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. Last Updated: 07/27/2016

Airlines Navigate a Turbulent Industry

The same charge that shattered the former Soviet Union in 1991 blasted the empire's airline, the largest in the world, into 430 pieces. The same inflation that ravaged private savings placed air travel far beyond the reach of most Russian purses, causing air traffic to plummet. And five years on, times are still hard for Russia's airline industry.


But the situation is changing rapidly. Already, those 430 airlines have consolidated into about 50 serious companies, and some in the industry predict that Russia will, in the end, have just four or five major airlines, and about 20 in all.


Aeroflot's international division, the only remnant of the empire that should still in fact carry the old name, has a new, politically connected chief, Marshal Yevgeny Shaposhnikov, who has started moving back into the domestic business.


And then there is the biggest success story of them all, Transaero, a company that started five years ago with just $5,000 in capital and expects this year to carry 1 million passengers.


But with so much happening in the industry, just what are its prospects for the immediate future? Does the future lie with private airlines such as Transaero, or with a reconstituted Aeroflot? How will the money required to rebuild aging fleets and restructure airports be found?


The answers, as one might expect, are complicated, and much depends on how the new companies come to grips with a competitive market, and on how monopolies that still ossify the industry can be overcome.


But to understand what the industry's economic prospects look like, one has to take a quick trip back to recent history. And that begins with the dramatic drop in passenger loads that began in 1993.





The lost passenger


In the immediate post-Soviet period, air traffic reached its peak in Russia and the former Soviet Union. In 1992, Aeroflot carried 137 million passengers. By 1995, that number had plunged by more than three-fourths, to between 35 million and 36 million, according to Paul Duffy, a Moscow-based airline industry consultant. In 1990, the Moscow Air Traffic Control center handled nearly 3,000 flights a day. The number is now about half that.


Domestic traffic figures, said Horst Herlemann, special representative for the former Soviet Union at the International Air Transport Association, remain depressed and even fell between 1993 and 1994. The exception was international travel, which rose by 34 percent in 1994, while 1995 figures are expected to show a further 10 percent increase, he told an international conference.


As with the fall in economic output in general, the situation is now stabilizing. At a recent briefing, Vadim Zamotin, head of the Transport Ministry's Department of Air Transport, said the bottom had already been reached, and that passenger traffic was expected to increase gradually from now on.


Though he predicted that Russia's passenger load will not reach 1992 levels for a long time, he foresaw another, more disturbing development, namely that in 1997, passenger traffic will already be too high for Russia's aging fleet of Soviet aircraft to accommodate.





Lease or fold


That presents a problem for Russia's airlines, which do not have the money to buy new airplanes outright, and few of which have the cash flow to lease planes from the West.


"Aeroflot is not in a position to replace its entire fleet," Shaposhnikov told reporters shortly after his appointment to the top post at the flag carrier. "For that reason, we will continue to use foreign airplanes and get the label of 'the enemy of the people.'"


Shaposhnikov added, however, that Aeroflot will pursue a strategy that includes leasing foreign jets and gradually acquiring Russian planes. At the same time, he pledged his support to the gradual rebirth of Russia's devastated aircraft construction industry.


The government knows the financial position of Russia's airlines, and late last year announced a leasing program to provide them with credit on easy terms to lease domestically built aircraft. The program is intended as a double-dose of medicine, providing airlines with the means to stimulate local aircraft production.


But the airlines are being squeezed from several sides in addition to the high cost of replacing their aging fleets.


Landing fees in Russia have contributed to these spiraling costs, increasing by anywhere from two to five times since the breakup of the Soviet Union, Duffy said.


It costs Transaero, for example, $7,000 to land a 757 at the simple airport in Yuzhno-Sakhalinsk on Sakhalin Island, whereas Duffy said the landing fees at Heathrow, in London, cost about $1,800. For the cost of one Transaero 757 to land in Norilsk, that same plane could land 2 1/2 times in Vienna, according to Sergei Grachev, Transaero's director of marketing and planning.


This steep rise in landing fees is largely the result of the privatization of Russian airports and the dramatic drop in traffic. Russian airports are attempting to maintain their pre-breakup income from landing fees, and since the number of arrivals and departures has dropped so dramatically, they are charging more per touchdown and take-off.


To understand the problem, any traveller to Moscow need only look at its flagship airport -- Sheremetyevo-2. Despite lucrative and growing traffic, the airport remains a mess, undercapitalized and notoriously inefficient. And the primary reason is that it remains unclear even now who owns it, and all financial and administrative headaches flow from that.


These problems are magnified elsewhere in the country. In some areas, airports and their local airlines -- regional fragments of the former Aeroflot -- remained as one company. In others, they went their separate ways and privatized as individual companies.


"Everything is in flux, and the state of privatization of the various airports is very unclear, with different signs coming from the locals and people in Moscow," said one diplomatic source, who spoke on the condition of anonymity.


"As with everything here, you have to get over the fear of liberalization," the source said. "Any change is going to be detrimental to the people who enjoyed monopolies."


Russia's 3,000 or so regional airports often control their local airline and use their power to stop competing airlines from landing. That may help the local airline, but not the airport, which forfeits landing fees and damages the company financially in a closed and vicious circle.


The industry, for example, was once rife with rumors that Pulkovo Airlines in St. Petersburg was doing everything it could to keep Transaero out of the lucrative Moscow to St. Petersburg route by blocking access to Pulkovo Airport.


"St. Petersburg is still organized as an old Aeroflot division would be," airline consultant Duffy said. "The airport and the airline are still the same people."


"St. Petersburg has always had the rights to the Moscow-St. Petersburg route," Duffy said, adding: "They don't want to see competition on the routes that they define as their own." Duffy said the only way Transaero eventually got into St. Petersburg was through old-fashioned political clout. The net effect is that airport costs remain far higher than the market can really bear.


"Unfortunately, airline expenses in Russia are not on the international average, they exceed it," Grachev said.


And there is more bad news. The aging aircraft that most Russian airlines use have engines that are highly fuel-inefficient. In Soviet times, this did not matter much, as the country had lots of fuel that was supplied at essentially meaningless prices.


These days, however, it is crucial. No longer are Russian aviation kerosene prices lower than world levels -- they can be higher, despite the fact that crude oil still remains below world prices.


"In the United States, a ton of jet fuel costs between $160-$170," Grachev said. "But here in the Moscow area, a ton costs from $90 to $210. In Norilsk -- $450 a ton and in Yuzhno-Sakhalinsk it's around $450 a ton," he said.


The price increases have been particularly dramatic in 1995, with the cost of aviation fuel rising more than 250 percent.


The fuel problem derives in part from the cost of transporting kerosene to Russia's various far-flung airports. But the other problem, Grachev said, stems from the near-monopoly conditions of the oil industry and the lack of competition among suppliers. The situation is reaching the point where Transaero, for example, may soon buy Korean kerosene for its flights to the Far East.


There are also problems with maintenance and other airport services. The spare-parts situation is particularly acute. Up to 30 percent of Aeroflot's fleet sits on the ground waiting for new equipment, particularly for engines.


All these costs are passed down to the consumer in the form of ticket prices, which have soared since 1991. A round trip ticket to the southern Russia resort city of Sochi in 1989, for example, cost 60 rubles at a time when the average Russian salary was 120-150 rubles.


That was pricey, but the relative cost has now doubled. Going to Sochi on Transaero now costs about 547,000 rubles ($123), when the average monthly salary is around 565,000 rubles ($127).


These prices are for Russian citizens. Russian airlines charge foreigners much more. Transaero, for example, charges twice the amount listed above if you are not citizen of the Commonwealth of Independent States.





Out of the ashes


Despite all these drawbacks, Russia presents an enormous prize for those airlines that survive to emerge from a period of intensifying competition and consolidation.


Some believe that the future of Russia's air traffic system does not look unlike the industry, post-deregulation, in America.


The introduction of competition in the United States has changed the dynamics of the business, with airlines developing 'hub-and-spoke' route systems to feed their major long-haul destinations. More recently, the introduction of smaller long-range airliners has led to the opening of long-haul links between less important city pairs. Grachev, for one, did not rule out the fact that the future of Russian aviation might see a development of something like a hub-and-spoke system, with smaller, regional airlines feeding major companies in Russia's larger cities. The Aeroflot route network remains overly focused on links from Moscow.


Duffy, too, already sees pieces of a feeder system emerging. "The hub-and-spoke system is in its conceptual phase and I would say that in five years it will begin to grow into a major development," Duffy said.


It is widely expected that the number of passengers flying in Russia will steadily increase. That is seen everywhere as a positive development. A slightly higher load factor, that is to say the percentage of seats on a plane which are filled by paying passengers, can mean the difference between profit and loss. Airlines live and die by it.


Growing traffic alone, however, will not be enough to restructure and rejuvenate the industry. It will take heavy government involvement in the form of credits for leasing, as well as stricter regulation that takes into account the financial condition of a given airline before it receives a permit to fly.


But when those extra passengers start lining up for tickets, some airlines simply will not have enough seats available. There are not enough operational planes to go round in Russia if traffic picks up substantially.


Not only are planes in short supply, many are old and have been in service for decades. Look around a Russian airport, and except for the new paint job on some of the planes, they are by and large the same models as were flying 10 or 20 years ago.


According to the State Committee for Defense Industry, about 70 percent of the more than 1,900 long-haul aircraft in use around the former Soviet Union will have to be retired by 2000. That statistic points the Russian airline industry in two directions -- either participating in the revival of domestic aircraft production or getting out their pens and signing leases.


One new carrier that has done so and has made significant inroads into the domestic market is Transaero, which flies Boeing jets and offers Western-style cabin service. It has already become a household name.


One of the rags-to-riches stories of nascent Russian capitalism, it was started in 1991 by Alexander Pleshakov, then in his late twenties, with $5,000. Its first operations were in the charter business, but it soon entered the market with both international and domestic scheduled flights. Helpful, perhaps, in its success was the fact that the founder's mother, Tatyana Anodina, is head of the committee which assigns airline routes.


In the first eight months of 1995, Transaero's flight schedule more than doubled, including new routes to Berlin, Frankfurt, St. Petersburg and Irkutsk. Charter service will mushroom over the next year to vacation spots in Turkey, Greece, Egypt, Cyprus and Spain, among others.


Transaero's rapid growth strategy, financed by cash from Moscow's powerful Bank Menatep, is expected to scratch U.S. soil for the first time this year with service to Chicago. Future U.S. destinations will include Orlando, Washington, D.C., Seattle and Dallas. Next year, passenger load is expected to double, to almost one million passengers. For comparison, the airline carried 25,726 passengers in 1992.


Company officials declined to release any financial information, but said it is too soon to talk about the airline being profitable, as all of its money is plowed back into the company's expansion plan.


While international routes are generally more profitable for now, Pleshakov said: "We think our main task is the development of our network here in Russia and on the territory of the former USSR. There are a lot of companies offering good international service here in Russia, but domestic service is something that needs to be sharply developed."


Some of Russia's more far-flung airlines, nevertheless, are growing. Krasnoyarsk Airlines, a "Baby-flot" that has managed to survive the breakup, is now flying to New York from Krasnoyarsk via Moscow on a leased DC-10.


But no other new private airline has made so big an impact. In 1993, for example, there were 413 airlines registered in Russia. According to Duffy, the airline consultant, with 156 of those airlines carrying 99.6 percent of Russia's passengers.


Most Baby-flots have not been able to survive in the emerging market, in many cases, because they are actually tiny airlines with a couple of airplanes, a few tanks of fuel and a couple of pilots.


The Transport Ministry, until recently, did not take an airline's financial condition into consideration when granting licenses, and many underfunded airlines were allowed to take to the air without the ability to stay there.But after a joint project with the U.S. Federal Aviation Administration, the Transport Ministry has revamped its licensing procedures, and will no longer grant an airline permission to fly if it cannot prove it has the resources to run a proper service.





Aeroflot, the motherlode


The chief threat to the new companies is not the small and under-financed Baby-flots, but the only company which these days can rightfully and legally be called Aeroflot. That is the international division of the former Soviet carrier, in full Aeroflot -- Russian International Airlines, which, with 117 planes, remains the Russian flag carrier. The airline was profitable, earning $160 million in 1994. All the other blue-and-white planes flying around Russia belong to the newly independent companies that have yet to repaint their fuselages.


Aeroflot has a new chairman in former Soviet Defense Minister Marshal Yevgeny Shaposhnikov, who, as marshals are wont, has a grand plan, and intends for his company to re-enter the Russian domestic market. Service has already begun to St. Petersburg, Novosibirsk and other domestic destinations.


"We are not paying attention only to international carriers, but also to internal carriers," Shaposhnikov said at his inaugural press conference. "Today, we have fallen a little bit behind these carriers."


That would involve elbowing out or gobbling up some of the "babyflots," but Shaposhnikov has the full backing of the government. It is expected that he will stay on only for a brief period, reorganize the airline's management structure, overseas offices and flight schedule, and then turn the airline over to a more experienced businessman.


As competition intensifies in the Russian skies, there are bound to be victims in any case. Many of the seat-of-the-pants operations that tried to make a go of it have already failed, and industry executives and analysts alike predict a thinning out of the market.


"If once their number grew to 430 [immediately following the Aeroflot breakup], this year according to the latest conference on air traffic safety at the Department of Air Transport, there were about 50 airlines," Transaero's Pleshakov said. "The others have just closed down."


"Formally, there will be a lot of airlines," Pleshakov said. "But there won't be more than 20 large carriers, and there will only be about three or five really big companies." Those companies will likely be big-city leaders like Moscow's Domodyedovo, Petersburg's Pulkovo and Orientavia, which flies from Moscow to Khabarovsk, Vladivostok, Petropavlovsk-Kamchatka and will soon add routes to western CIS cities and Yuzhno-Sakhalinsk.


"There will be consolidation, there has to be," said Paul Duffy, the airline industry consultant. "The huge growth in Russian airlines has stopped. They're contracting now. Arkhangelsk, Komi, Krasnoyarsk and Yakutia airlines are beginning to form themselves from the myriads of Aeroflot daughter companies into larger, stronger airlines."


Transaero, Pleshakov hopes, will be one of those three or five companies, right behind Aeroflot, which he sees at number one. The two airlines hold stock in each other and Pleshakov foresees strategic cooperation between them in the future. Aeroflot reputedly holds 10 percent of Transaero's stock; figures are not public.


And as for Aeroflot's future status, Shaposhnikov said the privatization of the airline should put it in the hands of only two parties -- the government and Aeroflot's employees.





Safety Last?


Horst Herlemann, the International Air Transport Association representative, said it could take up to a generation to develop the necessary senior management talent to build a strong industry.


Duffy, for one, thinks it could be about 10 years before Russia has an airline industry that generates a profit.


"I don't think the Russian accountancy system yet shows profit in a sense that we would understand it in the West," he said.


Lack of money and spare parts raises further questions in regard to the poor safety record of Russian aviation. But Duffy thinks the situation is not as bad as often painted, and could be improving.


"In terms of safety, I think Russia does reasonably well," he said. "The Russian Department of Air Transport has done a huge amount of work to improve flight safety."


The past year did see a significant improvement in air safety. Until the downing of a Tu-154 on a flight from Yuzhno-Sakhalinsk to Khabarovsk in December, the year got by without a major accident.


Indeed, 43 people died from air crashes in the first half of 1995, compared with a record high 231 deaths for the same period in 1994, according to statistics from the Interstate Aviation Committee.


Many of the improvements in air safety have come via a cooperative effort in 1994 between the Department of Air Transport and the U.S. Federal Aviation Administration that tightened up licensing requirements and inspection procedures.


Russia's problems may be severe, but the airline industry here is not the only one with problems. Among European airlines, few make money, with British Airways and Lufthansa as the region's leaders. The airline industry in the United States is only now emerging from a period of severe losses. There too a process of further consolidation is expected.





***Next week, Business Review takes a detailed look at the other half of the Russian aviation industry in crisis, the manufacturers of airliners.***