Lure of the east

Western European airlines and overhaulers are increasingly looking to the former Communist bloc for expansion and joint venture opportunities

As an outpost of the Soviet Union, Latvia felt desperately vulnerable to the West, but 15 years on from the collapse of Communism it is facing an onslaught from the exact same direction.

While the nuclear bunkers set deep in the ground are now being turned into shooting ranges, popular with stag parties keen to be on the business end of a Kalashnikov assault rifle, both domestic and foreign aircraft maintenance providers have set their sights firmly on capitalising on the low maintenance, repair and overhaul (MRO) labour rates in the region – estimated to be roughly about half those of western Europe.

Swiss-based maintenance provider SR Technics has recently confirmed it is studying the joint establishment of an aircraft engineering and service centre at Riga airport together with private Latvian aviation company Concors.

Concors, which already operates chartered and scheduled services with a fleet of Soviet-built types, has been working to establish a maintenance centre for Western-built narrowbodies – and has been recruiting and training its future workforce in anticipation of the deal.

Under the proposed joint venture, the two companies are planning significant investment to provide line, base and heavy maintenance for Airbus and Boeing narrowbodies as well as technical training and possible future component and technical management services. Concors is constructing an additional hangar for three narrowbody aircraft to be fully operational by mid-year and plans to begin C-check work from the third quarter. The strategic business plan also foresees the construction of a widebody hangar to be built in around five years’ time.

A Latvian centre not only allows SR Technics to make significant inroads into new maintenance contracts in central and eastern Europe, with many local airlines having ordered a significant number of Western-built aircraft, it will also help fulfil its long-term strategy to perform labour-intensive narrowbody maintenance work where it makes most sense – and with partners where necessary.

Declan O’Shea, SR Technics executive vice-president of sales and marketing, says the business assessed around 40 different MROs within the region as part of its eastern European strategy. “We determined that Concors was exactly the right fit. Essentially, we can come in and contribute our management expertise, quality systems and customer focus,” he says.

Growing opportunity

The reason is clear. “With more and more Western-built aircraft operating in the CIS and Russia, there is definitely an opportunity to service this growing market as the number of Western aircraft going into that region just cannot be serviced there.”

Concors chief executive Sergey Ratnikov confirms this. “Our first clients will be airlines from Russia and CIS. The aircraft market of these countries has huge potential. In the next five to seven years, the majority of Soviet-built aircraft will be replaced by Western aircraft. The Russian aircraft industry is not able to fulfil this demand for aircraft. As a consequence, in several years there will be a high demand for maintenance of these fast-growing aircraft fleets.”

The regional strengths in labour-intensive airframe heavy maintenance have long been touted as a prime partnering opportunity for major MRO providers and a future overspill of existing client work is not being discounted by O’Shea.

This is a significant statement since the jewel in SR Technics’ crown remains its $1 billion 10-year contract with UK budget carrier EasyJet, which opted last August to retain the company’s line, light and base maintenance services for an Airbus A319 fleet set to grow to 120 aircraft by 2008.

The long-term deal followed an intensely fought battle and warnings issued by the UK carrier in late 2004 that it was considering MRO partners as far east as Turkey to perform all of the heavy maintenance on its rapidly expanding fleet.

At the time, EasyJet valued the deal at around $1 billion and said it provided a reduction in maintenance costs of more than 25% over the term of the contract, something which O’Shea attributes to the way SR bundles its services within its unique integrated airline solutions system.

“The joint venture with Concors gives us the option and, while we did not go about this because of the EasyJet contract, there would be potential benefits on several levels. EasyJet, however, would have to be happy with that,” says O’Shea.

The wooing of Concors proved an arduous exercise, with many a promising suitor such as CSA Czech Airlines, Ryanair, Singapore Technologies Aerospace (ST Aero) as well as SR Technics discussing different forms of co-operation with the Latvian business.

Aircraft maintenance in central and eastern Europe has shown rapid growth since the mid-1990s. Along with CSA, Aeroplex-Malev, Maersk Air, Tarom and various Lithuanian MROs are making concerted efforts to improve competitiveness and all boast well-developed infrastructures and a sufficient workforce of trained technicians and engineers.

Concors’ Ratnikov, however, points out that some of the more basic difficulties these central and eastern European MRO operators face should not be dismissed. “First, there is an insufficient level of English language skills and a lack of work experience with Western-built aircraft.”

There is also a frustrating “chicken and egg” scenario, according to David Stewart of consultancy Aerostrategy. “Virtually all MRO companies point to a lack of capacity in terms of both hangars and people. To win more work from western Europe, more capacity is needed and this will not happen without investment. The region’s MROs are dependent on parent airlines that are struggling with fierce competition and declining yields, so to justify the investment the parents need more customers.”

Investment difficulties

Tomas Heczko, executive vice-president technical for CSA Czech Airlines, agrees and says the investment for an additional hangar at its maintenance base in Prague – increasing available bays from three to five when operational later this year – was secured with “some difficulty internally”.

But, for an MRO business that does more third-party work for customers such as Air Berlin, Lufthansa and Transavia than maintenance on its own fleet, the future investment has to prove its revenue-generating merits.

“We are confident that we can fill this capacity increase with business from western Europe. We are, however, intentionally not focusing on any business further east from the Czech Republic as we believe there is intrinsically more risk, the most important aspect of which is the securing of payment,” says Heczko.

“The end price is not the only factor in a maintenance contract as it centres also on turnaround times and high-quality work. East of the Czech Republic there is more potential for lower pricing, but quality is not guaranteed. We think at CSA that we have struck the right balance.”

Details have also emerged about a joint $50 million aircraft maintenance project, to be located either in Latvia or Poland, between ST Aero and Irish budget carrier Ryanair. The fact that ST Aero is still in the game after missing out to SR Technics on the EasyJet and Concors deal must serve as proof that the region retains its attraction as a destination where low-cost MRO opportunities remain.

Ryanair says the project to establish a maintenance base in central Europe – which will be owned by Ryanair, but run by the partner company – will employ 1,500 staff and that it is in discussions with three airports to house the facility. Rzeszow in south-east Poland is thought the most likely of Polish locations.

Ryanair’s industrial rationale is obvious: the low-cost carrier intends to start expanding its operations in Poland, from serving eight airports this year to establishing three Polish bases, and serving 80 routes from 16 airports, by 2011 – at a time when there is a growing shortage of MRO capacity in Europe.

From April 2007, Ryanair says it expects to use the three- or four-bay Boeing 737 maintenance facility to carry out C- and D-check heavy maintenance on its own 737-800s. In addition, the plant will offer third-party heavy maintenance on widebodies, although Ryanair will not have equity in this part of the business.

High labour costs have long forced western European MROs to look to their laurels, and resolve the endless hard-fought price-driven battle to hang on to labour-intensive airframe maintenance. Lufthansa Technik (LHT) anticipated the trend of shifting narrowbody MRO work from central Europe to eastern or southern regions such as Hungary or Malta and will in June celebrate the fifth anniversary of its Budapest subsidiary, a joint venture with Hungarian flag carrier Malev.

Hunting grounds

LHT admits to eyeing Russia and the CIS as maintenance-rich hunting grounds and has been orienting itself as an important partner in technical servicing for airlines operating Western-built aircraft since the 1990s, supporting not only the daily operations, but especially the phase-in of Western-built aircraft such as the Airbus A310/A320 family and Boeing 737, 757, 767 and 777.

LHT’s approach is underpinned by a rationale of helping develop the technical capacity of airlines in the region, nurturing self-sufficiency, as typified by its latest contract win with KrasAir, Russia’s fourth largest carrier, to provide component support for the carrier’s 11-aircraft 737-300 Air Union fleet, from the carrier’s hubs in Krasnoyarsk and Moscow Domodedovo.

This followed April victories, including at Polish low-cost carrier Wizz Air, where LHT signed an expanded component and maintenance support contract for the airline’s growing fleet of A320s and full-care support with components for Star Alliance member LOT Polish Airlines’ Embraer regional jets.

“On the basis of our existing partnerships – and of course for new start-up airlines and fast growing carriers – we are ready to give further support to an aviation market that is bound to grow in the course of the coming decade. Our commitment to the region will stay strong and will support the striving for a higher degree of self-sufficiency,” says Dmitri Zaitsev, LHT’s regional director eastern Europe and CIS.

LHT is still planning for the maintenance peaks in around six years’ time following the recent influx of Western aircraft and has not discounted the possibility of developing closer links in the absence of any heavy maintenance capacity in Russia. “When the right business opportunity presents itself, we would possibly consider a joint venture with a partner airline bringing its own aircraft,” the company says.

Aerostrategy’s Stewart notes, however, that on the basis of interviews with central and eastern European MROs, the growth of airframe heavy maintenance business from western Europe is expected to remain the most fruitful source of future business.

“The growing Russian/CIS fleet is seen as a short-term opportunity,” Stewart says. “Airlines will want start-up support and expertise, but with even lower labour costs, they will want to bring work in-house quickly. Strategic outsourcing by large carriers to reduce costs may look to the region for supply – but the question remains: who has the capacity? Increased volumes from western Europe are perceived by MROs in this region as the major opportunity, but the cautionary note they sound is that it will only happen if they get the investment and additional hangars and people.”

Volga-Dnepr centre

Stewart’s research seems to be borne out. Russia’s Volga-Dnepr Group only last month said it was aiming to establish a 747 maintenance centre at its Ulyanovsk base later this year to offer third-party servicing, and even conversion work.

The centre would initially perform work on the three 747 freighters of its scheduled division AirBridge Cargo, which now uses LHT for its maintenance – and another three 747s are on order. Under the second phase of the project Volga-Dnepr could begin offering services, including C and D checks, to third-party carriers, while a third phase could see the launch of freighter conversion work.

“With a fleet of six aircraft it is sensible to go for in-house maintenance,” says AirBridge Cargo managing director Denis Ilyin, who points out that other Russian carriers, such as Transaero, are introducing 747 operations. “Our first incentive is to reduce costs. It’s quite a project on its own, but I’m sure we’re able to do it.”

Stewart predicts a secondary phase of industrial consolidation that will follow in the wake of the formation of super groups such as Air France Industries/KLM, SR Technics/FLS and TAT/Sabena Technics, all of which will seek out their own low-cost sources of airframe maintenance as acquisition targets. “It is possible that a number of western MRO suppliers will follow the Lufthansa Technik Budapest route,” says Stewart.

Fragmented work

But for the near term, Stewart believes the MRO landscape will be dominated by fragmented try-out opportunities, with small bundles of work on limited numbers of aircraft put out to tender to the central and eastern European MRO community.

CSA’s Heczko agrees: “We‘ve definitely seen this sort of shopping behaviour and we have increased the frequency of distributing RFP quotations, especially where we have had no previous contact with that customer.”

Stewart concludes: “The prevalent behaviour is for airline customers to ‘shop the checks’, shopping around to see how low MRO prices can go, and you can bet that there will be many small victories and skirmishes along the way.”

AIMEE TURNER / LONDON

Source: Flight International