Ryanair Holdings (NASDAQ: RYAAY), the low-cost Irish air carrier known for its broad array of ancillary revenue, discovered in 2013 that seeing your brand through your own Instagram filters rather than through your customers' travel-smudged reading glasses can be dangerous. Ryanair issued two profit warnings within two months this fall after projecting that average fares would decrease by 9% for the remaining months of its fiscal year, ending in March 2014.
The profit warnings come as emerging low-cost rival easyJet (NASDAQOTH: ESYJY) increased its own earnings by 51% during the 12 months ended Sept. 30, 2013. EasyJet has apparently benefited from dissatisfaction with Ryanair's often aggressive relationship with its own customers. While Ryanair is an acknowledged pioneer of no-frills air travel in Europe, it has had to scramble to adapt its revenue model as of late.
Where Ryanair went wrong in 2013
During the last four fiscal years, Ryanair enjoyed a trend of rising revenues and profits; current-year profit will be the first decline in five years. The company erred in seeming to believe that a core group of passengers who valued a cheap fare above all other criteria would continue to fuel the airline's growth, regardless of the pre-flight and in-flight aggravations thrown at them. Excessive baggage fees and a plethora of in-flight advertising are two notable examples of widely bemoaned customer irritants.
That core group of passengers may exist, but it's smaller than Ryanair realized. In a particularly bad moment, the airline's customer satisfaction scores ranked dead last among British brands, 100th out of 100, in a fall survey by Which?, Britain's largest consumer body. Ryanair's current brand perception is so dismal that it has managed to do the improbable, and inadvertently position a low-cost rival as an aspirational brand. EasyJet notably attempts to compete on fares with Ryanair, while offering customer service closer to that found on larger carriers. The inference is that EasyJet was able to peel off the true outer layer of Ryanair's core customers: those who value an inexpensive fare, but have enough leeway in their budget to upgrade to another low-cost carrier.
It's ironic that Ryanair would forecast a decline in earnings from having to lower fares to meet stiff competition in its EU routes. Ryanair's business model is predicated on a low base fare sweetened by online ticketing add-ons, boarding and baggage fees, and in-flight sales of food, beverages, and merchandise. The airline's base fares are typically quite competitive to begin with. It's undoubtedly troubling to Ryanair's management to have to incentivize customers back into its fold who are opting for higher fares within striking distance of its own, offered by carriers such as easyJet or Ireland's Aer Lingus.
The company has moved to address a number of fronts on which it lost to easyJet in 2013. It is trimming its baggage fee by 50%, upgrading its notoriously laborious website, and introducing "quiet flights" on some evening routes.
Ryanair's experience, while humbling, is most likely a short-term issue. But it serves as a cautionary tale for companies seeking to cater to the thrifty in the global economy. There are three major conclusions we can draw from the airline's experience.
1. Though the global recovery is fragile, some consumers indeed have more purchasing power than before. Companies that have catered only on price for the last five years will feel the pinch as things pick up. In the U.S. and indeed in plenty of other countries, it's true that a segment of the population has never regained its footing in the work force, and that segment is both spiritually and financially exhausted. Companies that focused to a fault on strapped consumers, from Ryanair to WalMart, will have to figure out how to draw in those with higher disposable income, while waiting for their base to find a way out of financial hardship.
2. As confidence rises, boomers may outspend millennials in the near term. Positioning your brand as the lowest-cost option can backfire when consumers enjoy rising paychecks, but it also can hurt when those who suffered no change in standard of living become confident enough to resume their old spending habits. This group will likely manifest itself as graying baby boomers. EasyJet's rise in 2013 was fueled partly by its decision to introduce allocated seating, which pulled in older customers who were attracted to the low base fare, but were willing to pay additional fees to reserve seats and thus avoid the general boarding scramble.
3. Customer motivations are changing in real time, so be pragmatic. While the sudden profit declines at Ryanair undoubtedly took its management team by surprise, retailers can learn from the company's quick and unflinching reaction to adversity. Chief executive Michael O'Leary, whose publicly abrasive persona seemed a top-down endorsement of the company's overall indifferent customer service culture, has decided to reduce public appearances for the time being; the airline will appoint a new sales and marketing director to serve as the company's new public spokesperson. More significantly, Ryanair is rolling out its own allocated seating to minimize easyJet's chief differentiation advantage. Finally, observe how the company rapidly instituted lower fares to stabilize any further losses. December numbers just in reveal that the price cuts achieved this goal: Passenger traffic increased 4% last month versus December 2012, for a record number of passengers at 81.4 million.
Ryanair enjoys a competitive cost structure, and its projected fiscal 2014 profit, even at a reduced number of approximately $690 million, is quite healthy. The airline will remain financially sound, but to grow net profit margin again, it will have to promote tangible results from improved customer service initiatives. While this is uncharted territory for the once tiny, scrappy carrier, it's time to grow up: easyJet's success has proven that a low fare doesn't have to equate to a grumpy customer.
Fool contributor Asit Sharma has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.