case 9 airasia

8/13/2019 Case 9 Airasia

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airline would require a careful analysis of the basis of its existing cost advantage and anevaluation of the transferability of these cost advantages to the long-haul market.

The growth of AirAsia is closely associated with the entrepreneurial effort of Tony Fernandes.Son of a Malaysian doctor, Tony was sent to boarding school in Britain with a view tofollowing in his father's footsteps into the medical profession. The son had other ideas and,after an accounting degree at the London School of Economics, went into music publishing,first with Virgin, then Time Warner. He describes his decision to start an airline as follows:

I was watching the telly in a pub and I saw Stelios [Haji-Ioannou] on air talking abouteasyjet and running down the national carrier, British Airways. (Sound familiar?Hahaha.) I was intrigued as I didn't know what a low cost carrier was but I alwayswanted to start an airline that flew long haul with low fares.

So I went to Luton and spent a whole day there. I was amazed how people were flying

to Barcelona and Paris for less than 10 pounds. Everything was organized and everyonehad a positive attitude. It was then at that point in Luton airport that I decided to start alow cost airline.2

He subsequently met with Conor McCarthy, former operations director of Ryanair. The twodeveloped a plan to form a budget airline serving the South-East Asia market.

Seeking the support of the Malaysian government, Prime Minister Mahathir Mohammadencouraged Fernandes to acquire a struggling government-owned airline, AirAsia. With theirown capital and support from a group of investors, they acquired AirAsia for 1 Malaysianringgit (RM)and assumed debts of RM 40 million (about $11 million). In January 2002,

AirAsia was relaunched with just three planes and a business model that McCarthy describedas: "a Ryanair operational strategy, a Southwest people strategy, and an easyjet brandingstrategy."3

Fueled by rising prosperity in Malaysia and a large potential market for leisure and businesstravelers seeking inexpensive domestic transportation, AirAsia's domestic business expandedrapidly. In January 2004. AirAsia began its first international service from KL to Phuket inThailand; in February 2004 it sought to tap the Singapore market by offering flights from JohorBahru, just across the border from Singapore, and in 2005 it began flights to Indonesia.

International expansion was fueled by its initial public offering in October 2004, which raised

RM 717 million. Airline deregulation across South-East Asia greatly facilitated internationalexpansion. To exploit the market for budget travel in Thailand and Indonesia, AirAsia adoptedthe novel strategy of establishing joint-venture companies in Thailand (Thai AirAsia) andIndonesia (Indonesia AirAsia) to create new hubs in Bangkok and Jakarta. In both cases, theoperations of these companies were contracted out to AirAsia, which received a monthly feefrom these associate companies.

From the beginning, Fernandes had set his sights -on long-haul travelguided by the exampleof his hero, Freddie Laker, the pioneer of low-cost transatlantic air travel. However, this riskedhis good relations with the Malaysian government because it put AirAsia into directcompetition with the national airline, Malaysian Airlines. Hence, Fernandes established a

separate company, AirAsia X to develop its long-haul business. AirAsia X is owned 16% byAirAsia (with an option to increase to 30%), 48% by Aero Ventures (co-founded by Tony


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Fernandes), 16% by Richard Branson's Virgin Group, with the remaining 20% owned byBahrain-based Manara Consortium and Japan-based Orix Corporation. Operationally, AirAsiaand AirAsia X are closely linked.

In 2007, flights began to Australia followed by China. By July 2009, AirAsia X and Hangzhou

in China; and Taipei ana London using five Airbus 340swith three more to be delivered byyear end. Planed future routes included Abu Dhabi (October 2009), India (2010) and laterSydney, Seoul and New York. At Abu Dhabi, AirAsia X planned to have a hub that would serveFrankfurt, Cairo, and possibly East Africa too: "You just can't get to East Africa from Asia,"observed Fernandes.4 To support its expansion, AirAsia X ordered 10 Airbus A350s fordelivery in 2016.

Strategy

AirAsia described its strategy as follows:

Safety first: partnering with the world's most renowned maintenance providers andcomplying with world airline regulations.

High aircraft utilization: implementing the region's fastest turnaround time at only 25minutes, assuring lower costs and higher productivity.

Low fare, no frills: providing guests with the choice of customizing services withoutcompromising on quality and services.

Streamline operations: making sure that processes are as simple as possible. Lean distribution system: offering a wide and innovative range of distribution channels to

make booking and traveling easier.

Point-to-point network: applying the point-to-point network keeps operations simple andcosts low.-5

Prior to its expansion into long haul, AirAsia identified its geographical coverage asencompassing three-and-a-half hours' flying time from its hubs. Fernandes' confidence in hisgrowth strategy rested on the fact that: "This area encompasses a population of about 500million people. Only a small proportion of this market regularly travels by air. AirAsia believesthat certain segments of this market have been under-served historically and that the Group's

low fares stimulate travel within these market segments."6 Its slogan "Now Everyone CanFly!" encapsulated AirAsia's goal of expanding the market for air travel in Southeast Asia.

To penetrate its target market, AirAsia placed a big emphasis on marketing and branddevelopment. "The brand is positioned to project an image of a safe, reliable low-cost airlinethat places a high emphasis on customer service while providing an enjoyable flyingexperience." For an LCC, AirAsia had a comparatively large expenditures on TV, print andinternet advertising. AirAsia used its advertising expenditures counter-cyclically: during theSARS outbreak and after the Bali bombings, AirAs'7 boosted its spending on advertising andmarketing. In addition it sought to maximize the amount of press coverage that it received.AirAsia also built its image through co-branding and sponsorship relationships. A sponsorship

deal with the AT&T Williams Formula 1 race car team resulted in AirAsia painting one of itsA3 20s in the livery of the a Williams race car. Its sponsorship of Manchester United has


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resulted in it painting its planes with the portraits of Manchester United players. It alsosponsors referees in English Premier League. A cooperative advertising deal with Timemagazine resulted in an AirAsia plane being painted with the Time logo.

Its internet advertising includes banner ads on the Yahoo mobile homepage and a Facebook

application for the Citibank-AirAsia credit card with the goal of increasing visibility,encouraging intetaction and allowing users to immerse themselves with the AirAsia brand.

This heavy emphasis on brand building has provided AirAsia with a platform for providingservices that meet other travelers' needs. AirAsia offers an AA express shuttle bus connectingairports to city centers with seats bookable simultaneously with online booking of planetickets. Fernandes has also founded Tune Hotels, a chain of no-frills hotels co-branded with AirAsia. Tune Money offers online financial servicesagain co-branded with AirAsia.

Culture and Management Style

AirAsia's corporate culture and management style reflect Tony Fernandes' own personality:

Mr. Fernandes says that he came to the industry with no preconceptions but found itrigidly compartmentalized and dysfunctional. He-wanted AirAsia to reflect his ownunstuffy, open, and cheerful personality. He is rarely seen without his baseball cap,open-neck shirt and jeans, and he is proud that the firm's lack of hierarchy (very unusualin Asia) means anyone can rise to do anyone else's job. AirAsia employs pilots whostarted out as baggage handlers and stewards; for his part, Mr. Fernandes also practiceswhat he preaches. Every month he spends a day as a baggage handler, every twomonths as cabin crew, every three months as a check-in clerk. He has even established a

"culture department" to "pass the message and hold parties".7

The share offer prospectus describes AirAsia's culture as follows:

The Group prides itself on building a strong, team-orientated corporate culture. TheGroup's employees understand and subscribe to the Group's core strategy and activelyfocus on maintaining low costs and high productivity. AirAsia motivates its employees

by awarding bonuses based upon each employee's contribution to AirAsia'sproductivity, and expects to increase loyalty through its ESOS [employee shareownership scheme] which will be available to all employees. The Group's managementencourages open communication which creates a dynamic working environment, and

meets all its employees on a quarterly basis to review AirAsia's results and generatenew ways to lower costs and increase productivity. Employees . . . frequentlycommunicate directly with AirAsia's senior management and offer suggestions on howAirAsia can increase its efficiency or productivity . . .

In addition to the above, AirAsia:

inculcates enthusiasm and commitment among staff by sponsoring numerous social eventsand providing a vibrant and friendly working environment

strives to be honest and transparent in its relations with third parties . . . fosters a non-discriminatory, meritocratic environment where employees are offeredopportunities for advancement, regardless of their education, race, gender, religion,


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nationality or age, and

emphasizes maintaining a constant quality of service throughout all of AirAsia's operationthrough bringing together to work on a regular basis employees based in differentlocations.8

AirAsia's operations strategy comprises the following elements:

Aircraft. In common with other LCCs, AirAsia operates a single type of aircraft, the AirbusA320. (It switched from Boeing 737s in 2005.) A single aircraft type offers economies in

purchasing, maintenance, pilot training and aircraft utilization.

No-frills flights. AirAsia offers a single class, which allows more seats per plane. Forexample, when it was operating its Boeing 737s, these were equipped with 148 seats,compared to 132 for a typical two-class configuration. Customer services are minimal:complimentary meals and drinks are not served on board (but snacks and beverages can be

purchased), passengers pay for baggage beyond a low threshold, and there is no baggage

transfer between flightspassengers must do this themselves. AirAsia does not useaerohridges for boarding and disembarking passengersanother cost-saving measure.Flights are ticketless and there is no assigned seating. Such simplicity allows quickturnaround of planes, which also permits better utilization of planes and crews.

Sales and marketing. AirAsia engages in direct sales through its web site and call center. Asa result, it avoids paying commissions to travel agents.

Outsourcing. AirAsia achieves simplicity and cost economies by outsourcing thoseactivities that can be undertaken more effectively and efficiently by third parties. Thus,most aircraft maintenance is outsourced to third parties, contracts being awarded on the

basis of competitive bidding. Most of AirAsia's information technology requirements arealso outsourced.

Information technology. AirAsia uses Navitair's Open Skies computer reservations system(CRS), which links Web-based sales and inventory system which also links with AirAsia'scall center. The CRS is integrated with AirAsia's yield management system (YMS) that

prices seats on every flight / according to demand. The CRS also allows passengers(toprint their own boarding passes. In 2006, AirAsia implemented a wireless delivery systemwhich allows customers to book seats, check flight schedules and obtain real time updateson AirAsia's promotions via their mobile phonesan important facility in the Asia-Pacificregion because of the high use of mobile phones. While the YMS maximizes revenue by

providing trend analysis and optimizing pricing, the APS minimizes operational costs byusing the information generated by the YMS to plan and schedule the needed facilitiesmore efficiently. These two IT systems allow Air Asia to reduce costs in logistics andinbound activities. During 2005, AirAsia adopted an ERP (enterprise resource planning)system to support its processes, facilitate month-end financial closing, and speed upreporting and dara retrieval.9 This was superseded by an advanced planning and schedulingsystem, which optimizes AirAsia's supply chain management and forecasts future resourcerequirements.

Human resource management. Human resource management has been a priority forAirAsia since its relaunch under Tony Fernandes. A heavy emphasis is given to selecting

applicants on the basis of their aptitudes, then creating an environment and a system withdevelops employees and retains them. Retention rates are exceptionally high for AirAsia


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of which:Staff costs 236.8 2179.9Depreciation 347.0 327.9Fuel costs 1389.8 6531.6Maintenance and overall. 345.1 1146.4

Loss on unwinding derivatives 830.2 Other operating expenses3 139.2 5020.0Operating profit (less) (351.7) 305.5Finance cost (net) 517.5 60.8Pre-tax profit (loss) (869.2) 264.7After-tax profit (496.6) 245.6Total assets 9520.0 10071.6of which:

Aircraft, property, plant and equipment 6594.3 2464.8Inventories 20.7 379.7Cash 153.8 3,571.7

Receivables 694.4 2020.1Debt 6690.8 433.4Shareholders' equity 1605.5 4197.0

a For AirAsia the main components are aircraft lease expenses and loss on foreign exchange.For MAS i the main components were: hire of aircraft, sales commissions, landing fees, andrent of buildings.

Kuala Lumpur to London: Price and Cost Comparisons

A comparison of prices and costs allows a clearer picture of AirAsia's ability to compete in thelong-haul marketwhere AirAsia must position itself against some of the world's major

airlines. Between KL and London, AirAsia competes with at least six international airlines,among which the closest competitors are Malaysian Airlines, Emirates and British Airways.

Table 9.2 AirAsia and AirAsia X compared

AirAsia AirAsia X

Concept Low cost short haul,no-frills

Low cost long haul, no frills

flying range Within four hours flyingtime from departing city

More than four hours flying time from departingcity

Aircraft Airbus A320 with 180seats

Airbus A330 with more than 330 seats

Seat type Single seat Economy seat and Premium (previously knownas XL) seat

Seat option Fiee seating with XpressBoarding option

Assigned seating with advance seat requestoption

Inflightdining

Wide range of light mealsand snacks available for

purchase onboard the

Pre-ordered full meals available includingAsian, Western, vegetarian and kid's meal; lightsnacks also available for purchase onboardaircraft

TABLE 9.3 Fare comparisons: AirAsia and its competitors between Kuala Lumpur andLondon

AirAsia Xa Cheapest otherairline*3 AirAsia priceadvantage Cheapest otherairlines


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KL-Lcndon roundtrip

London-KL round

trip

US$433.96C

US$433.96C

US$683.68

US$530.35

36.5%

18.2%

1. Gulf Air,2. Qatar Air3. Emirates

1. Emirates,

2. Etihad,3. Gulf Air

a. Average fare between September 1 and October 1, 2009.b. Average of lowest airline fare on each day between September 1 and October 1, 2009.c. Average outbound fare: U.S.$187.87; average inbound fare: U.S.$209.48; meals and

baggage charges: U.S.$36.61.

A comparison of economy, round-trip airfares between the two cities is shown in Table 9.3. AsTable 9.4 shows, these fare differentials reflect differences in cost between AirAsia and itslong-haul competitors. These cost differences do not take account of differences in loadfactors, which can make a major effect on the average cost per passenger. AirAsia reports that

its KL-London flights have a load factor in excess of 90%. For the airlines as a whole, Table9.5 shows load factors.

There can be little doubt that AirAsia has been remarkably successful in building a budgetairline in South-East Asia. Its cost efficiency, growth rate, brand awareness and awards forcustomer service, airline management and entrepreneurship all pointed to outstandingachievement, not simply in replicating the LCC business model pioneered by SouthwestAirlines but adapting that model and augmenting it with innovation, dynamism and marketingflair that derived from Tony Fernandes' personality and leadership style.

TABLE 9.4 Flight operating cost comparison, Kuala Lumpur to London (in U.S.$)

AirAsia BritishAirways

MalaysiaAirlines

Aircraft typea Airbus Boeing Boeing

340-300 747-400 747-400Route KUL-STN KUL-LHR KUL-LHRMaximum

passenger286 337 359

capacity

Flight fuel cost 79 299 159 522 159 522

Leasing costs 5952 0 0

En rou~tenavigation

7949 12294 12 294

chargesTerminalnavigation

419 645 645

arrival chargesLanding/parking 1100 2200 2200Departure handling 6000 12000 12 000Arrival handling 6000 12000 12 000Segment totals

TOTAL cost per 106719 193 661 198 661flightb


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Average cost per 373.14 58S.50 553.37passenger6

a. KUL= Kuala Lumpur, STN = London Stansted. LHR = London Heathrow, DXB = Dubai.b. Excluding maintenance, depreciation, meal services and crew salaries.Source: S. Buchholz, N. Fabio, A. Ileyassoff, L. Mang, and 0. Visentin, AirAsiaTales from a

Long-haul Low Cost Carrier (Bocconi University, 2009). Data based on NewPacs AviationTool Software. Used by permission of the authors.

However, its AirAsia X venture presented a whole set of new challenges. AirAsia hadsuccessfully transferred several of its competitive advantages from AirAsia to AirAsia X. Thelow costs associated with fuel-efficient new planes, secondary airports and human resources

practices had allowed AirAsia X to become the low cost operator on most of its routes. TheAirAsia brand and reputation provided

TABLE 9.5 Difference between airlines in load factors (/o)

2004 2005' 2006 2007 2008

AirAsia 77.0 75.0 78.0 80.0 75.5

Emirates 73.4 74.6 75.9 76.2 79.8British Airways 67.6 69.7 70.0 70.4 71.2MalaysiaAirlines

69.0 71.5 69.8 71.4 67.8

Source: S. Buchholz, N. Fabio, A. Ileyassoff, L. Mang and D. Visentin, AirAsiaTales from aLong-haul Low Cost Carrier (case report, Bocconi University, 2009). Used by permission ofthe authors.

The Console Suppliers

For the console makers, 2009 was a troubling year. Sony and Microsoft had achieved revenuesthat were not far behind Nintendo but both were still losing money on their video game

businesses. During the first two years of product launch, losses were to be expectedbut Xbox360 had been on the market for almost four years and PS3 for almost three years. Mostobservers believed that these losses were primarily the result of the costs associated with thetechnologically advanced specifications of the two consoles. This was particularly the casewith PS3. By contrast, as a result of its inexpensive components, Nintendo had been earning acontribution from its Wii from the outset.

Moreover, profits from software were failing to fill the gap. Only 3.8 PS3 games per consolewere sold in the U.S. by March 2008 and 3.5 Wii games per console. By contrast, each Xbox360 user bought an average of 7.5 games. This pointed towards the emergence of Xbox as the

preferred platform both for serious game players and for games developers.

For Sony, the losses associated with PS3 pointed to the challenges of designing a console thatwould be a favorite among game players while also establishing the video game console as ageneral home entertainment device. The decision to incorporate a Blu-ray DVD player in PS3had little to do its ability to offer a superior video gaming experiencethere were few gamesthat exploited its functionality and few consumers had HDTV.

As the three leading console providers looked towards the future, two issues preoccupied them.First, what factors would determine which of them would emerge as a leader in the competitive

battle for the next generation of video game consoles? Second, as the games developers andpublishers grew in size and strength, had the console makers lost the capacity to dictate


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industry evolution and with it the capacity to reap profits?

Nintendo

1998 1999 2000 2001 2002 2003 2004 2005 2006

Total sales 534 . 573 531 463 554 504 514 515 509

Operating income 172 156 145 85 119 100 110 113 91Net income 84 85 56 97 106 67 33 87 98Op. income/Av. 10.6 9.9 6.1 9.7 9.5 8.9 10.5 .9,7 7.9total assets (%)Return on av. 14.0 12.9 7.7 12.2 12.0 7.4 3.7 9.6 10.4equity (%)

Sony

1998 1999 2000 2001 2002 2003 2004 2005 2006:

Sales of which: 6761 6804 6687 7315 7578 7474 7496 7160 7475

Games 700 760 631 661 1004 936 754 703 918

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