Low Fare Airline An Attractive Place To Compete Management Essay

The scope of this essay is to critically analyse the European low-fare airline industry and evaluate if it is an attractive place to compete. Major external factors influencing the European LCC market will be examined through PESTLE analysis. Porter’s 5 forces framework will be used to explore the attractiveness of the industry and Bowman’s strategic clock will be employed to evaluate business level strategies used by LCCs.

Background Information

Low-Fare airlines have transformed the competitive environment within the European airline industry and have made a significant impact of the European domestic passenger market, which was previously controlled by the full service airlines. The first LCC to operate in the EU was Air Littoral which was launched before 1990. From 1990 – 2009 there were 102 LCC start-ups. By the end of 2009 only 37 LCCs remained, with a total of 586 aircrafts flying to 2174 destinations, with 3086 flights per day (December) carrying 143.1 million passenger. The average load factor was 82.7% (Data only of comparable airlines, excluding new ELFAA members and closed airlines).

Strategic Decisions

LCCs incorporate various operation strategies to maximise their operating margins. They implement a rigid structure and are constantly finding out ways to reduce their overheads and increase their profit margins. The business model followed by LCCs is as follows:

a). Same and Single class Aircrafts – Using one type of aircraft helped LCCs to reduce training and servicing cost, while having one class helped them to increase its capacity which increased their load factor.

b). No prior seat reservation – This helped LCCs to reduce their turnaround time as passengers boarded the plane early.

c). Airports – Using less congested secondary airports reduced operations costs as the fees charged by these airports were far less than the main hub airports.

d). Point-to-Point Service – No connecting flights were offered thus reducing operations costs incurred by baggage transfer and airport fees. This also helped LCCs to reduce their turnaround time and increase aircraft utilisation.

e). No added benefits – LCCs preferred not to provide complementary services like in-flight catering. However, passengers can purchase food and beverages on-board, providing additional income.

f). Limited Ground Service – To reduce labour costs, LCCs maintain minimal requirements required by the IATA and their employees take on multiple roles.

g). Ticketless Check-in – By not issuing tickets to passengers, LCCs reduced their turnaround time and operations costs. Additionally, LCCs sold tickets directly to customers though their websites rather than through travel agents. This also reduced their operations costs.

h). Ancillary – LCCs boosted their revenue by selling ancillary products and services.

i). Yield Management – Yield management enables airlines to dynamically adjust fares according to demand appeal to different target groups by offering customised rates. The aim is to sell goods and services for the highest price a customer is willing to pay (Schusteritsch, 2009). Yield management also helped LCCs to increase their load factor faster as passengers booked early to get the best rates. In 2000 Ryanair sold 78% of their seats while easyJet sold 80%.

PESTLE Analysis

To understand the macro-environment in which the European low-fare airlines operate and identify key influential factors, we shall use the PESTLE framework for analysis.

Political: In the mid 1990s, the EU deregulated the airline industry and cut state subsidies for national airlines. This opened up the market to new LCC airlines such as easyJet and a re-launched Ryanair. In 2004, 8 Eastern European countries joined the EU which allowed their citizens to work in Western Europe. This presented a huge growth opportunity for LCCs who responded by offering inexpensive inter-country routes to migrants visiting their home countries. Collapsing regulatory barriers also attracted new entrants into the LCC sector. Between 2002 and 2005, there were at least 10 LCC start-ups albeit also several failures. By the end of 2009, there were no further substantial political influences to the LCC sector.

Economic: The 2008-2009 recession negatively impacted the European economy and similarly on the European LCC industry. Consumer confidence and spending remained depressed and oil prices increased. In 2009, European economies declined by 4.2% and consumer spending fell by 8.4%. The LCC sector was marked by several bankruptcies, mergers, acquisitions and a reduction in fleets. Italy’s MyAir.com, Slovakia’s Sky Europe, UK’s flyglobespan and Denmark’s Sterling Airlines went bankrupt. The latter was purchased by Cimber Group. In Spain, clickair merged with Vueling and LLCs such as bmibaby reduced their fleets. By 4th quarter 2009, IATA estimated that global airline industry had lost $11billion during the year. The recession also led to a collapse in the S. Europe construction boom. Thousands of holiday homes were left incomplete or unsold, reducing demand for travel to the region. LCCs responded by reducing or completely cutting services to these destinations. By early 2010, several W. European nations such as Greece, Italy, Spain, Ireland and the UK had high debt levels. Actions to reduce debts resulted in increased risks for unemployment and raised government welfare costs, thus renewing the recession. In 2008, Wizzair reduced its services from Poland to the UK due to the sharp reduction in Polish workers in the UK.

One of the major economic factors that affected the LCCs was the fluctuation of the fuel prices. In 2008, fuel prices increased from $100/barrel to $140/barrel. By early 2009, fuel prices had decreased to $50/barrel, but rose to $80/barrel in the 4th quarter. Fuel costs were also kept high due to the scarcity of easily extracted oils globally. In early 2010, fuel costs accounted for 30% of Ryanair’s passenger fares. Uncertainty about how much longer the recession will last together with high fuel costs could significantly impact the success or failure of a new entrant into the sector.

Social: The rising number of retired people and economic recovery after the dot-com bust in 2001 had a positive impact on consumer behaviour in the LCC industry. In addition to their traditional two week annual vacation, consumers began to take shorter vacations thus increasing demand for low cost flights. Additionally, LCCs opened up routes to cities that offered cultural or historical attractions – destinations that previously could only be reached by large-hub airports – further fuelling demand and the LCC boom. Low cost fares also appealed to business travellers, who further increasing demand for LLCs. However, the 2008-2009 recession negatively impacted holiday travellers. The construction boom of S. Europe holiday homes collapsed, leading to reduced consumer demand and in turn reduced supply of services by LCCs to the region.

Technological: Through usage of powerful websites LCCs were able to connect directly with the consumers thus removing the need of travel agents and costly call centres which helped them to reduce their operation cost. Additionally, smart “yield management” pricing systems helped to increase load-factors. Airlines such as Ryanair were also able to buy aircraft with better fuel efficiency which reduced their operation costs and incurred lower financing costs.

Environmental: Climate change – Carbon emissions from air travel are a great concern in Europe. Efforts to reduce emissions include: an introduction of airline passenger taxes aiming to slow down growth of carbon emissions in UK and Ireland, and an EU target for a 30% reduction in carbon emissions by 2020. The latter makes it likely that EU policy would favour the extension of high speed trains which poses a threat to the airline industry. Achieving the EU targets would impact the European airline industry and is therefore a key consideration for potential entrants.

Legal – In 2008, BAA’s monopoly over London airports was broken, resulting in the opening of Gatwick and Stansted, as well as that of Scotland’s Edinburgh airport to other operators. Additionally, in 2008, the Polish Airports Authority expressed plans to close a terminal in Warsaw and doubled their airport charges levied on the airline. On the other hand Spain scrapped passenger taxes and reduced airport charges. Potential entrants should investigate airport charges in each EU country to determine how this would affect their profitability if they offered services to these routes.

In can be said that the ongoing recession and high fuel prices in Europe has had the strongest impact on the LCCs. Potential entrants may struggle to compete in this challenging environment. However, by adopting different strategies some newer entrants such as Vuelig and Norwegian were able to make profits during the recession. Additionally, potential entrants should consider airport charges, usage of technology advanced aircrafts to reduce operation cost and abide by the EU carbon emission targets. New entrant should also focus on the different market segments that LCCs can cater to.

Porter’s Five Forces Analysis

a). Threat of Substitutes: LOW

HSTs are substitutes that threaten LCCs especially for shorter routes. HSTs take passengers directly to city-centres with higher comfort level. This is more convenient for passengers than using LCCs which use secondary airports and passengers can save the money they would have used to commute to city centres. Check-in times are shorter for passengers using HSTs compared with using airlines. Furthermore, passengers also have the option to use full-service airlines and road transport. Additionally, HSTs have less environmental impact due to use of environmental friendly fuel resulting in low carbon emissions.

The price variances among its substitutes are small. Therefore, there is low switching cost for passengers in a price sensitive market.

b). Threat of New Entrants: MEDIUM

Scale and experience – Establishing a low-fare airline requires a big investment, including buying or leasing planes, contracting and training pilots, maintaining the aircraft and other kinds of service investment. This acts as a barrier for any new entrant as they would require high investments. Also the barrier may come from experience curve effects that provide incumbent LCCs with cost advantages. This will act as a barrier as new comers will take time to understand these opportunities.

Economies of Scale – Existing LCCs have reached high scale production in terms of high load factor and servicing to large customers which helps them to reduce their cost through yield management. It would be difficult for a new airline to reach high economies of scale which will affect their profitability.

Expected Retaliation – The sector is highly competitive. LCCs strive to increase their load factor and attract more customers. New entrants could experience huge retaliation from the existing competitors.

Brand Recognition – Existing LCCs have the advantage of brand identity. Generating awareness and brand recognition will be tough for new entrants.

c). Supplier Power: MEDIUM

Concentrated Suppliers – There are two main aircraft manufactures Boeing and Airbus, therefore the competition between them to get larger orders are high therefore it is easier for airlines to negotiate but smaller airlines have low bargaining power towards them.

High switching cost – With only two airline manufacturers, investments costs for purchasing aircrafts are high. Switching costs are high and LCCs prefer to use the same manufactures for their entire fleet to reduce their training and repair costs.

Forward Vertical Integration – By using websites to sell their services directly to customers, LCCs were able to eliminate intermediaries like the travel agents.

Airports – Primary airports have higher power than secondary airports, but as LCCs mainly focus on secondary airports with less fluctuation in airports charges, their power is low.

Fuel – LCCs do not have much control of fuel prices which increases the power of fuel suppliers.

d). Buyer Power: HIGH

Low Switching Cost – There are many LCC in the market and they are weakly differentiated. It is easy for buyers to switch from one to another through the usage of the websites, forcing LCCs to lower their prices and engage in price wars.

Price Sensitive – LCCs cater to a price sensitive market where customers’ decision on selecting the airlines depends primarily on the cost of the ticket.

Concentrated Buyers – There are various market segments that a LCCs needs to cater to like people travelling for holidays, young passengers who like to travel to experience new culture and see new places and immigrants who work in a different country and would like to visit their relatives. But unfortunately the LCCs haven’t been able to tap the market for people who travel frequently like business travellers and this is primarily due to their low services and usage of secondary airports.

e). Degree of Competitive Rivalry: HIGH

Competitor balance – By the end of 2009 there were only 31 airlines left and few of them grew enormously. Therefore, to remain competitive and increase their profitability they have to increase their load factor. There is intense competition to gain more customers and dominance in the industry.

Industry Growth Rate – The LCC industry appears to have reached the shakeout phase in which increased rivalry has pushed out weaker players. The growth rate of airlines industry has increased therefore there is a high competition within the industry to gain more customers in order increase their profitability.

High Fixed Costs – LCCs have high fixed costs as they therefore require high investments in capital and equipment. To reduce their costs LCCs try to increase their volumes (load factor) by reducing their prices which triggers price wars.

High exit barriers – Due to high investments cost, LCCs have high exit barriers. They try to avoid bankruptcies by being more competitive to remain profitable, therefore increasing rivalry.

Low Differentiation – LCCs are weakly differentiated making it to influence customers to switch between their competitors. Using price as a main competitive factor increases rivalry.

Business Level Competitive Strategies

Strategies to achieve competitive advantage include Porter’s Generic Strategy and Bowman’s strategy clock. Porter’s generics strategies are: overall cost leadership, differentiation and focus. Bowman’s strategic clock built on Porter’s generic strategies by providing 8 different strategic options based on a product or service’s price levels in comparison to its perceived benefits. Bowman’s clock also advises on which strategies are destined to fail.

Using Bowman’s clock as a guideline, we can analyse strategies used by Ryanair, easyJet, and airberlin to achieve competitive advantage. As they are all LCCs, they all generally maintained low prices in comparison to full service airlines. However, there were some differences in how they positioned themselves.

i) Ryanair

Ryanair adopted a strict no frills strategy. It focused on keeping prices very low in order to order to get huge volumes of customers and also win price wars against new entrants. This strategy seemed to work in its favour. For example in 2004, Ryanair’s fares fell by 6.5 Euros and 7 LCCs went out of business. These very low fares offset any inconveniences that Ryanair’s customers experienced in commuting to the secondary airports usually far from the cities they served.

ii) EasyJet

EasyJet was able to charge higher prices by adopting a hybrid strategy. It offered more value to customers by using established airports closer to population centres. This approach helped easyJet secure business travellers who did not want a long commute to secondary airports. In addition, easyJet began to offer services such as options for “speedy boarding” at £5 for passengers who wanted first choice of seats. It also offered departure lounges and a card scheme for frequent customers to get discounts for add-ons.

iii) airberlin

Airberlin also used a hybrid strategy albeit in a different way from easyJet. It offered short-to-medium haul LCC services, charter flights and longer-haul full service routes. Additionally, airbelin used travel agencies as well as online booking. It also targeted high yield business travellers. It also claimed to offer better services than other LCCs for example, offering free drinks and snacks on all flights.

Ryanair plans to continue its strategy of offering the lowest fares while easyJet and airberlin both seem to be adding back some service elements. Elements of their fares and financial results can be compared using the table below.

TABLE: Comparison of fare prices and financials for selected airlines.

Hybrid strategy is the most preferred stratergy by all airlines as it covers low cost with little benefits or something like that or we can put this in the conclusion it will look good as a strategic plan for a new entrant as we have already mentioned new comers came into no frills and low cost and failed.

Conclusion

The above analysis indicates some opportunities for entering the European low-fare industry. The entry of 8 countries into the EU offers a wider customer base including migrants, leisure and business travellers. Yield management technology can be used to reduce costs and improve load factors. Additionally, some airports are decreasing their charges.

However, the LCC industry faces significant challenges including an ongoing recession and uncontrollable high oil prices. There is high rivalry and high buying power. Many LCCs could not compete with Ryanair’s no frills in a recession and went bankrupt. Some airlines were able to grow and remain profitable by differentiating themselves. However, it is not clear how many potential destinations remain un-served and also how EU targets for carbon emission will affect the industry. Potential entrants have to find profitable routes, achieve fuel efficiency, aircraft efficiency and high-load factors to succeed. There were many airlines which took the strategy of low fare but went bankrupt or merged with other airlines as there is less differentiation towards customers and no frills take the advantage on that. That’s the reason we don’t have any one is low fare. 

In conclusion, while there may be some opportunities in the European low-fare airline industry, it is not an attractive place to compete.

PART-B

From your experience of using LoFare business simulation, to what extent can a business or industry be replicated using a business simulation?

LoFare Business Simulation

LoFare is an accurate and realistic computer based business simulation that uses real data and model in the low cost airline industry. The data used in the simulation is been updated o meet up annual challenges and this process is maintained in order to reflect the dynamic nature of this exciting international business and to ensure effective, highly relevant, experiential management and business training. Full company annual reports are produced for modifications done in the scenario. The decisions may also be recorded on paper decision forms. The simulation can be expanded by the use of extra modules designed to emphasize and develop particular areas of business.

“Kolb defines learning as the process whereby knowledge is created by the transformation of experience. Business simulations are one form of experiential learning, which often is a very effective way of learning. People learn from their experience.” (Haapasalo and Hyvonen, 2001) LoFare simulation provides experiential learning by requiring teams to select a strategy, implement the strategy, experience the results of their decisions, and compete directly with the companies established and run by their team mates. The simulation begins as early start-up low cost airlines in an emerging market. After the initial investment, the student must organize a management team to take over the firm and make decisions each quarter including pricing, marketing, marketing research, production, inventory, employment, employee training, and financial decisions. In addition to these decisions, the simulation has eight management dilemmas to challenge the team. The advantages of the simulation include the following:

All decisions are interrelated as decisions are in a real business.

Experience the growth and maturity of an industry.

Learn the value of market research.

Participants are emotionally engaged from the start of the simulation and become more passionate about their firm during the simulation process.

Measuring the Effectiveness of Business Simulations

If simulations should be an integral pedagogy in strategic management courses, then the question remains of how the students’ learning experience of business/industry can be demonstrated. Any attempt to answer this question is filled with challenges, because it is difficult to quantify the learning benefits of a business simulation. Anderson and Lawton (2002) identified two key questions: “Two key questions surrounding the use of simulations have been troubled users since the very earliest days of gaming are:

What do participants learn from engaging in a simulation experience?

LoFare business simulation has helped in understanding interconnectedness of all departments within a company working together towards company’s primary mission. It gives insight of low cost airline industry and the factors affecting it. During this Lofare simulation we realized importance of the short term and long term strategic decisions on different departments:

Marketing:

Pricing

Promotion

Competition

Market research and data on competition

Customer Service

Finance:

Loan repayment

Investments

Depreciations

Costs and inflation

Fixed overheads

Operations:

Expansion of route and demand for new aircrafts to maintain load factor

Capacity to handle existing and new customers

Decisions made helped us in analyzing different effects on company’s growth measured in:

Balance sheet

Cash flow

Profits

Company market value

While working on LoFare it was clearly visible that how a decision to increase marketing spend affects overall company performance including departmental performances and it helps you to be flexible with your strategy for being competitive. It was found that LoFare simulation covered almost every aspect of low cost airline industry but there was no provision to introduce unavoidable circumstances which can arise due to recession or ash cloud.

Is a simulation better than alternative pedagogies for accomplishing certain learning objectives?

How can the benefits of the simulation be demonstrated in light of the two problems was also noted by Schumann, Anderson, Scott and Lawton (2001): (1) “There is a void in the literature that reports the effect of simulation exercises on results either from the student’s or from the employer’s perspectives.” Schumann (et al) present the following recommendation: “Since business simulations are designed to be a more realistic environment in which to learn, one might therefore hypothesize that the use of simulations will result in improved behaviors.” As simulators are designed to provide real time scenario but excluding any unknown factor it becomes quite easy to understand basics of particular industry/business including various factors affecting overall performance.

Simulation Vs Real Life Business

Cost: Experimenting in real life is costly. It’s not only the capital expenditure of hiring new staff or purchasing new aircraft, it’s the cost of the ramifications of these decisions. What if you fire three staff and then find you can’t cope with the workload and you lose customers? The only cost with simulation is the software and the man hours to build the simulation.

Repeatability: In real life it’s really difficult to repeat the exact circumstances again so you only get one chance to collect the results and you can’t test different ideas under exactly the same circumstances. With simulation you can test the same system again and again with different inputs and can formulate your strategy.

Time: If you want to know whether hiring three more customer care staff will reduce customer waiting lists over the next two years you’ll actually have to wait two years. With simulation you can run two, ten or even one hundred years into the future in seconds. So you get the answer now instead of when it’s too late to do anything about it.

Managing change: Aside from the machine operations, companies also have to deal with product changeovers, variability and unpredictable events such as workforce absenteeism, material shortages or accidents. All of these affect the productivity of a production line.

Test driving new scenarios: Because of the high cost of both inefficiencies and new equipment, optimizing systems design and operation is critical to improving overall productivity, customer service and the bottom line. Simulation lets you build up your system and then test it; you can combine process simulation and optimization to help demonstrate, predict and measure system performance; you can find out where and why problems occur, (e.g. why a bottleneck builds up), allowing you to identify areas for improvement, test out new ideas and, most importantly understand how a system works without taking any significant risks and before introducing changes to live operations.

Communication: With graphical and animated packages you can communicate your understanding and improvement ideas to others. You can visualize how work flows through your system and see its dynamics in fast forward time. You can actually watch bottlenecks building up and see what is causing the problems.

Simulation is quite useful while formulating business strategy as it gives idea of running business and helps in predicting real time scenarios. Simulation will never give you real time values but surely it can get you near to it.

Conclusion

The simulation gives us the opportunity to operate companies and to develop its strategy during the business management. It also required us to consider about our rivals and other external factors. When making the group decision we should take into account the overall aspects inside the company. However, the simulation cannot give us an entire picture as the real business.

In the simulation, before operating further process, it is necessary to collect the data. Once found all the necessary charts and information, one should try to analyze them with different aspects. For example, the former marketing investment may give the information about the sensitivity between sales and marketing investment. The financial report can offer the overview of our business trend, according to which can be better forecast an appropriate direction for future investment.

The simulation also gives some information about the competitors. Their performances indicate the current competition and how competitive they are. According to the analysis of the rivals, one can develop its strategies for better competing with them.

As in the simulation, there were four positions, the CEO focuses on the overall control. First he should divide different tasks for various positions. During the discussion, he tried to smooth the cooperation among the group. Then he took final decision after the group discussion for every strategy taken.

The CFO, CMO and COO play their own roles at the beginning. Everyone might pay more attention on the interests of their own department. As the simulation went on, the management realized that more focus should be put on the overall interest. Then the group turned to be more negotiated and worked together for the final result.

References

Anderson, P.H., Leigh, L., (2002), “Is Simulation Performance Related to Application: An Exploratory Study,” Developments in Business Simulation and Experiential Learning, Volume 29.

Anderson, P.H., David A. B., Timothy W. S., David, L. H., (2003), Threshold Competitor: A Management Simulation, Prentice Hall, New Jersey, Version 3.0.

Haapasalo, H., Johanna H., (2001), “Simulating Business and Operations Management – A Learning Environment for the Electronics Industry, International Journal of Production Economics, Volume 72, Issue 3, Oct. 13.

Johnson, G., Scholes, K. and Whittington, R (2008). Exploring Corporate Strategy, 8th Edition. Harlow, Pearson Education.

Schusteritsch, F., (2009), Airline Yield Management. [Online],

Available at: http://www.scribd.com/doc/36474090/Airline-Yield-Management. [Accessed 22 May 2011]

Warren, K. Case Study. Competitive Dynamics in the European Low-Fare Industry, to 2009. London Business School.