Changing Skies: The Importance of Maintaining Our Budget Airlines

In January 2024, US federal courts ruled against the proposed merger of JetBlue and Spirit Airlines, leaving Spirit in shaky financial territory, unable to compete with larger airlines. The primary rationale for rejecting this merger was to preserve competition in space, the court fearing that further joint ventures of airlines would have consumers at the mercy of predatory pricing practices. One month later, Lynx Air, a Canadian low-cost airline carrier (LCC), announced bankruptcy and closure only two years after its launch, citing financial difficulties and inability to compete with market giants Air Canada and WestJet. Flair Airlines, a slightly more well-known LCC, also sits in deep debt as they cut flights to eastern Canada. Such activity, though seemingly insignificant on its own, signals a trend in airline markets that consumers should pay attention to, especially regarding personal low-budget travel options. By exploring the changes in the airline industry and the most powerful entities involved in setting consumer choices, the importance of these budget-style airlines becomes more obvious as the risk of them leaving the market increases. That being said, it is paramount to ensure the survival of LCCs in the North American market through partnerships, as the benefit of their continued presence outweighs the costs of mergers with larger players.

Why is the presence of LCCs important?

In 1978, US airspace was officially deregulated, allowing airlines to expand their networks and set their fares and routes for the very first time. Immediately, competition spiked, bringing down fares and allowing passengers both the economic and practical freedom to take to the skies. As small carriers grew by nearly 74% post-deregulation and new ones broke into the industry, fares dropped and widespread infrastructure was developed. But as these airlines established themselves, they also merged into mega-airlines and consolidated their resources in the name of efficiency and market dominance. Most notably, these structures emerged as legacy carriers such as Delta, American Airlines, and Southwest Airlines, as well as the business models that these full-service carriers (FSCs) operate to this day. This is where concerns in competition are most prevalent: partnerships between these legacy carriers further cement their status as the primary suppliers of commercial airfare. It is fair to say that further consolidating these legacy options limits consumer choice: by outlining specifically which airlines lay claim to routes, airports, and services, they no longer compete with each other.

On the other hand, budget airlines exist as options with significantly less supplier power - they rely on making sure that their flights are as full as possible and they are flexible enough to be able to respond to greater consumer demand for flight paths and activity. In practice, this results in low-cost carriers operating very similar short-haul routes as legacy carriers for much lower prices, increasing consumer’s options and allowing them greater choice in how they want to travel. The airline industry is expected to be worth $708 billion by 2027, and 36% ($254 billion) of that market share, is expected to be taken by LCCs, having been expanding for the last seven years. In addition, LCCs compete purely on price, with no ticketing class differences, lounge access, baggage options, or many of the perks that are associated with major carriers; they simply operate in the business of moving passengers from one location to the other. For the goal of passengers to get to their desired location, the presence of LCCs and their options create significantly more choice for consumers who may not be able or willing to pay the convenience premium built into legacy carrier models.

Given the creation of greater choice through the presence of budget airlines, it is also important to recognize that these two models do not directly compete. FSCs and LCCs have different business propositions, and they offer their passengers different experiences beyond their flight paths.

The legacy carrier model uses a hub and spoke model, centralizing their operations around specific airports, which allows more complex infrastructure to be built for operations as well as consumer convenience. The sense that certain airlines “own” an airport emerged from the hub model that large legacy carriers have built in airports. Here, tickets tend to be more expensive - both due to the lack of other options, as well as deals that these dominating airlines have made with the airports. These deals include gate and priority status perks that edge out other airlines for convenience. Because budget carriers only offer base services and use a point-to-point model, they are able to respond to consumer demand much more rapidly than full-service carriers as they allow flexibility of flight paths based on where the market falls short. This strategy keeps flights as full as possible but also prevents meaningful cost savings without permanent infrastructure - a significant barrier when these entities compete purely on cost. These different models and pricing points draw in different demographics of passengers: business travel, long-haul international travel, and frequent flyers and leisure customers who value non-financial benefits over their potential cost savings tend to rely on legacy carriers. In contrast, LCCs appeal to younger passengers, regional flyers and cost-conscious adventurers.

This contrast in passenger priorities ensures that LCCs create more options for all consumers, as they draw in an underserved market without poaching from established brands. By recognizing that budget carriers do not compete directly with legacy carriers, the opportunities presented by allowing partnerships between the types of carriers become much more apparent; far from removing options, LCC carriers provide a different set of services and create greater options in the airline space as a whole.

Why are partnerships important?

As mentioned, LCCs are dependent on price competition to operate, but under current models, there is limited space to cut costs any further, and therefore limited opportunity to continue to compete on lower consumer ticket prices without taking losses. Based on the priority of flexibility and adjusting to demand, as well as lower overall margins, LCCs have had fewer opportunities to build infrastructure that can aid in spreading out their costs, stemming from rising fuel costs, aircraft maintenance, labour, and airport fees. LCCs compete on price; they have to keep ticket fares as low as possible while dealing with these high expenses, leaving little room for profit as they jockey for sales. Despite record high revenues of USD 964 billion, LCC's profit margins are expected to be just 2.6% in 2024. As demand shifts away from budget flights and the remaining carriers race to the bottom, this profit is further eroded, leaving LCCs to step out of the market, as Lynx has done.

On the other hand, legacy carriers depend on the existing infrastructure that many airlines have established efficient systems already in place in their hub airports. For instance, Delta built a prominent hub at Hartsfield Jackson Airport, allowing them to efficiently inspect and repair their fleet by pooling resources, including maintenance facilities and staffing requirements. In addition, Delta has made investments in building lounges and obtaining terminal space, which has allowed them to have a substantial presence on airport property, and bring in customers on convenience and price without having to cut fares to the same extent as LCCs. This unified infrastructure allows the company to spread its costs more effectively and improves the overall Delta passenger experience. Though both systems experience the same costs, this resource base is unavailable to most LCCs, so they lose out on both the efficiency of the systems, the cost savings and spreading involved, and margin expansion in the long run. Partnerships between established airlines provide a two-fold benefit in sharing resources, allowing acquiring airlines to maintain their existing operations and capitalize on a market they currently do not appeal to, while supplementing the LCC model with their existing infrastructure to further cost savings, allowing a greater competitive edge in that market.

This cost-saving model is particularly important to note in the recovery of the airline industry after COVID. Without backing from powerful airlines and their existing infrastructure, these budget models struggle and may cease to exist - placing consumers in a much tighter position than the potential risks of absorption of LCC into legacy airline models. Through COVID, the airline industry changed rapidly and consumers saw huge trends sweep the market as countries regulated their borders, airspace, and travel policies in the name of public health. Commercial airlines felt the pressure, with half-capacity flights and unpredictable airport lockdowns in addition to mandated refunds to passengers. Planes flew empty in order to maintain flight plans, causing significant losses for carriers. From 2019-2022, the airline industry grew at a compound annual growth rate (CAGR) of just 0.7%. In the aftermath of the sweeping global lockdowns, LCCs found their niche and expanded quickly, taking advantage of the economic climate and consumer preferences that formed strong demand for short-haul, regional flights.

The slimmed-down and streamlined offerings of budget carriers were appealing on the cost side, and their ability to respond to demand allowed them full flights to secondary airports, bolstering their financials and operations as they cut administrative costs and sold seats to casual travellers - any budget carrier’s primary demographic. As airline activity normalized and consumer interest recovered in international travel, LCCs are learning that their business model of the bare base flight offering is less applicable for a long-haul flight environment.

By diving deeper into the closure of Lynx Air just two years after its launch, the fundamental challenges of running a budget airline are apparent. Lynx fell victim to unstable finances, fierce competition from other LCCs and established carriers, and operational difficulties - all of which were exacerbated by the COVID-19 pandemic's lasting effects. These barriers have caused them to see no way out other than closing their doors, leaving Lynx to join the ranks of numerous LCCs that could not continue to operate. Additionally, LCCs are particularly vulnerable to risks after the pandemic, including changing consumer preferences for travel, thin profit margins, and resource and infrastructural limitations. Support for LCCs is imperative at this point to protect competition and promote economic growth while upholding vital air connectivity.

Recognizing the risks of partnerships

While the benefits of partnerships between FSCs and LCCs are evident, it's crucial to acknowledge the associated risks. The most prominent concern is the potential for FSCs to absorb LCCs offerings into their own, reducing consumer choice and competition while facing the risk of higher prices due to the increase in supplier power of airlines. In this situation, consumers would lose access to their independent legacy carriers, and FSCs would have only more resources and more power in their strong-hold airports and flight routes.

For instance, while major routes like New York to California boast 10,000+ annual flights, less-travelled routes such as North Carolina to Oregon see significantly fewer flights at just 1,500 on an annual basis. By consolidating airlines, the new entities may find that splitting routes up between their budget brand and the full carriers would be more profitable than offering both options. Attempting to monopolize such routes through partnerships would have distinct negative effects on consumers, driving prices higher and limiting alternatives within air travel. The reduced demand for flights on these routes could also strain LCC's finances, potentially worsening the current situation by leading to additional operational challenges and increased costs. Thus, while partnerships between FSCs and LCCs offer potential benefits, careful consideration of the implications for competition and consumer choice is extremely important to avoid monopolistic outcomes. Additionally, the aviation space is already concentrated, as the Herfindahl–Hirschman Index (HHI), a common market concentration metric, shows when applied to the airline industry. A high HHI implies higher industry concentration and higher fares. This can be seen in the merger between US Airways and American Airlines. After the merger, the prices increased by 4.3% while output decreased by 6.3%; the overall merger resulted in a less competitive market.

Despite the multitude of risk factors, partnerships between LCCs and legacy carriers still carry many advantageous factors that bring mutual benefit to airlines and customers, provided that partnerships are monitored and flight paths are kept independent. An area of partnership synergy comes in the form of ticketing: a 7.5% excise tax is levied on base airline tickets. This tax is not imposed on add-on costs which constitute much of the revenues earned by LCCs, incentivizing partnerships to maintain the LCC pricing model to keep this revenue stream constant. Additionally, partnerships such as Korean Air and existing LCCs such as Supernal Air have worked without an impact on consumer choices and mutual benefit for airlines. In this partnership, Korean Air provided insights into the Korean market requirements and AAM aircraft specifications, helping Supernal improve its product and market development strategies. On the other hand, Supernal provided more business for Korean Air which goes to show that risks of monopolies can be mitigated through incentives and mutually beneficial partnerships, creating a final competitive environment that benefits consumers and business entities alike.

Conclusion

It remains of paramount importance that competition is upheld and consumers are offered as much choice as possible. As it stands, the presence of the different offerings of both budget and full-service carriers maintain this variety, encapsulating different ways to travel that appeal to the widest possible range of consumers - from business travellers, college students, non-profit travellers, and family vacationers. Legacy carriers form the foundation of this system, but budget carriers are the options that respond and offer flexibility, and their contributions to upholding variety in aviation cannot be overlooked. Given their importance and the issues they face on their own as flight demand moves away from regional activity, the risk of allowing these airlines to go under compared to allowing partnerships should be more deeply examined. By allowing monitored joint activity, it is possible to extract the best of both worlds - operational efficiency for the airlines without infringing on the availability of choice for consumers.