Europe’s regionals struggle to fend off LCCs

 - October 4, 2007, 10:14 AM

While regional airlines in the U.S. enjoy something of a renaissance as a result of post-9/11 capacity restructuring, Europe’s regionals continue to register unspectacular traffic growth and progressively deteriorating yield performances. The reasons vary, but delegates at last month’s ERA spring conference in Barcelona more often than not pinned the blame on the rise of the discount fare segment.

Although low-fare airlines have devoured a big chunk of the market on both sides of the Atlantic, the trend in Europe has accelerated even faster than in the U.S. Forced to function in an environment where discount carriers now control 28.7 percent of the continent’s air traffic capacity and an ever-growing piece of the short-haul business, Europe’s regional airlines even more so than their U.S. counterparts face direct competition from the likes of Ryanair and EasyJet. Although the situation has created more flying opportunities for affiliates pressed into service on low-fare routes by their mainline parents, it has also suppressed yields to levels not seen in four years.

“Put simply, airlines are carrying more passengers, but earning less revenue,”
said ERA director-general Mike Ambrose, who identifies several factors driving the “pause” in yield. Aside from the prevalence of so-called low-cost carriers (LCCs), “[European] airlines are struggling against costly legislation, such as increased security and insurance costs since 9/11,” he explained. “The recent law on passenger compensation and assistance will add a further 1.5 billion Euros to the annual bill [next year].”

Last year growth in scheduled passenger numbers and traffic averaged 5.4 percent and 4.5 percent, respectively, according to ERA figures. Passenger load factors ended close to 60 percent for the year, peaking at 65 percent in June. With no sign of pricing flexibility in sight, regional airlines will have to do better than that to escape their doldrums.

Addressing almost 150 people, including nearly 20 airline presidents from more than 100 companies, former airline executive turned academic Professor Rigas Doganis compared the performance of the regionals with annual growth of 28- to 63 percent for Irish operator Ryanair and 23- to 99 percent for UK-based EasyJet from 1998 to 2002. “The conventional network airline model has been battered by LCCs, [which have] undermined conventional short-haul [practice],” said Doganis.

The professor predicted that “two or three” European LCCs will continue to enjoy 25-percent annual growth and high profit margins, becoming dominant on most intra-European routes and squeezing out smaller start-ups and regionals. By the beginning of last year, LCC market penetration in Belgium, Ireland and the UK (the most active “no frills” markets) exceeded 25 percent. Citing the Irish operator’s share of up to 98 percent on non-monopoly London routes to Italy (and 6- to 46 percent where there were three or more competitors), Doganis asked, “Is Ryanair a new ‘regional’?”

Airports Thrive
The distinction matters little to regional airports, where the rapid growth of the LCC sector has created a windfall, according to David Cumming, managing director at BAA’s Southampton Airport on Britain’s south coast. He cited growth of 400 percent in overall passenger traffic (to around 5.5 million) among LCCs serving Southampton and BAA’s two principal Scottish airports at Edinburgh and Glasgow from 2000 to 2003. Cumming predicted that in the European regional-airline market LCCs will carry up to 45 percent of all passengers over the coming 10 years, ahead of the full-service operators’ share of 40 percent, while non- scheduled charter carriers account for a declining balance of 15 percent.

Following the model pioneered in the U.S. by Southwest Airlines, Europe’s discount carriers adhere to the same “keep it simple” philosophy, said Doganis, with unrestricted fares, point-to-point networks and no seat allocation. Typically, such operations involve 440- to 550-mile sectors between secondary or other uncongested airports. High use of aircraft and high-frequency schedules see LCCs such as EasyJet flying up to 12 hours per day, compared with six to nine hours among European major airlines. This means “five EasyJet aircraft do the work of six British Midland [machines] or nearly eight at British Airways or SAS.” Doganis estimated that extremely high load factors have allowed Ryanair and EasyJet to undercut BA’s costs per passenger mile by up to 66 percent.

Departing from the partisan rancour at past ERA events, some delegates actually admitted that the discount sector has brought with it some positive changes. “Lower fares stimulate demand for all carriers, create new markets [and] stimulate mature markets,” said Doganis. Indeed, he said LCCs provide several lessons for “conventional” carriers, an education that Fredheim recommended established airlines should “steal with pride.” They include the need for simple, single-class fare structures and direct sales. Young employees make up a competitive, highly productive staff that draw lower wages than those in established operations, but enjoy profit sharing or share options. Swedish air-transport consultant Kjell Fredheim, a former chief operating officer at SAS and chief executive of Air Botnia, said that “enthusiastic, motivated” LCC employees project a “nothing is impossible” attitude to the business.

Rather than encouraging established airlines and their regional partners to emphasize more service and choice, many ERA delegates advocated an approach more like that used by the discount segment–higher seat density, fewer aircraft types, fewer hubs and routes, quicker (15 to 30 minute) turnarounds, more flexible labor arrangements, minimum cabin crew numbers and more outsourcing from fewer suppliers.

Van Galen added that European regionals should also consider self-service passenger transfer at hub airports and constant feed into major networks (instead of the predominant “wave” system).

Fredheim offered consolation, pointing out the advantages enjoyed by established carriers, not least of which remains “grandfather” rights to airport slots. But “old-fashioned” union agreements and fat corporate structures now tend to outweigh the advantages of experienced staff, developed networks and sophisticated revenue/capacity/ yield-management systems, said Fredheim, who added that older airlines carry a “higher responsibility” toward society, suffer from complicated network and price structures and still bear the burden of low aircraft and employee productivity.

A Case for Outsourcing
To compete, both regional and major airlines must adopt a completely new mindset, for which Fredheim offered an uncompromising recipe: “Cost reduction is a constant process; what is not required must go; it is always possible to take [out] another 20 percent; all non-airline activities such as heavy maintenance, information technology, catering and airside ground operations [should] be outsourced.”

Simon Evans, chief executive of the UK Civil Aviation Authority’s Air Transport Users’ Council (AUC), offered a passenger’s perspective, praising the discount segment’s contributions to increased choice of routes, service levels and fares. Evans also cited numerous “buts” that offset the advantages: inconvenient airports and lack of schedule flexibility, free meals, business class and interlining. Doganis added that the sector’s development could collapse if LCCs try to grow too quickly or fail to restrict growth in costs or direct competition. Other disadvantages facing LCCs remain their dependence upon high traffic volumes and unabated growth, said Fredheim.

Nevertheless, Evans concluded that LCCs are “here to stay,” a prospect Aegean Airlines’ Antonis Simigdalas didn’t seem to relish. “The LCCs are seeing more than exponential growth in markets and passenger numbers, and the network carriers are by and large not competitive,” said Simigdalas. “What happens when mega-LCCs operating with multi-hub systems start to compete? What will be the overall benefit? Will we need to change the regulatory structure?”

Doganis dismissed Simigdalas’ concerns about bureaucratic structures, assuring that air-transport regulators “are well disposed to the LCCs come what may.” Doganis conceded, however, that direct competition between LCCs when their markets expand will present a major challenge, but not an overwhelming one. “Ryanair and EasyJet have tended to avoid each other,” he said. “Competition when it arrives will come from new-entrant LCCs, so Ryanair and EasyJet will survive.”

Given the departure of regional operator British European Airlines from the ERA, many have begun to question whether regional airlines that have adopted the low-fare model have a place with the association, particularly given Ambrose’s historic antagonism toward discount carriers. British European, last year re-branded as FlyBE, has joined the recently established Low Fare Airlines Association (LFAA), a potential rival. “ERA offers a considerable amount more to them than does the LFAA,” argued Ambrose. “LFAA concentrates on political matters, while we cover technical areas et cetera. LFAA does not have the expertise, while ERA provides the ability to digest and synthesize information.”

Predictably, Ambrose questioned the need for another association, but avoided rousing any animosity: “We have worked closely and successfully with the Association of European Airlines and IATA for more than 15 years. Where the LFAA is prepared to join in and cooperate in a constructive fashion there may be a role for it alongside the rest of the European industry.”

Acknowledging that airlines other than British European have begun to adopt “no frills” models in attempts to survive competition, including that from subsidized surface transport that does not face the same “hostile” regulatory environment, Ambrose reiterated the now familiar refrain that lower fares mean lower yields. “It is a simple equation: prolonged low yield combined with additional costs from excessive legislation equals higher risk of casualties,” he warned. “What is not understood by the lawmakers is that this will be detrimental to the traveling public and to European regional economies.”