2.4 Option on the Deutche BA
The terms under which easyJet plc would acquire an option to purchase British Airways' German subsidiary, Deutsche BA (DBA) were agreed with British Airways on 8th May 2002 and the option agreement was signed in August 2002. This was after easyJet had been given the approval to acquire DBA by the German competition watchdog. Under the key terms of the option agreement easyJet had the right to exercise the option to acquire DBA at any time up to 30 April 2003. The airline was permitted to extend this date till the 3 August 2003. In order to facilitate the transition of DBA towards a low-cost airline model, easyJet was required to contribute 5 million euros for capital expenditure and was to pay an additional 600,000 euros per month until the option was exercised. If easyJet decided to exercise the option and desired to acquire DBA on a debt free basis, it was required to pay an additional amount between 30 million euros and 39 million euros to British Airways. The amount paid would be determined by the time easyJet decided to exercise the option (easyjet.com, 2003).
The purchase of DBA would give easyJet access to the biggest domestic air market in Europe which in comparison to the UK, was poorly served by the low-cost airlines.
Seven routes in Germany are served by DBA from Berlin and Munich. DBA flies to the major cities of Dusseldorf, Cologne/Bonn, Munich and Stuttgart from Berlin and to Dusseldorf, Hamburg and Cologne/Bonn from Munich.
The DBA fleet consists of 16 Boeing 737-300 aircraft, which are the same as those of easyJet and operate approximately 110 flights per day. easyJet’s CEO, Ray Webster, said:
"This arrangement gives us the opportunity to establish easyJet as the largest low-cost airline in Germany in one step and enhance our growth opportunities" (Airwise, 2002).
Increasingly aggressive pricing policies of Lufthansa and the more competitive nature of the German aviation, caused the financial performance of airlines in the German market, including DBA, to suffer substantial deterioration from the time the option was negotiated. In addition to this, key staff groups found it impossible to accept easyJet’s conditions of employment due to the rigidity of the German labour legislation (Airwise, 2002).
The accumulation of these hurdles caused easyJet to terminate the option to purchase DBA before 3rd July 2003 whilst the total cost relating to the option had totaled £9.1 million.
3. INDUSTRY ANALYSIS/CURRENT STRATEGIES
3.1 Competitive Analysis
3.1.1 Porter’s Five Forces
Michael Porter’s five competitive forces model will be used to analyse the airline industry in detail. It will determine which of these forces are relevant and to what extent. It will also consider the intensity of competition and therefore the profitability and attractiveness of an industry.
Figure 1: Porter's Five Forces
(Recklies D, 2001)
Bargaining power of suppliers
The airline industry tends not to have that much control over the larger suppliers, but do so over the smaller suppliers. A close examination of the main suppliers is considered and their impacts to the industry.
Airplane manufactures are concentrated in the industry, with Boeing and Airbus providing the majority of commercial aircrafts. Before the Airbus order in October 2002 easyJet had only operated one type of aircraft, Boeing 737. They were dependent on Boeing as the supplier of any spare parts, therefore were open to a high level of risk. easyJet’s move to expand their range of aircraft has reduced the bargaining power of the manufactures. There has been a reduction in the powerfulness of the aircraft manufactures, therefore increasing the strategic options available to easyJet. easyJet now has a greater bargaining power when placing further orders in the future.
Fuel suppliers are very much uncontrollable within the airline industry. The price of fuel is related to the cost of crude oil, so as oil prices increases so do fuel prices. Due to the Iraq war oil prices have increased in recent times. The aviation industry benefits from not having to pay any taxes on fuel. The only way they may be able to influence the price is if they buy in bulk, this relates to economies of scale. As the airline expands the power it has over the suppliers would increase. As fuel is purchased in US dollars easyJet is also impacted by the foreign currency risk.
Future growth of easyJet will reduce the bargaining power of suppliers. easyJet would be able to influence the prices of goods to a small extent due to economies of scale.
Bargaining power of customers
Like any industry, the consumers have a powerful bargaining power; this is mainly due to amount of competition within the industry. Consumers tend to have a wider range of choice available in terms of which company to use. The main reason for the bargaining power of the customers is highlighted below.
Civil Aviation Authority (CAA) protects the customers by providing,
- Protection against the failure of travel organisers for people who buy package holiday, charter flights and discounted scheduled air tickets.
- Airline licences and ensures compliance with requirements of European and UK legislation (CAA, 2003).
They make sure that customers are receiving the right service. As they provide the licences for the airlines, easyJet needs to satisfy the requirements of the CAA.
Low-cost airlines attract customers that are looking for the best possible price. This has increased due to the majority of the tickets are being sold via the internet. The use of the internet makes it possible to find price differences amongst various airlines more easily thereby putting more pressure on airlines to keep a closer eye on the prices they offer.
The consumers have very little bargaining power. This is due to there being very few substitutes for travel (The treats from substitutes can be seen below). Also consumers are unable to produce airlines themselves therefore there is no possibility of backward integration. Backward integration occurs when a company takes over or acquires its suppliers.
Threat of new entrants
A threat from new entrants is minimal within the industry due to the barriers of entry. The barriers are the obstacles incurred in the start up phase. Cost implications of starting an airline, acquiring slots and airport spaces all act as a barrier against new entrants. A new entrant would most likely have to be a loss leader in the early stages of the product life cycle. This would then allow them to compete with the established low cost airlines, easyJet and Ryanair.
Threat of substitutes
The threat from substitutes is also minimal. This is due to the other methods of transport being too timely. Other methods would include cars, trains and ferries. Due to the current consumer trends, doing things in the shortest amount of time, it is unlikely the airline industry would have any problems of threats from substitutes.
Competitive Rivalry within the industry
High competitive rivalry results in pressure on prices, margins and hence, on profitability for every single company in the industry. In the UK, the main competitors of easyJet are Ryanair and BMIbaby. Competition within Europe includes Air Berlin and Hapag Lloyd Express.
The low-cost airline industry is very aggressive, this due to them having very similar strategies. There is very little differentiation between the service offered by easyJet and Ryanair and therefore there is much price competition. Booking over the internet has also increased the price competition as it allows consumers to compare prices easily and therefore obtain the cheapest fares.
There is also increasing competition surrounding the allocation of airport slots and routes as this is key to expansion plans. Airlines are continuing to look towards mergers and acquisitions for growth opportunities.
easyJet is currently facing aggressive competition from Ryanair. It is not focusing on potential markets to exploit. 50% of easyJet’s customers are business customers who are not even in their target market.
Consideration has been made to the four forces that could affect the competitiveness of the industry. Only two forces, bargaining power of suppliers and bargaining power of customers affect the industry. The threat of new entrants and substitutes is limited. The barrier to entry limits, new entrants and substitutes, tend to be timely and costly.
3.1.2 Generic Strategies
According to Porter (1986), there are a number of ways an organisation can achieve a competitive advantage over its rivals. Competitive advantage is achieved either by having lower costs than competitors, or by differentiating the product. Differentiation is achieved by offering customers something, which they value and is not offered by competitors. Companies can choose from four “generic” strategies: Cost leadership; cost focus; differentiation and differentiation focus.
Figure 2: Four Generic Strategies
The European low-cost airline industry follows the overall cost leadership strategy. Cost leadership means achieving competitive advantage by being the lowest cost producer within the industry. Strict cost control is achieved partly by the elimination of “frills”, which are offered to passengers traveling via the full-cost operators. These include the use of Internet, ticket-less operation, no free refreshments, less legroom on the aeroplane, refunds not permitted:
- Higher seating density: By removing business class and reducing legroom, low-cost airlines can significantly increase the number of seats on their aircraft. This enables them to increase the load factor.
Apart from keeping costs down, companies also have to focus on maximising their efficiency. This is done by,
- Minimising the maintenance costs by using only one aircraft type and this in turn reduces inventories. easyJet is an exception to this, since the placement of the Airbus order meant they are using two types of aircraft.
- Maximising aircraft utilization by operating young and reliable fleet and using less congested airports resulting in quicker turnaround times. The turnaround time is about 25 minutes for the average low-cost airline. This includes disembarking passengers, unloading and loading baggage, refueling and cleaning aircraft and embarking new passengers. No frills service requires less catering and cleaning. The non-assigned seating and the absence of freight also facilitate rapid turnaround. The same activity takes twice as much time for traditional airlines. Rapid turnaround time ensures more flights a day per aircraft. (Doganis in Lawton,2002, pg 40)
- Low-cost airlines operate a point-to-point system, where airlines fly passengers directly from one airport to another. If a passenger wishes to fly via a hub, two separate flights have to be booked. No baggage transfer is provided, so the passengers must collect their baggage and recheck it for the next flight. If they miss the flight the airline is under no obligation to offer another flight or a refund. The point-to point system enables airlines to maximise the number of flights per day. This generates more revenue and lower unit costs per flight. (Lawton, 2002, pg 51)
Doganis (2001) estimates that the low-cost airlines’ cost per passenger is about one-third those of a conventional airline’s. (Lawton, 2002, pg 119)
Although low operating costs and cheap ticket prices are key requirements for success, an airline’s long-term competitiveness also depends on providing a safe and reliable product. (Lawton, 2002, pg 88) Thus, it is essential to be on time (departing and arriving), have low rates of flight cancellations, ensure baggage is not lost or damaged and have helpful customer service personnel. Cost reduction should not be achieved at the expense of a reliable product/service.
easyJet has a proven record of profitability and market growth, despite not being the lowest cost or price provider. (Lawton, 2002, pg 187)
3.2 Market analysis
3.2.1 The BCG growth-share matrix
The BCG growth share matrix classifies services according to the present market share and the future growth of the market. The matrix is divided into four sections which are ‘question mark’, ‘star’, ‘cash cow’ and ‘dog’. The low-cost airline industry is surrounded with growth issues. As stated in 2.4 the September 11th tragedy has benefited the low-cost industry, where growth has increased due to more consumers looking to travel into Europe rather than Cross-Atlantic. Also due to fears of recession it had caused businesses to readdress their policies on business travel.
Each category within the matrix requires a different growth strategy to be implemented.
Figure 3: BCG Matrix
The BCG matrix above identifies companies within the airline industry and where they are in terms of market share and market growth.
easyJet and Ryanair account for 88% for the European low-cost market share. However, within the European airline industry as a whole, the low-cost airline industry is still in its infancy accounting for only 11%. Mr. Koehler, an economist, forecasts that easyJet and Ryanair will increase their share to 28% in 2010 (The Economist, 2002). In addition the overall air transport market is expected to grow substantially. According to the International Air transport Association, from 176m passengers in 1999 the market will grow to 215m in 2003 (Mintel, 2003, No-frills/Low-cost Airlines – UK).
As shown above, high growth rate but still relatively low market share suggests the European low-cost airline industry is, according to the BCG analysis, in the “Star” phase. According to Mintel over 50m passengers travel via the low-cost airlines. However, it is expected to expand substantially in the future (Mintel, 2003, No-frills/Low-cost Airlines – UK).
3.2.2 Product life cycle
All products and services have a product life cycle and tend to follow the same type of pattern. The length of the product life cycle depends on the product or service. The airlines tend to have a long life cycle.
Figure 4: Product Life Cycle
The European low-cost airline industry is still in its growth stage. However, low-cost carriers are here to stay in the long term. This has been concluded by knowing,
- The huge success in the US where they have been operating/around for over 30 years.
- The EU is densely populated, which is an essential/principal requirement for success within the industry. The EU expansion in May 2004 means that approximately 100 million people will be joining the EU. Thus, there will be further opportunities for the low cost airlines to expand. easyJet believes that there is a substantial intra-European growth potential…(Lawton T C, 2002).
- There is still scope for further expansion as new entrants are still emerging. New start-up ventures include Gemanwings, Hapag-Lloyd Express in Germany, Volareweb.com in Italy, Jet2 in England and SkyEurope in Slovakia (The Financial Times, 2003). However, in this increasingly competitive market not every airline will survive and there will be some failures.
- The low-cost airlines continue to grow even during periods of economic downturn. The reason for this is that they offer value for money. Within the low-cost airline industry market growth is achieved by the strategy of “grow the market rather than take traffic from the major airlines” (Mintel, 2003, No-frills/Low-cost Airlines – UK). This means, airlines do not compete directly against each other. They try to enter bases where there is no or little competition. However, the fast-growing budget carriers have lured travelers away from using European charter carriers such as the German AeroLloyd. The European charter sector provides capacity for tour operators on holiday routes from UK, Germany and the Scandinavia to the Mediterranean. They responded to the low-cost competition by launching their own scheduled operations, such as Monarch and My Travel in the UK and Air Berlin in Germany. However these companies are still struggling against the low-cost operators: they have lost market share and as a result they entered the decline or “Dogs” stage. AeroLloyd filed for insolvency in October 2003, while My Travel is struggling as they experience serious cash flow difficulties (Harnischfeger U, 2003).
According to the Mintel report (2003) the average rate of growth within the low-cost market has been at around 30% (Mintel, 2003, No-frills/Low-cost Airlines – UK). However, such rate cannot be maintained in the long term. This is due to airlines such as Ryanair giving away free tickets to fill seats.
3.3 SWOT Analysis
Now we have considered the environment and the market structure, we can take a close look at the corporate appraisal. The corporate appraisal can be carried out by using what is known as SWOT analysis. It looks at the internal appraisal of the organisation by considering the strengths and weaknesses. The external appraisal is done through the opportunities and threats.
Consideration will be given made to both the internal appraisal of easyJet and external appraisal in terms of the industry.
Internal Appraisal:
Strength: The easy brand is a well known brand across the UK and some areas of Europe. It is known for ‘low cost for the masses’ which is implied by their orange culture. They want to paint the world orange, implying that they want to provide goods and services at the lowest possible price.
easyJet only offers a single fare class. Its pricing strategy is to offer ‘value for money’ and this is done by keeping costs to a minimum. Unit costs are kept low by eliminating travel agents, maintaining high aircraft utilisation, focusing on internet sales, eliminating unnecessary service frills, operating a fleet of similar aircraft and establishing long-term agreements with suppliers.
One of the key strengths of easyJet has been the utilisation of the internet. easyJet bookings over the internet relate to over 92% of total sales and is expected to increase. They see themselves as becoming the first internet only airline.
All of the strengths of easyJet can be seen in the diagram below.
Weaknesses: easyJet has many weaknesses but the main include the lack of service,
flexibility and business focus making the low-cost model unappealing to business travellers. Business travellers are not included within easyJet’s business model. Since September 11th business travellers account for 50% of passengers and therefore should be a target for marketing and should be included in the business model. This can be seen as a weakness for not targeting this segment.
easyJet’s business model also relies on people flying more often. However, there is a limit as to how often people fly. The growth is not infinitive, it is possible that the low-cost market will be saturated. It will come to a point when the low-cost airlines will not be able to stimulate any more demand from low prices. (CPRE: The Future Development of Air Transport in the UK, July 2003, )
Opportunities: The opportunities in the industry mainly come from the EU expansion. On the 1st of May 2004, 10 countries will be joining the EU. Thus, the EU’s membership will be expanded from 15 to 25 countries. The new states include former members of the Eastern Block and smaller “island” states. (bized.ac.uk) These are Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland and the Slovak Republic. Further EU expansion is expected in 2007 when Bulgaria and Romania are hoping to join the EU, while Turkey is now currently negotiating its membership. (europa.eu.int)
The addition of more than 100 million people to the EU’s market of 370 million will present an opportunity for further growth for the low-cost airline industry. easyJet has already announced its new routes from Luton, Berlin and Dortmund airports to Budapest (Hungary) and from Stansted airport to Ljubljana (Slovenia). (easyJet.com)
Threats: There are many threats hanging over the industry. Some of these include EU compensation rules, UK taxes and subsidies and slot auctioning.
EU compensation rules
New EU-wide measures have been agreed to give passengers compensation for cancellations and delayed flights. They will come into force in 2005. This is a fixed rate tariff set by the EU. Airlines will be forced to pay out up to £400 in compensation. Passengers can also claim hot meals, hotel rooms and alternative flights regardless of the cost of their tickets.
BA, easyJet and Ryanair are threatening legal action to block the new rules. If the new EU regulation is implemented by the UK government, airlines will face “endless legal battles if they have to pay for mistakes by other companies”. This will result in increased airfares, abandoned routes, which in turn can threaten the future of the low-cost airline industry. (Carrell: 2004 : 15) Currently easyJet’s passengers are allowed a full refund if the flight departs more than one hour later than advertised. However, the refund is in the form of a credit note (not cash), which is only valid for six months. (Charlton: 2004: N/A)
UK taxes and subsidies
The UK government is concerned, that the forecast growth in the air travel industry could have negative effects on air pollution, noise pollution, public safety and traffic congestion.
At the moment the airline industry is heavily subsidised by the UK government. For example train travel is less subsidised than flights. Consequently, rail routes in the UK cost more than the equivalent flights. It is estimated that the UK airline industry receives approximately £ 6 billion worth of subsidies (or negative taxation) a year. These include subsidies on the aviation fuel, airfares, duty free flights outside the EU and a cap on landing charges:
At the moment no tax is paid on aviation fuel worldwide. If the aviation fuel tax was introduced, it is estimated that there would be a 10% fall in demand. (Department for the Environment, Transport and the Regions (DETR). Further, 75% of flights are for leisure travel. In contrast, fuel for cars are heavily taxed.
Currently air fairs are exempt from VAT. It is estimated that 17.5% VAT would generate £2.5 billion a year. This in terms would result a 22% cut in air travel demand.
Flights for outside the EU benefit from Duty Free. If it was removed it would generate £400 million and would mean a reduction of 1% in flights.
Furthermore, there is a cap on landing charges, which is set by the Civil Aviation Authority (CAA). This means that airports have to charge less for landing than they would charge otherwise.
Changes to the current system would have a significant impact on the low-cost airline industry. It is unlikely that the government will abolish all of the above subsidies. However, the government might introduce taxes “on the grounds of fairness and the environment”. For example if the tax on fuel cannot be introduced and the zero rating on VAT cannot be ended, the government could raise the Air Passenger Duty (APD) to ensure a fairer taxation for the aviation industry. (bized.ac.uk) The APD was first introduced in 1993 to offset the tax-free status of the industry.
The government could also introduce taxes based on noise, air pollution and greenhouse gas emissions.
Slot auctioning
Currently if an airline holds a slot in one operating season, it has first claim on it in the next equivalent season and indefinitely thereafter. This is known as “grandfathering”. Currently most of the slots are claimed under these grandfather rights. The remainder are placed in a pool for allocation. It is suggested that where demand of slots exceeds supply, the price of slot should increase until demand equalled supply. (Select Committee on Environment, Transport and Regional Affairs: Eighteens Report: July 2000) This would affect the low-cost airline industry as they would have to pass on the extra costs to their customers, which in turns would mean a sharp increase in the ticket prices during busy periods.
Figure 5: SWOT Analysis
3.4 Financial Analysis
Within the low-cost/no-frills airline industry in the UK, Ryanair is easyJet’s main competitor. In evaluating the financial performance of easyJet, it is therefore useful to compare its performance with that of Ryanair. For the purpose of this comparison, we will be making use of a number of ratios whose formulae follow that of FAME. The data used for this financial analysis are easyJet’s unaudited preliminary results for their financial year ended 30 September 2003, which provided results for both the year ending 30 September 2002 and 2003. Ryanair’s financial year-end however is 31 March 2004. Therefore in order to obtain data that would be directly comparable, it was necessary to use data from their half-year which ends 30 September 2002 and 2003, and to use figures taken from their financial year end 31 March 2002 and 2003. This enabled us to obtain figures for a full 12 months ending 30 September 2002 and 2003. For a quick overview of all ratios refer to Appendix 3 and details of all calculations are contained in Appendix 4. All financial reports were obtained from downloads available on and .
The first numerical set of data to be analysed is the Profit and Loss Account. This deals with the running of the business, i.e. the amount of turnover, the cost of what has been sold, the expenses generated during the year and of course the profit that has been made, perhaps the figure that the shareholders are most interested in, but there are other criteria that could affect the profitability of the company.
Turnover:
easyJet has shown a 68.9% increase in turnover from £551.8m in 2002 to £931.8m in 2003. This is due to an increase of easyJet’s fleet with the addition of 9 Boeing 737’s and an Airbus A319. This represented an increase in the average number of aircraft operated during the year from 34.2 to 66. This in turn led to a 79 % growth in passenger numbers from 11.4m to 20.3m. In comparison, Ryanair has shown an increase of only 30% in turnover from 744.4 million euros in 2002 to 974.2 million euros in 2003. The addition of 18 new Boeing aircraft resulted in a 45% increase in passenger numbers from 13.2m in 2002 to 19.2m in 2003.
easyJet’s revenues from non-ticket sales went up by 103% from the previous year whilst Ryanair had a growth of 46%: this includes complimentary in flight sales, commission on credit card bookings, travel insurance etc.
Profitability:
easyJet’s profit before tax for the financial year ended 30 September 2003 was £51.5m, a decrease of 28% on the previous year. The main reasons for this include
- an increase in airport charges, which had a 103% change
- increased fuel costs (118%) partly due to the Gulf war
- an increase in crew costs (training, increased number of employees from 2045 in 2002 to 3372 in 2003)
- ground handling costs, navigation costs and marketing etc.
Further, one-off costs associated with the DBA option, the integration costs of GO and the Iraq conflict also contributed to the significant reduction in profit.
Ryanair’s profit before tax for the half year ended showed an increase of 19% from 238.1 million euros to 283.3 million euros. This was despite incurring the following costs:
- an increase of airport and handling charges of 28%
- increased fuel costs of 22%
- staff costs have increased by 25% due to a 50% increase in average number of employees to 2465.
The acquisition of Buzz on 10 April 2003 led to re-organisation costs of 3 million euros for the half year ended 30 September 2003 but this figure is substantially lower than the DBA option and Go integration costs incurred by easyJet. The impact of the Iraq war and the depressed economic environment in Europe are the same factors as those experienced by easyJet. easyJet’s operating profit margin has shown considerable decrease from 12.36% in 2002 to 5.05% in 2003 whilst compared to Ryanair who have only had a decrease from 30.82% in 2002 to 30.00% in 2003. easyJet’s Net Profit Margin as a proportion of the sales has also worsened noticeably from 12.97% to 5.53% and its Retained Profit Margin has shown a decrease form 8.88% to 3.48%. This is not dissimilar form the profit margins of Ryanair which has also decreased in 2003 from 2002 results. These decreases are attributed to the increase in charges mentioned above which affect both companies.
Rate of Return:
The Return on Capital Employed illustrates how much of a return is earned by the company based on the capital that has been invested into it, i.e. the money invested by the shareholders.
Return on Capital Employed (ROCE) has decreased from 8.89% in 2002 to 5.95% in 2003. Although Ryanair has also suffered a decrease on ROCE from 10.80% in 2002 to 10.37% in 2003, it still yields a return for its shareholders greater than that of easyJet. In order to improve ROCE, easyJet will have to improve profit margins and make the same amount of capital generate more sales.
The Current Bank of England interest rate is at 4%. Thus easyJet’s actual ROCE of 5.95% would not seem very attractive for a potential investor. However, in the long term easyJet’s ROCE is expected to improve.
Dividends:
Dividends are the payments made to shareholders from the profits retained in the business in relation to the number of shares held. easyJet and Ryanair both operate a no-dividend policy and investors are therefore expected to rely on capital gains, which is reflected in the ROCE ratio and basic earnings per share.
Basic Earnings per share (EPS):
As investors desire to obtain a return on their investment, how much return each share earns is also of vital importance to future possible investors (McKenzie. W., 1998, P242). Earnings per share is viewed as the after tax profits available to ordinary shareholders, it is also a measure of performance during a period.
The basic earnings per share for easyJet reduced by 44 % from 14.61 pence in 2002 to 8.24 pence in 2003. This is mainly due to the increased goodwill amortisation of to £17.6m form £3.1m, the committed contribution costs of Deutche BA, Go’s integration costs and the accelerated depreciation costs. The reason for the accelerated (or additional) depreciation is that four aircraft are due to be retired in 2004, earlier than planned. For the same period, Ryanair by comparison only showed a 21% increase in their EPS from 19.68p to 23.85p.
P/E Ratio:
This ratio is a measure of what the investor is willing to pay for the share. (McKenzie. W., 1998, P246). In order to calculate this ratio, it was necessary to take the share price as at 30 September for 2002 and 2003 and divide this figure by the EPS for the same dates. This was done for both easyJet and Ryanair. easyJet’s P/E Ratio increased from 18.27 in 2002 to 26.39 in 2003 reflecting easyJet’s shares being considered more valuable. Ryanair’s P/E Ratio has however decreased from 20.12 in 2002 to 16.75 in 2003.
Interest:
Over a period of 5 years easyJet has gone from paying out interest of £8.2m in 2000 to £5.2m in 2002 and £1.5m in 2003 and its interest cover has increased from 14.69 in 2002 to 34.26 in 2003. This reflects that easyJet is able to repay interest on borrowed funds and therefore is able to service the debt. One reason for the reduction in bank loan interest may be the fact the out of the 74 aircraft in its fleet, easyJet only owns 12 while the remaining 62 are under operating lease. As a result easyJet’s lease costs increased by 101% from £41m in 2002 to £82.7m in 2003. However the interest payment is expected to increase, as further debt finance will be used for the four new Airbuses. Ryanair however has seen a decrease in their interest cover from 10.74 in 2002 to 8.15 in 2003. This is due to an 8.7 million euros increase in the level of debt arising from the acquisition of 18 new Boeing aircraft.
The consolidated balance sheet also provides information about the financial position of the company and will include changes that have taken place with the assets and liabilities of the company.
Liquidity:
The current ratio and acid test ratio are used to measure a company’s liquidity i.e. the assets that can be turned into cash quickest. The current ratio is used to determine if the company is able to meet its short-term liabilities (McKenzie. W., 1998, P90). The acid test ratio takes stock into account but since both easyJet and Ryanair are service organisations the same result would be achieved for the current ratio and acid test ratio. easyJet’s liquidity position has decreased from 2.01 in 2002 which was considered acceptable to 1.83 in 2003. Ryanair’s liquidity position has also increased from 2002 to 2.97 in 2003 which is considered to be a more acceptable level that than of easyJet’s. There has only been a slight increase in easyJet’s current liabilities but the decrease in liquidity is mainly attributed to the amount of cash at the bank and in hand. easyJet will need to exercise tighter control over its cash flow position.
Gearing:
Gearing is a measure of whether the company has borrowed more funds than raised from investors. It measures the relationship between debt and equity (McKenzie. W., 1998, P182). easyJet’s level of gearing has increased from 13.48% in 2002 to 15.25% in 2003 as it increased its long-term liabilities from £76m to £108m. However, this is a significant improvement on the 2000 figure, when the gearing ratio was 185%. By comparison Ryanair has significantly increased it’s gearing from 58.42% in 2002 to 81.16% in 2003.
Z-score:
The Z-score is a test which will determine whether or not the company will fail. Anything above 3 means it is unlikely to fail, and below 3 would mean the company will possibly fail. The Z score is greater then 3 so according to Altman (1968), who designed the Z score test this means that easyJet is a secure company that is unlikely to fail and should be considered a safe company to invest in.
3.5 Routes and bases
easyJet focuses on European routes, targeting business and leisure travellers. Its network has steadily grown since absorbing the merger with GO Fly.
At 30th September 2003, easyJet’s flies to 38 airports and covers 105 routes (easyJet’s annual report 30th September 2003, 2003). By February 2004 it will have grown to 39,128 respectively (Pramit, G & Reid, R. 2004).
New bases in Paris Orly, Berlin Schoenfeld and Geneva provide a substantial presence at major airports enabling the airline to strengthen its growth strategy, thus conveniently linking flights to central and Eastern Europe (opening up of EU 1st May 2004).
easyJet priorities its network strategy to be able to:
- Continue to increase flight frequency on existing routes. This brings ‘economies’ both in terms of operations and increases its attractiveness to its customers accounting for 2/3rds of its net growth.
- Add flights between existing destinations. This benefits from synergies with existing operations and customer destinations.
-
Expand its network by adding new destinations. This accounts for the remaining 1/3rd of the net growth (easyJet’s annual report 30th September 2003, 2003).
Route strategies vary across LCA. easyJet’s business model operates on a ‘point-to-point’ basis, flying passengers directly from major city airports A to B. It claims to negotiate excellent deals for lucrative price slots. It concentrates on increasing the frequency of daily flights by maximising the number of flights per day. Therefore, by efficient aircraft utilisation, easyJet’s strategy is to generate more revenue and lowers unit costs per flight, providing shareholder value for both the airline and the airport.
In contrast, Ryanair concentrates on maximising the number of routes to regional airports (127 routes) without creating dense frequency. Therefore, whilst both are LCA’s, they avoid direct competition.
In addition to the cost efficiencies gained, Ray Webster, chief executive of easyJet, believes that customers will pay a slight premium for the convenience of direct, city to city flights.
easyJet’s network competition is coming from the national flag carriers, which target the same short-haul routes. In response to low-cost competitors, they have substantially reduced their fares.
Webster argues that easyJet is not in danger of being squeezed between Ryanair and the major flag-carries. He believes that prices offered by the main airline sectors are ‘unsustainable’ (O’Toole, K Airline Business December 2002).
Many routes throughout Europe still lack a low fare alternative. easyJet has proven that it can successfully expand in markets which are currently higher priced.
3.6 Airbus deal
easyJet’s Fleet
easyJet began operations with two leased Boeing 737 aircraft in November 1995. In April 1996, the airline bought two planes to fly on international routes.
Since then, the fleet has expanded rapidly, partly due to the merger with Go Fly (eastJet.com).
As part of easyJet’s ongoing growth strategy, in October 2002, the airline placed an order to purchase 120 Airbus A319 aircraft from September 2003 over the next four years, with a further ‘price protection’ for an additional 120 Airbus A319 aircraft until 2012 (eastJet.com).
At the end of the financial year, 30th September 2003, easyJet’s fleet consisted of 74 aircraft, of which 73 Boeing 737’s and 1 Airbus A319, an increase on 64 Boeing 737’s at the beginning of the year. By spring 2004, another 11 A319’s will be delivered.
At the year end September 2003, financing of easyJet’s fleet consisted of 12 aircraft owned (with a further 4 Airbus delivered in October 2003) and 62 under operating lease (with a further 6 leases) (easyJet’s annual report 30th September 2003, 2003).
Figure 6: Aircrafts in service (easyJet’s annual report 30th September 2003)
Fleet uniformity
Evidence suggests that airlines with the most uniform fleet have shown better financial results over recent years. In the past, easyJet have operated a ‘single aircraft’ type fleet (Boeing 737). The higher number of specific aircraft type, the more efficient easyJet is able to fully utilise its pool of pilots. Moreover, in addition to its lower maintenance costs, its overall employee per aircraft ratio is reduced (easyJet’s annual report 30th September 2003, 2003).
Nevertheless, with the introduction of the new fleet of A319’s, easyJet argues that the overall costs will be reduced further by some 10%.
The A319 has a wider aisle allowing for two passengers to pass each other making it quicker to embark/disembark ensuring a speedier turnaround time. There are 156 seats on the airbus as opposed to the existing Boeing aircraft which have 148/149 seats.
The airlines extra seating can contribute an additional £48.00 per seat, per flight, a substantial contribution to profits over the entire life of the craft (www.bbc.news.co.uk, 2002).
The planned delivery stream underlies easyJet’s long-term growth strategy. It is expected to give the company a large, modern, efficient and relatively environmentally friendly fleet. High levels of asset utilisation will reduce unit costs.
With the introduction of the Airbus A319 aircraft, combined with the retirement of the older Boeing 737 aircraft, the company will enjoy a two-type ‘new technology’ fleet (easyJet’s annual report 30th September 2003, 2003).
3.7 Corporate Governance
The manner in which a company is directed and controlled is referred to as corporate governance. The role of the directors and the necessity for an effective framework for the accountability to the shareholders by the directors is of particular importance (Buckley, A., 2000, p43). The Combined Code prescribes principles of good governance and code of best practise. The Combined Code was issued by the Hampel Committee on Corporate Governance and is derived from the Cadbury and Greenbury Reports (ACCA, 2003, p376). Part of the listing agreement of the London Stock Exchange is the requirement for listed companies to conform to The Combined Code (Millichamp, A., 2002, p378). Listed companies are required to make a two-part disclosure statement relating to the Combined Code which requires the company to report on how it has applied the Code’s principles and to confirm that is has complied with the Code’
In July 2003 the Combined Code was revised to take into account the Higgs Report and Smith Report. The Higgs report was prepared by Derek Higgs and reviewed the role and effectiveness by non-executive directors while Robert Smith reviewed audit committees in the Smith Report (www.fsa.gov.uk). The new Code applies to reporting years that began on or after November 2003 and therefore does not apply to easyJet’s current financial year which began 1st October 2003. After having reviewed the new recommendations applicable to their company, easyJet’s Board of Directors have stated in their Annual Report and Accounts for 2003, that they are in compliance with a vast majority of them (www.easyjet.com).
easyJet’s Annual Reports and Accounts for their year-end 30th September 2003, provide details of Corporate Governance application and compliance. The Board of Directors comprised six non-executive directors and two executive directors as at 30 September 2003 which satisfies the requirement that they should not be more executive directors than non-executive directors (www.fsa.gov.uk). The Chairman is one of the non-executive directors. Although easyJet complied with the provisions of the June 1998 Combined Code, there were two circumstances where it did not (www.easyjet.com).
-
One of the Remuneration Committee (Nick Hartley) was considered not to be wholly independent, as he had provided services to other companies in which Stelios Haji-Ioannou had an interest ().
- Certain Board members still have outstanding share options that do not have performance criteria attached to them. These share options were issued prior to easyJet’s admission to the Official List of the UK listing authority and easyJet no longer issues share options without performance criteria attached (www.easyjet.com).
Stelios Haji-Ioannou, easyJet’s founder resigned as Chairman and as a director on 26th November 2002 in order to abide by high standards of corporate governance as he was no longer considered to be an independent Chairman (www.easyjet.com).
4. LOOKING IN THE FUTURE
4.1 PEST analysis
PEST analysis is chosen, to look at the possible business environmental impacts that may affect the industry and easyJet. It can be used to infer a variety of trends, patterns and projections which will influence easyJet’s future strategic decisions (ACCA 2004). PEST analysis was chosen over SLEPT analysis as we found it difficult to differentiate between legal and political factors. The legal is subsumed into political. Consideration will be made to the political, economic, social and technological environments that may affect the industry and easyJet in the future.
Political Environment
The industry and easyJet must react to any regulations that are imposed by the political party and the corporate governance code. The EU compensation ruling that will take affect in 2005 is currently being challenged by easyJet as well as other airlines. If this challenge is unsuccessful then it would mean increases, in legal battles, compensation payouts and overall increases in costs. As a result, fare prices will increase and demand will fall. This would make it very difficult to see the future for the low-cost industry.
Expansion of the UK airport system will play a major role in the future of the airlines growth model. Stansted is expected to have one additional runway and terminal, increasing UK air traffic growth to 402 million by 2020, 501 million passengers by 2030 (Mintel report 2003). The government are seeing the benefits that the aviation industry can bring to the country. The question that remains to be answered is, for how long are the government willing to help the growth of the industry before they start to intervene? Any intervention from the government is likely to be costly in the future to the industry.
Economic Environment
The government may decide to impose taxes on the industry. A possible introduction of a ‘Green tax’, a tax on fuel to try and reduce the pollution that it causes, would increase the costs and as a result could raise easyJet’s fares by more than 20% (Financial Times, 1st November 2003). Also the £6 billion worth of subsidies that is currently received from the government may be reduced over time to limit the growth of the industry. The growth of the industry may need to be controlled to keep pollution to a minimum. As subsidies decrease there will be an adverse affect on fare prices causing demand to fall. This will also affect the business model as it would need to be revisited.
The recent rises in the UK interest rate, which currently stand at 4%, has increased the public’s liabilities. People have less disposable income and as a result are less likely to travel abroad. The increases will also affect easyJets’s loan repayments on its new order of aircrafts. At present, payments relating to the purchase are not included in the hedging policy and therefore will affect the liabilities of easyJet.
Social and Cultural environment
The UK population as a whole are aging, people are living longer. The number of people between the age of 25 and 34 has been decreasing but the age group between 55 and 64 are expected to increase from 2005 (Mintel report 2003). The older age group tends to have more disposable income (SAGA holidays target this group) and therefore should be targeted more by easyJet. Saying this, younger people who have less disposable income are now starting to go abroad for their holidays. This means that the airline industry is attracting more potential passengers because of their low fares.
Technological environment
easyJet’s use of the internet needs to be enhanced, they are aiming to become the first ‘web-only’ airline. Currently 92% of their tickets are sold online and improving this figure will bring cost saving which in turn could be passed on to the consumers. This will make easyJet more competitive on price. easyJet will need to keep track of technical developments in e-commerce and aircraft manufacturing in order to compete against its rivals.
4.2 Balance Scorecard
Kaplan and Norton (1992) balanced scorecard provides a comprehensive framework for translating a company’s objectives into performance measures. Thus balance scorecard enables us to look at the future goals of easyJet and measures required in order to meet these goals.
Figure 7: Balance Scorecard
6.4 Compensation
6.5 Eastern Europe/Ameri
4.3 Predictions
With the expansion of the European Union in May 2004 we expect easyJet to continue to connect its point-to-point network within these new member countries.
The EU and government intervention through the compensation ruling and subsidies could result in easyJet’s costs increasing. We would expect the EU not to back down from their ruling and as a result easyJet will find themselves tangled in legal battles. By 2010 we anticipate the government will introduce VAT on air fares and remove of the cap on airport charges. This will also increase costs and therefore the easy concept of ‘value for the masses’ could be under threat. Theses two possible interventions could threaten the low-cost industry but in comparison to the national flag carriers they will still remain cheaper.
Due to public pressure we expect easyJet to investigate possible ways of helping the environment. easyJet could introduce a cause related marketing scheme, whereby they would be trying to improve their reputation as being a caring airline. The objective would be to raise money for environmental charities. Possible ways of them instigating this would be by collecting foreign currency on flights or by promoting environmental schemes such as planting trees.
easyJet will need to continue to market their low-cost flights. They should be looking to target both the business and leisure travellers. This is because they are currently concentrating more on leisure travellers but the business travellers count for 50% of easyJet’s customers. We expect marketing to be increased on the internet as they are looking to be the first ‘Web-only’ airline. We anticipate that easyJet will become the first ‘Web-only’ airline by 2008.
By 2010 we expect the European low-cost airline industry and subsequently easyJet will be moving away from star stage of the BCG matrix and entering into the cash cow. We expect by 2010 the low-cost industry will have grown substantial leaving little room for further growth. As a result we expect easyJet to look into other markets. We suspect that easyJet may follow the route of Richard Branson, who is looking into the US for possible opportunities. It will not be possible for easyJet to expand themselves into the American airline industry due to legal issues. If easyJet expand into the low-cost industry in the US we suspect that they will be looking to become major shareholders in an exciting US airline.
easyJet remains in an enviable position to strengthen its market position and remain a viable competitor to challenge the other ‘low-cost’ and larger, more established airlines.
5. CONCLUSION
The low cost airlines have succeeded in revolutionising the European airline industry. In adopting the strategy of Southwest Airlines, easyJet has established itself as a most profitable and strong competitor in the European air passenger market.
It is very difficult to predict what the future holds for easyJet but we expect its growth strategy to continue. easyJet will continue with their strategy which supports the competitiveness and substantial growth:
- Simple fare structure – book early for low prices;
- Low unit costs;
- Strong branding;
- Multi base network – point-to-point services;
By 2010 we expect easyJet to be in the following position:
In 2004 and 2007 more countries will be entering the EU, as a result we feel easyJet will be looking to continue to connect their point-to-point routes. We feel that in order to enter these new member countries and to reduce potential competition easyJet will try to take over some of the smaller airlines that exist within the new member countries. We have seen that easyJet has taken over GO and were attempting to acquire Deutche BA. . This implies that easyJet are still looking for growth potential. If an airline with good routes becomes available we see easyJet trying to take it over. By 2010 we feel that the European market will be saturated and as a result we predict:
easyJet would be looking to get into new markets by 2010. We feel that the American market or the Asian market may be an option. Whichever market they may consider, the EU will not have any growth potential and as the entrepreneur Stelios is, likes to expand/grow, the only option would be to enter a new market.
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7. APPENDIX
Appendix 1: List of easy companies
Appendix 2: Growth of the internet since 1998
Appendix 3 : Financial Ratios - easyJet Plc vs. Ryanair Plc
Appendix 4 : Financial calculations of easyJet and Ryanair
easyJet calculations
Operating Profit Margin = Operating Profit / Turnover x 100
30/9/2003 = 47,120 / 931,845 x 100
30/9/2002 = 68,213 / 551,844 x 100
Net Profit Margin = PBT / Turnover x 100
30/9/2003 = 51,523 / 931,845 x 100
30/9/2002 = 71,577 / 551,844 x 100
Retained Profit Margin = Retained Profit / Turnover x 100
30/9/2003 = 32,402 / 931,845 x 100
30/9/2002 = 49,009 / 551,844 x 100
Shareholders Return on Capital Employed (ROCE) = PBT / Capital employed x 100
30/9/2003 = 51,523 / 866,652
30/9/2002 = 71,577 / 804,692
Earnings per share = Net profit / number of ordinary shares x 100
30/9/2003 = 32,402 / 393,165
30/9/2002 = 49,009 / 335,493
P/E Ratio = Share price / EPS
30/9/2003 = 217.43 / 8.24
30/9/2002 = 267.00 / 14.61
Interest cover = Net profit before interest and tax / Interest
30/9/2003 = 53,072 / 1,549
30/9/2002 = 76,805 / 5,228
Current ratio = Current assets / current liabilities
30/9/2003 = 476,969 / 260,925
30/9/2002 = 523,899 / 260,614
Gearing ratios = Total liability / Equity shareholders funds x 100
30/9/2003 = 7.483 + 108,191 / 758,461
30/9/2002 = 21,099 + 76,988 / 727,704
Ryanair calculations
For 12 months 1 Oct 2002 to 30 Sept 2003:
(1 Apr 2002 to 30 Mar 2003) – (1 Apr 2002 to 30 Sept 2002) = (1 Oct 2002 to 30 Mar 2003)
(1 Oct 2002 to 30 Mar 2003) + (1 Apr 2003 to 30 Sept 2003) = (1 Oct 2002 to 30 Sept 2003)
For 12 month 1 Oct 2002 to 30 Sept 2002:
(1 Apr 2001 to 30 Mar 2002) – (1 Apr 2001 to 30 Sept 2001) = (1 Oct 2001 to 30 Mar 2002)
(1 Oct 2001 to 30 Mar 2002) + (1 Apr 2002 to 30 Sept 2002) = (1 Oct 2001 to 30 Sept 2002)
Turnover
30/9/2003 = [ (842,508 – 464,589) + 596,374]
30/9/2002 = [ (624,050 – 344,227) + 464,589]
Operating Profit Margin = Operating Profit / Turnover x 100
30/9/2003 = { [ (263,474 – 167,495) + 196,386] / [ (842,508 – 464,589) + 596,374] } x 100
30/9/2002 = { [ (162,933 – 101,464) + 167,945] / [ (624,050 – 344,227) + 464,589] } x 100
Net Profit Margin = PBT / Turnover x 100
30/9/2003 = { [ (264,550 – 168,704) + 187,535] / [ (842,508 – 464,589) + 596,374] } x 100
30/9/2002 = { [ (172,374 – 102,881) + 168,704 / [ (624,050 – 344,227) + 464,589] } x 100
Retained Profit Margin = Retained Profit / Turnover x 100
30/9/2003 = { [ (239,398 – 150,946 ) + 168,941] / [ (842,508 – 464,589) + 596,374] } x 100
30/9/2002 = { [ (150,375 – 88,038) + 150,946] / [ (624,050 – 344,227) + 464,589] } x 100
Shareholders Return on Capital Employed (ROCE) = PBT / Capital employed x 100
30/9/2003 = { [ (264,550 – 168,704) + 187,535] / [ (2,089,168 – 1,779,003) + 2,422,911] } x 100
30/9/2002 = { [ (172,374 – 102,881) + 168,704] / [ (1,581,380 – 1,155,031) + 1,779,003] } x 100
Earnings per share = Net profit / number of ordinary shares x 100
30/9/2003 = { [ (239,398 – 150,946) + 168,941] / [ (755,055 – 755,031) + 756,341] }
30/9/2002 = { [ (150,375 – 88,038) + 150,946] / [ (728,726 – 724,196) + 755,031] }
To convert the EPS from € to £ use the exchange rate as at 30 September 2003 ()
34.03 / 1.426687 = 23.85p
28.08 / 1.426687 = 19.68p
P/E Ratio = Share price / EPS
30/9/2003 = 5.70 / 0.3403
30/9/2002 = 5.65 / 0.2808
Interest cover = Net profit before interest and tax / Interest
30/9/2003 = { [ (295,436 – 182,758 + 210,338] / [ (30,886 – 14,054) + 22,803] }
30/9/2002 = { [ (191,983 – 111,586) + 182,758] / [ ( 19,609 – 9,151) + 14,054] }
Current ratio = Current assets / current liabilities
30/9/2003 = { [ (1,114,346 – 1,007,084) + 1,214,964] / [ (377,539 – 353,239) + 420,565] }
30/9/2002 = { [ (937,766 – 748,451) + 1,077,804] / [ (308,192 – 234,955) + 353,239] }
Gearing ratios = Total liability / Equity shareholders funds x 100
30/9/2003 = { [ (848,756 – 636,515) + 1,008,389] / [ (1,241,728 – 1,153,220) + 1,415,524] } x100
30/9/2002 = { [ (584,611 - 404,725] + 636,515] / [ ( 1,002,274 – 758,054) + 1,153,220] } x 100