The European budget airline industry: origins, growth, market and competition

BestJet B:

May 2006

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Allan Kinross prepared this case. It is intended to be used as a basis of class discussion rather to illustrate the effective or ineffective handling of an administrative situation

Introduction to the European budget airline industry

After 9 years of spectacular growth and success, at the beginning of 2006 the European low cost budget airline sector still faced a number of challenges. Though the industry had consolidated with easyJet’s acquisition of Go and Ryanair’s takeover of Buzz, every month in the new millennium seemed to see the start up of new budget airlines and new routes or bases being announced. There were over 75 in autumn 2004. Leading players, easyJet and Ryanair, had orders between them for over 300 aircraft  requiring both to more than double in size in the face of growing competition from new entrants, a fight back by established airlines and powerful tour operators.  In the two and a half years to October 2004, average seat prices had continued to fall, and Ryanair had not managed to sell all of its ‘free’ seats on offer in special promotions.  Revenues were under attack from extreme overcapacity and costs were hit by high fuel prices. In the future, would there be enough (profitable) growth for all, and where would that growth come from?   By early 2005 the decline in average fares had stabilised and Ryanair and easyJet announced encouraging financial results. Despite the continuing rise in the price of fuel in 2005 and 2006 few budget airlines went bankrupt and low cost airlines expanded their networks.

Market size and growth rate

The initial explosive growth of low cost airline passenger numbers reflected the unsatisfied demand for a range of leisure activities which was not met by either high-fare traditional airlines or inflexible charter firms. 

Most passengers who fly with low-cost airlines aren’t defectors from the incumbents. Rather, lower prices encourage people to fly when they would otherwise have gone by road or rail—or not at all. Most of these passengers are on vacation; some are workers or self-employed business people commuting on a regular basis.  The overall air traffic in a market typically rises sharply when a low-cost carrier breaks into it, our analysis shows.” [1] 

Despite five earlier years of phenomenal growth, budget airlines continued to grow spectacularly in 2002 and 2003, despite the fact that this was a time of extreme difficulties for traditional airlines after the trauma of September 11, and the effects of recession, particularly on business travel, the outbreak of SARS and the Iraq conflict.  In these two years, budget airline seats increased by 75% on routes within, and to and from, the UK, and 175% in the rest of Europe.[2]  By Dec 2003, budget airlines accounted for nearly 50% of seats on UK domestic flights, and 40% of seats between the UK and mainland Europe.  What started off as the UK phenomenon had in 2003 spread to mainland Europe.   “Across Europe the sector is still in a phase of explosive growth” commented one observer[3].  Low cost airlines were expected to carry around 80m passengers in Europe in 2004, up from 47m in 2003.

Not everything is rosy

As one commentator noted, “Low cost airlines have almost had too many opportunities in the last year and it is difficult to sustain growth at these levels.”[4]  The British Airline Pilots Association said that these growth levels had led to the situation where, “among a lot of low-cost airline pilots there is a quiet concern that they are being over stretched and that safety could suffer”. [5] The success of low cost airlines has also brought criticism from the environmental lobby, particularly that the extra flights encouraged by low fares are damaging the environment, and there have been calls for an environmental tax on all flights or a tax on aviation fuel. In late 2004 the European Union agreed to wait three years before reconsidering these taxes.   The European Union also dismayed the budget airline sector with a proposal that all passengers unable to travel because of cancelled or overbooked flights would be entitled to compensation ranging from €200 to €600, well in excess of some budget airline fares.  Early summer 2003 also saw strikes in France and other countries by public sector workers over pension reforms.  “Regrettably these types of strikes are occurring across Europe more frequently than we’d like”, a BA spokesman was reported as saying after the cancellation of 80% of French international and domestic flights.[6]  Low charges at secondary publicly-owned airports were being challenged as illegal subsides by both the French courts and the EU.

The main market segments

More so than traditional airlines, the main market segment for low cost airlines is the leisure market.  Many low cost airlines’ passengers, Ryanair’s in particular, are tempted by low prices into making journeys they would otherwise not have considered making at full fare.  “They are not part of the existing market that has been lost to flag carriers but part of a new market summoned into existence by bargain basement fares”. [7]   The leisure market breaks down into a number of categories.  The main market segments are sunshine flights, ski flights, city and culture breaks, and the holiday home/second home market.  Other significant segments include the business market[8], the student market[9], the expatriate market[10], the day-trip market[11], and the sports market.[12] Like charter airlines, budget airlines have developed the market for direct flights to and from regional airports. The ideal route for a budget airline is one that caters for more than one market segment.  Additionally, on these ideal routes there are as many people wanting to travel from (originate from) the destination as those who want to fly to it.   

Competition in the European budget airline industry

In the early days of the European budget airline industry, low cost carriers were not to any great extent in direct competition with either each other or established carriers.  By 2005 the competitive environment looked quite different.  Scheduled airlines and some powerful charter groups, who had stayed on the sidelines as the low cost sector developed, had entered the fray to grab a slice of, or avoid missing out on, what appeared to be the only major growth area for the next five to ten years.  What would the impact of this be for the low cost sector? Would the budget airlines start to directly compete with each other as they added more planes to their fleets?   Would the fight back from traditional carriers persist and would it succeed?   Would powerful charter airlines successfully develop their own low cost airlines into serious challengers to the current budget airlines?   What would happen in the German battlefield where many low cost airlines had sprung up? Some of these issues will be considered in the exploration of the three main categories of competition:

  • competition between  budget airlines
  • competition with charter operators
  • competition with traditional carriers

Competition is not just with other airlines.  On some routes in Europe, high speed rail services represent direct competition to airlines on journeys up to 4 hours in length, along with, to a lesser extent, cars and buses.  Will business travellers in the future prefer a first class rail service from city centre to city centre, avoiding traffic to and from airports and security-related delays?  In 2004, some German train fares were slashed to compete with cheap flights. 

Competition between budget airlines[13]

Other low cost airlines represent direct competition; however by the end of 2003 the different strategies pursued by low cost airlines continued to result in little head to head competition.  Consolidation was however taking place. EasyJet’s takeover of Go in 2002 had combined the number two and number three players and it had ended competition between the two companies with the most similar strategies, which had led them into head to head competition on some routes (8 routes in all).  In early 2003 Ryanair surprised the industry by announcing that it was to acquire the loss-making, fourth largest player, Buzz,  from its parent, Dutch national carrier KLM.

At the beginning of 2004, out of some 300 routes served by over 70 budget airlines, only 15 to 20 or so routes saw direct competition between one low cost operator and another.  As Ray Webster of easyJet said, “There’s no reason why a low-cost airline has to go stamping on the patch of another.  The market is immense.”  According to industry observer Simon Calder, “Ryanair and easyJet are hardly the best of friends, but neither wants to take on the other.  Their real targets are the established full-service airlines[14]. Whether this will continue as the market consolidates and matures is a major issue, and new routes have to be found for all the planes ordered; however experience has demonstrated that where there is head to head competition on smaller routes there are generally winners and losers. Competition is most prevalent on routes from Nottingham East Midlands in the UK where BMIbaby and easyJet fly to the same 8 destinations. In 2005 Ryanair also commenced flights form Nottingham East Midlands. In November 2004 both easyJet and Ryanair started flights from Stansted to Valencia, though easyJet declined to compete directly with Ryanair on the London to Riga route. In late 2004 easyJet announced it would challenge Ryanair on the London to Shannon and Cork routes where it said Ryanair had been charging high prices.  Berlin Schoenefeld looks set to for direct competition with Germanwings establishing a base there in direct competition to easyJet.

The main European budget airlines

The main budget airlines to be covered in this section include:

EasyJet                Ryanair           BMIbaby         Flybe.com                  Virgin Express (Virgin)

EasyJet  

EasyJet’s development

Launched in November 1995 by 28 year old Stelios Haji-Ioannou, with the help of a £5 million loan from his father few thought that the brash, bright, orange-livered airline would make it.  Doubters suggested that passengers would hate the ‘vulgar’ orange colour, people would not want to fly from London Luton, and that British Airways would crush them.   But Stelios, as he likes to be known, proved them wrong.  BA tried to buy them out a year after they started, and BA set up its own budget airline Go, some say in a direct attempt to cripple easyJet. In September 2004, easyJet flew 92 aircraft on 169 routes between 45 European airports. By Sep 2007 it would have 149 aircraft.  Where would these extra aircraft be deployed?

EasyJet’s strategy

EasyJet’s strategy had been quite different from its fellow competitors Ryanair and Buzz who had steadily expanded organically the number of destinations they served.  Since 1999, EasyJet’s strategy had been to concentrate growth on increasing frequency on existing routes to existing destinations and “infilling between existing destinations” – “joining the dots”.  EasyJet acquired new bases, routes and destinations with the acquisition of Go and this increased the possibilities for “joining the dots”, meaning that easyJet’s medium term strategy would be concentrated on this approach and that no new cities would be added.  Departures from this strategy were the establishment of a new base at Paris Orly in late 2002, and two new bases in the low cost battlefield, Germany, with one at Berlin Schönefeld and one at Dortmund.  By the middle of 2005 there were flights from Berlin to 28 existing and new destinations and 10 from Dortmund. New 2004/2005 destinations from the UK included Bratislava, Krakow, Warsaw, Riga, Ljubljana, Tallinn, Basel, Turin, Almeria and Valencia

EasyJet’s business model

Most airline industry observers agree that there are important differences in the business models of Europe’s biggest low cost carriers.  While Ryanair was extremely focused on low costs, easyJet and Go were in more direct competition with established airlines.   EasyJet flies to established airports and their route network, flight timings and frequencies, and their overall approach is designed to appeal as much to budget-conscious business travellers as it is to price sensitive leisure travellers.[15]  The difference between the two models is emphasised when one compares the operating profit margins of the two airlines in 2002. Despite lower average fares, Ryanair managed to achieve twice the profit margin of easyJet.   EasyJet had unit cost per available seat kilometre (ask) of 4.52 pence whilst Ryanair has unit costs per ask of 2.98 pence.  In contrast, US low cost leader SW had unit costs of 7.2 pence per ask.  EasyJet’s revenue is higher than Ryanair’s at 5.10 per ask compared to Ryanair’s 3.97 pence, giving easyJet a profit margin of 12.8% compared to Ryanair’s 24.9%.  In 2002 and 2003, much of easyJet’s organic growth was centred on more expensive primary airports.   Compared to Ryanair, easyJet has significantly higher input costs, particularly passenger charges, landing charges and other airport related costs associated with flying to major rather than secondary airports. 

Input costs and process costs

It is also thought that Ryanair’s staff costs are lower than easyJet’s due in part to higher productivity and easyJet’s higher expenditure on customer service related staff.  In 2002, there were some labour relations problems at easyJet and pilots complained about long hours.   EasyJet were pioneers of internet booking and exploiting the benefits of yield management systems and pricing models.  In 2002, distribution costs fell further as the percentage of seats sold on the internet increased 5% to 91.4%.  Its decision to purchase Airbus 319s instead of Boeing 737s provoked concerns about increased aircraft related costs with a split fleet.  In spring 2004, easyJet experimented with a fully automated check-in system.

Service quality

After the operational problems in the summer of 2002, a newspaper article suggested that ‘many passengers who said they were on the whole happy with easyJet nonetheless complained about the attitude of staff.’[16]  However, on balance for every negative comment there seems to be a positive one and easyJet do seem to have taken some steps to improve service performance by deploying more aircraft on stand-by, by in-sourcing some activities, and by employing more check-in staff at their main base Luton and at other airports.  EasyJet claimed that the 2003 Skytrax airline quality survey found that there was very little difference between easyJet’s service and traditional airlines economy class service and that it beat traditional airlines on the friendliness of cabin crew. Some problems with crew shortages, delays and cancellations continued in summer 2003, though. In July 2004 a significantly larger cabin baggage weight allowance was introduced.

Conclusion

The announcement of a £48 million half year loss in May 2003, prompted “experts to say that easyJet runs the risk of being squeezed between Ryanair and full-service airlines which had lowered their prices”. [17]  2004 was a difficult year.  The airline issued two profits warnings – one in the spring and one in June – when little growth in earnings was forecast for the year because of fierce competition.  A trading statement in September indicating that fares would remain under pressure into next year saw shares hit an all-time low – 75 per cent below their high of 504p in 2002. As a result, the company scaled back its plans to increase its fleet of 93 planes.  In October Icelandair acquired a stake of over 10% in easyJet. In early 2005, the airline confirmed that winter 2004 had not been as tough as expected. Its share price rose significantly in 2005.

Ryanair

Despite its outstanding growth rate and profitability, which makes it one of the world’s most profitable airlines, Ryanair faces a number of issues. It has the absolute cost leadership position in the European low cost market but it had seen criticism in the press and from public bodies for its response to a large number of customer service problems. Ryanair is Europe’s largest low fares airline with 15 bases and 303 low fare routes across 22 countries.  The airline suggested that this could rise to 22 bases by 2007-2008.   At the end of March 2006 Ryanair operated an entire fleet of 103 new Boeing 737-800 aircraft with firm orders for a further 131 new aircraft (net of planned disposals) to be delivered over the next 6 years.  Ryanair made a profit of €268 million on revenues of over €1.33 billion for 2004-5.  Some commentators have suggested that in 2005 it was probably the most profitable airline in the world.  In December 2005, Ryanair had cash pile of £1.15 billion.   

Ryanair’s strategy

Ryanair’s strategy and public face is inseparable from the persona of its chief executive, Michael O’Leary. There are contrasting views about the maverick Michael O’ Leary. In 2002, Michael O’Leary said that he was determined Ryanair would stick to the template of its role model, Southwest Airlines, cheap point-to-point flying from secondary airports, rather than shadowing and undercutting the major carriers as, he said easyJet increasingly seemed to be doing[18]He believed that Ryanair would ‘wipe out’ point-to-point competition in Europe within five years. He believed Ryanair would dominate the low-cost sector, and there would be four major carriers in the top echelon – BA, Air France, Lufthansa and easyJet, which by that time would have expanded into long-haul and airline partnerships. [19]   The fact that Ryanair generally fly to secondary airports means that they are not often in direct competition with established carriers.  There seems to be further opportunities for them to expand on this strategy without facing direct competition.  A key to Ryanair’s success is that many of Ryanair’s passengers are tempted by the price of its seats, making trips that they would not otherwise have considered or made.

Ryanair’s business model

Ryanair’s cost leadership position is based on a completely no frills approach and ruthlessness with respect to costs.  In particular, Ryanair saves costs by flying to cheap secondary airports from which they normally extract very cheap landing charges and passenger fees.  According to one report,[20] Ryanair received sizable inducements to set up bases in continental Europe, particularly at its first continental base at Brussels South Charleroi. At small secondary airports, aircraft can be turned around in 15 to 20 minutes and there is little or no congestion.  Cabin crew collect boarding passes at the gate.   For a number of years Ryanair operated elderly 737-200 aircraft. These are now being replaced and supplemented by new, larger, fuel efficient 737-800s, which have lower operating costs per seat mile than A320s and 737-700s. Ryanair had managed to buy its new 737-800s at record low prices at the bottom of the aircraft market[21].  In the report for the half year to September 2002, Michael O’Leary emphasised the benefits of the new aircraft,  “The fact that the maintenance, fuel performance, and technical reliability of the 737-800 has exceeded even Boeing’s initial estimates, means that our costs will continue to decline over the coming years as we take delivery of 103 more 737-800 aircraft.” Overall, it is claimed that Ryanair has reached a position of critical mass that ‘has locked-in lower future unit operating costs.[22]  In late 2004, Ryanair announced that it would introduced in flight entertainment at a cost to passengers of between €5-7. In 2005 it intensified its direct challenge on Alitalia by starting up domestic routes within Italy, and it indicted that it may do the same in other European countries such as Spain.[23]

Marketing and yield management

Ryanair generates significant income from the sale of snacks and beverages at prices 25-35% more expensive than rivals like easyJet. Substantial additional revenue (almost 10% of revenue) also comes from the sale of travel insurance, hotel and car hire bookings through its website. 

Service quality

The UK Airline Users Council, which collates airline passenger complaints, report for 2002 branded Ryanair as the worst airline for customer service to which Ryanair responded by calling them “a bunch of half wits”.  This was widely publicized in newspaper articles.  The press and angry passengers have complained that Ryanair’s lean and mean approach to flight operations also applies to customer service.  In the middle of 2002, there were concerns raised about internal quality issues. There were allegations that ‘the low cost carrier is exploiting a legal loophole to force pilots to work beyond the recommended limit of flying hours.’  One pilot was reported as saying, “If we complain or refuse to work more than 900 hours we fear we will be sacked”. [24] [25]  At the end of 2002, there were, however, signs that one of the root causes of service problems, technical delays, was being resolved as deliveries of new 737 800s significantly lowered the average age of their fleet.  Ryanair claimed in August 2003 that the Association of European Airlines ranked Ryanair number one European airline in terms of punctuality, least cancellations and fewest lost bags.  In 2005 it claimed to be the most punctual major airline in Europe.

Conclusion

When asked about the future of Ryanair, Michael O’Leary said, “I’m absolutely convinced that nothing will stop us, unless we screw it up ourselves through self-inflicted stupidity or arrogance, or we start to think we can walk on water”.[26]   According to one report, Michael O’Leary said of the growth strategy, “If we are aggressive now, we are going to make a bloody fortune”, and that his earlier estimate of 25% growth for 2003 was likely to be conservative.[27]  After the 2002-3 results and the May 2003 traffic figures, there was a different view from another respected observer.  “The airline is flying into a headwind; to maintain its growth rates it will have to deploy increasing quantities of capital and keep wielding the price cut weapon.  Mr O’Leary’s basis for confidence looks shaky.”[28]  Another analyst was also cautious about the short term, but added “it’s a super company and the long term business model is still intact.” [29]  

bmibaby

British scheduled carrier, BMI British Midland, started Bmibaby in 2002.[30]  The airline recognised that the large population catchment area in Central England and Northern England was underserved by low cost airlines.  As a result, BMIbaby launched as a no-frills airline flying from Nottingham East Midlands Airport to destinations including Barcelona, Nice, Palma, Faro, Malaga and they soon added routes to Geneva, Munich, Milan (Bergamo), Lyon and Alicante.  BMIbaby was also the first budget airline carrier to fly from Wales, and it initially based two Boeing 737 aircraft at Cardiff airport.  Go, who easyJet took over, also had set up a base at East Midlands and in middle of  2003, BMIbaby and easyJet were in direct competition on routes to Barcelona, Geneva, Faro and Prague.

For the 2005 summer season, BMIbaby’s expansion means that it flew 16 aircraft from 5 bases (Nottingham East Midlands, Cardiff, Manchester, Birmingham and Durham) on a total of 49 routes to 25 destinations (including UK domestic ones, of which Edinburgh was one).  See Exhibit 1 for details of routes.   No separate results were available for Bmibaby and the parent company has not disclosed whether it is still loss-making; however the parent company, after 5 years when the highest profit margin recorded was 3.4%, suffered its worst ever performance for the 2002 financial year, with an operating loss of £21.7m, following an operating loss of £29m the previous year when it was hit by exceptional charges of £17m.  It lost £12m in the 2003 financial year.  In June 2003, BMI and Virgin Atlantic admitted that they had been in talks about a merger, that both groups had conducted due diligence investigations but that there had been ‘insurmountable’ barriers over valuations and governance. [31]  Majority shareholder Sir Michael Bishop has an agreement with Lufthansa that they will buy his majority stake in the airline at an agreed price should he wish to sell.  In September 2005, Ryanair announced that it would set up its 16th base at Nottingham East Midlands, giving this airport three low cost carriers with bases there.

flybe

British European, or flybe as it re-branded itself, is a relatively small privately owned regional airline that has been forced change due to the huge shift in the airline industry brought upon by the budget airlines.   Flybe has adopted some of the features of low cost airlines, a £5 online booking discount, ticketless travel, and a £3.50 credit card fee, and ticket changes for a fee.  It offers headline discount £19 to £29 one way fares from and to mostly UK regional and secondary airports such as Jersey, Guernsey, Exeter, Birmingham, Bristol, and Newcastle.  Their main bases are at Birmingham, Southampton (increasingly so), Exeter and Belfast City, with Norwich added in 2005. 

They rarely (4 routes) compete on routes directly with low cost airlines. They mainly fly the more expensive-to-operate BAe 146s or Avro regional jets; however their lower passenger capacity means that they have fewer seats to fill on less popular routes.   They are not single class but offer Flybe Economy Plus for business travellers and they have partnerships with Air France and Continental Airlines.  They also sell through travel agents. In 2003, they introduced further new routes and destinations, mainly from regional airports to destinations in the UK and mainland Europe.  By summer 2003 they had added routes to Milan, Geneva, Dublin, Ibiza, Bergerac and Toulouse.  They lost £28 million in the 2 years to Mar 2002, but made a profit of £0.3 million in the year to March 2003.  £22.5 fresh capital was injected to support the move to a low cost airline and keep the airline afloat and a trade sale or stock market flotation of the airline was being sought by 2007.  A £2 to £3 million loss was forecast for the 2003-4 financial year as the airline sought to replace its fleet of regional jets with Boeing 737-700’s or Airbus 319’s.  How the airline could fill these planes from small regional airports was an unanswered question, yet it restructuring seemed to have paid off and it managed to make a profit of £10.4m in the half year to Sep 2004.  In the end it decided on 80-seater Bombardier Q400 turboprop aircraft which it claimed were fuel efficient and environmentally friendly. By 2005 its route profile had changed, with UK and Ireland domestic routes accounting for only 46% in 2005 compared to 80% in 2003.  In 2005 France and Spain accounted for 23% and 17% respectively.

Virgin Express

Virgin Express was part of Richard Branson’s airline stable that included Virgin Atlantic and Virgin Blue, the low cost Australian airline.  Virgin Express operates 11 (mostly) 144 seat Boeing 737-300s and flies from the main Brussels international airport and claim to have one of the lowest costs per available seat kilometre of European airlines. They also claim to have one of the best punctuality records in Europe with over 90% of flights leaving and departing on time. It has a business model which has seen the growth of business passenger traffic, with over 60% of passengers on many routes flying on business, with an average of 50% overall.   In many ways they are more similar to traditional airlines, and they are different from other low cost airlines in that:

  • flights can be booked through travel agents (who are paid 9% commission)
  • seating is assigned at check-in
  • they code share with other airlines
  • recently, however,  the airline stopped offering a free sandwich, coffee and soft drink

The Virgin Express mission statement is ‘Treat everybody as you would like to be treated yourself’, which seems to be supported by its approach to customer service, problem resolution and customer retention.  Customer Service seminars are organised three or four times a year for all members of the Virgin group of companies in order to ensure that ‘every Virgin product and service meets the customer service expectations of the Virgin brand.’[32]

They have had a turbulent 6-year history, finding it difficult to be consistently profitable.  In 2001, after a loss of £41m  they were forced to cut back flights and routes significantly, though there was a resurgence in 2002, with June 2002 revenues 97% higher than the previous year as they focused on the busiest and most profitable routes.[33] In summer 2002 they forced to make a swift retreat from the German market after their announcement that they were to set to set up base at Köln/Bonn airport was followed by similar announcements by the much more powerful players.  They announced disappointing figures for the three summer months in 2003, with profit down from £4.6 to £1.7m, the airline saying that it was being squeezed by low cost rivals and a price war instigated by traditional carriers.  Revenue was down 6%, despite an increase in passengers flown of 7%.  Revenue per passenger kilometre was down 22%.  They lost £12.7m for the full 2003 year

Like easyJet, Virgin Express flies 11 aircraft to major European destinations, 16 in all from Brussels international airport.  In the middle of 2002, they announced a logo change from Virgin Express to Virgin, so that Virgin Atlantic, Virgin Blue and Virgin Express would all have similar logos making the concept of “best value for money more recognizable throughout the world’”.[34] What their strategy will be after having to abort their plans to set up a base in Germany at Köln-Bonn  will be interesting to observe, though in early 2003 they started new routes from Amsterdam to Rome and Milan. In early 2003 they had obtained slots at Paris Orly, though by the beginning of 2004 these had not been taken up.  After months of talks, in October 2004, they announced that a merger with SN Brussels Airlines, who emerged from the bankrupt Belgian national airline, Sabena, had been agreed.  It was expected that both brands would continue to operate separately but that there would be rationalisation on routes where they competed directly.

Sustainability of the low cost business model as traditional carriers fight back

A key uncertainty for the budget airline industry is the extent to which established carriers can replicate some of the features of the low cost model and compete better against it.  They have already reduced what they offer for free, they are already trying to bypass travel agents by selling on the internet and they are also gradually reducing their dependency on the hub and spoke model by flying direct, point to point, flights using smaller regional jets.  Others argue that some aspects of the budget airline product and process design are hard for traditional airlines to replicate since they may require changes in employee attitudes, skills and systems, and they may compromise other features of their service such as connecting flights.  On the other hand, as budget airlines grow they may have to replicate some of the national carriers’ characteristics such as larger size, wider geographical coverage, and increased frequency of flights – all without adding the complexity, costs and bureaucracy of the national carriers.[35]

According to Kevin Done, traditional airlines belatedly woke up to the pent-up demand in the leisure market by changing their fare structure to take account of what they see as “recent changes in the European market, including the ‘sharp increase in the leisure traffic’”.[36]   The fare changes have included the selective introduction of one-way fares and scrapping of Saturday night stay requirements for the cheapest fares. They also may want to simply fill more seats on their planes.  In 2002, for instance, Lufthansa’s load factor was only 63%.  Traditional carriers in their advertising and pricing strategies have started to frequently target destinations flown to by low cost airlines such as Edinburgh, Glasgow, Belfast, Brussels, Madrid, Nice, and Milan.  However, many traditional carriers still lost considerable sums of money on European routes[37] with most of the above mentioned carriers making all their profit on long-haul routes. 

Future prospects for the low cost sector: the debate

Despite good short-term growth projections, some analysts see storm clouds on the horizon for the budget airline industry. There were some worrying signs in 2003.  Another ongoing concern was whether the commercial pressures of the low cost business model was causing unacceptable flight delays, alienating passengers and employees due to poor service quality and whether pilots and crew were being pushed too hard.  The media had given front page coverage to stories about the tendency for low cost pilots to ‘challenge and sometimes ignore instructions from’ air traffic control ‘in an effort to save time’.[38]  

In one of Ryanair’s free seat sales (customers only paid the tax and passenger charges), between 150,000 and 200,000 free seats (15%-20%) were not taken up by customers. Chris Avery, airline analyst at J P Morgan was quoted as saying, “there are just some locations in the depths of winter that even free seats won’t attract people to[39] [40].  The challenges for the long term are highlighted by the McKinsey report,

 “Where could long-term growth come from? Our analysis suggests that it would require the low-cost airlines to take market share from the big incumbents and charter companies. But the no-frills will find it difficult to overcome the structural limitations and competitive challenges in these markets.” [41]

 Not everyone is pessimistic. Morgan Stanley forecast that low cost carriers will have 28% of the intra-European market by 2010, compared to 9% in 2002.[42] In late 2002, KLM forecast an annual growth rate in the European low cost sector of between 20 to 27% for the period 2002 to 2006, with a 9 to 11% annual growth rate in the next 10 years to 2016.  In 2003, only 3.5 million of Germany’s 82 million populations took low cost flights, compared to 21 million trips by the UK’s 59 million.  By late 2004 the number of routes operated by low cost carriers in Germany had grown from four in 2002 to 300 while the number of no frills airlines had increased from two to 15.

Although McKinsey say that ‘viable new routes from London are scarce’,[43] Simon Calder an experienced travel journalist,[44] predicts further expansion after liberalisation in May 2004 into countries joining the EU such as Hungary, Poland,[45]  Cyprus and, perhaps later, even Turkey.   The huge aircraft orders by easyJet (120) and Ryanair (130) certainly seems to suggest optimism and that both will continue to pursue aggressive growth strategies.

In late 2004, there were concerns about extreme overcapacity, falling fares and rising costs.  Winter 2004 was forecast to be a ‘bloodbath’ as marginal carriers were forced into bankruptcy though the expected severe price war never materialised and average fares actually rose at Ryanair.  However there were concerns that the shakeout or restructuring of the industry may be delayed between 12 to 36 months particularly since some new entrants (notably in Germany) were backed by well capitalised parents or supporters who could ride out any difficulties in the short to medium term.  Despite the continuing rise in the price of fuel 2005 was a relatively calm year in the budget airline industry and the industry continuing to grow strongly particularly within and from Germany.  Development continued outside the EU with new routes started to North Africa, Turkey and Russia. 

 Exhibit 1     Main Routes of the main low cost carriers at August 2005

 EasyJet & GoBMIbabyRyanairVirgin
Austria SalzburgGraz, Klagenfurt, Salzburg, Linz 
Belgium BrusselsBrussels Charleroi*Brussels*
Czech  RepPraguePragueBrno 
DenmarkCopenhagen Aarhus, EsbjergCopenhagen
FranceNice, Lyon, Paris CDG, Paris Orly*(9 routes), Toulouse, MarseillesParis CDG, Nice, Toulouse, BordeauxBiarritz, Carcassonne, Dinnard, Montpelier, Nantes, Nimes, Paris, Pau, Perpignan, Reims, St. Etienne, Strasbourg, Toulouse, La Rochelle, Limoges, Rodez, Bergerac, Poiters, Tours, Grenoble, ToulonNice, Bordeaux
GermanyBerlin*(28 routes), Dortmund* (10) , Munich, Cologne/Bonn Frankfurt Hahn* – (36 routes) x,   Hamburg (Lubeck,), Berlin, Friedichshafen, Leipzig Niederrhein (Dusseldorf), Erfurt, Leipzig           Hamburg
GreeceAthens x  from Oct 2006Athens
IrelandBelfast, Shannon and Cork, KnockCork, Dublin, Belfast, KnockCork, Derry, Dublin (27 routes)*, Kerry, Knock, Shannon (15)* 
ItalyBologna, Milan, Rome, Venice, NaplesMilan (Bergamo),PisaAncona, Alghero, Bologna (Forli), Brescia, Genoa, Milan * (17 routes) Pescara, Pisa(9)*, Rimini, Rome* (20) Trieste, Turin, Venice (Treviso), Brindisi, PalermoMilan, Rome
NetherlandsAmsterdam, MaastrichtAmsterdamEindhoven, 
Norway  Oslo, Haugesund 
PolandKrakow, Warsaw Bydgoszcz, Gdansk, Krakow, Lodz, Poznan, Rzeszow, Szczecin, Wroclaw 
PortugalFaroFaroFaro, PortoFaro& Lisbon
ScotlandAberdeen, Edinburgh, Glasgow, InvernessGlasgow, EdinburghGlasgow Prestwick*  (16 routes) 
SpainBarcelona, Madrid, Malaga, Mallorca, Bilbao, Almeria, Asturias, Alicante, ValenciaAlicante, Ibiza Barcelona,  Malaga, Murcia Mallorca,Santander, Zaragoza, Valladolid, Valencia, Girona(19 routes)*, Reus, Almeria, Murica, Santaigo de Compostella, Jerez, Seville, Malaga, GranadaBarcelona, Madrid, Malaga, Mallorca
Sweden  Gothenburg, Kristianstad, Malmo, Stockholm Vasteras & Skavsta* (12 routes))Gothenburg, Stockholm
SwitzerlandGeneva* (11 routes), Zurich, BaselGeneva  
United Kingdom       * Represents a base    London Luton* (25 routes)               London Stansted* (26 routes)              London Gatwick* (24 routes)          Liverpool* (13 routes) Bristol*- (24 routes  ) East Midlands*(8 routes ) Newcastle* (14routes)Nottingham E Midlands * Cardiff* (11 routes) Manchester*(8)Teeside * (8routes) Birmingham* (8 routes)  JerseyBirmingham, Blackpool, Bournemouth, Bristol, Cardiff,  Durham, Leeds-Bradford, London Luton(11routes)* Liverpool (16) *, Manchester, Newquay, Nottingham East Midlands (5), Teesside, These are primarily destinations from Dublin.  London Stansted (89routes)* Ryanair also flies to Riga (Latvia), Kaunas (Lithuania), Bratislava (Slovakia)        * Represents a base

Sources: www.easyJet.com; www.Ryanair.com; www. Virgin-Express.com; www.bmibaby.com

 Exhibit 2: Comparative revenues, costs, load factors and profit margins in 2005-6

 Ryanair year to March 2005EasyJet year to Sep 2005 (2004)South West 2005 (2004)JetBlue Year to Dec 2005 (2004)UK charter firms[46]British Airways [47] 2005
Unit revenues
 (p) per ask
2.964.17 (4.29)3.01 (2.91)2.42 (2.26)4.054.51
Unit costs (p)
 per ask
2.313.92 (4.04)2.68 (2.63)2.35 (2.07)3.734.22
Load factor %84%  85.2% (83.8%70.7% (69.5%)85.2% (83.2%)88%  74.8%
Profit margin
(p) per ask
0.650.25 (0.25)0.33 (0.27)0.07 (0.19)0.320.47
Operating profit margin %22.10%6.6% 5.8%10.8% (8.5%)2.8% (8.8%)7.9%6.9%
Number of planes103 March 2006109 (92)445 (417)96 (60) 290
Internet bookings97%96.9%65% (60%)77.5% (75.4%)lowrising  
Average fare£27.58£42.43 (42.28)£50.63 (47.87)£59.62 (£57.56) £181
Passengers millions27.629.6 (24.3)77.7 (70.9)14.7 (11.7) 35.7

Sources:  Merrion stockbrokers, Ryanair.com, easyJet, Ryanair, Southwest Airlines and JetBlue annual reports, Association of European Airlines, (AEA) and author’s estimates.  $/£ at 1.85

Unit Revenue per available seat kilometre   – this represents the total revenue earned from fares divided by the total number of seats multiplied by the total distance flown.  This ratio gives one a very good idea of the pricing power of the airline’s offering, overall and on particular routes.

Unit Cost per available seat kilometre – in combination with the previous two this is another key ratio.  This demonstrates the relative cost effectiveness and efficiency of the airline, and it often reflects the basis of their low cost business model and how well they implement it. 

Yield or average load factor – this represents the number of passengers flown as a percentage of the number of seats available or, in other words “how full the plane was on average”.  This is an important ratio since services like airline seats cannot be stored and sold later.  Budget airlines use their sophisticated yield management systems to try to maximise their load factors since with the no-frills, nothing free approach, provided that passengers pay taxes, and landing and security charges, the marginal cost of carrying additional passengers is fairly small.

Average Sector length is the average length of routes flown by an airline. This is important because, generally speaking, the longer the route (sector length) the lower are the costs per ask. British Airways operates many long haul flights reducing unit costs despite providing a full service.  JetBlue had an average sector length of 2142kms, lowering its unit costs significantly. Southwest’s average sector length was 971kms and easyJet’s 884kms.  JetBlue used its aircraft for 13.5 hours per day.

Internet bookings – The % of internet bookings is important as commission will not be paid on these to travel agents and the costs of handling them are significantly lower than through call centres or company outlets.


[1] Hyped hopes for Europe’s low-cost airlines,  Urs Binggeli & Lucio Pompeo, The McKinsey Quarterly,  2002, No 4.  Passenger numbers between Edinburgh and Glasgow to Belfast grew by 325% and 235% respectively after Go and easyJet started flying on routes, 90% of them  on the low cost airlines. Source: http://www.go-fly.com/templates/NewsStory.

[2] Budget airlines take off across the Continent, Amos Cohen, Financial Times, 16/12/2003

[3] Flying high, around the world, Kevin Done, Financial Times, 4/11/2003

[4] Pilots to demand better safety at low-cost carriers, Matthew Jones and Andrea Felsted, Financial Times  10/8/2002

[5] ibid             

[6] Yet another strike could bring France to its knees, The Observer 18/5/2003

[7] EasyJet takes a difficult route, Peter Martin, Financial Times, 9/5/2002

[8] Though catering for both leisure and business segments which have competing priorities is not easy as McKinsey point out, some budget airlines have successfully managed to target certain segments of the business market. In particular, EasyJet, and Virgin Express seem to target the time-sensitive, price-sensitive segments of the business market by flying to primary city airports in Europe. On certain flights between London Luton and Amsterdam, Glasgow and Edinburgh the majority of passengers at certain times of day are flying on business, and this reaches 80% on the London to Amsterdam route. 

[9] Students traveling to and from home to University or college e.g. Greece – UK, London to Glasgow or Edinburgh

[10] In Europe, many people do not live in their ‘home’ country or city, though many travel back regularly to their ‘home’ country or city; in turn friends and relatives may visit them.  For instance, many British and Germans live in Spain, France and Italy.

[11] Low fares have made it more possible, for example, for people from Glasgow, Edinburgh and Newcastle visit London for a day’s shopping or visiting exhibitions, galleries or museums. 

[12] Sports fans fly to support their team in Champions League, UEFA cup, the Bundesliga, or for other sporting events.

[13] Estimated passengers carried in 2003 by budget airlines in millions – Ryanair 21.3, easyJet 21.1, Air Berlin 4.3, Flybe 3.5, BMIbaby 3.0, Germanwings 2.6, Virgin Express 2.5, Volare 2.0, Hapag Lloyd Express 1.8, Basiq 1.6, Norwegian 1.3, Mytravellite 1.2, Snowflake 0.4  Source Merrion stockbrokers 27/5/2004

[14] The battle of Europe, Charlotte Hindle, Sunday Times, 3/11/2002

[15] EasyJet takes a difficult route, Peter Martin, Financial Times, 9/5/2002

[16] Passengers express anger but not surprise, Marianne Brun-Rovet, Financial Times , 10/8/2002

[17] EasyJet slumps £48m into the red, Andrew Clark, Guardian, 8/5/2003

[18]ibid

[19] ibid

[20] Revealed: how Ryanair did Belgian deal,  Conal Walsh, December 16, 2001, The Observer

[21] Low-cost carrier shows how it’s done, Kevin Done, FT 11/6/2002.    

[22] Ryanair & easyJet, Merrion Stockbokers, 31/5/2002

[23] Spain, including the Canary islands is Europe’s biggest domestic market, followed by France, Germany and Italy.

[24] Ryanair pilots face the sack, Liz Edwards, The Sunday Times, 25/8/2002

[25] Ryanair pilots’ hours under scrutiny, Mark Odell & Matthew Jones, FT 23/8/2002

[26] The battle of Europe, Charlotte Hindle, Sunday Times, 3/11/2002

[27] Ryanair out to avoid growing pain battle, Russell Hotten, The Times, 1/2/2003

[28] The unfriendly skies,  Lex Column, FT 4/6/2003.  Route cuts and a further drop in fares in Nov 2003 seem to confirm this.

[29] John  Mattimoe at Merrion Capital quoted in We will overtake BA says O’Leary, The Guardian 4/6/2003

[30] SAS owns 20% of BMI and  Lufthansa 30% minus 1 share.

[31] BMI pours cold water over Virgin Atlantic merger, Kevin Done, FT 6/6/2003

[32] Virgin web site, www.virgin-express.com

[33] ibid.   They made £0.5 profit in 2001.

[34] RedHot, Virgin Express magazine, Sep-Nov 2002

[35] easyJet takes a difficult route, Peter Martin, Finanical Times , 9/5/02

[36] KLM cuts fares to meet no-frills competition, Kevin Done, Financial Times, 9/7/2002

[37] In the financial year to March 2003, BA reduced its operating loss on European routes from £224m to £117m. BA had debts of £4.8bn at the end of 2003. BA cut 17% of European capacity between 2000 and 2003. Swiss was in ‘deep trouble’ and in early 2005 it was in advanced talks with Lufthansa about a takeover.  Alitalia and Austrian were also struggling.

[38] Budget airlines fly on a knife edge, Andrea Felsted, Finanical Times  10/8/2002

[39] Ryanair could not find takers from 1,000,000 free seats, Edward Simpkins, The Scotsman, 12/1/2003.  The same happened over Easter in 2003, when Ryanair’s ‘free’ seat offer was taken up by only 520,000.

[40] This author flew from Frankfurt Hahn to Glasgow Prestwick on 23/2/2003 for €13.21, including all charges and from Pisa to Frankfurt Hahn for €14.66  in Feb 2004.

[41] Hyped hopes for Europe’s low-cost airlines,  Urs Binggeli & Lucio Pompeo, The McKinsey Quarterly,  2002, Number 4

[42] European Low-Cost Airlines: This is a buying opportunity, Morgan Stanley Equity Research Europe, 19/9/2002

[43] Hyped hopes for Europe’s low-cost airlines,  Urs Binggeli & Lucio Pompeo, The McKinsey Quarterly,  2002, Number 4

[44] No Frills: the Truth behind the Low-Cost revolution in the skies, Simon Calder, Virgin Books, 2002

[45] In 1998, Poland, Czech Republic and Hungary were the 5th, 8th and 10th most visited European countries

[46] Authors estimates

[47] British Airways Annual Report and Accounts, Association of European Airlines, 2004 and Authors estimates from Association of European Airlines data.  www.aea.be