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. Last Updated: 07/27/2016

Plane Builders' Backs to Wall

Flights leave chronically late or not at all. Dozens of routes which existed in Soviet days are no longer served. Such are the everyday problems of travel in Russia, and the causes are legion. Sometimes it's a lack of fuel, but sometimes it's also a lack of planes that can fly.


This is extraordinary irony in a country that has, on paper, the second-largest aircraft manufacturing industry in the world. Yet last year Russia made just a handful of civilian jets.


Deliveries of Tupolev Tu-154s, the mainstay of the Aeroflot domestic fleet, amounted to six. A few more were produced, but they sit as "white tails" -- planes without customers -- at the production plant in Samara.


The main aero-engine plants produced only a handful of engines.


The collapse of the Russian aircraft industry is not only contradictory, it is momentous. Paul Duffy, a Moscow-based aviation consultant, estimates that at its height Soviet aviation employed as many as 3 million people. There were 20 major design bureaus and around 20 major manufacturing plants.


As such, it was far larger than its Western manufacturing equivalent. The big three Western airframe manufacturers -- Boeing, McDonnell Douglas and Airbus Industrie -- and their main subcontractors employ around 600,000 people, Duffy estimates. The payroll of the three main engine-makers -- General Electric, Pratt & Whitney, and Rolls Royce -- would add several hundred thousand more, but still a fraction of the Soviet total.


Peter Smith, chief executive of Kasparov Consultancy and another aviation expert in Russia, says he understands the industry may still employ as many as 2 million workers. The economies of cities such as Voronezh, Kazan, Ulyanovsk, Samara, and Perm are heavily dependent on civil aviation.


In 1994, most of these factories were idle as funding dropped drastically. Government support for aircraft production, planned to be about 820 billion rubles ($175 million), was cut by the parliament to 554 billion rubles, according to Anatoli Bratukhin, deputy head of the State Committee on Defense Industries. In 1995, the civil aircraft manufacturers of the West produced around 600 large aircraft and their engines. Their Russian equivalents produced just 100 planes, both civil and military, according to the Aviaprom export agency.





Airline Woes


Part of the problem is the crisis of domestic airlines, as described in last week's Business Review. Passenger traffic has dropped rapidly since the collapse of the Soviet Union and is only some 25 percent of its 1992 total. Traffic is now leveling off, however, and can be expected to grow if the economy does.


Before long, more airworthy planes will be needed. There are already fewer than there used to be. When Soviet aviation broke up with the end of the Union, many of its planes were grabbed by the newly independent Soviet republics. Others sit around on the edges of runways waiting for new engines or unobtainable spare parts.


More crucially, the fleet is aging. According to Aviaprom, more than half of Russia's aircraft has outlived its warranty and is in dire need of replacement.


Vadim Zamotin, head of the air transport department of the Transport Ministry, said at a press conference last month that by 1997 the existing fleet will not be able to cope with the rising passenger flow.


Somewhat unexpectedly, a turnaround in passenger traffic, and a concomitant increase in the all-important load factor, would leave a number of airlines in fairly good shape. Most Western airlines labor under heavy debt from aircraft financing. But most Russian ones, at least those which derive from the old Aeroflot monopoly, do not, as they did not have to pay for their Soviet-made planes. In improving economic conditions they could soon have cash flow available for new aircraft, as long as they could pay for them over a number of years.


New planes have advantages, besides the obvious ones of comfort. Aviation fuel has become expensive in Russia, while routes are long. Newer planes have much lower fuel consumption than two- or three-decade-old designs and lower maintenance costs.


Unfortunately for the Russian aviation industry, this does not mean a flow of orders anytime soon. In fact, as things stand, there may not be a flow of orders anytime at all.


Russian airlines that can afford to lease or otherwise finance new aircraft -- notably Aeroflot - Russian International Airlines, the overseas flag carrier, and new entrant Transaero -- are taking foreign planes, not Russian ones. There are at least 25 foreign airliners now in Russian fleets, according to Aviation Week magazine.





Three Key Designs


One line of argument about the demise of the Russian aircraft-making business is that it is no longer capable of producing a plane that anyone wants. In the 1980s, there was a dearth of new designs. The Tu-154 entered service in 1971; most of the two-engined Tu-134s, still flying in large numbers, were built during the 1970s.


But even in the United States, the aircraft manufacturing industry relies heavily on older designs. McDonnell Douglas has not introduced an all-new design since the DC-10, and the Boeing 737, the world's best-selling jet, is hardly new either.


Russian capabilities lag, but there are some new or recent planes that domestic airlines would be more than happy to fly, aviation expert Smith says.


The new two-engined 160-200 seat Tupolev Tu-204 is the principal hope. It would suit the medium-density routes, while the now-established four-engined Ilyushin Il-96, fitted with more modern engines of the same type that power the 204, would be suitable for the high-density trunk routes.


For shorter routes a contender is the Yakovlev Yak-42, which had teething problems and a lengthy introduction but now appears to have proved itself.


Russian airframes might never have been the lightest, their control surfaces the most sophisticated. But they were always sturdy, designed to be used with Russia's ill-equipped airports and poor runways. Fitted with Western avionics, and perhaps Western interiors, there is nothing seriously wrong with them.


Furthermore, they remain cheap. Tu-204s can be bought, according to one source, for less than $20 million each with Russian engines for a multi-plane order. The 204's U.S. equivalent, the Boeing 757, costs around $50 million to $60 million before discounts Sergei Grachev, director of marketing and planning of Transaero, and a graduate of the Moscow Aviation Institute, knows Russian airplanes well. He is a fan of the new Tu-204, but he is not enamored of the Russian engines.


"The PS-90s are just not fully developed," he says. "People ask me, 'Why not take the Tu-204?' But they're not certified [by Russian aviation authorities] yet, and we need them now!"


A commercial company like Transaero is not in the final analysis in the business of handing out industrial subsidies.


Nor is Aeroflot in a position to give much immediate help. "Today we have to support our industry, so that it has the grounds to exist and develop," said Yevgeny Shaposhnikov, the new chairman of Aeroflot. "On the other hand, right now the state pays very little attention to this matter, and Aeroflot is not in a condition to replace its entire fleet."


"For that reason, we will use foreign airplanes, and get the label of 'enemy of the people, enemy of Russia,'" Shaposhnikov said. "On the other hand, we can't, even though we want to, fully finance the development of the Russian industry."


While the Russian manufacturers are in disarray, Western ones are in there doing some marketing."Is there a market here? Absolutely," said Tamara Christen, whose job it is to get McDonnell Douglas jets into the Russian market. "But how the market will look -- it's going to go through an evolution in the next three to five years."


McDonnell Douglas, which has had a manufacturing operation assembling its venerable DC-9/MD-80 jets in China for years, is not sufficiently enthused about the Russian aviation industry to set up a similar arrangement yet. Nor is Boeing, despite being courted by Aviakor in Samara, a privatized factory which has traditionally turned out Tupolevs.





The Financing Dilemma


The Il-96 has flown with Pratt & Whitney engines, and versions of the Tu-204 with both P&W and Rolls Royce engines are taken to international air shows. There has been a lot of interest, but most of the 204s built so far by the main factory in Ulyanovsk sit without buyers.


Smith of the Kasparov Consultancy says that this underlines his argument that the successful introduction of the PS-90 engine is not the main problem. He points out that engines for the new Boeing 777 still have development difficulties, and he believes that once in mass production the PS-90 would prove its reliability.


"There is no technical reason why the 204 should not be flying in large numbers in Russia now -- the airlines need 204s as fast as they could be produced," he says. "The same is true for the Il-96. There are instead financial, legal and [industry] structural reasons why they are not doing so."


Instead, the central problem facing the industry, he believes, is that the "product support ethos" just doesn't exist in Russian aviation.


Smith, who says he has spent his career in aircraft financing, explains that an airline does not simply buy a plane, it buys an asset with a known working life. These days as much as 90 percent of airliner sales are financed in one way or another by a bank or financial intermediary, he says. The design life of the aircraft is only one, limiting, factor in this equation: just as crucial, he says, is a guaranteed supply of spares at set prices. On a Western jet engine spares normally cost four times the engine purchase price over its working life. Western purchase contracts stipulate supply terms and guarantees, he adds.


If a plane may not be able to fly because of lack of spares, depreciation cannot be accurately calculated, and financing institutions will decline to be involved.


Already in Russia some spares are close to unobtainable -- auxiliary power units being one example. The vicious circle of indebtedness that has come about in the aviation industry means that companies producing crucial parts have stopped production and will not restart until their debts have been paid off.


The division of design bureaus from manufacturing plants means that it is not even clear who has responsibility for the performance of aircraft at all. And who would like to guess whether a parts manufacturer would still be around at the end of a plane design life of 20 years?


As a result, at present virtually no financing is available at all for Russian jets. There is one deal for Aeroflot -- Russian International Airlines to buy 20 Il-96s with Pratt & Whitney engines, with Western financing, but this came from the U.S. Export Import Bank (after fierce resistance from Boeing), a federal institution which may lend money where commercial banks would not when a major export order is at stake for U.S. industry.


Smith says commercial financing could be available, both from Russian and Western sources, but it will not start until the circle of providing the conditions under which planes could be financed is squared.


The government would like to help the industry, and the Kasparov Consultancy, for one, says it has been retained by the European Bank for Reconstruction and Development and Coopers & Lybrand to study the financing question. But the Russians, Smith says, remain far too oriented upon manufacture, not on financing.


Belatedly, with the help of the Ministry of Economics, Russian aviation officials intend to launch a government-sponsored leasing program to give domestic airlines the money to jumpstart production among Russia's struggling aircraft builders.


The state-controlled Vneshtorgbank will lend the government $100 million -- enough for seven new passenger planes -- at a rate of 17 percent per year. Airlines would pay the loans back at 7 percent a year, a low interest rate within Russia, and the government would make up the difference.


Unfortunately, $100 million is a drop in the ocean in terms of overall need.


The total cost of fleet replacement, which may begin to really make itself felt by the end of the century, is between $60 billion and $70 billion, if Russian aircraft flying elsewhere in the CIS are included, said Bratukhin of the State Committee for Defense Industry.


Only workable arrangements which attract private capital are likely to prove sufficient. There is another problem too, tax. Russia is an exception in taxing the purchase of aircraft by airlines. Most countries, even those which do not have a substantial interest in aircraft manufacture -- Japan in particular -- give very lenient capital depreciation allowances for aircraft financing. The rationale is that the airline business is essential to the economy, and that the business is so low-margin that airlines must effectively be made exempt from tax.


Russia, on the other hand, levies 21 percent VAT on aircraft, and a 50 percent import tax, though exceptions are said to have been made. There is also a 21.5 percent tax on domestic air tickets.


Nor is the government encouraging a restructuring that would consolidate the current surplus of design bureaus and manufacturing plants. The centripetal force within the industry worldwide is so strong that even Boeing and McDonnell Douglas were considering merging, though reportedly they now will not. There are no similar moves in Russia.


In theory the government has already chosen whom it would support, and has adopted a "Federal program of civil aviation technology development up to 2000."


The program makes sense: it selects the Iluyshin Il-96, Tupolev Tu-204, and Yakovlev Yak-42, though it also advocates production of the new smaller twinjet Tu-334 for medium routes, which Duffy believes needs another $15 million to $20 million to develop, and the Ilyushin Il-114 for commuter routes. In addition, there is a new short-haul propjet, the Antonov An-38.


The government does not seem to have enough courage to force the pace of restructuring to streamline the industry around a smaller number of integrated producers making these chosen designs. The design bureaus still produce little models of planes they will never make, while factories compete with each other for the same scant foreign interest. Tu-204s, for instance, are to be made at two factories, one in Ulyanovsk and one in Kazan, which are separately trying to market their planes.


The first level of the aviation industry, civil and military, still has nine major design bureaus, and at least 15 major production plants. A second level includes hundreds of smaller design bureaus and research centers, which are in charge of engines, navigation systems, avionics and weaponry.


Experts say that the loss of some of the famous design bureaus and production plants is inevitable, but none will voluntary consign themselves to the scrap heap.





The Rosy Scenario


If Russia could sort out the industry sufficiently to solve the financing problem, what might the future hold?


Airline manufacture is a cutthroat and often unprofitable business. Boeing launched itself into big airliners through mass wartime production of bombers. Airbus got going on government subsidies and hides its real financial position behind opaque accounts. McDonnell Douglas, the laggard of the big three manufacturers, struggles to stay in the game. Worse, a price war is breaking out, with Boeing said to be slashing prices for major customers on its big-selling, though relatively small, 737 jet to little more than $20 million -- less than the cost of many fighter jets.


Russian production costs are rising, and manufacture is inefficient. Still, with wages low, keeping prices below Western levels should be possible.


Aircraft manufacture has become a global industry, with Airbus a pan-European consortium, and Boeing and McDonnell Douglas sourcing components from a host of countries. Even under the most rosy of scenarios, independent Russia manufacture of aero-engines and avionics may be on the way out longer-term.


The airframe industry could survive, and sell abroad. Russian military jets sell well to foreign customers -- the MiG-29 in particular is reputed for its maneuverability, even if it too has engines that are thirsty and require a lot maintenance by Western standards, and spares can be difficult to obtain.


But there is one big difference between buying airliners and buying jet fighters: The latter are bought by governments, and do not require bank financing.


As things stand at the moment, with the industry in such disarray, and no financing, there is a real fear that if -- and when -- economic recovery does begin to feed through to the airlines, a lot of the replacement aircraft Russia will inevitably need will end up foreign, perhaps older second-hand models, because the Russian manufacturers will no longer be able to make planes any more.


"The capability is drifting away from the industry," says Duffy. Adds Smith: "If the situation cannot be dealt with fairly quickly, an incredible assembly of talent will dissolve."





-- Charles Hecker and Anton Zhigulsky contributed to this article.