Problem Definition
Sky China, a government-backed Chinese airline, has recently seen profits plummet due to COVID-19. Profits are down 80% in the months of February and March, but are showing early signs of a rebound in April.
They've brought you in to first investigate what can be done immediatedly to prevent hemorrhaging cash and surive in the short-term. They are also looking to see how the current situation can be viewed as an opportunity, and what can be done to prepare for the future.
Comments
Sky China is a SOE (state-owned enterprise). This means it has the full weight of the Chinese government behind it, allowing it to find cheap capital and be sure of its future.
A good interviewee will understand that profits are likely down due to both rising unit costs and falling revenue.
80% of Sky China's sales are for domestic flights, while 20% are international. The international routes are as one might expect (i.e. Asia-centric, with journeys to major hubs outside Asia such as Dubai, London, Paris, New York, and LA).
- Costs need to be dramatically cut in both the short-term and the long-term, for a total savings of $535.6M. This is from:
- Temporary furlough and reduction in pay of labor
- Locking in low priced fuel futures
- Purchasing of discounted planes
- Temporary cuts to marketing
- Temporary cuts/renegotiation of fees
- Immediate steadying of revenue can occur through protective domestic actions
- Future revenue growth can be gained through planned opportunitistic behaviour in the international market
Detailed Solution
Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section
Paragraphs highlighted in blue can be verbally communicated to the interviewee
Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case
I. Cost cutting
Airline Cost Brainstorming
Here the interviewee should investigate the possible options for reducing costs. They should do this of their own accord. If the interviewee is struggling, prompt them to thinking about what needs to be done immediatedly with the company. They should consider what is faster in preventing a profitability fall (cut costs or increase revenues). Once they understand that the most pressing matter is costs, ensure that they brainstorm the largest costs for airlines companies.
The major costs for airlines include:
- Labor
- Fuel
- Planes
- Marketing
- Back-office
- Hangar rent + plane maintenance
- Fees (airport fees, insurance, travel agent commissions, etc.)
Once you're satisfied with their brainstorming of costs, share diagram 1 to illustrate the cost drivers.
Cost Drivers – Possible Cost Cutting
The candidate should realize that some costs are prime candidates to be cut. They should also note the relative importance of each cost. Specifically, the candidate should understand the following:
- Labor – can be furloughed or put on reduced pay
- Fuel – costs could be lowered through futures contracts
- Planes – could be purchased at fire-sale rates, reducing/eliminating leasing costs
- Marketing – should be almost 0 during these times
- Back-office – probably cannot be reduced (still need to deal with complaints, refunds, legals, etc.)
- Hanger rent + plane maintenance – cannot be reduced (planes still exist and need to be store + maintained)
- Fees – could be reduced (i.e. negotiations with airports, travel agents no longer selling, etc.)
Cost Reduction Estimations
Try to get the candidate to estimate the reduction in costs for the above items. They should also think about whether the reductions are short-term (temporary) fixes or long-term fixes.
Provide Exhibit II if the candidate asks about fuel prices.
A good candidate will think critically through each cost, and rationalize which can be cut and how. Ideally, they should come close to the logic in the next section. If not, their logic should be reasonable.
Cost Reduction Calculations
You should provide the below information verbally to the candidate:
- (Short Term) Labor costs can be cut by 90% by furloughing employees, forcing leave, and reducing pay
- (Long Term) Fuel costs can be cut 50% through futures contracts (current prices are 20% of trend, but futures would incorporate expected rises)
- (Long Term) Leasing costs can be cut through the purchase of planes through capital received by government – new monthly costs (which include amortization) is 75% of current rate
- (Short Term) Marketing costs can be cut 90%
- (Short Term) Fees can be cut 50%
The candidate should calculate the amount by which costs can be cut through these actions. Short term actions last for 1 year while Long-Term actions last into perpituity. They should follow the below logic + calculations:
| Cost |
Monthly Expense |
Reduction % |
Annual Savings (calculated) |
Time Period |
Total Savings |
| Labor |
$60.0 |
90% |
$54.0 |
1 Year |
$54.0 |
| Fuel |
$46.0 |
50% |
$23.0 |
Perpituity |
$230.0 |
| Leased planes |
$30.0 |
75% |
$22.5 |
Perpituity |
$225.0 |
| Marketing |
$24.0 |
90% |
$21.6 |
1 Year |
$21.6 |
| Backoffice |
$20.0 |
0% |
$0.0 |
|
$0.0 |
| Rent + Maintenance |
$10.0 |
0% |
$0.0 |
|
$0.0 |
| Fees (airport, insurance, etc) |
$10.0 |
50% |
$5.0 |
1 Year |
$5.0 |
Total Savings from cost cutting exercises: $535.6M
II. Revenue fixes (including Future Plans)
This is a quick brainstorming exercise with the candidate. You should prompt the candidate about what Sky China should do when restarting operations.
A strong candidate will understand there are both short term options and long-term options. Additionally, they will understand that short-term options relate mostly to domestic operations (protect 80% core business), while long-term options relate to international operations (expand 20%).
In the short term:
- Ensure safety protocols adequately implemented, to both get government flying approval and assuage the public's fear
- Prepare aggressive marketing to encourage passengers to fly again
- Consider raising flight prices, given 1) Social distancing may reduce seats allowed and 2) Those flying will have a strong need/desire (business, pent-up demand, etc)
In the long term:
- Plans for international expansion should begin now, ready to be executed when the time is right
- Acquisition of companies weakened due to the crisis
- Purchase of planes at significantly reduced prices
- Identification of routes lost due to bankrupt/failing competing airlines
