Capsim CT3- Strategy

Mini Case Studies 1

Strategy Low Cost vs Legacy – definitions get cloudy

Mini Case Studies Strategy: Low Cost vs Legacy – definitions get cloudy

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While these low cost carriers (LCCs) are making profits, legacy airlines are struggling to cut costs and increase margins.

Strategy: Low Cost vs Legacy – definitions get cloudy

EasyJet – the British-born low cost airline that launched in the mid-90’s with the slogan ‘flights as cheap as a pair of

jeans’ – announced record profits of 686 million pounds in

2015. That was 18% above its previous year’s results and its

5th record profit in a row. Southwest Airlines, the U.S. low

cost airline that started it all in the 1970’s with hostesses

in orange hot pants and white go-go boots, also finished

2015 with record profits of 620 million U.S. dollars. It was

Southwest’s 43rd consecutive year of posting a profit.

While these low cost carriers (LCCs) are making profits, legacy airlines are struggling to cut

costs and increase margins. Low fuel costs have helped the legacy airlines’ bottom line in

recent years, but profitability has been far more variable than for LCCs.

Disrupting the market Low cost airlines disrupted the traditional air travel market, changing the concept of a

domestic flight from a luxury to a commodity. They focused on short-haul flights, leaving the

costly long-haul flights to the legacy carriers. As the low cost carrier market has matured,

however, the gap between low cost and legacy airlines services has narrowed significantly. In

recent years legacy airlines have watched their markets erode, they cut costs and services in

an attempt to match the competition. Meanwhile, the no-frills airlines have become successful,

and begun to introduce a few fancy ruffles, if not fully fledged frills – like assigned seats and

perks for business passengers.

The LCC sector took off in new markets as well. According to the Center for Asia Pacific

Aviation, the region’s LCC fleet increased 50% from 2013 to 2015 in Southeast Asia, from 400

to 600 aircraft. AirAsia, the leading Asian LCC based in Malaysia, was voted World’s Best

Low-cost Airline at the Oscars of the aviation industry, the Skytrax Awards, for the 8th year in

a row in July 2016.

New profit model Low cost carriers developed a new profit model for air travel. They cut costs in a myriad of

ways. Specifically, they cut fleet costs by using one type of aircraft with minimal additions

(seats on Ireland’s Ryanair planes, for example, did not recline or have seat back pockets to

reduce weight and maintenance costs). They hedged gas price contracts to smooth their fuel

Mini Case Studies Strategy: Low Cost vs Legacy – definitions get cloudy

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costs. They cut labor costs by hiring less experienced staff at lower pay grades. According to

The Economist, one Indian low-cost carrier hires only female flight attendants because they

are on average 10–15kg lighter than men. Such parsimony pays off. Fuel accounts for a third of

an airline’s costs and every kilogram thus shed removes $100 from an aircraft’s annual fuel bill.

Many ways to cut LCCs cut passenger amenities to the bone, offering no inflight entertainment and charging for

each service including food, beverage, luggage, pillows, blankets – even debating the merits

of charging for bathroom use. They cut airport fees by ensuring planes spent less time on the

ground, using secondary airports instead of major hubs and avoiding jetways that attract high

usage fees. The result was an ability to cut prices – sometimes to as low as zero (excluding

taxes and charges) – with simple fare structures such as one-way fares priced at half return

fares and seat prices that increase as flights fill up. For some time, all that cutting allowed the

LCCs to offer what European guide book publisher and media personality Rick Steves called

“remarkable, it-must-be-a-typo deals”.

Major shake-ups, and more to come The shake-up has led to several dramatic shifts. Delta and Northwest Airlines have merged.

Legacy airlines like Lufthansa have acquired their own LCCs (Eurowings). United failed in

building a low-cost brand (Ted). Over time, the price gap has even slightly closed between

low cost and legacy airlines. Analysis by The Economist in May 2013 showed it cost a typical

legacy carrier 2.5 cents more to move one seat through the air for one kilometer (0.6 miles)

than it cost a low cost carrier – but that was down from a 3.6-cent premium in 2006: “The

cost gap between traditional and budget airlines has fallen by an average of 30% in six years,

partly because legacy airlines have abandoned old differentiators like free baggage and in-

flight catering on short-haul flights.”

For customers, the price of a flight has dropped more than 20% since 1995. Customers are

winning; for airline shareholders the story is less clear. Airline stocks are down an average of

more than -15% to mid 2016, “and if you include all of 2015 the average is worse than -20,”

according to Forbes.com.

With cost cutting being the only game in town for airlines, further innovation in the industry

is likely. Suggestions like containerizing passengers and crew in portable cabin pods that are

loaded into the plane in minutes is one suggestion. Whatever technologies are employed,

however, the overall impact of the LCCs means the search for lower costs will continue until

the next big disruption in the industry.

... the gap between low cost and legacy airlines services has narrowed significantly.