LAURIE PRICE FRAeS considers the latest trend in airlines: long-haul low-cost. A new concept for today’s ultra-efficient airliners or back to the future?

The announcements by IAG (the parent company of British Airways, Iberia, Vueling and Aer Lingus) and Air France that they will be launching low-cost long-haul operations as ‘Level’ and ‘Boost’ respectively and that Lufthansa is also reviewing its options, suggests that the apparent success of long-haul operations by low-cost operators such as Norwegian, Scoot, Icelandair, WestJet, Wow and others is causing the legacy carriers to think again about both the opportunity of low-cost long-haul and meeting the competitive threat. (Albeit the name ‘Level’ might need a rethink as a call to ATC ‘Level 300 level at 350’ might cause some confusion and compromise safety). Any review of such operations needs to recognise the basic economic tenets of air transport. 

Regardless of stage length, airline operations are about maximising volume – number of passengers or amount of freight carried against realisable payload – and value – extracting the highest yield or net revenue earnings per seat against the cost of operation under the prevailing market conditions, through active capacity and yield management. For any low-cost operation to work profitably, it means achieving the lowest seat mile cost (thus operating at the maximum permissible aircraft seating configuration) and limiting the level of ‘inclusive’ service within the ticket price and charging for all add-ons. That can include extra charges for pre-boarding, seat selection, hold baggage, meals, drinks, entertainment and Wi-Fi.

The rise of the low-cost carrier

Deja vu all over again? British Caledonian began long-haul charter operations in 1964. (RAeS/NAL)  

For short-haul operations in the USA and Europe, US deregulation in 1979 spawned the growth and success of carriers like Southwest and Jet Blue but hastened the demise of others, Eastern, Braniff, Pan Am, TWA etc, while EU Open Skies transformed the short-haul market leading to today’s dominance by Ryanair, easyJet and other low-cost carriers (LCCs) in Europe. This, in turn, led to the legacy airlines consolidating on their hubs to focus on long-haul operations and associated feeds.

Low-cost long-haul is not new. It has been around for nearly 60 years, initially as long-haul charters. These were often the only markets that the innovative and hungry post-war independent airlines were allowed to access, because of the highly restricted licensing, international bilateral and effective state-airline-influenced cartels then in existence.

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The irony is that the twin-engined 737-900 with 220 seats is capable of offering more efficiency and with greater capacity than its now great grandfather four-engined, 188-seat 707 pioneered in the 1960s"

As an example, Caledonian Airways (forerunner to British Caledonian) was formed in 1961. In May 1963, the US Civil Aeronautics Board granted Caledonian a foreign air carrier permit under Section 402 of the US Federal Aviation Act. Caledonian became the first overseas charter carrier to obtain this permit. That case established a legal basis for all airlines that had sought to operate transatlantic charters but had faced objections from carriers like Pan Am and British Overseas Airways Corporation. Caledonian’s US authority led to it receiving charter service rights to Canada and subsequently the UK Air Transport Licensing Board licensing Caledonian for North Atlantic charters in September 1964, initially using DC-7Cs then Britannias and finally, 188-seat B707-320C. By 1970 it was carrying 1.4m transatlantic passengers. That protracted licensing and bilateral process could happen again if the UK is not allowed to stay within established EU Open Skies agreements post Brexit.

Scheduled vs Charter

Norwegian will pay tribute to long-haul budget pioneer Sir Freddie Laker with this 737MAX tail fin livery. (Norwegian)   

Since then, for many EU charter airlines faced with increasing LCC short-haul competition, survival has depended on expanding their long-haul charter operations.

Most charter operations are seasonal, with airlines deploying aircraft to different markets according to demand and season. They also tend to be low frequency with a focus on specific days of the week, often weekends, to minimise costs, aircraft and crew to achieve the highest possible productivity and maximise utilisation.

The key question is: can successful long-haul charter operations translate into successful long-haul low-cost scheduled services?

A fundamental difference between scheduled and charter operations is that charters are wholesale – the airline gets the full revenue regardless of load factor; whereas scheduled operators are retailers selling seats individually, so all risk remains with them.

In addition, a major constraint on long-haul low-cost is productivity. Short-haul low-cost carriers can sell an aircraft seat six or eight times a day. By comparison, despite unit cost reducing with range, long-haul carriers can only sell seats a maximum of twice. If the stage length goes beyond 10 hours, then it’s only once in 24 hours.

Such services also require positive regulatory encouragement. Hence why, post the EU – US Open Skies agreement, most EU originating scheduled low-cost operations have been focused on US destinations. Operations to most other long-haul destinations require bilateral approval.

Making the numbers work

Level best? Level began services on 1 June with an A330 flight from Barcelona to Los Angeles. (Level)

Historically, the omens for low-cost long-haul success are not auspicious with the failure of Laker, People Express, Oasis and on-off operations of Air Asia X; the market conditions, competition and economics were not right. Both IAG and Air France recognise they will have to reduce unit cost by 20% to make their new operations work. Will they achieve that when so many costs such as fuel, interest and lease rates and exchange rates are outside their control? As at the middle of March 2017, Jet A1 is at $1.44 a gallon, up 26% from a year earlier and, in sterling terms due to currency devaluation, it is up even more.

Fuel remains the largest single cost for long-haul airlines. Modern long-haul aircraft are significantly more fuel efficient than their predecessors. Achieving a 25% reduction in fuel burn per seat is only relevant if all other costs of the new type are lower and aircraft utilisation can be maximised.

If the opportunity is as good as some suggest, why have Europe’s most successful low-cost airlines – easyJet and Ryanair – not entered the market? If it were easy and profitable, then they would have done it.

The answer is down to economics and the operating model, lower productivity and the higher costs involved, including having to slip and night stop crews, plus competing with well-established legacy airlines with higher frequencies of operation. How does a low-cost long-haul carrier operating an infrequent, often less than daily service to the largest US – UK market, New York, compete with more than 30 services a day from Heathrow alone? That is before BA squeezes 52 more seats into its B777s and it and other legacy carriers use their marketing power and distribution to offer highly competitive, if targeted restricted fares.

A new Airbus A330 or Boeing 787 will be about $250m but a used A330 capable of transatlantic operations can be bought for circa $30m, so despite having higher fuel burn, the ownership costs – lease or interest/mortgage cost – of the older aircraft (even allowing for higher maintenance costs) will be lower, thus enabling them to remain competitive while providing similar capacity and performance. This is even though Norwegian claim its B787s have transformed the low-cost long-haul market opportunity. How much of that is down to low interest rates and historically low fuel prices? What happens when interest rates or fuel prices rise or exchange rates worsen?

Ryanair has recognised that the short-haul LCC model will not work for long-haul and that they would have to change the product and pricing focus to include a premium cabin, as that is where the legacy carriers make their major return. IAG’s new Level airline recognises this and will offer 21 premium economy and 293 economy seats on A330-200s operating limited frequencies to Los Angeles (two per week), San Francisco (three per week), Buenos Aires (three per week) and Punta Cana (Dominican Republic) (two per week). IAG is testing the market out of Barcelona from June 2017, thereby limiting self-dilution at Madrid or, more critically, BA’s position in London, particularly fortress Heathrow.

In addition, while short-haul LCCs ignore freight, for long-haul carriers, 25% or more of the total payload can be freight capacity and filling it helps cover the airline’s direct operating costs – the ‘no fly no pay’ costs such as fuel, en route charges, landing fees etc. Adding a cargo product also increases complexity and operating cost.

Is long-haul wide-body operation necessarily the way that low-cost long-haul operations might evolve, given the intense competition from, capacity already available with, and market power of, the legacy carriers? No amount of operational and cost efficiency, including use of secondary airports such as underused New York Stewart, 40 miles in upstate New York, is going to allow low-frequency long-haul operations to compete effectively, other than at the margin.

Although the low-cost long-haul operations of Norwegian and others are established, they are characterised by low-frequency operations to largely leisure destinations and do not generally compete directly with the established legacy operators. However, they do face headwinds, not least the lack of network ‘feed’ or connecting traffic, which at Heathrow is one third of total traffic and 50% at Terminal 5, which is so crucial to the legacy carriers.

Making LCLH work

Can the new breed of low-cost long haul airlines avoid the fate of Laker Airways? (Eduard Marmet)

Any long-haul low-cost carrier will either have to depend on point-to-point traffic or work with other short haul LCCs to provide feed. But will it work? A passenger connecting via Amsterdam with KLM will have an almost guaranteed connection and know that, in the event of a problem, the airline will look after them; the liability is with the airline. When a passenger is transferring from Ryanair to Norwegian and self-connecting, then the risk remains with the passenger. That cost could outweigh any real or perceived savings from using a long-haul LCC.

There are other developments which suggest that low-cost long-haul can and does work in specific markets. For many years Icelandair has been operating a very successful low-cost alternative between the USA and Europe via its hub at Reykjavik, from where it connects 26 European points with 18 in North America, using its fleet of largely narrow body B757 aircraft. WOW Air also offers similar networks via Iceland using a mix of A320s and A330s, emulating the Loftleidir CL44 turboprop services of the 1960s. For UK passengers, flying via Iceland not only means lower fares but also an Air Passenger Duty of £13 compared with £73, saving £60 per person.

Potentially the greatest opportunity for low-cost long-haul is the advent of the next generation of the 737 and A320 with their 737-900 MAX and A320neo. Both types will offer Europe – East Coast capability with (in the case of the 737-900 MAX) a payload of 220 passengers. West Jet from Canada has already pioneered use of one-time short-haul aircraft on transatlantic operations using Boeing 737s from Halifax (Nova Scotia) to Glasgow and St John’s (Newfoundland) to Gatwick on a seasonal basis, while Canadian carriers Air Transat and Air Canada Rouge are well established in the low-cost long-haul market.

Norwegian plans to utilise some of its fleet of 737-900s from points in Europe to East Coast US and Canada destinations including Stewart for New York and Brady Airport for Boston from 2017.

Once the concept is established and accepted by the market (more used to travelling on wide-body aircraft on sectors over four hours), then the performance and economics of such types could enable more low-cost long-haul operations to be developed. Serving smaller markets at lower financial risk and higher frequencies, they may also attract the more price-sensitive elements of the business market.

While such operations are relatively easy to develop under the EU-US Open Skies agreement, getting access for low-cost long-haul operations to the large and rapidly developing markets, such as India, may prove more problematic as protectionism still reigns to protect local carriers.

In addition, when not flying long-haul sectors, the economics of the new 737s and A320s mean that they can be integrated into the short-haul networks of the carriers concerned, improving utilisation and financial performance.

The irony is that the twin-engined 737-900 with 220 seats is capable of offering more efficiency and with greater capacity than its now great grandfather four-engined, 188-seat 707 pioneered in the 1960s; low-cost long-haul air travel.

The industry really is coming full circle!

Laurie Price
2 June 2017