Profits Ain’t Peanuts (Part One: The Peanut Uprising)

Even Southwest’s Nuts have evolved over recent years. TOFU Nuts Image provided by Southwest Airlines, © 2013

This is the first post in a five-part series comparing and contrasting the approaches of Low-Cost Carriers, Traditional Airlines, and New Airlines as they compete for the travel budgets of increasingly savvy travellers.

In his summary of Airline Trends for Landor’s 2014 Trends Forecast, Peter Knapp, Global Creative Officer based in Landor London, entitled his report on the dominant trend for our industry next year Evolution, citing the changes to the Low-Cost Airline model.  He asked the question, “have..Low-Cost Carrier[s]..finally grown up?”

His excellent summary struck a nerve with me.  It encapsulated a feeling I’ve had about the Low-Cost Carrier model over recent years.  I don’t think it’s a future trend.  I think it’s been happening for a while and is only now becoming apparent with some of the most recent changes made by airlines who have bucked the original LCC Model, like JetBlue.

The change, though, hasn’t been one-sided.  It has not been limited to LCCs.  It has bounced from LCCs sector to Traditional Airlines and back again through all service sectors, until it has spanned our industry.  That’s what I want to discuss in these posts.

The game has changed, but I want to look into why, where, how, and just how much.  I also want to know what comes next.  Not just in 2014, but beyond.

The Base Line

For years some airlines have offered us peanuts and others have offered us the world.  The market was divided between the Low-Cost Carriers getting us to short-haul destinations at bargain prices, and the Traditional Carriers taking us nearly anywhere we like.

Over more recent years the pioneers of Low-Cost service have shed their bare-bones image, leaving a market gap for Ultra-Low Cost Airlines to fill.

Many Traditional carriers have trimmed their operations, reduced the amount of free-services they offered on board, and modified their cabins to compete with Low-Cost Carriers and their ever-increasing market reach.

Other airlines have taken a completely different approach, and provided levels of unprecedented luxury.

Sometimes the competition has been downright ugly, but competition is always good.

Where air travel was once out of reach for many because of its prohibitive cost, today you can fly somewhere for peanuts (provided you read the fine print).

Passenger complaints over punitive added costs, occasional iffy service, uncomfortable cabin conditions, and remote airport connections aside, low fares attract a good share of the market.

Customers who want more far more than peanuts, can choose between traditional airlines and newer luxury carriers.

The passenger has been the real winner in this competition.

A greater industry mix, coupled with the rise of online services which let us shop around, has made finding the right combination of fares and services relatively easy.

Recent events in the world economies temporarily slowed passenger growth in what have traditionally been the world’s largest aviation markets.  This has served to increase competition and forced innovation in cabin services to attract new customers and retain established ones.

While Low-Cost Carriers have famously based their success on giving customers nothing more than peanuts and a safe ride at low fares, new economic realities increasingly push them to modify their models.

The manner in which both Low-Cost Carriers and traditional airlines adapt to changing market conditions has generated a push for cabin innovation inconceivable in years past.  It is sure to benefit passengers for many years to come, so long as the evolving business models hold up to the financial strain.

We’ll be reviewing those market conditions, the changes airlines are already making, and what changes they might make to stay ahead of the game.

The Bottom Line

Unique burdens on airline operators, make it difficult for airline businesses to succeed.  Many have operated at a loss for years.  A great number have required mergers and government intervention in order to continue operations.

Historical IATA statistics on airline profitability reveal an industry which constantly struggles to keep their collective heads above water.  Profit Margins have never been high.  They have fallen and risen only to fall again, never much above 6% sometimes falling below -4%.

Overall, airline stocks have not been good investments.  In any other market sector, businesses operating at such low and unstable profit margins would be short-lived.

The bottom line has always been a problem for airlines; one they struggle to address.

It’s too easy to dismiss this dismal performance as poor business management.  In fact, it is inaccurate.

While there have been airlines with business models so broken that the airlines have disappeared, most of the world’s carriers have trimmed their fat and reinvented themselves entirely in the years since privatisation.

The reasons for the poor performance of many traditional airlines are increasing competition in what were once protected markets, rising fuel costs, and the considerable burden of aircraft parts and equipment inventories required to operate a multiple route system.

Low-Cost Carriers have succeeded by infringing on once exclusive markets, but they contend with the same rising fuel costs which eat away at their profits.  Their successful business models are based on universality and interchangeability of equipment which significantly reduces their operating costs.

That one-part-fits-all approach has been a very clever innovation of Southwest Airlines, followed by every other successful Low-Cost Carrier which has emerged around the world.  It has also been the principal limiting factor on their expansion.

Low-Cost Carriers are spreading their international wings, but equipment range is still a limiting factor, as is the availability of slots at many international airports.

The major international carriers must carry a range of aircraft to service their varied ranges of routes.  They could never adopt this Low-Cost Carrier Model of interchangeable equipment.  By necessity, they must invest in large spare parts inventory to support safe operations.

In short, the competition is not like to like.

Low-Cost Carriers have been able to maintain higher profit margins than the industry average in great part due to the business advantage of this single-equipment model.

As they increase efforts to reach routes outside their established networks, it will be interesting to see how Low-Cost Carriers resolve the limitations of the single equipment business model which has been so good to them.

Hungry for More?  Profits Ain’t Peanuts Part Two: Nuts for Business will be published Monday.

Smiling Peanut Feature Image by Richard Elzey shared under Creative Commons License