High capital requirements coupled with high risk are still not a deterrent for entry into the airline industry. This is evident with the numbers of start -ups in 2004 of which there were 10. Economic profits2 achieved by the market leaders are attracting new entrants. Financing for airline companies is relatively easy either through stock and capital markets, private financing or venture capitalists. However 4 firms in 2004 failed, thus indicating that it is difficult to keep costs to a minimum whilst having sufficient cash flow to fund initial operating costs.
Existing firms or first-movers have considerable cost advantages benefiting from economies of scope resulting in lower unit costs. 3 This is then passed on down to the customer in the form of lower fares. These low fares can be difficult for new entrants to achieve as they have not benefited from “The experience curve effect4” (Michael E. Porter) of cost effectiveness. This may make it difficult for the new carrier to attract volumes of passengers as their pricing strategy may not be competitive enough.
As new entrants enter the market, fares are being pushed down by existing LCA’s, a form of predatory pricing so market share can be retained and entrants forced out. Entry barriers for traditional carriers are also low. They have the capital requirements and finance available to launch their own LCA. The low cost market is stealing a large share of the European traffic thus leaving traditional carriers rethinking their strategy. In response to this many are reducing their fares so to increase demand for their services. 2. Bargaining power of suppliers
There are two main aircraft suppliers to the airline industry Boeing and Airbus which makes the suppliers concentrated. There is little bargaining power as airlines contribute most if not all to the success of these suppliers. Fuel is a considerable part of airlines operating costs anywhere from 15 to 30% of its operating costs. Oil being a commodity is open to fluctuations on the commodities market. Supply is also a concern as conflicts (Climate Change) in the Middle East continue. The airline has no control of these costs. 3. Bargaining power of buyers
Flight travel has increased rapidly over the last five years. Growing economies across Europe have given people higher disposable income and increased leisure time. There are many LCA’s operating the same route thus giving the buyer considerable choice. The internet is now the preferred distribution method for ticket sales, access is relatively easy and comparisons can be made. Air travel is price elastic, demand will increase the lower the fares, suggesting the customer will search and select the lowest fare available for their destination.
This is dependant on the convenience of the date and time of the flight; otherwise they will select the next best alternative within their budget. All these factors give customers high bargaining powers. 4. Availability of Substitutes Rail travel is the main substitute to air travel in Europe but poses little threat in the current market as it is more expensive than current air travel and involves longer travelling times. The emergence of the high speed train offering lower fares and faster travelling times could cause a threat in the domestic markets in the future.
5. Competitive Rivalry Over the last five years the sector has grown at an average of 35% per annum. The total share of the low fare traffic in Europe is expected to reach 40% by 2010. The high fixed costs nature of the industry increases rivalry as the airlines must maximize their capacity to attain the lowest cost per unit. In the airline industry this is known as the load factor5 which measures how efficient the airline operates their tangible assets. The airline has a break even load factor and anything above that is profit.
The low cost sector has little product differentiation indicating that competition is intense as the airlines are offering more or less the same product. The winner is basically the one who can capture the most passengers. Exit barriers in the airline industry are high due to high fixed costs. Although there is asset specificity, an airplane cannot be used for other purposes, however, it is mobile. Markets in other European countries are opening up with the widening of the EU adding another 12 countries into the European aviation market, giving scope to a wider network. 6. Relative Power of other Stakeholders
Government Legislation may cause a barrier of entry or increased fares. Within the airline industry the EU is proposing an Emissions Trading Scheme (ETS). This scheme (Airline Business, Vol. 22) takes into consideration the environmental impact aviation has on the environment. It is set to propose a Kerosene tax on all domestic and intra EU flights. This will push costs up for the airlines thus reducing revenue and profits. This could have a great impact on LCA’s as they are price sensitive. This could push up fare prices (elfaa) as much as 8%, which in turn may reduce demand by 12 %.