Why Budget Airlines are Suddenly Failing

The recent struggles of budget airlines can be attributed to several interrelated factors that have emerged since the peak profitability experienced by these carriers in the mid-2010s.

Overview

This report examines the operating margins of selected low-cost airlines in the USA and India from 2020 to 2023. The data highlights the impact of the COVID-19 pandemic on these airlines, their subsequent recovery, and recent performance trends.

USA Low-Cost Airlines

Spirit Airlines

• 2020: The operating margin was negative due to the pandemic's impact, resulting in significant losses.
• 2021: The airline began recovering, reporting an operating margin of around -5%.
• 2022: Spirit's operating margin improved to approximately 10%, benefiting from increased travel demand.
• 2023: The airline faced challenges again, with an operating margin of about -16.4%, reflecting ongoing financial difficulties and a decline in revenue by 6.2% year-over-year.

Southwest Airlines

• 2020: Experienced a significant loss with an operating margin of -20.2%.
• 2021: Rebounded with an operating margin of 5.4%.
• 2022: Improved further to an operating margin of 12.3%.
• 2023: Continued strong performance with an operating margin of around 10%.

Allegiant Air

• 2020: Reported a negative operating margin due to the pandemic.
• 2021: Saw an operating margin of 12.7% as travel demand began to recover.
• 2022: Operating margin increased to 14.5%.
• 2023: Maintained a strong margin, estimated at around 15%.

India Low-Cost Airlines

IndiGo

• 2020: Faced a major downturn with an operating margin of -38.4%.
• 2021: Recovery began, with an operating margin of about -10.5%.
• 2022: Returned to profitability with an operating margin of 10.5%.
• 2023: Continued strong performance with an operating margin of approximately 15%.

SpiceJet

• 2020: Reported significant losses with an operating margin of -40%.
• 2021: Margins improved slightly to -20%.
• 2022: The airline struggled, with an operating margin of around -15%.
• 2023: Continued to face challenges, with margins still negative but improving slightly to -10%.

Declining Profit Margins

Budget airlines, which once boasted impressive operating margins, face significant financial challenges. For instance, airlines like Spirit and Allegiant have seen their margins drop to between 5.6% and 11.2%, while legacy carriers have rebounded to 8% and 10.9% margins. This shift has raised questions about the sustainability of the budget airline business model.

Recovery Post-COVID

While passenger volumes have rebounded to record levels following the COVID-19 pandemic, budget airlines have not capitalized on this recovery as effectively as their legacy counterparts. Legacy airlines have adapted their services to cater to the increasing demand for leisure travel, while budget airlines have struggled to adjust their offerings accordingly.

Competitive Environment

The competitive landscape has intensified, with an oversupply of flights in many markets. Budget airlines face challenges from legacy carriers and other low-cost carriers, leading to increased passenger competition. Spirit Airlines, for example, has cited a "challenging competitive environment" as a factor in their struggles.

Changing Consumer Preferences

Consumer behaviour is shifting, with many travellers seeking more premium experiences that budget airlines typically do not offer. This trend towards "premiumization" means that budget airlines may lose customers to carriers providing better service and amenities. Additionally, the rise of remote work has reduced business travel, which was traditionally a stronghold for airlines.

Operational Challenges

Budget airlines also contend with operational hurdles, including rising fuel prices and increased costs associated with labour and aircraft maintenance. These factors have eroded the cost advantages that budget airlines previously enjoyed. Furthermore, adverse weather conditions have led to more delays, impacting the efficiency of budget airlines' operations. In summary, declining profit margins, a challenging competitive environment, changing consumer preferences, and operational difficulties have put significant pressure on budget airlines, leading to their current struggles in the aviation market.

How have legacy carriers managed to regain their profitability

Legacy carriers have successfully regained profitability through strategic adjustments, operational efficiencies, and market adaptations following the challenges posed by low-cost carriers and the COVID-19 pandemic.

Strategic Cost Reductions

Legacy airlines have focused on significantly reducing costs to improve their financial health. Many carriers sought to lower their operating costs by approximately 20%, which involved renegotiating labor contracts, optimizing fleet management, and streamlining operations. This cost-cutting effort has been crucial in enhancing their competitiveness against low-cost carriers, which traditionally operate with lower overheads.

Revenue Management and Pricing Strategies

In addition to cost reductions, legacy carriers have implemented sophisticated revenue management systems to optimize pricing and maximize yield. They have adjusted their fare structures to capitalize on the recovering demand for leisure and business travel. This includes introducing premium economy seats and enhancing service offerings, which cater to travellers willing to pay more for added comfort and convenience.

Adaptation to Market Demand

The recovery in passenger demand, particularly for business travel, has played a significant role in bolstering the profitability of legacy airlines. As business travel rebounds, many carriers have reported that their revenues from both leisure and business segments have surpassed pre-pandemic levels. For instance, American Airlines noted strong demand from small and medium-sized businesses, contributing to their profitability.

Focus on Network Connectivity

Legacy carriers have leveraged their extensive networks to provide services that low-cost airlines do not offer, such as connecting smaller U.S. communities to international destinations. This strategic advantage allows them to maintain a revenue premium associated with their network service, differentiating them from low-cost competitors.

Operational Flexibility

In response to the unpredictable nature of travel demand post-COVID, legacy airlines have also focused on maintaining operational flexibility. They have worked to quickly restore capacity while effectively managing overhead costs. This approach has allowed them to adapt to fluctuations in demand without incurring significant losses.

Conclusion

Through strategic cost management, enhanced revenue strategies, adaptation to market demands, and leveraging their network advantages, legacy carriers have successfully navigated the challenges posed by low-cost competitors and the pandemic, leading to a resurgence in profitability.

What innovative strategies have legacy carriers implemented to compete with low-cost airlines?

Legacy carriers have implemented several innovative strategies to compete effectively with low-cost airlines. These strategies focus on enhancing their offerings, optimizing operations, and leveraging their established networks.

Multi-Brand Airline Holdings

One significant strategy is the creation of multi-brand airline portfolios. Legacy carriers have established or acquired low-cost subsidiaries to capture market segments that traditional models might overlook. This allows them to compete directly with low-cost carriers while maintaining their premium services under the main brand. By offering a range of brands, they can cater to different customer preferences without diluting their core brand identity.

Mass Customization of Services

Legacy airlines are increasingly adopting a "mass-customization" approach, which involves tailoring services to meet the diverse needs of travellers. This strategy recognizes the evolving expectations of customers who seek personalized experiences. By segmenting their customer base more effectively and offering a broader array of services, legacy carriers can better compete against the simplified offerings of low-cost airlines.

Enhanced Customer Experience

Legacy carriers have focused on improving the overall customer experience to differentiate themselves. This includes investing in better in-flight services, upgraded seating options, and enhanced loyalty programs. By creating a more appealing travel experience, they aim to attract passengers who might otherwise choose lower-cost alternatives for their price sensitivity.

Operational Efficiencies

Legacy airlines have also pursued significant cost reductions, aiming for approximately 20% cuts in operating expenses. This has involved optimizing fleet management, renegotiating labour contracts, and improving fuel efficiency. By lowering their cost base, they can offer more competitive pricing without sacrificing profitability.

Strategic Partnerships and Alliances

Legacy carriers have strengthened their partnerships and alliances, which enhance their route networks and provide customers with more options. By collaborating with other airlines, including low-cost carriers, they can offer seamless connections and comprehensive travel solutions that appeal to a broader audience.

Focus on Business Travel

Legacy Airlines capitalizes on its established reputation and service quality to attract business travellers, a segment that values reliability and comfort over cost. They have tailored their offerings to meet the needs of business customers, such as flexible ticketing, premium lounges, and enhanced frequent flyer programs, which are less emphasized by low-cost carriers.

Conclusion

Through these innovative strategies—multi-brand holdings, mass customization, enhanced customer experiences, operational efficiencies, strategic partnerships, and a focus on business travel—legacy carriers have positioned themselves to compete effectively with low-cost airlines while maintaining profitability and market share.

Citations:

[1] https://www.airwaysmag.com/new-post/spirit-q1-2024-results

[2] https://www.statista.com/topics/4567/spirit-airlines/

[3] https://www.fool.com/investing/2024/07/21/spirit-airlines-has-fallen-82-this-year-should-you/

[4] https://www.reuters.com/business/aerospace-defense/spirit-airlines-forecasts-weak-q2-revenue-slow-growth-domestic-demand-2024-05-06/

[5] https://www.cirium.com/thoughtcloud/cirium-monthly-on-time-performance-reports-2024/