Five Star Value Carrier:

Business Transformation Plan (BTP 2)

Disclaimer
This Business Transformation Plan (BTP 2) document is issued to staff and external stakeholders with the following disclaimer in line with Bursa Malaysia guidelines: 1. These headline Key Performance Indicators (KPIs) in the BTP 2 are targets/aspirations set by Malaysia Airlines to reflect transparent performance management practices. To all intents and purposes, financial figures referred to as forecasts and estimates in the BTP 2 are KPIs. 2. These KPIs should not be construed as forecasts, projections, estimates or representations of the companys future performance, occurrence or matter as the KPls are merely a set of targets/aspirations of future performance and aligned to the companys strategy. It is our view that because the airline industry faces a tough business environment which MAS is not spared from, it is only appropriate that we disclose information to the public, in a manner that is as balanced and objective as possible. It should be pointed out that in this BTP 2 document, while MAS is announcing its 5-year (2008 - 2012) P&L aspirations, this does not necessarily mean that MAS will make the said profits during the period. The BTP 2 and its targets have been approved by the MAS Board of Directors, but are not to be considered as forecasts reviewed by external auditors.

CONTENTS

A Joint Message from the Chairman, CEO and CFO

1-2

Executive Summary

3-4

A: Achievements to date

5-12

B: Current Airline Industry Environment

13-24

C: MAS will fail without a Business Transformation D: Strategy : Transforming to become a Five Star Value Carrier

25-30

31-38

E: The Transformed MAS: What will we look like?

39-50

F: Executing the Business Transformation KBAs

51-84

G: Size of Prize

85-89

Abbreviations
January 2008

90

A Joint Message from the Chairman, CEO and CFO

Dear colleagues, It is great to see how well we have achieved our Business Turnaround targets to date. Together, we kept and delivered on the promises we made in our Business Turnaround Plan (BTP 1) and delivered signicant results. We would like to take this opportunity to thank everyone for your contributions over the last 2 years. We worked really hard and pulled together as a team to successfully implement the BTP 1. Of course, we owe part of our success to the Government-Linked Companies Transformation (GLCT) Programme which provided us essential guidelines and a framework throughout the BTP 1 journey. We must, however, remind everyone that we are not out of the woods yet. There is still a long way to go and there is no room for complacency. For 2008 and beyond, there will be overcapacity in the industry and competition will intensify; our yield and prot margins will erode. Based on current industry trends i.e. overcapacity, increased competition and volatile fuel prices, MAS will surely fail unless we radically change the way we run our business. We need to continue the momentum we have already built and fundamentally transform our business into one that will grow in the face of adversity and deliver lasting success. We are pleased to announce our Business Transformation Plan (BTP 2), which is a continuation of our BTP 1. It is called Transformation because we have successfully completed our turnaround and returned to protability. Now, we want to transform MAS to achieve our vision of becoming the Worlds Five Star Value Carrier (FSVC) i.e. providing 5-Star products and services at affordable prices. Our BTP 1 started with 3 phases: nancial survival in 2006, prot generation in 2007 and protable growth in 2008. Now that we have achieved the target of prot generation, we will shift our focus to protable growth by transforming MAS into a FSVC. Our ability to deliver this strategy is the cornerstone of our efforts to grow MAS into a champion in the global arena. This transformation is vital to MAS continued success and relevance in the long term. If we succeed in achieving this transformation within the next 3 to 5 years, we can realise a net prot of anywhere between RM1.5 and RM3 billion per annum. Over the last 2 years, we have seen many of our employees grow as leaders during the BTP 1 journey. We have learnt a lot and today, there are plenty of opportunities to grow as leaders for those willing to rise to the challenge. To quote John Ruskin, The best reward for a mans toil is not what he gets from it but what he becomes of it. We sincerely hope that throughout our next journey to become a FSVC, many of us will become better at what we are doing and above all, better persons and true leaders in our own right. We will win this together. Whilst this document, like the BTP 1, is aimed primarily at communicating the Business Transformation Plan to our staff, we felt that it should be made available to external stakeholders. We have decided to be as transparent as possible about our problems and how we intend to address them, without disclosing condential and competitive information. What we are NOT disclosing is how precisely we will implement the transformation plan. The key to success is indeed in the execution of this plan and that is our secret. The journey ahead is going to be arduous and challenging. It will require unleashing the talents of all our employees and the support of all our stakeholders. Over the next 3 to 5 years, look out for regular updates on our progress and the impact of our actions. Much lies ahead of us, but we will succeed. As always, we are truly grateful for the support and encouragement that we receive from all Malaysians, far and near. We look forward to working with you to transform MAS into a Five Star Value Carrier.

Standing from left to right Dato Dr Mohd Munir Bin Abdul Majid, Dato Sri Idris Jala, Tengku Dato Azmil Zahruddin Bin Raja Abdul Aziz

Dato Dr Mohd Munir bin Abdul Majid Chairman

Dato Sri Idris Jala Managing Director & Chief Executive Officer

Tengku Dato Azmil Zahruddin bin Raja Abdul Aziz Executive Director & Chief Financial Officer

Executive Summary
MAS has certainly come a long way. For the nancial period 2005 (9 months), MAS reported a loss of over RM1.3 billion the biggest in the companys history and it was expecting to hit an even deeper loss of RM1.7 billion for the full year 2006. The nancial position was so precarious that we had only a few months until April 2006 before we ran out of liquidity. In the wake of the prot and cash crisis, we announced our Business Turnaround Plan (BTP 1) in February 2006. The BTP 1 was developed using the Government-Linked Companies Transformation (GLCT) manual as a guide, and targeted to cut our losses from RM1.7 billion to RM620 million in 2006, achieve a prot of RM50 million in 2007 and a prot of RM500 million in 2008. With hard work, radical changes and tough decisions, we were able to overcome the cash crisis to ensure our nancial survival in 2006, achieved a record prot of RM610 million for the 9 months, year-to-date to September 2007, and we are now on track to generate further prots in 2008. We made it! We have demonstrated to our stakeholders, nation and world at large that we are a winning team. However, new challenges loom ahead of us. The single largest concern that MAS will face in the industry is overcapacity. Based on industry estimates, about 400 plus new aircraft have hit the skies of Asia Pacic, India and Middle East in 2007, and another 400 plus is expected in 2008. This phenomenon of unbridled growth will intensify competition in the market, and erode our yield and prot margins. Coupled with the liberalisation of ASEAN skies and rising oil prices, MAS will, with everything else remaining equal, inevitably hit a wall and fail badly if we do not transform ourselves. Thus, as we go into 2008 and beyond, our focus will clearly need to shift to securing our future success. This phase represents the most challenging yet for MAS this is the real mountain that we need to scale. To chart our path onwards and upwards, we have developed a Business Transformation Plan (BTP 2). The plan, outlined in this document, will build on the 5 key thrusts of The MAS Way (see Exhibit 1) which served as the guiding principle for our BTP 1. Exhibit 1: Transforming the company The MAS Way
VISION: To be the Worlds Five Star Value Carrier (FSVC)

MAS aspires to become the Worlds Five Star Value Carrier. We believe that we have to reinvent ourselves to achieve this vision. Our transformation journey towards achieving this vision is tough but exciting. It will require leadership, teamwork and relentless passion to pursue this vision. Our vision will be supported by the mission to be a consistently profitable airline. The strategy is to transform MAS into a Five Star Value Carrier (FSVC) i.e. providing 5-Star products and services at affordable prices. There are 5 bold steps which make up the FSVC Virtuous Cycle of Profitable Growth:

Step 1 - 5-Star: We must maintain the high quality products and services offered (5-Star) and these have to be constantly matched to the specific needs of our customers; Step 2 - Lower Costs: We must reduce our structural and operational costs (without compromising on safety and security); Step 3 - Competitive Fares: With a lower cost base, we will be able to offer low and competitive fares to our customers, and still be able to make a profit; Step 4 - Get more customers, more revenue: With high quality products and services at low/competitive fares, more passengers will choose to fly on Malaysia Airlines. This translates into more revenue; Step 5 - Grow network, build capacity: With more revenue and profit, we can invest in growing our network and building our capacity. We will open up more routes and acquire more planes, and this leads us to sustainable, profitable growth. The process repeats in an upward spiral (see Exhibit 2).

ro Exhibit 2: The Virtuous Cycle of Profitable Growth Growth

Grow network, build capacity Competitive fares

Flying to Win Customers

5-Star 5 Star Get more customers, more revenue

COMMERCIAL

OPERATIONS

Mastering Operational Excellence

FINANCE

Low cost

MISSION: To be a consistently profitable airline

Financing and Aligning the Business on P&L Unleashing Talents and Capabilities

PEOPLE

STAKEHOLDERS

The philosophy behind the BTP 2 is aiming and planning for the best, assuming the worst. On aiming and planning for the best, MAS will go for the seemingly impossible target i.e. record profit. On assuming the worst, MAS must transform to become a FSVC. MAS has to build a ship that can weather the storm, in our case, the imminent liberalisation and overcapacity in Asia. Based on a series of focused key business activities, our aspiration in the plan is to achieve RM400-550 million (on target), RM551-650 million (exceeding) and RM651-1000+ million (outstanding) in 2008. We believe that if we aim for the best and stretch our limits, we can achieve an annual profit of RM1.5 billion by 2012 even after factoring in the industrys challenges such as overcapacity, air traffic liberalisation and rising fuel cost. Should the magnitude of overcapacity and liberalisation be less than our anticipation, it is possible for MAS to achieve an even higher profit - between RM2 and RM3 billion per annum. On an annual basis, we will review our financial targets and update these targets as we achieve them. Over the past 2 years, we have managed to outperform our announced targets and we have every intention to continue to meet and exceed the targets set forth in our KPI Scorecard. FSVC is our path to long term survival and success. Our ability to deliver this FSVC strategy is the cornerstone to grow MAS into a global champion. We can do this, and we will.

Winning Coalitions

STRATEGY: Business Transformation

In the premium market segment, MAS is under tremendous pressure from full service carriers (FSCs) who are striding ahead with rst class products, new and modern aircraft, and fast-expanding routes. On the other hand, in the price driven market segment, MAS is also strongly pushed by low cost carriers (LCCs) with low fares. In a nutshell, MAS must reinvent itself to fend off competition from FSCs and LCCs. It is precisely for this reason that we are adopting a strategy which deals with this dual challenge i.e. we will continue to improve the quality of our product and services (hence, Five Star Airline) and at the same time, reduce our costs so that we can offer low fares (the notion of Value Carrier). We are mobilising the entire airline to become a Five Star Value Carrier: one with products, eet and network that are in the league of the worlds premium airlines, with a cost structure and operational discipline to match the best fares the LCCs can and will throw at us.

The year 2005 was possibly the worst and most difficult time in the history of MAS. With a record financial loss of RM1.3 billion in 2005 (9 months), MAS plunged into a cash and profit crisis. The financial position was so precarious that we had only a few months until April 2006 before we ran out of cash. MAS also had a people crisis. Based on a staff survey conducted in 2005, it was clear that we were rated poorly for employee related matters and staff morale was at an all-time low.

A:

Achievements to date

We announced our Business Turnaround Plan (BTP 1) in February 2006. The Plan focused on financial survival in 2006, profit generation in 2007 and profitable growth in 2008 and beyond. With a clear mission to become a profitable airline, we pursued a business turnaround strategy which promised to cut our losses from RM1.7 billion (full year) to RM620 million in 2006 (representing RM1.1 billion improvement in just 1 year), a profit of RM50 million in 2007 and a record profit of RM500 million in 2008. Our BTP 1 was part of the Government-Linked Companies Transformation (GLCT) Programme, which was launched by the Prime Minister in 2004. The Programme is intended to make all Government-Linked Companies (GLCs) more successful and effective. The Programme provided a framework and acted as the spearhead for our business turnaround. We worked within the guidelines prescribed which went a long way towards making this turnaround possible.

FINANCIAL PERFORMANCE
We beat our financial targets for 2006 and 2007. For the 2006 full year results, we have exceeded our RM1.1 billion BTP 1 improvement target. We made a loss after tax of RM136 million, which was a RM1.6 billion improvement over the RM1.7 billion base case loss for 2006. In addition, we improved our cash position and recovered fully from the cash crisis. For year-to-date September 2007, we made a net profit of RM610 million (see Exhibit A1). This exceeded our BTP 1 target of RM50 million for 2007, and even our target of RM500 million profit for 2008. In fact, this is the highest profit in our 60-year history. Our previous highest annual profit of RM460 million was recorded in 2004 (see Exhibit A2). Even with the Q407 result still to be included, we have already surpassed our 2004 record. Exhibit A1: Financial results to date (2005 to YTD 2007)
(all figures in RM)

610m

2005

2006 YTD 2007

-1.3b
(Jan - Sep)

-1.7b
(annualised)

Exhibit A2: Achieving record profits in MAS 60-year history

1. Revenue/Yield improvements
(Full year) 461 (9 months)

(All figures in RM million)

610
326

For the passenger business, we implemented 2 important projects to improve revenue/yield namely the Route Profitability Project (RPP) and Revenue Enhancement Project (REP)1 . Both the Revenue Management and Sales & Marketing teams worked really hard to implement many initiatives under these projects. We set out to significantly close the yield gap against our key competitors and we did it. As a result of this work, we improved our yield or Revenue per Revenue Passenger Kilometer (RRPK) by 28% from 20.5 sen/RPK (full year 2005) to 26.3 sen/RPK (YTD 2007). Revenue per Available Seat Kilometer (RASK) also increased by 28%. With this, we increased revenue by some RM973 million in 2006, and approximately another RM1 billion in the 9 months of 2007 (January to September 2007). These increases in revenue do not include any one-off gains or sale of assets.

288 222 112 151 154 111 144 7 86/87 87/88 88/89 89/90 90/91 91/92 92/93 93/94

319 261 233

337

260 700 259 417 836 94/95 95/96 96/97 YTD 07 02/03 03/04 04/05

97/98

99/00

Dec 06

00/01

Exhibit A3: Improvements in Yield and RASK

01/02

23.6
Dec 05

24.2

26.1

26.3 25.9

Yield* RRPK (sen/RPK) Increased by 5.8 sen/RPK

98/99

(28% increase)
18.9
RASK* (sen/ASK) Increased by 4.1 sen/ASK

22.6

22.7

18.5

18.3

Yield

20.5

16.8 16.5 15.5 15.6

(28% increase)

How did we achieve this strong financial performance?

At the start of 2006, MAS assembled a team to diagnose the problems which led to our RM1.3 billion loss in 2005. Our prognosis was: MAS has excellent products and services as a multiple award winning airline, as well as favourable load factors. Once we knew that the business model is sound, we focused our attention on fixing the P&L. MAS had 4 P&L problems then: low yield, inefficient network, low productivity and lack of cost control. Our immediate task for the next 3 years (2006-2008) was to fix these problems, and these were clearly laid out in the BTP 1. Doing a business turnaround is very different from business improvement. When a company embarks on a business turnaround, it is about big results, fast. It was made clear to all MAS employees then that if significant results were not achieved within the first 6-12 months, this meant that the team was not focusing on the right business activities. So, being focused was absolutely important. The turnaround was successful because the BTP 1 was totally focused on delivering immediate results by anchoring everything on the P&L i.e. addressing all the 4 P&L problems head on with: 1. Revenue/yield improvements 2. Network improvements RASK
14.8

FY 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007

Q3 2007

*YTD cumulative figures *Includes Fuel Surcharge and Admin Fees

In terms of the Cargo business, we achieved record profits of RM179 million for the year 2006, surpassing our target of RM150 million. We expect to repeat the same success for the year 2007. The yield improvements in MASkargo were the key driver behind this achievement. In addition, we took on more third party maintenance work to optimise available resources at Engineering & Maintenance, and increase our capability as a major facility in the country for Maintenance, Repair & Overhaul (MRO). For example, in 2006, third party maintenance work and other engineering activities brought in a record sum exceeding RM212 million in revenue.

1In the latter part of this document, we will explain that these 2 commercial initiatives, Route Profitability Project (RPP) and Revenue

3. Productivity improvements 4. Cost reduction

Enhancement Project (REP), eventually evolved into Projects Alpha and Omega.

2. Network improvements
Based on the comprehensive network review supported by analysis from the RPP, we took specific steps to optimise our existing network where possible via rescheduling and redeployment of the aircraft to match individual routes. We also took the drastic step of suspending unprofitable routes after exhausting all route profitability actions. Although we did stop a number of routes, we also increased our capacity to other routes such as Jakarta, Bangkok and Los Angeles. We applied the same approach to our domestic network. As a result, the 25 domestic routes which the Government handed back to MAS (as a result of domestic network rationalisation) on 1st August 2006 are showing positive results. We pursued a "hub-and-spoke" strategy as a means to increase the feeder traffic onto our trunk routes. We tirelessly pursued codeshare and interline partners namely KLM for North Europe, Alitalia for South Europe, Virgin Blue for Australia, South African Airways for Africa, China Southern Airlines for China and are currently pursuing a key player in India and Turkey respectively. With these new partners, we now have a well-balanced network covering all our key markets and this has a direct positive impact on our bottom line.

4. Cost reduction
We achieved a significant cost reduction of RM665 million in 2006, and more than RM700 million to date in 2007, mainly through improving fuel efficiency, manpower productivity, inflight spend, corporate sponsorship and other initiatives. However, this is only the beginning of the journey and our aim is to build on this as part of our strategy going forward (covered in greater detail in the latter part of this document).

NON-FINANCIAL PERFORMANCE
Despite going through the challenges of the business turnaround over the past 2 years, we have continued to maintain the momentum in garnering awards by distinguishing ourselves amongst passengers for providing excellent services and hospitality. The highlights of our achievements in 2006 and 2007 are: 1. 5-Star Airline Award, 2006 and 2007, Skytrax 2. Best Cabin Staff Award, 2006 (Top 3) and 2007 (No.1), Skytrax 3. Asias Leading Business Class Airline, 2007, World Travel Award 4. Best Airline for Cabin Service Worldwide, 2007 (Top 5), SmartTravelAsia 5. Malaysias Top 12 Most Valuable Brands, 2007, Interbrand 6. Global winner for Economy Class Onboard Service Excellence, 2006, Skytrax 7. Best Airline to Asia, 2006, Travel Weekly Globe Award 8. Best New Business Class Seat, 2006, Global Traveler 9. Best Economy Class, 2006, World Airline Awards 10. Best South Asia Airline, 2006, Hospitality India Awards 11. Platinum Award, 2006, Readers Digest Trusted Brand Award We have successfully retained our 5-Star rating for 2006 and 2007. Despite the focus on improving the P&L, we were able to maintain, and at times, enhance the quality of the services offered to our passengers. We are all very proud of this achievement. Given our successful turnaround, we were awarded the Airline Turnaround of the Year in 2006 by the Centre of Asia Pacific Aviation (CAPA). This recognition by the industry is a testament to our collective efforts in realising the objectives set in our BTP 1.

Exhibit A4: MAS hub-and-spoke network

Bergen Stockholm Oslo Stavenger Aberdeen Sandefjord Gothenburg Edinburgh Glasgow Teesside Belfast Copenhagen Leeds Dublin Manchester Amsterdam London Frankfurt Brussels Vienna Munich Geneva Milan Barcelona Madrid

Helsinki

Legend -------- - Operated by Malaysia Airlines -------- - Operated by Alitalia -------- - Operated by South African Airways -------- - Operated by Virgin Blue -------- - Operated by BMI -------- - Operated by Gulf Air -------- - Operated by KLM ---------------- - Operated by Air Mauritius --------- - Operated by All Nippon Airways --------- - Operated by Qatar Airways --------- - Operated by Garuda Indonesia --------- - Operated by Sri Lankan Airlines --------- - Operated by Cathay Pacific Airways Turkey (Aspiration)
Tashkent

- Operated by China Southern Airlines to 90 destinations from Guangzhou and 38 destinations from Beijing

Beijing
Inchon Seoul Kansai Tokyo

Rome

Athens

Nagoya Bahrain Doha Muscat Yangon Bangkok Phuket Langkawi Penang Medan

India (Aspiration)

Fukuoka Shanghai

Guangzhou
Hanoi

Hong Kong

Siem Reap Phnom Penh Ho Chi Minh

Manila Cebu

Colombo

KUALA LUMPUR
Singapore Kota Kinabalu

Exhibit A5: Airline Turnaround of the Year Award Malaysia Airlines has launched an aggressive turnaround programme and the early positive signs could mean it achieves its ultimate goal of returning to profitability well in advance of its 2008 target.
Peter Harbison, CAPA Executive Director, CAPA Aviation Awards of Excellence 2006

Dar es Salaam TANZANIA Maputo MOZAMBIQUE Mauritius Gaborone, BOTSWANA Durban Maseru, LESOTHO East London

Jakarta Surabaya Denpasar Darwin

Harare, ZIMBABWE Victoria Falls, ZIMBABWE Windhoek, NAMIBIA

Broome

Cairns Townsville Hamilton Island Mackay Rockhampton Fraser Coast Sunshine Coast

Brisbane Perth Adelaide Melbourne

Johannesburg

Gold Coast Ballina Byron Coffs Coast Newcastle

Port Elizabeth

Canberra

Sydney

Launceston Hobart

3. Productivity improvements
We reduced manpower by 15% (over 3,000 staff) through the mutual separation scheme (MSS), retirement and contract expiry. Despite this, we continued to offer high quality products and services to our customers and achieved record profits. The Human Resource team, with the support of our Unions and Associations, has made this effort possible.

Overall, we achieved good on-time performance throughout 2006 and 2007, maintaining an average of ~87%, which is comparable to the International Air Transport Association (IATA) and Association of Asia Pacific Airlines (AAPA) average. We have also achieved all our safety milestones, including the implementation of our Corporate Safety Management System (SMS) and passed the rigorous IATA Operational Safety Audit. On human resources, we pursued various improvements with specific focus on unleashing the talents among MAS employees, our key asset. First, based on the People Lab recommendations, we rolled out the performance management system across the company, the first for 60-year-old MAS. This was done in tandem with a reward and recognition scheme, so that we could directly reward employees for their performance and contributions. For the achievements between 2006 and 2007, we granted 2 separate ex-gratia payments of RM1,000 each to all employees, and 5-7% salary increments to graded and executive staff. We have also awarded bonuses to deserving staff who were instrumental in successfully leading key projects or making exceptional achievements. Furthermore, we launched our Employee Share Option Scheme (ESOS) in 2007, providing us with a systematic way of aligning staff contributions and reward mechanisms to the companys performance. On corporate governance, MAS strives to continuously improve the corporate governance practices by focusing on enhancing policies, processes, structure and people. The Audit & Business Advisory (ABA) Department with support from Risk & Policy Advisory Services (RPAS), launched the Internal Control Enhancement Programme (ICE Programme) in April 2007 as part of a mid to long term programme to inculcate the risk and control culture within the organisation. This will directly enhance the overall internal control systems and corporate governance practices within the company. Among the key initiatives that have successfully materialised in 2006 and 2007 were the adoption of a company-wide internal control framework, roll out of the Whistleblower programme, enforcement of the Commend and Reprimand Programme (CaRP), establishment of Code of Ethics, and formalisation of the Risk Management policy.

At the tail end of 2007, we constantly reminded all MAS employees: We have only arrived at base camp; the real mountain is still looming ahead of us. Scaling its steep slopes will require us to take bold strategic steps and tackle head on the impending industry challenges facing us. We have seen many full service airlines in US and Europe that have collapsed because the competition was too great and costs were out of control. We are taking the cue from these painful examples and working in a united manner, maximising every single opportunity to take the company to even greater heights of financial and operational success. This document charts out the Business Transformation Plan (BTP 2) that we intend to undertake, and it covers our transformation roadmap over the next 5 years.

THERE IS MORE WORK TO DO

We gave ourselves 3 years to complete the Turnaround. The achievements from 2006 to 2007 have been most encouraging. In fact, we achieved our BTP 1 profit target (RM500 million by 2008) a year earlier than originally scheduled despite the increase of crude oil price from USD65 per barrel (2006 average) to USD73 per barrel (2007 average).2 We managed to reach this pole position at a much quicker pace, through the sheer determination and dedication of our employees who rose to the challenge to make BTP 1 a success. Whilst we have been commended for our remarkable turnaround and success, we must remember that we have only reached base camp. MAS cannot rest on its laurels. History offers us valuable lessons on how turnaround efforts have faltered when not sustained and built upon. Continental Airlines famous successful turnaround programme was launched in 1994. However, the programme had to be re-invigorated to address the impact of an industry downturn post September 11. This then produced results which brought Continental Airlines back into the black in 2006. In contrast, the well-documented US Postal Service turnaround programme was short-lived because the organisation was unable to sustain momentum, despite its initial success. New stronger competition as well as a lack of follow through on large turnaround initiatives ultimately led to the failure of this programme. Learning from this, our collective intent and ultimate objective must be to secure and sustain the future success of our national carrier. We have to ensure that the success we have achieved to-date is built to last. We will do everything humanly possible to ensure that MAS does not slide back to making a loss of more than RM1 billion in light of the initial successes we have achieved.
2Source: IATA fuel data

In 2006, we were faced with a P&L and cash crisis. Now, we are faced with a different kind of crisis which is looming on the horizon. This is actually not new. In the earlier published BTP 1, we highlighted the challenges facing the airline industry. These challenges remain; indeed these realities have become even more severe and, if left unchecked, can lead to a crisis situation for MAS in the near future. The MAS Business Transformation Plan or BTP 2 proposes bolder actions compared to the earlier BTP 1. Embracing these actions requires an understanding of the industry and environment within which MAS operates.

ASIA AT THE FOREFRONT OF THE STORM, FACING INTENSE COMPETITION

Current Airline Industry

B: Environment

The cold reality is that the airline industry is a tough one. Most markets eventually mature into intensely competitive arenas where very few players are able to earn consistent profits. Asian airlines have enjoyed a few years of excellent returns, reflecting relatively light competition and robust growth, but the signs of deepening competition and worsening market conditions are now evident in Asia. Indeed, the following is true of the current environment for the airline industry: Recent trends are leading to profit erosion in the industry. Asian carriers have been protected to date, but not for much longer. While the industrys structural dynamics virtually guarantee eventual crisis, a number of trends have converged to possibly develop into the deepest and longest downturn that the industry has ever seen. The collective impact of these trends is tremendous.

Recent trends are leading to profit erosion in the industry

Key trends observed in the industry include the following: Trend #1: Overcapacity i.e. massive additions to capacity by 2009. Airlines, with their optimism fuelled by the strong profits currently being generated in Asia, are competing with one another by placing large aircraft orders. The demand for new aircraft has been so good that Airbus and Boeing are seeing record orders. Emirates alone will take delivery of their huge order of the A380s and most of these planes will be deployed on the important Kangaroo route i.e. Australia Europe. Any order made for an aircraft today will generally see delivery beyond 2012. Exhibit B1: Annual aircraft capacity in Asia Pacific, India and Middle East

13

14

Based on industry estimates, about 400 plus new aircraft have hit the skies of Asia Pacific, India and the Middle East in 2007, with another 400 plus expected in 2008. The total of 800 aircraft in 2007 and 2008 alone translates into an annual supply growth of ~8% against a projected demand growth of ~6%. This is likely to lead to lower prices and/or erosion of profit margins since demand does not increase in tandem with capacity. Although many of the planes are to replace the existing fleets, the fact is that the old planes will remain in the system. They are not going to be scrapped like cars. The older planes are deployed elsewhere for other purposes and many of them will find their way back to the soon-to-be saturated Asia market. In addition to growing their fleet through new aircraft purchases, many of the traditional full-service competitors are also investing heavily to enhance their premium service offering. For instance, several mega full-service carriers have upgraded their B777s with premium business class seats and state-of-the-art inflight entertainment systems. With more and more airlines upgrading their aircraft, and adding new aircraft to their fleet, industry analysts predict that a product war is inevitable. The pressure on yield will be significant. Airlines (and aircraft manufacturers) have traditionally based their forecasts on assumptions of relatively large ratios between air traffic growth and GDP growth. For several decades, airline growth significantly outstripped economic growth. However, since the 1990s, airline growth in most parts of the world has become more closely aligned with the economic growth. Nearly all additional growth in Europe, for example, has come from the low cost carrier (LCC) segment. A joint study done by MAS and the global consulting firm, McKinsey & Company shows that there has been a slowdown of global air traffic growth. Much of the growth of the last 40 years has been driven by price declines and increases in access (that is, a new service that makes it much easier to get between 2 points). Both drivers are reaching natural limits. Prices cannot go below zero or are not likely to and virtually every point in the world can be reached from another in less than 24 hours. As revenue growth slows, the factor costs (especially fuel, labour and airport charges) which have been rising in the background all these years will catch up with the airlines. The good years of growth have also shielded all the inefficiencies in the airlines. These inefficiencies, which were not addressed but rather postponed, will eventually haunt the airlines when the revenue growth slows down. Trend #2: Low-cost competition is on the rise In nearly every market, we see low-cost (or at least low-fare) competitors dumping large numbers of very low priced seats in core markets in the hope of stimulating demand. These airlines are attempting to generate new pools of discretionary traffic. Even though these airlines do not explicitly target the business passengers from which full service carriers make their living, they create a devastating residual effect. When LCCs drop leisure fares, they also typically remove restrictions such as advance purchase requirements or minimum stay. Because of this, full service carriers are faced with a choice: to either match these fares and conditions and lose valuable premiums from business passengers, who now have access to these lower fares, or to continue to take premium fares from business passengers and risk losing significant market share in the leisure segment. Research shows that following the entry of a LCC on a route, the profits of the incumbent carriers on that route decline by an average of 31%. As for the Asian market, the threat from growing LCCs will mean a loss of market share for the traditional full service carrier. Projections show that LCCs in the Asia Pacific region will increase their presence, resulting in an increase of capacity share from less than 10% to 25% of the available seats. Furthermore, LCCs are aggressively expanding beyond the traditional short-haul routes to medium-and long-haul markets. The few that have started include Oasis from Hong Kong to London, and from the Kuala Lumpur hub, 2 other airlines i.e. JetStar and AirAsiaX have started flying to Australia.

Trend #3: Rising factor costs particularly fuel Between January 2005 and December 2007, the crude oil price increased from USD38 per barrel to USD90 per barrel which is a massive jump of 135%. In January 2008, it touched USD100 per barrel. This is the highest oil price that mankind has ever known. The increase in fuel prices alone has added nearly USD88 billion to the industry cost structure, bringing the industry total fuel bill to USD149 billion. So severe was the impact of the increased oil price that United Airlines announced in early November 2007 that it was contemplating grounding 100 planes within its fleet. Giovanni Bisignani, IATAs Director-General and CEO, when asked to forecast the outlook for the aviation industry, warned that the escalating price of jet fuel would seriously dent airline profit margins, erode the yields and even cripple a number of airlines. Trend #4: Increased public scrutiny on environmental issues Based on data from the United Nations, aviation is responsible for only 2% of global carbon emissions a small quantum compared to ground transport and power plants that burn fossil fuels. IATA estimated that this figure will grow to, at most, 3% by 2050. With global warming and climate change being key topics of debate at world forums, attention is drawn towards aviations role and its stand on the issue. Governments in various parts of the world are in unison in supporting the global strategy i.e. to curb the increase of greenhouse gas emission. However, there is a lack of globally accepted standards and solutions to the issue. There are governments or economic regions which are taking a unilateral approach to address the issue. For example, EU is forging ahead unilaterally to design a legislation on emissions trading - which is not in tandem with developments in other parts of the world e.g. Asia, Middle East, South America, etc. Once this law is passed in EU, it will affect a lot of non-EU airlines which are unprepared, causing these airlines to suffer financial losses as they will need to stop flying the European sectors overnight. IATA is currently advocating a 4-pillar strategy: invest in new technology, operate efficient infrastructure, fly planes efficiently, and introduce economic measures (tax credits for re-fleeting, offset programmes and emissions trading). It has also made public its interim fuel efficiency target i.e. 25% improvement in fuel efficiency by 2020. Many international airlines are rallying behind IATAs strategy because it offers more structured and palatable solutions to the environmental issues. In fact, IATAs strategy has shown positive results to date: 15 million tonnes of CO2 savings in 2006 and a further 10 million tonnes in 2007. IATA is now working with the International Civil Aviation Organisation (ICAO - an international body representing governmental representatives from various nations) to map out the options to achieving carbon neutral growth and to develop a strategy to guide the efforts of governments, airlines and manufacturers. Most airlines, including MAS, continue to be guided by IATAs direction. Trend #5: Possibility of slower global macroeconomic growth While the Asia Pacific economy in 2007 remained positive, there are early indications of turmoil ahead. The volatility of oil prices and the uncertainty of US economic growth due to a weakening housing sector may spill over and impact Asias economic growth. This could amplify the negative impact on developments in the aviation industry over the next couple of years. There are also rising concerns among economists with regards to the possibility of global shocks due to the continuous unrest in the Middle East and Africa, and an economic downturn in China post-Olympic 2008. Historical events such as September 11, the SARS outbreak and the Gulf War have proven to have devastating effects on the aviation industry, with short-term changes in demand in some regions exceeding 30%. While it is arguable whether such global shocks are increasing in frequency, it is clear that when they do happen, these events will have a greater impact on our industry. Today, as much as 70% of travel is purely discretionary.

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Simply put, many of our customers do not need to travel. In addition, with the immediacy of global media, we may end up with increasingly volatile demand. Airlines used to plan for demand shocks of up to 5%-10%. Today, we need to have the flexibility and agility to react to demand shocks of up to 30% or more.

There are tight controls on competition Most Asian markets (particularly North Asia and ASEAN) have limited competition as these markets are highly regulated. Of late, there has been increasing liberalisation in Asia. Constrained capacity for growth in supply has kept demand strong in the past Traffic from Asia to North America and Europe has grown rapidly, by 6% and 11%3 per annum respectively since 2002, dramatically outstripping supply growth. Intra-Asian demand has increased by 40%4 in the same period. The Asian economic recovery has been fast and full, leaving airlines to profit from the excess demand. In most markets, such an increase in demand would have been rapidly followed by supply growth. Between 2002 and 2005, Asian markets benefited from constraints on supply as manufacturers order books were generally full. Airlines in Asia had to wait for new aircraft up till 2006 after which new aircraft started to pour into the region in large quantities.

Exhibit B2: New IATA Financial Forecast Predicts 2008 Downturn Geneva International Air Transport Association (IATA) released a new industry financial forecast estimating a global industry profit of USD5.6 billion in 2007, falling to USD5 billion in 2008. IATA sharply revised downward its outlook for 2008 to USD5 billion from the previously forecast USD7.8 billion. The spike in fuel prices is expected to add USD14 billion to the industry fuel bill, driving it up to USD149 billion (based on an average price of USD78 per barrel). The broadening impact of the credit crunch is expected to slow revenue growth to 4.7% and traffic growth to 4.0%. Simultaneously, capacity expansion is expected to accelerate in 2008 with an increase in aircraft deliveries to 1,281 (up from 1,041 in 2007). The challenges get tougher in 2008. A favourable economic environment and effective efficiency measures helped mitigate the impact of high fuel prices and underpinned profitability improvements. With the credit crunch, that is changing. The peak of the business cycle is over and we are still USD190 billion in debt. So, we could be heading for a downturn with little cash in the bank to cushion the fall, said Giovanni Bisignani, IATAs Director-General and CEO.
Source: Extracts of IATA Press Release (12 December 2007)

HOW MAS WILL BE AFFECTED

Many of the factors that have eroded profits in the West are emerging in Asia with some of the effects already being felt. MAS, in particular, has been and will continue to be, affected in the following ways: Overcapacity Issue

Asian carriers have been protected to date, but not for much longer
For years, many in the industry have pointed to Asia as a bright spot on the aviation horizon. Planes are full, many carriers have returned to profitability, and aircraft manufacturers order books are filled with new planes to refresh the Asian fleet. Indeed many Asian carriers have been enjoying record profits, for example, Singapore Airlines, Qantas and Cathay Pacific. However, it is increasingly clear that the factors that have lifted the performance of Asian carriers are transient, and that the ills that have affected airlines in the US and Europe are around the corner. While these airlines have certainly worked hard to be resilient after the September 11th, post-SARS era, much of their good fortune comes from the environment they operate in and, in particular, from the following factors:

Asian carriers (and carriers plying the Asian markets) have ordered massive numbers of long-haul aircraft. The A380s and B777s ordered by Singapore Airlines, Emirates, Qantas and others will need homes quickly and will find them in the core routes across the region. Research suggests that the combined effect of this capacity could result in yield declines by as much as 7% in core markets by the end of 2008. ASEAN Air Transport Liberalisation The opening of air space in ASEAN will invite new entrants (foreign and smaller local carriers) into the currently protected ASEAN market. In November 2004, the ASEAN Transport Ministers agreed to open up the ASEAN skies in an orderly manner. To facilitate the process, the ASEAN Transport Ministers adopted the ASEAN Roadmap for Air Transport Integration (see Exhibit B3). This will lead to additional competitive pressure in the ASEAN market. In a study done by McKinsey & Company, based on liberalisation in the European market and past cycle downturns, the overall industry margin is expected to decline by 4-5 percentage points on average over the next few years (see Exhibit B4). This will affect all airlines, albeit in different degrees.

3Based on passenger volume between 2002-05. Source: International Air Travel Association (IATA) 4Based on passenger volume between 2002-05. Source: International Air Travel Association (IATA)

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Exhibit B3: ASEAN Roadmap for Air Transport Integration Section 1: ASEAN Liberalisation of Scheduled Passenger Services 1.1 December 2008: The full liberalisation of scheduled passenger services between capital cities for 3rd and 4th freedom traffic. 1.2 December 2010: The full liberalisation of scheduled passenger services for 5th freedom rights between capital cities. 1.3 December 2015: Single aviation market for ASEAN with total freedom of operations. *On 25 October 2007, the Malaysia and Singapore governments announced that the Kuala Lumpur Singapore route would be liberalised on a limited basis. Both governments granted permission to LCCs namely AirAsia, Tiger Airways and JetStar, to operate a total of 4x daily frequency starting from February 2008, which is 10 months ahead of the ASEAN liberalisation road map. This is yet another clear sign that liberalisation is imminent, in tandem with worldwide industry trend, and we have to face the reality and start confronting it. MAS needs to pick up its pace and get ready for the eventual opening up of airspace in ASEAN. Section 2: ASEAN Sub-Regions Liberalisation 2.1 Between December 2005 and December 2008: The liberalisation of scheduled passenger services for the ASEAN sub-regions of Brunei, Indonesia, Malaysia, Philippines - East ASEAN Growth Area (BIMP - EAGA) and Indonesia-Malaysia-Thailand-Growth Triangle (IMT-GT). Section 3: ASEAN Liberalisation of Cargo Services 3.1 Between December 2006 and December 2008, the liberalisation of cargo services will proceed within ASEAN.

Exhibit B4: Using the European market as an analogy, ASEAN liberalisation would lead to 4% 5% lower margins

Operating margin (%)

8 6 4 2 0 -2 -4 1980 85 90 95 2000

World EU

Implications After EU liberalisation, operating margin

for EU airlines dropped significantly, especially compared to the global industry level.

Intra-EU routes that are affected by

liberalisation are estimated to drive 40% of total revenue for EU airlines.**

+0.7

Indicates that EU liberalisation reduced

overall operating margin by 1.8% and intra-EU route operating margin by 4%5%.

EU vs. World diff in average op margin* %

-1.1
Before liberalisation After liberalisation

* Before liberalisation includes 1980-1989. After liberalisation includes 1993-2000. ** Estimated domestic/Intra-EU/Intercontinental percentage split for EU airlines: Pax: 31/45/24, ASK: 6/17/77, Revenue: 14/26/60 Source: ICAO

More intense low cost competition on the regional level New low-cost entrants are already eroding yields in regional markets, but the combination of excess investment funds interested in the space and the gradual opening of markets will lead to further proliferation and yield destruction. As we have seen in the US and Europe, not all of these new entrants will have rational or viable strategies. Some will choose to take on incumbents in core business markets, and perhaps even long-haul. While low cost players might not succeed in these markets, the more relevant fact for incumbents is that they will try. The fight will be long and hard, with devastating effects on yield or profit margin. Clearly, as AirAsias fleet grows and it looks for new market opportunities, we see it attempting to enter MAS core markets. There will be increasingly difficult competition from foreign carriers now made much stronger by tough fights at home US, European and Australasian carriers never easy competitors have been forced to become much leaner by intense competition on their home turf. These carriers, with their lower cost structures, leaner processes and faster decision cycles will prove to be much tougher competitors than their former selves. As they look for new growth opportunities, they will look to the as-yet-untroubled skies of Asia as a prime target. In the late 1990s and early 2000s, many European and US airlines dropped their services to Malaysia as their cost structures did not allow adequate returns in what has historically been a low yield market. As these carriers become leaner, they will return.

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Exhibit B5: Public Policy Impacts Our Business The liberalisation policy has clearly been embraced by the Malaysian government. However, when and how domestic aviation policy is made and implemented whether in relation to liberalisation generally, or to the growth of the domestic low cost sector or to the introduction of other competitors into the market - will surely affect overall business interests and the airlines bottom line. For example, when the decision to rationalise the domestic aviation sector was made in August 2006, quite rightly in the interest of a free, open and competitive market, the rush for its implementation without proper understanding of what was needed to fulfil the needs of the people and the tourism industry in Sabah and Sarawak, resulted in substantial losses to the nation and aggravation among the public. Again, in November last year, when the decision was made by the government to open up the Kuala Lumpur Singapore sector ahead of the ASEAN liberalisation timetable, it meant our airline had to face, a year earlier than it anticipated, the reality of having its bottom line shaved a year ahead of planned ameliorative action. The government, the market and, particularly, all of us in the company must learn lessons from policy making and implementation, and must cope with outcomes, even if we might think their predisposition unfair or ill-advised. The reality is that there is another airline in the country, which has made considerable advances and obtained support, now serving the market. This may not be comfortable, but we must take it as serious competition which we must better. For as long as policy formation and implementation is not capricious and inconsistent, our airline should be able to find its own space especially if we transform our business attitudes and practices. On the other hand, if the companys business is adversely affected by unfair practices, part of our transformation plan must include a disciplined approach to protect our interests as a listed public company.

Exhibit B6: Airline Market Phases*

Phase 1:
Limited competition

Phase 2:
Emerging competition

Phase 3:
Traditional competition

Phase 4:
Intense traditional and non-traditional competition

Environment Regulated Supply & Demand Supply < Demand

Deregulating Supply = Demand Brand loyalty has to be bought Medium Medium Breakeven/some profitable

Deregulated Supply > Demand Shop around (lowest price, etc) Competitive Low Many unprofitable

Highly deregulated Supply >>>Demand Highly choosy

Customers Loyal to the brand

Cost to serve High Price/ margin High Profitability Profitable

Low Very low Mostly unprofitable

History

Asia/ME

Europe

US

Phase 1 In the early years of the airline industry, most markets were highly regulated. Governments dictated both pricing and supply on nearly every route. Most regulators had a similar objective: to ensure profitability. The consensus was that a healthy and profitable national airline was a critical component of national security and sovereignty. Regulators carefully allocated supply to ensure that the national airlines benefited and prices remained high; that customers, facing few choices, remained loyal to the brand; and that, despite relatively little attention to costs, airlines earned good profits. This so-called Phase 1 market is now history as nearly every country and region has been forced to open its doors to competition. Phase 2 On the positive side, MAS is not alone in its exposure to these factors. To some extent, they will affect all of our regional peers, with some already being impacted. While the regulatory policies associated with Phase 1 markets ensured healthy airlines, they constrained demand. Customers complained of high prices, and would-be competitors, eager to enter markets, complained of favouritism. The first action most regulators took to increase competition was to allow new entrants to compete on key routes. Capacity and, in some cases, pricing were still strictly controlled, but customers now had choices. In this second phase of airline market development, airlines needed to compete for customer favour through product and service features. The frequent-flyer programme, business-class service, and plush lounges were all inventions of this phase. Despite increased competition and relatively high costs, most airlines in Phase 2 markets were able to earn reasonable returns as the regulatory control over market capacity ensured reasonably high prices. Most experts consider Asia to be in the late stages of this phase, with less-than-free competitive access to most markets and the competitive battlefield being played out along brand and product lines rather than cost lines.

Maintenance and capital costs will rise as the fleet ages The aircraft bought during the fleet investment exercise in the mid-1990s are now entering a more maintenance intensive phase. The average age of the aircraft in our fleet is between 10 and 12 years. Older aircraft require more maintenance and there has been a 10% increase in the number of annual heavy maintenance since 2004.

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Phase 3 In the early 1980s, the US began a complete deregulation of its airline market, with free access to nearly all markets and a complete release of pricing controls. Europe followed in the late 1990s/early 2000s. The US experience in the early 1980s is the archetype of this third phase. Multiple new players entered the market and supply quickly outstripped demand. The advent of the Internet allowed customers the opportunity to shop around for the lowest price and the best schedule. The advent of price and schedule as key purchase drivers quickly turned the competitive battlefield into a size and costgame. The airlines with the most flights and lowest costs were able to sustain themselves in a price and scheduleshopped environment and outlast the competition. Europe is largely in Phase 3, with incumbents closely controlling costs while pursuing consolidation to maintain scale. Phase 4 Unfortunately, it is now clear that the deregulated environment of Phase 3 leads to a natural end: new entrants proliferate some free of the legacy costs (pensions, old-debt, out-dated processes, etc.) that plague incumbents and low-cost supply dramatically outstrips demand. To keep planes full, all players radically reduce price, and the resulting customer base, with its high mix of discretionary travellers becomes nearly 100% influenced by price. In this final, fourth market phase, it is only the player with the lowest cost that is able to make money. The only avenue to sustainable price increases is collaboration among the players to increase load factors through joint capacity reduction. It is clear that consolidation through mergers and acquisitions is a strategy that many winners will have to pursue.

* Excerpt from BTP 1.

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C: MAS will fail without a

Business Transformation

MAS has successfully turned around and we have earned the right to stand alongside our peers. However, we have not reached a state of sustainable growth and profitability. We cannot remain on our current course as Asia, and Malaysia in particular, is rapidly progressing towards the Phase 4 market condition (see Exhibit B6). The liberalisation of the ASEAN skies will result in more intense local competition while boosting the presence of foreign carriers. Our yields and margins will be further challenged as prices drop with the expected increase in capacity. To make matters worse, fuel prices are currently very volatile and the crude oil price broke the USD100/bbl barrier in January 2008. Unless we take drastic action, MAS will hit a wall and fail, badly. In 2007, the MAS management team engaged in a comprehensive forecast exercise while preparing our business plan for 2008 to 2012. We tried to forecast what would happen to our financial results based on a number of reasonable business assumptions and revenue scenarios. The exercise demonstrated that, along with declining industry profitability and without business transformation, MAS stands to lose RM650 million (pessimistic) to as high as RM1 billion (worst case) in 2012. This will place us squarely back to where we started in 2005.

Exhibit C1: On current course, we will hit a wall

Our environment will get much tougher ...the wall is closing in P&L if we carry on with business as usual

Overcapacity (supply outstripping demand) Liberalisation accelerating progression to Phase 4 market condition Competitors cabin and fleet upgrades, kickstarting Product Wars Possibility of slower macroeconomic growth

P&L (RM)
+RM610m

MAS 2008 Corporate Scorecard On target : RM400-550m Exceeding : RM551-650m Outstanding : RM651-1000+m

2007 YTD (Jan-Sep)

2008

2009

2010

2011

2012

Pessimistic
* Yield drop ~5%yoy * Minimal seat -RM650m factor drop

Worst case
* Yield drop >5% yoy * Seat factor -RM 1b drop 5-6% yoy or more

This time, though, there will be no turning back for us. MAS would spin into a downward spiral from which it will not likely recover. Such losses will damage our credit rating and cripple our balance sheet, eliminating our ability to pay for new aircraft orders, and invest in products and talents. Our suppliers will cut us off and shareholders will abandon MAS for better investment prospects elsewhere.

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THERE IS HOPE MAS CAN STILL EMERGE AS A WINNER

Against this potentially grim outlook, we have in front of us, a golden opportunity to forge an alternative path towards a totally different outcome. We have unique intrinsic strengths: a strong reputation for excellent products and services, world-class cabin crew, widely acknowledged technical skills, unit labour costs that are amongst the lowest in the region if not the world, and located in a region that enjoys robust traffic growth. These are strengths that we have not fully tapped. If we are able to harness these strengths effectively, we will be able to create a winning combination to spearhead the transformation of MAS. Exhibit C2: There are winners and losers in each phase
Average return on total assets employed, 2001- 2006 Operating EBIT* / adjusted asset* in percent
75% quartile Virgin Blue Median 25% quartile ( ) No. of airlines Ryanair Aeroflot Thai Westjet AirTran Southwest LH BA Frontier

The typical features of top performers in each market phase are: Large full service carriers that have strong home market presence and an efficient-scale network (partly driven by the advantages of being in an alliance which provides the benefits of hub-and-spoke networks). Examples are Air France-KLM, British Airways and Lufthansa. Large LCCs that have leveraged first-mover advantage (first in region) gain sufficient scale. These LCCs include Southwest and Ryanair. The typical features of poor performers in each market phase: Mid-sized carriers with a legacy cost structure, without a sizeable home market or an international brand presence to attract passenger traffic. Legacy flag carrier with government influence. Late LCC entrants. In Phase 4, airline consolidation through mergers and acquisitions is inevitable. When the consolidation takes place, it will be led by the remaining few that are profitable. Some of the notable and successful mergers such as Air France-KLM (and the potential addition of Alitalia) and Cathay Pacific-Air China have propelled the new entities to greater heights in terms of financial performance and market share.

13.0 11.0 9.0

AirAsia Copa Jet Airways

7.0

6.6
5.0 3.0 1.0 -1.0 4.7 3.4 3.0

LAN Asiana Korean

Qantas SQ

MANY AIRLINES AROUND THE WORLD ARE RADICALLY RESTRUCTURING AND TRANSFORMING THEIR OPERATIONS TO SURVIVE
Globally, airlines that are being hit by the crisis are faced with a choice: either radically transform the business or wallow in a continued state of turbulence. Those that have attempted incremental changes have floundered only to eventually find themselves being restructured by the courts as part of a bankruptcy proceeding. Between 2005 and 2006, more than 50% of the industry capacity was operating under bankruptcy protection, including Delta Airlines and Northwest. In 2005 alone, United Airlines reported losses of USD2.1 billion. To survive and win, airlines will have to radically restructure themselves, leaving no assumption untested and seizing all possible opportunities. The good news from all this turmoil is that those who successfully manage the transformation will be positioned to dramatically outperform the rest. Some common measures taken by airlines undergoing restructuring: Across-the-board reduction in manpower cost Since 2001, airlines in the US have reduced employee wage and benefit costs by over 35%5. In addition, they have dramatically altered the mix of full-time, part-time and temporary employees. The goal is not just to reduce wage costs one time, but to create an employment structure that is capable of holding costs constant over time. It is clear that in an industry where prices decline by 2% year on year on a real basis, continuously rising labour costs through both wage increases and the natural ageing of the workforce is unsustainable. Shift to automation and outsourcing Airlines have embraced technology, automation and outsourcing with vigour, looking to automate non-value activities such as check-ins and outsource non-core activities such as maintenance and call centres. British Airways is in the process of rolling out web-based check-ins for the entire system, with the goal of virtually eliminating the airport check-in process (and queues) over time. Delta Airlines is outsourcing maintenance, call centres, and certain ground handling tasks in an effort to reduce costs and increase accountability.

4.0

CX

3.3
China Airlines JAL

Iberia

2.8
SAS Cyprus Alitalia

Continental Alaska NWA

0
Delta

-3.0

Phase 0: China

Turkish Airlines UAL Phase 1: Phase 2: Phase 3: Phase 4: Msia, Korea, Africa Spore, Thailand, Europe US S. America Japan, Taiwan, South Asia HK, ANZ

Highly regulated

Degree of liberalisation

Highly liberalised

* EBIT adjusted for interest expense for operating lease; total asset adjusted based on operating lease payment and cost of debt Source: Team Analysis / Bloomberg data

Based on data gathered, we have mapped out the return on total assets employed of several airlines against the various degrees of liberalisation (see Exhibit C2). Our study provided useful insights: As markets move from Phase 1 to 4, profitability declines. While the average performance of all carriers declines as their market liberalises, certain carriers fare better than others. Simply put, there will be winners and losers in each market phase all the way to Phase 4. It is noted that a prerequisite to winning is having the lowest cost. This will enable airlines to offer more competitive pricing, attract more passengers, and sustain their growth.

5Source: Herald Tribune

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Making tough choices about strategy In the past, this has been an industry characterised by a near complete disconnect between product and network investment and returns. Marketing departments have designed product specifications based on what they believed customers wanted and network structures based on where they believed customers wanted to fly to. In recent years, airlines have been forced to take a much sharper line on these investments. Airlines in the US and Europe have been forced to recognise, for instance, that however much passengers might appreciate food onboard, it does not influence the purchase decision for short-haul flights in the US and Europe, and is therefore, an investment with negative returns. Several full service carriers now charge for food. Similarly, these airlines have rationalised their networks, focusing on destinations where they can earn acceptable returns, and look to alliance partners to fill the void left by cancelled routes. British Airways, for example, reduced its available seat departures by 7.4% over the course of the last 5 years while increasing its operating margin by 4.7 percentage points6. These examples may or may not apply to MAS, and only those which are appropriate within MAS market will be implemented. The industry evolution towards a Phase 4 market with more intense competition and liberalisation will lead to an even greater divide between those airlines that achieve sustainable profitable growth and those that do not. The former a select few will be rewarded with more customers and greater capital for growth while the latter will languish, lag further behind and perhaps even perish. For MAS to win, we must seize the day. We must take bold and quick action to ensure our survival. We have come a long way since the start of our BTP 1. Most importantly, we were able to overcome a cash crisis to ensure our financial survival in 2006 and we are now on track to generate further profits in 2008. We must continuously build the foundation to adapt ourselves to the needs of our immediate future. We need to fundamentally transform our business into one that will deliver lasting success. As we go into 2009 and beyond, our focus will shift upwards to secure sustained, profitable growth for MAS. The next phase of our journey is the most challenging yet for MAS this is the real mountain that we need to scale. To chart our path onwards and upwards, we have a strategy that is tailored to meet the challenges ahead. Our strategy is to transform MAS into a Five Star Value Carrier, and we are determined to achieve this.

6Source: British Airways company reports

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The threats of overcapacity and liberalisation of the ASEAN skies are real. On a do nothing basis, MAS stands to lose RM650 million (pessimistic) to as high as RM1 billion (worst case) in 2012. This will place us squarely back to where we started in 2005. Given our strategic challenges, the only way forward to achieve lasting success is to transform into a Five Star Value Carrier (FSVC). Simply translated, this can be equated to building our business model around being a 5-Star Airline with an LCC-like operational structure vis-a-vis costs. We have a golden opportunity to harness the intrinsic strengths we possess to make this happen.

Exhibit D1 MAS should aim and plan for the best, and assume the worst. On aiming and planning for the best, we need to go for seemingly impossible targets e.g. record profit and grow in a profitable manner. On assuming the worst, we expect the business environment to be highly challenging and problematic. Therefore, we must transform to become a Five Star Value Carrier to survive and prosper. We have to build a ship that can weather the storm, in our case, imminent liberalisation and overcapacity in the industry. FSVC is our path to long term survival and success. Dato Sri Idris Jala Managing Director/CEO Malaysia Airlines

D:

Strategy:

Transforming to become a Five Star

Our goal is to build an airline capable of achieving best-in-class returns in the airline industry, delivering earnings of at least RM1.5 billion by 2012 even after factoring in the challenges in the industry such as overcapacity, air traffic liberalisation and rising fuel costs. The benefit of embarking on transforming MAS to become a FSVC is that we are building a ship that can weather the worst of storms. Should the magnitude of the overcapacity and liberalisation turn out to be less than what we anticipate or if fuel cost drops, there is an optimistic chance that MAS can achieve an even much higher profit our estimate is anywhere between RM2 and RM3 billion per annum. Hence, the FSVC strategy provides MAS a foundation to become a key player in the global airline industry.

Value Carrier

WHAT DO WE MEAN BY FSVC?

The term Five Star Value Carrier conjures an image of an airline that comes first to mind when customers seek quality air travel and real value-for-money. This is an airline that people go out of their way to fly with and to recommend to their friends because the airline understands what they REALLY NEED (not what the airline thinks they need) and does its best to meet these needs. This way, there is no unnecessary cost and therefore, fares can remain low and competitive. We will offer products and services that provide our customers with more value compared to those of our competitors. Our target customers are those who want service excellence and quality, and do not make decisions solely on price. Their reasons for flying with us could revolve around connectivity, inflight service, seat comfort and a host of other reasons. This means that we will not always compete directly with the lowest fares offered by the LCCs or other full service carriers. Our aim will be to have a yield premium that is above the lowest priced competitor on our routes.

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At the same time, we will place a lot of emphasis on delivering value for money as we know that price is still an important consideration for many. Thus, we aim to offer very competitively priced tickets in all classes. Delivering value will require us to improve our customer service and increase the efficiency and productivity of our behind-the-scenes infrastructure. This then needs to be matched with appropriate choices about how and where we spend on product development and ensuring that there is a clear Return On Investment (ROI) on every ringgit spent.

IS THIS CONCEPT OF FSVC PROVIDING 5-STAR SERVICE WHILE MAINTAINING LOW COST POSSIBLE?
There will be a lot of sceptics who will say that FSVC cannot be done. Based on some of the work we have done at Malaysia Airlines, we are confident that this is achievable. Some key examples are: Example 1: Modifications made on hot meals for long-haul sector On a particular route, we discovered that although the lamb briyani costs us more, customer satisfaction was poor compared to the nasi goreng with satay ayam (fried rice with chicken satay), a lower cost item. There are many similar examples when this approach is applied on a route by route basis.

Exhibit D2: Hot meals Cost vs. Customer Satisfaction

KUL-CHINA, Lunch / Dinner

Cost (RM)
High cost
Lamb briyani Wild salmon teriyaki

Demographics
Malaysian Chinese Indian American Australian Others 36% 11% 11% 8% 5% 29%

Deep-fried fish pollack with szechuan sauce Chicken mild curry

Undisclosed

Sweet and sour chicken Pollack fish with black-bean sauce Chicken yakitori with leek

Seasonal salad topped with grilled chicken Nasi goreng with satay ayam

Achieving higher customer satisfaction at lower costs

Stir-fried egg noodles with chicken

Low cost
3.00 3.10 3.20 3.30 3.40 3.50 3.60 3.70 3.80

Customer Preference
(1= least, 5 = most)

Customer Satisfaction

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Example 2: Introduction of light meal boxes for selected short-haul sectors A second example is the introduction of the Light Meal Box (LMB) on selected routes. When we scanned the industry, we realised that many European and Asian carriers have introduced light meal boxes. When we launched ours, we did a survey based on 383 flights (35,000 passengers). The findings showed that 91% found our light meal boxes acceptable, 5% complimented them and only a small group i.e. 3% did not like them. The meal boxes have enabled us to increase inflight service efficiency, improve aircraft turnaround time, and reduce our overall inflight costs.

Example 3: Increase in Internet sales Sale of air tickets via the Internet plays a critical role in realising FSVC. With our improved Internet Booking Facility, our customers can purchase tickets from the comfort of their home without having to incur the Global Distribution System (GDS) fee which is standard for purchases made via travel agents. In other words, we can offer our customers the convenience of self-booking without charging them for services they do not really need. Our Internet Booking Facility, together with the MAS Passenger Services System (PSS), will offer customers a hassle-free travelling experience from reservations to ticketing whilst at the same time, substantially reducing operating costs.

Exhibit D3 : Light Meal Box Cost vs. Customer Satisfaction

Cost (RM)
High cost Fresh meal

Source: Inflight Services LMB Survey (Oct 07 - Nov 07); International Inflight Survey (Sep 06 - Oct 07)

Undisclosed

Light Meal Box

Achieving higher customer satisfaction at lower costs

Low cost 5.00 5.50 6.00 6.50 7.00 7.50 8.00 8.50 9.00

Customer Satisfaction (5 = least, 10 = most)

Customer Satisfaction

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Exhibit D4: Examples of Other Airlines Transformations

A few other airlines have made transformations similar to what we are about to embark on. The best examples are Aer Lingus, Air Canada and LAN. Aer Lingus slashed its costs by dramatically altering its business model to adopt several key features of LCCs. It increased Internet bookings to 70%, bringing down distribution costs by 40%. On short-haul sectors, it eliminated Business Class, free food and newspapers. It also redesigned its operations around its assets its planes and people to ensure that productivity, not the beliefs of the marketing department, governed schedule design. That said, Aer Lingus recognised that it needed product and brand advantage to Ryanair, its key competitor. Following extensive research, it focused on a handful of attributes around which it could create brand strength and pull. Aer Lingus slogan, Low Prices, Way Better sums up its brand position well.

Air Canada has been very vocal about how its model, focused on low costs and significant sources of protected revenue, delivers superior profit. Air Canada introduced 5 product-based branded fare bundles, each with specific virtual characteristics (e.g. extra frequent flyer miles, seat assignments, reduced change fees, etc). The added value gives people a reason to purchase a higher fare even when Air Canada is matching LCC prices, resulting in 46% of Air Canadas passengers buying a higher fare than the lowest fare available.

Aer Lingus transformation levers

33% staff reduction (at 6% less ASK's) down 35% 55% reduction in management group Pay freeze Distribution costs down 56% (commissions cut, on-line booking, e-tickets) Single aircraft type
Cost/RPK Revenue/ RPK down 23%

Aer Lingus key group data

%

LAN, a successful regional airline group has recently redesigned its short-haul business model from scratch. By redesigning the operating model, it increased short-haul aircraft utilisation from 8.4 hours to 10.4 hours, and from 36% to 41% direct flights. The results were a sharp increase in its operating margin from 3.7% to 7.3% between the second quarters of 2006 and 2007.

Operating Margin
6.7 9.3 11.8

-4.7

MAS has the advantage of being in a better starting position than any of these carriers. None of these carriers had the labour cost advantage over their competitors that MAS has. None of these carriers started its journey with the strong reputation of being a 5-Star airline. None of them was as well-placed to venture into new business opportunities such as our Maintenance, Repair and Overhaul (MRO). If we take advantage of our better starting position, we will be able to achieve greater success.

Reduced full fares by up to 60% (7% revenue reduction) Simpler fare structure Lowest fares available only on aerlingus.com Value-based offering

Seat Load Factor

78 71 81 82

Value

proposition Focus on 4 key differentiators

Internet Sales Penetration

66 50 28 8 2001 2002 2003 2004

vs. LCCs Consideration Direct flight Assigned seating Recovery

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E: The Transformed MAS: What will we look like?

MAS transformation strategy over the next 5 years is to become a FSVC. Creating the FSVC requires us to transform the entire airline at every point. Customers have to be won and retained with our new fares, products and service offerings. Talented employees need to be developed and stretched to help us sustain our growth. Significant cost reduction challenges have to be met to deliver this. In a nutshell, to our customers and employees alike, we must look, feel and behave differently.

Business Transformation
Business Transformation is not about incremental change or minor tweaking of the organisation. Business transformation entails a fundamental change in the way an organisation DOES its business (Doing) as well as the CHARACTER of the organisation (Being). No business transformation will be complete and successful, in terms of creating a lasting impact, without addressing both sides of the equation as per Exhibit E1.

Exhibit E1: The Doing and the Being of Business Transformation

Five Star Value Carrier (FSVC)

Key Business Activities (KBAs)

Doing (Action)

Being (Character)

The MAS Way

The Being is the end state. It provides the clue to where we want the transformation journey to take the organisation. In the case of MAS, The MAS Way is the Being and its 5 thrusts are the guiding principle as to where we want to go as an organisation in the next few years. The Doing points to all Key Business Activities (KBAs) that MAS undertakes to move the organisation towards the end state.

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One thing is true: as long as we fundamentally change our actions, this will result in the change of the organisations character. Hence, the proven business transformation formula:

Exhibit E3: Transforming MAS into a Five Star Value Carrier

From To

Brand equity tied to national

identity

Brand loyalty built on delivering true Malaysian

Hospitality at affordable quality

Flying to Win Customers

Business-focused Premium fares with fixed package Inappropriately configured fleet High distribution costs

Leisure-focused and business-interested Affordable fares for standard package with

optional services

Doing (Action)

Drives

Being (Character)
Mastering Operational Excellence

Tightly-matched fleet combination Lower distribution costs

Tailored procurement to meet customer needs Leading edge aircraft utilisation High productivity Precise low-error operations Rapid closure on safety issues

Denotes change

Old procurement practice Middle-of-range aircraft utilisation Low productivity High variable operations Slow closure on safety issues

In this section, we will detail out what we envisage as the Being. We will continue to build on the 5 thrusts of The MAS Way (see Exhibit E2) which have served as our guiding principle for BTP 1.

Financing and Aligning the Business on P&L

Incremental cost saving targets Focused on image Decentralised monitoring of

operational performance MAS People Entitlement culture Silos Opaqueness

Structural cost-reduction targets Focused on profit Integrated monitoring of P&L performance

MAS Leaders Real accountability and performance culture Cross-functional teamwork Transparency

Unleashing Talents and Capabilities

Exhibit E2: MAS The 5 Thrusts of The MAS Way

Winning Coalitions

Flying solo Reactive

Winning partnerships Proactive engagement with stakeholders

VISION: To be the Worlds Five Star Value Carrier (FSVC)

COMMERCIAL

Flying to Win Customers

OPERATIONS

Mastering Operational Excellence

FINANCE

Financing and Aligning the Business on P&L Unleashing Talents and Capabilities

MISSION: To be a consistently profitable airline

PEOPLE

STAKEHOLDERS

Winning Coalitions

STRATEGY: Business Transformation

MAS aspires to become the Worlds Five Star Value Carrier. We believe that we have to reinvent ourselves to achieve this vision. Our transformation journey towards achieving this vision is tough but exciting. It will require leadership, teamwork and relentless passion to pursue this vision. Our vision will be supported by the mission to be a consistently profitable airline. Make no mistake about this: our primary obligation to the Government and all other stakeholders is to drive top-tier financial performance. Everything we do must be designed to achieve that objective. We also have a responsibility to the country to help promote national growth and development, and to do this, we must first be profitable and earn an appropriate return for our shareholders. A healthy profitable national carrier is an important part of any country's economic prosperity. The good news for us is that we have completed the turnaround and MAS has returned into the black. The organisation is in a state of readiness to handle the transformation that we have planned for 2008 and beyond. We have identified clear transformation milestones to be achieved under each of these thrusts, as well as the specific transformation levers required (see Exhibit E3).
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1. FLYING TO WIN CUSTOMERS

The FSVC that we envisage will have strong and sustainable revenue streams. These will be earned through winning customers who believe in our brand and want to fly with us knowing that we provide an affordable, yet high quality travel experience. As long as we relentlessly keep our costs low, we are able to offer competitive fares to a wider range of customer segments, and enjoy a virtuous cycle of keeping existing loyal customers and attracting new ones. We will construct a focused commercial platform that consistently wins in the marketplace. We will build a market-facing capability by being an agile organisation that allows us to out manoeuvre our peers in the markets in which we choose to compete. Customers will choose MAS because of its products and services, flight timings, prices and promotions, not because it is the only game in town. For MAS to Fly to Win customers, we will fundamentally make the following changes:

Exhibit E4: Traffic Flow Matrix

Business-focused, Leisure-interested

Leisure-focused, Business-interested

Leisure-focused

Large connecting flow

Niche connecting flow

Point-topoint flows

From brand equity tied to national identity to brand loyalty built on delivering true Malaysian Hospitality at affordable quality We proudly carry our nations name and we have to understand and live up to what that name embodies. Beyond the mere fact that we are Malaysias national carrier, our name represents a brand promise we make to our customers i.e. that MAS will always deliver an affordable, quality offering to our customers. That we will do so in true Malaysian Hospitality treating our customers as our guests and family. That we provide a hassle-free service and take care of our customers all the way. This is the essence of our brand. It is the embodiment of what we seek to do with our FSVC strategy sincere, quality service that always makes our customers feel welcome, delivering what they need, when they need it, with minimum fuss. Our competitiveness has to be built on establishing a following of loyal customers. Hence, the fundamental change we have to make is to move from a traditional price driven marketing approach into one that is brand and customer loyalty driven. To be clear, we are not pursuing this FSVC strategy with the intention of buying customer loyalty through cheap fares. We know that we will need to earn our customers loyalty by always delivering what they want quality at the right price, textured deeply with Malaysian Hospitality, throughout their journey.

From premium fares with a fixed package of services to affordable fares with a standard package and fees for optional services To deliver value to our customers, we will need to match our prices to the needs and demands of the market. In domestic and ASEAN markets, we will price the majority of our fares in the Economy cabin within an affordable range. With such fares, we will be extremely competitive and target to maximise many new sources of traffic. Regardless of whether the traffic is from China, Indonesia or India, we will be well positioned to capture the strong traffic flow demand driven by the growth of these economies. Our business model will shift from one of trying to protect yield and market share against LCC erosion into one that leverages on low fares to optimise new growth opportunities and market positions. With the stimulation effect of our lower fares, we aspire to fly more than 25 million passengers by 2015. Even as we lower our fares to offer value pricing, we will develop new alternative revenue sources to rebuild our yield losses. Our revenue generation will have to shift from a fixed package of services differentiated by fare policies into standard packages with optional fee-based services. We will introduce value-added services such as travel insurance as well as other products and services that will be developed or made available through partnerships. Our customers will benefit from the fact that they now have a choice of whether they want to pay for selected services, rather than having to buy a single fixed package. This will enhance our yield.

From business-focused to leisure-focused and business-interested Our recent investments in large aircraft with low seat-density and top-range products implicitly suggest a focus on large, business point-to-point connecting flows. The reality is that Malaysias premium traffic to and from Malaysia is too small to make this strategy profitable. For example, the European business traffic to and from Malaysia is less than half of that to and from either Singapore or Hong Kong. Given our existing fleet and market realities, we must increase our competitiveness in the key connecting flows and focus on leisure traffic (see Exhibit E4). It will mean that we recognise our competitiveness in the leisure segment will emerge as the key driver of our profitability. We will fly only where there are large, attractive flows of leisure customers. This does not mean that we will compromise the quality of our business offering. On the contrary, we will maintain and improve the quality of these products over time. Our premium cabins will provide us with much needed 'gravy', but on their own, they will not sustain our profitable growth.

From inappropriately configured fleet to tightly-matched fleet that meets our needs and commands premium Getting our product and fleet configuration right is one of the single most important levers for our cost transformation. Amongst major carriers for long-haul, MAS has the widest seat pitch in our Economy cabin. We have also generously configured cabins that overly consume space for non-revenue generating usage, such as the galley. Based on industry observation (see Exhibit E5), beyond a threshold comfort level, customers are not willing to pay a premium price for these extras as they do not value it highly. Instead, we need to direct our space allocation towards increasing density so that we can reduce our cost per seat and consequently, offer lower and more competitive fares. The savings on cost per seat can be reinvested to ensure that we are providing our customers what they value, i.e. a better inflight experience through innovative inflight entertainment systems.

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Exhibit E5: The American Airlines Experience American Airlines widely publicised their wider seat pitch as a selling point, with the slogan, more room throughout coach. However, they were not able to command higher fares than their competitors (with high seat density). A few years later, they abandoned this program completely and acknowledged that the leisure market they served would not pay for the wider seats. The 12,000 additional seats released enabled them to increase revenues by an additional USD100 million per year.
Source: Industry Reports

It will be important that MAS positions itself well in direct channels, particularly the Internet. We target to achieve 50%-60% Internet penetration by 2010. More efficient and effective use of such channels will allow us to serve our customers better. In line with our MH value proposition, we plan to reduce the usage of paper tickets, save our customers time and provide greater transparency on our inventory. All these ultimately lead to better value and lower costs to customers, and in turn, for us too.

2. MASTERING OPERATIONAL EXCELLENCE

The situation of overcapacity, early liberalisation of ASEAN skies and proliferation of low-cost carriers will lead to erosion of prices and margin. To remain a key player, we need to become more competitive. Before we can offer more competitive fares, we need a cost base that is very low. This is the only way that MAS can strategically differentiate itself in the region and defend its market share. We target to structurally reduce our systemwide unit costs (CASK) by 20% from the current 18 sen/ASK down to 14.5 sen/ASK. This must come from stronger cost controls, better asset utilisation, improved labour productivity, and more efficient processes. Many have asked whether it is possible to maintain 5-Star service while reducing costs. The answer is Yes!. This requires a shift in mindset. From the current cost structure with complex full services, towards an aggressively stripped down cost structure with zero tolerance for non value-added costs. This means each service-related cost will have to be scrutinised and value-tested against what customers will pay for. Items that customers are not willing to pay for include inefficient usage of assets, wastage in work processes and products/service features that customers do not value highly. From procuring based on rating-driven product offering to tailored procurement exactly meeting customers needs Our product offerings determine a large part of our costs. Ranging from the whole catering supply costs through to inflight entertainment services, many areas of our costs are determined by the decisions we make in what product offerings our customers want and will pay for. The impact can be extremely significant. The fundamental change we need to make is to be willing to focus and make trade-offs in our product offerings. By understanding what our key customers really want, we need to focus ruthlessly on delivering just that at the right cost-value trade-off. We will not be able to structurally reduce costs while giving all customer segments everything that they say they want. We will build a supplier base that is aligned to our aspirations and well integrated with our operations. They should be willing to partner us to seek continuous improvements that is mutually beneficial. Suppliers who subscribe to MAS aspiration will stand to benefit from our business growth and remain our preferred partners. From middle-of-range aircraft utilisation to leading-edge aircraft utilisation Our aircraft and flight crews make up a large part of our revenue generating assets. The productivity of our aircraft, measured by their utilisation, is therefore of great importance to our profitability. Revising our schedules by reducing turnaround times to increase utilisation of our aircraft could lead to significant savings. In 2007, with our Boeing 737 fleet, for example, we reduced the aircraft turnaround time by 5 minutes and we were able to free up 1 aircraft which we used to mount an additional 8 flights per day. Multiply this by 345 days a year (assuming 20 days are put aside for aircraft maintenance checks), this works out to an additional 2,900 flights and resultant additional revenue.

Our fleet is currently not best matched with the routes we deploy them on. Consequently, we either incur higher costs than competitors and/or become operationally constrained in how we serve our customers, e.g. limited range. To win in the leisure-focused, business-interested space, we will increase the density in Economy cabins and decrease the size of premium cabins. In our fleet renewal exercise, we aim to move our fleet towards having aircraft that are more agile and fuel efficient. This will allow us to provide higher frequency to those destinations that we choose to serve. (More details in Section F/5-Year Fleet Plan). From high distribution costs to lower distribution costs via greater usage of direct channels and Internet distribution Distributing our tickets is integral to how we serve our customers. On average, GDS distribution costs constitute up to 2.5% - 3% of an airlines total costs and it is easily one of the top 5 cost items on the P&L. Many airlines are moving towards Internet distribution to reduce their distribution cost. Aer Lingus, for example, went from 3% to 75% Internet penetration in 2 years. Air Canada went from 10% to 50% in the same timeframe, with no price differential as a result.

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Beyond cost-savings, improving fleet utilisation has other important knock-on effects. By freeing up additional capacity on a given fleet size, we can deploy the aircraft to grow our business on strategically important routes and with new customer groups, enabling us to capture our full growth potential. The fundamental shift we have to make is to take a holistic view of the cost of our inventory, from commercial requirements through to operational goals, to fully optimise our assets. This could mean relaxing the time constraints around which our flights can depart or arrive in a day or tweaking the gap between flights on an individual airplane. We aim to improve our fleet utilisation by 10%-20%. From low productivity and lack of operational planning to high productivity and world-class lean airline While we benefit from operating in a low labour cost environment, comparison of our productivity against other carriers indicate that we have room for improvement. We will need to be leaner to reach our goal of increasing employee productivity. Stripping out inefficiencies in our processes is something we can achieve easily as it will not adversely affect our customer value proposition. Rather, it will enhance our value offering and our competitive position. By adopting lean practices in our daily work from marketing and selling our products and services and operations on the ground to activities in the air we will transform into a distinctive FSVC. From highly variable operations to precise low-error operations As we grow, we will deliver more consistency and precision. Service delivery must be consistently good and meet customers expectations. In order to achieve this, it is extremely important that everyone in MAS pays attention to details and does the ordinary things, extraordinarily well. Everything we do will be on time, according to specifications and cost. We will reflect this precision in our operating performance, i.e. better on-time arrivals, fewer lost bags and also in our customer experience, i.e. shorter queues, greater consistency. We will treat every task, from selling a ticket to a customer and checking in a passenger to unloading a bag, with the same determined discipline. Our goal is to eliminate wastage, variability and error. From slow closure on safety issues to immediate attention and rapid closure on safety issues Safety is our licence to operate the airline and it is the responsibility of every single employee in MAS. We will never compromise on safety. Our safety record thus far has been good but we cannot be complacent. Going forward, we will intensify our attention on any safety issues, however small, that appears on our radar and we will endeavour to close the safety issues/gaps within the stipulated time. We will work together through the Safety Management System framework and continually seek opportunities to improve. Discipline of action in the area of safety is of utmost importance. We will focus on developing this habit in our journey to build a strong and sustainable safety culture across the company.

From incremental cost savings targets to structural cost reduction targets Traditional cost-saving measures will not be sufficient to help us achieve our new vision of structural, breakthrough, non-incremental cost-savings. A break in the mindset shift is required to ensure that we work cohesively as one, single-minded team. The big opportunities lie in cross-functional interactions which are connected to overarching decisions about changing the business model. We will develop clear targets with both top-down and bottom-up analytical support to ensure upfront buy-in and effective execution. From 'focused on image' to 'focused on profit' Our decisions must be anchored on profitability - not political favour, false imagery, keeping up with the latest aircraft and technologies or individualised glory in the international community. If it does not help us make more money, we will not do it. To achieve this, we will re-focus on routes, businesses and activities where we can make money. If we need to, we will shrink, as we will limit our reach to where we can win. We will make every effort to transform each part of our business and we simply will not operate where we cannot make money. We will set up mandatory monthly review meetings in departments, with clear agendas and processes to ensure the productivity level of these meetings. We will review KPIs for each department and revise them as necessary to ensure they are fair and relevant. Performance against targets will be transparently reported and challenged every month by the Managing Director and the MAS management team. Any shortfalls will be scrutinised immediately and early corrective action will be taken. From decentralised monitoring of operational performance to integrated monitoring of P&L performance Historically, MAS practices decentralised monitoring of operational performance. While this is important, it is not enough. Commercial and Operations functions have been focusing mainly on meeting their respective divisional KPIs and handling localised fire-fighting matters. However, this silo behaviour in the organisation (which may ensure that the interests of respective divisions or departments are taken care of) does not contribute positively to the bigger picture at corporate level. A significant portion of the cost base is tied up in the friction that exists between the Commercial and Operations functions. Eliminating that friction is not as simple as asking managers to work together, but is critical to how MAS transforms into a FSVC. The MAS management team are now made jointly accountable for the corporate scorecard. The P&L targets are decomposed into divisional and departmental levels so that heads/managers of various functions also share the accountability for specific financial targets, on top of their usual operational targets. These heads/managers will be equipped with clear processes, information flows and new analytical tools to ensure standardisation and integration. Because of this integrated approach, various functions are inter-dependent on each other to meet their KPIs and hence, cross-functional collaboration is not negotiable. It is a must.

4. UNLEASHING TALENTS AND CAPABILITIES

We can only realise the FSVC dream if we pull together as one team. Participation from every one in MAS is crucial. The employees of MAS represent our most important asset. We need to unleash the hidden talents in the company, developing leaders in everyone, and this will be the greatest source of profitability. As we talk to our employees and managers, we consistently see passion, energy and drive. In this thrust, we will make fundamental changes to our working environment so that we can harness and direct this passion and drive to ensure that our people succeed at various levels.

3. FINANCING AND ALIGNING THE BUSINESS TO P&L

To sustain any industry cyclical shocks whether it is shock from rising fuel prices or the increasing presence of LCCs we need to move from fighting to stay afloat to being well-prepared for future storms. This will ensure the progressive development of our finance capabilities in line with our Business Transformation Plan.

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From MAS people to MAS leaders We will move empowerment down the line, developing leadership skills in everyone, and create a pool of future leaders who will continue to carry the torch of MAS transformation. We do not want administrators to take up leadership positions. We want only leaders people who assume leadership roles and lead initiatives to deliver breakthrough performance such as turning around an unprofitable route, substantially increasing yield, dramatically improving on-time performance, or significantly improving fuel efficiency. We prize such leadership attribute in our employees. There could be such leaders at every level in MAS today, and we will create the right environment for these exceptional talents to step up and deliver breakthrough results, regardless of their seniority, education or background. Under our new talent management framework, we have put in place a structured programme to develop future leaders. We will identify future leaders early and through succession planning. For every critical leadership position, 3 successors have been identified, each with a personalised training and developmental plan. We will help these future leaders achieve their full potential with frequent reviews and tailor-made trainings, e.g. Airline Business Course, Transformational Leadership Development Program, etc. The aspiration is to ensure these future leaders are well-equipped with the right mindset and leadership behaviors, and groomed to grow and achieve their full potential. From entitlement culture to real accountability and performance culture We need to break the legacy mindset and entitlement culture that is attached to the national carrier. We will ensure that all employees are fully accountable for not just their tasks but more importantly, for the ultimate outcomes and benefits to MAS. We will generously and immediately reward those who perform and success must be celebrated, without jealousy. On the other hand, we will ask those who do not perform to leave. MAS will no longer be merely a nice place to work with a job for life, but one that is intense and dynamic and where only performance, high values and integrity matter.

From 'flying solo' to 'winning partnerships' We will cooperate more closely with other airlines (through sharing of engineering and maintenance facilities, forming alliances, etc) and with Malaysian business partners (through joint loyalty programmes with other Government-Linked Companies etc. From reactive to proactive engagement with stakeholders We will proactively share with all our stakeholders our results, issues, plans, what we do and why. We will also insist that all our stakeholders do the same for us.

Exhibit E6: Project PINTAR MAS participates in Project PINTAR (Promoting Intelligence, Nurturing Talent and Advocating Responsibility), which is a joint community project by Government-Linked Companies (GLCs), in support of the Governments efforts to reduce the economic imbalance in Malaysia. This project aims to provide assistance to improve the academic standards of underprivileged children. Initiatives taken by MAS include assistance in the form of tuition packages, provision of library books, study materials for needy students and providing motivational/career talks. MAS also provides complimentary air tickets to motivate top students and for Outstanding Teachers who contribute to the overall academic excellence of these needy children. In 2007, MAS adopted 2 schools in Penang and achieved early success in the form of improvements in student examination results (passing rate for UPSR examination increased by 10%). In 2008, MAS intends to adopt a few more schools in the Northern, Eastern and Southern regions of Peninsular Malaysia as well as Sabah and Sarawak.

From silos to cross-functional teamwork Silos are typical in complex network businesses like MAS, where most decisions involve the input of many functions. But a silo culture is also the reason why many airlines fail. We will work increasingly in cross-functional teams and hold people accountable for cross-functional results. For example, we will hold people accountable for route profitabilityan opportunity that cuts across the Sales, Pricing, Network and Operations functions. From opaqueness to transparency We will be transparent with our people. In turn, our people must behave with real integrity, respect company confidentiality and be transparent in their interactions with each other and our stakeholders.

5. WINNING COALITIONS
We know that we cannot achieve our goals alone. MAS needs the resolute support of its customers, employees, partners, suppliers, agents, investors and government. We need to build winning partnerships to grow and sustain profits in this industry. This thrust is focused on fundamentally transforming how we work with stakeholders to ensure that national and community needs are met while still providing MAS with the room required to operate profitably.

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Using the 5 thrusts of The MAS Way as our guiding principle, we have identified a set of Key Business Activities (KBAs) that will enable us to fulfil the FSVC strategy. In fact, over the past 1 year, the MAS management team jump-started some of these KBAs e.g. MH campaign, Project Delta in Operations, Project Alpha and Omega in Commercial, etc. The KBAs in our Business Transformation Plan did not happen by coincidence. These KBAs have been carefully developed after a series of engagement sessions with the Board, employees and stakeholders e.g. Khazanah Nasional Berhad. We have also studied external examples of airline transformation cases for insight into their key success factors. In general, the KBAs that we have identified and developed have the following characteristics:

Focused
It is important to emphasise that everyone in MAS must focus on the things that really matter. There are, no doubt, hundreds of new and existing opportunities that MAS could exploit; however, we must and will focus only on what will deliver results. This was the main reason for the success of our business turnaround efforts. Our business turnaround approach employed a startlingly simple logic that reversed the typical view of corporate cause and effect. Many organisations undergoing turnaround and transformation focus their attention on infusing the organisation with the right capabilities, processes, systems and technology, in the hope that someday, these magic ingredients will come together to make the company successful. This was not how we approached our turnaround efforts, nor how we will drive our transformation programme. Instead, in MAS, we have chosen to focus on activities that immediately deliver results. We aim for big results, fastall at once, and immediatelyby anchoring everything on the P&L. No matter how busy people are, no matter how desperate the need for more resources or better information, no matter how weak the systems or how untrained the staff are, any organisation can achieve better results right now with what they already have. Wherever and whenever possible, everyone in MAS has tried, and will continue to try, to make the most of what we have.

F: Executing the Business Transformation

KBAs

Fast, decisive and responsive

Where possible, we will avoid projects with long lead times that only pay off many years down the track. We will build capabilities while we work, but we must focus on actions that will deliver quick and fast results. We will also be expeditious in our decisionmaking. In any transformation, there will be tough and sometimes painful decisions that need to be made. We are prepared to make these decisions quickly, supported by an adequate and reasonable level of analysis. In reviewing business cases involving airline transformation programmes which failed, procrastination was the key factor that got in the way of creating impact. Discipline of action is crucial.

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Fully supported by management, employees and stakeholders

We are aligned as a team, i.e. within management, with our employees and with our stakeholders, as to the direction and implications of the plan and the risks we are taking. The BTP 2, like the BTP 1, is communicated in a clear and transparent manner to our employees and stakeholders.

Exhibit F2:

Key Business Activities (KBAs) Making the Most (MTM) Step 1: Maintain 5-Star products and services MH Campaign (Revitalising our customer value proposition) PSS Project Project Delta E & M Breakthrough Programme (part of Project Delta) Procurement Revamp Programme Reduction in Distribution Cost Project Omega

Consistent with GLCT guidelines

The BTP 2 has been developed using the GLCT Manual as a guide. It takes into account the recommendations in the manual and adapts these for implementation within MAS in the context of our business transformation. The KBAs that we have identified fall under 3 categories: Making the Most, Gaining New Business and Breaking New Ground (see Exhibit F1). There are KBAs that do not fall into any of these categories, yet they play a critical role as backbone support to the entire transformation effort e.g. transforming the finance, HR and safety functions. Beyond these, we have consciously put aside any other activities that are not focused on the P&L.

Step 2:

Reduce structural and operational costs

Step 3:

Offer competitive fares

Step 4: Exhibit F1: Making the Most, Gaining New Business and Breaking New Ground Step 5:

Get more passengers and increase load factors

Project Alpha Project MOSAIC

Grow our network and build our capacity

5-Year Network Plan 5-Year Fleet Plan

Breaking New Ground (BNG) Gaining New Business (GNB)

To enter into unchartered territories

Gaining New Business (GNB)

To proactively seek and create new opportunities

Firefly MASwings Malaysian Aerospace Engineering (MAE) MASkargo

Breaking New Ground (BNG) Supporting KBAs

Making the Most (MTM) A relentless pursuit to optimise resources

Forming Strategic Partnerships

2005

2007

2008

2009

2010

2011

2012

Finance Transformation Initiatives HR Transformation Initiatives Safety, Security, Health and Environment (SSHE) Action Plans Revitalisation of IT Services Corporate Governance Initiatives

Making the Most (MTM) MTM is focused on realising the full potential of MAS by stretching our employees and sweating our assets. Examples include the MH Campaign, PSS, Project Delta and Project Omega. Gaining New Business (GNB) While MTM focuses on our existing core businesses, GNB refers to expanding MAS horizons; identifying and creating new markets/opportunities. Firefly, MASwings and Malaysian Aerospace Engineering (MAE) are some of the vehicles currently being used to capture these opportunities. Breaking New Ground (BNG) BNG are a series of confidential projects that, if realised, would fundamentally change the size and shape of MAS.

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1. MAKING THE MOST (MTM)

With the MTM KBA, it would be useful for us to stop and visualise the following diagram which depicts the Virtuous Cycle of Profitable Growth (see Exhibit F3). The diagram captures the course that we will need to stay on. In a nutshell, the cycle of profitable growth will require us to take 5 bold steps: Step 1 5 Star: We must maintain the high quality (5-Star) products and services offered and these have to be constantly matched to the specific needs of our customers; Step 2 Lower Cost: We must reduce our structural and operational costs (without compromising on safety and security); Step 3 Competitive Fares: With a lower cost base, we will be able to offer low and competitive fares to our customers, and still be able to make a profit; Step 4 More customers, more revenue: With high quality products and services at low/competitive fares, more passengers will choose to fly on MAS. This translates to more revenue; Step 5 Grow network, build capacity: With more revenue and profit, we can invest in growing our network and building our capacity. We will open up more routes and acquire more planes, and this leads us to sustainable profitable growth. And the process repeats in an upward spiral.

Step 1 : Maintain 5-Star Products And Services

Without customers, there will be no MAS. It is due to our customers who consistently patronise our 5-Star products and services that MAS is recognised as one of the few elite 5-Star airlines in the world alongside Singapore Airlines, Cathay Pacific, Qatar Airways, Asiana and Kingfisher (2007). Therefore, it is imperative that we strive to keep, attract and grow our customer base. For this to happen, we have to keep improving our customer value proposition (CVP). Early 2007, we launched a new campaign to revitalise our CVP which focuses on creating brand awareness and build loyalty among customers, both leisure and business travelers. This launch was done only internally, and not externally, as we wanted to manage the change internally before shouting about it.

i. MH Campaign
Most airlines have pretty much the same type of aircraft and equipment from ground to air. We needed a compelling and a clearly defined CVP that would stand out in the crowd. Some of the MAS employees are familiar with earlier CVPs e.g. 'Destination Service Excellence' (DSE) and 'Going Beyond Expectations' (GBE). In view of our aspiration to become a FSVC, it was timely to come up with a new CVP. For a long time in 2006, we sat in lab after lab to define what it is that we needed to deliver as our CVP. We knew that from the customers perspective, it had to be unique, differentiated and compelling. We then identified Malaysian Hospitality, hassle free, all the way as our CVP. The beauty of this is that the acronym for Malaysian Hospitality, MH, is also our flight code. On 25 January 2007, we launched internally MH=Malaysian Hospitality, hassle free, all the way.

Exhibit F3: The Virtuous Cycle of Profitable Growth

Profitable Growth

MH = Malaysian Hospitality
Breaking New Ground (BNG)

Gaining New Business (GNB)

5

Grow network, build capacity

1 3

Competitive fares
2

5 Star

More customers, More revenue

Malaysian Hospitality picks up on the threads that weave the fabric of the Malaysian way of life from open houses to respect for different cultures and traditions, to an ingrained sense of treating visitors like we treat guests in our homes. We are leveraging on these strengths which come naturally to Malaysians. Through a planned global employee engagement programme, we introduced and emphasised 4 MH behaviours - Natural, Spontaneous, Determined and Willing which we wanted our employees to exhibit in all their interactions with each other, and with our customers.

Lower cost

Making the Most (MTM)

Exhibit F4: MH Brand Promise MH. More than just an airline code. It is where everything comes from the heart. Where different cultures and needs are understood. And respect is not learnt from a training manual. It is us treating everyone like a guest in our home. And ensuring smooth journeys all the way. This is MH. Our Malaysian way of hospitality.

2005

2007

2008

2009

2010

2011

2012

This is not a linear set of activities, but one that is cyclical. It is an upward spiral movement that will give us greater flexibility and options to grow, build and expand our business. It means that we will not remain in one spot, but we will have to keep changing and growing, upwards. It also means that we have to keep an eye on the changing and dynamic marketplace all the time and be extremely vigilant to changes that are happening. We cannot afford to be complacent and wait for the changes in our surroundings to prompt us. Always, we have to be many steps ahead of the competition and the industry. There will be hundreds of actions and activities going on simultaneously, all aimed towards transforming MAS into a FSVC. In order to manage these numerous activities in an efficient and effective manner, we have grouped the activities according to the 5 steps of the Virtuous Cycle of Profitable Growth. In the next section, we will detail the Key Business Activities (KBAs) e.g. projects, initiatives and daily operational efforts in each of these steps.

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Hassle free, all the way

For years, our inflight services have been renowned as the worlds best. Our cabin crew has been awarded the Worlds Best Cabin Staff accolade for 4 consecutive years from 2001 to 2004 and again, in 2007 in annual independent surveys conducted by Skytrax, U.K. However, winning in the air alone is not enough. In order to compete successfully with other major global airlines, we need to win at every touchpoint. Based on IATAs Global Airline Performance survey which benchmarks customer satisfaction for airlines operating long-haul, we have identified areas for improvement and have embarked on various projects to enhance the quality of our products and services. Our aim is to make our customers journey with us seamless and delightful - from the time they purchase the ticket, to when they check in and when they board the plane, their inflight experience and even after they disembark. The launch of the MH campaign was deliberately confined internally to MAS staff initially. This was to ensure that everyone was on the same page before we introduce MH to the public in 2008. Throughout 2007, a lot was done to galvanise employees, for them to understand and embrace the values of MH. Once the organisation was in a state of readiness to deliver the value proposition (after fixing key breakages, and investing time and effort to improve the products and services), we were ready to introduce MH to the world. Because this is such an important initiative, the role and responsibility of the Chief MH Officer was taken up by the Managing Director & CEO himself. He also chairs the MH Steering Committee which deliberates on all issues pertaining to service delivery, changes that need to be implemented, and ensures that consistent delivery of the highest service quality is embraced as a culture in the airline. All the members of the top Management team are also required to walk the talk. Every month, the Chief MH Officer sends out circulars to all employees to remind them about MH, shares updates on MH initiatives and discusses his views about how MAS employees can deliver MH in their daily work. The MH campaign encompasses both soft and hard initiatives. Soft initiatives deal with rallying staff to garner support and buy-in, which we do via townhalls, physical meetings or coffee sessions, brand films, intranet, etc. Hard initiatives deal with fixing top breakages, tracking and benchmarking our product and service qualities, and developing new service offerings. Under the MH campaign, we have close to 500 hard initiatives (as of end 2007) which cut across all our customer touchpoints and these are aimed at improving our physical product and service offerings.

Exhibit F6: MH Campaign Framework

Malaysian Hospitality
Our Philosophy

Treat Everyone as a Guest in Your Own Home Personality

Our Personality

NATURAL

SPONTANEOUS

DETERMINED

WILLING

Hassle Free, All the Way

Purchase Pre-embarkation

Embarkation

Inflight

Disembarkation

Exhibit F5: Progress of MH initiatives (as of end 2007)

100%
Outstanding Exceeding 85% 85% 86%

600

85%

80%

On Target 77% Threshold 68% 73% 63% 65% 65%

83%

82%

82%

80%

81% 493

500

446 426 351 312

449

400

60% 55%
335

300

40%
244 165

248

200

20%
119 71 121 126 120 122

Total (initiatives registered) Completed

493 331 77

100

Cumulative closure rate is 81%

Delayed

0%

0
Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07

Cumulative Closure Rate

Total projects initiated

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ii. Passenger Services System (PSS)

Exhibit F7: MH - More than just an airline code It is Malaysian Hospitality. It has been with us since we began. It is in our nature. It is in everything we do. MH, Malaysian Hospitality, is what we need to deliver internally and externally. Everyone in MAS needs to remember: We are not merely employees; but we are hosts. We don't have passengers, we have guests. We are hosts who treat every guest - internally or externally - as we would treat guests who come to our home. When a guest comes to your home, you do everything to make sure that your guest has a delightful experience. From the time they call or arrive at your doorstep, to the time when they are in your home, and even after they leave. Throughout the entire experience, instinctively you will do everything that is within your capability to make sure they are comfortable, relaxed, well fed, happy and remember that special time with you. Now think of that experience and think of how you can make that same experience come alive for our MAS guests. For this experience to be the same throughout MAS, and for it to be the same from start to finish for our guests, we must remember that when we work with each other, although we come from different departments, the end goal is one. Our guests must not feel that they are dealing with different departments, but that they are dealing with one host. That is MAS. For Malaysian Hospitality to come alive, I will ask you to focus on 3 things: Departure Control Be innovative: Don't be afraid to test and try out new ways. You know your job better than anyone else and it is important for you to build on this knowledge and try new things. I know many people say that `If it ain't broken, don't try and fix it' but the flip side of that should be `Why not?'. Be consistent: Doing things exceptionally well in one area, and getting it terribly wrong in another area means that we will only be remembered for the wrong things, not the exceptional delivery. We need to be exceptional in our delivery, from end to end, at every touchpoint. Achieve more with less: We have moved into a different era and we have to rethink how we work and how we achieve our goals. Within a year, we have achieved so much. In fact, much, much more than we thought would be possible. We have done it. We have to keep doing this and we have to keep doing it even better. MH = Malaysian Hospitality is our competitive edge. And we should not allow anyone to take this away from us. I know I can count on you to make MH truly come alive in MAS. Remember, MH is our reminder to treat everyone as a guest. Every time you see MH (and you do see MH many times in a day), remind yourself you are not dealing with passengers or colleagues. You are a host making people feel good in your own home. 'This is MH. Our reminder to treat everyone as a Guest'. Thank you. The Departure Control stream complements Ticketing by offering a number of new options to passengers. In addition to supporting the industry standard eTicketing processes, we will introduce web check-in and kiosk check-in facilities (defined by IATA as Common Use Self-Service) for passengers. Revenue Integrity The objective is to ensure that every booking produces an actual passenger upon departure. Revenue leakage occurs for many reasons and often because of fraudulent practices by various parties. Every reservation created or updated will undergo a series of cyclic checks to verify its authenticity. Cases such as fictitious names and multiple bookings on a single flight will be removed early on in the booking cycle. Fare Management Improvement in the Fare Management system will enable the airline to distribute fares more efficiently around the world and improve pricing decisions. A key enabler to support all the 5 project streams is the eCommerce platform. Through this platform, MAS will offer passengers a series of solutions to make travelling easier, faster and more efficient. These solutions are broadly categorised under eBooking, eTicketing and eCheck-In. With the PSS initiative, a significant improvement in business processes and customer service is expected. Business-wise, there will be faster revenue recognition while the number of ticketing fraud cases will be reduced. In addition, the number of cancellations, no-shows and overbooking is also expected to drop substantially. Customers can look forward to a more convenient and efficient travelling experience, from the making of reservations to the boarding of flights. More efficient passenger movement at airports and reduced congestion are expected with the introduction of various passenger self-service options, such as web and kiosk check-in. The Passenger Services System (PSS) seeks to offer passengers a more convenient, efficient and hassle free travelling experience. In May 2006, MAS announced SITA as its preferred partner in providing the PSS solution. The PSS is a key component of BTP 1. It entails the adoption of industry best practices in sales and airport operational processes, reduction of development costs and time-to-market for new capabilities, and an increase in passenger self-service offerings. The PSS programme is divided into 5 streams: Reservations The objective of the Reservations stream is to create a more efficient system. The current reservations system will be replaced with a platform that meets industry standards and requirements. Ticketing MAS will move away from traditional paper tickets to electronic tickets (eTickets) before May 2008. This is in line with the International Air Transport Association (IATA) requirement that all airlines will have to be 100% eTicket capable by 31 May 2008. With the elimination of material costs and back-end processes, we will realise savings of approximately RM19 per ticket sold.

Dato Sri Idris Jala Chief MH Officer

Excerpts of monthly circulars from Chief MH Officer to all MAS employees (2007)

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Step 2 : Reduce Structural And Operational Costs

Exhibit F8: IATA Simplifying the Business (StB) IATA launched the Simplifying the Business (StB) programme in 2004 which leverages technology, automates and streamlines processes to reduce complexity and cost, whilst making the transportation of passengers and freight more convenient. The StB is projected to bring a win-win situation to all airline members and air travellers, and also to deliver annual industry cost savings of USD6.5 billion. MAS finds the StB highly beneficial and aligned with its strategy to become a Five Star Value Carrier. As such, we are following closely the 5 StB initiatives: As the Asian airline industry shifts towards Phase 4 and LCC competition intensifies, profit margins will erode very quickly. We must continue to relentlessly and ruthlessly cut our cost base. It is not only about defending our profits and market share but also laying a solid foundation for profitable growth. Profitable growth cannot happen unless we radically cut costs. Our cost challenge is to reduce our systemwide unit cost (CASK) by 20% from the current 17.5 sen/ASK down to 14 sen/ASK, which will enable us to achieve a breakeven load factor of 60%-65%. Only with a breakeven load factor of 60%-65%, can MAS grow its network. We are embarking on systemwide structural cost reduction via 2 key programmes i.e. Project Delta and the Procurement Revamp Programme. By instituting structural cost savings, we take a step closer to realising our dream of becoming a FSVC. We will make our organisation more resilient to external competition and demand shocks. With lower structural costs, we will be able to offer more competitive fares when we want it and on routes we want to compete on. It is important to reiterate that cutting costs is NOT about shortchanging our customers, cutting corners or compromising on safety and quality. It is about transforming our business and reducing costs in areas that will allow us room to grow by providing service elements that reflect the 5-Star status we want to be known for.

Electronic ticketing (eTicketing) MAS started to shift towards eTicketing via our Passenger Services System (PSS). We are targeting to be 100% eTicket capable by 31 May 2008. Common Use Self-Service (CUSS) Bar Coded Boarding Passes (BCBP) IATA eFreight MAS cutover at KLIA in December 2007. MAS cutover at KLIA in November 2007.

Introduce paper-free cargo (i.e. no hardcopies of documents) on key trade routes. Exhibit F9: Aspired total cost savings

Baggage management improvement programme This explores the usage of radio frequency ID (RFID) to minimise mishandled or lost baggage. MAS is awaiting the outcome of IATAs pilot project.

Project Delta (Operations & E&M)

: RM476m : RM100-200m : RM200-300m : RM200m Up to RM 1 billion

The common theme globally is the need for efficiency. IATAs Simplifying the Business programme is delivering critical efficiencies from eTicketing to eFreight. In 2008, IATA will launch 3 major initiatives that will cut costs and improve service. IATA will further revolutionise the travel experience with expanded self-service options to give passengers more control over their journeys.

Procurement Revamp Programme Reduction in distribution cost

(e.g. increased Internet penetration)

eTicketing
Source: Speech by Giovanni Bisignani, Director General and CEO of IATA (12 December 2007)

Total

Note: There may be some overlap between cost savings in Project Delta and the Procurement Revamp Programme.

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i. Project Delta (Operations and E&M)

Project Delta which started off as Operation Boot Camp was officially launched on 1st October 2007, 22 months after the introduction of BTP 1. Like a football match of 2 halves, the first half was predominantly focused on Commercial initiatives, while the second half is predominantly focused on transforming the Operations and E&M areas. You do not win if you do not intend to win this was the challenge that MD/CEO Dato Sri Idris Jala threw to the 120-strong Operations team in October 2007. This inspired the team to aim for an ambitious target of RM476 million cost reduction. With the combined forces of Commercial, Operations and E&M, the target is to achieve a RM1 billion per annum in structural cost savings. To achieve the RM476 million, over 66 initiatives have been identified as Key Business Activities to reduce structural costs in the company. The Project Delta Steering Committee meets on a monthly basis to monitor the progress and discuss cross functional issues and constraints. Processes and guidelines have been put in place to help teams deliver in a big way.

Further efficiency improvement by identifying and removing bottlenecks in processes so that there is seamless integration and lesser flight delays, reviewing resource allocation to ensure fit for purpose; outsourcing non-core processes to external parties; reduction of wastage; improving quality and consistency of outputs, etc. Some examples include: o Inflight Services and Airport Operations are working with all MAS local & overseas stations to further reduce the amount of wastage from meal uplifts. o Enhancing the Operations Control Centre processes by integrating the participation of all operational areas so more accurate and speedy decisions can be made on critical situations. This will further improve the passenger travel experience. Further reduction of input costs through cost effective procurement practices such as re-negotiation of contracts. Harnessing the full capability of information technology to enhance productivity and performance, such as the introduction of a new Crew Management System for optimising crew rostering; maximising the use of the Flight Planning Flight Following (FPFF) system to minimise potential flight disruptions or delays due to adhoc changes in weather, flight paths, airspace and airport environments.

Exhibit F10: Project Delta

Operations Division together with E&M generated more than 66 initiatives with a potential increase in revenue as well as cost savings of RM475.6 million

Exhibit F11: Project Delta (Examples of initiatives)

7 Initiatives 18 Initiatives 15 Initiatives 10 Initiatives 16 Initiatives RM95m RM141m E&M FO AO IFS OC RM73m RM 84m RM 83m

Total 66 Initiatives

Department Flight Operations

List of Initiatives Introduction of new alternate airports Improve accuracy of Zero Fuel Weight (carried out jointly with AO) Flight Planning & Flight Following optimisation Reduction of overflight charge rates Revised taxi fuel policy to minimise fuel burn off

RM 476m

Airport Operations

Jet fuel saving through the increased usage of GPU & minimise APU usage Excess hand baggage collection at the gate Rationalise baggage tags & boarding passes Introduction of meal box, heat sealed meal & meal optimisation Reduce meal wastage at KUL & Stations Improve inventory management Reduction of dry stores costs by 15%

Total FY08 Target

Inflight Services

These 66 initiatives will cover various areas ranging from Engineering & Maintenance (E&M), Flight Operations (FO),Airport Operations (AO), Inflight Services (IFS) and Operations Control (OC) but will not compromise on safety and service quality. These initiatives focus on: Fuel Conservation MAS has always been prudent in the area of fuel savings as fuel prices continue to rise and with the aviation industry under increasing pressure to be more environmentally conscious. In September 2005, the Fuel Efficiency Task Force was set up to identify and implement fuel saving initiatives. In 2006, the IATA Fuel Efficiency GO Team and MAS jointly conducted a 3-day fuel efficiency gap analysis. The IATA GO Team applauded the efforts initiated by MAS to address fuel conservation. Some of the fuel conservation initiatives implemented include the removal of crew bunks, optimising water uplifts, etc. MAS will continue to optimise fuel burn off and savings through the selection of closer alternate airports, improved accuracy of Zero Fuel Weight (ZFW), and minimising the usage of Ancillary Power Unit (APU) by utilising alternate power supplies.

Operations Control

Variable crew deployment (under study) Renegotiate hotel rates Reduction of hangar TAT by 50% Optimise maintenance schedules by maximising maintenance during off peak season Improve inventory management through Integrated Material Management Revised third party maintenance marketing plan Engineering Breakthrough Programme tackling manpower productivity, process improvement, etc

Engineering & Maintenance

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ii. E&M Breakthrough Programme (Part of Project Delta)

In July 2006, our E&M division embarked on an aggressive programme to transform itself into the preferred Maintenance, Repair & Overhaul (MRO) centre in the region within the next 5 years. Under the E&M Breakthrough Programme (which is now part of Project Delta), E&M will introduce fundamental improvements in all areas. E&M will contribute RM141 million per annum to MAS P&L by embarking on the following: Enhance and streamline core E&M processes, embrace lean manufacturing principles and upgrade existing systems. Enhance planning capability to reduce turnaround time for MAS and third party aircraft. Improve spares planning, ordering, stocking and issuance to maximise aircraft dispatch reliability and to reduce hangar turnaround time.

Through the Procurement Steering Committee, we will: Achieve annualised cost reduction of about RM200 million from 4 major areas: inflight and ground handling, engineering and maintenance, fuel and general spend out of MAS annual spend of RM8 billion (see Exhibits F12 and F13). Roll out new procurement process and policies. Reinforce monthly reporting. We are creating a more integrated procurement organisation whereby the KPIs of Central Procurement and business units are more aligned with the P&L.

Exhibit F12: MAS annual spend by main categories (2006 full year) Optimise the use of fixed assets i.e. hangars and workshops in Subang and KLIA. Improve manpower productivity level at all hangars, workshops and support shops so that the additional workforce capacity can be released from MAS aircraft maintenance and be reassigned to deliver the increased third party maintenance work. Develop and implement manpower plan, comprehensive training schedules and skill matrices to meet long, mid and short term demand for manpower for MAS and third party aircraft maintenance. Strengthen business practices, sales capabilities and marketing efforts to attract and retain customers globally.

Inflight and Ground

984

Maintenance

794

Direct Flight and Fuel

5,516

General spend

824

Procurement Revamp Programme

The past procurement organisation in MAS was that of a decentralised model with business units having their own units which were in turn coordinated by Central Procurement. These procurement units were largely autonomous in their purchasing activities with Central Procurement exercising control through a common one size fits all approach and built-in approval controls. The launch of the Red Book by the Putrajaya Committee for GLCT provided the catalyst for a complete revamp of the procurement practices at MAS with a view to reduce Total Cost of Ownership (TCO), improve procurement efficiency, and create a stable, yet competitive supply base.
Wave 1
Total 8,118

Exhibit F13: List of Procurement Initiatives

Category Fuel Inflight meals Ground Handling Quick Wins Engine overhaul Phase 1 Facility Management IT & Telco Airframe Ground Handling/MAB General Spend/Insurance LSGB Lounges & loyalty programs

Annuallsed Impact RM Mil

The Procurement Lab, set up in October 2006, conducted an exhaustive assessment and concluded that there was huge potential for additional reductions on TCO and room for improvements in the procurement processes. Another shortcoming identified is the skills gap in the areas of purchase management, vendor/contract management and strategic sourcing which require very different skills namely analytical, strategy development and negotiation capabilities.

~70 ~40

Wave 2

Wave 3

~50

Wave 4

Other Inflight Initiatives Fuel II Advertising and Comms Engine overhaul Phase 2 General equipment Crew accommodation Overflight charges, airport fees and traffic handling Others (TBD)

~25

Wave 5

~10

Wave 6

~5
Total ~ 200 ~

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iii. Reduction in Distribution Cost

In line with industry practice, MAS introduced zero commission for all appointed agents in Malaysia effective January 2008. This move has altered the business model of travel agents from commission-based to service-oriented as they have to charge passengers a service fee. Customers who want to purchase directly from MAS may opt to purchase their tickets through our improved Internet Booking Facilities (IBF). We also provide IBF kiosks at all MAS ticketing offices in Malaysia. With our improved IBF, our customers can purchase tickets conveniently from the comfort of their home without having to pay for the standard Global Distribution System (GDS) fee for purchases made via travel agents. MAS aims to increase Internet sales up to 50% - 60% by 2010, which will help us to save a substantial amount in GDS costs i.e approximately 2.5% - 3.0% of the airlines total costs. Nonetheless, travel agents will continue to remain important partners for MAS as they provide value-added services like complex itinerary planning, group travel and also non air-related services such as hotel bookings and car rental. Travel agents who are willing to embrace change will always have an important role to play and MAS views these partnerships as critical to its success in achieving FSVC status.

Step 3 : Offer Competitive Fares

Once we have managed to reduce our structural and operational costs, we will be in a much better position to offer competitive fares. Competitive fares here means not lowering or even throwing fares recklessly, but matching our fares, in a systematic manner to what the market is offering on each route. Revenue management i.e. management of yield and inventory allocation provides us a means to offer competitive fares at the right time on the right route/sector to the right customer segment. It is possible to offer a combination of high and low fares on any given route, and still increase our yield. A number of factors contribute to this seasonality, point of sales, when the passengers make the booking, relative load factor of individual routes (high or low demand routes), etc. We introduced Project Omega, and later Project Alpha, as a sequel to the Route Profitability Project (RPP) and Revenue Enhancement Project (REP). Both Project Omega and Alpha aspire to provide an annual revenue increment of RM550 to RM700 million.

Exhibit F15: Project Omega & Alpha Targeted revenue increment RM550-700m p.a.
Key Business Initiatives

Exhibit F14: Managing rising volatile fuel cost The oil price has reached the highest level that mankind has ever experienced and it will negatively impact the financial performance of all airlines. SIN Jet was as low as USD68 per barrel in January 2007 and it went up to as high as USD115 per barrel by December 2007. To mitigate the impact of the volatile fuel market, MAS management team is taking the following measures: 1. 2. 3. 4. 5. Review its fuel hedging portfolio. Recover part of the costs through increased fuel surcharges. Implement IATA's best practices (GO team recommendations) on fuel efficiency. Make full use of Flight Planning Flight Following (FPFF) System. Review fares and implement smarter, sharper inventory control.
Sin Jet Fuel Spot Price (USD/bbl)
115 110 105 100 95 90 85 80 75 70 65 60 55 50 45 40 Jan/2005 Aug 11, 2006, 90.86

Project Omega Fare class realignment Fare structures and rules development Fare publishing Tighter inventory management

Project Alpha Boost sales via corporate accounts, big swing, low season action plan Channel management Enhanced revenue integrity

} }

RM 250-300m p.a.

RM 300-400m p.a.

Source: Energy Information Administration, US Department of Energy

Dec 2007: USD115

Project Omega
Project Omega, launched in early 2007, aims to radically improve the companys revenue management practices. It focuses mainly on enhancing the pricing of fares to optimise passenger yield and maximise operating revenues for MAS. Since the launch of Project Omega, and boosted by the Revenue Enhancement Project (REP) and Route Profitability Project (RPP) in BTP 1, MAS has achieved sustained yield improvement (see Exhibit F16).

USD per barrel

Sep 02, 2005, 81.63

Jan 19, 2007, 68.05 Jan 07, 2005, 46.52 Jan/2006 Jan/2007

Week Ending

Prior to Project Omega (and even before its predecessor, RPP), the sales team in Malaysia and overseas stations had absolute control on pricing. Given that each sales teams KPI is to maximise station sales and hence load factors, there was excessive fare discounting in an un-orderly fashion to boost sales, with minimal coordination by the Revenue Management team at the head office in Kuala Lumpur. There was also limited coordination and interaction between Sales, Revenue Management and Airport Operations, which resulted in poor demand forecasting. This in turn led to low passenger yields across the network, regardless of whether head office had a good control on costs. This was a key reason for the financial losses in the past.

67

68

Following the new management reporting structure, the entire revenue function has been placed directly under the Revenue Management team at head office. The Revenue Management team now takes control of all ticket pricing decisions and manages a centralised ticket inventory pool. By controlling the inventory ticket pool, the Revenue Management team can monitor and optimally price fares to maximise revenues. This shift in pricing decisions from boosting seat sales to fare optimisation (and profit maximisation) is crucial for MAS to secure high yield while offering competitive fares in a sustained manner across the network.

MAS will make full use of fare publishing to widen its distribution reach. We have increased the use of Airline Tariff Publishing Company (ATPCO) to distribute fares to the various agents and online website channels worldwide. Optimising fare and yield: The long-term focus is to develop a transparent fare structure and consistent rules for our sales and travel agents. MAS will offer several differentiating fare products and price the fares according to passenger demand. To ensure competitiveness, the fare pricing will be adjusted on a timely basis to reflect market conditions. To increase its market base, MAS will widen its storefront by selling its products to as wide an audience as possible and listing published fares through ATPCO.

Exhibit F16: Sustained yield improvement due to REP, RPP and Project Omega

23.6 22.6 22.7

24.2

26.1

26.3 25.9

Yield* RRPK (sen/RPK) Increased by 5.8 sen/RPK

ii. Fare distribution

MAS classifies its fare distribution under 4 categories Freedom, Contained, Dominated and Restricted (see Exhibit F18). In terms of ranking (order of preference) : Freedom Yield is the highest; MAS has very strong control on fare distribution across a large pool of travel agents (and other channels). Contained Yield is the second highest; MAS has fairly strong control on fare distribution in smaller markets (countries with small population e.g. Sweden) and works closely with a small number of agents to keep the yields high. Restricted Yield is low; MAS fare distribution is influenced by a few major agents who tend to suppress MAS yield in order to protect their mark-ups. Dominated Yield is the lowest; MAS fare distribution is controlled (monopolised) by 1-2 travel agents in the local market.

(28% increase)
18.9
RASK* (sen/ASK) Increased by 4.1 sen/ASK

18.5

18.3

Yield

20.5

16.8 16.5 15.5 15.6

(28% increase)

RASK

14.8

*YTD Cumulative figures FY 2005 Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 *Include fuel surcharge and administration fee

i. Pricing
The 3 key pricing initiatives are : fare class realignment (FCR), fare structures (and rules) development and fare publishing. These initiatives will help improve MAS pricing practices and fare distribution, leading to higher passenger yields. Through FCR and fare structures development exercises, the overall fare system has been restructured, resulting in a consistent pricing structure across the entire network that is both competitive and responsive to the market.

Currently, the profile of our fare distribution (% of total revenue contribution) is approximately 35% Freedom, 5% Contained, 30% Restricted and 30% Dominated. This means that there is tremendous opportunity for MAS to improve its yield. We believe we can increase the Freedom proportion up to 40% - 50%.

Exhibit F17: Mechanics of fare class realignment (FCR) To optimise passenger yield and revenue contribution, MAS managements strategy is to drive as much of the Restricted and Dominated categories to the Freedom category. This may mean expanding the ASEAN, Indian and China markets, which traditionally have higher yields due to the fragmented travel agent market environment. The long term target is to drive passenger yield up by 3-4 sen/RPK, an aggressive target, but nonetheless, an achievable goal.
Illustration only RM110
Fix lowest fare

Exhibit F18: Fare distribution strategy

SALES

Step 1 : Establish the lowest fare on each route Step 2 : Fix MAS lowest fare Step 3 : Build the fare (RBD) ladder using small steps

+ve

RESTRICTED
Few major agents contribute a large portion of MAS inventory sales out of the particular POS on specific O&Ds and supressing our yields for their mark-ups

FREEDOM
Highly fragmented published environment in big markets selling on MAS

RM146 RM133 RM121

NIAT IMPACT

-ve
Bulk of MAS Inventory sold by 1-2 Agents whilst supressing our yields Smaller markets whilst leveraging on few agents to generate higher revenue efficiency

+ve

RM100

DOMINATED
-ve

CONTAINED
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iii. Tighter Inventory Management

Key initiatives here include: demand recalibration, improving demand forecast and exercising disciplined management (allocation and release) of seat inventories. Demand Recalibration. Setting correct pricing and fare structures upfront alone is not enough. Ticket pricing has to be consistently monitored and continually adjusted based on the underlying passenger demands for the respective routes in the different regions. This is known as demand recalibration which continually on each, realigns or revises fares up or down the fare ladder according to the underlying passenger demand profiles. In doing so, MAS is able to maximise its revenue. Demand Forecast. Forecasting relies on the quality of data compiled and the ability to use the data to interpret the underlying trends. The new pricing process collects and monitors pricing and traffic data continually. The objective is to use the underlying data to improve revenue and yield forecasting for MAS. Currently, MAS forecast accuracy is about 80% - 85%. The target for MAS is to get its forecasting ability up to 97% accuracy, 30 days before departure and 99% accuracy, 7 days before departure. This will enable MAS to determine accurately when to offer lower and more competitive fares to boost demand and increase yield. More disciplined management of seat inventories. This entails the route managers at Revenue Management adopting a bond trader mentality. They must consistently monitor the demand of their portfolio (routes designated under their care), take a measured approach and follow the inventory plan, instead of releasing seats too early if there is a shortfall in bookings. A disciplined approach would enable the route managers to match the demand and supply, such that revenue is maximised: for low demand routes, cheaper seats (lower fare classes) are offered; for high demand routes, low fare classes are closed and higher fare classes are opened and offered for sale. In addition, MAS has also improved its policies and procedures on overbooking and denied boarding to strengthen inventory management.

i. Increasing Sales
Corporate accounts. Since the launch of the Corporate Signature Programme (CSP) in 2006 i.e. where corporate travel packages are tailor made for various large and medium-sized business entities, we have achieved significant improvements. A more targeted CSP sales approach is in place to win major corporate accounts. Big swing. We will work with selected travel agents in each region to offer more attractive ventures which are complemented by equitable incentive schemes so that these agents are incentivised to promote MAS tickets and swing their sales towards MAS. Low seasons. We have developed a low season action plan and strategy by region to address the pockets of low demand periods throughout the year. This includes using promotional fares, which are the cheapest fare band category (these generally have the most restrictions attached) to boost our load factor during the lean period. Loyalty programme. The aim here is to increase membership. This includes an Enrich programme aimed at large corporate accounts and partnerships with various banks and credit card companies.

ii. Channel Management

Increase market share via closer cooperation and strategic arrangements with various distribution channels i.e. travel agents, tour operators and independent online booking engines. Review and determine the ideal channel mix to maximise revenue/profit e.g. direct vs indirect; online outlets vs. physical outlets. On a topline basis, MAS intends to increase its distribution via Internet up to 50% - 60%.

Step 4: Get More Passengers And Increase Load Factors

With 5-Star service, low cost structure and competitive fares in place, MAS can stretch its sales and distribution effort to increase its customer base and fill up the aircraft.

iii. Revenue Integrity

MAS has invested in a revenue integrity system to detect and curb abuses in the sales and booking process. The system is able to sieve out fictitious and duplicate bookings well ahead of departure, and free up seats for MAS to sell to customers who will actually fly. This way, we can minimise seat wastage. We will tighten existing procedures so that revenue integrity checks increase in frequency and swift remedial actions can be taken. We have also put in place a mechanism to identify ticketing abuses by our ticket offices and travel agents, resulting in better inventory control.

Project Alpha
Project Alpha works hand in hand with Project Omega to unleash the full potential of the foundation laid by Project Omega i.e. the fares (after fare class realignment) and seat inventories available in the system. In fact, the new and revamped Revenue Management practices necessitate new sales practices. The initiatives under Project Alpha include increasing sales via corporate account acquisition, big swing, low seasons strategy, restructuring channel management and enhancing revenue integrity.

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Project MOSAIC
Project MOSAIC which stands for MAS Overall Strategic Alliance Integration Concept is aimed at extracting the maximum value from our hub-and-spoke network built over the period 2005-2007. The scope include: a. b. c. d. e. Identify high-value codeshare and Special Pro-Rate Agreement (SPA) partners. Increase agreements with partners that have positive P&L impact to MAS. Discontinue agreements that are not beneficial to MAS. Perform misconnect analysis to optimise our network connectivity. Identify new codeshare and SPA agreements to pursue.

Exhibit F20: Project MOSAIC Between 2006-2007, we have built our hub-and-spoke network

We will ensure that the agreed special pro-rates are competitive in the marketplace and that the rates are aligned to MAS yield aspirations. It is estimated that we can extract additional RM70-100 million worth of revenue from an enhanced hub-and-spoke network.

Bergen Stockholm Oslo Stavenger Aberdeen Sandefjord Gothenburg Glasgow Edinburgh Belfast Teesside Copenhagen Leeds Dublin Manchester Amsterdam London Frankfurt Brussels Vienna Munich Geneva Milan Barcelona Madrid

Helsinki

Legend -------- - Operated by Malaysia Airlines -------- - Operated by Alitalia -------- - Operated by South African Airways -------- - Operated by Virgin Blue -------- - Operated by BMI -------- - Operated by Gulf Air -------- - Operated by KLM ---------------- - Operated by Air Mauritius --------- - Operated by All Nippon Airways --------- - Operated by Qatar Airways --------- - Operated by Garuda Indonesia --------- - Operated by Sri Lankan Airlines --------- - Operated by Cathay Pacific Airways Turkey (Aspiration)
Tashkent

- Operated by China Southern Airlines to 90 destinations from Guangzhou and 38 destinations from Beijing

Beijing
Inchon Seoul Kansai Tokyo

Rome

Athens

Nagoya Bahrain Doha Muscat Yangon Bangkok

India (Aspiration)

Fukuoka Shanghai

Guangzhou
Hanoi

Hong Kong

All 3 projects; Omega, Alpha and MOSAIC work hand in hand. To date, both Projects Omega and Alpha happening in tandem have demonstrated that we are able to increase yield without losing our load factors. In fact, we see an increase in load factor (see Exhibit F19).
Harare, ZIMBABWE

Colombo

Phuket Langkawi Penang Medan

Siem Reap Phnom Penh Ho Chi Minh

Manila Cebu

KUALA LUMPUR
Singapore Kota Kinabalu

Dar es Salaam TANZANIA Maputo MOZAMBIQUE Mauritius Gaborone, BOTSWANA Durban Maseru, LESOTHO East London

Jakarta Surabaya Denpasar Darwin

Exhibit F19: Impact of Project Omega and Alpha Increasing yield and load factor

Victoria Falls, ZIMBABWE Windhoek, NAMIBIA

Broome

Johannesburg

Perth

Cairns Townsville Hamilton Island Mackay Rockhampton Fraser Coast Sunshine Coast Brisbane Gold Coast Ballina Byron Coffs Coast Newcastle Canberra

Port Elizabeth

Adelaide Melbourne

Sydney

Sen/RPK 72.0% 71.5% 71.0% 70.5% 70.0% 69.5% 69.0% 68.5% 68.0% 67.5% 67.0% 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07
Load Factor

Launceston Hobart

27 26 25 24

Now we need to maximise value / benefit from interline and codeshare partnerships

Review existing SPAs and codeshares

23 22 21 20 3Q07

Terms and conditions against industry best practices SPA / NSU (Net Settlement Unit) rates vs MPA rates Develop interline business management practices benchmarked against selected airlines best practices

Potential revenue increment:

RM70 - 100m

Cumulative Yield (sen/RPK)

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Step 5: Grow Network And Build Capacity

Exhibit F21: The Resilience Curve With Steps 1 to 4 in place, MAS is ready to grow its network and capacity profitably. Imagine a theoretical curve called the resilience curve which captures the trade-off relationship between yield and seat factors, while achieving Revenue per Available Seat Kilometer (RASK) that equals Cost per Available Seat Kilometer (CASK). In other words, the resilience curve is also the breakeven curve.

i. 5-Year Network Plan

We have developed our 5-year network plan based on various network planning tools, together with traffic flow and consumer preference modeling. Based on footprint, we will grow our business from 2008 onwards, when we will develop new routes and also increase frequency on existing routes with growth potential.

Yield
(sen/RPK)
* Include 30 fuel surcharge 29 and admin 28 fee

Project Omega Project MOSAIC

27 26 25 24 23 22 21 20 68 69 70 71

2007 (Jan-Sep)
Yield : 26.4 SF : 71.4% Op Profit: +RM 615m Net Profit: +RM 610m

We will focus our additional efforts and resources on our core network in ASEAN, China and India, all of which are estimated to experience higher-than-average growth in air traffic (based on IATAs industry data). To serve the core network better, we are looking at acquiring long range narrowbody aircraft which will allow us to operate the new routes profitably where our Airbus 330 is too large and our Boeing 737-400 does not have the range. We will continue to develop further our hub-and-spoke network to improve traffic flows. It must be emphasised that we will not grow for the sake of growth but rather, we will focus only on profitable growth. The network plan also features Firefly and MASwings which are 2 new subsidiaries launched in 2007. These 2 airlines will play a key role in complementing the overall MAS network as well as exploring new business opportunities for MAS (refer to next section 2. Gaining New Business for more details).

2006
Yield : 24.2 SF : 69.7% Op Profit: - RM 303m Net Profit: - RM 136m

Project Alpha
* Breakeven curve RASK = CASK (17.5 sen/ASK)

2005
Yield : 20.5 SF : 71.8% Op Profit: - RM1.1b Net Profit: - RM1.3b

Exhibit F21: 5-Year Network Plan (2008-2012)

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73

Seat Factor (%)

In the long term, we can move the breakeven curve outwards or inwards depending on changes in the MAS cost structure. This breakeven curve will move outwards (towards the Northeast quadrant) if our costs (CASK) keeps increasing perhaps due to higher fuel prices or inflation. On the contrary, the breakeven curve will move inwards (towards the Southwest quadrant) if we are successful in cutting our costs (CASK) year on year.
North America

Core Network
Europe

China

North Asia

However, in the short term (1 year), the breakeven curve tends to be fixed. If MAS can achieve a set of company wide yield and seat factor (refer to the dots on Exhibit F21) that sits on the curve, then it will breakeven. If it is below the curve, then MAS is in a sub-optimal region basically, this means we are making a loss. Ideally, we should be above the curve making profits. At a yield of 26.4 sen/RPK and seat factor of 71%, MAS was able to achieve an operating profit of RM615 million between January and September 2007.

Middle East

South Asia ASEAN

South America Australia South Africa New Zealand

Project Alpha, Omega and MOSAIC are tools which we can use in isolation or combined to move the dot outwards, which brings us towards a more desirable state where MAS can be even more profitable. The companys focus for the next few years will be to move the dot outwards to the Northeast quadrant and to simultaneously move the breakeven curve towards the Southwest quadrant.

Restructure / Hold Monitor Hub & Spoke Grow

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ii. 5-Year Fleet Plan

Based on the 5-year network plan, MAS has also designed a 5-year fleet plan. The fleet plan has been designed to deal with our intended network growth. Key features in this fleet plan include: Increase in fleet size. Fewer aircraft types (this will reduce the level of spare inventory and simplify crew resource needs e.g. rostering and training). In all likelihood, we will review the density in economy cabins and decrease the size of premium cabins. We will reduce space on non-revenue generating usage, such as the galley (suboptimal space allocation) and redirect the space towards increasing the number of seats. This reduces our cost per seat and increases the number of sellable seats. Inclination towards more agile and fuel efficient aircraft for the short and medium haul. Shift aircraft portfolio towards aircraft ownership for core network and lease agreement for the rest of the network (non-core), taking into account our capital management objectives. A carefully managed plan for the transition from our existing fleet towards complete change-out within the 5-year period and beyond. In 2008, once we have completed our commercial and technical evaluations on the aircraft types, we will place our order for the new fleet. As an interim measure, the existing fleet will be refreshed in line with our MH campaign.

2. GAINING NEW BUSINESS (GNB)

On top of maximising existing assets in MAS, we recognise that we need to create new vehicles to complement MAS existing business as well as capture and create new opportunities for MAS. These include Firefly, MASwings and Malaysian Aerospace Engineering (MAE).

i. Firefly
Firefly was launched in April 2007 and operates turboprop aircraft. Firefly complements MAS' network by serving secondary routes that could not be viably served by the typical single-aisle jet aircraft. It is aimed at capturing the growing population of value-focused and discerning passengers who demand convenience, affordability and excellent customer service. In late 2007, Firefly obtained approvals to operate 72 domestic and regional routes out of Penang, Subang (Kuala Lumpur), Johor Bahru and Kota Kinabalu. To support its expansion plan, Firefly has placed firm orders for 10 ATR72-500 aircraft with options for another 10. The new aircraft will progressively replace its current fleet of 3 Fokker-50 aircraft starting July 2008. Apart from its profit contribution to MAS, Firefly also acts as a test bed for MAS to break new grounds in the area of cost efficiency. If proven successful, processes in Firefly may be adapted into MAS where suitable and relevant.

ii. MASwings
As preparation to purchase new aircraft, we conducted a Rights Issue and Redeemable Convertible Preference Share (RCPS) exercise to partially raise funds to the tune of RM1.5 billion in 2007. The fund, together with our cash balance, will enable us to finance the aircraft acquisition (on top of other existing projects e.g. PSS and debt repayment). MASwings was launched in October 2007 as a subsidiary of MAS. Unlike Firefly, MASwings was set up as a special purpose vehicle (in line with MAS corporate social responsibility) to serve the rural areas in Sabah and Sarawak, which cannot be served viably on a commercial basis. The P&L is owned by the Government and the airline is operated by MAS.

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MASwings is a crucial complement to MAS network because it provides feeder traffic into MAS global network. It connects Sabah and Sarawak to the world, while attracting tourists to the states which are well known for their world heritage sites. MASwings plays a vital role as an engine of economic growth in Sabah and Sarawak. As of January 2008, MASwings operates 7 Fokker-50 and 5 Twin Otter aircraft, serving 21 destinations in Sarawak and Sabah. MAS and MASwings schedules are fully aligned to provide customers seamless connectivity and baggage interlining.

3. BREAKING NEW GROUND (STRATEGIC PARTNERSHIPS)

We have a few projects which we are working on confidentially to explore new business opportunities. These projects are at this stage kept strictly confidential. Once the ideas are tested for commercial viability and have passed reality checks, we will announce them.

4. SUPPORTING KBAS iii. Malaysian Aerospace Engineering (MAE) - MRO

As mentioned under the E&M Breakthrough Programme (EBP), our prime focus for the next 5 years will be third party maintenance work, although emphasis will continue to be given to the management and maintenance of MAS aircraft. In 2007, we set up MAE as a subsidiary of MAS with its own management team and P&L responsibility to tap into the huge potential in the global MRO market. This aspiration is in line with the Governments National MRO Action Plan. This ambition is also articulated in the Ninth Malaysia Plan and we intend to play a key role in its implementation. With clear and visible accountability to its own P&L, the MAE team works hard to generate more revenue from MRO and find ways to reduce its costs in order to win in the competitive MRO environment. To date, there are early signs of success: efforts to increase its customer base have led to new maintenance contracts signed with a number of major airline groups and productivity is on the rise. In 2005, the revenue from third party work was approximately RM100 million. It doubled to RM220 million in 2006 and we have achieved over RM300 million in 2007. We hope to grow our third party work from 30% of total MRO work to 50% by 2010. The growth will come from joint ventures and collaborations with other reputable MRO players and airlines. This will enable MAE to spread its wings globally.

i. Finance Transformation Initiatives

We aim to create a world class Finance function, one that is anchored on the P&L. The Finance function will consistently deliver proactive target-setting based on external benchmarks; insightful, intense and transparent daily/weekly/monthly monitoring of KPIs; reliable forecasting; rigorous financial evaluations of major decisions; active management of cash and working capital; and commercial management of fuel hedging and risk. The timeliness and quality of our financial and management reporting have improved substantially since the start of BTP 1. However, there is scope for more useful insight to be produced in order to help the airline make better decisions. We will also look towards automating and streamlining a number of processes which will improve efficiency and productivity across the company. In order to help us achieve these objectives, we will explore the appropriateness of an Enterprise Resource Platform (ERP) solution. As we exit the turnaround mode and shift into profitable growth, we will re-look our balance sheet management strategies in order to support our growth, minimise costs and optimise our capital structure.

ii. HR Transformation Initiatives

Our employees are the enablers of FSVC. We are committed to unleashing the talents and capabilities of our employees as well as transforming MAS into one of the best places to work in, not only in Malaysia, but in the world. From our customer-facing cabin crew to the engineers maintaining our aircraft and the support staff responsible for payroll, the transformation to a world class business can only take place once we have world class employees. Our employees will be nurtured in a culture of integrity and transparency. Silo mentality will be eradicated and replaced by open and honest communication, effective consensus building and teamwork.

iv. MASkargo - Cargo Business

The strategy for MASkargo is to maximise value extraction from its existing belly and freighter network by continuously winning new cargo business and migrating to higher value cargo contracts. MASkargo has come a long way. After MASkargo went through its massive restructuring between 2001 and 2003, its profitability and operational performance improved tremendously, so much so that it achieved record profits of RM179 million in 2006. Since mid-2007, due to a slowdown in global air cargo traffic, the cargo business environment is now more challenging than before. The reduction in belly capacity and high fuel prices resulted in a forecasted profit of slightly above RM100 million in 2007. We believe that via MASkargos new revenue management system and new account acquisitions, we can sustain an annual profit of RM150 million over the next few years.

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FOR THE NEXT 5 YEARS (2008 - 2012)

Consistent with MAS philosophy of aiming for the best, and assuming the worst, we believe that if we aim for the best, stretch our limits and go for the impossible, we can achieve an annual profit of at least RM1.5 billion by 2012 even after factoring in the industrys challenges such as overcapacity, air traffic liberalisation and rising fuel costs. The benefit of embarking on MAS transformation to become a FSVC is that we are building a ship that can weather the worst storm. Should the magnitude of the overcapacity and liberalisation turn out to be less than what we anticipated or the price of fuel drops, there is an optimistic chance that MAS can achieve an even higher profit. Our estimate is anywhere between RM1.5 and RM3 billion per annum. So FSVC is indeed the right way to go for MAS. However, on an annual basis we will review our financial targets and update these targets as we achieve them. Over the past 2 years, we have managed to outperform our announced targets and we have every intention to continue to meet and exceed the targets set forth in our Corporate Scorecard.

WE NEED THE COMMITMENT OF OUR STAKEHOLDERS AND THERE ARE BENEFITS IN RETURN
We need the commitment from all our stakeholders to make this work. MAS can only succeed if we get everyone behind our plans. When MAS succeeds, our stakeholders succeed. If MAS fails, it will be detrimental to the interests of all our stakeholders. No airline has ever transformed itself without full commitment from its stakeholders. In giving this commitment and support, each group earns the right to share our success and reap the benefits. Our employees When MAS succeeds, our employees will be rewarded for their performance and contribution, and they can be proud of being part of a successful airline. To succeed, it is critical that we maintain our labour cost advantage and our employees must be amongst the most productive in the industry. We have shown to everyone that we, as MAS, have a right to be at the international airline table. Now, to stay at this table, we will have to focus and work even harder. We, the MAS management, are commited to create and introduce state-of-the art tools and lend our support to create a more productive and value-adding work environment. We also need the unions support. If MAS is successful on this growth journey, we can retain more jobs and create more value-adding jobs. Our management As MAS succeeds, our high performing managers will be given exciting new opportunities and generous rewards. We will ask our managers to put real skin in the game. Those who are willing to take on real accountability and deliver results will be rewarded. For those who have looked at MAS as a source of guaranteed employment and relatively generous perks, this could be a painful process.

Exhibit G2: MAS 5-year P&L Aspirations/Targets

(Figure in RM)

Optimistic RM2b 3b

Base case RM1.5b

+RM610m

2007 YTD (Jan-Sep)

2008

2009

2010

2011

2012

Pessimistic
* Yield drop ~5% yoy - RM 650m * Minimal seat factor drop

Our customers Customers can look forward to higher service levels as we master operational excellence. Through the MH campaign and various other initiatives, they will receive improved products and services that they are willing to pay for. We will give the customers the most value in the industry. This is what MAS will stand for. To ensure we are achieving this, we will extensively seek customer feedback and we will urge our customers to share with us what they value most. Our agents Travel agents will continue to remain important partners for MAS as they provide value-added services to our customers. However, we simply must reduce our cost of distribution and respond to specific customer segment preferences, and deal directly through the Internet. We will work with our agents to ensure that they can enjoy an equitable share through partnering MAS. Travel agents who are willing to embrace change will always have an important role to play and MAS views these partnerships as critical to its success in achieving FSVC.

- RM1b or more

Worst case
* Yield drop >5% yoy * Seat factor drop 5-6% yoy

THE FULL EXECUTION OF THE PLAN WILL TAKE 5 YEARS AND CONTINUE BEYOND
We strongly believe that The MAS Way will transform MAS into a FSVC but this will not happen overnight and it will not be easy. A transformation is not just a series of quick actions, it is also a multi-year programme designed to create an organisation that can adapt to whatever the market will throw our way. It is important to note that lasting airline turnarounds take years of concerted action. We fully understand the magnitude of this change and recognise that much of this takes time. We expect that there will be setbacks along the way; although we will do all that we can to manage these. The nature of quick and firm decision making is that we might make mistakes. Many of our pricing changes, for example, will increase revenue, but some could result in a reduction of market share. Some new markets will be a success; some will prove a struggle. While we hope that we will achieve common ground with our unions and suppliers, we may encounter difficult situations, and we cannot ensure that there will not be interruptions to service along the way.

Our suppliers As MAS succeeds, we can expect our suppliers to grow and develop with us. Those suppliers who offer the highest value for money can also look forward to increased transparency and merit-based decisions. However, we cannot survive and prosper with imbalances in risk and rewards with our suppliers. We will negotiate with our suppliers until we are convinced that we share equitably in the risks and rewards from the marketplace. If we cannot do that, we will replace them with those who can. We are striving for long-term partnerships. These partnerships need to create win-win results for our customers and MAS.
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v. Corporate Governance Initiatives

On corporate governance, MAS will continue its efforts to improve corporate governance practices by focusing on enhancement of policies and processes. MAS will also inculcate a risk and control culture within the organisation as part of the Internal Control Enhancement (ICE) programme launched in April 2007. Key initiatives are as follows: Enterprise Risk Management (ERM). MAS will intensify risk management activities at strategic and operational level via ERM. The objective is to enhance the speed of detecting critical risks and prompting management to take immediate action to mitigate the risks. Control Self-Assessment initiative. This initiative aims to instill accountability among MAS managers and business heads to execute proper risk and control assessments that are linked to their KPIs. Quality Assurance Collaboration initiative. Going forward, Audit & Business Advisory will work closely with Quality Assurance functions to provide greater assurance to the Board and the management using the Internal Control Enhancement (ICE) framework. The establishment of the internal control scorecard and incident reporting will assist the Board and management in monitoring the overall state of internal controls within the organisation. Enforcement of Commend and Reprimand Programme (CaRP). We will follow through on CaRP which was launched in 2007, where exemplary behaviours are commended whilst the opposite are reprimanded. Corporate Information Technology Policy (CITP). The CITP is formulated to ensure the effective, efficient and responsible use of IT across MAS.

TAKING A STEP BACK

Executing a business transformation such as this requires well planned and coordinated actions. We have started many initiatives required to execute our BTP 2. Many of these are built on the efforts that were started as part of the BTP 1. They are a continuation of our existing initiatives, albeit with a renewed focus towards achieving the FSVC strategy. What has been presented in this document are just the current initiatives and as our business evolves, new KBAs, guided by the principles of The MAS Way, will be developed. We have to build on the successes we have achieved. Taken as a whole, past and future initiatives will come together to form our transformation programme of making MAS into a FSVC.

Exhibit F23: Key Business Activities

Focused Approach

Strategic Partnerships

Breaking New Ground (BNG)

MASwings Firefly MASkargo Project MOSAIC Project Omega & Alpha Network & Fleet Plan MRO / MAE

Gaining New Business (GNB)

PSS

Procurement Revamp

MH Campaign

Project Delta

Reduction of Distribution Cost

Making the Most (MTM)

Finance Transformation

HR Transformation

SSHE Action Plan

IT Revitalisation

Corporate Governance

2005

2007

2008

2009

2010

2011

2012

Exhibit F24: From where I sit as Managing Director, I see many paintings being created in many rooms such as Projects Alpha and Omega, Project Delta, Network Plan, Firefly, etc. All these are groundwork for the intention to win beyond the present time. As long as we focus on the things that really matter i.e. Key Business Activities that impact the P&L, then we can definitely achieve our aspiration to become a FSVC.
Quote from Dato Sri Idris Jala MD/CEO

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Executive Summary
MAS has certainly come a long way. For the nancial period 2005 (9 months), MAS reported a loss of over RM1.3 billion the biggest in the companys history and it was expecting to hit an even deeper loss of RM1.7 billion for the full year 2006. The nancial position was so precarious that we had only a few months until April 2006 before we ran out of liquidity. In the wake of the prot and cash crisis, we announced our Business Turnaround Plan (BTP 1) in February 2006. The BTP 1 was developed using the Government-Linked Companies Transformation (GLCT) manual as a guide, and targeted to cut our losses from RM1.7 billion to RM620 million in 2006, achieve a prot of RM50 million in 2007 and a prot of RM500 million in 2008. With hard work, radical changes and tough decisions, we were able to overcome the cash crisis to ensure our nancial survival in 2006, achieved a record prot of RM610 million for the 9 months, year-to-date to September 2007, and we are now on track to generate further prots in 2008. We made it! We have demonstrated to our stakeholders, nation and world at large that we are a winning team. However, new challenges loom ahead of us. The single largest concern that MAS will face in the industry is overcapacity. Based on industry estimates, about 400 plus new aircraft have hit the skies of Asia Pacic, India and Middle East in 2007, and another 400 plus is expected in 2008. This phenomenon of unbridled growth will intensify competition in the market, and erode our yield and prot margins. Coupled with the liberalisation of ASEAN skies and rising oil prices, MAS will, with everything else remaining equal, inevitably hit a wall and fail badly if we do not transform ourselves. Thus, as we go into 2008 and beyond, our focus will clearly need to shift to securing our future success. This phase represents the most challenging yet for MAS this is the real mountain that we need to scale. To chart our path onwards and upwards, we have developed a Business Transformation Plan (BTP 2). The plan, outlined in this document, will build on the 5 key thrusts of The MAS Way (see Exhibit 1) which served as the guiding principle for our BTP 1. Exhibit 1: Transforming the company The MAS Way
VISION: To be the Worlds Five Star Value Carrier (FSVC)

MAS aspires to become the Worlds Five Star Value Carrier. We believe that we have to reinvent ourselves to achieve this vision. Our transformation journey towards achieving this vision is tough but exciting. It will require leadership, teamwork and relentless passion to pursue this vision. Our vision will be supported by the mission to be a consistently profitable airline. The strategy is to transform MAS into a Five Star Value Carrier (FSVC) i.e. providing 5-Star products and services at affordable prices. There are 5 bold steps which make up the FSVC Virtuous Cycle of Profitable Growth:

Step 1 - 5-Star: We must maintain the high quality products and services offered (5-Star) and these have to be constantly matched to the specific needs of our customers; Step 2 - Lower Costs: We must reduce our structural and operational costs (without compromising on safety and security); Step 3 - Competitive Fares: With a lower cost base, we will be able to offer low and competitive fares to our customers, and still be able to make a profit; Step 4 - Get more customers, more revenue: With high quality products and services at low/competitive fares, more passengers will choose to fly on Malaysia Airlines. This translates into more revenue; Step 5 - Grow network, build capacity: With more revenue and profit, we can invest in growing our network and building our capacity. We will open up more routes and acquire more planes, and this leads us to sustainable, profitable growth. The process repeats in an upward spiral (see Exhibit 2).

ro Exhibit 2: The Virtuous Cycle of Profitable Growth Growth

Grow network, build capacity Competitive fares

Flying to Win Customers

5-Star 5 Star Get more customers, more revenue

COMMERCIAL

OPERATIONS

Mastering Operational Excellence

FINANCE

Low cost

MISSION: To be a consistently profitable airline

Financing and Aligning the Business on P&L Unleashing Talents and Capabilities

PEOPLE

STAKEHOLDERS

The philosophy behind the BTP 2 is aiming and planning for the best, assuming the worst. On aiming and planning for the best, MAS will go for the seemingly impossible target i.e. record profit. On assuming the worst, MAS must transform to become a FSVC. MAS has to build a ship that can weather the storm, in our case, the imminent liberalisation and overcapacity in Asia. Based on a series of focused key business activities, our aspiration in the plan is to achieve RM400-550 million (on target), RM551-650 million (exceeding) and RM651-1000+ million (outstanding) in 2008. We believe that if we aim for the best and stretch our limits, we can achieve an annual profit of RM1.5 billion by 2012 even after factoring in the industrys challenges such as overcapacity, air traffic liberalisation and rising fuel cost. Should the magnitude of overcapacity and liberalisation be less than our anticipation, it is possible for MAS to achieve an even higher profit - between RM2 and RM3 billion per annum. On an annual basis, we will review our financial targets and update these targets as we achieve them. Over the past 2 years, we have managed to outperform our announced targets and we have every intention to continue to meet and exceed the targets set forth in our KPI Scorecard. FSVC is our path to long term survival and success. Our ability to deliver this FSVC strategy is the cornerstone to grow MAS into a global champion. We can do this, and we will.

Winning Coalitions

STRATEGY: Business Transformation

In the premium market segment, MAS is under tremendous pressure from full service carriers (FSCs) who are striding ahead with rst class products, new and modern aircraft, and fast-expanding routes. On the other hand, in the price driven market segment, MAS is also strongly pushed by low cost carriers (LCCs) with low fares. In a nutshell, MAS must reinvent itself to fend off competition from FSCs and LCCs. It is precisely for this reason that we are adopting a strategy which deals with this dual challenge i.e. we will continue to improve the quality of our product and services (hence, Five Star Airline) and at the same time, reduce our costs so that we can offer low fares (the notion of Value Carrier). We are mobilising the entire airline to become a Five Star Value Carrier: one with products, eet and network that are in the league of the worlds premium airlines, with a cost structure and operational discipline to match the best fares the LCCs can and will throw at us.

We will embark on a HR transformation programme to ensure that HR delivers 5-star services to its customers i.e. the MAS employees. This transformation encapsulates the following initiatives which will lay the necessary foundation: Performance Management System (PMS). This is the cornerstone institutionalising a performance based culture within MAS. Introduced in MAS systemwide in 2006, it will continue to be used to align the behaviours and activities of employees in order to realise the company's vision and aspirations. As it matures, it will be fine tuned to eliminate grey areas in the organisation and will ensure that every single person, across all levels of the organisation, is accountable for their actions. Our rewards and remuneration framework will be guided by performance at the company, divisional and individual levels. Job Grading and Salary Structure. By the end of 2008, MAS would have completed the job evaluation project and migrated towards a new job grading structure that ensures every employee in MAS has clarity on their respective roles and responsibilities. Along with this, an internally equitable and externally competitive salary structure that commensurates with the new job structure will be developed. This migration is critical to enable us to attract and retain the right talent for the right job at the right price. Talent Management. Every leader in MAS must be responsible for securing the companys future. Developing the next generation of leaders is a critical component of MAS future. During BTP 1, we initiated many formal training and development programmes e.g. MDP (Management Development Programme), TLDP (Transformational Leadership Development Programme) as well as established the MDC (Management Development Committee) to identify successors for key positions in MAS. While this is all great, talent management is not just about attending training sessions at the MAS Academy. It is about providing opportunities to those employees that demonstrate the ability and determination to push themselves out of their comfort zones. We are committed to supporting these identified future leaders by assisting them throughout their career as well as providing them opportunities for growth and exposure through international placements, cross GLC or cross divisional postings. MAS will invest in its future. We will continue to collaborate with universities, vocational schools and flying academies across the nation to secure a continuous stream of talent from cadet pilots to engineers and management associates. Human Capital Relations. We believe in constructive and continuous engagement with our employees and unions in order to maintain industrial harmony. We do not believe in sitting at the opposite ends of the table but prefer a side-by-side approach and working together to find solutions that mutually benefit both the employee as well as the rest of the organisation. HR Process Improvement. We are currently reviewing key HR processes to ensure that they can effectively and efficiently support the business. From recruitment to benefits disbursement and simply updating personnel records, each process will be improved and realigned to the business. This program will build a HR function that applies discipline, adopts the best-suited practices and acquires the necessary skills required to improve its service delivery. It is not a one-off exercise but the start of an effort to continuously re-examine our processes and improve them (Kaizen approach), as the business evolves.

iii. Safety, Security, Health and Environment (SSHE) Action Plan

Safety is our license to operate the airline and the responsibility of every single employee in MAS. Discipline of action is of utmost importance. In 2007, MAS management combined the safety matters together with security, health and environment to form a new department called Corporate Safety, Security, Health and Environment (CSSHE). The first thing the new department did was to launch a SSHE action plan which is the "fulcrum" for key SSHE agenda items at board and management meetings. The MAS management team has instituted a regular management safety performance process comprising safety councils, accountable manager and board safety meetings. The outcomes of these meetings are reported on a monthly basis at every board meeting as the first item on the agenda. All SSHE incidents are reviewed, risks appraised, corrective and preventive measures taken to strengthen our safety integrity and assurance.

iv. Revitalisation of IT Services

MAS needs a business-centric and service-oriented IT management approach that is responsive to the business dynamics. In recent years, the management of IT has shifted its focus from building and operating IT systems towards managing the demand and supply of IT, with 3 areas of emphasis: Enhancement of relationship management capabilities. We have formed the Business Solutions Group (BSG) and appointed a team of IT Relationship Engagement Managers who aim to fulfill all the needs of business units so that the key business activities like PSS, Project Omega, Project Delta, etc can be carried out smoothly. Alignment of service level with business P&L. We put in place KPIs on the IT function so that the role of IT is aligned with the company P&L objectives. For example, MAS will fine-tune its IT sourcing strategy that will deliver the aspired business values at a lower cost. Vendor SLA management. We will work with key vendors to maximise service delivery and to proactively address business needs which emerge as MAS moves towards being a FSVC.

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The BTP 2 aims to transform MAS into a Five Star Value Carrier within the next 3 to 5 years, based on a series of focused key business activities. Achieving this position in the challenging market will help transform MAS into an airline with no peers in the region. The MAS of the future aims to achieve a positive economic profit on a sustained basis, meaning we will provide positive returns to our shareholders even after factoring in the cost of capital. Given the challenges in the airline industry, where many large, well established and profitable airlines do not earn their cost of capital, this will be a significant achievement.

FOR THE YEAR 2008

G:

Size of Prize

For 2008, we aspire to achieve RM400-550 million (on target), RM551-650 million (exceeding) and RM651-1000+ million (outstanding) as stipulated in the corporate scorecard (see Exhibit G1). The scorecard is built on reasonable business assumptions i.e. sustained revenue growth of 7%, against a tight control on cost despite rising fuel prices (Jet Kero at USD100 per barrel). Generally, our scorecard aims to surpass BTP 1s projection of RM500 million (Jet Kero at USD78 per barrel), which was set at the start of 2006.

Exhibit G1: MAS 2008 Corporate Scorecard7

Target Levels

UOM
FINANCIAL (70%)
Net income Unit Cost (airlines excl fuels) RM Mil CASK (vs Budget)

Weight

Below Threshold

Threshold

On Target

Exceeding

Outstanding

50% 20%

<150 >4%

150 - 399 0% to 4%

400 - 550 0% to -2%

551 - 650 <-2% to -4%

651 - 1000 < -4%

CUSTOMER (8%) CVP and MH Implementation On-time performance Systemwide Aircraft Utilisation Baggage delivery NBD Milestones PEOPLE (5%) Performance-Based Culture / Rewards

0%

8%

<70

70 - 79

80 - 89

90 - 95

96 - 100

OPERATIONAL EXCELLENCE (12%)

0% Hours/Aircraft /Day No. of cases/ 1000 pax 4% 4% 4%

<80.0 <9.23 >3.50 Level 1 Level 1

80.0 - 82.4

82.5 - 85.9

86.0 - 87.9

88.0 12.75 13.33+ < 3.05 Level 5 Level 5

9.23 - 10.14 10.15 - 11.59 11.60 -12.74 3.50 - 3.36 Level 2 Level 2 3.35-3.21 Level 3 Level 3 3.20-3.06 Level 4 Level 4

BUSINESS GROWTH (5%)

5%

5%

Note: SAFETY is of paramount importance and the overall corporate scorecard must be achieved without compromise on safety. In the event of serious safety issues, management will apply appropriate discretion to the final score. Disclaimer: These headline KPIs in the scorecard have been approved by the MAS Board of Directors, but are not to be considered as forecasts reviewed by external auditors.

7In BTP 1, we started to institute a cross-company set of KPIs that allow us to measure the progress and performance of the company as well as those of the Managing Director/CEO and the management team.

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FOR THE NEXT 5 YEARS (2008 - 2012)

Consistent with MAS philosophy of aiming for the best, and assuming the worst, we believe that if we aim for the best, stretch our limits and go for the impossible, we can achieve an annual profit of at least RM1.5 billion by 2012 even after factoring in the industrys challenges such as overcapacity, air traffic liberalisation and rising fuel costs. The benefit of embarking on MAS transformation to become a FSVC is that we are building a ship that can weather the worst storm. Should the magnitude of the overcapacity and liberalisation turn out to be less than what we anticipated or the price of fuel drops, there is an optimistic chance that MAS can achieve an even higher profit. Our estimate is anywhere between RM1.5 and RM3 billion per annum. So FSVC is indeed the right way to go for MAS. However, on an annual basis we will review our financial targets and update these targets as we achieve them. Over the past 2 years, we have managed to outperform our announced targets and we have every intention to continue to meet and exceed the targets set forth in our Corporate Scorecard.

WE NEED THE COMMITMENT OF OUR STAKEHOLDERS AND THERE ARE BENEFITS IN RETURN
We need the commitment from all our stakeholders to make this work. MAS can only succeed if we get everyone behind our plans. When MAS succeeds, our stakeholders succeed. If MAS fails, it will be detrimental to the interests of all our stakeholders. No airline has ever transformed itself without full commitment from its stakeholders. In giving this commitment and support, each group earns the right to share our success and reap the benefits. Our employees When MAS succeeds, our employees will be rewarded for their performance and contribution, and they can be proud of being part of a successful airline. To succeed, it is critical that we maintain our labour cost advantage and our employees must be amongst the most productive in the industry. We have shown to everyone that we, as MAS, have a right to be at the international airline table. Now, to stay at this table, we will have to focus and work even harder. We, the MAS management, are commited to create and introduce state-of-the art tools and lend our support to create a more productive and value-adding work environment. We also need the unions support. If MAS is successful on this growth journey, we can retain more jobs and create more value-adding jobs. Our management As MAS succeeds, our high performing managers will be given exciting new opportunities and generous rewards. We will ask our managers to put real skin in the game. Those who are willing to take on real accountability and deliver results will be rewarded. For those who have looked at MAS as a source of guaranteed employment and relatively generous perks, this could be a painful process.

Exhibit G2: MAS 5-year P&L Aspirations/Targets

(Figure in RM)

Optimistic RM2b 3b

Base case RM1.5b

+RM610m

2007 YTD (Jan-Sep)

2008

2009

2010

2011

2012

Pessimistic
* Yield drop ~5% yoy - RM 650m * Minimal seat factor drop

Our customers Customers can look forward to higher service levels as we master operational excellence. Through the MH campaign and various other initiatives, they will receive improved products and services that they are willing to pay for. We will give the customers the most value in the industry. This is what MAS will stand for. To ensure we are achieving this, we will extensively seek customer feedback and we will urge our customers to share with us what they value most. Our agents Travel agents will continue to remain important partners for MAS as they provide value-added services to our customers. However, we simply must reduce our cost of distribution and respond to specific customer segment preferences, and deal directly through the Internet. We will work with our agents to ensure that they can enjoy an equitable share through partnering MAS. Travel agents who are willing to embrace change will always have an important role to play and MAS views these partnerships as critical to its success in achieving FSVC.

- RM1b or more

Worst case
* Yield drop >5% yoy * Seat factor drop 5-6% yoy

THE FULL EXECUTION OF THE PLAN WILL TAKE 5 YEARS AND CONTINUE BEYOND
We strongly believe that The MAS Way will transform MAS into a FSVC but this will not happen overnight and it will not be easy. A transformation is not just a series of quick actions, it is also a multi-year programme designed to create an organisation that can adapt to whatever the market will throw our way. It is important to note that lasting airline turnarounds take years of concerted action. We fully understand the magnitude of this change and recognise that much of this takes time. We expect that there will be setbacks along the way; although we will do all that we can to manage these. The nature of quick and firm decision making is that we might make mistakes. Many of our pricing changes, for example, will increase revenue, but some could result in a reduction of market share. Some new markets will be a success; some will prove a struggle. While we hope that we will achieve common ground with our unions and suppliers, we may encounter difficult situations, and we cannot ensure that there will not be interruptions to service along the way.

Our suppliers As MAS succeeds, we can expect our suppliers to grow and develop with us. Those suppliers who offer the highest value for money can also look forward to increased transparency and merit-based decisions. However, we cannot survive and prosper with imbalances in risk and rewards with our suppliers. We will negotiate with our suppliers until we are convinced that we share equitably in the risks and rewards from the marketplace. If we cannot do that, we will replace them with those who can. We are striving for long-term partnerships. These partnerships need to create win-win results for our customers and MAS.
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The Government The aviation sector has a high economic multiplier effect. A study by Khazanah and the global consulting firm, Bain & Company, shows that aviation has a multiplier effect of 12.5 to the Malaysian economy. For every ringgit invested in the aviation sector, there is a positive spin-off of RM12.50 to the Malaysian economy in terms of tourism, infrastructure and logistics development. Furthermore, we will do our part to deliver on the governments GLCT Programme. Given this, we expect Malaysia to develop with MAS' success. As the flag carrier for Malaysia and more so as a GLC, MAS is well aware of its socio-economic responsibilities to the country. There is a need to strike a fine balance between the socio-economic and business requirements. However, like any business organisation, we will have to stay profitable and grow. To succeed, we ask that we are given a fair regulatory framework, the freedom to act as a business and be compensated for any social obligations we must fulfil.

Abbreviations
AAPA AFIS ASK ATPCO BTP 1 BTP 2 CAPA CASK CSP E&M EU FCR FSC FSVC GDP GDS GLC GLCT IATA ICAO KBAs KPIs LCC LMB MOSAIC MRO MSS O&D P&L PINTAR POS PSS RASK REP RPK RPP RRPK SMS SSHE TCO TSR Association of Asia Pacific Airlines Agency Flown Incentive Scheme Available Seat Kilometer Airline Tariff Publishing Company Business Turnaround Plan Business Transformation Plan Centre of Asia Pacific Aviation Cost per Available Seat Kilometer Corporate Signature Programme Engineering & Maintenance European Union Fare Class Realignment Full Service Carrier Five Star Value Carrier Gross Domestic Product Global Distribution System Government-Linked Company Government-Linked Companies Transformation International Air Transport Association International Civil Aviation Organisation Key Business Activities Key Performance Indicators Low Cost Carrier Light Meal Box MAS Overall Strategic Alliance Integration Concept Maintenance, Repair & Overhaul Mutual Separation Scheme Origin & Destination Profit & Loss Promoting Intelligence, Nurturing Talent and Advocating Responsibility Point of Sale Passenger Services System Revenue per Available Seat Kilometer Revenue Enhancement Project Revenue Passenger Kilometer Route Profitability Project Revenue per Revenue Passenger Kilometer (or Yield) Safety Management System Safety, Security, Health and Environment Total Cost of Ownership Total Shareholder Returns

Our investors MAS is always focused on enhancing shareholder value. While the turnaround over the last 2 years has been challenging, we have, nevertheless, delivered on our promise to return our company to profitability. Investors who have believed in MAS ability to turnaround and invested in us have been handsomely rewarded (over 90% return based on share price from 1 Jan 2006 to 31 Dec 2007). We believe there is still significant upside yet to be achieved, and MAS is still a relatively untapped investment opportunity with one of the lowest P/E ratios in the industry. Now that we are once again profitable, our next challenge is to ensure that we build on the foundations we have put in place to grow profitably. We invite you to continue to place your trust in our ability to achieve and surpass our financial targets, and in the process, transform Malaysias flag carrier into a global champion.

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Malaysia Airlines of tomorrow will be recognised as the worlds Five Star, customer focused airline with a competitive cost structure, and achieving a profit between RM1.5 RM3 billion annually. Malaysia Airlines will be renowned as one of the best places to work in Malaysia, and a company that is a source of pride and admiration for its employees and all its stakeholders. We can do this, and we will.

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