Introduction
Low-cost carriers such as Southwest Airlines and AirAsia are becoming increasingly prevalent worldwide. They offer their customers access to quick travel at considerably lower prices than their more traditional network, or flag, carrier counterparts. As a result, their popularity has grown rapidly since the inception of the concept in the 1970s, when Southwest Airlines started operations. However, despite their popularity, not all low-cost carriers succeed, and there have been numerous closures of operators. Moreover, many network carriers also remain in business despite not introducing competitively priced services. These tendencies suggest that the low-cost carrier model has some underlying issues, while the traditional approach retains some distinguishing strengths. This report will analyze the theoretical foundation of the low-cost airline industry, compare it to the flag carrier model and describe the opportunities and threats that face the new and disruptive industry.
Theoretical Basis and Business Environment
The emergence of low-cost carriers is generally associated with a phenomenon known as deregulation. According to Bowen (2019), before it, national agencies controlled who could and could not operate aircraft as well as fly specific routes, generally refusing to provide licenses to new companies. As a result, pre-deregulation carriers worked in an industry with little to no competition, which enabled them to set high prices. However, after deregulation, it became much easier for a company to obtain permission to fly a route. Moreover, customer interest in air travel was growing continuously due to the novelty and convenience of the mode of travel. As a result, the industry became highly attractive due to a combination of factors that are outlined in the following Porter’s Five Forces analysis:
- Competition in the sector: weak. Before deregulation and immediately after it, the various carriers chose not to compete and effectively formed an oligopoly.
- Potential of new entrants into the industry: high. While aircraft were expensive, once the company obtained them, it could begin competing almost immediately.
- Power of suppliers: medium. Airline companies were dependent on airplane manufacturers but could easily replace the providers of the other necessary resources.
- Power of buyers: low. Customers had few choices if they wanted to have access to air travel, which enabled the traditional airlines to charge high prices.
- The threat of substitution: medium. Customers could use other modes of travel, such as trains or buses, but these substitutes would not offer the same speed advantage.
As a result, some companies saw the opportunity to enter the market and challenge the concept of airlines that was used previously. Gross and Lück (2016) identify numerous opportunities for cost savings by adopting a point-to-point structure that focuses on short, intensive routes and removing additional services or outsourcing them to more cost-effective companies. The combination of a variety of such practices enabled businesses such as Southwest Airlines to offer considerably cheaper flights to passengers than their established counterparts. The quality of the experience was lower due to the omission of various comforts, but since the companies preferred to operate on shorter routes, many passengers accepted the trade-off. After the success of the original approach, numerous companies that used the same method, such as RyanAir and AirAsia, began emerging throughout the world.
The difference from Network Carriers
Traditional airlines, also known as flag carriers because many of them have powerful associations with specific nations, operate on the network model. As Bieger and Agosti (2017) note, they rely on the ability to fly passengers to as many locations worldwide as possible, establishing a network of connections that lends its name to the approach. Additionally, they try to provide excellent comfort, introducing expensive and luxurious seats for passengers who are willing to pay for them. In doing so, they build a loyal customer base that trusts the company’s service quality and can use its services when traveling regardless of location. However, these comforts are costly, and the number of people worldwide who can afford to use them consistently is limited. In the BCG matrix, network carriers would be cash cows, with a high market share but low growth.
In comparison, as mentioned above, low-cost carriers tend to fly shorter routes, relying on the ability to satisfy consistent demand instead of securing individual satisfaction. They aim to attract cost-conscious customers who need fast transit, such as people who need to travel regularly for their work. To that end, low-cost carriers use simple pricing systems, where the cost of the ticket is segmented into numerous optional categories such as luggage, and offer a single transport class for all customers (Bieger and Agosti, 2017). This strategy allows them to attract a broad category of fliers, many of whom will use its services frequently, though people who need long-range flights will typically not find low-cost carriers useful. Nevertheless, with their significant market share and high growth, they would likely qualify as stars in the BCG matrix.
Value Creation
Low-cost airlines rely on optimization to create value for their customers by reducing costs and increasing traffic. Unlike large network carriers, which manage numerous planes and can take advantage of the economy of scale, they resort to outsourcing in the task as well as many others (Gross and Lück, 2016). Bieger and Agosti (2017) add that they rely on transport as the sole source of revenue where network carriers often generate significant income from the services that they offer. As a result, low-cost airlines have simple revenue structures that can be isolated for individual routes. Once a particular flight is established and becomes profitable, the company can open another, enabling straightforward and effective expansion. As a result, they serve increasing numbers of customers and purposes, adding value through low cost and convenience.
With that said, while these advantages enable low-cost carriers to obtain an advantage over network airlines, companies also have to consider competitors who use the same approach. Ison (2017) discusses attempts to differentiate, such as business model changes, frequent flyer programs, catering, entertainment, and two-cabin arrangements. However, the airline industry remains mostly homogeneous due to the nature of the product that it offers, and low-cost carriers often have to compete on price, as it is their primary selling point. When a company adopts a cost-saving measure, others can often copy it. As such, it is challenging for a business to obtain a meaningful advantage through this method. When competition is intense, companies may have to reduce their profit margins, with the escalation having the potential of reducing their efficiency significantly.
Challenges and Opportunities
Table 1: Low-Cost Airline Industry SWOT Analysis
The most significant threats for the low-cost carrier industry are fuel prices and competition. The former is dependent on the cost of oil, which is prone to fluctuation and can often shift dramatically depending on unpredictable and uncontrollable circumstances. Bowen (2019) describes a situation where, due to high oil prices and competition, Indian carriers were losing significant amounts on every passenger. The efforts of airlines to undercut each other’s prices drove profits down, and the sudden increase in costs resulted in a scenario where flights were a liability. In Greiner’s growth model, low-cost carriers are likely in the ‘alliances’ stage, where they are prone to crises of growth due to competition. With that said, this consideration only applies to saturated markets, and the model has not been embraced worldwide yet. As such, there are opportunities for the industry to grow further while addressing the challenges.
Low-cost airlines facilitate routes with high traffic, which exist in large numbers in every region. As such, they can capitalize on these opportunities and improve their coverage in areas where they are already present. However, they can also expand into other nations that show demand for fast and inexpensive transport. People who live in developing countries may be interested in low-cost carriers as an alternative mode of business and leisure transportation. Bowen (2019) claims that these emerging nations are rapidly urbanizing and creating a middle class, which can afford low-cost flights and may be interested in the concept. As such, the standard model that has been used in other nations to significant effect can also be applied in their cases.
With that said, new local companies that operate in these developing countries are likely to emerge organically. Current low-cost carriers will likely have to investigate different strategies, such as challenging network carriers in the international arena. Tourism destinations are likely to be particularly interested in enabling low-cost flights, as they allow faster and more convenient access for visitors and, consequently, improve their attractiveness. Another option would be to adopt new technologies to improve cost savings. Gross and Lück (2016) highlight how some carriers started switching to automatic or phone-based check-ins to save on staff costs. Overall, automation presents significant opportunities in many aspects of low-cost operations along with a variety of other technologies.
Conclusion
Low-cost airlines, which emerged as a result of deregulation and aimed to make flights more accessible, have demonstrated the feasibility of their model by capturing a significant portion of the market in developed nations. They achieve this level of performance by forgoing the hub-based model in favor of short-range local flights and savings costs on anything nonessential. However, as the concept becomes more popular, more competing carriers emerge, and businesses struggle to differentiate themselves in the homogeneous industry. As a result, they may struggle to add value to their offerings and remain profitable, an issue that is exacerbated by airline reliance on oil. However, the industry will likely continue expanding in the future, improving its local coverage, entering developing nations, and adopting new cost-saving technological solutions.
Reference List
Bieger, T. and Agosti, S. (2017) ‘Business models in the airline sector – evolution and perspectives’, in Delfmann, W., et al. (eds.) Strategic management in the aviation industry. New York, NY: Routledge, pp. 41-64.
Bowen, J. (2019) Low-cost carriers in emerging countries. Amsterdam: Elsevier Science.
Gross, S. and Lück, M. (eds.) (2016) The low cost carrier worldwide. New York, NY: Routledge.
Ison, S. (ed.) (2017) Low cost carriers: emergence, expansion and evolution. New York, NY: Routledge.