MBA Full Time

Module

Management of Innovation.

“LOW COST”AIRLINES COMPANIES

Submitted by:

0796101 & 0796112

Jennifer Tann

March, 2006

Words count:

2,987

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"We are determined to show the world that low prices and quality operations can go together thanks to innovation.”

Mr Stelios Haji-Ioannou,easyJet founder.

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CONTENTS

INTRODUCTION 4

I. Innovating in the airlines sector 6

2. The context in which the innovation has emerged 6

3. The emergence of “low cost” airlines companies 6

4. Which barriers did this innovation meet 7

V. The characteristics of innovation 9

6. “Low cost” airports 9

7. No frills flights 9

8. Reservation channels 10

9. Le Yield management 10

10.“Low cost” destination network 11

11.Human Ressource management 12

XII. Consequences of the innovation 13

13.For the traditional airlines companies: the reorientation of traditional airlines compa-nies: rather a “low fares” diversification than a “low cost” one. 13

14.For airlines customers 14

15.Innovation development obstacles 16

16.Evolution of the business model itself 16

CONCLUSION 18

NOTE ABOUT THE REDACTION OF THIS REPORT 19

REFERENCES 20

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INTRODUCTION

In today’s fast changing society, innovate effectively and managing change is crucial in any sector. There are a lot of different ways to be innovative. The innovation challenge consists in finding a new concept in order to greater directly or indirectly profitability.

Over the last decade, the aerial sector encountered the establishment of an innovative concept: the “low cost” model which can be characterized by three innovative principles:

Figure 1: The innovation challenge

Taking advantage of the breakthrough of the Internet, “low cost” airlines really succeeded in managing the innovation challenge since it created a new business model through a new service based on costs saving for travellers.

This new concept integrates three major mechanisms which offer advantageous position in the market as described in the following table:

THE INNOVATION CHALLENGE

NEW PRODUCT /

SERVICE

COST SAVINGS

NEW MATERIALS

NEW TECHNOLOGIES

NEW PROCESSES

NEW WAYS OF WORKING

NEW RELATIONSHIPS

NEW BUSINESS

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Mechanism Advantage Description

New product / service Little / No competition - “low cost” airlines companies are a new business model

New Process Faster, cheaper, customised

- Cheaper service- Better use of new technology ( Internet bookings)

- Fit customer needs (traveling at low price)

Extend competitive factors

Change basis of competition

- No frills airlines- New way of traveling

Figure 2: The innovation strategic advantages

This innovation seems to have been really successful since “low cost” airlines gained important market shares in the airlines sector. Not only did it modify the rivalry among existing firms but also changed the travellers’ behaviour. Indeed, people are more willing to travel on a more frequent basis using no-frills airlines which have been increasingly popular.

The context in which emerged this innovative concept had a major role which will be analysed in the first part of this essay, then we will focus on the core characteristics of the “low cost” model implemented in the aerial sector. Finally, we will shed the light on the consequences of this innovation not only in the airlines industry but also at a wider scale for all stakeholders.

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I. INNOVATING IN THE AIRLINES SECTOR

1. The context in which the innovation has emerged

The dereglementation of the aerial sector began in 1978 in the USA with the « Dereglementation Act », and has slowly come across the whole world. The competition liberalization and reinforcement in the airline market led to important modifications of this sector. Not only did it accelerate the concentration phenomenon (strategic alliances) the development of the concept of "hub" and the development of consumer loyalty but it also led to a fundamental innovation: the “low cost” airline companies.

Nowadays, there are three major business models in the airlines market:

• The traditional model: consists of structured network around one or more central locations of correspondences, the « hubs ». This one tries to offer a global service to its consumers with minimum travel durations all around the world with different fares. This is the model of the traditional airlines companies which have been cooperating and regrouping themselves into strategic alliances over the last years.

• The concept of « charter » flights: consists in chartering a plane on a given date for a given flight, at low fare. This kind of flights is not scheduled in advance, which implies non-fixed timetables. Proposed initially to offer to the public theoretically economic tariffs, they are subjected to many conditions of use.

• The “low cost” model: this concept relies on the principle of giving a no-frills short/medium-haul service on low-cost regular flights at competitive fares.

In Europe, sociocultural factors encourage people to travel by plane: increase of leisure time and internationalisation of business constitute important opportunities for the aerial sector. All the more, travelling by air is increasingly safe and convenient. Thus, this innovation appeared in a sector with a good industry attractiveness.

2. The emergence of “low cost” airlines companies

The innovative "low cost" concept was firstly implemented in the United States in 1970 by Southwest Airlines, which is today the fifth world company with a sales turnover of 5.9 billion dollars. In 1978, “The Deregulation Act” was voted, allowing companies to move towards free competition across the United States. Thus, the Southwest became bigger and bigger and developed its concept: reducing the operating and management costs and offering a service as effective as possible. The aim was to propose to customers low fares regular flights on short/medium-haul no-frills airliner.

We will focus on the two largest European “low cost””low cost” companies: Ryanair and easyJet.

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Establishment date 1985 March 1995

Number of passengers (’000 000 passengers) 27,6 29,6

Turnover (’000 000 €) 1337 1341

Figure 3: Ryanair and easyJet statistics - source: Official websites

3. Which barriers did this innovation meet

This innovative concept involved important strategic consequences for already established companies. Nevertheless, there were barriers to the entry these new companies had to cope with that can be regrouped in three main types:

Financial barriers:

• Entry investments: the capital that a company has to invest in order to enter the market. All the more, in the aerial sector, establishment costs are really high since new companies have to buy aircraft and make that kind of important capital expenditures.

• Economies of scale: they consist of reducing the costs when dealing with bigger quantities. Indeed, the fixed-costs decrease when the production quantities grow. Therefore, new entrants have to face this difficulty as already existing companies benefit from higher activity volumes and thus lower per-seat costs.

Commercial barriers :

• Reputation: a company trying to enter the airline market will have to make big investments in communication campaigns in order to increase its notoriety. Indeed, notoriety and safety are crucial to gain confidence from potential consumers, especially as far as flights are concerned.

• Distribution channels: this barrier has been overtaken by “low cost” companies by using the Internet. Indeed, it has been really useful to be in direct contact with final costumers without coping with traditional networks as tour-operators or travelling agencies.

Skills and competencies barriers:

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• Learning curves: a new company in the sector doesn’t benefit from learning curves whereas already existing companies do.

• Rare resources: for example, when a company tries to innovate in this sector, it doesn’t benefit from already existing suppliers networks and thus do not have bargaining powers in negotiations.

Legal barriers:

Even if free competition tends to be permitted by the European Commission, every new entrant still need legal documents such as licences to operate in the aerial sector.

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II. THE CHARACTERISTICS OF INNOVATION

Figure 4: The characteristics of the innovation

1. “Low cost” airports

Although traditional airlines companies prefer to implement hubs in the biggest airports, “low cost” companies innovated by operating in secondary airports rather than hubs and principal airports (Figure 1: Ryanair destinations map) for the following reasons:

• Reduced airport taxes;

• Bigger bargaining power in front of small airports. For example airports like Luton or Stansted have a weaker bargaining power than Heathrow for the city of London;

• Less waiting time for airplanes since these airports are less used. This reason should be balanced because of the success of “low cost” model: the estimated average time spent on the ground is reduced to twenty minutes which allows a better fleet turn-over and productivity and reduced airports costs;

• Delays are less frequents.

2. No frills flights

There are a lot of services offered to traditional airlines passengers that are not included in the “low cost” flight tickets but which are still available. That is the core of the “low cost” innovative concept: passenger’s surveys showed that they don’t mind these services and are willing not to have these kinds of services for lower fares.

No frills flights Reservation

channelsLow-cost airports

Yield Management

“Low cost” destina-tion network

“Low Cost”Airlines

Companies

Human Ressource management

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• Catering: This service is optional in “low cost” companies. Consumers can obtain them by paying extras.

• Entertainment: As for the catering, low-cost companies can provide their consumers with dvd-players for example (approximatively 7 euros for a movie hiring on Ryanair flights since November 2004) or other entertainment facilities. Obviously, as “low cost” companies focus on short haul airliners, this factor need to be taken into account as a movie can’t be shown during 1-hour flights.

3. Reservation channels

The costs of distribution are reduced to the maximum by a quasi-exclusive Internet (or phone) booking. Thus, there are no commissions taken by the travel agencies (approximately 8% of the traditional companies ticket price). In order to privilege on-line reservation, “low cost”

companies (such as easyJet) increase their ticket prices when booking is done by phone (5€

booking fee for a Paris-Dublin flight with Ryanair). When booking is completed, a reservation number is allotted to each passenger. This number will be used when checking in. These electronic tickets led to costs reduction avoiding ticket printing and sending costs. Indeed, this innovative channel has been really useful for “low cost” companies as it has allowed them to avoid traditional airlines costs.

4. Le Yield management

An important part of the innovation in the low-cost model is the use of yield management. Indeed, this system allows real-time best pricing on a demand forecast basis to obtain the more profitable fares as possible. The software enables constant adjusting on seat bookings.

The concepts consists in proposing the cheapest fare when booking opens and then increase it slowly until the departure date become closer or the seats availability is decreasing.

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Figure 5: easyJet yield management

5. “Low cost” destination network

As we said earlier, most of the « low-cost » flights are short and medium haul airliners. For example, European “low cost” companies like Ryanair have only European destinations. This kind of short travels allowed companies like Ryanair to innovate in the characteristics of the service they wanted to offer to their clients. Indeed, being short haul airliners allows the company to be no-frills airlines which is one of the characteristics of the “low cost” business model.

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Figure 6: Ryanair destination map - Source Ryanair website

6. Human Ressource management

« Low-cost » airlines employ less people than traditional ones: ground and in-flight crews are smaller (easyJet hires 3 cabin-crew members whereas traditional companies employ 4 or 5 persons). Moreover, a more important polyvalence is required for crew members. For example, stewardesses and stewards are also in charge of the plane cleaning when arrived at final destinations. Furthermore, crew members are working on a more frequent basis.

More to the point, a important specificity of the European “low cost” companies is that their head offices are located in countries offering advantageous social taxes: Ireland, United Kingdom, Nederland. Indeed, in this way, Ryanair and easyJet are paying half-reduced social taxes compared to French airlines on twenty percent less expensive wages.

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III. CONSEQUENCES OF THE INNOVATION

This innovation has been widely recognized as one of the most important change in the sector which had led to major changes as shown in the following statement from The Observer:

1. For the traditional airlines companies: the reorientation of traditional airlines companies: rather a “low fares” diversification than a “low cost” one.

The “low cost” innovation in the airline market generated an important modification of the sector. The following figure shows how the “low cost” airlines are firstly creating a new market before gaining market shares from traditional airlines. In that case, easyJet is creating a new market from 1998 to 2000 before entering really in competition with British Airways in 2000.

In 1990 no one would have blinked at paying £160 for a flight to Venice, but now anyone quoted that price would splutter in disbelief and get on the internet to see what the low-cost airlines have to offer. The young pretenders, trading largely on the internet and with prices kept low by getting rid of 'frills' such as in-flight drinks and snacks, changed the way we travel. Ticket prices plummeted and weekends in Europe were suddenly within everyone's grasp. Even though Ryanair set up a cheap alternative to Aer Lingus in 1985, it was Brussels ordering our airline industry to deregulate that opened up the skies to real competition and shattered the major airlines' price agreements which kept fares high. Stelios Haji-Ioannou launched EasyJet in 1995 with a £29 London to Scotland fare, a third of the BA fare. Now EasyJet, Ryanair, Buzz and Go, formerly owned by BA, all offer flights that are a fraction of the price of the flag-carriers. The airlines are not without their critics; no frills can sometimes mean no baggage, no punctuality and no spare planes should something go wrong. But the allure of the £9.99 flight to Venice keeps the low-cost dream alive, with 14 per cent of all international passengers in UK airports flying on a low-cost airline.

Source: http://observer.guardian.co.uk/life

Source : site aéroport Genève - 2002

Figure 7: Ryanair passenger growth

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In order to maintain their market shares coping with the growth of “low cost” companies, traditional airlines companies are in front of three major strategic options:

• The first one consists in changing their fares: British Airways, which in 2002, announced reduction of its fares up to 80%, can illustrate this principle. This strategic reorientation has been implemented in 2004 with a massive communication campaign. It has also set up a “Size and Shape” plan which was offering, for example, ten different fares against twenty on its London-Paris flights.

• The second one is to create its own “low cost” airline company: indeed, some of them, which could not become a “low cost” airline, developed subsidiaries with same characteristics as their new competitors. In order to illustrate this second option we can once again take the example of British Airways which created its own “low cost” airline company, “Go”, in 1998. Nevertheless, it didn’t work out as planed since in 2002 “Go” was finally sold to easyJet. Another example can be Buzz, a “low cost” airline company created by the Dutch airline KLM in 2000. Finally, it was also a failure since Buzz had been acquired by Ryanair in 2003. Theses failures illustrate how difficult it is for a traditional airline company to implement an innovation developed by others companies. Indeed, as easyJet and Ryanair were the original changing agents, they could develop their own business model with brand new characteristics whereas the traditional airlines company such as British Airways or KLM had to deeply modified their ones.

• Finally, the last solution for a traditional airline company is to become a “low cost” airline. Some traditional companies tried to transform themselves into “low cost” airlines. We can take the example of Air Lib case, a French traditional airline trying to become a “low cost”. Nevertheless, Air Lib got into troubles and finally bankrupt in January 2003 as they couldn’t achieve to cut costs as required to succeed in the adaptation.

2. For airlines customers

The “low cost” innovation in the airlines sector also had consequences on customer’s behaviors. In the airline sector, the bargaining power of the buyers depends on the following conditions:

• There are a lot of airlines companies, which reduce their individual power of bargain;• There are different substitutes such as train, car or even coaches;

• There is an important amount of information available and thus clients can double check if they benefits from the most attractive fares. The Internet strongly facilitated the access to the information especially with the appearance of prices comparator websites such as skyscanner.net or cheapflights.co.uk;

• The price sensibility: this factor depends on the customer’s need: some clients are less likely to be price sensitive and look particularly for comfort and in-flight services, whereas other ones prefer saving money on their flight tickets;

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• Switching costs: there is a risk when changing airline company that the customer never tried. Indeed, they can’t be sure of the quality and reliability of an airline company they never heard about. Furthermore, security, punctuality, services quality are other risks that customers may take in account.

The dissatisfaction of the customer with the status quo must be stronger than the perceived cost of this innovation. It seems that for the "low cost" airlines, the change equation had been respected. Indeed, the innovation fitted the customers requirements and it may be the major reason of its huge success (Figure XX: Ryanair passenger growth).

Figure 8: The Change Equation

Figure 9: Ryanair passenger growth

MUST BE

- Price dissatisfaction

- Complexity of fares and long bookings

- Congestioned airports

- Informations available on the “low cost company”

- Airport accessibility- No-Frills

THE PERCEIVED COST

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3. Innovation development obstacles

Every firm in the airline sector has to face directly the threat of companies offering substitutable services. Short/medium haul airliners have to cope with the important threat of other transport means such as the train, the boat, the car or the coach. These competitors are increasingly competitive and represent a real threat for the airlines companies. Even innovative companies as “low cost” airlines have to pay important attention to this particular threat which can lead to a price rivalry. Indeed, we can see nowadays the competition between airlines companies and the Eurostar for travels between Paris and London. Another example can be the impact of the high-speed trains from Paris to other French cities on the aerial sector.

Figure 10: the impact of high speed train

4. Evolution of the business model itself

The new business model created by the “low cost” innovation in the airline sector has been changing since it was implemented in the beginning of the 1970’s. “Low cost” airlines companies are always looking for making profit and thus have slowly moved into traditional airlines companies’ market shares.

Thus, easyJet has oriented the company into business travels. This strategic change can be perceived through different strategic choices:

• The company started to use principals airports such as Paris Orly, Amsterdam, Geneva…(Figure 16)

• The fleet has become more diversified with the acquisition of 120 A319 Airbus aircrafts since 2004.

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Furthermore, easyJet implemented a massive communication campaign which was targeting not only the public but also business travelers of companies looking for economic flights with a certain comfort.

Figure 11: easyJet destinations map

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CONCLUSION

Low-cost airlines companies managed to apply an unconventional logic in order to implement a new business model in the airline sector. As can be illustrated by the figure below, the innovative companies only raised the price attractiveness really well above industry standards by cost savings. Thus, it has allowed them to strongly reduce all the other frills. They didn’t focus on competition with traditional airlines but on key elements that are significant for travellers. By increasing price attractiveness, they caught travellers’ attention as their price sensibility is very high compared to the services they need.

Figure 12: value innovation in airlines

To conclude, we can observe that the “low cost” model started with the airlines is now implemented in an increasing number of sectors. Indeed, there are now a lot of sectors using “low cost” business model such as” low cost” trains, “low cost” cruises, “low cost” hotel, “low cost” mobile phones or even “low cost” pizzas that shows that the model will continue to have repercussion in other sectors in the future.

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“Low Cost” airlines

Low High

Airport Accessibility

Airport facilities / comfort

Loyalty programs

Included catering

Included entertainments

Diversified booking channels

Number of crew members

In Flight comfort

Price attractiveness

Traditional airlines

NOTE ABOUT THE REDACTION OF THIS REPORT

Even if it seems to be a non-innovative choice to do this assignment as a “French team”, it was still a challenge for us. Indeed, according to the innovation styles profile questionnaire we did in the first class, we both have extremely different profiles. One of us is experimenting and a little bit modifying (Arnaud) as the other is exploring and a little bit visioning (Elsa). Thus, we realized that working together asked us to make some compromises to agree on how the assignment was going to be written.

According to us, the aim of this assignment was not only to report about an innovation but also to realise it in a creative way, using the techniques we learned in classes (brainstorming, fishbone diagram and other frameworks).

More to the point, working in English was new for us and we had to adopt a totally different method to fit the requirements of the “MBA” style of writing assignments (short report and necessity to summarize, different structure…) and deal with the French and English information we found during our researches.

Finally, we really enjoyed doing this assignment and it showed us that we can still be innovative when working with peoples we have been working with for a long time.

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REFERENCES

• Books:

Keith Goffin & Rick Mitchell (2005) - Innovation management; Strategy and Implementation using the Pentathlon Framewor, (Palgrave Macmillan)

Michael E. Porter - Competitive Advantage : Creating and Sustaining Superior Performance (Free Press)

Michael E. Porter - Competitive Strategy: Techniques for Analyzing Industries and Competitors (Free Press)

Michael E. Porter - Michael E. Porter on Competition (Harvard Business School Press)

Gerry Johnson, Kevan Scholes, Richaard Whittington - Exploring Corporate Strategy (Prentice Hall)

Clayton M. Christensen, Michael Overdorf, Ian MacMillan, Rita McGrath, Stefan Thomke - Har-vard Business Review on Innovation (Harvard Business School Press)

• Internet Websites:

www.ft.com www.time.com www.businessweek.com

www.lesechos.fr www.innovation.gov.uk www.nouvelobs.com

www.lepoint.fr www.lemonde.fr www.lejournaldunet.fr

www.guardian.co.uk www.challenges.fr www.enac.fr

www.europa.eu.int www.staralliance.com www.skyteam.com

www.snitem.fr www.oneworld.com www.airfrance.fr

www.ba.com www.aa.com www.klm.com

www.lufthansa.fr www.united.fr www.iberia.com

www.southwest.com www.easyjet.com www.ryanair.com

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