STRATEGIES AND EFFECTS OF LOW-COST AIRLINES

Strategies And Effects Of Low-Cost Airlines

Strategies And Effects Of Low-Cost Airlines

On 5 April Simon Smith, an economist with Steere Davies Gleave, spoke on the subject of “The strategy and effects of low-cost airlines”. Budget airlines are having a profound effect on the operations of all airlines, especially in North America but also in Europe, where easyJet and Ryanair are the principal operators. They compete through higher seating density and loads (typically over 80 per cent), uniform aircraft types, minimal commission payments through Internet bookings, and simple fare structures.

Question 1: Compare the strategy persuade by Ryanair with that of an established long haul airline such as BA.

Both British Airways (BA) and Ryanair (RA) are successful airlines at the top of their respective markets. BA is a more traditional, long haul full service carrier, while RA is part of the new bread of short haul, low cost, low frills carriers. The aim of this report is to give an overview of the industry, and the two companies, looking briefly at their history and future strategy and then to perform a financial analysis on both companies from users perspective: long-term investment for the common shareholder, creditors, analysts and providers.

The airline industry, as many industries, is an imperfect oligopoly. A few carriers dominate long-haul traffic, while several dozen small carriers compete for short-haul flights. After five consecutive years of losses, major providers are losing market share.

S&P Airlines stock price underperformed the overall market. In 2004, the overall airline industry lost $5 billion dollars. To overcome this situation, large airlines are undertaking aggressive cost cuts to survive, but many of them have been unable to offset oil prices cost increase. Oil prices, labour costs, overcapacity, competitive pressures and a high debt to assets ratio are driving major airlines to ally, merge or change dramatically its business strategy in order to survive. British Airlines and Ryanair have been successful during this difficult period. (Carpenter, 2007, Pp 110)

Oil prices. Airlines are energy-intensive operators. Fuel costs accounted for 19% of total revenues in 2004, versus 15% in 2003. Incumbent airlines have been forced to acquire new airplanes and to reduce waiting time in airports. (Fottrell, 2004, P 125-26)

Labour costs. Airlines are intensive in capital, labour and technology. Labour costs represented 36% of the revenues of the industry in 2004, down from 39% in 2003 and 44% in 2004. This is forcing major carriers to enter into salaries and benefits renegotiations, including pension plans.

Overcapacity. Low fare and regional airlines are entering to markets that were dominated by big airlines. The cost structure of low cost airlines (low labour, maintenance and fuel costs) is 40% lower than major airlines. A 50% load factor break-even point allows these companies to cut prices and continue its market share expansion. Discount carriers are growing rapidly, offsetting capacity cuts by the incumbent carriers in niche markets.

Both RA and BA have shown varying levels of ROE since 2001 with both firms converging around the 10% mark ...