How the legacy full service airlines have responded to rising LCC competition

Faced with these challenges, established airlines have become victims of their past success, struggling with a combination of several of the following:

• Entrenched management and labour practices;
• Substantial debt commitments as a result of both growth and volatility;
• Ageing facilities in their base airports;
• An often extensive network of high cost stations;
• Uneconomic routes, including routes sustained as feeders;
• Complex and costly marketing arrangements and distribution channels; and
• Dated information technology and systems.

Under such circumstances, it is difficult to differentiate the survival strategies adopted by ageing corporations from responses to price-driven competition from LCCs.

There is also some debate over how far LCC growth is attributable to market expansion from lower cost travel and new markets, and how far to increasing market share at the cost of established carriers. If their expansion has come from market growth, then the weakness of network airlines can be put down to a failure on their part to engage with new market realities and to manage the impact of repeated shocks by adapting the underlying business model.

Either way, there can be no doubt that LCCs have demonstrated an alternative to their networked rivals as well as to their customers. In doing so they have put pressure on airfares and at the very least obliged - and sometimes enabled - incumbent airlines to review their cost and operating structures.

This extract, 'How the legacy airlines have responded' is from CAPA's Global LCC Outlook report, available for free download at: centreforaviation.com/lcc/report

Reduce fares: "low fare-high cost", a dangerous formula

The most obvious - and perhaps least sustainable - reaction to LCCs was for full service carriers to stretch their yield models to breaking point by placing loss leader fares in the market place. The result was generally predictable - more losses. Ultimately, more than matching LCC fares on legacy airlines without restructuring could only be used in isolation and as a short-term anti-competitive measure. Otherwise, a large share of low yield seats in traditional economy cabins simply places pressure on the premium end of the aircraft. Profitability depends increasingly on high business class occupancy at high fares. In good financial times this may be sustainable. When the economy falters, however, so does a price driven, defensive strategy.

Low cost airline subsidiaries: a growth market

A second response has been for full service airlines to create a subsidiary in order to compete with low cost operators on their own turf and terms. Apart from the ephemeral Continental Lite, Air New Zealand's subsidiary, Freedom, was a pioneer along these lines, operating between New Zealand and Australia and, later, into the Pacific islands. It was established in 1995 and operated out of secondary cities, successfully driving out independent start-up Kiwi Airlines. Freedom Air was recently discontinued, as Air New Zealand moved to an alternative strategy of streamlining its economy service in response to continued challenges in both the domestic market and trans-Tasman routes.

Many others have suffered this fate or worse. The strategy of responding with start-up subsidiaries has had only limited success. Embedding a low cost culture within a legacy environment poses its own set of challenges, especially where services and systems are shared. A constant threat is that the subsidiary cannibalises the principal's mainline traffic. This concern then ricochets around the strategic sphere of the operation.

Examples include Song, Tango, Ted and Zip in north America: in Europe, SAS' Snowflake, BA's Go and KLM's Buzz were failures. The following chart summarises the failed attempts.

Failed low cost airline subsidiaries of full service airlines

Name	Owner	Launch date	Termination	Comments
North America
Air Canada Tango	Air Canada	2001	2004	Folded back into Air Canada
Continental Lite	Continental Airways	1993	1995	Dropped as "too expensive"
Delta Express	Delta Air Lines	1996	2003	Replaced by Song
MetroJet	US Airways	1998	2001	Abandoned after September 11
Song	Delta Air Lines	2003	2006	Folded back into mainline operations
Ted	United Airlines	2004	2009	High fuel prices led United in Jun-2004 to discontinue separate Ted operation. Folded back into mainline operations
Zip	Air Canada	2002	2004	Folded back into Air Canada as a fare option
Europe
Basiq Air	Air France/KLM via Transavia	2000	2005	Merged with Transavia, still operates some services under Basiq Air branding
Buzz	KLM	2000	2003	Taken over by Ryanair
Go	British Airways	1998	2002	Sold to private equity then on-sold to easyJet
Snowflake	SAS	2002	2004	Ceased separate operations in 2004 when SAS decided to offer a "no-frills" Snowflake service in a section of the economy class cabin on its existing short-haul routes from Copenhagen.
Virgin Express	Virgin Group	1996	2007	Merged with SN Brussels Airlines to form Brussels Airlines
Asia Pacific
Impulse	Qantas	Acquired 2001	2004	Absorbed to form Jetstar
Freedom Air	Air New Zealand	1995	2008	Absorbed into the parent, due to minimal brand and cost advantages

Source: Centre for Asia Pacific Aviation

While not a long list, it includes the great majority of subsidiaries that were started up. Finding out why the subsidiary success rate is so poor is probably not so hard, typically involving failure to identify the appropriate role for the airline and allowing too much overlap between managements of the parent and daughter. Where establishment is largely left up to an internal team in the parent, this tends towards disaster, as there is neither the necessary understanding of the low cost model, nor sufficient freedom of action - eg in routes and prices - for the LCC to operate effectively.

But when the equation is struck, there can be remarkably valuable synergies, as seen below in the case of Qantas/Jetstar.

In other cases, the mistakes can offer valuable pointers for others.

LCC Subsidiary Case Study

1. Delta's Song Air, the women's subsidiary. They're (not) playing our Song… 15-Apr-2003 to 30-Apr-2006

Song was one of those airlines that the industry needs every now and again, so it can learn what works and what doesn't. There have been many full service airline low cost subsidiaries that fall into this category. One of the recurring reasons - as airlines didn't learn from each others' mistakes - was that to respond to the low cost airline threat, you had to risk cannibalising your own service by competing on the same routes as the competition.

Laden with psycho-babble and marketing hype though it was, Song was actually a quality airline that really tried to make a difference - but found that all those fancy bits did not make a profitable airline. Nor, more importantly, did it help its parent respond to the low cost airline threat.

Delta had tried in the 1990s to compete on leisure routes, with Delta Express, set up in 1996. It at least survived longer than Song, only disappearing in Nov-2003. Now Delta had decided to try a new focus, one of quality, perhaps inspired partly by JetBlue's arrival. All other subsidiaries had hurt their parents, or simply failed for other reasons. But, although Song's product received almost universal praise, it neither made money, nor provided the solution for Delta in competing in the 21^st century US domestic market.

For, even if all the market research, clever branding and healthy inflight experiences had been well conceived, the concept missed the plot, largely because Delta lost sight of why it was being set up. It was targeted largely at women, because the market research found that women conduct about 90% of online research into travel and leisure (including professional assistants, a diminishing breed), and make about 75% of the travel decisions.

But it didn't put the commercial logic together with the market forces. To avoid shooting the mainline airline's business in the foot, its routes were almost exclusively confined to leisure markets. That was great, but it didn't help Delta much on routes where it was under heaviest attack from the LCCs.

So, when singing the requiem for Song, the carefully crafted, upbeat message put out in Oct-2006 by Delta CEO, Jerry Grinstein, announced that Song was to "merge…into Delta, creating a new and unique long-haul domestic Song service that will set a new standard in transcontinental travel". In other words, it simply hadn't filled that gap. He continued, "Song's route network…has been limited to high-density leisure markets."

Now, Delta with Song was going to redeploy the B757s with a two class configuration. Recognising that the subsidiary idea was a no-go, now came the massive backflip: "By merging the brands, we will also benefit from a more simplified operation, reduced overhead costs, and more focused marketing resources."

Apart from the misdirected strategy, the airline had also had a number of no-go areas. For a start, all of the airline's flight crew came from the mainline carrier. Flight attendants were fitted out in trendy designer Kate Spade's outfits. Then there was a massive preoccupation with marketing. Building on the recently-launched JetBlue's leather seats and live TV, the marketing team looked for "a greater emotional context". This was to be through "an optimistic, can-do, up-tempo, up-beat, attitude." It hired New York's Meatpacking district bartenders to create a signature Song cocktail, then opened a song store. Not much in there on the subject of being brutal about costs….

But Delta was anyway in big trouble by then. It had meanwhile, in Jan-2005, introduced its highly controversial across-the-board massively discounted SimpliFares, a desperate cash-raising measure that unhappily coincided with a substantial rise in fuel prices.

Delta filed for Chapter 11 bankruptcy protection on 14-Sep-2005.

Today the largest airline in the world, Delta decided that bankruptcy, combined with buying Northwest, was a better survival strategy than struggling with subsidiaries.

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