Russian reformer

REPORT BY GUNTER ENDRES IN MOSCOW

Five years after Valery Okulov became director general at Aeroflot, the airline has come a long way in mending its reputation. Now he is preparing to turn attention towards rebranding, fleet modernisation, domestic expansion and perhaps joining a global alliance

It is a sign of Valery Okulov's determination to show the world how much his airline has changed, that an overhaul of its brand has not fallen victim to its cost-cutting actions. Okulov, who is now in his fifth year at the helm of Aeroflot, has tasked a design consultancy with presenting its rebranding proposals by year-end.

The former Aeroflot pilot was originally brought in by Russia's then-president Boris Yeltsin to rid the airline of the unsavoury influence of local tycoon Sergei Bereskovsky, who used his large shareholding to appoint cronies to top jobs with the carrier. Okulov has presided over a significant repositioning of Russia's flag carrier. During his term he has retooled Aeroflot's management, corporate governance and its role in the domestic and international markets.

Having Yeltsin as a father-in-law was clearly an advantage when Okulov was appointed, but obviously no longer has the same significance with the present administration. Okulov has proven himself an able manager and reformer, and today's Aeroflot has emerged out of the shadows of the "bad old" Soviet days, when it was an unwieldy and inefficient monolith perceived - with good reason - as unfriendly, uncomfortable and unsafe.

The country's latest financial crisis in August 1998 marked a setback, but with the Russian economy growing again, the negative effects have largely been overcome. Looking back over his five years, Okulov lists the network and fleet renewal as the most vital elements of the "new" Aeroflot.

The establishment of an effective route network, he stresses, has been central to Aeroflot's progress. "The strengthening of our domestic activities - we had only two domestic routes in 1997, but became the leading domestic airline in 2000 - has played a major part in this process," he says. "We will continue growing our domestic routes as a priority to create a fully integrated international and domestic network."

Corporate governance is another area that has shown vast improvement under Okulov, as is evidenced by the remarks made by rating agency Standard & Poor's (S&P), which gave Aeroflot high marks for financial disclosure and transparency, the enforcement of internal finance control and efforts made to bring accounting up to international standards.

The presence of a majority government shareholder, however, is seen by S&P as a drawback, and another cautious note was sounded about the difficulties of identifying owners behind nominee or shell companies. For his part, Okulov professes to be unconcerned with the 51% government stake, saying it is entirely appropriate, "at least in the medium term". A large part of the reason state ownership is not more troubling is that that the alternative has often been having powerful - and not always transparent - private interests taking control of the flag carrier. The remaining 24% of the airline's ownership is shared almost equally by employees and the public.

One area that needs attention is the company's capitalisation. Aeroflot issued bonds early this year for 600 million roubles ($20 million), but this is not nearly enough for long-term requirements. The issue of further shares has been considered, but director of corporate property Kirill Budaev says this will be difficult to implement, as it effectively would require the government to contribute more funds to maintain its controlling stake.

Okulov says dialogue is ongoing with the investment community, but the carrier will have less need of new funds if it becomes more efficient and improves its corporate management. He believes that there is much to be done towards these goals, adding that 11 September have thrown yet another -and this time totally unforeseen - obstacle in his way.

Terrorist fall-out

Aeroflot, like other major airlines, has not been immune from the fallout of the terrorist attacks on the USA. But unlike Western carriers, it has not resorted to mothballing aircraft, nor cutting staff levels - even in post-Soviet Russia, the latter is virtually impossible to force through. Aeroflot has had to reschedule its US services, downgrading service on several routes and suspending flights to Chicago. Capacity has largely remained as before, as the carrier redeployed aircraft and boosted frequencies to the Far East. Routes that have seen increased capacity owing to these circumstances, include those from Moscow to Shanghai, Delhi and Mumbai.

Nevertheless, Okulov estimates that the terrorist attacks will directly result in some 100,000 fewer passengers by year-end. Consequently, Aeroflot has revised its revenue projections downwards from the $1.6 billion budgeted for 2001, although Okulov says that it will still be higher than the $1.4 billion achieved last year. Forecast profits will also not materialise, but he is confident that the airline will not slip into the red. "We will reach a break-even situation," he says. Still, he concedes that further measures are required if Aeroflot's progress is not to be seriously checked. Cost reduction is high on Okulov's list here. He hopes to achieve this through a better optimisation of the route network, closure of more non-profitable routes and introducing greater efficiencies in the carrier's maintenance, repair and overhaul business.

Okulov is also tackling non-operational costs such as advertising, social programmes and outside consultancy services, although the airline is proceeding with its corporate revamp exercise being undertaken by UK consultancy Identica. The airline is not yet as lean as Okulov would like. Employment levels are still too high, a legacy from the Soviet days. But many staff are nearing retirement age, especially in maintenance and overhaul - an area that has been identified as ripe for major cost efficiencies. For the first time in Russia, a voluntary redundancy package is being floated for older employees with the maintenance division.

Negotiations are also nearing completion with the three major unions on a new contract for 2002, which should ease relations between management and employees. Last summer, only the intervention of the courts prevented a damaging strike by maintenance staff, although the threat of action in support of pay claims remains.

The new contract, which will focus on a pay increase, working conditions and benefits, is being formulated to remove friction and enable Aeroflot to move forward with its modernisation programme. "We need to create a new internal culture," says Okulov, "not just an external rebranding."

It has been difficult for Aeroflot to shake off its image of poor service and safety failings, but the airline no longer deserves this tag. Efforts aimed at improving passenger service have helped narrow considerably the previously large gulf between Aeroflot and major Western airlines. "Passengers are appreciating the changes to our in-flight service, and Aeroflot's share of Moscow traffic has improved," insists Okulov. "Not only are Russian travellers who had switched to foreign airlines returning, but we have also managed to attract foreign passenger traffic. Foreign passengers too are beginning to see Aeroflot as an acceptable alternative."

Central to Aeroflot's future will be the new Sheremetyevo-3 terminal. It will go a long way towards bringing Moscow's main airport, little improved since the completion of Sheremetyevo-2 for the 1980 Moscow Olympic Games, into the 21st century. Long queues at immigration, cramped terminal space and poor transport into central Moscow have all been a thorn in Aeroflot's side. They have also directly led to the defection of several foreign airlines to the more modern and user-friendly airport at Domodedovo.

Realising the importance of a comfortable passenger facility, Okulov says Aeroflot has been the driving force behind Sheremetyevo-3, which will have an annual capacity of nine million passengers and will be run as a joint venture between Aeroflot, the Moscow airport authority and private investors.

Alliance ambitions

Among other goals for the terminal project is Aeroflot's accession into the SkyTeam alliance. Part of Aeroflot's appeal is Moscow's potential as a hub for services between Europe and Asia, a plan that the new terminal - which will only serve alliance members - makes possible.

Olukov says that transit passenger flows between Europe and the Far East now represent 18% of Aeroflot's traffic, up six points from last year. Upon completion of Sheremetyevo-3, he envisages this figure will rise to 30%. "The shortest routes between Europe and the Far East and South-East Asia are via Moscow," Olukov says, "and the majority of Eastern European airlines either do not have direct links or insufficient frequencies for a viable operation. Many are hubbing through Frankfurt, Vienna and Zurich, but to take flights via Moscow is much more logical."

Of course, Aeroflot will have to meet other requirements to gain access to the alliance, such as schedule co-ordination, maintenance standards, IT systems harmonisation and compatibility of frequent-flyer programmes. These are already being implemented stage by stage, Okulov says, and he believes they should enable Aeroflot to become a fully-fledged SkyTeam member by 2003.

Formerly mandated to serve only the international market, Aeroflot's plans now include extensive domestic service. "We have a large domestic programme, which also provides for the establishment of additional hubs," says Okulov, citing Yekaterinburg, Novosibirsk and Khabarovsk, as well as Rostov-on-Don in southern Russia. There Aeroflot has set up a majority-owned joint venture with local investors, known as Aeroflot-Don. The most interesting development is at Novosibirsk, where Aeroflot is linking with Sibir Airlines. The integration of their two networks is expected to be completed by next summer, Okulov reveals.

Aeroflot currently operates a fleet of 112 aircraft, made up of 11 different types, the majority still from Soviet days. Fifteen of its Soviet-built aircraft have recently received new interiors, but of more importance has been the gradual move towards placing Western aircraft on high-profile routes.

This initiative culminated in the acquisition of 16 Boeing and three Airbus aircraft between 1998 and 2000. The airline has been accused of not doing enough to support the local aircraft industry, but Okulov is unswayed. "I see my task as getting the best deal for Aeroflot and the passenger in terms of acquiring aircraft." Whether these will come from Western or Russian manufacturers will be subject to these requirements, but Okulov admits that import taxes for aircraft are so prohibitive as to make the acquisition of foreign aircraft uncompetitive.

While Okulov understands that the imposition of high taxes is designed to encourage Russian airlines to buy at home, he says this is not presently an option for Aeroflot, and the airline will continue to look to the West. "The Russian industry does not provide the aircraft we need," he says, specifically referring to the lack of long-haul types and short-haul regional jets of up to 100 seats. These are central to Aeroflot's long-term fleet plan, which envisages just two families of aircraft with no more than four different types by 2007. He adds that with the new strategy of building its Moscow hub, the absence of an efficient regional jet is also acutely felt.

Local requirements

The combination of government pressure and high import taxes has, therefore, led to the signing of a memorandum of understanding (MoU) for a new regional jet family planned to be developed for the local market in a joint programme by Boeing, Ilyushin and Sukhoi. The MoU initially commits Aeroflot to 30 aircraft, but the eventual total could be many more. "We could use 30 aircraft today," Okulov points out.

The frustration that he feels with Russia's aircraft manufacturing industry is clearly discernible, particularly with Ilyushin which has been unable to meet delivery schedules. It is little wonder then that he is looking to the West. Aeroflot has been largely able to circumvent the tax burden by registering recent additions to the fleet in the Bahamas, and intends to take this a step further with plans to set up an operation in Europe.

Earlier this year, the airline pulled away from acquiring Virgin Express (Ireland), but is determined to find an alternative solution. Aeroflot, which has a long association with Ireland, wants to base a company at Shannon, which would use Irish-registered aircraft to operate services from European cities to Moscow.

The most likely outcome is an Irish/Aeroflot joint venture, with majority shares held by citizens or companies of the European Union, but Okulov would prefer to use an already registered but dormant Irish carrier, to speed up the process. He says there is such an airline, but declines to give details. The new carrier would start with four to eight aircraft, he says.

The impact of 11 September and the subsequent war on terrorism will not deflect Okulov from his strategy of building Aeroflot into an airline that can finally lay to rest the trials and tribulations of the past. By the end of the next five years, he would like to see a doubling of traffic volumes and revenues, on the back of a strong Russian and CIS market and using Moscow as a secure airbridge between Europe and Asia. "The Russian economy holds promise for stable development," he says, "and demand for air travel is growing."

But more than that, Okulov wants Aeroflot to become known and accepted as a "customer-oriented company and a safe airline with a modern fleet". The task now is to build on achievements to date and complete the process. If it fails - and Okulov does not consider that possibility - it will not be for lack of effort.

Aeroflot scheduled revenue traffic - five-year record
1996			1997	1998	1999	2000
Passengers carried	Million	3.81	3.904	4.451	4.6	5.1
	Change	9.2%	2.5%	14.0%	3.3%	10.9%
Passenger traffic	RPK Million	14,633	14,610	16,449	16,405	17,434
	Change	4.9%	-0.2%	12.6%	-0.3%	6.3%
Seat capacity	ASK Million	24,028	24,513	28,657	27,639	26,551
	Change	0.3%	2.0%	16.9%	-3.6%	-3.9%
Load factors	%	60.9%	59.6%	57.4%	59.4%	65.7%
	Change pts	2.8	-1.3	-2.2	2.0	6.3
Financial results
Revenues	$ million	957	1,000	865	1,074	1,207
	Change	n/a	4.4%	-13.5%	24.1%	12.4%
Operating result	$ million	-96	-52.6	-6.2	7.3	82.1
	Op margin	-10.0%	-5.3%	-0.7%	0.7%	6.8%
Net result*	$ million	-82.3	-77.9	-75.5	-6.1	39.5
	Net margin	-8.6%	-7.8%	-8.7%	-0.6%	3.3%
PRK= revenue passenger kilometre; ASK= available seat kilometre; 1 mile = 1.609 kilometres; *Net = pre-tax

Source: Airline Business