Individual Written Paper Students will be assigned an Integrative Case from the back of the…

Individual Written Paper

Students will be assigned an Integrative Case from the back of the textbook.  The paper is an opportunity for you to express discussion points covered in class and develop and articulate original thoughts and views, as well as exhibit comprehension and understanding of course material.  Students will write up a case by responding to specific questions that will require students to analyze the case using course content (theoretical models and tools). You should display an understanding of the strategic issue in a logical, well-supported written form and be prepared to discuss in class, if required. Maximum length is five (5) pages of single-space text with maximum of 1” margins (not including any supporting material within an appendix)

 

  Ryanair1

From industry-based, resource-based, and institution-based views, how can we understand the drivers behind Ryanair’s success? From an ethical standpoint, is CEO Michael O’Leary a loose cannon or an astute strategist?

Charles M. Byles, Virginia Commonwealth University

Always in the news and not shy of adverse publicity, Ryanair has been soaring in profits for the past few years. In November 2011, CEO Michael O’Leary announced a 20% increase in profits that in his words was “a testament to the strength of Ryanair’s lowest fare/lowest cost model.” Ryanair did not start with this model, however. Founded in 1985 with its headquarters in Dublin, Ireland, Ryanair began flights between Ireland and the UK and later launched services on the lucrative Dublin-London route after challenging the British Airways-Aer Lingus duopoly. But its initial foray into the airline business was not profitable. As a result of severe financial losses in 1990, Ryanair changed its strategy, adopting the Southwest Airlines business model and becoming the pioneer of low fares in Europe. The next two decades showed growth from 745,000 passengers in 1990 to 73.5 million in 2010. Based on passengers carried, the airline is now Europe’s largest low-cost carrier and second largest airline.

Resources and Strategy

While Ryanair competes primarily on low cost, it also differentiates (through certain aspects of customer service) and raises revenues on non-ticket items (through ancillary services) as a means of offsetting the lower fares. Although successful, this strategy has been controversial. The airline has been accused of concealing its ancillary fees and offering customer services that are only available for a fee. How does Ryanair deliver on its low-cost strategy? Five value chain activities are key to its low-cost advantage: (1) operations, (2) human resource management, (3) customer service, (4) use of the Internet, and (5) ancillary revenues.

Operations

Use of a single model of aircraft (the Boeing 737-800) is the primary method of cost control because it allows inventory, and more flexible scheduling of flight crews. The popularity of the 737 model also means that flight crews are more readily available for hire. Finally, because Ryanair purchases a large number of aircraft from Boeing it can negotiate price concessions.

Other cost savers are the use of secondary and regional airports that offer competitive prices, the use of outdoor boarding stairs instead of jetways, having all passengers check in on the Internet, and the introduction of a checked bag fee, which reduces the number of bags carried by passengers (hence reducing handling costs and the number of check-in desks). Airports are chosen because of their low fees rather than for market reasons. Some agreements with secondary and regional airports base the airline’s fees on traffic volume.

The short-haul flights operate without the costs of meals, movies, and other in-flight services expected by passengers on longer flights. While the distance of the secondary airport from the main cities and the charge for checked baggage are inconvenient, a benefit is more frequent on-time arrivals, quicker turnarounds (fewer bags to check), and more frequent on-time departures because these airports are less congested. Quicker turnarounds and more frequent on-time departures are also enhanced because the airline offers neither connecting flights nor the transfer of baggage to other flights, whether operated by Ryanair or not.

Human Resource Management

The productivity-based incentive system is another activity contributing to greater ancillary revenues and efficiency. Flight attendants receive commissions for onboard sales and, along with pilots, payments based on the number of hours or sectors flown. For the 2010 fiscal year, productivity-based incentives accounted for approximately 39% of a typical flight attendant’s total earnings and 37% of a typical pilot’s total compensation. The cost of customer service is reduced by outsourcing ticketing and other services at airports. For these services, Ryanair has been successful in negotiating fixed-price multi-year contracts.

Customer Service

Although Ryanair has a reputation for poor customer service, the airline states that customer service is an important aspect of its strategy. Ryanair’s stated approach to customer service is the deliberate reduction of services in some areas (e.g., free checked bags, meals, flights to major airports) while raising it in others (e.g., on-time departures and arrivals, fewer lost bags). Its December 2011 customer service statistics (published on the Ryanair website) state that 89% of flights arrived on time, complaints were less than one per 1,000 passengers, and mislaid bag claims were fewer than one per 2,000 passengers.

The airline believes that customers prefer fewer services plus extra fees as needed for meals and other items in exchange for low fares. The Air Transport Users’ Council, however, claims that in 2009, easyJet and Ryanair had the most complaints of any major European airlines. Cancellations, missing bags, and denied boardings were top complaints. In a recent Bloomberg Businessweek article titled “Ryanair’s O’Leary: The Duke of Discomfort,” even CEO O’Leary suggests that customer service is poor:

In exchange for cheap fares, he [O’Leary] says, passengers will put up with just about anything. On Ryanair, that can include high luggage fees; relentless in-flight sales pitches for smokeless cigarettes and scratch-off lottery games; minimal customer service; bad, expensive food; cramped seats; and flights to secondary city airports that are sometimes hours from the actual city.

In the same article, O’Leary criticizes competitors for treating budget travelers with a level of courtesy that they do not receive elsewhere nor expect when traveling. O’Leary believes that customers will endure discomfort and indignity as long as they get to their destination cheaply and with their suitcases.

Ancillary Revenues

Ancillary revenues (revenues beyond the sale of a ticket and including sales of related items such as hotel reservations or car rental, as well as charges for food, checked baggage, priority boarding, and other items) allow the airline to make up income lost through lower ticket prices. Ryanair has been particularly creative in coming up with new means of generating ancillary revenues. For example, in 2009, the company announced the sale of smokeless cigarettes to ensure that passengers get their “fix” of nicotine without lighting up.

The company’s website contains offers for car hire, travel insurance, hotels, airport transfer, credit cards, hostels and bed and breakfasts, cruise holidays, villas and apartments, campsite holidays, and others. Ancillary revenues are also generated by charging fees for priority boarding, reserved seats, airport boarding card reissue, checked baggage, excess baggage, infant equipment, sports equipment, musical instruments, and many others. One controversial fee is the boarding pass reissue fee (charging €40/£40 for a passenger who fails to print out his boarding pass) that has been ruled illegal by a judge in Barcelona, Spain. Without the charge, Ryanair argues that it would have to employ numerous handling agents to issue boarding passes for passengers who forget to print them.

The Irish Examiner newspaper reported that Ryan-air’s ancillary revenues for 2009 were €663 million, more than any European airline, and in the top five ranking of airlines around the world (the top three are United, American, and Delta). For the half-year ended September 30, 2011, ancillary revenues increased by 15% to €486.5 million, faster than the increase in passenger volume.

Use of the Internet: Booking, Check-in, and Boarding

Passengers must book and pay for fares on the Ryan-air website or through the call center. An administrative fee applies to all bookings made through the call center and also to web bookings made without using Ryanair’s free payment method (MasterCard Prepaid Debit Card). Flights are booked one-way only, and tickets may be changed for a fee but cannot be cancelled. Passengers must check in online starting 15 days before the flight and up to 4 hours before departure time. An online check-in fee applies to all tickets booked (€6/£6 for flights booked online and €12/£12 for those made via the call center or at the airport). After checking in, the boarding pass must be printed and presented at boarding. No changes can be made to passenger name(s), flight dates, times, or route once the check-in is completed. Seating is not assigned unless “Reserved Seating” has been purchased (on the website) or where passengers have indicated that they need special assistance. Passengers who have purchased “Priority Boarding” (also from the website) may board before others provided they arrive at the gate no later than 30 minutes before boarding. Refunds are possible only in the event of a flight cancellation or the death of an immediate family member (within 14 days of the travel date).

Loose Cannon or Astute Strategist

CEO Michael O’Leary has served as a director since November 1988, deputy chief executive from 1991 to 1994, and CEO since January 1, 1994. In 1991, he went to Dallas to meet Southwest executives and took the lessons back to Ryanair. While O’Leary embraced a few central aspects of Southwest’s model (e.g., a single aircraft model, secondary airports), he went much further with the constant drive to keep costs down. In particular, the extensive use of ancillary fees to balance the low ticket prices became a trademark of Ryanair and now forms a core element of its low-cost strategy.

Known for his aggressiveness, outrageous public statements, and insults to almost any group or individual who gets in the way of Ryanair—including customers who complain about poor service—O’Leary has been accused of making outlandish suggestions (for example, to have standing passengers on aircraft or to replace one of the pilots with a computer) to gain publicity. One recent proposal is to remove two of the three toilets on each aircraft in order to add six seats.

O’Leary referred to the decision to close Scottish airspace in May 2011 because of the volcano eruption in Iceland as “bureaucratic incompetence.” To demonstrate that there was no safety threat to aircraft and the designation of it as a “red zone” by the UK’s Civil Aviation Office was flawed, Ryanair deliberately flew an aircraft (without passengers) through that closed airspace.

Despite giving the impression of being a loose cannon, however, industry experts say O’Leary is an astute strategist who has created a singular focus on cost control that competitors have been unable to imitate. He leads by example—staying in budget motels, having no smartphone, and flying on Ryanair. His office is sparse and the company headquarters in Dublin is a drab 15,000-square-foot building.

Operating and Financial Performance

For the half-year ended September 30, 2011, total operating expenses increased 26% to €2.06 billion as a result of increased fuel prices, an increased level of activity, and costs associated with the growth of the airline. Fuel remains the main cost (€907.0 million or 44%), but airport and handling charges are also significant (€316.3 million or 15%), as well as route charges (€271.5 million or 13%) and staff costs (€222.5 million or 11%). Fuel costs increased by 37%, while route charges increased by 22% and airport and handling charges increased by 18%. Ryanair aggressively tries to hold costs in check through fuel hedging and negotiation with airports over their charges. Adjusted profit after taxes increased 20% to €543.5 million compared with €451.9 million in the previous half-year. The increase was primarily due to increases in fares and strong ancillary revenues of €486.5 million, an increase of 15% over the previous year.

Government Regulation

Ryanair owes much of its success to the liberalization of air transportation in Europe, starting first with air transportation between Ireland and the UK. In 1992, the Council of Ministers of the EU adopted measures to liberalize air transportation. EU carriers were allowed to set fares provided they created access to routes throughout the EU. A licensing procedure was also established. Beginning in April 1997, EU carriers have generally been able to provide service on domestic routes within any EU member state outside the home country in which the airline is based. Ryanair is subject to both Irish and EU regulation.

The Irish Department of Transportation (DOT) is responsible for implementation of EU and Irish legislation and international standards relating to air transportation. Of importance to Ryanair, in 2005, the DOT enacted legislation in response to EU legislation requiring compensation and assistance to passengers in the event of denied boarding, flight cancellation, and long delays (EU 261).

Ryanair views the EU 261 regulations as “unfair and discriminatory” because they require airlines to pay compensation to passengers as well as cover other costs in circumstances beyond the control of the airline such as air traffic control strikes or failure by airports to clear snow from runways. Ryanair argues that compensation in such circumstances be limited to the ticket price paid as is required for train, coach, and ferry operations. (The regulation itself states that airlines are not responsible for passenger compensation for events beyond the airline’s control.) In the case of denied boarding, cancellation, or a long delay (which is deemed the same as a cancellation), short-haul airlines such as Ryanair would be required to pay €250 per passenger (for inconvenience to that passenger). Airlines are also required to reroute or refund the ticket and may be required to provide meals, accommodation, and other amenities to passengers.

Questionable Practices

Ryanair has been accused of a number of questionable practices, particularly the use of controversial or misleading advertisements. Several complaints have been filed against Ryanair with the Advertising Standards Authority (ASA), the UK’s independent regulator of advertising. BBC News reported that, in 2008, Ryanair faced an ASA probe asserting that it made exaggerated claims about the availability of flights at advertised prices that did not include taxes and fees. Even Ryanair acknowledges its controversial advertisements by a statement on its website that it engages in “punchy advertising that sometimes gets us in trouble.” In 2011, the ASA criticized a Ryanair advertisement featuring a bikini-clad woman promoting trips to a “place in the sun.” The ASA argued that some of these places had as little as three hours of sunshine per day. Many of these advertisements appear to violate Ryan-air’s own policy against “misrepresentation of the facts” (part of the airline’s published ethics code).

Industry and Competition

The European airline industry is highly competitive with a number of low-fare (e.g., EasyJet, Air Berlin, and Germanwings, traditional (e.g., British Airways, Lufthansa, and Air France, and charter airlines (e.g., Monarch Airlines and Titan Airways. Charter flights are offered by low-fare as well as traditional airlines, and some charter airlines (e.g., Monarch) offer scheduled services. Airlines compete on fares, time and frequency of services, service quality (e.g., number of on-time departures and arrivals, frequency of lost baggage, and frequency of involuntary denied boardings), amenities such as frequent flyer programs, and reputation. Ryanair believes that state-owned competitors have advantages because of subsidies and other state aid provided to them. In addition, the EU-US Open Skies Agreement that took effect in 2008 allows US carriers to offer services in the intra-EU market that result in increased competition. The increasing consolidation in the industry (for example, the recent acquisition of BMI by International Airlines Group, the parent company of the merged British Airways and Iberia) poses additional threats for Ryanair as these airlines control large percentages of short-haul slots at major airports.

Although Ryanair boasts having the lowest fares, a survey in May 2011 by The Telegraph showed how the cost of a flight on a low-cost carrier can escalate when all fees are added, making prices on a traditional carrier such as British Airways more competitive. The survey was of return flights for a family of four from London to Madrid traveling on the same dates in August with two checked bags, golf clubs, and a cot (baby crib) and paying with a debit card. The base fares were: Ryanair £271.92; easyJet £275.92; and British Airways £476.20. While Ryanair had the lowest fare, the costs went up substantially once all fees were added. To Ryanair’s ticket cost would be added an online check-in fee (£48), luggage fees (£80 plus £80 for golf clubs and £20 for the travel cot), administration fees (£48), and the new delay/ cancellation fee (£16) for a total cost of £563.92, the highest of the three carriers. While this survey represents a snapshot of a particular trip and may not be applicable to all trips, it makes the point that Ryanair is not always the cheapest way to travel; passengers must consider the added fees before making the ticket purchase. To the extent that passengers become more familiar with the complex Ryanair fee structure, Ryanair may be placed at a disadvantage compared to low-fare and traditional airlines as illustrated in this survey.

Airlines also face competition from substitutes such as high-speed rail systems and sea transportation (which in Ryanair’s case would be more relevant to travel between the UK, Ireland, and continental Europe, as well as travel to Morocco). Finally, the industry faces cost pressure from monopoly suppliers such as airports and air traffic control services as well as revenue pressures from buyers with low switching costs.

Future Risks and a Bold Idea

Ryanair’s recent financial performance shows growth, profitability, and strong returns to shareholders. CEO O’Leary attributes this success to the company’s strategy. But the company also faces risks of cost increases from suppliers (primarily fuel) and regulatory agencies that may impose additional costs associated with environmental, safety, and security measures. Fuel prices are expected to rise in 2012. Increasing legislation, in particular EU 261, could have continuing adverse effects on Ryanair. One new piece of legislation that took effect in January 2012 is the European Union’s emissions trading scheme. Under this requirement, airlines must pay for the carbon dioxide they emit. Estimates are that airlines are likely to pay about €1.4 billion for carbon permits in 2012, rising to €7 billion by 2020. A certain number of permits will be issued free to each airline, but they will have to buy permits on the open market for emission beyond the allowed amount.

Could other airlines successfully imitate Ryanair’s strategy much as it imitated Southwest’s strategy? Should Ryanair raise the competitive stakes? One bold strategic idea is to offer free flights in perpetuity (the airline already has some free flights) given Ryanair’s remarkable success with ancillary revenues. Ken Fisher, founder of Fisher Investments (and a Ryanair shareholder), told CNBC in an interview, “You get on the plane; they sell you stuff; the stuff they sell you is what pays for you going.” Is this idea a realistic possibility? The most recent financial data show that while ancillary revenues had record growth in the previous six months, they make up only 18% of total operating revenues. Ryanair would have to generate significantly large increases in revenues to cover its expenses and generate a profit, especially given the cost increases cited earlier.

Sources:

(1) Airlines to spend estimated €1.4bn on carbon permits in 2012, The Guardian, January 3, 2012;

(2) Ancillary charges account for 20% of Ryanair income, Belfast Telegraph, September 11, 2012;

(3) Annual Report, Ryanair Holdings PLC, (Form 20F filed with US Securities and Exchange Commission), July 20, 2010;

(4) Careers: Working for Ryanair, Ryanair website, 2011;

(5) S. P. Chan, Monarch to compete with Ryanair and easyJet as it steers away from package holidays, The Telegraph, June 1, 2011;

(6) Child free flights from October 2011, Ryanair News, April 1, 2011 (website);

(7) easyJet and Ryanair top complaints league, guardian.co.uk, 12 March, 2010;

(8) N. Emerson, Ryanair challenges Spanish court over boarding passes, BBC News, 21 January, 2011;

(9) N. Erlich, Bullish on Ryanair’s free flights: Investor, CNBC Stock Blog, 19 April, 2011;

(10) F. Gillette, Ryanair’s O’Leary: The Duke of Discomfort, Bloomberg Businessweek, September 2, 2010;

(11) N. Hennessy, Baggage, credit card charges driving Ryanair’s €663 million ancillary revenue haul, Irish Examiner.com, July 23, 2010;

(12) History of Ryanair, Ryanair website, 2011;

(13) M. Leroux & A. Schaefer, Ryanair fights to reduce passenger luggage, The Times, February 25, 2009;

(14) S. Lyall, No apologies from the boss of a no-frills airline, The New York Times, August 1, 2009;

(15) R. Massey, Cross your legs and prepare for takeoff: Ryanair reveals plan to have just one toilet on each plane to make room for more seats, Mail Online, 13 October, 2011;

(16) M. Maier, A radical fix for airlines: Make flying free, CNNMoney, March 31, 2006;

(17) D. Milmo, Ryanair to charge for seat reservations, guardian.co.uk, April 19, 2011;

(18) Ryanair faces probe over adverts, BBC News, September 4, 2008;

(19) Ryanair flies plane through Icelandic volcano ash cloud, The Telegraph, May 24, 2011;

(20) Ryanair half year profits rise 20% to €544m, traffic grows 12%, full year guidance raised 10% to €440m, half year results 2012, Ryanair website;

(21) Ryanair No 1 customer service stats—December 2011, Ryanair News, January 18, 2012 (website);

(22) Ryanair’s bikini advert banned by ASA, BBC News, 27 April, 2011;

(23) Ryanair’s Michael O’Leary: Outrageous success story, Travel Sentry, August 2, 2009;

(24) Ryanair to allow passengers to ‘smoke’ on board, Ryanair News, September 20, 2009 (website);

(25) Ryanair will comply with unfair EU 261 regulations, Ryanair News, April 22, 2010 (website).

1 © Charles M. Byles. Reprinted with permission. As of February 2012, the exchange rates were approximately €1 = £0.83 = US$1.32.

 

Specific questions: From an industry-based view, assess the strength of the five forces and determine the extent to which Ryanair is positioned against those forces. From a resource-based view, what explains Ryanair’s success? From an institution-based view, assess the opportunities and threats presented by the current and future institutional environment (both formal and informal). How should Ryanair respond? What is your evaluation of the proposal that Ryanair offer free flights in perpetuity? Draw on the three views in your answer. ON ETHICS: Evaluate Ryanair’s ethical (or unethical) behavior, especially in light of the questionable practices discussed in the case. What changes, if any, would you recommend to CEO Michael O’Leary?

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