Legacy Carriers Airlines and Future Challenges - Research Paper Example

 Legacy Carriers Airlines and Future Challenges Abstract In the context of the deregulation in the aviation industry and the emergence of low cost carriers, the full service legacy carriers are reported to have facing many threats and challenges .This study examines the main challenges faced by the full service carriers and also attempts to examine whether these carriers are able to survive these challenges. The financial and non financial performance of selected airlines in USA, Europe and Asia are done in this regard. The results show that the revenues for legacy carriers face high competitive pressures from the low cost carriers. The operating expenses have been increasing significantly in the period of analysis for the legacy carriers while the revenue generating capacities have not been sufficient to cope up with them. .Most legacy carriers face significant losses in 2008 while the low cost carriers operate profitably except those in Asia. Passenger preferences also favour the low cost carriers. The study recommends the need for a relook on the business and marketing strategies of the free service airlines to compete with the low cost carriers. However the success of low cost carriers cannot be considered to be everlasting and cannot be considered as the success of a business model. The legacy carriers still form an integral part of the aviation industry. 1. Introduction With the wave of liberalization and deregulation in the 1980s, airline industry has also undergone deregulation. Since the 1970s, there was tight regulation and rising hyper competition. The two main features of the regulated era were tacit collusion and avoiding head on competition (D’Aveni, 1995; Jarach, 2004).With the wave of deregulation, low cost carriers emerged as the new category attracting huge customers creating big challenge to the traditional full service legacy carriers. Traditional carries have found out difficult to compete with these low cost carriers in the deregulated era. It was argued that the tight regulatory practices in the airline industry might have led to many economic inefficiencies. This in turn had resulted in achieving low cost air transportation to public which was one of the core objectives of air transport policies. Hence deregulation wave started in the industry to improve efficiency and reduce airfares through rise in competition, air networks rationalization and airline governance enhancement (Gonenc and Nicoletti, 2001). Before deregulation, the industry was within a protective environment and the full service state owned airlines were highly protected. In the initial years of deregulation the industry was able to concentrate on revenue side strategies and reduce demand segmentation (Gitto and Minerveni, 2007). In the later years of the deregulation, however, with the rapid spread of the low cost carriers, growth in IT access among travellers and the reduction of willingness of companies to pay for high fare airlines all have created huge threats to the full service airlines(Gillen-Morrison,2005;Gitto and Minerveni,2007 etc). In this context, this report examines whether the full service airlines are able to survive the challenges faced by the deregulatory practices and the low cost carriers. This report is organized as follows. Section 2 discusses the literature review on deregulation and full service airlines Section 3 discusses the aim of the report, section 4 discusses the research methodology, section 5 discusses the findings and section 6 concludes the report. 2. Literature Review Levine (2003) examined the future of the US domestic airline industry in a very comprehensive manner. The study showed many US legacy carriers now restructuring from bankruptcy. Regarding others not in bankruptcy, the study shows most of them facing serious liquidity problems. It also shows many external challenges faced by the legacy carrier airlines like fragile economy, high fuel prices, risks of terrorist events, conflict in the Middle East etc. The deregulation is obtained to have brought many competitive challenges to the legacy carries due to the contractual protection under regulatory commitments. The revenue generating capacities of these airlines declined considerably with the high competition from low cost carriers. Gitto and Minervini (2007) empirically examined the performance of European full service airlines after liberalization based on a fixed effect model for 10 selected European airlines. The period of analysis was 11 years. In the analysis the variables selected were number and type of aircraft in the fleet, number and type of destinations, investments, number of employees and alliances. The results showed the main strategy of full service airlines was to increase the number of aircrafts and destinations. The study suggested these airlines to adjust the composition of their fleet rather than increasing the number of aircrafts. Moreover, it suggested the full service airlines to make long haul destinations as their focus and not domestic destinations .These are very necessary according to the results for these airlines to compete with the low cost airlines. However, the study has not considered the impact of many variables like customer satisfaction indicators, institutional variables etc in the analysis. Cook(2008) examined the reasons for the failure of mergers in the US legacy carriers till 2007.The analysis showed two main reasons one is the attractiveness of investing in airline industry and the other is the downward pricing pressure put forward by the low cost carriers which make the mergers of legacy carriers non profitable. In the study by Hussain and Bachceci(2008), the evolution of network structure and design of the post deregulated US airline industry is examined. For the analysis, LN (1998) model is used in the study. Based on the model it is shown that the entry of low cost carriers has affected the prices of legacy carriers in all markets even though there is no direct competition. The analysis shows that the low financial performance of the legacy carriers might not be due to the inefficiency of these airlines per se. Rather it is shown that this is due to an efficient Hub and Spoke network undermined by competition from inefficient point to point networks. Moreover the model also demonstrates the social welfare can be increased even more with regulation of the entry and exit in air passenger industry. Button (2009) showed that though many examples can be shown to illustrate the success of the low cost airlines all over the world, the success of the low cost airlines as a business model is doubtful. The success is only for a few firms and not for the model as such as shown by the study. The success of the few firms is mainly due to the fact that the full commercial costs are borne by the users. The success of the low cost carriers is described as a transitory situation and is not sure to be everlasting as shown by the study. The study shows the low cost airlines not meeting the basic problems of providing scheduled services in a highly competitive market. Centre for Asia Pacific Aviation (2009) has examined whether the full service business model has broken in Asian countries taking the examples of Cathay Pacific, Singapore Airlines etc. The article shows tremendous decline in revenues and number of business class tickets for these full service carriers especially after the global economic crisis. Hinton (2010) has shown that the future of legacy carriers with the latest mergers and acquisitions is in dark cloud giving the examples of Delta and its legacy carrier peers. The high competitive pressures these carriers are facing from the low cost carriers are clearly demonstrated in this report. The above literature review thus clearly shows the full service legacy carriers face significant threats and challenges with the wave of deregulation and the emergence of low cost carriers all over the world. There has been huge decline in the revenue generating capacities; numbers of passengers etc for these legacy carriers .Many of these carriers are facing downward pricing pressure and competitive pressure from the low cost carriers. At the same time, the review also shows that the success shown by the low cost carriers is not likely to sustainable as a business model. The studies also show the social welfare higher with regulation than under deregulation. Given this, this study examines in detail how far the emergence of low cost carriers and deregulation have affected the legacy carriers .Moreover it attempts to give some recommendations regarding how to overcome these challenges. 3. Aim of the Study The main objective of the study is to examine how far the far the emergence of low cost carriers and deregulation have affected the legacy carriers and whether they can survive these challenges. The specific objectives of the study are (1)To examine the effects of deregulation and the emergence of low cost carriers on the legacy carriers in terms of financial performance (2) To examine the effects of deregulation and the emergence of low cost carriers on the legacy carriers in terms of nonfinancial performance (3) To suggest recommendations for overcoming the challenges of legacy carriers 4. Research Methodology Quantitative data analysis is chosen as the strategy for the present study. It is included in the research methodology called positivism. Positivism argues that research needs to be done based on observation and reason. These two are suggested as the two different methods to understand human behaviour according to this method (Comte, 1865). This is mainly based on empirical and quantitative techniques rather than qualitative studies. The financial and non financial indicators are examined from 2006 to 2008. . The analysis is done for selected full service airlines and low cost carriers in USA, Europe and Asia. The financial and non financial indicators are compared for the legacy carriers and low cost airlines in the selected period for each region. The selected legacy carrier airlines in USA include American airlines and US Airways while low cost carriers include Jetblue and Airtran. The selected full service airlines in Europe include Aer Lingus, British Airways, Iberia and Lufthansa while low cost carriers include Easy Jet, based on data availability. The selected legacy carrier airlines in Asia include Cathay Pacific and Singapore Airlines while low cost carriers include Air Asia and Jet Airways. The data base includes Centre for Asia Pacific Aviation and the websites of the different airlines mentioned above. 5. Findings 5.1. USA Legacy Carriers American Airlines US Airways 2006 2007 2008 2006 2007 2008 Revenue 22563 22935 23766 11692 11813 12244 Operating Costs 21503 21970 25655 11135 11289 14017 Operating Profits 1060 965 -1889 557 524 -1773 Passenger Revenue per Km 0.08 0.08 0.09 0.104 0.107 0.11 Passenger Numbers(thousand) 6786 5436 5543 57345 57871 54820 Passenger Load factor(%) 73.4 70.2 71.4 78.23 80.21 81.68 Source: Centre for Asia Pacific Aviation (2010) Low Cost Carriers Jetblue Airtran 2006 2007 2008 2006 2007 2008 Revenue 23310 25721 26069 18920 23099 25524 Operating Costs 21453 20987 20676 23456 23543 23124 Operating Profits 117039 166184 84588 40861 144160 -72010 Passenger Revenue per miles 2.33 2.5 2.6 1.3 1.7 1.8 Passenger Numbers(thousand) 18507 21304 21824 20033 23741 24573 Passenger Load factor(%) 81.6 80.01 80.37 72.68 75.99 78.9 Source: Centre for Asia Pacific Aviation (2010) Comparing the revenues for the legacy carriers and the low cost carriers in US, it can be seen that the legacy carriers face high competition from the low cost carriers. The operating costs for the legacy carriers are increasing over the period while the revenues are not increasing enough to cope up with the costs. At the same time the revenues of the low cost carriers are increasing over the period. The legacy carriers face losses in 2008 while the low cost carriers have increased their profits significantly in the period of analysis. From the non financial statistics, it can be seen that the passenger revenues per km of the low cost carriers are higher than the legacy carriers .The number of passengers are also higher in low cost carriers than the legacy carriers. The load factor on an average is also higher in the low cost carriers than in the legacy carriers. The above analysis thus shows that the legacy carriers face downward pricing competitive pressure from low cost carriers .At the same time, the passengers prefer the legacy low cost carriers than the legacy carriers as shown by the analysis above. The next section discusses the results for Europe. 5.2. Europe Legacy Carriers Air Lngus British Airways Lufthansa 2006 2007 2008 2006 2007 2008 2006 2007 2008 Revenue 1273 1284 1357 8492 8758 8992 1984 2242 2487 Operating Costs 1205326 1206239 1375006 7936 7880 9212 8384 9358 11069 Operating Profits 68832 78638 -17650 602 878 -220 1078 1586 1383 Passenger Revenue per Km 6.13 6.79 7.16 6.31 6.44 6.42 134786 135011 154155 Passenger Numbers(thousand) 1143 1235 1264 7263 7600 7836 6134 6290 7250 Passenger Load factor(%) 72.3 73.6 74.9 70 70.4 73.4 73.8 74.5 71.5 Source: Centre for Asia Pacific Aviation (2010) Low Cost Carriers Easy Jet 2006 2007 2008 Revenue 1619.7 1797.2 2362.8 Operating Costs 38.34 35.88 43.39 Operating Profits 172 91 60.1 Passenger Revenue per miles 41.66 40.42 45.51 Passenger Numbers(thousand) 1343 1432 1543 Passenger Load factor(%) 76.7 77.8 79.8 Source: Centre for Asia Pacific Aviation (2010) Comparing the revenues for the legacy carriers and the low cost carriers in Europe, it can be seen that the legacy carriers face high competition from the low cost carriers as in the US case. The operating costs for the legacy carriers are increasing over the period while the revenues are not increasing enough to cope up with the costs. At the same time the revenues of the low cost carriers are increasing over the period. The legacy carriers face losses in 2008 while the low cost carriers have increased their profits significantly in the period of analysis. From the non financial statistics, it can be seen that the passenger revenues per km of the low cost carriers are higher than the legacy carriers .The number of passengers are also higher in low cost carriers than the legacy carriers. The exceptions are British Airways and Lufthansa. The load factor on an average is also higher in the low cost carriers than in the legacy carriers. The above analysis thus shows that the legacy carriers face downward pricing competitive pressure from low cost carriers .At the same time, the passengers prefer mostly the low cost carriers than the legacy carriers as shown by the analysis above. The next section discusses the results for Asia 5.3.Asia Legacy Carriers Cathay Pacific Singapore Airlines 2006 2007 2008 2006 2007 2008 Revenue 45538 50727 38445 11344 12760 13050 Operating Costs -55565 -67619 -94039 10317 11116 12227 Operating Profits 5218 7739 -7461 1027 1644 823 Passenger Revenue per Km 7.2 8.2 9.1 90345 91485 90128 Passenger Numbers(thousand) 2243 2325 2495 1898 1912 1829 Passenger Load factor(%) 78.9 79.8 78.8 79.8 80.3 76.5 Source: Centre for Asia Pacific Aviation (2010) Low Cost Carriers Air Asia Jet Airways 2006 2007 2008 2006 2007 2008 Revenue 1071 1094 2635 74013 95510 117869 Operating Costs 997 858 2966 73499 98941 134216 Operating Profits 86.2 276.7 -869 280 -2531 -4023 Passenger Revenue per miles 6702 5930 13485 4.82 4.4 4.4 Passenger Numbers(thousand) 5719 5197 1180 5432 5234 5432 Passenger Load factor(%) 78 80 85 69.5 69.2 67.7 Source: Centre for Asia Pacific Aviation (2010) Comparing the revenues for the legacy carriers and the low cost carriers in Asia, it can be seen that the legacy carriers face high competition from the low cost carriers as in the other two cases. The operating costs for the legacy carriers are increasing over the period while the revenues are not increasing enough to cope up with the costs. At the same time the revenues of the low cost carriers are increasing over the period. For the legacy carriers, Cathay Pacific faces loss in 2008 while the profits of Singapore Airlines declined significantly. Unlike the other two cases, the low cost carriers examined for Asia also face losses in 2008. From the non financial statistics, it can be seen that the passenger revenues per km of the low cost carriers are higher than the legacy carriers .The number of passengers are also higher in low cost carriers than the legacy carriers. The load factor on an average is also higher in the low cost carriers than in the legacy carriers. The above analysis thus shows that the legacy carriers face downward pricing competitive pressure from low cost carriers .At the same time, the passengers prefer mostly the low cost carriers than the legacy carriers as shown by the analysis above. 6. Discussion and Conclusion In this study the financial and non financial performance of the legacy carriers and low cost carriers in USA, Europe and Asia are compared. The findings show that in all the case the revenues for legacy carriers face high competitive pressures from the low cost carriers. The operating expenses have been increasing significantly in the period of analysis for the legacy carriers while the revenue generating capacities have not been sufficient to cope up with them. In fact the revenues have declined significantly .Most legacy carriers face significant losses in 2008 while the low cost carriers operate profitably except those in Asia. Passenger preferences also favour the low cost carriers. The main advantages for the low cost carriers compared to the legacy carriers include convenient schedules and many facilities that are far above those offered by the legacy carriers. Moreover, the low cast carriers have been able to take advantage of the internet facilities very well than the legacy carriers since the legacy carriers are constrained with the regulations connected with the network and distribution systems. Though the analysis show huge challenges for the legacy carriers in the future, as shown by many studies, the business model of low cost carriers cannot be considered as everlasting. This is because the analysis shows the low cost carriers in Asia not showing significant profits which means that the success of some low cost carriers cannot be considered as the success of the business model as such. The importance of the legacy carriers all over the world cannot be undermined since the travellers can reach anywhere in the world at just one connection .The legacy carriers need to relook at their business strategies and to reduce costs for competing with the low cost carriers and to get back their old reputation. Based on the analysis, it can be recommended that the legacy carriers can survive the present challenges provided they need to relook at their business strategies, marketing techniques and make advantage of the IT facilities to cope up with the low cost carriers. In spite of the challenges, the full service carriers still form an integral part of the air transport system in many countries. Moreover, the success of the low cost carriers cannot be considered as the success of a business model as a whole and may not be everlasting. 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