As stranded passengers scrambled to get home last week, airline industry watchers wanted to know if the end of WOW Air, the Icelandic budget carrier, was a sign of a bigger story. Does WOW’s shuttering mean that the long-haul, low-cost airline model is dead? The answer is, not necessarily. But the airline’s swift disappearance from the market does provide some clues.
After decades of success with a simplified business model and high-density aircraft configurations, Low Cost Carriers (LCCs) have defined the future for most short-haul markets. In almost every country or region where airline markets have been liberalized, the LCC model has grown to account for at least one third, and up to two thirds, of all airline seats operated. Meanwhile, remaining network carriers have embraced many tenets of the LCC church, including basic fares for dense-pack economy seating and á-la-carte options for most anything more.
WOW was one of several recent experiments to test whether the Low-Cost-Carrier concept could succeed equally in long-distance markets. Industry wisdom for many years was that it couldn’t work for long-haul. But those were views formed in the years when only very large aircraft could make long trips, and when the smaller aircraft that could go the distance incurred substantially higher costs per seat. It was also before development of ancillary revenue programs, which now can generate over $50 per passenger above the base fare.
Given new technology aircraft and internet-based sales techniques, a number of startups have experimented with long-haul, low-cost models in recent years. And a number have struggled. Primera shut its doors last October. Norwegian, the largest of the bunch, announced a month ago that it had lost almost $300 million in the previous quarter – immediately after announcing an investment of a similar amount. So the collapse of WOW could reasonably be viewed as a sign of the end. That conclusion would be misreading the lessons of WOW.
Each of the long-haul, low-cost startups has its own particularities, and some of the specifics of WOW’s business model made it more vulnerable than others. More than anything, the decision to hub the entire airline in Reykjavik was a risk. Iceland itself, despite its engaging mud baths and awesome volcanoes, was never the destination, even if the sudden abundance of cheap flights did boost tourism.
Instead, WOW was using Iceland as convenient connecting point to participate in the crowded transatlantic market. Icelandair has shown for decades that such a concept can work, at the right size and with the right economics. But the math was harder for a new entrant on a growth tear.
The transatlantic market is notoriously unforgiving. Since the dawn of deregulation, at least half a dozen airline failures have dumped money into the Atlantic, starting with Laker Airways’ SkyTrain in the 1970s and the boom-and-bust PeoplExpress in the ‘80s. America-to-Europe is a highly seasonal market. Travel between North America and Europe more than doubles in the summer compared to the winter. Many airlines move aircraft out of transatlantic service in the off-season, or selectively sell to passengers making onward connections. WOW did not have that option.
Most surviving transatlantic carriers have demonstrated a few success factors, none of which WOW enjoyed. The first is access to the lucrative corporate market. This includes not only business class tickets, but also large corporate contracts that deliver high-priced economy class tickets year-round, often purchased by loyal travelers on short notice. In the airline industry, it is the largest airlines and their alliances that win corporate deals — not the purple start-ups with a handful of routes.
Missing the lucrative corporate traffic, startups need to find another way to deliver similar revenue per flight. After all, even with lower-cost labor, there is nothing low-cost about aircraft rent, fuel and maintenance, costs which together comprise about 40-45% of a typical transatlantic flight. To make up for the corporate revenue, LCCs rely on selling more seats and on selling add-ons to more passengers. Norwegian, for example, packs on average 70-to-100 more passengers on a 787 than the likes of American, British Airways, or Virgin Atlantic – in part by having more economy class seats and in part by filling more of the seats they have.
WOW clearly recognized this challenge. In its final months, WOW had discussed plans to remove its premium economy seats in a bid to squeeze in more leisure travelers. This decision made it clear that WOW was unable even to win over independent business travelers who are not tied to a company contract. As WOW was considering removing premium economy, other airlines, including American, United, and most recently SWISS, were telling investors they expected to grow revenues by adding new premium economy cabins on long-haul flights.
The large network carriers are able to balance the seasonality of the transatlantic market by shifting aircraft onto other routes during the winter. Delta, for example, moves roughly 50 aircraft to European routes in the summer that can be used at other times of the year for the Caribbean and other sun destinations. British Airways, Air France and Lufthansa all add flights and up-gauge. Even larger LCCs, like Norwegian, WestJet and perhaps soon, JetBlue, have some options to balance seasonality by shifting aircraft onto other routes during the winter. By contrast, WOW had 100% of its fleet in the Atlantic, all year long.
WOW’s other challenge was endemic to its geography. Unlike Norwegian and the legacy airlines, WOW did not offer any direct flights. Every ticket WOW sold between Europe and North America required a stopover. As enticing as duty-free smoked salmon and Nordic sweaters may be, passengers are clear that they expect a discount for the inconvenience of a stopover when direct flights are available. In ICF’s research, we have found that on average, connecting flights to Europe sell at a discount of 10 to 15% on average compared to direct flights.
With no corporate traffic, business class fares or nonstop routes, WOW struggled to earn enough revenue to cover costs on each flight at the best of times, even with competitive costs. In the long, cold low season, WOW may also have struggled to fill its planes at all, unable to move capacity to other seasonal routes or flex its network into other markets.
What probably did work for WOW was the idea that efficient narrowbody aircraft can profitably serve transatlantic routes. Indeed, new A321s and 737-Max aircraft are perfectly suited for routes between secondary cities across the Atlantic, routes that might not otherwise enjoy nonstop service, such as Providence to Cork or New York Stewart to Bergen. Within their range, these aircraft offer per-seat costs that rival those of many widebodies while reducing the burden to sell enough tickets to fill the plane. In the peak season, they offer an easy way to skim the market without upsetting industry pricing.
It also remains an open question whether low cost airlines, on the right routes, can earn enough revenue in dense-pack economy and premium economy to match the revenue that legacy airlines earn from a smaller number of business class seats in the same footprint. With the right ancillary revenue strategies and product offering, this may yet prove possible.
More likely, the long-haul, low-cost model will survive as an extension of larger networks. One scenario is that lower-cost — but not truly low-cost — carriers like WestJet and JetBlue will successfully extend their networks with long-haul flights that attract business travelers. For example, WestJet has already announced new 787 flights with a competitive business class from its hub in Calgary, and JetBlue has teased of a similar possibility from JFK and Boston.
Closer to the long-haul, low-cost model, larger legacy airlines like British Airways and Air Canada may find that high-density aircraft with a simplified product are a successful means to tap more price sensitive demand segments. For example, British Airways’ Level unit gives the group more flexibility to match its product to price-sensitive demand in specific markets. And Air Canada has aggressively deployed its low-cost Rouge unit to service leisure routes.
Other long-haul LCCs with larger counterbalancing networks, such as Norwegian and Air Asia X, may be able to survive independently. And established LCCs like WestJet and JetBlue will certainly be able to add long-haul flights successfully. But startup airlines without a deep cash cushion or network flexibility will always struggle, all the more so if their schedule is not competitive. WOW lacked all three.
So, the collapse of WOW may tell us something about the viability of the long-haul, low-cost model. Or it may tell us more about the viability of WOW.
Samuel Engel is the global managing director of aviation at ICF.
