Low-cost, low-price service: the secret of low-cost airlines’ success
The secret of low-cost airlines’ success is that they concentrate on low-cost, low-price service and every aspect of the firm is focused on this goal. In an oligopoly aviation market, McCartney (2007) points out that the best strategy for the newcomers is to identify a segment of the market and then shape the firm to fit that segment in order to compete with established airlines. Based on this strategy, a few newcomers in aviation industry, such as Southwest Airline, provided low-price, no-frills airline flight to customers who fly relatively short distances after deregulation. Following will take Southwest Airline (McCartney, 2007) for example to analyze the cost structure of low-cost airlines because the cost can influence airlines’ revenue and profitability directly.
- Operating cost
In aviation industry, operating cost (Productivity Commission, 1998) accounts for a significant proportion of total cost. Thus it influences the airlines’ ability to operate efficiently and increase the revenue. For example, Southwest Airline (McCartney, 2007) provides low-price, no-frills airline fight, that is there is no first-class or business sections—only coach seats are available in Southwest’s plane. Furthermore, Southwest’s planes land on the secondary airports between midsize cities, thus it can avoid the delays at the congested airports. In term of frequency, Southwest is able to keep its planes at the airport gate for only 15 minutes which is much less times than other airlines. Because of less time at airport, it allows Southwest lower its costs by keeping its planes in the air longer and to provide more flights with fewer planes. Southwest also lowers costs through not assigning passengers to particular seats, not offering meals, and not checking luggage. Consequently, providing “no-frills” airline service and frequent flight reduce the operating cost and increase the budget airlines’ revenue.
2. Labor cost
The advantage of lower labor cost is striking in budget airlines (The Economist, 2004). For instance, Southwest (The Economist, 2004) needs only 80 workers to fly and support each plane rather than 115 or more at traditional established airlines through flexible working policy and the wage of workers is lower than the average of established airlines. In addition, flight attendants work in multiple roles, they are not only cleaning the plane but so work as gate agents. Thus, budget airlines can reduce labor cost through flexible working conditions and a wage structure.
3. Input cost
After deregulation, some newcomers having nothing to lose choose the low-cost, low-price strategy to compete with the established airlines (Robertson and Ward, 1983). Southwest airline (Wikepedia, 2010), for instance, just used the single type of plane that can reduce the maintenance cost, and training and servicing costs. What’s more, low-cost airline minimize the optional equipments, such as entertainment systems, seat recliners, seat pockets and so on. Eliminating these optional equipments further reduce cost of acquisition and maintenance, as well as keeping the weight of the plan lower and thus saving fuel.
Based on analyzing the cost structure of budget airlines, minimization of cost plays an significant role in survived in increased competition even keep gaining profit steady. With increasing price competition, budget airlines increase revenue through the low-cost, low-price service rather than irrational price war by big established airlines.
Established airlines’ mistake: overestimate the advantage of price strategies
At the beginning of deregulation, established airlines noted that the newcomers would threaten their profit and shared their market, and they actively took a serial of measures to drive competitors out of business.
- Non-price competition
The most significant measure of established airlines is the development of computer reservation systems (CRSs), hub and spoke flight networks, and frequent flier programs (Harvard Business School, 1994). Additional, established airlines brought a lot of new planes to expand the new market. The purpose of these measures is reinforcing the barriers to entry and increasing the firm’s demand and revenue.
2．Yield management
Established airlines practice price discrimination on fares as a method of yield management. Yield management (Hubbard and O’Brien, 2008) refers to adjusting prices to take into account fluctuations in demand. The advantages of yield management are earning a higher revenue, and able to drive competitors out of business, Sloman and Norris (2005) claims that established airlines used their high priced ticket to break into another market and withstand a possible price war.
However, the measures above are seems to the disadvantages of the established airlines, especially in recession and war, and ignore the cost control. Firstly, expanding aggressively not only increases the fixed costs and maintenance costs of established airlines, but also losses the market. Under the increased competition, established airlines overestimate the advantage of the newer and larger systems and equipments, but this advantage is cost-efficient only when passengers are full ; which they have not been often enough (The Economist, 2004). Secondly, many established airlines relied on increased revenues generated from yield management to meet increased competition and their high fixed costs, rather than try to cut costs and raise productivity after deregulation (The Economist, 2004). It is not sensible to withstand price war if the established airlines are not focusing on cost control. Established airlines are vulnerable in the price war, because price has limited leverage since competitors almost always match it in an oligopolistic market.
Unfortunately, it is very difficult for big established airlines, such as American and United, to compete with low-cost airlines and copy their business model, such as Southwest and Jetstar. Because big established airlines just rely on increased the revenue generated from irrational lowered fares but not provide low-cost, low-price service after deregulation. After the heavy losses, the predicament promoted established airlines to seek other ways of achieving as same benefits as before.
Merging: the only path to profitability or work in vain?
With increased competition with low-cost airline by price war, established airlines’ profit turns to larger losses. In addition, established airlines are confronted with increasing price of fuel and recession. Considering their recent dismal track record, established airlines realize that yield management, newer and larger systems and equipments, and price war do not work anymore. The predicament promotes established airlines to seek other ways of saving cost and achieving as same benefits as before (Productivity Commission, 1998). Airline merging has grown in recent years, it is proposed as the path to profitability for established airlines.
- The benefits of merging
The purpose of airline merging is minimizing airline costs and extending market thus increasing profitability. The merging of two airlines, for example, allow them reduce or eliminate overlapped operating cost, such as overlapped cost of service and labor, so that achieve saving costs. It would also represent a remarkable financial turnaround after US Airway absorbing America West, which survived two bankruptcies due to the terrorist attacks and increased competition (Schlossberg, 2006); Furthermore, merging is able to extend network and enhance their competitiveness thus increasing market share and providing more service to passengers. Consequently, lower costs and increased revenue through merging improve the financial condition of established airlines.
2．Challenges of merging
It seems that merging is a path to profitability through lower costs and increased revenue; however, the further of merging among airlines is full of challenges and uncertainty.
The significant challenge of alliance is the degree of synergies between the airlines. Firstly merging may not be able to achieve as the same level revenue and the same saving costs as before integration at actual. One of the reasons of merging is stopping losing in profit between airlines. If both of the airlines combine simply not a deeper integration, it dose not improve saving cost and increased revenue, but lead to more serious financial situation (Productivity Commission, 1998). Secondary, there is different culture class between the two airlines. Sakakeeny (2010) states that Continental’s staffs had their pensions and benefits when the airline bankrupted while United’s didn’t.
Furthermore, the merging will be not probably successful, and there are many bumps along the way because the negotiations of merging are costly, wide ranging and complex. Merging is involved lots of cost, such as the costs of negotiating and managing the alliance, monitoring the performance and benefits of the alliance partner, and spend a long time to finish. Because of different agreements and benefits, the merging will probably fail during negotiations (Productivity Commission, 1998).
With the growth of airline mergers with America and international, another challenge is the intense antitrust scrutiny (The Economist, 2003).
Conclusion
After deregulation for aviation industry, established airlines gained the initiative through their economic capabilities and yield management. However, with the increasing competition between the established airlines and budget airlines, established airlines’ profit turned to large losses while low-cost airlines not only survived from competing but also kept profit steady. The reasons of such different situation are that the established airlines focused irrational price strategy in competition rather than cost management. In contrast, budget airlines concentrate on low-cost, low-price service. After the heavy losses, the predicament promoted established airlines to seek other ways of achieving as same benefits as before. Merging is proposed as a path to profitability. Actually, merging help established airlines to minimize airline costs and extending market thus increasing profitability. Nevertheless, merging is confronted with some challenges, such as the degree of synergies, costly and complex negotiations, and the intense antitrust scrutiny.
According to the briefing paper, it recommends that low-cost airlines not only continue to provide low-cost, low price service, but also pay attention to safety and develop stronger brand. In addition, established airlines should find more strategies to profitability. For example, Qantas established a separate airline-Jestar to meet increasing competition with Virgin Blue.
References:
Sloman, Norris, 2005, “Principles of Microeconomics”, Pearson Education Australia
Hubbard, O’Brien, 2008，“Microeconomics (Second Edition)”, Pearson Prentice Hall.
Scott McCartney, February 6 2007, “A Report Card on the Nation’s Airlines”, Wall Street Journal, p.D1
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May 11 1994, “American Airlines’ Value Pricing (A)”, Harvard Business School
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Sean O’Neill., April 15, 2008. Airlines Merging-what it means for you at: http://www.msnbc.msn.com/id/24128795/ns/travel-tips/ [Accessed 12 May 2010].
Editorial., May 8, 2010. Why Merge at: http://www.nytimes.com/2010/05/09/opinion/09sun2.html?scp=3&sq=airlines%20merge&st=cse [Accessed 20 May 2010].
Wikipedia., May 20, 2010. Low-cost carrier at: http://en.wikipedia.org/wiki/Low-cost_carrier [Accessed 20 May 2010]
Kalleel Sakakeeny., May 3, 2010. When an Airline Merger Isn’t Marriage at: http://technorati.com/lifestyle/travel/article/when-an-airline-merger-isnt-a/ [Accessed 20 May 2010]
