Flying into the Storm: Sustainability of The Airline Sector - Research Paper Example

Flying into the Storm Introduction Back in 2001, Professor Rigas Doganis, the renowned aviation expert, had shown his concern about the low-cost airline sector of Europe by saying, “Whatever else can be said about Europe’s low-cost airline sector, it has rarely been dull” (Doganis, 2001). The doyen had also raised two fundamental questions regarding the sustainability of the players. First, he had asked whether the low-cost carriers are capable of withstanding the turmoil and stay. Secondly, he wanted to know who among the existing players will probably endure the storm and survive in the long run. For a period of more than twelve years, the aviation sector in the European Union (EU) has been completely deregulated. This major breakthrough was materialised through a ministerial agreement that was intended to promote competition on the existing routes. Prior to the agreement, many of these routes were operated by national flag carriers with the effect that new entrants were barred from making a foray. Once the agreement was implemented, operational restrictions were abolished, thereby lowering the entry barriers and permitting new carriers to enter the market. Deregulation brought with it a phenomenal trend as it was observed that most of the new entrants maintained their operating costs as low as possible and offered lower tariff to both business as well as leisure customers. In the recent years, especially between 2005 and 2008, the EU has provided new carriers with business opportunities and as a result more than four hundred new routes were etched across the European skies. Despite all these, the European airline industry has been going through a phase of uncertainty since 2009. As aftershocks of the global recession fuel prices have been fluctuating and moreover the availability of credit has been constricted. Stalwarts like Japan Airlines and the British Airways are still grappled in the woes of financial crisis. Quite obviously, the overall scenario does not quite roll out a red carpet to prospective new entrants. However, the two basic questions that arise are, ‘will this situation be potent enough to create opportunities for the new entrants who venture into the stormy skies?’ and, ‘are the odds stacked so high against the new entrants that they won’t be brave enough to give it a try?’ This research will aim at addressing to the prospects of a new LCC in the London – Copenhagen route while taking into consideration the various demand and supply factors, as well as the overall business environment that prevails in the European airline industry. Most of the aspects related to the operations of LCCs in this particular route will be discussed on the basis of information pertaining to Ryanair, an Irish airline which has flights scheduled on this transnational route. Prospects of Low Cost Airlines Venture: The Demand Factors Market Segments: The low-cost carriers of Europe have exhibited stupendous growth between 2005 and 2008. These four years have been extraordinarily successful for the European low-cost airline sector as almost all the players reaped heavy benefits of deregulation and an increasing demand for economic air-travel. However things have changed substantially since 2009 and it has been observed that the most of the key markets in northern as well as central Europe have become saturated. The low-cost carriers (LCCs) are not being able to generate profitable markets any more. In order to counter the situation and grow continually, the LCCs are required to woo passengers from their competitors. Factors that are found to shape the traffic for LCCs are competition for similar source markets and cost-cutting. It has been observed that in order to augment their market segment, LCCs have to reduce operational costs and at the same time expand more into diverse as well as new markets (Binggeli & Pompeo, 2005). Growth Prospects: Despite the decelerating effects of the recession, LCCs have been expanding their rotes as well as customer bases and as per forecasts by industry experts, their penetration in the lucrative European market may reach up to 25%. Such a figure being quite remarkable, the questions that arise primarily centre on customer satisfaction and sustainability. A January 2002 research by PricewaterhouseCoopers (PwC) indicated that the sector is in a growth phase characterised by healthy trading. It has been found that among the European low-cost markets, the most developed is the UK. It has been projected that the growth prospects for this sector, particularly in Europe, are quite high as the markets offer substantial growth opportunities (Anonymous, n.d.). Though the ability of carriers to generate traffic has been reduced to some extent, a number of new entrants have ventured into the airspace thereby giving their traditional counterparts a considerable competition. The LCCs have been found to perform optimally on the denser routes that do not involve major airports (Dennis, 2007). In terms of growth prospects, Copenhagen is also a promising market for LCCs and it has been projected that operations will be largely profitable in the near future (Due & Partners, 2010, P. 2). Frequency of Usage: Most of the prospects of LCC ventures have been influenced by the deregulation. This being a milestone in the history of the European aviation industry, has a remarkable effect on the usage frequency too. The carriers closely compete with each other within the tight airspace and hence fares have been lowered. This in turn has allowed more people to fly, thereby increasing the frequency of usage as well as load factors. Since most of the destinations are connected through nonstop flights, passengers do not require changing carriers often. Obviously, this has resulted in better coordination and customer satisfaction in terms of air travel (Smith & Cox, n.d.). In order to make use of this trend, new LCCs should operate in routes that have high traffic and at the same time, should try to fly nonstop. As usage frequency as well as load factor ensues from customer satisfaction, the LCCs should strategically price their services to achieve the same. Irregularity in Usage: Owing to certain intrinsic characteristics of the LCCs, some degree of irregularity in terms of usage may be observed. The LCCs differ from the regular carriers in almost every aspect except for the fact that both fly! Hidden costs are generally high and they charge the passengers on an itemised basis. Moreover, unlike regular carriers, LCCs generally charge the full ticket-price for the subsequent flight in case any passenger misses the scheduled fight that he was supposed to board (TheSite.org, n.d.). These factors lead to some degree of customer grievance and in turn make usage often irregular. Prospects of Low Cost Airlines Venture: The Supply Factors Existing Competition: The European Union has “has the most deregulated aviation market in the world; any airline with a valid Air Operators Certificate can operate within the EU at market-determined prices” (Loughnane, 2005, P. 130). As a result any carrier that has an official Air Operators Certificate is allowed to operate at prices that are determined by the aviation market. Entry barriers have been lowered and there has also been an introduction of price competition in this market. It has been observed that price-competition is remarkably low and hence “the low cost carriers are now having to look at other ways of increasing revenue, for example, charging for checked in baggage, selling travel insurances, claiming fuel surcharges and claiming for unrealistic added charges for purchasing tickets on line with credit cards – all just to keep a margin at the end of the day” (Due & Partners, 2010, P. 1). These factors along with the fact that inter-carrier collusion (cartelisation, etc.) has been substantially prohibited have made deregulation highly successful in the European context. In the recent years there has been remarkable increase in number of passengers that avail air-travel and fares have fallen to add fillip to the growth of this sector. Though this is perceived to be a contestable market, “incumbent airlines continue to dominate hub-airports and this restricts the ability of new entrants to enter into these markets” (Loughnane, 2005, P. 131). Unfair competition exists in the forms of monopolistic ground handling, predatory pricing and slot allocation. Moreover, mergers as well as instances of cartelisation also accentuate competition and impede new entrants from penetrate the market space. Infrastructure of the Airports: European airports have developed into full fledged businesses that have fairly complex infrastructure as well as product diversity. In order to maintain infrastructural excellence these airports strive to align their operations with consistent transfer processes. Computer reservation systems (CRS) add to the competitive edge of the airports as well as that of the carriers. Another important aspect of infrastructure is ample runway capacity coupled with terminal infrastructure that helps in guaranteeing shorter transfer times. It has been pointed out that European airports should proactively plan out infrastructure strategies “to cope with the expected passenger and cargo traffic demand of the next 20 years” (Schulte, 2009, P. 3-7). Capacity of the Airports: It has been observed that currently the capacities as most of the European airports, including the likes of London-Heathrow and Frankfurt – both of which are major hub-airports – are largely insufficient. It has been forecasted that these airports will not be able to meet the demand – in terms of both passenger as well as cargo – in the near future. A lot of secondary/ regional airports have also been facing an incremental demand for both domestic as well as overseas point-to-point traffic. Owing to the rising demands, it has been suggested that European airports should augment their capacities as well as infrastructure in order to ensure sustenance. These activities have to be prioritised because it has been projected that “Unless capacity can keep pace with this traffic growth, passengers, airports and airlines across Europe will suffer from congestion, delays and service reductions” (Schulte, 2009, P. 3-4). Surface Access to the Airports: This is generally taken care of through roads as well as railways. In the context of London as well as Copenhagen, the cities have an extensive network of motorways as well as roads that provide connectivity to the airports. In the UK, the county councils ensure that the airports are served by the local roads. Private companies provide rail services to the airports. Apart from these, there are express coaches as well as local buses connect the airports with the various towns (Jones, 2004). Copenhagen too has an efficient surface transport system which has realised the rising popularity of low cost airlines and as a result, “the surface transport operators adapt their schedules to fit in with the LCC flights” (Morell, 2003, P. 2). Analysis of Business Environment: Porter’s Five Forces Analysis Industry Competitors: The European aviation industry is geographically fragmented to give rise to regional networks. The market is dotted with numerous small carriers that operate from their individual hubs and thus, they have trivial network scope as well as depth. Moreover, these carriers do not have much of online competition too. “Despite the documented need for consolidation, the number of European carriers has grown in recent years” (Whitaker, 2003, P. 4-5), thereby resulting in a market scenario wherein there are numerous airlines and a proportionally large number of hubs. Due to these reasons competition has been intensified. Factors that have contributed to the close competition are pricing, airport slots, in-flight service, frequencies, etc. (Wang, 2007, P. 107). Potential Entrants: Thanks to deregulation, new entrants can easily make foray into the contestable airline sector of the European Union. The primary reasons behind the market being contestable are lack of stringent monopoly and trivial sunk costs (Wang, 2007, P. 107). Again the sunk costs comprise mainly the expenses incurred in the forms of aircrafts – either leasing or purchasing, and advertising. However, when advertising costs are significantly high – especially during launch of new services, sunk costs become quite obvious. Bargaining Power of Suppliers: Suppliers may be considered as a potential threat as long as their products do not have many substitutes and are essential for the viability of a company. In the context of the airline industry aviation fuel, which is among the major operating costs, does not have any substitute and hence fuel suppliers exercise substantial control over airline operations. Aircraft manufacturers are also significant suppliers in this contestable industry (Wang, 2007, P. 107). Maintaining good terms with these suppliers, who by themselves are powerful organisations, is extremely necessary in order to avoid any cartelisation among them. Owing to the fact that their products practically do not have substitutes, they may dictate unfavourable prices to stifle the operations. Bargaining Power of Buyers: Customers of the airline industry are generally not perceived as a potential threat as they cannot exert significant individual influence. However, they may pose competitive threat to some extent when their demands for quality as well as services become higher. The European airline industry, following deregulation, has become increasingly contestable with competition mainly focussing on product differentiation. Under such circumstances, the carriers may reduce this particular threat by having a comprehensive knowledge of customers’ expectations and catering to the same through specific products. These will enable them to “realize the ultimate objective of maximizing revenue and profits in the long run” (Wang, 2007, P. 107). Threat of Substitutes: The airline industry does not have many a substitute. Though one may think of substituting it with sea-travel and land transportation, these are obviously inconvenient as well as time consuming. Moreover, competitive pricing strategies have lowered the tariff considerably thereby making air-travel quite affordable for nearly all income groups. However, one potent threat that this industry has been facing lately is that people, frightened due to worldwide terrorist activities as well as political unrest, are giving preference to alternatives such as domestic holidays (Wang, 2007, P. 107). Analysis of Business Environment: Potential Entry Barriers Economies of Scale: LCCs such as Ryanair skim the European airline market by virtue of their economies of scale that they have achieved through various cost-cutting tactics (Dhalla, n.d.). Each of these players generally employ just one fleet of aircrafts and thus achieve economies of scale with respect to training and scheduling of crews, maintenance, etc. they often violate safety norms and purchase second hand aircrafts in order to minimise capital expenses. In this context, it is justifiable to suggest that the players should instead buy new aircrafts to reduce recurrent maintenance costs. These carriers also use point-to-point and secondary airports that again help in keeping their operational costs quite low. Economies of scale are further achieved by eliminating conventional in-flight services. Capital Requirements: Owing to their scales of operations, the capital investments of airline industry are usually quite high. Huge volumes of capital are required in order to commission aircrafts in an adequate number and to simultaneously acquire maintenance facilities. However, it has been observed that with the introduction of aircraft leasing schemes, and other allied schemes for MRO (maintenance, repair and overhaul), as well as aircraft parts, new entrants are being able to take off even with smaller capitals (Geiger, Schlottke & Schrade, n.d., P. 3-4). Access to Supply or Distribution Channels: This is an important factor that may pose a potential entry barrier to prospective entrants. Generally, the players develop easy access to supply as well as distribution channels over time as these require a lot of understanding about market dynamics, inter-organisational politics and politico-legal power plays. It is quite obvious that carriers having easier access to supply and distribution channels enjoy certain advantages which may be in the forms of preferential pricing, etc. These factors play a vital role in giving cold shoulders to the new entrants. Differentiation by Existing Players: The existing carriers in the European airline industry have already undergone substantial product differentiation to cater to the differential needs of various customer groups and in order to gain competitive advantage. Cost advantages as well as innovative ideas in support of enhanced operations can be easily copied by rivals. Moreover, the sales are driven largely by a low tariff and hence soft factors such as service quality take a backseat (Geiger, Schlottke & Schrade, n.d., P. 4). The new entrants shall have to take these into consideration while designing their marketing strategies. Experience: Industrial experience is extremely valuable for any organisation and when it comes to the LCCs it plays an equally vital role in shaping their course of operations. It might be a possibility that the prospective new entrants might lack relevant experience and making use of this major drawback the experienced players may corner them and even throw them out from the industry. Lack of experience may even prevent the new entrants from making a successful foray into the market space of the airline industry. Experience also determines the access of the players to supply and distribution channels and enables them to understand the industrial undercurrents. New entrants, by virtue of lacking this important factor, may be obliterated altogether. Expected Retaliation from Incumbents: The European airline market is characterised by a phenomenal breakneck competition. Hence it is quite common for the incumbents to retaliate the entry by new players into it. In the European context where deregulation has lowered the entry barriers, incumbents may retaliate through cartelisation and other offensive strategies such as blocking the airport slots. By virtue of their prolonged existence in the market they enjoy considerable degrees of command over the suppliers and distributors, and even the customer base. Hence, they may stiffen the entry barriers by manipulating any of these factors against the interests of new entrants. Legislation or Government Action: This is a situational factor that may be revised as per the circumstantial requirements of any particular nation. However, it is a potent threat for the new entrants and may act as a strong entry barrier. As a matter of fact, deregulation of the European airline industry was a dynamic action that was taken by the council of ministers (Doganis, 2002, P. 51). Though this step was lauded internationally as it had opened the doors to new carriers and helped reduce tariff through increased competition, it was also observed that the same council had refused to take a vital step “that would have taken aviation liberalization to an entirely new level” (Shane, 2004, P. 4). Conclusion It has been observed through the course of this research that the European airline market is crowded with numerous low-cost carriers that provide services both within national boundaries as well as across national borders. However, this industry is found to be geographically fragmented which in turn has given rise to regional networks. Following deregulation of this sector in the 1990s, entry barriers have been substantially lowered and levels of inter-carrier competition have also increased remarkably. The LCCs thrive on low ticket-price which is their strategic mainstay and they continually try to achieve economies of scale by reducing operational costs. In order to achieve this, the LCCs cut down on the additional benefits that are provided as complimentary services by conventional carriers, and some of them even go to the extent of violating safety norms and procure second hand aircrafts. Operational details apart, the LCCs have successfully established a trend in the area of air-travel and have also achieved milestones that the conventional carriers couldn’t. They have been successful in maximising usage frequency as well as the load factor and thus have enjoyed popularity as well as considerable market share. Though the industry exhibits symptoms of offensive undercurrents in the forms of monopolistic attempts and blockage of airport slots, new entrants have reasonable chances to make successful forays into this sector, provided they pay due importance to the highly volatile business environment. 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