A Significant Problem of the Airline Industry and the Profitability of the Company - Research Paper Example

The case of Air Asia Air Asia is an airline company whose core competencies are its budget low fares and the management efficiency. It is the first airline company that introduced low cost fares in Asia in December 2001. The no frills, low fares concept of airline service of Air Asia resulted to a new height in sales leadership and have excited other airlines to follow the trend. 1. External Factors that affect Air Asia. The factors that happen outside the business are external factors or influences. These external factors affect the internal functions of the business and possibly the objectives of the business and its strategies. Porter’s model for industry analysis describes these external factors as threat to business that categorize buyer and suppliers power as threatening to business. Some of the developments in Air Asia as a result of Porters are given below: Potential entrants. There are unlikely to have significant new entrants to the airline industry in Asia given the economic climate prevailing today and the high cost of capitalization, except maybe when powerful government would like to establish its presence in Asia. Suppliers. Oil costs are the significant variable cost to Air Asia that they cannot control but could be weaken by the strategy of forward buying of oil and futures exchanges in dollars that will provide a cost advantage to the company. Buyers. Because of low price competition, travelers can freely switch to one airline to another, thus there is a struggle to capture customers. It is most likely that budget fare companies will discount heavily just to fill in their seats. In like manner, corporate travelers, particularly, global companies will exert effort to make a good deal with airline companies to get discounts and lower prices. Substitutes. The development of high speed trains, buses and other transportation will have an impact to budget airlines as consumers will substitute local travels to airlines. Competitive intensity. The Rivalry is a major factor that influences operation of a business in the industry. At present, there are 10 best budget airlines operating in Asia that has been rated by Smart Asia Travel, an online travel magazine (rediff.com, 2008) as Asia’s top 10 budget airlines. On the basis of cheap tickets, reliable schedules, decent service, route network and access, Air Asia has been rated number one by this travel magazine. Other budget airlines that follow are Jetstar Asia, Nok Air, Tiger Airways, Cebu Pacific, Virgin Blue, Air Deccan, Spice Jet, Viva Macau and Hongkong Express. Rivalry among the budget airlines is considered intense because of its big number that competes for the same number of customers and market shares. Thus, there is a continuing race for leadership in budget airlines. Others reasons that intensifies rivalry among budget airlines are the high fixed costs of that requires airlines to implement strategies to attract passengers and fill the airlines into full capacity to attain the lowest cost per unit. High fixed cost is required in operating an airline, thus Air Asia needs to sell to a large number of passengers in order to attain profitability. This situation leads to increased rivalry. Because of these high fixed costs, a firm finds it hard to make an exit in the industry. Take for example, the situation of Air Asia that incurred huge losses before 2001 when it was owned by the government. The takeover of Tony Fernandez, a private investor revived the business and steered it to profitability. The new owner believed that “Before a business can grow, it needs to have its costs under control; it must be cost efficient and profitable” (rediff.com. 2008). Cyclicality. The airline industry suffered from the economic cycle and the underlying growth has been significantly lower than in previous years (New York Times, 2009). According to this report, hardest hit are the full-service carriers in the Asia Pacific Region where passengers and freight traffic have fallen rapidly than anywhere else. The news report said the global trend of travelers toward more affordable seats is hurting many full carriers like Cathay Pacific and Singapore Airlines. IATA estimates revenue losses from their 230 carriers of about $107billion this year. On the contrary, the trend towards use budget low fares airlines has seen significant growth during this time. Budget airlines like Air Star, Jet Star and Tiger Airways are unaffected and seem to be benefitting from this economic cycle (New York Times, 2009). SWOT analysis Strengths Weaknesses Opportunities Double digit passenger growth. Expanding network and ancillary revenue with low cost. Power of Air Asia network and subsidiaries Increasing demand for travel Outgrowing of terminals. Threats Rising Fuel Costs and currency movements. Expansion of competitions Fuel costs comprise bulk of airline expenses. Buyers’ power on switching airline The demand for Asian travel has shown an increase in tourist arrival. Xinhua News Agency (2003) cited the General-Secretary of World Tourism Organization who reported an 8.3 percent growth rate in tourist arrivals in the East Asia Pacific region. This news report said that there are about 131 million tourists’ arrivals in Asia thus ranking the region as the second in terms of world most welcomed region in the world for tourism. Asian tourism is further encouraged by governments thru its relaxed regulation policies as a means of tourism promotion (Xinhua News Agency (2003). Based on this trend, tourism experts believe that the Asia-Pacific region has the greatest potential in tourism development. 2. The core resources and competences of Air Asia In identifying the core resources and competences of the organization, Mckinsey’s 7S model that states that strategy, structure, systems, shared values, style, staff, and skills are important factors in analyzing the current situation and to ensure that the company is working well has been adopted (Mindtools.com. n.d.) In doing this, a profile and head to head analysis against key competitors on critical success factors is undertaken. Factors considered are network, airport facilities, landing slots and destinations, financial and brand strength, people, technical and logistic capability Air Asia has three separate operations: one in Malaysia, one in Thailand and one in Indonesia. The group network has a fleet size of 103 aircrafts, comparatively higher than from among the rest of airline companies offering low budget fares in Asia. Table 1 presents a comparison of network, airport facilities, landing slots and destinations and revenues of the 10 best budget fares airlines in Asia. There is lack of data for purposes of uniformity of comparison in a particular year, say 2009, but on the basis of what is available, Asia Air leads the rest of its competitor in terms of fleet, hubs, destinations and net revenues. Table 1. Network, airport facilities, landing slots and destinations. Budget fare airlines in Asia Fleet size Total passengers carried Hubs Destination Net Profit/Year Air Asia 103 12.1 million 9 60 US$160.88m(2009). Jetstar 55 Not found 5 30 US$115M (2007) Nok Air 6 Not found 1 14 US$8.666m(2009) Tiger airways 19 2.8 mil 3 37 US$22.7m (2010) Cebu Pacific 30 Not found 4 50 US$74.804m (2010) Virgin Blue 60 Not found 3 31 US$58m (2009) Air Deccan 21 1.65million 1 65 cities in India Fs9.64 crore (2006) Spice Jet 21 Not found 4 16 cities in India 10 crores (2010) Viva Macau 3 Not found 1 7 Not found HKExpress 3 Not found 1 7 passengers 5 cargo Not found Sources of data are gathered from each company’s report available at the company’s website. All of the ten airlines listed above are offering budget fares, but it could be judged that Air Asia’s core competency is its fleet size, hubs and destinations that offer travelers shorter travelling time in arriving at their destination. As shown, the core competency of Air Asia is its strategy to adhere to its 3-1/2 time flying time model (Zhu, A. 2008). 3. Evaluation of the organization’s strategic choices and its implications Air Asia has stated a mission “to be Asia’s leading low fare no frills airline and the first to introduce ticketless traveling”. Its company logo that states “Now everyone can fly” describes the company’s values. As the fares go down, Air Asia becomes a recipient of customers that previously cannot afford airline fares. Low budget airlines also capture the momentum of the economic cycle because of travelers who now look for cheaper ways of travelling. In line with the company’s strategy of cost leadership, Porters generic strategies for Air Asia would show: Competitive Advantage Target Scope Advantages Low Cost Product Uniqueness Broad industry(wide) Cost leadership strategy Differentiation strategy Narrow (market segment) Focus strategy (Low cost) Focus strategy (differentiation) Porter’s Generic Strategies Source: quickmba, n.d. Air Asia builds its strategy for providing a price much lower than its competitors in the industry and deriving income from ancillary services. Its strategies are differentiated by the efficiency and effectiveness in operations. For instance it has maintained the 3-1/2 time model of flying for cost efficiency. This strategy enables Air Asia to maintain some profitability edge against its competitors, and even if the price declines, the company can still maintain its operations more cheaply and will remain profitable for a longer period of time. Air Asia targets a broad market as shown by the number of its flight destinations in Asia Pacific region. For strategic broad industry wide target, Air Asia is able to establish cost leadership by being the first airline company to introduce budget fares travel in Asia. In a sense it has applied a differentiated approach that made the budget travel plan unique when it was started in 2001. Cheap flights were unheard of in Malaysia before Air Asia introduced the concept that practically cut the cost of tickets more than 50% to some destination compared to the conventional airlines (Air Asia) As part of the business strategy of cost leadership, revenue from ancillary services, air cargo services and baggage fees compensate for the increase of fuel and oil expenses. Ancillary revenue from this source contributed 18% or USD 53.1 million to the total 2nd quarter revenues of the company (Center for Asia Pacific Aviation 2010). Analysis of Air Asia current financial position, share performance and future prospects The budget fare strategy shifted the loss of the company in 1996 to a record high of sales in 2009 until today. Following are the financial highlights of the company for 2008 and 2009 Table 2. Financial Highlights of Air Asia for 2008 and 2009 In RM, millions 2008 2009 Net Profit/loss( millions) (496) RM 506 Net profit margin - 16.2% Return on Assets - 4.4% Return on capital employed - 9.6% Net debt 6,453 6,862 Total assets 9,406 11,398 Shareholders equity 1,606 2,621 Passengers carried 11,808,058 14,253,244 Capacity 15,660,228 19,016,280 Aircraft utilization per day 11.8 12.0 Source: Air Asia (2010) Note that the negative profit loss in 2008 has not been properly explained for lack of data. However, in 2009, Air Asia has positively transformed the loss to profit. As a result of the increased volume of capacity, passengers carried by Air Asia also correspondingly increased in 2009 along with its net revenue (Air Asia 2010). Competitive Analysis. Comparing ratios of company’s performance with that of its competitors will show relative performance that will present either the weakness or strength of the company. The analysis would show that Air Asia has exhibited its strength in financial performance because it has a higher profit margin than its closest rival air lines. Asia has a profit margin of 29.1% (Air Asia. 2010) while Jet Star, its closest rival, claims to have 23%. profit margin (Creedy. S. 2009). Another financial ratio that is relevant for business valuation is the Enterprise Value divided by the enterprise earning before interest, taxes, depreciation and amortization (EV/EVITDA). Air Asia shows an EV/EBITDA ratio of 7.80 for the next 12 months (Infinancials 2009). It could be observed that ratio is significantly higher than the median of its peer group that is 4.67. It could also be examined from the table that the financial ratios of Air Asia valuation is way above the market valuation of its peer group's; it is slightly lower than the average of its sector (Airlines) 8.15 % and is also consistent with the market valuation of its sector. Table 3. EV/EBITDA of Air Asia AIR ASIA BENCHMARK EV/EBITDA NEXT 12 MONTHS Company Air Asia 7.80 Peer group Air Asia excluded 4.67 Air Asia included 4.78 Sector Airlines 8.15 S & P 500 7.76 DJ Stoxx 600 6.64 Country MYS 7.92 Source: Infinancials 2009 In 2010, Air Asia reports growth of profits during its 2nd quarter performance that show positive outlook. The competitive landscape of Air Asia and Malaysia Airlines as shown in the chart below presents a contrasting outlook and a net loss of US$169 million to Malaysia Airlines due to higher fuel costs and hedging losses (Centre for Asia Pacific Aviation. 2010) AirAsia net margin vs Malaysia Airlines net margin: 1Q2008 to 2Q2010 Air Asia share performance Air Asia share price growth: Jan-2010 to Aug-2010 Air Asia is a publicly listed corporation in the Malaysia Stock Exchange. During the 2nd quarter performance, share of Air Asia shares show 24% increase that is almost on the level with Tiger Airways of 26.5% and had passed the Malaysian benchmark of KLSE 8.3%. 4. Devising a strategy As a move to step up further operations, India is recommended to be the next strategic target for Air Asia’s operation because this country is now considered as an emerging economy. India is proposed to be the next target market because of the following reasons. 1. Demand. India is a growing market and it will be advantageous for Air Asia to grow with the market. India has 1.1 billion people, US$3.1 trillion economy with a positive growth of 6.8%. (“Economy of India” n.d.) Demand for travel comes not only from tourists but also from small and medium enterprise business that do a lot of travel for business purposes and leisure. 2. Government policy in India is attractive for investors as government controls on foreign trade and investment have been reduced in some areas, but high tariffs (averaging 20% in 2004) and limits on foreign direct investment are still in place. The government has indicated it will do more to liberalize investment in civil aviation, telecom, and insurance sectors in the near term source.(“Economy of India” n.d.) 3. The present industry system. Air Asia adopts a low fare budget policy and a 3-1/2 time model of flying that could also be followed in the proposed Indian operations. An India Distance Chart attached as an appendix 1 shows many places could easily be covered by the proposed Air Asia Operations in India using its 20 airports as destinations. It is not recommended that things be done differently in India as the business model of Air Asia has been tested in many areas of its operations. 4. Considering the competition. At present there are two existing airlines serving the Indian route, the Air Deccan and the Spice Jet. The entry of Air Asia will not be a threat because the Indian market is big and there is still enough room for competition. 5. Estimating the future. The proof of the growing demands for aircraft in India is shown by the forecast of Boeing Co. that stated that there will be a need for 1,150 commercial planes worth US$150 billion for the next 20 years (Sharma, S. 2010). Boeing has estimated that airline passengers in this country will go up to 50 million this year, a growth from 44 million in 2009. 6. The average life style in India has changed because more and more Indian consumers are now buying luxury cars, going into customized holidays, eating out and spending on foreign vacations (Indian Report 2009) Definitely, this is a potential market opportunity for Air Asia because the number of foreign travelers is rising not only because of the increasing number of business trips, but also due to the growing popularity of India as a destination for medical tourism, rural tourism, heritage tours and adventure tourism. Even within India, more and more Indians are doing a lot of domestic and foreign travels for business and travel and the web-site travel has gained momentum (Indian Report 2009) Conclusion. Clearly, from the data presented, Air Asia has established its leadership in low budget fares in Asia. External factors that would most likely affect its operations are the availability of substitutes and the suppliers. Customers are always looking for a bargain and if rivalry becomes intense in pricing, the race for customers and to fill in the seats in the airlines will be one of the concerns of Air Asia. Added to this, are the developments of fast trains and buses that comes as an alternative for domestic travel. The volatility of the oil prices is a significant problem of airline industry and if remain uncheck cuts the profitability of the company. The forward buying of oil and hedging in exchange rate are risky proposition as there is an up and down trend in monetary exchange rate and in the prices of oil in the world market. The recommendation to pursue operations in India is based on the burgeoning population of the country, the growing economy and the changing lifestyle of the middle class travelers who travels for leisure, vacation and business purposes. Proposal is also based on the rising interest of tourists to visit India due to its numerous attractions as well as the growing attention to the country’s medical tourism. The tourism promotion is backed up by the Indian government that has relaxed its aviation rules and investment policies to attract investments. Appendix 1. Distance Chart or Distance Table of distances between some of the major cities in India. Distance From City Distance To City Distance (km) Mumbai (Maharashtra) Delhi (Delhi) 1166.17 Bengalooru (Karnataka) Kolkata (Bengal) 1560.04 Madras (Tamil Nadu) Ahmadabad (Gujarat) 1369.89 Hyderabad (Andhra Pradesh) Pune (Maharashtra) 504.09 Surat (Gujarat) Kanpur (Uttar Pradesh) 964.93 Jaipur (Rajasthan) Lucknow (Uttar Pradesh) 505.8 Nagpur (Maharashtra) Indore () 379.34 Patna (Bihar) Bhopal (Madhya Pradesh) 822.95 Ludhiana (Punjab) Agra (Uttar Pradesh) 463.8 Vadodara (Gujarat) Gorakhpur (Haryana) 832.84 Nasik (Maharashtra) Pimpri (Maharashtra) 151.96 Kalyan (Maharashtra) Thane (Maharashtra) 20.03 Meerut (Uttar Pradesh) Faridabad (Haryana) 71.68 Ghaziabad (Uttar Pradesh) Rajkot (Gujarat) 972.52 Benares (Uttar Pradesh) Amritsar (Punjab) 1058.87 Allahabad (Uttar Pradesh) Vishakhapatnam (Andhra Pradesh) 874.64 Jabalpur () Haora (Bengal) 858.73 Aurangabad (Maharashtra) Solapur (Maharashtra) 252.21 Srinagar (Jammu and Kashmir) Coimbatore (Tamil Nadu) 2575.91 Jodhpur (Rajasthan) Chandigarh (Chandigarh) 616.04 Madurai (Tamil Nadu) Guwahati (Assam) 2305.93 Gwalior (Madhya Pradesh) Vijayawada (Andhra Pradesh) 1108.33 Mysore (Karnataka) Ranchi (Jharkhand) 1532.6 Hubli (Karnataka) Jalandhar (Punjab) 1776.81 Thiruvananthapuram (Kerala) Salem (Tamil Nadu) 377.75 Distance From City Distance To City Distance (km) Tiruchchirappalli (Tamil Nadu) Kota (Rajasthan) 1625.41 Bhubaneshwar (Orissa) Aligarh (Uttar Pradesh) 1158.03 Bareilly (Uttar Pradesh) Moradabad (Uttar Pradesh) 81.92 Bhiwandi (Maharashtra) Raipur (Chhattisgarh) 918.89 Gorakhpur (Uttar Pradesh) Bhilai (Chhattisgarh) 646.55 Jamshedpur (Jharkhand) Cochin (Kerala) 1776.67 Amravati (Maharashtra) Cuttack (Orissa) 847.05 Bikaner (Rajasthan) Warangal (Andhra Pradesh) 1285.41 Bhavnagar (Gujarat) Guntur (Andhra Pradesh) 1062.85 Dehra Dun (Uttarakhand) Durgapur (Bengal) 1192.68 Ajmer (Rajasthan) Ulhasnagar (Maharashtra) 818.48 Kolhapur (Maharashtra) Shiliguri (Bengal) 1839.52 Asansol (Bengal) Jamnagar (Gujarat) 1734.73 Saharanpur (Uttar Pradesh) Gulbarga (Karnataka) 1406.58 Bhatpara (Bengal) Jammu (Jammu and Kashmir) 1722.38 Ujjain (Madhya Pradesh) Nangi (Bengal) 1277.39 Calicut (Kerala) Tirunelveli (Tamil Nadu) 350.88 Malegaon (Maharashtra) Jalgaon (Maharashtra) 119.29 Akola (Maharashtra) Belgaum (Karnataka) 602 Gaya (Bihar) Udaipur (Rajasthan) 1143.21 Korba (Chhattisgarh) Bokaro (Jharkhand) 371.76 Mangalore (Karnataka) Jhansi (Uttar Pradesh) 1450.04 Nellore (Andhra Pradesh) Tiruppur (Tamil Nadu) 466.75 Quilon (Kerala) Panihati (Bengal) 1983.75 Ahmadnagar (Maharashtra) Dhule (Maharashtra) 202.06 Source: India distance Chart. Globefeedcom. References Air Asia. 2010. Financial Analysis. GPRV Financial Analysis. Infinancials.com. Retrieved 09 December 2010 Air Asia 2010 Five Year Financial Highlights. Retrieved 08 December 2010 http://www.airasia.com/my/en/corporate/ir5yearfinancialhighlights.html Center for Asia Pacific Aviation. 2010. Air Asia Reports ‘record quarter’ in 2Q2010 ; 43% surge in profits; ancillary revenue and pax up. Retrieved 8 December 2010 from http://www.centreforaviation.com/news/2010/08/19/airasia-reports-record-quarter-in- 2q2010-43-surge-in-profits-ancillary-revenue-and-passengers-i/page1 Creedy S. 2009. Jetstar unveils big plans for home market. Business. Wall Street Journal. Retrieved 08 December 2010 from http://www.theaustralian.com.au/business/aviation/jetstar-unveils-big-plans-for-home- market/story-e6frg95x-1225808818798 Economy of India (N.d.) Mybangaloreproperty.com. Retrieved 09 December 2010 http://www.mybangaloreproperty.com/Economy_of_India/page_1897257.html 2 India distance chart. Globefeed.com. Retrieved 09 December 2010 http://distancecalculator.globefeed.com/India_Distance_Calculator.asp Indian Report 2009. Retrieved 09 December 2010 http://www.india-reports.com/Tourism- wk/index.aspx Mindtools.com (n.d). The Mckinsey’s 7S Framework. Mind Tools. Retrieved 08 December 2010 from http://www.mindtools.com/pages/article/newSTR_91.htm New York Times.09 June 2009. Downturn in Asia turns the tables on airlines. Intellasia. Retrieved 08 December 2010 QuickMba (n.d.). Porter’s Generic Strategies.Retrieved 08 December 2010 Rediff.com 23 October 2008. Asia’s top 10 budget airlines. The low cost flights. Retrieved 08 December 2010 http://thelowcostflights.com/asia-top-10-budget-airlines/) Xinhua News Agency. 16 July 2003. Asian Pacific Countries Unite for Tourism Promotion. Top News. China.org. Retrieved 09 December 2010 www.china.org.cn/english/2003/Jul/70055.htm Sharma S. 2010.Boeing raises India market forecast by15% as economic growth fuels travel”. Bloomberg. Retrieved 09 December 2010 http://www.bloomberg.com/news/2010-08- 03/boeing-raises-india-market-outlook-as-economic-growth-boosts-travel-demand.html. Zhu, A. 2008 Porter’s Generic Strategies n.d. quickmba . Retrieved 09 December 2010 from http://www.quickmba.com/strategy/generic.shtml Read More