Rationalisation Plan Gone Sour

On the 16th of March 2006 and after two years of negotiations, the Government finally announced the long-awaited plan to rationalise the market for domestic passenger air travel in Malaysia. Under the Plan, Malaysia Airline System Berhad (MAS) was allocated seven trunk routes in Peninsular Malaysia, seven trunk routes in Sarawak and five trunk routes in Sabah. Meanwhile, AirAsia was allocated 19 trunk routes, the other 99 non-trunk routes and rural air services. Furthermore, MAS will cease offering any discounts on its fares under the 'supersavers' programme. Instead, a price floor will be imposed on MAS. The Rationalisation Plan is scheduled to take effect on the 1st of August 2006.

Initial press reports suggest favourable reactions from both MAS and AirAsia to the rationalisation plan. In a joint press conference on the 27th of March 2006, MAS and Airasia pledged to cooperate and provide strong competition to the Singapore Airlines (SIA). However, as subsequent events were to reveal, both airlines have major disagreements over details of the Rationalisation Plan. In late April 2006, MAS appealed to the government to reconsider the scrapping of the 'supersavers' discount scheme citing reasons such as inflexibility to increase sales during off-peak periods and large investments in a few trunk routes (e.g. Johor Bahru - Kuching). MAS' appeals obviously worked as the govenment subsequently rescinded its decision on 'supersavers' scheme in early July 2006. The government also allowed MAS to operate three additional routes, namely, JB-Kuching, KL-Tawau and KL-Sandakan. The government's recent decision sparked a strong protest from AirAsia, citing unfair competition due to the RM1 billion that MAS receives from the government for restructuring purposes. At the same time, AirAsia also expressed disappointment over the failure to conclude any agreements on interlining with MAS.*

How did the government respond to AirAsia's complaints? In press reports dated 13 July 2006, the Transport Minister is reported to argued that the Cabinet's decision to remove the floor price for MAS should be seen as creating fair competition between the two airlines (since AirAsia was not going to be subjected to any floor price under the Plan) and this move was for the benefit of the people and the aviation industry. Did the Government do the right thing by changing its earlier decisions on floor price and allocation of routes? Was it being fair and transparent to both Airlines as well as the public?

The removal of the price floor for MAS will certainly, as claimed by the government, intensify competition between the two airlines. However, are the two firms competing at a non-level playing field and will the resulting competition be unhealthy? AirAsia's concern about the unfairness of having to compete with a company that access to RM1 billion funds from the government is valid to some extent. If there no specific rules on how such funds are to be used by MAS - it is plausible that MAS may indeed use it to cross subsidize its operations in routes that it is competing with AirAsia. Furthermore, if MAS uses such funds to engage in a price war with AirAsia, the playing field is not only uneven but will become increasingly so. Consumers may benefit from lower fares in the short run but if such a price war results in AirAsia exiting the market, MAS will emerge as a monopoly to the detriment of consumers. While such predatory behavior is not illegal in Malaysia (due to the absence of a competition law), surely the government would not tolerate such a conduct if it is the guardian of public interest.

In a media statement issued by the Prime Minister's Office dated 16 March 2006, the government did indeed state that one of the objectives of the rationalisation plan is to promote healthy competition in the domestic air sector. When, one might ask, is competition healthy? Unfortunately, there is no further clarification on what is meant by healthy competition. Turning to the literature on economics of regulation, one can perhaps infer that competition is unhealthy when an industry is a natural monopoly. This occurs when, due to high initial capital expenditures and a high ratio of fixed to total costs, the average cost in the industry declines as the volume of output or services increases. Under such circumstances, the industry achieves minimal cost if and only if one firm is allowed to operate. But is the domestic airline industry a natural monopoly? Prevailing evidence suggest that domestic airline industry is not a natural monopoly.** This implies that the allocation of high volume domestic routes exclusively to one airline is a bad idea. In this regard, the government's decision to allow MAS to compete in such routes is a correct one provided MAS do not engage in predatory pricing using funds obtained from the government.

Obviously, interlining is an issue the government should quickly step in to resolve. As the sole 'owner' of interlining rights, MAS clearly has the upper hand in this area. Such rights are a form of 'essential facility' that can impact MAS' competitors. Without access to interlining facilities, AirAsia may not be able to compete effectively in routes requiring such facilities. The government should recognize this fact and ensure that MAS does not use it to unfairly disadvantage AirAsia. The solution to such problems usually requires government intervention to ensure that the determination of the access pricing for such facilities do not lessen competition significantly.

Finally, an issue that is important but not highlighted by the media is the need for the government to be consistent in their regulatory decisions. AirAsia has a valid complaint on the sudden and non-transparent manner in which the government changed its decisions on key elements of the rationalisation plan. While such actions are laudable if they are undertaken to correct errors or improve upon the earlier plan, the government should try harder to get their key decisions right the first time so as to avoid creating unnecessary regulatory uncertainties to the deriment of the airlines, their shareholders and investors.

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*Interlining is an agreement between two airlines to mutually issue tickets and boarding passes for each other’s flights. A Under such an agreement, both airlines are able to provide automatic baggage transfers to passengers on their connecting flights.
** "Competition and Regulation in Airline Industry," Federal Reserve Bank of San Francisco Economic Letter, January 18, 2002.