Russian airlines are being pushed aside by foreign competitors.  Foreign companies can offer economy-class customers lower fares and business-class customers better service.

Alexander Mansilia-Kruz and Alexei Khazbiev

Recently, three European airlines—AirBerlin, Niki, and Germanwings—all announced they would begin flights to Russia for unprecedented low fares starting January 1st. Roundtrip tickets from Moscow or St. Petersburg to Stuttgart or Düsseldorf will cost less than 140 euros. Flights to Vienna from the Russian capital will cost a mere 110-120 euros. This is exactly half of what Aeroflot and Siberia are charging, even during special promotions.

The arrival of European fares on Russian routes has sent shockwaves through the Russian aviation industry. According to Valery Okulov, General Director at Aeroflot, the new European airlines in Russia will inevitably increase competition and bring about a re-division of the market. Natalia Kirillova, Deputy Department Director at the Russian Transportation Regulatory Agency, believes that some Russian airlines will go under and those that survive will suffer serious losses. Nikolai Shipil, Director of the Federal Aviation Agency (FABT), announced that low-cost European airlines should not be allowed onto the Russian market at all. It seems that only East Line, the managers of Domodedovo Airport, are pleased with the Europeans’ plans. Sergei Gorbunov, Deputy Chair of the East Line Board, told journalists that in the near future, his company would build a separate terminal at Domodedovo for these lost-cost airlines.
What are Russian aviation officials so afraid of? How could three little Western airlines bring the elite of Russian aviation to its knees?

The no-frills secret

Officials are right to be concerned. When low-cost airlines appeared in the US and Europe in the mid-1990s, they revolutionized world aviation. Thanks to the open sky policy of the EU, local airlines were able to make an unlimited number of flights between airports in various EU countries. Marketing innovations and the fight to keep costs low created a completely new type of “no-frills” airline. Passengers were offered flights from airports far from city centers at inconvenient times without meals and often without flight attendants. On some discount flights, passengers had to bring their luggage with them on board. In addition, low-cost airlines did not refund or exchange tickets. As a rule, they use only one type of plane, either Airbus A-321s or Boeing 737s. The uniform fleet reduces maintenance costs and keeps the number of personnel low. In return, passengers get ticket prices (often only available online) that more than make up for the lack of creature comforts.

In the late 1990s, this type of flight became popular among students and retirees, and then among the traveling public at large. However, discount airlines really took off after September 11th. The fear of flying that gripped Europe and the US exacerbated the big airlines’ problems. This helped low-cost airlines not only take over the market but get a firm footing. In the last five years, the number of passengers on cheap flights has increased by almost five times, while the overall number of passengers worldwide has decreased. Currently, discount airlines are carrying more than two million passengers a week, and some of them have become some of the largest airlines in the world. At the same time, the profit margin at nearly all low-cost airlines is consistently above 10%, which makes them some of the more profitable companies in the industry.

Having scrambled into the world aviation elite, discounters have become some of the largest purchasers of new planes. While American, United, and US Airways faced financial crises and demanded billions in subsidies from the US government, Southwest placed a record-breaking order for 290 new planes to the tune of $15 billion. On the other side of the Atlantic, EasyJet made a similar deal at around the same time and bought 120 new places for $4 billion. Now Southwest has the eighth largest commercial fleet in the world, with more planes than British Airways or Lufthansa.

The share of traditional airlines in the market for flights within Europe has fallen dramatically due to discount airliners’ aggressive marketing tactics. Moreover, many airlines could not withstand the competition and simply went bust. This bitter experience led traditional airlines to found low-cost subsidiaries of their own. As a result, by the middle of last year, Europe had more than fifty low-cost airlines.

According to Michael O’Leary of Ryanair, the skies over Europe have gotten crowded and airlines have begun to look for new, fast growing markets where the competition is weak. It’s already clear that the big battle between discount airlines will happen on the Russian market.

The onslaught begins

For the time being, only one low-cost airline flies to Russsia, Germania-Express. This airline began making daily flights to Moscow last winter. Tickets from Munich or Berlin cost around 130 euros. According to Gunter Seibt, who represents Germania-Express in the NIS, the company would break even if planes were only 44% full. The arrival of the German discounter led to rapid fare reductions for flights to Germany. For example, Aeroflot was forced to cut its fares by nearly a third from $700 to $480 for a roundtrip ticket. The number of passengers on Aeroflot flights remained unchanged. This can be explained by the fact that the Russian air travel market grew by almost 15%. In monetary terms, the market had grown to almost $6.5 billion. International routes grew by 35% for the year. For this reason, Germania-Express did not hurt Russian airlines at all. Yet when AirBerlin, Niki, and Germanwings arrive, losses for Russian companies are inevitable. If they will not be able to offer similar prices, they will lose out to the competition. According to Boris Rybak, Director of Info-Most Consulting, to offer the same prices in economy class as low-cost airlines, Russian airlines will have to fill up business class. However, the business-class situation in coming years will only get worse. Russian business passengers already prefer to fly with Western airlines.

The lost business class

Along with low-cost airlines, traditional Western companies are also exhibiting greater interest in Russia. In the last year, a dozen foreign companies have started regular flights to Russia, such as Emirates, Qatar Airways, Pakistan Airlines, and Vietnam Airlines. Emirates deserves separate mention. This airline is known as the company the world aviation industry watches. Most of its passengers are not only well-off, but are extremely wealthy and willing to pay as much as $15,000 for a first-class ticket. The arrival of Emirates in Russia means that a stable demand for high-price flights has developed (as the airline does not fly to poor, non-Muslim countries). Last summer, the President of Emirates, Sheikh Ahmed bin Saeed Al Maktoum stated in an interview with Expert that “Russia is a very good market with a lot of growth potential. We believe that the number of international flights from Russia will increase consistently.” The prince hit the nail on the head. In the last several months, nearly all Western airlines operating on the Russia market began to expand the routes they offer and fly to more Russian cities. This year British Airways will implement plans it made five years ago to increase traffic between London and Russian cities to 250-270,000 passengers. According to Daniel Burkhart, British Airways’ Commercial Director for Eastern Europe, the company’s further growth will depend on whether it can secure permission to fly into other Russian cities. Lufthansa’s future also depends on this permission. Two months ago, the German national airline renewed the regular flights between Moscow and Düsseldorf and Hamburg it cancelled three years ago.

The majors’ success in Russia has attracted other companies that wouldn’t have dreamed of flying to Russia only a year ago. For example, last week Continental executives announced that the company would begin flying between New York and Moscow next May.

If foreign airlines make their plans for the Russian market a reality, Russian airlines will be in a tough spot. Discounters will empty the seats in their economy class, while at the same time the expansion of companies like British Airways, Emirates, and Lufthansa will mean Russian airlines will lose even their loyal business-class passengers.

Only Russian aviation authorities have the power to block the expansion of Western airlines. All international flights between Russia and other countries are regulated by strict international agreements based on principles of parity. Of course, in practice these principles are not observed. Nonetheless, should the situation at Russian airlines become critical, these principles could be brought into play, which is exactly what Federal Aviation head Nikolai Shipil is threatening to do. Yet artificially limiting competition in the industry is not likely to eliminate the fundamental problems facing Russian airlines. If the best passengers continue to fly foreign, even government dictates will not help.

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