Budget carriers create a new map for airlines

When two airlines started offering cut-price fares in the 1990s they fired up a process of change that is reshaping Europe’s aviation industry and leaving winners and losers in its wake.

Irish carrier Ryanair took inspiration from the US, where Southwest Airlines – its flight attendants clad in orange hot pants – had in 1971 been the originator of low-cost flying with $10 and $20 fares.

Ryanair was quickly followed by easyJet in taking advantage of deregulation and bringing the no-frills concept to Europe. The focus on low fares and simply getting the passenger from A to B was a revolution for passengers used to higher fares and the fuller service of traditional airlines.

But the resulting competition set in place a transformation that is blurring the boundaries between low-cost carriers and their traditional rivals. The cut-price upstarts have so far gained the advantage.

“Lower-cost carriers are taking the lunch of legacy carriers,” says Jonathan Wober, analyst at the Centre for Aviation, a consultancy. “Legacy airlines have had to become more efficient and lower their costs.”

Low-cost carriers have about half of the market and have seized customers from the traditional airlines, many of which are seeking to slash costs or are engaged in difficult restructuring. For example, International Airlines Group – parent of British Airways – has cut 3,000 jobs at Iberia, its Spanish subsidiary.

Low-cost airlines have pounced on opportunities in countries with struggling national carriers. In Italy, Ryanair, easyJet and Vueling are competing over the territory of Alitalia, which has not made a full-year net profit since 2002.

“Low-cost carriers have demonstrated that short-haul air travel is largely a commodity product where the lowest-cost producers win,” says Oliver Sleath, airlines analyst at Barclays.

“On a two-hour flight, the vast majority of passengers simply want a safe, punctual, comfortable journey at the best-value fare. That is what the low-cost carrier business model can deliver – and highly profitably too.”

Short-haul is a commodity product where the lowest-cost producers win

Average profit margins of leading low-cost airlines are in double-digits. Traditional carriers struggle to break even. To fight back, flag carriers have launched their own low-cost brands, such as Lufthansa’s Germanwings and IAG’s Vueling.

But the era of travel at the very lowest cost is over, say airline executives. Ryanair, which has the lowest costs in the industry, according to Centre for Aviation data, last year announced plans to improve its customer service amid two profit warnings by the company. It has aped easyJet with improvements, such as a more user-friendly website, dropping punitive charges for forgotten boarding cards and allowing a second small bag to be carried free on board. Yet analysts are divided on Ryanair’s ability to polish up its public image

Already Europe’s biggest airline with 82.7m passengers in the past year, Ryanair is looking to take a bigger slice of the lucrative business traveller market, as easyJet has done. This amounts to another step into the territory of traditional carriers.

While the pair have built an advantage as Europe’s leading budget carriers, Ryanair has been less successful than easyJet in developing a route network. EasyJet, Europe’s third biggest carrier after Lufthansa – with 63.4m passengers in the past year – has steadily built slots at the bigger and popular primary airports, such as Charles de Gaulle in Paris.

The budget airlines’ success has enticed new entrants into the market. Norwegian Air Shuttle, Europe’s number three low-cost airline, is mounting a big challenge with its attempt to take budget flying into a new phase – long-haul, another preserve of the traditional airlines.

Behind Norwegian are Vueling, Hungary’s Wizz, and Turkey’s Pegasus.

“We see a push from the low-cost carriers to move upwards,” said Holger Taubmann, vice-president of distribution at Amadeus, an online distributor of tickets and other services for the industry, whose clients include easyJet and Germanwings.

It is a reflection of their success that the budget airlines have seen traditional carriers copy them. Just as Ryanair sells assigned seating and hold space for luggage as extras, British Airways has started to charge more for additional checked baggage. “Full-service carriers are emulating low-cost carriers, trying to sell additional services,” says Mr Taubmann.

Average revenue from such services has risen for airlines from zero in 2007 to almost $20 per passenger now, says the International Air Transport Association.

Competition may be toughening but it comes at a time of rising commercial airline profitability in Europe, where total net profit of all airlines, including low-cost carriers, is expected to reach $2.8bn this year. That compares with $500m in 2013 and is driven by the low-cost airlines, says Iata.

With airlines’ business models converging and traditional airlines forced to retrench, analysts agree that the sector is set for further consolidation.