Easyjet and budget airline case study
Prior to 1992, the European Airline industry was an oligopolistic industry with virtually insurmountable entry barriers. Individual countries ensured the competitive success of their own national flag carrying airlines by imposing restrictions on the numbers of landing slots available at their airports.
In December 1992, EU legislation was passed which ensured the deregulation of the airline industry, so any company could demand landing rights at any airport. With the restriction on landing slots removed the industry was opened up to competition. Entry barriers were still very high due to the expense of acquiring aeroplanes. Years of freedom from competition had ensured established airlines charged high prices for flights, so there was a niche in the market for new, budget airlines.
Threat of substitute products was low as the speed of air travel remained unsurpassed.
Towards the end of the decade, the new ‘no frills’ airlines had succeeded in attracting large numbers of leisure travellers, and a significant number of the business market. To compete with these newcomers, the traditional airlines either introduced their own budget services, or formed budget companies of their own. As a result of the increased competition, the market again became less attractive to new entrants.
Easyjet was established in 1995 “to bring low cost air fares to the masses.” Its initial strategy of low cost no-frills service, combined with an aggressive marketing strategy, ensured its survival.
Once established, the company modified its strategy to ensure it competed directly with other low cost airlines through marketing, publicity stunts and legal action. The resulting success was shown through exceptionally high asset utilisation and rapidly increasing business.
As the new century approaches, the challenge for Easyjet is to move into a sustained period of growth as its earlier entrepreneurial strategy becomes less appropriate, and the company seeks stock market flotation.
1/ Considering the business and competitive environment up to 1999, evaluate the overall attractiveness of the budget airline sector.
Common sense dictates that to operate, an airline needs to be able to land at, and take off from, an airport. Prior to 1992, the European airline industry was dominated by few firms, the national ‘flag carriers,’ whose monopolies on landing slots within their own countries were protected by individual governments and legislation. A raft of agreements allowed only specific airlines to operate from a particular airport. The high entry barriers within this oligopolistic industry ensured stability and monopoly based pricing.
In December 1992, the EU passed legislation which deregulated the industry, and meant that any airline could demand take-off and landing slots at any airport. As a result, any company could now offer services between any EU countries, free of domestic protectionism. This effectively opened up the market to free competition between airlines.
The Business Environment
The business (or industry) environment has been postulated by Grant (2002) to be constituted from a firm’s customers, suppliers and competitors.
Pre 1992, the pricing policy of the industry meant that the majority of short haul scheduled flights were comprised primarily of business travellers. The charter sector serviced the needs of the leisure market taking people on packaged holidays to Majorca etc.
The EU had an impact not only on deregulation, but also in terms of lifestyle. People could now work within the EU more easily, many bought second homes abroad, and the growth of the free market increased business across national boundaries. This meant the private, self financing traveller was increasing in numbers. Aggressive advertising from budget airlines, together with truly low cost air fares meant that interest in air travel increased, and those who would not previously have considered travelling by air would now do so.
As the number of airlines increased, so competition for landing slots and airplanes and parts also increased. With Heathrow being the gateway between America and Europe, the competition for landing facilities either there, or at Gatwick was intense (and therefore expensive), yet proximity to the long haul flights from those airports could be a major advantage to any company then carrying out short flights and wishing to service people arriving or departing from the EU.
As a result, smaller airports such as Stanstead and Luton were more attractive to new market entrants.
Easyjet illustrate the advantage to be gained from close supplier relationships by including that philosophy within their mission statement, utilising exclusively Boeing 737 airplanes so a relationship can be established with that company, and basing the company HQ at Luton, the airport which serviced the majority of its routes at its inception.
This increased post 1992, as the number of airlines multiplied. The budget airlines approach to pricing, and their strategy of ensuring that the customer paid less, meant that they began to compete directly with the national carriers. Aimed at the self-funding, leisure traveller, and concentrating on short haul flights, the budget airlines began to make inroads into the profitability of the traditional airlines. Initially the market appeared to fragment slightly, with the low cost airlines attracting the budget conscious traveller, and the traditional airlines competing for the less price conscious businessman. In response to the decrease in revenue, the flag carrying airlines also began to slash prices to regain their leisure market.
The Competitive Environment
Porter (1980) devised the ‘five forces’ framework which assists in considering the attractiveness of a specific industry or sector thereof.
The budget airline sector provides a travel service between national and international cities, in this case within the UK and EU.
Threat of Entry
Bain and Mann (as discussed by Grant) found that profitability was high in sectors with very high entry barriers, and lower in those sectors which have moderate to low barriers. Prior to deregulation, the entry barriers within the airline sector were virtually insurmountable, with flag carrying airlines enjoying almost monopolistic freedom within their own countries. Post 1992, these barriers were removed, but substantial barriers still existed due to the high cost of commencing operations within the industry. In 1999, these barriers still existed, and were made more formidable due to the reputation and market share of the new budget airlines.
The threat of entry within the budget airline sector can be considered by using the structural determinants of Porter’s model.
Capital Requirements – The cost of entry into the sector is extremely large, and is a big barrier to new firms. Stelios invested ï¿½5 million initially, and had to raise another ï¿½50 million to remain competitive within the industry. Established companies already have planes, and may well be able to negotiate bigger discounts with their suppliers.
Economies of scale – Fixed costs of flights form the bulk of operating costs within the industry, so it is imperative to ensure high utilisation of capacity on each flight. To ensure this was achieved, new entrants were required to invest heavily on advertising campaigns. Easyjet had to spend 10% of their revenue to ensure an appropriate market was created for its services.
Absolute Cost Advantages – Established airlines already have trained staff, and experience in operating, all resources which would need to be purchased or otherwise acquired by a new entrant.
Product Differentiation – Established firms have an advantage in brand recognition. In 1992, traditional airlines had brand loyalty, so the new entrants such as Easyjet had to differentiate their services in order to gain competitive advantage. Low pricing and telephone or internet booking established a niche market, and high levels of advertising achieved brand recognition. Post 1999, entrants may find it harder to differentiate their offering, and have to contend with a greater degree of brand awareness of the newer offerings within the industry.
Access to channels of distribution – Although the main airports were opened up to competition in 1992, the demand on landing slots meant the price was high. Easyjet and other market entrants post 1992 based themselves at smaller airports to reduce costs. New entrants would find it harder to find landing slots at busier airports than ever before.
Government and Legal Barriers – pre 1992 these effectively prevented new entrants to enter the market. Post deregulation, within the EU these have been removed, but they still cause problems within non-EU countries, such as the battle between Easyjet and Swiss Air for landing rights at Geneva.
Retaliation – The new budget airlines could have been vulnerable to retaliation from the established airlines, who could have begun their own price cutting and marketing strategies, but this did not emerge until after the new airlines became established themselves. Easyjet illustrated this danger by running a publicity exercise on the inaugural flight of the new airline “Go.”
To summarise, pre 1992, entry was prohibitive due to monopoly based control through regulation of landing slots at airports. Following deregulation, the barriers to entry remained the high initial start up costs. Since then, increased competition for landing slots, together with greater niche marketing has made entry more difficult.
Rivalry between established competitors
Pre 1992, the oligopolistic nature of the industry ensured that profitability within the industry was high, and that competition was limited.
Post deregulation, the numbers of firms within the market increased, and competition over specific profitable routes also increased. The policies of the budget airlines in cutting costs, and passing these price reductions to the consumer created a new market segment for air travel, and the policy also engendered a change in the marketing policies of all airlines. As a result, the ‘gentleman’s agreement’ of pre 1992 was superseded, and rivalry between competing airlines increased markedly.
Threat of substitutes
The airline industry effectively occupies the travel market, and direct competition exists from cars, ferries and high speed rail travel. Substitution depends on the relative strengths of the alternatives, such as speed, price and convenience.
The greatest strength of air travel lies in its speed, so it is unlikely that alternatives pose a realistic threat, especially in the UK, where rail and road are subject to so many delays.
While the Eurotunnel may be an alternative for those persons wishing to travel to France, pricing shows that there is little economic difference between that and air travel. As greater distances are considered, the threat of substitute products become weaker.
Bargaining power of Buyers – The advent of the internet allows customers to research relative costs between companies easily. There is no cost to change for the consumer, so the buyers enjoy a high level of bargaining power. In effect, the cheapest offering is likely to win out.
Price sensitivity – This is a primary factor in the choice of airline. Many customers use the budget airlines for transport for short breaks abroad. As the price of the ticket may be a large proportion of the total holiday cost, the sensitivity of consumers to flight prices may be considered high.
The service offered by many of the airlines is similar, being a simple A to B travel service. As a result, the buyer may well be more likely to switch suppliers on the grounds of cost alone.
These factors mean that for the budget sector, ticket price will be the primary factor in the decision making process, so the rivalry between firms is increased. While this was not the case to the same extent pre-1992, any firm wishing to establish itself at the present time will be competing with like offerings.
Bargaining Power of Suppliers
Suppliers to the industry are:-
* Airports (landing slots)
* Check in staff
* Baggage Handlers
* Aircraft Builders
* Travel Agents
The primary supplier which affects running costs is the airport. Budget airlines limit these costs by utilising smaller airports. Should these costs rise, the final ticket price would also have to rise. New entrants would increase demand, and as such may result in increased fares.