Problems Faced By Easyjet

Problems Faced By Easyjet A comment on problems being faced by EasyJet and evaluation of strategies adopted by EasyJet Introduction EasyJet, a British airline company which has been fund in 1995 by Stelios Haji-Ioannou with 2 Boeing airplanes and 2 routs, has now expand to European market with 189 airplanes and more then 400 routes (Suit 101, 2009). Nowadays, EasyJet along with its well known low cost strategy is consisting on capturing larger market share. However, there has generated two main conflicts inside the firm. First, Stelios as the biggest shareholder against managers future growth plan of purchasing more aircrafts. Second, Stelios insist that shareholder of EasyJet should be paid by dividend. In order to examine the current issues of EasyJet, this report will analysis issues relate to EasyJet in aspect of economics and finance. In the economics section, this report will first discuss business objectives of EasyJet while focus on growth as its main objective. After that, the report will look into the separation theory of ownership and control issues and apply it into the discussion of current problems exist between shareholders and managers. Thirdly, this report will describe the market structure of British airline industry and discuss whether the low cost strategy could fit the market. In the finance section, this report will first examine the reflection of strategy adopted by EasyJet on the accounts using ratio analysis and trend inspecting. Then it will move on to a comparison among EasyJet, Jet2 and Ryanair, and explore the investment risk of EasyJet. Finally, this report will make a conclusion as well as recommendations that may probably solve the problems exist in Ea syJet. Part A. Economics A.1 Business Objectives According to Neild and Carysforth (2004, p.47), Business objectives are targets which must be achieved for an aim to be met. Strategies or plans adopted by firms are often based on targets such as profit, sales and growth. A.1.1 Growth Growth as the major objective of EasyJet, it is relatively easy to achieve during recession as well as recovery period. Growth of a company is regarded as expand size and enlarge sales. It is based on the scarification of short-term profit in favor of long-term profit. For example, EasyJet use retained earnings to push fleet growth. As a result, shareholders are not satisfied without dividends. In order to balance interests of both sides, managers have to increase the short profit through enlarge sales. Moreover, as managers are controllers of the company, they are free to choose growth as objective to fulfill their interests such as bonuses and share options based on acquiring a large volume of business (Stokes, 2010, p.477). A.1.1.1 Growth Strategy EasyJet adopts several strategies such as advertising and diversification to stimulate growth and enlarge market. Based on EasyJets dramatic investment programmes such as increase fleet size, EasyJet experienced a high rate growth of revenue even during the recession periods from  £264 million to  £2667 million. It increased nearly 10 times respectively and from 2000 to 2009 (EasyJet, 2009). However, certain growth strategies may result in rising expenditure and reducing price. Increase promotional expenditure While EasyJet already has a total number of 189 airbus A320 and Boeing 737 aircraft in 2010, it is respected to acquire another 59 planes in the next 4 years in favor of adapting increasing number of passengers and various destinations (Flightglobal, 2010). However, in order to get good revenue performance,  £86 million is spent on fuel costs in 2009 which partly lead to a reduction in profit margin (EasyJet, 2009). Decrease price In order to share larger market and promote growth, EasyJet carries out a strategy to make their travel fees as well as cost base lower than other established carriers. Since 1999, EasyJet has been voted as the Best Low Cost Airline by Business traveler Magazine and recognized as the first European carrier that won the award for Best Low Cost Carrier at OAG Airline Industry Awards in 2008 (EasyJet). A.1.2 Other Business Objectives Sales Revenue Maximising Sales revenue maximizing is achieved by increasing products and reducing price. Higher sales could efficiently help to expand and compete for the market. In addition, aim to maximize sale revenue could also benefit managers by enhancing their credibility as well as wages (Jain Khanna, 2009, p.22). EasyJet purchase more airplanes, provide various domestic and international flights and adopts low cost strategy to attract more passengers. According to EasyJet (2009), total revenue per seat has increased 10.9% with total revenue increased 12% from 2008 to 2009. Profit Maximizing Profit is considered as the strongest motivation of the company. Maximizing profit sometimes means maximizing the value of shareholders wealth when net cash flows back to the company in the long run. However, fixed cost may increase in a short term to promote output (Dransfield, 2004, p. 215). In future development, the objective that EasyJet might follow is profit maximizing. Nowadays profit margins are spend on aircraft purchase to meet the needs of passenger and capture larger market share, these will return to positive cash generation beyond the period of higher than normal capital expenditure (EasyJet, 2009). Managerial Utility Maximizing It is known that managerial utility could maximize when there is a higher level of output. The case indicates that EasyJet has ordered more airplanes to serve more passengers and explore new market. By increasing sales and profit, managers could provide enough money to make shareholders happy. Meanwhile, extra money could be used to promote salary, bonuses and many other perks as well as develop discretionary projects (Stoke, 2010, p.470). A.2 Ownership and Control Issues A.2.1 Ownership of EasyJet EasyJet is owned by shareholders who invest money for future dividends and for the potential increased value of their shares. Shareholders have been seen as the monitor of the operation and management of a company. Due to their interests on investment returns, they may indirectly influence company to increase share value or maximize profit (Turner, n.d.). On the other hand, shareholders could sale their stocks to express their dissatisfaction on the operation of the company. However, this conduct may lead to a reduction on share price and increase the risk of take-over bid by raider (Stokes, 2010, p. 478). Stelios Hajiloannous owns 38% stocks of the company, followed by Standard Life, who is the second large shareholder, owns 9.45% stocks (London Night Standard, 2010). Due to the family of Sir Stelios is the biggest shareholder, he could possible exercise an effective influence on the company, and directs the decisions made by directors and managers correspond to shareholders interests. A.2.2 Ownership Issues The biggest shareholder as well as Non-Executive Director, Stelios has been strongly opposed to EasyJets rapid expansion strategy and management strategy. Shareholders are more concern profit maximizing rather than sale revenue maximizing. Stelios claims that the capital cost and profit is no longer balanced and the expenditure for new airlines are from the expense of profit margins. Stelios insists that approximately 190 aircrafts is enough to operation and other excess ones should be sold to conserve cash (Flightglobal, 2010). The fleet growth strategy is not suitable for recession period as there are poor economic returns and market changes. Sometimes non executive director has insufficient influence on the Board. As a result, Stelios tries to persuade other shareholders to reject the growth strategy. However, Stelios failed to gain enough support to exert power on managers. Standard Life, who is the second large shareholder, expressed his satisfaction with management team (London Night Standard, 2010). Shareholders have the right to benefit from the company. According to the case (2010), Stelios argues that the firm is a mature company that the share price do not has the capacity to increase. Thus Stelios claims that shareholders should receive reward from dividend payments instead of the share price of the stocks they hold. Huge capital expenditure should be limited while cash should be conserved. Stelios quitted the Board to against growth strategy. There generates another disputation about the brand license. The Easy brand belongs to Stelios Easy Group and was licensed to EasyJet. However, he now is concerns to reclaim the brand and license to another airline (Daily Mail, 2010). A.2.3 Control by Managers EasyJet is controlled by managers. Although shareholders own the company, they left the operation and governance power to the Boards and management. There are two kinds of executive in the board: non-executive director who purely give advice and executive director who really exert power to make decision. The decision made by executive director and managers should be based on the interests of stakeholders to a certain degree. Thus, managers can be viewed as the agents of shareholders (Stocks, 2010, p. 477). On the other hand, managers have their responsibilities be loyal to the company while exercise judgment to operate the company. Managers should be informed the business environment to make decision that benefits the company. Rewards such as bonus are the motivations of managers. However, it may also be the stimulation of risky policy making (Bevans, 2007, p. 220). It is known that appropriate corporate governance is the guidance to achieve success operation of the company. It requires greater administration managers. However, it is difficult to balance different interests between shareholders and managers, thus lead to several problems (Rees Sheikh, 1995, p.145). A.2.4 Control Issues With the aim of growth, EasyJet sets the goal to maintain a growth of 7.5% and increase its European market share from about 7% to 10%. EasyJet believes that its growth plan on fleet size could contribute to occupy larger short-haul European market (Flightglobal, 2010). EasyJet indicates that they earned a profit of  £ 4 million and performed well in the recession period, the expansion plan is under control instead of taking huge risky (London Evening Standard, 2010). Andy Harrisons chief executive position was taken place by McCall due to the disagreement with Sir Stelios (New Statesman, 2010). Although there is a 5% drop of share price due to the long battle between shareholders and managers, EasyJet claims that overall there was a 34% rise of the share price in 10 years which shown a remarkable potential among European airline carriers as well as a sufficient reward to shareholders (Independent, 2010). A.3 Market Structure A.3.1 Market Structure of British Airline Industry According to Moschandreas (2000, p.10), market structure is the characteristics of the market that could have impact on the mode of competition. Those characteristics include product diversification, barriers of entry the market, number of suppliers and the level of price control. The market structure of British airline industry is oligopoly. Oligopoly is an imperfect market with standardized or differentiated products and a high degree of interdependence which dominated by a few companies (Chauhan, 2009, p.65). A.3.1.1 The Characteristics of Oligopoly Few Sellers: The market is dominated by few companies. Figure 1 shows the market share in the UK main airport London Heathrow. British Airways, BMI and Virgin Atlantic have relative higher market shares than others. Figure 1. Top Airlines market share at London Heathrow. AnnaAero. (2008). [One line] Available from: http://www.anna.aero/2008/12/05/flybe-heading-for-no-1-in-uk-domestic-market/ [Accessed 05th December 2008] Product diversification Many companies in oligopoly market established brands and offer various products (Jain Khanna, 2009, p.115). For example, British Airways with the slogan The worlds Best Airline serves more than 300 destinations by 238 aircrafts (British Airways, 2009); BMI with the slogan Better for Business serves various destinations by 43 aircrafts (BMI, 2010). Entry Barriers There are several barriers that protect incumbents from new firms. First, due to diversification of the products, established companies could consolidate market by branding and promotion. As a result, new firms have to spend more money on advertising and branding to conquer customer loyalty to incumbent companies and attract passengers. Second, financial requirements or vital resource also restrict new entrants, such as difficulty in accessing available landing airports and huge cost of purchasing aircraft (Tucker, 2008, p.178) A.3.1.2 Common Strategies of Oligopoly There are several price strategies or non-price strategies which could be used in oligopoly market. A.3.1.2.1 Price Strategy (Stokes, 2010, p.148) Prestige pricing. If one firm increases the price of the product, it may still attractive to customers. This may because of the promotion of quality and service or conspicuous consumption behavior. Price discrimination. Charging different price in different market could help to increase revenue. There are three degree of price discrimination (Dwivedi, 2008, p.328): First degree discrimination exits when sellers charge the highest price of the product that customer willing to buy. For example, BA offer free drinks and snacks, they could charge a higher price compare to EasyJet, who do not offer free airline catering. Second degree price discrimination exits when sellers charge different prices for the different quantities of purchase or different category of consumers (p.328). Such as first-class and economy class charge differently in airline industry as economy class is frequent required by passengers. Third degree price discrimination occurs when different price are charged refer to different submarket. For example, airline companies may offer discounts according to the time that customers book ticket in advance. Limit pricing. Limit pricing occurs when firms pricing products lower but still can get profit. Such strategy could help to deter competitors or new entrants. Price elasticity of demand. When demand is inelastic, increase price could result in revenue increase. On the other hand, when demand is elastic, decrease price could also result in revenue increase. A.3.1.2.2 Non-Price Strategy Non-Price Strategies in oligopolistic markets could help to increase demand and develop loyalty among consumers (Riley, 2005, p.83) Expanding into new markets Develop new markets could help to enlarge network and strengthen market power as well as increase sales. For example, recently EasyJet has lunched new route from Edinburgh to Dortmund, which is expected to carry more than 55000 passengers during the first year (EasyJet, 2010). Diversification of the product A company could be benefit from the diversity of its product against rivals. The more distinct products they sale, the smaller their rivals could occupy the market (Mukherjee, p.460). For example, EasyJet offer 422 flight routes among 27 countries and 114 airports (EasyJet, 2009). Advertising and Branding Advertising and Branding are essential especially for the new entrant. Advertising could establish brand images to customers. For example, EasyJet use orange as its main colors and permitted ITV operating a reality show named Airline that present EasyJet plane in the air to increasing its popularity (Fastcompany, 2002). EasyJet used to advertise its low price flight and claims that people could fly to Scotland for the price of a pair of jeans (Fastcompany, 2002) A.3.2 Low Cost Carriers Strategy of EasyJet EasyJet adopts a low-cost model to attract passengers and seize larger market share (Dunmore Gleave, 2003) Offer cheap fares: EasyJet sale tickets through internet or phone in order to avoid commissions. By the end of 2005, 98% of tickets were sold online (EasyJet, 2005). Customers could book in advance for cheap seats and transform flight for different time schedule without extra charge. Do not offer airline catering. Uniform airplane types: Airbus A320 and Boeing 737. Have higher aircraft utilisation: EasyJet aircrafts operate 11 hours a day which more than 3 hours than BA. Use high seating density airplane and increase load factors to reduce cost base: By the end of June 2010, the load factor has increased to 87.2%, thus reduces per seat costs by 16% compared to BMI (EasyJet, 2010) Use smaller airports to reduce charges: Such as London Luton and Liverpool A.3.3 Low Cost Strategy in Oligopoly Market In the UK oligopolistic market, as oligopolists are interdependent among others, firms are sensitive to competitors actions. A rational company may try to speculate reactions of competitors using game theory before they adopt various strategies such as price changes. However, even one company reduce its price, it is unlikely lead to a price war or significant profit changes. According to the theory, when companies change prices, their competitors will adjust strategies such as advertising to avoid loss (Stokes, 2010, p.152-156). As a result, low cost strategy which aims to enlarge market by reducing price is not typical in oligopoly market. However, due to the conception of price elasticity of demand, reduce price may lead to the increase of demand. Lower price strategy combined with higher frequencies could attract more business passengers who account for a remarkable proportion of passengers for EasyJet. Although such strategy could make overall cost considerably lower, it still enjoys an average growth of 4.4% while 10.5% in some major routs when fist became a low cost carrier. Apparently the successful low cost airlines are more profitable than established carriers, thus easy to survive in the market (EasyJet, 2009). In the first part, this report has discussed the features of growth strategy and low cost strategy adopted by EasyJet. The next part of the report will examine these features by analysing the financial accounts of EasyJet. Part B. Finance B.1 Strategies reflect on EasyJets Accounts B.1.1 Growth B.1.1.1 A Growth Company From Figure B1, it can be seen that sales revenue has shown a consistently upward trend and nearly doubled from  £1341.4 million to  £2666.8 million during the 5 years. Hence, according to product life cycle, EasyJet still being in the period of introduce to the market instead of maturity. Figure B1* Figure B2 shows a significant increase in trade creditors and debtors. However, it can be seen in Figure B2 that EasyJet could pay suppliers more slowly while receive debtor quicker than before. As a result, working capital as well as financial environment may probably get better, which could benefit for its growth strategies. It can be seen from Figure B3 that the market value per share has increased from 2005 to 2007 before it reduce sharply in 2008. However, it has recovering in 2009 after the recession period. The overall trend shows a growth in shareholders wealth as well as the company itself. P: E ratio is the indicator of investors wishes for long term profit. It reduced from 2005 to 2007 followed by an increase since 2008. The upward trend could reveal a huge potential growth in the future. B 1.1.2 Growth Strategies Increase promotional expenditure Figure B5 illustrates a growth of current assets and current liabilities. Current ratio of EasyJet reflects that the growth rate of current assets is slowly than current liabilities, which could reflect EasyJets fast growth of borrowings for increase promotional expenditure, as current ratio shows a downward trend. Nevertheless, the ratio is fluctuating above 1, which means that current assets always more than current liabilities and EasyJet has the ability to pay future bills. However, the more the ratio near 1, the less cash or cash assets could be contributed to short term debt. A large amount of cash of EasyJet is used to pay for aircraft order for future long term profit. Interest cover ratio could reveal whether EasyJet pay interest borrowings by generating enough profits. However, from Figure B5, EasyJet experienced a dramatic decline on interest cover ratio and lower than 1.5 in 2009. Due to the sacrifice on short term profit and large amount of borrowing for airline purchase, EasyJet may burdened by interest of debt. Gearing ratio could be used to describe the proportion of long term liabilities in capital employed. The higher a gearing ratio is, the more debt a company loaned and the more risk a company may take. From Figure B6 one could know that overall the gearing ratio has increased with a peak in 2007. Due to the huge cost of aircrafts, EasyJet is now in serious financial problem. Decrease in short term profit Gross profit and net profit margin ratio is helpful to know the percentage of profit generated from total revenue. Profit margin of EasyJet has shown an upward trend until 2007, both gross profit and net profit margin ratio decreased about 10% by the end of 2009. Such reduction indicates a increase in cost of sales and may not be satisfied by shareholders. However, despite of the rising in tax rate, this trend could reflect EasyJets strategies to explore new market, increase net work as well as route length which lead to a rise of fuel costs, airport charging and advertising costs. Capital employed includes shareholders funds and long term liabilities. Figure B8 indicates that EasyJets capital is rising, which indicates an expansion of EasyJets size. Although the investment of EasyJet has been increasing, profit has been used for further expansion. Hence, large short term profit may not be generated from capital. The situation is reflected on the reduction on ROCE. It also can be seen from Figure B8, return on equity has shown the same trend as that of profit. They both have increased till 2007 and then decreased sharply. Although the reduction of return on equity may due to the tax policy released in 2009 and increasing costs, which lead to a reduction on earnings after tax, it also partly result in the expansion of shareholders funds (EasyJet, 2009). However, overall it shows a lack of ability to return profit for owners investment. Figure B9 shows that after 2005, assets turnover decreased and has been fluctuating around 1, which reflects a poor utilization of assets and less profit return on assets. However, this primarily because of the large bulk of airplane purchase plan during the next few years. As a result, the long term benefits may not be reflected in more than one year. B.1.2 Low Cost strategy Figure B10 shows increase both in sales revenue and number of employee, which indicates the expansion of companys size and growth of finance performance. This may probably base on the low cost strategy. According to low cost strategy, EasyJet offer more frequencies on flight and larger capacities than other companies, thus lead to an increase in passenger flown as well as efficiency in airplane utilities. Aiming to enlarge its market, EasyJet has lunched more airports and increase its route length to various European destinations which result in a raise in cost, especially fuel cost. As a result, it can be seen from Figure B11 that a sharp rise of cost per passenger has increased since 2007. B.2 Compare EasyJet with Jet2 and Ryanair In order to discuss investment risky of EasyJet, this part of the report will compare EasyJet with Jet2 and Ryanair, both of which also adopt low cost strategy as EasyJet. B.2.1 Differences and Similarities in Balance Sheets Apparently from Appendix 1, Appendix 2 ad Appendix 3, EasyJet shows a significant higher increase rate of total assets, liabilities and capital employed, which indicate a rapid expansion of companys size. Ryanair also shows a slightly development of the company. By contrast, although Jet2 experienced an increase in total assets, the total liabilities has reduced, mainly due to the decline of non-current assets. Although the current assets of Jet2 raised sharply from 2008 to 2009, according to Figure 15, unlike Ryanair and EasyJet, the current assets of Jet2 is much lower than current liabilities. Thus Jet2 may not have the ability to pay bills or have enough cash to develop business. By comparing the proportion of total liabilities and shareholders fund in total assets, it can be seen that all three companies liabilities is higher than shareholders funds. Thus, EasyJet, Jet2 and Ryanair are mainly financed by debt. As Ryanair has the largest number of assets while Jet2 has the lowest, one may presume that Ryanair has the largest size of company while Jet2 has the relatively smallest. While the major liabilities of both EasyJet and Ryanair is long term borrowings, Jet2 takes trade payable as major total liabilities and deferred tax as major non-current liabilities. This situation may probably indicate that the working capital of Jet2 could be influenced negatively due to a poor ability of paying debt. B.2.2 Investment B.2.2.1 Comparison among EasyJet, Jet2 and Ryanair By comparing current ratio in Figure 12, it can be see that Jet2 current liabilities is more than current assets, thus Jet2 may have difficulty to pay bills immediately. On the other hand, Ryanairs current ratio has increased to 1.84 in 2009, as current assets in much higher than current liabilities. The figure may indicate a poor utilization of resource. Compared to Jet2 and Ryanair, EasyJet has a better management on assets and liabilities. It can be seen that EasyJet has the highest rate of gearing ratio, as the operation of company is largely depend on borrowings. Meanwhile, according to Figure 12, EasyJet has the relative lower interest cover ratio, which indicates that EasyJet may have more difficulty to pay interest expense than other company. As a result, an investment in EasyJet is more risky than invest in Ryanair and Jet2. Earning per share has been widely used as measurement for the growth of a firm as well as the indicator of the amount of profit could return to each share. Although the EPS of Jet2 rose remarkably, the PE ratio also declined dramatically. On the other hand, it can be seen that the PE ratio of EasyJet as well as Ryanair has increased sharply. It indicates potential capabilities of future growth of the two companies which could give confidence to investors. From Figure B16, it can be seen that Jet2 has the longest time to pay creditors, thus has a longer time to utilities liabilities. However, it also needs the longest time to collect receivables. On the other hand, although Ryanair has to pay creditors quicker compared to the time in 2008, the period is still longer than EasyJet. Moreover, Ryanair could receive debt much quicker than EasyJet. Thus Ryanair may have the best efficiency cash flows which could contribute to company operating. Obviously from Figure B13, Ryanair has much higher figure of return on capital employed, which means that Ryanair could profitably operation the company by using investment. As a result, investor could receive more interests in the short run from Ryanair rather than EasyJet, which has the lowest ROCE ratio among others. B.2.2.2 Brief Evaluation Based on the ratio discussed above, it can be seen that overall Ryanair is the best choice for investors compared to EasyJet and Jet2 despite its lower efficiency on the utilization of assets. It has the highest PE ratio and return on capital employed rate. Moreover, the working capital of cash flows is also considered as the best one among others. Investment on Ryanair could have less risky than EasyJet. Jet2 relatively has a poor condition of capital. It seems that Jet2 may easier fall into the dilemma of debt difficulty. Although EasyJet has a large amount of borrowings, and the lowest return on capital, a more flexible cash flow as well as a proper utilization of capital could be compensations. In addition, higher PE ratio implies a potential power of growth. Thus, investment on EasyJet could have less risky than Jet2 and may probably get better profit in the future. Conclusion To sum up, EasyJet as a growth company has adopt several strategies to compete in oligopoly market. EasyJet utilise low cost strategy to increase it efficiency in business operation will use growth strategy to seize larger market share and expand the size of the company. However, scarification of short term profit may leads to unsatisfactions of shareholders. Moreover, by looking at the accounts of EasyJet, it can be seen that its growth plan of aircraft purchasing lead to a heavy burden on debt. EasyJet has potential risky due to the large proportion of liabilities. In recommendation, EasyJet could reduce its growth plan while pay dividend to shareholder in order to alleviate the conflicts. As a result, the reputation of EasyJet could be maintained and attract more funds invest in the capital. Hence, EasyJet may not need to largely depend on liabilities and the risk of investment could reduce. References AnnaAero. (2008). Flybe Heading for #1 in UK Domestic Market; Overall Demand Down Around 4% in 2008. [One line] Available from: http://www.anna.aero/2008/12/05/flybe-heading-for-no-1-in-uk-domestic-market/ [Accessed 05th December 2008] Bevans, N. R. (2007). Business Organizations and Corporate Law. New York: Thomson Delmar Learning. Chauhan, S. P. S. (2009). Microeconomics: Theory and Applications. New Delhi: Learning Private Limited. 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