By Chan Quan Min
Strong headwinds ahead for the flag carrier Malaysia Airlines as the regional aviation market is further liberalised and new competitors enter the airline’s once sheltered territory. Gone are the days of its monopoly position of the nineties. In this third part of our five-part series we explore if Malaysia Airlines has what it takes to turn open competition into opportunity.
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These are tough times to run an airline. This is an industry that is seeing, on average, paper-thin profit margins worldwide.
Back home, Malaysia Airlines is expanding capacity so rapidly as to dilute already meagre yields, potentially jeopardising profitability.
Yesterday, we discussed the airline’s aggressive strategy to maximise revenue by selling as many tickets as possible, even dropping prices by as much as 14% on average in the second-quarter to do so.
Meanwhile, Malaysia Airlines has added a 20% increase to seat capacity in the year to date and is planning to add an additional 18% for the second-half of this year.
Is the airline playing a dangerous game of courting market share at the expense of profitability? While Malaysia Airlines’ senior management has been silent on this issue, there is every indication the flag carrier is attempting to muscle in on the battle for the skies.
‘Net profits per passenger were just US$2.56 (RM8.38)’
A July International Air Transport Association (IATA) report titled ‘Profitability and the air transport value chain,’ found:
“Over the past 30-40 years the airline industry has generated one of the lowest returns on invested capital among all industries.
“Despite the clear value being created for customers, the airline industry has found it difficult to make an adequate level of profits… after paying tax and debt interest, net profits per passenger were just US$2.56.”
Asia-Pacific’s incumbent network carriers, read: Malaysia Airlines, reported average return on invested capital of just 3.7% while low-cost carriers in the same region managed a higher 6.9% return on invested capital between 2004 – 2011.
Meanwhile, North American airlines, at best, are only able to extract a 3.3% return on invested capital, according to data compiled by McKinsey & Company for IATA.
But not all airlines face the same predicament of elusive profits. While the industry as a whole has been reporting anaemic profit margins, there are clear winners and losers.
Indeed, Malaysia’s very own AirAsia boasts one of the highest reported profit margins in the airline industry, consistently over 20% over the past several years.
As the IATA report noted, “profit is of course a reward for risk.”
While the report did not find a conclusive explanation for poor airline profitability along the lines of business model or geography, it is obvious competition within the airline industry is severe.
And in the next few years, the competitive environment is expected to intensify as regional markets are opened up to competition.
Eroding market share
Malaysia Airlines dominated the local aviation market for much of its history up to the late nineties. In the absence of any significant competition the flag carrier grew comfortable, after all, ticket prices could be kept high without objection.
Then, a low-cost carrier by the name of AirAsia entered the scene and ushered in a new age of, ‘Now everyone can fly.’ Competition was inevitable, and the spunky new airline has since grabbed half the domestic market and a sizeable chunk of international capacity out of Malaysia.
Today, the industry is again seeing a new wave of additional capacity, in the domestic arena in particular. The two big players Malaysia Airlines and AirAsia have added in the year to date a huge number of new flights, as has the new market entrant, Malindo Airways.
Trunk routes from Kuala Lumpur to East Malaysia have seen the largest capacity increases. Combined, the Kota Kinabalu, Kuching, Miri, Sibu and Tawau routes, between January and August this year experienced a 36.3% increase in total seat capacity.
Coincidentally these five East Malaysian routes were the first handful of routes served by Malindo Air.
Despite adding flights to these five East Malaysian destinations, Malaysia Airlines’ market share has shrunk 3.7 percentage points to just under a third of the market, unable to keep up with AirAsia and Malindo Air.
A new expansion phase
Malaysia Airlines is entering a new expansion phase, Malaysia Airlines CEO Ahmad Jauhari Yahya announced in an Aug 21 presentation to the media.
Jauhari said Malaysia Airlines would no longer be cutting routes. Instead the airline will be adding frequencies to already served destinations as well as opening up new or previously cancelled destinations.
To be exact, the national airline had been hard at work adding capacity as early as the beginning of this year. Some 20% additional seat capacity has been added this first-half, and the airline has indicated that the second-half will see an 18% increase.
According to Jauhari, the airline is expanding capacity by ‘sweating its assets’ – working its planes harder and flying them for more hours in a day. In industry speak this is called increasing the utilisation rate.
With new aircraft entering the fleet on a one-for-one replacement basis much of the capacity increase is due to a larger aircraft with more seats replacing an older plane, as is the case with the Airbus A380 replacing the Boeing 747.
Malaysia Airlines is a ‘victim of consequence’ when it comes to capacity expansion, said Mohshin Aziz, an analyst at Maybank. The decision to buy humongous aircraft was made by the last management team with the present team having no choice but to accept delivery of the newly purchased aircraft.
If indeed the capacity expansion was inevitable because of both the timing of aircraft deliveries and the move to improve efficiency by ‘sweating the assets’ then this turns on its head the view that the airline had been foolish in their expansion.
While there are no hard and fast rules to airline management, Malaysia Airlines’ capacity increase has come at the expense of yields or revenue per revenue passenger-kilometre.
As discussed in yesterday’s issue, much of Malaysia Airlines’ financial troubles are due to weak yields.
CIMB Investment Bank analyst Raymond Yap sums up perfectly Malaysia Airlines operational strategy:
“(Malaysia Airlines’) strategic objective in 2013 has been to increase the utilisation of its fleet and grow capacity even if it comes at the expense of yields. The goal is to maximise revenue as long as revenue growth exceeds growth in variable costs. While logical, this goal is difficult to execute successfully in the current weak yield and highly competitive environment.”
The next few years should see changes afoot at Malaysia Airlines. The airline recently joined the Oneworld alliance and should be able to derive some synergies from increased cooperation with partner airlines within the alliance.
Joining the Oneworld Club
Malaysia Airlines is now part of an international airline alliance, Oneworld, along with aviation bigwigs such as Cathay Pacific, British Airways, Japan Airlines and Qantas.
There is no doubt Malaysia Airlines will soon see the benefits from joining a global airline alliance. For far too long the airline was one of only a handful of international airlines unaligned to any of the three big airline alliances.
Very few, if any, major international airlines continue to operate independent of an alliance, the most obvious example being Emirates.
Joining a global alliance has opened up the entire network of its Oneworld partners for Malaysia Airlines to offer connections on.
Joining an alliance is a sure and tested way to expand an airline’s network ‘virtually’ by offering seats on partner airlines flights to destinations not currently served.
Partner airlines also cooperate on common routes through codeshares and an integrated frequent flyer mileage rewards programme – for Malaysia Airlines this is called Enrich.
At this stage it is difficult to quantify the net benefit of alliance membership for Malaysia Airlines, as data is not readily available. But anecdotal evidence is promising.
Malaysia Airports Holdings (MAHB) managing director Bashir Ahmad speaking at the CAPA Australia Pacific Aviation Summit on Aug 9 was reported as saying, “we have seen our transit traffic improving (since Malaysia Airlines joined Oneworld).”
Malaysia Airlines head of commercial, Hugh Dunleavy said interline passengers (passengers from partner airlines connecting to Malaysia Airlines flights) increased 60%. He said this in mid-June, just months after the airline joined Oneworld.
Asean Open Skies set to take off in 2015
Come 2015, when Asean Open Skies takes effect, the regional aviation market will be liberalised to allow an unlimited number of flights between all 72 international airports across the Asean economic bloc.
The open skies agreement grants third, fourth and fifth freedom rights to all airlines from Asean member countries.
“This will enable airlines to access more cities within the region, and also give them the right to fly beyond the first destination onwards to the second destination in the region – provided that these are international routes,” said Mohshin Aziz, explaining the details of the agreement.
Granted, Asean Open Skies is not true ‘open skies’, because there is still a demarcation between international and domestic sectors, with domestic sectors within Asean nations still protected from foreign airlines.
But it will grant greater operational freedom across international boundaries from the current situation.
Ownership rules will be relaxed, with Asean based shareholders allowed to own up to 70% of airlines, up from the current 40% to 49% limit.
Airlines eyeing regional expansion used to have to establish local affiliates with the help of local partners. The new ownership rules might change that.
Analysts predict competition will heat up when Asean Open Skies comes in force, in line with developments with other open skies jurisdictions.
“Competition increased with record numbers of new airliner start-ups, resulting in lower fares for travellers, greater numbers of people travelling, greater choice of airlines and routes, and improved service levels,” said Mohshin in reference to both the European Union and Trans-Tasman (Australia and New Zealand) open skies agreements.
The AirAsia group, said Mohshin, will be the single largest beneficiary of Asean Open Skies. He explained: “With the Open Skies in hand, (AirAsia) can mobilise its capacity and manpower freely across the region and derive the densest route permutations imaginable.
While the Malaysian aviation sector as a whole stands to benefit from Asean Open Skies because of the country’s relatively low cost of operations, excellent infrastructure and robust aviation market, Malaysia Airlines is set to lose a little, according to Mohshin’s analysis of the effects of open skies on the carrier.
“Asean Open Skies is slightly negative to MAS, in our view. (Malaysia Airlines) will have to endure a higher level of competition on its Asean routes, and this may dilute down on its profit margins,” Mohshin said.
“We also doubt that MAS is keen to use its fifth freedom rights across intra-Asean airports given that it is focused on its hub-and-spoke strategy.”
To sum up, liberalisation can be a double-edged sword for Malaysia Airlines. Will the airline use it as an opportunity to expand into new regional markets? We are seeing signs of a revitalised more aggressive Malaysia Airlines.
With a relatively young fleet and an excellent product, Malaysia Airlines is far more ready than most to compete regionally. But first the airline will have to fix problems closer to home. It will need to balance its books and deliver a sustainable profit.
Can the management team succeed in delivering a profit by end-2014 before Asean Open Skies kicks in?
Yesterday: Malaysia Airlines can gain lots from revenue management
Tomorrow: Third time lucky for Malaysia Airlines turnaround?
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