Malaysia Airlines can gain lots from revenue management

By Chan Quan Min

The airline business is hardly straightforward. Airline managers have to balance a multitude of influencing factors to coax maximum revenue from finite seat capacity. When done right, revenue management is a powerful tool. But it is also temperamental. One wrong step is all it takes to wipe out hundreds of millions from the bottom-line – or the reverse. Right now the odds favour Malaysia Airlines and now is NOT the time for the government to sell it.

________________________________________________________________________

On balance, evidence indicates that if Malaysia Airlines can manage to improve its revenue management then most of its problems are sorted out. Just a small increase in yields – a measure of average fares – can result in hundreds of millions of ringgit in additional revenue, making all the difference between respectable profits and deep losses.

It is after all a 5-star airline, one of only a handful according to Skytrax, an airline rating organisation used in the industry. For the last seven out of eight years, Malaysia Airlines was on that 5-star list, which measures passenger satisfaction using some 800 indicators.

That basically means that the product is not just good but excellent and among the best in the world. The problem is Malaysia Airlines is unable to get airfares which commensurate with that kind of a quality product. What gives?

The art of revenue management

Much of the answer lies in the realm of the inexact science of revenue management which we attempt to explain below and interpret it in the context of Malaysia Airlines.

Airfare bargain hunters should be familiar with this scenario:

Day one, an email arrives in your inbox screaming free seats (excluding taxes, fuel surcharges and booking fees of course). You point your cursor to the dedicated booking webpage and key in your travel dates. Ah, there they are, not the choicest travel times but who is to argue with ‘free’ tickets.

Day two, credit card and passport in hand, you log in to the booking webpage for a second time, ready to purchase your ‘free’ tickets. Hopefully they won’t have been snapped up this early. Alas, you are a day too late. The discounted fares have vanished!

Airline fare sales may be one extreme example of how airlines worldwide manipulate ticket prices in an attempt to stimulate demand. Less dramatic are the subtle changes in everyday airfares, which adjust according to a multitude of factors.

In aviation circles this is called revenue management, the use of pricing to extract maximum revenue out of a finite, quickly expiring resource – seat capacity. Revenue management is based on price optimisation strategies – knowing when and at which price to charge for an air ticket.

Airlines do this by first segregating the market according to buyers’ propensity to spend. For instance, as a general rule, ticket prices become more expensive closer to the departure date.

Much of the work is done by complex computer programs running revenue maximising algorithms. Airfares for each route are divided into several fare brackets. System-wide, there could be thousands of such fare brackets tailored to a specific need or situation.

Some definitions first

The field of revenue management comes with its own vocabulary. For some of the key terms used in revenue management see the accompanying table.

The common buzzword of revenue management is passenger yield, or simply yield, a measure of average ticket prices calculated by dividing revenue over the total number of  revenue passenger-kilometres or RPK.

Thus passenger yield differs from RASK only slightly, in that it measures revenue based on seat-kilometres actually occupied by a paying passenger whereas RASK measures revenue based on system-wide seat capacity.

Passenger yield is often used as an indicator of maximising revenue and is closely linked to average ticket prices. If ticket prices rise, then the yield rises. For the same load factor (capacity utilisation) and capacity, higher yields mean higher revenue.

Dropping fares can give higher load factors or capacity utilisation. The trick is to find the balance that maximises revenue. If load factors increase but by a lower amount than the fall in passenger yield, revenue will fall if capacity remains the same.

But in Malaysia Airlines’ case, capacity has increased, by 20% this year and there is therefore some justification in reducing fares (dropping passenger yields) to fill the planes up. But the sharp rise in load factor despite the substantial increase in capacity is clear indication that the fares may have been dropped too much. This is reflected in the sharper drop in yield compared to the rise in load factor.

Yield junkies

But Malaysia Airlines’ director of commercial, Hugh Dunleavy contends that the airline industry is too fixated on passenger yield as a performance measure:

“An airline’s goal is not about maximising load factor, it’s not about maximising yield; it’s about maximising revenue, and that’s what we do. But there is a control point… Growing revenue past the point where it does not cover the variable cost of operations doesn’t make sense either.”

“But the focus on yield, a lot of airlines do this. And most airlines I’ve worked with, whether it is Lufthansa, Continental or Cathay, are what I call yield junkies. The moment things go well the company says, raise the yield,” he added.

Dunleavy’s style of revenue management prioritises growth in absolute revenue before that of passenger yield, an approach sometimes at odds with conventional thought.

Interestingly, experts in the field sometimes refer to revenue management as yield management, in an indication of the importance of passenger yield as a profitability indicator.

“Our goal is to maximise revenue. We increased the load factor by six points. Yes, yields went down by 14%. But at the same time, capacity (ASK) is up 20% and 30% more people flew Malaysia Airlines than the year before,” Dunleavy explained, citing official company numbers.

“This translates to a 12% improvement in revenue, even as yields have come down 14%,” Dunleavy asserted.

He said the crux of the improvement in revenue was the increase in passenger numbers above the quantum of the fall in ticket prices, measured by passenger yield.

More satisfied now with the higher load factors the airline is reporting this year, Dunleavy said pushing for a higher load factor was part of a plan to extract incremental gains.

Dunleavy, who honed his network and revenue planning skills at various airlines before his last stint at the Canadian low-cost carrier, WestJet, was roped in to steer Malaysia Airlines to profitability in mid-2012.

He has 30 years of experience in the field under his belt.

Passenger numbers up on heavy discounting

Dunleavy and Shihaj Kutty, vice president of network and revenue management are the men in charge of revenue management at Malaysia Airlines. They are equally passionate about the airline’s new strategy of aggressive pricing.

“We are competing in a space of low-cost carriers. There was one decision we needed to make; are we in that space or are we not in that space?

“We like to think we’re not but the fact of the matter is: You as a consumer, you’re in that space. Are we interested in you? Absolutely, we are,” Shihaj said.

Shihaj admitted that airfares at Malaysia Airlines have been reduced through heavy discounting to entice passengers away from competitors, both full-service and low-cost alike.

“That is a strategic decision we have taken, that is to compete in that space until a reasonable point,” he said.

Malaysia Airlines CEO Ahmad Jauhari Yahya is understood to also believe in “pricing to the market.” He said this during an Aug 21 presentation on the progress of his business turnaround plan.

Jauhari has declined requests for an interview with KiniBiz.

Malaysia Airlines’ aggressive discounting in the year to date has delivered the intended results. The airline recently posted a June 2013 load factor of 84.3%, a 10-year record high for the airline.

Second-quarter passenger load factor, meanwhile, is standing at approximately 80% up 6 points from last year despite a massive increase in seat capacity this year. According to data provided by Malaysia Airlines, ASK, or available seat-kilometres has shot up 20% this year.

On paper, a load factor of 84.3% definitely looks good for the airline. Unfortunately it has come at the expense of passenger yield.

Both RASK, revenue per available seat-kilometre and passenger yield have fallen by 6% and 14% respectively between corresponding second-quarters.

For industry analysts such as Mohshin Aziz of Maybank, the link between load factor and yields is clearly antagonistic. From the passenger load numbers, it was immediately clear that Malaysia Airlines had suffered a steep drop in passenger yield.

While Mohshin commends the airline for its load factor achievements, he, like many other aviation analysts do not see the current ‘load active, yield passive’ strategy as sustainable.

“With the business turnaround story headed in the right track, the focus must now be to find a way to overturn the yield decline,” he wrote in an Aug 21 report on the national airline.

Malaysia Airlines’ current predicament is a telling example of the intricacies of revenue management. Airline managers need to balance price and availability. As the airline increased both capacity and load factor, carrying a record 1.5 million passengers in June, it was inevitable that yields would crash.

Yield growth has not kept pace

Malaysia Airlines’ passenger yield has over the past four years, diverged from that of the airline’s regional competitors.

The national airline has been unable to keep up with its peers, registering yield growth below that of its regional competitors; Singapore Airlines, Thai Airways and Cathay Pacific.

The global financial crisis (GFC)  hit all airlines equally hard, with all four airlines tracked by KiniBiz (including Malaysia Airlines) registering double digit decreases in passenger yield that year.

All three of Malaysia Airlines’ competitors reported passenger yields returning to pre-crisis levels immediately after the 2008/9 GFC.

Unlike its competitors, Malaysia Airlines’ yields did not recover as strongly and continued to trend sideways.

Interestingly, the national airline for one year led Singapore Airlines in passenger yield. This was 2008, the year before the GFC, when the airline was still under Idris Jala’s stewardship.

There are some broad trends that can be gleaned from comparing Malaysia Airlines’ financial reports against that of its passenger yield trends.

In the period from 2006 to just before the GFC hit in the last quarter of 2008, passenger yield was on the uptick, increasing quarter-on-quarter, coinciding with an improvement in the company’s bottom-line under Idris Jala.

Post-GFC the airline sank into a protracted period of weak yields. It could be inferred that the losses incurred by the airline during Tengku Azmil Zahruddin’s tenure could be due to the yields not recovering to pre-crisis levels.

When assuming more or less static fixed costs, a fall in yield could mean the difference between reporting in red or black ink.

Worryingly, 2013 has seen passenger yield fall further, believed to be due to Malaysia’s airlines capacity increase and subsequent heavy discounting to fill seats.

Similarly, RASK has fallen to the lowest level since 2010. In order to be profitable by end-2014 as Jauhari has promised, it is imperative for Malaysia Airlines to raise RASK.

As Jauhari himself recounted in a briefing to analysts in February this year, every one sen increase in RASK equates to a RM500 million improvement in revenue.

But increasing RASK will be a struggle for the airline as long as capacity growth continues apace. Note that RASK is calculated with ASK (available seat-kilometres) as the denominator.

A new growth phase

Malaysia Airlines has entered a new growth phase, Jauhari said in his Aug 21 address to the press.

The flag carrier is no longer cutting routes. Instead, the airline is now ramping up an expansion into regional markets led by a reinstatement of flights to Dubai and the introduction of Kochi and Darwin (after a long hiatus) to the network.

Indeed, the airline is planning to add almost 18% in system-wide seat capacity or ASK by the end of this year.

From late November the airline will add an extra daily flight to both Sydney and Melbourne from its hub in Kuala Lumpur. This will take the number of daily flights to both Australian cities to three times daily.

Closer to home, Malaysia Airlines has upped capacity to East Malaysian destinations from Kuala Lumpur in an effort to defend the airline’s market share against local competitors; AirAsia and new market entrant, Malindo Airways.

The next six months will determine if the Malaysia Airlines’ revenue management team of Hugh Dunleavy and Shihaj Kutty will be able to pull off a profit turnaround with their unconventional revenue maximisation strategy.

Can they pull off a recovery to silence their critics without an increase in yields?

They just might be able to if they manage to do exactly as Dunleavy has said:

“As capacity is added and RASK (revenue/ASK) falls, CASK (cost/ASK) will fall too. The trick is, which will fall faster and finding where the two cross.”

But would it not be easier to raise yields and RASK instead of diluting them further? If Malaysia Airlines can push yields up to match its competitors – this would be four sen at the least – the national airline will be able to add a staggering RM2 billion to revenue, assuming of course that load factor or capacity utilisation remains the same. That may be too much to ask for.

Yes, yield is not the only factor affecting profitability but right now it, or more accurately revenue management, is all important. Given Malaysia Airline’s low yield relative to other airlines and its quality product (i.e. a 5-star airline), the right positioning and marketing will get better results.

How many people know for instance that Malaysia Airlines is among the best in the world in terms of product quality? The main problem is marketing and revenue management.

Take a look again at the yield comparison chart. There is a yawning gap – a chasm between Malaysia Airline’s yield and those of its competitors. If  revenue/yield management is right, that gap will close and Malaysia Airlines will make lots of money.

If it can cut costs further – and Malaysia Airlines’ costs are not particularly high – it will make even more money.

No wonder so many people seem to be interested in buying Malaysia Airlines now but of course now is definitely not the time for the government, through Khazanah Nasional, to sell its near 70% stake – and it won’t be for a while yet.

Tomorrow: A brave new world for Malaysia Airlines

Yesterday: Malaysia Airlines, the ailing 5-star airline