AGENDA: Can airlines win the price wars? - As the latest price war flares between British Airways and Virgin Atlantic, Joanna Walters asks why it is an annual event, and whether it damages brand image

When British Airways and Virgin Atlantic declared the latest ticket

bloodbath there was one sound that could be heard above the cheers of

the consumer - the weeping of the accountants. What is a bargain for

travellers is a headache for the airlines - yet they are drawn into a

vicious fares war on their lucrative routes almost every year.

Return fares such as pounds 139 to New York, pounds 167 to Los Angeles

and pounds 279 to Hong Kong are among the lowest ever sold and Virgin

chairman Richard Branson cheerfully admits ’it could cost a fortune’.

Even so, it is a strategy that BA chief executive Robert Ayling seems

willing to endorse.

But are the airlines damaging their long-term ability to raise fares and

tarnishing their brands by plunging into the bargain basement? And how

much do they really lose?

Balancing the fares

Whenever airlines declare a fares war or a burst of seasonal special

offers they never reveal to the public or the investment community how

many thousands of seats are going on sale at precisely what prices.

The marketing and accounting teams have to strike a balance between

putting enough seats on offer at the lowest prices to make the sale

’genuine’, and making too many available, thus squandering the chance to

extract the highest price the market will stomach.

Mike Stoddart, transport analyst at stockbroker Charterhouse Tilney,

says that the City has always found it impossible to calculate exactly

how much it costs airlines when they go on a discounting binge.

If, despite the banner headlines and talk of fighting rivals to the

death, the fares war is not allowed to spiral downwards too deeply or go

on too long, then BA and Virgin will probably both benefit. In other

words, it will be a phoney war with more gain than pain.

Both airlines will win passengers from other airlines that put fewer

seats on sale and less muscle into advertising. They will fill seats,

albeit at bargain fares, that otherwise would have flown empty or

carried a passenger using up frequent flyer points, which brings in no

revenue.

And any revenue is good revenue to an airline in the depths of

winter.

But gain certainly turns to pain if the market weakens by more than just

a seasonal blip, or two airlines are actually trying to put each other

out of business. (And BA has probably accepted by now that Virgin

Atlantic, which made pounds 90m profit last year on a pounds 942m

turnover, is not just conveniently going to disappear.)

Out of BA’s pounds 637m operating profits for the 1996-97 financial

year, pounds 317m (47%) was earned in July, August and September.

Only pounds 30m of operating profit was earned in the January-March

period.

Figures for the financial year 1997-98 were distorted by the summer

cabin crew strike that cost BA pre-tax profits of pounds 125m.

Nevertheless, July-September operating profits were still pounds 200m,

while the January-March trough brought in only pounds 76m. Passenger

numbers were 20% down in December compared with August, so even fare

wars have only a limited effect on volumes.

It might seem logical for airlines to stay out of the bloodbath by

operating fewer, fuller flights during the winter, thus preserving their

fares structure and exclusive image and saving on adspend. But that is

not feasible.

According to Stoddart: ’The aircraft are sitting there and the airlines

suffer the financial charges of owning them whether they fly or not.

That could be a monthly leasing charge or the depreciation and interest

cost if they have the equivalent of a mortgage on the planes. The staff

are there too, being paid. So most of the fixed costs stay the same.

’The flights have to operate for the business passenger, who demands

frequency and is paying full fares. For the extra amount it costs to

carry each economy passenger, in terms of airport landing charges, fuel,

in-flight meal, check-in, it is better to earn pounds 200-odd for the

seat than fly it empty.’

The latest fares war is being blamed not only on the slump in traffic at

the end of the summer but also on rapid capacity growth as airlines take

delivery of aircraft ordered years ago. BA’s capacity has been rising at

a rate of 12% this year. Turmoil in world markets and the whiff of a

recession are adding spice to the conflict.

But airlines have been reaping the benefits of the strong UK economy

over the past two years by putting fares up in the limited-capacity

business- and first-class cabins. The American Express Corporate Travel

Index shows that average business class fares out of the UK in this

period have risen by 19%.

Price differential

Transatlantic business-class fares have risen by 23%, with a London-New

York business return fare typically costing pounds 3100. First-class

costs around pounds 5000 while passengers in economy on the same Boeing

747 could have paid anything from pounds 850 down to the lowest

special-offer price.

Keith McMullan, managing director of London consultancy Aviation

Economics, says: ’An airline such as BA will have dozens of different

fares on a jumbo to New York, often on sale as much as six months in

advance. They will tweak the selling process right up to the last minute

to achieve the maximum revenue - deciding how many seats to make

available at what price and when.

’It is inevitable that someone on a bargain fare will sit next to

someone who paid twice as much, but each one is likely to have different

conditions attached to the ticket.’

Companies do not discuss breakeven points openly and City analysts say

that the best airline capacity-planning and fare-setting systems mean

that it differs from flight to flight even within one airline and to the

same destination.

It is generally agreed that once an airline such as BA has filled its

first- and business-class cabins with full-fare paying passengers it has

more than covered the cost of the flight, and tickets sold in economy

are straight profit. A fares war, or seat sale, is simply a way of

maximising return at the margins.

Seat sales

Chris Avery, aviation analyst at Paribas, says: ’At this time of year as

the summer peak wanes, airlines always sell off seats at the back of the

plane. They have more control if they conduct the ’fare wars’ themselves

rather than sell the cheap seats to the bucket shops. They have better

control of the marketing and the price and quantity of seats sold at the

lowest prices.’

Extra competition has entered the short-haul market in the shape of new

low-cost airlines such as Ryanair, EasyJet, AB Airlines, British

Regional Airlines and BA’s new offshoot Go. They are pushing fares as

low as pounds 29 to Ireland and pounds 99 to Italy and Scandinavia.

Most of these are in the process of raising their aircraft capacity,

which increases the pressure on economy fares. There is always some

element of trading down by price-conscious consumers, particularly in a

recession when business-class passengers downgrade en masse to

economy.

On the whole, autumn price wars will not impede an airline’s ability to

charge high fares in a strong market. There is no evidence that winter

discounts drag significant passenger numbers away from the high-spending

summer peak.

Bargain fares prompt some changes of habit but the most significant

effect is to expand the market, draw in new passengers and increase

volumes.

Most observers do not believe that fare wars damage brand image,

provided they do not spiral out of control and quality and safety

standards remain high.

’BA is such a big company that it always has to have a fare out there

that will appeal to everyone who is likely to fly - whether that’s

pounds 6000 on Concorde or pounds 180 for a heavily-restricted leisure

ticket across the Atlantic. If you need flexibility and want luxury you

still have to pay for it,’ explains Stoddart.

Joanna Walters is transport business editor for The Observer

TRAFFIC CONTROL

- Passenger volumes in August are normally 20% higher than in

December

- Once first- and business-class seats have been sold any other seats

are pure profit

- Current fares are some of the lowest ever recorded: pounds 139 to New

York, pounds 167 to Los Angeles and pounds 279 to Hong Kong

- Prices on the same plane vary massively. London to New York can be

pounds 5000 for first class, pounds 3100 business, pounds 850 standard

and pounds 139 discount Business fares up 20% 1996-98.

This article was first published on Marketing