Airline Industry: An Analysis

Introduction:

In the following report we would like to present an economic analysis of the airline industry in United Kingdom. Airline industry is going through a period of profound transformation in the UK. A fundamental reshaping due to three remarkable developments, shrinkage of high-end demand for air travel that began in late 2000; the emergence of low-cost carriers and the increased transparency of alternative airline offerings and less expensive routes. Today, it’s one of the most competitive industries with all players trying to introduce new ways of fighting competition through services and lowers costs which are difficult due to the high costs of operations and capital investments. In this report, we aim to understand the dynamics of the airline industry in UK in terms of its competition.

Competition and its changing trends:

Competition in an airline industry is that of an oligopolistic nature where pricing and production strategies of individual firms in a market influence the industry price.The collapse of high-end demand was not simply a change, but an important structural change driven by a powerful combination of economics and technology. Leisure travellers chose airline based on price and the business travellers more price sensitive cutting travel budgets which increased the scope for low-cost carriers. The inspiration behind low cost carriers comes from the case of South West (Calder, 2002).

The competition in the airline industry can be fitted in to the pricing rivalry model of Bertrand. When companies like EasyJet with low initial budget and relatively smaller infrastructure need to fight off big competitors like British Airways, they need to fight using the anomalies between the big airlines and target the customer segments who are not concerned about the quality of the service. For example, the lack of harmony and the limited transferability in the frequent flier programme between the traditionally big airlines could make the frequent flier programme of the big airlines’ less attractive to the customers. This may result in making the low cost airlines more attractive to them as they are already cheaper. Moreover, due to a cost cutting effort in response to the low cost airlines, the cost of the traditionally high cost airlines become affordable for more people, therefore, gets sold out quickly. This increase in demand creates spillover. Low cost airlines enjoy the share of customer ‘spillovers’ from the traditionally high cost airlines. (Besanko, 2000)

New Generation of Europe’s low cost carriers like Ryan Air, EasyJet & Virgin Express:

The success of the low-fare model is dependent on the maintenance of a low cost base and which will eventually take a large part of the overall market, forcing substantial reduction in the number of traditional carriers. EasyJet maintains high margins despite reducing yields through cost management. Low costs are the only competitive advantage in the short-haul economy sector since air travel is effectively a commodity product. EasyJet bluntly fought its way into the market with an aggressive pricing strategy.

One of the competitive strategies by most of the low cost airline in recent time is no-frill service. Especially after the liberalization of air-line industry this strategy is becoming more and more popular for flights over short distances. A particular example is Southwest Airline which has eliminated the need of such things like frills, various classes, in-flight films, design chairs and hub-and-spoke systems etc. In addition, it uses less congested airports, turnaround time less than 20 minutes and last but not least its fleet consists of only one type of planes. This simple strategy provided the flexibility to company to offer prices 60% less than the traditional high-cast airlines. The Southwest Airline is quite profitable in the highly competitive US aviation industry. According to Nalebuff and Bradenburger (1996) “they have chosen to stimulate demand rather than taking shares from major carriers, no market penetration but market development”.

As compared to USA the concept of low-carriers was introduced quite late in Europe. The reason behind this is that smaller regional Airlines didn’t have the budget and infrastructure to fight off their traditional counterparts. In the UK there were three major players in the aviation industry KLM, British Airways and British Midland for quite a number of years. British Midlands less bureaucratic structure enabled it offer lower prices and it has also made one thing clear in the industry that flag carriers will have to concentrate on long routes while no-frills smaller players have to focus on shorter routes. British Midland was the first in the industry that have started the price war and Ryanair, Easyjet and Virgin Express were followers. (Jagersma, 2001)

EasyJet's no frills strategy does not only mean a cut in Cabin crew, but also allows for a faster pre-flight preparation, thereby reducing the time grounded as well maintaining low fare.

The last factor underlying the structural changes in the industry is the internet, not as a substitute for travel but as a perfect purveyor of information about travel. Low-cost carriers have online ticket sales as a means of reducing distribution costs and in a better position to take the greatest advantage of internet distribution. Travelers now have the means to compare price and service offerings of all airlines quickly and efficiently.

In Europe flights offered by the low-cost airlines increased by 48 percent from August 2001-2003 (Baseler 2004). By 2004 there were 60 low-cost airlines carrying 80 million passengers (up from 47 million in 2003). This involved 20% of the European market, a figure projected to rise to 40% by 2010 (Economist, January 27, 2005).

There are numerous implications that follow from such a dramatic growth of the low-cost carriers in Europe. The most obvious effect was on employment relations. In the UK British Airways, has cut its pay roll by 25 percent in the past five years, but it is seeking to cut it by a further œ300 million by March 2007. It is also facing a œ1.4 billion pension deficit and has experienced unofficial strike action in the last three summers (Sunday Times, October 2 and 9, 2005).

What makes the winners and losers in the airlines industry?

The interactions between the airlines are taking place in wide range of activities and services within the airlines industry. Some of them are described below.

Price:

This is the front line of the interaction between airline companies. The airlines compete on the price level for most of the time. Customers are given a choice of choosing the level of service they expect. It ranges from low cost airline flight to business class travelling. Initially, the low cost airlines. They only tried to create a demand which didn’t exist at that time: market development instead of market penetration. (Jagersma, 2001)It also depends on the choices of airports. Low cost airlines usually use the quieter airports in the major cities or airports within the vicinity of the major cities where the parking charges are relatively lower. Whereas the commercial airlines and the flag carriers tend to use high profile airports of the major cities. For example, low cost airlines like Easy jet, jet2.com and Ryan Air use small airports like Luton, Liverpool and Stansted, whereas traditional airlines use airports like Heathrow and Manchester in the UK.

Check-In Services:

Check-in services are another service that is being provided by different airlines. Most of the airlines provide online check-in services now-a-days. The passengers are also allowed to choose their own sit through online check in services. The front desk check-in is also available for all the airlines. Big airlines’ provide priority check in for their premium customers.

Airline Lounges:

Traditional high cost airlines provide airport lounges with different lounges depending on the air fare class of the passengers. Passengers who paid high premium enjoy refreshments and priority boarding in the airport lounges.

Arrivals / Transfer:

Upon arrival the traditional big airlines provide chauffer service to their premium customers. The low cost airlines avoid such services in order to lower costs.

Cabin seating:

The traditional big airlines allocate prior seating arrangement for the customers whereas the low cost airlines usually go for the first come first service options.

Onboard Catering:

Again the traditional airlines provide their passengers with 3-5 course meals with choices of drinks. The customers who travel on business class receive even better choices of meals. The low cost airlines like Easy jet on the other hand, provide no meals on board.

In-flight Entertainment:

The in-flight entertainment is a source of differentiation with traditional high cost airlines. Airlines like Emirates and Qatar airways that fly frequently to and from British and other European airports provide in-flight very rich collections of multilingual in-flight entertainments to attract a range of customers.

Cabin Staff Service:

The traditional airlines have high cabin crew-passenger ratio than the low cost airlines. Low cost airlines thus reduce the cost of overhead. Traditional airlines often provide personal cabin staff for executive passengers.

Environmental issue:

The airlines now-a-days are becoming environment friendly and are competing on low carbon emission technology. The airlines are trying to promote flying a fully booked flight thus reducing number of the flights and reduce emissions. Aircrafts manufacturers are also trying to produce low emission aircrafts. Once the flagship aircraft of Britain and France, Concorde’s reputation was marred due to high carbon emission.

Travel Agents/Direct selling:

The usage of middlemen in booking the flights of traditional airlines is a common selling procedure. The low cost airlines tend to avoid the middlemen by direct selling utilizing their customer service centres and website. Easy jet has its customer service centre easyland in Luton. From Luton, Easyjet operates most of its European selling operation. Traditional airlines use both direct selling and travel agents.

“The winners”:

Customers

Customers are getting more choices. They are availing low cost air travels due to the rivalry between the airlines.

Aircraft manufacturing companies

The ultimate winners of the widespread and affordable air travelling are the air craft manufacturing companies. The two main aircraft manufacturing companies Boeing and Airbus have a stranglehold on the aircraft manufacturing agency. They are also planning their R&D using a cooperating rivalry. We have recently seen that the Airbus had released its Airbus 380 for long haul flights whereas the Boeing had been developing the Boeing 787 Dreamliner which is a smaller aircraft and mainly targeted towards the short haul market.

Losing out…

Traditional Airlines:

Traditional airlines are the biggest victim of the intense competition caused by the low cost airlines. To catch the market share of the low cost airlines, British Airways (British Airways Go), BMI and KLM (KLM Buzz) had started their own low cost short haul services. But apart from BMI baby, both miserably failed and were thrown out of market. Thus were forced to concentrate more on the long range flights and on differentiation rather than the cost expect of the competitive advantage.

Value Creation:

In the UK airline industry, airline companies can be simply divided two groups by their different business strategy. In the first group the airline companies support a higher quality service, have more flexible choice on the flight timetable, and offer higher price. Moreover, these companies mainly focus on long-haul and medium-haul routes market segmentation. The second group of these airline companies supports basic quality service, has inflexible choice on the flight timetable, and offers lower price. These companies focus on the short-haul and medium-haul routes market segmentation. (See table1)

	Main Features	Companies
1st group	Higher price, higher quality service, more flexible timetable for flight long-haul, medium-haul route use the main airports in each route (i.e. Heathrow)	British Airways
2nd group	Lower price Basic service (i.e. no free food service in the flight) Inflexible timetable for flight Short-haul, medium-haul rout Use the airports which are low labor cost and airport fee (i.e. Luton)	Easy Jet, Jet2.com

Table 1

It seems that these two groups create value in two different ways. The value created by the first group through using its competitive advantages by it exit advantages in capabilities and resource such as reputation, trademark, network of airline in all over the world, and large assets and capital, high-skills talent (especially pilots), large marketing expense and customers database. Simply, the value which created by the first group is through higher consumer surplus and higher profit.

The value created by the second group through using its competitive advantages by its cost advantages. It uses the lower buyer perceived benefits but much lower cost. For example, the second group only offers a basic service and inflexible timetable for flight which both reduces the BPB but control its cost from lower airport fee, no free food service, online ticket booking system and less employee.

From the table 2 we can see clearly that Easy Jet and British Airways which are good examples of the 1^st and 2^nd group respectively how to appropriate the value. As the big brother of the UK airline industry BA has the most aircraft, employees, market capitalization. Therefore UK can support the customers higher BPB through higher quality service such as unique in-flight food and entertainment and independent check-in service. Moreover, because BA’s Position in industry it also has differentiation advantage which means it can achieve higher value from different service such as , more legroom in the economy class seats, unique first class seats in airplane and the modern and expensive aircraft. As the new entrant in the UK airline industry Easy Jet has very good performance on profit margin, ROA (return on assets) and load factor. It seems that it appropriate the value through focused cost leadership in porter’s generic strategies. Whatever “non-frills travel”, on-line ticket book system and higher utilization of flight, the only strategy for Easy Jet is to control the cost while supporting basic airline service as one of the transportation.

Furthermore, the two different groups appropriate the value through target different market segmentation. The first group targets the business man who prefers good service, flexible timetable flight and reputation rather than the price. Meanwhile, these business men travel by airplane more frequently. The second group targets people who not travel by airplane frequently and young people who prefer lower price to the good service.

	Easy Jet	British Airways
Revenue	123 US$ million	14,264 US million
Operating expenses	121 US$ million	13557 US$ million
Net profit	4 US$ million	330 US$ million
Market Capitalization	1,940 US$ million	6,504 US$ million
Pre-tax profit margin	3.0 US$ million	2.5 US$ million
Return on assets	32.3	1.6
Load factor	75%	71%
Employees	394	63,799
Number of aircraft	8	278

Table 2 (source: Rogers, 2002 no page given)

Drivers of change:

Flying has become the most popular form of public transportation. Now air transportation is as much a part of life as telephone or computer. Speed, efficiency, comfort and safety – these are the symbols of both modern civilization and modern air transportation. If you want to get there in a hurry, and most businesses do, because time means money, then fly. Following are three main drivers of change to the airline industry including UK airlines namely:

1. Globalization:

Globalization has influenced many industries including airline, the industry has progressed along the way towards globalization. It has done this through the establishment of alliances and partnerships between airlines, linking their networks to expand access to their customers. Hundreds of airlines have entered into alliances, ranging from marketing agreements and code-shares to franchises and equity transfers.

The UK's largest international scheduled airline, British Airways operates flights to more than 550 destinations worldwide and is a member of the one world alliance, along with prestigious airlines such as American Airlines and Cathay Pacific, which allows it to provide passengers with even more great flights and airfares to more than 600 destinations. The airline also has a range of alliances and code share agreements with various partner airlines, providing an extensive worldwide route network for flights and a range of customer benefits. Global alliances have a great stabilizing effect in our present times of economic uncertainty.

2. Liberalization:

Liberalization can create the freedom for airlines to operate on a fully commercial basis. This will allow them to allocate capital more efficiently, to respond better to changes in demand in the markets and to improve productivity. It provides a platform for the airline industry to expand capacity and ownership in accordance with customer needs. It can also improve the return on capital invested that is earned by the airline industry as a whole. In a fully liberalized market, the key for firms is to recognize where its competitive advantage lies and to focus on it. Liberalization provides opportunities for expanding into new markets as well as threats to existing markets.

For example: Airlines of both the United States and the United Kingdom obtained unlimited access between any set of airports. These steps caused a steady expansion of air services and traffic. Since 1995, traffic between Chicago and London has more than doubled.

Air service liberalization, which replaces a set of strict rules, has repeatedly proven a decisive influence in expanding the industry, and making its benefits available to more people. Many airports, airlines, academic institutions, governments and private organizations have documented the relationship between liberalization and economic growth.

3. Information technology

The information revolution has dramatically reshaped global society and is pushing the world every more towards the information based economy. The emergence of the Internet in the mid 1990s as well as the development of Intranets and Extranets forced airlines to refocus their strategy on technological innovations in order to enhance their competitiveness. Airlines identified the Internet as a major opportunity to tackle distribution costs and to reengineer the structure of the industry. Airlines will have to continue development such as on-line distribution, ticketless travel, self-service ticketing and smart cards. There is a great opportunity for the integration of airport and airline systems, along with new applications for biometric security, electronic passports, wireless bag tracing and much more.

Conclusion:

The British airline industry has undergone a period of rapid transformation led by globalization and rapid advancements in Information technology. The lower investment and working capital requirement for the low cost entrants has reduced barriers to entry and has created intense rivalry among the players. The new industry that has emerged has players carefully carving out niches for themselves driven by micro segmentation. While the big traditional players are involved creating value on long hauls flights through service differentiation, the new low cost airlines use price cutting on shorter routes through their “no frills” policy to gain a competitive advantage. With this new structure the traditional players have recognized that focus needs to shift on customer retention through enhanced value creation features such as a robust frequent flier program, check in services and in-flight entertainment. While, traditional players have lost market share in this process the ultimate winner is the consumer with easy access to price and service comparison through the internet providing options for all situated preferences. What has emerged is an industry that is more efficient with the removal of the traditional one size fits all approach to travel and with players making more effective capacity allocation decisions.

References:

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