to achieve as they have not benefited from “The experience curve effect” (Michael E. Porter) of cost effectiveness. This may make it difficult for the new carrier to attract volumes of passengers as their pricing strategy may not be competitive enough. As new entrants enter the market, fares are being pushed down by existing LCA’s, a form of predatory pricing so market share can be retained and entrants forced out.
Entry barriers for traditional carriers are also low. They have the capital requirements and finance available to launch their own LCA. The low cost market is stealing a large share of the European traffic thus leaving traditional carriers rethinking their strategy. In response to this many are reducing their fares so to increase demand for their services.
2. Bargaining power of suppliers
There are two main aircraft suppliers to the airline industry Boeing and Airbus which makes the suppliers concentrated. There is little bargaining power as airlines contribute most if not all to the success of these suppliers.
Fuel is a considerable part of airlines operating costs anywhere from 15 to 30% of its operating costs. Oil being a commodity is open to fluctuations on the commodities
market. Supply is also a concern as conflicts (Climate Change) in the Middle East continue. The airline has no control of these costs.
3. Bargaining power of buyers
Flight travel has increased rapidly over the last five years. Growing economies across Europe have given people higher disposable income and increased leisure time. There are many LCA’s operating the same route thus giving the buyer considerable choice. The internet is now the preferred distribution method for ticket sales, access is relatively easy and comparisons can be made. Air travel is price elastic, demand will increase the lower the fares, suggesting the customer will search and select the lowest fare available for their destination. This is dependant on the convenience of the date and time of the flight; otherwise they will select the next best alternative within their budget. All these factors give customers high bargaining powers.
4. Availability of Substitutes
Rail travel is the main substitute to air travel in Europe but poses little threat in the current market as it is more expensive than current air travel and involves longer travelling times. The emergence of the high speed train offering lower fares and faster travelling times could cause a threat in the domestic markets in the future.
5. Competitive Rivalry
Over the last five years the sector has grown at an average of 35% per annum. The total share of the low fare traffic in Europe is expected to reach 40% by 2010. The high fixed costs nature of the industry increases rivalry as the airlines must maximize
their capacity to attain the lowest cost per unit. In the airline industry this is known as the load factor which measures how efficient the airline operates their tangible assets. The airline has a break even load factor and anything above that is profit.
The low cost sector has little product differentiation indicating that competition is intense as the airlines are offering more or less the same product. The winner is basically the one who can capture the most passengers.
Exit barriers in the airline industry are high due to high fixed costs. Although there is asset specificity, an airplane cannot be used for other purposes, however, it is mobile. Markets in other European countries are opening up with the widening of the EU adding another 12 countries into the European aviation market, giving scope to a wider network.
6. Relative Power of other Stakeholders
Government Legislation may cause a barrier of entry or increased fares. Within the airline industry the EU is proposing an Emissions Trading Scheme (ETS). This scheme (Airline Business, Vol. 22) takes into consideration the environmental impact aviation has on the environment. It is set to propose a Kerosene tax on all domestic and intra EU flights. This will push costs up for the airlines thus reducing revenue and profits. This could have a great impact on LCA’s as they are price sensitive. This could push up fare prices (elfaa) as much as 8%, which in turn may reduce demand by 12 %.
Easyjet (EJ)
EJ was founded by Stelios Haji-loannau in 1995. Headquarters are based at EasyLand next to Luton Airport. EJ’s current fleet has 122 planes, flying 282 routes on a network of 74 airports and 21 countries. It has 16 bases from which it flies domestic and intra Europe flights.
Flights began in November 1995 from London-Luton to Edinburgh and Glasgow using two leased Boeing 737-200 and contracted staff, pilots and cabin crew. The airline grew rapidly through heavy marketing campaigns that grew the customer base. In October 2000 the company was floated on the London Stock Exchange. The acquisition of Go Airlines in 2002 has allowed expansion into more markets and expand its network.
EJ focuses on customers, markets and cost reduction. The airline provides low cost, high frequency, point-to-point air services (www.easyjet) for leisure and business customers within Europe.
The generic strategy adopted by the company is overall cost leadership. This is achieved by having a standardised fleet, reducing maintenance, servicing and staff training costs. They provide point-to-point services, carrying no cargo which allows for fast turnarounds resulting in higher utilisation of aircraft. Ticket sales are made entirely via the internet reducing costs of intermediaries and call centres. There are no onboard meals or services included in the fare. These factors have enabled the company to have one of the lowest costs per unit thus offering low fares to customers yet still maintaining a profit.
See Appendix for financial data and statistics
Ryanair
Ryanair was founded in Ireland and began its operations n 1986 flying routes from Waterford in Ireland to Gatwick, London. Throughout the 1980’s they rapidly grew their networks but made a significant loss. In 1995 mimicking the Southwest Airlines model Ryanair relaunched and became the first LCA in the UK. In 2003 they acquired Buzz Airlines giving access to 11 more airports in France. They currently have 16 bases and operate 341 routes.
The fleet is standardised with one type of aircraft Boeing 737-800 of which currently there are 107 (www.Ryanair) with firm orders for a further 189. The aircraft are relatively new so are efficient on fuel burn giving off less co2 emissions than older aircraft.
Ryanair has much the same business model as EJ but serves more secondary airports as landing and airport fees are cheaper and caters mostly for the leisure customer. The overall cost leadership strategy is also used.
Key Success Factors
It is important to keep controllable costs to a minimum to keep a competitive advantage in the airline industry. This ensures you are able to offer fares at the lowest possible price yet earn a profit. Both EJ and Ryanair have strategies to implement this. The offering of such low fares is preventing many of the larger European airlines to enter as they have higher costs so would be struggling to maintain a profit. Ryanairs average fare is the lowest at £41 followed closely by EJ £45.17.
Sufficient cash flow is crucial as the industry is not only open to fluctuations in operating costs but also cyclical demand. By having a strong balance sheet the airlines are able to weather any short-term variables such as a fall in demand through winter and sharp fuel prices. Again both airlines in question have this; EJ has cash and cash equivalents of £861m and Ryanair has £907m. Fuel hedging is a strategy taken to cope with price shocks. This is when fuel is bought in advance for a set price to combat any sharp rises. Ryanair hedged 90% of its fuel prices from June 2006 to October 2006 to offset any risk.
Differentiation could increase demand for services from a particular airline. Ryanair is embracing technology and adding mobile phone use to their in-flight services and website and onboard gambling. This again will bring increased revenue through their ancillary services. EJ is focusing on businesses that are looking to minimise their travelling expenses.
Aggressive marketing, web presence and strong branding are key success factors. Both airlines have strong marketing backgrounds both good and bad. EJ has a strong brand image, through heavy marketing, televised series “Airport” and web presence through their website. However is also well known for flight delays which may sway potential customers given a choice. Ryanair is steeped in controversy, (McDonald, ITV), following reports of bad customer care and Michael O Leary’s’ marketing tactics which have been deemed as somewhat controversial.
Load Factor is important as it is the key to revenue and profitability. If seats are not filled on particular flight revenue is lost forever. Ryanair currently has a load factor of 83% whilst EJ has 84.8% (2006) so both airlines are utilizing their assets well.
Conclusion
There is room in the sector for both airlines although there is head to head competition between them for new networks and passengers. By focusing on the business segment EJ can spread its services and gain a market niche. Bad publicity for customer service is a key issue; this could have an adverse effect as now there are many airlines covering the same routes giving more choice to customers. Gaining market share on the profitable routes is a major key to success, which both companies are aiming for through increasing their capacity and expanding networks by setting up bases across Europe and acquiring more aircraft. Size and market share are critical for a long-term success which both airlines have achieved. Acquisitions and differentiation are the way forward for both companies deterring further competition as the market will become saturated. The traditional carriers such as BA are now implementing new strategies, cheap flights to gain passenger traffic. It is important that EJ and Ryanair keep their fixed costs low and hedge their variable costs to ensure they can continue to offer low fares.
Appendix
Financial and statistical data
Easyjet
Market Capitalization £1.8billion (current stock price times the number of outstanding shares)
Net Profit 2006 £94.1m 2005 £59m
Net Margin 3%
Cash and cash equivalents £861,000,000
Return on Equity 10.1% up from 7.1% in 2005
Unit costs reduction of 1.5%
Passenger numbers 33 million (year end Sept 2006)
Ryanair
Market Capitalization £3.8billion (msn money)
Net Profit €302million rising 12% from 2005 £204,000,000(currency converter)
Net Margin 18%
Cash and cash equivalents €1,439,004,000 £907,000,000(currency converter)
Return on equity 19.10%
Unit cost reduction of 6%
Passenger numbers 34.8million (year end March 2006)
References
http://www.advfn.com/p.php?pid=ukfinancials&symbol=L^RYA
http://www.guardian.co.uk/frontpage/story/0,,1757288,00.html
“MEP’s back aviation emissions scheme”, Baker, Colin, Airline Business Aug 2006 Vol 22 issue 8
http://www.elfaa.com/documents/FrontierEconomicsreportforELFAA-Economicconsideration.pdf
Tonight with Trevor McDonald, ITV, 12th November 2006
http://www.economist.com
“Climate Change”, Airline Business, Aug 2006 Vol.22 Issue 8
http://money.uk.msn.com/Investing/Insight/Special_Features/Markets_Comment/article.aspx?cp-documentid=849533
Bibliographpy
Porter, Michael E. (1980), Competitive Strategy
The University of Edinburgh Management School, Business Studies 1, Volume 1 Second Edition, Chapters 1, 4, 5, 6
Business Source Premier, Airline Business, Aug 2006 Vol 22, Issue 8
Business Source Premier, Datamonitor, Industries
http://en.wikipedia.org/wiki/Easyjet
“Tonight with Trevor McDonald”, ITV, 12th November 2006
http://www.ryanair.com/site/EN/about.php
http://www.easyjet.com/EN/About/index.html
“Turbulent Skies”, Economist, 7th October 2004, Vol 372, Issue 8383
http://www.airbus.com/en/x1.html
“Crowded Skies”, Economist, 00130613, 4/24/2004, Vol.371, Issue 8372
http://www.elfaa.com/documents/FrontierEconomicsreportforELFAA-Economicconsideration.pdf
http://www.iata.org/index.htm
http://www.eurocontrol.int/inde
http://www.economist.com
Beyond a certain production level, productivity increases at a decreasing rate.
Profit far above normal profits.
Operating costs per available seat per kilometer.
This shows the relationship between experience and efficiency. The more times a process is done the more efficient the process becomes.
In the airline industry this is the percentage of seats filled. Revenue passenger miles/available seat miles per kilometre.
Passenger revenue divided by number of passengers flown.
Extra revenue generated through onboard services and services through a website, such as car hire and hotel bookings.
