How do budget airlines work?

Budget airlines, as their name implies, offer cheap tickets to its passengers. Sometimes the price of a ticket is as low as €5. Airlines manage this by cutting their own expenses and operating costs. What’s behind the success of budget airlines? Do they cut expenses also on safety? Let’s find out!

Airline operating costs
One of the major costs for every airline company is the price of airplanes themselves. For instance, a Boening 737, a relatively small passenger jet costs around €40 million. Hiring pilots, first officers and crew members is also a significant expense. Fuel costs instead of being another major cost, also tend to vary often.

Countless other expenses not mentioned before are maintenance costs, fees paid to airports, government, costs of food and drinks served to passengers as well as costs of running booking systems and websites.

How do they cut costs then?
There is no single model for cost-cutting however budget airlines tend to specialise in similar matters. What they try to do generally is to trim costs where possible and use the gains to offset reduced ticket prices. Simple as that :) One of the most important ways for an airline to save money is through fuel hedging. All airlines use fuel hedging, but budget airlines seem to be particularly good at it. For example, between 1991 and 2008, Southwest Airlines paid $3.5 billion below the industry average for jet fuel by using aggressive fuel hedging. (source: http://www.usatoday.com/money/industries/travel/2008-07-23-southwest-jet-fuel_N.htm website)

What is hedging then? Those of you interested in economics may know the word hedging from funds. “Fuel Hedging is a contractual tool some airlines use to stabilize jet fuel costs. A fuel hedge contract commits an airline to paying a pre-determined price for future jet fuel purchases. Airlines enter into such contracts as a bet that future jet fuel prices will be higher than current prices or to reduce the turbulence of confronting future expenses of unknown size. If the price of jet fuel falls and the airline hedged for a higher price, the airline will be forced to pay an above-market rate for jet fuel.” (source: Wikipedia.org website)

Fuel price risk management is a risky business but may be very effective if leveraged wisely. Another effective way of cost-cutting is using only one kind of plane. Ryanair for example uses only Boeing 737-800 airplanes. This saves a lot of maintenance costs as the airline stocks parts only for one type of plane. They also save on pilots and mechanics trainings. Another significant cost-cutting method is avoiding expensive airports situated near (or in centres) of big cities. True budget airlines usually choose smaller cities (smaller and simpler airports usually at the same time) over modern and well located airports as they have much lower fees. Stockholm Skavsta airport instead of its name is situated 100 km from Stockholm. Bus ticket to city centre is a similar expense to airplane ticket :)

Yesterday's Future Today: Air Travel from Xeth Feinberg on Vimeo.

Budget airlines safety
The word "budget" implies something made cheaply, without much concern for quality. This is something that budget airlines fight against. Many people come to conclusion that if it’s cheaper it must be of worse quality. Well, yes it is, but does the quality aloes concern safety? Fortunately not. Budget airlines are no less safe than any other airlines. While they cut operating costs on luxuries, they are aware that if they cut costs on safety it could ruin their business. The bottom line on safety is that plane crushes happen and they are not more susceptible to low cost carriers.

Another Low Budget Airline is going to be launched in India very soon...

Budget airlines maths
While browsing through the Internet I have found a very interesting essay (in Polish). It describes in close details economics and maths standing behind budget airline. Authors state that budget airlines sell approximately:

• 30% of lowest price tickets
• 30% of middle price tickets (it’s estimated that with compounded 60% of lowest and middle price tickets they already have revenue)
• 30% of expensive tickets
• 10% of very expensive tickets (usually more expensive than regular airline tickets)

This model provides airline companies with quite a revenue if they manage to sell ALL tickets for a given flight. On the other hand, 30% of passengers have the opportunity of buying very cheap tickets. It’s a great fun combining many cheap flights in a single trip as you are able to visit many places for a low cost.

Discussion topics

1. Is the term fuel hedging new to you? Do you think it's a model that is able to last long till it's to risky?
2. Would you be interested in combining a trip along with your friends using connecting flights from budget airlines? Maybe you;ve already had the opportunity?
3. Are you convinced of the low cost carriers safety?