Update: Ryan Air recently changed their baggage policy to no longer allow carry-on items for the overhead bin without paying a surcharge. They no longer collect carry-on items at the gate. They are, however, significantly reducing the cost for checked bags.

In the last decade, Europe has seen an explosion in low-cost airlines. Ryan Air, Wizz Air, and Easyjet are some of the major players in this market, but there are many more smaller regional competitors. There are two reasons for this proliferation: airline deregulation and a new business model.

Because much of Europe is within one common market, airlines are now able to offer service between countries outside their home country. International aviation agreements require that airline companies can only fly domestically within their home country or from their home base to an international destination. So for example prior to this liberalization movement, British Airways could offer flights from London to Manchester or from London to Berlin, but not from Paris to Berlin. The only exception is for stopover flights. For example British Airways could fly to Dubai and then on wards to Sydney technically offering a service between Dubai and Sydney which would normally be illegal but isn’t because it is just a stopover.

Airline deregulation allowed aviation companies within Europe to offer services from any city within the common market as if it were their home country. That’s why Ryan Air, which is based in Ireland, can offer flights from Italy to Romania. This ability to offer more services to more destinations greatly increased competition within the aviation industry and brought down prices.

But deregulation isn’t the only reason prices have become so low. After all, Lufthansa still offers flights between Frankfurt and Rome and they’re much more expensive than the Ryan Air flight. The reason Ryan Air has been able to cut prices is because of their unique business model that focuses on turnover and efficiency over luxury and experience.

DuPont Identity

This business model can be analyzed by looking at the classic corporate finance concept called the DuPont Identity. This important analytical tool was thought up by the DuPont Corporation in the early 20th century to better understand how a firm creates value. The identity essentially says that the value of a firm or the return on equity (ROE) can be broken down into three components:

1. Operating efficiency, which is measured by profit margin; 2. Asset use efficiency, which is measured by total asset turnover; 3. Financial leverage, which is measured by the equity multiplier.

Operating efficiency refers to the firms profit margin. The easiest way to make more money is to raise the prices. As long as a market is relatively inelastic at a certain price point, raising the prices while losing some customers will generate more revenue than it would lose from lost customers.

Asset use efficiency refers to a firms overall sales. Rather than raising the prices, a firm could get more efficient by cutting costs or growing their business to increase profits through scale.

Lastly financial leverage refers to a firm’s debt ratio. As anyone who has taken corporate finance knows, increasing leverage (up to a certain point) can increase the overall return on equity and value of a firm as corporate debt has lower rates interest and those interest payments create tax shields for the company.

Looking at this identity, it is clear that there are two different airline business models operating in Europe. On the one hand, airlines like British Airways charge higher prices but offer more luxurious service. They often let customers check free bags, provide meals, let the seats recline etc. This is a premium that many customers are willing to pay and thus help British Airways to turn a profit.

On the other hand, Ryan Air has gone the opposite direction. They try to offer the lowest price possible making up the difference through extreme efficiency and increased sales. Ryan Air does this in a number of ways. For example, Ryan Air uses just one aircraft model. This means they only need to train their mechanics for one type of plane, and they only need to keep spare parts for one aircraft. This greatly reduces costs and improves efficiency.

Another important part of Ryan Air’s business is keeping their planes operating as many hours as possible. Aircraft are extremely expensive and they are a huge investment for any airline company. An airplane in the air is making money while an airplane on the ground sits idle. This is why airline companies try to make as much use as possible of their aircraft assets.

Almost all standard airline companies offer connecting flights to get their passengers around the world. This helps increase the overall number of destinations they can fly because they don’t need to offer flights between obscure destinations with little passenger interest. For example, few airline companies offer service between New Mexico and Asia as there just isn’t much interest for Asian customers to fly to New Mexico or vice versa. But there are some New Mexicans that have business in Asia so how can an airline like United offer this service? They use connections. Many people in New Mexico are interested in traveling to San Francisco on a daily basis and many Asian customers want to come to San Francisco. So when a New Mexican want’s to go to Beijing, for example, they can fly to California then on wards to China on a connecting flight.

But in order for these airline companies to be successful they need to set up a system where flights only leave once passengers have had ample time to connect. This often means that airlines use a strategy called “flight banking”. This means that flights often leave in two-hour increments. During a two hour period multiple flights arrive to a hub airport, passengers connect to their new flights, and then all flights leave again. While this is an efficient way for this hub and spoke airline model, it often means flights sit idle for several hours a day waiting for new passengers. Every time a plane sits on the ground, airlines aren’t making money on the asset not to mention the cost of the staff that must wait around for the incoming passengers. This is certainly one of the reasons why an airline like United or Lufthansa costs significantly more than Ryan Air.

Ryan Air, on the contrary, does not offer connecting flights. They are a point to point carrier. If you want to buy a connecting flight with Ryan Air, it will be sold as two separate tickets and they plan none of their flights around guaranteeing good connection times. Ryan Air’s sole concern is keeping the plane in the air as much as possible. A typical daily flight plan for a Ryan Air aircraft might see itself bouncing around between multiple countries, dropping off passengers then quickly refueling to get back in the air with a new set of customers. At the end of the day, their final flight brings them back to their home destination so they don’t have to pay for accommodation for the crew. This keeps prices low and increases Ryan Air’s overall efficiency which is why they have been able to be a profitable company despite selling flights for sometimes just 10 or 15 euros.

Ryan Air in Practice

Ryan Air has come up with some pretty clever solutions to increase aircraft efficiency. In 2018, they changed their policies to no longer allow large carry-on baggage onto their airplane without paying a fee. Customers are still allowed to bring carry-on baggage, but anything that does not fit underneath the seat must be checked at the gate. Update: Ryan Air recently changed their policy to no longer allow carry-on bags at all unless passengers pay a fee.

This change greatly increases boarding and unloading efficiency while creating a new premium option for certain customers to generate a bit of extra revenue. This policy has now become the standard across budget aircraft carriers in Europe since it shifts the wait time for passengers trying to get their bags off the airplane to the baggage claim area. This means Ryan Air can free up their plane to keep flying and thus keep earning money.

But while all of these business concepts seem to make a lot of sense, the reality is that many budget airline companies tends to not always follow through with these great ideas. For example, a Wizz Air flight from London to Luton was ridiculed by the Telegraph for never once leaving on time. They said over a nearly one-year period Wizz Air “Flight W62206 to Budapest has been delayed by anything from two minutes, to 12 hours and 18 minutes.” According to the flight records, the plane literally never once left on time. To be fair EU rules, “define all flights departing within 15 mins of the scheduled departure time, as on time” which brings Wizz Air’s on time average up to 70%, but short delays add up overtime in a business with thin margins like Wizz Air.

Anecdotally from my experience flying, I have never once seen a Ryan Air flight leave on time, and I’ve been all over Europe from Spain to Moldova. It’s actually almost become a joke to me. Ryan Air lists a boarding time and a final call time on every ticket, but only an idiot would show up at the gate at the boarding time. Better to come at the final call time. You will still wait in a long line as the gate usually doesn’t close until 20 minutes after this “final call”. To think for a company that relies so much on efficient airplanes and on time arrivals, they should be hammering their staff to get it right.

To be fair, not all delays are caused by the airline company. Often ground control can hold flights up because of inefficient use of the run way, but it’s hard to believe that the control towers in just about every airport in Europe are that inefficient. Eventually Ryan Air must take some of the blame. With each flight consistently 20-30 minutes late, those hours really add up and could be the difference between an extra flight each day when all is said and done. That’s a huge revenue loss for Ryan Air. If boarding takes longer, they really should start the process earlier or work to speed up the ticket check-in process. Without carry on luggage, getting onto the plane is now the easiest part, but there always seems to be hold ups with either starting the check-in process late or employing just one person to scan the tickets. This is a huge opportunity Ryan Air is missing out on, and they should do more to increase their efficiency thus gaining from the DuPont identity. While my evidence is just anecdotal, with all the flights I have been on this year, it really seems to be a problem worth addressing.

Ryan Air’s latest baggage policy as of August 2018 no longer allows carry-on baggage unless customers pay an additional fee. This change may speed up boarding procedures and reduce delays. Ryan Air found that their previous baggage policy did not actually deter customers from bringing carry-on bags. Because everyone still had to check their bag at the gate, the boarding speed barely improved. They are now charging passengers to bring on a carry-on and getting rid of the checked carry-on at the gate procedures. They are however lowering the cost of checked bags from the ridiculous 25 euro amount to something closer to 8 to 10 euros. They’re doing this by selling tiered checked bag options. Bags under 25 kg will still pay the full price, but now bags under 10 kg will be charged a separate price. Splitting this up provides a couple different price points for passengers and may actually increase revenues by being able to price to customers based on their price sensitivities. This may encourage passengers to check bags at the initial check-in counters in order to speed up boarding time and increase Ryan Air’s operational efficiency.