The Low Cost Aviation History

Published Date: 02 Nov 2017

The term "low-cost" in aviation refers to airlines with a lower operating cost structure than that of their competitors. According to Pompl, different airline business models are: scheduled, charter, low-cost airlines and freight carriers (Pompl, 2002). The idea of low-cost airlines was born almost 40 years ago, when a Texas lawyer Herb Kelleher decided to make people happy by regular intra-state flights. After a series of drawn out legal battles instigated by other carriers and several years spent getting the license, Kelleher created a precedent and in 1973 a new carrier, Southwest Airlines, was set up. The concept was "Spartan conditions for low prices". In two years, the airline became profitable and stayed profitable ever since.

Low-cost strategies became popular in the period of 1990s with their rapid spread around the world. The recent growth of low-cost carriers leads some authors to the statement that the most dramatic impact on air transportation in Europe will come from the rapid growth of low cost, no frills airlines (Doganis 2001). There are several points of view as to why it took almost twenty years for low-cost strategies to be implemented. Regulatory liberalization is the first explanation. The agreement for the setting up of the Single Aviation Market of the European Union in 1993 gave opportunities for new entrants, which never existed before (Shaw, 2004). Airlines from member states can operate with full traffic rights on any route within the EU and without capacity restriction even on routes outside their country (Doganis, 2001). Internet as a distribution channel was also significant - it was a part of a fast and cost-effective model because it simplified the process of reservation procedures. Also the changing nature of business air travel market provided an explanation for the growth of low-cost strategies (Lawton, 2002). Until the 90s, business travelers were the main consumers of airline services, the companies advertised travelling by plane as something prestige and status. Nowadays the air travel market is diversified and includes not only business customers but also leisure travelers who are not ready to spend as much of their savings on air travel and find the process of flying solely as a means of getting from point A to point B. According to IATA "aviation fosters economic development by providing and enhancing access to regional and global markets. It is a key driver of business, travel and tourism exports and it creates employment around the globe [ ] raises living standards and alleviates poverty…" (IATA, 2003a, p. 2). The steady reduction in the cost of air fares is making air travel more attractive to tourists. This reduction of costs and hereby air fares is partly derived from improved technology (aircraft have become larger, faster and are able to carry more passengers) and partly linked to the fact that airlines upgraded their fleets and made second-hand aircraft available (at low cost and in good condition) to other airlines (Pender, 2001).

The first low-cost airline in Europe was Ryanair which was founded as early as 1985 serving the market Ireland-United Kingdom. It was mostly used by people working abroad and flying home to visit their families. Ryanair offered cheaper flights than British Airways or Aer Lingus and served routes that had not been considered before. As the demand for the Ireland - United Kingdom connection was high, Ryanair expanded very fast. Despite the increasing demand, the airline was almost bankrupt in 1991 and they had to restructure their business strategy (Calder, 2003). Following the example of Southwest Airlines (the biggest low cost airline in the United States) Ryanair introduced the low cost concept. The fleet was standardized and unprofitable routes were cancelled. In return, the airline was cheaper and flew more frequently. Ryanair opened a new market in the United Kingdom and other start-ups followed, like easyJet and Go. Go was the first low cost airline founded by a traditional airline (British Airways).

Table 1 gives a summary of some major European low-cost airlines:

Low-cost carrier

Country

Founded

Ryanair (&Buzz)

Ireland

1985

Virgin Express

Belgium

1992

Easyjet (&Go)

UK

1995

Germanwings

Germany

2002

Wizz Air

Hungary

2003

All the low-cost airlines that operate in the European market follow more or less the model of the most successful low-fare airline in the United States: Southwest Airlines. The strategy of Southwest Airlines includes:

• Establishing a corporate ethos of ongoing and rigorous cost reduction

• Translating these savings into lower prices than competitors

• Growing existing markets through stimulating demand with the low prices

• Developing markets neglected by competitors such as secondary routes or visiting friends and relatives (Lawton, 1999)

Low-Cost Aviation Principles

Distinctive product

The nature of low-cost is to be able to buy tickets at a very low price. The major invention though was not only low level of fares but also the availability of such fares on a one-way single basis and with no minimal restrictions. Until the low cost model came to Europe all the low fares offered by the conventional scheduled airlines were beset by restrictions such as the need to stay a Saturday night (Doganis, 2001). Fully flexible travel is possible through simplified pricing structures based on demand-regulated single fares or flexible return tickets (Pender & Baum, 2000). The product is simple. People travel ticketless in one class and they cannot make a seat reservation. There are no free drinks and meals on most flights and no business lounges at the airport. This simple product leads to cost savings which enables these airlines to offer cheap fares. Unlike traditional scheduled airlines low-cost companies have a different yield management strategy. They first sell the cheapest advertised fares and then they progressively move to higher fares as departure dates approach. Ticket prices end usually way above the advertised fares. Pender calls this a "first come first served basis" (Pender, 2001, p. 173).

Low fleet costs

Most of low-cost airlines use a so-called "fleet commonality" policy, according to which the company use one type of aircraft in the fleet. Low-cost airlines often purchase used aircraft of a single type so as to minimize the capital outlay (Lawton, 1999). The goal is to decrease spendings in such areas as pilot training and maintenance. Recent developments though show that the major players in the market order new aircraft to be able to expand their services. The most popular is the Boeing 737 family. However, such successful cost leader airlines as Jetblue and Easyjet retargeted to Airbus A320 and A319 respectively.

Low Landing and Airport Fees

Since pricing advantage over rivals is the goal for a successful low-cost airline model, ticket price is the target of minimization, to which all-corresponding cost items have a substantial impact. Shaw (2004) found out that landing fees and passenger embarkation charges are an important cost item that stand for nearly 10% of costs. Cost information of the British Midland (Table 2) Airways illustrates this principle:

Table 2. Cost Structure of the British Midland Airways, Financial Year 2000/01, (Shaw, 2004)

Depreciation and Rental

18.2

Handling Costs, Parking fees, and Station Costs

11.1

General and Administrative

10.1

Landing Fees, Passenger Embarkation Charges

8.8

Flight Crew Costs

8.0

Maintenance and Overhaul

7.7

Aircraft Fuel and Oil

7.1

Commission

6.0

Passenger Services

5.2

Cabin Crew Costs

4.7

Navigation and En Route Charges

4.1

Reservations

3.2

Advertising and Promotion

2.2

Sales

1.5

Specific Cargo Costs

1.0

Insurance

0.8

Total: 100%

Most of the low-cost airlines support the policy of the underutilized airports. In the expansion policy of Ryanair, the existence of the underutilized airport is the most fundamental requirement, even if it is a long way from the city. The benefits of using underutilized airports are enormous. The gains from low landing fees, as airport operators reflect that they are better off having substantial number of passengers, who will provide commercial income for the airport from such activities as car parking and shopping. The airline will also be able to expand rapidly, free of the slot-availability constraints that hub airports lack.

Short Turnarounds / High Aircraft Utilization

When uncongested airports are chosen, low-cost airlines try to achieve another important requirement, that of short turnarounds and high aircraft utilization. Turnarounds usually amount to 20-25 minutes instead of 50 minutes to on hour for traditional airlines. It allows additional rotations to be operated each day. In turn, this permits a wider spread of capital costs, in case of aircraft, which are owned, or of lease rentals. These turnarounds must be built up so that they can be achieved consistently – otherwise an unacceptable punctuality penalty will result.

Limited On-board Service

Low-cost airlines have a choice to make on-board catering. Some of them have chosen to be completely "no frills", that allows cheaper aircraft acquisition costs due to the absence of a galley cabin, speeds, aircraft cleaning and extra seats. Others offer meals, like simple drinks and snacks, but for the relatively high prices. Thus, passenger service became a source of revenue rather than a cost item.

Point-to-Point Only

One of the most important reasons of low-cost airlines success is that airlines use point-to-point traffic. Thus, they eliminate an unacceptable level of cross-subsidy from point-to-point to connecting passengers.

Any airline, offering a transfer and connections product at a hub have additional costs. First, these are investment in communication: passengers checking in for a connecting flight expect to be given a boarding pass for their onward flight. They also assume that the luggage will be checked-inn in the point-of-origin and reclaimed at the end of the flight.

Overview of previous Russian low-cost airline failures

Russian Airline Company Sky Express became the first low-cost airline in Russia. Sky Express was established in March 2006 and launch the market with the regular air transport operations in January 2007. Corporate entity calls ZAO "Nebesnyj express". The project is invested by main stockholder, CEO of "KrasAir". On the first stage the company decided to invest 35mln dollars, on the second one – 70mln dollars, of which about 20mln is invested by the European Bank of Reconstruction and Development. In November 2012, federal air transport agency Rosaviatsia suspended Sky Express' license, citing weak financial and operational results as the reason (www.avia.ru).

Another low-cost carrier Avianova was founded in 2009. Avianova had served a network of some 20 destinations from Sheremetyevo airport, as well as a handful of routes from St Petersburg, Krasnodar and Sochi, using a fleet of six Airbus A320s. The continued shareholder impasse over management changes and over funding for the company led to Avianova stopping ticket sales on 3 October as a prelude to stopping operations on 9 October 2011 (Kurt Hofmann, Air Transport World).

The potential challenges and financial risks facing the low-cost aviation industry in Russia

According to the Russian Federal Air Transport Agency, Russian airlines carried over 70 million passengers during 2012, up more than 15% over the previous year. There are a number of factors influencing the current growth and success of Russian aviation. The economy is performing well, resulting in increasing consumer wealth and disposable incomes. Air transportation is also becoming more accessible, with infrastructure improvements and investment. This growth in passengers carried is predicted to continue for the next five years, boosted by the Winter Olympics in 2014 and the FIFA World Cup in 2018. The sheer size of Russia also means that domestic air transportation is key, accounting for 60% of the total volume of flights.

In Russia, the low-cost market has just started to develop. At the same time, it is characterized by a number of difficulties and challenges, which the new entrant has to manage, and a number of new potential customers. These facts outline the significance of improvement and development of low-cost model in Russia. In Russia, the low-cost model is quite a new "wave of doing airline business". Not all companies are ready to cost leader strategy, not all market, technological and other conditions are suited for implementation.

Schedule airlines dominate Russia's aviation industry, with only a handful of foreign low-cost carriers offering limited flights. Whilst the destinations served by low-cost carriers are growing, the conditions operating in Russia make it difficult for budget operators to thrive. The classic low-cost model characterized by Southwest or Ryanair is impossible to maintain. The recent demise of two Russian carriers, Sky Express and Avianova, illustrate the pitfalls faced by budget airlines operating in Russia.

First of all, Russia lacks cheap airports. According to consulting company Leigh Fisher, Sheremetyevo Airport is ranked 12th globally in terms of airport charges. It is four times as expensive as both Malaysia's Kuala Lumpur International Airport and Hong Kong International Airport. As a result, ground maintenance fees account for approximately 17 percent of ticket prices, according to Aeroflot.

Secondly, owning and maintaining an aircraft fleet is expensive, and it accounts for another 22 percent of total costs. The 180-seat version of the Airbus A320 is one of the popular models among budget carriers, because of its reasonable fuel economy. However, this model is subject to prohibitive duties in Russia, which (together with VAT) can be as high as 42 percent.

Third, airlines are legally obligated to provide certain free services to passengers, such as in-flight meals. Introducing baggage fees would shave costs by 5-7

percent, while selling non-refundable tickets would help lower the price of flights by 10 percent.

Altogether, Russian airlines combined for total losses of 25 billion rubles ($822.8 million) in 2011, with discount carriers failing completely.

Despite these challenges EasyJet has just started operations to Russia, with flights between London and Moscow. The carrier provides up to 14 flights a week from London Gatwick Airport to Moscow Domodedovo Airport. Ticket prices start from US$200, about half of the average price of a London to Moscow scheduled flight.