alone especially in meeting the different demands of the target consumers. In addition, factors such as terrorist threats has affected demand and with a large supply of low-cost aviation services results to a limited or highly saturated market making it challenging to operate through a low-cost structure alone. As such, Ryanair shifted to the strategy of integrating cost leadership with functional benefits such as efficiency and punctuality. This is different from the strategy of other low-cost airlines of integrating low cost with emotional benefits. This indicates the effort of Ryanair to integrate low-cost with differentiation strategy. The differentiation strategy applies because of the determination of low-cost value augmentation that is different from its competitors. While its competitors considered emotional benefits such as the design and color of airplane seats and walls or the manner of interaction between personnel and employees, Ryanair went beyond these value offerings to focus on timely service to bring passengers to their destinations on time at low costs. At present, Ryanair is maintaining its low-cost structure augmented by functionality values while seeking out possible ways of augmenting its service as fuel prices continue to rise and the European economy experience a slowdown.
Based on these developments and expectations of future changes in the competitive environment in the next years, a future competitive strategy for Ryanair is still to maintain its low-cost operating structure. The increasing fuel prices mean that the company’s operating expenses is increasing. In the short-term, the company may have to assess its routes and alliances to determine possible cancellations or stoppage to enable the company to maintain its cost leadership. In addition, it has to determine other ways of decreasing its operating costs but ensuring the provision of no less than the no frills service augmented by functionality values.
In addition, the airline also needs to augment this with more differentiating values to keep the airlines in the leadership position in terms of low cost service while at the same setting the airlines apart from other low-cost airlines. Additional areas comprising augmentation for its low-cost structure include the establishment of promotional and reward activities for its passengers such as on the spot discounts for randomly selected passengers or discounts for frequent flyers. The airline needs to create closer links with its consumers to ensure satisfaction and ensure loyalty. The serious business-like tone of the no-frills service may not be sufficient to support patronage of the firm. This serves as a security measure in case fuel prices continue to increase.
Furthermore, Ryanair also needs to prepare to service the routes vacated by the airlines that would close because of rising fuel prices and competitive measures. The statement of O’Leary that there would only be two low cost airlines by 2008 has not come about and not likely to come true because this would be contrary to the low-cost business model and the low-cost industry remains to be a viable industry regardless of the challenges that it faces. Nevertheless, Ryanair needs to consider possible industry players likely to close and fill the vacated routes or merge with these firms to continue the service. It also has to continue establishing partnerships with local communities engaged in tourism activities to bring tourists to these communities in exchange for referrals and booking arrangements with Ryanair.
Conclusion
The European low-cost industry is changing because of changes in rising fuel prices, protective regulatory response of national carriers, and market saturation. These changes are influenced by tourist traffic in the same manner that the low-cost airline industry has affected tourist traffic. As such, negative developments in the low-cost industry would also have an effect on the tourism industry. As such, there is need for collaboration between the two industries to ensure positive outcomes for both industries.
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