At first, no one was betting that low-cost airlines would succeed. However, time has proven them to be a success. In Europe, such companies as Britain’s EasyJet, Ireland’s Ryanair, Germany’s Air Berlin and Spain’s Vueling are gaining ground and winning over customers from such traditional airlines as Iberia, British Airways and Lufthansa.


Low-cost airlines are becoming cheaper and cheaper. They offer flights for the same prices as bus rides, threatening to poison carriers that are used to operating as national monopolies and pursuing a policy of high prices. In Spain, there has been strong growth in low-cost flights, which took in 30% of all foreign passengers that arrived in the country in 2004. These carriers have changed the status quo in airspace. According to experts, we may also be witnessing a major change in the way tourists travel, and the distribution of the components of costs. According to the Institute of Touristic Studies in Spain 1.85 million tourists arrived to the country on low-cost airlines during the first three months of this year, or 11.5% more than during the same period in 2005. This means that low-cost airlines are growing much faster than traditional companies, which only grew by 1.4%.


It is the largest revolution in the airline industry since the European Union’s deregulation policy was adopted during the 1990s. That initiative did away with the monopoly of flagship airlines and permitted any company to operate on any route. Although those barriers no longer exist, none of the old airlines has directly entered this market. It has been the low-cost companies that have profited the most from deregulation, bringing down their prices and winning market share. Ryanair and EasyJet have acquired the lion’s share of low-cost traffic, a [combined] 46.2%.


As a strategic destination, Spain handles a large volume of tourists from foreign countries of origin. Now, as low-cost airline flights proliferate there, traditional carriers are being forced to withdraw from some pan-European routes as well as from some domestic flights where low-cost carriers are entering in full force. When it comes to flights between Spain and Europe, low-cost carriers have managed to take a significant share of the market within only a few years. Last year, EasyJet and Ryanair controlled 23% of the passenger traffic [between Spain and the rest of Europe], compared with 6.6% of that traffic back in 2000. Faced with this harsh reality, Iberia and such other flagship carriers as British Airways, Air France and Lufthansa are focusing their strategy on international flights, a sector that the low-cost carriers have not been able to fit into their business models. One of the keys to this approach is long distance routes. Another is business class, which neither EasyJet nor Ryanair has any plans to offer.


A Defensive Strategy


Iberia is embarking on a possible solution, using the same [low-cost] weapon to compete. In January, it began conversations with Iberostar, an operator of hotels and resorts, aimed at jointly owning a new low-cost airline. On April 26, details of the alliance were revealed. It would have a base of operations in Barcelona, and its inaugural flights would be in October


Those low-cost airlines that operate in the Spanish market minimize the potential impact that Iberia’s arrival would have in the market. Ryanair, EasyJet and Vueling are prepared to stand up to the competition. They are maintaining their ambitious plans for expanding in Spain. Iberia’s plan is not causing them any concern, say the people who run these companies.


Alfons Calderón, a professor of international business policy at the ESADE business school in Madrid, believes that Iberia’s approach is not the only way to confront the power of low-cost airlines. “Iberia must be very clear about which market it wants to be in. There are two options: It can be in international flights, based on hub connections. This requires a complex system of logistics, an impenetrable network of interconnections and a policy of maintaining well-oiled alliances. Although this model involves great infrastructural costs, it guarantees that they are connected with the large market in Latin America. On the other hand, does Iberia want to adopt a low-cost model?” In Calderón’s opinion, it is difficult to combine the two business models under the same roof. “It seems that Iberia is placing its bets on the former model, and it will participate in the latter model only in a limited way. Does this constitute a firm commitment?” Calderón leaves that question up in the air.


For Antonio López de Ávila, director of the executive master’s degree program in tourism management at Madrid’s Instituto de Empresa, Iberia’s current approach is not a defensive maneuver. “Iberia abandons some routes that are no longer profitable because of the [high] costs they involve. Why renounce a piece of the pie that low-cost carriers throughout Europe are eating up? In addition, isn’t it an attractive idea to compete against other low-cost companies by using their own weapons?”


Nevertheless, a few months ago, Ángel Mullor, Iberia’s chief executive, denied that the airline has lost the battle against low-cost carriers. “The low-cost airlines are our big enemy,” he said. “We cannot compete with the ticket prices on domestic routes.” A year and a half have passed, and Iberia, Spain’s flagship carrier, has put together a plan for getting into the low-cost sector and confronting the enemy with its own weapons.


Iberia has been slow to create its plan because the company intends to take a meticulous approach to entering a sector where other flagship carriers – such as British Airways – have failed. “Iberia has not responded to the changes in its environment,” explains Calderón. “On the one hand, the low-cost airlines have eroded the market for medium-distance flights. On the other hand, this plan permits Iberia to put a stop to – or at least, soften – the impact of its competitors’ arrival in Iberia’s original market, which is Spain.” Calderón agrees that this sort of plan reflects a defensive attitude to the attack by the low-cost airlines.


Keys to the Success of the Deal


For this sort of plan to be commercially sustainable, Calderón argues that Iberia “will have to clarify a clear strategy, as well as two main points: What segment of the market are they going to compete in, and with what products and services.” Even more important, “in what ways are they going to combine their new focus with the traditional approach?” López de Ávila wonders if there is enough room for everyone [in this market.] “This is something that the market will decide, although it seems that there is still room for a new operator that does things the right way. It seems that the secret [of success] will be innovation in the processes that leads to [corporate] cost reductions.”


For months, Iberia has made it clear that it did not want to have a majority ownership in the new airline. Ultimately, they will wind up with 20%, the same percentage as the other partners, which are Cobra, Nefinsa, Quercus and Iberostar. Their goal is to avoid one of the reasons that other plans have failed. Iberia is aware that launching an airline in order to compete with low-cost companies means that it has to reduce it supply of flights. “Surely, they will make collaborative deals that help the new airline’s operations and generate synergies,” notes López de Ávila.


Although Iberia has yet to set up a functioning plan, the company has not been inactive. In addition to looking for partners, Iberia has registered several names [for the new airline] in the Patent Office of Spain, including Air Mediterraneo, Mediterránea Airlines y Mediterráneo Airlines. It has also established a corporation known as Catair Airlines, which is now awaiting flight authorization by civil aviation authorities. That is the last step before requesting airport slots and beginning operations in October, when the summer season ends.


The airline will maintain its operations base in El Prat [airport] in Barcelona. It will be managed in an autonomous, independent way when it comes to opening new routes, requesting [airport] slots and managing its fleet. In just a few years, Barcelona has become the capital of Spain’s low-cost aviation. Sky Europe flies from Eastern Europe. EasyJet provides lots of connections with the United Kingdom. Ryanair markets the city of Girona with the slogan, “Barcelona North.” Vueling, a Catalonia-based airline has direct flights to and from Germany and other northern cities. It is jointly owned by Planeta, as well as Apax Partners, a venture capital firm; and Air Berlin.


In Spain, low-cost carriers have already snatched away 30% of the market. In the first quarter of 2006 alone, their traffic volume grew by 9.2%, reaching 3.06 million passengers. That contrasts with the traditional airlines, whose traffic fell by 0.1% [during that period] to seven million passengers. The worst is about to arrive. Ryanair has announced that it will begin to operate in Spain in 2007. EasyJet is negotiating to set up its Southern European operations base in the oldest terminals of Madrid’s Barajas airport, which are now underutilized. For its part, Vueling will expand its routes from the new T-4 terminal [in Madrid]. None of these initiatives is good news for flagship carriers. That’s why Iberia has decided to act. The airline hopes that, as a result of this plan, it will be able to put a stop to the explosion of low-cost carriers, as well as compensate to some extent for reduced supply on domestic routes. “The new company must be flexible so that it differentiates itself from Iberia, and does not cannibalize the operations of the flagship operations,” advises Calderón. “That way, it can take advantage of a market that is growing so fast in Spain and the rest of Europe.”


Although the results won’t be visible in the short term, the new company was necessary, adds Calderón. “Founding it is no guarantee of success. The best thing is for it to function and to do that well, primarily when it comes to management. At the moment, there are five partners who have equal ownership. Its management should be independent of the five companies that comprise it, and it must have clear goals. It must look for segments in emerging markets. Obviously, it must also emphasize measures for containing costs, which are so high for the big companies.”


For López de Ávila, the synergies are quite clear. “The key for the new company is to occupy the positions that Iberia leaves on some domestic and European routes,” he emphasizes. “And it will have to become the low-cost airline associated with Iberia, with shared codes and similar agreements.”


The Future of European Skies


Either the flagship companies “adapt to the new situation, or they disappear,” says Calderón. “It’s better for them to adapt themselves in good times, such as current conditions. If they don’t do that, take a look at SABENA and Swissair, to cite two cases” of companies that have disappeared. When it comes to Europe, Calderón foresees a future that leads to further concentration and to additional moves, and to an upsurge of new airlines that take advantage of the rigidity and the opportunities left open by the old flagship companies.


In taking such a step, Iberia has been joined by Nefinsa, parent company of Air Nostrum, a Spanish company that has been expanding ever since it was founded 11 years ago. “It has committed itself to a very clear market segment – the regional market; it has differentiated itself from other competitors. Its aircraft are especially designated to deal with its special requirements,” says.


López de Ávila foresees a future in which flagship airlines will continue to specialize in long distance flights, and where they face no competition from low-cost carriers. Continuous innovation in their processes will enable them to cut costs. “The low-cost companies have developed a model designed exclusively for domestic and European routes, and customers have adapted very rapidly,” he says.


Calderón believes that Spanair and Air Europe, the other two big Spanish airlines, need to wake up. “Not because of the new company so much as because of their own position in the markets,” he says. “They are in the middle. That is a hard position to maintain over the long term.”