O'Leary: Ryanair-style Atlantic long haul LCC. Average fares below EUR100? Stansted likely airport


Ryanair CEO Michael O'Leary's latest musings about a possible low cost transatlantic project indicate that he believes any such operation would need average fares below EUR100. This raises the question of just what is a sustainable fare in this market? Until recently the exclusive preserve of legacy full service carriers, the North Atlantic has witnessed the entry of LCC Norwegian over the past year.

However, it was always possible to find relatively low fares and Norwegian's pricing, while lower than that of premium airlines such as British Airways, does not appear to be substantially lower than the average all-inclusive economy fare of AEA member airlines between Europe and North America.

Mr O'Leary's thoughts suggest he would aim for a discount of 60% or more to legacy airline fares. This would undoubtedly drive volume. It would also be greater than the equivalent average discount offered by Ryanair in short haul. However, it may be difficult to find and sustain the cost savings necessary to make this profitable on long haul routes, even with a high fare premium cabin as part of the model.

According to the Irish Independent (24-Jan-2015), Mr O'Leary said: "Our average price on short-haul across Europe is EUR46. We'd want to have an average price in economy on a transatlantic low-cost carrier of under EUR100. The average price should be somewhere in the mid-EUR80s or mid-EUR90s." Mr O'Leary added: "If we wanted to get into the pan-European transatlantic market, then starting in Dublin would be the wrong place to start. It's a tiny market... We'll need something in the order of 30-50 aircraft."

Aircraft availability at the right price will be crucial

Mr O'Leary has speculated over establishing a transatlantic LCC for many years, using a separate vehicle from Ryanair itself, but has to date not moved beyond the concept stage. One of the keys to Ryanair's success in short haul has been its ability to buy large numbers of aircraft at attractive prices at the bottom of the aircraft valuation cycle.

The equivalent opportunity to acquire wide body aircraft has not presented itself since the Ryanair chief first started to toy with the idea of a long haul affiliate and this is one of the principal reasons for his not proceeding. The current order backlog enjoyed by Airbus and Boeing suggests that the ability to receive large numbers of long haul aircraft direct from the manufacturers is years away.

Mr O'Leary's return to the theme recently may indicate that he believes the cycle is turning down, or perhaps he believes that lower oil prices make such a project more attractive. Maybe he is just keeping the idea alive, so that the market remains warm to the idea if and when, one day, it is implemented. We can but speculate.

Are average fares in the mid EUR80s to mid EUR90s realistic on the North Atlantic?

Leaving aside, for now, the topic of which city pair(s) to target for any new Ryanair-affiliated transatlantic venture, the main focus of the current report is to consider its pricing. How does Mr O'Leary's suggestion that average fares in economy should be in the mid-EUR80s or mid-EUR90s compare with market rates on the North Atlantic?

Irish airline Aer Lingus is one of the more cost efficient operators between Europe and North America and has one of the shortest average trip lengths (5,430km in 9M2014 versus just under 7,000km for member airlines of the Association of European Airlines) and so it might be expected to generate lower average fares on the North Atlantic than other carriers.

AEA average North Atlantic passenger revenue per passenger was EUR415 in 2012…

Indeed, Aer Lingus' average long haul fare revenue per passenger of EUR378 (9M2014) compares with passenger revenue per passenger of EUR415 for the AEA as a whole (calculated from 2012 data on passenger revenues and passenger numbers on the North Atlantic, source: AEA STAR). An average fare in the mid EUR80s or EUR90s looks fantastically low compared with this AEA figure. EUR95, at the upper end of Mr O'Leary's range, is a massive 77% discount to EUR415.

…but average AEA trip length is longer than likely Ryanair-affiliated transatlantic project…

However, the figure of EUR415 is not the right comparison for Mr O'Leary's mooted price. First, as noted above, the average trip length for AEA members on the North Atlantic is just under 7,000km. Mr O'Leary is likely to be thinking of a shorter route when musing over his average fare range. (Given London's strength as an Atlantic O&D market and Ryanair's strong presence at London Stansted, and from there across Europe, it seems reasonable to adopt a working assumption that any route would have London at one end).

For example, London-New York is less than 5,600km and London-Boston is less than 5,300km. Using data from AEA STAR for 2012, we can calculate average passenger revenue per passenger and average trip length for different destination regions for Europe's legacy airlines. As would be expected, a plot of these variables (see chart below) illustrates that revenue per passenger increases (or decreases) as average trip length goes up (or comes down).

However, the relationship between the two variables is not linear, but it flattens out a little as trip length increases. Passengers expect to pay more to travel further, but they will not pay double if the distance doubles. This is partly demand-related and partly related to the cost of production (fixed costs do not vary with distance and certain variable costs, such as fuel, are more efficiently consumed as distance increases).

The line of best fit through a scatter plot of passenger revenue per passenger versus average trip length for the different AEA destination regions can be used to estimate the market level for revenue per passenger at a short transatlantic distance of 5,300km. Using the curve in this way, suggests revenue per passenger of around EUR360 for this trip length is consistent with market pricing.

The O'Leary figure of EUR95 is a 74% discount to EUR360.

Association of European Airlines: passenger revenue per passenger (EUR) versus average trip length (km) 2012

…and the AEA figure also includes premium cabins…

The second reason why the unadjusted AEA figure of EUR415 per passenger is not the right comparison is that the AEA data include all cabins, premium as well as economy. IATA's most recent premium traffic monitor, for Nov-2014, indicates that premium cabins account for 14% of traffic, but half of revenues, on the North Atlantic. These proportions vary seasonally (and by route region), but the average passenger revenue per passenger figure hides a wide discrepancy between economy and business class. Typical business class fares can be between three and six times economy fares.

CAPA estimates that the average passenger revenue per passenger in the economy cabin only is around EUR290 for AEA members between Europe and North America and not the EUR415 figure mentioned above. Moreover, at the shorter average trip length of 5,300km, the average passenger revenue per passenger in economy would be closer to EUR270. Mr O'Leary's EUR95 is still a discount of 65% to this figure.

Association of European Airlines: estimated economy cabin passenger revenue per passenger (EUR) versus average trip length (km) 2012

…and ancillaries too

But we are still not quite comparing apples with apples. Mr O'Leary is talking about average fares, whereas the AEA data is based on total passenger revenue per passenger, which includes ancillaries. Levels of ancillary revenue vary significantly by airline and by route. Ryanair generated 25% of its revenues from ancillaries in FY2014, when its average fare was EUR46, but its average revenue per passenger was EUR62.

The global average level of ancillary revenue as a proportion of total revenue is around 7% for airlines tracked by IdeaWorks in its annual analysis of ancillaries. It would be reasonable to assume that there is however a large element of ancillary revenue built into any projections for basic fares at Mr O'Leary's levels.

Mr O'Leary's suggested transatlantic pricing would mean a greater discount to AEA levels than Ryanair's short haul operation

Let us assume that Ryanair's long haul associate does not achieve the same level as Ryanair itself, but does better than the global average and manages to generate 10% of revenue from ancillaries. This would equate to roughly EUR10 on top of the EUR95 average fare, giving a total figure of EUR105 in revenue per passenger in the economy cabin of the Ryanair-style North Atlantic airline. This is the figure with which to compare the EUR270 derived above for AEA members and is a discount of just over 60%.

Average revenue per passenger of EUR105 is, therefore, still a big discount, even by Ryanair's standards. It is a greater discount than the roughly 50% discount we estimate for Ryanair's total revenue per passenger versus AEA passenger revenue per passenger within Europe (adjusted to Ryanair's average trip length).

Then again, applying a percentage ancillary revenue figure against such a low base price would understate the potential revenue from this source. More appropriate perhaps would be to apply actual monetary levels.

This pricing is also lower than the market might expect, based on current ultra-LCC pricing on short haul

Coming at this from another angle, based on average revenue per passenger for European LCCs at their existing average trip lengths on short/medium haul routes, what level of pricing would we expect from them on long haul?

Splitting them into two groups, we can plot revenue per passenger versus average trip length for Europe's LCCs and ultra-LCCs (see chart below) and then project the trend line that best fits the data points on the resultant chart forward to an average trip length of 5,300km.

European LCCs and ultra-LCCs: revenue per passenger (EUR) versus average trip length (km) compared with estimated economy cabin passenger revenue per passenger for AEA members 2012

The curve for the ultra-LCCs, which include Ryanair, is much lower than the equivalent curve for the AEA and for the 'ordinary' LCCs and seems a reasonable way of estimating the kind of revenue per passenger that the market might expect and support from an ultra-LCC operation in the economy cabin on longer trips. This exercise suggests an average revenue per passenger of EUR120 would be viewed by the market as consistent with an ultra-LCC type of operation if its average trip length were extended to 5,300km. The EUR105 figure derived above for the Ryanair-type North Atlantic operation is 13% below this figure.

The only European LCC currently operating on the North Atlantic is Norwegian. It does not separately report revenue and traffic figures for its long haul business, but we can see prices on its website. The lowest price currently available for London Gatwick to New York JFK on Norwegian's website is EUR279 (GBP209) for most of the year, with two fares at EUR239 (GBP179) in Oct-2015. These fares look broadly consistent with the LCC curve in the chart above projected to distances of 5,000km to 6,000km, although Norwegian's average revenue per passenger in economy from London will be higher than this since these are its low fares.

That said, London is not representative of all Europe-North America markets, since the strength of London O&D demand can sustain higher prices than elsewhere. Norwegian offers much lower fares on Oslo-New York, for example. It is also worth noting at this point that Norwegian's overall profitability has suffered since it launched long haul routes, suggesting it has faced a challenge in keeping costs low enough (although it has suffered some teething and setup costs).

See related reports:

Simply projecting the LCC curve for revenue per passenger into long haul may not be enough to determine the appropriate level for LCC fares on the Atlantic. Adjusted for trip length, average LCC fares probably need to be higher on long haul than on short haul to cover commensurately higher costs, even if they can still undercut FSC fares.

Mr O'Leary appears to be setting the bar too low, but there is likely to be method in the madness

Our analysis, while fairly rough and ready, suggests that Mr O'Leary's thoughts on pricing for his mooted North Atlantic venture may be a little too low. On a trip length adjusted basis, Ryanair's existing operation has the lowest average revenue per passenger in Europe. The average fares reportedly under consideration for a new Ryanair-style North Atlantic operation imply a total revenue per passenger significantly lower than any other airline in that market and, adjusted for trip length, below any airline in any market to/from/within Europe (including Ryanair).

But the Ryanair CEO is too canny and too experienced just to have got his sums wrong.

It is probable that Mr O'Leary expects to generate a higher level of ancillary revenues than we have assumed, although ancillaries as a percentage of the total tend to be lower on long haul than on short haul. This is partly a definitional point, since more product features are bundled into the ticket price on long haul. Certainly, the pricing strategy, including where it is positioned on the spectrum of bundling versus unbundling will be crucial to any new low cost North Atlantic airline.

Mr O'Leary may also be planning a highly priced business class cabin to cross-subsidise the economy cabin. Indeed, he has previously spoken of the need for a strong premium offer on any transatlantic venture. This has always been the means for profitability for long haul carriers and Asia's long haul LCCs have business seating, sometimes neo lie-flat. The challenge facing any Ryanair-affiliated long haul operation in this regard is that it does not currently have significant access to relevant business travellers, either directly through a FFP, or indirectly through corporate travel offices and agents. Moreover, it does not have a brand that is consistent with this market segment and does not offer a global network.

See related report: Ryanair SWOT: low costs remain the key strength, even as customer service enhancements take root

If Mr O'Leary still intends to implement any long haul plans via a separate vehicle, it may be possible to establish a new brand, but this would risk losing the advantage of Ryanair's low fares image. Perhaps he is waiting until Ryanair's own initiatives to attract business passengers and to develop relationships with agents and TMCs gains some traction.

Publicity is one of Mr O'Leary's greatest currencies, but low costs are his USP

It may also be that Mr O'Leary is following his well-worn path of generating publicity around low fares. The fares that he has been suggesting are certainly very low. Ryanair's strategy in short haul was always about generating volume through low fares and this looks like an approach that Mr O'Leary hopes to repeat if he launches the transatlantic venture. It is straightforward to have low fares, but the key to keeping them low is to have low costs.

If anyone can generate a significant cost advantage on long haul, Mr O'Leary's track record suggests that he can. Nevertheless, it is more difficult to generate the same degree of cost advantage on long haul than on short haul, due to factors such as aircraft rotations, on-board frills, crew accommodation costs and airport charges. That deserves a fuller analysis in a separate report. In the meantime, a Ryanair-affiliate operating on the North Atlantic is unlikely to be a near term prospect - but then the cuddly Mr O'Leary usually has something up his sleeve.

See related report: Ryanair: Europe's most profitable airline "not cheap and nasty". FY target raised after strong 2Q

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