While it awaits the next stage of privatisation, Hungary's flag carrier is busy improving its efficiency. Richard Whitaker reports from Budapest. Ask a Malev executive what the carrier's ownership structure will be in a year's time, and the response will be very simple: it's almost anybody's guess. But ask about the carrier's business development, and the priorities are very clear: improve productivity and profits, develop the personnel, enhance the schedule, and complete the transformation into a western style company. 'Healthy performance - financial stability - is priority number one,' says chief executive officer Sandor Szathmary. 'The company was a socialist style monolith structure. That monolith structure has to be re-engineered.'

Malev appears to have turned the corner financially. After notional profits in both 1992 and 1993 followed by a loss in 1994, last year the carrier reported a net profit of HUF186 million ($1.5 million) on revenue of $360 million. This year's business plan predicts that there will be an operating profit - the first since 1992 - as well as a pre-tax profit of HUF800 million ($5.6 million).

The opportunity to purchase shares in Malev arises because the government's privatisation agency, AV, wants to reduce its shareholding from the current 63.9 per cent to the legal minimum of 25 per cent plus one share. Observers believe that AV will attempt to sell just under 29 per cent to financial institutions and transfer 10 per cent to the national social security fund.

However, the situation is complicated because the other major shareholder, Alitalia, may change course. Alitalia's new management is reviewing its investment in Malev, and a decision on whether to sell up, retain the stake, or even increase it, was expected by the end of May. Alitalia purchased 30 per cent of Malev in 1992 alongside Italian government investment agency Simest, which acquired 5 per cent.

'We are keeping our options open based on our currently valid agreements with Alitalia,' says Szathmary. The options are: Alitalia increases its stake by buying AV shares up to the 50 per cent limit on foreign shareholdings; AV makes a private placement to financial investors; or another airline buys Alitalia out.

Officials from Malev and Alitalia refuse to speculate as to the most likely outcome, but their commercial alliance has been disappointing. Joint transatlantic flights were abandoned and other proposed links have failed to materialise, leaving only the joint operations between Budapest and Rome, Milan and Venice and a frequent flyer programme link. These could easily continue without Alitalia owning equity in the company, along the lines of Malev's other route-specific alliances with Austrian Airlines, Air France, CSA and Iberia.

It would therefore not be surprising to see Alitalia's stake in Malev come onto the market, although it will want at least to recoup its initial investment of over $60 million. The problem here is that Malev's net worth has been eroded by the forint's devaluation.

Finance director Peter Kis says the carrier is working on a prospectus and an audit to international accounting standards is planned for later in the year. The sale is unlikely to take place before early 1997.

Malev hopes to secure a capital increase alongside the privatisation given that it received the entire proceeds of the Italian stakes last time. 'We do believe that the airline itself will receive some of the further incoming money,' says Szathmary. Kis dreams of $100 million of new equity, which would enable him to purchase aircraft. However, he stresses that the company can self-finance its development for the next two to three years if necessary.

All Malev's western aircraft - two B767s, six B737-200s, three B737-300s, two B737-400s and three Fokker 70s - are on operating lease and a decision on replacing the older B737s is due soon. Due to Fokker's problems, Malev does not know if it will receive a fourth F70 which was to arrive in June on lease from the manufacturer. Five Tupolev 154s are retained for charter flights, and there are five backup aircraft - two Tu-154s and three Tu-134s.

As potential investors prepare to examine Malev, the carrier is proceeding with its plans to boost profitability. A new schedule is increasing asset utilisation and allowing for higher revenue generation, and the MA2000 programme aims to cut costs and improve the company's management processes.

Sales and marketing director Ferenc Turi says Malev spent last year preparing for growth by cutting costs and introducing an Iata revenue management system and an integrated, automatic market pricing system. This year, the company is aggressively expanding its scheduled services.

The 1996 schedule is based on the same number of aircraft as last year - 16 - but with 19 per cent more flights, 17 per cent more block hours, and 17 per cent more available seat km. In this way, the company aims to increase passenger numbers by 15 per cent to 1.87 million, at a load factor up 3.1 percentage points to 58.3 per cent. Yet operating costs will rise by only 12-15 per cent.

Malev is slashing turnaround times from 75 minutes to 45, and is modifying departure times following extensive market research. The carrier is aiming first for the majority of the Hungarian outbound market, where it can achieve a significant penetration of business traffic, helped by the newly revamped frequent flyer programme, Duna Club. Second comes inbound traffic, but in some cases the carrier is going for higher yield leisure traffic.

The most radical change is in Malev's third priority - sixth freedom traffic, mostly intra-Europe. 'We would like to increase the number of connecting passengers, which in 1995 was about 110,000, to 230-240,000 passengers in 1996,' says Turi. He acknowledges that this will result in lower average yields, but says the keys to success will be revenue management and promotion to large wholesalers and consolidators.

Since Malev is too small to operate anything like a US-style hub and spoke system, it has opted for less frequent niche market connections at days and times suggested by the market research. 'On Monday, we connect west Europe with east Europe, on Tuesday we connect south Europe and east Europe, and so on,' he explains. 'We are trying to cover the market segments which are left untouched by the mega-carriers.' Malev has doubled the weekly connections at Budapest to 1,400 this year, and has cut minimum connecting times from 45 minutes to 35. Turi says passenger numbers increased 18 per cent and load factors rose 4 points to 49.7 per cent in the first quarter.

Most of the growth arises from higher frequencies, but Malev plans to re-enter Belgrade and launch flights to Odessa, Ukraine. Turi claims the carrier has identified 15 new markets for the next two and a half to three years, not counting any which may arise if Malev joins forces with a new strategic partner.

One of Malev's Boeing 767s operates a daily schedule to New York, on which Delta Air Lines buys half of the seats. The other flies long-haul charters to Bangkok, Tokyo, the Caribbean, Kenya, Toronto, Cleveland and Atlanta, with a series of charters to Cape Town due to start in November. Some of these are pathfinders for new scheduled routes - Bangkok is to become a twice-weekly scheduled operation from October, and the Hungarian government wants a bilateral with Canada. The Bangkok schedule will allow Malev to pick up Thai originating passengers for the first time, and the carrier expects substantial sixth freedom traffic. 'We are going after the secondary west European gateways which are not well served,' says Turi.

Turi accepts that Malev is not yet ready to face the full force of competition should Hungary adopt the European Union's third package. Still, he rejects the notion that true competition has not yet arrived in Hungary. While almost half of its routes are monopolies, joint operations or codeshare flights, and published fares are high, Turi says this is only part of the story. 'For most of the west European carriers, Budapest is a sixth-freedom market,' he says. The majors typically operate two daily hub feeder flights and fill up with local traffic at a discount, he adds. In addition, they enjoy the advantages of refined skills and global networks.

Part of the answer lies with Malev's several codesharing and block space agreements, where the partners still compete for the passenger, but cannot use capacity as a competitive weapon. The Delta alliance is the latest route-specific agreement. Following the abortive joint transatlantic flights with Alitalia, which failed because Hungarian passengers objected to the stop in Italy, Malev switched to a nonstop flight to New York on which Delta buys half of the seats. Starting on 1 May, Malev will buy 20 seats on Delta's new daily Budapest-Vienna-Atlanta flight.

The changes to Malev's schedule are the most visible element of a much wider change in thinking. Following a benchmarking exercise by Mercer Management Consulting, Malev has implemented the first phase of its MA2000 programme, which is designed to ensure the carrier is working fully on western lines by the turn of the century. This programme aims to improve productivity, quality of service and the working environment, and make Malev truly customer driven.

CEO Szathmary says the target is a HUF800 million ($5.6 million) reduction in annual operating costs at today's prices, with 80 per cent to be achieved this year and the rest in 1997. Rumoured drastic cuts in Malev's workforce have not come about, but 200 of the carrier's 3,500 jobs were cut last year through early retirements and layoffs, and Szathmary says there will be a further gradual decline in numbers despite traffic growth. Salary costs fell last year in real terms: Malev's employees received a 4 per cent increase in January and a 6 per cent rise in October, compared with annual inflation of over 25 per cent.

Changes in human resource management are at least as important to MA2000 as the productivity increases. Management training will be improved, formal personnel appraisals introduced, and job rotation will be encouraged to give employees wider experience.

Meanwhile Malev's maintenance arm, Aeroplex of Central Europe, has its own restructuring programme. Created in 1992 as a 50:50 joint venture between Malev and Lockheed Martin, ACE combines Malev's engineering department with capital and know-how from the US partner. The idea was to acquire the ability to maintain western aircraft, reduce Malev's maintenance costs, and bring in revenue from third-party work.

By becoming eastern Europe's first maintenance facility to be approved by the US and European airworthiness authorities, ACE has succeeded by the first yardstick. But productivity has not improved enough and third-party business has been elusive.

ACE managing director Richard Crail stresses that costs have fallen, with overall man-hour costs down to $36 and employee numbers down from 1,000 to 850. Malev and ACE have changed from a cost-plus contract to a fixed-price scheme with incentives which ACE can earn in three ways: by keeping costs within the fixed-price target, by bringing in more third-party work, and by achieving quality of service targets covering dispatch reliability, aircraft availability, ground time for each maintenance job, and the time to complete deferred items.

ACE measured these four parameters for the first time last year, and while Crail will not divulge the results the main concern is over ground times. Now that the data is known, work can start on improvements - all part of the change in culture from the old days, when there was no rush to complete a job as aircraft utilisation was very low. The biggest incentive is that Malev's exclusive contract with ACE expires in mid-1997.

Malev accounts for over 80 per cent of ACE's 700,000 man-hours of work this year and Crail says he is targeting a doubling of third-party work from last year's 50,000 man-hours. ACE's largest third-party customer is Ukraine International Airlines, for which the Hungarian company established an entire maintenance programme. Lithuanian and Delta are also regulars and there is line maintenance at Budapest airport, but otherwise ACE mainly seeks out one-off jobs.

ACE's problems in attracting third-party business stem from the 30 per cent overcapacity in the market, marginal pricing and generous payment terms offered by the majors, and the fact that most winter capacity is needed by Malev itself.

Since Malev does not have a large enough fleet to justify the current facilities, the ideal solution is to find a long-term customer of similar size, says Crail. Unfortunately the likely candidates all have their own facilities. One possibility being discussed is a deal with CSA, under which the two carriers would share B737 work.

Other potential niches for ACE include avionics upgrades, working with emerging carriers in the former Soviet Union, military business, and spinoffs from other Lockheed Martin business such as thrust reversers and a new precision approach system.

Malev's future will depend heavily on Hungary's economic performance. The Economist Intelligence Unit estimates that Hungary's GDP growth last year was only 2 per cent, by far the lowest in central Europe, although it is expected to increase to 3 per cent this year. While the government's austerity programme has narrowed the budget and current account deficits, social security spending is frightening and inflation remains high - 28.2 per cent last year, slowing to 22 per cent in 1996. The forint devaluation and the imposition of import taxes have hurt Malev.

Any economic improvement will clearly benefit Malev significantly. The carrier also needs a period of stability among senior management, following changes in the last year. A new head office would create cohesion by bringing together people who are currently based in several offices downtown and at the airport. But most of all, Malev needs the clarity of strategy which will only come when its ownership has been settled for the long term.

Source: Airline Business