The End of Cheap Flights? The Future of Low-Cost Carriers

Ben Tinker

After the COVID-19 pandemic took hold in 2020, the global airline industry faced severe jeopardy. As lockdowns were enforced and travel limited, many airlines were forced to store their planes, lay off employees, and scrabble for emergency funding. Global airline revenues fell by over 50%, with some of the biggest losses for European airlines. Due to outdated regulations on airport slots and fierce competition, many airlines were forced to fly empty 'ghost flights' to maintain their slot portfolio. 

Running an airline is no easy task at the best of times. An industry dominated by high fixed costs, fierce competition and particularly cyclical demand, airline revenues tend to be exceptionally variable, leading some investors, including the likes of Warren Buffett, vowing to never invest in them. One class of airline that has defied the odds in the last 40 years and now makes up the largest share of passengers globally is the budget airline segment. But, with rising fuel costs, geopolitical tensions and increasing environmental concerns, is the era of cheap aviation tickets coming to an end?

Beginning with the opening up of aviation regulations in California in 1978, Herb Keller began the first budget airline, still operating today as Southwest Airlines and recently ending 50 years of straight profitability in 2020. After a famous meeting between Keller and newly-appointed Ryanair CFO Michael O'Leary, O'Leary returned to Ireland to bring the budget airline's business model to Europe. He found success doing so, and others soon followed in his footsteps. As the number of flights leaving the tarmac soared, the budget airline prices continued to plummet and continued taking market share from traditional full-service airlines globally. The key operating model differences of the budget airlines (or low-cost carriers, LCCs) are as follows:

- Single aircraft and class type

- Point-to-point flights

- Using secondary, less expensive airports

Fast forward 50 years, and the airline market has changed drastically. LCCs carried 984 million passengers in 2015, 28 per cent of the world's total scheduled passengers. Southwestern recently ended a streak of 47 years of consecutive profitability in 2020. LCCs are a massive player in the global airline industry and rebounded exceptionally fast after the pandemic to continue building market share globally. However, narrow margins and fierce competition have left them susceptible to cyclical demand damaging profitability.

Figure 1

One of the most significant issues facing LCCs is fuel price volatility. Fuel prices make up one of the largest elements of an LCC's cost base, and they have proven to be volatile and have reacted sharply to various geopolitical events across the globe. Conflict in Ukraine and the Middle East has caused price spikes severely damaging LCCs' profit margins. Further environmental concerns and global climate warnings have forced airlines to adopt sustainable aviation fuel (SAF), an environmentally friendly fuel mix to replace jet fuel. The supply is not forming fast enough for this product, priced close to 3x over conventional jet fuel.

Another issue related to environmental considerations is consumers choosing not to fly with LCCs because of their highly polluting nature. A report by the International Council on Clean Transportation (2021) explains more on the situation in the US:

"Low-cost carriers (LCCs) are the major driver of US emissions growth. Network carriers offset almost 90% of their traffic growth via improvements in fuel efficiency from 2005 to 2019. In contrast, LCC traffic increased nearly three and a half times faster than fuel efficiency improved in terms of revenue passenger miles per gallon (RPM/gal) over the same period, driving large increases in fuel use and CO2. This is despite LCCs having relatively high fuel efficiency due to factors like newer aircraft, higher load factors, and higher seating densities. As a result, LCCs were responsible for 88% of growth in fuel use and CO2 emissions from US airlines between 2005 and 2019."

Some airlines want to address the emissions problem by shifting to electric passenger aircraft. Although projects are still in their infant stages, the investment bank UBS forecasts that the electric and hybrid planes market will be worth $178bn by 2028.

“Embracing [hybrid electric] aviation could benefit the sector’s appeal from an [environmental, social and corporate governance] perspective, prolong the long-term four to five per cent [per year] growth in air travel and stimulate the regional market,” UBS said. Airbus and Boeing plan to create hybrid planes in the coming years. EasyJet is the leading competitor in the European LCC industry in terms of electronic passenger aircraft. The budget airline’s partnership with US startup Wright Electric has led to the development of the Wright 1 – an all-electric, 186-seat passenger jet with an 800-mile range set to enter service by 2030.

LCCs in Europe have further adapted to recent challenges by expanding into new areas – one recent success being easyJet Holidays, a package holiday subsidiary formed in 2019. easyJet Holidays offers package holidays using easyJet’s preexisting flight network. Before this, easyJet outsourced its holidays division and took some of the profits. Since appointing new chief executive Garry Wilson from TUI, easyJet has been able to negotiate contracts directly with hotels and utilise existing easyJet visitor traffic. The subsidiary's rapid growth has rewarded easyJet with expanded airline load factors, enhanced customer data capture and improved group margins. It seems likely competitors will look to further their offerings in this market to replicate the early success of easyJet Holidays.

Rising operating costs and insufficient demand have sent the LCCs' current operating model and the future of cheap airfares into a tailspin. It’s uncertain whether technological innovation and market expansion can keep them airborne. As Michael O'Leary of Ryanair noted in 2022, "The era of €9.99 tickets is probably over, but that doesn't mean people will stop flying."