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Battle of the Low-Cost Carriers

The aviation industry has witnessed a mammoth growth in the last decade. IATA or the International Air Transport Association reported that revenues in the sector increased to $746 billion (2014) from $369 billion (2004). A significant portion of this growth can be attributed to the low-cost carrier segment, which is said to account for about 25% of the market share. LCCs or the “no-frills airlines” have cemented their operational viability by offering low-cost alternatives to the legacy carriers. Although these operate on both the short and long routes, LLCs have largely found success on short haul trips and long-haul accounts for only 6% of their traffic; albeit the latter now seems to be changing. The global popularity of LCCs has grown tremendously, with India leading the world average (accounting for about 60% of the domestic market).

The LCC model was pioneered by Southwest Airlines (USA based) in the 1970s, the sector presently comprises countless competing players along with some of the major premium carriers, which are setting up subsidiaries in the segment. An increase in tourism coupled with the falling jet fuel prices has strengthened the passenger yields leading to high profits. Three new LCCs entered the market in 2016 and offered customers a higher flight frequency. In the recent years, LCCs has started offering more advanced in-cabin facilities like the LED lights, slimline seats (which offer more comfort and enhanced leg room), audio and video entertainment and loyalty programs, etc. Other measures such as transport of cargo and passengers on the same flight and the introduction of long-haul flights may help in capturing the market further. At the same time, LCCs is concentrating on cutting down the expenses through automation of their business services.

Operating Statistics

Source: Televisory’s Research

The Ireland-based Ryanair competes directly with EasyJet (United Kingdom) in Europe. Ryanair’s fleet consists of a single type of aircraft, the Boeing 737-800; 83% of which is owned by the company. The average age of its fleet is around 6.3 years; relatively lower than the typical 9-11 years of the European carriers. EasyJet, on the other hand, functions with two types of aircraft, the Airbus A319 and A320 and have a high number of leased aircraft in its portfolio. Additionally, an increase in Ryanair’s departures by c. 4% YOY in 2015 enabled by its choice of secondary airports (low-cost and uncongested) helped bring down the turnaround time by 25-minutes.

EasyJet’s operating cost, both including and excluding fuel was higher than that of Ryanair’s. The cost difference was compounded by Ryanair’s efficient ground operations and lower airport handling and landing charges owing to a higher use of secondary airports and cities. Moreover, Ryanair hedged the fuel at around $90 a barrel and Easyjet hedged this nearly in the range of $110-125 a barrel. On the other hand, as indicated by RASM, EasyJet was able to command a higher ticket price in comparison with RyanAir. This can be attributed to EasyJet offering a more enhanced customer experience and better flight connectivity from primary airports. From 2014, Ryanair began to shift its focus towards business travellers; something that has been an area of focus for EasyJet for long. In order to achieve this Ryanair plan to expand its fleet to 546 by 2024 from 308 in 2015 and to serve 180 million passengers per annum by 2024. Ryanair issued an unsecured eurobond worth 850 million euros in 2015 to fund the purchase of these aircraft. Similarly, EasyJet’s shareholders approved the purchase of 35 Airbus A320 aircraft and 100 A320 new aircraft due to be delivered by 2021.

The US-based Southwest Airlines is the world’s largest LCC. It operates only one type of aircraft, the Boeing 737-800 with a comparatively higher fleet age of 11 to 12 years. In comparison to Southwest Airlines, JetBlue operates the one-third number of flights and has a fleet age of 7 to 8 years. Although Southwest has an average stage length of 776 miles, JetBlue operates at an average stage length of 1,092 miles. An increase in the stage length decreases the fixed costs as they are spread over a great number of miles. Adjusting for stage length, RASM and CASM for Southwest changed to $11.4 cents and $7.6 cents, while for JetBlue RASM and CASM changed to $13.6 cents and $8.9 cents. While the adjusted CASM is higher for JetBlue due to additional amenities provided to the customers, it also helped the airline charge a higher ticket price (RASM).

Southwest implemented a successful hedging strategy in the 2000s that resulted in a hedge gain of $1.3 bn in 2008. But, post this period Southwest somewhat routinely lost money due to its hedging practices with estimates, according to its 2016 hedge book that the airline will pay c. 50-60 cents more per gallon than some of its competitors. In spite of this, the company saved c. $2 bn in its fuel cost between 2001-15. However, looking forward Southwest airline will likely ratify agreements on pay raises with three of its labour groups such as mechanics, flight attendants and pilots which will significantly push up the costs further. JetBlue instead has been minimising its hedging practices over the years.

Talking about operating volume reveals that Ryanair has 28% more fleet than EasyJet, translating into ASM and RPM being higher by 53% and 46% respectively. Ryanair also has the greater stage length and a higher number of departures. However, EasyJet’s payload factor at 91% was higher than Ryanair’s 88% signifying better capacity utilisation. In 2013, when Ryanair realised that there was a problem with its load factors being lower than that of EasyJet’s, it rolled out an improvement plan “Always Getting Better” to better its in-flight experience. This included full allocation of seats, allowing customers to carry an additional small hand baggage and the CEO implemented few PR strategies to improve Ryanair’s tarnished image. This enabled Ryanair to improve its payload factor to 88% in 2015 from 82% in 2012. EasyJet also stepped up its efforts to reach out to potential customers through emails, text messages, offers from affiliates, a more interactive website and mobile applications.

LCCs too started offering loyalty programs to gain from regular customers. Although for Southwest the ASM increased by 7%, RSM increased by 9% with a payload factor of 84%. Likewise, for JetBlue, while the ASM increased by 9%, the RSM increased by 10% with a payload factor of 85%. 

Profitability Indicators

Source: Televisory’s Research

EasyJet's GP margin increased from 2013 to 2015. This was because of a higher increase in revenues than the cost of sales. The rise in the cost of sales can be attributed to high  flight maintenance expenses. Southwest Airlines GP margin increased on account of an increase in revenues and a drop-in COS, this was in turn due to a fall in fuel costs. Ryanair's GP margin improved in 2015 because of improved payload factors, coupled with an increase in traffic by c. 11% YOY to 90.6 million. The selling and marketing costs incurred by Ryanair and EasyJet were in sharp contrast. However, Ryanair’s selling and marketing expenses increased by 23% to €148 million ($204.2 million) in 2015 from €181.5 ($226.3) in 2012, EasyJet’s expenses continued to trend around €102 ($156 million).

EasyJet's pre-tax profit margin was similar to its operating margins owing to minimal interest expenses. In contrast, Southwest's pre-tax profit margin improved from 2013 to 2015 owing to lower fuel expenses even though it had a large one-time expense. Ryanair's pre-tax profit margin improved from 2013 to 2015 due to lower interest charges. However, these charges are expected to increase in the future as Ryanair further expands its fleet.

EasyJet's NP margin improved from 2013 to 2015 because of the reduced fuel costs and lower tax rates of 20% or less. Southwest's NP margin was similar to EasyJet's because of higher taxes. In addition, for Southwest, the operating costs declined in 2015 by c. 4.1% YOY resulting from lower fuel prices and continued cost control measures including ongoing fleet modernisation. Ryanair's NP margin was the highest among the three.

The competitive pricing pressures and cost efficiencies will further play out as LCCs expand into long-haul routes and international markets while capturing the market share of Legacy carriers. In future, jet fuel prices are projected to increase from $52.10/bbl in 2016 to about $64.90/bbl in 2017, which will likely pressure margins. While LCCs may go all out to slash prices to attract customers, cost efficiencies will define those that will survive and thrive in this industry.