The world has changed – and so has the low cost carrier

It is beyond dispute that low cost methodology has transformed the aviation sector; for evidence it is not necessary to look beyond the fact that there has been no growth in seat capacity in the full service sector of the market for the past eight years. The expansion has been accounted for by LCCs (even while low fares offered by the full service airlines increased massively too).

This extract is from the 'Conclusion' section of CAPA's Global LCC Outlook report, available for free download at: centreforaviation.com/lcc/report

A new plateau is reached

But it is now equally clear that a new plateau has been reached in the evolution of low cost operations and strategy. There are several reasons, with regional variations in the relative importance of each.

During four years of ideally fertile breeding conditions for new entrants - cheap fuel, cheap aircraft, easy credit and strong consumer demand - the low cost market grew significantly. And so did the intensity of competition for the short haul, low price passenger.

Then, following a serious fuel cost shock in 2008, when jet fuel prices threatened to reach USD200, a credit and demand crisis replaced fuel concerns, accompanied by the flow-through of the previous three years of unprecedentedly voracious aircraft ordering. The sorcerer's apprentice had turned on the fleet expansion tap, pushing capacity growth where prudence would not have dictated. All of these took their toll on any airline model which lacked resilience.

The proliferation of low fare entrants - not always as low cost, or as well conceived as they should be - meant that the level of head to head competition among them became ferocious, where previously it had often been possible to avoid direct confrontation.

When the competitive intensity reaches a certain level, the larger and "purer" low cost models come into their own, even (or particularly) in a period of economic decline.

Of these there is today a very limited number, among the 130 or so LCCs we have loosely identified:

• Europe: Ryanair and Wizz Air;
• US: Allegiant and Spirit Airlines;
• Asia Pacific: AirAsia, Cebu Pacific Air, Mandala Airlines and Tiger Airways;
• India: GoAir, Indigo and SpiceJet; and
• The Middle East: Air Arabia.

It is even necessary to qualify several of these for variations from the "original" Southwest model - and Southwest itself has in any event long since ceased to conform to its own model.

And so to diversification, hybridisation…and convergence?

The other airlines seek new solutions. Competition and external cost pressures are driving diversity, away from the basic low cost/low fare concepts, as carriers seek higher yields to improve revenues.

And temptation too is a motivator for hybridisation, even where necessity does not dictate. Leveraging from the base of a low cost model, the attraction of higher yielding corporate business and international connectivity can be very powerful. These imply added frills, such as lounges, loyalty programmes, GDS links, physical connectivity over "hubs" and interlining.

Each of these can be unbundled and made into revenue centres, but they make the product more complex and do intrinsically involve adding capital and running costs. Generating adequate levels of compensating revenue is never a given.

These moves impliedly also accelerate convergence of the full service and low cost models - although, as we have observed in this report, the process is more painful, if not impossible for legacy airlines.

However, one "group model" which appears increasingly robust is that of Qantas, which appears to combine the strengths of each of the full service and low cost models without attracting all of the negatives. The trio of full service airline, low cost subsidiary and lucrative loyalty programme has synergies that are far reaching and, as yet, un-imitated. Lufthansa is arguably developing a similar collective, but through acquisition, rather than organically.

The main beneficiary has been the consumer

If there is one epitaph that the LCC movement deserves it is that the main beneficiary has been the consumer. Low fares have transformed the way people travel and, more fundamentally, even the way they use their leisure time. In turn, economic development has been the winner, most valuably in regional corners where aviation had previously been excluded, or at best strangled by high fares.

…but there is a witch at the wedding

Sadly, the only actors not to come to the party are governments. With few exceptions, despite the enormous public benefits in stimulating regional development, most governments carelessly disregard the importance of each ponderous addition of a few dollars here and a few pounds there in taxes. Rather than abating, this ugly grab for cash is growing. Its effect is to starve the downstream multiplier benefits of employment, economic growth and, in human terms, of providing new opportunities for emerging middle classes.

The Outlook: Centripetal forces towards a new global model

In most of the more likely scenarios, yield will become increasingly attractive as a refuge for all but the lowest cost operators.

High fuel prices - the main threat - are the most likely catalyst of change in the short term. With the unlikely levels already experienced despite the global financial crisis, speculative activity is tipped to push prices even higher as the economy improves. Surges in price can be highly destabilising and one of the few risk management options that most low cost operators have to guard against this is to search for higher yields.

This and other uncontrollable externalities - both in cost and demand - will relentlessly force most low cost airlines towards reconstituting the network model, domestically and internationally.

But the new network version will differ in two main ways:

• It will use unbundled pricing methodology; and
• Low cost mentality will pervade all phases of the operation.

Perhaps the most marked example of this evolution is found in the AirAsia/AirAsia X short haul-long haul combination. It is early days to pronounce this a format which can be imitated everywhere, but it does have characteristics that point the way to building an international network system. Virgin Blue is following a more conventional, but still expansive, full service approach in its New World Airline model.

Other, more tentative steps are being undertaken by carriers such as JetBlue, partnering and codesharing with Lufthansa, Southwest and others codesharing with foreign LCCs and going international. There is a common theme in much of this evolution, so a pattern develops.

In turn this drives suppliers such as GDSs and IT providers to explore new lower cost, stripped-down initiatives. Airports and airways systems feel the pressure to drive costs down and cooperate progressively in innovating - all of which supports the need to find more environmentally friendly ways of maintaining the global tourism and travel industry.

All of these centripetal forces offer probably an even greater threat to the full service flag carriers than has the short haul movement. The possibility to deliver a networked high quality long haul service at low cost - much easier to achieve when extrapolating from a low cost local base than by contracting from an existing full service global model - represents a serious challenge for the legacy carriers.

That will be the fiercest battlefront for the next decade, as input costs rise and yields recover.

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