Airline business: Cut-throat competition
BOTH FULL SERVICE AIRLINES AND LOW-COST CARRIERS ARE SEEKING TO PROVIDE GREATER DIFFERENTIATION BETWEEN THE PRODUCTS THEY OFFER
The world’s airline companies are facing more intense competition, which could force them to cut air fares to below the marginal costs of providing services in order to be able to survive.
The network legacy (full service) airlines around the world have encountered a revenue problem with the emergence of low-cost carriers (LCCs) as a formidable competitive force. It has also become clear that network airlines have fundamental operating costs and productivity disadvantages compared to their low-cost rivals.
The differences in the cost structures between network legacy airlines and LCCs reflected substantial differences in the productivity of both aircraft and employees.
One of the biggest challenges in the airline business is the cut-throat competition. Some CEOs of LCCs believe that cutting prices to rock bottom is the only way to win competition.
Having the lowest price is the only means to increase market share and become a dominant player in the market. These cost leadership tactics do not come from a revenue management strategy, but are sometimes created from the top as a predatory way to dump competitors.
Air fares below operational costs have caused losses, which in the long term could kill airline companies. Lowering prices as a weapon to deteriorate the market in order to kill the competitor means no one will win.
Healthy competition will benefit customers substantially. Stronger industry performance creates lower industry costs and efficiencies, which in turn are passed through to the price of the tickets.
In this equation, LCCs tend to operate in a “point-to-point” manner to minimize aircraft ground times. Shorter ground times result in higher aircraft utilization rates, in contrast to the hub-and-spoke networks of the largest legacy airlines.
LCCs also have implementing systems and operating procedures based on safety criteria and revenue management strategies. As a result, LCCs have been able to achieve aircraft utilization rates more than 45 percent higher than what legacy carriers achieve for the same aircraft type. This contributes to 35 percent lower aircraft operating costs per unit.
Tourism has been a key industry in the LCC equation. Due to the nature of LCCs, their key focus has been on leisure travelers and tourism. They play a bigger role particularly in connecting small cities, isolated islands and remote regions to the big cities.
Both network legacy airlines and LCCs are seeking to provide greater differentiation between the products they offer, enhancing the travel experience and establishing customer loyalty to a specific airline rather than viewing the product as a commodity.
Network airlines and LCCs are increasingly competing over service by investing in technology to enhance their websites, upgrading their fleets and airport lounges and providing the types of services and onboard amenities that consumers may value.
By introducing new technology, including mobile applications, airlines make it easier than ever to purchase tickets, but in this area there are some third parties (online ticket vendors) that are able to book higher revenues than those made by carriers, which have spent a lot of money buying airplanes. It is more or less like Google, which has larger revenues compared to the telecommunications operators that spend a lot of money building the infrastructure.
They use the infrastructure belonging to airlines to create profits. The danger will come if this kind of company becomes a super-hub selling tickets to customers, becoming hegemonic powers to dictate the prices and profitability of the airline without sharing risks and revenues.
Efforts by network legacy airlines to reduce costs have also been a key factor in the improved financial performance of the airline industry. In US, experts found that bankruptcy restructuring during the last decade played a key role in enabling network airlines to reduce costs.
The bankruptcy process of Delta Air Lines and American Airlines present an example of how network airlines can cut their costs by negotiating contracts and pay concessions with their labor unions. Through bankruptcy they can restructure and do personnel reductions.
Network and low-cost airlines are also purchasing new airplanes, as evidenced by new aircraft orders from Garuda, Lion Air and Sriwijaya in the case of Indonesia. Passengers may benefit from these new planes. They are quieter and offer enhanced entertainment options and other in-flight amenities. Some airlines, for example, offer flat-bed seats, premium economy seats, faster Wi-Fi and larger overhead bins.
Airline revenues have also been supplemented by the growth in ancillary fees for optional services. These include fees for services that were previously included in the airfare, such as checked bags, early boarding, seat selection and meals and such new services as Wi-Fi access. Ancillary fees have been beneficial for airlines by enabling them to collect revenues that are related to the costs imposed by individual passengers.
Some airlines are also waiving certain fees, such as bag fees, to increase customer loyalty to their brand. Network airlines also are marketing their ability to offer travelers access to more global destinations through expanded networks. For certain passengers, some airlines are introducing premium services such as limousine pick-up at the gate.
The global air passenger market is building strong momentum in 2016. The industry outlook is improving as the global economy continues to recover. The fall in oil prices strengthens the upturn. Global passenger traffic in January was 7.1 percent higher than in the same month in 2015.
Capacity is increasing and is expected to move ahead of demand growth in 2016. Yields, however, continue to deteriorate amid stiff competition. The strengthening industry performance today is being driven by lower oil prices, which dropped to an average of US$55 per barrel in 2015 and is projected to further fall to $51 per barrel in 2016, giving airline profits a boost.
Average global fares in reported US
dollar terms fell by around 12 percent in 2015. The strong appreciation in the US dollar seen over the period exaggerated the downward trend in airfares. Adjusting for the currency effect, nominal global fares were approximately 4 to 4.5 percent lower than in 2014.
Competitive pressures within the industry and the declines in oil prices seen around the end of last year and into 2016 are likely to translate into further declines in fares. While we see airlines making about $25 billion in after-tax profits in 2015, it is important to remember that this is still just a 3.2 percent net profit margin, although efficiency gains by airlines are illustrated by record high load factors of 80.6 percent in 2015, tapering slightly to 80.4 percent in 2016.
“Creating a 3.2 percent net profit margin does not leave much room for a deterioration in the external environment before profits are hit,” said Tony Tyler, IATA’s director general and CEO. Although the industry story is largely positive, there are a number of risks in today’s global environment.
The rapid growth of the global airline industry and the continued threat of terrorist attacks, like what happened in the Brussels airport, recently made safety and security issues critical to every airline and every passenger in every airport. For the airlines, the new security procedures have increased operating costs and induced more securityrelated flight disruptions and delays.
Airlines around the world are encountering a growing wave of liberalization, if not outright deregulation. Airlines are facing competitive pressures, both from new entrant low-cost airlines and restructured legacy carriers, and the need for expanded aviation infrastructure, both airports and air traffic control, is of particular importance to the emerging economies of the world. Like in Indonesia, where much greater rates of demand growth are forecast for both airline passengers and cargo.
In other regions, a challenging situation is growing into a new threat. There is a new aviation power emerging in the Middle East comprising three carriers of significance: Emirates, Etihad and Qatar. These carriers offer all of the comforts that the world elite carriers provide. They serve hundreds of important world destinations from their
Antara Flying low: A Lion Air airplane gets ready to land at the Ngurah Rai International Airport in Denpasar, Bali. Lion Air Group has established subsidiaries in Malaysia and Thailand to tap into the growing market in Southeast Asia.
Airstrip: Passengers walk to a waiting aircraft at DC Saudale Rote Airport in Baa, Rote Ndao regency. The airport can only accommodate ATR and Twin Otter airplanes.