Impacts Budget Airlines had on the Travel Market Term Paper

Impacts-Budget-Airlines-Had-on-the-Travel-Market-Term-Paper

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by Alex

30 July 2018

Budget airlines have had a profound effect on specific air transport markets. However, the nature and the degree of this impact differ for various regions. The low-cost business model in the airline industry commenced in the United States and developed into a crucial service concept from an operational and financial perspective. Despite the homogeneous nature of low-cost airlines with regard to their definition, it can be found in the literature that there are significant variations of business models. Understanding the potential and dynamics of the low-cost business model in the airline industry poses the necessity to consider the variations of the concept. Some of the core features, common to the various low-cost models, include: point-to-point services, no flight connections, no seats allocation to facilitate faster boarding, the use of electronic ticketing, simpler price strategies and airfare structures, refraining from carrying cargo, short turnaround times, the use of a single seating class, lower scales of wages, lower employees’ cooperation, minimal crew, utilization of secondary booking, internet booking, and the maximum use of an aircraft. It is important to note that tough competition in the airline industry results in legacy airlines incorporating some of the low-cost business model features in order to increase their survival chances in the deregulated airline industry. Budget airlines could use the principle of offering low airfares in conquering market earlier; however, nowadays they are fading away from flying because of prices. Prerequisite for success in budget airlines is that low-cost operations make low airfares sustainable. Studies have pointed out that the low-cost business model in the airline industry can result in cost savings up to 57%, especially in managerial and operational domains. Despite the fact that legacy airlines have also been reducing their airfares, they are still lagging far behind budget airlines. Consequently, legacy airlines are increasingly targeting a smaller market share comprising of passengers who are ready to pay higher fares. In addition to this, it has been reported that legacy airlines are having their demand curve fallen because of budget airlines.

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Impact on Passenger Traffic and Prices

Passenger traffic and pricing in the airline industry are influenced by multiple factors including competition from other modes of transport, the degree of market saturation, the efficiency of the hub-and-spoke system, and the emergence of budget airlines among others. Besides these factors, budget airlines constitute one of the most significant determinants of passenger traffic and pricing. As a result, the vast literature has been dedicated to exploring how budget airlines affect passenger traffic and air travel prices. There is a mutual agreement in the literature that the emergence of budget airlines significantly depressed prices because of the subsequent increase in passenger traffic on the particular routes. Numerous empirical studies have been conducted to explore the impact of the entry of budget airlines on passenger traffic and pricing. For instance, Vowles found out a significant negative relationship existing between the budget airlines entry and the pricing adopted by airlines in the United States domestic market. Similar inferences were made by Goolsbee and Syverson, who utilized a structural model comprising of variable prices, budget airlines entry and market saturation. The researchers also reported that price and entry of budget airlines are negatively related. This negative relationship can be attributed to the fact that reductions in concentration because entry of budget airlines tend to result in significant price decreases. Another study by Franke is examining the entry of People Express Airlines impact (a budget airline that operated during 1981-1987 before being merged with Continental Airlines) on airfares. The authors reported some evidence indicating a negative relationship between the presence of People Express Airline in the market and overall airfares. One more impact of Southwest Airlines presence, the pioneer of the low-cost business model, on passenger traffic and pricing was investigated by Barrett, who reported that the presence of Southwest Airlines resulted in passenger traffic increase as well as in airfares reduction on a particular route the airline was operating. Simultaneously, it also reduced passenger traffic in other competing routes. The underlying inference from these studies is that the entry of budget airlines in a particular route results in significant airfare reductions and the considerable increase in passenger traffic.

The short-term and long-term effects in specific airline markets associated with the entry of budget airlines have also been explored. The effect of Southwest Airlines on the market it enters has been used to represent the overall impacts associated with the budget airlines entry in a particular market. In this regard, Southwest Airlines have been found lowering the market concentration of the route it joins by 25% whereas the average long-term decline in the market concentration is 15%. With respect to airfares, it has been established that the entry of Southwest Airlines depresses the airfares by about 48% comparing to pre-entry fares whereas the average long-term decline is 19%. Additionally, the entry of Southwest Airlines in a particular route results in passenger traffic short-term increase of 300%, and an average long-term increase is only 75%.

Ben-Yosef utilized regression analysis in explaining the airfares variations. The regression model comprised of various issues that have influenced airfares including market share of legacy airlines, the market share of budget airlines, Southwest effect, resorts, and distance. The results of the regression analysis revealed that the entry of additional budget airlines predictably causes an airfare decrease by 45-47%. The authors used these findings to suggest that the entry of budget airlines in the market has a profound impact on the air travel pricing. In order to affirm the significant role of budget carriers on airfares, Daraban notes that Southwest Airlines reduced their prices significantly. It is worth mentioning that legacy carriers usually react to the entry of a budget carrier by reducing airfares. The reduction of an air travel price further results in passenger traffic increase. In addition to this, it has been found out that legacy carriers usually lower their airfares in order to discourage budget carriers from joining their routes.

Effect on Competition in the Airline Industry

Most budget airlines operate solely in the short-haul segment. Consequently, budget airlines refrain from competing with legacy airlines operating within the long-haul segment and also those operating short-haul feeder routes. In order to be able to sustain their activity on the international routes, legacy airlines make use of their regional networks by collecting passengers. Despite the fact these routes tend to be short-haul, they form a crucial component of the long-haul transportation as a result since there are relatively few passengers who may be willing to travel on different airlines for the same journey. Thus, in practice, budget airlines refrain from competing in feeder flights. In order to have an understanding of the competitive nature of the airline industry, it is necessary to have a detailed look at every city pair or route served. Owing to the fact that budget airlines operate on a point-to-point basis, competition usually takes place at the same level. In addition, many budget airlines tend to design their own routes, implying that budget airlines number increase does not necessarily make the tougher competition. Jones identified two primary operating strategies in the budget airlines market, which include developing new markets and opting for entering into large and well-known markets that other airlines already serving. Ryanair, which is the larger budget airline in Europe, develops new markets; this entails identifying potential markets that are yet to be explored. The airline usually targets secondary airports. The goal of this strategy is in evading competition and fostering passenger traffic. Under this strategy, the target audience comprises of customers, who currently use other modes of transport or those who do not travel. In most cases, such passengers are leisure customers who are more likely to be price sensitive. Therefore, the competitiveness of an airline stems from reducing airfares to a threshold price that can attract new passengers or stimulate the existing ones’ readiness to pay. In addition, there is no need for airlines to place emphasis on matching schedules while being devoid of competition.

EasyJet, the second largest budget airline in Europe, pursues the second strategy characterized by entering large markets that are already being served by other airlines. Contrary to the strategy adopted by Ryanair, EasyJet has embarked primarily on choosing routes that other rival airlines are already operating. In order to increase its market share, EasyJet opted for competing in terms of frequency by providing at least double flights on a daily basis. Higher frequency implies that variety of choice is granted to the customers, something that is crucial for business customers. The goal of this strategy is to ensure that the airline is economical and will be a good alternative to legacy airlines. Budget airlines pursuing this strategy usually target the leisure market with low airfares, exploit the passengers’ readiness to pay and the business market using high flight frequency and low fares. As a matter of fact, EasyJet has a business market share of 50% in some routes.

Irrespective of the strategy pursued, it is evident that budget airlines’ competitive advantage is derived from offering low airfares. The intensity of competition is mainly felt on the already established routes operated by rivals. The point for the competition effect associated with the budget airlines entry is how airfares have evolved on a particular route (city pair Toulouse-London) after the entry of EasyJet and Ryanair. Thus, both British Airways and Air France were compelled to reduce their air travel fairs upon Ryanair entry. After Easy Jet began to operate the route in 2005, Air France was compelled to leave the market.

Effect on Competition with Other Transport Modes

According to Lawton, competition between various modes of transport becomes evident after the deregulation of the transport market. In a regulated environment, the freedom and incentive to compete by transport companies are extremely limited. In addition to this, a regulated transport industry means that there is precise segmentation. This segmentation includes international destinations and national remote destinations served by different airlines as well as national destinations served by road and railway transport. However, this does not imply that an overlap in various modes of transport does not exist. In contrast, a commercially driven market is characterized by transport companies ready to enter direct competition with other companies operating the same or different transportation methods. There is empirical evidence for the competition existing between air transport and other modes of transport. For instance, Ben-Yosef reported a significant increase in competition between road transport, railway transport, and air transport companies following the liberalization in the US. With regard to this, the two dominating road transport companies in the United States were forced to reduce their prices in order to prevent passengers from shifting to using budget airlines. Additionally, Amtrak, the famous American railway company, was also forced to reduce its prices and started introducing special packages for its customers. Similar effects have been reported in other markets, for example in the Australian transport market.

Conclusion

This paper has evaluated the impacts of the budget airlines emergence in the transport market. Three impacts have been discussed in detail including effects on passenger traffic and airfares, effects on competition within the airline industry, and effects on collaboration between air travel companies and other modes of transport. With regard to the impact on passenger traffic and pricing, it has been reported that the budget airlines entry resulted in an increase in passenger traffic and reduced airfares at the same time. Next, regarding the effect on airline industry competition, it is obvious that the budget airlines entry in some routes have resulted in significant price cuts, which have forced rival airlines to leave the corresponding market share. Lastly, there is evidence indicating that the emergence of budget airlines following industry deregulation forces road and railway transport companies to cut their prices due to stiff competition.