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Prologue
"Why do we do this? I think we can make a lot of money. The agreement allows us to refocus on growing the airline 100 percent and each of us will have routes to grow." Fernandes told reporters at a briefing to announce the share swap. Malaysian Airline System (MAS) and rival AirAsia said on Tuesday they will swap shares in a partnership that analysts say will eliminate overlaps and boost the bottom line of both companies. Under the deal, which is valued at about $364 million, Tune Air, controlled by AirAsia founders Tony Fernandes and Kamarudin Meranun, will take a 20.5 percent stake in MAS while state investment arm Khazanah Nasional will hold 10 percent in AirAsia. MAS would also have a new board of directors including Fernandes, Kamarudin, builder IJM Corp's executive deputy chairman Krishnan Tan and pay-TV Astro's chief executive Rohana Rozhan. MAS' managing director Azmil Zahruddin will leave to join Khazanah as an executive director. The share swap would also see MAS shareholders receiving one AirAsia warrant for every 30 MAS shares held while AirAsia shareholders will get one MAS warrant for every 10 AirAsia shares. This is the second major restructuring for MAS in the last 10 years, and some critics have painted the latest exercise as a bailout of the national carrier which was rescued with about $472 million of state money in 2001. After the restructuring, MAS will dominate the premium travel airspace and AirAsia the low-cost service, allowing each to focus on their respective markets.

Background
The Malaysian airline industry is in an oligopoly market structure, where it consists of one full service carrier (FSC) Malaysia Airline System (MAS) and two no-frills carriers, namely AirAsia and Firefly. The Malaysian airline industry is tightly regulated by the government and was dominated by the state-controlled MAS before the governments domestic liberalization exercise opened up the market to allow AirAsia to join the industry. Following Porters (2001) generic competitive strategy, MAS and AirAsia operate on different business models. As a full service carrier (FSC), MAS follows a differentiation strategy and charges a fare premium. In contrast, AirAsia uses a cost leadership strategy. Due to their different strategic positioning, AirAsia and MAS differ in their customer value propositions as well as target market segments. Table 1 provides a summary of the main differentiating characteristics between MAS and AirAsia. In year 2001, AirAsia had successfully stimulated and captured the growth of discretionary air travel traffic by targeting mostly first-time travelers and budget leisure travelers. The business expansion was tremendous and has since captured a significant market share in South East Asian countries. AirAsia is currently the leading domestic carrier with 6.5 million passengers compared to MASs 5.4 million. Its low cost strategy and successful positioning strategy in Asian market that has putting it as the market leader in the Asian airline industry. MAS, despite being an award-winning

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airline, has struggled financially in the past and has only recently completed its business turnaround exercise. Moving on, MAS is embarking on a business transformation to secure its future competitive position.

Competition between the two is intensifying as both begin to move into each others core markets and engage in price-cutting measures. AirAsia has set up a new franchise airline, AirAsia X to service long-haul routes and as a defensive move MAS has set up its own LCC, Firefly (Thomas, 2007). This, in addition to the airline industrys turbulent operating conditions, declining yields and increased foreign competition paints a long and difficult road ahead for both airlines. Competitive advantage will have to be gained through operational effectiveness and strategic positioning (Porter, 2001).

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Air Asia
AirAsia was established in 1993 and commenced operations on 18 November 1996. It was originally founded by a government-owned conglomerate DRB-Hicom. On 2 December 2001, the heavily-indebted airline was purchased by former Time Warner executive Tony Fernandes's company Tune Air Sdn Bhd for the token sum of one ringgit (about $USD0.40 at the time). This was after great deliberation as the initial offer was fifty sen. Fernandes proceeded to engineer a remarkable turnaround, turning a profit in 2002 and launching new routes from its hub in Kuala Lumpur International Airport at breakneck speed, undercutting former monopoly operator Malaysia Airlines with promotional fares as low as RM1 (US$0.33). Since 2001, AirAsia has swiftly broken travel norms around the globe and has risen to become the worlds best. With a route network that spans through more than 20 countries, AirAsia continues to pave the way for low-cost aviation through our innovative solutions, efficient processes and a passionate approach to business. Together with our associate companies, AirAsia X, Thai AirAsia and Indonesia AirAsia, AirAsia is set to take low-cost flying to an all new high with our belief, "Now Everyone Can Fly". AirAsia X was established in 2007 to provide highfrequency and point-to-point networks to the long-haul business. AirAsia Xs cost efficiencies are derived from maintaining a simple aircraft fleet and a route network based on low-cost airports, without complex code-sharing and other legacy overheads that weigh down traditional airlines without compromising on safety. Guests continue to enjoy low fares, through cost savings that we pass on to our guests. AirAsia Xs efficient and reliable operations are fully licensed and monitored by Malaysian and international regulators, and adhere to full international standards. AirAsia X is committed in offering X-citing low fares, X-emplary levels of safety and care, and an X-traordinary in-flight and service experience to all our guests spreading the amazing AirAsia experience to X-citing destinations in Australia, New Zealand, China, Taiwan, Japan, Korea, India, Middle East and Europe.

Malaysian Airlines
The story of Malaysia Airlines starts in the golden age of travel. A joint initiative of the Ocean Steamship Company of Liverpool, the Straits Steamship of Singapore and Imperial Airways led to a proposal to the Colonial Straits Settlement government to run an air service between Penang and Singapore. The result was the incorporation of Malayan Airways Limited (MAL) on 12 October 1937. On 2 April 1947, MAL took to the skies with its first commercial flight as the national airline. Fuelled by a young and dynamic team of visionaries, the domestic carrier turned into an international airline in less than a decade.

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With the formation of Malaysia in 1963, the airline changed its name to Malaysian Airlines Limited. Soon after, Borneo Airways was incorporated into MAL. Within 20 years, MAL grew from a single aircraft operator into a company with 2,400 employees and a fleet operator using the then latest Comet IV jet aircraft, six F27s, eight DCs and two Pioneers. In 1965, with the separation of Singapore from Malaysia, MAL became a bi-national airline and was renamed Malaysia-Singapore Airlines (MSA). A new logo was introduced and the airline grew exponentially with new services to Perth, Taipei, Rome and London. However, in 1973, the partners went separate ways. Malaysia introduced Malaysian Airline Limited, which was subsequently renamed Malaysian Airline System or in short, Malaysia Airlines. Today, Malaysia Airlines flies around 50,000 passengers daily to some 100 destinations worldwide.

Market Entry and Competition: The MAS vs. AirAsia

One of the more interesting cases of competition in the services sector has been the competition between Malaysian Airlines (MAS) and AirAsia. Prior to 2002, MAS was virtually a monopoly operator in the domestic airline market. With the entry of AirAsia the domestic airline market became more competitive. AirAsia offers no-frills domestic flights at low fares. MAS responded by introducing a new pricing scheme (Super Saver Scheme) which offers 50 percent discounts for ten seats in every flight in response to competition from AirAsia. This is surprising since, only a year earlier, in July 2001, the government had granted a request by MAS for an increase in the fares for domestic services within Peninsular Malaysia by about 52 percent. AirAsia also responded to MASs pricing strategy by offering lower fares in September 2002. Despite MASs plea for government (Ministry of Transport) intervention to resolve the perceived price war, the government has maintained that the competition between the two firms as healthy competition. The MAS vs. AirAsia case clearly highlights the impact of market entry on competition in the services sector.

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The Swap Deal

The share swap is seen as a prelude to the ironing out of issues related to such a policy, including route rationalisation which could see AirAsia monopolises most domestic and short-haul routes, a committed traffic to feed into MAS' long-haul network and AirAsia using MAS' maintenance, repair, and operations (MRO) facilities. With Asean Free Skies scheduled for 2015, most regional airlines were now aggressively growing and starting up their own low-cost carriers (LCCs), which were turning out to be effective vehicles to garner regional traffic to feed into legacy, premium airlines' long-haul routes, added AmResearch. Strengthening and co-coordinating the two local airlines are necessary to stave off incoming competition, particularly considering that KL International Airport is stuck between Singapore as a major business hub and Thailand as a major tourism hub. According to Maybank IB analysts, it was a stark reality that Firefly's jet operations would be discontinued, as Firefly was encroaching into AirAsia's market and severely depressing yields on the East-West Malaysia services. Firefly's turbo-prop operations might be merged into MAS branding and operate as a regional link airline similar to Silk Air and Singapore Airlines. The report said that roughly 70% of the combined capacity of MAS Group (MAS, Firefly and MasWings) and AirAsia Group (Malaysia, Thailand, Indonesia and AirAsia X) were deployed on overlapping routes. Often, these flights are duplicates (as they depart at the same time) which severely undermines yields, load factor and ultimately profitability. Unfortunately, these irrational practices are a permanent feature due to both airlines' adamant quest for domination. A tie-up involving operations would provide synergies of up to RM1bil annually in the form of yield, network, growth, fleet, staff, MRO and cargo, but the full synergy could take time to materialise.

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Analysts believe that leakages can be done away with if both groups share data and make decisions objectively, helping to stop irrational capacity deployment, overcapacity on selected domestic routes and predatory pricing. While this tie-up could be viewed as a cartel, business overlap between both groups can be reduced, allowing them to prosper financially together as MAS focuses on premium travel and AirAsia focuses on the low-cost market. In a report done by Standard & Poor's equities, the MAS-AirAsia alliance could lead to a politically correct 1Malaysia Airlines, allowing both carriers to focus on the premium and budget sectors, respectively. While there were no direct comparisons of such a deal in the region, the closest would be the cross-shareholding between Cathay Pacific and Air China Cathay owns about 19% of Air China and Air China owns 30% of Cathay. This tie-up was driven by business (creating a force in Chinese aviation as well as developing Hong Kong and Beijing as hubs) and political needs. Although the synergy and benefits appear substantial, it is also highly dependent on whether both companies can work together. After all, MAS and AirAsia have been at loggerheads from the time AirAsia took flight almost a decade ago. Analysts said with Tune Air buying into MAS, it was the fastest way for AirAsia to put a stop to Firefly eroding the former's market share in the LCC space while its partnership with Khazanah would help AirAsia X secure international route rights, which had hampered its growth and was pivotal ahead of AirAsia X's plan to list next year. Meanwhile, Khazanah's presence in AirAsia as a shareholder will give it exposure to a leading Asean LCC. Khazanah clearly understands the benefit of air travel to the country's economy. It is crucial that it has exposure to a winning airline rather than one airline versus the other a situation that has prevailed in the past decade. By teaming up with AirAsia, Khazanah can extract great value for its investment and to the country's benefit (Maybank IB). Standard & Poor's equities research analyst Shukor Yusof attributed the gain to AirAsia's market position, expertise and slick management.

Back to Monopoly?
The global aviation sector has been hit by rising fuel prices and economic instability, but MAS and AirAsia have adopted different strategies to deal with the challenges. MAS managing director Azmil Zahruddin told Reuters in March that the airline was prepared for a stronger future, although the Japan earthquake in March posed a challenge. In May, MAS posted a first quarter net loss of 242.3 million ringgit ($80.4 million) compared to a profit of 310.6 million ringgit a year earlier, after a decent FY2010 that saw its net profit surpass expectations of a net loss. In 2001, the authorities bailed out the then loss-making MAS with about $472 million of state money, drawing fierce criticism from investors who painted the deal as government interference in the market.

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"AirAsia was set up to liberalize Malaysian skies, but with this partnership, I see us going back to monopolies," said another aviation analyst with a local bank. "At the end of the day, it's the consumers who will suffer as monopolies usually mean higher airfares." AirAsia recorded a net profit of 171.9 million ringgit in the first quarter, down almost 25 percent from a year earlier. It is on a regional expansion drive, with a source saying it had recently drawn up plans to buy an extra 100 Airbus A320 neo jets, potentially taking a record-breaking order to 300. The budget carrier plans initial public offerings in Bangkok and Indonesia as it capitalizes on demand in the region for cheap air travel. AirAsia shares last traded at 3.95 ringgit before they were suspended, up 56 percent since the start of the year, while MAS' stock was last traded at 1.60 ringgit, down 23 percent so far this year. The overall index has fallen 2.4 percent since the start of the year.

Co-operation and Competition

ECM Libra, in its research note, said the partnership would allow AirAsia to continue what it does best with less predatory competition, while MAS can concentrate on serving the premium segment with better revenue yield. It also said that there are opportunities for cost-savings as both airlines would be able to bargain better for future aircraft purchases, as well as minimise duplication of resources such as that in the maintenance, repair and overhaul (MRO) area. AirAsia currently outsources its MRO to Singapore but the share swap deal could push the low-cost budget carrier to use MAS services instead. An analyst agreed the partnership will allow MAS to cut the queue for aircraft such as the A380 as AirAsia is one of Airbus largest customers with more than 200 orders and options. MAS used to have clout with the airplane makers but its scarce purchases over the years has diminished that, the analyst said, pointing out that MAS will only start getting the A380s next year, some four years after the initial delivery scheduled for May 2008. MAS can get more aircraft, faster and cheaper, if AirAsia is in the picture. The analyst also said market segmentation will help both carriers benefit from the range of travelling types in the 21st century, saying MAS could potentially be the premium long-haul and short-haul airline to AirAsias budget service for both markets. Some prefer to go business class and refuse to take AirAsia even for short-haul flights. Perhaps Firefly can fill that market. The possibilities are limitless, he explained, saying this would still mean competition for passengers in the Malaysian market. Opposition lawmakers have said the impending share swap could lead to a monopoly or cartel but the analyst noted that Singapore Airlines has announced it will set up a low-cost carrier while Australias Qantas already operates a budget service under Jetstar.

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Theres always some competition. Dont forget that AirAsia is Asias biggest low-cost operator and that is what makes it an attractive option for travel, another analyst said, adding it will remain a strong force in the growing regional passenger market as it services all 10 Asean capitals.

Realising KLIAs potential

One main beneficiary will be the KL International Airport (KLIA) which can now act as an interlining hub for both premium and low-cost carriers. It is said that KLIA will give travelers more options especially when KLIA2 starts operations. People can pick and choose if they want to go premium or low cost in one hub and even buy a combination of tickets from one as the new lowcost terminal being built now. The fact that KLIA had never fulfilled its promise as a hub as it lay between Bangkok and Singapore, the traditional hubs for European and Asian airlines, the tie-up between MAS and AirAsia can push KLIA to be a major hub. In the end, Malaysia will benefit from having two airlines that can cater to all segments of the passenger and cargo market. Both sides can win from this deal as it can resolve MAS operational issues. MAS would gain the most from this deal on an individual stock basis, as MAS was coming off from a very low base and given the negative investor sentiment as the airline is expected to post full-year operational losses this year.

Epilogue
As to whether the share swap will lead to a cartel, an industry source said both companies will keep their respective boards and compete on some routes but still benefit from several synergies. Some aviation analysts see this plan as a long-awaited move, as it now means that the two liners may be able to move away from inefficiencies in their operations such as overlapping of routes and improved sharing of information that would result in cost-savings, better yields and profitability. It is also believed that with this collaboration pact, AirAsia and MAS will be differentiated in terms of flight services, with MAS concentrating on premium long-haul flights, while AirAsia continues its reign as a leading low cost-carrier. Differentiation between the two liners have gotten vague in recent years, as MAS embarked on a strategy to offer passengers value flightsfull-services flights at a lower price, which in turn, puts it into competition with AirAsia, rather than other premium full-service liners such as Singapore Airlines. The result of it is that these two liners are often in head-on competition to provide lower fares for passengers.

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However, an industry observer says with this deal in place, the government is now seen as controlling the countrys aviation industry all over again, which may not be a healthy development for the industry. As both Khazanah and Fernandes will be holding major stakes in the two Malaysian-based airlines, it is no surprise that this has sparked concerns that domination in the aviation industry by these two shareholders will result in higher fares. AirAsia may have started as a low-cost carrier, but now that it has common shareholders with MAS via Khazanah and Fernandes, an industry observer says AirAsia has fewer incentives to price its flight services lower, as it no longer has a compelling competitor. From a consumer perspective, this is not very good news, as competition ultimately enhances the efficiency of pricing for goods and services. Competition also forces companies to embark on differentiation strategies, which allows consumers to pick and choose the goods and services based on their affordability and needs.

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References
Air Asia Corporate Profile http://www.airasia.com AirAsia, Malaysia Airlines form alliance through major share swap deal http://atwonline.com/airline-finance-data/news/airasia-malaysia-airlines-form-alliance-throughmajor-share-swap-deal-0809 Analysts say MAS stands to benefit more than AirAsia http://biz.thestar.com.my/news/story.asp?sec=business&file=/2011/8/9/business/9259865 Cartel concerns remain for AirAsia-MAS share swap deal http://asiancorrespondent.com/62393/cartel-concerns-remains-for-airasia-mas-share-swap/ Malaysia Airlines System Corporate Profile http://www.mas.com.my Malaysia's MAS, AirAsia plan share swap http://www.reuters.com/article/2011/08/08/us-mas-airasia-idUSTRE7770IF20110808 Malaysia's MAS, AirAsia swap shares in $364 million deal http://www.reuters.com/article/2011/08/09/mas-airasia-idUSL3E7J90LK20110809 Malaysia Airlines, AirAsia Agree on Share Swap http://online.wsj.com/article/SB10001424053111904140604576497700370386230.html Malaysia Airlines posts loss, AirAsia profit down http://travel.usatoday.com/flights/story/2011-08-24/Malaysia-Airlines-posts-loss-AirAsia-profitdown/50118112/1 MAS, Air Asia in share-swap deal http://thestar.com.my/news/story.asp?file=/2011/8/6/nation/20110806214633&sec=nation MAS 2007, Business turnaround plan http://cms.malaysiaairlines.com/mys/eng/about_us/investor_relations/MAS Way_F.pdf MAS 2007b, Business transformation plan http://www.malaysiaairlines.com/getfile/ Porter, M.E. (2001). Strategy and the Internet, Harvard Business Review, 79(3), 62-78. Rivals MAS and AirAsia to become allies http://biz.thestar.com.my/news/story.asp?file=/2011/8/9/business/9260731&sec=business

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Who benefits from the MAS, AirAsia share swap? http://www.themalaysianinsider.com/malaysia/article/who-benefits-from-the-mas-airasia-shareswap/