Budget Airline Sector - Case Study Example

Strategic Management - 2 Ryanair Case study Ryanair - a Brief Background: The airline was established in the year 1985 with 2 aircrafts and carried 82,000 passengers. In the year 1991 Michael O'Leary took charge of the airline and converted it in to a low cost airline. As per the year 2005 figures the airline had 12 bases, serving 220 routes to 95 destinations across 19 European nations carrying 27 million passengers annually. (Yan Mei - Guihang Guo and Riaan Barnard, 2005) 1.0 Porter's 5 Force Analysis of Budget Airline Sector Michael Porter's 5 Forces analysis of the Budget Airline Sector is presented below: Competitive Rivalry: All said and done the budget airline industry is highly competitive with a number of players operating. There are plenty of chances for the rivals to copy and take advantage of any cost cutting measures introduced by one airline. The existing rivalry between the two major budget airlines (Ryanair and Easyjet) is comparatively lower as both have strategically avoided the direct competition by choosing not to serve the same sectors and routes. In case another airline chooses to operate on the same basis as being done by Ryanair there would be heavy pressure on the prices, operating expenses and the resultant profits. In budget airline industry there can be no much differentiation in the services being provided and the price is the important differentiating factor for the competitive edge. The increased competition between rivals in the budget airline industry may lead to price wars which will greatly benefit the customers only. "This is why Ryanair has an advantage over other airlines because their policy of bundling low frills and low prices together means that they are competing for the more price sensitive customer." (Sean Brophy and Dominic St. George, 2003) The demand for short haul flights is ever increasing in Europe. Hence it became important that Ryanair had to take all the benefits of the first mover advantages, since there are many airlines trying to copy the services being provided by Ryanair. Davy (2003) believes that "there are only two pan-European low cost operators where first mover advantage and scale and cost efficiencies gave the two largest players, Ryanair and Easyjet, a significant advantage." The fact remains that after deregulation almost 80 airlines started operating at low cost in the similar lines of Ryanair and 60 of them have since become bankrupt. According to Michael O'Leary, Ryanair need not bother about the competitive rivalry since according to him "at the lower end of the market Easyjet and Go don't really compete with Ryanair." Ryanair had a distinct competitive advantage in being the cheapest 'no frill' carrier in the Europe. It was possible for the airline to have the lowest costs as they drove down costs in every possible area. In the matter of competitive rivalry Ryanair has taken away large amount of market share from the rivals Aerlingus and British Airways and to some extent from other airlines. According to Reuters (11th February 2005) "Ryanair also announced it would offer 2 million free seats, a move designed to pressure full-service airlines such as British Airways whose fuel surcharges have widened the gap on fares between budget and traditional airlines. Ryanair is fully hedged until the end of next March and has refused to impose a fuel surcharge, betting that low fares and even free tickets will draw passengers away from rivals." These strategic moves of Ryanair keep a check on the competitive rivalry. Michael O' Leary said"The more we can put pressure on high-priced airlines, the more we can convince them there's no point competing with us (on short-haul European routes)," Bargaining Power of Customers: The customers for the airline industry especially in the budget airline are highly price sensitive. Switching to another competitive airline is relatively easier and simple thanks to the presence of internet and online booking facilities. The switching also does not entail a higher cost. The budget airline cannot expect any loyalty from the customers. The cost of travel and punctuality only counts. The customers are well aware of the costs to the airline in providing the service since the seats are sold through internet and the customers can compare the relative prices. As outlined above the bargaining power of the customers in the budget airline industry has many deciding factors. To illustrate some of the factors that determine the bargaining power are the standardisation of the services, change in demand for the airline, brand identity and the quality of the service being provided by the airline. In this respect the customers of the airline industry especially in the budget airline sector enjoy a high bargaining power due to the very low switching costs. In the case of low cost airlines all the customer has to do is to go to the website of the competitor and book online. There is a high level of transparency in the prices of the competing low cost airlines as most of them are selling the seats through internet. This implies that Ryanair had to keep its prices at comparatively lower rates than its competitors to attract the customers. Barriers to New Entrants There exist some barriers to entry in the form of high investment costs It is difficult to find airports for operating the services due to very limited slot availability There is a definite need for low cost base Getting flight authorisations is very difficult There is the threat of an immediate price war if there are plans to encroach an existing low cost carrier route. Threat of Substitutes: In budget airline industry no brand loyalty from the customers can be expected. There can be no close relationship with the customers. There are virtually no switching costs for the customers There is always the competition from other modes of transports like Eurostar, Trains, Ferries and car travels. Bargaining Power of Suppliers: With the possibility of getting the aircrafts from only two suppliers - Boeing and Airbus - Ryanair's main supplier of Aircrafts were Boeing. The switching cost from one supplier to the other would cost Ryanair heavily, with the retraining of all pilots and mechanics. The cost of aviation fuel is highly volatile and is influenced by the oil prices. ( However Ryanair could control the fuel cost by indulging in Hedging) The bargaining power of the regional airports since there is dependence on one airline or other The bargaining power of larger airports is greater. As a strategic policy Ryanair would try to avoid operating from these airports 2.0 Ryanair and Cost Cutting: Ryanair's cost cutting results in a sizeable cost advantage to the airline giving it the utmost competitive edge over the rivals. Such cost advantages range "from the in-plane seating structure, high aircraft utilisation, in-flight catering, the use of secondary airports, direct sales (mainly over the internet) and its fleet all being the same plane." (Sean Brophy and Dominic St. George, 2003) In the early the airline started to focus on low cost travel basing the model of Texas SouthWest airlines. The airline concentrated exclusively on the cost reduction and became the industry leader in budget air line in the Continental Europe. Their strategy involved cost cutting by doing things such as: "Having one low cost class of seating Dropping it's cargo service in 1997(annual cost IR400,00 in revenue). Shorter turnaround times No more free drinks (charging for drinks Outsourcing non essential services (bag handling) outside its Irish base Fleet commonality Boeing 737-200's, most widely flown commercial aircraft in the world. Reducing travel agent commission Eventually selling e-tickets almost exclusively online Using smaller airports with lower fees Point to point flights, no connecting flights or reliance on other airlines Low basic pay for staff with commission for increased productivity(performance related pay, adopted 1992) Lowering marketing costs(providing advertising on outside of it's jets) Ryanair direct limited(1996) to handle phone bookings (avoiding travel agents) More routes to non Irish-Anglo destinations Its refusal to acknowledge trade Unions" (NCI) In the following areas the airline adopted the policy of outsourcing: Baggage Handling Ticketing Heavy maintenance Ryanair derived its best cost advantage from the two basic principles of 'a higher seat density' and ' a higher daily aircraft utilisation' compared to other airlines in the industry. As a policy Ryanair did not operate business class. Ryanair by carefully planning the seat pitch could accommodate 15 percent more seats in their flights than the competitors who are regular airlines. This enabled Ryanair to have more number of passengers per flight than normally being carried by other airlines. "The effect of these extra passengers is exacerbated when one realises that Ryanair actually has more planes in the air. This is done because they try to achieve a 20 minute turnaround at each destination which means that the planes are rarely left idle." (Sean Brophy and Dominic St. George, 2003) Another factor that helped to achieve the short turnaround time was that there was no need to clean the aircraft at the end of the flight as no food was served in-flight. In fact this was also turned out to the advantage of the airline by selling snacks and drinks to the passengers inside the flight and this revenue was added to the operating profit of the airline. For the year ended 31st March 2002 the revenue from this source accounted for 11.7 percent of the total operating margin of Ryanair. Another biggest cost saving measure for Ryanair is their usage of secondary airports to the maximum extent possible. This was crucially important for the airline as the airport charges of major airports on short haul flights may come up to 10 to 13 percent of the total operating costs of the airlines. Any reduction in the airport charges would directly enhance the profitability of the airline. It was found that the airport charges per passenger of Ryanair were only one third as compared to that of British Midwest. According to (Sean Brophy and Dominic St. George, 2003) "In fact, since 1997, Ryanair has convinced the IATA to redesignate Beauvais, Charleroi, Hahn, Torp and Nykoking airports, obtaining concessions from them in order to fly there." Mckinsy (2001) reports "Ryanair are in a particularly strong position when it comes to negotiating new agreements with the various airport officials because many of the airports they operate from have a very minimal scheduled service. These low airport fees help to keep Ryanair's costs at about 65% below those of traditional airline meaning that they can offer cheap fares and still make a profit if more than 55% of its seats are occupied." Another distinct cost advantage resulted to Ryanair from the way in which they were selling their seats. Since they adopted a direct selling method they were able to keep their costs very low. With the introduction of their website on the internet in the year 2000, the airline started selling the seats via internet having more than 50,000 bookings per week while they started online booking in 2000. They could sell 75 percent of their capacity through internet by 2001 and later on it increased to almost 90 percent of their daily bookings. The online bookings had the effect of eliminating the cost of agency commission which may work out to almost 7 to 9 percent of the sale value. Moreover the airline did not have their own booking offices in the cities to which they operated flights which would have necessitated incurring additional costs for renting those offices at prominent locations. In order to gain more cost advantage Ryanair maintained all its aircrafts of the same type. They had Boeing series of aircrafts for all routes which had the advantage of reduced training costs of the pilots and also the maintenance costs were also kept to the minimum. "This is furthered in 2002 when Ryanair agreed to purchase 100 new Boeing 737-800 aircraft plus additional rights to purchase an extra 50; and although maintenance costs increased by 29% at the end of the quarter ended June '02, this is explained by the fleet that operated increasing and a subsequent increase in the number of hours flown." (Sean Brophy and Dominic St. George, 2003) Ryanair issued tickets only for point to point service which eliminated the transfer and endorsements in favour of other airlines. This also enabled the airline to simplify its passenger revenue accounting and allowed the airline to completely computerize the accounting and also the entire other functions. "Michael O'Leary outlined that "despite strong growth Ryanair continues to deliver impressive cost discipline", this is justified by the fact that although in June '02 operating expenses had increased by 22% from the previous year, and revenues had increased by 29% "(Sean Brophy and Dominic St. George, 2003) From an observation of the above cost cutting measures undertaken by Ryanair it can be stated affirmatively that this is the limit of cost cutting in the airline industry as Ryanair has explored the possibility of cutting costs wherever possible. Therefore it appears that it may not be virtually possible for any other airline to cut costs in any other areas where Ryanair has not experimented cost cutting exercises. In case if some other airline makes it possible to find some other areas where it can really introduce cost saving measures and try to compete with Ryanair then it would amount to heavy and unbearable pressure on prices for both the rivals. Such a price war will only be advantageous to the customers and the airlines will have to suffer from a reduced profitability. Since in the budget airline industry there can be no differentiation in service and the competitive edge lies exclusively on the price factor. The only way to gain competitive edge is by identifying new areas where cost cutting can be effected. But still it has to be remembered that whatever cost saving measures are adopted the resultant gain would have to be passed on to the customers in case if there is a stiff competition and no airline can take advantage of such cost cutting exercises. But once again it can be reiterated that if any airline is able to identify any new cost cutting measures other than employed by Ryanair that airline deserve to take over the position of the industry leader of the budget airline industry from Ryanair. Total Word Count: 2421 References: NCI 'Ryanair Case Study' http://nci.wikispaces.com/case-study-ryanair Reuters 'Ryanair Says All May Fly Free if Gambling Pays off' 11th February 2005 http://www.usatoday.com/travel/flights/2005-11-02-ryanair-no-airfare_x.htm Sean Brophy and Dominic St. George, (2003) 'How Ryanair has Exploited the Economic Theory Behind Airline Contestability and Deregualtion' Student Economic Review Vol. 17 pp 245-257 Yan Mei - Guihang Guo and Riaan Barnard, (2005) 'Ryanair Case Study' http://72.14.235.104/searchq=cache:4PBiZKwfULIJ:online.glos.ac.uk/colin_clarkehill/MB471Web%252004/Ryanair_presentation_group1.ppt+five+forces+%2B+ryanair&hl=en&ct=clnk&cd=15&gl=in&client=firefox-a Read More