In our humble opinion - The truth about low cost

The name Low Cost is misleading

Ryan Air and Easy Jet par excellence and even before them South West in the USA (the founder of this organizational model), are not airlines that base their business only on low company costs and, above all, this is not the model on which they are based.

“Low Cost”, this misleading name that has been pinned on them has created a false myth.

Low cost: perhaps the intention was to indicate the low cost of tickets (low cost therefore for users and not for the companies) but many times it is misunderstood with the fact that it is the companies that have low costs, in a negative, speculative and distorted sense.

The main topics that are debated without in-depth analysis are:

• speculation on personnel (we don’t want to get into union reasoning or management philosophies),
• tax evasion (if that were the case they wouldn’t have been on the market for so long),
• unpaid suppliers (perhaps there is some truth to it and we’ll see)
• the belief that they generate significant savings by skimping on maintenance (the most false thing!); you may have heard your seatmate whisper: “with what I paid for the ticket, I hope they have the money to check that everything works!”.

We would like to bring to attention the fact that there are multiple cross-checking systems on aircraft navigability, it would therefore be a speculation of the entire sector on people’s lives and it does not seem to us that this is really the link to the economic sustainability of these companies.

Let’s go back to the name: low cost

“Low-cost” should be changed to “low-price” because for the airline it is the selling price that is low and not the management costs, which are optimized and we will see it shortly.

Actually, to be technically precise, rather than “low-price” it is “dynamic-price” as hoteliers and tour operators know, knowing “revenue management”. In fact, thinking about the quote about the maintenance of your seat neighbor, the one sitting opposite might also come to mind saying “so much for low-cost, I paid for this ticket as much as a business flight!”.

Revenue management of prices

So here’s the logic: first of all, between the passenger who paid 1 Euro for the ticket and the one who paid 300 Euros, there is you who potentially paid 150 Euros, which is a good price, neither too low nor too high, following the principle that everything should be sold at the highest price at which the market is willing to buy it. Price dynamization allows you to do just that: it sells the ticket at 1 Euro to the user who took the flight for fun, at 300 Euros to the one who absolutely needs it and at 150 Euros to someone like you, who was just looking for a good price.

The mechanism (or algorithm) works to understand in real time how much demand there is for a given flight and, based on this, adjusts the price: with high demand the price will increase until it stabilizes, with low demand it will decrease up to 1 Euro per ticket.

Whether full or empty, the plane takes off

Yes, because scheduled flights must always be guaranteed by the companies that grab the slots and therefore: whether the plane is full or empty, you have to take off but the costs are more or less the same (except for the taxes per passenger that are actually paid separately). So being able to add a passenger who pays even just 1 Euro will still be a revenue (that is, one euro less on the total costs that must be covered); in jargon, 1 Euro more, therefore of throughput… but here we are going towards the complicated.

Now imagine having the amount of passengers carried by Ryan Air for example and earning 1 Euro for each additional passenger you carry on your planes on each route, every day… at the end of the day that’s a lot of money (imagine that the cheapest ticket is not always 1 Euro, usually 20 or 30 Euro; here: multiply!). Also consider that there are flights that don’t have any seats sold at low prices, in fact maybe they all pay 300 Euro, like your neighbor, because it could be that they are periods coinciding with important events or subject to seasonality and the company can keep prices high right from the start. This is another element of revenue management that the world of tourism in general applies.

These are the strategies to sell at the maximum price that can be sold on the market and, even if this price is sometimes very low, we guarantee that it is always higher than the space that the flag carriers leave empty for not having lowered their prices (in reality all the companies now adopt these systems but the precursors were certainly the low-cost ones!).

The principle is this: if I can’t lower costs beyond a certain limit (with the optimizations we’ll see in a moment) I can always increase revenues by managing prices, even if only by one euro at a time.

Airline costs

Now let’s get to the costs we mentioned before: do you have any idea of ​​the face of the Boeing CEO when O’Leary (CEO of Ryan Air) went to place an order for 30 planes at $100,000,000 each (give or take a few bucks)? We like to imagine that maybe he managed to get a little bit of a discount.

And when he went to buy fuel for the entire fleet? Who do you think was in charge of the negotiation?

These are simple market laws between supply and demand, customer and supplier but then O’Leary, Tony Ryan (owner of Ryan Air) before him and South West even before him, made two epochal upstream reasonings: the first that seems the most obvious, is to have only one type of aircraft.

In aviation, companies do market research, check the routes they have to fly, how many passengers they could carry, check the performance of the planes on the market and then buy planes here and there.

The real low cost airlines choose a type of aircraft and build all their operations on those performances. A single type of aircraft means:

• a single supplier (said above about quantities and the CEO’s face),
• same training for everyone (pilots and technicians),
• ease of forecast calculation,
• cost of the spare parts warehouse (those in the sector perhaps imagine what this means),
• cost of the machines (the overall one that does not only concern depreciation but the entire management of the operational life) that is halved!

Now the second topic, definitely interesting: the planes of the companies, from the smallest to the largest, from the airline to the air taxi and arriving at the pilot owners and the aeroclubs, when they land at an airport they pay the ground service and state taxes based on tonnage, passengers, goods, etc… the low-cost companies have instead revolutionized the system and go to the airports being able to say (we trivialize it a lot… don’t read us literally):”What will you give me if I bring flights to your airport? Have you seen how Bergamo airport was 20 years ago and how it is now? How many shops can you rent? How much is the space in the airport worth when my low-cost arrives, how much do the parking attendants earn, what is the total induced effect?”

Well, we don’t know the answer to all these questions, but evidently the answer lies in the economic sustainability of these companies.

Low cost: devil or holy water?

In the face of all these arguments, some see low cost airlines as the devil and others worship them but it is not our habit to give judgments other than “modest opinions”, so we can only say that the economic model works, that it has revolutionized the world of aviation and travel in general, that it has opened the possibility of traveling to many more people and created thousands of jobs but pollution, speculation, exploitation are not part of our evaluation.

On the other hand, Amazon is also an economic model that is on one hand successful and on the other questionable… but that’s another story.

In conclusion, as a mere accountant, I can only say that the “low-cost” model is fascinating and Copernican both from the point of view of aviation and the economic world in general.