Big lessons from the discount airlines
He may be battling through headlines as well as headwinds, but Ryan Air CEO Michael O’Leary remains doggedly optimistic that passengers will continue flocking to his increasingly notorious airline. Despite the potential for 20,000 flight cancellations before Christmas, the controversy over passenger compensation, and a potential pilot strike, he’s adamant their low prices will more than offset any customer ill-will: “Our booking engine is full of passengers who have sworn they will never fly with us again,” has been his claim on more than one occasion. And he may well be right.
O’Leary knows his market. Tell a committed bargain hunter that you probably won’t get to sit together, there might not be a toilet on board, and there’s a slight chance a wing might fall off, but the tickets are really cheap, and after a slight pause, you’ll probably be asked, “Ok… how cheap?” His published prices are often half the price any other airline – right now £20 will get you a one-way flight to Malta or a return trip to Cologne. And sure, you’ll pay more once reservations, luggage and administration costs are bundled on top, but if you’re looking for cheap flights, that headline price certainly catches the eye.
The biggest danger in a discount market, like Ryan Air’s, is that the people who are most attracted to your discounts are inherently the most price-sensitive, and they’ll happily abandon you as soon as a better offer comes along. That’s why traditionally, the only people who can win in a discount market over the long term, are the ones who can sustain the deepest discounts because they have the lowest cost, most efficient operation. But that isn’t the case with Ryan Air, nor with many other new-breed lowest-cost players. They have a different solution.
The reason Ryan Air can make those headline prices work, is because of its “ancillary revenue” – like those optional fees for bags and reservations, commission on insurance and hotels, the in-plane advertising so prevalent on its flights. In fact, 27% of Ryan Air’s income last year was ancillary revenue, delivering the group’s entire £600m profit, and subsidising fares to the tune of almost £900m on top. And that’s well behind it’s US rival, Sprint, which generated over 46% – yes, almost half – of its total revenue from those “extras” in 2016.
Multi-sided business models like this are nothing new. Cinemas make a huge chunk of their profit from sweets and drinks, newspapers make a big slice of their income from advertising, and Facebook has half a dozen major income streams, from games and adverts to its “firehose” big-data sales. The difference with the likes of Ryan Air, Sprint, and their spiritual grandfather Southwest Airlines, is not that they were the first to do it, but they were the first to do it seriously in a big, traditional market. By repositioning the ticket as a loss-leader, they’ve fundamentally transformed air travel.
Amazon may be a less dramatic example, but its impact has arguably been more profound. Almost all of Amazon’s divisions lose money. It’s international retail division, which includes amazon.co.uk, had an operating margin of -2.9% last year. The only reason they make a meaningful profit, is Amazon Web Services (AWS) – a cloud-computing platform that grew, seemingly by accident, out of their IT department selling spare processing power from their servers. AWS contributes just 10% of Amazon’s total revenue, but over two thirds of the group’s total profit, hugely subsidising the bits that you and I see every time we shop. And they haven’t stopped there. In one of the biggest loss-leader investments in recent history, Amazon has created its own versions of Netflix and Spotify, and made them free for Prime users.
The business landscape is one of constant evolution, and its history is littered with extinctions. As more and more businesses develop multi-sided models, the age of the straightforward business, selling in one way, to one group of customers, could well be dying out – defeated by competitors who can offer those things as loss-leaders, because they have other ways to make money on the backs of those customers.
All of which raises two important questions: what could you add into your business model to create entirely new profit streams; and how could you respond if a big loss-leader came after your business?