Globalization and growing interdependencies between states all over the world have determined an ever growing demand for the development of commercial aviation. The global airline industry is currently characterized with rapid growth. Thus, the revenue, generated by the industry has more than doubled over the past decade (PwC Strategy&, 2015). Much of the above growth was driven by low-cost airlines that currently control more than a quarter of the world aviation market, and are continuously expanding, especially in emerging markets (PwC Strategy&, 2015). Important trends, characterizing the development of the modern aviation industry, are as follows. Firstly, carriers are facing an increase in consumers’ expectations in relation to all the aspects of air travel. Secondly, there is an ever growing pressure to achieve cost reductions and improvements in operational efficiency. Thirdly, it is crucial to consider shifting airline landscape, characterized by the rapid growth of air travel in emerging markets, as well as an increase in competition between traditional and low-cost carriers (PwC Strategy&, 2015).
In view of the above, current assignment will focus on LCC industry analysis, the peculiarities of the LCC business model, as well as the impact of LCC growth on traditional airlines in Gulf Area (competition aspects).
An in-depth analysis of the LCC business model requires an investigation of external forces that impact the business, as well as an industry analysis. The analyses will be based on the experience of flydubai, an LCC that operates in the United Arab Emirates.
The application of PESTEL tool reveals the following results. Referring to political and legal factors, it is necessary to underline the importance of regulatory environment for running LCC business. Despite the fact that the majority of Middle Eastern countries (including the OAE) are currently moving towards the liberalization of regulatory environment, the degree of liberalization is still significantly lower than in Europe. Economic conditions also tend to exert significant impact upon the functioning of LCCs. General negative trends in economy (e.g., inflation) exert profound negative impact upon the airlines’ functioning, because customers may refuse from leisure and some of the business trips.
Socio-demographic trends are highly favorable for flydubai, because ever larger number of people gets interested in traveling, and get used to airlines as convenient and affordable means of traveling. The activities of flydubai are subject to being influenced by environmental factors, because any new environmental regulations can result in an increase in operational costs. Finally, technological factors play an important role in the functioning of flydubai. The company has to trace technological developments in order to be able to reduce cost and simultaneously do its best to meet ever increasing clients’ expectations.
The industry analysis with the help of Porter’s Five Forces tool allows addressing the following findings. The barriers to entry can be estimated as high due to the regulatory factors and significant costs of operation (e.g., the costs of buying several aircrafts and making agreements with airports).
The bargaining power of customers is medium. On the one hand, high switching costs make customers’ bargaining power lower. However, customers’ education about the product and little differentiation between products (in case of same destinations) are factors that contribute to an increase in customers’ bargaining power.
The bargaining power of suppliers can be estimated as high due to the limited number of suppliers, producing highly necessary products for the industry (e.g, aircraft details, fuel for aircrafts). Airports also have a significant bargaining power, because agreements with airports constitute the basis for the functioning of LCCs. The industry has the medium level of risk as regards substitute products. While customers can potentially switch to other transportation means (e.g, cars, trains, buses), sometimes these means are not suitable to cover significant distances and far more time –consuming than airplanes. At the same time, switching to traditional airlines is a costly option.
Finally, the competitive rivalry is very intense in LCC industry for several reasons. Firstly, the number of competitors tends to stay the same in a long run. Secondly, a variety of carriers from all over the world tend to operate in Gulf area. Importantly, low-cost carriers tend to compete not only between themselves, but also with traditional full-service airlines that tend to lower their fares to be able to sustain competition.
High bargaining power of suppliers and intense competitive rivalry represent major complexities for LCCs in terms of internal environment.
LCC business model
A low-cost carrier (LCC) or budget carrier is an airline that tends to have lower fares and fewer services, included into fares. In other words, the reduced price of the ticket is (at least partly) compensated by fees for extras, such as snacks, beverages, priority boarding, luggage etc. Apart from this one, the LCC business model is characterized with a range of other peculiar practices.
Most commonly low-cost carriers operate a single type of aircraft, where single passenger class is available. LCCs also have a specific fleet strategy. They tend to buy aircrafts in large volumes at highly discounted prices and sell them at significantly higher prices soon after purchase. Such approach helps airlines make great savings and keep their aircrafts modern. New aircrafts are cost-saving due to their efficiency in terms of the use of fuel, maintenance costs and crew costs per passenger.
Furthermore, LCCs tend to ensure that their aircrafts operate with a minimum set of non-mandatory equipment, aiming to reduce the weight of the aircraft and save fuel. This practice also allows reducing acquisition and maintenance costs.
It is important to mention that the LCCs tend to offer simpler fare schemes than traditional carriers (e.g., charging round trip as two one-way tickets). Furthermore, LCCs usually operate in secondary airports. In this way they manage to avoid delays, caused by air traffic, and avoid high landing fees. Another source of compensating for lower fares is maximum utilization of aircrafts that is ensured through short turnaround time. An emphasis on non-flight revenue (e.g., generated with the help of commissioned goods) and limited personnel costs (e.g., achieved through online ticket sales and online check-in).
Aiming to get competitive advantage, some LCCs (e.g, AirAsia) employ highly innovative practices, such as developing specially designed airport terminals that require far lower maintenance costs. Finally, LCCs focus on differentiation and marketing in order to be able to compete with both traditional airlines and other LCCs.
SWOT analysis of external environments of LCCs, industry environment and LCC business model reveals the following findings.
Major strengths of LCCs (in relation to traditional airlines) deal with socio-demographic factors and the peculiarities of LCC business model. In socio-demographic terms, it is important that ever more customers prefer air transport to other means of transportation. Furthermore, growing business interdependencies between the countries of Gulf area, as well as strengthening links between Europe and Middle East determine an increase in business trips. The popularity of tourism also contributes to success of LCCs. LCC business model allows for significantly lowering operational costs by comparison with traditional carriers.
At the same time, the LCC model is subject to several weaknesses, such as difficulties in scheduling flights due to extremely limited turnaround time and incapability of meeting particular clients’ expectations (e.g, strict refund policy).
Most important opportunities for LCCs are directly connected to competing with traditional airlines. Combining low fares and services, peculiar to traditional airlines is an important way for LCCs to differentiate through both price and quality. Emphasizing the limits for growth for LCCs worldwide, aviation management experts advise LCCs to expand to primary airports (Dannis, 2007).
The LCC’s operation is concerned with a range of threats, such as possible changes in regulation, economic decline, new environmental rules, as well as suppliers’ capability of influencing market operators and intense competition with other LCCs and traditional airlines.
The impact of LCCs on traditional airlines in Gulf area
An analysis of LCC sector of aviation industry provides for the fact that major opportunities in LCC sector deal with overplaying traditional full-service airlines. On the one hand, competing with traditional airlines in terms of service and offering flights from primary airports are the major ways for LCCs to overcome growth limits, peculiar to LCC sector. At the same time, it is not likely that LCCs become capable of cannibalizing long-haul routes because of the peculiarities of LCC business model. An emphasis on extremely limited turnaround time can hardly be used to generate competitive advantage with regard to long-haul routes. Furthermore, operating long-haul flights requires including a variety of services into the fare, because passengers spend a lot of time onboard. Another important barrier to LCC’s overcoming traditional airlines deals with governmental regulation.
Despite a small base, LCCs managed to grow to 13.5 percent in the Middle East in 2013 (Cornwell, 2013). The LCC growth in the Gulf Area has been significantly above the LCCs worldwide (major players include UAE-based flydubai and Air Arabia, Kuwaiti-based LCC Jazeera Airways). Hungarian-based LCC Wizzair is also going to enter the market of Middle East with “extra-low cost message”. Despite evident growth of LCCs in Gulf Area, it is claimed that they are not capable of significantly decreasing the market share of government-owned full-service airlines, such as Etihad, Emirates and Qatar Airlines.
This statement is substantiated by the fact that the LCCs tend to use small planes to smaller markets that large airlines lack interest to enter. The Gulf Cooperation Council’s reluctance to promote “open skies policy” leads to the fact that large state-owned airlines, capable of using all the advantages of the regulatory system do not consider LCCs as equal competitors (Cornwell, 2013).
Explaining such attitude, the representatives of large traditional full-service airlines use two major arguments. Firstly, the LCCs’ penetration in the market of Gulf area is significantly lower as compared to European countries and the USA (the total market share, owned by major LCCs accounts for approximately 13 percent). Secondly, LCCs are perceived as secondary to legacy airlines, because they may provide for hidden fees and do not offer a comprehensive range of services (Pivac, 2015).
While it is clear that LCCs currently hold an insignificant market share in the Gulf Area, overall trends in the competition between traditional airlines and LLCs show that there is an important concern. The study, conducted by the worldwide known consultancy, KPMG, reveals that the cost gap between legacy full-service airlines and LCCs has fallen by approximately 30 percent in six years, and demonstrates a further trend to decrease (Gulliver, 2013). Bridging the above gap is partly conditioned by the fact that traditional airlines tend to implement particular elements of LCC business model (e.g, refusing from free baggage policy and in-flight catering during short-haul flights) (Gulliver, 2013). Some of the traditional carriers also started to charge for seat reservations and places near the window. Thus, it is possible to conclude that Europe and the U.S. currently face a trend of traditional airlines’ and LCC convergence. On the one hand, LCCs try to do their best to reach the standards of legacy carriers in terms of service, maintaining low fares. On the other hand, traditional carriers implement particular elements of LCC business model and lower fares at the expense of service range.
A question remains whether the above trend is currently true for Middle East. In this regard, it is worth revising the differences in regulatory environment. While the U.S. and Europe enjoy lsignificant extent of liberalizations, state-owned airlines in Middle East tend to have significant advantages. Therefore, it is currently hard to imagine European and U.S. convergence-related trend coming to the Middle East. Nevertheless, in case the market becomes more liberalized, it is still possible that LCCs will become important competitors for traditional carriers in short-haul flights’ terms.
While LCC and traditional airlines do not actively compete in the Middle East nowadays, further liberalization of the industry will lead to gradual convergence of the sectors. A debatable question remains whether such liberalization will ever occur. Nowadays the state of play can be characterized as a “division of labour” between traditional and low-cost carriers.
Cornwell, A. (2013). Low-cost airlines to take off in the Middle East. Retrieved 23 January 2016 from http://gulfnews.com/business/aviation/low-cost-airlines-to-take-off-in-the-middle-east-1.1244532
Dannis, D (2007). Stimulation or saturation?: perspectives on European low-cost airline market and prospects for growth. Journal of the Transportation Research Board, Vol. 13(5),pp. 311-321
Gulliver (2013). Legacy vs low-cost airlines. Spot the difference. Retrieved 23 January 2016 from http://www.economist.com/blogs/gulliver/2013/03/legacy-vs-low-cost-carriers
Pivac, D.Z. (2015). Turning the corner. What do the region’s low-cost carriers bring to the market and what does that mean for their competitors. Retrieved 23 January 2016 from http://www.bq-magazine.com/industries/aviation-industries/2015/03/low-cost-carriers-in-the-middle-east
PwC Strategy& (2015) 2015 Aviation Trends. Retrieved 23 January 2016 from http://www.strategyand.pwc.com/perspectives/2015-aviation-trends