ROUTES CIS: Is It Time for Change in Russia’s Skies?

The Russian aviation market has been steadily growing since 2000. Following a turbulent decade in the 1990s, the industry saw a compound annual growth rate (CAGR) of 10 per cent, with the Moscow Airport System (MAS) experiencing even growth at 12 per cent.  A brief decline in 2009 has been followed by a fast recovery.  But, despite impressive levels of traffic growth, regulatory and market challenges mean Russia still lacks home- grown low-cost carriers.  The statistics, from a recent report from Lufthansa Consulting, also revealed that MAS - which comprises Domodedovo, Sheremetyevo and Vnukovo airports - is today the 10th largest airport system in the world in terms of air passengers.  

Lufthansa Consulting believes Russia will reach close to the same levels of air mobility enjoyed by states in Western European, such as Germany, the UK, France and Italy, by 2030.  “Growth rates are likely to slow down, correlated to the economy, yet will remain above Western Europe or North America,” explains Stanislav Solomko, Lufthansa Consulting’s associate partner responsible for Russia. “We are forecasting a CAGR of minimum 6% over the next 20 years.”

In Moscow, Russia’s major carriers tend to base themselves at one airport with a focus on point-to-point travel, although Aeroflot bucks that trend by steadily turning Sheremetyevo into a hub.  In the last three years, passenger traffic between regional cities in Russia has grown at a faster pace than Moscow, demonstrating a vigorous intra-regional market.  But despite growth, the majority of regional gateways are still experiencing financial difficulties.

In fact, the number of airports is steadily decreasing, shrinking from more than 500 in 2000 to about 300 last year. Meanwhile, the number of passengers transported by Russian airlines has grown from 20 million passengers in 2000 to more than 70 million in 12 years.  But one part of the aviation market which is ubiquitous elsewhere, but notably absent in Russia, is low-cost carriers (LCCs).

The disappearance of Sky Express and collapse of Avianova in 2011 effectively left the world’s second- largest country with no home-grown, no-frills airlines.  While the reasons for each carrier’s demise vary, Russia’s strict regulatory environment has been widely blamed for making it tremendously challenging for low-cost airlines to thrive.

Currently, every ticket sold by a Russian airline is fully refundable up to 24 hours before departure, and carriers are also obliged to offer a full meal service to all passengers.  This simple clause undermines the ability of the low-cost carrier to operate a flexible fares model and effectively stifles competition based on prices, argues Daniel Burkard, external and international relations director at Moscow’s Domodedovo Airport.

“Anybody setting up a low fares airline on the standard global model, it wouldn’t work, because you would most probably do the same pricing distribution strategy as the other carriers around the world. So you opened up the carrier for booking well in advance at a very low fare, when you get to the departure date, the fares will increase if the seats are filling,” he says.

“Now that only works if you don’t run the risk that 48 hours before departure anyone can cancel and take their money back. It doesn’t work.  This is why Russian carriers are not trying to compete on price but on product. They have frequent flyer schemes, they have add-ons, limo services and taxi services, some of which are very attractive,” he continues.

“Schedule plays a much greater role. If you look at all Russian airlines compared to Europe, schedule plays a greater role because price plays a smaller role. So airlines try to get passengers into the aircraft by offering the right schedule at a reasonable price, whereas in Europe you can get a very, very cheap ticket if you just fly at a very inconvenient time,” he concludes.

There is evidence that the Russian government is waking up to the difficulties, with media reporting government officials are considering opening up domestic markets to foreign carriers, while sources suggest it is considering amending consumer legislation, including last-minute refunds and reducing the mandatory minimum fleet size to encourage new Russian LCCs. However, Burkard and Solomko remain unconvinced.

“Aeroflot announced a plan to launch an in-house LCC by latest 2014,” comments Solomko. “There is also certain interest from other airlines among the top four to venture into the LCC business model.  It is unlikely that the Russian government would allow foreign carriers to gain cabotage traffic rights. The most likely change is to allow foreign pilots to fly for Russian airlines, which would address the current challenge of airlines seeking new pilots.”

Transaero operates 164 international routes and 32 domestic services and, uniquely, offers flights from Domodedovo, Sheremetyevo and Vnukovo airports. It has a fleet of 98 aircraft, mostly Boeing, and has 35 on order, including four B787 Dreamliners and four A380s.

“The airline has been thinking of launching a low-cost carrier.  However, after careful consideration, we have made the conclusion that, at the current stage, the Russian laws regarding airlines are insufficient for low-cost operations,” says Dmitry Stolyarov, first deputy general director of Transaero Airlines.  “Despite the declarations of some airlines of their intention to launch low-cost operations, there have been no changes in the Russian aviation market. There is no legal basis that could ensure efficient implementation of a low-cost service model.

“The existing airport infrastructure does not allow for the level of handling services necessary for them. A contributing factor is the sub-standard travel infrastructure in Russian regions – specifically a lack of cheap and affordable hotels and hostels,” he adds.

Stolyarov says there are several measures the government could introduce to stimulate further growth. However, he also poured cold water on media speculation that the Russian authorities are considering allowing foreign carriers to operate in the domestic market.  “There are a number of measures that could be brought in,” he says. “Anti-monopoly measures; allowing foreign pilots to work on the domestic market; access to affordable loans to develop and maintain airlines’ aircraft; exemption from VAT and import taxes on foreign-made aircraft; and enhancement of ground infrastructure.”

Aeroflot, meanwhile, flies to 122 destinations in 52 countries. It has 36 destinations in Russia, as well as seven cargo destinations. The carrier is also a member of SkyTeam and operates codeshares with 29 Russian and foreign airlines. It has a fleet of 137 aircraft, consisting of A320s, A330s and Sukhoi Superjet 100 airliners.  It has 22 B787 Dreamliners and 22 A350s on order, with deliveries starting in 2018. Deliveries of a further 16 B777s, ordered in 2011, will start this year.

Aeroflot’s own figures show that the airline is the market leader in Russia, with a market share of 37% in terms of passenger numbers.  Breaking those figures down, internationally, its market share is 41.3% and, domestically, 32.5%.  It is perhaps for this reason that people believe it will be the first of the main carriers to establish an LCC.

“Aeroflot has declared its willingness to establish a low-cost operator, but there are certain legislative obstacles in this process,” explains Alexander Lukashin, head of International Relations. “To make sure a future low-cost carrier can operate in a proper way, we need legislative amendments to be introduced.”

easyJet, one of Europe’s leading low-cost carriers, recently succeeded in entering the Russian market. In March, it launched flights from London and Manchester to Moscow Domodedevo after winning bmi’s rights to operate from the UK to Russia.  “We are focused on Manchester and London to Moscow for now,” explains Paul Moore, easyJet’s communications director. “We’ve only been running the service for eight weeks and we have our hands full building two new routes in a new country. On the London route, in particular, the inbound passengers are comfortably outselling those from the UK.  It shows that our business model works well in Russia and that our brand awareness is also high.”

Moore says the airline has no immediate plans to expand in Russia. However, bilateral arrangements could allow the UK carrier to launch flights from Geneva. There are also no restrictions between St Petersburg and Manchester.  However, the strict bilateral framework within which easyJet and other carriers have to work does represent another regulatory challenge to expanding low-cost services any further.

St Petersburg’s Pulkovo Airport is seeking to become the Russian airport of choice for long-haul and low-cost carriers. Footfall at the airport grew by 16.1 per cent last year to 11.2 million, and director general Sergey Emdin recently said he was confident that figure would reach 12.5 million in 2013.  Moscow’s three main airports account for 27 per cent of seat capacity from Pulkovo. Germany is the next largest destination, with Lufthansa, Rossiya Airlines and airberlin collectively operating 300 flights per month – equivalent to 8.8 per cent of capacity.

Rossiya presently operates 38.9 per cent of flights at the airport, dwarfing nearest rivals Aeroflot (9.7 per cent), UTair (4.7 per cent), S7 Airlines (4.3 per cent) and Transaero (4.2 per cent), according to the airport.  Emdin says there is “huge interest” among Chinese companies in developing trade with Russia. Pulkovo is already served by Hainan Airlines and Korean Air, but the gateway “would like to expand this”. A direct link to a major US hub, such as New York, is also actively being sought.

There are hopes that easyJet’s recent entry into the London–Moscow market could be a catalyst for change.   “There is a good possibility that easyJet will start operating from St Petersburg,” he says.  “It might be not just London but also some other destinations as well.  We are in talks about Manchester flights, and Geneva flights too, because they have a company registered in Switzerland.  Bilaterals definitely create a problem, but they are trying to work around them.”

The picture at regional airports is somewhat different from the capital with some struggling to survive, and domestic flights suffering at the hands of international routes.  With Russian carriers still pursuing hub operations out of the main city airports, the country’s smaller airports are crying out for connectivity, and given the vast distances within Russia it seems they would make fertile ground for regional carriers or LCCs.

“Restoration of regional air services has been constantly discussed in recent years at all levels of government and in the industry too,” says Sergey Dotsenko, director for aviation commerce at Airports of Regions Management Company, which operates Ekaterinburg Koltsovo Airport.  “It is a very multifaceted problem, which involves both aircraft production here in Russia, staff training and [other factors].  Since the mid-2000s, with national borders opened, the trend has consisted increasing international services from regional airports.  It is this growth of international flights from regions that continues to oust regional traffic.  As a result, the share of regional services is shrinking and was expected to be around 11% in 2012.”

Dotsenko adds that “the big four airlines” take up 75 per cent of the market.  With the addition of Ural Airlines, Nordwind and VIM Airlines, 85 per cent of civil aviation services are provided by seven carriers. Apart from UTair, all these airlines are focused on either Moscow or the international market, he says, concluding by suggesting that the authorities incentivise regional services by linking the provision of domestic flights with permits for international operations.

Currently, government legislation makes a low-cost operation near-impossible, while less profitable domestic routes are suffering at the hands of international operations.  However, the market is still growing in Russia, and this shows that there are opportunities to be had.  Bilateral agreements are slowly being liberalised and as soon as the Russian government sees fit to throw off some of the shackles that are preventing home-grown LCCs, there could be another explosion in growth.  Only time will tell.

This article was modified from a story that appears in the latest issue of Routes News, the world air service development magazine, and which can be viewed online here.