Rival Approaches to Air Travel

Aeroflot

Russia's airline industry is about to undergo another wave of transformation with the launch of more budget seats through Aeroflot's Pobeda subsidiary.

It is not by any means the first Russian budget airline — Red Wings and Blue Wings (half Russian) have come and gone, and before them SkyExpress and Avianova. Even Pobeda (Russian for victory) is a replacement for the suspended Dobrolet, which was† grounded when western sanctions forced it to cancel its leasing arrangements.

But with the might of Aeroflot behind it, Pobeda may stand a greater chance of success. It offers prices 20 to 40 per cent lower than Aeroflot, a higher density of seats, one cabin class, and with extras at a price, such as checked luggage, in-flight food, numbered seats and priority boarding.

Aeroflot's CEO, Vitaly Savelyev, says he aims to make air travel more accessible. "The most essential step is the creation of a national low-cost air carrier. We are dedicated to increasing mobility and accessibility of transport among Russia's regions, and our budget carrier is focused on price-sensitive customers," he told The Moscow Times publication, Doing Business In Russia.

The timing of its launch — the first flight was scheduled for December 1st — amid an economic downturn, raises a number of challenges. Airlines may want to raise their prices in the face of falling revenues, yet the federal government is pressing carriers to lower their prices, for example to develop the tourist industry in Sochi, as delegates to the Wings of Russia International Aviation Forum discussed in October.

Savelyev said the effort to trim costs was not limited to Pobeda. "On our initiative foreign pilots have been granted permission to work in Russia, and non-refundable have been introduced. All of this has a positive effect on reducing the cost of tickets." Russia's transport ministry is working to clear obstacles to cheaper flights by removing the obligation to provide food in flight. The Duma changed the law to let Russian airlines offer different classes of fare and non-refundable tickets.

Aeroflot modeled Dobrolet around internal cost savings. Assuming Pobeda continues with the same model, it will fly new aircraft with a rapid turnaround, gaining the maximum from improved fuel efficiency. It also sells tickets through online channels, restricting administrative staff to the very low hundreds. CAPA Centre for Aviation's analysis suggested that aircraft leasing would generate savings but western sanctions rendered that more difficult. Sanctions remain a risk if the EU or U.S. impose new requirements or restrictions on third country operators, especially in terms of destinations.

Pobeda operates new Boeing 737-800NG aircraft from Moscow's Vnukovo airport, initially serving the domestic cities of Samara, Yekaterinburg, Perm, Kazan, Tyumen, Surgut, Belgorod and Volgograd. The minimum fare in one direction is 999 rubles ($22) plus fees and taxes.

Aeroflot currently intends for Pobeda to have 40 737s serving at least 45 domestic and international destinations.

In addition to internal cost savings, many European budget operators benefit from regional airports reducing the fees they charge for landing and baggage handling. In the case of Britain's easyJet or Ireland's Ryanair, for example, regional airports are even willing to subsidize airlines, effectively paying them to bring tourist and business visitors. European Union rules allow the payments so long as they do not seriously distort competition.

About 85 per cent of Europe's 450 airports are state owned, according to the industry's trade body, Airports Council International Europe, and most of them are small and loss making. They receive about $4 billion of taxpayer money, much of it redistributed through the EU's regional support plan.

The ACI says airports need subsidy as their costs are higher, per passenger, than for big airports. Politicians agree, and favor the boost that airports can give to the local economy. Last year the Scottish government bought Prestwick airport near Glasgow and the Welsh administration bought Cardiff.

The distribution of airports is greater in Europe: nearly two-thirds of Europeans live within two-hour's drive of at least two airports. One difference with Europe is the longer flight distance on domestic Russian flights, which averages 2,000 kilometers, or almost double the average for flights within Europe.

Full-cost airlines like Air France and Lufthansa are struggling to control costs while low-cost airlines like Ryanair are raising profit forecasts (as of September). The big, scheduled airlines fear that competing directly with low-cost airlines, or launching their own no-frills subsidiaries, would cannibalise their revenues. Aeroflot also faces growing competition from low-cost carriers on international flights to Europe.

Aeroflot has some advantages, however. On the plus side, it already has younger aircraft than many global competitors. It continues to modernize, even while it reverses the depletion of Russian jets within its fleet. In November Aeroflot signed an agreement with Sberbank Leasing to take delivery of 10 SuperJet-100s in a $354 million contract. †

Aeroflot also has lower wage costs than many of its competitors. Both Air France and Lufthansa failed to persuade pilots to reduce long haul costs or to discuss expanding their low-cost units, Transavia and Eurowings, respectively.

Lufthansa's operating margin was 2.6 per cent in 2013, Air France-KLM's was a negative -0.89 per cent. Aeroflot's was 6.8 per cent. But when Europe's airlines improved their profitability in the first half of 2014, Aeroflot suffered a net loss for the first time since 2008. International margins are likely to have suffered as international capacity grew only 0.5 per cent in the first half. European routes were more profitable than Asian and North American destinations, as were Russian routes. Aeroflot's domestic market share was 38 per cent in the first half of the year. †


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