Tuesday, 11 November 2014

Upstarts Vie For The Ryanair Pie

Ryanair is planning a huge increase in capacity in the coming decade.
Other European airlines have the same plan, writes GERRY BYRNE

(Published in the October issue of Business Plus magazine)

It’s official: European airlines are moving back into growth mode. From an Irish perspective, Ryanair’s recent order for 100 newer generation Boeing 737-Max jets, plus
options on a further 100, might seem enormous but in European terms it is
simply a part of a pan-continental surge in aircraft orders. This surge
will see many low-cost carriers add hundreds of new planes to their fleets
over the next decade.

Yet despite the massive volume of new seats being launched into Europe’s
skies, Ryanair and UK rival EasyJet are tipped to come out on top. Ryanair
profits have been sluggish over the past few years and net profit fell by 8% in
the year to March 2014. So will it be an easy ride for the Irish carrier which
prior to its latest order was also starting to accept deliveries from an earlier 180-
plane booking with Boeing? Can it economically deploy 380 new planes
on top of the existing aircraft it decides to keep from its current fleet of 300
planes, and profitably carry a predicted 75% more passengers by the middle of
the next decade?

Growing Pains
Ryanair will not be alone - the lowcost sector’s second-largest carrier,
easyJet, has 144 new aircraft yet to be delivered, while other smaller lowcost
rivals are also augmenting their fleets. Some are doubling the
numbers of aircraft they fly, while Norwegian Air Shuttle has 400 on
order, more than four times its present fleet.

Apart from planning another major spurt of growth, Ryanair is also
changing its business model. It wants to be nicer to customers and fly less to
and from out-of-the-way secondary airfields. In a bid to capture a greater
share of the business travel market, Ryanair is also flying to more prime
city airports. Travel agents will once again have direct access to Ryanair’s
booking engine thanks to a new deal just announced with Amadeus, the
travel industry IT service provider.

Ryanair’s original business model, a whittled-down version of the
successful business plan pioneered by Southwest’s Herb Kelleher, is now
being tweaked. When the metrics are run on both Ryanair and easyJet, its
main low-cost carrier (LCC) rival, easyJet emerges as the clear winner
on several key ratios. Despite a smaller fleet (200 aircraft to
Ryanair’s 300), easyJet had revenues of €28m per aircraft, compared with
Ryanair’s €16.7m. Ryanair’s pre-tax profit per aircraft was €1.9m, while
easyJet (based on forecast 2014 profits) earned €3.6m.
Ryanair almost sucked the lifeblood out of remoter airports in its bid to
make flying to them profitable, but easyJet took care to always include
a larger proportion of mainstream airfields in its destination portfolio.
As a result, and despite higher average fares, easyJet always got
more higher-fare business travellers,  a breed that never patronised
Ryanair to the same degree.

Conventional, full-service companies like IAG (which owns BA),
Air France-KLM, Lufthansa and even Aeroflot are all deploying LCC offshoots in bids to win back traffic lost to the low-cost sector, or to at least preserve some portion of their leisure traffic. IAG’s
Spanish LCC, Vueling, has a fleet of 90 jets, and despite being a relative
minnow compared with Ryanair nonetheless controls a significant
proportion of the Spanish leisure market. Vueling has a top three share of
traffic at most of its Spanish bases and outstrips even Ryanair with its 30%
share of traffic at Barcelona’s main airport. More than 10% of Vueling’s
passengers come to it as transfer passengers from other routes, another
demonstration of the benefit of using main city airport hubs.

However, one cannot assume that Ryanair will be able to continue
fielding its hugely successful business model as before, because several
aspects of the old-look Ryanair will simply get in the way. For example,
Ryanair’s status near the top of the daily aircraft utilisation table is not
guaranteed to last.

While Lufthansa does well to keep an average aircraft airborne earning
revenue for almost 10 hours a day, Ryanair was almost 20% better at 11.8
hours (or, more accurately, ‘block’ hours, which includes time spent
taxiing — something Ryanair will do more of at main city airports). EasyJet
manages a respectable 11 hours, compared with a mere 8.4 hours for
IAG’s short-haul fleet. The biggest operational advantage
for Ryanair of flying to so many remote airports was the avoidance of
congestion. Over the past year or so, Ryanair has culled some 220 routes,
including the abandonment of at least ten secondary airports.While many of
those routes and airports were replaced, their replacements — like
Glasgow International for the remote Prestwick — are busier airfields. And
busy can also mean delays, especially at peak times.
As this process of substitution of primary airports for secondary ones
continues, expect to see a gradual reduction in block times for Ryanair
and, with that, some loss of operational efficiency, which will
inevitably reduce cost-effectiveness.

However, there will also be significant upsides, such as a greater number of
transfers and higher fares from a growing number of business travellers
who tend to prefer main airports.

One intriguing fallout of the swing to primary airports will be some reduction
in the often generous per-capita subvention or marketing aid Ryanair
receives from secondary airports or local tourism and business interests.
Quantifying this not-inconsiderable sum is difficult, mainly because
Ryanair treats it very sensitively and does not log it under a separate
heading in published accounts.

A European Court decision ruling that such subventions represented
illegal state aid at Charlerois, near Brussels, was overturned on appeal
due to a failure by the European Commission to have properly tested
the measure’s legality in advance. Since then, the EU has nevertheless
continued to rigorously investigate other alleged illegal subvention
examples brought to its attention.

The first estimate of the size of Ryanair’s airport/local tourism income
was revealed in 2008, when the French local government auditor listed
€36m in funds Ryanair had received in a single year from a number of
French secondary airports, which were, in turn, in receipt of local or
central government funds. Based on that French figure, Air France
estimated that Ryanair at the time was probably in receipt of more than
€300m from secondary airports throughout Europe.

At the time, the subsidy figure was more or less equal to the company’s
net profit, a coincidence which led some of its rivals to unfairly suggest
that Ryanair actually ran at a loss and was only made profitable because of
the income it received from airports. New routes that Ryanair flies to or
from new primary airports should still qualify it for discounted airport
charges if no other airline is servicing that route. However, such discounts
are on a sliding scale and usually expire after no more than five years.
Secondary airports often continue their incentives for as long as Ryanair
is prepared to stay.

Meanwhile, Air France-KLM is attempting to shift domestic leisure
traffic to its LCC, Transavia, which is forecast to grow its fleet from 36 to
100 planes. The move led to several days of strikes by pilots in September,
and after a week of disruption Air France-KLM shelved its plans to
expand Transavia outside of France and the Netherlands, pending further
talks with the pilots union. There is similar disquiet among German pilots
over Lufthansa’s moves to expand its LCC, Germanwings.
The tension is a reminder that lowcost  carriers and trade unions often
make uncomfortable bedfellows.

While EasyJet and the US’s Southwest — Ryanair’s inspiration — are
unionised, Ryanair is not. Coupled with Ryanair’s Irish registration, this
comprises two of the main pillars of its  amazing cost-control, and Davy
Stockbrokers cites Ryanair’s non-fuel costs as being 50% lower than most of
its rivals.

Zero Hour Contracts
Ryanair’s no-tolerance approach to unions in any shape or form, allied
with libertine Irish labour law, allows the airline to employ more than 70%
of its flight crew on zero-hour, armslength contracts. They are paid only
when the aircraft is moving and can be laid off without compensation in the
off-season, enabling the company to exactly tailor its labour costs to traffic.
Ryanair copperfastens its legal position by insisting that pilot and cabin crew
contractors register in Ireland for tax and social welfare, even though they
might not live or even work here.

Rivals complain that while this allows Ryanair to maintain an
enviously tight ratio of manpower costs to passenger numbers, they are
obliged to pay escalating social insurance costs. Ryanair’s good
fortune has not escaped attention. Norwegian Air Shuttle’s ex-fighter
pilot boss, Bjorn Kjos, registered an Irish LCC subsidiary earlier this year
to provide direct flights from Gatwick to the US using low-wage Asian crews
on zero-hour Irish contracts, none of whom may ever set foot in Ireland.

This is perfectly legal under Irish law (the Irish Aviation Authority
accepted his papers with alacrity), but officially frowned upon in
Norway. The US Department of Transport doesn’t like the idea either,
and Kjos has been forced to rethink his Irish-flagged long-haul
subsidiary. Some observers think it’s only a matter of time before he
reflags the entire airline as Irish.

Were this to happen, it would pose a serious challenge to Ryanair and easyJet. Norwegian’s combative boss has much in common with Ryanair boss Michael O’Leary, and has
successfully beaten off Scandinavian unions and governments in several
bitter face-offs. His short-haul fleet  of 91 jets is soon to be dramatically
enlarged by deliveries from a 400- aircraft order (which includes 150
options) shared between Airbus and Boeing, and his costs are being
reined in as productivity improves. For example, Norwegian has
managed to attain an aircraft utilisation of 11.6 block hours a day,
just behind Ryanair’s enviable 11.8 hours.

Given the relative modernity of much of his fleet, Kjos is likely to
retain a higher proportion of the new aircraft he has ordered. Ryanair will
dispose of many increasingly uneconomic older jets, which require
more maintenance, to make way for newer ones. This is especially likely
following the arrival of the new Boeing 737Max, which carries 11% more
passengers than the 737-800 Ryanair currently flies, in addition to having
greater fuel economy.

The honour for the best block-hour performer goes to the cheeky
Hungarian upstartWizz, which has its 54 Airbus fleet on the move for
12.4 hours daily. Sixty-one additional aircraft are on order and the company
is reputed to be considering an IPO in London. Net profit surged almost
threefold this year to €89m, while income per passenger is up 5% to
€72.80 compared with €61 at industry leader Ryanair.

With upstart LCCs snapping at his heels, O’Leary has upped Ryanair’s
marketing spend, increased route frequencies and tailored the product.
The new ‘Business Plus’ fare offers business flyers flexibility on ticket
changes, 20 kilos checked-in bag allowance, fast track at selected
airports, priority boarding and premium seats.

O’Leary has described initial uptake of the new business fares as ‘positive’,
and through September the load factor increased five points to 90%,
and 500,000 more tickets were sold than a year earlier. Full year profit
guidance is for an improvement of €120m on last year, for a net surplus
of around €640m.

That would be a net profit margin of 12% at a time of Europe-wide
austerity. No wonder so many competitors want to join the party.