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.

Let 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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• Airlines may jettison in-flight entertainment as personal gadgets proliferate (venturebeat.com)

When an airline tries to meet the demands of all market segments, it will fail. Apple focuses on the higher end of their markets and are very successful. Can legacy airlines do the same?

On the same day (July 22, 2009) Delta Airlines reported a $257 million loss for the second quarter while Continental Airlines announced a 1,700 jobs cuts, Apple Inc, the iPhone and Mac maker, posted a quarterly profit of $1.23 billion that blew past Wall Street forecasts thanks to strong sales and improved profit margins. In fact, this iconic company has consistently returned strong sales performance and profit levels bucking the trend of this unprecedented recession that seems to be depressing all other companies around the world. How did they do this?

Apparently, whatever Apple is doing, it is working out very well for them.  Can the airline industry, especially those so-called “legacy airlines’”, learn a thing or two from Apple? Can Apple’s business principles work their magic in the airline industry? I believe yes.

Target the market segment where you can compete profitably

Apple has been very careful about which segment of the market they participate in, they steadfastly refused to compete in market segment where the profit margin is too thin.

Take the netbook market as an example, since invented by Asus Computer about a year ago, this low cost, yet underpowered, stripped-of-all-bells-and-whistles small computer category has taken the consumers by storm; because of the growing demand, almost all PC manufacturers, from HP, Dell to Acer and Gateway have joined the market, churning out a large variety of netbooks, albeit all with cut-throat thin profit margins, furthermore, the netbook sales is threatening to cannibalize their more profitable traditional laptop sales.

A clear parallel can be drawn here with the airline industry. The product provided by low cost airlines such as Ryanair is not unlike the netbook of airline industry: they get you from point A to point B for a low fare, but that is pretty much all they offer. Forget all the comforts and amenities people used to associate with air travel: there is no complimentary food and drinks onboard a Ryanair flight, the seat pitch is small, seat back does not recline and a boarding pass will cost you 40GBP extra at the airport. In spite of these bare bone product offerings, the low cost airline sector has grown tremendously both in Europe and the US. Many legacy airlines (such as Delta and United) responded by lowering their fares to compete, yet couldn’t get their operating costs low enough to be competitive, as a result, they not only lost market share to companies like Southwest and AirTran, but also drove their own system profit margin too low to be profitable.

When confronted by reporters about Apple’s plan on the netbook market, Apple COO Tim Cook responded: “Our goal is not to build the most computers, it’s to build the best. Whatever price point we can build the best in, we will play there. At this point, we don’t see a way to build a great product at that price point, $399, $499.” Apple is clearly targeting the medium to high end computer market, and refuse to be entrenched in a mud war with all the other manufacturers in a low margin market segment.

In the same spirit, an airline’s goal should not be providing travel solutions for all the segments of the market, but the “best” segment for their product offering and cost structure.

Legacy airlines should concentrate their resources and efforts on the long haul international markets and the corporate travel markets where product features and services are valued by travellers and the profit margin is much higher. Usually, low cost carriers can’t compete in this segment effectively either. Passengers might forgo food and drinks on a one to two-hour flight, but on a flight last more than 5 hours, they will value food, comfortable chair and blankets much more. For business travellers, they are usually willing to pay a higher ticket price to be able to fly with an airline where they can continue to work during their journey or rest well before arriving for a meeting. Most low cost airlines will not be able to satisfy these needs.

Provide the most innovative products and best customer services in the market you choose to play

Apple products are expensive, they command at least 30% premium over competing product in the same category, yet people line up for them, because Apple products are innovative, provide excellent user experience and come with good customer care. Take the iPhone as an example, within two years of debut, it has grabbed nearly 50% of smart phone market and changed the Smartphone landscape with its revolutionary multi-touch screen and Apps store. The company’s profit surged with the release of new iPhones.

Legacy airlines like Delta, Continental or United should strive hard to find their own hit product like the iPhone. Instead of waiting for customers to tell them what to do, they should research their core customer base thoroughly, anticipate the needs of modern day corporate travellers before they realize those needs themselves and find a way to satisfy them. It could come in the form of a teleconference room in the airline’s lounge, free onboard WIFI, gourmet food or excellent frequent flyer services, it could also come in a package that include everything a business traveller needs to stay productive during his/her journey. The airline which can successfully do so will no doubt be able to charge a premium for its product and commend the loyalty of its most valuable customers.

Be creative in marketing and leverage social media!

Another reason Apple products enjoy such an loyal following has to be attributed to the company’s marketing prowess: it turns regular consumers, reporters and bloggers into not only loyal customers, but also vigorous brand advocates.

 Apple’s advertising campaign is always creative and memorable, Mac vs. PC, is a big hit on TV, as well as on You Tube, and Apple’s ability to generate buzz and free publicity for new product launch is unrivalled in any industry. Usually speculations begin months before Mac Expo and Apple’s developers conference in San Francisco, where Steve Jobs’ presentation was the highlight of the event for the past few years, and his famous catch phrase: “oh, one more thing…” will send all the traditional and new media into overdrive for weeks or months about whatever product Apple was launching.

For the airline industry though, we haven’t experienced anything remotely like that for a long long time, what happened? Airlines used to be such a sexy industry! Nowadays, when people talk about airlines, they are usually complaining about delays, poor customer services, or their broken guitar!

Airline industry in general needs a image make over, however, if an airline can manage to stand out from the pack and give passengers something positive to talk about its brand, it will build a tremendous competitive advantage; one way to achieve that is to have a well planned and executed social media strategy. Blogs, online communities and Twitter are powerful tools for airline to build a relationship with customers and engage brand advocates, increasingly, goodwill generated online will crossover into traditional media as well. One the other hand, negative stories about your brand in the social media universe can do serious damage, United Airline learned that in a hard way recently.

In summary, what airlines can learn from apple is: participate in the market where you are the strongest, for low cost airlines, that is the domestic leisure market, for legacy airlines, that is long haul international market and corporate travel market; airlines should invest in research and development to provide innovative travel products for their targeted markets, and they should put more efforts in launching effective marketing campaigns, social media is powerful tool that can help them achieve that goal.

Dear readers, any thoughts? Feel free to leave a comment!