Low Cost/Low Fare Model

Since US domestic Deregulation in 1978, there have been innumerable Low Cost Carriers that have come and gone, mostly gone; due to a limited life design that usually runs out of gas within 10 years. Only two examples maintained low cost/low fare sustainability for at least 25 years. Southwest Airlines in the US and Ryan Air in Europe.

Three balanced objectives are necessary to achieve long term sustainable success:

1) Strong Financial returns to provide shareholder benefits, and to provide the cash flow for strong and steady growth.

2) Employees sharing in the increasing prosperity appropriately. This provides continuity in one's career expectations, and helps create the underlying commitment to providing superb Customer Service to build the Brand and generate genuine Customer loyalty. Consistent with this is the focus on building an authentic internal Culture.

3) Maintaining true and absolute low costs which economically provides for a long runway of market opportunities that will be available well into the future.

This virtuous cycle can be replicated again and again. Scale and market development in any community will enhance productivity. Efficiency from this combination will present a sustainable competitive moat if discipline on unit costs is maintained.

I will explore in some detail what I think are essential elements in a deep and expansive market like the domestic US.

The most critical component to provide for continued top line revenue growth is comparative and true low unit costs. The following details how this can be accomplished.

Relative to previous fares in a given city pair, the system must be able to enter markets and provide profitable fares (including ancillary fees) that are 35% to 50% lower than before entry. This economic model repeated again and again over 35 years at Southwest Airlines demonstrated the efficacy of this model. Time and again, the stimulation factor for short hauls produced 300% to 500% in traffic stimulation and 200% to 350% increases in market revenue by converting previous ground travel Customers and increasing the ability of current Customers to increase their travel frequency. Intermediate haul markets achieved 100% to 300% market revenue growth. Long haul markets typically produced 100% traffic gains but usually little market revenue growth. Even in this segment of the market place, if you have the lowest unit costs, an airline will have enhanced competitive ability to provide better service and capacity due to a deeper and stronger Network as well as a more profitable base. This process does not create business, but instead provides the combination of fares, capacity, and frequency that meets the underlying market need.

Today, while there is some limited low fare availability, there is very little true capacity expansion due to generally higher costs within the industry as well as limitations within the ULCC model. While the ULCC model provides for an overall lower Customer cost in terms of choice; their capacity additions are very spread out and thin in terms of individual city pair capacity. Market development and growth is limited. Usually, depending on competitive fare matching, the market is fairly stimulated with the limited capacity offering, resulting in the ULCC being able to achieve margins that can be very high.

The industry today generally predicates revenue development on "fee" extraction posed as "Customer Choice". It is difficult to find Customers who in general find additional fees as a desirable choice. It is a good choice where the competition has been extracting much higher fares and fees.

Carriers are now addicted to historically high load factors and compressed seat pitch. It has been demonstrated in the past that at 68% load factors we would see the beginning of rejected demand in the marketplace. The industry aims for load factors in the low to mid 80's now. How often does this provide availability to book a seat at all within the last couple of days before a flight; unless at the highest fare? Does it provide the opportunity for a low fare unless you are to make plans well in advance of travel? This has become normal at the present time due to the necessities of generating substantial financial returns. Higher break even load factors than in the past leave fewer seats to generate the revenues to provide a reasonable profit.

To provide sustainable low unit costs requires great market discipline in addition to a never ending focus on base cost inputs. The model needs to produce an environment that allows all aspects of the system to effectively operate. A combination of short, medium, and long haul flights need to be combined in a way that allows flight crews and flights to be fully utilized within legal and contractual requirements. In terms of long term cost pressures "quality of life" issues must also be productively managed to demonstrate effectiveness in gaining confidence and trust with flight operations crew members.

While aircraft utilization has been well recognized as an important input for productivity, it can only be sustainable if efficient. The shortest possible turn time while maintaining on time performance is required. For some time, aircraft turn times have been increasing to deliver improvements in Customers' on time experience. Despite improved tools and data, the execution for performance has become less effective. Turn times have been getting longer and longer. Utilization can be maintained, but if it results in having to start the operating day in the 500a-600a time frame, and running with departures in large numbers after 800p-900p. Customers are forced to take flights at the industry's convenience. It also increases station costs by having staff available for much longer periods of time to handle the same number of flights that operated in what was considered preferred times. This only works if there is tight industry capacity discipline. We have had that for the last several years. Most importantly greater turn times lose too much prime time during the day that could be applied to naturally higher yield demand periods regardless as to a carriers' relative cost position. If industry capacity increases materially, Customers will naturally gravitate towards better timed and available capacity.

Within station operations, increasing turn times increases unit costs dramatically. Assignment of staff grows into additional shifts, gate utilization during key departure times is reduced, and flexibility within the operation is compromised for operational recovery from weather events and maintenance issues.

• Sustaining Profitable Growth

Gradual but steady gowth of 10%-15% a year with somewhat steady average operating margins of 12%-15% will provide the underlying financial basis that will provide capital to grow the fleet, produce an appropriate ROI, as well as to provide an environment that will provide for promotional opportunities for employees. It is also a rate of growth that the organization can grow with by retaining operational discipline and continuity in its' Cultural development.

Current availability of rapidly evolving productivity tools such as web site development, product development and Customer choices through AI, and big data analytical tools are effective in strengthening the business. Ultimately all these advantages are available to all competitors. Superior operational design and leadership will result in utilizing them more effectively for dominant market success.

Most importantly is the relationship with the people who produce the product. Running an airline is fundamentally a business between Customers and front line staff. Leadership must know and understand the perspective of front line staff. Unless there is an authentic connection, it will be difficult to affect trust and confidence. Belief that leadership knows what it is doing and legitimately takes into account consideration of employees needs and concerns is essential.

We see the optics of how all airlines recognize the need for a strong and positive Culture. Unfortunately we often see that at the slightest buffeting we see revelations that the relationship is tenuous at best. As with most experiences there is no substitute for strong leadership that can get folks focused on what needs to be done, and within the limitations and realities of the marketplace.

A healthy Company Culture. It is very hard to be successful in developing it. Consultants, Academics and Executives talk about it, plan for it, and invest in it. Too often it frustratingly does not really happen despite declarations otherwise. It takes a very long time, and must stand up to pressures, both negative and positive. It must be genuine and attended to every day, in every way within the normal course of any work activity. Easy to say I'm afraid, but hard to do. Obviously important for all service companies, but especially important for low cost producers, as the most important aspect of the business will be the accurate and positive delivery of what is promised.

It is likely impossible to produce and sustain a long term low cost/low fare model without the interaction of these inputs. It produces a virtuous cycle that gets stronger and stronger due to the underlying inputs. If you try to select and choose parts, it will often appear to continue to work for a period of time, but inevitably the original impetus for success will be gone. Trying to reconstitute is extraordinarily difficult. Stay true.

Published as a White paper for the Terrapinn LCC conference; London U.K. September 2017