Presentation to John F. Kennedy School of Government, Harvard University, as part of Transportation Issues Speaker Series, 21 September 2011.

1. Evolution of
Low Cost Airlines
Mark Diamond, P i i l ICF SH&E
M k Di d Principal,
MPP 1986
Prepared for:
21 September 2011
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2. Agenda
1. ICF SH&E summary
2. What defines a Low Cost Carrier (LCC)?
3. Evolution of LCC’s
4. Added bonus: the airline network planning process
5. Q&A
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3. SECTION 1
ICF SH&E summary
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4. ICF SH&E is a consulting firm exclusively dedicated to the
g
global air transport industry
p y
 Specialty consulting firm with over 70 staff
 Founded in 1963
 Performed over 8,000 individual engagements worldwide
 Full-service offices in Boston, New York and London, with
specialists worldwide
 Staff recruited from airlines airports academia finance
airlines, airports, academia, finance,
government agencies, manufacturers and IT
 Joined publicly-held ICF International in December 2007
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5. Our client base spans the aviation industry and its
participants
 Passenger airlines
 Air cargo express & integrated logistics operators
cargo,
 Major & regional airports
 National, regional & local governments
 International development agencies
 Maintenance, repair, & overhaul (MRO) providers
 Airframe, engine & avionics suppliers
 Leasing companies, IT, equipment & service providers
 Investors & financial institutions
 Booking, distribution & travel services
 Corporate & business aviation
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6. Selected airlines we’ve worked with
Spain
p Ireland France UK Luxembourg
g Netherlands Germany Scandinavia Finland
y Poland Hungary Romania
g y Russia Bulgaria
g Czech.
Iberia Aer Lingus Air France BA Luxair KLM Lufthansa SAS Finnair Central Wings Malev Tarom Aeroflot Balkan CSA
Air Littoral Br. Midland Condor & LOT S7
Canada
EasyJet Neckermann UTair China
Air Canada Switz. Italy Greece Turkey Cyprus
Virgin Atlantic China Eastern
WestJet flybaboo Alitalia Olympic Pegasus Aegean China Northern
THY Cyprus China Southern
United States
Helios Formosa
American Maxjet
Alaska/Horizon Mesa Air South
So th Korea
Aloha Midwest Asiana
Am. West Netjets Korean Air
Atlantic Coast Northwest
Japan
Atlas Air Pan Am
ANA
Bus. Express Polar
Japan Airlines
Continental SkyLink
Commutair Southwest Hong Kong
Delta Spirit Air Hong Kong
DHL TWA Cathay Pacific
Emery United Dragon
Falcon Air UPS
Taiwan
FedEx US Airways
Formosa
Great Plains Western Pac.
Harmony Virgin America Thailand
Hawaiian Thai
Airways
Mexico Venezuela Chile
Aeromar Aeropostal LanChile Philippines
Aeromexico VIASA Philippine
Peru
ALMA
Ecuador Aeroperu Indonesia
Mexicana
Ecuatoriana Garuda
TAESA Argentina
TAME
Aerolineas Micronesia
Cayman Islands
Antilles Argentinas Air Micronesia
Cayman Airways
ALM Austral
Malaysia
Central America
Colombia AirAsia
Copa Airlines Bahrain Saudi Lebanon Kuwait U.A.E. Oman Sri Lanka
Avianca MAS
Grupo TACA Bex Air Arabia MEA Jazeera Royal Jet Oman Air Lanka
Brazil Gulf Air NAS Kuwait Etihad New Zealand
Jamaica
BRA Saudia Air New Zealand
Air Jamaica
GOL Netjets
West Indies Australia
Transbrasil
ALM Morocco Egypt Ethiopia Ivory Coast Uganda S Africa
S. Madagascar Mauritius Qantas
TAM
BWIA Royal Air Egyptair Ethiopian Air Afrique Uganda SAA Air Air Mauritius Australian
VARIG
Maroc Airlines SA Express Madagascar
VASP
Mango
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7. Management consulting services
 Strategic and business planning
 Alliances
 Privatization advisory
 Process improvement
 P bli policy / economic research
Public li i h
 Litigation support
 Business and industry analysis
y y
 Financial services support (investment analysis,
due diligence & advisory)
 Bankruptcy merger & financial restructuring
Bankruptcy,
 Financial management audits
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8. Financial and technical services
 Asset management
 Appraisals
 Aircraft and engine repair oversight
 Financial modeling
 Interiors management
 Reliability analysis
 Inspection services
 Litigation support
g pp
 Future value forecasts
 Maintenance reserve requirements
 D dili
Due diligence
 Aircraft procurements
 Aircraft & other asset remarketing
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9. Airport services
 Demand forecasting  Cargo marketing
 Air service marketing and  Cargo facility & business
route development planning
 Strategic & master planning  Safety & security
evaluations
 Airport system planning –
commercial and GA  Air traffic control
infrastructure planning
 Capacity & delay analysis
 Airport concession &
 Environment / noise analyses lease structure
 Economic impact studies  Bilateral & regulatory
advisory
 Airport privatization
 Operational restructuring
 Airport finance, rates & charges
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10. Aviation safety & security services
 Aviation safety and security audits of commercial
i li i t d i ti th iti
airlines, airports, and aviation authorities
 Program design
 Professional training
 Safety-related technical analysis
 Security, quality and loss control
 Legal and regulatory support
 Aviation claims services
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11. SECTION 2
What defines a
Low Cost Carrier (LCC)?
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12. First of all – why is this important?
 Whether you’re in industry or government, it’s critically important to
understand how the industry works
 LCC’s are a fundamental driver of airline industry evolution worldwide
• There are 9 LCC’s in the U.S. and 100+ worldwide, accounting for about 21%
of U.S. airline industry revenue and about 25% of scheduled seats globally
 Plus – it’s interesting
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13. What defines a Low Cost Carrier (LCC)?
 Simplicity, consistency, repeatability
 Maximize asset utilization – to spread fixed costs
• M i
Maximum aircraft operating h
i ft ti hours per d
day, quick t
i k turns
 Minimize number of aircraft types
• Enable economies of scale in crews, training, maintenance, p
g procurement, spares
p
inventory
 Outsource non-core functions
• E g reservations & distribution handling maintenance etc
E.g., distribution, handling, maintenance, etc.
 Drive costs out of the system & eliminate overhead wherever possible
• Direct online booking vs. agency & Global Distribution System (“GDS”)
commissions,
commissions automated check in etc
check-in, etc.
 Simplified pricing structure
 Low unit costs -> enable low fares -> stimulate market
> >
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14. How does the LCC model differ from the traditional
“legacy” airline model?
Legacies have evolved, but were traditionally characterized by:
 Complexity
 Focus on revenue generation via hubbing
• Susceptible to peaking of activity, poor resource utilization
 More services performed in-house
• Reservations, passenger handling, aircraft handling, maintenance, etc.
 High overhead
 Distribution via intermediaries
• Travel agencies & GDS’s
 Multiple aircraft types tailored to mission
 Complex pricing structures
 C ll ti b
Collective bargaining agreements
i i t
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15. Comparative domestic unit operating costs –
U.S. LCC’s vs. Majors
Domestic U.S. Cost per Available Seat Kilometer (CASK) – USD, CY 2010
$0.16 Legacy
g y
$0.14 LCC
$0.12
United Continental
ASK - USD
D
$0.10 US Airways Delta
Frontier American
$0.08 Alaska USA 3000
Southwest Hawaiian
JetBlue
CA
$0.06
$0 06 AirTran Virgin America
Vi i A i
Allegiant Spirit Sun Country
$0.04
$
$0.02
$0.00
0 500 1,000 1,500 2,000 2,500 3,000 3,500
Average Sector Length, Km
Source: US DOT Form 41, domestic entity
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16. Cost & productivity metrics, U.S. LCC’s vs. Majors –
domestic market: aircraft utilization, unit labor cost
Hours Average Daily Narrowbody Aircraft Utilization, CY 2010
16 13.9 LCC Legacy
14 13.0
11.6 11.2 11.2 10.6
12 10.4 10.3 10.2 9.9
99 9.8
98 9.3
93 9.1
91 8.8 8.6
10
8 6.0
6
4
2
0
Cents Labor Costs Per ASK, CY 2010
ASK
7¢ 6.0¢ 5.9¢ 5.8¢ LCC Legacy
5.7¢ 5.7¢ 5.5¢
6¢ 5.1¢
5¢ 4.5¢ 4.3¢
3.8¢ 3.7¢
4¢ 3.3¢ 3.0¢ 3.0¢ 2.8¢ 2.6¢
¢
3¢
2¢
1¢
0¢
Source: US DOT Form 41, domestic entity
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17. Revenue & traffic generation metrics, U.S. LCC’s vs. Majors
– domestic market: yield vs. load factor
y
Domestic Avg. Yield (Rev. per Passenger-Km, USD) vs. Load Factor, CY 2010
$0.16
$0 16
Legacy
$0.14 Delta
United LCC
US Airways
$0.12 Continental
Alaska
American
Yield - USD
$0.10 Southwest
Frontier Hawaiian
AirTran
$0.08 JetBlue
d
Virgin America
Vi i A i Spirit
S i it Allegiant
$0.06
$0.04
$0.02
$0.00
75% 80% 85% 90% 95%
Load Factor
Source: US DOT Form 41, domestic entity
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18. LCC’s offer the potential for tremendous fare-driven
market stimulation
 When Southwest launched service at T.F. Green Airport (PVD) in
Providence, R.I., in 1996, passenger traffic grew 85% in one year
Total E l
T t l Enplaned Passengers & Avg. Yield (Constant 2010 $) at PVD CY 1991 – CY 2007
dP A Yi ld (C t t t PVD,
Enplanements Yield ($ / RPK)
3,000,000 16¢
14¢
14
2,500,000
12¢
2,000,000
10¢
1,500,000 8¢
6¢
1,000,000
Enplaned Passengers 4¢
Southwest starts
500,000 Yield (¢/RPK)
service Nov. 1996 2¢
0 0¢
Source: US DOT O&D Survey
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19. History of Low Cost Carriers
‘71 ‘72 ‘73 ‘74 ‘75 ‘76 ‘77 ‘78 ‘79 ‘80 ‘81 ‘82 ‘83 ‘84 ‘85 ‘86 ‘87 ‘88 ‘89 ‘90 ‘91 ‘92 ‘93 ‘94 ‘95 ‘96 ‘97 ‘98 ‘99 ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11
Southwest (1971 – Present)
Midway (1979-1991)
People Express (1981 – 87)
Ryanair (1985 – Present)
Kiwi International (1992 1999)
(1992-1999)
Valujet / AirTran (1992 – Present)
1978
CAL Lite
U.S. Airline
(‘93 – ‘95)
Deregulation Act
Shuttle by United (‘94 – ‘01)
Easyjet (1995 – Present)
yj ( )
WestJet (1996 – Present)
1983 Metrojet (US
Airways) (‘98-’01)
U.S. Industry Allegiant (1998 – Present)
Fully Deregulated JetBlue (1999 – Present)
Gol (2001 – Present)
Song (Delta)
1997 (2003 – 2006)
Completion of Wizz Air (2003 – Present)
EU Liberalization Jetstar (Qantas) (2003 – Present)
Air Arabia (2003 – Present)
Ted (United)
(2004 – 2009)
Spicejet (2005 – Present)
Virgin America
(2007 – Present)
Air Asia X
(2007 – Present)
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20. LCC’s are operating today in every region of the globe
Europe
A i
Asia
 Ryanair  Air One Smart Carrier
 Bmibaby  Blu-express  Spring Airlines  Jeju Air
 easyJet  Meridiana  Air India Express  Jin Air
North America  eastJet Switzerland  Windjet  Goair  T’way Airlines
 Belle Air  airBaltic  IndiGo  Air Asia
 AirTran Airways
 InterSkyy  ArkeFly y  JetLite  AirAsia X
 Allegiant Air
 Niki  Norwegian Air Shuttle  Jet Konnect  Firefly
 CanJet
 Jetairfly  Jet Air  Kingfisher Red  Air Blue
 Frontier Airlines
 Wizz Air  Blue Air  Spicejet  Shaheen Air
 JetBlue Airways
 Wizz Air Bulgaria  Avianova  Batavia Air  Airphil Express
 Southwest Airlines
 Wizz Air Ukraine  Sky Express  Citilink  Cebu Pacific
 Spirit Airlines
 Smart Wingsg  g
Vueling Airlines  Indonesia AirAsia  Spirit of Manila Airlines
 Sun Country Airlines
 Climber Sterling  Anadolujet  Lion Air  Zest Airways
 USA3000 Airlines
 Transavia  Corendon Airlines  Air Next  Mihin Lanka
 Virgin America
 Transavia.com France  Onur Air  Hokkaido Intl. Airlines  Jetstar Asia Airways
 WestJet
 XL Airways France  Pegasus Airlines  JAL Express  Tiger Airways
 Germanwings  SunExpress  Skymark Airlines  Valuair
 TUIfly
y  Flybe
y  Skynet Asia Airways  Nok Air
Latin America / C
Carib.  Iceland Express  Jet2  StarFlyer  Orient Thai Airlines
 REDjet  Air Busan  Thai AirAsia
 Azul Brazilian Airlines Middle East/ N. Africa  Eastar Jet  Jetstar Pacific
 Gol Airlines
Sub Saharan Africa  Jazeera
 WebJet Linhas Aereas
 Fly540  Nas Air
 EasyFly
 Aero Contractors  Air Arabia
 Viva Colombia Australia/Pacific
 Kulula.com  Air Arabia Egypt
 Aires  Jetstar
 1Time  Air Arabia Maroc
 Interjet  Tiger Airways Australia
 Mango  Jet4You
 VivaAerobus
 Velvet Sky  Flydubai
 Volaris
 RAK Airways
 LC Busre
 Felix Airways
 Peruvian Airlines
 Karthago Airlines
 Star Peru
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21. Some key prerequisites for a successful Low Cost
Carrier operation:
 Deregulated market
• Little or no controls on fares, capacity, schedule
, p y,
 Ability to turn aircraft quickly
• Premium on passenger & aircraft handling
 Ability to drive costs out of the system
• Work rules
• Outsourcing
• Strategic procurement
 Financing
 Understanding the market and the competition
• Legacies will not sit still and let their market disappear
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22. SECTION 3
Evolution of LCC’s
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23. Over the years the original LCC model pioneered by
Southwest has evolved to include numerous variations
 Point-to-point flying  Connectivity & hubbing
 Short-haul  Long-haul
g
 Single aircraft type  Multiple aircraft types
 Domestic only  International
 Operate in  Operate in unserved or underserved
contested markets markets
vs.
 “No frills”  Quality product, in-flight entertainment
 Single class  Economy + business
 Secondary airports  Primary airports
 Go-it-alone distribution  Code-sharing & alliances
 Direct booking  Use of intermediaries for booking
 Standard, simple product  Unbundling of services + ancillary
revenue sources
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24. Many LCC’s now carry a considerable amount of flow traffic
U.S. LCC’s: Transfer Revenue (Multi-Coupon) as Percent of Total Revenue
CY 2009
50%
43%
40%
31%
30%
21%
20%
10% 8% 7%
3%
0%
Frontier AirTran Southwest JetBlue Spirit Virgin America
Source: US DOT Origin-Destination Survey
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25. The lines between LCC’s and legacies have been blurring
Legacies have adopted many cost efficiency practices, many of which
L i h d t d t ffi i ti f hi h
were pioneered by LCC’s:
 Outsourcing non-core functions
 Direct on-line booking and automated check-in
 Unbundling of services and ancillary revenue offerings
 Focus on aircraft utilization “continuous hubbing”
utilization, continuous hubbing
At the same time, LCC’s have moved closer to some legacy practices:
 Greater focus on connectivity, hub-and-spoke
 Code-sharing & alliances
 Multiple aircraft types
 L
Long-haul
h l
 Quality on-board amenities, multi-cabin product
 Primary airports
 Distribution via GDS’s
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26. Recent developments
 JetBlue code-share with Lufthansa (2008)
 Southwest code-share with Volaris (2010)
 JetBlue & Westjet code-shares with American Airlines (2011)
 Southwest launches service at New York LaGuardia & Boston Logan (2009)
 Air Asia X – establishment of long-haul low cost service (2010)
 Growth of international LCC joint venture carriers
• Air Asia • Air Arabia
– Japan – Morocco
– Philippines – Egypt
– I d
Indonesia
i – Jordan
– Thailand
– Vietnam
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27. Legacy “airline-within-an-airline” LCC’s have largely
disappeared in North America & Europe
pp p
 In an effort to hold back the growth of independent LCC’s, a number of
legacy carriers launched their own LCC’s:
• CAL Lite (Continental): 1993-1995 • Bmibaby (British Midland): 2002-present
• United Shuttle (United): 1994-2001 • Song (Delta): 2003-2006
• Delta Express (Delta): 1996-2003 • Ted (United): 2004 2009
2004-2009
• Metrojet (US Airways): 1998-2001 • Jetstar (Qantas): 2004 - present
• Go (British Airways): 1998-2003 • Mango (South African Airways): 2006-present
• JAL Express (Japan Airlines): 1998-present • FlyDubai (Emirates): 2009-present
• Tango (Air Canada): 2001-2003
 Many have now disappeared
• Difficult-to-resolve issues: Cannibalizing the parent airline’s business, and
achieving enough independence from the parent carrier to achieve true low costs
• Th need f LCC subsidiaries h d
The d for b idi i has decreased as l
d legacy parent carriers h
t i have
reduced costs and become more efficient
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28. Legacy airlines have reduced their costs in recent years,
but there is still an important cost gap relative to LCC’s
 The wide wave of Chapter 11 filings in 2002 – 2007 helped the Majors
considerably in restructuring their costs
 F l costs remain a difficult-to-control cost driver for both legacies & LCC’
Fuel t i diffi lt t t l td i f b th l i LCC’s
LCC and Legacy Carrier Average CASK (Constant 2010 $)
CY 2005 - CY 2010
2010 US$
12¢
10¢
8¢
6¢
4¢
LCC Legacy
2¢
0¢
¢
2005 2006 2007 2008 2009 2010
Source: US DOT Form 41
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29. Public policy implications of LCC’s
 Stress on airport and airway infrastructure, potential for congestion
• From fare driven market stimulation
fare-driven
• LCC’s now account for 29% of scheduled operations and 33% of scheduled seats at
Boston Logan
 O
Opportunity to develop air service – and local economies – at
t it t d l i i dl l i t
underserved airports and markets
 Outside the U.S.:
• Whether / how to protect a nation’s flag carrier from encroaching LCC competition?
• Whether / how to ease the market into liberalization?
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30. SECTION 4
Added bonus: the airline
network planning process
t k l i
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31. Network management is one of the core planning
activities of any airline
y
 Route selection, capacity & frequency planning, scheduling, code-
sharing & alliances fleet selection aircraft assignment, rotation plan
alliances, selection, assignment
 Can have a huge impact on profitability and ROI
 But highly complex to manage
 Carriers must understand:
• The implications of market & competitive developments
• Where they’re making and losing money
• How networks can be optimized to generate the most revenue with
the most cost-effective use of resources
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32. Network planning is all about managing trade-offs
Yield vs. On-Board Load
Local O&D (Origin-Destination) vs. Flow Traffic
Locally Focused Schedule vs. Connectivity-Focused Schedule
Schedule to Meet Market Needs vs. Schedule to Maximize Utilization
Higher Frequency with Smaller Lower Frequency With Larger
Aircraft -- But Higher Unit Costs
vs. Aircraft – But Lower Unit Costs
High Frequency / High Capacity to Risk of Excess Capacity,
Capacity
Generate “S-Curve” Market Benefits vs. Diluting Loads and Yields
Planning Your Network to Managing Constraints – Fleet,
Meet Customer Needs
vs. Airport Capacity, Regulatory
Capacity
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33. The “S-Curve” concept: adding frequency & “presence” in
a market will increase demand, yield and revenue
,y
Risk: too much capacity can dilute onboard loads and / or yields
S Curve
S-Curve Illustration: Revenue Share vs. Capacity Share
100%
90%
80%
Revenue Share (%)
70%
60%
S
50%
40%
30%
20%
10%
0%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Frequency or Capacity Share (%)
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34. Hubbing concept: each new spoke exponentially increases
the number of O&D city-pair markets an airline can access
yp
Risk: too much focus on connectivity may result in undesirable
schedules for important (and higher yield) local passengers
Illustrative Hub-and-Spoke Network:
Number of Spokes vs. Number of O&D City-Pairs
350
300
ty-Pairs
250
200
O&D Cit
150
100
50
0
0 5 10 15 20 25
Spokes
S k
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35. The network planning process:
Profitability, Load Factor,
P fit bilit L d F t
Evaluate Current Network Performance Yield, RASK, CASK, Utilization, etc.
Traffic Growth, Regulatory Actions,
Evaluate Industry Trends and Projected Demand Price Elasticity by Segment, etc.
Aircraft Orders, Capacity &
Evaluate Competitor Actions and Plans Schedule Trends, etc.
Incremental Change vs.
Develop Strategic Options for Network Optimization New Business Models
Translate Strategic Options Into Destinations, Routes, Frequencies,
Fleet & Network Scenarios Aircraft Payload/Range, Fleet Size
Forecast Share, Traffic,
Model and Test Network Scenarios Revenue, P fit bilit
R Profitability
Select Optimum Network Plan Iterative Testing
Incorporate Aircraft Rotations,
Refine Into Routed Schedule Other Operating Constraints
Operate Tactical Adjustments
Measure Results and
Review R
R i Results
lt Incorporate Lessons
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36. Modeling of network scenarios has become a
widespread practice
Profitability, Load Factor,
Evaluate Current Network Performance Yield, RASK, CASK, Utilization, etc.
Traffic Growth, Regulatory Actions,
Evaluate Industry Trends and Projected Demand Price Elasticity by Segment, etc.
Aircraft Orders, Capacity &
Evaluate Competitor Actions and Plans Schedule Trends, etc.
Incremental Change vs.
Develop Strategic Options for Network Optimization New Business Models
Translate Strategic Options Into Destinations, Routes, Frequencies,
Fleet & Network Scenarios Aircraft Payload/Range, Fleet Size
Forecast Share, Traffic,
Share Traffic
Model and Test Network Scenarios Revenue, Profitability
Select Optimum Network Plan Iterative Testing
Incorporate Aircraft Rotations,
I t Ai ft R t ti
Refine Into Routed Schedule Other Operating Constraints
Operate Tactical Adjustments
Measure Results and
Review Results Incorporate Lessons
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37. A network model permits rapid testing of “what if” network
scenarios and hypotheses
 Proposed new routes and
network & capacity plans
 New schedules & schedule
modifications
 Optimal service timing &
hubbing analyses
 Aircraft size vs. frequency trade-offs
 Code-shares & alliances
 Fleet planning – optimal aircraft types & fleet size
 Predict the impact of competitor actions
Rationale: Model the impact of scenarios to understand
likely results, before risking costly assets and resources
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38. The fundamental principle: projected results are related to
the airlines’ service attributes relative to the competition
In each O&D city-pair market across the carrier’s network
 Departure/arrival times
p
 Total elapsed trip time from origin to destination
 Capacity offered (seats)
 Service frequency
 Number of stops enroute
 N b of connections enroute
Number f ti t
 On-line vs. code-share vs. interline
The model calculates a “QSI” (“Quality of Service Index”) value for each service
offered in every O&D market, based on a combination of these attributes
The carrier’s projected share of that market is a function of its
carrier s
“QSI” value relative to its competitors
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39. Effective network optimization typically requires multiple
rounds of iterative testing and retesting
g g
Analyzing a proposed network and schedule scenario:
Base Calibrate
C lib t Input
I t Create New
C t N
Schedule Model Constraints Network &
 Market Sizes  Operational Schedule
Scenario
 Time of Day Preference  Commercial
 Airline Preference  Maintenance
 Aircraft Preference
 Non-stop or Connecting
Service
Final Adjust Analyze Run
Optimized Network & Results Proposed
Network & Schedule Network &
 Share
Schedule Scenario Schedule in
 Projected Traffic & Spill Model
 Projected Load Factor
 Revenue
 Profitability
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40. SECTION 5
Q&A
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41. icfi.com/aviation | 40