06-Apr-2012 8:14 AM

MAS adjusts short-haul strategy again as plans for separate premium brand are dropped

Analysis

Malaysia Airlines (MAS) has dropped plans to establish a new short-haul premium brand, which was slated to take over the carrier's regional routes and had been a major component of its new business plan. The ongoing restructuring at MAS, which is aimed at restoring profitability at the flag carrier by next year, will now focus primarily on the long-haul operation. By and large it will be business as usual for the flag carrier's short-haul operation although it will still be separated out as a new division. As part of this separation, MAS will stop entirely the use of widebodies on short-haul routes, which is a common practice in Asia where regional routes are often thick enough to support large aircraft that otherwise sit idle between long-haul flights.

The reversal of last year's decision to establish a new company and brand for the full-service short-haul sector, under what MAS had called Project Sapphire, raises some questions about the long-term viability of the group's short-haul operation. But rapid renewal of the MAS narrowbody fleet, network adjustments and anticipated coordination with AirAsia could still lead to the financial improvements required for the new short-haul division to become profitable.

Project Sapphire began last year at about the time MAS and AirAsia agreed to their historic partnership agreement, which included an equity swap and the appointment of AirAsia's two top executives to the MAS board. Four months later, in Dec-2011, MAS confirmed plans for the new premium carrier as part of its new business plan.

The new business plan, which MAS said at the time was required to avoid bankruptcy, also included the discontinuation of several unprofitable long-haul routes, a 12% overall capacity cut, accelerated fleet renewal, long-haul premium product upgrades and new partnerships with foreign carriers as part of membership in oneworld. MAS quickly moved forward with its network restructure. The capacity cuts have been is place since early February and MAS is on track to achieve later this year more milestones that were outlined in the business plan, including placing into service five of its six A380s on order (required to improve its long-haul premium product) and formally entering the oneworld alliance.

But MAS has been very slow in proceeding with the planned changes to the short-haul operation. MAS initially said it would start shifting some of its 737-800s to the new short-haul premium carrier in early 2012. It also had outlined a network for the new carrier focussing primarily on major regional international destinations where there is high premium demand. As recently as late February, MAS told analysts that its short-haul operation was on track to be re-launched by the end of 1H2012.

MAS, however, never decided on a name or branding for the proposed new carrier (Sapphire was only the project name). MAS also never announced a configuration and product spec for the new carrier.

MAS had planned to split its traditional blue and red logo and branding according to business division: blue for long-haul and red for short-haul. This was partially realised when MAS announced an all-blue branding for its forthcoming A380s. Red for the short-haul operation would also have been a token gesture to the identity of Qantas, who MAS had considered establishing the operation with. Those talks ended in Mar-2012. MAS now says its all-blue branding will only be featured on its A380s.

Additionally, although the launch was supposedly only a few months away, MAS never lodged an application for a new air operator's certificate (AOC). MAS management said only two and a half weeks ago that it still planned to establish a separate premium short-haul carrier. But earlier this week MAS management disclosed there had been a change and that a new premium carrier and brand will no longer be established.

MAS to still establish new short-haul division

MAS says the separation of its short-haul and long-haul operations, which is already in the process of being implemented, will continue as planned with different management teams for both divisions. The new short-haul division of MAS will include the group's two turboprop operators, MASwings and Firefly, as well as the existing 737 mainline operation.

Firefly, which also briefly operated 737s under a hybrid regional/low-cost model before quickly closing the operation after MAS forged its partnership with AirAsia (FireFly's 737s competed with AirAsia), will continue to operate under its own code (FY) and AOC. MASwings and the 737 operation will continue to fall under the existing MAS brand and MH code.

Some changes to the MAS 737 operation are still expected in line with the new business plan and the carrier's increased focus on the top end of the market. But in light of the decision to not proceed with a separate premium brand and company for some short-haul routes, the changes will be less pronounced than originally expected. MAS plans to release more details on its revised short-haul strategy, potentially including product improvements, over the next few months.

MAS to no longer operate widebodies on short-haul routes

MAS tells CAPA there will be total separation between the two divisions and the long-haul unit will not operate any short-haul routes. MAS has not yet said where it will draw the line between its short-haul and long-haul divisions. But the carrier previously stated the new short-haul premium carrier would operate routes of four hours and less, encompassing destinations throughout Southeast Asia and parts of the Indian subcontinent and greater China.

MAS already only operates 737s on the international routes initially identified for the new premium short-haul carrier: Kuala Lumpur to Bangkok, Singapore, Jakarta, Manila, Ho Chi Minh City. On the domestic trunk routes to Kuching and Kota Kinabalu, which were also identified in the original network plan for new premium carrier, MAS currently operates 737s with the exception of two weekly flights to Kuching and three weekly flights to Kota Kinabalu.

Operating widebody aircraft on short-haul routes is not inherently poor strategy. In addition to genuine high demand that can support widebody capacity, great efficiences can be had by operating widebody aircraft on short-haul routes during times the aircraft would otherwise remain on the ground between long-haul flights. Such so called intentional misuse is a prominent strategy of carriers including Cathay Pacific, Thai Airways and Singapore Airlines.

In addition to reducing capital expenditure for short-haul aircraft, using long-haul aircraft on dense short-haul routes gives carriers a competitive advantage by offering a very premium product on a route that would otherwise see a regional product. This gives long-haul transfer passengers a high level experience throughout their trip. MAS will need to ensure it will not lose any of these advantages.

MAS mainline and new premium carrier planned network: as announced in Dec-2011

Unlike Thai Airways and Singapore Airlines, MAS already uses narrowbody aircraft for almost all its international routes within Southeast Asia (the only exception is Bali, which is served with a mix of 737s and Airbus A330s). But MAS operates widebodies on several international routes of four hours or less to the Indian subcontinent and greater China including Dhaka, Guangzhou, Hong Kong and Xiamen. It would seem MAS will be transferring these routes over to the new short-haul unit as part of the new short-haul strategy. MAS already uses 737s for some routes to the India and China including Bangalore, Hyderabad, Colombo, Male and Kunming. Routes to India and China in the five to six hour range such as Delhi, Mumbai, Beijing and Shanghai will most likely stay with widebody aircraft although technically most are just within narrowbody range.

The short-haul unit will account for a significant portion of MAS' overall seat capacity as routes of four hours or less account for five of the carrier's 10 biggest routes by seats. Singapore is the the carrier's biggest destination by seat capacity, followed by Jakarta.

MAS top 10 international routes by capacity (seats per week): 2-Apr-2012 to 8-Apr-2012

Dwindling labour advantages see premium carrier lose edge

The decision to not proceed with a new short-haul premium brand could be seen as a move to reduce risk and costs. Establishing a separate brand is an expensive exercise and can be risky as it is unknown how consumers - in both Malaysia and overseas markets - would respond. The process of establishing a new AOC and company also involves significant fixed costs.

One of the potential primary benefits of establishing a new company to operate premium-short-haul services was to lower labour costs as the new company was not intending to hire MAS employees at current wages and conditions, or absorb the inherent inefficiencies of MAS. But union resistance made moving forward with the plan for establishing a new company for the premium short-haul operation challenging. As it became unlikely the new company would be able to significantly reduce costs compared to the existing operation, the idea of going through the tedious and expensive exercise of establishing the new company became less desirable.

MAS will now need to focus on how to reduce costs of its short-haul operation without a significant change in labour costs. Costs can still potentially be somewhat reduced through re-fleeting as the 737-800s MAS are in the process of acquiring are significantly more efficient and can be utilized more than its ageing 737-400s.

MAS to replace 17 737-400s with 13 737-800s this year

MAS was never expected to expand its short-haul capacity as it introduced the new short-haul premium brand, but simply replace on a roughly 1:1 ratio the capacity now provided by its ageing 737-400s. Originally the plan was for the new 737-800s to be delivered directly to the new premium carrier while the 737-400s under the existing MAS brand and operation were phased out. MAS will still continue to take 737-800s at a rapid pace but the aircraft will now continue to be painted in MAS colours and operated under the MAS code.

MAS is slated to take delivery of 13 additional 737-800s in 2012, including six leased and seven purchased aircraft. The carrier plans to return 17 737-400s this year, leaving it with a fleet of only 15 737-400s and 29 737-800s at the end of 2012. MAS began the year with 16 737-800s, including seven owned and nine leased aircraft. Seven of these were added in 2011 as five 737-400s exited the fleet. MAS has been planning to phase out its last 737-400 by 2015 although with only 15 to be left in its fleet at the end of this year that date could easily be accelerated.

MAS also plans to take delivery this year of five of the six A380s it has on order and five additional A330-300s. The A330-300s will replace nine older A330-300s that are being returned to lessors while the A380s will replace eight 747-400s. MAS will be left with only one 747-400 at the end of 2012.

At the end of this year MAS will have a widebody fleet of only 36 aircraft and a narrowbody fleet of 44 aircraft, excluding the turboprops at Firefly and MASwings. It began the year with 43 widebody aircraft but no longer requires as many given the cuts to its long-haul network, its ability to increase average utilisation as the age of the fleet decreases, the higher capacity of the A380 compared to the 747-400 and its decision to stop using widebody aircraft on short-haul routes.

MAS planned aircraft movements: 2012

The rapid fleet renewal with 23 deliveries and 34 retirements this year will reduce the average age of MAS' fleet from 12.2 years to 7.7 years in only 12 months. MAS was already planning to renew its narrowbody and widebody fleets but decided to accelerate the process as part of its new business plan, bringing forward some A380 and 737-800 deliveries as well as some 747-400 and 737-400 retirements. The accelerated fleet renewal programme is a key part of the business plan as MAS is banking that a younger and more efficient fleet will help it return to profitability in 2013.

MAS incurred a net loss of MYR2.532 billion (USD826 million) in 2011, compared to a net profit of MYR220 million (USD71 million) in 2010. Revenues were up only 2% last year to MYR13.901 billion (USD4.54 billion). The operating loss for the full year was a staggering MYR2.296 billion (USD749 million), translating into an operating margin of negative 17% - by far the worse margin among major Asian flag carriers.

MAS financial highlights, 2011 vs 2010

The recently completed restructuring of its long-haul network should significantly improve the profitability of its widebody operation. MAS will now need to drive yield and revenue improvements across its short-haul operation without introducing a new brand. This could prove to be more difficult, especially as the short-haul network has been impacted by the cuts to the long-haul network, resulting in hundreds of city pairs being dropped from the MAS offering.

While MAS initially thought a new brand would help drive yield improvements to its short-haul operation this was contingent on the brand being successfully positioned as a premium brand. MAS may still be able to improve its short-haul yield using the existing brand. Improved revenue management, network adjustments and an enhanced premium service could lead to higher yields.

With MAS now partnered with AirAsia, it is crucial MAS differentiates its short-haul product regardless of if it introduces a new brand. MAS will continue to operate major domestic and regional international routes alongside AirAsia, with MAS focusing on premium traffic and connections to its long-haul network. Thinner leisure-focused short-haul routes will primarily only be operated by AirAsia. There are already several such routes that only AirAsia operates. The partnership envisions MAS and AirAsia cooperating on these routes with AirAsia helping feed MAS medium-haul and long-haul routes (at least those routes not operated by AirAsia X).

Regional premium carrier strategy represents untested waters

The decision at MAS to abort Project Sapphire highlight the challenges of a strategy that involves establishing a separate brand for the upper end of the short-haul market. The strategy of full-service carriers establishing a separate end for the lower end of the short-haul market is well proven, particularly in Asia. Most flag carriers in Asia now have multi-brand strategies, with the second and sometimes third brands focussed on the budget sector. Establishing a separate premium brand is inherently more difficult as the upper end of the market is much smaller and is not growing as fast. In addition, the main brand is already full-service and well established.

Thai Airways is now in the process of establishing a new brand, Thai Smile, for regional services. But it is only a sub-brand that leverages the mother brand and Thai Simle will use the same TG code as Thai Airways (in this respect Thai Smile is similar to MASwings). Thai Smile is also not a premium brand but will follow a hybrid regional full-service/low-cost model that aims to capture the upper end of the budget sector as well as some premium traffic.

Qantas also recently shelved plans to establish a regional premium carrier in Asia. The reasons behind the Qantas decision are different but the two cases are somewhat intertwined and combined they show the challenges confronting this kind of strategy. Qantas was originally preparing to launch its premium carrier in Singapore, where it has a large mainline operation. But Qantas decided in the end a Singapore-based premium regional carrier was too risky of a proposition given the uncertainty involved with securing the landing rights that were needed for the proposed 11-aircraft operation to be successful.

The business case for Qantas' Asian premium carrier was focussed heavily on China and India, where there is now little room for new services from Singapore-based carriers because of bilateral restrictions. Qantas was essentially told that it would be at the back of the queue if and when more rights for these countries became available. With only leisure focused markets such as Thailand available, Qantas decided the project was too risky to proceed, particularly in the current economic environments. Rights to India and China may have eventually become available but it was not a sure thing and waiting for such a scenario was simply too risky of a bet for Qantas.

Qantas, after grudgingly ruling out Singapore, decided to re-look at the Malaysian market, which it evaluated in its initial studies last year before deciding Singapore was the best place to base the proposed premium carrier. Establishing a premium carrier in Malaysia on its own was seen as too risky as the Malaysian premium market is smaller and Qantas currently does not serve Kuala Lumpur, therefore limiting options for feed. Establishing a joint venture regional premium carrier with MAS - which essentially involved Qantas investing in the carrier MAS was already planning to establish - became a possibility after MAS decided to join oneworld. But Qantas in the end decided against this concept as well. Such a joint venture could have been messy as the new premium carrier would have not been completely independent given its need to connect with MAS. Frequent changes in strategy at MAS as well as frequent political changes in Malaysia, which impact MAS as the carrier remains primarily government-owned, were a further deterrent.

MAS has gone through several strategic shifts, business plans and restructuring programmes in recent years. So it hardly comes as a surprise that its plan for a premium short-haul carrier, which just a couple of months ago seemed like a critical component to its medium and long-term strategy, has gone by the wayside. It is not necessarily the end of the world as the success of the new premium carrier was far from certain. But the challenges facing MAS' short-haul business have not disappeared. The ailing flag carrier still faces an uphill battle as it tries to quickly turn around a highly unprofitable operation.