By Stephanie Jacob
Malaysia Airlines is a great airline in terms of its services, on-time performance and safety – notwithstanding the crashes. So what’s wrong with it? It just does not seem to be able to command the kind of prices that a full-service five-star carrier should. And that comes down to the science and art of revenue management.
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Malaysia Airlines chief executive officer (CEO) Christoph Mueller has to grapple with two key variables when he thinks about maximising revenue from an airline which is basically operationally quite sound as we saw in the previous article – airfares and capacity utilisation.
In simple terms, this involves setting the right fare at the right time which will result in the planes being filled by the right amount for every single route. In practice, that is a hugely complicated task typically done with the aid of computers.
Former MAS CEO Idris Jala, now a minister in the Prime Minister’s Department, estimated that there were over two million price combinations for the airline’s routes depending on the type of ticket, when the booking is made and terms and conditions, among others.
Get the revenue management wrong, and the airline is doomed even if everything else is right. The idea is to get the right kind of price for the kind of service level provided. You cannot charge low-cost fares for premium service levels, for instance.
That was what MAS was doing for some regional and local routes where its fares were lower than competitor AirAsia’s in an attempt to fill its planes.
Finding the revenue sweet spot
An extremely simplified version of the task facing Mueller can be explained through the challenge a nasi lemak seller faces when he tries to maximise revenue. Imagine Pak Khairie a nasi lemak seller agrees to buy 20 packets of nasi lemak from a nasi lemak maker at 50 sen per packet, for a total cost of RM10.
Pak Khairie’s aim is to sell as many packets of nasi lemak at a price which will get him as much profit as possible. On day one, he prices the nasi lemak at RM1.50 per packet and sells 10 packets. This earns him RM15 in revenue and RM5 in net profit.
On day two, he decides he still needs to boost sales. So he prices his nasi lemak at RM1, in the hope that increased sales would make up for the revenue shortfall from dropping his price. He succeeds in increasing the number of units sold to 14. Because of the lower price, revenue falls RM1 to RM14 despite more packets sold. Profit too falls by RM1 to RM4.
He now knows that RM1 per packet is not enough, because he was not able to match his first day’s earnings even though he sold more packets than on day one. So on day three, he sells the nasi lemak at RM1.20 per packet and manages to sell 13 packets, and this gives him a profit of RM5.60.
Finally, Pak Khairie has found the sweet spot between price and sales, because at RM1.20 per packet he has managed to sell more of his inventory than when he was selling at his highest price, while also making a greater net profit than he did then. He did this through effective revenue management.
Of course, Mueller’s task will be significantly more complex given that there are about two million possible price combinations that MAS has to take into account when trying to establish a balance between capacity utilisation and fares. Nonetheless, revenue management will need to be the key area of focus for MAS’ management team.
MAS has a revenue disadvantage to its peers
Many have pointed out that some immediate relief might come from cost savings which could come from route rationalisation, fleet reduction and workforce cuts – analysts have called this the low-hanging fruit that can and should be addressed quickly.
But reducing cost alone is unlikely to be enough to rescue the airline from its financial doldrums as MAS in fact has a slight cost advantage to its regional peers. As can be seen in Graphic 1, the peer average for the airlines’ unit cost or cost per available seat kilometre (CASK) is about 22.2 sen, while MAS’ unit cost is 21.4 sen, making it the lowest among its regional competitors.
However, this slight cost edge is nullified by the more significant revenue disadvantage MAS has to those others, as MAS’ yield is also lower than that of the other airlines. The peer average is about 22.7 sen while MAS’ is 20 sen – 13.5% lower from the average.
This is a significant issue which Mueller will have to address. Former CEO Ahmad Jauhari Yahya might have prioritised load over yield, but himself said in early 2013 that a single sen increase in yield translated into a RM500 million increase in revenue.
So the 1.3 sen difference between MAS’ yield and the peer average is setting it back almost RM650 million in revenue.
The terms you need to know for revenue management are given in the table with their definitions. ASK is essentially a capacity measurement while RPK represents capacity used. The load factor, RPK as a factor of ASK, then is a measure of capacity utilisation.
The yield is often used as the de facto measurement of pricing, effectively the amount paid for every RPK flown. But this is not as important as RASK, which takes into account capacity utilisation and measures the revenue obtained for every ASK flown. RASK = yield X load factor, where yield is the de facto indicator of price.
And then you total up the costs of operations and divide this by capacity (ASK) to obtain the CASK. Subtracting CASK from RASK gives you the unit operating profit per ASK.
Typically, if you raise the price (yield), less people may buy tickets and the load factor goes down. But unless the load factor goes down by more than how much the price goes up, you are still in positive territory. So the idea is to increase yield up to a point when revenue is maximised.
Focus on yield has been positive for MAS before
When Idris Jala took the helm of MAS, he placed a focus on yield management. Jala was appointed by the government in late 2005 to rescue the airline after it posted a RM1.3 billion loss in the first nine months of that year.
As can be seen in Graphic 2, yields grew sharply under his charge and by 2006 MAS’ yields were in tandem with some of its regional peers like Cathay Pacific and Thai Airways. The impact of the increasing yields on MAS’ bottom line was quick, and in 2006 losses were reduced to RM100 million.
In 2007, MAS’ yields surpassed that of Cathay and Thai Airways and this helped contribute to a RM900 million net profit. The airline remained in the black in 2008 recording a profit of RM200 million as yields continued to grow and at one point even surpass that of Singapore Airlines.
The global financial crisis (GFC) began in 2008 and continued into 2009, and during this period MAS’ yield fell significantly in tandem with that of its regional peers.
But unlike its competitors MAS’ yields did not recover after the GFC (see Graphic 2). And in 2011 with MAS’ yield lagging behind its peers, the airline fell back deep into the red with a RM2.5 billion loss.
Although AJ and his team did succeed in paring those losses down to a certain extent, as at the first half of 2014 MAS losses still stood at about RM750 million. The airline was delisted by Khazanah Nasional Bhd in December 2014.
What has caused MAS’ low yields?
Certain key decisions and strategies have impacted MAS’ yields such as the strategy to compete with low-cost carriers AirAsia and AirAsia X. Over the past few years, MAS significantly raised its capacity especially on regional routes such as those to Australia.
To fill its planes, it then discounted fares heavily and at times were offering rates lower than AirAsia X while offering full service carrier products. The move certainly hurt AirAsia X, but it did not do much for MAS’ bottom line either.
The “load active, yield passive” strategy also has been proven to not work for MAS as finding the balance between capacity, cost and fares has proven elusive. In 2013, MAS posted record high load factors of more than 80% but ended the year with RM1.3 billion in losses.
The focus on regional operations is also questionable given the large low-cost carrier presence which makes it hard for MAS to command the kind of prices (yield) it needs to be able to offer the product it does.
Mueller must get MAS’ revenue management right and that depends largely on yield. If his predecessor was correct and 1 sen of yield translates into RM500 million in revenue, then even a small improvement in MAS’ yield will go a long way in getting the airline back into the black.
Based on Graphic 3, if MAS can get a yield equivalent to that of Thai Airways, the next lowest, it will gain 1.25 US cents which works to about 4 sen. This translates to a huge revenue gain of RM2 billion which should be more than enough to wipe out its 2014 losses.
Yesterday: What’s right with Malaysia Airlines
Tomorrow: What should Malaysia Airlines do
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