Low-cost carriers may have undergone significant change since the model was launched by Southwest Airlines in the 1970s, but they remain true to the core principle of keeping fares as low as possible to maximise load factors, writes Emma Kelly.
Years ago, when low-cost carriers (LCCs) first made an appearance, airlines were either classified as following budget or full-service business models. Now, however, the landscape has become much more complicated, with LCCs morphing into no-frills operators, hybrid airlines and even “new-world carriers” as the changing economic climate forces carriers to adapt to the market.
Many carriers that started out as LCCs have over the years embraced some of the trimmings associated with more traditional, mainline carriers – including in-flight entertainment, frequent-flyer programmes, codeshares and alliances, and membership of global distribution systems. But all of these have come at a cost to passengers, with ancillary revenues a focus of the operators.
While their outward appearance may have changed, LCCs remain true to their original principle of maintaining the lowest possible cost base.
US low-cost pioneer Southwest Airlines launched services in 1971, operating high-frequency Boeing 737 services to secondary US cities with limited on-board service and low fares. Laker Airways was the first to see the potential in long-haul, low-cost services, operating trans-Atlantic services until it collapsed in 1982. Later, People Express followed on trans-Atlantic services in the 1980s, charging passengers for food and beverages and bags.
The low-cost phenomenon really kicked off in Europe in the 1990s, thanks to liberalisation of the air transport market and the growth of the internet. Leading the charge was Ryanair, which had first launched services between the UK and Ireland in 1985. Today, Ryanair operates 250 Boeing 737-800s, connecting 160 destinations. In November, the airline announced half-year profits up 20 percent to 544 million euros (US$729 million), on traffic growth of 12 percent, despite a European recession, with 73.5 million passengers expected to fly with the carrier in 2011.
EasyJet, Europe’s second-largest LCC after Ryanair, launched operations in 1995 and today carries 50 million passengers per annum using a fleet of over 200 Airbus A319s/A320s on more than 582 routes between 128 airports in 29 countries.
In the US, New Air, later renamed JetBlue, was launched in 1999. JetBlue was responsible for a change in LCCs, still maintaining a focus on offering low-fares, but with an eye on on-board service as well.
The Asia-Pacific region was relatively slow to follow the LCC trend, with AirAsia and Virgin Blue launching services in the region in 2000-2001. Since then, the market has grown rapidly, with LCCs appearing in countries throughout the region, despite not experiencing the liberalisation and common market benefits that allowed European LCCs to prosper and proliferate.
The major LCC groups, including AirAsia and Jetstar, have successfully deployed the LCC model in countries throughout the region – from Singapore to Australia to Vietnam and all points in between, with new subsidiaries waiting to take flight.
AirAsia, for example, has grown from an airline with 250 employees, two aircraft and one destination to a group with operations throughout the region, with more than 8,000 employees, 104 aircraft and serving more than 78 destinations. The airline has been operationally profitable from its launch and is now the largest LCC in the region, with units in Malaysia, Indonesia and Thailand, in addition to its Kuala Lumpur-based long-haul affiliate, AirAsia X.
In its latest financial results, for the second quarter released in late August, AirAsia Group reported a 15 percent increase in revenue to 1.08 billion ringgit (US$344 million) and a profit before tax of 145 million ringgit – up 0.6 percent year-on-year. Passenger loads were up four percentage points to 81 percent, as were ancillary revenues from baggage charges, seat selection, in-flight merchandise and meals. Ancillary revenues were up in all three operations.
The improved results came despite “a stormy environment of volatile fuel prices, rising costs and global economic uncertainty”, says the airline. Paying dividends
The company’s “load active, yield passive” strategy is paying rich dividends, says group Chief Executive Officer Tony Fernandes, with low fares attracting more passengers who contribute more in ancillary revenues. “We’ve always maintained that instead of raising fares for higher yields – running the risk of dampening air travel – we’d rather keep fares at reasonable levels so as to attract higher passenger loads and boost revenue through ancillary services,” he says.
Beyond 2011, AirAsia will focus on containing or driving down costs, raising yields and further expanding network reach, Fernandes adds.
AirAsia Philippines is on track to launch in the fourth quarter of 2011, and AirAsia Japan, in conjunction with All Nippon Airways, is set to launch in August 2012. “Japan is a huge, huge market with a very low LCC penetration rate. It’s our first venture outside of ASEAN and we’re very excited about the prospects there,” says Fernandes.
However, AirAsia has decided not to proceed with its AirAsia Vietnam proposal, which was to be a joint venture with Vietjet Aviation. The collapse of that plan was caused by failure to meet all regulatory requirements under the joint venture deal.
In August, AirAsia entered into a collaborative agreement with Malaysia Airlines (MAS), designed to explore areas of mutual cooperation in areas including: maintenance, repair and overhaul; ground handling; training; catering and cargo. Fernandes says the partnership will “steer AirAsia to new heights while independently assisting MAS in ways to seek synergies that could benefit both airlines and Malaysia even more in the future”.
The company is also setting up an AirAsia Asean office in Jakarta in order to promote the group as a regional brand and enhance coordination and strategic planning. The airline also has an agreement with financial services company Tune Money to develop a loyalty programme. Dubbed BIG, the programme will be launched in Malaysia and then introduced across all AirAsia operations in the region.
The airline’s fleet is also set to grow, with the group holding firm orders for 200 re-engined Airbus A320neo jetliners, with deliveries scheduled from 2016 to 2026.
Like AirAsia, Jetstar has spread its operations throughout the region. The Jetstar Group, which comprises Jetstar Airways in Australia and New Zealand, Singapore-based Jetstar Asia, Vietnam-based Jetstar Pacific and its newest venture Jetstar Japan, lays claim to being the largest low-cost airline in the region by revenue.
Since Qantas launched Jetstar in 2004, the airline has carried over 75 million passengers. In fiscal year 2010-11 alone, it carried 18.8 million passengers and by the end of 2011 the group operated 3,000 flights a week to over 60 destinations in 17 countries across the region, using a fleet of 86 aircraft – A320-200s, A321s, A330-200s and 737-400s.
In 2013, Jetstar will start to take delivery of the first of its 25 Boeing 787s on order, while 99 A320s, including 78 A320neos, are also on order.
Jetstar, which is wholly owned by the Qantas Group, launched short-haul domestic operations in Australia in May 2004. It added international long-haul services in November 2006.
The airline has been profitable every year since launch. In the last financial year, ended 30 June 2011, the carrier reported record underlying earnings before interest and tax (EBIT) of A$169 million (US$173 million) – A$38 million up on the previous year – driven by a 19 percent increase in total revenue to A$2.6 million. Total passenger numbers rose 14 percent.
Jetstar “is now an established, successful low-cost brand,” says Qantas Chief Executive Officer Alan Joyce.
The launch of Jetstar Asia services from Singapore followed in December 2004. In 2005, Singapore carrier Valuair became a sister carrier, focusing on services to Indonesia. From Singapore, Jetstar Asia currently operates over 400 weekly flights to 27 destinations across 15 countries and territories in the region. Jetstar New Zealand came on line in December 2005, adding international long-haul services in March 2011.
Vietnam-based Jetstar Pacific is 27 percent owned by Qantas, with the remaining shares held by Vietnamese investors. The airline serves seven destinations across Vietnam.
Jestar Japan is the latest affiliate to take up the brand. The new operation is a partnership between Qantas, Japan Airlines (JAL) and Mitsubishi Corporation. Each partner will have equal voting rights, but the Qantas Group will have a 42 percent economic interest.
The Japanese Jetstar arm plans to start domestic short-haul operations by the end of 2012 from Tokyo’s Narita and Osaka’s Kansai International airports, with an initial fleet of three new A320s, fitted with 180 seats in a single class. The fleet is set to grow to 24 A320s within a few years, the partners say. Short-haul international flights will be added during 2013.Market experience
Jetstar already has considerable experience of the Japanese market, having served Osaka and Tokyo from Cairns and the Gold Coast since 2007.
“We are an Australian airline being invited to partner with two of the most established companies in Japan and apply our successful formula on their turf. We feel very proud about that,” says Bruce Buchanan, Jetstar chief executive officer.
China has also been a focus of the Jetstar Group in recent years. Jetstar made its inaugural flight to Greater China with its first service to Hong Kong in December 2004. By the end of 2011, Jetstar was operating 147 weekly flights from Singapore to 10 destinations in Greater China.
Compared with its LCC counterparts, Tiger Airways has had a difficult year, thanks to the grounding of its Australian operation for six weeks because of safety issues in July and August. The company’s Singapore-based operation continued as normal, but the grounding of Tiger Airways Australia “significantly impacted” the group’s financial performance and it is now striving to rebuild the Australian business.
The group is forecasting a “significant net loss for the year” due to the Australian grounding and the group’s exposure to high and volatile jet fuel prices. In the 12 months to June 2011, the group carried 6.2 million passengers, an 18 percent increase from the previous year.
Further expansion is on the cards for the airline, with six additional A320s set for delivery by March 2012, bringing the fleet to 20. Tiger Airways has also purchased a 33 percent stake in Indonesia’s Mandala Airlines and is looking to put that carrier back into service, as a low-cost operator, as early as January 2012. It is also buying 32.5 percent of Philippines-based Seair. A proposed Bangkok-based LCC venture with Thai Airways, however, has not got off the ground due to failure to secure regulatory approval.
One carrier that has changed more than any other in the region is Virgin Australia, formerly known as Virgin Blue.
The company started out life in 2000 as a traditional LCC, operating low-fare services throughout Australia using a fleet of 737s. But over the years it introduced in-flight entertainment, different classes, lounges and a frequent-flyer programme, abandoning the LCC moniker, instead labelling itself a “new world carrier”.
Virgin Australia is now an airline group, comprising a domestic short-haul operator, a long-haul airline and medium haul operators.
Under current Chief Executive Officer and Managing Director John Borghetti, the airline is undergoing yet another transformation under its Game Change strategy, moving further away from its leisure market roots and instead taking on Qantas head to head in the high yield corporate and business end of the market. The changes have already included a thorough network review and elimination of underperforming routes, an organisational restructure, a new fleet of turboprops, a new brand, a relaunched frequent flyer programme and a raft of alliances and partnerships with carriers such as Etihad, Delta Air Lines, Air New Zealand and Singapore Airlines, in a bid to create a “comprehensive virtual global network”.
The former Virgin Blue was over-reliant on the leisure market, according to Borghetti. The revamped airline is now seeking to build its share of the corporate and business market from 10 percent to 15-20 percent over its first two years.
Borghetti explains: “Our strategy is simple and logical – we need to ‘hedge’ our revenue base. We have to continue to attract the leisure and SME market and use our cost advantage in pursuing the corporate sector.”
Announcing the carrier’s financial results for the year ended 30 June, Borghetti said the Game Change strategy was already beginning to show results. “Our progress in repositioning the airline has already seen us make significant gains in the high-yield corporate and government business market. This important segment now makes up 13 percent of our total revenue, up from 10 percent in the 2010 financial year,” the airline chief said in August.
However, the airline announced a full-year net loss of A$67.8 million, reflecting the impact of “an unprecedented series of external events”, including floods, earthquakes, volcanic ash and the failure of the airline’s Navitaire reservations system.
The result merely reinforces “the importance of our Game Change programme strategy to increase our share of the more resilient corporate and government markets”, Borghetti said. “Our Game Change programme is already delivering results, with an increase in Virgin Australia’s corporate and government market revenues of 29 percent year-on-year,” with further gains expected in 2012.
Others in the region are entirely abandoning the traditional LCC model. Struggling Indian carrier Kingfisher Airlines, for example, is dropping its low-cost service, Kingfisher Red, in order to focus on premium passengers in a market that is struggling with high costs and reduced yields. Kingfisher was established as a full-service carrier, but entered the LCC market with its acquisition of Air Deccan.
The carrier offers three classes of service – Kingfisher First, Kingfisher Class Economy and the no-frills Kingfisher Red. The airline announced in late September that over the next four months it will phase out Kingfisher Red and reconfigure its fleet.
“Over the past six months, Kingfisher Class [full-service economy class] has generated higher yields and seat factors than the no-frills Kingfisher Red class of service,” the airline says.
“The airline industry in India is going through a tough period due to high costs and lower yields,” says Sanjay Aggarwal, the carrier’s chief executive officer. “This is evident by the unprecedented losses recently reported. To counter these pressures and leverage its strengths, Kingfisher decided to rationalise the network, drop unprofitable flights and expedite its fleet reconfiguration. This initiative will improve the long-term profitability of the airline.”
Over the past two years, LCC capacity in India has outpaced the demand in the domestic market. Meanwhile, business-related travel is increasing significantly, says Aggarwal. The airline’s analysis shows that “of the incremental yield, only 25 percent is spent on providing the extra services associated with a full-service carrier. The remaining 75 percent is net contribution to the bottom line,” he adds.
Aggarwal notes that there are currently five carriers operating in India’s LCC market and only three full-service carriers. “Like any other prudent business, we are taking steps to improve our financial performance,” he says.
Elsewhere in the region, new carriers are keen to enter the LCC market. In Japan, for example, Osaka-based Peach Aviation plans to launch services from Kansai Airport in March. The airline – Japan’s first true LCC – will operate ten Airbus A320s in 180-seat, single-class configuration initially on domestic routes and later internationally across Asia.
The carrier is being established by All Nippon Airways (ANA), First Eastern Investment Group and Innovation Network. ANA is the latest full-service carrier to make moves into the LCC market by establishing a low-cost offshoot.
Another emerging development in the sector is the interest in long-haul, low-cost operations. New, Singapore-based budget airline Scoot is a wholly owned subsidiary of SIA, which will operate medium- and long-haul no-frills flights. The airline will be independently operated and managed.
The airline is currently working with the Civil Aviation Authority of Singapore (CAAS) to secure its air operator’s certificate, which it hopes to achieve around the end of the first quarter of 2012. Scoot will operate four Boeing 777-200s purchased from the parent company.
Engineering retrofit and certification of aircraft is scheduled for April-June and the first commercial flights are targeted for the middle of the year, Scoot says.
Scoot will operate from Singapore Changi Airport Terminal 2. Destinations in the first year will include points in Australasia and China, with the network growing – and longer-range aircraft joining the fleet – to cover points in India, Europe, Africa and the Middle East.
The aircraft will operate in a two-class configuration, with passengers able to customise their travel experience, including meals, preferred seats and baggage. The airline is aiming to offer fares up to 40 percent cheaper than legacy carriers.
Airlines in the region have tried long-haul, low-cost operations in the past, with Oasis Hong Kong Airlines, for example, failing in the market. Others, such as AirAsiaX and Jetstar, have been more successful in the medium- and long-haul low-cost market. Jetstar was the first LCC to offer long-haul international services in November 2006. International markets served to and from Australia including the Philippines, Indonesia, Vietnam, Singapore, Fiji, Thailand, Japan and the United States (Honolulu).
AirAsia X was established in 2007 and serves Australia, China, India, Japan, Taiwan, the Middle East and Europe with A330-300s and A340-300s, with considerable expansion on the horizon.
If the first ten years of LCC operations in Asia have shown anything, it is that flexibility is the key to survival in an unpredictable air transport market. This lesson will serve the industry well as Asia is forecast to lead global air traffic growth over the next two decades.