how lccs cope with financial turbulence_the 2008 crisis

© 2015 Millennium Aviation, Inc. – All Rights Reserved

Q1 – 2015, February

Airline Business Model Health Index - Quarterly

How do Low-Cost Carriers perform in times of crisis?

Airline Recovery Techniques Since 2007

The last 40 years have produced 6 crises with an average expansionary economic cycle requiring 6 years.

The last malaise, the financial crisis, is now approaching a 7-year slump with growing concern that the

global recovery is running out of chances. One of the deepest global recessions in history is showing us a

different kind of recovery under continued global instability. The lingering weakness of the developed

world has also increasingly worn on emerging economies, which in the last decade have been a breeding

ground for low-cost carriers (LCC). In fact, emerging economies have remained more reliant on external

demand to keep their economic engines hummingi.

With the global airline industry reporting billions in losses in 2008-2009ii, the crisis begged the question

how low-cost carriers were affected and how they coped with a drastically changing trading climate. In

more mature aviation markets, such as North America and Europe, low-cost carriers were facing a

multitude of challenges as their growth appeared to saturate with ever-increasing unit costs.

So how did they do? Were they badly impacted much like the rest of the industry? And were they equally

hurt as full-service network airlines such as AirFrance-KLM, Lufthansa, British Airways?

Moreover, how long did it take to recover?

2014: 7 years after the crisis started

Airline Profit per Passenger

(Source: Millennium Aviation Analysis, Airline Annual Reports)

The 2007-2009 Financial Crisis

Did Low-Cost Carriers weather the crisis unscathed?

Which tactics did they employ? Did it work?

What does their future hold?

$6.08(2007)

-$10.50(2008)

-$1.86(2009)

$10.20(2007)

$2.29(2008)

$5.77(2009)

Industry

LCC


2 Airline Business Model Health Index Quarterly, February 2015. How do LCCs cope with crises?

Immediate Impact of the Financial Crisis on LCCs

While the airline industry’s overall revenues initially climbed from USD 510 in

2007 to USD 570 billion in 2008, the business shrunk to USD 476 billion in

2009, representing a 16.5% decline. Interestingly, the top 15 low-cost airlines

displayed revenue growth of 32% within the first 12 months of the crisis and 8%

growth in the following 12 monthsiii.

Unlike the rest of the industry, the low-cost airlines continued to grow throughout

the crisis although expansion slowed during the second half in 2008 when the

impact was most severe due to the soaring fuel prices. Nonetheless, capacity and

passenger volume increases of 17.6% and 18.0% respectively far exceeded the

industry’s passenger volume growth of 1.5%. By 2009, the low-cost airlines were

still growing their passenger counts by 9.1% while industry traffic fell by 16%.

However, LCCs were hard hit by the rapid increases in fuel prices with fuel

representing some 36% of operating cost at the peak price of USD 180 per barrel

of oil. The cost of fuel represented some 26-28% of operating expenses for full

service airlines, whereas the industry average was 33% in 2008.

Operating margins fell by 40.1% to 7.29% in 2008. They fell another 24.7% to

5.49% by 2009. Meanwhile, the overall industry’s operating profit evaporated

completely (fell by over 100% in 2008 but climbed to 0.4% in 2009)iv.

Interestingly, during the crisis LCCs

earned a profit per passenger that

was higher than the industry

average profit per passenger up to 4

years after the trough

First 12 months 12-24 monthsAug 2007-July 2008 August 2008-July 2009

LCC

Ind

ust

ry

+32%

+11.7%

Revenue Growth

+7.3%

-0.2%Operating Margin

LCC

Ind

ust

ry

+8.0%

-16.5%

Revenue Growth

+5.5%

+0.4%

Operating Margin

Low-cost airlines generated over 5

time more profit per passenger

carried compared to the industry

average during the financial crisis



Whose Passengers Are (More) Profitable?

As shown before, the passengers of low-cost carriers are more profitable than the

industry average by a ratio of 1.7 (2007) to 4.6 (2008) and 3.1 (2008). In fact, in

2008 the overall airline industry lost USD 10.50 for each passenger it carried,

with industry losses that year totalling USD 26.1 billion. Also, even though the

break-even load factors of LCCs were higher than for the industry as a whole

(71% versus 62%), their ability to fill the planes with revenue traffic (80% vs

77%v) and boost it with ancillary revenue surpasses average performance.

Even average fares exceeded industry averages, which may be counterintuitive.

This can be explained by the dense local/regional networks of full service carriers

relative to the LCCs that increasingly fly longer (international) sectors.

Duration of Recovery

The financial crisis started in August 2007 when US bank Lehman Brothers

shed its junk bonds. The delayed impact on the airline industry coincided with

skyrocketing fuel prices in June 2008. The recovery of the airline industry was

18 months in top-line terms (revenue) and 25 months in bottom-line terms (net

profit). However, even though the low-cost airlines experienced no revenue

declines, their operating and net profit margins had not yet returned to 2007

levels by July 2010 (>36 months). As such, their bottom-line recovery took

longer than the industry as a whole. This is predominantly due to the

disproportional impact high fuel prices and hedge commitments have on low-

cost airlines.

2007

LCC

Ind

ust

ry

$185

$165

Average fares

LCC

$203

Ind

ust

ry

$178

LCC

$196

Ind

ust

ry

$150

2008 2009 2010

LCC

$201

Ind

ust

ry

$158

Contrary to common belief, average

LCC fares were higher than the

industry average

Only 5 top Full Service Network

Carriers had an average fare ($228)

that was higher than the LCCs.

(Delta, American, AirFrance-KLM,

Lufthansa, British Airways)

18 months

LCC

Industry

Revenue recovery (top line)

39 months

25 months

LCC

Industry

Profitability recovery (bottom line)

Zero months



What happened? What did LCCs do?

Airlines around the world swiftly realized the severity of the imminent crisis and

emergency boardroom meetings were abound. The industry as a whole attempted to delay

capital expenditure and find protection against fuel price volatility exposure. However,

while full service carriers focused on reducing capacity by reducing service frequencies,

low-cost carriers deployed additional capacity and opened new routes and operational

bases. Where full service airlines, such as AirFrance-KLM, Lufthansa and British

Airways were wary of losing precious airport slots, LCCs were bold enough to axe routes

and enter new markets that could provide more of a cushion to stem falling demand. They

were successful enough to increase their average fares by 9.9% in the first 12 months,

although they were reduced to stimulate further traffic growth in the following 12 months

(by 3.1%). Also, LCCs were more progressive in implementing an ancillary revenue

strategy, extracting an average of USD 8.67 in ancillary per passenger in 2007. By

monetizing additional services (such as checked bag fees), they were able to push this

number to USD 11.02 in 2009.

Expressed differently, for each paying passenger the LCCs carry over a distance of 1

kilometer, one cent (USD 0.01) is generated in additional revenue through related

services, such as in-flight sales or as part of other ancillary revenues (e.g. checked bag

fees and charges). LCCs generated average ancillary revenues of USD 9.50 per passenger

throughout 2007-2009, but by 2010 the full service airlines had adopted similar profit

models in their business models and surpassed this level by USD 0.94 to USD 10.44.

Whereas LCC revenues climbed an average of 19.9% during 2007-2009, the total

ancillary revenues of the Top 15 low-cost carriers climbed no less than 34.3%.

First 12 months 12-24 monthsAug 2007-July 2008 August 2008-July 2009

$203

$178

+9.9%Average fare

+7.8%

$196

$150

-3.1%

-32.6%

LCC

Industry

LCC

Industry

LCCs are subject to varying degrees

of competition from surface

transportation in short-haul markets.

This competition can be more

significant during economic

downturns

2007

LCC

Ind

ust

ry

$8.67

$1.01

Average ancillary revenues per LCC passenger vs industry average

LCC

$9.51

Ind

ust

ry

$4.12 LCC

$11.02

Ind

ust

ry

$5.43

2008 2009 2010

LCC

$8.68

Ind

ust

ry

$8.0

To some extent the drop in average

fares between 2008 and 2009 was

cushioned by a rapid increase in

ancillary revenues



Tactics Deployed by LCCs – What Worked?

Low-cost airlines adopted a very decisive expansionary approach

as part of a tactical offence when the financial crisis hit. While

there are similarities between LCCs and other carriers in terms of

how they handled the crisis with commercial and operational

tactics, there are a number of stark differences. These differences

are contrasted below in the table containing the Top 8 tactical

strategies that were implementedvi. Of the Top 15 low-cost

airlines, only Ryanair consistently lowered it fares. This is one of

Ryanair’s commitments as part of its business model.

Other Measures

There were a number of other measures that were taken to control the soaring expenses

and profit leakage following the 2007 collapse of financial markets. The list below

provides a number of airlines’ self-reported measures:

Operate new aircraft* Reduce complexity (booking) Improve the online offering

Ground older aircraft Reduce airport infrastructure Focus on being the dominant carrier*

Dispose aircraft Improve yield management Increase sector length*

(international routes) Control labor costs Introduce new fuel surcharge

Selective redundancies Introduce checked bag fee

Introduce Internet check-in* Strict cash conservation

Renegotiate supplier contracts Focus on international flights

Focus on the business traveller

proposition*

Simplify distribution system * = Particular LCC strategies, notably Air

Asia, Ryanair, EasyJet

The recession and declining

consumer confidence proved to be

good for LCC growth, as millions of

passengers switched to lower fare,

thanks in part to changing corporate

travel policies and restrictions

Although full service airlines

suffer from operational

complexity, it was the LCCs

that pursued a simplification

of commercial and

operational complexity

1. Exit least profitable routes 1. Cut costs(reduce headcount, wage freezes)

Industry

Top 8 Strategies adopted to cope with the 2007-2009 financial crisis

LCC

2. Delay capital investments

3. Reduce capacity (5-7%)

4. Reduce frequencies

5. Solidify hub, strengthen density

6. Improve offering (fare structure)

7. Adjust business to demand(reduce J, introduce premium Y)

2. Launch new routes

3. Increase capacity (17%)

4. Limit capital expenditures

5. Launch ancillary products

6. Increase fares(maximize load factors)

7. Write-off fuel hedges(take advantage of spot market)

8. Launch ancillary services(monetize offerings, fare bundles)

8. New airport deals(identify underused substitutes)

Ryanair only: Reduce lower fares to encourage switching

9. Pursue consolidation strategy(mergers & acquisitions)



Not all LCCs born equal – Scale matters?

Even though low-cost carriers’ business models have many similarities, notably the strict

discipline on efficiency and cost control, they vary greatly in terms of their approach to

market offerings and service aspects. Where airlines such as Ryanair continue to reduce

their cost base and average fares, others are differentiating their services by adding other

value propositions to counter their increasing cost base (easyJet, jetBlue, Southwest) or as

a result of saturating (domestic) markets.

Nonetheless, scale does not appear to be a strong attribute of enhanced

differentiation / value propositioning or profitability. Even Southwest’s

dominance does not lead to above-market customer profitability. For instance,

while Southwest is the largest LCC in the world, carrying 134 million

passengers in 2013, it produces an average profit per passenger of USD 5.67.

This is 61% lower than Air Asia’s profit of USD 14.34 per passenger. But with

42.3M passengers, Air Asia’s size is 69% smaller than Southwest’s.

FrontierPegasusAirlines

CebuPacific Air

VuelingAirlines

Jetstar IndiGo WestJetNorwegia

nJetBlueAirways

Air Berlin Gol AirAsia EasyJet RyanairSouthwest

Airlines

(million p.a) 10.7 13.1 13.3 14.8 15.4 15.8 17.4 17.7 29.0 33.3 39.2 42.34 58.4 79.3 134.1

profit/pax -$4.58 $5.38 $6.39 $8.84 $6.49 $1.71 $13.97 $2.88 $4.41 $0.26 -$19.69 $14.34 $6.92 $7.18 $5.67

10.7 13.1 13.3 14.8 15.415.8 17.4 17.7

29.0 33.339.2 42.34

58.4

79.3

134.1

-$4.58

$5.38 $6.39 $8.84 $6.49 $1.71

$13.97

$2.88 $4.41 $0.26

-$19.69

$14.34

$6.92 $7.18 $5.67

An

nu

al #

of

Cu

sto

me

rs

LCC/Hybrid Airline Profitability per Customer (USD, 2013)

(million p.a) profit/pax

Southwest, who is a dominant

carrier on 90% of its routes, does not

generate disproportional profits per

passenger carried



Productivity Indicators

One of the key characteristics of today’s low-cost carriers is their

lean approach to business processes, the removal of complexity,

modern systems (software) and aircraft. Their (mostly) point-to-

point networks and flight operations enable high levels of

productivity and their efficiency is shown in the revenue and

profit generating power per aircraft, per available seat mile

(ASM) or per employee. A few of these productivity indicators

are depicted below and contrasted with full-service airlines.

During the crisis years until slow recovery (2010), the low-cost carriers displayed an

average operating margin of 8.93%. Although net profits declined initially, the rapid

recovery still generated an average 4.95% net margin with positive Earnings per Share

growth (averaging an increase of 166% after initially falling 62% in 2008 over 2007).

Interestingly, while the costs rose slightly (2.9%) as a result of high fuel costs and a

stagnant labor force, average yield for the Top 15 low-cost airlines increased by 32%.

Where low-cost airlines do particularly well, relative to the industry and in particular full-

service airlines, is in overall commercial productivity and operational efficiency. During

the crisis years, each LCC employee generated an average net profit of USD 15,521, and

an average revenue of USD 405,136. Each aircraft in the fleet generated no less than

USD 0.85M ($867,855) in net profits, with average annual increases of 6% while keeping

the head count stable (+0.0%) and increasing the average sector length by 2% to 776

miles.

5 Full Service Airlines

Productivity Indicator

Avg. Value(2007-2010)

Trend Impact onProfitability

Commercial

Efficiency

Operating MarginNet Margin ROEEarnings per ShareNet cash generatedAverage fareAncillary per paxYield/RPMCost/ASMLoad Factor

+8.93%+4.95%+8.73%$0.35$1.2B (avg)$196.16$9.50$0.078$0.05579.7%

+37.2% growth-9.9% decline-35.6% decline+166%+18.3%+3%+1%+32.3%+2.9%+0.1%

↑↓n/a

↑↑↑↓≈

↑

Net profit/paxNet profit/employeeRevenue/employeeNet profit/aircraft#Employees/aircraft#Pax per employeeASMs/aircraftAvg sector lengthDaily a/c utilization

$6.62$15,121$405,136$867,855465479180M776 miles10.8

+34%+3.25%+6.62%+106%+0.0%+0.0%+3%+2%0.0%

↑↓↑↑≈≈↑↑≈

↑

*RPM = Revenue Passenger Miles / ASM = Available Seat Miles / ROE = Return on Equity

Top 15 Low-Cost Airlines

-3.6%-0.2%-4.5%$ -2.12

$236.75

81.7%

Avg. Value(2007-2010)

$-25.36$-18,116$230,399$-2.10M187714

Employee and aircraft productivity

is higher for low-cost carriers

relative to full-service carriers. Their

employees and aircraft generate

disproportional profits.

During 2007-2010:

Full service network carriers lost as

much as USD 25 per passenger or

incurred losses as much as USD2M

per aircraft. In terms of productivity,

they also employ over 4 times the

amount of staff as expressed in

aircraft terms.



Business Model Life Cycles?

Like products, business models have life cycles. The first wave (1970s-1990s)

and second generation of low-cost carriers (1990s-2005) were able to grow

rapidly as a result of a void in the market place and complex fare structures that

were put in place by full-service networks. As the third generation of low-cost

carriers is effectively blending models due to the hybridization of pure “no-frills”

and “value-based frills”, many existing lower-fare airlines are also facing

saturation in (domestic) markets. Between 2005 and 2015 there has also been a

steep increase in low-cost and ultra low-cost (ULCC) start-ups, while some full-

service airlines have started their

own discount carriers (e.g. Air

Canada Rouge, Singapore Airline’s

Scoot).

Business model life cycles can be

measured by means of key performance

indicators that measure multiple

dimensions, such as the profitability per

value proposition (e.g. Premium Economy or ancillaries), average profitability

per customer and incremental profitability of added-value (ancillary) revenues.

Transformation efforts can also be measured by means of the number of

personalization and customization projects a carrier launches in order to update

its market offering relative to the market and get closer to the customer to

enhance the overall end-to-end experience. A business model health index should

thus include an overall commercial index as well as a transformation index. Using

a combination of 45 indicators, each airline can be assigned a weighted score,

indicating how progressive their business model is evolving in a profitable

fashion.

In recent years, it has become

increasingly noticeable that airline

business models actually have a

shelf life and that innovation is

accelerating.



The 45 dimensions based upon which each airline is monitored continuously using

moving averages of five years include multi-dimensional metrics, such as profit per

passenger and the ratio of passenger haul versus average sector length. Productivity

metrics such as Available Seat Miles (ASMs) per aircraft and the number of passengers

per aircraft or per employed staff member indicate how lean firms are. Yield growth and

average fares are compared to incremental ancillary revenues as a percentage of operating

expense increases. This shows how the firm is growing profitably. Finally, profitability

and cash generating capability is explored at gross, operating and net level from different

perspectives, even per flown seat mile, as related to sector length and network type.

What Does the Future Hold?

Given the hybridization of airline business models, i.e. the

blending of no-frills with premium amenities within and across

in-flight cabins and airports through bundles or à-la-cart

products, all airlines are attempting to get closer to each

individual traveler through personalization and customization.

In addition, Gulf-based airlines are pushing for ultra-luxury in

what appears to be a growing segment.

Key objectives in the next years will be to

Increase share of wallet through creative experiential add-ons

Monetize each relationships & partnership through value

Solidify market leadership & retention through stickiness

Create stickiness by moving away from 1-time transactions.

1. Some Major LCCs will replace legacy carriers

In market like Australasia, legacy carriers are struggling to stay afloat. With a heritage of

excess infrastructure and costs, some legacy carriers may not be able to execute a

transformation of their business model in a profitable way, paving the way for major low-cost

carriers to replace them through bankruptcies or partial carve-outs.

2. New Ultra-Low-Cost Carriers as Next Generation-LCC

As much as some low-cost carriers are “maturing” and extend their business model life cycle

through hybridization of their models and innovation, their costs invariably are going up. This

is also creating a larger market for a new generation of ultra low-cost carriers that return to

the bare bone model as start-ups. This is already being witnessed in the USA (Allegiant),

China (Spring Airlines) and Canada (announcement of JetNaked and Canada Jetlines).



3. Airlines will widen their service reach / breadth

Airlines have been successful in increasing the average revenue obtained from passengers

through the offering of ancillary revenues. However, the focus has mostly been on

transportation and travel-related aspects. However, with affiliate marketing programs, airlines

will be able to branch into experiential and life concierge type services, making themselves

relevant at any point in anybody’s life every day. Hence, there is a lot of talk about “lifestyle”

based relationships between an airline and its customers. The challenge will be for airlines to

drive the relationship, rather than having other companies that interact with the same

customers drive such relationships through constant relevant content and useful applications.

Ideas such as creating interest-based communities for members in the same loyalty program

tier (Air Canada Altitude) and LinkedIn-style business introductions (“Cruising to Profits”vii)

are already happening.

4. Many new (travel) experience retailers will enter the scene

In an Internet-based and App-rich world, many new players will enter the market surrounding

people that travel or have an interest in travel and anything related to foreign places, cultures,

adventures, experiences and languages. Those players that can navigate through this fragmented

field will be those that create new business models around what used to be a very traditional and

transportation-focused business. While airlines do not have the modern retailing skills, many are

rapidly building new capabilities, starting with new skills to interact directly with individuals,

first through social media. An exemplary case is KLM, part of the AirFrance-KLM group, who is

one of the leading firms. Others include jetBlue and Air New Zealand.

Commercial health will entail

business innovation around a wider

perspective of how airlines can

support their customers when they

do not travel, as a daily lifestyle

concierge



5. Business Model Transformation skills and techniques needed

Tweaking a business model or various profit models within the mechanics of how an airline

generates a return for its shareholders can be tricky. Changing one service or price can have ripple

effects throughout the company. For instance, charging seat selection fees and checked bag fees

to very loyal customers can upset them and impact on whether they will come back.

Modifications in loyalty program tier structures, reward requirements and changes in fare

products impact on the bottom line depending on which customer groups are affected. Even

changes in an alliance partner’s business model can affect an airline’s customer groups and thus

the business results.

When airlines need to “update” their business model with new services and prices (value

propositions, money flows, costs) or the way it is delivered (through channels, partnerships) as

experienced by the customers (service for specific customer groups), they thread carefully.

Business model innovation or fundamental transformation requires a systematic process. An

airline needs to look at how ideas impact on other parts of the business as perceived and

experienced by the customer. This exposes blind spots and requires a certain extent of rigor. But

practical steps, exercises, techniques and metrics can be used so that new revenue streams can be

identified and be executed well for each of the targeted customer segments at the right costs.

The next Airline Business Model Health Index will explore a number of airlines and their

transformation programs as explained through “Transforming to Profits”, the process and toolbox.

Business model innovation or

fundamental transformation

requires a systematic process.

Structured but open

Step-by-Step but flexible

Exercises, unorthodox

Metrics

Tools

Techniques

Results

Author: Ricardo V. Pilon, Managing Partner, Millennium Aviation, Inc.

Millennium Aviation, Inc. is a boutique coaching firm specialized in business model and profitability enhancement. It

specializes in profit maximization and business model innovation in commercial aviation. The firm was founded in 1995

and has served 216 customers. Millennium Aviation is based in Canada, and offers world-wide service out of Montreal,

Amsterdam and Singapore with a team of Senior Associates and three strategic partners. The company enables its

customers to revive, grow, or sustain profitability by identifying strategic blind spots and using techniques to address

them. The company applies its proprietary Transforming to Profits® Business Model Transformation Process and

Methodology. It includes a toolbox that consists of techniques, practical exercises and specific metrics.

millavia.com / transforming2profits.com

@millavia.com / @rvpilon

http://millavia.com/



i The Economist, November 2014.

ii The International Air Transport Association (IATA) reported a USD 26.1 billion and USD 4.6 billion net loss for its member

airlines for 2008 and 2009 respectively (Source: IATA, 2011). iii The top 15 LCCs that were part of the analysis are: Southwest Airlines, Ryanair, EasyJet, AirAsia, GOL, Air Berlin, jetBlue

Airways, Norwegian, WestJet, IndiGo, Jetstar, Vueling, Airlines, Cebu Pacific Air, Pegasus Airlines, Frontier. iv Source : Millennium Aviation analysis, based on airline annual reports and analytics on the top 15 low-cost airlines. A list of these airlines is provided in the Appendix. v These numbers reflect the average load factor between 2007-2010 for the Top 15 LCCs that were analyzed, relative to the industry’s average load factor for that period. vi The information compiled in the list was obtained from IATA’s global reports as well as individual annual reports from the Top 15 low-cost carriers and full service airlines such as AirFrance-KLM, Lufthansa, British Airways, Air Canada, American Airlines, Delta Airlines and Singapore Airlines. vii ”Cruising to Profits”, Pilon. R., Curmill Aviation Publishers, Montreal, Canada, ISBN_9780993688904.

how lccs cope with financial turbulence_the 2008 crisis

Documents

lowcost airlines

financial crisis

times of crisis

crisis unscathed

lowcost carriers lcc

airline profit

industry lcc

airline recovery techniques