Table of Contents
Section Page
Executive Summary 1 Introduction 2 Objectives 2
Background 3
Financial Side of Gross Margins 3
Marketing Side of Gross Margins 6
Trends and 2006 Assumptions 7
Recommendations and Conclusions 8
Bibliography 9
Executive Summary
This CEO report has found out that CPAL is more efficient, productive and profitable than CSACL. This is related to arrive in a conclusion that the size of the fleet, number of workforce and flight destinations can be eclipsed by the ability of the firm to diversify internationally and concentrate to a specific market. CPAL controlled its cost of goods sold particularly in depreciation and maintenance factors at a minimal level due to efficient and optimal utilization of its aircrafts. It also controlled its sales revenues at a maximal level due to international diversification and serving the high-end market. With this reasons, it is recommended for CPAL to continue its diversification, hedge fuel price escalations and remain its focus on the present market.
Introduction
Gross margin shows how profitable a firm is (Investor words). It is the difference between the total sales revenue minus cost of goods sold, or when expressed as percentage, further divided by the former (). It is also used to measure the efficiency of a manufacturer and mark-up of a retailer (Money Chimp). In aggregate, it quantifies both the income-generating capabilities of a firm as well as its cost-saving strategies and productivity programs. With this respect, this presentation will deal on gross margin management of a particular firm listed in Hong Kong Stock Exchange, Cathay Pacific Airways Limited (CPAL). This will be a CEO report and evaluation regarding aspects of CPAL gross margin management.
Objectives
Generally, the financial aims of managing gross margin are to determine how to minimize the cost of goods sold through scrutiny of the cost of producing and buying inputs, inventory looses and declined value of unsold inventories during a certain period (Superior Investor). In the marketing side, it aims to establish a value-creating marketing mix that involves products, price, place, and promotion aspects to stimulate sales capability. In this view, CPAL will be analyzed based on these key areas with benchmark for comparison being China Southern Airlines Company Limited (CSACL) which is a top/ major competitor (). After the analysis, conclusions and recommendations will be drawn for testing the depth of the report and concretizing evaluations.
Background
CPAL and CSACL are both competing in the aviation industry in Hong Kong although the later is considered the leading player in the region while the later is named as the largest in China (). The size of CSACL, however, is undermined by CPAL’s capability to earn. In 2004 records, CPAL has a total of .0 billion in sales which is .0 billion dollar short from CSACL. Also, net sales favored the former at 0 million versus a loss million for the latter. Only CSACL had excelled in year-on-year sales growth. CPAL operated at a mere 90 global destinations compared to CSACL’s 540 routes including 435 domestic destinations (). On the contrary, the former is a member of an alliance wherein British Airways and AMR’s American Airlines obtain membership. Currently, the latter shrank its operations into 320 routes wherein 260 are domestic, 39 international and 20 within Hong Kong ().
Financial Side of Gross Margins
Table 1: Related Cost of Good Sold Items
2005 (in HK$ billions)
2004 (in HK$ billions)
CPAL
CSACL
CPAL
CSACL
Flight Operations
28.2
18.6
23.4
10.0
Maintenance
4.5
4.4
3.7
3.3
Depreciation, Leasing, Servicing
5.5
9.7 (with amortization)
5.1
5.6 (with amortization)
As shown, the bigger number of employees (30,000 against 15,000), aircrafts (200 against 90) and destinations (300 against 90) being held by CSACL does not reflect to its cost of good sold as CPAL overtake most of major expenses. Other factors may affect this scenario.
Table 2: Selected Factors that Affect Table 1 Figures
2005
2004
CPAL
CSACL
CPAL
CSACL
Revenue Passenger Kilometers
HK B
HK B
HK$ 57 B
HK$ 36 B
Passenger Load Factor
78.7%
70%
77.3%
69%
Revenue Tonne Kilometers
HK.8 B
HK.9 B
HK.4 B
HK.4 B
Tonne Load Factor
67%
63.3%
68.7%
62.6
Cargo and Mail Carried
1.1 M tonnes
775,000 tonnes
900,000 tonnes
545,000 tonnes
Available Seat Kilometers
82 B
88.3 B
74 B
53.7 B
Cost per Available Tonne Kilometer
HK.19
HK.43
HK.07
HK.41
Aircraft Utilization
12.6 hours/ day
9.6 hours/ day
12 hours/ day
9.9 hours/ day
With the additional data, CPAL was able to overtake the expenditures of the bigger CSACL because it utilizes its passenger and cargo spaces more as reflected by load factors. The passenger load factor is higher for CPAL despite CSACL having more available seat kilometers. As a result, flight operation expenses rose partly due to additional flight attendants that are needed including more amenities inside CPAL’s aircrafts. Also, relatively narrow spaces require increased ventilation and air-conditioning in which CSACL has lesser burden to face with. And even though CPAL has higher cost per available tonne kilometers, it is paid-off by higher cargo and mail being carried and revenue tonne kilometers compared to CSACL. The former also has higher aircraft utilization which means that its efficiency measures require additional expenditures in fuel, overtime work, etc.
By cross-referencing the first two tables, it suggested that even though CPAL uses its aircraft more frequently and derives more revenues by doing so than CSACL, their maintenance and depreciation expenses are rather non-distant. Questions such as accident rate, expertise and diligence of employees, aircraft policies to passengers, among others are suspicious to CSACL. High losses from wear and tear or lower aircraft space utilization from both passenger and cargo are non-reflective of CPAL. Higher flight operations of CPAL which is at least 50% higher than CSACL is also rationalized by additional expense incurred in higher passenger and cargo load factor. Lastly, CPAL has also good returns from its leasing contracts that makes lease payments headache free.
Table 3: The Revenue Side
2005
2004
CPAL
CSACL
CPAL
CSACL
Revenues (HK $)
50.9 B
36.7 B
42.7 B
23 B
Gross Margin (HK $)
10.6 B
(1.2 B)
8.9 B
0.872 M
Gross Margin* (%)
20.8%
(3%)
20.8%
3.7%
* Note: Gross Margin / Revenues
This table shows how well CPAL converted its relatively high cost of good sold to positive cash flows. On the other hand, CSACL (deceptively looking efficient in Table 1) has shown its lack of income generating capability. Its lower expense may illustrate the gap of its internal organization and associates unlike CPAL which gained from its investment effectively.
Marketing Side of Gross Margins
Table 4: Comparative 4Ps
CAPL
CSACL
Products
Passenger Transportation, Catering, Aircraft Maintenance, Ground Handling, Cargo Carrier (CPAL Website)
Passenger Transportation, Catering, Aircraft Maintenance (CSACL Website)
Price
More Expensive (Epinions)
Less Expensive (Epinions)
Place/ Distribution Channel
Global Network
Mostly Local in PRC
Promotion
Spent HK9 M in commissions
Spent HK.5 B in promotions and sales
CAPL has been able to maximize the productivity of its aircrafts because of its global network. In fact, it is one of the founding members of One World Global that afford it to use over 600 destinations worldwide. Also, it is a major stake holder in AHK Air Hong Kong Limited, an all cargo carrier, which serves the entire Asia. These aspects, along with the presence of key associates, are what CSACL misses that resulted to minimal costs and minimal revenues at the same time despite of its size and prominence in the PRC.
Further, since Hong Kong is a commercial hub for international business transactions, CPAL benefits the income status of foreign passengers who are most likely prefer better service than better price. In this view, its expensive fees and tickets are less intimidating for the specific market. In the contrary, CSACL transports mostly in Chinese provinces and major cities that placed it within the cheap-waged workforce, thus, unable to increase revenues through better services since customers tend to be price sensitive. In effect, it can only concentrate its resources and capabilities highly in being cost-effective with little product development or diversification. In this reason also, CAPL is less pressured to promote its products and attach some lucrative incentives to stimulate demand.
Trends and 2006 Assumptions
CPAL derived its highest operation expense and year-on-year increase in its fuel account at HK billion and 48.5% respectively with an aggregate flight operation expense at HK.2 billion (CPAL Website). This makes its flight operations very expensive at times of oil price hikes and cited by the company to be a significant barometer of its future earnings (). Since CPAL treats fuel factor as an external variable, efficiency can only be attained by maximizing the space of its aircrafts for both passenger and cargo. As presented in the preceding discussions, it can be assumed that fuel prices has relatively less impact for minimizing the cost of goods sold by CPAL (refer to Table 2).
The capacity and breadth of its services is reflective on its hub presence, fleet growth rate, technology and partnerships. It cannot stimulate its revenues without growing and upgrading its value chain. At best, it cannot achieve integrated cost leadership and differentiation strategy which is cited as the most value-adding business strategy ( 2003). To resolve these issues, CPAL intensifies its service flights in Los Angeles, London and Xiamen including additional services in Amsterdam, Beijing, Nagoya, Rome, Frankfurt, etc. It also has pending deliveries for Boeing and Airbus aircrafts while it is the pioneering user of internet in global aviation industry. In this view, including its code sharing feats and increasing membership in One World, it can be assumed that it can stimulate revenues and be efficient at the same time (all else equal).
Recommendations and Conclusions
1. Being lean but mean, CPAL has been able to become Hong Kong’s premier airlines. The key to this success is the type of market that it caters wherein its marketing mix can be easily and profitably controlled. Also, with strategic alliances, it can minimize the risk and its associated cost of underutilizing its resources particularly aircrafts that can aggravate its resource depreciation and maintenance costs. As a result, it is recommended that it should continue its global diversification to pinpoint the high-end portion of the market. In this endeavor, however, it should caution its hub development and other operating forecasts against the socio-economic indicators of the country.
2. Its diversification and increased service to selected destinations around the globe does not only increase its overhead cost but also maintenance particularly fuel costs. Currency exchange risks should be hedged in order to minimize the impact of oil price escalation. It can also use forward contracts in buying fuel wherein frequent demand will be the contract motivation since it has relatively greater aircraft use.
3. It is also recommended for CPAL not to compete with the low-end market (e.g. competing in the provinces of PRC). Lowering its prices especially in abrupt manner can imply decreased in service value. Since this can happen when efficiency persists, it can divert the derived gains for expansion, replacing old aircraft models or increasing its stake in its good performing portfolio like its cargo services. This recommendation is validated by the fact that CPAL has been recognized as “Airline of the Year 2005” by a UK-based research company (CPAL Website). This means that the international market responded how well it deliver its services, thus, they feel the higher CPAL tickets and fees worthy for the derived satisfaction.
Bibliography
Credit:ivythesis.typepad.com
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