Britain takes to the air

Low-cost carriers are transforming not just the travel business in Britain, but also the way people live

The air of gloom surrounding much of European business made Ryanair's results, announced on June 25th, particularly impressive. The low-cost airline reported a 37% year-on-year increase in pre-tax profits, and its chief executive, Michael O'Leary, said he expects business to grow by 25% over the next year. Thanks to Ryanair and its sort, Britons are beginning to hop on and off planes the way Americans do.

Air travel in and around Britain has grown by nearly 40% in the past five years, but the really spectacular growth has come from the low-fare airlines, which have carried around 20m passengers in the past year. By spotting and satisfying the untapped demand for travel from and between the regions, they have fueled the growth of Britain's smaller airports and undermined Heathrow's dominance.

EasyJet, the first of the low-cost carriers, was set up in 1995 at Luton. Eastwards around the M25 at Stansted are Ryanair, Go, the low-cost offshoot of British Airways (BA) sold to a management buy-out earlier this year, and Buzz, the British arm of KLM, which uses the airline partly to feed its international hub at Amsterdam. While Heathrow has seen the number of passengers rise by about 19% over that period, traffic at Luton and Stansted has more than trebled. Traffic at Liverpool's airport nearly quadrupled.

Demand for air travel is highly elastic. Bring down the price and sales rise sharply. The low-fare carriers are often cheaper not just than the mainstream operators but also than the railways. While low-fare airlines keep their fixed costs to a minimum, the railways are burdened by the need to maintain and improve their crumbling network. Last year was a disaster for them. A crash blamed on a cracked rail led to mass disruption as managers tried to locate and mend other dodgy rails. Delays drove passengers onto the airlines.

Low-cost airlines fill their planes differently from mainstream carriers. BA, British Midland, Air France and Lufthansa aim to make their money out of business travelers who pay over the odds to enjoy meals and loads of drinks in the air and on the ground in exclusive lounges. The economy seats are sold off, discounted as need be, some in advance and some at the last minute. Cheap seats are made available through downmarket travel agencies which publicize their deals through newspapers' classified columns.

The low-cost carriers see their aircraft as a series of buckets. The first set of buckets are the lowest-priced seats, with the eye-catching prices. Once these are all sold, demand flows into the next, slightly more expensive, bucket of seats. As the flight's departure approaches, seats get progressively more expensive. On a typical low-cost flight there could be up to ten different price buckets, with one-way fares ranging from 30 ($42) to 210. But even the most expensive tickets tend to be cheaper than for the mainstream airlines.

Early assumptions that the low-cost carriers would struggle to make headway in the business market, because businessmen do not care how much their companies pay for their tickets, have turned out to be wrong. Stelios Haji-Ioannou, EasyJet's founder, says that one of the things he first noticed when the airline launched was how many business passengers he seemed to be carrying. Not that business travelers are set apart, since everybody piles into the same nofrills cabin, with free-for-all seating and pay-for-all drinks and sandwiches; but business travelers tend to book late (and so more expensively) and travel mid-week. It turns out that businessmen are more price-sensitive than had been assumed. Some, presumably, are running their own businesses, so have an interest in keeping costs down; others are responding to cost-cutting memos from above.

WIRED FOR TAKE-OFF

The Internet has also helped the low-cost airlines. Airline tickets rival pornography as the hottest-selling commodity on the Internet, with sales estimated at more than $5 billion worldwide. Mainstream airlines sell around 5%of tickets over the web. EasyJet decided to focus on Internet sales, so it offers discounts for online booking and has built a site that is easy to use. These days, some 90% of EasyJet bookings are made online. Ray Webster, EasyJet's chief executive, reckons that older or techno-illiterate people get a younger or more wired friend to do it for them.

Some 65% of Ryanair's bookings are made online. Even this figure is twice as high as the highest e-booking airline in America, Southwest, the original low-fare, no-frills carrier which was the model for the British low-cost operators.

The low-cost airlines have not just brought down the price of flying. They have changed the way British people travel, and also where they live, holiday and work. Air travel no longer involves the crowded hell of scheduled flights at Heathrow or charter flight delays at Gatwick. Cheap fares and European second homes have almost replaced house prices and school fees as a topic for dinner party chat.

At four o'clock on a summer afternoon at Luton airport, a queue is forming for the 5.40 to Edinburgh. A holidaying couple are returning to Edinburgh from Spain. The EasyJet flight was so cheap that it was worth their while taking an Airtours package from Luton, rather than flying from Scotland. Behind them is a management consultant who uses EasyJet from Luton because he lives just three exits up the M1 and it is quicker than hacking round the M25 to Heathrow. A technology transfer specialist at the Medical Research Council in Edinburgh says EasyJet is a way of coming down to London once a month for a fraction of the fare on British Airways or British Midland. 'It seems silly paying extra when you are dealing with public funds,' she explains.

Businessmen from small and big companies alike are hopping onto cheap flights. Robert Jones, shipping and travel manager for Smit Land and Marine, a Liverpool-based Anglo-Dutch pipeline company, reckons he is saving 50,000 a year by using budget airlines. Half of his company's regular 30 trips a month from Liverpool to Amsterdam are by EasyJet, at 120 each, instead of the 350 he would spend on a scheduled airline. Travelling to Spain, he saves around 500 a trip. And, he says, the low-cost airlines make it easier to change passenger names if one employee has to substitute for another at a meeting. According to airport managers at Liverpool, since Ryanair and EasyJet have built up their flights from the city, the number of executive-type cars parked at the airport has shot up.

Leisure travel is changing too. Until recently, most people flew once or twice a year, to Florida or the south of Spain. These days, people increasingly hop on planes several times a year. It's no big deal any more. A salesman in a London electronics shop says his parents have a holiday house in the south of France, which he had stopped visiting after they stopped paying for his holidays. Recently, however, he has discovered that if he books ahead on the Internet, he can fly EasyJet to Nice and back for under 50, making a monthly visit an affordable treat.

Perhaps the most astounding change is the number of long-distance commuters using the new airlines. Hang around long enough at Luton and you will meet a businessman or woman, usually middle-aged owners of companies in the south-east, who spend half their week as lotus eaters in Provence, nipping back for the other half to oversee their business being handled day-to-day by their staff. Most incredible of all, there is a resident of the Luton area who commutes to bustling Glasgow every morning, only to return to lovely Luton in the evening. That could be called some sort of progress.

Questions

(A) What conditions make price discrimination possible in the airline industry, and what types of price discrimination are possible? Explain how different demand elasticities are relevant.

(B)Explain the differences in pricing strategy between the mainstream airlines and the low-cost airlines, in terms of the different types of price discrimination used.

(C) Explain the role of the Internet in the pricing strategies above.