Academic journal article The McKinsey Quarterly

Hyped Hopes for Europe's Low-Cost Airlines: Europe's Most Successful No-Frills Carriers Are Making a Lot of Money. but as They Mature, They Will Have Problems Expanding

Academic journal article The McKinsey Quarterly

Hyped Hopes for Europe's Low-Cost Airlines: Europe's Most Successful No-Frills Carriers Are Making a Lot of Money. but as They Mature, They Will Have Problems Expanding

Article excerpt

Low-cost airlines are all the rage in Europe. With rock-bottom fares that entice travelers from the chillier north to places like Barcelona, Nice, and Rome, such carriers have introduced Europeans to a cheap, fast mode of transport--a tangible benefit to consumers in the fitful march toward deregulation. As bookings pour in, the low-fare carriers are making ambitious expansion plans and placing large orders for new planes. Some are even earning profits that defy the cyclical nature of the airline business. Long-protected national-flag carriers are beginning to respond to the low-cost airlines, and capital markets are paying close attention to their business strategies, which many believe foretell the future of intra-European air travel.

It is easy to see why. In 2001, while most traditional players reported losses and some succumbed to the competition, Europe's leading low-cost carriers were more than merely profitable: Ryanair and easy Jet boasted operating margins of 26 and 9.5 percent, respectively--results that traditional airlines only dream about. In June 2002, Ryanair had a market capitalization of [euro]4.9 billion ($4.82 billion), 45 percent more than that of British Airways (BA), which has revenues that are 20 times larger.

Expectations are high among some financial analysts, investors, and industry experts that the low-cost airlines, which now hold only 7 percent of the intra-European air travel market as reckoned by the number of passengers they fly and less by revenue, can reach the penetration levels achieved by their US counterparts (Exhibit 1). Since Southwest Airlines pioneered its low-cost strategy, 30 years ago, no-frills operators in the United States have captured a 25 percent share of the passengers in domestic air travel and a 15 percent share of the revenues.

We doubt that Europe's low-cost carriers can do equally well. As they expand full throttle from a predominantly UK base, they could indeed double their European market share in the next five years. But they are unlikely either to dominate short-haul travel in Europe or to approach the market share enjoyed by their US cousins. More likely, their longer-term growth will bump up against the ceiling of a European market in which the contestable low-cost segment is smaller than it is in the United States and well-established packaged-tour operators and national-flag carriers can block deeper inroads into the leisure- and business-travel segments. Europe's business market is more limited, too: fewer routes have enough traffic to sustain the frequency of low-cost departures that could attract business passengers.

These considerations should limit scheduled low-cost airlines to a successful niche strategy, mainly on routes to and from the United Kingdom and possibly to and from a few other Northern European countries.

Interlopers in the skies

Before European air travel was deregulated, in the mid-1990s, the market was neatly divided. Scheduled carriers, focusing primarily on business travelers, controlled 75 percent of the intra-European market. Charter airlines held the remaining 25 percent by selling aircraft capacity to tour operators and shuttling sun-seeking package tourists from cold Northern European countries to the beaches of Southern Europe. Both scheduled and charter incumbents were shaken by the emergence of low-cost carriers that targeted leisure and, to a lesser extent, business markets.

Low-cost airlines rely on a simple business design: one kind of aircraft, one class of passenger, and more seats crammed into the airplane--as well as no airport lounges, no choice of seats, no newspapers, no food, no frequent-flyer programs, no connecting flights, no refunds, and no possibility of rebooking to other airlines. Also, there are no travel agents and expensive computer reservation systems; about 90 percent of easyjet and Ryanair tickets are booked over the Internet. …

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