Low cost carriers’ competitive advantage challenged by fuel costs

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Jul. 23 2014, Updated 12:00 p.m. ET

Low cost carriers’ competitive advantage is challenged

In the table below, both low cost carriers (or LCCs), Southwest (LUV) and Jet Blue (JBLU), have lower cost per available seat miles (or CASM) of 12.6 cents and 11.71 cents, respectively, compared to its legacy peers Delta (DAL), United (UAL), and American (AAL) whose CASM are higher by 17%–28%. The low-cost structure acting as a competitive advantage has enabled LCCs to out-perform its legacy peers in profitability despite having lower yields and lower revenue per available seat miles. Operating profit margin of Southwest, at 7.2%, and Jet Blue, at 7.9%, are higher compared to United, at 3.3%, and American, at 5.2%, but lower than Delta’s, at 9%.

Adverse effects of rising fuel prices

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Low cost carriers are able to keep their CASM lower despite a relatively higher percentage of fuel cost. Although Southwest’s fuel consumption per ASM is lowest reflecting its efficiency, it has the highest average fuel price per gallon of $3.16 which has increased its fuel cost to 35% of total operating expenses. The cost is higher than Delta’s and United’s.

Like all companies in the airline industry, Southwest has been constantly challenged by higher fuel prices. In the past decade the average price per gallon has increased almost 4x from $0.80 to $3.16 per gallon increasing the fuel cost more than 6x from $920 million to $ 5,763 million in 2013 and the percentage of fuel cost to total operating expenses from 16.5% to 35%.

 

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