Why Norwegian Air is so cheap: a thorough look into the airline’s business model

Anyone versed in the airline industry has already heard of Norwegian Air Shuttle, the first European airline which may very well manage to become a viable long-haul, low-cost carrier.

Same goes for your occasional traveller, thrilled at the thought of 200-buck transatlantic, return flight, which seems too good to be true.

In both cases, there is one tantalizing question which is as simple in its form as complex in its answer: how do they do it? This is what I chose to address in this article.

Methodology

As far as methodology goes, I would like to remind first that this is not an academic study. All the information that you should find in this note is the result of hard-proven facts mixed with my vision and experience of the industry. While I shall try my best to remain objective, I am neither a journalist nor a market analyst.

Most of the data that you will encounter is taken directly from Norwegian’s 2014 annual report, which is, compared to other airlines in the industry, very well-documented and transparent. I have also focused on articles and data from the CAPA (Centre for Aviation), which is top-notch when it comes to aviation economics. Last but not least, you may occasionally encounter articles from mainstream newspapers.

Finally, as a last word, I would like to point out that I may use various terms to design Norwegian Air Shuttle. When referring to the brand or the group, I shall use the term “Norwegian” or “NAX”. The terms NAIS, NAS or NAN stand for a specific subsidiary owned by the Norwegian group.

An introduction to aviation mechanics: ASK, Load factor and yield

Before discussing any further about Norwegian, it is paramount to make an introduction about ASK, load factor and yield. If you never encountered one of those terms before, you are either a greenhorn to aviation’s mechanics or you should consider changing passion.

In a nutshell, Available Seat Kilometer (ASK), Load Factor and Yield are three economic concepts used in aviation to measure an airline’s performances. ASK is the number of seats available multiplied by kilometers flown (i.e. if a Boeing with 100 seats available fly 10000 km, it will generate 100 + 10000km, that is to say 1000000 ASK).

ASK is what measures best an airline performance as it is a common ground to calculate RASK (average revenue per ask) or CASK (Cost per Available Seat Kilometer), that is to say how much an airline gains or loses when they fly. Load factor (how many passengers are occupying a plane) is determinant to measure the Yield (the revenue divided by occupied seat kilometers) or the RPK (Revenue Passenger Kilometers), which gives a more accurate reflect of an airline’s economic performance.

The word of the author

While I love writing, I have never been particularly fond of editorials. These kind of self-centred exercises often drift away from the point, which has always been my main concern when writing.

Yet, for my first article on Medium, I must admit there is no better format to introduce my note on Norwegian Air Shuttle.

The airline, which has over the last couple of years managed to grasp the attention of the media, has been eyed by other carriers for a while now. Since 2014, Norwegian has pioneered long-haul low-cost flights to the US and Asia. Conventional wisdom in the aviation sector had dubbed it impossible before.

Which raised the tantalising question: how did Norwegian make it happen?

I searched for explanation in Norwegian Air Shuttle’s primary source of information, and as it was explained in the airline’s annual report in 2014, Norwegian’s “business model is based on high volume and competitive low fares”, the use of “low fares to attract new customers” in markets with “low brand awareness” in order to attract customers and also states that it “promotes high load factors and higher capacity per flight”. In itself, this is not even remotely close to a concrete or valuable answer.

Equally unsatisfying was the answer of Bjørn Kjos in his interview for the Guardian in 20141, where the CEO of Norwegian Air Shuttle simply replied that their business model was made financially possible thanks to fuel efficient planes, the internet and a “shift in global economic power”.

In both cases, the answers given are either shady or unsatisfying. Hence this note, which means to provide valid answers to the question left unanswered: how are Norwegian’s long-haul flights financially possible?

A brief history of Norwegian Air Shuttle

Norwegian Air Shuttle or NAS was founded in 1993 as a regional airline to take over the operations of crumbling carrier Busy Bee (a subsidiary of former flag carrier Braathens ASA). Much like many regional carriers at the time, NAS would lease its aircraft. When Braathens collapsed and was bought by its rival SAS, the latter terminated all of Norwegian’s contracts without any notice, forcing it to “reinvent itself”.

That was in 2002. The Norwegian company quickly turned to a low-cost model, somewhat mimicking the business model Southwest had made famous2 (fast turnaround, same plane for all operations, wet-leasing when necessary). During this period, Norwegian did not only diversify its destinations, growing into a continental airline while opening bases to Finland, Poland and other nearby countries, but also made experimentations that prepared it for a bigger scheme. In 2008, the company announced its intention to do non-stop flights between Oslo and Dubai. In 2010, it contracted with a leasing company for two Boeing 787 Dreamliners with delivery in 2012 — an announcement which echoed previous statement about Norwegian’s will to start flights from Oslo to New York and Bangkok. The placement of the “largest aircraft order in Europe’s history”3 the same year allowed NAX to gain the momentum it needed to start its operations. From there, everything unfolded fairly quickly.

A “born again” Norwegian: how the airline reshaped completely

During the 2013/2014 period, Norwegian reshaped completely and adopted a whole new face. From the word of the company itself, “a key consideration in the restructuring activities of 2013/2014 was building a structure that maintains Norwegian’s flexibility and adaptability when growing internationally”.

A brief history of Norwegian Air Shuttle

Most of the subsidiaries which exist within the Norwegian group today were created throughout 2013, almost every other month: Norwegian Air International (NAI), the infamous Ireland-based subsidiary in charge of the long haul, but also Norwegian Cargo, Arctic Assets (the subsidiary in charge of handling the planes), Norwegian Air Resources Holding Limited (the subsidiary in charge of paying the HR), Norwegian Brand Limited, etc. In total, 19 subsidiaries were created in 12 months: a business that is running like a clock!

Therefore, it is rather accurate to say that Norwegian as a group was born in 2013 and continued expanding its empire later on. Ultimately, the Scandinavian airline had taken six years to figure out a business model which holds its ground.

Thanks to the complex web of subsidiaries that the Scandinavian carrier had built, the long-haul, low-cost operation officially started in 2013. It gained traction in 2014 and now Norwegian’s expanding its routes. All of this was made possible thanks to a clever use of corporate structure. For that matter, it is worth noting that out of 32 subsidiaries possessed by the group, more than half are based in Ireland… which poses the tantalising question of whether NAX is still Norwegian at all.

Ultimately, the Scandinavian airline had taken six years to figure out a business model which holds its ground: and as we shall see, it relies heavily on cost controls, exotic company structure and — according to media evidence and despite NAX’s claims — the use of potentially unethical loopholes.

II. NORWEGIAN’S CORPORATE STRUCTURE: A KEY ASPECT IN COMPANY’S SUCCESS

Similar to big companies in other industries such as Apple or Google, exploiting financial, structural or social loopholes is crucial to becoming n°1, however unethical the process.

Among the new contenders to the title of biggest airlines in the world, NAX is one of a kind. As the first European long-haul, low-cost carrier ever created, Norwegian has always puzzled. While everyone thought that long-haul LCC was a folly few years back, NAX managed to prove the odds wrong and could very well succeed in establishing a profitable long-haul LCC. Yet, how does it manage to run a long-haul, low-cost, in a European environment characterised by the highest CASK in the world?4

The secret lies in its very particular cost structure. Any professional from the aviation industry will tell you this. It is so complex that Crankyflier.com, one of the most influential blogger in the aviation sector, pointed out how Norwegian itself had set up a page to explain its own corporate structure5.

In total, Norwegian group is composed of over 30 subsidiaries according to its annual record in 2014. At the end of the document, you can find a comprehensive list of all the said subsidiaries.

As this list proves to be rather difficult to understand, I have chosen to explain this structure in a more graphic way.

As shown in the graphic, Norwegian group is one that rules over three separate types of subsidiaries:

• Commercial airline activities
• Workforce provider
• Miscellaneous activities (among which Assets management activities, mainly from Artic Aviation Assets LTD)

This greatly helps the company in controlling its costs while circumventing some laws, especially in Norway. At the core of this structure, there is a “geo-centred” approach with a subsidiary based in most of the countries Norwegian flies to or does business with. I’ll provide a detailed look into all of those types, explaining and describing them, so one can understand how Norwegian cleverly uses them in order to drive down costs.

Commercial airline activities: from Oslo to Bangkok, a flag-of-convenience business model?

NAS — NAI — NLH — NAN, who is who?

The very specificity of Norwegian lies in its very particular use of subsidiaries. The whole world is a playground for NAX, which simply pings back and forth from Thailand to Ireland, back to Norway. In total, there are four subsidiaries which ensure commercial airline activities, with the same planes, and some times flying the same route:

• NAS: for Norwegian Air Shuttle ASA, Fornebu, Norway
• The “historical” Norwegian firm, NAS is based in Norway in order to respect Norwegian rules. It is the group tha
• NAN: for Norwegian Air Norway AS, Fornebu, Norway
• NAN “operates routes from Scandinavian bases”6, most likely to respect Norwegian law. Right now, NAN is the subsidiary which flies most of the group’s routes
• NLH: for Norwegian Long Haul AS, Fornebu, Norway
• The first subsidiary that operated long-haul flights, as opposed to NAS which operated short-haul, medium-haul. It has been set up in 2013 to operate the new B 787 Dreamliner. Yet “most of the activities were transferred in 2013 and during 2014” to Norwegian Air International Ltd, Dublin, as if the airline had found a better, more suited business model. It appears that this company still holds 100pc of the share of Norwegian Long Haul Singapore Ltd, based in Singapore
• NAI: for Norwegian Air International Ltd, Dublin, Ireland
• The most infamous subsidiary of Norwegian, Norwegian Air International with its Irish AOC operates most of long-haul routes of NAX. NAI is actually the subsidiary which unions are lambasting at for its so-called use of Flag of Convenience (FoC)

Can we really speak of flag of convenience?

Analogies are always tricky. Whichever way you look at it, one could always argue against one particular aspect of it and debunk your reasoning completely. Claiming that Norwegian Air Shuttle flies under a “flag of convenience”, a term originating from the maritime sector is one of those analogies that could be undermined or supported in both cases.

Yet, there are some concrete reasons to support the idea of a flag-of-convenience (FoC) model. As stated by Emmanuel Jahan, the Chair of the European Sectoral Committee of Social Dialogue for Civil Aviation, Norwegian does use its Air Operator Certificate (AOC) as a “flag” to “avoid local rules and apply instead ones chosen to be more lenient and commercially expedient”. It is particularly relevant in NAI’s case as it is obvious that Norwegian attempts to avoid local taxes. “This Irish AOC’s main effects are: to circumvent Norwegian labour law, to avoid paying any social charges in Norway or any EU country, and to fictitiously base its pilots in Thailand (Bangkok) — employed by a temporary work agency in Singapore” explains Mr Jahan in a letter dated of November 2014 to Mrs Violeta BULC, the new European Commissioner for Transport.

This is primarily the reason why Norwegian, in its answer to the Department of Transportation on June 1, 2015, confirmed that “NAI is now in a position to commit to use only European and U.S. pilots and crews on NAI transatlantic flights (except if compelled by extraordinary and unforeseen operational reasons)”. To the uninitiated, it might look like NAI has backed off. Such is not the case. The reason why NAI was set up in Ireland was to avoid costs in Norway. Therefore, the commitment to fly only with European & US crew is misleading: it is likelier than NAI will hire European pilots only, more precisely Irish-based pilots in a fashion similar to Ryanair (for the record, the Irish-based airline has found a crafty way to “self-employ” its pilots through a complex network of accountants in a way that exempts it from most of its social costs). With the lowest social costs in Europe, self-employed pilots in Ireland offer a significant cost advantage7.

To defend itself, Norwegian stated that it is being targeted because it is “the first low-cost airline to break the transatlantic oligopoly” and to offer “affordable non-stop flights to the flying public”. It also justified its Irish AOC for the reason that Irish Law is friendlier when it comes to planes management, which is true (it also explains why the company has created twelve subsidiaries for asset management). Nevertheless, the accusation of flag of convenience seems valid, especially when one considers that Norwegian doesn’t fly from or to Ireland at all…

Norwegian’s HR subsidiaries: a “country-centred” approach

What strikes the most with Norwegian, aside from its three subsidiaries dedicated to commercial flying, is the number of subsidiaries dedicated to Human Resources. As a matter of fact, the whole HR department has been outsourced to subsidiaries in 2013/2014.

“Hire crew where they are based”

Basically there are 8 subsidiaries dedicated to HR within the Norwegian group and one holding that controls 5 subsidiaries. According to Norwegian, the airline hires crew where “they are based” as it “increases efficiency and ensures that crewmembers are protected by the full range of labour and employment laws of their home base country”. This reflects NAX’s new “country-centred” approach for its HR management, that is to say that crews are now based and managed by a local subsidiary: Norwegian Air Resources Spain in Spain, Norwegian resources Denmark, Norwegian Resources Sweden, etc.

This was also confirmed by Norwegian in its annual report: “On 5 March 2015, Norwegian Air Norway AS established three new subsidiaries for its pilots in Norway, Sweden and Denmark respectively, and all employees were transferred to the companies in his/her respective country with the existing tariff agreements, working conditions and benefits.”

However, and this is interesting to note, all of the new established subsdiaries exist in Scandinavian countries where unions and social laws are very powerful. But what about the nationality of the pilots that operate from the US or from the UK?

Norwegian Resources Holding: a sub-holding established in Ireland

The most interesting subsidiary is clearly Norwegian Resources Holding which is a holding within a group. Like many subsidiaries, the holding is based in Ireland. There is no solid evidence to prove this, but this alone leads me to believe that NAX might be using Irish contracts for its crew, pilots and stewards. Contrary to the declaration that crews are employed in their “home base country”, I believe that NAX actually hires specifically from some countries, and temporarily leases the rest of the pilots, thus taking advantage of an overloaded pilot market.

Lately, a vast study for the European Commission carried out by the University of Ghent on the atypical forms of employment8 seemed to confirm this vision. Norwegian Air Shuttle and Ryanair were in the top list of airlines considered to use “bogus self-employment”.

Why NAI is accused of bogus self-employment?

Aside for the aforementioned study, many trade unions pointed out the not straight-forward and surprising employment scheme of NAI. Sometimes, it is said that the airline hires pilots from Singapore. Other time, it is said that NAI employs them under Thai contracts. Truth is, it is a mix of both.

As you can see in the graph, NAS established an Irish subsidiary (NAI) to operate flights towards Asia, the US and also the Caribbean. NAI outsources its contracts to a Singapore firm

Norwegian cleverly, albeit unethically, exploits social laws from all over the world with no loyalty whatsoever to a flag — in this case the Norwegian flag.

Norwegian’s assets and brand management subsidiaries

Finally, Norwegian has also established a galaxy of subsidiaries with segmented activities for all of them. Some of them are wholly dedicated to assets management, while the rest have other objectives.

How assets are managed

Arctic Aviation Assets Limited is a company based in Dublin, Ireland. It is the parent company of numerous subsidiaries, such as the DY Aviation Ireland Limited series (from DY1 to DY7) and many others. According to Norwegian’s annual report, the company was established “with the purpose of administering the group’s aircraft assets”. Arctic Aviation Assets owns “100 per cent of the shares in the owner- and leasing companies designated for the group’s aircraft assets”.

The choice of this scheme is no surprise as owning a plane in Ireland makes it fairly easy for NAX to use tax planning. In the industry, Ireland is the most important aviation cluster in Europe which allows better leasing and financing conditions, especially since the country decided to adapt the Cape Town Convention9.

Tax and assets management are also considerably lower. For instance, you can “own” a plane virtually registered in Ireland but owned in Luxembourg. While this move makes sense for a business man, from a Norwegian point of view, this could be seen as tax optimization.

There are also some thicker zones of uncertainties. For instance, Norwegian Assets Ltd, which is a 100% subsidiary of NAI, “was established with the purpose of operating the group’s long haul activities”. Isn’t it weird that a company with the word “Assets” in it is in charge of operating the group’s long haul activities, when its parent company is already doing the same thing? What is the real purpose of Norwegian Assets?

Other miscellaneous companies

Most of the other subsidiaries NAX has set up are currently based in Norway (Norwegian Cargo, Norwegian Holiday and Call Norwegian). Those three activities are activities which came as a support to the commercial flight activities which imply passengers. Obviously, Norwegian Cargo administers the group’s Cargo activities, while Norwegian Holiday and Call Norwegian are respectively established to provide holiday packages for the former and serve as a call center for the latter. For a company to be based in Norway, where its mother company is based too, seems perfectly normal. This is the reason why the establishment of Norwegian Brand Ltd in Ireland seems so curious.

Why would Norwegian set up the company in charge of “the group’s overall brand and IP management activities”10 so far away from the parent company? Most likely, the answer lies in the particularly favorable IP laws in Ireland. IP tax planning through Ireland effectively gave birth to the most cunning schemes in order to avoid tax, i.e. the now notorious Double Irish Dutch sandwich scheme used by Apple or Google to circumvent taxes in Europe.

The European Parliament acknowledged this issue and even requested a research paper on this very subject last year11. The paper said, I quote, “Intangible assets constitute a major value-driver for multinational companies. The related intellectual property (IP) most notably patents, trademarks and copyrights usually does not have a fixed geographical nexus and can be relocated without significant (non-tax) costs. Multinational companies can use this flexibility to reduce their overall tax burden by allocating valuable IP to group companies resident in low-tax countries.”

Considering Norwegian’s specific “country-centred” approach, I believe that it is fair to say that the group chose to install its brand and IP management subsidiary in Ireland for tax reasons.

In the end, NAI is more a threat to European long-haul carriers than US which made sure that NAI wasn’t a problem. The main reason is simple: when an archenemy emerges, US carriers are united (as their recent lashing at Gulf carriers show). Such is not the case for the European carrier, which are often too divided and fail to protect their market.

Conclusion: Norwegian Air shuttle moved from company’s structure to cost control

Neophytes tend to explain an airline’s success by linking it to their products and performances. This is admirably mistaken. With very tight margins, the sale of the product (the “ticket”) has increasingly become as important to airlines as the control of their costs. The reason is mainly because the sale of tickets can be subject to a number of random factors that can undermine it: geopolitical events, environmental disasters, terrorism… Therefore, it is almost never certain how an airline will perform if one only bases itself on the tickets sold.

As Bjørn Kjos, CEO of Norwegian accurately pointed out: “Dumping the ticket price to attract traffic is done at the push of a button — the hard part is lowering the cost correspondingly”.

Cost control means cheap tickets, cheap tickets means market advantage over your competitors. This is the reason why CASK12 has become vital for airlines, which have started hedging their (their most random — and important — source of cost) and this is why carriers with lowest unit costs such as Ryanair, easyJet or Pegasus Airlines achieve profits when historical, flag carriers do not.

This is particularly relevant when you consider how CASK has gradually taken importance and why low-cost carriers have become so profitable, especially in Europe13. Nowadays, Norwegian has one of the best CASK in Europe. About 14 times lower than its competitors, British Airways.

The reason is because, as I have demonstrated through this note, the airline has optimized its corporate structure by setting up subsidiaries in the right countries, that is to say Ireland. Of course, I lack primary material to turn assumptions into assessments.

What can be said from the facts right now is that Norwegian Air Shuttle has been slowly shifting towards Ireland to the point that it can hardly be called a Norwegian group anymore. This is tax optimisation at its finest.

References

1 “How are Norwegian Air Shuttle’s low-cost US flights financially possible?”, The Guardian, 2014/02/04, http://www.theguardian.com/business/2014/feb/04/norwegian-air-shuttle-low-cost-gatwick-bjorn-kos

2 This is hardly new. Carriers such as Ryanair or easyJet embraced low-cost at the same time.

3 Ibid

4 Ibid

5 https://www.norwegian.com/us/about/company/corporate-structure/

6 Annual Report, p.12

7 Read “Hire crew where they are based” for more information about NAX’s employment model.

8 Atypical forms of aircrew employment in the European aviation industry

9 A Convention for aircraft financing.

10 IP stands here for “Intellectual Property”

11 See : http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/563454/IPOL_IDA(2015)563454_EN.pdf

12 See above “An introduction to aviation mechanics: ASK, load factor,

13 See CAPA’s “CASK Airline Unit Costs” report

14 Source: Norwegian Air Shuttle Annual Report