ROUTES EUROPE: High and Lows - The Changing LCC Model in Europe

"It’s very easy for an airline to offer low fares. It’s keeping to a low-cost operating model that’s the difficult task.” That’s the view of Heinz Joachim Schoettes, spokesperson for Germanwings, but it’s an opinion that is widely echoed by many others in the European low-cost carrier (LCC) industry.

For some budget airlines, the challenge of maximising profit margins in a market primarily defined by low ticket prices, has proved impossible in the face of intense competition, rising fuel prices and the wider economic effects of the European sovereign debt crisis, with the most recent casualty being Spanair, which collapsed in January 2012.

Others airlines have been more successful in achieving this tricky balancing act. Ryanair, one of the first carriers to adopt the low-cost model in Europe, continues to lead the pack. Last year, it carried 76.4 million passengers, up 5.1% on 2010. Second-place easyJet, meanwhile, carried 55.5 million, an 11.6% increase on its 2010 passenger numbers.

Trailing these two market leaders by some distance are Norwegian (15.7 million in 2011), Vueling (11.6 million) and Pegasus (11.3 million). According to the European Low Fares Airline Association, low-fare airlines now account for over 35% of scheduled intra-European traffic.

In the early days of European LCCs, the recipe for success didn’t vary much from airline to airline. These carriers sought to attract customers seeking the lowest fare possible and willing to compromise on amenities such as reserved seating and free baggage check-in, and they sold to these passengers directly, usually over the Internet.

They offered point-to-point services with fast turnaround times that enabled them to push up daily aircraft utilisation. They operated standardised fleets of same-model aircraft, which kept maintenance low and enabled them to drive better deals on parts and equipment. And they typically flew to secondary airports that levy lower charges, evaluating their networks frequently and quickly closing down routes that failed to reap the desired level of profits.

In recent years, however, that model has started to shift – and the evidence suggests that, in 2012, the pace of change is increasing. For a start, LCCs are increasingly seeking to boost ancillary revenues by offering new services to those willing to pay for them. According to research by Ideaworks, Ryanair generated €987 million in ancillary revenues in 2011 while easyJet made €703 million.

Take, for example, reserved seating: Ryanair trialled this service on 100 routes last summer, before rolling it out across all routes in January 2012, charging €12 for reserved seats in the first two rows and those next to emergency exits with extra legroom. EasyJet, meanwhile, began a similar trial in April 2012 and will be charging €14.7 for extra legroom seats, €9.8 for front row seats and €3.7 for seats elsewhere.

In part, the introduction of new services aims to attract more business customers, a class of customer that is simply more profitable, according to John Strickland, a former director of LCC Buzz and now director of aviation consultancy JLS Consulting. “They’re more likely to book at the last minute and far more likely to pay for ancillary services, which allows LCCs to increase revenues while still maintaining the same low costs for their other passengers,” he says.

At easyJet, customer and revenue director, Cath Lynn, is frank about the company’s goal to increase its business audience. “We think we’ve got plenty of scope to develop that sector further,” she says, adding that the company’s June 2011 introduction of Flex Fares is a good example of how it’s putting that strategy in to action. These fares may be more expensive, but don’t include booking fees and allow unlimited data changes, while also including speed boarding and one piece of hold baggage.

Some airlines go even further to offer the kinds of services more commonly seen on traditional network carriers (NCs). At Vueling, CEO, Alex Cruz, is adamant that airlines must evolve, not stick to a rigid format.

He prefers the term ‘new generation airline’ to describe his company as it describes a business model, he says, that combines the best of LCCs and NCs – a very low cost base, combined with options that include business-class travel, a frequent flyer programme, corporate accounts and booking via the major global distribution systems.

“We face intense competition and we’re based in a very depressed Spanish economy, but we’re intent on continuing to improve our product and, by next year, I think we’ll be able to surpass what’s offered by traditional carriers on short-haul services,” he says. “We’ll keep going down that road for as long as we can still find avenues to lower our costs on a yearly basis, which so far, we’ve been able to do.”

Vueling is 46% owned by Iberia, but operates more or less independently from the Spanish flag carrier. However, the differentiation provided by its hybrid approach may prove useful in light of Iberia’s launch of Iberia Express in March 2012.

Just as LCCs are starting to explore the service offerings more commonly associated with NCs, so NCs are heading downstream, and exploring the LCC model. Troubled Air France-KLM, for example, is reportedly considering starting a new low-cost service in order to compete with LCCs – although the recent strikes experienced at Iberia in response to the Iberia Express launch may give it reason for hesitancy.

Not only do NCs recognise the need to compete on price, says Strickland, but they also see LCCs as an attractive way to feed passengers into their major hubs. Iberia Express, for example, may be able to supply new passengers into Madrid-Barajas Airport.

This practice is also apparent elsewhere with a recent codesharing agreement between Lufthansa-owned carriers Germanwings and Austrian Airlines, and in Etihad’s December 2011 acquisition of a larger stake in airberlin (a member, incidentally, of the oneworld alliance). These relationships, however, can be fraught with difficulties, Strickland says.

“My personal experience from my time at Buzz [when it was a subsidiary of KLM] is that the parent company never understands their adolescent, low-cost offspring and find it hard to have a successful relationship with them,” he says, joking: “Perhaps some family counseling services [for LCCs and NCs] might be in order.”

While LCCs have to focus on every element of cost to be successful, he adds, these kinds of partnerships tend to drag them into new, complex areas – interlining agreements, for example – that previously, only traditional NCs had to deal with.

But there is one LCC that seemingly has no intention of experimenting with its model: Ryanair. Both Strickland and Cruz agree that it has so far stayed true to its mission of delivering a no-frills service at the lowest prices possible.

When asked if Ryanair would consider a business-class service, for example, the response from company spokesperson Stephen McNamara is admirably frank: “Business class is just another term for ‘rip-off’,” he said. “A business fare is just a multiple of the base fare, whereas with Ryanair’s reserved seating, the fare is the same, you only pay extra if you want to select a particular seat.”

Ryanair, he says, will always offer “the lowest fares and the customer service that matters – the most on-time flights, the least lost bags and the fewest flight cancellations.”

It will almost certainly continue to drive a notoriously hard bargain with its suppliers, too – especially airports. When the company announced plans to cut further services from Edinburgh Airport in April 2012, a public statement by airport managing director, Jim O’Sullivan, makes clear Ryanair’s commitment to vigorously paring down its cost structure remains as strong as ever.

He says: “We have tried extremely hard to negotiate with Ryanair but sadly on many issues we have not been able to find common ground. We continue not to be able to accept their wish to not pay the agreed air traffic control costs that all other airlines pay.”

Elsewhere, however, it is likely to become increasingly difficult to differentiate between ‘converger LCCs’ – those that are progressively including some aspects of full-fare airlines – with the legacy NCs, that have adopted low prices, with fewer trimmings on their short-haul routes in order to compete, says Richard Sharp, principal in the aviation practice of management consultancy firm, AT Kearney.

He expects to see far more ‘unbundling’ of services, with each airline providing a menu of add-ons in order to complement a very basic, low-cost service.

Sharp says: “The traditional concern has been that seat bookings would end the traditional low cost scramble for seats and therefore increase turnaround times. However, it would also mean that the LCCs have the opportunity to serve passengers who are turned off by this sort of low-grade process and are likely to find a shift from legacy carriers more acceptable as a result.

“It could also be seen as representing a basic minimum for carriers to operate as feeder services. The impact on price is interesting. Arguably, as most of the passengers pay for the extras, the base cost for the highly price sensitive and savvy customer on the ultimate base services could get even lower.”

What’s clear, however, is that the European short-haul market no longer offers passengers a stark choice between full-service NCs and no-frills LCCs. Instead, it is increasingly a crowded market, offering a wide (and arguably confusing) range of service options.

This story appears in the latest issue of Routes News. A copy of the latest issue of the world air service development magazine is available to all delegates at Routes Europe.

Richard Maslen

Richard Maslen has travelled across the globe to report on developments in the aviation sector as airlines and airports have continued to evolve and…