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The true reason behind El Al’s “Low Cost Economy Class”

2009 July 25

El Al’s new “Low Cost Economy Class” is not really low cost, but we think it might be a smart move, here is why.

 

I first read about the story about El Al’s “Inferior Economy Class” on travel blogger Steven “Fish” Frischling’s  blog flyingwithfish .

Here is how he described it:

El Al plans to integrate this stripped out economy class into its existing economy class cabin. Roughly 20% of the economy class cabin, sectioned off in single area of the aircraft, will be designated “Inferior Economy Class.”   Passenger who purchase seats in the “Inferior Economy Class” will have the same size seats and leg room as those seated in plain old “Economy Class” however these passenger will no provided amenities.

Passengers choosing the “Inferior Economy Class” will pay for everything when flying with El Al. No inclusive baggage, no headsets, no snacks, food, drinks, pillow, blankets, in-flight entertainment, nada, nothing.   Passengers in this section of the cabin will be subject to paying for everything in cash (or credit card) as an additional fee.

At first glance, this really looks like a bad idea on El Al’s part:

First of all, it put the airline image in a bad light.

It is the kind of airline initiatives that passengers love to hate:  Look what they have done now! They took all the little nice things away from flying, and ask us to pay extra for them? how awful!

Second of all, it does not even make economical sense for the airline.

By creating this “Inferior Economy Class”, EL Al must be selling those seats at price level much lower than their regular economy class fares; the problem is, for the airline, the cost to carry a “Low Cost Economy Class” passenger is almost the same as the cost to carry a regular economy class passenger.

How so? well, when you look at the operating costs of a flight, the big ticket items are:

  • Aircraft ownership cost
  • Crew labour costs
  • Fuel
  • Maintenance
  • Navigation and terminal charge
  • Ground handling
  • Commission

After all these costs are accounted for, the catering costs associated with a little food and drink, some recyclable pillow and blankets in the economy class really are – just peanuts, they usually only make up for about 1% to 5% of the total operating costs.

So basically, the cost savings on a “Low Cost Economy Class” seat is only between 1% to 5% for the airline, yet fares on these seats are probably 20% to 50% lower than normal economy class fare. It seems that El Al is going to lose money on these seats, so why would they do it?

 

Actually, there are two possible scenarios where “Low Cost Economy Class” makes a lot of sense for an airline like El Al.

Scenario 1: When there is constant over capacity or low “Load Factor” on a certain route, in other words, unfilled empty seats on a regular basis.

 

El Al 737-800 Seats with breakeven point-webLet us use El Al’s Boeing 737-800 as an example, this aircraft has 142 seats in total, with 16 in business class, 142 in economy. At reasonable cost level and price point on a particular route, the flight will break even  when about 100 tickets (see note 1) are sold,  anything beyond that point are pure profit. If there are empty seats left on the flight, it will be in the airline’s best interest to sell those seats, even if that means to sell the tickets at very low price points to attract customers, because at this point, the cost of the flight has already been recovered, any additional passengers just mean extra revenue.

In this case, a new economy class with super low fares to stimulate demand makes a lot of economical sense for the airline.

 

Scenario 2: The airline is in a “war” to protect its market share against invading low cost airlines.

This scenario is probably the real reason behind El Al’s decision to add a “Inferior Economy Class” to their current product mix. As Fish pointed out in his post, some low cost European carrier starts to serve Tel Aviv, a market no doubt very import in El Al’s network and crucial in its financial performance, since Tel Aviv is a popular destination for both business and leisure air travellers.

When a low cost airline enters a market, three things will happen:

  • Its low fares stimulate local air traffic, attracting people who otherwise would not have flown.
  • It will “steal” price sensitive passengers away from the incumbent legacy carrier in the market.
  • It will drive down the Yield level on all the routes they serve for all the airlines in the market.

As the challenger in a new market, the low cost airline will under tremendous pressure to build up traffic quickly in order to fill those seats and sustain flight frequency.

On the other hand, the incumbent  legacy carrier, in this case El Al, really has no choice but to vigorously defend its market share at all costs, because if it does not, the airline might lose so much traffic that it has to cut flight frequency and lower fares across the board in order to keep a reasonable load factor, measures that will have a very negative impact on its bottom line.  In this situation, “Low Cost Economy Class” is a brilliant idea, El Al will be able to offer fares comparable to that of low cost airlines, therefore keeping the price sensitive market segment, at the same time, it will not alienate those passengers who are paying normal economy class fares because of the very visible service level differences; although in terms of underlying costs, as we discussed before, the two classes are essentially the same.  The airline will lose some money on those IEC fares, but if El Al play its card well, it might drive the low cost airline out of the Tel Aviv market: low cost airline usually withdraw from a market quickly if they fail to attract enough traffic in order to build up frequency and to turn a profit in a short period of time. After they left, fares will be restored to previous levels, that will be the best outcome from El Al’s perspective.

From a consumer’s perspective though, the best scenario will be that El Al and the low cost airline achieving some kind of equilibrium in the Tel Aviv market, so both high flying business travellers and bargain hunting families all have access to air services when they need to fly.

Note 1: 100 is randomly picked number to illustrate a point, it reality, the breakeven point varies, it depends on factors like sector length, underlying cost structures of the airline, its  fare levels and many other factors.

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