Bud He t Airlines

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Budget Airlines – Ryanair

High Technology Entrepreneurship & Strategy

Mukund BhagavanOguz Ertekin

Peter GeijermanVasily Kuznetsov



High-Tech Entrepreneurship & Strategy – Budget Airlines / Ryanair 2

European Airlines.. ......................................................................................................3

Nature of Competition in the Airline Industry..........................................................4

Value Chain.............................................................................................................7Cost Structure..........................................................................................................7

Customers................................................................................................................9

Airlines..................................................................................................................11

Ryanair......................................................................................................................14

Entry Strategy........................................................................................................14

Construction of Value Chain.................................................................................. 16

Perceptions of Key Success Drivers....................................................................... 17

Market reactions........................................................................................................19

Analysis .................................................................................................................... 21

Choosing Firm Boundaries ....................................................................................21

Managing Growth..................................................................................................23

Future Landscape of the Airline Industry ...............................................................26

References.................................................................................................................27




European Airlines

Since its conception after World War I, the European airline industry went through

consolidation around the 1950s and consisted mainly of nationally owned airlines. Air

travel between any two countries within Europe was regulated through pooling

agreements, which basically allowed the national carriers to share revenue, capacity and

profit. Domestic travel was also strictly regulated and since the respective governments

had interest in the national airlines through equity stake, they discouraged entry of new

airlines. While there had been advances in aviation, significant barriers existed for entry

into the scheduled flight services between major European cities.

The first attempt to break through this stronghold happened in the 1960s through the

introduction of chartered airlines that addressed consumer’s frustration with high airline

prices and need for cheap fares. Chartered airlines were able to get around regulatory

because they were non-scheduled flights. In response, the incumbents set up their own

chartered airline subsidiaries to capitalize on this new opportunity.

In the early 1970s, the US went through a deregulation of the airline industry that freed

up pricing and route scheduling and reduced barriers for entry and exit. Following

deregulation, competition forced down prices for the average consumer. The freeing up

of the airline industry and its ensuing benefits to customers in the US put pressure on

European governments to take a similar path. Beginning in 1987, over a period of several

years, the European airline industry was completely deregulated allowing any European

carrier to fly between any two destinations. Much earlier, the UK, as a result of change in

government, ushered in deregulation of the airline industry in the hope that it would

benefit consumers through cheaper airfares.




Chronology of deregulation

Dec 1987 “December 1987 package” - First phase of liberalization in Europe, ends

bilateral capacity sharing between national carriers

June 1990 “Second Package” - price controls, capacity and market access restrictions

lifted

Jan 1993 “Third Package” Complete deregulation with the advent of the EU open

market, any European airline can fly anywhere

When flight travel originates or terminates in a country outside Europe, regulations

governing this travel are still set on a bilateral basis with that country. For example, the

US negotiates separate bilateral flight treaties with each European country and the

airlines are still bound by regulations listed in these treaties. There is a natural division

for European airlines – the intra European market that is completely deregulated today

and the extra-European routes that are still regulated through bilateral agreements. Given

this key distinction, our analysis will focus on approach to opportunity in the deregulated

intra-European market.

Nature of Competition in the Airline Industry

We apply Porter’s 5 forces framework to analyze the competitiveness in the intra-

European airline industry. As the industry evolved significantly after deregulation, the

timing for our analysis is right after deregulation, i.e. 1993.




Threat of new entry (medium)

Regulation was the most significant obstacle for new entry until the airline industry was

completely deregulated in 1993. Existing players through wide networks had low costs

through economies of scale. Other deterrent to entry was access to scare resources. Afterderegulation, economies of scale and access to scarce resources (landing at airports) were

some of the major deterrents of entry. However the ability to outsource some of the

operations reduced the benefit of economies of scale increasing threat of new entry.

Rivalry (Low)DuopoliesUsed pricing signalingas a mechanism toavoid intense rivalry

Supplier Power(Medium)

Airports had some bargaining power Other suppliers suchas agents were toofragmented

Threat of entry(Medium)

Regulated until 1993Airports were scarceresourcesHigh fixed costs,some EOS

Buyer Power(Low )

Buyers a fragmentedgroup

Substitutes(Low)

Some substitutes suchas buses/ fast trainsfor leisure travelers;

but speed of travelkey for businesstravelers




Substitutes (medium)

The incumbents focused on business travel for much of their revenue generation, and

since business travelers required speed (high performance), other options such as trains

and buses were weak substitutes. This was especially true for travel from the UK to

continental Europe.(Eurotunnel wasn’t built until eh late 1990s). However they were a

viable alternative to price sensitive consumers.

Supplier power (medium)

Suppliers in this industry are the employees, aircraft manufacturers and airports.

Employees wielded some power through unions; Since maintenance was significant cost

item, airlines were interested in purchasing same kind of planes. Given that there were

only two aircraft suppliers – Boeing and Airbus, they both had high supplier power. Sincemajor airports were a scarce resource, they too had significant buyer supplier power.

Travel agents were another group here, however fixed commissions and high

fragmentation meant little leverage.

Buyer power (low)

Buyers were a fragmented group and had little bargaining power.

Rivalry (low)

Until deregulation was completed in 1993, the national carriers dominated most European

routes. Even after deregulation there was a period of time when most of the dense intra-

European routes continued to be operated as duopolies. As a result, there was little rivalry

for intra-European routes, and meant comfortable profits for the incumbents.




Value Chain

Airlines and their partners undertook the following set of activities to provide

transportation:

Supplies consist of procuring materials (sourcing) and undertaking maintenance of

flights. Operations ensure flight operations (piloting, flight attendance, etc) and the

support from ground operations (passenger handling, cargo, catering, etc). Marketing and

distribution are closely interlinked and involve market analysis, advertising, value

appropriation through pricing. Distribution was done through travel agents (online and

offline) as well as direct to consumer.

Cost Structure

The airline industry is characterized by high fixed costs in equipment, labor and facilities.

In the long-term, some of the excess capacity is fixed assets can be disposed throughreductions in workforce, subleasing of aircraft, etc.

The most significant operating costs that airlines face are labor costs, cost of fuel and

charges for landing and en-route navigation.

- Compensation levels are a key determinant of labor costs and flight staff at European

airlines was generally paid high remuneration levels in comparison with American

and Asian airlines. Flight crews were paid by productivity, and productivity intraditional airlines was measured by number of flight hours. Also resistance from

labor unions made it difficult for airlines to usher major reforms.

- Airlines have had little influence over fuel prices. The larger airlines were able to get

lower price for volume consumption. While Airlines could plan their purchases and

OperationsFlight oper.Ground oper.

SuppliesMaintenancePurchasing

MarketingPromotion.Sales

DistributionReservationTicketing




buy at an airport where it was least expensive, the cost of carrying the fuel diminished

any savings gained.

- Due to air travel congestion at airports near large European cities, landing charges

were especially high. For example, in the early 1990s landing charges at London’s

Heathrow International was several times that of New York’s JFK. Among other

costs, depreciation, ticket distribution and ground handling were other significant cost

sources.

After the European airline industry was deregulated, most major airlines saw little

difference in the unit costs for all of the costs resources mentioned above except for labor

costs. Since they were using the same airports, the cost of other resources was equal

across airlines. Therefore cost cutting often focused on cutting labor costs.As we will see, Ryanair was able to leapfrog competition with a strategy that let them cut

costs beyond just labor.

Strategic implications

The business model adopted by the national airlines internalizes certain cost structures

that cannot be removed without disrupting the whole value proposition:

- To provide connectivity the hub-and-spoke system is designed so that arrivals and

departures are clustered in waves over the day, minimizing the waiting time for

transfer passenger. This inevitably causes a lower utilization of both human resources

and the aircrafts 1

- The interdependence of flights in the networks means that the airlines have to

internalize a large amount of variability, forcing them to have a higher reserve

capacity, since a delay in one flight will effect a large number of other flights, causing

high costs or leading to the airlines not providing the service they charge large

premium for - The loyalty programs, a means of competition among the major airlines, had become

an increasing burden, that constitutes a respectable part of their costs 2

1 “Hyped hopes for Europe’s low-cost airlines”, McKinsey Quarterly 4, 20022 “Frequent-flyer economics”, Economist , May 2, 2002. “Fly me to the moon”, The Economist, May 2,2002.




Customers

The airline customers have traditionally been divided into two groups – business

travellers and leisure travellers . Different strategies have been developed in order to

create and capture maximum value for and from these customer groups, and the industry

structure has, as will be discussed below, reinforced this segmentation of customers.

Business Travelers

The business traveller is targeted with such product features as:

- frequency

- flexibility

- connectivity

- service – airport and in-flight- loyalty rewards

The business travellers need for frequency and flexibility comes from the relative

unpredictability of the need and timing for travel in business. It is provided by dense

flight schedules (frequency) and booking facilities and rules (flexibility) allowing for last

minute booking, rescheduling, cancellation, reimbursement etc.

The need for connectivity arises from the business travellers need to go from one given

point (the location of one’s own corporation) to another given point (the location of the

customer). Though the macroeconomic argument that business interact where

communication (among other factors) make it possible, today’s business landscape in

general makes the travel a function of the business and not the other way around.

The services offered to the business traveller range from on ground facilities such as

lounges with faxes, Internet connection, fast line check-in etc. to in-flight services such as

hot meals newspapers, spacious seating allowing to work or rest.

The loyalty programmes have become an increasingly important component in the

airlines competition for business travellers. These programmes have the effect of locking




in a customer (the company) by locking in the consumer/decision maker (the business

traveller) by offering free miles to the traveller, thereby increasing loyalty to a certain

airline and increasing the price sensitivity of the decision maker.

The growing internationalisation of business and the integration of the European markets

have increased the market for business travel and the market is expected to grow by up to

40% by 2010 3.

The business travellers have been the target group of almost all major airlines because of

the higher profitability and the better fit between the customer needs and the structure of

the services provided.

Leisure Travelers

The leisure traveller is targeted with such product features as:

- price

- attractive destinations

- bundling with hotels and activities at destination

For the leisure traveller price has a much higher relative importance for the decision on

if, where and how to travel, since the leisure traveller is paying out of his own pocket,

and travelling often involves the whole family. More time consuming but lower priced

means of transportation are considered as substitutes. The possibility to plan ahead gives

a lower WTP for flexibility , and the level of comfort and service is more easily traded

down for a cheaper ticket. The frequency is of much lower importance as long as it fairly

well coincides with the planned length of the stay (which normally last much longer than

the ordinary business stay).

The traditional leisure traveller looks for a destination that can offer the desired features,

often sun and sea combined with a certain service infrastructure such as hotels, bars,

3 Air Transport Action Group, “Fast facts”, www.atag.org




restaurants, nightclubs etc. The air travel has been a component of a more complicated

bundled product, with implications on the supply side (below).

Leisure travel is a function of population density and economical well being in the

departure area and of the attractiveness to the travellers of the destination. This makes

leisure travel dependent on macroeconomic factors, on social factors as changing

vacation behaviour, more individualistic and less family travel, big cities as tourist

attractions etc.

Airlines

Major Carriers – Specializing in business travel and yield management

The major carriers have specialized in serving the business traveller and have – in order

to provide the flexibility, frequency and connectivity desired by the customer – developed:

- the hub and spoke system, designed to concentrate traffic to a limited number of

airports, thereby decreasing fixed costs and to gain higher utilization of aircraft by

pooling travellers from many connecting flights into one

- the CRS-systems (international booking networks) which enables the airlines to link

the point-to-hub-to-point flights together

- the code sharing programs which allows an airline to sell tickets to a destinationserved by another airline belonging to the same alliance. The international

competition is to a large extent concentrated to four big alliances.

To fill up seats, cheaper over-the-week-end tickets are sold to leisure travellers to almost

all of the scheduled flights as well. This is however not the focus of these players.

Capturing Value

Although the flexibility, frequency and connectivity are provided for the business

traveller, they are surely appreciated by the leisure traveller as well. The airlines

however, have no other choice than to restrict the service provided to leisure travellers by

internal rules in order to capture more of the value provided to the business travellers. By

introducing limitations such as requirements to book long time in advance, a rule that




forces you to stay over a Saturday night etc., the airlines are able to prevent the business

traveller from benefiting from the services at the economy price, and thus are able to push

the prices up the demand curve, which proves to be very inelastic. (The upper limit to this

strategy would theoretically be the cost for the employer to have an employee out of

office for an extra day or two, including higher compensation and hotel expenses etc.)

Charter Airlines – Specializing in leisure travel and product bundling

The charter airlines – selling a commodity, point-to-point transportation service – are

much more dependent on the complementary services provided to their customer. When

the leisure traveller buys a ticket to go to a certain destination, he almost always do so

because he has bought a service provided at the destination, and the ticket is in most of

the cases sold through a third party, bundled with other products – being the actual objectthe customer is purchasing. The operators don’t schedule their flights, other than to the

day and approximate time of take-off, usually operate from smaller airports or in

unattractive slots on major airports. They fill their planes in advance by selling seats in

bulk, often to closely related agents.

The industry has historically been dependent on other industries providing the services

that created the demand for the travel such as hotel packages etc. The travel agencies had

the customer relationship and bundled the air ticket with products from other providers,

giving them an advantage in capturing value, making the air travel more of a commodity.

As a response, the charter airlines have in many cases integrated forward.

Changes in social behaviors and the internationalization of society have now created new

types of leisure travelers. The modern leisure traveler takes on many of the functions

earlier provided by the airlines, such as booking of hotel and recreation at the destination,

made possible by the adoption of the Internet of both consumers and service providers.These changes makes leisure travelers less dependent on travel agencies, something that

also make the airlines less dependent on the agencies for selling their tickets. There is a

trend of de-bundling the leisure travel products.




Low Cost Airlines

By exploiting the ’white spots’ between the two models described above, the low cost

airlines provide a scheduled point-to-point service at routes with enough travellers to

sustain a scheduled flight. They provide the benefits of frequency, more flexibility than

the charter airlines but no connectivity. The service level is lower than the major airlines

and some of the charter airlines. They run no loyalty programmes. The low cost allows

them to focus on price, and hance to expand the market.

Due to the different natures of the service provided and the different customers targeted

there is very low level of competition between the major airlines and charter airlines. The

low cost carriers compete for business traveler that travel mainly and repeatedly on the

haul they are operating, while they cannot compete for the majority of business travel.

They compete more directly with the charter airlines for independent leisure travelers

looking for the lowest priced tickets.

Different Value to Different Customers

The elements of the service provided by the low cost airlines are embedded in the service

provided by the traditional business and leisure travel providers. The low cost airlines are

targeting another mix of consumer preferences and income level - from which the airlines

focused on business traveller are locked out from because of their price discriminating

operational models (providing more than half of their revenues). The more independent

leisure traveller - less willing to pay for the add on services provided by the travel agents,

is more likely to use a scheduled low cost service to reach a destination where all the

other arrangement have been done through the Internet.

Another important feature of the low cost airlines is that they touch a price-point that

actually expands the market instead of only stealing market share from the incumbents.They are priced in a range that makes them a real substitute for many of the on-ground

transportations preferred by the price sensitive travellers.




Differentiation

While the traditional industry is an oligopoly where the players swiftly adopt any

successful innovations the competitors implement, and where the close interdependence

created by code sharing, common booking systems etc prevent full competition it is hard

to differentiate. This might well be one of the factors driving the industry profitability

down 4.

The low cost carriers have benefited from this difficulty of their competitors to

differentiate themselves in their marketing by provocative campaigns directed directly to

the consumers, profiling themselves as the ‘consumer’s friend’.

The different approaches to distributions are of no less importance in understanding how

the low cost carrier differ from the traditional carriers. The business traveler targeted by

the major airlines normally doesn’t spend a lot of time searching the market but outsource

this to a travel agency – a push system in the ticket distribution from the airlines’ point of

view, where agencies have to be courted in order to benefit from their customer relations.

The low cost traveler buys the ticket directly through the Internet and the carriers create

demand by targeting travelers with direct advertisements promoting the low cost feature.

Ryanair

Entry Strategy

Ryanair has been the pioneer in the European low-cost carrier industry. It started

operating in 1986 on the Ireland-UK route. It adopted a classical airline business model

focusing on customer service. In order to gain foot in the market it priced 10% below the

duopoly of Aer Lingus and BA. When Ryanair began operations on their Waterford-Gatwick and later on Dublin-London routes, they primarily chose to differentiate in two

ways. They did offer meals and amenities comparable to what Aer Lingus and British

Airways provided, however they focused on first-rate customer service, and a single,

4 Best practice Best strategy, McKinsey Quarterly 2, 2000




simple fare with no restrictions. They distinctly targeted the large Irish immigrant

population working in England, who had to suffer through a 9-hour long rail or ferry

journey to visit home because they could not afford to fly. This target customer

segmentation not only clearly identified their niche market, but it also elevated them to a

“hero” status among the poor immigrant population, for standing up to the big players.

This factor raised their psychological and social barriers to exit and strengthened their

commitment.

In 1987, after 2 years of start-up losses they posted their first profit. At this point they

became a more credible threat and faced intensified competition from the flag carriers in

the markets where they competed. This period was characterized by struggle for survival

and incremental but unstructured cost reduction efforts in search of the “right” businessmodel which culminated in heavy losses until the Jan 1991 cash crisis.

In 1991 the shareholders appointed Michael O’Leary to turnaround Ryanair. Under the

new leadership Ryanair reemerged as a passenger transportation company not constrained

by the typical business model (ferries, railroads, busses). Following the EU airlines

deregulation, in 1997 Ryanair entered the routes between the British Isles and the

Continental Europe. It has focused on North-South routes transporting primarily leisure

travelers.

Business Model

Ryanair adopted a strategy targeting not only existing airlines’ customers but also

customers of other modes of transportation as well as people who didn’t consider

traveling because of prohibitively high prices. The key competitive advantage of the new

business model was pricing 50-90% below competitors. To sustain this competitive

advantage Ryanair had to adopt a cost structure different from its competitors so thateven if the competitors responded with price war Ryanair would be still operating at

profit. Unwilling to change the existing operations model the incumbents could not match

the new Ryanair prices.




To support the strategy of the low-cost low-fare airline Ryanair redesigned the process by

flying point-to-point. It also avoided head-to-head competition by serving unconventional

routes from secondary airports. Ryanair has substantially redesigned its product to offer a

low-cost low-fare. It cut all the frills, increased the number of seats on the plane, reduced

costs by introducing direct sales, standardizing the fleet and increasing the personnel

productivity. It compensated the foregone revenues from ticket sales by the revenues

from onboard sales and extensive advertising (even on the exterior of the planes).

Impact on the Transportation Industry

Essentially Ryanair created a sub-segment of the passenger transportation industry for

itself. It was a segment with economics and customers different from the traditional

airlines. It competes with the existing airlines because their markets overlap. Its truecompetitors are all modes of transportation, but primarily the cheaper on-ground modes

and the low-cost carriers that mimicked Ryanair.

Construction of Value Chain

The outsourcing of non-core activities (e.g. ground handling, partial maintenance) and

keeping distribution chain in-house made Ryanair’s value chain different form the

traditional value chain. The logic behind this model was to keep the costs down. It is

worth mentioning that Ryanair didn’t compromise safety and maintenance in its ferocious

pursuit for cost reduction.




RYANAIR’S VALUE CHAIN CONSTRUCTION

Standardizedfleet’

Signed long-term contractsin theeconomicdownturn

MarketingOperationsSupplies Distribution

Purchasing Maintenance Groundhandling Flight Reserva-tions Ticketing

Bothoutsourcedand in-house;

“No-frills”concept didn’tapply tomaintenance

Outsourced Product ivi tyhigher thanindustryaverage

Controversialmarketing

Not integratedin theindustry-widereservationssystmes

Direct sales

Perceptions of Key Success Drivers

The key success driver of the management was the ability to focus. To focus in the long-

term on setting low-fares, sustaining low-cost position and finding extra revenues from

ancillary services. And, to focus in the short-term on the most critical issues and keeping

the organization flexible in order to respond to the issues.

Organizational Success Drivers

The key organizational success factor has been the focus on low costs, which is an

integral part of the Ryanair’s corporate culture. For examples, employees are encouraged

to bring pens from home or lift pens from hotel rooms.

The low-cost spirit is also reflected in the compensation system. Most of the employees

(except of the maintenance workers) are paid based on productivity (number of flights,

sales on-board etc.). Ryanair doesn’t pay pilots based on their tenure which is an industry

practice. In order to motivate employees the management promotes primarily from within

and encourages employees’ involvement in management through Employee

Representation Committees. It also updates employees on the current state of affairs and




the challenges the company is facing by communicating daily performance and other

information through TV stations in the offices.

Flexibility is another key attribute of the Ryanair’s organization. The company rotates

personnel between jobs depending on the company needs.

Competitive Success Drivers

The primarily competitive key success driver of Ryanair is its low cost structure. An

additional success driver is focus on ancillary sources of revenues such as on-board sales

and advertising both inside the aircrafts and on the exterior.

Source: Association of European Airlines, Civil Aviation Authority, McKinsey analysis

RYANAIR’ COST ADVANTAGECosts per available-seat-kilometer (ASK), 2001, cents

Top 3 majorflag carriers

(international)

1. Ov erhead

• Lower generaladministrativecosts

21 3 4 5

0.512.0 1.7

0.80.6 2.6

1.3

4.5

6 Ryanair

2. Distribution

• Direct sa les only• No fees for 3 rd

party computerreservationsystems

• No commission onticket sales

3. Passengerservices

• Direct s ale s only• No fees for 3 rd

party computerreservationsystems

• No commission onticket sales

4. C rew cost s

• Low compen-sation costs

• H igher crewproductivity

• R educ ed crewcomponent

5. Airport charges,ground handling

• Lower ai rportcosts through useof secondaryairports; lowertaxes

• Lower ground -handling costs

6 . Seat density

• 15% more seatper aircraft

Ryanair’s cost advantage

Ryanair’s cost advantage

Consumer Success Drivers

The primary driver here was the use of yield management to gain new customers through

fare drops rather than to find opportunities to raise fares without loosing customers.




Market reactions

Ryanair’s growth comes from taking away market shares from other transportation

companies and from creating new segments. For example, by 1999, Ryanair became the

biggest carrier on the Ireland-UK market, by taking over traffic from ferries, BA and AerLingus as well as by boosting the overall market. A famous example of creating market

segments is Ryanair’s launch of London-Carcassone flights, which led to creation of a

Euro200M tourist market in a medieval town in the South-West of France. 5

Following deregulation, Ryanair was able to disrupt the European airline industry and

change the basis of competition. Here we revisit how the nature of competition changed

following Ryanair’s entry.

Threat of new entry (increased)

Deregulation lowered the barriers to entry. At the same time, new routes need to reach a

critical mass before they can be profitable and many routes can only sustain one airline.

Hence, Ryanair was able to gain a first mover advantage on several routes. Ryanair’s

success prompted a wave of imitating start-ups and charter operators (e.g. AirBerlin)

entering low-cost carrier market. Most of them are loss-making and many did not last

long (Debonair, AB Airlines, ColorAir). In fact, as McKinsey Analysis shows “excluding

Ryanair, the European low-cost segment accumulated losses of almost $300 mln from

1996 to 2001). …Ryanair and easyJet between them account for more than 88% of the

scheduled low-cost market in Europe. In US, SW alone holds 50% of the US low-cost

market. This pattern suggests that a winner-takes-all dynamic favors the first entrants,

which can use low prices to stimulate demand and build brand power” 6

Supplier power (decreased)

It also decreased the suppliers’ power because the owners of these airports were willingto accept essentially any offer. However, Ryanair’s exponential growth and profitability

make the airports negotiate the high airport fees as they renew their contracts.

5 Gimeno, Javier et al; European Airline Industry: Ryanair in 2003, INSEAD, 2003, p.36 “Hyped hopes for Europe’s low-cost airlines”, McKinsey Quarterly 4, 2002




Rivalry (medium)

It also managed to keep the degree of rivalry relatively low by competing directly only on

a limited number of routes (as opposed to other low-cost carriers such as easyJet). For

instance, at the end of 2002 it faced competition only on 43 out of 85 routes. 7 On less

profitable routes the incumbents withdraw or shift towards full-fare business travelers.

For instance, BA withdrew from the Dublin-London route after Ryanair began its

turnaround. On more profitable incumbents responded with low-fare spin-offs. For

instance, BA launched Go and KLM launched Buzz, Virgin – Virgin Express. Most of

them could not compete with low-fare airlines and went bankrupt. Essentially they

operated a low-fare high-cost business model, since they could they could not abandon all

the frills (such as pre-assigned seats, food and drinks on-board) or were constraint by the

use of a heterogeneous of non-standard airplanes inherited from its incumbent parent.

Virgin Express went bust in 1999, Buzz was acquired by Ryanair in 2003, Go – by

easyJet in 2002. Some traditional airlines adopted elements of a low-cost carrier strategy.

For example, in 2002, SAS dropped its business class for intra-Scandinavian flights, and

started operating part of its fleet on a point-to-point basis. Incumbents also responded by

presenting the deals Ryanair stroke with its airports as a government subsidizing. Most of

the airports Ryanair flies to are owned by local or national governments. “The European

Commission launched an investigation to see whether the discounts Ryanair receivedfrom Brussels-Charleroi airport amount to illegal subsidies. A decision is not expected

until September 2003, but O’Leary says he’s “confident Ryanair will be vindicated.” 8

Power of substitutes (increased)

At the same time, the power of substitutes for Ryanair’s services has increased since it

competes for cost-conscious leisure travelers. The buyers’ power is as low as before the

deregulation and Ryanair’s entry.

7 Gimeno, Javier et al; European Airline Industry: Ryanair in 2003, INSEAD, 2003, p.128 Kerry Capell; Ryanair rising, Business Week, June 2, 2003, p.20




Analysis

We’re looking at a family that got into the airline business mainly because they had some

cash and experience through their earlier career with a flag-carrier airline. While they

attempted to capture a share of the market through lower prices, they had no competitiveadvantage over incumbents that could help them sustain in a price war. They faced fierce,

almost predatory, competition from the incumbents early on, and burned a lot of the Ryan

family money for years, trying to survive against the big players. This is a fascinating

success story highlighting flexibility, discovery/learning driven planning and

determination.

Choosing Firm Boundaries

Ryanair’s “innovation” can be described as the discovery of the extremely high demand

elasticity of the European leisure traveler at price levels comparable to other means of

transportation, and close scrutiny of each element in the traditional airline cost structure

to attain that level. Although it seems they set out with the goal of direct competition with

rail and ferry transportation, they went through a few phases in perfecting their business

model. In the process they gradually realized that the available market was much greater

than what they originally envisioned and adjusted their “firm boundaries” accordingly.

The 1991 cash crisis proved to be a key turning point for Ryanair. In desperation,

O’Leary was appointed deputy CEO and the third phase began: Radical cost cutting and

drastic price reduction on existing routes followed by expansion into continental Europe.

The new price levels managed to hit the sweet spot of the demand curve, volumes

exploded and the company returned to profitability. Ryanair had completed its

transformation from a niche airline serving the poor Irish immigrants to mainstream

super-low-cost European carrier targeting mostly the leisure traveler.

In retrospect, back in 1985 launching into a business that they ended up evolving to

would have posed several risks. However, they managed to spread these risks over time

and plan according to their learnings and discoveries.




Interdependence risks

- Scope and timeframe of airline deregulation.

- Secondary airports. Will they be able to reliably handle additional traffic? Do they

have the necessary infrastructure to support higher passenger volumes?

- Internet availability. Although Internet was not even in the radar screen in 1985, some

for of low-cost booking mechanism needed to become available to be able to bypass

costly travel agents. Even the “call center” concept was new in Europe.

- Aircraft technology. Emergence of an “industry standard” aircraft. Improvements in

aircraft reliability, maintenance requirements and fuel economy to support low-cost.

- Development of IT technologies to enable better capacity utilization and scheduling.

Integration risks

- Customer awareness. Realization of affordable new means of transportation, air vs.

rail/ferry/car.

- Customer education. Learning to plan and book their own flights through call centers

and/or Internet.

- Existence/development of complementary forms of transportation to/from remote

airports to points of general interest.

Most of these risks have been largely eliminated today, although there is still potential for

increasing passenger volumes as cheaper complementary transportation becomes

available to/from remote airports.

Appropriability

We have mentioned above several key ingredients to maintaining cost leadership. Each

one of these factors in isolation is easy to replicate, however in order to create overall

value and be competitive one has to replicate the entire package which requires strong

corporate culture. This cultural aspect is what makes imitation so difficult and is also one

of the main reasons why many new entrants have failed.




Complementary assets

Key complementary assets are 1) secondary airports, 2) ground handling and 3) aircraft

maintenance, all of which have been outsourced. These are also assets that are freely

available. Secondary airports to a certain degree are the potential scarce resources,

however current projected levels of passenger traffic to secondary airports and the

potential to second source suggests that they are unlikely to gain much bargaining power.

Launching across Europe - Crossing the Chasm umm.. Channel

Once they had perfected the art of operating a low-cost airline, after 6 years of continuous

profit, Ryanair launched their first route to continental Europe in 1997. They were

targeting the larger market of British and Irish tourists looking for sunnier skies in other

parts of Europe. They also launched a route to Sweden that let them capture shortvacationers shuttling across large cities. Throughout their growth they stubbornly stuck to

the elements of their strategy that helped them keep their costs low.

Although the move to expand into continental Europe was a risky one, and targeted a

slightly different customer segment than their “adoption drivers,” they did not change

their business model significantly, nor did they abandon their original customer base. In

that sense the move was merely and application of the internal competence they

developed over the years to a larger market rather than a strategic shift in their business

model to enable explosive growth.

Managing Growth

Key enablers of Ryanair’s business model are high degree of standardization, and point-

to-point operation coupled with obsessive scrutiny of operating costs. These factors, for

the time being, seem like competitive advantages that the traditional carriers are not

likely to be able to replicate. They have to deal with two major sources of variation whichturn out to be significant cost drivers, and which they simply cannot eliminate without

radically changing their business models.




Limitations to standardization

Because of the much larger variation in the geographies, distances and passenger

volumes they serve, traditional airlines are limited in the degree to which they can

standardize their fleets. This imposes all the additional cost of qualifying, purchasing,

maintaining, training resources required for a heterogeneous fleet.

Limitations to scheduling

Hub-and-spoke structure inherently introduces bottlenecks at the hubs both in space and

time. Even if very large airports are chosen or built to serve as hubs to avoid spatial

constraints, external effects such as weather will always cause variation in arrival and

departure times. This is a direct consequence of the hub-and-spoke structure and small

variances in arrival times lead to ripple effects that could explode. Cost of trying tocontrol such variations and dealing with consequences once they do happen is an

additional burden that the traditional airlines must carry. Once again, their large network

of destinations they must serve precludes them from adopting a point-to-point structure.

The low cost carriers’ proposition of a point-to-point service excludes the costs of

connectivity. With a fast growing industry and a diminishing supply of pilots (decreasing

air forces) the utilization of the pilots is becoming more and more crucial. Thanks to their

high turnaround time, made possible not only because of operational excellence but also

by the fact that there are no connections to match, the low cost carriers have up 50%

higher utilization of their crews than the traditional carriers. The variability is directly

transferred back to the customer, by not compensating for delays.

There are also limitations to the no-frills and point-to-point service that Ryanair faces.

Long-haul effects

As flight distance increases the competitive advantage that low cost airline begin to erode

for three reasons. First, traveler’s willingness to trade off convenience for lower costs

will be lower. People are less willing to fly without food and in a crammed seat on longer

routes (e.g. London – New York). Second, as the distance increases, direct variable costs

such as fuel, pilot time etc. make up a bigger portion of the total cost leaving less room to




play with, in percentage basis, by cutting back on frills. And finally, it is much harder to

maintain a point-to-point network on a large scale without making connections. Low-cost

airlines would incur the additional costs if they tried to provide connections in addition to

having to solve the issue of transporting between remote and major airports.

We believe that the biggest threats to Ryanair and other low-cost airlines are

- Consolidation and repartitioning of routes among the major carriers to reduce excess

capacity. By trimming excess capacity and avoiding direct competition, traditional

airlines may be able to bring their prices to levels that are on the same “indifference

curve” as those of the customers served by low-cost airlines, i.e. those same

customers may be willing to pay some premium for better service and convenience.

- Gradual adoption of key low-cost practices by traditional airlines.- Adoption of better costing mechanism by traditional airlines to reflect costs related to

connection handling and associated scheduling risks. As mentioned above, scheduling

restrictions and assumed risks associated with providing connections constitute a

large cost inherent in the hub-and-spoke structure which is currently mostly allocated

evenly across all operations. Traditional airlines may move to relax their scheduling

at the expense of longer layovers, offer more point-to-point-like service in local

geographies and charge passenger separately for routes that require connections. Even

then they would have an advantage over low-cost carriers since they often do not

serve those routes, and they service secondary airports which offer no connections.

- Saturation of availability of high-volume point-to-point routes. Few low-cost airlines

were able to identify and move in to “low-hanging-fruit” type potentially high-

volume point-to-point routes. However, as the number of low-cost airlines and their

networks grow it will become increasingly hard to find routes that will “break even in

3 hours”, which has been one of Ryanair’s own success criteria for a new route.

For all of these reasons, we believe, Ryanair’s business model seems sustainable for the

time being, however not scalable to a size much larger than that of today’s, at least until

advances in aircraft technology makes it feasible and economical to serve point-to-point

networks across the globe.




Future Landscape of the Airline Industry

Is consolidation inevitable? Will there be a few major traditional airlines, remnants of

flag-carriers, confined to long-distance transcontinental routes, abandoning local point-to-

point service to low-cost carriers? They fly the “hubs,” low-costs service the spokes? But

then how difficult is it for the low-cost carriers to take over the large network? Is this a

Western Union story all over?

Consolidation does seem necessary if not inevitable. And, full-service airlines may very

well find themselves pushed out of the local leisure travel segment and into longer

distance and business segment. However, we don’t believe that the Western Union

analogy applies here, since the key advantages that the low-cost airlines have require

their “local networks” to be disjoint from those of the major airlines. Instead, we believe

a new – third – segment is being created in addition to the traditional full-service business

travel and charter operations.



References1 Air Transport Action Group, “Fast facts”, www.atag.org2 Best practice Best strategy, McKinsey Quarterly 2, 20003 Doganis, Rigas: The Airline business in the twenty-first century, Routledge 20014 “Frequent-flyer economics”, Economist , May 2, 2002. “Fly me to the moon”, The Economist, May 2,2002.5 Gimeno, Javier et al; European Airline Industry: Ryanair in 2003, INSEAD, 20036 “Hyped hopes for Europe’s low-cost airlines”, McKinsey Quarterly 4, 20027 Kerry Capell; Ryanair rising, Business Week, June 2, 20038 Rivkin, Jan: Dogfight over Europe: Ryanair (A), Harvard Business School, 20009 Rivkin, Jan: Dogfight over Europe: Ryanair (B), Harvard Business School, 200010 Rivkin, Jan: Dogfight over Europe: Ryanair (C), Harvard Business School, 200011 Seristö, Hannu: Airline performance and costs:an analysis of performance measurement and costreduction in major airlines, Helsinki School of Economics and Business Administration, 1995

Bud He t Airlines

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