ANALYSIS: Low-cost carriers eye expansion into former Soviet states

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With economic growth in Russia and other CIS countries outperforming much of Europe, many EU carriers, as well as those from the Middle East, are eyeing expansion opportunities in the region.

Low-cost carriers in particular have long been looking at the potential of a market where air fares are often notoriously high.

József Váradi, chief executive of Hungarian budget carrier Wizz Air, says: "Those markets are very attractive from the perspective of the customer profile available and from the perspective of their underserved nature."

However, applying the low-cost model to many CIS countries, as well as others in the region such as Georgia and Ukraine, has so far proved extremely difficult from both a regulatory and operational perspective. A particularly high-profile casualty was the collapse of Russian budget carrier Avianova.

Váradi says many countries on Europe's eastern periphery "still apply a fairly closed regulatory regime, basically favouring the national airline status quo, protecting the market from competition".

He says that access to these countries depends on "the regulatory environment which can be boiled down to access to routes, the capital investment regime in the particular country, some of the embedded inefficiencies in regulations like strict labour rules".

Yet deregulation and the European Commission's efforts to expand its aviation area to neighbouring states means that Wizz Air, which hopes to soon open a route to Moscow, is one of a handful of low-cost airlines making inroads into the region.

"Given that we have become an increasingly mature business - and we have proven ourselves in various markets - we have started accessing other markets and routes that were unavailable to us before," says Váradi.

Wizz has recently begun flights from Ukraine to Georgia and received bilateral designations from Hungary to Russia and Ukraine. "That process is ongoing but it is very slow. It is not like acting within the EU... there is a process you need to go through," he says.

EasyJet recently began selling tickets for its new four-times-a-week service from Manchester to Moscow with headline prices starting from £47.49 ($76.70) one-way. It will also begin operating services to the Russian capital from London Gatwick in the Spring.

The budget carrier hopes to open the market from the UK to Moscow by bringing in competition and lower fares, which, it says, cost an average of well over £400 for a return economy ticket. Chief executive Carolyn McCall says the airline is in discussions with Russian airline Transaero over co-operation in Russia. Talks over what form the "commercial agreement" will take are still ongoing, according to EasyJet.

Ryanair chief executive Michael O'Leary also acknowledges his airline's interest in serving Russia, but remains cautious. "Generally speaking we haven't been too impressed with the deregulation plans, they generally seem to require having a Russian partner.

"Europe is the focus of our growth, I think there will be some expansion into, maybe not Russia, but former [Soviet] republics like Ukraine and areas like that, as they join the European Union's Open Skies."

"Russia, even if you get there with a deregulated market, may deliver some growth in year five to 10 [from now], but won't be a focus for our growth," O'Leary adds.

Aware that low-cost carriers from outside the region are eyeing its market, Russia's Aeroflot says it could set up a low-cost subsidiary if favourable legislation is passed in the country.

The airline's general manager, Vitaly Saveliev, describes "a need for several amendments to the air code". He says: "If they are made, we'll be able to establish an affiliate low-cost operator. It may take us from six months to a year."

He explains that in order for airlines to sell cheap non-refundable tickets, charge passengers for carry-on luggage and to not provide food and drinks on-board in Russia, a change in the law will be required.

Saveliev's comments follow the proposal of regulatory changes that will open up Russia's domestic market to foreign low-cost carriers, using cabotage as a catalyst for increased competition between local operators.

In addition to Russia, Váradi says that "central Asia is becoming increasingly exotic, especially looking at it from [eastern Europe]". He views Georgia as a potential stepping stone to the region, but describes expansion there as a medium-term priority. "Being headquartered here in Geneva and, let's say, flying in Kazakhstan, it is quite a challenge how you connect, how you govern such a business," he says.

Peter Foster, chief executive of Kazakhstan's flag carrier, Air Astana, is unconcerned that a no-frills operator could steal its market share. Although Turkish low-cost operator Pegasus Airlines has indicated that it could pursue a venture in the country, Foster points out that Sharjah-based budget carrier Air Arabia has been operating in Kazakhstan for "many years".

"It's hard to say what elements of the low-cost model could threaten us," he says. "We could take out business-class seats, decrease the seat pitch, remove all the food and stop serving any wine or vodka tomorrow if we wanted to. But those are only very small and minor parts of the low-cost model."

Foster says that budget airlines can only operate with "certain elements of infrastructure available, with a certain route structure".

"You need secondary airports in major cities, we don't have any [in Kazakhstan]," he adds. "You need a charging mechanism that recognises a low-cost airline, we don't have any of that.

"You need to be able to turn aircraft around in 20 minutes. Well, you can't do that here in this country, the airports will not allow you to turn aircraft round in less than an hour."

Foster also says that low-cost airlines require a "very strong culture of e-commerce and online retail" and, despite the fact that Air Astana is an e-commerce pioneer, the internet still accounts for only 10% of its sales.

Yet while limited progress is being made by low-cost carriers into the CIS and other neighbouring states, Váradi shares O'Leary's view that serious expansion is unlikely to take place in the near future.

"Something that is pretty universal wherever you are is that people want low fares. The customer need is there, [but] I think the efficiencies and regulations are not necessarily there yet.

"They need to change to an extent that can accommodate the fundamental principals of the low-cost model, but I'm very optimistic from that perspective that those markets those countries will get there. It's hard to predict whether this is a year from now or ten years from now, but it's just a matter of time," he says.