Central European budget airlines struggle to take off

By bne IntelliNews February 29, 2008

Matthew Day in Warsaw -

When Central Europe's low-cost airlines first took to the skies, optimism was in abundance. Fired with youthful enthusiasm, they entered the market happily, pointing out that the low-costs/low-fares business model was perfect for a region teeming with millions of people eager to fly but unable to afford to do so with conventional carriers.

On this point they were right; all the region's low-cost airlines have seen passenger numbers grow at impressive rates. But where life hasn't quite gone according to script is when it comes to making money. With the exception of Hungary's Wizz Air, most of the regional low-costs have struggled to make it into the black.

The publicly-listed and Bratislava-based SkyEurope has had a depressing run of results since its first flight in 2002, and in the financial year that ended September 30 last year it posted a loss of €21.4m, following on from a €57.3m loss the year before. Centralwings, the low-cost of arm of Polish national carrier LOT, has also found it hard to make money, with the press reporting that the airline was close to bankruptcy after running up a €20m loss last year. Haunting them all is the ghost of Poland's first low-cost carrier, Air Polonia, which went bankrupt in an unashamedly hurried manner in December 2004, leaving many passengers either stranded or ticketless.

Just why the region's low-cost carriers have struggled has had much to with a level of competition that has seen them forced into battle with Europe's established low-cost giants, Ryanair and EasyJet – both of which possess a seemingly unquenchable thirst for new markets and pockets deep enough to survive any price wars – and a plethora of smaller players. Troubled Centralwings now has to contend with competition from 16 other airlines for the Polish market.

The furious competition that now characterises the sector has chipped away at margins, but also helped keep Central Europe's low-costs confined to a small number of bases, and this, according to Peter Morris, chief economist at air-transport consultancy Ascend, has had a limiting effect on the regional players. "The level of competition has risen, which is great for customers, but the problem is that while the low-cost model has robustness and advantages, the key element is mass," he explains. "When the low-cost model works best is when they become a supplier across a huge market – much like Ryanair and EasyJet – rather than just out from a particular hub.

"The problem with the Eastern European low costs – yes, they have an advantageous cost base and don't have the heritage problems – is that they still are pivoted around particular hubs. Maybe one, maybe more, but they are going to and from one particular point. The big players don't have a dependence on single-source destination markets," Morris says.

As well as eliminating dependency, having a web of destinations gives airlines flexibility and allows them to utilise their aircraft better – essential if costs are to be kept down. Being big also has an advantage when it comes to striking deals. Morris says that that the sheer size of Ryanair, for example, means that it can negotiate lucrative discounts on anything from the purchase price of aircraft and leasing rates to maintenance costs.

One way

Another problem that has hit the regional low costs is that until now, up to 75% of the traffic has been inbound first. People flying into Central Europe have a tendency to fly with airlines they know, and many, significantly, tend to pay premium rates as booking is done at reasonably short notice, which gives the airline a healthy supply of money. In contrast, customers flying out of Central Europe tend to book well in advance to take advantage of low prices.

All this comes at a time when the storm clouds of economic slowdown are gathering on the horizon, which could heap further woe on an airline sector already battling with high fuel prices.

But it's not all doom and gloom. Central European bases mean that the regional low-cost carriers have a cost advantage over their Western rivals, and, says Ascend's Morris, "there is room for a Central-European low cost that knows the market." They can also still take easy chunks out of national flag carriers, such as Hungary's ailing and loss-making Malev: a much preferable, and far easier, option to taking on Ryanair.

It also looks as if the low-cost carriers are putting the past behind them. In 2007, SkyEurope took an axe to its business, cutting away as much deadwood as possible. "The reasons for the attack on our cost base are simple: our costs were too high to be profitable," says the airline's CEO, Jason Bitter, on a process that saw it close its Polish and Hungarian bases in an effort to save money and consolidate business. So far it appears to working; SkyEurope posted fourth-quarter profits on its financial year ended September 30, of €14.3m, while seeing passenger numbers jump 30% to 3.3 million.

Wizz Air, in contrast, has decided to push for expansion. Backed by US venture capital, the airline has 50 Airbus A320s on the order books and on option on a further 25 as it strives to reinforce its position as one of the region's biggest players. As a further indication of market confidence, even the sector's most recent arrival, Romania's Blue Air, has splurged an estimated $150m on two new Boeing 737-800s.

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Central European budget airlines struggle to take off

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