Airline Business Models - Low Cost Vs Full Service Carriers

Since commercial air travel first started up in the early 1950's with Boeing developing the 707, the aviation industry has changed a lot since then. Deregulation played a major role in opening up the market to new 'players' wishing to enter. With this deregulation, 'low cost carriers' were attracted to the market, to try and take on some of the bigger, full service airlines. This report outlines the main characteristics of both business models, and provides a small insight into how the two models go about doing business. Further on in the report, the current profitability of the commercial aviation industry is discussed, in particular Australia. The report then finishes with outlining some challenges that the industry is faced with at the current time.

Airline Business Models

Full Service Carrier

The first type of business model is that of a full-service carrier. Its core business is Passengers, Cargo, and Maintenance. The following are some of the main facets of a FSC's business model;

Hub & spoke network: The major object is the full coverage of as many demand categories as possible through the optimisation of connectivity in the hub.

Global player: Domestic, international and intercontinental markets are covered with short, medium and long haul flights from the hubs to almost every continent.

Alliances development: No individual airline has developed a global network covering all major destinations. Therefore, FSC's join alliances which practically enlarge their network to be interlining with partner carriers.

Customer relationship management (CRM): Every FSC has a loyalty program to retain the most frequent flyers. The frequent flyers programs have become part of the broader strategy, which is referred to as CRM. The general purpose of CRM is to enable carriers to better manage their customers through the introduction of reliable processes and procedures for interacting with those customers. The ultimate goal of the CRM is to further improve the passenger's buying and travelling experience in order to add a personalisation component to the carrier. In other words, the CRM is an extra tool to differentiate their product from others. (Cento, 2008)

Low Cost Carrier

The 'low cost carrier' (LCC) concept began in the United States with the start up of Southwest airlines in the early 1970's. In Europe, the Southwest model was essentially copied by Ryanair in 1991, and was followed by other carriers like easy Jet in 1995. Low cost carriers are also sometimes referred to as a 'no frills airline', due to the low passenger services they provide. Cento (2008) defines an LCC as an airline company designed to have a competitive advantage in terms of costs over a full service carrier. In order to achieve this advantage, an LCC relies on a simplified business model, when compared with the FSC. The core business of an LCC is passenger air-service, despite the ancillary offers that are increasingly becoming part of their core business. The following are some of key elements of this business model type;

Point to point network: The LCC network is developed from one or a few airports called 'bases', from this point, the carrier starts operating routes to the main destinations.

Secondary airports: City pairs are connected usually from the secondary of even tertiary airports (eg. London Luton, Hamburg Lübeck, Stockholm Skavsta) that are less expensive when it comes to landing tax and handling fees, and they experience less congestion than larger airports, like London Heathrow. Small airports will attempt to gain the LCC's operation by reducing airport charges.

Single aircraft fleet: Generally, the LCC operate with on type of aircraft such as the Airbus A320 with a 150 seat configuration. This lowers the costs of pilot and crew training, maintenance etc.

Aircraft utilisation: The aircraft is in the air, on average, more hours a day compared with a FSC, that need to spend ample time cleaning, and also that are at mercy of connecting flights. LCC's really operate by, "Aeroplanes don't make any many sitting on the ground."

No frills service: The product is not differentiated as they do not offer lounge services at airports, choice of seats, and in flight service, and they usually do not have a frequent flyer program. Fare restrictions are also removed so that the tickets usually cannot be refunded and there is no possibility to book with other airlines in the case of a delay or cancellation.

Ancillary services: LCC increasingly have revenue sources other than ticket sales. Typical examples are commissions from hotels and car rental companies, credit card fees, excess luggage charges, in flight food and beverages, advertising space. Mintel, (2006) reported that Ryanair's revenue from sources other than ticket sales contributed 259€ million to its 2005-06 net profit of 302€ million (Ryanair Ltd, 2009), and for easy Jet, that kind of income originally represented only 6.5 percent of the airline's total revenue, but it increased by 41.3 percent from 2004.

Challenges facing the Aviation Industry

At the moment there are many challenges facing the aviation industry in the 21st century. The airline business now generates USD 528 billion in sales revenue each year and in 2007, a good year by industry standards, it made a net profit of just USD 5.6 billion. The year before, the industry only broke even and in 2008 the industry's combined lost was USD 9 billion. In 2009, profitability deteriorated further, primarily as a result of the GFC racking up losses in excess of USD 11 billion. (Holloway, 2003)

Source: IATA March 2010 Economic Presentation

The airline industry is moving in the right direction. Compared with five years ago the following efficiencies have been obtained:

- Labour productivity is up 56%

- Distribution costs are down 13%

- Non-fuel