Low cost carriers: Business model, expansion, challenges

Across a wide range of industries, traditional market leaders are threatened by low price competitors. These low price firms are steadily eroding the profit margins and market share of their more established rivals, writes WOLE SHADARE

Intense competition

Beginning in the North America and spreading to Europe, the airline passenger market has witnessed a growing intensity in price-based competition.This intensified competition has been facilitated by policy deregulation initiatives until the emergence of the phenomenon low cost airlines. European low cost airlines have changed people’s leisure and travel habits, opening up direct services between city pairs that were not available before.

Over the recent few years the African middle class has been growing rapidly increasing the demand for low cost air travel across the continent giving rise to low cost carriers (LCC).

Flybe’s collapse

The collapse of Flybe is said to have occurred last week as a result of its flawed business plan. Yes, coronavirus hastened its collapse but at the end of the day, Flybe’s pricing policy was adjudged to be wrong.

For any form of travel, the operator with the fastest service generally charges the most. That used to be the case before the arrival of low-cost airlines when domestic flying would be considered a luxury.

In Flybe’s case, although it held a monopoly over most of its mainland domestic routes, it was undercutting rail fares sometimes by as much as 50 per cent or more.

This scenario applied especially on those niche regional routes where Flybe competed with train operating company cross country, which is known to be pricey.

LLC’s headway in Africa

Low-cost carriers are starting to slowly – very slowly – penetrate Africa’s regional international market. LCCs currently only account for about 0.2 per cent of international capacity within Africa, making it one of the last frontiers for the global LCC sector.

Tanzania-based LCC fastjet launched services from Dar es Salaam to Johannesburg on October 18, 2013 completing a tedious delay-ridden process. It is the first of several planned international routes for fastjet from Tanzania and other potential new bases throughout Africa.

Incredibly there are currently only five international routes within Africa operated by LCCs. The opportunities for LCCs to penetrate the intra-Africa market are huge but so are the challenges.

Fastjet in 2013 became only the third LCC to operate international services within Africa, joining sister carrier Fly540 Kenya and South African Airways (SAA) subsidiary Mango. The three carriers combined to provide about 4,000 weekly seats in the intra-Africa international market, which is equivalent to approximately a 0.2 per cent share of total capacity.

It has been nearly two decades since LCCs began to penetrate the Middle East and Africa markets. Comair was the pioneer in Africa, launching its budget brand kulula.com in 2001, and Air Arabia was the pioneer in the Middle East, launching operations in 2003.

LCCs in Africa do face large challenges politically and economically which hinder their growth. The LCC model works best when the airline has multiple hubs across their network.

Government’s action

In Africa many governments are not giving permission to airlines like FastJet and Mango airlines to set up hubs within their countries in a effort to protect their national carriers. These issues have hit FastJets income statement negatively with them posting a loss in 2015 due to politics hindering their growth and disrupting their strategy.

In Nigeria, how low can the airlines operate considering the fact that air fares are very low because of the poor purchasing power of many Nigerians?

Low-cost concept

The concept of a low cost airline was started in the seventies by the American domestic carrier Southwest with the sole objective of offering cheap airfares to the consumers.

This created a situation where already established flag ship carriers or legacy airlines lose a significant amount of the market share to these newly formed low cost airlines, purely because of their ability to charge a lower price over traditional full cost airlines. Many of the low cost airlines all around the world initially based their strategy on the South West’s model.

However, as the number of low cost airlines (LCAs) increased over time, more and more of these airlines have deviated or ‘modified’ this model in order to survive in the industry due to competition.

The basis of operation of low cost airlines remains the same, which is to provide the lowest price for the consumers by undercutting the price levels of legacy carriers.

But because there are a number of airlines competing with each other, some LCAs have modified their strategy in order to try and stand out from their competition. This strategy is known as differentiation strategy.

Poorly priced fares

Airfares do not reflect the actual cost of operation because of the low disposable income of Nigerian citizens. At the current cost of aviation fuel and maintenance, for a Nigerian airline to make profit it should charge between N40,000 and N45,000 for one-hour flight and between N55,000 and N65,000 for one hour-plus one way trip.

This amount will appear too much for so many people whose salaries are less than N100,000 per month. But that is the actual pricing that could generate profitable revenue for airlines and make them to be in business. Currently, air fares oscillate between N19,000 and N25,000 and in rare cases N28,000.

This is not sustainable for any airline that wants to be in business as the carriers already offer what is generally termed ‘low-cost’. This is even made worse because airlines have lost over at about 25 per cent per cent of traffic since the beginning of the year.

Expert’s view

Vice President, International Air Transport Association (IATA), Raphael Kuuchi, recently told New Telegraph at a forum that low cost airlines, wherever they exist, play a very critical role contrary to thinking by some legacy carriers that low cost carriers have come to take over their market.

He noted that the model had the tendency to stimulate additional demand and come up with a new market segment that in most cases has not been seen before.

He, however, lamented that “unfortunately, what we are seeing in Africa is a concentration of low cost carriers still in a few markets,” adding that this was because the low cost business was based on low price and high volumes and in many markets in Africa, they have the volumes.

He said: “The volumes are in South Africa domestic market.” To some extent, Nigeria might eventually come up with low cost model in the future. You see that in North Africa, we have low cost model in Egyptian market, in Morocco because of the volumes there.

Within Africa, it is a huge challenge because the volumes are not there. The second limitation in the growth of the low cost carriers is the existing limited Bilateral Air Services Agreement (BASA).

Aero’s low cost experiment

It would be recalled that Aero Contractors, seven years ago, introduced low fares on all the routes it operated. The fares were as low as N5,000. The model it adopted led to huge traffic for the carrier and huge cash flow for the airline, as passengers thronged the carrier.

The model entails that intending travellers made their bookings at least two weeks before their next flight. Low-cost airlines are taking off across the region, serving routes that cater to the continent’s growing middle class.

Last line

In upcoming markets such as Africa and Asia, it will take a few more years before the low cost market reaches maturity due to the restrictive nature of governments involved.