Russia's rescue plan for six regional carriers - their consolidation into Aeroflot - has still some way to go before being fully realised, and raises many questions

Russia's competitive environment will change after Prime Minister Vladimir Putin's approval to merge into Aeroflot six struggling regional carriers, taken over by state holding Rostekhnologii when fuel prices pushed them near to bankruptcy.

Previous intentions to create a new carrier, Rosavia, from the six - Rossiya, Orenair, Kavminvodyavia, Vladivostok Avia, Saratov Airlines and SAT - were abandoned in favour of strengthening Russia's principal airline. But implementation is not straightforward.

"The merger process is not yet completed," says Aeroflot chief Vitaly Saveliev. "Three out of six airlines are federal state unitary enterprises, which need to be re-incorporated into joint-stock companies. Currently, all companies are under our operating control through a special committee.

 Transaero 777
We are reviewing the fleet of these airlines, examining their financial performance and comparing the route networks. Plans for the future will depend on results of the present investigations."

Aeroflot and Rossiya plan to establish a daughter company at St Petersburg, with 75% belonging to Aeroflot and 25% to the St Petersburg government. Saveliev expects consolidation to increase the domestic share of Aeroflot Group to 35-40%, although this is still a long way below that seen during its Soviet-era dominance.

Privately-owned Transaero's chief executive Olga Pleshakova appears unconcerned: "We are neither afraid of, nor surprised at, the simultaneous takeover of six companies by a single carrier in and of itself."

She says the "most outstanding" event in Russia's domestic market was the elimination in 2007 of certification permission for Russian carriers: "This means there are now 'open skies' for Russian carriers on domestic routes, which provides a powerful impetus for more dynamic development of the Russian air transport market."

Transaero launched several domestic routes over the following three years, she says, enabling it to move from eighth to fourth in the domestic ranks. "All the more remarkable, when one considers that Transaero only holds 10% of the total domestic market," says Pleshakova.

But growth in the domestic market is hampered by several negative influences, often outside the control of the operators. Putin has blamed local flights' high fares on a lack of competition, although high fuel costs, taxes and poor infrastructure also contribute.

"We do all we can to keep tariffs as low as possible," says Saveliev. Aeroflot does not hedge fuel procurement, but is successful in a storage programme, which, in 2009, enabled fuel savings of some $26 million, and reduced fares.

Saveliev points out that while the airline is trying to improve labour productivity and minimise costs, carriers have to bear in mind value-added tax at 18%, the fact that certain Russian airports can handle only fuel-intensive Russian-made aircraft, as well as variations in fuel price among regions. "Plus, the tariff strongly depends on when you buy the ticket - the earlier you do it, the lower the available tariff," he says.


S7 Group chief Vladislav Filev says that a rising fuel price in Russia "has two hands". Airlines suffer from the increased cost, but, given that Russia is a major energy centre, the carriers benefit from the business. "Oil is our black gold," he says. "We all prayed for this price."

Filev adds: "It doesn't matter whether there are high or low prices. We suffer from the fast change - we cannot compensate for [the] fast changing of prices."


 Filev S7 (cover pic 200)
 Read the Airline Business cover interview with S7 Group chief executive Vladislav Filev
Federal aviation regulator Rosaviatsia lists 155 airlines in Russia. "With many of them, the fleet includes just one or two aircraft," says Aeroflot's Saveliev. "Such companies have difficulties in ensuring safety and comfort. We share the opinion of experts highlighting some 30 airlines required for the country. These, however, should be strong and reliable enterprises. Consolidation is the calling of the time, and we strongly support this incentive."

Pleshakova from Transaero adds her thoughts: "Another important question has arisen - namely, liberalisation of government restrictions on international flights, which, should they come to pass, could lead to increased competition. Fewer restrictions could ultimately result in more competitive air fares on international flights, increasing overall passenger flow and offering opportunities for Russian carriers to improve the quality of their product."

Russia's international air travel market remains governed by bilateral agreements from the 1960s. "This is just nonsense," says Pleshakova. Transaero is calling for the market to become more effective and competitive.

Rosaviatsia figures for 2009 show just 45.1 million passengers were transported by Russian airlines - a decline of 10% over 2008. Sixty percent travelled with the top five carriers. International traffic in the year declined by 9.3%, and domestic by 6.9%.

To put this in context, Aeroflot - flag-carrier of the world's largest country - barely made it into the world's top-50 airlines.

Saveliev says that Aeroflot can "easily transport 40-50 million passengers a year and compete successfully with world leaders", but his immediate plan is to "achieve leadership" in Russia and the CIS, and lay foundations to become a global network airline. SkyTeam membership is proving beneficial. Its marketing activities for passengers on alliance partner flights has netted $46.8 million, and further savings and synergies will accrue through Aeroflot's launch of SkyTeam's Terminal D at Moscow Sheremetyevo.


Aeroflot is adding new services to India, Thailand and the Dominican Republic, plus several new routes within Russia and the CIS. Transaero launched services to Miami and New York in October and November respectively, as part of 18 new services, which also include more flights to European and CIS cities. Almost two-thirds of new routes will be operated from the regional cities of St Petersburg, Kazan, Khabarovsk, Samara, Ufa and Vladivostok. A Moscow-Rio de Janeiro service will be opened in 2011, and there are also plans to serve Los Angeles and possibly San Francisco.

S7 Airlines became the second Russian carrier to link up with a global alliance when it joined oneworld in November, bringing access to its large domestic network - including its hubs at Novosibirsk and Irkutsk, to reach the population living beyond the Urals.

"Russian aviation is spread unevenly because its population is distributed unevenly. When people from other cities look at Russia, it's usually only at Moscow," says S7 Group's Filev. "The rest of Russia's inhabitants have other habits and speed of life - it's like comparing a city in the middle of the USA to New York. It's quite different."

Only Star Alliance has yet to gain a foothold. Transaero would be the only logical candidate, but Pleshakova is in no hurry: "International experience provides examples of carriers developing successfully without being members of global alliances. And at the same time, there are others that haven't found the success they expected after joining the alliance. This is why Transaero will consider the possibility of joining an alliance only in terms of its own successful, independent development in the future. If we see that joining will benefit the company - and especially our passengers - Transaero will go for it."

Pleshakova is also unhurried over a possible flotation: "We have always stated that Transaero constantly considers different options for financing its activities, including the possibility of attracting capital from public markets. Transaero has a very strong financial position and a good reputation among bankers, and for this reason we have not yet faced any serious difficulties in attracting finance. Though I have to admit that the process of preparing the company for an IPO has been on the table for several years, it has always been a part of a more general pattern of constantly reviewing our position and options."

Sky Express, which started operations in January 2007, was the first budget carrier to emerge in the country. It operates single-class Boeing 737s from Moscow Vnukovo to 12 cities in European Russia.

In the first nine months of 2010, Sky Express transported 854,000 passengers - 5.4% more than in the same period in 2009. Of these, 617,000 flew on its domestic schedules, with the remaining passengers carried on overseas charters, at an average passenger load factor of 77.4%. But the carrier has struggled and has been forging a tie-up with Russian billionaire Oleg Deripaska's Basic Element, which also owns Kuban Airlines.

There has only been one new budget entrant since: Avianova, which began operations in August 2009, and flies with a handful of Airbus A320s.

Aeroflot A320 - Air Team 
There seems to be reluctance by carriers to move into this market segment. Saveliev says Aeroflot will stay with the full-service concept, but adds that Rostekhnologii's assets transferred to Aeroflot might serve the business and economy segments.

"We do not exclude the possibility of setting up a low-cost and charter carrier," he says. "But, as far as demand for these services is concerned, it is worth mentioning that while charter activities have developed proactively, low-cost transportation widely spread throughout Europe is partially impeded in Russia by the country's vast territories."

High-priced aircraft also hinder the market. Avianova is having to reconfigure its A320s to reduce the impact of taxes. Saveliev says: "Creating a low-cost sector is a big project, which calls for substantial work."

Deputy transport minister Valery Okulov, the former Aeroflot chief, has been quoted as saying: "There is no market. The development of low-cost travel requires some essential factors. The first is large-scale passenger flows between cities. We have only Moscow-St Petersburg, Moscow-Sochi in summer. And let's say Moscow-Ekaterinburg. Second: using alternative airports. It's less expensive, but we simply don't have them."

Pleshakova largely echoes this assessment: "Given the current conditions in the Russian market, evidence points to the low-cost airline as a model more suited to the future."


The long-haul market is the priority for Transaero and is the reason why the majority of the company's fleet of 57 is composed of long-range, high-capacity types. "The Russian aircraft industry has nothing to offer us in this segment," observes Pleshakova. "This is why our plans for further acquisition of long-haul aircraft are focused on Boeing."

Transaero will continue to acquire Boeing 747-400s and 777s, as well as 737-800s "to improve the company's competitive edge", she says. The airline's experience with Russian aircraft has not been favourable, especially with its three Tupolev Tu-214s.

"Transaero originally contracted to receive 10 of these aircraft by 2007, but the manufacturer failed to deliver, and the contract expired long ago. Moreover, problems emerged with after-sale service and replacement of large components. All told, this was not up to our standards of quality, in terms of products or relations," Pleshakova says.

"As for other Russian types, if the declared parameters would coincide with the actual performance after test flights, we would gladly consider the real possibility of acquiring the [United Aircraft] MS-21. Other aircraft types produced within the Russian aviation industry are not of interest, as they do not meet the requirements of our business model."

Aeroflot, with its more diverse network and state control, has fewer options to shun local industry products. "As a leading Russian airline, we cannot go on without supporting the domestic aviation industry," says Saveliev, who has faced direct pressure from Putin on the issue.

Along with a firm order for 30 Sukhoi Superjet 100s, it has a programme to acquire a number of other domestic aircraft by 2020 - another 10 Superjets and 50 MS-21s. It also intends to take 11 Antonov An-148s and 25 An-140s.

"As to the fleet of Rostekhnologii, this is [the] most heterogeneous, and we are examining the expediency of replacing old aircraft with new Russian-made or foreign types," says Saveliev. Rostekhnologii ordered up to 85 737s in October.

UTAir, based in Khanty-Mansiysk, is planning to lift domestic industry prospects. "UTAir is closely monitoring the Russian aircraft industry," notes chief Andrei Martirosov. The airline has selected two versions of the Superjet - the -75 and -95 - for short-haul use.

UTAir derives some 58% of its revenues from fixed-wing scheduled passenger and charter services, with 42% coming from helicopter operations, and has no strategic plans to add new business or alter the balance of its various business segments.

"The company is focused on organic growth across all its principal segments, and seeks to enhance diversification - both geographically and in terms of client base," stresses Martirosov. "This business model is the most resilient, and permits UTAir to mitigate the effects of fluctuations in separate segments."

Global alliance membership is not a priority for UTAir, he says, although the carrier is planning to open 25 new routes connecting some 15 Russian cities, as well as Hannover, Prague and Tallinn.

UTAir is also "Westernising" its operations to a significant degree. It has taken nine out of a batch of 15 Bombardier CRJ200s - the rest are due by April 2011 - plus six Boeing 737-400s and 10 737-500s, all scheduled for delivery before April 2011. It is also replacing its older ATR's with new ATR 42/72-500s and is introducing longer-haul aircraft on its schedules - including two 757-200s for charter flights.

While Russia's aircraft industry has yet to get its act together, its purchase of foreign-built aircraft has undergone positive changes, says Transaero's Pleshakova.

"Specifically with regard to customs duties, I should emphasise that the Russian government has taken some very important steps in eliminating the import duties on most aircraft types," she explains. "More recent evidence of the government's effort to remove barriers in the aircraft industry can be seen in the resolution of issues in the framework of the Customs Union between Russia, Belarus and Kazakhstan. Transaero is completely behind this important government initiative, which stands to provide better economic conditions for Russian carriers, improving their competitive advantage in the international markets, and consequently allowing them to offer passengers a better product and higher service quality."

Russia's market is brimming with potential. The challenge is to make this a reality.

Read here for more on Aeroflot's consolidation moves, acquiring six other carriers

Source: Airline Business