Will it be the end of Low Cost Carriers?
By: Prakash Devara
Tags: Aviation, Airlines, Covid 19, Aviation Industry

“Low fares. Nothing to hide!” “Now Everyone Can Fly” “Fly cheaper” “Pay less fly more”

Does it sound like a slogan competition? Nah! These are the taglines of some of our favorite Airlines — Southwest, AirAsia, Ryan Air, and Air Arabia in the order. What do they have in common? They are all Low-cost carriers! Just a glimpse at those taglines will tell you the kind of disruption they have brought to the flying world! If not for them, flying would still be a distant dream for many.

One of the major innovations in the post-deregulation of Aviation industry is Low cost model, started in US led by Southwest and replicated across the globe. With no-frills concept, Fares have come down drastically in whichever market they have entered benefiting the PAX in big way. And it is not like ‘One man’s loss is another man’s gain’ — entry of LCC’s expanded the market, increased competition among carriers resulting in innovation and eventually benefiting the aviation ecosystem in large and communities on whole.

In this article I would like to share my views on how the current Covid crisis is impacting and will impact LCCs. Before we dig deeper, let us understand few basics of LCC model.

Target PAX: LCC’s core customer base comprises of leisure travelers who are largely price sensitive. While in FSC (Full-service carriers) — business class passengers contribute to the larger revenues and are profitable customers, LCCs do not have such customer segment. Smarter LCC’s bank on ancillary services to increase their revenues. For example, 30% of Ryan Air’s 2019 revenues come from ancillary services. By and large, ancillary services contribute 30–50% of LCC’s annual revenues. Ancillary services include- baggage fees, internet services, extra legroom, seat preferences, retail sales, Hotel/travel operator commissions etc.

With that said, when economic scenario is grim, leisure travelers tend to look for alternatives. Below excerpts are taken from 2019 Annual report of Southwest Airlines.

For some consumers, leisure travel is a discretionary expense, and short-haul travelers, in particular, have the option to replace air travel with surface travel. Businesses are able to forego air travel by using communication alternatives such as videoconferencing and the Internet or may be more likely to purchase less expensive tickets to reduce costs, which can result in a decrease in average revenue per seat.

So, LCC PAX are price sensitive in nature and easily move towards other substitutes when Air Travel becomes costlier. This brings us to the next important aspect, Fare.

Average Fare: Average ticket fare is calculated by dividing total ticket revenue with total revenue PAX. For the analysis purpose, I have taken the data from Ryan Air’s 2019 annual report, for 2 reasons.

Ryan is, in my opinion, the most innovative and successful LCC from Europe And, it has all the historical data with key metrics for the analysis

In the below graph, if you look at the trend, fare is decreasing YoY while PAX numbers are growing YoY. The inference from the this graph tells us, how fall in average fare led to more traffic for Ryan Air.

In the next graph, you could see while ticket revenue per Pax(Average fare) is in decreasing trend, ancillary revenue per PAX is slightly increasing. Which tells us how LCCs have banked upon ancillary revenues to increase overall revenues.

Break-even load factor: Now, let us look at another important metric — Breakeven Load Factor (LF). It tells us the no of seats that need to get filled in a flight to cover the costs. While the oveall LF is at steady rate of 94–95%, Breakeven LF has increased significantly from 72% in 2016 to 83% in 2019. This implies of cost carrying PAX per flight has increased and they were achieving breakeven only after filling their seats at 83%

So, what does it all imply?

LCC business is a volume game, carriers make money only when maximum number seats get filled Low fare is the main attraction for the customers; if price gets increased, customers will look for alternate transportation modes To remain profitable, LCCs need to make sure flights are filled with PAX with good Load factors Ancillary revenues will remain crucial for profitability, any dip in this share will affect financial health of LCCs

Now, let us look at the key changes brought by Covid-19 to aviation:

As of 3rd week of April 2020, IATA estimated PAX demand will get plummeted by 48% in 2020 compared to 2019

Recovery in the industry is a long battle as experts are estimating beyond 2023 by when recovery happens to pre-Covid levels (I would say it is very optimistic)

Social distancing will become a norm in Aviation and carriers, may have to keep either rows or middle seats empty, which means carriers will have to fly with lesser capacity

Key question is — Can Airlines, especially LCCs, afford this? Obviously, no, not all LCCs can afford this. Due to the present travel restrictions across the globe, and unemployment & global recession, income levels of leisure travelers will take a hit. This reduces the demand naturally, which means the struggling carriers and operationally inefficient carriers will have to close the shops, which leads to natural reduction in supply. There will be a situation where both Supply and Demand levels will come to an equilibrium.

The only carriers who can withstand this shock-wave are those carriers with strong balance sheet and operationally efficient ones. Even then, we can expect price wars within these few carriers to gain market share in short term, till a point competition is edged out. But, in the long run, it will be naïve to expect the low cost being the core model of LCCs.

To summarize, in my view, Low-cost carriers may exist, but Low-cost travel may not.

Thank you for your time in reading this article and would welcome your thoughts. Stay safe and take care.