AVIATION INDUSTRY
Paul Duffy - Regional Editor of ATW Media Group, Correspondent for Russia and the CIS 
Bullets
- Russia’s aviation industry can be a vital tool to build the national economy.
- With proper finance, the industry can be saved.
- The State must decide to fund or privatise the industry.
- Investment essential for industry future,
- Surplus skilled staff could form the base for light engineering production.
- Finance for airlines to acquire new aircraft (through leasing or loans) vital.
- Industry must consolidate and develop family of aircraft for market. Not all design bureaux and production factories can survive as such.
- Russian aircraft, if intended for sale on international market, must have cockpits, equipment and manuals in English language and international certification.
- Market development and strong marketing essential.
- Need to build world confidence in its products.
- Essential need for strong support (training, spares, design improvements and finance) programme to equal (or raise) international practice standards. Support must be included in aircraft price.
- Tax package for industry and funders of aircraft, with tax relief for imports only if Russian aircraft have access to foreign markets. Sales tax should provide research and development funding for aircraft and materials.
- MAK must continue work to harmonise regulatory standards.
- Where not available from Russia, some components and materials should be imported free of tax.
- Support need to retrain staff in essential skills.
Background
The civil aviation industry in most of the world has experienced strong growth and boom conditions over the last several decades (with a resulting move towards consolidation as new programmes increased in cost) until the effects of the September 11th terrorist acts. That of Russia and the CIS, however, has been in a deepening crisis since the early 1980s.
The Russian industry has long been a part of the Military- Industrial Complex, and the political and fiscal consequences that followed the end of the Soviet Union left the complex unprepared for the resulting changes. The current downturn should be used as an opportunity to rebuild the industry into a valuable tool for Russia’s economy, and to have the industry prepared for the upturn.
The crisis still continues, augmented by a lack of industry leadership and the need for customers (airlines and air forces) to pay directly for the first time, at a time when the State no longer has the money, or the appetite, to do so. The State budget has many new demands, and an insufficient economic base, and it likely to take many years before it could meet all the country’s needs.
Today, up to a million workers remain in the aviation industry. These are talented and capable people, with enormous and very valuable skills, who could be working to improve the overall wealth of the country.
Instead, they are a drain on the State budget, which is forced to provide them with money and services to stay alive. Were the industry producing, they would be paying taxes to the State, and thus be a benefit to the budget.
On the international market, consolidation has resulted in just two manufacturers of large civil aircraft – Airbus in Europe, which is a conglomeration of almost all the European industry. And Boeing, which has steadily absorbed most of the US manufacturers of civil (and some military) aircraft.
Both say that there is room for a third major manufacturer, and there is little doubt that another will come. Today, Russia is the only region with skills enough to do this, but Asia, particularly China and Japan, have been adding to their base over the past twenty years.
If Russia wants to share the economic and technological rewards of a major world provider of civil aircraft, it must start to act in the immediate future. If not, it will pay other countries to provide the aircraft it and spares it will need in the future.
Although as the industry declines, it is becoming more difficult, Russia can still achieve a significant share of the world market. With a product like civil airliners, this will have considerably higher prices and export value than the simple delivery of raw materials, such as aluminium and titanium. With Russian design and manufacturing added to these materials, the value to the economy and the budget will increase exponentially.
Consolidation
The first step will need to see severe rationalisation in the Aviation industry. The industry, located in three countries (Russia, Ukraine and Uzbekistan), has about ten aircraft and helicopter design bureaux, plus many more in component sectors. It has at least twenty- two production factories (for aircraft manufacture and final assembly), plus many for sub assemblies and components. And it has a wealth of excellent research facilities. All are more or less independent, today under the umbrella of the Russian Air and Space Agency (Rosaviakosmos - RAKA). Although RAKA has worked quite well to develop funding and partners for Space programmes, it has shown little interest, and achieved very little, for the aviation industry. It had not wanted to accept responsibility for the industry, and has not provided the necessary leadership or focus to adapt old thinking to meet changing conditions. If this continues much longer, the industry will close down. The Ukrainian industry, although much smaller, has made more progress than that of Russia in the past decade.
This has not prevented each design bureau fighting to get its own project for every purpose into production. Today, Ilyushin, Antonov and Tupolev are all offering rival military transports with possible civil versions: Beriev, Antonov, Tupolev, MiG and Sukhoi are all offering regional or feeder passenger programmes. Ilyushin and Antonov have regional turboprops on offer, and so on. At a time when the industry has severe money problems, each member is offering competing products. Manufacturing factories are equally fighting for suitable aircraft types to produce.
The industry must work together to offer a family of aircraft to meet (not what the industry decides to offer, but) market needs. Today, no airline will buy what it does not need, and the industry must react by developing new aircraft in co-operation with its customers. If Russia cannot provide some materials or components, they should be bought in. For example, the materials used in aircraft cabins in Russia do not currently meet world requirements, and the industry should therefore find a foreign partner until it can provide a suitable range.
The industry must be consolidated, with the main sectors being one strong military company, another strong civil company, and a strong helicopter company. The suggested union of the Russian and Ukrainian industries would add considerable weight to a consolidation.
There is a reasonable case to keep the military producers under close State control. There is an equally strong case to privatise the civil production side to ensure it will have the funds to prosper. The State should retain a “Golden Share” to provide for any eventuality in the future.
Where Western partners have worked with Russian aviation – most notably Sirocco Aerospace and United Technologies – they have been given no advantages by Russia. Both find their products are subject to heavy import taxes, even where Russia manufactures more than half the overall cost value of the product offered to the market. This should be periodically reviewed.
Future Ownership
If the State does not have the wish or the money to develop the industry, finding the right future owners will be complex. The objectives must be outlined, and they could be:
Any purchaser is likely to be a consortium, even if the price is set at a reasonably low level, because of the huge investment programme necessary to develop the industry and future projects. It will be essential to show that the resources and commitment are there to upgrade the industry to meet world and domestic market needs.
A first step in meeting these needs has to be the building of confidence in the market that the industry can provide world standard products at attractive prices. It must also prove that it can provide the support needed to allow operators to work the aircraft to meet the needs of the international market.
That support must begin with the foreign certification of Russian aircraft and components. Without this, there can be no market.
Next must come the international publication of aircraft statistics for the last generation of airliners – numbers produced, total flying time, numbers and causes of accidents, and numbers of passenger or cargo tonnages carried with details of revenue kilometres flown. This will allow them to be measured against their foreign equivalents. It can be clearly shown that, despite operating in conditions where western types would usually not fly, in most cases their accident record is better than the western “analogue”. That information alone, if credibly presented, will begin to build international confidence in the industry.
The support must include foreign language manuals (operating and engineering), finance, training, spare parts and engineering services. Certification by Europe and the United States is also essential until full harmonization with the ARMAK standards has been completed. Over the (usually about 20 year) life of an aircraft, for every $1 of purchase price, the operator will usually expect to spend $2+ on spare parts. If a $30m aircraft (effectively a business tool for airlines) is stuck on the ground for a month waiting for a $1000 spare part, then the manufacturer's reputation will be destroyed. As this confidence was not present for Soviet aircraft, it must be a priority to build a visible and effective support structure before sales can begin. These areas of support can be very profitable, so it makes good business sense to develop them.
To encourage investment in the industry with a view to future economic benefits, the State should provide tax incentives. This can be done, for example, by providing allowances for investments in modernisation, equipment purchases and research and development costs. To get airline customers to acquire new aircraft, banks and leasing companies should be granted tax relief for funding aircraft. (Legislation to allow funders to repossess aircraft when the airline fails to pay its lease or loan charges could allow the funder to quickly find another customer. This would build confidence in leasing companies, which are essentially banks lending aircraft instead of money to airlines.
Employment
A vital factor in any economy is ensuring jobs for as many people as possible. When people are earning reasonable salaries, they pay taxes and this benefits the budget. When they are unemployed, the budget has to provide reasonable support at a cost to the budget. In the last five years, production at aviation factories in Russia has been at a level that has caused the budget to lose considerable revenue. The industry can be revived, but it will take some time. In the meanwhile, the surplus of the considerable skills in engineering and technical science could be used to build a range of light engineering industries across Russia. These could be targetted at producing well- designed consumer goods for homes and offices, and here a study of products imported from other countries should give a indication of domestic market needs. As design and quality are brought to international standards, then export markets can be sought. For the start, these new industries could use vacant sections of aviation (and other) industry premises.
It will be important to retain a core of essential skills in the industry in order to ensure the passing on of these skills to a new generation. The last ten years has seen little recruitment in the industry, and many of the younger workers have been forced to seek other work. For future development, recruitment of young workers cannot be delayed for much longer.
Training
To restore the industry’s ability to manufacture aircraft, suitable training programmes are urgently needed to augment the skills lost over the past decade.
Ideally, these should be supported by the State. Institutes in regions where the aviation industry is located should work with the designers and factories to develop the courses needed to fill the gaps in skilled workers.
Russia has an excellent education system, and this would be a practical step to economic development.
Markets and Marketing
The industry’s first market must be Russia and the CIS. If it cannot sell in its own territory, other customers will not come forward. To begin to gain sales, airlines of the region have to have access to finance. Recently, there has been evidence that money is available in Russian banks, but the banks have little confidence in the ability of most airlines to repay loans or lease funds.
Before banks will readily provide the money needed airlines to buy or lease aircraft, they will need to have this confidence, and this will only come when the airlines can develop business plans for the medium-term future. In turn, this will need a well-defined statement of government policy, which can allow the industry to build detailed plans and profit projections to show an ability to repay.
It will take perhaps ten years of development before Russia is ready for a full open skies policy. In the meantime, some controls are needed over the number of airlines operating on any route, either passenger or cargo.
Russian aircraft can have a place on the world market, although considerable work is needed before this will happen. Some, limited, progress has been made already: the MAK (Interstate Aviation Committee) has agreed a Bi-lateral Air Safety Agreement with the USA. In theory, this means that Russian aircraft (cargo versions with approved engines and avionics) can be sold to, and operated by, US airlines. Work is underway to have the first Russian aircraft, the Tu-204, go through a certification audit with Europe’s JAA. But these are only the first steps to give Russian aircraft the reputation and the record they will need to penetrate world markets. It will be important for the MAK to continue its work on harmonization of air register standards, in conjunction with the FAA (the US authority) and the JAA.
Real progress will come when foreign airlines begin to understand that they can get the technical quality they need, including safety and passenger comfort, at a good value price from Russia.
For any industry to survive and prosper, it must have income. In the Soviet system, this was provided by the State. Now it will have to come by selling the aircraft it will manufacture.
To do this, a strong marketing team must be built which will take the information about the industry’s products directly to the airlines, and even more importantly, to the banks and leasing companies that will fund them.
The marketing team is as vital to the industry’s success as are the designers, producers and financiers. They must be well-motivated professionals, able to justify their products, both technically and financially, to some of the smartest business people in the world. For this, they should ideally have a sound technical, business and marketing education, and know their products thoroughly.
They should be paid by results - if they work effectively, they will make a considerable difference to their industry. If they are not successful, the industry will fail.
Finance
The investors in the industry must demonstrate their ability and intention of providing core capital for the necessary development. A second source of money must be available to enable airlines to buy or fund aircraft. This can be banks, investment groups or lease companies, which are essentially banks that lend aircraft instead of money to airlines, with the repayment of the loan termed lease costs rather than repayment. The lease companies remain the owner of the aircraft, and expect to make a profit by selling, re-leasing or scrapping it at the end of the lease.
Residual Vales:
While there are readily available rates for the sale of any western aircraft at any stage in its life (in terms of years, hours or cycles), these are not internationally established for Russian aircraft. Thus, the early leasors and funders will add some cost to the lease price until the “residual value” is known. (Residual value is the worth in money terms at the end of the lease period or the life of the aircraft). To begin to establish a base of residual values, it may be necessary for the Russian government to offer to buy back aircraft at the end of their first leases on clearly defined terms until market confidence is established, These can then be sold or leased to domestic carriers.
Taxes
It will be necessary to offer tax relief to the industry and funders of new aircraft, as mentioned earlier.
A sales tax of 2 or 3% should be introduced in order to provide funding for future development of the industry and aviation materials, and to allow sectors such as avionics to develop products.
Aircraft imports should only be given exemptions when a “level pitch” is in place, allowing Russian aircraft to be sold abroad. This is in terms of certification and import taxation policies of the other country.
It is likely that the forthcoming WTO membership will require Russia to allow the tax- free importation of aircraft.
PS - STATISTICS
Another factor would be the open publication of the operating and safety statistics of the last generation of aircraft. Although regularly operated in conditions where western aircraft would be grounded, the safety record of most Soviet aircraft are close to, or better than their similar generation western counterparts. The lack of information on these subjects has meant that western specialists do not believe that the country’s aircraft are as good as their western rivals. If the next generation is to find western markets, the full data must be available for examination and comparison.
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