Nova School of Business and Economics 2012/2013 DOGFIGHT OVER EUROPE: RYANAIR Case Study This set of questions refers to Version (A): 1. Which kind of customers was Ryanair trying to attract when, in 1999, Michael O’Leary took charge of the firm? Those with a low price elasticity of demand or those with a high price elasticity of demand? Explain.
Considering that we are talking about the same product, in an industry with many firms, where producers and consumers know all quoted prices and where the consumers can identify the product as homogeneous, it is fair to say that we are talking about a scenario close to perfect competition, thus demand for the product is very elastic. So, Ryanair is trying to attract high price elasticity customers.
Accordingly to the article: Ryanair marketed itself as “the low fares airline”; before open new routes, the company cared about low landing fees, low turnaround costs in order to be able to charge low fares to customers; it made agreements with secondary airports, where they did not pays fees (in fact those airports paid to Ryanair to use their locales); it tried that 70% of the available seats in the two lowest fare categories; it made fewer restrictions on its tickets (important for who had extra bags, or who wants to change the flights in order to pay less); it observe competitors, so it would be able to apply a lower fare; its customers were a mix of leisure travelers (70-75%) and business travelers, mostly from small and mid-sized businesses (25-30%). ifferences in airfares could persuade some leisure travelers to visit one destination rather than another; it has chosen the cost leadership so it seeks to be the lowest cost producer in Europe by selling standardized, mass products and Ryanair’s profit maximization was through lower fares in order to attract more customers contrarily to competitors where they maximize their profits through find opportunities to increase fares without losing customers. So accordingly to the customers with a high PED (price elasticity demand) following the formula (Q/P) x (P/Q): a little negative variation in prices (decrease in fares), will originate a big positive variation in the amount sold. 2. Why was cost cutting so essential for the strategy chosen? First of all it is important to refer that in 1991, Ryanair was facing a bankruptcy.
In response, ‘the company removed all frills from its service, cut its costs to the bone, and dropped its fares to levels unheard of in Europe’. It became priority, to connect all the efforts to preserve and generate cash. Company’s main concern was charge lower fares in order to attract high elasticity price demand customers, with this new strategy, the company became low-cost or low-fare airlines and to maintain it within these measures the firm needed to adapt its strategy to new restrictions, which means, cost cutting. The flag airline faced a really competitive market (in 1999), and to keep competitive the firm had to keep its strategy, and for that was necessary cost cutting. Cost cutting, if it is efficiently done, brings more profits.
Besides, using the model used in classes, “Bertrand – Asymmetric Model” where it says that if certain firm charges ‘P1’ for its product, and other firm charges ‘P1-e’ (because it is able to reduce its marginal cost), so the second firm will get all the demand. Well, Ryanair did not get all the demand, but is observable in ‘Exhibit 4’ that the company carried approximately 60% (353/575) and 56% (180/321) of the passengers on the route ‘Dublin-Manchester’ and the route ‘Dublin-Glasgow’ respectively. 3. Ryanair uses a performance-based pay scheme to compensate its flight attendants. Why? A performance-based payment scheme combines the interests of both flight attendants and the company. This happens because obviously, the flag airline will gain more if the attendants are working efficiently (making an effort to sell the snacks, drinks, or whatever they have on board; being nice with the passengers, and help them as much they can), then if they are lazy during work. If a salesperson receives a fixed wage, no matter how much it sells, then he or she will not have any incentive to sell more than the expected. But, of course, if they receive an extra commission for each sale, then the salesperson will do the effort that it maximizes its utility. By having a higher effort, the workers have a higher payoff which maximizes its utility.
A sector payment or an in-flight sales commission allowed flight attendants to earn 10% more than those from competitors and allowed the firm to fly to 50% more sectors than its rivals. Consequently, a higher number of flights increase the profits of Ryanair. The company’s rapid growth permitted job mobility, for instance, a flight attendant could take a job at the yield operations management on the headquarters; job mobility was a solution for the company to avoid coordination problems. 4. Why wasn’t this performance scheme also offered to maintenance personnel? The majority of European airlines pay their employees based on the length of their tenure with the company. However, Ryanair only applied this to their maintenance and engineering personnel.
As a company obsessed with cash, the most important part of the business was the operational part, the one which actually gave money to the company: flights and duty-free revenues. So, this was the only personnel where it was justifiable to apply a performance-based pay scheme. Engineering and maintenance were paid based on their formal qualifications: more qualified personnel would do the job more accurately. Maintenance personnel only represented 9,34% of the total employees as of March 31, 1999. Besides the company concerns about security: let’s say that if they receive a fee for each plane that is ‘fixed’, they will want to fix the maximum planes, as fast as possible, and that may not be the best for the passenger’s security.
It’s more important to seek personal with higher qualification, and pay them a reasonable (but fixed) salary, because this is kind of business where mistakes cannot happen, and so, the personnel has to be focus in its work, and not in the ‘extra money’. 5. Can you suggest means of rewarding maintenance personnel that would induce high productivity without hindering Ryanair’s strategy? Ryanair’s strategy is keep low fares so it will be able to keep “fiercely competitive” and “ferociously cost conscious”, which implies, minimize costs (everywhere where it is possible), so increase their salaries would hurt the company’s strategy. Given this, it would be a good idea to search for some ‘non-monetary’ alternatives.
First of all give them some lectures about how important is to do a good maintenance of the aircraft, aware them that a single mistake can be fatal for hundreds of people (unless they are murderers or mentally sick people they will get alert! ). They can make promises to them in the long-run like if there are no mistakes, Ryanair’s credibility increases, and that will attract more passengers, which means more revenues, which means they can increase wages (and keep the same profit). Monitoring them is a good way of keep the high productivity, this measure leads to an increase in veracity of the employee’s reports, in other words, if an employee knows that he or she is being watched, then it will for sure do a better job.
The creation of bureaucracy that implies the creation of rules in order to limit the employee’s actions, these rules can be benefit for the maintenance workers, for example, the creation of a rule that says it is mandatory to do a 15 minutes break, every two hours. 6. What are the likely consequences for Ryanair of a steep decrease in the price of jet fuel brought about by a significant decline in the price of oil? Consider both the direct and the strategic effect. All the airline companies are strategic complements, which mean that if one firm takes one action, the others will respond with aggressively actions (upward sloping). And they exhibit tough commitment, in other words, is a commitment that is going to have an adverse effect on the competitors.
In Bertrand (this case), the company makes a tough commitment, no matter how much its rival changes the price, the firm’s price will be lower than it would have been if there were no commitment. The companies make tough commitment to avoid that new entrants increase the price competition. Given this, we built the following graph: The red line stands for direct effect and the blue line stands for substitution effect. The direct effect is the commitment’s impact on the present value of the firm’s profits, assuming that the competitors’ behavior does not change. Applying to the case is basically the profits that all the others airline companies would earn if Ryanair would not decrease its prices as well (point 1 to point 2).
The substitution effect takes into account the competitive side effects of the commitment, this means, how much does the tactical decisions of the rivals change, under the commitment conditions. Basically is the adjustment made by Ryanair after the competitors decrease their prices (point 2 to point 3). Decline in the price of oil, brings a decrease in the price of jet fuel. With this shock, all the airline companies will decrease their prices, P1*’. As it was said before, Ryanair always observes its competitors, and then make its move, so they will decrease their tickets’ prices even more, P2*’(one of the principals of tough commitment). As it says in exhibit 2, ‘fuel ; oil’ constitutes approximately 16% of its costs (6. 0/37. ), so despite it is not visible on the graph (due to lack of data related to prices), the prices of the flight’s tickets will decrease considerable, because (repeat) this is a really competitive market, and the airline companies find themselves in a tough commitment, that it will originate a decline even bigger that the one it would happen without though commitment. It is important to refer that the company’s product has a low-level of horizontal differentiation because the difference between the products of each one of the companies is based on the quality in the in-flight zone. And there are tons of people who simply do not care about that.
For those ones, their only concern is to get to their destination. 7. What are the most serious threats that Ryanair faces? Explain your perspective. Europe Union’s measure “Under the package, carriers were given full freedom to set fares. Any company was allowed to start an airline provided that it had majority European ownership, adequate financial backing, and the ability to meet safety requirements. The package permitted any European airline to fly any route between two EU countries and, starting in 1997, any intra-country route between two European cities. ” This measure means no patents’ system, which means that as long as there is positive profit, other companies will enter in the market.
Without proper cautions this may lead to perfect competition, where the companies will lower their prices until it equals the marginal cost, which implies that the profit will be zero. Even worse than that is if Ryanair adheres to a new technology (in order to decrease its marginal cost), and if we are in a situation where the other companies can copy and use the technology discovered by Ryanair, the company will have negative profits. Contrarily if the competitors are able to decrease its marginal cost, and the antitrust agencies that may lead to monopoly (if there is a patented system that says that is illegal to copy and use technology of others firms). Possible merges by competitors, which would increase their market share. For example, in 2002, easyJet purchased Go for ? 374m.
Ryanair may face laws taken by the antitrust agencies that may limit its actions, for example the use of ‘dumping’ strategy (‘monopolistic strategy’ where the firm sells its products below their production cost in order to eliminate competition, and when it occurs, the firm increase its prices again). Ryanair has faced aggressive marketing campaigns and charity efforts by Virgin Express, subcontracts and reliability on third parties (lower costs), total direct selling and a very informal environment by easyJet, predatory pricing by British Airways’ Go and in-flight entertainment and comfort by Debonair. The last one went bankrupt but all the others provide serious competition to Ryanair despite not achieving the profitable results desired.