Airlines are often categorized into groups differentiated by their business models—in particular, their cost structures and revenue approaches:
- Legacy carriers (also known as full-service airlines) tend to offer multiclass cabins and a wide range of amenities, with many service features included in the ticket price. Examples include American Airlines, British Airways, and Cathay Pacific.
- Low-cost carriers and ultra-low-cost carriers—a combined group known as (U)LCCs—tend to sell discounted base-fare tickets and then charge extra for a range of amenities. Examples include Southwest Airlines, Spirit Airlines, Ryanair, and AirAsia.
In the course of our research on airline profitability, we’ve found that (U)LCCs have typically delivered better financial returns than legacy carriers. This outcome has been true across geographies and over multiple decades.
But (U)LCCs in North America, one of the world’s largest airline markets, have recently been underperforming their legacy counterparts—falling behind, by some measures, on both growth and profitability. Changing economic conditions that influence passenger demand could, of course, push this trend in unexpected directions, but it’s worth investigating how such a major reversal occurred.
Which actions or circumstances clouded the picture for North America’s (U)LCCs? And what important business model implications should be considered by airlines of all types, in all regions?
Budget airlines have propelled industry growth and profitability
From 2012 through 2019, (U)LCCs generally outperformed legacy airlines across the globe with respect to ROIC (Exhibit 1). This trend was especially pronounced in the years leading up to the pandemic, when (U)LCCs benefited from structurally leaner cost bases than legacy carriers—thanks to simplified operations and lower overhead and labor costs.
A key factor in (U)LCCs’ success has been their overall cost structures. They often use streamlined route network designs, opting for point-to-point service over hub-and-spoke models, thereby enabling more efficient aircraft utilization and limiting the operational complexity of connecting passengers. Additionally, they tend to fly to secondary airports (which generally involves lower costs) and operate denser aircraft with a single-cabin layout (fitting more passengers on the same plane by narrowing the seats and decreasing legroom).
(U)LCCs have also excelled at generating incremental revenue at relatively high margins from optional services such as baggage fees, seat selection, and onboard refreshments. These services are unbundled from base fares, priced dynamically, and often purchased at the point of need. While legacy carriers have adopted similar unbundling strategies, (U)LCCs have built an entire business model around this approach, which reinforces their value-oriented positioning (thanks to low base fares) while bolstering financial performance.
Over the past decade and a half, (U)LCCs have grown at a faster rate than legacy carriers. Across most regions of the world, (U)LCCs’ share of total available seat kilometers (ASKs)—a measure of airlines’ carrying capacity—has significantly increased (Exhibit 2).
Discount carriers have stalled out in North America
While (U)LCCs outperformed legacy airlines in the period preceding 2020, more recent data show legacy carriers beginning to lead in ROIC in North America (Exhibit 3). Although (U)LCCs continue to grow modestly in terms of scheduled capacity, their growth rate now trails that of legacy carriers for the first time in many years.
While North America presents the clearest example of this shift, recent data suggest it is not the only region where changes are afoot. In Latin America, for instance, legacy carriers are now leading (U)LCCs with respect to ROIC (though some have improved their financial positions through postpandemic bankruptcy restructuring). There are indications that the North American trend may not be isolated, and that it could reflect broader changes in the industry’s competitive dynamics.
This raises two important questions: What caused this novel divergence in North America? In light of this development, what implications should global airline leaders consider?
What happened to North America’s discount airlines?
Based on interviews with airline leaders, public statements from across the industry, and McKinsey research, we find that the slowed performance of North American (U)LCCs—in comparison with their better-performing legacy counterparts—has resulted in large part from three factors: increased labor costs, a divergence in spending between higher-income and lower-income travelers, and a concerted effort by full-service carriers to mimic (U)LCCs’ popular offerings while providing better value and improved onboard experiences.
Cost convergence between (U)LCCs and legacy airlines
The postpandemic pilot and labor shortage has increased labor prices for all airlines. For legacy carriers with broadly higher pay scales, this increase was more muted as a percentage of total existing costs. For (U)LCCs, labor costs as a percentage of operational expenditures increased at a far faster pace (Exhibit 4). This increase resulted in a drastic reduction in the cost differential between (U)LCCs and legacy carriers.
Growth in premium demand—paired with softer demand for budget options
Postpandemic US consumer spending has become increasingly reliant on households earning more than $250,000 a year—the upper 10 percent by income. These households have increased their spending above inflation levels. Travelers from these households are more likely to value products traditionally associated with legacy carriers (such as premium-economy or business class seats, airport lounges, and other upmarket offerings).
Meanwhile, on the other end of the consumer-spending spectrum, inflation has cut into the discretionary spending budgets of lower-income households. When these households spend less on travel, (U)LCCs feel the effects more acutely than legacy carriers do.
Legacy-carrier products targeting (U)LCC traffic
Legacy carriers have launched their own versions of “basic” economy tickets. United Airlines has reported that more than 15 percent of its ticket sales fit into this category. These products directly target (U)LCC customers, using price points and fare rules that mimic (U)LCC offerings.
Despite the overall softening of budget demand, legacy carriers have succeeded with budget products by offering basic fares within a broader premium-brand experience—combining low entry prices with expansive route networks, robust loyalty programs, and strong brand familiarity. This strategy has not only attracted budget-conscious travelers but also enabled legacy carriers to upsell passengers to higher-margin options and ancillary services, enhancing overall revenue performance.
What implications should global airline leaders consider?
Based on the state of order books for narrow-body aircraft—a broadly indicative measure—(U)LCC growth still appears to be outpacing legacy-carrier growth outside North America, in line with its past trajectory (Exhibit 5).
But the same factors that influenced (U)LCCs’ fortunes in North America could certainly show up in other geographies. Global airline leaders can monitor whether similar developments are brewing in their own regions. Additionally, they might draw a few broad lessons from the shift in North America:
- Cost control is crucial. For airlines of all types, focusing on meaningful cost control will always be a proven path to improving profitability. In today’s environment, rising labor costs—particularly for pilots and technical staff—are placing pressure on operating models that were once highly cost-competitive. While these dynamics could be difficult to reverse, there are opportunities to improve efficiency through better utilization, scheduling, and resource deployment. A systematic approach that is grounded in detailed cost diagnostics, bottom-up planning, and implementation across operations could help airlines identify areas of untapped productivity. Amid continuing volatility, building a more resilient cost base will be critical to sustaining performance.
- The value story matters. Customers like cheap fares—and they want a good experience when they fly. In North America, legacy carriers have been investing in customer experience, for instance, by improving their on-time performance, offering robust streaming or seat-back in-flight entertainment, providing free Wi-Fi, and serving more appealing free snacks and drinks. Many of these enhancements are available to all customers, including those flying on restricted economy tickets. If customers are presented with an attractive price point, they will likely pick the carrier with the better customer experience.
- Customer segments can be captured using different approaches. A traveler may choose a full-service, nonrefundable ticket for a week-long trip to Paris and then, a couple of months later, opt for a basic budget fare for a weekend jaunt to Las Vegas. How can an airline best serve both needs? In North America, legacy carriers have introduced basic-economy products—replicating (U)LCC offerings—by creating low-cost, unbundled fares within the same cabin as their full-service products. Similar unbundling strategies have been adopted by legacy carriers worldwide, but there is a notable divergence. North American legacy carriers have largely managed the low-cost challenge within a single airline brand, but legacy carriers in other regions have often responded to low-cost competition by creating group-owned, low-cost carriers under different branding (such as Lufthansa Group’s Eurowings, Singapore Airlines’ Scoot, and Qantas’s Jetstar), while, in many cases, also unbundling their mainline products.
As airline business models continue to converge, the industry may be approaching a turning point. The North American example could portend not just a short-term shift but a deeper change in how airlines compete. Legacy carriers have shown they can adapt by borrowing tactics from (U)LCCs while using broader networks and premium services to compete across customer segments. For (U)LCCs, competing on price alone may no longer be enough, and they could be better served by offering a clearer value proposition—maintaining their low-cost edge while selectively improving the customer experience in ways that build loyalty. The most successful airlines, across categories, will be those that stay agile, rethink their business models regularly, and focus on what customers truly value. As the lines between airline types blur, enduring differentiation becomes even more vital.
