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Low-cost Carrier: Other Margins?

Mon Dec 17, 2001 10:44 pm

Ok, probably rather not interesting for most, but anyway: I want to know just why do low-cost carrier such as Ryanair not only survive but are profitable in the long-term term.
Yes, ok, because they are low-cost, good, but that's not the whole truth. There are fixed costs that are just not reducable:
1. Aircraft: Acquisition and maintenance, or leasing and maintenance. Do low-cost carriers prefer to lease or to buy? (with all well-known consequences). Is maintenance out-sourced, and if yes, are these companies really cheaper than i.e. Lufthansa Technik doing it for LH equipment, if they are situated in Germany?
2. Staff: I hear Ryanair crews do get paid quite handsomely, so it must be ground staff, that's low-cost, and not too many of them.
1. Low airfares, lots of promotion prices, that indicate their load factor is not 100%. There's no way to increase in order to keep away from the non-low-cost carriers. You can increase the frequency only as long as earnings of the additional flight are above variable cost. Do they work on low margins and high numbers of pax?
2. Choosing only highly-frequented routes. Right, not-so-profitable services are a problem for the Big boys, that's why they set up Alliances /Code shares etc.
Longhaul services are obviously not relevant for the low-costs, also they are not able to do feeding service for other longhaul services, because they use other, cheaper airports.
Now I wonder: Is that it? Is this basically the secret of their success? What would be your risk assessment for such a company?

Thanks upfront
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RE: Low-cost Carrier: Other Margins?

Mon Dec 17, 2001 10:49 pm

It generally comes down to very high utilisation of the aircraft and high load factors; as well as much lower costs as a result of no interlining, no free meals, no FFP, little advertising cost, no distribution costs (ie BSP, ICH etc). They make money out of commissions from hotel bookings and car rentals as well as selling on board catering, gifts and tax free items.

All of their services - ground handling, maintenance, training etc are outsourced.

As you say, margins are low and volumes are high. As Freddie Laker used to say "bums on seats!"
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RE: Low-cost Carrier: Other Margins?

Mon Dec 17, 2001 11:03 pm

Actually they even get money for selling the food abord the aircraft. Ryanair also get money by selling advertising space on their airplanes (Jaguar, Sun Magazine, Kilkenny, etc...)

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RE: Low-cost Carrier: Other Margins?

Mon Dec 17, 2001 11:10 pm

Ryanairs success is down to obsessive cost control, and excellent negociations with service providors; alongside yield management and 'extra charges'.

All Ryanair staff are working at 110%, so are the assets, where they pay for any... The FR head office in DUB is rent free, same with Brussels. They are paying little or no landing charges at their outstation airports, and focus cities, such as PIK, CRL and HHN are low cost outfits. They also have Boeing charging them less than others!

Every year Ryanair strips more and more variable costs from the business, this year commissions, and GDS fees. Last year... Call Centre, ticketing.

However, Michael O'Leary is a bit excessive on cost cutting. Gone this year is the christmas party, mobile phones and expensing hotel bills on foreign travel (staff have to pay for hotels themselves - yes you heard me right!).

On the fare side, yes the fare is cheap.. and when its too good to be true.. it usually is.. there are lots of additional charges...

Airport taxes... much higher than they really are in reality - designed to make the fare lower.
£4 credit card fee
15kg luggage (+£4 stg per kilo over this)

£2.50 coffee
£4 sandwich

Ryanair is the only true 'low cost' carrier in Europe. Go and EasyJet still have 'frills' attached, but will be eventually as low cost as Ryanair.

Buzz is a full cost carrier charging low fares, and has probably only six months left in it - unless France works out successfully. (if they can't make money flying into Linate (now Europes most capacity restricted airport - they cant make money in france)
You are 100 times more likely to catch a cold on a flight than an average person!
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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 12:22 am

Bestwester, I 100% agree with your conclusion expecially about the Buzz future. Also AZ is very profitable on the 3 daily LIN-London and if Buzz couldn't make money in a restricted city airport in a so rich financial city like Milan, no way to survive (except if KLM make an huge recapitalization).

I want to add that in my opinion only Easyjet really follows the Southwest model here in Europe, cause GO and FR have a different approch to the low-cost market.
FR is something new and more modern than the Southwest model.
It's interesting to see if the FR model will be better than the 30 years old Southwest successful story.
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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 2:09 am

Ryanairs costs have to be far lower than either EZY or GO as FR's load Factors are lower... about 8% lower on average.
You are 100 times more likely to catch a cold on a flight than an average person!
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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 5:12 am

Andreas, maybe stupid to say it to you but haven't you looked into easyJets or Ryanairs annual report and/or website? Moreover, there's an excellent report about the economics of low cost airlines in Europe from either Merrill Lynch or UBS. They're probably your competitors but if I'm not mistaken it can be found on Bloomberg for free.

As for aircraft they own them allthough I've been told that they do have special "arrangements" for the aircraft (and off course the odd public offering). Anyway easyJet outsources as much as possible and thus reduce costs.

easyJet reduces distribution costs by forcing you to buy on the internet (currently 90% of all tickets are sold over the internet). Loadfactor is approx. 85% on average.

As for fares. I guess their yield isn't bad on certain routes. AMS-LON is full of business pax and they don't pay the rock bottom fares (allthough less than flying on KL, BD or BA). Moreover it seems as if they have very highly sophisticated yield systems in place to get the most out of every seat.

As for their secret to their succes: their yield system and ability to control costs.

BTW Bestwestern, I don't agree that easyJet will follow Ryanair is all its cost cutting. For one easyJet will always focus on a premier airport (like LGW, AMS, BCN, MAD or NCE) and not an airport x miles away from the actual city. In my view this is something which may cause some serious problems in the future for FR.


RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 5:12 am

Another factor is flexibility in work-rules. Southwest made a deal with its workers early in its history by offering them profit-sharing in exchange for not having the stringent rules in place at unionised mainline carriers.

Therefore, everybody at Southwest and other low-cost carriers is expected to work as a team to ensure punctuality and profitability, even if it means that the pilots help clean the cabin during a turnaround -- something that would probably never been seen on a mainline carrier.

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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 5:31 am


One argument always used here in Brazil, where we have a low-cost carrier which is GOL Linhas Aéreas Inteligentes, is that low-cost airlines beat "majors" because they are indebtedness-free. VARIG, TransBrasil, VASP and even TAM, they all have huge debts and hence need to always reserve some cash from the profits and/or charge price surpluses in order to pay debts and the interest rates above them.

As for the rest, GOL is flying some marginal routes (services to Belém, Goiânia, Campo Grande, Cuiabá and Macapá for instance) as well and not just premium cities such São Paulo, Rio de Janeiro, Brasília, Porto Alegre, Belo Horizonte and I can't believe their cost control is superior to any major airline such TAM or VARIG. No way! At least, equal. I can't call TAM or VARIG incompetent airlines!

Anyway, this low-cost emergence around the world is still unexplained at detail for me and I share Andreas doubts and intrigations about it...

Hope to have helped,

TP343, São Paulo, Brazil.
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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 6:07 am

Remember folks that the only true difference between low-fare carriers and majors are the expenses the company has to deal with. Keep cost low, and you can make it on low proifits, and you will be killing the competition as well.

100% load factor is never desired. You want between 80-95%. Once it gets over 95 you are overbooking too many flights, and upsetting too many passengers.

As far as leasing vs buying, its best to buy if you are a low cost carrier. Up front cost is greater, but you have no long-term debt and no accumulating liabilities, plus you have some retail vailue left. Thats why America West is about ready to go out of business. They lease all of their aircraft, and since they can't fly all of them, they're not getting the revenue, and they're still paying the leases...and no capital from them on top of it all.
Southwest owns the highest percentage of their fleet of any US carrier. That means lower operating costs, and huge flexibility during times like this.
If you are going to lease, you need to look into the two different types..Capital and operating leases. Capital leases tend to be cheaper in the long run, but count as long-term debt on the balance sheet. Operating leases count as a current liability, but tend to cost more in the long term. Remember thought, that any lease (besides some special deals) will leave you paying at least the cost of the aircraft after so many years, and no aircraft.

As for outsourcing Mx, it raises costs. The more you do on your own, the lower the long-term cost. Just think of the days when the steel mills bought every company they bought supplies from...cost went down. Same applies with the airlines. Run your own Mx, buy your own aircraft, don't outgrow yourself, and most importantly realize that all your company is, is a group of people. Without those people, the airline is a name on paper, so treat those people well. Remember those, and you've got a great start to a low-cost carrier.

(Can you tell I've done some thinking on this?)

RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 6:19 am

Miller22 - have to disagree with you on some of your points. WIth the European low cost carriers, all fares are non refundable; and if you don't show, you lose your money. They therefore don't have a no-show problem.

All of the low cost carriers here lease: it gives them plenty of flexibility. They buy, but then immediately refinance. It also keeps the liabilities off balance sheet, which is important for them. Another major advantage is that they can contract for fleet renewals, so that they get their aircraft swapped out every few years - without having to take the financial risk that the market will be bouyant at the time.

As for outsourcing, again you're wrong - as a buyer in a buyer's market, you can shop around for the best deals and get them for a fraction of the cost of having to set up and run MX and other services. Over here, most airlines have realised that having MX inhouse is simply a waste of money - which is why people like FLS, Marshalls etc are around. Through outsourcing, MX costs are reduced because they are spread amongst many more aircraft than they would be if it was an inhouse function.

Other than that, I agree with you! Big grin Big grin
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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 7:43 pm

Mx outsourcing is cost effective only if you have a small fleet. However it still stands that the cheapest way is to have a fleet large enough to require your own Mx department. If you only have one type of aircraft in your fleet, Mx costs plummet and it becomes even more feasible to run your own Mx.

Regardless of whether tickets are refundable or not, 100% load factor is not preferred. Unless you don't overbook a single flight, in which case you're losing valuable revenue, you'll be causing problems. Also standby travel is a boost to the airline itself. Not to mention employee travel. They're much happier if there's a seat left for them.

The best of the best low-cost carriers in the US buy aircraft. Operating cost is simply the lowest, and you get a nice return on investment that you don't get by leasing.

Of course if you're operating a small carrier these go out the window. However don't forget that Airlines are oligopolies and on of the characteristics of an oligopoly are economies of scale. The bigger the cheaper.
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RE: Low-cost Carrier: Other Margins?

Tue Dec 18, 2001 7:56 pm

A yield managed 100% load factor is an airlines dream! On average, 5% of leisure passengers don't turn up for flights, and 25% of business passengers never show up either.

Not necessarily true about oligopolies and airlines.

Back to basic Economies of scale... they work until a limit when to add extra capacity or complexity costs a lot more money, driving unit costs up.

Take the airport industry.. An empty airport with underused terminal space and runway capacity has little fixed costs involved in attracting a low cost carrier at low rates (take Brussels Charleroi for example). Every additional passenger costs them little of nothing to put through the airport... until they have to invest capital to increase capacity. Every additional passenger over the maximum capacity has a far higer cost involved.

Good example of this is Dublin, which had an underused terminal, and it made sense to charge 99p per passenger to get maximum utilization out of the assets. When time came to extend... the costs per new passenger rose to cover extension costs. And The airport could not afford to grant discounts of this extent.

Im in Madrid Airport at the moment.. talking about a badly run state monopoly if I ever saw one... this apparantly this place is slot controlled to protect the Iberia Monopoly.

You are 100 times more likely to catch a cold on a flight than an average person!
Topic Author
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Gentlemen, Thanks To All Of You!...

Wed Dec 19, 2001 12:16 am

..First of all I'm amazed about all the infos coming in and the picture is a lot clearer now. Obviously it is some sort of mixture of all aspects, that I suspected would be part of the story. I found it rather plausible that there is no "single secret of the success", which I would have doubted anyway.
Lj: Thanks for the advice, I sent an email to our research in LON to find that report for me. As for the financial statements: well, in my experience these are of no use for me in order to find out cost structures, pricings and margins except overall earnings margins like EBITDA and EBIT and so on, which are not that interesting for me. I'm rather trying to get the picture as a whole (no, fortunately no transaction in that sector right now *ggg*).
Bestwestern: Your comment on Ryanair's cost-cutting and pricing policy was quite instructive, I thought so, and it definitely fits into the overall-picture.
TP343: I still have my doubts, currently it seems to work, but it will be quite interesting to see if those nice-weather managers are able to handle their ship in foul weather (that's a German saying, I hope you get the picture).
Mcdougald: You're basically right but: Pilots on Laudaair were do/did have to clean the cabin or at least the cockpit (even Niki Lauda himself did it, though in front of some TV cameras *ggg*).
Ceilidh and Miller22: Though you disagree, nevertheless instructive for me, I'll just have to look up in that report Lj mentioned if there is that "one policy for all". I have to admit though that Ceilidh's point seems more convincing.
Airblue and Vtual: Thanks!
Nice evening to everybody
I know it's only VfB but I like it!
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RE: Low-cost Carrier: Other Margins?

Wed Dec 19, 2001 1:44 am

Unless one has experienced the workings of a "full-service" major airline from the inside, it is impossible IMO to grasp the inordinate amount of time (i.e., cost) that is expended in offering "with frills" service to customers who, for the most part, respond by expecting even more than what is offered -- for the same fare available from low-cost, low/no frills airlines.

Even in the best of times, profit margins for the full-service majors are razor thin. The added costs incurred by full-service airlines in attempting to appease customers with promises like "for the same price you get more" virtually guarantees that profits will be earned only in the very best of times and equalled or exceeded by losses the rest of the time. Record profits are followed by record losses with the result that the traditional major airlines are constantly in a hurry about going nowhere over the long term.

At the same time, airlines like Southwest and Ryanair have emerged with the highest market capital values of the airlines in their respective continents. When last checked recently, Southwest was worth more than the six largest U.S. majors combined while Ryanair had overtaken Lufthansa (the best-managed European full-service major IMO) for the highest market cap value in Europe.

The smart money is telling us (by its willingness to put its $$$ where its mouth is) that the low-cost, no/low frills carriers are on to something while the "full-service" majors on both sides of the pond need to wake up and face the real world as described by the title of a USA Today article that appeared less than one month before 9/11:

"Air Passengers Picking Price Over Perks"

If that was true before 9/11 (and it most certainly was true then) it is all the more true now and in the forseeable future. Air pax may talk the talk of demanding the perks that represent "the way it has always been done" but when walking the walk of giving their credit card info for ticket purchases, it's about getting from point A to point B in hours instead of days for the lowest cost.

As I shared in a letter to Southwest earlier this year, the basis for their consistent and unparalleled success in the airline industry in the areas of profitibility, employee morale, and customer satisfaction may be as much about what they don't do as in what they do.

From my inside perspective, one of the leading reasons the U.S. full-service majors are their own worst enemies is in their insistence on incurring the inordinate cost of providing frills that frequently result in overpromising and undelivering while wiping out profit margins in all but the best of times in the post-deregulation marketplace where price has become paramount. In the process, it also seems that more cynicism is created than satisfaction among the many customers whose unrealistic expectations (created by smoke and mirrors marketing of the full-service airlines) frequently go unmet.

All of which makes a huge difference on the bottom lines of airlines in the short term and even more so over the long term.

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