ANALYSIS: June 18 2009

LCCs at the crossroads

Over the last ten months, the news from the airline industry has been relentlessly bad. Just this week, American Airlines has said it will shed 1,600 staff while Delta Air Lines announced another round of capacity cuts. In case there was any doubt, that constant harbinger of doom, the International Air Transport Association said airline losses for 2009 would be $9bn - nearly twice what it forecast in March.

But this all refers to the traditional airlines, the full service carriers. What of the low cost carriers (LCCs) with the cut price fares and pay-for-what-you-want approach - surely they are faring better in this recession?

Well no, not really. According to one expert, Cyril Tetaz, senior manager distribution for Amadeus' airline business group, they are also facing difficult challenges and difficult choices which has not been the case for them before.  The LCCs, after years of "formidable" growth, are now at the crossroads, he said.

Mr Tetaz said that LCCs were, for the first time in their history, having to deal with an industry crisis. The "perfect storm" of falling demand and rising prices has hit them as well as the legacy carriers.

But if many are still making a profit, they are also seeing their load factors and yields fall. One or two had already gone out of business. The LCCs are, Mr Tetaz said, looking at what can be done in this current climate.

They are broadly faced with three options: consolidation and external growth; focusing on their costs; or lastly organic growth.

Some, notably the two Spanish carriers Vueling and Clickair have chosen the first by amalgamating. But Mr Tetaz said this, in effect copying the legacy carriers, would not work for all LCCs. "The reason why airlines merge or buy others is to reduce competition in the domestic market, acquire new slots and to gain scale," he said.

"But while this might work for full service carriers, it is a challenge to LCCs. These guys are not network operators who need market synergies. The LCCS are known for their focus on costs."

He argues that mergers between LCCs would not necessarily drive down costs or bring economies of scale. They might, paradoxically, actually lead to a more complex operation with high costs. 

On focusing on cost, this is what they do anyway. There is for example, a board room row at easyJet on whether or not to go ahead with the purchase of new aircraft.

It is the third option, organic growth which offered the LCCs the best chance. But this, Mr Tetaz warned, also came with a price.

This is not the growth in revenue offered by unbundling which LCCs and some full service carriers had seized on as a way of increasing revenue when demand was falling. Nor is it only about opening new routes as this is a necessarily limited option.

But it was about changing or rather widening the business model to attract more passengers, especially the higher yield business travellers. Mr Tetaz said that LCCs carried about 450m passengers a year while travel agents made 1.1bn reservations in 2008. About 40-50% of these were for business travellers.

"Business travel may be down about 20% in the recession but people still have to travel for business although they will maybe change the way they travel. This is a huge opportunity for LCCs. The LCCs need to start working on a close relationship with travel agents to sell their products and target travel agency customers," he said.

But this needed not only a change in attitude among LCCs to travel agents and distribution systems like GDSs - it also needed a change in technology to enable LCCs to target agency customers much better.

He said there were already signs that this was happening. easyJet was now offering fully flexible fares which allowed business travellers to change flights without extra costs while Vueling was offering seat selection and the free middle seat, if available, to give passengers more space.

In term of distribution, agents wanted a system whereby they could make a booking for an LCC in the same way as they made one for Air France or BA. But while some LCCs had signed up and agreed to put their content onto the GDS, many had not.

The technology solution which Amadeus had produced, Mr Tetaz said, was to say loading up content was not necessary. "Now we are just saying we are going to connect you to the agency's system. This has reduced complexity dramatically," he said.

 "But the LCCs which are going to go down this path are going to have to change their attitudes and be ready to work with a travel agent. They will need to advertise their content and develop a relationship with the travel agent. It is a change of culture.

"But we are already seeing LCCs paying commission to travel agents to drive up their volume."

Mr Tetaz said there was more to it than this however. "One of the messages we have for the LCC is that technology is an enabler but it is not the only one. You have to talk about your marketing programme, to build up awareness of your product. Again this is a culture change."

Done properly, Mr Tetaz said this will work. He quotes the case study of Vueling which embarked on a change in its model to attract more business. In late 2007, the LCC decided on a new approach and in the following May launched its new plan.

 Up to then its customers were overwhelmingly leisure travellers who booked on the airline's website. The project was to attract, in addition to these direct bookers, more customers, notably high yield business travellers, from indirect bookings through agents.

There were already the beginnings of such an approach with some customers already booking indirectly, receiving no ticket and being required to pay instantly with a credit card. But the potential of going through an agent was promising. Of Vueling's small number of business travellers, 73% went through an agent.

To attract more of these profitable customers, Vueling both used the new Amadeus technology and set about making its product more attractive to the business traveller. This included an increased focus on routes they would use, like Barcelona to Madrid, Seville and Paris, priority seating, first row seating and more loyalty points.

In a trade off, they accepted the agent way of booking which included the need to review its distribution model. In the words of the case study report: this meant that "Vueling had to accept that allowing for standard BSP payments with ticketing through full Amadeus integration was the best fit for agents. Vueling's understanding of agency preferred methodologies was the key to fast adoptive rates and fast sales."

Basically Vueling adopted two models, its original one of ticketless online booking and the new one of ticketed offline booking.

The results have been impressive. The LCC recorded a post tax profit of €8.5m and a 21% increase in revenue to €438.9m. Ancillary income rose by 70% and revenue per flight went up 22.8% with a third coming from GDS sales. Ticket agency sales now account for 18.2% of Vueling's ticket revenue, 40% of passengers on the Barcelona-Madrid route are corporate and revenue per passenger has risen 27.9%.      

But there is also another area where LCCs can increase revenue. West Jet of Canada and Volaris of Mexico have both signed interlining and codeshare deals with South West Airlines. Air France also has a deal with West Jet.

"A lot of discussions are now taking place between full service carriers and LCCs about interlining and codesharing. The business logic is quite simple," Mr Tetaz said.

With LCCS often dominating its domestic market, codesharing with a full service carrier was a way to expand its network. It was also a way to advertise internationally its routes. For the traditional carriers, partnering LCCs added to the number of feeder flights for its long haul services. It is a "win-win" situation.

"I think we are going to see increasing discussions on interlining and codesharing deals between full service carriers and LCCs," he said.