The Exit of Malaysia Airlines from Competitive Market s by Haris Awang

The Exit of Malaysia Airlines from Competitive Market 1

The Exit of Malaysia Airlines from Competitive Market

A. HARIS AWANG

A. HARIS AWANG MBA2016-04-1001 MBA 6063 Managerial Economics

Assignment: Part 4

Submitted to: Assoc. Prof. Dr. Abdul Rahim Abdul Samad

Department of Economics,Faculty of Economics and Management,

Universiti Putra Malaysia15th Oct, 2016

ASIA METROPOLITAN UNIVERSITY

Managerial Economics (MBA 6063)

Contents

CHAPTER 1: INTRODUCTION....................................................................................................1

Shutdown vs Exit.........................................................................................................................1

Market Entry and Exit formula and curves..................................................................................2

CHAPTER 2: LITERATURE REVIEW.........................................................................................4

Perfect Competitive Market.........................................................................................................4

Financial Performance.................................................................................................................6

The Restructuring, the Bailout and the Exit..............................................................................11

Economic Exit of MAS.............................................................................................................12

CHAPTER 3: DISCUSSION AND CONCLUSION....................................................................13

Did MAS Really Exit.................................................................................................................13

Implications on Exit...................................................................................................................13

REFERENCE................................................................................................................................16

APPENDIX....................................................................................................................................17

The Exit of Malaysia Airlines from Competitive Market i

CHAPTER 1: INTRODUCTION

While other airlines from the same region were making profits, Malaysia Airlines (MAS)

continued to make losses prior to the 2014 double disasters where flight MH370 from KL to

Beijing was lost and flight MH17 was shot down in Ukraine during its flight from Amsterdam to

KL. MAS was in the red for three years in a row prior to the disasters and suffered another year

of loss in 2014.

If MAS suffered a streak of losses and disasters why is it still operating today? Has it not faced

with the decision to exit? Did the situation raise a red flag to call for MAS to quit?

This paper is written from the context of MAS at its turning point after the double disasters in

2014. What happens now is a different story as it has undergone a transformation to a newly set-

up company with a big capital injection. The purpose of this paper is to look at the situation from

the economic perspective whether MAS made an exit and if it did, whether the action conforms

to the theory of long-run exit by taking into consideration the economic revenue, costs and

profits.

First, let’s take a look at the theory of long-run exit.

Shutdown vs Exit.

While shutdown is a short-run decision not to produce anything because of market conditions,

exit is a long-run process of reducing production in response to a sustained pattern of losses

which eventually leads to a long-run decision to leave the market. A firm that shuts down


temporarily must still pay its fixed costs. A firm that exits the market does not have to pay any

costs at all, fixed or variable.

Market Entry and Exit formula and curves.

In the long run, a new firm will enter the market if it is profitable to do so: if TR > TC.

Divide both sides by Q to express the firm’s entry decision as: Enter if P > ATC

MC

MRATC

profit

Costs, P

Q

P

As there’s profits to be made in the short run, more firms enter the market driving profits to zero

and restoring long-run equilibrium.

On the contrary, if a firm exits the market, revenue falls by TR, costs fall by TC. So, the firm

should exit if Total Revenue, TR < TC, Total Cost.


Divide both sides by Q to rewrite the firm’s decision as: Exit if P < ATC

MC

MR

ATC

loss

Costs, P

Q

P

Firms that suffer losses in the long run exit the market, driving profits to zero and restoring long-

run equilibrium.

The theory applies to firms that are under perfect market competition where there are many

buyers and many sellers, the goods offered for sale are largely the same and firms can freely

enter or exit the market.


CHAPTER 2: LITERATURE REVIEW

Perfect Competitive Market

Zhang and Czerny (2012) in their research on economics of transportation cite that airlines at

major hub airports usually are not atomistic and hence price-takers.

To see which type of market (Perfect Competitive, Oligopoly, Monopolistics or Monopoly)

under which MAS is operating, its characteristics have to be examined as in table 2.1 below.

Perfect Monopolistic Monopoly Oligopoly AirlinesIndustry

No. of sellers Many Many One Few ManyFree entry & exit Yes Yes No Yes YesLong run economic profits

Zero Zero Positive Depends on behavior*

Zero

The products firms sell Identical Differentiated No comparison

Identical Identical

Firm has market power None, price taker

Yes Yes Depends on behavior*

None, price taker

D curve facing firm Horizontal Downward sloping

Downward sloping

Depends on behavior*

Horizontal

Close substitutes Many Many None Limited ManyImportance of strategic interactions between firms

Low Low None Depends on behavior*

Low

Likelihood of fierce competition

High High None Low High

Table 2.1. Today’s airline industry is a perfect competitive market. *Oligopolies can end up looking like monopolies or like competitive markets, depending on the number of firms and how cooperative they are.

The operation of MAS has to be looked from the global perspective instead of local. Locally, it

appears to be a market with very few players i.e. MAS, Air Asia and Malindo but on the global


scale, there’s many players. MAS is also an international airlines operating across continents and

it serves not only the Malaysian market but also international. During the 2014 disasters, most of

the passengers affected were foreign nationals.

Table 2.1 illustrates that the airline industry under which MAS is operating is a perfect

competition market. The main characteristics that set it apart from other markets is the zero long

run economic profit as well as the price-taker or no market power in deciding price. Another

characteristic is that there are many players in the market, not only network airlines but low-cost

carriers (LCCs) as well. Although there are several reasons for losses suffered by MAS along

with other major Southeast Asia airlines, they are partially the result of the development of the

Middle East Big Three (Emirates, Etihad, and Qatar), the increasing penetration of low-cost

carriers (LCCs), and slowly spreading liberalization. (Pearson et al, 2015). Furthermore, Roy

(2015) states that MAS faces stiff competition in the international sector from rivals such as

Singapore Airlines, Thai Airways, Emirates, United Airlines, Lufthansa, British Airways, Virgin

Atlantic, Garuda, Cathay, China Eastern and China Southern. It is also noted that bargaining

power of buyers is strong with a number of airlines offering similar routes and services meaning

the industry is highly competitive and is likely to yield low returns. Based on the above

comparison and the nature under which MAS is operating, it is neither monopoly, monopolistic

nor oligopoly but a competitive firm operating in a perfect competitive market.

Under the competitive market, the long-run exit theory as explained in Chapter 1 can be applied

to MAS.


Financial Performance

After the downing of MH17 in Ukraine, MAS executives were focusing on finding a way to save

the company. Bankruptcy is one option. Taking the company private is another. Staying put,

however, is not an option. “In the current form, I firmly believe Malaysia Airlines won’t be able

to survive,” Mohshin Aziz, an analyst at Malayan Banking, told Bloomberg. “They will largely

exhaust all their capital and won’t have any money left to continue flying by the middle of next

year.” Hong Leong Investment Bank analyst Daniel Wong questioned whether the airline will

have the funds to endure two disasters in just four months. In the first quarter of 2014, MAS had

a cash-flow loss of RM350 million ($110 million) and RM2.3 billion ($726 million) in cash on

hand. Those dismal numbers included two months before the first disaster, the disappearance of

MH370, began hurting business. “With the expected worsening load factor and lower yields for

the remaining 2014, we believe MAS may need to raise fresh capital to keep MAS afloat by

2015,” wrote Wong. Hong Leong expected the airline to lose RM1.39 billion on sales of RM16

billion in 2014, following a loss of RM1.17 billion in 2013. And there’s no profit in sight for

Malaysian Airlines, with Hong Long estimating more losses next year and the year after.

(Einhorn, 2014).

Christoph Mueller, the newly appointed CEO in 2015 stated that, “We are technically

bankrupt… The decline of performance started long before the tragic events of 2014.” (Topham,

2015). His initial plan was to “stop the bleeding” in 2015, stabilize the business in 2016 and look

for growth in 2017. Unfortunately, he himself made an early “exit” in less than a year later,

citing personal reasons. (Wikipedia, 2016).


For three years in a row MAS registered after tax losses with 2011 being the worst at RM2.52

billion followed by RM431 million in 2012 and RM1.17 billion in 2013. (See table 2.2).

Table 2.2 MAS three-year financial performance 2011-2013. Source: Malaysia Airlines (2014).

A comparison with other neighboring Southeast Asia airlines is necessary to see if only MAS

alone suffered the consecutive losses. These other airlines are also subject to continuous

downward pressure on yields especially on competitive international routes and markets attacked

by low-cost airlines which destabilizes the process of matching supply and demand profitably.

Falling yields can be offset, where possible, by further reductions in unit cost levels. When this is

not possible then airlines must push up their load factors to compensate for the fact that they are

receiving less per passenger or per ton carried. It is when airlines lose control of this dynamic

process of matching yields, unit revenues and load factors that they start making losses.

(Doganis, 2010). Since these airlines are operating in the same industry, same region and

therefore subject to similar markets, the comparison is justified.


Table 2.3. Singapore Airlines three-year financial performance. (*Fiscal year ending 31, March). Source: Singapore Airlines (2014).

For approximately the same period*, Singapore Airlines registered an after tax loss of S$694.1

million in 2012, and after tax profits of S$390.2 million and S$538.5 million in 2011 and 2013

respectively as shown in table 2.3.

Table 2.4. Thai Airways three-year financial performance. Source: Thai Airways (2014).

Thai Airways registered net losses of 12 billion Baht in 2013 and 10.2 billion Baht in 2011.

However, in 2012 it registered a profit of 6.5 billion Baht as in table 2.4.


Table 2.5. Garuda Indonesia three-year financial performance. Source: Garuda Indonesia (2014).

Garuda Indonesia on the other hand, registered positive net incomes (profits) for the three

consecutive years of the same period. (Table 2.5).

Compared to other neighboring airlines that operate from the same region, MAS fared worst. To

compare the performance among airlines, ratios of (Loss)/Profit as a % of Revenue are

summarized as in table 2.6 and figure 2.1. It can be observed that while other neighboring

airlines are making profits, MAS continued to make losses with 2011 being the worst. Each

airline has its share of ups and downs but unfortunately MAS looks as though it was headed for a

nose dive.


Table 2.6. Performance comparison among four neighboring Southeast Asia airlines. Figures are in respective local currencies, conversion factors and annual reports.

Figure 2.1. (Loss)/Profit as % of Revenue of four neighboring Southeast Asia airlines.


The Restructuring, the Bailout and the Exit

The nation's state investment firm, Khazanah Nasional, which controls nearly 70% of Malaysian

Airline System Bhd., in August 2014, disclosed a $430 million plan to take the airline private, a

first step toward a restructuring exercise that aims to strengthen its financial. The government

injected more than five billion ringgit ($1.56 billion) over the last decade just to keep the airline

flying, and the double disasters were devastating blows. (Ng, J, Venkat P.R & Raghuvanshi, G.,

2014).

The next step by MAS was to cut 6,000 jobs, or about 30 percent of its work force. It also

received a bailout of RM6 billion from the Malaysian government as announced by Azman

Mokhtar, the managing director of Khazanah Nasional. (Fuller, T & Clark, N., 2014). By the end

of 2014, MAS shares were taken off of the Malaysian stock exchange.

In July 2015, under a recovery plan initiated in September of the previous year, Khazanah set up

a new company, NewCo, to take over all of the airline’s operations with 4,000 supply contracts

to be renegotiated and 6,000 employees due to be laid off. A new chief executive, former Aer

Lingus head Christoph Mueller, was appointed to head MAS. (Kumar, PP., 2015).

Christoph Mueller who later resigned less than a year after being appointed, in an interview with

German broadcaster Deutsche Welle (DW), pointed out several problems that have plagued

MAS for many years. Many of the 20,000 employees were “doing nothing”. “Despite all the

announcements by the government, a turnaround wasn't initiated by the time I became CEO. In

fact, when I walked through the hangars, people were sleeping.” MAS was also plagued by poor

personnel management and a bloated workforce. Mueller said MAS also suffered from a bloated

and overpriced supply chain, partly because the airline bought products from suppliers at prices

20 to 25 percent higher than the market value. “Everything from pens to US$200-million aircraft

were purchased at these rates. I am not saying that we were bad negotiators, and in any case

corruption is punishable also in Malaysia.” Mueller also pointed out that MAS had about 20,000

suppliers and, as a result, the glut made it difficult for the airline to get a volume discount from

anyone. (Malaysiakini, 2016).

The set-up of a new company NewCo marks the exit of MAS from the competitive market.

Profitability could not be sustained despite a decade long of government support. Despite bearing


the same brand, the new company under the bailout is another story and will not be covered

under this paper. Technically, MAS was bankrupt and has exited the competitive market.

Economic Exit of MAS

This section will discuss the economic theory with regard to the exit of MAS from the

competitive market. When Total Revenue, TR is more than the Total Cost, TC (TR > TC), it is a

signal for firms to enter the competitive market. When it is the other way around (TR < TC), it is

a signal for a firm that suffer losses to exit the market. For MAS it falls under the exit category.

From its annual report for 3 consecutive years prior to the double disasters and the restructuring,

MAS was running at a loss. Its total revenue has always been lesser than the expenditure. In

other words, MAS spent more than what it made. Even without going through economic

calculations, we can see that MAS was not financially healthy. If fact, it was technically

bankrupt and should be closed for good. From the economic point of view, it can be shown that

TR < TC, an exit signal which warranted for its exit. By 2014 it should have exited had it not

been a firm supported by the government bailout.

Profit = Total Revenue – Total Cost

Total Cost = Total Revenue – Profit

Profit = After Tax Profit + Tax,

(Note that the profit is actually Before Tax Profit)

Total Cost = Total Revenue – (After Tax Profit + Tax)


Calculating each year’s Total Cost using data from MAS Annual Report 2013 (Table 2.2, in

RM’000):

TC2011 = 13,901,421 – (-2,521,325 + 8,441) = 16,414,305 (> 13,901,421)

TC2012 = 13,756,411 – (-430,738 + 5,937) = 14,181,212 (> 13,756,411)

TC2013 = 15,121,204 – (-1,168,839 + 16,051) = 16,273,992 (> 15,121,204)

The Total Cost for each year is bigger than the Total Revenue for each year, (TC > TR). So,

based on the calculations, the exit of MAS from the competitive market is supported by the

economic long-run exit theory.

CHAPTER 3: DISCUSSION AND CONCLUSION

Did MAS Really Exit

Technically, yes. MAS exited the competitive market in July 2015 when Khazanah set up

NewCo to take over all of its operations. The present firm, Malaysia Airline Bhd. is a new set-up

operating under government bailout that inherits the old MAS’ assets, employees and culture.

The performance and the direction of the new MAS is beyond the scope of this paper. A research

is recommended to study if the new MAS is headed toward the right direction and whether it can

be as competitive as other airlines.

Implications on Exit

Had MAS really made the exit for good with no bailout, no NewCo or no government support

what will be the consequences or implications on consumers, markets and employees? This


section will discuss the implications with the assumption that there’s no more MAS old or new in

the market.

Musa M.B. (2014) pointed that, “Malaysia does not need MAS to project the nation’s image

abroad. Besides, the image MAS now projects is of the worse kind. Malaysia also does not need

MAS to bring in tourists. The other airlines including Air Asia do a fine job at that, and at no

cost to the government. Malaysians do not need MAS for their international travels. You can

choose from a dozen airlines to fly from Kuala Lumpur to San Francisco.”

In term of economics, the exit of MAS will shift the supply curve to the left which increases the

price and decreases the number of leisure travelers as the group is more sensitive toward price

changes compared to business travelers. The impact will be temporary as there will be other

firms entering the market to gain the market share vacuum left by MAS as the market proves to

be profitable.

P2

PRICE

QTY

S2

D1

S1

P1

Q1Q2

Table 3.1. The shift in supply when upon MAS exit from competitive market. Price goes up, travelers go down.


The exit would have cost 20,000 jobs which is a big loss to individuals’ economy. As technical

knowledge and skills related to the airline industry is not easily transferrable, employees may

find a hard time looking for jobs in other industries. Moreover, the airline industry in Malaysia is

very limited which makes it even harder for laid off employees to get back into the same

industry. A hard time for laid off employees means difficulty in maintaining financial

commitments and obligations which is a serious consideration that has to be looked into at the

governmental level.

In conclusion, there’s always reasons why MAS did not exit completely and instead rely of

government’s support. MAS has been a symbol of pride in Malaysia and closing it down is like

closing down a part of the country. But opinions may differ.


REFERENCE

Al Jazeera. (2015). Malaysia Airlines lays off 6,000 employees. Retrieved 09 October, 2016, from http://www.aljazeera.com/news/2015/06/malaysia-airlines-lays-6000-employees-150601105838604.html

Awang, A.H. 2009. Japan Trip. Photo for front cover.

Doganis, R. (2010). Flying Off Course: Airlines Economics and Marketing. (4th ed). UK: Routledge.

Einhorn, B. (2014). Bloomberg. Retrieved 11 October, 2016, from http://www.bloomberg.com/news/articles/2014-07-24/will-double-disasters-put-malaysia-airlines-out-of-business

Fuller, T & Clark, N. (2014). The New York Times. Retrieved 14 October, 2016, from http://www.nytimes.com/2014/08/30/business/international/malaysia-airlines-to-cut-30-of-work-force.html

Kumar, PP. (2015). Anadolu Agency. Retrieved 10 October, 2016, from http://aa.com.tr/en/economy/second-phase-of-malaysia-airlines-bail-out-announced/70542

Malaysia Airline System Bhd. (2014). Annual Report 2013. Selangor DE: Rizani bin Hassan (LS 0009520).

Malaysia Kini. (2016). Outgoing CEO: Many MAS employees were doing nothing, some sleeping. Retrieved 10 October, 2016, from https://www.malaysiakini.com/news/345682

Musa, M.B. (2014). Malaysia Today. Time to Sell or Liquidate Malaysia Airlines. Retrieved 10 October, 2016, from http://www.malaysia-today.net/time-to-sell-or-liquidate-malaysia-airlines/

Ng, J, Venkat P.R & Raghuvanshi, G. (2014). The Wall Street Journal. Retrieved 14 October, 2016, from http://www.wsj.com/articles/malaysia-airlines-set-for-buyout-1407467385

Pearson et al.. (2015). Competition between Asian Network Airlines and Low-Cost Carriers: Strategic Analysis. Journal of the Transportation Research Board, 2501, 56-65.

Roy, A. (2015). What determines airline profitability: Industry conditions or firm level capabilities? Academy of Taiwan Business Management Review, 11(2), 17‐23.

Samuelson, W.F & Marks, S.G. (2012). MANAGERIAL ECONOMICS. (7th ed.). US: Wiley.


Sidhu, BK. (2016). The Star. Retrieved 12 October, 2016, from http://www.thestar.com.my/business/business-news/2016/09/13/mas-picks-up-market-share/

Singapore Airlines. (2014). Annual Report FY 2013/14. Singapore: Ethel Tan.

Thai Airways. (2014). Annual Report 2013. Bangkok: Suvimol Bualerd.

Topham, G. (2015). The Guardian. Retrieved 12 October, 2016, from https://www.theguardian.com/business/2015/jun/01/malaysia-airlines-technically-bankrupt-christoph-mueller-cuts-boss

Wikipedia. (2016). Christoph Mueller. Retrieved 12 October, 2016, from https://en.wikipedia.org/wiki/Christoph_Mueller

Zhang, A & Czerny A.I. (2012). Airports and airlines economics and policy: An interpretive review of recent research. Economics of Transportation, 1, 15–34.


APPENDIX

Assignment: You are required to choose a topic from the course outline. Relate the topic to a

real issue and discuss it in three chapters. Chapter one should contain the theoretical explanation

of the topic. Chapter two should present the real issue. While chapter three should focus on the

main discussion of the real issue with policy implications.

END


The Exit of Malaysia Airlines from Competitive Market s by Haris Awang

Economy & Finance

Transcript of The Exit of Malaysia Airlines from Competitive Market s by Haris Awang