📰 Grad Paper Example 2

Graduate Paper 2

March 29th, 2021
Economics of Low Cost Carriers

Airlines are characterized by high costs and intense competition that have led to very thin operating profit margins. Some of the main costs incurred include fuel, aircraft leases, maintenance, and labour. One business model that seeks to improve the profitability in this extremely cost conscious industry is that of low cost carriers (LCCs). The economics of the LCC approach is considered in this paper.

The first main aspect of LCCs is standardization (www.managementstudyguide.com). The limiting of the fleet/aircraft type is central to this; for instance, Southwest airlines only uses the Boeing 737 aircraft. The training for pilots and maintenance personnel will thus be restricted to only one aircraft type. This reduces the regulatory training costs required over time and flattens the learning curve. Limiting the fleet type also leads to economies of scale with respect to spare parts and other maintenance operations. Another major aspect of standardization hinges on the processes employed in the operations. Processes are optimized and simplified to reduce costs. LCCs for instance do not have connection transfers from their flights to other flights and vice versa due to the increase in complexity and costs that are created.

Economies of scale and economies of density play a big role in the LCC business model. Firstly, economies of scale are created by having a large fleet size and secondly utilizing these planes as much as possible. This spreads the fixed cost across more aircraft and more flights which effectively reduces the average cost (Cost per Available Seat Mile CASM) with increased operations. Thus, the profitability is increased across each flight (provided that the flights have adequate load factors). Delta airlines has sought to capitalize on some of these efficiencies by streamlining their fleet during the COVID-19 pandemic. According to an article on Delta airlines on www.seekingalpha.com by Adam Levine-Weinberg “This fleet simplification effort could cut the number of pilot aircraft categories at Delta in half… Adding in maintenance cost savings and gauge benefits, this fleet transformation could eventually generate double-digit unit cost savings: literally billions of dollars a year.” In many instances LCCs include more seats on the same plane compared to the number of seats on a similar plane in legacy airlines. This also effectively spreads the fixed cost across the revenue earning asset of seats and creates economies of scale.

Economies of density are created through airport hub and spoke operations where the number of flights needed to connect destinations to each other is reduced versus a direct airport point to point structure. Ironically though, the demand for hubs increases the costs associated with them so that it became cheaper for LCCs to operate point to point flights. In fact, this has led LCCs to also operate out of less popular airports that have lower landing and airport operating fees. Again, providing a reduction in operating cost compared to legacy carriers.

The use of technology is also key to LCCs as this allows for greater efficiencies and cost minimization. Technology and related automation reduce the labour requirements in airlines and hence their operating cost. One example of this is the use of the web as a channel for customers to book versus the traditional travel agent or direct call center within the company. Mobile technology has also aided this development so that customers for instance can now have digital boarding passes that saves printing and check-in agents. Finally, machines that check in persons also help to reduce the cost to the airlines of having check-in agents.

Ultimately, one of the key elements to the LCC model is the unbundling of services. This allows the airline to charge more in aggregate for several individual items that may have been previously grouped together but are now sold separately. For instance, meals and seat selection that were included in the ticket price in legacy airlines are now unbundled and sold separately in LCCs. Unbundling in some instances causes bidding for limited resources and in others allows the airline to sell some of these services as a premium. Spirit airline competes specifically on low prices due to unbundling (www.commons.erau.edu). The low base fare then helps to rank the attractiveness of their flights higher on online travel agents like Expedia. Low base or ticket fares (unbundled) attract a low cost price sensitive segment, but in fact the total fare can be higher than a legacy fare if customers select enough add-ons or ancillaries. This can thus result in a significant competitive advantage for LCCs.

References:

1. Economics of Low Cost Carriers
   Management Study Guide
   https://www.managementstudyguide.com/economics-of-low-cost-airlines.htm
2. Delta Air Lines: Fleet Simplification Will Be A Game Changer
   Published July 23, 2020 by Adam Levine Weinberg
   https://seekingalpha.com/article/4360284-delta-air-lines-fleet-simplification-will-be-game-changer
3. Spirit Airlines: Achieving a Competitive Advantage Through Ultra Low Cost
   Fall 2013 by James Elian
   https://commons.erau.edu/cgi/viewcontent.cgi?article=1602&context=jaaer