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The long-haul low-cost carrier: A unique business model
Journal of Air Transport Management 15 (2009) 127–133
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Journal of Air Transport Management journal homepage: www.elsevier.com/locate/jairtraman
The long-haul low-cost carrier: A unique business model John G. Wensveen, Ryan Leick* School of Aviation, Dowling College, 1300 William Floyd Parkway, Shirley, NY 11967, USA
a b s t r a c t Keywords: Low-cost carrier Long-haul low-cost carrier Airline business model Airline strategies
While many industries reach a point of maturation, the airline industry is evolving to incorporate flexible strategies for business models that adapt to the changing economic environment. New business opportunities have emerged as a result of a variety of internal and external forces. This paper discusses opportunities for long-haul low-cost airlines by looking at the evolution of the model and defining three types of new business models. Ó 2008 Elsevier Ltd. All rights reserved.
1. Introduction The airline industry is a risky industry to invest in, statistically second only to the hospitality industry, and yet investors are continuously attracted to it regardless of its economic state. One of the main reasons it is attractive to investors is that it is one of a few industries that can provide a large payback if things work out well. It is helpful to have a full understanding of trends in the industry to comprehend its current position. It is also important to realize that there have been trend breaks and that new trends have emerged to present fresh challenges to the industry. The airline industry is often unstable and unpredictable, forcing airlines to restructure and create flexible strategies that can respond as external operating environment changes. New airlines have an advantage over existing carriers in terms of implementing such strategies because they are devoid of legacy indebtedness or an out-of-date business model.
2. The global airline industry The global industry operates in periods of survival, adaptation, recovery and innovation, resulting in the need for flexible business strategies more than ever. Following the terrorist attacks on the US on September 11th, 2001, the airline industry was in survival mode. These unfortunate events have pushed the airline industry over the edge and resulted in a record number of bankruptcies, mergers and acquisitions. The global aviation industry suffered financially and
* Corresponding author. Tel.: þ1 631 244 1903; fax: þ1 631 244 1334. E-mail address: [email protected] (R. Leick). 0969-6997/$ – see front matter Ó 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.jairtraman.2008.11.012
still continues to recover. In 2002, airlines in the US lost $10 billion (Wensveen, 2007a). In the 2002–2003 period, airlines were forced to adapt to the changing environment. Airlines that survived the immediate shake up sought ways to adapt in the new industry. This period saw a focus on cost -reduction as airlines reduced capacity, cut many inflight amenities, downsized management, outsourced non-critical operations and parked older aircraft. From 2003 to 2005, airlines entered a period of recovery. Much of the opportunities for cost savings were exhausted and airlines returned to focusing on revenue maximization. During this period, revenue and yields returned to pre-September 11th levels and US airlines posted profits (Fig. 1). In the 2005-current period, which is expected to last until another cataclysmic event occurs, airlines have continued to innovate and rethink the way they do business. It can be argued that the recent oil crisis has been another cataclysmic event and has forced many airlines into survival mode. This is evidenced by the numerous failures, acquisitions and mergers. Both legacy and lowcost carriers have differentiated their business models to capitalize on emerging market trends. Air Canada made a drastic change towards unbundling the airline product and offered customers the choice to personalize its product. Though US carriers have made similar changes to their business models, those changes have not been as drastic as those made by Air Canada. Aer Lingus evolved from a typical legacy carrier with no unique competitive advantage to a low-cost network carrier with a focus on long-haul routes. Aer Lingus took large measures to make their cost structure competitive with those of the short-haul low-cost carriers (LCCs) by moving to a modern, all Airbus fleet. The airline has further attempted to change employee work rules and generate ancillary revenue by unbundling its product. Much of the innovation during this period came from the many low-cost, long-haul start-ups.
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different models emerged but all of them encountered similar challenges.
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3.1. Definition of ‘‘low-cost’’ 0
The airline industry has become accustomed to the term ‘‘lowcost carrier’’ otherwise known as LCC. Unfortunately, aside from the various perceptions or stereotypes associated with the term lowcost, few understand the true meaning that often results in a misuse of the definition. Equally curious is the way in which industry experts use multiple definitions for what essentially means the same thing. Examples include:
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78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E
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Fig. 1. Net profit/loss for world airlines 1978–2007 Morrell (2008).
3. Evolution of the long-haul low-cost model Airline strategy, once politically motivated, is now driven in large part by consumer demand in liberalized and deregulated markets (Leick, 2008). Airline business models are adapting to changing passenger lifestyles and behaviors (Taneja, 2005). Technology has increased the availability of information and has shifted leverage into consumers’ hands, which has resulted in less homogeneous customer segments. It has also provided suppliers in all industries with the ability to meet the needs of individual consumers more efficiently and cost effectively. As a result, airline passengers expect a more ‘logical’ product, while innovative technologies and ideas have provided space for airline business models to evolve. Shifting consumer behaviors have resulted in network carriers steadily loosing market share to a variety of more innovative business models. Low-cost airlines have existed in some form even before the liberalization of air transport markets. Southwest Airlines, established in the early 1970s, is considered the grandfather of the model. Even before Southwest Airlines, commuter carriers often operated at costs below those of the national carriers. It was not until carriers such as Pacific Southwest Airlines (PSA) began offering fares less than those of their competitors that the low-cost, low-fare model emerged. JetBlue later took the low-cost model to a new level by adding amenities superior to those of network carriers. Their leather seats and live satellite televisions in each seat became a trademark of the airline. As of 2005, LCCs in the US and UK had grown to control 30 and 40% of the market capacity respectively (Taneja, 2005). Conversely, the emerging trend of corporate, high-yield business traffic migrating to fractional ownership and corporate jet operations such as NetJets and ExpressJet threatens the airlines’ premium market. Very Light Jets (VLJs) have recently emerged on the scene and threaten to cut into the high-yield business market even further. High yielding first and business customers have always been the cornerstone of network carriers. However, these customers no longer provide the revenue stream they once used to. Premium cabins have largely become a loyalty reward and have all but disappeared outside of long-haul routes where they remain a high-yielding product. The large global carriers have shifted much of their capacity out of domestic markets to capitalize on the more profitable long-haul routes and invested large sums of money to make their premium cabins competitive. Out of these changes in the global air transport industry evolved the low-cost, long-haul model. Entrepreneurs took to the skies determined to cash in on the untapped demand for low-fare, highvalue air travel in the international long-haul market. Several
Low-Cost, No Frills Carrier (LCNF) Low-Fare, High-Value Carrier (LFHV) Less Frills Carrier Value Carrier New Generation Carrier
We take the view that there is no such thing as a low-cost carrier. Airlines, regardless of their business model or geographic location, essentially have the same root costs (i.e., fuel, labor, maintenance). Granted, some airlines have major advantages over others in terms of these root costs, but the cost structures for all airlines are essentially the same. This is evidenced by the equal number of difficulties that both legacy and LCCs face in the current market environment. With that said, the author does use the term LCC in every day practice but the reader should have a full understanding that such terminology is used very loosely. 3.2. Long-haul vs. short-haul flying The differences between the low-cost, long-haul carrier and the low-cost, short-haul carriers are inherently different, particularly when it comes to crew requirements, security requirements, airport facilities, turn around times, route authorities, extended-range twin-engine operational performance standards (ETOPS), training differences, distribution challenges and route density. Short-haul LCCs derive their competitive advantage from operational efficiencies. The opportunity for carrying over this competitive advantage into long-haul operations is rather limited. Instead, long-haul, low-cost carriers aim to achieve a competitive advantage by optimizing yields from the available aircraft capacity. Legacy carriers use highly discounted economy seats to fill the excess space left after premium demand is met. Revenue from premium cabins subsidizes the cost of the economy cabin. Long-haul, low-cost carriers maximize all available space with profitable, premium seating at a rationalized price. To be successful, a new entrant must seek real advantage in all of these factors and find markets where lower fares than the competition can be profitable. The concept of low-cost, long-haul flying is not new to the industry but it is not an established sector as of yet. Skytrain, started by Freddie Laker in 1977, operated between London and New York and offered return airfares substantially lower than its legacy competitors. Unfortunately, Skytrain was out-priced by the competition. The air transport market has changed dramatically in recent years and the low-cost phenomenon has now become widely accepted. The continuing deregulation of the industry and the restructuring of multiple bilateral agreements between states in the rest of the world have increased the number of opportunities to start new operations. To survive in the long-haul market, lowcost airlines have to avoid the common pitfalls in airline business planning.
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4. Failures in airline business planning A majority of the high profile airline start-ups during the last evolutionary cycle were long-haul, low-cost carriers. Understanding the common errors in airline business planning is essential to understand the challenges facing the success or failure of these carriers. There are literally hundreds of reasons leading to the failure of airlines throughout the world and each case should be analyzed individually. However, when it comes to common trends, the list is rather short. Excerpts from Wensveen (2007b) on failures in airline business planning are expanded up below. 4.1. Unable to obtain sustainable, competitive advantage Establishing sustainable, competitive advantage in the airline business plan is difficult but it must be done. When looking at the business plan, the reader is primarily interested in knowing what the market is. Does the market actually exist? How will this company fit into the market? Does this airline have the ability to compete with other carriers and if so, what will be the long-term gain? It is very important not to underestimate the competitors. If no competition exists, don’t assume it will. Always assume that competition will appear and build a contingency plan on how the airline will survive not if that happens but when that happens. The airline business plan should identify what the company’s strengths are and how these strengths will be used to gain competitive advantage. Failure to identify need is a common mistake made in the development of the airline business plan. The business plan must be superior to any potential competitor’s business plan and should be able to gain the investor’s attention and money. Examples of mistakes associated with market need include: inadequate presentation of market needs, failure to identify the size of the market, failure to identify the niche market the airline will operate in, and failure to identify why the airline will be superior to any other. In other words, what is the difference between this airline and its competition? What sets this airline apart from the others? Adding uniqueness to the business concept is important, otherwise, the airline is like any other and will most likely fail to raise the funds needed to fly. 4.2. Failure to demonstrate revenue growth and profitability Many airline business plans fail to demonstrate revenue growth and profitability. Historically, top line growth is mentioned but bottom line growth is not. In order to sell the business concept, bottom line growth is essential and this growth must be based on credible financial assumptions. It is important to have quantitative sections backed up by qualitative sections. All financial projections should be consistent with accepted accounting principles. Unrealistic financial projections should not be incorporated into the airline business plan. In most cases, being able to show ‘‘less’’ rather than ‘‘more’’ can be very powerful in terms of obtaining interest. The financial section of the business plan determines the success or failure of the business concept. If the numbers are falsified, the company will fail. Be realistic with numbers and follow a simple lesson. Whatever the actual costs work out to be, double them. Whatever the actual profits work out to be, half them. Implementing this philosophy will create a strong, well-rounded, realistic business plan. Examples of common mistakes made associated with revenue growth and profitability are: failure to show how ROI (return on investment) will be generated for investors, no clear ROI, lack of return on investment figures, too much concentration on financial numbers, vague assumptions regarding
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potential cash flow, lack of understanding business start up costs, and lack of research. 4.3. ‘‘Wrong’’ leadership Choosing the right person for the right job is important in the management team selection process. In many airline business plans, the importance of the management team is often underestimated. Many investors believe that a superior management team can make a mediocre idea successful. This was proven in the case of Continental Airlines when the airline filed for bankruptcy in 1990. A new Chief Executive Officer, Gordon Bethune, was put into power and the management team was restructured. A failing airline was turned around into one of the most successful carriers under a new management team. A strong management team will help reduce any doubts the investor might have about the ability of the airline to be successful. The airline business plan must promote the team and introduce key advisors that will assist in the company’s success. The management team becomes important in outlining strategic objectives and implementation of the business plan. A good team will be fully aware of all risks involved and such risks should be highlighted in the actual business plan. With each risk should appear a solution or strategy on how the airline will deal with each risk. Failure to provide a thorough SWOT analysis (‘‘strengths, weaknesses, opportunities, threats’’) combined with strategies will enhance the investor’s doubt factor. In addition, a PEST or PESTE analysis (political/legal, economic, socio-cultural, technological, ecological) will only strengthen the content of the business plan. In many cases, the developers of the airline business plan often does not believe that the management team introduced in the business plan could be a major weakness. However, investors often see this as a major weakness and can be critical in deciding whether money will be invested or not. Examples of mistakes associated with the management team include: not focusing on the management team and its experience and lack of information on management or inexperience in the field. 4.4. ‘‘Wrong’’ money During the different phases of airline development, ranging from ‘‘dream’’ stage to day one commercial operations and beyond, the need for capital is continuous. A solid business model should have no trouble attracting money but it is important to distinguish the difference between ‘‘right’’ money and ‘‘wrong’’ money. It is important to attract money from investors who fully understand the airline industry empowering leadership to make decisions in the best interests of the company. Allowing investors to have decision making power without understanding the airline business could be detrimental. Unfortunately, in the business world, the holder of the purse strings is usually more powerful than the ‘‘brains’’ behind the business model often leading to the wrong decisions being made. 4.5. Undercapitalization Airlines are highly capital intensive and most of their failures are blamed on the inability to attract a suitable amount of capital during the ‘ramp-up’ stage and throughout commercial operations. Many potentially successful business models have failed due to limited funding. Interestingly though, many business models have also failed not because of limited funding but due to their poor business plans. Leaders must have a full understanding of the constant need to raise money no matter how successful their airlines are. In the cases of MAXjet Airways, EOS and Silverjet, all
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failed because of lack of funding and competitive forces that crushed their business models. The challenge to create a successful business is really two fold. First, one must estimate the required amount of capital to raise the massive sum of cash needed. Management often underestimates the rate at which cash will burn during the setup and initial operations. Even as revenue starts to come in, it is often below even the most conservative estimates. Convincing savvy investors to invest hundreds of millions of dollars into an industry which historically provides little to no return on investment is a challenge in and of itself. The challenge only grows when additional capital is required during the initial launch at a stage when the airline is loosing money. If the investors’ aim is to take the venture public, the interests of growth and profitability must be balanced to demonstrate revenue growth and the potential for profitability. 4.6. Overexpansion There seems to be a tendency in the airline industry that bigger is better. In other words, the number of destinations served and the greater the volume of aircraft in the fleet, the more successful the airline will be. Unfortunately, in most cases, if this theory is pursued, the airline is on a path to failure. Steady, moderate growth is one key to success in the airline business including the low-cost, long-haul market. The challenge arises in finding the right critical mass. Start-up airlines must balance frequency and breadth of network. High route frequency attracts high-yielding business passengers but dilutes the overall load factor. Often, business travel is determined by corporate contracts which won’t even be considered until airlines have established themselves with a wide network serving a majority of the company’s frequent destinations. 4.7. Lack of flexibility Airlines of all sizes neglect to insert one key ingredient when it comes to their business plan structure – flexibility! Historically, many airlines failed because of this factor. Not being able to adjust the business according to the changing environment in which the airline operates strangles the company to the point where it becomes dependent on a life support system, usually in the form of government subsidies, loans, or employee share plans. In short, not being flexible prolongs the life of the company until it can no longer breathe resulting in bankruptcy, a merger with a competing carrier, or permanent closure. Simplicity in the business model coincides directly with flexibility. A leaner, streamlined strategy will provide more options and minimize complexities when airlines are forced to react. At the same time, simplicity must be balanced with optimization. Rarely does simplicity result in the optimum efficiency. Operational efficiencies achieved from optimization must be weighed against the risks associated with complexity. Only then can a truly flexible business model emerge. 4.8. Wrong business model The airline industry has always been a challenging environment to operate in and it seems, with each passing year, new challenges are presented making success more difficult to achieve. Too many airlines, including the new entrant long-haul, low-cost carriers, have had difficulty mastering the concept of a successful business model. Successful airlines often evolve through the trial and error of others. Unfortunately, airlines which test different business models are the ones to collapse, opening doors of opportunities for new airlines to evolve. Historically, rather than developing
a completely new business model, airlines have copied each other and have often failed to combine all the ingredients that will ultimately lead to successful operations. Many well-intentioned management teams have started an airline with the intent of building a logical airline from a clear drawing board. While many of their proposed innovations appear good on paper, challenges arise when they attempt to implement too much change at one time. Even established LCCs like Southwest, jetBlue and AirTran Airways have reneged on their direct distribution strategy and joined global distribution systems (GDSs). Many airline policies may seem illogical from a customer perspective but serve a purpose in the industry. Carriers attempting to implement drastic changes often experience challenges raised by unions, government regulations and even frequent flyers. Efforts by Air Canada, easyJet and US majors like Northwest to unbundle the product have all encountered resistance from suppliers and customers. This challenge is amplified for start-up carriers which already have difficulties setting up an operation and which have no established base of customer loyalty. Airline business model innovation is a slow evolution, not a revolution. 5. Does the long-haul, low-cost model work? van der Bruggen (2008) examines the pros and cons of the lowcost application to long-haul travel. At first glance, there are clear competitive advantages to the low-cost model in long-haul markets. For instance, no direct substitute exists for long-haul air travel. The captive market allows legacy carriers to excessively inflate fares in premium cabins. The result is high yielding, longhaul routes subsidize less profitable short-haul routes in legacy carriers’ networks and expose the carrier to higher overall cost structures. The higher fares associated with long-haul travel make price a more critical criterion in the purchase decision. However, longhaul economy fares are already competitive and there is little evidence that lower airfares will translate into increased demand in long-haul markets as it has in short-haul. More opportunity for competitive products exists in the premium cabin where price is less of a factor for business and affluent leisure passengers. The challenge is now in finding opportunities for cost advantages that apply to the long-haul environment. Most secondary markets have no existing long-haul service and provide little competition for point-to-point demand. However, existing long-haul aircraft are designed for a high-density configuration, which makes profitability more difficult when applied to medium and small sized long-haul markets. Few routes have the potential to support point-to-point frequencies and secondary airports often do not have the infrastructure to support large aircraft and around the clock operations. Operational efficiencies from secondary airports are minimized for long-haul networks while hub connectivity becomes more critical. Long-haul flights operate at lower frequencies and achieve higher utilization through longer stage flights. Less congested secondary airports do not necessarily translate into quicker ground turn times. Fewer landings mean that landing fees are a smaller percentage of operating costs. High frequency connectivity to short-haul markets becomes more critical to long-haul operations since many passengers connect on either or both ends of their long-haul flights. Many of the competitive advantages enjoyed by short-haul lowcost airlines do not apply to long-haul operations. Legacy carriers already achieve low seat mile costs and high load factors. Further increasing aircraft utilization is difficult due to the long stage lengths and minimal number of turns. Cutting frills on long-haul flights would only alienate passengers who find more value in inflight entertainment, meals and seat pitch on longer flights. Overall,
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the cost-advantage of long-haul low-cost carriers is expected to be 20–25% compared to 40–60% for their short-haul counterparts (van der Bruggen, 2008). The core fundamental in operating long-haul flights is rather simple. As distance increases, operating costs rise while unit costs decrease. This is particularly true when it comes to fuel burn, crew cost, maintenance cost, passenger services and over-flight. Incumbent carriers primarily make up this difference through substantially higher premium fares, not economy fares. It is very difficult to achieve a fare advantage with an all economy seating configuration in long-haul markets. Economy fares increase slowly with distance. Airlines trade fare advantage for limited market applications with a wide-body aircraft. Narrow body, long-haul aircraft also have limited applications. Despite the factors limiting the application of the existing low-cost, short-haul strategy to long-haul operations, great opportunities still exist. The key is to concentrate on developing a new business model which capitalizes on opportunities and accounts for limitations of the long-haul market. 6. New business models The dynamics discussed in this article have driven new airline business models in the long-haul market to include the following: Network Specialists, Product Specialists and Price Specialists. 6.1. Network specialists A network specialist operates as a corporate shuttle catering mainly to business passengers and executives on high-yield routes. PrivatAir, based in Geneva, Switzerland, is the pioneer of this business model and appears able to survive successfully while other airlines fail. The network specialist often has contracts with major corporations for the transport of executives between locations. In the case of PrivatAir, the airline offers business class seating on trans-Atlantic flights and utilizes a mixed fleet of aircraft including Airbus A319-100, A319-100LR, Boeing B737-700BBJ, B737-800, B757-200, B767-300ER and has orders in for the B787-8 Dreamliner. The key differentiators for the network specialist are the ability to operate as a corporate shuttle, Aircraft Crew Maintenance and Insurance (ACMI) operator for existing airlines and tailored or customized services for a wide range of clients. Both Lufthansa and KLM utilize PrivatAir in their network for all business class service from Du¨sseldorf and Amsterdam, respectively. The success of PrivatAir can be attributed to limited competition and lucrative corporate contracts. 6.2. Product specialists A product specialist is an all-business class, all first-class or a combination of both, with a primary focus on large and small business and affluent leisure travel. Scheduled services are offered on routes with high load factors and premium fares. The product specialist competes on the strength of legacy yields in premium cabins on long-haul flights. Pioneers in this market include Eos Airlines, MAXjet Airways, Silverjet and L’Avion. Unfortunately, the first three carriers listed have all gone bankrupt. The fourth, L’Avion, has recently been acquired by British Airways and the airline was most likely never profitable either (Lagorce, 2008). Eos Airlines (UK) operated a 48 seat first-class configuration utilizing the Boeing 757-200 between London Stansted and New York JFK. The airline closed operations in April, 2008. MAXjet Airways (US) operated a 100 seat business class configuration utilizing the Boeing 767-200 between London Stansted and New York JFK as well as London Stansted and Las Vegas. The airline
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closed operations in December, 2007. Silverjet Airways (UK) operated a 100 seat business class configuration which utilized the Boeing 767-200 between London Luton and Newark as well as London Luton and Dubai. The airline closed operations in May, 2008. L’Avion (France) operated a 90 seat business class configuration by utilizing the Boeing 757-200 between Paris Orly and Newark. British Airways plans to operate these aircrafts under their Open Skies subsidiary with 24 lie-flat beds, 28 premium economy and 30 economy seats from airports within continental Europe to the US. The key differentiator for the product specialist is the ability to offer low airfares with flexible tickets in a premium cabin. Given the recent history of the four product specialists, it is evident that this business model has not yet been mastered. Of the three recent bankruptcies, all reported the same reasons for failure, including rising fuel and oil prices, undercapitalization and newly created competition by legacy carriers offering premium cabins on similar routes. Despite these failures, there do not appear to be any inherent problems with the model; however, aggressive competition from legacy carriers and an ever difficult operating environment make initial success difficult. 6.3. Price specialists The price specialist incorporates low-cost strategies to compete on price. They offer long-haul flights against lower fares than legacy competitors and therefore require large aircraft with highseating configuration to be profitable. Essentially, the price specialist has attempted to duplicate the successful short-haul, low-cost business model and apply it to long-haul. The pioneers of the price specialist market are Oasis Hong Kong, Zoom, Jetstar, Viva Macau and AirAsia X. Oasis Hong Kong (China) operated a 359 seat mixed business and economy configuration utilizing the Boeing 747-400 between Hong Kong and Vancouver as well as Hong Kong and London Gatwick. The airline closed operations in April, 2008. Jetstar (Australia) operates three aircrafts including the Airbus A320-200 with a 177 seating configuration, the A321-200 with a 213 seating configuration and the Airbus A330-200 with a 303 seating configuration. The airline operates domestic flights in Australia with additional services to Cambodia, Hong Kong, Indonesia, Japan, Macau, Malaysia, Myanmar, New Zealand, Philippines, Singapore, Taiwan, Thailand, USA and Vietnam. Jetstar’s Australian operation is owned by Qantas Airways. The key differentiators of the price specialist are the ability to offer low fares by utilizing high-density cabins in high demand markets. The price specialist model offers more flexibility than the two models mentioned previously and more opportunity to expand into new markets. Oasis Hong Kong and Zoom went bankrupt while the others appeared to be growing successfully. Based on the mixed result of price specialists there appear to be no inherent problem with the model. The bankruptcy of Oasis Hong Kong and Zoom can both be attributed to the failures in airline business planning discussed in Section 4. However, it remains to be seen how sustainable the price specialists’ cost savings are over the long-term. 7. Low-cost long-haul opportunity For the foreseeable future, network specialists will secure and capitalize on opportunities fitting the corporate shuttle profile on thin, long-haul routes producing high yield. The markets are somewhat limited allowing only a small number of air carriers to tap into such opportunities on point-to-point networks linking a major business centre with another major business centre. The main advantage to this type of operation is the increased cost
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Table 1 Basic features of airline business models. Product Feature
Low-Cost Model
Legacy Model
Charter Model
Aircraft Usage
High
Moderate to high: union contracts
Airport
Secondary (mainly)
Primary
Lower usage but larger aircraft than low-cost carriers Secondary (mainly)
Brand
One brand (low pricing)
Extended brand (price and service)
Check-in Class Segmentation Connection
Ticket, IATA ticket contract Multiple classes Interlining, code-share, global alliances Full service, offers reliability Online, direct booking, travel agent Complex: structure þ yield management
Fleet
Ticketless Single class Point-to-point, no interlining, no baggage transfer Generally underperforming Online, direct booking Simplified fare structure: peak and off-peak. Time of booking also important: the earlier, the cheaper. Low price (60% or more below legacy carriers). Young, single type
Multiple types
Multiple types
Frequency
High
Moderate
Frequent Flyer Programme In-flight
No (mainly)
Yes
Depending on demand (usually higher during summer) No
Target Group
Leisure, time and price sensitive Leisure and business business travelers 25 min Low; congestion and labor
Customer Service Distribution Fare
Pay for amenities, onboard selling Operational Activities Focus on core (flying) Seating Small pitch, no assignment
Turnaround Time
Will be achieved because of longer sector lengths Primary and secondary depending on individual airport facilities Low price for leisure traffic One brand (low pricing), but clear about service Paper ticket Ticketless Single class (sometimes multiple) Multiple classes (usually two) Point-to-point Point-to-point, no interlining, no baggage transfer, self-connecting Via tour operator Unknown Via tour operator Online, direct booking Fares are part of holiday packages, Simplified fare structure: the earlier including accommodation and you book, the cheaper the fare. sometimes car hire, etc. Low price (20–25% cost advantage to legacy carriers likely)
Complementary extras
Complementary extras, but not as luxury as with legacy carriers Extensions (i.e., maintenance, cargo) Passengers þ cargo (sometimes) Generous pitch, seat assignment Seat assignments, pre-bookable
savings and increased productivity for executives. Network specialists with sound business models will be able to secure agreements to operate on behalf of an airline. In other words, an operator who specializes in this area can offer a service that makes financial sense when the actual airline is not able to. This arrangement ultimately results in a ‘win win’ situation for the operator, the airline and the passenger. To date, there is limited competition in this sector. Given the recent history of the product specialist carriers, it is evident that the product specialist model must continue to evolve. In July 2007, British Airways announced that it was purchasing L’Avion with the idea of folding the company into Open Skies, British Airway’s new luxury carrier on the trans-Atlantic. Rising fuel and oil prices combined with low yields resulting from high competition in limited markets ultimately led to the downfall of MAXjet, EOS and Silverjet. In terms of opportunities for product specialists, future business models will have to capitalize on the relative strength of legacy yields in Premium cabins on long-haul flights while at the same time developing an operation that reduces high fixed costs. Whether or not this is even possible remains to be seen. Of the three types of emerging carriers discussed, the price specialist has the greatest number of potential opportunities. Success will be based on the ability to identify high-density markets where legacy competition exists and yet allows the price specialist to survive. Such markets will tap into point-to-point operations as well as hub-and-spoke operations. This means that some passengers will make transfers on other carriers using separate itineraries. The price specialist entrants use seating density to capture lower-yield traffic profitably. In the longer term,
Long-Haul Low-Cost Model
Leisure Low
Young, single type but one aircraft type may not be suitable for all routes (range and capacity issues) Low to moderate (currently about once per day) Maybe more valuable Longer-haul passengers are likely to value this more highly Focus on core (flying). Sometimes cargo Comfort more important the further you fly. Pre-allocation might be demanded Leisure, time and price sensitive business travelers Less important since aircraft spend more hours in the air. Also depending on work/rest periods
the authors expect that such airlines will be able to establish connections with short-haul price specialists in specific markets with the ultimate goal of creating a global network. Depending on specific situations, such partnership arrangements may be in the form of IATA agreements but for simplicity and ease of efficiency, most relationships will probably be non-IATA agreements that eliminate the burden of legal and financial responsibilities established in such contracts. 8. Market characteristics 8.1. Independents The non-legacy, long-haul airlines operating in today’s environment can be characterized in terms of the network model that includes the Frequency Model and the Destinations Model. The former, also referred to as Scale Model, provides service for large corporate clients in markets with strong catchment areas. The target market often consists of affluent leisure and VIP traffic operating sub-nine hour stage length with a once daily aircraft rotation. The latter model, also referred to as the Scope Model, consists of a mixture of affluent leisure and movable business with broad regional catchment areas. There is a seasonal and economic balance combined with availability of peak-time slots operating seven to twelve hour stage lengths. 8.2. Network or legacy airlines The legacy long-haul airlines operating in today’s environment can also be identified by certain characteristics in terms of network
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model including the hub complement and the hub bypass. The former allows the route network to build from hub infrastructure with strong corporate demand, lean leisure, frequent flyers and cargo demand. Typically, stage length is up to nine hours. The latter leverages product superiority versus competition attracting incremental corporate business combined with lower-cost competitive responses. Table 1 provides a more detailed comparison of shorthaul, legacy, charter and long-haul low-cost models. 9. Conclusions A new competitive environment is emerging in the international air transport market. Long-haul, low-cost carriers bridge the networks of short-haul, low-cost carriers allowing LCCs to compete with the mega-alliances of the international network carriers. Interactive marketing agreements allow low-cost carriers around the world to form loose alliances for interlining and frequent flyer programs. At the same time, changes are taking place between the established world-wide alliances. Liberalization has reduced the need for alliances but the benefits of a shared network still hold much value. Consolidation is taking place within the global alliances creating three evenly distributed network alliances. An ad-hoc fourth global alliance is forming with low-cost carriers around the world linking networks in order to compete with the legacy alliances. Low-cost carriers have always been restricted by their inability to satisfy the demand for long-haul, trans-continental travel. Long-haul, low-cost carriers represent an opportunity for LCCs everywhere to join forces and compete with the global alliances. The long-haul point-to-point model integrates well with the similar point-to-point focus city model of the short-
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haul carriers. There are several examples where long-haul and short-haul carriers have entered into interactive marketing agreements to promote cross-selling, integrate websites and advertise cooperatively. These agreements permit passengers to fly to and from small markets in any region of the world via lowcost carriers. If long-haul, low-cost carriers are to survive and adapt in the evolving air transport environment, they must continue to innovate. Opportunities should not focus on low-cost long-haul models but instead focus on the three types of emerging carriers; Network, Product and Price Specialist. The keys to future success of the model include a solid business plan that demonstrates a sustainable competitive advantage, flexibility, the right management team, steady and moderate growth along with a long-term vision.
References Lagorce, A., 2 July, 2008. British Airways to buy l’Avion for $107 million. MarketWatch. http://www.marketwatch.com/news/story/british-airways-buy-lavion-107/ story.aspx?guid¼{1AB71CC2-2361-4CA0-AE8D-5B067B9EB55F}&dist¼msr_1. Leick, R., 2008. Building Airline Passenger Loyalty Through an Understanding of Customer Value: A Relationship Segmentation of Airline Passengers. Ph.D. Thesis, Cranfield University. Morrell, P., 2008. Airline Industry Problems and Prospects. Presentation at Cranfield University. Taneja, N.K., 2005. Fasten Your Seatbelt: The Passenger is Flying the Plane. Ashgate, Aldershot. van der Bruggen, J., 2008. Low-Cost Aiming for Long-Haul. Masters Thesis, University of Amsterdam. Wensveen, J.G., 2007a. Air Transportation: A Management Perspective, sixth ed. Ashgate, Aldershot. Wensveen, J.G., 2007b. Wheels Up: Airline Business Plan Development, second ed. Krieger, Malabar.
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Journal of Air Transport Management journal homepage: www.elsevier.com/locate/jairtraman
The long-haul low-cost carrier: A unique business model John G. Wensveen, Ryan Leick* School of Aviation, Dowling College, 1300 William Floyd Parkway, Shirley, NY 11967, USA
a b s t r a c t Keywords: Low-cost carrier Long-haul low-cost carrier Airline business model Airline strategies
While many industries reach a point of maturation, the airline industry is evolving to incorporate flexible strategies for business models that adapt to the changing economic environment. New business opportunities have emerged as a result of a variety of internal and external forces. This paper discusses opportunities for long-haul low-cost airlines by looking at the evolution of the model and defining three types of new business models. Ó 2008 Elsevier Ltd. All rights reserved.
1. Introduction The airline industry is a risky industry to invest in, statistically second only to the hospitality industry, and yet investors are continuously attracted to it regardless of its economic state. One of the main reasons it is attractive to investors is that it is one of a few industries that can provide a large payback if things work out well. It is helpful to have a full understanding of trends in the industry to comprehend its current position. It is also important to realize that there have been trend breaks and that new trends have emerged to present fresh challenges to the industry. The airline industry is often unstable and unpredictable, forcing airlines to restructure and create flexible strategies that can respond as external operating environment changes. New airlines have an advantage over existing carriers in terms of implementing such strategies because they are devoid of legacy indebtedness or an out-of-date business model.
2. The global airline industry The global industry operates in periods of survival, adaptation, recovery and innovation, resulting in the need for flexible business strategies more than ever. Following the terrorist attacks on the US on September 11th, 2001, the airline industry was in survival mode. These unfortunate events have pushed the airline industry over the edge and resulted in a record number of bankruptcies, mergers and acquisitions. The global aviation industry suffered financially and
* Corresponding author. Tel.: þ1 631 244 1903; fax: þ1 631 244 1334. E-mail address: [email protected] (R. Leick). 0969-6997/$ – see front matter Ó 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.jairtraman.2008.11.012
still continues to recover. In 2002, airlines in the US lost $10 billion (Wensveen, 2007a). In the 2002–2003 period, airlines were forced to adapt to the changing environment. Airlines that survived the immediate shake up sought ways to adapt in the new industry. This period saw a focus on cost -reduction as airlines reduced capacity, cut many inflight amenities, downsized management, outsourced non-critical operations and parked older aircraft. From 2003 to 2005, airlines entered a period of recovery. Much of the opportunities for cost savings were exhausted and airlines returned to focusing on revenue maximization. During this period, revenue and yields returned to pre-September 11th levels and US airlines posted profits (Fig. 1). In the 2005-current period, which is expected to last until another cataclysmic event occurs, airlines have continued to innovate and rethink the way they do business. It can be argued that the recent oil crisis has been another cataclysmic event and has forced many airlines into survival mode. This is evidenced by the numerous failures, acquisitions and mergers. Both legacy and lowcost carriers have differentiated their business models to capitalize on emerging market trends. Air Canada made a drastic change towards unbundling the airline product and offered customers the choice to personalize its product. Though US carriers have made similar changes to their business models, those changes have not been as drastic as those made by Air Canada. Aer Lingus evolved from a typical legacy carrier with no unique competitive advantage to a low-cost network carrier with a focus on long-haul routes. Aer Lingus took large measures to make their cost structure competitive with those of the short-haul low-cost carriers (LCCs) by moving to a modern, all Airbus fleet. The airline has further attempted to change employee work rules and generate ancillary revenue by unbundling its product. Much of the innovation during this period came from the many low-cost, long-haul start-ups.
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10
different models emerged but all of them encountered similar challenges.
5
3.1. Definition of ‘‘low-cost’’ 0
The airline industry has become accustomed to the term ‘‘lowcost carrier’’ otherwise known as LCC. Unfortunately, aside from the various perceptions or stereotypes associated with the term lowcost, few understand the true meaning that often results in a misuse of the definition. Equally curious is the way in which industry experts use multiple definitions for what essentially means the same thing. Examples include:
-5 -10
78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E
-15
Fig. 1. Net profit/loss for world airlines 1978–2007 Morrell (2008).
3. Evolution of the long-haul low-cost model Airline strategy, once politically motivated, is now driven in large part by consumer demand in liberalized and deregulated markets (Leick, 2008). Airline business models are adapting to changing passenger lifestyles and behaviors (Taneja, 2005). Technology has increased the availability of information and has shifted leverage into consumers’ hands, which has resulted in less homogeneous customer segments. It has also provided suppliers in all industries with the ability to meet the needs of individual consumers more efficiently and cost effectively. As a result, airline passengers expect a more ‘logical’ product, while innovative technologies and ideas have provided space for airline business models to evolve. Shifting consumer behaviors have resulted in network carriers steadily loosing market share to a variety of more innovative business models. Low-cost airlines have existed in some form even before the liberalization of air transport markets. Southwest Airlines, established in the early 1970s, is considered the grandfather of the model. Even before Southwest Airlines, commuter carriers often operated at costs below those of the national carriers. It was not until carriers such as Pacific Southwest Airlines (PSA) began offering fares less than those of their competitors that the low-cost, low-fare model emerged. JetBlue later took the low-cost model to a new level by adding amenities superior to those of network carriers. Their leather seats and live satellite televisions in each seat became a trademark of the airline. As of 2005, LCCs in the US and UK had grown to control 30 and 40% of the market capacity respectively (Taneja, 2005). Conversely, the emerging trend of corporate, high-yield business traffic migrating to fractional ownership and corporate jet operations such as NetJets and ExpressJet threatens the airlines’ premium market. Very Light Jets (VLJs) have recently emerged on the scene and threaten to cut into the high-yield business market even further. High yielding first and business customers have always been the cornerstone of network carriers. However, these customers no longer provide the revenue stream they once used to. Premium cabins have largely become a loyalty reward and have all but disappeared outside of long-haul routes where they remain a high-yielding product. The large global carriers have shifted much of their capacity out of domestic markets to capitalize on the more profitable long-haul routes and invested large sums of money to make their premium cabins competitive. Out of these changes in the global air transport industry evolved the low-cost, long-haul model. Entrepreneurs took to the skies determined to cash in on the untapped demand for low-fare, highvalue air travel in the international long-haul market. Several
Low-Cost, No Frills Carrier (LCNF) Low-Fare, High-Value Carrier (LFHV) Less Frills Carrier Value Carrier New Generation Carrier
We take the view that there is no such thing as a low-cost carrier. Airlines, regardless of their business model or geographic location, essentially have the same root costs (i.e., fuel, labor, maintenance). Granted, some airlines have major advantages over others in terms of these root costs, but the cost structures for all airlines are essentially the same. This is evidenced by the equal number of difficulties that both legacy and LCCs face in the current market environment. With that said, the author does use the term LCC in every day practice but the reader should have a full understanding that such terminology is used very loosely. 3.2. Long-haul vs. short-haul flying The differences between the low-cost, long-haul carrier and the low-cost, short-haul carriers are inherently different, particularly when it comes to crew requirements, security requirements, airport facilities, turn around times, route authorities, extended-range twin-engine operational performance standards (ETOPS), training differences, distribution challenges and route density. Short-haul LCCs derive their competitive advantage from operational efficiencies. The opportunity for carrying over this competitive advantage into long-haul operations is rather limited. Instead, long-haul, low-cost carriers aim to achieve a competitive advantage by optimizing yields from the available aircraft capacity. Legacy carriers use highly discounted economy seats to fill the excess space left after premium demand is met. Revenue from premium cabins subsidizes the cost of the economy cabin. Long-haul, low-cost carriers maximize all available space with profitable, premium seating at a rationalized price. To be successful, a new entrant must seek real advantage in all of these factors and find markets where lower fares than the competition can be profitable. The concept of low-cost, long-haul flying is not new to the industry but it is not an established sector as of yet. Skytrain, started by Freddie Laker in 1977, operated between London and New York and offered return airfares substantially lower than its legacy competitors. Unfortunately, Skytrain was out-priced by the competition. The air transport market has changed dramatically in recent years and the low-cost phenomenon has now become widely accepted. The continuing deregulation of the industry and the restructuring of multiple bilateral agreements between states in the rest of the world have increased the number of opportunities to start new operations. To survive in the long-haul market, lowcost airlines have to avoid the common pitfalls in airline business planning.
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4. Failures in airline business planning A majority of the high profile airline start-ups during the last evolutionary cycle were long-haul, low-cost carriers. Understanding the common errors in airline business planning is essential to understand the challenges facing the success or failure of these carriers. There are literally hundreds of reasons leading to the failure of airlines throughout the world and each case should be analyzed individually. However, when it comes to common trends, the list is rather short. Excerpts from Wensveen (2007b) on failures in airline business planning are expanded up below. 4.1. Unable to obtain sustainable, competitive advantage Establishing sustainable, competitive advantage in the airline business plan is difficult but it must be done. When looking at the business plan, the reader is primarily interested in knowing what the market is. Does the market actually exist? How will this company fit into the market? Does this airline have the ability to compete with other carriers and if so, what will be the long-term gain? It is very important not to underestimate the competitors. If no competition exists, don’t assume it will. Always assume that competition will appear and build a contingency plan on how the airline will survive not if that happens but when that happens. The airline business plan should identify what the company’s strengths are and how these strengths will be used to gain competitive advantage. Failure to identify need is a common mistake made in the development of the airline business plan. The business plan must be superior to any potential competitor’s business plan and should be able to gain the investor’s attention and money. Examples of mistakes associated with market need include: inadequate presentation of market needs, failure to identify the size of the market, failure to identify the niche market the airline will operate in, and failure to identify why the airline will be superior to any other. In other words, what is the difference between this airline and its competition? What sets this airline apart from the others? Adding uniqueness to the business concept is important, otherwise, the airline is like any other and will most likely fail to raise the funds needed to fly. 4.2. Failure to demonstrate revenue growth and profitability Many airline business plans fail to demonstrate revenue growth and profitability. Historically, top line growth is mentioned but bottom line growth is not. In order to sell the business concept, bottom line growth is essential and this growth must be based on credible financial assumptions. It is important to have quantitative sections backed up by qualitative sections. All financial projections should be consistent with accepted accounting principles. Unrealistic financial projections should not be incorporated into the airline business plan. In most cases, being able to show ‘‘less’’ rather than ‘‘more’’ can be very powerful in terms of obtaining interest. The financial section of the business plan determines the success or failure of the business concept. If the numbers are falsified, the company will fail. Be realistic with numbers and follow a simple lesson. Whatever the actual costs work out to be, double them. Whatever the actual profits work out to be, half them. Implementing this philosophy will create a strong, well-rounded, realistic business plan. Examples of common mistakes made associated with revenue growth and profitability are: failure to show how ROI (return on investment) will be generated for investors, no clear ROI, lack of return on investment figures, too much concentration on financial numbers, vague assumptions regarding
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potential cash flow, lack of understanding business start up costs, and lack of research. 4.3. ‘‘Wrong’’ leadership Choosing the right person for the right job is important in the management team selection process. In many airline business plans, the importance of the management team is often underestimated. Many investors believe that a superior management team can make a mediocre idea successful. This was proven in the case of Continental Airlines when the airline filed for bankruptcy in 1990. A new Chief Executive Officer, Gordon Bethune, was put into power and the management team was restructured. A failing airline was turned around into one of the most successful carriers under a new management team. A strong management team will help reduce any doubts the investor might have about the ability of the airline to be successful. The airline business plan must promote the team and introduce key advisors that will assist in the company’s success. The management team becomes important in outlining strategic objectives and implementation of the business plan. A good team will be fully aware of all risks involved and such risks should be highlighted in the actual business plan. With each risk should appear a solution or strategy on how the airline will deal with each risk. Failure to provide a thorough SWOT analysis (‘‘strengths, weaknesses, opportunities, threats’’) combined with strategies will enhance the investor’s doubt factor. In addition, a PEST or PESTE analysis (political/legal, economic, socio-cultural, technological, ecological) will only strengthen the content of the business plan. In many cases, the developers of the airline business plan often does not believe that the management team introduced in the business plan could be a major weakness. However, investors often see this as a major weakness and can be critical in deciding whether money will be invested or not. Examples of mistakes associated with the management team include: not focusing on the management team and its experience and lack of information on management or inexperience in the field. 4.4. ‘‘Wrong’’ money During the different phases of airline development, ranging from ‘‘dream’’ stage to day one commercial operations and beyond, the need for capital is continuous. A solid business model should have no trouble attracting money but it is important to distinguish the difference between ‘‘right’’ money and ‘‘wrong’’ money. It is important to attract money from investors who fully understand the airline industry empowering leadership to make decisions in the best interests of the company. Allowing investors to have decision making power without understanding the airline business could be detrimental. Unfortunately, in the business world, the holder of the purse strings is usually more powerful than the ‘‘brains’’ behind the business model often leading to the wrong decisions being made. 4.5. Undercapitalization Airlines are highly capital intensive and most of their failures are blamed on the inability to attract a suitable amount of capital during the ‘ramp-up’ stage and throughout commercial operations. Many potentially successful business models have failed due to limited funding. Interestingly though, many business models have also failed not because of limited funding but due to their poor business plans. Leaders must have a full understanding of the constant need to raise money no matter how successful their airlines are. In the cases of MAXjet Airways, EOS and Silverjet, all
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failed because of lack of funding and competitive forces that crushed their business models. The challenge to create a successful business is really two fold. First, one must estimate the required amount of capital to raise the massive sum of cash needed. Management often underestimates the rate at which cash will burn during the setup and initial operations. Even as revenue starts to come in, it is often below even the most conservative estimates. Convincing savvy investors to invest hundreds of millions of dollars into an industry which historically provides little to no return on investment is a challenge in and of itself. The challenge only grows when additional capital is required during the initial launch at a stage when the airline is loosing money. If the investors’ aim is to take the venture public, the interests of growth and profitability must be balanced to demonstrate revenue growth and the potential for profitability. 4.6. Overexpansion There seems to be a tendency in the airline industry that bigger is better. In other words, the number of destinations served and the greater the volume of aircraft in the fleet, the more successful the airline will be. Unfortunately, in most cases, if this theory is pursued, the airline is on a path to failure. Steady, moderate growth is one key to success in the airline business including the low-cost, long-haul market. The challenge arises in finding the right critical mass. Start-up airlines must balance frequency and breadth of network. High route frequency attracts high-yielding business passengers but dilutes the overall load factor. Often, business travel is determined by corporate contracts which won’t even be considered until airlines have established themselves with a wide network serving a majority of the company’s frequent destinations. 4.7. Lack of flexibility Airlines of all sizes neglect to insert one key ingredient when it comes to their business plan structure – flexibility! Historically, many airlines failed because of this factor. Not being able to adjust the business according to the changing environment in which the airline operates strangles the company to the point where it becomes dependent on a life support system, usually in the form of government subsidies, loans, or employee share plans. In short, not being flexible prolongs the life of the company until it can no longer breathe resulting in bankruptcy, a merger with a competing carrier, or permanent closure. Simplicity in the business model coincides directly with flexibility. A leaner, streamlined strategy will provide more options and minimize complexities when airlines are forced to react. At the same time, simplicity must be balanced with optimization. Rarely does simplicity result in the optimum efficiency. Operational efficiencies achieved from optimization must be weighed against the risks associated with complexity. Only then can a truly flexible business model emerge. 4.8. Wrong business model The airline industry has always been a challenging environment to operate in and it seems, with each passing year, new challenges are presented making success more difficult to achieve. Too many airlines, including the new entrant long-haul, low-cost carriers, have had difficulty mastering the concept of a successful business model. Successful airlines often evolve through the trial and error of others. Unfortunately, airlines which test different business models are the ones to collapse, opening doors of opportunities for new airlines to evolve. Historically, rather than developing
a completely new business model, airlines have copied each other and have often failed to combine all the ingredients that will ultimately lead to successful operations. Many well-intentioned management teams have started an airline with the intent of building a logical airline from a clear drawing board. While many of their proposed innovations appear good on paper, challenges arise when they attempt to implement too much change at one time. Even established LCCs like Southwest, jetBlue and AirTran Airways have reneged on their direct distribution strategy and joined global distribution systems (GDSs). Many airline policies may seem illogical from a customer perspective but serve a purpose in the industry. Carriers attempting to implement drastic changes often experience challenges raised by unions, government regulations and even frequent flyers. Efforts by Air Canada, easyJet and US majors like Northwest to unbundle the product have all encountered resistance from suppliers and customers. This challenge is amplified for start-up carriers which already have difficulties setting up an operation and which have no established base of customer loyalty. Airline business model innovation is a slow evolution, not a revolution. 5. Does the long-haul, low-cost model work? van der Bruggen (2008) examines the pros and cons of the lowcost application to long-haul travel. At first glance, there are clear competitive advantages to the low-cost model in long-haul markets. For instance, no direct substitute exists for long-haul air travel. The captive market allows legacy carriers to excessively inflate fares in premium cabins. The result is high yielding, longhaul routes subsidize less profitable short-haul routes in legacy carriers’ networks and expose the carrier to higher overall cost structures. The higher fares associated with long-haul travel make price a more critical criterion in the purchase decision. However, longhaul economy fares are already competitive and there is little evidence that lower airfares will translate into increased demand in long-haul markets as it has in short-haul. More opportunity for competitive products exists in the premium cabin where price is less of a factor for business and affluent leisure passengers. The challenge is now in finding opportunities for cost advantages that apply to the long-haul environment. Most secondary markets have no existing long-haul service and provide little competition for point-to-point demand. However, existing long-haul aircraft are designed for a high-density configuration, which makes profitability more difficult when applied to medium and small sized long-haul markets. Few routes have the potential to support point-to-point frequencies and secondary airports often do not have the infrastructure to support large aircraft and around the clock operations. Operational efficiencies from secondary airports are minimized for long-haul networks while hub connectivity becomes more critical. Long-haul flights operate at lower frequencies and achieve higher utilization through longer stage flights. Less congested secondary airports do not necessarily translate into quicker ground turn times. Fewer landings mean that landing fees are a smaller percentage of operating costs. High frequency connectivity to short-haul markets becomes more critical to long-haul operations since many passengers connect on either or both ends of their long-haul flights. Many of the competitive advantages enjoyed by short-haul lowcost airlines do not apply to long-haul operations. Legacy carriers already achieve low seat mile costs and high load factors. Further increasing aircraft utilization is difficult due to the long stage lengths and minimal number of turns. Cutting frills on long-haul flights would only alienate passengers who find more value in inflight entertainment, meals and seat pitch on longer flights. Overall,
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the cost-advantage of long-haul low-cost carriers is expected to be 20–25% compared to 40–60% for their short-haul counterparts (van der Bruggen, 2008). The core fundamental in operating long-haul flights is rather simple. As distance increases, operating costs rise while unit costs decrease. This is particularly true when it comes to fuel burn, crew cost, maintenance cost, passenger services and over-flight. Incumbent carriers primarily make up this difference through substantially higher premium fares, not economy fares. It is very difficult to achieve a fare advantage with an all economy seating configuration in long-haul markets. Economy fares increase slowly with distance. Airlines trade fare advantage for limited market applications with a wide-body aircraft. Narrow body, long-haul aircraft also have limited applications. Despite the factors limiting the application of the existing low-cost, short-haul strategy to long-haul operations, great opportunities still exist. The key is to concentrate on developing a new business model which capitalizes on opportunities and accounts for limitations of the long-haul market. 6. New business models The dynamics discussed in this article have driven new airline business models in the long-haul market to include the following: Network Specialists, Product Specialists and Price Specialists. 6.1. Network specialists A network specialist operates as a corporate shuttle catering mainly to business passengers and executives on high-yield routes. PrivatAir, based in Geneva, Switzerland, is the pioneer of this business model and appears able to survive successfully while other airlines fail. The network specialist often has contracts with major corporations for the transport of executives between locations. In the case of PrivatAir, the airline offers business class seating on trans-Atlantic flights and utilizes a mixed fleet of aircraft including Airbus A319-100, A319-100LR, Boeing B737-700BBJ, B737-800, B757-200, B767-300ER and has orders in for the B787-8 Dreamliner. The key differentiators for the network specialist are the ability to operate as a corporate shuttle, Aircraft Crew Maintenance and Insurance (ACMI) operator for existing airlines and tailored or customized services for a wide range of clients. Both Lufthansa and KLM utilize PrivatAir in their network for all business class service from Du¨sseldorf and Amsterdam, respectively. The success of PrivatAir can be attributed to limited competition and lucrative corporate contracts. 6.2. Product specialists A product specialist is an all-business class, all first-class or a combination of both, with a primary focus on large and small business and affluent leisure travel. Scheduled services are offered on routes with high load factors and premium fares. The product specialist competes on the strength of legacy yields in premium cabins on long-haul flights. Pioneers in this market include Eos Airlines, MAXjet Airways, Silverjet and L’Avion. Unfortunately, the first three carriers listed have all gone bankrupt. The fourth, L’Avion, has recently been acquired by British Airways and the airline was most likely never profitable either (Lagorce, 2008). Eos Airlines (UK) operated a 48 seat first-class configuration utilizing the Boeing 757-200 between London Stansted and New York JFK. The airline closed operations in April, 2008. MAXjet Airways (US) operated a 100 seat business class configuration utilizing the Boeing 767-200 between London Stansted and New York JFK as well as London Stansted and Las Vegas. The airline
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closed operations in December, 2007. Silverjet Airways (UK) operated a 100 seat business class configuration which utilized the Boeing 767-200 between London Luton and Newark as well as London Luton and Dubai. The airline closed operations in May, 2008. L’Avion (France) operated a 90 seat business class configuration by utilizing the Boeing 757-200 between Paris Orly and Newark. British Airways plans to operate these aircrafts under their Open Skies subsidiary with 24 lie-flat beds, 28 premium economy and 30 economy seats from airports within continental Europe to the US. The key differentiator for the product specialist is the ability to offer low airfares with flexible tickets in a premium cabin. Given the recent history of the four product specialists, it is evident that this business model has not yet been mastered. Of the three recent bankruptcies, all reported the same reasons for failure, including rising fuel and oil prices, undercapitalization and newly created competition by legacy carriers offering premium cabins on similar routes. Despite these failures, there do not appear to be any inherent problems with the model; however, aggressive competition from legacy carriers and an ever difficult operating environment make initial success difficult. 6.3. Price specialists The price specialist incorporates low-cost strategies to compete on price. They offer long-haul flights against lower fares than legacy competitors and therefore require large aircraft with highseating configuration to be profitable. Essentially, the price specialist has attempted to duplicate the successful short-haul, low-cost business model and apply it to long-haul. The pioneers of the price specialist market are Oasis Hong Kong, Zoom, Jetstar, Viva Macau and AirAsia X. Oasis Hong Kong (China) operated a 359 seat mixed business and economy configuration utilizing the Boeing 747-400 between Hong Kong and Vancouver as well as Hong Kong and London Gatwick. The airline closed operations in April, 2008. Jetstar (Australia) operates three aircrafts including the Airbus A320-200 with a 177 seating configuration, the A321-200 with a 213 seating configuration and the Airbus A330-200 with a 303 seating configuration. The airline operates domestic flights in Australia with additional services to Cambodia, Hong Kong, Indonesia, Japan, Macau, Malaysia, Myanmar, New Zealand, Philippines, Singapore, Taiwan, Thailand, USA and Vietnam. Jetstar’s Australian operation is owned by Qantas Airways. The key differentiators of the price specialist are the ability to offer low fares by utilizing high-density cabins in high demand markets. The price specialist model offers more flexibility than the two models mentioned previously and more opportunity to expand into new markets. Oasis Hong Kong and Zoom went bankrupt while the others appeared to be growing successfully. Based on the mixed result of price specialists there appear to be no inherent problem with the model. The bankruptcy of Oasis Hong Kong and Zoom can both be attributed to the failures in airline business planning discussed in Section 4. However, it remains to be seen how sustainable the price specialists’ cost savings are over the long-term. 7. Low-cost long-haul opportunity For the foreseeable future, network specialists will secure and capitalize on opportunities fitting the corporate shuttle profile on thin, long-haul routes producing high yield. The markets are somewhat limited allowing only a small number of air carriers to tap into such opportunities on point-to-point networks linking a major business centre with another major business centre. The main advantage to this type of operation is the increased cost
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Table 1 Basic features of airline business models. Product Feature
Low-Cost Model
Legacy Model
Charter Model
Aircraft Usage
High
Moderate to high: union contracts
Airport
Secondary (mainly)
Primary
Lower usage but larger aircraft than low-cost carriers Secondary (mainly)
Brand
One brand (low pricing)
Extended brand (price and service)
Check-in Class Segmentation Connection
Ticket, IATA ticket contract Multiple classes Interlining, code-share, global alliances Full service, offers reliability Online, direct booking, travel agent Complex: structure þ yield management
Fleet
Ticketless Single class Point-to-point, no interlining, no baggage transfer Generally underperforming Online, direct booking Simplified fare structure: peak and off-peak. Time of booking also important: the earlier, the cheaper. Low price (60% or more below legacy carriers). Young, single type
Multiple types
Multiple types
Frequency
High
Moderate
Frequent Flyer Programme In-flight
No (mainly)
Yes
Depending on demand (usually higher during summer) No
Target Group
Leisure, time and price sensitive Leisure and business business travelers 25 min Low; congestion and labor
Customer Service Distribution Fare
Pay for amenities, onboard selling Operational Activities Focus on core (flying) Seating Small pitch, no assignment
Turnaround Time
Will be achieved because of longer sector lengths Primary and secondary depending on individual airport facilities Low price for leisure traffic One brand (low pricing), but clear about service Paper ticket Ticketless Single class (sometimes multiple) Multiple classes (usually two) Point-to-point Point-to-point, no interlining, no baggage transfer, self-connecting Via tour operator Unknown Via tour operator Online, direct booking Fares are part of holiday packages, Simplified fare structure: the earlier including accommodation and you book, the cheaper the fare. sometimes car hire, etc. Low price (20–25% cost advantage to legacy carriers likely)
Complementary extras
Complementary extras, but not as luxury as with legacy carriers Extensions (i.e., maintenance, cargo) Passengers þ cargo (sometimes) Generous pitch, seat assignment Seat assignments, pre-bookable
savings and increased productivity for executives. Network specialists with sound business models will be able to secure agreements to operate on behalf of an airline. In other words, an operator who specializes in this area can offer a service that makes financial sense when the actual airline is not able to. This arrangement ultimately results in a ‘win win’ situation for the operator, the airline and the passenger. To date, there is limited competition in this sector. Given the recent history of the product specialist carriers, it is evident that the product specialist model must continue to evolve. In July 2007, British Airways announced that it was purchasing L’Avion with the idea of folding the company into Open Skies, British Airway’s new luxury carrier on the trans-Atlantic. Rising fuel and oil prices combined with low yields resulting from high competition in limited markets ultimately led to the downfall of MAXjet, EOS and Silverjet. In terms of opportunities for product specialists, future business models will have to capitalize on the relative strength of legacy yields in Premium cabins on long-haul flights while at the same time developing an operation that reduces high fixed costs. Whether or not this is even possible remains to be seen. Of the three types of emerging carriers discussed, the price specialist has the greatest number of potential opportunities. Success will be based on the ability to identify high-density markets where legacy competition exists and yet allows the price specialist to survive. Such markets will tap into point-to-point operations as well as hub-and-spoke operations. This means that some passengers will make transfers on other carriers using separate itineraries. The price specialist entrants use seating density to capture lower-yield traffic profitably. In the longer term,
Long-Haul Low-Cost Model
Leisure Low
Young, single type but one aircraft type may not be suitable for all routes (range and capacity issues) Low to moderate (currently about once per day) Maybe more valuable Longer-haul passengers are likely to value this more highly Focus on core (flying). Sometimes cargo Comfort more important the further you fly. Pre-allocation might be demanded Leisure, time and price sensitive business travelers Less important since aircraft spend more hours in the air. Also depending on work/rest periods
the authors expect that such airlines will be able to establish connections with short-haul price specialists in specific markets with the ultimate goal of creating a global network. Depending on specific situations, such partnership arrangements may be in the form of IATA agreements but for simplicity and ease of efficiency, most relationships will probably be non-IATA agreements that eliminate the burden of legal and financial responsibilities established in such contracts. 8. Market characteristics 8.1. Independents The non-legacy, long-haul airlines operating in today’s environment can be characterized in terms of the network model that includes the Frequency Model and the Destinations Model. The former, also referred to as Scale Model, provides service for large corporate clients in markets with strong catchment areas. The target market often consists of affluent leisure and VIP traffic operating sub-nine hour stage length with a once daily aircraft rotation. The latter model, also referred to as the Scope Model, consists of a mixture of affluent leisure and movable business with broad regional catchment areas. There is a seasonal and economic balance combined with availability of peak-time slots operating seven to twelve hour stage lengths. 8.2. Network or legacy airlines The legacy long-haul airlines operating in today’s environment can also be identified by certain characteristics in terms of network
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model including the hub complement and the hub bypass. The former allows the route network to build from hub infrastructure with strong corporate demand, lean leisure, frequent flyers and cargo demand. Typically, stage length is up to nine hours. The latter leverages product superiority versus competition attracting incremental corporate business combined with lower-cost competitive responses. Table 1 provides a more detailed comparison of shorthaul, legacy, charter and long-haul low-cost models. 9. Conclusions A new competitive environment is emerging in the international air transport market. Long-haul, low-cost carriers bridge the networks of short-haul, low-cost carriers allowing LCCs to compete with the mega-alliances of the international network carriers. Interactive marketing agreements allow low-cost carriers around the world to form loose alliances for interlining and frequent flyer programs. At the same time, changes are taking place between the established world-wide alliances. Liberalization has reduced the need for alliances but the benefits of a shared network still hold much value. Consolidation is taking place within the global alliances creating three evenly distributed network alliances. An ad-hoc fourth global alliance is forming with low-cost carriers around the world linking networks in order to compete with the legacy alliances. Low-cost carriers have always been restricted by their inability to satisfy the demand for long-haul, trans-continental travel. Long-haul, low-cost carriers represent an opportunity for LCCs everywhere to join forces and compete with the global alliances. The long-haul point-to-point model integrates well with the similar point-to-point focus city model of the short-
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haul carriers. There are several examples where long-haul and short-haul carriers have entered into interactive marketing agreements to promote cross-selling, integrate websites and advertise cooperatively. These agreements permit passengers to fly to and from small markets in any region of the world via lowcost carriers. If long-haul, low-cost carriers are to survive and adapt in the evolving air transport environment, they must continue to innovate. Opportunities should not focus on low-cost long-haul models but instead focus on the three types of emerging carriers; Network, Product and Price Specialist. The keys to future success of the model include a solid business plan that demonstrates a sustainable competitive advantage, flexibility, the right management team, steady and moderate growth along with a long-term vision.
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