The Low-Cost Airline Model - Coursework Example

Portfolio which summarises findings for specific case study-based tasks and critically analyses current data and information that relates to rapidly changing market and competitive conditions Table of contents Topic 4: Real world demand and supply factors influencing oil prices Oil price determinants are complex. However, as it is with other commodities, the demand and supply of oil in the world has a significant effect on the prices. In the supply end, the Organisation of Petroleum Exporting Countries (OPEC) acts as the main price swinger. OPEC member countries can deliberately decrease or increase oil production and supplies to influence the price of oil in the world market (World Bank 2015, p. 157). Demand also has a significant effect on the oil prices. As would be expected, a high demand against limited supply would lead to increased prices and vice versa. In the recent past for example, Sill (2007, p. 22) indicates that the supply of oil has been higher than had been anticipated, while the demand has also been lower than was projected. Combined, the high supply and the low demand have led to low oil prices. One of the contributors of increased oil supplies was the shale oil production in the US, which in 2014, accounted for an estimated one percent of the global oil supply. Slow economic growth on the global front has also led to reduced oil demands in the same way as increased energy efficiencies, which result in oil users getting greater value from the same amount of oil compared to several years ago. The World Bank (2015, p. 158) indicates that macroeconomic factors affect oil prices in three main ways. They include slow economic activity, real income shifts, and fiscal and monetary policies. During and after the 2008/2009 economic crisis, most global economies slowed. Because oil acts as feedstock in different sectors of the economy, the slow economic activity meant that the demand for oil declined. Deloitte (2012, p. 3) specifically indicates that the global economic activity affects the demand for oil globally. Intense economic activity translates to a higher demand for oil, which theoretically leads to oil price increases, especially when supply is limited. Real income shifts have an indirect effect on the price of oil. Real income is adjusted for inflation, hence meaning that unless there are income increments in an economy, people in an economy where inflation is high will most likely spend less on consumer items (including oil). If the same money they earned a year before buys fewer commodities in the present, the demand of such commodities (including oil) declines. As would be expected, low demand would have a negative effect on prices, especially if the inflationary pressure is felt in the large oil-consuming countries. Fiscal and monetary policies have also been indicated as having an effect on the price of oil (World Bank 2015, p. 159). Monetary policies meant to reduce inflation by supporting growth can for example lead to increased activity, and subsequently a high demand of oil. Consequently, a high oil demand would push the prices up especially in the face of limited supply. Contractionary fiscal measures meant to reduce the money in an economy with the intention of controlling inflation may have the opposite effect on oil prices. Specifically, such contractionary measures would lead to less demand for oil, hence leading to a lowering of prices as illustrated in the figure below. The contractionary fiscal measure is meant to reduce demand for commodities (including oil) from AD1 to AD2. As a result, the price level shifts from P1 to P2. Figure 1: Contractionary fiscal measures The effect of oil prices and costs in road/rail/transport Almost all vehicles in the transport sector are fuelled by oil products. Changes in the prices of oil therefore have an impact on the cost of the entire transport system, because naturally, it is expected that the cost of transport would rise with an increase in the price of oil. As Ecorys Transport Consultrans (2006, p. 24) notes, oil prices affects the price of oil, which in turn affects transport costs. The prices of diesel and petrol (the two main fuels used in the transport system) have been found to have similar price movements as crude oil. However, as Ecorys Transport Consultrans (2006, p. 25) notes, oil price is not the only factor that affects the cost of fuels used in transport. The fuel marketers mainly factor in the price of crude oil when pricing diesel or petrol, but also consider the exchange rate, taxes levied by governments on oil products, and as would be expected, they also factor in a profit margin. In a study conducted in Europe by Ecorys Transport Consultrans (2006, p. 28), it was found out that crude oil price increases only accounted for 25-60 percent of transport cost increases. Beyond the 60 percent mark, oil companies choose to reduce the profit margins in order to make the fuels used in the transport system affordable to consumers. In the research, Slovenia was found to be the country whose fuel prices were most affected by crude oil prices because 29 percent of the fuel price was linked to the cost of crude oil. Thirty two percent of Slovenia’s fuel price, for example, was related to labour costs, while 24 percent was related to interest. A further 11 percent was related maintenance, while four percent of the fuel cost was related to insurance costs (“Transport in Cijfers” 2004, p. 34). In the United States, the situation is a bit different compared to Europe. Transport Economic & Management Systems (TEMS) (2008, p. 5) notes that between 2002 and 2008, crude oil prices rose from $20 a barrel to $140. The increases led to an increase of more than 50 percent of the operating costs in the transport industry up from an estimated 20 percent. Transport costs were on the other hand found to have risen by almost 100 percent in the same period, thus indicating that unlike Europe, more impact has been felt in the US as a result of the crude oil price hike. TEMS (2008, p. 5) argues that in the US, a dollar worth of increase in the price of crude oil almost always leads to about one percent increase in transport costs as reflected in the graph below. From the graph, it is evident that the cost implication is felt more in ocean transport than in land transport. Figure 2: The price of transporting goods on sea and land relative to different crude oil prices. Topic 5: The low-cost airline model A brief outline and evaluation of the low-cost airline model There is arguably no single airline model that can define how low-cost airlines (LCAs) operate. According to Mason (2008, p. 7), some LCAs use a network avoiders model where they target operating in smaller cities compared to network carriers, use smaller airports, fly daily to specific destinations, and avoid competing with the network carriers. Examples of LCAs that adopt such a model in Europe include Ryanair and FlyBe. A different model is characterised by airlines that opt to fly to larger cities, use primary airports, fly up to four times (including to and from a destination) and compete with the main network carriers. The latter model has been labelled the network supplanters and includes such airlines as Air Berlin and EasyJet. Beyond the foregoing differentiation in the LCA models, several factors are applicable to both categories. According to Mason (2008, p. 5), the LCA business model is designed to contain no unnecessary costs, to enhance the utilisation of an airline’s assets, and not to charge customers for non-flight items such as meals. The business model is premised on a simple low fares strategy, which gives the LCAs a competitive edge over the network carriers. Moreover, the LCAs fly from one point to another, hence avoiding connections or interlining. For this to happen, Mason (2008, p. 6) notes that the LCAs fly over short hauls. The short flying distances makes it easier for them to utilise their aircrafts optimally, and also makes the low comfort inside the aircraft acceptable to passengers. Moreover, flying short hauls provides LCAs opportunities to save costs through labour productivity and aircraft utilisation. Grunewald (2008, p. 10) has however noted that LCAs have taken up medium-hauls in response to demands by costumers and as competition in the short-haul routes stiffened. Elements of the economic production function of an LCA Capital Although it is hard to quantify the exact amount of capital that Ryanair invested in the LCA business, it is rather obvious that the cost may have amounted to millions of pounds. As Ryanair (2015b) implies in its website, the money went into purchasing the first aircraft (a 15-seater Bandeirante), getting the needful license, marketing, and employing the first 25 staff members who worked for the company. The airline’s share capital at the time (1985) was just £1 (Ryanair 2015b). Further capital investment would be used in subsequent years to acquire more aircrafts, aircraft maintenance and to employ more staff to handle the increasing passenger numbers. In 1990, the Ryan family, who were the main investors, had to invest a further £20 million due to poor business outcomes brought about by increased competition and low customer numbers. Labour When Ryanair first started in 1985, it had 25 people to handle all aspects of the business (Ryanair 2015b). With time, however, the labour force in the LCA increased as it gained a larger fleet and as it gained more passenger numbers. In 2013, for example, the airline had 9,500 staff members who were responsible for handling the 81,668,225 passengers that used their services that year. The 2013 employee numbers had increased by 363 from the previous year (2012) when the passenger numbers were 79,325,820. Land In the airline industry, land is used in reference to all natural resources that an airline may require. Usually, natural resources are nature’s gift to mankind, but that does not mean that Ryanair does not pay for using the land where it lands and keeps its fleet. Airspace is free for use, but airports, which have been developed by individual countries, have to be paid for. According to Ryanair (2015a), the airline has 74 bases for its flights and flies to 185 destinations. Arguably, the land-related charges in Ryanair’s economic production mainly relate to the destination it flies to and the 74 bases that it uses for its aircraft. Entrepreneurship As a factor of production, entrepreneurship refers not to only the initiative to start a business, but the creativity, foresight, and strategic thoughts that makes the company running and profitable (Rae 2007, p. 209). The management at Ryanair has shown entrepreneurship by the business decisions they have made over the years, including growing their fleet size, employing more people, increasing their destinations and attracting more passengers (Rae 2007, p. 209). As a result, the airline’s profitability has increased. Technology Ryanair has invested in technology to boost its business. In 2015 for example, the company launched a smartwatch that would make it easier for its customers to access flight schedules (Paris 2015). Another investment in technology led to the establishment of 160 kiosks that utilise a chip and pin to ease passenger booking and arrival (IBM 100 2011). The airline also started utilising its website for online bookings in 2000, at a time when the concept was not widely embraced by both its competitors and passengers (Kennedy 2015). SWOT analysis for Ryanair Strengths A strong brand which is renowned for affordable airfare. A relatively new fleet, which the company keeps updating as time goes by. Flies to many destinations (185 so far) with prospects of expanding to others in future. High labour productivity, hence meaning that all units of production are optimised and the airline has the lowest cost base (Centre for Aviation 2013). Weaknesses Like other airlines, Ryanair’s earnings are seasonal based on high travel months (July to September). The frequency of travel by Ryanair is low compared to its competitors Its reliance on secondary airport has in the past deterred some of its potential passengers. Low brand perception, especially since it is regarded as an uncaring and business-minded airline. Opportunities The airline is expected to grow in the future and as a market leader, Ryanair will most likely get a share of the growth. A strong company, Ryanair will probably get good deals for new aircrafts it will purchase hence enabling it lower its unit costs. The deal between Manchester Airport Group and Stansted Airport could be beneficial to Ryanair which cut capacity in 2007 owing to increased airport charges at Stansted Airport. Threats The political climate in the EU might limit the airline’s operations in future especially since the airline CEO has indicated that the airline is being unfairly targeted by the EU (Centre for Aviation 2013). Geopolitical events could threaten the airline’s operations. An increase in airport charges could risk Ryanair’s profitability. The volatile nature of jet fuel and the unstable exchange rates. Topic 6: Price and non-price competition in oligopoly markets Issues related to price and non-price competition in oligopoly markets In oligopoly markets, market players (oligopolists) are interdependent. A price increase by one oligopolist most likely affects the sales of other market players (Sagi 2007, p. 4). Therefore, to compete in an oligopolistic market, each market player needs to understand the strategy that its rivals are using. Yet, it is not always clear what the rivals are doing. As Sagi (2007, p. 4) indicates, rivals’ actions are often shrouded by uncertainty, thus making it hard for one firm to have clarity about the product/service and marketing strategies used by another company. To understand how prices are set in an oligopoly, Scherer and Ross (1990, p. 45) indicates that price-based competition often varies between oligopolistic markets. Despite the differences in markets, Sagi (2007, p.5) notes that oligopolistic firms are faced with issues resembling a contest. Specifically, the competitive strategy that a firm chooses has to have the ability to maximise profits. The firm must therefore consider the strategies adopted by other rival firms. Sagi (2007, p. 7) notes that the profitability of one firm depends on the value that rival firms are offering customers. The rival is gauged based on the price, quality and quantity of the product/service. Notably, price-based competition in an oligopoly encounters the “prisoners’ dilemma game” theory, where when they are starting off, each market player prices their products independently, often using the competitors’ prices as a benchmark. Independent pricing is a non-cooperative and static approach, which might lead to price wars as each market player try to outdo the rest. The paradox in the “prisoners’ dilemma” theory however suggests that all market players would be better off if they agree to cooperate. In other words, the players would cooperate in their pricing for purposes of ensuring that each one attains profitability. Such cooperation is maintained until one market player deviates, leading to other firms setting their prices or non-price elements (output quality) at a competitive level. The game theory also highlights some of the issues related to price and non-price competition in oligopoly markets. Game theory implies that games are regulated by rules, contain payoffs and are characterised by strategies. In an oligopolistic market, the rules would govern how the firms operating in the market would conduct themselves. The payoff would be an indication of whether some win or lose or all firms will draw. The strategies adopted by firms collectively or individually influence how pricing and product or service decisions are made. Specifically, the strategies influence decisions regarding the raising, lowering or holding the prices. The strategies also affect the decisions regarding whether to develop new products or keep existing ones. Moreover, players in an oligopolistic market make decisions on whether to spend more or less on advertising or whether to retain the current advertising expenditure. The payoffs, depending on the strategies and decisions that firms make, could lead to enhanced competitiveness as evident from improved profits, greater market share, enhanced likelihood of surviving in the market, and ultimately, beating rival firms. Green and Porter (1984, p. 87) observe that firms usually try setting prices that match for similar products in the market. However, should there be a decline below a specific level, firms rely on producing goods that will provide them with maximum profits when sold at a specific price. Other firms would however choose to undercut their rival’s prices, as long as the prices they sell their products at are higher than the costs of producing the same (Sagi 2007, p. 5). The roles and importance of price and non-price competition strategies in mobile telecommunications in a national market The telecommunications sector is interesting because of the interconnectivity requirement, which means that customers in one mobile network provider may (and will) need to call customers using a competing network provider (Chakravarty 2006, p.2). Since network providers cannot always agree on how best to enhance connectivity, Amstrong (1997, p. 65) indicates that most governments have traditionally acted as a regulator which ensures that interoperability between different network providers is observed. Basing his writing on an Asian perspective, Chakravaty (2006, p. 3) observes that regulators also cap the price that network providers charge customers. To compete effectively, therefore, the telecom companies in the Asian continent lower their prices below the set prices, often benchmarking their prices against each other. The effect of such kind of pricing is that customers are able to access telecommunication services cheaply (Gupta 2011, p. 23). Price-based competition does not however seem to give any of the telecom companies a major competitive edge over the rivals. Resultantly, the firms use non-price competition strategies that include better services and promotions. Two real world companies as an illustration of price and non-price competition strategies and their outcomes In the East African country of Kenya, the telecoms industry has several players namely: Safaricom, Airtel, Orange and Essar (Njuguna 2012, p. 4). The most dominant players are Safaricom and Airtel. The price and non-price competition strategies of the two companies include price wars between the two. While Safaricom has the largest market share between the two – 65.3% compared to Airtel’s 15.3%, the latter wages more price wars by lowering its calling rates (Njuguna 2012, p. 11). There seems to be some unwritten rules among Kenyan telecoms to maintain the calling rates at below four Kenya Shillings (approximately $0.04) per minutes. While Safaricom charges about $0.02 for calls within its network and $0.04 for calls made outside its network, airtel charges its customer $0.02 for all calls regardless of internetwork connectivity. The effect of the foregoing strategy is that consumers in the East African country have are able to access cheaper calling rates. Non-price competitive strategies include development in networks made by the two operators. In the early 2000s, Airtel invested in good telecommunications infrastructure hence assuring its customers seamless connectivity. The effect of such non-pricing competitive strategies was that Airtel won over consumers who were interested in quality communication as opposed to cheap communication (Sande 2014, p. 23). Afraid of losing market share, Safaricom worked on improving its network infrastructure too (Njuguna 2012, p. 20). Resultantly, consumers of mobile telephony services in Kenya now enjoy better mobile services. In the same period, Safaricom came up with a mobile money innovation dubbed as M-PESA (mobile money), loyalty scheme named Bonga points and has had a more vibrant corporate social responsibility approach among other innovations that endeared it to consumers (Njuguna (2012, p. 6). While Airtel’s call rates are relatively cheaper compared to Safaricom’s, it is the non-price competitive strategies in the latter that has made it a market leader in Kenya. References “Transport in Cijfers” 2004, viewed 19 November 2015, . Deloitte 2012, ‘The UK market review: crude oil’, RAC Foundation Fact Sheet, pp. 1-8. Ecorys Transport Consultrans 2006, ‘Analysis of the impact of oil prices on the socio-economic situation in the transport sector’, European Commission, DG TREN- Final Report, Nederland BV, pp. 1-123. Sill, K 2007, ‘The macroeconomics of oil shocks’, Business Review, no. 1, pp. 21-31. Transport Economic & Management Systems (TEMS) 2008, ‘Impact of high oil prices in freight transportation: modal shift potential in five corridors’, Maritime Administration, US Department of Transportation, Technical Report, pp. 1-53. World Bank 2015, Global economic prospects, January 2015: having fiscal space and using it, World Bank Publications, Washington, DC. Centre for Aviation 2013, Ryanair SWOT analysis – Michael O’Leary maniacal focus on being the lowest cost producer, viewed 19 November 2015, . Grunewald, E 2008, Analyses of the European air transport market: airline business models, German Aerospace Center (Dduetches Zentrum fur Luft- and Raumfahrt –DLR) Air Transport and Airport Research, pp. 1-41. IBM 100 2011, IBM helps Ryanair develop ground-breaking kiosk technology, viewed 19 November 2015, . Kennedy, J 2015, John Beckett, entrepreneur who built the first Ryanair website, Silicon Republic, 11 April, viewed 19 November 2015, . Mason, K 2008, The challenge of low-cost airlines, Air transport Management Seminar, Cranfield University, 7th-11th January, Lisbon. Paris, N 2015, ‘Ryanair to woo passengers with smartwatch technology’, Telegraph Travel, viewed 19 November 2015, . Rae, D 2007, Entrepreneurship: from opportunity to action, Basingstoke, Hampshire, Palgrave Macmillan. Ryanair 2015a, About us, viewed 19 November 2015, . Ryanair 2015b, History of Ryanair, viewed 19 November 2015, . Amstrong, M 1997, ‘Competition in telecommunications’, Oxford Review of Economic Policy, vol. 13, pp. 64-82. Chakravarty, S 2006, ‘Determinants of cellular competition in Asia’, IIMA Working Papers, no. WP2005-06-01, pp. 1-31. Green, EJ & Porter RH 1984, ‘Noncooperative collusion under imperfect price information’, Econometrica, vol. 52, no. 1, pp. 87-100. Gupta, S 2011, ‘Cellular mobile in India: competition and policy’, Working Paper, no. 353, pp. 1-28. Njuguna, VW 2012, Competitive strategies adopted by Safaricom Kenya Limited to tackle competition, unpublished thesis, University of Nairobi, Nairobi. Sagi, G 2007, ‘The oligopolistic pricing problems – a suggested price freeze remedy’, Columbia Business Law review, vol. 269, no. 2, viewed 20 November 2015, . Sande, AE 2014, Competitive strategies adopted by Airtel Kenya, Unpublished Thesis University of Nairobi, Nairobi. Scherer, FM & Ross, D 1990, Industrial market structure and economic performance, 3rd ed., SAGE, London. Read More