Long-haul Low-cost Airline Operations

Long-‐haul Low-‐cost Airline Operations

Airline Operations Coursework

Simon Riha, student # EAC0212171

Cohort 13, Aviation Management

Emirates Aviation College

November 14, 2012

EAC AO Long-‐haul Low-‐cost Airline Operations Simon Riha

November 14, 2012 2

Table of Contents

INTRODUCTION 3

HISTORY OF FAILURE 4

SKYTRAIN BY LAKER AIRWAYS 4 PEOPLE EXPRESS AIRLINES (PEOPLEXPRESS) 5 OASIS HONG KONG AIRLINES 7 LESSONS LEARNT FROM HISTORY OF FAILURE 8

SUCCESS FACTORS FOR THE LONG-‐HAUL LOW-‐COST AIRLINE BLUEPRINT 10

FACTOR A: EXTERNAL ENVIRONMENT AND COMPETITION 10 FACTOR B: AIRLINE GROWTH AND FINANCIAL MANAGEMENT 12 FACTOR C: AIRCRAFT CHOICE IMPORTANCE 13 FACTOR D: DESTINATION CHOICE IMPORTANCE 15

CONCLUSION 17

REFERENCE LIST 19


November 14, 2012 3

Introduction

Several airlines, such as Air Asia X and Jetstar, have been trying to implement the

popular short-‐haul low-‐cost model to stretched routes. Whether this model can

work usually provokes hot debates.

"The [long-‐haul] business structure has an unproven track record, whereas

short-‐haul has been successful," says Mark Webb, aviation analyst for HSBC in

Hong Kong. (Syed, 2011) Webb opinions that cost savings applicable for short-‐

haul routes are hardly applicable for longer distances. For example, long-‐haul

flights do not benefit from high frequencies. Thus, costs cannot be easily spread

out over many flights.

Others say there are enough travelers willing to fly with no frills on between five

and eight hours long. "[From Singapore] to Tokyo, Beijing, Shanghai and many

destination in India, that will work," says Leithen Francis, Asia editor for

Aviation Week. (Syed, 2011)

This paper first studies three failed pioneers of long-‐haul low-‐cost airlines, which

marked the aviation history, in order to uncover the history of failure. Based on

the history of failure, the paper detects and investigates four principal factors,

which foremost impacted airlines’ fiascos.

This paper’s goal is to contribute to setting a blueprint for a successful long-‐haul

low-‐cost model. If future ventures avoid the past mistakes and develop right

strategies to master the four failure factors, their success probability is likely to

be significantly higher.


November 14, 2012 4

History of Failure

Machiaveli stated: “Whoever wishes to foresee the future must consult the past;

for human events ever resemble those of preceding times. This arises from the

fact that they are produced by men who ever have been, and ever shall be,

animated by the same passions, and thus they necessarily have the same results.”

Applying Machiaveli’s wisdom on the long-‐haul low-‐cost airlines (LHLC), it

makes sense to analyze their history in order to identify the reasons of their

failures. This will help determine the success factors for a blueprint of next

similar future ventures.

This chapter describes three failed LHLC pioners from three different continents.

The very first low-‐fare air scheduled service pioneering the LHLC airline concept

was so called “Skytrain” launched by Laker Airways in the 1970s.

Skytrain by Laker Airways

Sir Frederick Alfred Laker, a British airline entrepreneur, formed his most

remarkable airline venture, Laker Airways, in 1966. Laker Airways was

considered to be the most profitable and the best–run charter airline in UK of its

days. Laker Airways was highly innovative and cost conscious. It developed cost-‐

saving ‘reduced thrust takeoff technique’, faster climbs and weight saving

measures to increase aircraft flight range. (Wikipedia, 2012)

However, the unique and fundamental innovation was an idea of Skytrain. He

designed Skytrain as a low-‐fare scheduled service between London Gatwick and

New York slashing airfares by two thirds compared to the fares offered by

established legacy carriers. Laker’s concept was an operation like a railway.

Tickets were sold directly at the airport for the flight departing on the day

without any reservations on a ‘first come, first served’ basis. Passengers bought

their own food, and low fares came through, cutting out the frills. Skytrain was to

concentrate on London and New York, using only brand-‐new cost-‐efficient DC-‐10


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aircraft with 345 seats, operating enormous 3270 hours p.a. per aircraft and

assumed 10-‐year depreciation was to result in a very competitive 60% break-‐

even load factor. (Ramsden, 1972)

It took 7 years (1971–77) to obtain all the governmental permissions. Skytrain

first departed on September 26, 1977 and quickly achieved load factors over

80% in the first five months of operations with the gross profit of £869,000 on

revenues of £4.9 million. (Flight International, 1978)

Based on its initial massive success, Skytrain expanded by adding frequencies,

new routes and aircraft. It asked for permission to fly to Los Angeles at the end of

1977 and ordered additional seven aircraft for $80 million. (Flight International,

1977) By summer 1981, Skytrain also flew to Miami and Tampa and carried over

two million passengers since the service commenced. Furthermore, Skytrain was

thinking of flying to Australia, Hong Kong, Chicago, Detroit, San Francisco, Seattle

and Washington DC and of creating a pan-‐European network of 666 Skytrain

routes, for which it initially ordered ten more aircraft. (Wikipedia, 2012)

Such significant success and expansion plans did not leave Skytrain’s major

competitors, such as British Airways, British Caledonian, PanAm, TWA, without

attention. Legacy carriers held secret meetings to close Skytrain down. They

undercut their fares (PanAm by 66% at one point) when utilizing a difficult

economic situation in 1981-‐82 with rising oil prices, recession and a falling

pound. Though Skytrain was always profitable, it was undercapitalized, with

only a few valuable assets, and with a significant bank overdraft. Skytrain ran out

of money and went bankrupt on February 5, 1982 owing over £250 million.

(Annoh, 2006)

People Express Airlines (PEOPLExpress)

PEOPLExpress was a venture to operate LHLC scheduled flights out of USA in

1981–87. The airline successively commenced flights from Newark to Buffalo,

Columbus, Norfolk, Florida, London Gatwick, Montreal and Brussels.


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PEOPLExpress turned out to be an instant success with all flights sold out for

several months within 24 hours of being offered. Its concept was simple – using a

simplified fare structure and modest pricing. Fares were paid in cash aboard

before the flight. PEOPLExpress pioneered to charge checked-‐in baggage by

imposing a fee of $3 a piece. The airline sold simple catering for affordable

prices, too.

Being extremely successful, PEOPLExpress purchased Frontier Airlines, Britt

Airways and Provincetown-‐Boston Airlines in the mid eighties. Thus,

PEOPLExpress quickly became the fifth largest US carrier with flights to most

major US cities. However, these aggressive purchases imposed an enormous debt

burden on the airline. Integration of the purchased airlines into PEOPLExpress’s

existing structures was failing. It caused labor struggles. The change to a low-‐

fare, no-‐frills mentality was alienating both acquired airlines’ staff and their

passengers. Last but not least, major legacy carriers managed to quickly improve

their yield and fare management schemes to better compete with PEOPLExpress

on fares.

The above pressures forced the carrier to change its philosophy. To boost its

revenues, PEOPLExpress introduced a first-‐class cabin and a frequent traveller

program as well as it abandoned its simplified fare scheme in favor of a more

traditional airline industry fare structure to attract higher yield business

travellers.

Despite all the efforts, PEOPLExpress was working with an investment bank to

seek buyers. In the end, PEOPLExpress was forced to sell entirely to Texas Air

Corporation, which merged it with its Continental Airlines under a joint

marketing agreement on February 1, 1987. (Wikipedia, 2012)


November 14, 2012 7

Oasis Hong Kong Airlines

Oasis is an example of a recent LHLC failure in Asia. Oasis launched its service

from Hong Kong to London Gatwick and Vancouver offering both economy and

business class with five Boeings 747 in 2006. There were four fare classes

starting at £75. (Wikipedia, 2012)

Oasis claimed it had quickly reached a load factor over 85%. Its strategy was

based on selecting appropriate destinations based on three criteria: 1) a major

business destination, 2) a major cargo destination and 3) a major low-‐cost

carrier hub. Oasis was planning to launch some 60 destinations of this art, such

as Berlin, Milano, San Francisco, among others. (Kjelgaard, 2007)

Oasis underlined the importance of choosing right aircraft. Ken Chad, Oasis’s

commercial director opinioned that B747 was quite expensive to operate unless

it could fill it up. Oasis was convinced it would commercially succeed if it were

selling the complete aircraft capacity at prices 40 to 65 percent lower than its

competitors. (Kjelgaard, 2007)

Another attribute of Oasis’s strategy was to compete against carriers offering

one or two-‐stop connecting service. Chad argued that though they were selling

tickets at lower prices, their costs were higher then Oasis’s nonstop connections

as a result of burning lots of fuel when taking off and landing at their connecting

airports. Oasis also believed that long-‐haul routes were better suited to the low-‐

cost model than short-‐haul networks, for intensive aircraft utilization exceeding

more than 15 hours a day, that is, more than the short-haul airlines may possibly

reach. (Kjelgaard, 2007)

On April 9, 2008, Oasis announced ceasing of operations after having accumulated a

loss of US$128 million. Oasis’s liquidation proved its strategy unviable. In an attempt

to be competitive, the airline was offering lower than sustainable fares leading to

rapidly piling losses. Oasis also faced stiff competition by a number of well

established carriers operating on its Hong Kong-London route including Cathay

Pacific, British Airways, Emirates, Air New Zealand and Virgin Atlantic, and by the


November 14, 2012 8

fact that its competitors flew into the more convenient and centrally located Heathrow

rather than to Gatwick. (Wikipedia, 2012)

Lessons Learnt from History of Failure

Having studied the failures of the fallen LHLC airline pioneers, the following

mistakes were detected and found principal and resilient for its repeating impact

on airlines’ fiascos.

• Underestimation of the external legal and market environment and

unreadiness to face fierce competition from network carriers.

Laker was working on receiving its permit for Skytrain for seven years.

British government rather supported Laker’s competitors. When the

competitors quickly mastered effective competitive methods, Laker,

PEOPLExpress and Oasis were not able to respond back effectively. None of

the carriers fully understood dangerous influences of the external

environment.

• Excessive airline expansion, undercapitalization and weak financial

management

Laker ordered too many new aircrafts at once using external funds at high

interest. Laker operated with little own capital and high leverage. Laker

miscalculated its finance, mainly its currency exchange operations at the

period of economic downturn. PEOPLExpress purchased other airlines to

quickly become a major market player. Oasis depleted its financial resources

ending up in deep debt after 17 months of operations.

• Operating inappropriate aircraft type

Oasis believed it could operate a relatively cost-‐expensive aircraft type while

earning profits at lower yields than its competitors.

• Flying from and/or to destinations, which are far too competitive

and/or do not generate enough demand to fill up aircraft capacity


November 14, 2012 9

Laker decided for a highly popular route London–New York, adding the

trendy Florida and Los Angeles. PEOPLExpress went for the favored New

York–London as well, among others. Oasis thought that having its hub in the

highly populated Hong Kong and flying to the promising London and

Vancouver would make success sure.

First, all such popular destinations were already well served by established

legacy carriers. Second, considering adding new seats on the market, taking a

Hong Kong–London route as an example, was there sufficient existing and

new demand to fill up a B747 with some 340 seats six times a week, resulting

approximately in 200 thousand seats p.a., at an adequate yield considering

the current competition?

The failures of three airlines reveal that the airline business is very intricate.

Even having viable air operations like Laker and PEOPLExpress used to have was

not any guarantee for any sure commercial success. Next chapter will examine

four areas of failure recognized above in detail in order to identify recipes for

future success.


November 14, 2012 10

Success Factors for the Long-‐Haul Low-‐Cost Airline Blueprint

Factor A: External Environment and Competition

Laker demonstrates an example of a carrier, which did not master strategies to

cope with its business environment and competition, though it was operationally

a successful airline.

Scheduled international operations were highly regulated by bilateral air traffic

agreements in the 1970s. Only a few existing UK agreements contained

provisions for a second British scheduled airline in addition to the incumbent UK

flag carrier, whereas they did not contain any provisions to designate a third

carrier. As a result, any license to Laker prevented British Caledonian, Britain’s

“second force” carrier from operating a competing service.

Another fact Laker underestimated was the concept of British aviation policy of

those days. British government supported British Caledonian as their chosen

instrument of the private sector. In addition, British Caledonian and Laker were

denied access to Heathrow, the main market for scheduled airlines in the UK,

having to operate out of much smaller Gattwick. (Wikipedia, 2012)

In this unfavorable environment, Laker needed seven years to obtain the

required license, after a few law suits and numerous changes in British

government’s opinions and decisions. Other large carriers, mainly British

Caledonian, exercised fierce competition including conspiratorial behavior.

Laker did not apparently have effective strategies and means to face it.

PEOPLExpress and Oasis failed in competition as well. After PEOPLEexpress

exploited its initial low fare advantage, it did not respond by the right strategy to

beat American Airlines’ new adjusted yield management supported by advanced

mathematical and software techniques. Similarly, Oasis did not beat carriers

such as Cathay Pacific and Emirates, after they managed to adjust their fares

benefitting from their outstanding yield management.



Sir Richard Branson summed up the lesson learnt: “Perhaps his [Laker’s] best

advice was to make sure that I took British Airways to court before they

bankrupted us — not after, as he did.” (Annoh, 2006) Anticipating and proactive

approach towards the external environment and competition may be worth as

validated by Branson’s successful Virgin Atlantic. New start-‐ups shall be

encouraged to analyze environment and competition ex ante and prepare their

actions and reactions in various scenarios before environment and competitors

strike. There are several helpful methods to assist.

A classical tool for examining the external environment is the PESTEL, which is

an analysis of macro-‐environmental attributes having effect on decisions of

managers and organizations. PESTEL examines political factors (for example,

bilateral air traffic agreements), economic factors (GDP growth), social factors

(changes in lifestyle and trends), technological factors (Internet), environmental

factors (environmental protection laws) and legal factors (competitive

regulations). (Gillespie, 2007)

To analyze micro-‐environment, market and competition, Porter’s five forces is a

time-‐proven method. It examines threat of new competition, threat of substitute

products, bargaining power of customers and intensity of competitive rivalry.

(Porter, 1980) Porter (1985) also offers a so-‐called value chain for analyzing

company’s own strengths and weaknesses, for the company is a synthesis of

activities performed to design, produce, market, deliver and support its product.

SWOT analysis (internal strengths and weaknesses, external opportunities and

threats) can be used to aggregate findings collected by the methods above.

(Kotler & Keller, 2012)

The outputs of the analyses may serve two key purposes.

First, they can be a basis for sound risk management, for example in the form of

Wrona’s approach including a simplified risk register. (Wrona, n.d.) Significant

risks are listed in a well arranged table. Risks are not only assessed and

prioritized, but preventive actions and contingency plans are developed timely.



Figure 1: Risk register example

Having such a risk system in place, LHLC carriers may compete more effectively.

For instance, if a competitor strikes by decreasing fares, the LHLC airline already

knows who will act (risk owner), what the trigger is and what the contingency

plan is. Besides, risk probabilities are already decreased by having taken timely

preventive actions.

Second, LHLC carriers may develop competitive positions and effective

competitive strategies. Kotler & Armstrong (2001) recognize four competitive

positions: (1) market leader, (2) market challenger, (3) market follower and (4)

market nicher. Kotler & Armstrong also offer applicable competitive strategies.

For instance, if the carrier identifies itself as a market follower, it can elaborate a

competitive strategy either based on “follow closely” or “follow at a distance”.

Factor B: Airline Growth and Financial Management

PEOPLExpress is a brilliant example of the consequences of disproportionate

expansion. PEOPLExpress abruptly bought two other airlines to quickly become

the fifth largest US carrier just in four years after its inception.

Prof. Mayo and Prof. Lance (1992) applied the sustainable growth, a financial

management tool used in making strategic marketing decisions, on the growth

histories of American Airlines, KLM, and PEOPLExpress. They proved that

PEOPLExpress’s growth was incompatible with its financial stability, since its

expansion was not accompanied with adequate increases in profitability.



According to Higgins (1977), company’s growth shall be sustainable, avoiding

deficient and excessive growths. Sustainable growth enables to set the optimal

growth pace in terms of the annual percentage of increase in sales that is

consistent with a defined financial policy considering financial indicators such as

target debt to equity ratios and others.

The other airlines had a similar tendency. Laker envisioned expansion to

Australia and Hong Kong and dreamt of 666 European routes. Oasis planned

fourteen aircraft and many more long-‐haul destinations by 2011. Both airlines

had little own capital (for instance, Laker’s paid-‐up share capital was £504,000,

whereas British Caledonian’s £12m and British Airways’ £100m.). (Wikipedia,

2012)

Skytrain documents the importance of financial management. Its weakness in

forecasting the sterling-‐dollar exchange rate in the winter 1981/2 led to massive

outflows of funds at a time of financial recession. When Skytrain ran out of

financial resources, it went bankrupt. (Annoh, 2006)

In conclusion, economic laws are valid for LHLC airlines like for any other

companies. There must be a balance between growth, profits, debts and assets to

sustainably develop the LHLC business. Sound financial management and

funding and elaborated currency exchange operations are a cornerstone of LHLC

airlines’ success.

Factor C: Aircraft Choice Importance

Referring to Porter (1980), being a LHLC carrier implies to strictly follow the

cost leadership marketing strategy, that is, to pursue the lowest cost among

competitors. Considering the long-‐haul direct operational cost (DOC), a half of

the DOC is directly related to aircraft operations (fuel consumption, airframe,

engine and line maintenance and landing and navigation fees). Specifically, fuel

represents approximately 35% of DOC nowadays. Hence, it is extremely

important which aircraft type the LHLC carrier operates.



Figure 2: Long-‐haul Direct Operational Cost (Source: Internal Airbus study)

This factor is multiplied by the fact that LHLC airlines usually reach in average

only 20% lower operational cost than legacy carriers compared to 30-‐60% cost

reduction reached by short-‐haul low-‐cost airlines. (Doganis, 2010) This fact is

further intensified by the ratio of the long-‐haul ticket price upon travelers’ total

long-‐haul trip expenses. According to a study conducted by UK Civil Aviation

Authority (2005), the long-‐haul trip usually takes many more days than a short-‐

haul one. At the same time, the long-‐haul ticket price usually plays a less

important role in the total long-‐haul trip expenses. This means, long-‐haul

travelers tend to be less sensitive to ticket prices than short-‐haul travelers. As a

result, the LHLC airline must offer a substantial ticket discount to dilute the

existing demand and attract the new, while maintaining desired profitability.

Oasis is an example of selecting an inappropriate aircraft type. While the B747

had the lowest potential operating cost per seat, this was applicable only for the

fully loaded aircraft; costs per seat increased rapidly as occupancy declined. A

moderately loaded B747 with a 70% load factor used more than 95 percent of

the fuel needed by a fully loaded B747. (Miljominsteriet, n.d.) Oasis did not

establish any viable and sustainable competitive advantage over its legacy

competitors and thus was predestined to fail in this respect.



To create a significant strategic cost advantage as proposed by Porter, LHLC

carriers need to reach more than any moderate 20% lower cost. A solution

seems to be coming. Boeing is introducing its 787, which operating cost is 20%

lower than any other similar long-‐haul aircraft. Rasch-‐Olsen, an equity analyst at

brokerage Carnegie, said: "If you take the Dreamliner, where the operating cost

is 20% lower and you also save 30% on the service, … , then [the operating cost

decrease] could get to 50%." (Stolen & Koranyi, 2012)

Factor D: Destination Choice Importance

History of failure demonstrated that even major destinations, such as Hong Kong

and London, did not guarantee any success. Morrell (2008) calculates that high

density LHLC services will have to offer at least 300 seats per flight in daily or

five weekly frequencies. This means that they need a market share of over

175,000 annual passengers. Otherwise they would be restricted to leisure

markets such as the Caribbean and Thailand, where low frequencies better fit

package holidays. However, such flights are already usually provided by long-‐

haul charter airlines, whose competitive operational cost and advantage of

selling most of seat capacity to tour operators in advance are hard to compete.

Boeing (2007) made an analysis of promising LHLC destinations. Boeing

calculated that a daily 300 seat LHLC service would have the market share on the

top ten long-‐haul markets as follows: 11% on LHR/JFK, 23% on NRT/HNL and

between 30-‐37% on the other eight routes. Boeing points out that these figures

are not only sufficient to stimulate demand but also many of these routes belong

to the most profitable.

Another aspect is the importance of connecting passengers to long-‐haul flights.

Though low-‐cost carriers usually ignore feeding and focus on pure point-‐to-‐point

services, the evidence, exampled in the Figure three below, proves that

connecting passengers play a vital role in long-‐haul business.



Figure 3: Connections made by passengers on scheduled long-‐haul services at Heathrow, Gatwick

and Manchester, 2005. Source: CAA Passenger Survey, 2005, in CAA (2007)

Oasis was thinking right when concentrating on both business destinations being

major low-‐cost carrier hubs at the same time. Still, Oasis apparently

underestimated the role of connecting traffic. Oasis did not arrange any

connections with other carriers and relied on spontaneous passengers’ own ‘self-‐

connect’.

Eventually, LHLC carriers should reconsider their strict point-‐to-‐point thinking.

For example, they could develop a new untraditional method for feeding and

interlining, which will not be as complicated as the methods used by legacy

carriers. LHLC flights connected to affordable trains and busses may be a viable

option. Distribution methods to enable this are already being developed. (Hahn

Air, 2012)



Conclusion

This paper analyzed the history of failure of three LHLC carriers, which marked

the aviation history: Skytrain, PEOPLExpress and Oasis Hong Kong Airlines.

Principal lessons learnt from their failures were identified as:

• Underestimation of the external environment and unreadiness to face

competition

• Excessive expansion, undercapitalization and weak financial management

• Operating inappropriate aircraft type

• Flying to overly competitive destinations omitting feeding

Addressing the four above issues, the paper contributes to setting a blueprint for

successful LHLC operations:

• External environment and competition: LHLC carriers shall approach the

external environment and competition anticipatively and proactively. They

can benefit from analytical methods, such as PESTEL, Porter’s five forces,

value-‐chain and SWOT, to create timely risk management and effective

competitive strategies.

• Optimal growth and financial management: LHLC carriers shall pay attention

to sustainable growth as proposed by Higgins. A balance between growth,

profits, debts and assets is important as well as sound financial management,

sufficient own funding and elaborated currency exchange operations.

• Aircraft choice importance: To create a significant strategic cost advantage,

LHLC carriers need to reach more than 20% lower operating cost. Boeing 787

may be an option, saving additional 20%.



• Destination choice importance: LHLC carriers shall remember that suitable

LHLC destinations must accommodate at least 175,000 passengers p.a.

Boeing’s study suggests several city-‐pairs and proves their viability for the

LHLC model. However, the LHLC model needs to include connecting traffic,

too.

In conclusion, this paper disclosed that three remarkable LHLC carriers had

failed for other than simple airline operational deficiencies. It can be advised that

future LHLC carriers pay close attention to the intricacies of the entire airline

business.

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Long-haul Low-cost Airline Operations

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