Ever since September 11, 2001, it’s been a bumpy ride for the traditional hub airlines — legacy carriers such as Delta, American, and United in the U.S.; Sabena, Alitalia, and Iberia in Europe; and Japan Airlines and Malaysia Airlines in Asia. Many have fallen into bankruptcy, most have embarked on large-scale restructuring efforts, and profits for all of them have been sporadic. Worse yet, they continue to be squeezed from above and below, as the premium players spirit away the most profitable customers and the low-cost carriers (LCCs) attract more and more price-conscious travelers. It’s a situation that promises only to get worse.
The premium carriers are wooing highly lucrative first- and business-class passengers away from legacy carriers with luxury, comfort, and convenience thanks to highly networked hubs. On selected routes and aircraft, for example, Emirates Airline now offers private cabins in first class — with doors. “When you want a meal, you call room service and order whatever you want on the menu,” says Chairman Sheikh Ahmed bin Saeed Al-Maktoum.
Meanwhile, low-cost airlines have been nibbling at the legacy carriers’ profits for more than 35 years, ever since Southwest Airlines took to the skies, cutting costs and ticket prices — and gaining loyal passengers. Other airlines followed Southwest’s lead in the U.S. and in Europe, with the rise of such discount airlines as Ryanair and easyJet, and more recently in Asia and the South Pacific with AirAsia, Jetstar, and Virgin Blue. Wherever they’re based, the discounters chant the same mantra: fast turnaround of aircraft at the gate; no frills (no free meals, one-class seats allocated on a first-come-first-served basis, extra charges for checked bags); and limited aircraft types. The ride in crammed seats is anything but grand, but the tickets are cheap. As Ryanair’s CEO Michael O’Leary is fond of saying, “It’s a bus.” And plenty of customers are willing to queue up: Seat capacity on low-cost carriers worldwide has more than doubled in just the past four years, and LCCs now account for about 16 percent of all global passenger-flight seat capacity.
Legacy carriers are thus caught in a kind of no-man’s-land. They have two choices: Adapt their business models to reflect the best of all worlds, or fail.
The obvious option — simply copying their low-cost competitors — is not, on its own, a particularly attractive alternative. Indeed, the landscape is littered with failed discount spin-offs of full-service carriers. The network carriers either closed their low-cost operations — as SAS did with Snowflake, US Airways did with MetroJet, and Air Canada did with Zip, or sold them off — as KLM did with Buzz and British Airways did with Go. The legacy players were generally not able to lower their operational costs, such as labor, enough to be competitive, and the difference was too great to be made up by economies of scale. Additionally, the traditional carriers faced potential brand dilution and competition among business units for the parent airline’s existing passengers, especially on feeder routes into the main hubs, as the distinction between low-cost leisure and business travelers became increasingly blurred.
However, despite this relatively poor track record, a few legacy carriers have shown that it is possible to launch and sustain low-cost operations, such as Qantas’s Jetstar and Lufthansa’s Germanwings. The key to success seems to be giving the low-cost airline operational independence in managing the network, the overhead, and its fleet. Although both Germanwings and Jetstar’s Australian division draw on organization-wide economies of scale for activities such as aircraft purchasing and maintenance, both discounters control the flight operations themselves, giving them wide latitude to set up new routes outside of the legacy carrier’s traditional hub-and-spoke network. Such decentralization of operations allows the low-cost airline to adapt its business model to changing competitive dynamics in passenger segments that might be fundamentally different from the legacy carriers’ customer portfolio.