Ryanair - Its vulnerability and exposure to the macroeconomic environment

University Degree Business and Administrative studies

Ryanair: Its vulnerability and exposure to the macroeconomic environment

Business vulnerability is a measure of how susceptible an organization is to external events and the possible consequential impact on its business costs and profits. In this essay, I will assess the vulnerability of Ryanair and its degree of expose to macroeconomic shocks. I will also analyse Ryanair’s performance since 2000 in comparison to its rival BA, as well as their strategies in how effective they are in raising profits and minimizing their exposure.

Ryanair is a low cost Irish airline and one of the most profitable in the airline industry. However, it can be seen as vulnerable and exposed to macroeconomic shocks. To a degree this is due to Ireland’s openness. Desmond Gillmor describes it as “one of the most open of economies,” and “because of this high degree of openness, the economy is strongly influenced by the external conditions prevailing in the international economic system.” (Gillmor 1985, p.5)

The airline industry in which Ryanair operates is fairly elastic as shown below.

(Knight, B. 2006, p. 14)

From the graph, one can see that if the GDP increases or decreases by 1 per cent, the demand for air travel will increase or decrease by 1.7 per cent: air travel and Ryanair is fairly exposed.

A firm’s average total cost curve (shown below) and the steepness of it can express the firm’s vulnerability. The steepness of the curve is mainly determined by the scale of fixed costs and as a result, those firms will experience more volatility in their financial performance. In addition, increasing returns to labour which is particularly found in professional services also impacts on the gradient. Furthermore, firms which are dependent on external inputs, for example, in construction, are vulnerable to shifts in the curve due to increases in the costs of their inputs.

The ‘flute’ curve shown above reinforces the vulnerability of Ryanair due to its steepness. This can be explained by high fixed costs such as a large number of fleet and the heavy dependency on external inputs such as fuel. The graph below shows that since 2003 Ryanair has more than doubled their fleet to 163 aircraft.

(Ryanair, 2008, p. 3)

The latest Chairman’s Report released by Ryanair reports on the effect of fuel prices: “The high and rising price of fuel is of major concern to Ryanair and the entire aviation industry. Last year our hedging programme delivered fuel at an average cost of $65 per barrel. Today we are facing prices of approximately $130 a barrel. Ryanair has responded to these higher oil prices by reducing costs across all other areas.” (Ryanair, 2008, p. 4) They are also exposed to fluctuations in foreign exchange rates, the extent to which they made a loss of over €5m due to changes in the American dollar and British Sterling exchange rates against the euro. This exposure can be minimized by hedging with financial derivatives.

Even though Ryanair incur costs that they have little control over such as fuel, “there are others that will influence the costs per seat-km flown that they can influence. These include aircraft utilisation, aircraft turnround times, seat pitch, the use of fewer crew and cheaper secondary airports, along with direct selling and paperless ticketing.” (Pitfield, D. E. 2007, p. 77) These factors all form a part of Ryanair’s strategy to penetrate the market further and reduce its vulnerability by exploiting market imperfections.

“Ryanair has responded to these higher oil prices by reducing costs across all other areas. A ...

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“Ryanair has responded to these higher oil prices by reducing costs across all other areas. A company wide pay freeze was implemented and redundancies have been suffered at our Dublin call centre. Significant cost reductions have also been achieved on airport, maintenance, and handling contracts, and we will benefit from the addition to our fleet of cheaper and more fuel efficient aircraft. We have also increased our charges for baggage and airport check-in as we continue to encourage passengers to avail of web check-in and travel with carry on luggage only.” (Ryanair, 2008, p. 4) They have even gone as far as planning to close down their check-in desks and the possibility of charging passengers to use the on-flight toilet facilities.

Source: Ryanair Annual Reports

Ryanair is one of the largest airlines in terms of passenger numbers (REF) and has continuously grown in size and value over time as shown above. The extent of such an expanding firm is conveyed over the last eight years as Ryanair’s profits have more than quadrupled. However, there have been drops in profits in 2004 and 2008. In 2004, the airline was hugely affected by the conflicts in Iraq, the renewed threat of terrorism and endless increasing oil prices. However, in this same period, Ryanair managed to launch new bases in Rome and Barcelona, launch 73 new routes, takeover their competitor Buzz for a knock-down price and carry more passengers than BA in the European market. The reason for the decrease in profits in 2008 was due to increases in fuel prices and significantly increased airport charges, particularly at their largest bases at Stansted and Dublin.

British Airways, a competitor to Ryanair, has reviewed its short-haul operations and is planning to spend a portion of its marketing budget promoting shorter haul flights. However, they believe that services such as in-flight refreshments and business class seats are expected by their customers, and intend not to cut back on these services but focus on this differentiation and thereby create market imperfections.

In the journal article titled “Easyjet and Ryanair flying high on the Southwest model”, Chris Avery, an analyst at JP Morgan, believes that the answer to the threats from low cost airlines by BA has been perfect. They acknowledged that they were no longer the public’s favored provider and have taken measures to, not only, protect their primary market, but also to learn from their rivals. With BA’s key financial figures reported in British pounds and Ryanair’s in Euros in their respective annual reports, there is difficulty in comparing them. Nevertheless, I will look at other key statistics.

(Ryanair, 2008, p. 6)

Looking at the figures above, one can see that Ryanair charges passengers considerably lower, including no fuel surcharge. This is one for Ryanair’s USP and such low costs form a barrier for new entrants.

(Ryanair, 2008, p. 7)

With regards to consumer satisfaction, Ryanair’s service is greater than that provided by BA.

Source: Mintel

From above, one can see that Ryanair have the second largest number of active aircraft behind BA. Nevertheless, if the average age of the fleet is taken into account, Ryanair has one of the largest young fleet.

However, one can’t disregard the different sizes of the two firms. Since British Airways is a larger firm compared to Ryanair and offers different services, as well as owning a larger fleet of aircrafts, it may be more greatly exposed to the external environment.

To be able to manage these uncontrollable external shocks, Ryanair needs to reduce its vulnerability and exposure to the market. To do this, its total cost curve needs to become gentler (and like a ‘saucer’ as shown on page 2). This can be explained by reducing the airline’s fixed costs and that a downturn in demand will cause profits to fall but not as much as previously. Also, with the average fare being €22 cheaper than its local rival Easyjet (see page 5), Ryanair could raise their price and still retain their customers.

Ryanair operates in an oligopoly:

Above the kink, the demand is relatively elastic as all other firm’s prices remain unchanged. However, below the kink, demand is relatively inelastic because all the competitors will introduce a similar price cut which would eventually lead to a price war. Consequently, the optimal output is that at the kink. Ryanair have decided to offer “all passengers on all routes their lowest fare guarantee. On those very rare occasions when passengers find a lower promotional fare on a competitor airline for a similar itinerary then we will happily refund them double the difference.” (Ryanair, 2008, p. 6) This ensures customers, especially in a downturn were consumers are looking for the cheapest prices.

Consequently, if Ryanair want to achieve supernormal profits, they need to erect barriers to entry and make the airline industry non-contestable. Such barriers can be placed by enhancing Ryanair’s current supply chain. For example “by solely operating Boeing 737 jets Ryanair can keep training, maintenance and operating costs in check. In January 2003 a massive order for 100 of the latest 737-800 variants worth $6 billion was announced in response to the airline’s escalating success.” (Anon. 2004, p. 5-6) This is unlike its competitors who have more than one type of aircraft.

Also, they could try and offshore the administrative side of the organisation to reduce their costs, as well as invest less in advertisement and try to offer more services to compete against BA’s new proposed plan and to differentiate themselves further. Such differentiating ideas include launching a new all-frills airline for flights to USA. Furthermore, since Ryanair has received previous criticism, they could strengthen the barriers by investing in the brand. Their competitors are forced to incur the same costs to build their brands to contest the industry, as well as new entrants. This reduces market contestability and enhances profits. If they fail, this sunk cost can’t be recouped.

London to Genoa (GOA), Hamburg (HAM), Pisa (PSA), Stockholm, and Venice.

(Pitfield, D. E. 2007, p. 78)

The table above shows the market share achieved by Ryanair in 2003, in the first month and year of operation. “There seems to be a difference between the Italian destinations and the other two. However, the Venice route also looks closer in character to the other northern European destinations in that although the initial market penetration is good, it does not grow as rapidly as GOA or PSA. This is almost certainly because of the competition offered by easyJet from STN to VCE. It seems that where competition is less and a dominant market role is achieved, large market shares can be achieved. The resulting market share is less if there is more competition.” (Pitfield, D. E. 2007, p. 79)

Consequently, to mediate this threat against opposition, Ryanair could analyse their current routes and maybe switch from more competitive routes to those that are currently non-existent, for example, Norway.

Finally, to increase its market share, Ryanair could seek to takeover a competitor. Having successfully taken over Buzz in 2003, Ryanair have mixed experiences with this strategy with two unsuccessful attempts to takeover Aer Lingus in 2006 and 2008. In the latter case, the approach was rejected due to valuation and competition grounds: “an aviation monopoly would not have been in the best interests of Irish consumers.”

References

Anon. (2004) Industrious times at British Airways and Ryanair: Winning the battle for the skies. Strategic Direction. 20 (4), 4-6.

Anon. (2006) Easyjet and Ryanair flying high on the Southwest model. Strategic Direction. 22 (6), 18-21.

BBC News. (2009a). Ryanair to abolish check-in desks. [Online]. Available at: http://news.bbc.co.uk/1/hi/business/7903656.stm [Accessed 15 April 2009]

BBC News. (2009b). Ryanair mulls charge for toilets. [Online]. Available at: http://news.bbc.co.uk/1/hi/business/7914542.stm [Accessed 15 April 2009]

BBC News. (2009c). Ryanair launches new Norway route. [Online]. Available at: http://news.bbc.co.uk/1/hi/scotland/edinburgh_and_east/8024769.stm [Accessed 15 April 2009]

Black, F. (2007) O'Leary plans new all-frills airline for flights to US. Independent.ie, [Online] Available at: http://www.independent.ie/national-news/oleary-plans-new-allfrills-airline-for-flights-to-us-43198.html [Accessed 15 April 2009]

Gillmor, D. (1985) Economic Activities in the Republic of Ireland: A Geographical Perspective. Dublin: Gill and Macmillan Ltd.

IATA (2007) Scheduled Passengers Carried. [Online] Available at: http://www.iata.org/ps/publications/wats-passenger-carried.htm [Accessed 15 April 2009]

Knight, B. (2006) EC1310 Topic 5.

Pitfield, D. E. (2007) Ryanair’s Impact on Airline Market Share from the London Area Airports: A Time Series Analysis. Journal of Transport Economics and Policy. 41 (1) Jan 07, 75–92.

Reuters UK. (2009). UPDATE 4-Ryanair concedes defeat in Aer Lingus bid. [Online]. Available at: http://uk.reuters.com/article/rbssIndustryMaterialsUtilitiesNews/idUKLM15889320090122?=undefined&sp=true [Accessed 15 April 2009]

Ryanair. (2008) Annual Report 2008. [Online] Available at: http://www.ryanair.com/site/EN/about.php?page=Invest&sec=download&ref=2008 [Accessed 10 April 2009]

BBC News. (2009a)

BBC News. (2009b)

Black, F. (2007)

BBC News. (2009c)

Reuters UK. (2009)