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European Management JournalVol. 17, No. 1, pp. 20±38, 1999 Ó1999 Elsevier Science Ltd. All rights reserved

Pergamon

Printed in Great Britain

0263-2373/99 $19.0010.00PII: S0263-2373(98)00059-0

Case Study

easyJet's $500 MillionGamble DON SULL,London Business School, andCommentators, Constantinos Markides,

Walter Kuemmerle, Luis Cabral.

This Case Study details the rapid growth of easyJet which started operations in November 1995 from London's Luton airport. In two years, it was widely regarded as the model low-cost European airline and a strong competitor to ¯ag carriers. The com- pany has clearly identi®able operational and mar- keting characteristics, e.g. one type of aircraft, point-to-point short-haul travel, no in-¯ight meals, rapid turnaround time, very high aircraft utiliz- ation, direct sales, cost-conscious customer seg- ments and extensive sub-contracting. easyJet's managers identi®ed three of its nearest low-cost competitors and the strategy of each of these airlines is detailed in the Case Study. But easyJet also experienced direct retaliation from large ¯ag car- riers like KLM and British Air- ways (Go). These challenges faced easyJet's owner,

Stelios

European Management JournalVol 17 No 1 February 199920

Haji-ioannou, as he signed a $500m contract with

Boeing in July 1997 to purchase 12 brand new 737s. The Case is followed by critical analysis from three Commentators in the ®eld.ã1999 Elsevier Science

Ltd. All rights reserved

It was July 1997, and Stelios Haji-ioannou Ð owner and chairman of easyJet Ð glanced at his $500m con- tract with Boeing to purchase 12 brand new 737s. As he signed the contract, Stelios steadied his shaking hand. The words of Richard Branson, chairman of Virgin Atlantic airline, ¯ashed through his mind: `the safest way to become a millionaire is to start as a billionaire and invest in the airline industry.'

With the Boeing contract, signed before easyJet

reached its second anniversary, Stelios (as he was called by everyone) committed to triple the size of easyJet's fully-owned ¯eet from six to 18 airplanes in

EASYJET'S $500 MILLION GAMBLE

the span of two years. When easyJet was launched with a party in London's Planet Hollywood two years earlier, no one had predicted the company's rapid growth. In its second year of existence, easyJet was widely regarded as the model low-cost Euro- pean airline and had helped shake-up the once cozy

European airline industry. With more than two

million passengers, ten European destinations served, and sales of more than £60m in 1997 Stelios had ample room for celebration. And yet several challenges loomed.

Turbulence in the Airline Industry

Historically, the European airline industry had been heavily regulated by individual countries to protect their own national carriers, called ¯ag-carriers. These

¯ag-carriers, many of which were State-owned,

dominated domestic travel in their national markets. Despite signi®cant government subsidies, most ¯ag- carriers accumulated losses due to high-cost struc- Table 1 Financial Performance of Major European Flag-carriers

Sales (million$) 1996 1995 1994 1993 1992

British Airways $14,043 $13,036 $12,057 $10,589 $9350

Lufthansa 12,551 11,817 11,321 10,670 10,435

Air France 7656 7132 11,059 9170 n/a

KLM 5024 4625 4456 4205 3988

SAS 4667 4688 4464 4105 3181

Alitalia 4373 4325 4051 3425 3149

Swissair 3497 3333 3327 3534 3604

Iberia 3081 2907 2801 2720 2733

Pre-tax pro®t/(loss) (million$)

British Airways $1075 $983 $549 $506 $311

Lufthansa 377 416 220 (5) (171)

Air France 6 (142) (749) (1131) n/a

KLM 56 328 273 48 (282)

SAS 226 333 151 90 110

Alitalia (165) (190) (93) (175) (25)

Swissair 1 3 2 5 14

Iberia 116 41 (242) (363) (252)

Pro®t margin (%)

British Airways 7.7 7.5 4.6 4.8 3.3

Lufthansa 3.0 3.5 1.9 0.0 (1.6)

Air France 0.1 (2.0) (6.8) (12.3) n/a

KLM 1.1 7.1 6.1 1.1 (7.1)

SAS 4.9 7.1 3.4 2.2 3.5

Alitalia (3.8) (4.4) (2.3) (5.1) (0.8)

Swissair 0.0 0.1 0.1 0.1 0.4

Iberia 3.8 1.4 (8.6) (13.3) (9.2)

British Airways, KLM and Air France close the ®nancial year in March, so their calendar year ®gures are those of the following

March (e.g. March 1997 for 1996 ®gures).

SAS, Alitalia and Iberia accounts are unconsolidated, while all others are consolidated. Swissair ®gures are for Swissair Ltd only, not the parent company SAir Group. The exchange rates used were those applicable on 27 March 1998 (e.g. £/$51.68, DM/$50.55). European Management JournalVol 17 No 1 February 199921 tures and operational inef®ciencies. Even in 1996, after several years of buoyant demand, most ¯ag car- riers provided disappointing returns (Table 1). The ¯ag carriers' strong position had historically deterred new entrants, and there existed very few inde- pendent scheduled airlines, apart from charter-¯ight operators which catered to the needs of seasonal leis- ure travelers.

During the late 1980s the European Union (EU)

initiated a liberalization program to increase compe- tition in the European skies, with major regulatory changes beginning in 1992. By April 1997, any EU carrier was allowed to provide a passenger service without restriction in any domestic route of an EU member-State. This liberalization was modeled after industry deregulation initiated in the US by the 1978

Airline Deregulation Act. The US deregulation had

attracted several hundred start-up airlines, but only two of the airlines founded in the 1978±92 period were still ¯ying in 1997. European deregulation also opened the door to new entrants, and approximately

80 new airlines entered the market in 1995 and 1996

EASYJET'S $500 MILLION GAMBLE

alone. Of the 56 airlines launched in 1995, 17 went bankrupt in their ®rst year of operations. Industry experts predicted that deregulation would spawn fewer new competitors in Europe than lib- eralization had in the US. Potential low-cost entrants faced signi®cant legal obstacles to gaining regulatory approval from the Civil Aviation Authority (CAA), and also incurred 40 per cent higher costs on average than their US counterparts, due to higher airport charges and relatively in¯exible labor conditions. As a result, low-cost competitors were slower to make inroads along European routes than they had been in the US. A 1996 EU report examining the impact of airline deregulation found that only 6 per cent of all routes within the EU were served by more than two airlines, with 30 per cent served just by two and 64 per cent still in monopoly status. easyJet and other low cost start-ups, however, planned to introduce competition along lucrative European routes.

Birth of an Airline

Stelios, 31, was the second son of Lukas Haji-ioannou a legendary Greek-Cypriot shipping tycoon. Lukas, who came from humble beginnings, began his career trading raw materials in Saudi Arabia, before moving to Athens to enter the shipping industry in the late

1950s. During a world-wide shipping crisis in the

1980s, Lukas accumulated a ¯eet of 52 super-tank-

ers Ð then the largest such ¯eet in the world Ð which he later sold at signi®cantly higher prices. Ste- lios, who grew up in Athens, moved to London in

1984 to obtain a Bachelor Degree from London School

of Economics and a Master in Shipping from City

University Business School. Upon his return to

Athens, Stelios joined the family shipping business, and at the age of 25, created his own specialized tanker company, Stelmar, with a ¯eet of ®ve tankers. Stelios' ®rst interest in the airline industry was almost accidental. In May 1994, on board an Athens ± London ¯ight of a Virgin Atlantic franchisee, he was approached by a shareholder in the franchise who tried to persuade him to invest in the company. Although Stelios decided not to invest in the com- pany (which soon after went bankrupt), he remained intrigued by the idea of a European low-cost airline. It was not until he ¯ew on Southwest Airlines Ð a successful low-cost competitor in the US Ð that Stelios felt `he had found the right concept' for a

European airline. Stelios intensively researched

Southwest, meeting with founder and CEO Herb Kel-

leher and buying 250 copies ofNutsÐ a book docu- menting Southwest's success Ð for distribution to potential employees and customers. In the summer of 1995, Stelios presented a business plan for a low- cost European airline to his father, who was won over by the idea and invested £5m in the venture. `If I European Management JournalVol 17 No 1 February 199922 didn't bring the concept to Europe,' Stelios explained, `someone else would.' easyJet's operations clearly mirrored the model pion- eered by Herb Kelleher at Southwest Airlines: one type of aircraft, point-to-point short-haul travel, no in-¯ight meals, rapid turnaround time and very high aircraft utilization. This concept promised signi®cant cost savings relative to ¯ag carriers (Table 2). How- ever, easyJet's founder modi®ed the model to bene®t from Southwest's experience: `The main reason for these modi®cations was that Southw- est had been in the business for 25 years whereas I was starting from a clean piece of paper. You have better opportunities to do things differently if you start from scratch.'

For instance, Stelios completely avoided travel

agents, and relied exclusively on direct sales, in con- trast to Southwest which derives 60 per cent of its revenue through travel agents. Stelios also designed easyJet to completely eliminate tickets. Stelios

Table 2 Cost Comparison Between a Flag-carrier

and a Low-cost Airline in Europe (Example of Lon- don ± Paris Route)

Cost item (£) Flag- Low-cost

carrier airline

1. Ticket sales costs £3.50 £0.80

2. In-¯ight service costs £1.30 £0.00

3. Pilots and cabin crew costs £4.00 £1.50

4. Fuel, maintenance, insurance £6.00 £7.50

5. `En route' charges £1.00 £1.00

6. Airport charges £9.50 £7.00

7. Aircraft rentals £7.80 £3.00

8. Overhead costs £17.00 £5.00

Total costs £50.10 £25.80

Cost assumptions

1. Include travel agent commissions, reservation agents com-

missions and/or computer reservation systems. Flag-carrier sells 80 per cent of tickets through travel-agents, low-cost air- line 0 per cent.

2. Include cost of meal and other in-¯ight amenities.

3. Include salaries and bene®ts of pilots and air hostesses.

4. Flag carriers enjoy economies of scale and use their superior

purchasing power.

5. Include costs of navigation etc. which are identical for all air-

lines.

6. Flag-carrier ¯ies main airports (Heathrow ± Orly); low-cost

airline ¯ies secondary airports (Stansted ± Beauvais).

7. Flag-carrier leases new Boeing 747-400 aircraft; low-cost air-

line leases old Boeing 737-200.

8. Estimation of overhead costs is based (a) for the ¯ag-carrier

on allocating a proportion of BA overheads to the European region and (b) for the low-cost airline on Ryanair's total over- heads.

General assumption

Load factor (68 per cemt) and aircraft utilization is the same for both airlines.

Of the 56 airlines

launched in 1995, 17 went bankrupt in their ®rst year

EASYJET'S $500 MILLION GAMBLE

decided to ¯y easyJet's 737s using their maximum seat capacity of 148 seats. While Southwest offers drinks and its famous peanuts for free, Stelios reckoned that in-¯ight frills add very little to passen- gers' satisfaction and therefore developed the `nothing for free, all for sale' idea. easyJet passengers even paid for soft drinks and snacks Ð only the in- ¯ight magazine was free. Stelios summarized his philosophy: `When someone is on a bus he doesn't expect any free lunch¼ I couldn't see why we cannot educate our customers to expect no frills on board.' Stelios and Managing Director Ray Webster also tried to recreate Southwest's culture of teamwork and cooperation. Southwest pilots would often help cabin crew clean up an aircraft to ensure on-time takeoff. Stelios and Ray believed the easyJet's operational model could be copied, but that their corporate cul- ture could create a sustainable advantage that com- petitors would have dif®culty emulating. easyJet Takes Off easyJet started operations in November 1995 from London's Luton Airport, with two leased aircraft, 16 teenagers as reservation agents and another company's operating license. Stelios recalled the company's start- up. `I was trying to start an airline without anybody who knew any- thing about airlines! On day one, it was me and my Finance director Ð everybody else was a subcontractor! We were the ultimate virtual airline!'

Stelios launched an extensive PR and advertising

campaign with the slogan: `Fly to Scotland for the price of a pair of jeans!' easyJet's £29 one-way fare for the 50 minute ¯ight from London to Glasgow cost a fraction of the price charged by British Airways (BA) on the same route and was signi®cantly cheaper than the rail fare. Most industry experts initially dis- missed easyJet: `Europe is not ready for the peanut ¯ight,' one senior BA executive predicted. Despite initial skepticism, the ®rst easyJet ¯ight was full, and the company soon added two more destinations in

Scotland Ð Edinburgh and Aberdeen. The routes

between London and these three Scottish cities rep- resented almost 30 per cent of the 14 million domestic UK passengers in 1995, allowing easyJet to rapidly reach critical scale. To support easyJet's rapid growth, Stelios recruited several seasoned airline executives, including Ray Webster Ð formerly General Manager Strategic Plan- ning in Air New Zealand Ð who joined easyJet as Managing Director with full responsibility for the day-to-day management of the airline. easyJet also European Management JournalVol 17 No 1 February 199923 hired several young professionals who were enthusi- astic about the company's concept. Stelios and his family invested an additional £50m in the followingquotesdbs_dbs20.pdfusesText_26