Air Scoop October 2008

Highlights in this Issue

Interview of Alex Cruz (CEO of clickair) Economic Growth & Air Traffic Penetration Oil: Ryanair Pays Twice The World Low Cost Airlines Congress 2008 Empty Plances & Fake Passengers

p. 3 p. 5 p. 7 p. 9 p. 13

The Low Cost Carriers Analysis Newsletter

EDITORIAL

AIR SCOOP ANNOUNCEMENTS A Glimpse of Headlines News!

European LCCs: An Evolving Market

Vueling September passenger traffic falls 20 pct Passenger traffic at Spanish budget airline Vueling fell 20.1 percent year-on-year to 500,977 passengers in September, the company said on Friday. Vueling’s passenger load factor, which measures the amount of available capacity filled on its flights, fell 8.5 percentage points to 70.3 percent of capacity compared with 78.8 percent a year earlier.

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he international situation locked with market recession, financial crisis and oil prices increase has a deep impact on the European low-cost carriers sector. Long time awaited by some, the famous “blood bath” should come any time soon, leading to consolidation and bankruptcies throughout Europe. These themes, among many others, were discussed in September during the annual World Low Cost Airlines hold in London. Top executives and analysts of the market were there to tackle main issues concerning the sector (p. 9). Oil prices increase was still the main issue, and hedging strategies were at the heart of many talks. Some carriers have done some good choice (Flybe for instance) while others seemed to have a miss their oil analysis, like Ryanair (p. 7). Alex Cruz, CEO of clickair, explains the strategy of its company in an exclusive interview (p. 3). Another big issue currently is about getting more revenues, others than by selling tickets. The way to generate more ancillary revenues is a key question (p. 2). Still other means are still ongoing, especially public subsidies, a hot topic in France and Belgium, according to some analysts. To get more subsidies to balance the low prices of their tickets, it seems that all means are good (p. 13). All areas in Europe are touched, including Central and Eastern Europe, about which we made an analysis of its economic growth and air traffic penetration (p. 5).

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Baltic airlines locked in legal battle Rival airlines airBaltic and FlyLAL- Lithuanian Airlines are prepared to take their dispute over alleged unfair competition all the way to the European Commission, the chairmen of both companies told Deutsch Presse-Agentur dpa on Wednesday. The spat began on September 30 when media reports from Lithuania said local airline FlyLAL had obtained a Lithuanian court order freezing airBaltic’s fixed assets in Latvia, including its headquarters at Riga airport. Spanish airline Clickair to ground 7-8 planes Spanish airline Iberia’s low-cost affiliate Clickair will ground seven or eight planes due to expected weak demand during the winter season, a spokesman for the airline said on Thursday. ‘Data from (airports operator) Aena shows that Barcelona’s El Prat airport has seen a notable decline in traffic,’ a Clickair spokesman said, noting that the carrier will be operating 17 or 18 planes compared with 25 currently. Passengers sueing Ryanair for cancelled flights Ryanair is being sued by passengers whose flights have been cancelled. A Dutch company has instructed lawyers in Dublin to start proceedings against Ryanair. EUclaim, which specialises in launching legal action against airlines, has offered to handle compensation claims on behalf of 40 passengers, reports The Telegraph. The legal action against Dublin-based Ryanair could lead to an «avalanche» of similar claims being made.

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BIRD’S EYE VIEW Ancillary Revenue Generation: Here and Now By Rapahel Bejar CEO, Airsavings SA email: [email protected] Ancillary revenue generation for airlines seems simple enough a concept. After all, hotels, retailers and other industries routinely generate substantial percentages of revenue from outside of their core product offerings; why couldn’t airlines, with one of the more perishable core products in the market, also develop those auxiliary streams? Low cost carriers were pioneers in the area of ancillary revenue generation, taking advantage of this key aspect of the airline business model years before their legacy counterparts began to. LCCs were often more innovative when it came to implementing ancillary revenue generation initiatives as well, creating opportunities for additional sales instead of charging for existing services or increasing existing fees (though, of course, that was done as well). But now that legacies have embraced the ancillary revenue phenomenon wholeheartedly, how can LCCs maintain their competitive edge in this arena? If legacies have usurped the ancillary advantage once possessed by LCCs, how will they then differentiate themselves in a newly crowded field? Low cost carriers can achieve this by focusing on three areas of ancillary revenue development where they are best positioned to compete with legacy carriers; First, LCCs must continue to evolve toward an ecommerce model at a faster rate than their legacy competitors. Second, LCCs must continue to leverage the flexibility of their business model to remain at the forefront of ancillary revenue innovation, and continue to lead the industry toward new products and services. And last, but perhaps most importantly, LCCs can make the next great leap forward in ancillary revenue generation by reimagining one of the more successful legacy-initiated concepts of the last three decades: the loyalty program. By excelling in these three areas - ecommerce, innovation, and loyalty - LCCs can beat back the legacy intrusion into the ancillary revenue arena and maintain their competitive edge.

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Leading Edge Again LCCs as a group were early to recognize the power of the internet to facilitate ancillary revenue generation. Just look at LCC pioneer Ryanair as it included the two most popular ancillary offerings - hotel booking and car hire- when it first launched its website in 2000¹. Other low cost airlines soon followed suit. Almost a decade one, the role of the individual airline website has increased exponentially for LCCs, becoming the engine of ancillary revenue growth and the launching pad for nearly every new initiative implemented by LCCs. As (increasingly) the only portal through which the customer has contact with an airline before actually boarding the airplane, the typical LCC website must focus on both meeting passengers’ expectations and extracting as much revenue from that encounter as possible. Fortunately, these are not mutually exclusive concepts, as the success of enterprises like Amazon.com demonstrates. LCCs will do well to incorporate some basic ecommerce tactics into their overall web strategies, primarily the effective tracking and management of customer data and the automatic presentation of additional high-adoption-potential offerings. This technology is already available; it has just needs to be taken up by the industry. And if the LCC sector can beat the legacies to the ecommerce model, it can and will maintain its ancillary revenue edge. The Ancillary Revenue Generation: A New Era If it seems like legacy airlines have stumbled into the ancillary era, it’s probably because they have. While it makes logical sense in a time of record fuel prices to effectively tax excess flight weight, thereby encouraging less fuel usage while simultaneously generating revenue (i.e., the checked baggage fees now imposed by many legacy lines), consumer and media backlash was strong against it. American Airlines began offering passengers the ability to choose their own seats, only to turn around a couple of years later and charge them for the privilege. While both of these examples had been implemented by LCCs long before the legacies adopted them (Spirit Airlines began charging a fee for the first checked bag in 2007², nearly a year before American³ become the first legacy to do so), the LCCs experienced far less consumer anger. In part, this is because many LCCs had the advantage of starting without frills, whereas legacies had to fight a heritage of bundled luxuries. And LCCs, with mostly point-to-point and regional service and operating models that preclude

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BIRD’S EYE VIEW large advertising and marketing budgets, are often farther outside the public eye than their legacy counterparts. But LCCs have also consistently been more innovative with their ancillary offerings, a trend that makes their ‘nofrills’ baseline a lot more palatable to consumers. With this, LCCs have created the perception of a customizable flight experience, rather than a slow degradation of a familiarly-packaged item. The myriad and inventive booking path options (including single-use lounge passes, online gaming, carbon offsets, and seat spacing upgrades) have facilitated this perception, as have new in-cabin options coming online (like in-flight internet service Gogo, which is already in use by American and coming soon to Virgin America). LCCs need to maintain their edge in new product innovation if they are to compete with the majors for ancillary revenue market share. A New Take on a Tried-n-Tested Concept Perhaps the newest take on an old standby is the substantial revamping of tired frequent flier programs. Probably the first ‘ancillary’ revenue, frequent flier programs began in 1981 with American’s AAdvantage and United’s Mileage Plus, and have been bright spots for legacy operations ever since. However, issues with mile redemption and perceived value have dogged the lucrative assets in recent years. Loyalty initiatives, particularly frequent flier programs, should be linked to ancillary services, either by promotion or by direct sale. This allows for the effective retention of ancillary-purchasing customers to the booking plat-

form. It also serves as an outlet for miles, points or other promotionals that have fallen on disfavor due to lack of redeemability. In fact, frequent flier programs are ideal ancillary opportunities, provided they are framed effectively to participants. 66% of airlines believe frequent flier programs generate significant ancillary revenue, with 65% of that revenue, on average, being derived from the sale of loyalty units (miles, etc.) to 3rd party credit cards. If LCCs can capitalize on this burgeoning phenomenon, they can lay claim to the first (and last) authentic legacyinitiated ancillary. With these three strategies firmly in mind, LCCs can continue to compete effectively in a difficult operating environment. Already in a good position from an expense standpoint (low cost, after all, being their defining characteristic), the sector’s continued leadership in the area of ancillary revenue generation should help LCCs to thrive, even perhaps grab some market share from the lumbering legacies. ¹ http://www.ryanair.com/site/EN/about.php?page=A bout&culture=GB&pos=HEAD ² http://travel.latimes.com/articles/la-trw-spirit19jun18 ³ http://www.nytimes.com/2008/05/22/business/22air. html?ex=1369368000&en=418084a719dc1cd6&ei=5124& partner=permalink&exprod=permalink 4 http://communication.howstuffworks.com/ff-programs.htm

Interview of Alex Cruz (CEO of clickair) What is the impact of oil prices increases on clickair’s activity? Due to oil prices increases, clickair has the worst EBIT results than planned for 2008. Having said, the end of the year trends might ease the tension, as prices are going down. For every euro of increase, we have only been able to pass on 40 cents in pricing. How much does the fuel count in your total costs? At the beginning of the year, fuel was 35% of our costs, and it jumped to 43% during the summer.

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Some other low-cost carriers announced they would reduce their expansion plans, cut jobs, ground some aircrafts, fly slower on some destinations… What is your strategy to limit the impact of fuel crisis on your business? To do so, we are reducing our fleet to support a decrease of 4 rotations (21 rotations during the summer, 17 rotations during the winter). This capacity adjustment does affect our fleet size and accordingly crew jobs. From a product perspective, there are few destination cuts, but mostly we have adjusted frequencies.

What is your current hedging policy? What is the fuel price where you break even? Sorry, we consider this information confidential at this time.

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BIRD’S EYE VIEW Economic growth and air traffic penetration – recent trends and future prospects A comparison between Western Europe and Central Europe A remarkably strong nexus has been observed between the global growth of air traffic (measured as passengers carried) and global economic growth. A study of the consultant firm, Frontier Economics, prepared for the European Low Fares Airline Association in 2006, contains the following chart illustrating this correlation in the period of 1985 to 2005:

One may not be too much surprised at this relationship observed at the global level especially because the regional level may still demonstrate significant variations. This article intends to highlight such recent differences in air traffic growth and economic progress between Central Europe and Western Europe. The aim of the analysis is to provide a follow-up on the editorial of the June issue of Air-Scoop (The oil price shock and its effects on low-cost business model) by identifying future growth opportunities for low-cost airlines on the one hand, and by drawing attention to the limitations to market expansion on the other hand. If oil prices keep rising, then not only the cost of transport increases but commodity prices as well. This may involve that a relatively larger share of household income will be spent on commodities and less will be spent on leisure expenses, like travelling. Obviously, rising prices may also trigger inflation which affects every single player in the economy. In turn, a drop in economic growth might (but not necessarily) happen. Nevertheless, under such conditions an expected outcome will be that both the demand and supply of air transport declines. If the decline is sharp and constant due to a deep economic crisis, then, only the most cost efficient and biggest players would be able to keep up with the intensifying competition. However, apart from taking cost-cutting, revenue-raising and efficiency-enhancing measures (which were discussed in the June editorial), another possibility is to enter into markets less affected by the crisis or to such markets where a rise

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in demand can still be expected. In this sense, a comparison between Western and Central Europe may reveal some interesting consequences. The following calculations are based on recent Eurostat and Eurocontrol data. First, we chose the five biggest EU member states, which generate the bulk of Western European air transport as well, France, Germany, Spain, Italy and the United Kingdom. Then, from Central Europe we selected the so-called Visegrád countries, Poland, the Czech Republic, Slovakia and Hungary. After calculating their average real GDP growth rates for the period of 2002-2007 and their air passenger growth rates (measured as passengers carried) for the same period, a comparison between these regional country groups is possible. Growth rates were calculated in relation to the previous year, thus the figures for each year represent the percentage change in air traffic and GDP vis-a-vis the preceding year. The next chart summarizes these findings:

First of all, throughout the observed period, the average real GDP growth rate of the selected Central European countries was significantly higher than that of the major Western European states. However, the difference between the average GDP growth rates stayed more or less constant through the entire period. When turning the attention to the passenger growth rates, there is a remarkable difference between the Western European and the Central European region. While the Western European area demonstrated a pattern quite similar to the global one, namely passenger growth rates more or less followed the GDP growth rates; this

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BIRD’S EYE VIEW was not the case in Central Europe. A steep increase in air traffic took place until 2007, which did not seem to correspond to economic growth. At least, its volume was much more dramatic than one would have expected it based on the rate of economic growth. What is the reason for such striking difference between Western Europe and Central Europe? One of the major underlying factors is the difference between the levels of air traffic penetration. While the Western European market had already undergone a considerable liberalisation by 2002, which resulted in a major expansion of the market due to the arrival of new players, Central Europe was only at the initial stages of this process at that time. There was a big gap therefore to fill, which meant great market opportunities for air carriers in the region. Given the peculiarities of the Central European market, low-cost carriers were mostly able to take advantage of liberalisation. Much of the growth of air traffic in Central Europe was caused by the entry of low-cost players. While the European market share of the low-cost segment (measured as total flight movements) was below 4 % in January 2002, by January 2005 it rose to 13,6 % and exceeded 18 % by 2007. To this sudden increase, as the above figures demonstrate, a major (but not exclusive) contribution came from Central Europe. Has this market already reached the point of saturation, or, in other words, has air traffic penetration reached levels comparable to that of Western Europe? In order to assess this, a potential measure can be the number of passengers (both international and national) carried per country inhabitants. The relevant figures are displayed in the following chart:

Again, there is a striking difference between Western Europe and Central Europe. In spite of the comparatively lower air traffic growth rate in the given period, the rise in the number of passengers carried per inhabitant in the selected five major Western European countries was quite similar to the Central European trend. Nevertheless, the gap between the two regions decreased significantly: while in 2001 approximately 5 times more passengers per inhabitant were carried in Western Europe than in Central Europe, by 2006 this gap shrank to 3.5. However, the gap

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is still enormous, which may suggest that future growth opportunities are still to be utilized in Central Europe. One may argue that the comparison between large Western European countries and small (except for Poland) Central Europeans is not appropriate. In order to mitigate such claims, we selected two Western European countries (Belgium and Portugal) of which population size (approximately 10 million inhabitants) is comparable to two Central European states, Hungary and the Czech Republic. The above observed difference does not disappear when comparing these four countries to each other. Air traffic penetration still remains significantly lower in Central Europe than in Western Europe:

In sum, the Central European market seems to offer more opportunities for expansion for air carriers, especially for LCCs. However, there are considerable limitations as well. First, the density of international airports is lower in the region (capacity limit) than in Western Europe and, overall, the existing airport infrastructure is also of a lower standard, a lot of investment is still required to improve it. This poses a certain limit to quick market growth. Second, while air traffic between Western European city pairs is intensive, connections between Central and Eastern European destinations are much less dense and are still vastly dominated by traditional carriers. The reason for this is the low air traffic penetration on the one hand and the low demand for service between these “East-East” city pairs on the other hand. There are exceptions, like Wizzair that has recently began to serve routes between major Ukrainian cities, but the dominant trend is that lowcost carriers primarily chose to serve West-East destinations. Third, even though there may be a potentially high demand for low-cost air carriers, this is also a disadvantage at the same time. People in this region spend significantly less from their disposable income on leisure activities and travel than in Western Europe. This implies that customers may be more price sensitive, therefore more likely to choose the low-cost carriers but at the same time a relatively little increase in fare prices may lead to a sharp

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BIRD’S EYE VIEW decline in demand. As a consequence, the oil price shock may have a greater impact on the Central and Eastern European air traffic demand than on the Western European one. From this perspective, the conclusion is twofold: on the one hand, Central and Eastern Europe may indeed offer further market opportunities for air carriers, primarily for LCCs. On the other hand, these opportunities can only be realised under favourable external and internal conditions: both stable economic growth and modest level of oil prices are crucial. The first condition ensures a continuously rising demand for air travel, while the second condition influences both the supply (LCCs business model) and demand side. However, at the moment

only the economic growth is there which, given that these countries are open economies, is endangered by external shocks such as the ongoing sub-prime crisis. In other words, these economies are more vulnerable than Western Europeans, thus the risk associated with pursuing economic activity in the Central and Eastern European region is higher. Those air carriers operating in this area that are unable to incur such risks will be driven out of the market or will be acquired by more powerful actors. These factors all seem to suggest that in the coming years the long-awaited consolidation of the air transport market will take place in Central and Eastern Europe, too.

Oil: Ryanair Pays Twice Fuel forms a major part of total costs for budget carriers. In the current situation when it is difficult to predict oil market movements, the real value of hedging is hard to estimate. The decision to hedge depends on perceived risk. That is, if crude oil prices fall below the locked price, hedging will appear to be a waste of money only. In other words, a carrier should be sure that the amount of money spent on hedge contracts won’t exceed the actual savings from hedging. Otherwise, it might be better for carriers to spend this money on maintenance and expansion needs. Obviously, there cannot be a unique rule for all carries as each of them has its own way of making money and its own hedging strategies. However, the recent cases have shown that hedging strategies might differ completely from carrier to carrier, and that there are some real hedging losers. Seems like Ryanair has fallen under some strange kind of a fuel spell. Having refused to hedge for the year at lower rates, Ryanair reported a first-quarter loss. In the first financial quarter ended June, 30 the carrier’s profit fell by 85% if to compare with the year 2007 to €21 million. At the same time, the carrier’s fuel costs increased 93% to €367 million which makes up about 50% of the overall operational costs. Though Michael O’Leary said earlier he would not hedge fuel until prices dipped below $100 per barrel, Ryanair hedged 90% of its September fuel at $129 a barrel. Looking backward over earlier mistakes, Ryanair even hedged 80% of fuel for the next three months till December, 31 at $124 per barrel. With the prices going down, this might be a loss-making decision. Interestingly, Michael O’Leary admitted his mistake in not having bought fuel hedging contracts when prices were below $100 per barrel. Here emerges a question as to why the Irish carrier refuses to look backward over earlier mistakes. Exactly two years ago, September 2006, Ryanair hedged

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a considerable amount of its fuel at a level much higher than falling market prices. On the other hand, a strong belief that prices would go down had already got Ryanair into trouble several years ago when the carrier remained unhedged against rising prices. Does this make hedging a matter of a lucky guess only? This time Ryanair has not hedged fuel for the period between January and March 2009 hoping that fuel prices will continue to go down so that the carrier would be able to gain profits starting January 2009. Savings made during the fourth quarter might come in very handy as analysts predict low yields this winter because of the global economic recession. Ryanair reported to follow its same old strategy and to launch large sales at reduced fares to stimulate passenger demand. According to preliminary forecasts, Ryanair is planning to carry more than 65 million passengers in the year ending March, 31. Michael O’Leary commented on other airlines as well, predicting more bankruptcies in the industry because of high oil prices. Speaking of Ryanair’s future, O’Leary was more optimistic if to compare to his July forecast and promised to break even if oil stays at $100 a barrel. Amongst potential bankrupts O’Leary mentioned SkyEurope, Flybe and Jet2. However, both Flybe and Jet2 rejected the claim stressing that they had hedged most of their fuel requirement at attractive rates. Unlike Ryanair, Flybe is sure to be able to break even if oil reaches $170 a barrel. This fact shows that aggressive hedging strategy comes to be more beneficial for an airline’s profit than aggressive expansion.

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BIRD’S EYE VIEW

The World Low Cost Airlines Congress 2008 23 - 24 September 2008, QEIICC, London This year again, the World Low Cost Airlines Congress turned to be the biggest event of the market in terms of number of attendees. According to Karen Forster (Managing Director, Terrapinn), more than 500 aviation professionals attended the event, and 300 the Budgies World Low Cost Airline Awards. The event covered many current issues facing the low-cost carriers industry: fuel crisis, overcapacities, environment… For Patrick Murphy, former Chairman of Ryanair, the upfront of the problem is the price of fuel, and furthermore, consumers’ capacities to pay have decreased. Facing oil prices, each LCC has its own hedging strategy. easyJet for instance have 50% hedged, and know that above 130$ per barrel, they won’t make any profits, said Hal Calamvokis, Strategic Planning Manager at easyJet, “which explains why it’s not well hedged”. Another current issue is the merger of the two Spanish LCCs, Vueling and clickair. “The merger is on track, but not on specific time. There will be challenges for the merger, but good values should come out of both companies”, said Alex Cruz, CEO of clickair. For Mike Rutter, CCO of Flybe, focused on 4 key areas: 1. “You need to be the leader in what you do” 2. “You need a more balanced passengers portfolio” 3. “You need to have a high frequency” 4. “You need to focus on the “cost base” “Something has changed in Europe and in the UK, last weeks. Customers trusted things they don’t believe real any longer. They will need to believe in true values from now on.”

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DOWN TO EARTH Daniel Skjeldam, CCO of Norwegian Air Shuttle, said they had to work restructuring their network due to fuel price. Norwegian is a LCC as it comes to costs (SAS has twice their costs), but it is a lot focused on the business market, with high frequency, frequent traveler program… “We do believe that leisure market has a problem. Leisure passengers will choose to go by bus, or stay in their sofa, instead of taking a plane”, he declared. “We believe there will be casualties between LCCs if they don’t have a strong local market.” Norwegian has invested a lot into technologies, in order to avoid waiting in long lines for instance. Discussions also turned around the evolving business models of LCCs. Thomas Winkelman, CEO of Germanwings, pointed out 5 key points: 1. “I believe customers don’t care about the definition of the carriers (LCCs, hybrid, charter, point-to-point, new generation…). They look for quality and price. There are business models flying from nowhere to nowhere for nothing, especially if these routes are paid by local subsidies.” 2. “Quality decides. SouthWest is my model as a high quality model. In the US, cheap quality carriers have simply disappeared.” 3. “We don’t have enough competition between carriers yet.” 4. “Not enough competition at airports and air traffic control.” 5. “Size does matter, but… carriers need ideas to generate revenue and value.” TUI is said to be in talks with Air Berlin about a possible merger between the german carrier and TUIFly, a subsidiary of TUI. This scenario could occur if current discussion between TUIFly and Germanwings and Condor should fail. TUI could acquire shares in Air Berlin if a merger happened. Coming mergers in the German market will have an important impact, as the new entity would become one of Germany’s largest airlines, active in low-cost and chartered flights. Another issue discussed during the congress was the shortage of pilots. “A prime problem Flybe has is the sourcing of pilots of the right caliber to operate with us and hopefully stay with the airline. I think you could say that this is probably one of our biggest challenges” said Brian Watts from Flybe. Some LCCs are now performing their own pilot training to face this pilot shortage. A new wave of consolidation could soon be made in the European LCC market. However, easyJet should not be involved in any further mergers, according to management’s statement to investors. Ryanair’s management told its investors to expect a breakeven result for its fiscal year (end in March 2009). Michael O’Leary believes more airlines will fail in the coming weeks and months, leading to a further decline in worldwide jet fuel prices. SkyEurope could be one of those. Still in deep losses, SkyEurope received a 14 million dollars loan from York Capital, its largest shareholder, and seeks 30 million dollars more.

Hallways Buzz in London

“Ryanair doesn’t always win. They made a weak hedging policy forecast.” “Is easyJet no longer concerned by environment? Nothing about it in their last statement to investors.” “Air Berlin hedged well, but still faces uncertainties with their balance sheet.” “Flybe has a good hedging. It’s getting out while the going is good.” “Norwegian is on SAS back, after rumors of takeovers. Lufthansa?” “Vueling still in great financial difficulties. Could the merger with clickair mean something?” “SkyEurope: doomed?”; “Zoom, XL… SkyEurope?”

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DOWN TO EARTH IATA had forecast an average price of 131.50 dollars a barrel for 2008. This price has been exceeded for most of the early summer, but still at this price, fuel would cost 74 billion dollars in 2008, around 14% of airlines’ revenues. So the industry would have to increase ticket prices by an average of 32 dollars per passenger for the fuel increase. Chris Tarry, from CTAIRA, declared: “I don’t buy the argument that low-cost carriers will necessarily benefit from other accriers. They still have to survive. They have a high break-even factor and low cash. We will see deferrals and cancellations of new aircraft orders. The industry is still two years away from the peak in deliveries of existing orders. They are too many planes in the backlog.” He also noticed that lease rates were falling, which is a marker of the industry’s current issues. Talking about Vueling/clickair current merger project, he said “Putting two weak businesses together doesn’t result in the emergence of a strong one”. The “holy graal” is now to identify ancillary revenues as key to LCCs’ profitability, as their share ranged from 2% to almost 30%.

Ancillary Revenues as a Share of Total Revenues The Budgies awards have been created to honor and generate public recognition of the efforts, accomplishments, and positive contributions of companies and individuals in the low cost airline industry. Best Newcomer: WINNER: AirAsia X.

Best Low Cost Airline - Americas: WINNER: Southwest Airlines

Best Passenger Experience: WINNER: Virgin Blue

Best Low Cost Airline Award: WINNER: Southwest Airlines

Best Website: WINNER: Germanwings

Lifetime Achievement Award: WINNER: Herb Kelleher, Founder and Executive Chairman, Southwest Airlines

Special Merit for Commitment to the Environment WINNER: Flybe

Best Low Cost Airline - Europe: WINNER: EasyJet

The next World Low Cost Airlines Congress 2009 will be hold in Barcelona, the 29th and 30th of September. For more information on the World Low Cost Airlines 2009, visit www.terrapinn.com/2009/wlac/.

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BIRD’S EYE VIEW Exclusive Analysis for Air Scoop www.airlinebulletin.com

LCC Contrast: The trend is fuller flights, so why are some carriers flying empty planes or using fake passengers? As fuel prices rise, LCCs have an even greater incentive to fly fuller planes with passengers paying higher fares. Ryanair and easyJet operate with the highest load factors in the industry (near 90% over the summer), and are increasing yields through higher ticket prices and higher ancillary charges. However, some smaller LCCs have chosen to fly emptier planes with passengers using free tickets. Earlier this year, Flybe was implicated in a scandal when the carrier hired actors to achieve a threshold passenger count on a route, thereby receiving a subsidy from the airport. Some carriers are even operating empty flights. With all the problems LCCs face, why do some companies engage in these behaviors? Two words: airport subsidies.

have become commercially successful for Ryanair and the airports, enabling airports to withdraw subsidies over a period of time.

Arguably, part of the problem lies with the airlines themselves. The airline business has low margins, and airlines are desperate for competitive advantage and additional revenue. In order to survive, carriers want to extract the best possible deals from airports, leading to higherthan-necessary subsidies. However, airports are mostly to blame. Many airports, and the local governments that support them, need LCCs to improve passenger levels and generate tourism. Subsidies are often needed because the barriers to receive airline service, in this era of higher costs, are increasing. However, oftentimes subsidies are handed out without sufficient assessment of a route’s viability. Therefore, airports sometimes dole out large cash amounts for relatively few passengers, especially on routes not specifically focused on generating tourist traffic. Moreover, airports all too frequently cross the line between legal and illegal aid, privately negotiating with one carrier, while refusing to offer comparable aid to other carriers.

Flybe, on the other hand, has tended to use subsidies from airports not to necessarily foster creation of a long-term, sustainable route, but rather to improve the bottom line. Subsidies are more effective in markets with large potential for traffic increases, such as tourist markets that have not yet been exploited. Markets that have a higher proportion of business traffic generally see slower gains in traffic. Moreover, airports that need to offer subsidies typically lack significant demand from business travelers because they’re typically distant from major trade centers.

This is not to suggest that all LCCs are created equal in terms of their attitudes towards receiving subsidies. Ryanair has been more successful than others in using subsidies to successfully launch new routes from small airports. Often, these facilities lack international service, and Ryanair is a boon for the small communities that receive an influx of valuable tourist dollars. In most situations, Ryanair will typically launch flights to London, and then if those are successful, to other bases. Many of these routes

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But, there have been occasions when Ryanair has opened a new destination, only to find that its expansion prospects are limited, as few of its other bases outside of London can support its services. Ryanair has withdrawn flights on many routes because of low demand, or because of an unexpected increase in the airport’s costs. This strategy, while somewhat ruthless, has helped the airline minimize losses on new routes. Often, the most successful airlines are those that know when to cut their losses early, and Ryanair has learned this lesson well.

Airports can be seen as subsidizing airlines in two ways, through direct subsidies and inefficient slot appropriation. By offering cash to carriers that add new routes or meet specific passenger count totals, airports can spur the creation of new services. Through poorly managed subsidy programs, airports can end up in a very undesirable situation, having to pay a subsidy to a carrier that did not fly passengers benefiting the airport in any way, such as what Flybe did in Norwich. Norwich, like any airport, should consider using subsidies, but should work closely with carriers to develop targets that are meaningful and realistic, on routes that will actually produce tangible gains in passenger totals. This means airports must carefully select routes to subsidize. Simply because a carrier is able to or interested in serving a route does not mean that it is the best use of airport dol-

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BIRD’S EYE VIEW lars. If a facility is looking for significant passenger gains, targeting subsidies at carriers like Flybe, which operate smaller planes shorter distances, on routes flown mostly by business travelers, may be less attractive than working with Ryanair or easyJet to bring in more passengers from greater distances to tourist markets. Unfortunately for airports, given the high fixed costs of the airline business, LCCs will need subsidies to take the risks associated with a new route. Until the EU more stringently regulates this practice, subsidies will continue to exist. However, more careful and conservative route analysis, along with consultation with airlines about ways to increase passenger totals, will help airports ensure their investments. Moreover, airports can artificially limit passenger counts through antiquated slot arrangements that limit competition. While this is a non-issue at most facilities, larger airports like Heathrow are grappling with carriers such as BMI, which intends to fly empty planes this winter in order to maintain slots. The slot restrictions, which require airlines at Heathrow to use the slots at least 80% of the time in order to keep them, are inhibiting the ability of new carriers who want to fly into Heathrow (with paying passengers) and introduce competition into the market. Since the introduction of Open Skies, Heathrow has become enormously popular for foreign carriers. Few lowcost carriers have been able to obtain slots there, because of high price and scarce availability. Many foreign carriers are willing to pay much more for a slot than LCCs are, since intercontinental flights can generate more revenue with larger planes and longer sector lengths. Regulation will be needed to ensure that slots are distributed more equitably, to carriers who fly paying passengers. Governments need to work with airlines and airports to ensure that the standards for keeping a slot are very high. Not only should airlines be required to use a slot at least 9095% of the time, but also, there should be a combination of regulations ensuring high load factors, as well as minimum plane size. My suggestion would be for airlines that fail to achieve an average 70% load factor on a given flight over a threemonth period would lose the slot for that flight. Airlines would be required to use aircraft with a minimum of 100 seats. This would force airlines to fill larger planes, more efficiently using the valuable runway space at Heathrow and airports like it. Moreover, to ensure such a high load

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factor, airlines might be forced to discount some seats, benefiting passengers and encouraging competition. However, these regulations would need to be implemented in careful consultation with airlines. A 70% load factor on early-morning flights sometimes is not feasible, and some carriers should be allowed exemptions on certain flights, but a target like this would ensure efficient movement of passengers using the least number of aircraft during the vast majority of operating hours. This regulation alone does not mean that many more LCCs will be able to operate from Heathrow, but it will make fares more competitive and ensure greater efficiency. Most LCCs are guilty of taking excessive subsidies from airports desperate to see new services. During this time of duress for carriers, airlines are under pressure to seek a competitive advantage in any way possible. This does not absolve carriers of their shortcomings, but it will require increased vigilance from governments and airports to ensure airlines don’t exploit public bodies. Airports need to do a better job of holding LCCs accountable for their investments, ensuring that routes are well chosen and are bringing in the desired passengers. Moreover, airports also need to work with governments and airlines to update outdated regulations addressing slot allocation, improving facility utilization and encouraging added competition to crowded airports like Heathrow. Remarks, questions… Join Sam by email (samsellers@ gmail.com) or on his website to comment this article… http://www.airlinebulletin.com.

Sam Sellers provides analysis and commentary on the airline industry at his website, www.airlinebulletin.com, and is the author of Take Control of Booking a Cheap Airline Ticket, an ebook for travelers in the United States who are interested in purchasing cheap airline tickets.

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Air Scoop - October 2008

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