Opportunities and Barriers for a New Entrant in Low Cost Airline Sector in EU - Research Paper Example

 Market opportunities and barriers for a new entrant in low cost airline sector in European Union Opportunities and Barriers for a New Entrant in Low Cost Airline Sector in EU Introduction The skies of Europe have been progressively deregulated during the last decade and now it has become a level playing field where any entrepreneur can test his entrepreneurial skills in a market that is not only prickling with cutthroat competition but also requires a substantial quantum of investment. This, however, does in no way mean that the ground reality is extremely forbidding. In fact, the market presents such an attractive proposition to prospective investors that during the brief interval of three years between 2005 and 2008; a little more than 400 new routes were added to the European skies. It is not that all those routes were roaring successes but low cost airlines have by and large reaped considerable profits from the deregulated skies. These airlines have tried to fill in a vital gap that was yawning in European Union countries. The distances are never very big in Europe – it is basically a hop if one wanted to go from one city to the other – but the options available were limited. A traveller had the option of buying a train ticket by causing a substantial drain on the wallet (leave aside the limited frequency and inconvenient train timings) or braving the perennially clogged highways or autobahns as the Germans prefer to call them, where one hardly gets the opportunity of having the wind in the hair as it were while constantly paying taxes at the almost ubiquitous toll booths that tend to pop up just when a driver feels the opportunity has finally come to floor the accelerator pedal. The other option, though one would rarely call that an option, was, and is, always there to pay ridiculously high prices that front ranking national aircraft carriers charge for hopping from one city to the other in Europe. The distances being short and consequently flight durations being less than two hours in most of the cases, all the additional frills of sumptuous meals and choicest wines and seats those open up 180° to form perfectly flat beds really did not have much of an attraction to travellers, at least not enough for them to voluntarily loosen their purse strings to pay for these amenities. (reidsguides.com 2006) Thus it was a situation where there was a substantial unfulfilled demand that the current market was unable to satisfy. It is precisely at this point low cost airlines positioned their offering where travellers could avail of the obvious benefits of air travel without spending a fortune for it. These low cost carriers offer no amenities, not even free drinking water in some cases, but they provide the service that brings travellers to airports in the first place. These low cost carriers deliver fast, punctual short-haul air routes at eminently affordable rates. The business model of these low cost airlines will be discussed in detail at a later part of this essay but one thing can be said with a fair degree of certainty that these airlines have made a substantial number of people who never ever thought of availing of air travel take to skies. This has made Europe a very small place where travelling from one corner of the continent to the other has become a normal practice like never before. One of the highly palpable fallouts of this revolution in low cost air travel is that people have now started considering the entire continent as a single country and do not mind owning immovable property in foreign countries. The point that needs to be emphasised is that this was never a new phenomenon among the rich and the famous as most of them owned French villas and Italian chateaus, but less than famous people have also started owning houses in foreign lands thanks to fast, cheap and dependable air travel that is now being provided by low cost airlines. It might not be entirely out of place to mention that at Dordogne, a region south-west of France, a large number of UK citizens have purchased vacation homes, so much so that locals are now referring the area as "the Dordogne-shire". It is surely not a one-way traffic as anyone aware of the tourist flow knows how Spanish golfers escape from the dreary heat of Spain to the cooler and salubrious climes of Wales during the summer months. (Welch 2005) This essay takes a close look at the possibility or otherwise of an entrepreneur breaking into this market with a single route offering. Route to be offered by the new entrant (airports used) Let us assume that a new entrant in low cost airlines market offers a single route from Stansted in London to Hahn in Frankfurt. Keeping in line with the usual practice of low cost airlines, this new entrant will most surely opt for secondary (or even tertiary) airports as these not only have markedly low airport charges but also much less congestion and less waiting time for runways. This obviously leads to faster turnaround times which happen to be a crucial factor in cutting down the cost of operation. But less used airports also have a problem of less than optimum connectivity that many a times puts off a prospective traveller or more importantly, the gains of low cost travel are at times considerably compromised through the irritating hassles and expenses of travel from the remote touchdown location to city centre. As it happens when one takes a Ryanair flight from London to Brussels. Ryanair never uses Zaventem, the main airport of Brussels. It is just ten miles away from the city centre with excellent and continuous connectivity through all hours of the day. Ryanair, however, uses Charleroi airport, also known as Brussels South Airport, which is not less than fifty miles away from the city centre with no direct rail link. Thus a traveller needs to factor in the extra one hour that will be wasted while negotiating towards the city centre from that remote touchdown location and of course the extra expenses of $30 for a round trip from Charleroi to city centre and back. The other factor that needs to be considered is that as these airports are not in the best category the facilities available at these airports are also threadbare and at times it does become a botheration when one needs urgent medical attention on touchdown, just to mention one among numerous emergencies that might befall an air traveller. (Carmichael 2009) The airports chosen by our new entrant however do not suffer from such severe drawbacks. Hahn airport though situated a massive 120 km away from the downtown Frankfurt is well connected through Terravision bus services and it takes around 75 minutes to reach Neu-Isenburg railway station and about 105 minutes to reach Hanau railway station. For those wanting to quickly reach downtown Frankfurt, Terravison drops passengers at S-Bahn Offenbach Kaiserlei stop from where metropolitan service takes less than fifteen minutes to reach city centre. It takes a lot of time to reach the city centre, there is no doubt about that, but this airport is better connected than most of the airports used by these low cost airlines. So, our new entrepreneur will not face any extra resistance from would be passengers on account of inaccessibility of destination airports. (Terravision 2004) Stansted airport being the third busiest airport in the UK has no such problems whatsoever. It is around 50 km away from central London and very well connected through rail and road with the Stansted Airport railway station located just below the terminal building connecting Cambridge, Leicester and the Midlands. Trains for Liverpool Street Station leave every fifteen minutes and takes around an hour to reach the destination. Bus services are equally frequent and they are cheaper too but they take longer to reach than trains. For those that are not in excessive hurry, bus services are a better option as an extra travel of five or ten minutes might work out to a saving of quite a few pound sterling. (BAA Stansted 2009) Thus the new entrant would not have to do much explaining and convincing to its customers as both the airports are frequently used by other low cost carriers and those passengers that frequently use low cost airline services are well aware of the logistics of reaching and departing from these airports. Nature of Traffic Frankfurt being one of the most prominent financial and transportation hubs of Germany always has a steady stream of business visitors especially those headed for the huge industrial fairs that are held throughout the year and seem to be a permanent feature of this metropolis. The traffic increases substantially during the Internationale Automobil-Ausstellung, the world's largest motor show, and the Frankfurter Buchmesse, the world's largest book fair, and Musikmesse world's largest music fair. The famous Johann Wolfgang Goethe University in Frankfurt is also a permanent attraction to the scholarly lot who, as everyone knows most certainly fly by low cost carriers. (Wikipedia 28 April 2009) But Frankfurt is also a city of immense tourist attraction with millions of tourists thronging the city every year. Thus, Frankfurt as a destination will never be short on passengers whether they are businessmen, scholars or simply wide eyed tourists. London, needless to say, is the financial capital of the world and together with New York and Tokyo forms the three most vital command centres of world economy. So, there will never ever be any dearth of passengers between these two very prominent commercial hubs of the world. The demand side of the envisaged project thus shows very healthy signs with no anticipated downswing in near future in spite of the global economic downswing that is affecting all sectors of the economy including low cost airline sector also. Extent of Competition This route being so vibrant it is no wonder that almost all the low cost carriers fly this route and thus there is very stiff competition that the new entrant must endure. But as it is starting with only one route and possibly one or at the most two aircrafts, the number of seats it has on offer are also very less and chances of them going empty becomes remote. The other area where it scores over other more established low cost airlines is that it has to spend very little on fixed overheads in the form of salary of aviation crews and hangar charges which forms a substantial part of the cost structure of other larger competitors. As this route is already a very popular, the new entrant would also not have to spend much on advertising – mere presence at the airports will more often than not result in fully packed flights, especially during the many famous fairs that are held almost every fortnight in Frankfurt. Thus, by simply collecting the leftovers from major competitors, the new airline can very well manage to survive. (Porter, Competitve Advantage 1985) In fact with substantial savings in production overheads and advertisement costs, this new airline might also pass some of these benefits to its passengers in the form of in-flight facilities or, what would be an immensely popular offer of allowing passengers to carry more luggages free of cost. So, this new airline could actually leverage the benefits of being small and instead of trying to blindly copy its more successful and well entrenched competitors start offering some special benefits to its passengers to create a loyal fan club. (Smith 2005) It has been observed that frequent fliers form a close knit community and frequently exchange notes on what these competing low cost airlines have on offer. As it is, all these airlines are so called ‘no frills’ airlines, so passengers would surely not mind shifting their allegiance from one provider to another if they get extra facility in doing so. But all the while the new entrant must never compromise on punctuality and should try to avoid at all costs cancelled flights as that is one issue which genuinely turns away customers. The supply side of the envisaged project thus is crowded with competitors but an intelligent handling of the market dynamics will provide enough leverage to the new entrant to not only survive but also prosper provided other parameters remain favourable to the new enterprise. (McGahan 2004) Commercial prospects for all airlines on this particular route Commercial prospects of an industry can best be judged through a comprehensive analysis based on Porter’s five forces that basically tries to measure the competitive intensity and the consequent attractiveness or otherwise of a particular market. Porter’s analysis of five forces measures the interplay of constantly evolving micro environments in a marketplace that add up to provide a scenario that determines whether an industry has the ability to survive or not. (Porter 1979) There must be a note of caution that needs to be sounded at this point of discussion. Though one can get a general idea about the profitable nature or otherwise of an industry through Porter’s analysis of five forces, the profitability of a particular organisation entirely depends on how efficiently its resources are being utilised by the management and how proactive the management is towards various opportunities and threats that continuously emerge in a dynamic market scenario. A typical example is airlines industry which is generally associated with low rates of return and high gestation periods. But there are particular airline companies, mostly these low cost carriers, which have recorded substantially higher rates of return over industry average and were able to sustain such high rates over prolonged periods till global meltdown started affecting all sectors of world economy. (Grant 2005) A strategic business manager thus has to minutely analyse the following forces in order to maintain strategic advantage over market competition (Hunger and Wheelen 2003): 1. Industry Competition: There is no doubt about the cutthroat competition that is prevalent in low cost airlines sector as is evident from the fact that during 2006 low cost carriers accounted for 81% of all the net additional flights that took to skies in Europe. 2. Potential Entrants: With complete deregulation of European skies almost anybody can enter this market segment but practical requirements of business model require that only an entrepreneur having substantial capital backing can enter this market. Ground reality showed that within a span of one year (from 2005 to 2006) nine new operators operating more than 50 flights per day entered this market. So, there is really no dearth of new entrants that is essentially making the competition more acute. (European Organisation for the Safety of Air Navigation 2007) 3. Suppliers: In the given situation, suppliers of inputs could possibly be the airport authorities that provide the runways and other infrastructure essential for an airline to operate. Though there have been certain roadblocks in increasing operating capacities of airports (like residents around Stansted airport are absolutely determined to resist any further extension of the airport) low cost airlines have by and large been able to negotiate favourable deals from secondary and tertiary airport authorities. In the year 2001, Ryanair received a net incentive of €3.4 million from Charleroi Airport in the form of new route incentives of €1.9 million, marketing support of €2 million and staff and infrastructure support of €1.5 million while it paid €2 million as airport charges and handling fees. Though Ryanair by virtue of its market standing could negotiate such a deal, most low cost carriers are able to obtain favourable treatment from second and third string erstwhile military airports that they use as their nodes. (Dennis 2003) 4. Buyers: Frequent fliers of low cost carriers have very little brand loyalty and are an extremely hard to retain lot of customers. Most of the frequent fliers are business travellers for whom punctuality is of prime importance and as they have very little to choose between rival airlines as far as amenities are concerned, usually do not hesitate to switch airlines. Word of mouth usually is the most potent form of advertisement in this highly competitive market. 5. Substitutes: Though in some cases railway or road transport might be considered as alternatives, they are by no means substitutes in the true sense of the word. The speed at which air travel takes place (even if we factor in remote airports hundred odd km away from city centres) and absence of pollution and hassles associated with road and rail transport really puts air travel in a separate class without any competition from any other alternative means of transportation. Barriers to entry Though there are no legal restrictions for a new player to enter low cost carriers market, one must appreciate there are certain barriers that are very difficult to overcome by an ordinary entrepreneur. (Johnson, Scholes and Whittington 2006): 1. Capital Requirements: Running an airline (even if it is low cost) requires a lot of capital as it requires millions of dollars to hire an aircraft (assuming that hiring would be the first option of a new entrant instead of outright buying of an aircraft) and airline pilots and flight crew will only work if they are paid high salaries. If you add to these, the maintenance expenses of an aircraft, the overheads become really substantial and an entrepreneur must be prepared to wait for at least six months before breaking even. 2. Economies of Scale: It is true without a doubt that higher frequency of flights is an automatic guarantee of higher market share but it is not possible for a new entrant to provide a high frequency of flights right from day one and it must try to make the best use of available space by packing in more seats in each flight. 3. Access to supply or distribution channels: It might require a bit of convincing but airports (in this situation, supplier of inputs) will never refuse access to any new player though they might give concessions to existing big players. 4. Customer Loyalty: There is hardly any customer loyalty as customers search value for money and flock to the provider who can satisfy them. 5. Experience: This is obviously a very important ingredient for success, but in this age of professionalism and outsourcing, it would not be a matter of concern to any player. 6. Expected retaliation from incumbents: Most of these low cost carriers operate on a no frills basis and at rock bottom levels of return, so there is hardly any scope of any form of retaliation in the form of price cuts or provision of extra amenities. Moreover, the route that our new entrant has chosen (London to Frankfurt) is already so overcrowded that there is hardly any scope of operating half empty flights or losing customers to bigger competitors. 7. Legislation or government action likely to affect the new entrant more than the incumbents: European skies have becoming completely deregulated more so after the attempt of regulation by E.U.'s Airline Commission in 2005 horribly went wrong. So, government intervention favouring established players can never be an issue. Conclusion Though there are substantial economic barriers that must be overcome before a new player can enter the market for low cost airline operators, the market itself is a level playing field. If the new entrant can choose a route that guarantees steady flow of passengers and if the management of the new airline company can ensure timely take offs and punctual touch downs with minimum or preferably nil cancellation of flights, there is no reason why the new entrant can survive and indeed prosper in this otherwise tough and unforgiving marketplace. References BAA Stansted. "To and from Stansted Airport." BAA Stansted: Official Airport Website. February 2009. http://www.stanstedairport.com/portal/site/stansted/menuitem.ef438b930a027dd8672fefaf9328c1a0/ (accessed April 28, 2009). Carmichael, Scott. "Budget Travel - The Low Cost Carrier." Gadling: Go there. February 3, 2009. http://www.gadling.com/ (accessed April 28, 2009). Dennis, Nigel. "Boom or Bust: The future of the low-cost airlines in Europe." ETC Proceedings. 2003. http://www.etcproceedings.org/paper/boom-or-bust-the-future-of-low-cost-airlines-in-europe (accessed April 28, 2009). 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