Harvards Business Case Study (HBS)

Briefly describe the trends in the global airline industry.

Firstly, cost pressures on airlines continue to be high. The industry is facing many challenges on the cost side. For instance, jet fuel costs, which are directly correlated with oil prices, continue to rise. Airlines are generally unable to pass these costs onto the consumer, especially in the face of growing competition and price-sensitive markets. Nevertheless, these high fuel prices have motivated manufacturers to create more fuel-efficient aircrafts. Secondly, airlines are becoming more environmentally conscious, partly (or mainly)due to stricter emission and noise regulations. Globally, governments are more concerned with the implications of air travel to issues such as global warming and climate change. This is seen by Australia being one of the first countries to implement a carbon emissions tax, and the EU’s plans to implement a similar initiative. Thirdly, customers have greater choice and bargaining power. This is due to deregulation and emergence of new carriers especially the low-cost carriers. More innovative pricing models and services are now available to compete for the consumers’ dollar. With growing affluence of regions such as Asia-Pacific, manufacturers such as Airbus have predicted passengers to double over the next 20years.Finally, the use of technology (such as mobile applications and social media) to advertise, engage consumers, build customer databases, and sell travel deals/ faresis becoming increasingly prevalent. Beyond just providing air travel, airlines will everage more on mobile technology and social networks to foster deeper and more responsive interaction with customers and build brand loyalty

What is the business level strategy adopted by Air Asia?

a) Single Class, No Frills Service

As with most low-cost airlines, Air Asia operated a single class-service, without frills and at substantially lower prices: passengers were not allocated seats, did not receive meals, entertainment, amenities (i.e. pillows or blanks), loyalty program points, or access to airport lounges. Air Asia’s aircraft were designed to minimize wear and tear, cleaning time and cost. This reduced cleaning and maintenance expenses, loading and unloading times and costs, and allowed quicker turnarounds between flights, improving process efficiencies (differentiation) and having lower costs (cost advantage).

b) High Aircraft Utilization and Efficient Operations

Compared with other airlines, Air Asia’s usage of its aircraft and staff was more efficient. Such (high) efficiency and utilization meant that the overhead and fixed costs associated with an aircraft were lower on a per flight basis. For example, seating configurations to Air Asia’s Boeing 737-300 aircraft were maximized, having 16 more seats than the standard configuration adopted by full-service competitors.

In addition, Air Asia’s aircraft (i.e. point-to-point services kept flights to no more than 4 hours, minimizing turnaround time), and employees (i.e. encouraged to perform multiple roles), were used more effectively and intensively than competitors. For example, its point-to-point services (in 2004) enabled Air Asia to operate its aircraft an average of approximately 13 hours/day. It was 2.5 hours more efficient then full-services airlines, which only managed to use their aircraft for an average 10.5 hours/day. Furthermore, the average turnaround time for Air Asia’s aircraft was lesser (e.g. 25 minutes), as compared to full-service airlines (e.g. 45-120 minutes).

c) Single Aircraft Type

Operating a single aircraft type enabled Air Asia to have substantial cost savings: maintenance was simplified (i.e. made cheaper), spare parts inventory was minimized, infrastructure and equipment needs were reduced, staff and training needs were lowered (i.e. easy for pilot dispatch), and better purchase terms could be negotiated.

For instance, its large purchase of A-320s would make Air Asia on of the relatively few low cost airlines operating this aircraft. With fuel accounting for almost 50% of the total operating costs for the airline, the A-320s would provide an important cost saving of lower fuel usage by about 12%; increasing the airline’s profitability.

d) Low Fixed Costs

Air Asia achieved low fixed costs through successful negotiations for low lease rates for its aircraft, low rates for its long-term maintenance contracts, and low airport fees. This enabled Air Asia to reduce its overheads and investments in equipment’s substantially in the absence of fringe services.

As a result of its successful negotiations, Air Asia’s contractual lease charges per aircraft decreased by more than 60% from 2001 to 2004. Aircraft maintenance contract costs were also reported to be substantially lower than other airlines, giving Air Asia a competitive advantage, which was further compounded by its young fleet. Furthermore, the airline’s high safety and maintenance standards allowed Air Asia to procure rates that were favorable on its insurance policies.

e) Low Distribution Costs

By utilizing information technology (i.e. being the first airline in Southeast Asia to utilize e-ticketing, bypassing traditional travel agents), Air Asia achieved low distribution costs by eliminating the need for large and expensive booking/reservation systems, and agents’ commissions. This saved the airline the cost of issuing physical ticket (i.e. estimated at US$10 per ticket).

f) Minimizing Personnel Expenses  

As a high portion of costs was the salaries and benefits for its employees, Air Asia implemented flexible work rules, streamlining administrative functions, which allowed employees to perform multiple roles within a simple and flat organizational structure. Having employees perform multiple roles enabled Air Asia to deploy fewer employees per aircraft (i.e. ratio of 106 per aircraft versus 110 employees or more for competitors), saving on overhead costs and maximizing employees’ productivity, as process efficiencies are improved.

Air Asia’s employees were not unionized, hence its rumination policy focused on maximizing efficiency and productivity, whilst keeping staff costs at levels consistent with low-cost carrier industry standards. Although salaries offered to employees were below that of rivals, all employees were offered a wide range of incentives (i.e. productivity and performance-based bonuses, share offers, and stock options).

In addition, rather than an hourly pay scale for its pilots, Air Asia adopted a sector pay policy: pilots were provided incentives to enhance flight operation efficacies by keeping flight and operating times to a minimum, and to cover as many flight sectors as possible within a day. The absence of in-flight services made it possible for the airline to reduce the number of cabin crew per light, saving on employee cost.

g) Maximizing Media Coverage

Being a leader among budget airlines in Southeast Asia, Air Asia received regular coverage from media outlets. Air Asia managed to promote brand awareness without incurring high sales and marketing expenses: in all of his media appearances, Frenandes always appeared wearing a red Air Asia baseball cap and his statements reinforcing Air Asia’s positioning to offer low prices; generating media attention for the airline.

However, Air Asia also invested heavily where required: Air Asia’s major sponsorship for Manchester United, involved global sponsorship and advertising, and promoted the brand beyond the region.

h) Use of Secondary Airports

Air Asia, as with most low-cost airlines, usually operated out of secondary airports which allowed Air Asia to charge lower fares, as operation costs were lower: landing, parking, and ground handling fees were lower, with more slots for landings and takeoffs.

i) Low-Cost Philosophy

To reinforce its low-cost structure, Air Asia instilled a low-cost culture, emphasizing on cost avoidance. For example, emphasis was placed on the elimination of avoidable expanses such as tag costing (despite reach tag costing less than US$0.05), turning off cabin lights at appropriate times, and not overheating in-flight ovens. Such cost saving measures enabled Air Asia to achieve costs per average seat kilometer of US$0.0213 (the lowest for any airline in the world), with its margins of 38% (before taxes, interests, depreciation, and amortization) being the highest in the world in 2004.

Therefore, in conclusion, by eliminating the provision of costly in-flight services, flying a standard fleet, selling tickets to passengers, and minimizing labor, facilities and overhead costs, Air Asia has managed to achieve a successful low-cost structure, which enables it to charge lower prices to achieve high passenger loads, market share, and profitability.

How has Air Asia achieved cost leadership or differentiation?

The business level strategy adopted by Air Asia is a cost leadership strategy that targets markets such as domestic flights, short-haul / regional flights and long-haul regional services and selling their services below the average industry price to gain market share. Beyond competing on prices, Air Asia also introduced value-added services such a ticket less travel and a free seating policy. Under the guise of offering more choice to customers, they also monetized services that were previously taken for granted under full-service premium airlines. For instance, they offered an internet check-in service that allowing the passengers to print their own boarding passes; charging additional fees for early boarding and seat selection; pre-book their checked baggage and meals, and sale of F&B on board the flight

4.   Identify the ways Air Asia can sustain its competitiveness through the business level strategy that is adopted?

Due the Southeast Asian region having the lowest rate of air travel per capita among the other regions indicates a strong potential for growth. As low prices alone cannot sustain Air Asia, it has to maximize its operational efficiency to maintain its competitive advantage (i.e. being the leader in budget airlines) in the advent of existing and new competitors. Therefore, Air Asia has to leverage on its core competency create cost advantages across multiple value chains.

For example, Air Asia could exploit the potentials of affordable (cheap) air travel by Asia’s burgeoning middle class by leveraging on its operational efficiency (i.e. expanding into China and India, which have large populations), propelled by Asian governments liberalization of the aviation industry (i.e. promoting tourism within and around Asia). When looking for (new) Indian routes (in its expansion into India), in order to adhere to its strict adherence to 3½ hours flying time model, Air Asia could start with routes (from Bangkok to India); leveraging on Air Asia’s efficiency and resources.

Efficiency creates cost (competitive advantage) savings that can be passed on to customers, resulting in lower ticket prices and improves its brand image (perceived value) for customers (i.e. cheap tickets and shorter flight times). Also, as Air Asia has established quite a number of Southeast Asian routes (e.g. China, Indonesia, Singapore, Malays Thailand, Hong Kong and Macau), it could look at joint ventures with pan-Asian budget airlines (e.g. Virgin Blue) to extend it services beyond (Southeast) Asia.

Moreover, Air Asia’s low cost model emphasizes on the importance of maintaining cost discipline (cost competitive advantage), it has no intention of moving up the airline value chain. This may prove to be a competitive advantage for Air Asia as it continues to provide customers with cheaper ticker (than competitors), with flights that are efficient and reliable (e.g. safety): increasing customer confidence and appealing to the increasing number of budget travelers who are willing to compromise on services for a cheaper, but safe and efficient flights.

For instance, in order to maximize its existing (cost and differentiation) competitive advantages, Air Asia could use its Thai subsidiary (Thai Air Asia) to claim use of Thailand’s ‘open skies’ agreements to overcome the barrier of bilateral aviation pacts that threaten to limit its growth (i.e. fly to Singapore, Brunei and Cambodia).

In addition, Air Asia would have to continuously identify new sources of cost advantage to enable it to provide the lowest price possible to budget-conscious customers, further improving its market position with a range of innovation and personalized services.

Air Asia managed to enhance its current offerings (and profitability) with substantial ancillary revenues derived from additional services (i.e. provision of in-flight food and drinks, and online sales of hotel, car, and holiday reservations, as well as travel insurance), and corporate travel services, and even had its own branded credit card, further increasing brand awareness and value for customers (differentiation competitive advantage).

Air Asia could further enhance its offerings by issuing smart cards, which are compatible with its existing ticketless booking system: one card for ordinary travelers (i.e. offering instant rewards when topped up and offers greater value than its purchase price), while the other offers unlimited travel for frequent travels (i.e. provisionally priced and allows customers to make as many trips as they want within a specified period); leveraging on its use of technology (differentiation competitive advantage).