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Low Cost Airlines

PART 1 of 2 – The Evolution of the LCC (Low Cost Carrier) Business Model in North America: WHO are the LCC’s ? WHAT is their Strategy ? WHERE are the big cost savings ? and WHY are there so many different LCC Business Models ? and which LCC’s are the best performers ?

For 2013, the U.S. airlines, both FSC (full service carriers) like Delta Air Lines (DL), American Airlines (AA) and United Airlines (UA), US Airways (US) and Alaska Airlines (AS) the 6 U.S. based LCC (low cost carriers) like Spirit Airlines (NK), Allegiant Air (G4), Virgin America (VX), JetBlue Airways (B6), Southwest Airlines (WN) and Frontier (J9), combined for a net profit of $US 12.7 billion, the 4th year in a row the industry has reported a net profit.

Atlanta based Delta Air Lines dominated the scene in reporting $10.5 billion in net income, but that is because the figure includes a $US 8 billion “non cash gain associated with the reversal of the company’s tax valuation allowance”, while complicated to explain, in short the industry really made $US 4.7 billion, and impressive turn around from a few year ago. The big turnaround has been the rather unusual discipline of senior airline management to reduce seat capacity in the U.S. market, nearly 15 million seats in the past year, which has driven load factors to new highs and profits are slowly catching up.

Southwest air

The LCC Pioneer in 1971 and still growing though not thriving as it used to – Southwest Airlines B737-700

Now, this article and the next 2 to follow, will be about the LCC (low cost carriers), and in Part 1, I will be discussing what an LCC Business Model is, where did it start, why it has been so successful in the U.S., but also in Europe and now Asia, who the LCC’s are today and how they have evolved the Business Model over time and how the various LCC today differe and compete with one another in the U.S. market. Now , the term ‘low cost carrier’ already spells out the major differentiation between LCC and FSC.

However it is more than low costs that differentiates the two, I do prefer LFA (low fare airline), my experience with 2 LCC’s has shown me that low cost is relative, we can also call Emirates, Singapore Airlines and Etihad low cost carriers, as their CASM is in the LCC category, but that is because they fly high capacity A380’s and B777-300’s on long haul services, but their fares are not close being called low. But, I will use the industry standard LCC, though I think LFA is more appropriate. An important characteristic of LCC is that the business focuses on P2P traffic (point to point) instead of routing everything through a hub.

Now back to the global airline industry, the industry in fact had a ‘real’ $US 4.7 billion net profit in 2013 in the U.S. of which $US 2.5 billion (53% of net U.S. industry profit) went to Delta (DL) as it is the largest carrier in the world with $US 38 billion in revenue after merging Northwest (NW) into its operation in 2009. So, after we take out Delta, it leaves a net profit of $2.2 billion, of which $US 1.03 billion (22% of net U.S. industry profit) went to the 6 LCC’s, while the remaining large FSC (full service carriers) like network giants United, US Airways & American (now merged) and Alaska Airlines managed only $US 1.17 billion in net profit in 2013.

The 6 LCC managed to to make 22% of the U.S. industry profit with roughly 20% of the share of ASM’s (available seat miles) in the U.S. market in 2013.  The industry as a whole had $US 199.7 billion in revenue, of which $US 3.3 billion was from baggage fees (1.7% of revenue), $US 2.8 billion in reservations (1.4% of revenue), which means that with out the ‘extra’ fees of $US 6.1 billion, the U.S. airline industry would have had a net loss of $US 1.4 billion !

These minor fees that passengers find annoying are ‘ancillary fees’ are an absolute must for airlines today, in 2013 these fees will generate $US 42.6 billion for airlines around the world, or 6% of revenues and given that in 2014 it is estimated that global airline industry will make a profit of only $US 5.94 per passenger, yes, per passenger ! than the global airline industry estimate for ancillary revenues of $US 13.00 per passenger in 2014 is the difference between a huge loss and a 4.0% to 4.5%  operating margin for the industry. In today’s airline industry, ancillary sales is the lifeline for the industry today, the difference between profit and loss, as passenger yields are basically flat and cargo revenue is still in a slight decline from 2008.

frontier a320

LCC Frontier Airlines was bought by Indigo Partners in 2013, from Republic Holdings and now being re-positioned to be the 3rd ULCC in the USA 

The the ‘new’ baggage and reservation fees, which are straight from the LCC business model playbook of un-bundling pricing and charging ancillary air fees for everything that is an extra, ‘a la carte’ pricing for checked baggage, carry on baggage, seat selection, call center booking fee, cancellations, food and drink and then ancillary fees for 3rd party sales like car rental, hotels, co-branded credit card.

Most of the LCC are very good at pushing ancillary sales, for instance Spirit Airlines average air fare ticket price per passenger was only $US 79.43 but non-ticket revenue per passenger (ancillary fees) was %US 53.84 (68% of the airfare ticket price), so that its total average revenue per passenger segment was a very low $US 133.27 which is a driver of a very high 86.7% average load factor, which drives RASM (low yield x high load factor) to be greater than its CASM, (note: RASM > CASM = operating profit) and thereby producing an industry leading 17.1% pre-tax margin and a capacity growth of 22.2% in 2013.

The first LCC was Southwest Airlines which started operation in 1971, and those early years their growth was very slow, by 1978 when airline deregulation came into effect, there were only 3 LCC’s in the U.S., PSA, Air California and Southwest Air and by 1986 only Southwest Airlines remained of those early LCC’s as PSA was acquired by US Airways and Air California was acquired by American Airlines after intense airfare wars took their toll on the small LCC. There was a very successful short lived LCC that got a lot of attention, PEOPLE Express Airlines (1981) out of Newark, with a simple fare structure, 2 fares, either “peak” or “off-peak”, and grew quickly, even to B747’s for trans-Atlantic services, but growth needs capital, and the airline slowly died out, sadly.

people express

Boeing 747 of PEOPLE Express the first US based long haul LCC, had a fleet of 75 aircraft and served 50 destinations, bought Frontier Airlines, PBA and Britt Airways and in 1986 when it was forced to sell to Texas Air Corp. and in 1987 merged with Continental Airlines, today the name has been resurrected for another try at the LCC market.

Not until the 1990’s did the LCC’s start to seriously challenge the FSC (full service carriers) in North America and Europe, with the likes of Frontier Airlines out of Denver (1994), ValueJet (CEO & President Maurice Gallagher, now CEO Allegiant Air) out of Atlanta (1996), Jetblue out of New York (2000), America West out of Phoenix and in Europe Irish based Ryanair (1991) which is the pioneer of the ULCC (ultra low cost carrier) model followed shortly after by UK based EasyJet. These were followed by many late adopters, many came and went, even many LCC’s were set up by the FSC, but they all failed for various reasons, Delta set up SONG, United set up TED, Continental set up Continental LITE, Air Canada had ZIP to compete with WestJet and also set up TANGO, British Airways had GO and sold it in a management buy out.


Delta Air Lines failed LCC attempt – SONG

Today, the U.S. market has 6 LCC’s, as mentioned before, there are three ULCC (ultra low cost carriers) which I will explain in detail later, but for now sufficient to know that Spirit Airlines, Allegiant Air are the two lowest cost carriers in North America (CASM between $0.099 to $0.104), with Frontier Airlines now under new ownership of Indigo Partners (a LCC investment specialist Group led by industry veteran Mr. Bill Franke) re-positioning itself as a ULCC as we speak. Then there is the more upscale, hybrid LCC which are positioned to offer a little more amenities to attract the mid-market passengers looking for medium frills at a reasonable price, but unit costs are higher for those extras (CASM $0.118).

Now several LCC have done very well financially between (2001-2010) and they are role models for many new and existing LCC, sadly not all LCC do well, many have failed, but these 5 are real money makers for their owners/investors (Ryanair, WestJet, AirAsia, GOL, Allegiant), Southwest should be in the list but recent years have not been as good as in the past and GOL of Brazil has deteriorated as well after buying national flag carrier Varig.

I have to digress a little here, the global airline industry is not very healthy, how can you make a net $5.94 per passenger and yet have $US 120 billion worth of annual aircraft deliveries and record backlogs and deliveries, who and how will that be financed ? The WACC (weighed average cost of capital) for the industry has been hovering between 7.5% to 8.0% for the past 3 years and yet ROIC (return on invested capital) was 5.5% in 2013, 4.0% in 2012 and as low as 1.5% in 2008. In short, the industry as a whole is not covering its cost of capital, OMG the emperor has no clothes! while airlines struggle to cover their cost of capital, service providers to the industry such as OEM’s (original equipment manufacturers), MRO’s (maintenance and repair organizations), airports, leasing companies, ground handlers, caterers to fuel suppliers all make much better margins than the 4.0% to 4.3% operating margin the industry does, which is only a net margin of 2.2% to 2.6%.

Now back to the LCC market, the strategy and value proposition for any LCC will include all of the following characteristics to some degree:

1. Primarily point to point (P2P) operations

2. Serving short/medium haul routes.

3. Serving regional or secondary airports.

4. Focus on price sensitive leisure passengers.

5. One service class.

6. Limited passenger services, charging for any extras.

7. Focus on ancillary revenues

8. Low fares, focus is on low price stimulation of high demand.

9. Different fares dependent on advance purchased tickets being the lowest.

10. Use of internet.

11. One type fleet, today new B737’s and A320’s, in the past used DC-9’s and B737 Classics.

12. Very high aircraft utilization rates per day +11 hours per day.

13. High density seating, maximum seats per aircraft.

14. Simple business model, the more complex the more it costs.

15. Unbundled pricing (everything-almost is extra).

The strength of LCC is in their ability to unlock traffic growth, through low costs which are then passed on as low fares which in turn drive higher passenger demand, this known as price elasticity, a key airline economic principal for any airline or manufacturer. In short, price elasticity is the percentage change in the quantity demanded resulting from a 1% change in price. It is not constant through the entire demand curve, but you can 1) measure it at a specific value (point elasticity) or 2) take the average of elasticity over a range of values (arc elasticity).

Price elasticity  is categorized into 3 groups based on price elasticity (Ep) being >1 which means it is elastic, when a 1% decrease in price results results in a greater than 1% increase in quantity demanded and total revenue increases with price cuts, this is THE fundamental core of LCC’s, lower price by say -40% and you get an increase in demand of 96% (40% x 2.40), when elasticity of demand is 2.40 (which air travel, long run is around). This is how ULCC like Spirit, Allegiant and Ryanair have grown their markets, lower prices significantly and you stimulate ‘new’ demand from price sensitive customers.

spirit A319

ULCC Spirit Airlines A319, a business model that thrives on ancillary sales, not fully understood by the travelling public

Now, a Ep<1 is inelastic which means that a increase in price of 1% results in a change in demand for that product of less than 1%, therefore a price increase results in a greater total revenue, consumers want the product or service and price is not key, this is the case for First Class and Business Travel to a lesser degree, customer that want the premium service will pay for it, no matter what the price increase (within reason).

The impact of of LCC cannot be under estimated, they are competitive and over powering when paired against FSC in the right markets. In Europe, LCC dominate the short haul market, and major FSC like Lufthansa (LH), Air France/KLM (AF/KLM) have had to scramble and change their entire European networks to compete with LCC, by setting up LCC of their own to compete, LH has set up GermanWings and AF/KLM have Transavia-France to try and compete with the LCC in Europe, especially Ryanair, EasyJet, Norwegian and Vueling.

In Asia, many LCC have set up subsidiaries in neighboring countries, Malaysia’s Air Asia the biggest LCC in Asia, has operations in Indonesia, Thailand and soon India, and others have done the same, some moving into widebody services with A330’s, B777 and soon B787’s and A350’s, and moving into medium and long haul services (will cover that in Part 3). Some airlines have gone just hog wild with many different LCC, Singapore Airlines (SIA) has Silk Air for medium haul, premium product provider, Scoot Air a long haul B777 operator with a budget LCC product to Tiger Airways a medium haul, budget LCC product, sure gets confusing. With FSC in Asia and Europe launching LCC all over the place, it is note worthy to discuss Indonesia’s Lion Air a fast growing LCC that has over 500 B737/A320 aircraft on order, and has set up a low cost subsidiary in Malaysia as well, but in twist to the LCC rush, Lion Air is launching Batik Air a FSC !

Now, presently there are several new LCC being formed by FSC around the world to tackle the LCC threat, such as:

1. IAG (which is the holding firm of British Airways, Iberia and LCC Vueling) is setting up Iberia Express (how that will work out with LCC Vueling will be interesting).

2. Russia’s Aeroflot is setting up LCC Dobrolet, several LCC have come and gone, like Avianova a 49% Indigo Partners/51% Alfa Group LCC, where western management was just “ousted”, in my 20 years in Eastern Europe, I have seen it all, the corruption from top to bottom, politicians, courts, police, judges, no surprise, I have seen the same at Fischer Air in Czech Republic.

3. Israel’s El Al is setting LCC UP, as open skies with the European Union has seen El Al flooded with LCC’s flying to Israel.

4. Taiwan’s Trans Asia is setting up V Air.

5. Vietnamese Airlines has set up VietJet Air.

6. Kenya Airways has set up Jambojet in an effort to take on LCC FastJet which has big plans for Africa.

7. China Eastern, one of the big 3 airlines in China, is using its China United Airlines subsidiary to transform it into a LCC before Air China and China Eastern Airlines launch their own LCC’s).

The way LCC impact the market and FSC’s is that through low fares and point to point services, they stimulate new traffic and secondly they divert traffic from the FSC. Some FSC believe that their business will not be affected by the LCC intrusion, but that is a foolish belief, and LCC have to be taken seriously, as they offer the top 3 factors sought by travellers (1. Low fares   2. Schedule   3. Non-stop vs connecting flights). So how do the LCC keep their costs so low ? in short higher productivity from its major assets (aircraft and people).


ULCC Allegiant Air MD-80, older fleet but low fixed costs make it work

Let’s look at the impact of higher seat density and aircraft utilization.  Take the Airbus A320, presently certified for a maximum of 180 seats, though that will be going up to 186 soon (+3.3% more seating will lower CASM) and the A321 will be going from its current maximum of 236 seats to 240 (+1.7% in seating). The LCC put as many seats as possible into their aircraft to keep seat costs as low as possible, in regard to the A320 we see many different seating configurations (Spirit has 178 seats, JetBlue 156 seats, Virgin America 146 seats, United 134 seats, Delta 150 seats, Air France 158 seats, Air Asia 180 seats, Air Canada 146 seats). So Spirit has 18.6% more productive A320 vs Delta (178 seats vs 150 seats) which gives it a 18.6% cost advantage even if all other things were equal. Now  we take average daily utilization for some LCC’s (Spirit 12.8 hours, Allegiant 5.4 hours, JetBlue 11.94 hours), yes Allegiant utilization is low, but it uses older MD-80’s and A320/319, so fixed costs are kept to a minimum and utilization is not as important as for new expensive aircraft.

JetBlue ERJ-190

JetBlue E-190, one of the few LCC that has strayed from the one aircraft type model as it operates A320/A321’s as well

If we take a Spirit A320 as an example for LCC productivity we can take 12.8 block hours x 480 mph x 178 seats and get roughly 1,093,632 ASM’s per day while a FSC A320 with only 150 seats and a daily utilization of only 8.5 hours will produce only 612,000 ASM’s per day, and here you have an example of why LCC can out produce the FSC, in this example 78% more in earnings capacity (ASM’s).

We can take this example further and use real Spirit numbers like average load factor for LCC Spirt Airlines of 86.7% (2013) and the CASM of $0.099 and RASM (yield x LF) of  $0.1129, which in our example gives us 948,178 RPM’s for the day, operating costs of $108,269 and revenue of $123,471 for an operating profit of $15,202 a margin of 12.3%. Now a FSC with 83.8% load factor, CASM of $0.1412 (UA) and RASM of $0.1463 (UA) in our example would have only 512,856 RPM’s for the day, operating costs of $86,414 (note: lower utilization) and revenue of $89,535 for an operating profit of $3,121 a margin of 3.4% that is the real world today for UA, tight margins for many FSC, how long can the industry survive when WACC (weighed average cost of capital) is above ROIC (return on invested capital) ? this is why many well run airlines now have ROIC annual targets, sustainability of the industry in the long run is questionable.


Columbus, Ohio based SkyBus went bust in 2008 after 1 year of operating A319/A320 aircraft, had $160 million in start up capital, but Columbus ? really ?

So I hope I have demonstrated the combined affects of high density seating on aircraft, high load factors, high aircraft utilization, low unit costs (CASM) and low yield, which when combined with a high load factor gives a wide spread between RASM and CASM, that is a brief summary of how LCC make money, though not all, let’s make it clear there have been many failures of LCC of all sizes all over the world in the past 8 years, such as:

  • Skybus Airlines (USA),  ATA Airlines (USA),  Tower Air (USA),  Vanguard Airlines (USA),  JetsGo (Canada),  Zoom Airlines (Canada),  Air Australia (Australia), SkyEurope (Slovakia),  GoodJet (Sweden),  Jet2 (UK), Air Finland (Finland),  BMI Baby (UK),  Globespan (UK),  Windjet Airlines (Italy),  Sterling (Denmark),  Onur Air (Turkey),  White Eagle (Poland),  Central Wings (Poland),  Aviacsa (Mexico),  Aero Califonia (Mexico), etc. etc.

jet green

The sole aircraft of infamous JetGreen Airways, a Boeing 757-200 (TF-FIS), the airline started May 4, 2004 and 8 days later ceased operations due to financial difficulties ! this is good example why financial planning and forecasting is an absolute MUST in the airline industry !

In brief, the following is a rough cost saving distribution breakdown of LCC’s CASM vs FSC’s  CASM (will vary by business model chosen, region and strategy):

-High seat density -18%

-Aircraft utilization -4%

-Lower Flight and Cabin crew costs -2%

-Using regional or secondary airports -2%

-Outsourcing maintenance and having a single type fleet -2%

-Minimum station costs and outsourced handling -5%

-No in-flight catering -3%

-No agent or GDS commissions -3%

-Reduced reservation costs with Internet bookings -2%

-Fewer staff and overheads -2%

The above adds up to a possible 43% savings over the FSC, only a guide but shows where LCC have a cost advantage over the FSC.

The success of LCC’s has not only been profitable but passengers prefer its low fares and fewer restrictions. There is no one strategy which will succeed for all carriers, , they have a variety of tactics which they can choose, and the boundaries today between LCC and some FSC is getting blurred as all airlines now trying to mix and match elements from both business models to give them the best position in the market. The range of tactics available are product, pricing, network, revenue management, marketing/sales and cost control.

The main differences between LCC Business Models is the offering of ‘frills’ and these are basically limited to the following:

1. Seat pitch

2. In-flight entertainment

3. Frequent Flier Program (FFP)

4. Low price

5. Customer focus

6. Connections

7. Premium seating

8. Food and drinks included in price

We see a wide variation here today between airlines like Spirit Airlines and Allegiant Air the two ULCC where there are no extras and all else is extra, where ancillary revenue is key, and then we have the new hybrid business models being adopted by JetBlue for instance which has ordered Airbus A321’s for transcontinental services featuring private suites and snack station in their MINT class with 16 lie flat seats as well as new slim seats with touch screen TV and more leg room, WiFi, a more upscale product than what Spirit offers. Virgin America also offers 3 class seating, in-flight entertainment, food and drink included and WiFi so we have a wide variation on service/product offerings between various LCC, which we will explore in Part 2.

Virgin America A320

LCC Virgin America A319, after 7 years it made its 1st net profit in 2013 ! a premium product provider with 3 class seating, IFE, but maybe too premium ?

Another indicator of where LCC are going with their business models is their trends in average domestic fares from 2007 to 2012, and here only the 3 ULCC have lowered their fares, but increased their ancillary sales :

Spirit -33%

Allegiant -11%

Southwest +25%

JetBlue +3%

Frontier -2%

Alaska +15%

American +9%

United +10%

Delta +6%

Now as for which model is best, well the jury is out on that, but if 2013 operating margins are anything to go by, the ULCC have higher margins, Allegiant Air (16.4%), Spirit Airlines (17.1%) while the hybrid LCC were lower, Virgin America (4.6%), JetBlue (7.9%), Southwest (7.2%), Frontier (3.6%) while FSC were slightly less, United (3.5%), Delta (8.5%), American (6.8%), US Airways (10.5%), Alaska (7.3%).

In Part 2, I will analyse each LCC’s Business Model and how each carrier is doing financially.

Till then, thank you.









About Aviation Doctor - Helping aviation companies to transform the present into a more profitable tomorrow

I am a Canadian and EU national with an MBA and 33+ years experience in aviation business development with 20 years overseas and work in 30+ countries. A former investment/merchant banker (mergers and acquisitions to corporate turnarounds). airline and OEM senior executive and past owner of 6 successful aviation companies in 3 countries (executive jet charter/management companies, aircraft sales, aircraft broker, airline/aerospace consulting to aircraft insurance). I have a very diverse aviation background with 75+ aviation companies (50+ airlines of all sizes, OEM's, airports, lessors, MRO to service providers) as consultant, executive management, business analyst and business development adviser. Excellent success track record in International Business Development. Most work with airlines is with new start-ups and restructuring of troubled carriers. I sold new business jets, turboprops and helicopters for Cessna, Raytheon, Gulfstream to Eurocopter as an ASR as well as undertaking sales and marketing of commercial aircraft for Boeing, de Havilland, Dornier, Saab and Beechcraft. Brokered everything from LET-410's to B747's and from piston PA31 to G550 business jets. I look beyond the headlines of the aviation news and analyze what the meaning and consequences of the new information really means. There is a story behind each headline that few go beyond. Picked the name Aviation Doctor, as much of my work has been with troubled companies or those that want and need to grow profitably. I fix problems in the business for a better tomorrow. You can reach me with comments or suggestions at: Tomas.Aviation@gmail.com I write a lot of Articles and Posts on LinkedIN: https://www.linkedin.com/in/tomas-chlumecky-3200a021/


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