The Hindu Business Line : Low-cost carriers: Sky is the limit

The LCCs are expected to dominate the airline industry's strategic landscape almost everywhere in the world. In India, more such outfits are set to take to the air close on the tail of Air Deccan.

Ironically, 9/11 which put traditional airlines through turbulent times, gave a lift to the LCC concept.

The chain of events starting with the terrorist attacks of September 11, 2001, followed by the Iraq war, and then the SARS epidemic in 2003, pushed in airline industry into a slump, and threatened the existence of almost all the six major airlines of the US.

Yet, more than 60 budget airlines have got off the ground in Europe and Asia, in the last three years. The LCCs have turned the crisis situation around.

As business travel declined due to a worldwide economic slowdown, mega airlines shrank their networks to contain losses.

There was an insistent demand for competitive fares. The LCCs filled the gap in the market with their "value for money "offerings, particularly in short-haul, niche markets.

LCCs have lower start-up costs: The recession in the airline industry gave the LCCs an excellent opportunity to lease or buy grounded aircraft at bargain prices; and the recession in the job market enabled these outfits hire trained pilots, engineers, and other airline staff on lower salaries.

According to aviation consultants, it now costs only $10 million to launch an LCC, as the narrow-body Boeing-737s, and Airbus A-320s and 319s, used for short-haul sectors, are now available at the half the 1990s prices.

Profit-centric business model: The secret of the LCC success is the business model that is cost-effective enough to be profitable. The traditional airlines, in spite of having a formidable market-share, are wedded to a wrong business model, proving to be a liability.

As seen from the chart, the LCCs have operating costs 70 per cent less than a traditional airline.

Southwest Airlines is a pioneer among LCCs. It has a simple and proven business model that has been successfully emulated by RyanAir and EasyJet (in Europe), and by AirAsia.

Avoiding fleet complexity: Achieving high utilisation of aircraft per day is crucial for any airline; having only one aircraft type helps airlines saving working capital locked in inventory of spares parts, minimising the need for multiple sets of crew and training, and avoiding duplication of support staff such as engineering and maintenance personnel, cabin catering equipment, and so on.

Operating high frequencies between niche markets, not served by the mega airlines, is key to the survival of an LCC.

The mega airlines operate on a hub-and-spoke model and cannot emulate the LCCs.

Low fares: By setting a fare that is much cheaper than that of competitor, the LCC ensures a consistently high seat factor, thereby minimising empty seats on a route.

The LCCs also squeeze 35 per cent more seats on aircraft in a single class, reducing seat pitch.

Lower the interest burden: The fledgling LCCs usually bring down debt by private placement or IPO of equity.

The airline industry is highly capital-intensive; a low debt-to-equity ratio is essential for survival when the cyclical airline industry goes through a slump.

Running a "no-frills " service means not spending precious money on exorbitant rentals for opulent airport lounges, gourmet cabin service, cutlery, choice of several meals in cabin catering, galley service for hot meals, even saving on newspapers providedon board!

AirAsia pilots are instructed not take off at full throttle to save fuel costs. RyanAir plans to introduce charges for carrying baggage in the hold of its aircraft.

Internet bookings: Most successful LCCs sell over 75 per cent of their tickets directly over the Internet, thereby saving on the distribution costs and travel agency commissions.

Within a year of its launch, Air Deccan has become the biggest e-commerce site of India with daily ticket sales in the range of Rs 1.15 crore.

Lean and mean structure: The LCCs usually have a ratio of 80:20 between cash operating costs and fixed costs, against 60:40 for an established airline.

The LCCs are much leaner organisations without the "fat" of establishment costs, managing loyalty programmes, sales and marketing, IT systems development, and so on.

This means that they can afford to make a small mark-up, of 10-15 per cent on their already lower cash operating costs, to generate operating surplus, even on low fares.

"SimpliFly", the slogan of Air Deccan, explains this well.

The LCCs usually avoid complexity of apex fares, multiple interline agreements and complex revenue management practices.

Avoiding bigger airports: The LCCs in Europe choose to operate from remote airports which offer free landing to a new airline in order to boost the local economy.

Large airports are notorious not only for high landing fees and higher handling charges but also cause congestion delays, leading to less utilisation of aircraft per day.

Saving in airport landing fees has been the key to the success of airlines such as RyanAir.

The success of Southwest, JetBlue, Ryan Air, EasyJet, and Air Asia has led to 60 new start-ups, crowding the skies of Europe and Asia.

The high population density in Asia, wherein many time more than Europe's population lives within few hours of airports, means the Southwest business model will succeed.

Better brand equity value: AirAsia, the Malaysia-based LCC, is a zero-debt airline, now valued at between $750 million and $1.2 billion.

LCCs in the US also manage profitable growth: AirTran, ATA, JetBlue, Midwest, are all US-based LCCs which have recorded profitable growth in 2002, as can be seen from Figure 1.

LCCs manage to offer best value to the air traveller, and yet make good return on investments, making them the darlings of the capital market. "Now everyone can fly", says the slogan of AirAsia.

Woes of traditional airlines: As the state owned traditional airlines reduce their flights, losing market share, they haggle with their recalcitrant unions to take pay cuts, increase work hours and reduce retirement pensions.

Thus they lose brand equity, making it impossible for them to tap the capital market. The traditional airlines are then often forced to depend upon government subsidies, and market borrowings.

The traditional network airlines have now decided to fight the onslaught of LCCS by launching subsidiaries which are LCCs. Will they succeed?

Aviation experts express doubts if the traditional carriers can make a success of the low-cost subsidiaries as they have neither the cost discipline nor culture of a genuine start-up.

LCCs will face acid test soon: Managing downturn is hard, as traditional airlines have found in last three years; but LCCs will soon discover that managing high growth intelligently is much harder.

In times of high growth, and flush with venture capital funds, the airline is tempted to overbuild capacity, infrastructure and headcount, and add to fixed costs.

Then, as growth recedes, the airline is struck with lot of resources and red ink on the balance sheet. Managing growth profitably will test the LCCs.

As more "me-too" low-cost subsidiaries come up, the survival skills of LCCs will be put to severe test.

In the 1990s, liberalisation of Indian skies gave rise to a plethora of private airlines, such as Jet Airways, Damania Airways, East West Airlines, NEPC, UB Air, Archana Air, and so on.

Most of these private airlines, with the exception of Jet Air, have now ceased to exist.

Were these private airlines formed before their time or did they pay the price for not following cardinal principles of the airline business?

Now, with income levels rising in urban India, private airlines have better prospects.

Close on the heels of success of Air Deccan, India's first low-cost carrier (LCC), many private airlines are planning to dot the Indian skies, promising to bring down domestic air fares and challenging the near-monopoly of Indian Airlines and Jet Airways

The expected fare wars between the LCCs and traditional airlines promise to make the short-haul air travel much cheaper.

And air travel, so far considered elitist in Asia, may pose a stiff competition to the railways and road travel in the decades to come.

(The author is a Senior Consultant, Infosys Technologies Ltd, Bangalore. Feedback may be sent to Pankaj_Pandit@infosys.com)