Case Study of Air Asia (Economic Perspective)

By | February 12, 2013

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1.        Introduction of Air Asia

 

1.1    Corporate profile

 

Air Asia since its foundation in 2001 with the vision to make “Everyone can fly” by focusing on the low cost aviation business sector through Air Asia’s own innovative solutions, efficient processes and a passionate approach to business as initially proposed and still facilitated now by the company’s original founder and the current CEO of the group, Tony Fernandes, it has successfully paved a viable way for its continual development in the aviation business. And now base in its headquarter, Kuala Lumpur, Air Asia has expanded its route network by connecting more than 20 countries and regions with the recently open flights connecting Tokyo and Paris though still the intra Southeast Asia middle to short distance flights still are the core business of the group, below is the route map of Air Asia flights originated from Kuala Lumpur, Malaysia.

 

Figure 1 Route map started from Kuala Lumpur

Source: Airasia.com 2011

 

 

1.2    Milestones achieved by Air Asia

 

Air Asia started to build its renowned brand as a quality low cost airline from the construction of its brand equity in the domestic market, for example in the single year of 2003 it had win the title of “Developing Airline of the Year 2003”, “CEO of the Year (Tony Fernandes)”, “the most popular website for online shopping in the 11th Malaysia” and so on; and since the next year, 2004, Air Asia had shown the fast growth trend and the potential to take the leadership in the Malaysian aviation industry and it win the “Market Leadership Award, 2005 Airline”, “Asia Pacific Low Cost Airline of the Year 2004” and other honors. And in the years of 2007, 2009, 2010, Air Asia were all awarded the “World’s Best Low Cost Airline” (Smith & Milligan 2011, p.53) and at the same period Air Asia had become the one of the most fast growing listed company and exhibited the power to be one of the best and most popular airlines in both the domestic and the international aviation industry. In October 2010, eight and a half years after the humble start of its business operations with just two aircraft and 200 staff, Air Asia had achieved the milestone of having carried more than 100 million passengers to become the continent’s largest low-cost carrier (LCC) in terms of passenger numbers (Eturbonews.com 2010).

 

1.3    Organizational structure

 

Organizational structure is the formal apparatus through which organizations accomplish two core activities: the division of labor and the coordination of work (Mintzberg 1979, p.2). And for the group of Air Asia, it has a number of functioning subsidiaries and partners in the group hierarchy with a joint effort to perform the tasks in the large business. The following figure shows the corporate structure and principal operating companies for Air Asia. And regarding the core business, Air Asia has three major strategic partners with which long term coorporation relationship have been built: Air Asia X (Focusing on the low-cost, long-haul segment), Thai Air Asia and Indonesia Air Asia. With the help of the functioning subsidiaries and strategic partners, Air Asia was able to make it known to the customers in a shorter period and also help it to save costs in a wide range of relative business activities.

 

 

Figure 2 Organizational structure

Source: Airasia.com 2011

 

1.4    Air Asia’s financial performance

 

Throughout the year of 2010, the overall financial performance of Air Asia group was very healthy and beyond people’s anticipation, in the single year it had achieved RM 1.07 billion in term of profit after tax with a 111% year on year growth, and its core operating profit grew by 83 percent by reaching 828 million ringgit, on the other hand the short term solvency was also very good with the cash balance totaled RM 1.5 billion in the end of 2009 to 2010 financial year. And in term of the financial leverage, the net gearing ratio had drop from 2.57 to 1.75 during the period from 2009 to 2010 representing a higher degree to which the company’s activities were funded by the company’s own funds rather than the creditor’s funds. The evaluation of the company’s financial performance compared with the company’s objectives will be elaborated more specifically in the discussion later.

1.5    Strategic orientation

 

In term of the strategic orientation, Air Asia has founded its core competitiveness based on four key foundations: low cost, efficiency, stimulate new markets and strong cash flow, and each foundation comes with respective company strategy adopted to achieve the same vision of the company which is to continue to be the lowest cost airline in every market the company is serving and will be serving and making more and more people being able to fly. And each foundation of the company’s core competitiveness comes with respective strategy to enhance the foundation and bring source of competitiveness to the company.

 

Figure 3  Air Asia’s strategic orientation

Source: Airasia.com 2011

 

2.        Objectives

 

There is dispute about the purpose of a for-profit corporation. The most common belief about the purpose of business articulated or not, seems to be that the primary purpose of business is to maximize profit (Duska 2007, p.40). And there is an increasingly popular view claiming that maximizing profit should not be the only principle of doing business for a company, the company should also pay attention to business ethics by being responsible to the employees, customers, local community and the society in a larger sense. This is also known as the view of stakeholder which involves any group or individual who can affect or is affected by the achievement of the organization’s objectives (Peng 2009, p.491), the view holds that the capacity of a business enterprises to generate sustainable wealth and the long-term value, is determined by its relationships with critical stakeholders (Post, Preston & Sauter-Sachs, 2002 p.52). And as we can see from the practical business experiences, the view of profit maximization actually does not necessarily contradict with the view of stakeholders because by taking good care of the stakeholders the profit generation and maximization could also be increased and enhanced especially in the long term’s perspective. This is also one of the key reasons why most of the large multinational companies will spend large sum of money and resource in building up good relationship with the stakeholders such as by participating the charity activities. Below we will use the stakeholder view to check the detailed objectives of Air Asia to the major stakeholders.

 

2.1    Maximize shareholders’ wealth

 

Before we can probe into the case of Air Asia, we have to distinguish the concept of shareholder wealth from the maximization of profits. On one hand, profit maximization is the predominant objective that emerges from static microeconomic model of the companies (Moyer, McGuigan & Kretlow 2009, p.9). One of the most frequent used methods to find out the profit maximization is the marginal revenue-marginal cost method. This method claims that profit could be maximized when marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC) for each unit sold. And if marginal revenue is greater than marginal cost, marginal profit is positive, and if marginal revenue is less than marginal cost, marginal profit is negative. When marginal revenue equals marginal cost, marginal profit is zero. And when the marginal profit is zero the profit is maximized because the output volume has reached equilibrium point and expanding which will incur higher cost than the revenue obtained.

 

Figure 4 Profit maximization using marginal revenue – marginal cost method

Source: (Hoag, A. J. & Hoag, J. H. 2006, p.174)

 

Three key problems with the model of profit maximization as an overall objective, as claimed by Watson and Head (2007, p.8), make this model only could be used as supportive tool in the managers’ decision making behaviors: firstly, the standard microeconomic model of maximization of profit is static which means that it does not consider the timescale factor. Decisions made based on the profit maximization model may not prepare a good basis to ensure the good profit generation in the long term; Secondly, there are various accounting definitions of the term profit and also it is still not clear that whether a company should maximize the total profit, the rate of profit or the earning per share (EPS). For example, expansion of the business will usually involve the issue of the new stock so that the new project could be funded, but this will mean that less earning per share. Let’s say currently there are currently 10 million shares earning 10 million dollar net profit annually, the expansion of the business will request the company to issue 1 million shares, but the new expanded business only brings out 0.5 million increase in the total net profit, such expand of the business though is advisable according to the rule of profit maximization but the earning per share has dropped from 1 (10 million / 10 million shares) dollar to 0.9136 (10.05 million / 11 million shares). Thirdly, the profit maximization objective offers no direct way for the management of the company to consider the risk associated with alternative decisions. As suggested by Baker and Powell (2005, p.10) that shareholders’ dividends are paid with cash rather than profit, and the timing associated risk of dividend payments are an important factor in determination of the shareholder wealth. So a company should focuses on increasing the shareholders’ wealth by taking into a number of factors including the time scale and risks factors but not just profit maximization.

 

Accordingly, as proposed by Ammon (2009, p.4), there are three key dimensions that can influence the shareholder wealth directly which include: (1) the amount of cash flows accumulating to the firm; (2) the timing of the cash flows accumulating to the firm and (3) the risk related with the cash flows accumulating to the firm. And companies could work hard on these three dimensions to maximize the shareholders’ wealth.

 

Though not mentioned in the mission statement, maximizing shareholders’ wealth is listed as one of the core visions that direct the development of Air Asia. It is stated by three points: (1) Resilient profit growth through our lower cost base; (2) Expansion of the Air Asia network in a prudent and disciplined manner; (3) Invest and enhance the Air Asia brand to increase investors’ returns. From this statement of the core value, we can see that Air Asia does pay attention to two of the three mentioned key dimensions to maximize the shareholders’ wealth: on one hand, Air Asia focuses on a prudent profit growth in a disciplined manner which could help control the uncertainties and risks in the business expansions; and on the other hand, Air Asia aims at increasing the investors’ return when investing and enhancing the Air Asia brand in the actual business practices.

 

2.2    Other stakeholders’ interest

 

As mentioned above, a stakeholder any group or individual who can affect or is affected by the achievement of the organization’s objectives (Peng 2009, p.491), and the key stakeholders’ interests need to be taken into consideration by organizations that are going to enhance their competiveness and increase the shareholders’ wealth in a long term perspective. Three major key stakeholders could be identified in the case of Air Asia considering current positions and its past experience: employees, customers and government.

 

2.2.1            The government

 

Though in a global scale, it is claimed that the airline industry should eventually become very commoditized and the market environment could be highly competitive (Holmes 2008, p.39), but as for the aviation industry which historically has strong government intervention, the government will always have a reason to intervene with the business behaviors in the airline industry because the control exerted by the government will allow safety and quality standards to be established and embedded within the industry and it also provides subsidies and other financial incentives to ensure the industry matures for the good of the nation especially after the happening of the 9/11 terrorist attacks. Looking back on the past 10 years, we still can see the severe influence from the government in the airline industry of Malaysia in particularly in term of the long time protectionist government policy toward the MAS (Malaysian Air). In 2006, the Malaysian government divided Malaysia’s domestic air routes between MAS (Malaysian Air) and the then new entrant, Air Asia which reduced the direct competition between the two giant airlines. And in 2007, the Malaysian government finally relieve the protectionist government policy toward the MAS by allowing the Air Asia’s sister company, the Air Asia X (in charge of the long-haul routes) to fly to Australia and some other long distance destinations. So we can see that it is very critical for Air Asia to build up good relationship with the home country government and foreign governments of the destinations that it is currently flying to and take into consideration of the government’s interest.

 

2.2.2            Focus on customer satisfaction

Consumer has always been one of the key stakeholders to many companies especially for those that are operating in a competitive market including the aviation industry where there are a number of domestic and international players who are interested in getting more market share by attracting more customers. In an economy perspective, customers will prefer to choose the products that are of greater values than other competitive products with easier access to them. So that the purchasing decisions that the customers make are of great important to the success and even the going concern of the companies. To care for the customers, Air Asia has its own value and goals in its business. Firstly, it targets at offering the much cheaper ticket in most of its routes to the great number of passengers though building up its own leanest cost structure in term of point to point operations and continuous cost reduction. This is in accordance of its vision to offer those who are previously can’t afford a ticket a chance to fly. Secondly, despite a low pricing strategy Air Asia also focuses in proving a unique and friendly Air Asia flight experience at every opportunity; Thirdly, Air Asia aims at providing a safest level that addresses people’s largest concern for low cost airlines.

 

 

 

2.2.3            Human Capital Development

 

Another business goal of Air Asia is based on the company’s mission to be the best company to work for whereby employees are treated as part of a big family, and this goal has been expressed as Human Capital Development in the company’s vision. To better integrate the employees into the company, Air Asia provide stock options to the employees to share with them the benefits and interest brought by the fast growth of the business which close relationship with the hard work has contributed by the employees. As the table shows, Employees Provident Fund Board as of 9 August 2010 owned 11.36% of the total share capital of Air Asia. What’s more, the company also treats the employees as human capital through encouraging the staffs to further develop their both hard and soft skills and do the job that they are really interested and the company work hard at providing such opportunities. For example, Air Asia in Kuala Lumpur has its own training base and there are even some stewardess became pilots after the internal training in the base.

Top 5 shareholdersPercentageHoldings
Tune Air Sdn Bhd25.95%729,458,382
Employees Provident Fund Board11.36%236,454,300
Genesis Smaller Companies6.01%184,208,552
Wellington Management Company5.02%152,647,600
The Nomad Investment Partnership Lp Cayman3.14%137,350,000
Others48.51%1,320,018,746
Total100.0%2,760,137,580

Table 1 Top 5 shareholders of Air Asia

Source: Airasia.com 2010

3.        Industrial analysis

 

3.1    Market structure and labor relations

 

Malaysia has long been referred as a “stifling regulatory environment” (Bamber 2009, p.53), and heavy regulation and strong power and influence from the government and relative department would means much less room for market competition. But such regulatory environment has been much loose for the near few years especially when in 2007 there was a relief effort of the protectionist government policy toward the MAS by allowing the Air Asia’s sister company, the Air Asia X (in charge of the long-haul routes) to fly to Australia and some other long distance destinations as mentioned above.

 

And in term of the labor relations, the two major airlines in Malaysia have two different strategies. Malaysian Airline (MAS) does accommodate unions in dealing with the labor relations while the Air Asia does avoid the unions. But MAS has a position called HR controller for discipline suggesting that MAS still adopts a control approach toward its employees (Bamber 2009, p.53). And as for Air Asia, it follows Southwest’s model by adopting a control approach with its employees and avoids unions (Belobaba, Odoni & Barnhart 2009, p.295).

 

3.2    Porter’s Five Forces analysis

 

One of the most frequently used tools in analyzing the competitive level of an industry is Michael Porter (1985)’s Five Forces model which suggests that the extent of attractiveness of a given industry is determined by five players which have a claim on the economic value created by the industrial activity. The five forces are: the intensity of rivalry among the existing competitors, the threat of potential new entrants, and the threat of possible substitutes, the bargaining power of buyers, and the bargaining power of the suppliers. Though it is claimed by (Hax & Wilde 2001, p.42) that the Michael Porter (1985)’s Five Forces model needs to be reinterpreted to recognize more economic forces, this model is still a very useful and widely applicable model of industrial analysis. Below we will start to perform an industrial analysis of the airline industry using the Five Forces model.

 

 

Figure 5 Michael Porter (1985)’s Five Forces model

Source: Mennen 2011, p.10

 

3.2.1            The intensity of rivalry among the existing competitors

 

The raising of the low cost airlines in the Southeast Asia followed the waves of the low cost airlines in the United States and the EU, and there had been high expectation for the experience of low cost airlines in the Southeast Asia, a market that is always very competitive according to Postorino (2010, p.69). And because that most low cost carriers (LCCs) in the Southeast Asia aviation industry have only enter into the business for a few years, the competition between the full-service carriers and LCCs has been intensified across the aria. Such rivalry among the existing competitors has been push up largely especially in the short-haul airlines in which passengers are more easily attracted by the operation efficiency and low tick fare which are the features of the LCC operations. Highly competition also could be seen between the regional low cost airline operators, for example, it is widely accepted that Tiger Airlines has been doing a better job in the route between Singapore and Kuala Lumpur as a LCC.

 

3.2.2            Threat of potential new entrants

 

In Malaysia, there is no state-operated airline though the government does own the Malaysia Airline, but the fact of privately-operated airlines shows that there is high degree to which the aviation industry has the freedom to operate for the potential new entrants. And also as reports said, in 2006, fed up with 34 years of red ink on the domestic routes of state-owned Malaysia Airlines, the government has turned to low-cost carrier Air Asia to bail it out. Starting in August, Air Asia will take over 96 of the airline’s 118 domestic routes, only four of which have been profitable (Sakran 2006). When the government could allow the entrance of Air Asia to bail out the state-owned airline, the new entrance would seek opportunities to enter into the Malaysian aviation industry to compete with Air Asia.

 

3.2.3            Threat of possible substitutes

 

It seems that threat from the substitutes of airplane is very limited because of the convenience, high safety record and great time saving provided by the flights. And also land transportations, the only substitutes so far have been trapped with a number of issues such as traffic jam and high risks in term of safety issues.

 

3.2.4            Bargaining power of the suppliers

 

The bargaining power of suppliers is strong in the aviation industry to the LLCs. Basically there are two suppliers in the industry: Boeing and Airbus, so the two suppliers will be able to exert very strong influence to the buyers, i.e. the airline operators. What’s more, due to the fact that the operation and control systems between Boeing and Airbus are very much different, the switching cost from one suppliers to the other will be very high, and also because the two type of aircrafts provide nearly the same onboard service in term of legroom, entertainments and other facilities so that basically it is claimed that there no reason for changing suppliers (Hill, Jones & Galvin 2004) resulting in high bargaining power of suppliers in the aviation industry in the perspective of the airline operators’ view.

 

3.2.5            Bargaining power of buyers

 

And obviously the bargaining power of the buyers which are the customers or passengers will have strong bargaining power of buyers, basically for each hot routes, there will be more than one airline operators which result in low cost and high possibility for passengers to change from one airline to the other airlines when they are not happy with the one of them.

 

4.        Performance analysis

 

4.1    Fulfillment of the goal- Maximize shareholders’ wealth

 

Below, the charts show performance in some key indicators of Air Asia from 2007 to 2010.

 

 

Chart 1 Financial performance from 2007 to 2010

Source: 2010 Financial reports

 

 

Chart 2 Financial performance from 2007 to 2010 (continued)

Source: 2010 Financial reports

 

The above charts provide two different conclusions. On one hand, Air Asia had largely grown its business in term of dramatic growth of the revenue, net cash flow and EBIT as shown in the data given. But on the other hand, the efficiency indicators suggest a much slower growth of the operation efficiency or even there is decrease in the return on total assets and net income margin. So we can see that Air Asia need to do a better job to increase its efficiency rather than focusing on the growth of the business or else it can not achieve the target of maximizing the shareholders’ wealth in practice.

 

4.2    Fulfillment of the goal- care for other key stakeholders

 

4.2.1            Punctuality figures

 

Chart 3 Punctuality figures from 2010 to 2011

Source: Airasia.com 2011

 

And because of the definition of ‘on-time’ departure is one that departs from the designated bay no more than 15 minutes from the scheduled departure time, the punctuality figures shows that the majority of the passengers (average more than 80%) due to whatever reasons (including the uncontrollable factors such as bad weather) will enjoy a punctual but still safe flight experience.

 

4.2.2            Number of passengers

 

One important key indicator the measure the fulfillment of Air Asia’s commitment to the customer numbers carried because the company’s vision is to provide the poor people who can’t afford the buy the tickets previously to be able to fly with Air Asia. The chart below shows that Air Asia is doing a good job in fulfilling its targets.

 

Chart 4 Number of passengers

Source: 2010 Financial reports

The End.

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