The article examines the sustainability of the low-cost, or
no-frills, airline business model. It looks at the background to the
development of this managerial approach within the context of some
prevailing business theories and considers variations on the basic
low-cost airline model. It assesses, drawing from the experiences of a
number of markets, whether the model in itself is likely to be enduring,
or whether it is simply a transient way for some airlines to recover
their full costs.
Low-cost airlines, airline markets, airline finances, market
The low-cost airline model (often called the "no-frills"
model in Europe because airlines offer only basic services to their
customers) has been the subject of intense interest and study. The
"Southwest effect," basically the drop in fares that occurs
when a low-fare airline begins serving an airport that had previously
had no low-fare carriers, has become part of the vocabulary of air
transportation. This article looks at just how successful the low-cost
model is in its broadest context. In particular, while clearly some
airlines pursuing the low-cost approach have largely endured and
prospered, the question remains as to whether this is because of the
underlying business model or is a function of good management exercised,
perhaps, with an element of Napoleonic luck on the part of the
individuals running these companies.
We begin by exploring the criteria against which success should be
measured, and the nature of the market environment in which low-cost
carriers have emerged, and then move on to see how they have fared in
the Spencerian world (Spencer 1882-96) of Lamarckian evolution in which
The Concept of a Successful Business Model
To assess the achievement of any business model one needs criteria
to set it against, essentially in some forms of matrices, and a
benchmark. Success in business can be assessed on several dimensions. In
terms of the business community, it may relate to profits, the standard
neoclassical rent-seeking criteria, but business success may also be
seen in relation to market share or sales revenues (Baumol 1962).
Internally, the management of a firm may also see success in the context
of how well the firm performs in a number of defined areas (Williamson
1975), or it may more broadly "satisfice" (Simon 1959) and
think in terms of meeting a much wider range of objectives such as
sales, profits, market share, labor-force retention, and share price.
From the perspective of antitrust authorities, success is the absence of
the exercise of market power, either in terms of extracting economic
rents from consumers or through the enjoyment of X-inefficiency. (1)
From a technology perspective, success is normally associated with new
or innovative processes that overcome some barriers to production and,
thus, reduce costs significantly, allowing economic development (Rostow
1960). From a social perspective, the issue is one of welfare
maximization, often articulated in the transport context as meeting some
standards of mobility or accessibility, whichever is the political
fashion of the day. The recent interest in the environment often sees
industrial success as something that may not always be consistent with
"sustainable development" in the Brundtland sense (World
Commission on Environment 1987). Finally, in the short term, the
macroeconomic climate after 2008 has often seen success couched in terms
of the creation or retention of jobs.
Here we treat the low-cost airline model as an attempt to
circumvent a particular and narrow market problem, namely the
historically low operating margins in the scheduled airline market.
Since the advent of gradual liberalization of scheduled airlines around
the world, there has been a singular difficulty in carriers maintaining
operating margins above zero, and certainly at a level found in most
other sectors of the economy. This problem and its root cause are
discussed in more detail in the following sections. Business models that
have tried to resolve this problem have been explored by airlines, most
notably those associated with hub-and-spoke operations and a number of
innovative practices, such as frequent-flier programs, business lounges,
and computer-reservations systems (CRSs). Among these various business
models, the low-cost model has often been seen as one of the more
What this notion of success may not coincide with is the short-term
maximization of consumer welfare. There seems little doubt that low-cost
airlines have, in many markets, resulted in lower fares in the short
term for travelers and a greater selection of service types. The notion
of success adopted here is geared more toward long term than short term,
and reflects the arbiter of enduring business success in a competitive
market. It construes social welfare maximization rather than
shorter-term considerations such as current share values or margins.
Essentially, success here is seen as the development of a sustainable
and pervasively X-efficient industry that is financially viable. Success
for one or two businesses pursuing a particular approach to their
activities is not axiomatically seen as a successful business model.
They may have benefited from other factors that added to their success
such as the quality of their management, or they may just have found a
narrow market niche into which they fit for a period of time. A
successful business model, in our context, has to be one that is widely
and successfully adopted, provides stability in the market, and remains
in use for an extended period of time. These are essentially soft
criteria akin to a structure, conduct, performance approach.
The Basis of Airline Competition
Although there were important national differences, until the late
1970s all airline markets were virtually highly regulated, and airlines
were often publically owned, frequently enjoying both direct and
indirect subsidies. The changes from the late 1970s thrust airline
management from a world with well-defined parameters into one not only
involving considerable commercial risk (the "known unknown" to
quote Donald Rumsfeld , the former US Secretary of Defense), but
also considerable uncertainty (Kahn 1988b). Risk is something that
management schools teach students to handle through various forms of
hedging and insurance, but uncertainty is more challenging. The natural
business inclination is to minimize it where there is an intuition that
it exists, and this is essentially what the legacy airlines have sought
to do. They have sought to minimize competition by developing fortress
hubs, and to tie customers in with frequent-flier programs. However,
this is only one of two broad strategies business may adopt.
Michael Porter (1985) in his classic book on management,
Competitive Advantage, argues that to be successful in a market, a
supplier must pursue one of two alternative broad business options.
First, it may try to differentiate its product to gain a degree of
monopoly power. In the airline context, this business option involved
traditional airlines that had grown under regulatory protection and, in
many countries, were still state owned. These traditional airlines tried
to exploit economies of scope and scale, as well as market presence, by
developing extensive hub-and-spoke networks around one or two major
airports. These airports then acted as consolidation and dispersal
points for traffic akin to a post office sorting depot (Morrison and
Winston 1995). They added to their strength by seeking to control
information flows through CRSs that allowed the airline owners of
systems, through travel agents, to favor their own flights when flight
options were displayed to potential customers. Such an effect was
further reinforced through the halo effects associated with bonuses
offered to agents who achieved high bookings for the CRS-owner airline.
The CRS system, and the flow of information that it provided, also
allowed the airlines to adjust the fares offered to customers to reflect
their willingness to pay and, thus, price discriminating between those
who are more or less fare sensitive. In addition, the traditional
carriers formed alliances with both other major airlines and feeder
carriers. The alliances created seamless services for customers and more
integrated schedules of service that minimized the time required to make
interline connection at a hub airport.
The alternative highlighted by Porter (1985) was for a business to
compete on the basis of cost, that is, to develop and maintain a market
share by offering its products at lower prices than its competitors.
This "low-cost leadership" business option has been the
approach of the low-cost carriers. They have sought to establish, and
subsequently sustain, themselves by undercutting the fares offered by
rival airlines. While the title "low-cost" airline is widely
used, the business models adopted can vary quite considerably between
carriers. Some carriers, for example, focus on secondary airports in
cities, whereas others serve the major hubs; some offer no online
services, whereas others do; and some have frequent-flier programs,
whereas others do not. In addition, in some cases traditional airlines
have operated divisions or subsidiaries that have sought to be low cost.
Defining a low-cost carrier is, thus, a little like the famed words of
the US Supreme Court Justice Potter Stewart when discussing obscenity,
"I shall not today attempt further to define the kinds of material
I understand to be [obscene].... But I know it when I see it." (2)
The low-cost approach in aviation has a long history. The first
successful low-cost carrier was Pacific Southwest Airlines in the United
States, which pioneered the concept in 1949, and companies like
Southwest have been in business since the early 1970 (Gittell 2005). In
that sense, one could say the business model has worked. This
proclamation, however, is somewhat deceptive not only because long-haul,
low-cost carriers have never really gained a market niche, but also
because numerous large carriers that do not follow the low-cost path
still survive, despite many years of "deregulation." (3)
The Underlying Issue
The financial performance of the airline sector in general has
hardly been stellar over the past two decades. The industry as a whole
suffers from severe cyclical fluctuations in demand and overall has
operating margins well below most other industries (as shown in figure
1). Even within the larger air transport chain, airlines perform poorly
compared to other players such as airports, global distribution systems,
and airframe and aero engine manufacturers (Button 2004).
[FIGURE 1 OMITTED]
The problem with the airline market is that it is highly
competitive, but at the same time has the peculiarities of a form of
fixed costs found in a number of service industries such as professional
sports and the theatre. (4) These industries are not characterized by
the fixed costs of bricks and mortar of the type Alfred Marshall (1890)
wrote about a century ago, but rather by the commitment to offer a
scheduled service. The fact that an airline has to have an aircraft,
whether owned or leased, is immaterial; sitting at a gate at particular
time, along with various services required at the origin and
destination, is de facto a fixed cost. Examples of services adding to
the fixed cost are pertinent to slots at both ends of a flight: a full
crew, fuel, and other supplies on board, and ground staff committed to
booking, ticketing, boarding, and baggage handling for the flight. It
matters little whether the flight has a zero load factor or a 100
percent load factor; these costs have to be borne. To further complicate
the matter, the commitment to the service is made months in advance.
Thus, costs cannot be completely known, albeit this is largely a matter
of commercial risks and can often be insured against in a variety of
ways, of which fuel hedging has attracted the most attention (Carter,
Rogers, and Simkins 2006).
While the cost side of air transport is not simple, it does in a
number of ways reflect many other industries. The challenge is the
recovery of fixed costs in a competitive market environment (Button
2003, 2005). In the extreme case of full information and atomized
competition and innumerable potential customers, airfares are pushed
right down to marginal costs and no contributions to fixed costs are
made. This problem of an "empty core" has been known to
economists for well over a century (Edgeworth 1881), and one reason that
Coase was awarded his Nobel Prize was for his work on cost recovery in
this type of market structure. (5)
Perhaps more by instinct than logic, the problem of the empty core
in the air transport case has either been directly handled by government
interventions, or by cross-subsidies. The former are most notably
through direct subsidies with the taxpayer covering the fixed costs,
while the latter are through the conceding of institutional monopoly
powers with the granting of licenses or concessions that allow airlines
to charge above marginal costs. These measures have largely been
abandoned because of the recognition of both political capture and the
degree of X-inefficiency that manifestly resulted. One practice that has
remained in the United States, although not to the same extent in
Europe, is simply to allow airlines to write off losses through Chapter
11 bankruptcy, despite the moral hazard issues it creates.
Any supplier's natural instinct in a perfectly competitive
market is to try to carve out some form of monopoly power, so as to put
some slope on the demand curve that is confronting it. This means
following the first approach posited by Porter (1985) in which
traditional airlines have sought to distinguish their products in a wide
variety of ways. In some cases, they have engaged in the international
market, focusing increasingly on services that have remained protected
under restrictive air-service agreements, although the scope for this
strategy has shrunk as the "Open Skies" and similar policies
have spread. Frequent-flier programs have offered "bonuses" to
loyal customers, and there has been market segmentation between various
types of traveler, both in terms of motivation (business, leisure,
visiting friends and relatives) and distance (short haul and long haul).
There have also been efforts to control terminal facilities (the
"fortress hubs") and measures to offer seamless services
(strategic alliances). (6) However, the aforementioned approaches have
generally only stemmed off competition temporarily. In some cases they
are easily replicated (as in the case of frequent-flier programs that
are now ubiquitous and largely uniform), and in others they have been
successfully counteracted by competitors (as with
"hub-busting," direct services).
While many of the measures of product differentiation remain in the
airline sector, their potency has seldom solved the cost-recovery
challenge, even when the business cycle has favored the airlines (as we
saw in figure 1). The second approach, lowering costs of production
below competitors, entails focusing on just one element in the
competitive matrix, namely fares. Of course, this approach does not
exclude other elements--things are seldom black or white--but it is all
a matter of degree. The low-cost airlines seek to attract traffic from
competitors in the short term, while generating new traffic to cover
their immediate costs with the hope of forcing traditional carriers from
the market in the longer term so as to allow them to enjoy some degree
of monopoly power. This approach is essentially Bain's (1949) limit
pricing theory of business behavior in that the low-cost carriers do not
push fares back to their previous level once in a market to ensure that
legacy carriers remain uncompetitive on the routes involved; they retain
monopoly power without fully exploiting monopoly prices.
The industry has also been kept afloat, and enjoyed a flow of
investment that would not seem justified by the returns earned, by
forces not always embodied in neoclassical economic models, for much of
this theory suggests it should have gone by now. One explanation for the
flow of investment has been a possible money illusion. Because fares are
collected well in advance of the delivery of services, airlines maybe
seen to be cash rich with the potential of owners using that money to
earn a return elsewhere. There also seems to be a "Las Vegas
effect" in the sense that while the returns for the industry as a
whole may be low, some airlines do well for periods. Southwest shares,
for example, earned well above the average for the US stock market
throughout the 1990s. The actors further up the value chain, such as
airports and airframe manufacturers, simply cannot allow the airline
industry to die because of the money they make by selling their goods
and services to it and thus support it. Finally, airplanes present a
largely irrational fascination for many people and this stimulates them
to invest; to them it is a "sexy" industry. Warren Buffet
considered himself in an interview to the Sunday Telegraph in 2002 a
"reformed aeroholic" after losing $300 million or so in a
USAir investment in the mid 1990s. Buffett, in his 2008 annual letter to
Berkshire Hathaway shareholders, perhaps best sums up the general
outcome of all of these forces.
The Low-Cost Airline Model
Although there is no single form and description of a low-cost or
no-frills carrier (Mercer Management Consulting 2002), there is some
agreement about its basic characteristics. In very general terms,
low-cost carriers offer low fares by using a range of broad
differentiation strategies. These strategies both remove some elements
of cost from their production functions and reduce the levels of many of
the remaining costs. (7) In doing so, they offer more limited services
and, in some cases, charge separately for the attributes they do offer,
which vary among low-cost airlines. (8)
Simple comparisons show that the operational advantage of low-cost
carriers such as Ryanair often lies in the radial short-haul networks
they operate with no online services. Such services are virtually
exclusive to second-tier airports centered around a "base"
airport that allows for the maximum utilization of a standardized
aircraft fleet and crew without the congestion. An additional advantage
is the avoidance of the repositioning costs associated with mixed
distance, on-line services through a hub using a varied fleet. Other
low-cost carriers have variants on the basic low-cost model. EasyJet,
for example, serves many of the larger airports, whereas Air Berlin has
a frequent-flier program and is joining the oneworld alliance. In spite
of these variations, all low-cost carriers are aggressive in keeping
costs to a minimum by charging for on-board services, having quick
turnaround times for their aircrafts, cutting out sales commissions, and
striking hard bargains with airports and other suppliers.
Essentially, a key element of the low-cost business model is one of
unbundling and a focus on core business. Many of the attributes of a
full-service, legacy carrier (e.g., meals, extra baggage, more
comprehensive insurance) can be obtained from a low-cost airline at an
additional price. (9) The overall philosophy and features of low-costs
carriers, whether or not admitted by all, were well summed up by Michael
O'Leary, Ryanair's chief executive officer, when he said,
"air transport is just a glorified bus operation." (10)
The Impact of Low-Cost Carriers on the Overall Airline Market
Numerous studies have examined the effects of low-cost airlines on
the fares and the markets they serve. This group of studies shows that
the effect is lower fares than those offered by incumbent airlines,
which in turn leads to significant traffic generation to the extent that
the actual traffic volume of incumbents is little affected. Rather, the
impact on the latter is on their bottom lines, resulting from lower
revenues as they must reduce fares to stay competitive. While much of
the analysis has been on the domestic US market, where a 10 percent
ticket sample offers good fare data, the effect seem to be fairly
general. In most markets, for example, where low-cost airlines have a
significant presence, there have been major structural changes with
fares falling, overall demand rising, and the traditional carriers
losing market share (UK Civil Aviation Authority 2006). (11)
As a more elaborated example, Dresner, Lin, and Windle (1996)
hypothesized that the effect of Southwest and other low-fare carriers
may be greater than previously estimated. This is because of possible
spillover effects that Southwest's service on one route has on
adjacent competitive routes that involve nearby airports. They found
significant effects on services on adjacent competitive routes but did
not aggregate their results. Morrison (2001) took a more macro
perspective and looked at the actual, adjacent, and potential
competition Southwest brought to US routes in 1998. Results showed that
Southwest's passengers benefited by $3.4 billion (current prices)
in low travel costs, while those on other carriers gained $9.5 billion
in terms of lower fares.
Comparing the situation on either side of the Atlantic, Pitfield
(2008) found that the impact of Southwest in the United States has been
less than that in the majority of Ryanair routes he examined, except for
the start-up routes involving Stockholm and Hamburg. This finding seems
to be because the Italian destinations analyzed are more likely to be
dominated by leisure traffic than those studied in the United States
(with the exception of Las Vegas). Further, the number of carriers on
the routes is greater in America, and the scale of traffic is
considerably higher on all corridors, except London-Stockholm, which has
competitive pressure on the Irish airline. Finally, with its frequent
offerings of flights at a unit cost of 0.01[euro] per available seat
mile, taxes and charges excluded, Ryanair may be a more aggressive
competitor. Overall Pitfield found that Southwest, when it has
significant effects, has a smaller initial impact than Ryanair, although
the latter establishes larger market shares as a result of its impact on
competitors. It appears that US competitors are more competitive than
most of Ryanair's in terms of pricing and product differentiation.
The advent of low-cost carriers has also affected other elements of
the air-service supply chain, particularly airports. To keep their costs
down, low-cost carriers often use small, second- or third-tier airports,
and/or dedicated low-cost terminals at some major airports (De Neuville
2008). This practice, in turn, has added a new dimension to the
competition between airports seeking to attract low-cost carriers. But,
in doing so, airports engage in a form of competition that has been
alien to them in a more regulated environment (Dresner, Lin, and Windle
1996). The nature and extent of this competition, and which airports
succeed, depend not only on their competitive position in relation to
other airports, but also on the extent of monopoly power they can
exercise over the airlines. Francis, Fidato, and Humphreys' (2003)
case study analysis raises questions about the sustainability of
airports' relationships with airlines. The success of many lowcost
carriers has been explained by the rapid growth in passenger volumes at
airports where they operate. Yet many low-cost airlines have failed.
Given the proliferation of new low-cost carriers and the instability of
macroeconomic conditions, the ability to develop contractual
arrangements that reflect the risks of failure incurred by either party
becomes more difficult.
The Airline-within-an-Airline Model
To combat competition within their established markets, many legacy
airlines have, at various times, established their own low-cost
carriers. (12) Institutionally, the arrangements between the traditional
elements of a company and its low-cost offshoot have differed for a
number of reasons. The difference can stem from local legal
stipulations, the airlines' internal constraints (e.g., labor
agreements and slot availability), and the challenges of the particular
low-cost carriers that were penetrating the market. They also, in some
cases, have had wider objectives, such as to spin off profitable
business or to test out low-cost elements that they could later adopted
in their mainline operations.
These efforts at emulating the low-cost model, largely that of
Southwest, have generally proved to be unsuccessful. There has in many
cases been confusion on the marketing side in terms of the ability to
develop separate brand images (Morrell 2005). Operationally, they were
handicapped in the United States in particular by labor union agreements
that prevented costs from being reduced significantly, and by internal
management constraints that limited their operational freedom and
financial autonomy. In effect, they were seen as part of a larger
business model, encompassing a range of products along the lines of the
Procter and Gamble generic competitive strategy of broad
differentiation. This fraction prevented costs from falling low enough
to compete with the single-brand, low-cost airlines.
The European experience, where there has been some physical
separation of the low-cost offshoot by making use of different airports
(for example), has been a little more successful than that of US
carriers. Transferring decentralized traffic flows to the low-cost unit,
and deploying the aircraft of the network carrier exclusively to hub
operations as a work-sharing and positioning strategy for the business
units (e.g., in the case of Germanwings and Lufthansa), has had some
There is also some evidence that the
low-cost-airline-within-an-airline concept has proved useful as a
stopgap measure to combat the increases in market presence of low-cost
carriers while a legacy carrier restructures its own core operations
(Graf 2005). There is also some evidence, as with JetStar in Australia,
which provides a low-cost offshoot as an almost totally independent part
of the parent airline, that the concept can be successful at least for a
period, although whether this outcome is strictly
"an-airline-within-an-airline" becomes a moot point. In
general, however, they have not proved a successful concept and do not
seem to have added much to the ability of the overall scheduled airline
to recover its long-run costs, or, in economic terms, to increase its
Competition in Low-Cost Markets
We now turn to the stand-alone low-cost airlines and assess their
contribution to the provisions of scheduled services. There is no single
matrix for such an assessment, but there are a number of ways in which
insights may be gleaned.
Market Financial Robustness
Figure 1 illustrates the largely poor economic performance of the
scheduled airline industry going back well before low-cost carriers were
a significant presence. In the United States, low-cost airlines began to
make serious inroads into the market in the mid-1990s, and about five or
six years later in Europe, following the enactment of the full three
packages of European airline deregulation. (13) Simple examination of
the Figure shows little impact on the overall performance of the sector
after the incursion of low-cost airlines into the market. More recent
evidence in 2008 suggests that the overall industry is no more capable
of handling significant macroeconomic shocks than it has been in the
past. In the context of Ryanair, for example, it laid up over 80
aircraft in the fall of 2011 because of weak demand. In sum, while
Southwest now enjoys about a 25 percent share of passengers and a 15
percent of revenues in the US domestic airline market, the overall
market performance has not deviated from the historic pattern of
cyclical fluctuations around a zero operating margin. (14)
In any competitive market, one expects a number of firms to fail
and new ones to enter it. This pattern reflects shifts in demand that
require overall capacity adjustments. It also reflects the fact that
management, for one reason or another, is not homogeneous and Spencerian
forces lead to the inefficient leaving, to be replaced by the more
efficient. It is a judgment call as to how many airlines should, in a
well-functioning market with firms adopting appropriate business models,
be entering and leaving.
Table 1 provides some details of European low-cost airlines that
were forced to exit the market between 2003 and 2010. The low-cost
airlines that are now defunct were diverse and ranged from a number that
hardly began operations to others that were relatively successful, but
merged or were taken over (e.g., Go and Buzz). One could draw up a
similar list of defunct airlines in the United States and most other
countries. The simple situation is that with this level of attrition,
the first-movers, Ryanair and easyJet, now account for more than 88
percent of the scheduled low-cost market in Europe. Southwest Airlines
holds 50 percent of the US low-cost market. There are, in other words,
successful companies, but that is not the same thing as a successful
business model. Replication seems to have been challenging. Further, the
successes seem to be those that entered the market first, indicating
that replication of the business models is far from simple.
At the more micro level, individual low-cost airlines are often
less than stable in terms of the services they provide. Where there are
exceptions such as in the case of Southwest Airlines, which has tended
to steadily build its network with few subsequent withdrawals, this is
not always the picture. In Europe, for example, the development of
services at Stansted Airport, Ryanair's main base, shows both new
routes and dropped routes (see table 2). While the growth is clear, it
has not been in a strictly incremental way; indeed if anything the
volatility of route entry and exit has grown as low-cost carriers
service have expanded.
In markets that have significant fixed costs, either the
conventional "brick and mortar" type or the fixed commitment
type that we have argued are associated with the scheduled airlines
services, suppliers require a degree of market power to recover their
costs unless government helps. The success of a market with these
technical features relies on such features. Testing for market power
using such measures as Herfindahl Indices to assess market concentration
is not very useful in this case, for it gives no insight into
contestable forces and provides no indication of the dynamics of the
marketplace. The fixed-cost element in air transport is also individual
service specific, rather than route specific.
One way that market power in offering a specific service has been
looked at recently is through the use of "data scraping." This
approach entails going to travel websites, often the airlines', and
examining the pattern of fares offered for a particular flight as the
time of departure approaches. In other words, it involves collecting all
the fares, F, for each day (or some other time division), t, from a date
prior to the flight until the actual takeoff. The airlines that practice
this dynamic price discrimination essentially try to capture the rents
from any flight seen under the normal demand curve (the shaded area on
the left element of figure 2) by offering fares that rise as the time of
a flight departure approaches (collecting the revenue under the
fare-offered curve in the right side of the figure). The highest fare
offered will not exceed F* or fall below the short-run marginal cost
[FIGURE 2 OMITTED]
Perfect third-degree price discrimination is more of a theoretical
concept than a practical reality, and so the full amount that temporal
fare variations capture will not completely see all consumer surplus
extracted by the airline. The extent to which a carrier can extract
sufficient rent above SRMC to cover its fixed costs of a committed
service is also influenced by the slope of the demand curve and, ipso
facto, the amount of revenue that is raised under the temporal
fares-offered curve in the right-hand element of the figure. Fares rise
toward departure because last-minute bookings are largely made by
individuals with limited choices and fewer prior insights into their
future travel needs (generally business travelers). (16)
Much, therefore, depends on the extent and time period seats to
which can be sold at prices above SRMC. A priori, one would anticipate
that if the airline is a monopolist, then the demand curve on the left
of figure 2 will be relatively steep and up-turn of the fares-offered
curve would come quite early and rise steadily. If there is imperfect
competition (essentially other flights on the route at nearly the same
time), then the ability to substitute between airlines increases and the
slope of the target carriers demand curve flattens on the left and the
up-turn in the fares-offered curve comes later and is less pronounced.
Less revenue is, thus, earned and the contribution to the fixed cost of
the service is reduced. There may also be some fluctuations in the
pattern of fares offered over time as the carrier seeks to "play
games" with competitors or to gain more insights into the demand
elasticity at a particular time prior to departure. If there were
perfect competition in the market for a particular service, then both
the demand curve and the fares-offered curve would be flat. (17)
There are clear limitations to this methodology, and we just list a
few. Only one class of seat (e.g., business class or coach) can be
analyzed at any one time, but competition between airlines extends into
mixture of classes they offer. It makes no allowance for free seats
occupied by frequent-flier-point redeemers. For comparative purposes,
there is generally a need to compare similar services, but definitions
of rival services are subjective. For instance, does the 8:30 AM flight
offered by airline Z between A to B on a particular date compete with
the 9:00 AM flight offered by airline X, or the 10.15 AM flight by
airline Y? The situation becomes even more complex if the 10:15 AM is
not provided by airline Y, but by Z. In other words, flights may compete
with others offered by the same airline. Perhaps most importantly, there
is little feel for the actual uptake of flights when data scraping, and
so the elasticity of demand that indicates the willingness-to-pay and
not what is being offered is not being explicitly measured.
Empirical analysis supporting the logical basis of the temporal
fares-offered curve has been fairly well established in studies of
European and American air transport markets (e.g., Pels and Rietveld
2004; Barbot 2006). As an example gleaned from figure 3, a US nonstop
monopoly market, served between Phoenix and Des Moines at the time by
America West Airlines, illustrates the fairly consistent rise in fares
as time of departure approaches. This general pattern of temporal price
differentiation holds irrespective of whether the monopoly airline is a
low-cost carrier or pursues the traditional, full-service business
model. Of more interest in terms of whether the low-cost model is
successful is what happens when two carriers offer nearly identical
services, differentiated largely by a small difference in departure
times. Again the pattern is consistent and has been examined in detail
in other works. Figure 4 simply offers an example, again from the United
States, of a duopoly situation and the volatility that arises in that
the lack of a significant and consistent fare rise close to takeoff is
clear. Other studies that have looked at services where there are more
than two competitors show a further flattening out of the temporal
[FIGURE 3 OMITTED]
Much of the analysis using data scraping has not been concerned
with the issue of the success of the low-cost model per se, but rather
with its relative performance vis-a-vis the traditional full-service
model. Of particular relevance to assessing the success of the low-cost
business model has been attempts to look for market leadership using
such techniques as Granger causality testing (Button and Vega 2007) and
ARIMA time series models (Pitfield 2005a, 2005b). The findings suggest
that there is little evidence of price leadership in markets where there
are several suppliers, which in turn indicates the lack of any marked
degree of monopoly power. Thus, even when there are both low-cost and
traditional, full-service suppliers offering near-identical services in
terms of departure times, there is no indication that one type of
business dominates others. More importantly, in terms of the absolute
success of a particular business model, there is no evidence that this
flattening out, and often irregular, pattern of fares being offered
diminishes when it is low-cost carriers competing with each other rather
than low-cost airlines confronting legacy carriers.
[FIGURE 4 OMITTED]
That low-cost airlines have enjoyed some financial success may,
thus, not be because of the business model per se, but rather the nature
of the markets that they have entered. Some airlines have enjoyed a
degree of economic rent, allowing full cost recovery by simply avoiding
competition, and the same would seem to be true of routes served by
traditional airlines on parts of their networks. Avoiding competition is
hardly a novel way of approaching business and cannot really be defined
as a business model in the full meaning of the term. More importantly,
in terms of success, it may only be a transitory solution. Traditional
carriers, for example, may respond by entering these markets to compete
and thus ensure the integrity of their larger operations. But regarding
short-haul market, other low-cost carriers may enter the market and thus
reduce the potential for rent extraction.
The Issue of Bilateral Monopolies
Low-cost carriers have exerted an influence on airports, both by
stimulating the development of basic, regional facilities, and by
forcing many established airports to reassess the way they operate.
Low-cost carriers seldom want the "frills" that are found at
traditional airports, but instead focus on keeping costs to a minimum
and in many cases forcing the airports to rely on land-side and
concessionary revenues rather than air-side, takeoff, and landing fees.
Ryanair, for example, has a reputation for being particularly aggressive
in its negotiations with airports (Barrett 2009).
The low-cost airlines have been able to do so in the past at
smaller airports because of asymmetries in the bargaining situation,
particularly in Europe (Button 2010). The situation has often been in a
bilateral monopoly context between a single low-cost carrier and a small
airport. (18) In these cases, the outcome, except in very specific
cases, is unclear and depends on the bargaining strength and information
held by both parties.
When the airport is spatially constrained, the ability of the
airline to choose to put its resources in other markets gives it an
advantage in many cases. For the traditional carriers, their need for
large hubs, of which there are few, and an integrated network involving
strategic nodes puts them in a weaker position.
While there are numerous examples of low-cost airlines that are
still able to enjoy the upper hand in negotiations with airports, the
situation is no longer as clear-cut as in the past (Francis, Fidato, and
Humphreys 2003). (19) The growth in the number of low-cost airlines,
plus the fact that in many cases the transactions are increasingly about
renewals of contracts at airports where a carrier has already sunk
costs, has reduced the power of the carriers.
That the low-cost airline model was initially successful for a
number of airlines is obvious. The expansion of the intrastate carrier,
Air Southwest out of Texas to become Southwest Airlines in the United
States, the rapid growth of Ryanair and easyJet in Europe, and the
emergence of carriers such as Gol and Tiger in emerging BRIC (Brazil,
Russia, India, and China) markets attest to the impact of the low-cost
airline model. It is also clear that low-cost airlines have been
instrumental on pushing down airfares, opening new markets, and allowing
people who could not do so before to travel by air. However, success for
a few firms is not the same thing as a successful long-term business
model; the achievement needs to be more widespread. Also, the generation
of social welfare through lowering travel costs does not establish a
successful business if the full commercial costs of the system are not
borne by its users, but rather by its investors.
Low-cost carriers have performed well when they have established
monopoly power, but this is a transitory situation in the context of
modern open-air transport markets. It is quite a legitimate tactic
within a Coasian world of competition and fixed costs but, as with other
strategies that have been deployed over the years, is not one that is
likely to prove enduring. The low-cost airline model is, thus,
successful in the same way that frequent-flier programs, fortress hubs,
and the like provided success to the traditional airlines. It is,
however, not a success in terms of meeting the fundamental long-term
problems of providing scheduled services in a highly competitive market.
One manifestation of this repercussion has been the gradual
transformation of Southwest in the United States. The airline has
entered more major markets, offered frequent-flier facilities, engaged
in yield management, provided online service (now about a third of its
traffic), and rewarded frequent fliers; all of which are not the
features of a low-cost airline. Ryanair has also seen changes, albeit
much less so, with limited services offered to major airports such as
Madrid-Barajas and London Gatwick.
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Earlier versions of this article were presented at the German
Aviation Research Society Workshop on New Issues in Airline and Airport
Economics held in Hamburg in 2009, and at the Aviation Policy Research
Association in Tokyo in 2011. I would like to thank attendees at these
meetings, and those who subsequently responded to a mimeo version of the
paper for their very helpful comments.
(1.) Market power per se is not normally an issue, but rather it is
whether firms abuse it (Kahn 1988a).
(2.) In his concurring opinion in Jacobellis v. Ohio, 378 U.S. 184
(3.) The first airline attempting no-frills transatlantic service
was Laker Airways with its famous "Skytrain" service between
London and New York City in the late 1970s.
(4.) These costs may also be seen as "sunk" costs in the
tradition of the analysis of contestable markets developed by Baumol,
Panzar, and Willig (1982). They are costs that cannot be recovered if no
one uses the flight and the resources are not easily transferrable.
(5.) The "empty core" problem can be couched in terms of
Alfred Kahn's famed statement in 1977, when he was about to
deregulate the US airline market: "I really don't know one
plane from the other. To me they are just marginal costs with
wings." This statement is true, but it relates only to short-run
costs, but some thought is needed regarding the long-run costs in a
competitive environment. As the Nobel citation said of Coase's
work, he had explained why "traditional theory had not embodied all
of the restrictions which bind the allocations of economic agents."
(6.) In perhaps slightly less technical terms, Michael
O'Leary, Ryanair's chief executive officer, summed up the
business model rather well; code-sharing, alliances, and connections are
all about "how do we screw the poor customer for more money?"
"Full-Service Airlines Are 'Basket Cases,'"
Bloomberg Business Week, September 12, 2002,
(7.) Barrett (2009) has a good explanation of how Ryanair works.
Some idea of the cost differentials between low-cost and traditional
carriers is that the 2005-6 unit cost per available seat mile for
Ryanair was 0.04 [euro], 0.059 [euro] for easyJet, 0.078 [euro] for
British Airways, and 0.097 [euro] for Delta (Davy Stockbrokers 2006).
(8.) The low-cost model is also not static, but has evolved since
its generally agreed introduction by Pacific Southwest Airlines
(Alamdari and Fagan 2005).
(9.) Michael O'Leary, CEO of Ryanair, for example, defines the
carrier's rather basic accident insurance policy thus: "We
don't fall over ourselves if they say, 'My granny fell
ill.' What part of no refund don't you understand? You are not
getting a refund so f*** off" (cited in Griffiths 2004).
(10.) "Full-Service Airlines Are 'Basket
(11.) There are about 60 airlines across Europe offering a version
of the low-cost theme. Ryanair is the largest air carrier of passengers
(12.) Graf (2005) offers a useful table listing the main ventures
by which legacy carriers enter into the low-cost airlines market.
(13.) In 1997 they accounted for about 2.5 percent of the European
air seat miles offered, but this share grew to over 95 percent by 2002.
Prior to that, scheduled carriers, focusing primarily on business
travelers, controlled 75 percent of the intra-European market. Charter
airlines held the remaining 25 percent by selling aircraft capacity to
tour operators and shuttling sun-seeking package tourists from cold
Northern European countries to the beaches of Southern Europe.
(14.) The recent operating margins for Southwest, for example, were
6.4 percent in 2003, 6.2 percent in 2004, 9.6 percent in 2006, 10.8
percent in 2006, and 8.0 percent in 2007.
(15.) The area under the fares-offered curve is not identical to
the revenues collected with price discrimination as seen in the right
side of the figure because there is no indication of the number of seats
actually sold in each period.
(16.) In multiclass-configured cabins, there may be fare dilution
as travelers trade between classes. In these cases, a distinction should
be drawn in the fares paid that separates out the rent extracted for
booking late from the additional costs of offering extra space, larger
luggage allowances, more extensive refreshments, a higher
attendant/passenger ration, and so on. All studies using data scraping
methods tend to focus only on the lowest fare for a flight, in part to
avoid this issue.
(17.) The fundamental definition of perfect competition is that any
supplier in the market is confronted by a perfectly elastic demand curve
(18.) Some indication of the ability of Ryanair and, albeit to a
much lesser extent, easyJet to exercise power at airports can be seen by
the fact that the former has on average 0.17 competitors and the latter
0.80 on a sample of 2,705 routes studied by the International Center for
Competitiveness Studies in Aviation (2010).
(19.) The withdraw of a 3 [euro] passenger surcharge at Frankfurt
Hahn Airport in January 2009 after threats of service transfers by
Ryanair is an illustration of this negotiating power dynamic.
The worst sort of business is one that grows rapidly, requires
significant capital to engender the growth, and then earns little
or no money. Think airlines. Here a durable competitive advantage
has proven elusive ever since the days of the Wright Brothers.
Indeed, if a farsighted capitalist had been present at Kitty Hawk,
he would have done his successors a huge favor by shooting
Table 1/European Low-Cost Carriers That Ceased to Exist
Aeris Color Air Hellas Jet
Agent Direct Fly Hop
Air Bosnia Dream Air Jet Magic
Air Andalucia Duo Jetgreen
Air Polonia Europe DutchBird JetsSky
Air Scotland EastJet JetX
Air Catalunya EU Jet MyAir
Europe Air Exel Europe Exel Aviation Group Low Fare Jet
Air Freedom Fairline Austria Maersk Air
Europe Air Flyglobespan Now
Air Littoral Fly Eco Silesian Air
Air Luxor Fly West Skynet Airlines
Air Madrid Flying Finn Sterling Airlines
Air Polonia Free Airways Spirit of Balkan
Air Wales Fresh Aer Swedline Express
Airlib Express Germania Express V Bird
BasigAir GetJet Poland VolareWeb
BerlinJet GetJet Virgin Express
Bexx Air Go Fly White Eagle
BuzzAway Goodjet Windjet
Note: Most of these airlines operated for a period and then went into
bankruptcy. Some, such as Go Fly and BuzzAway, merged with successful
low-cost airlines. In a few cases, the airline was registered,
but never offered actual services.
Table 2/Route Changes at Stansted Airport, London
Year New Routes Dropped Routes Net Change in Routes
1996 6 -2 4
1997 5 -8 -3
1998 16 -3 13
1999 21 -3 18
2000 23 -8 15
2001 18 -13 5
2002 18 -13 5
2003 27 -11 16
2004 19 -13 6
2005 18 -7 11
Source: UK Civil Aviation Authority (2005)