Transaero has not quite shaken off the past. A strategy which has flirted with the purchase of TWA and looks to a 15-year-old Aeroflot timetable for guidance on route planning may offer little comfort to the western financiers needed to carve the Moscow-based carrier's niche a little deeper.
Transaero captures all the classic features of a fast-growing, thinly capitalised carrier. Confidence is high and expenses are rising. Opportunities are limitless and failure is, well, possible.
Alexander Pleshnakov, who co-founded the airline in 1993 with Greg Gurdavoy, has built an impressive operation which faces its greatest strategic dilemma. The international market which has fuelled its rapid growth remains buoyant but highly competitive. The airline still lacks traffic rights to many key destinations while Lufthansa, Swissair and Austrian Airlines have made substantial inroads through direct services to the Russian hinterland. But the domestic market in which Transaero enjoys a competitive advantage remains sluggish.
Pleshnakov moved from the director general's role to chair the airline following the departure of Gurdovoy in July to set up his own project management business. The switch at the top is expected to lead to a strategic focus on the domestic side at the expense of international expansion.
However the Russian domestic market has been in freefall since the collapse of the Soviet Union in 1991: passenger numbers fell by two thirds between 1991 and 1996. While the international market has proven more robust, total passenger traffic reached 3.8 million last year, still well short of the 4.7 million in 1990.
Pleshnakov says that while increasing frequencies and on-time performance have helped Transaero achieve preferred status in the domestic market, it has been held back by high price sensitivity. 'The passengers which are left in the market are generally frequent flyers,' he says. '[This year] we have seen a tendency for passengers, especially business flyers, to pay attention not so much to service quality as to price.'
The reluctance of the domestic market to rebound or respond purely to improved service quality is a source of frustration for Transaero, which had sought to establish its niche through the addition of a quality business class product and a frequent flyer programme.
In February the carrier attempted to kick-start the market by piloting a new fare structure on the dense Moscow-Novosibirsk route, where it competes with two other carriers and rail services. The new system involved 10 fare levels and halved average tariffs, taking them below the cost of the rail trip. Passenger traffic on the route had followed the national average with a 10 per cent drop before the pilot scheme was launched. It rebounded with a doubling of traffic in the four months to July, with passengers switching from rail and more travel by existing flyers.
Pleshnakov says the Novosibirsk experiment was the catalyst for the extension of a new domestic fare structure through the network.'It brought an understanding that the time was right to change and introduce affordability as our motto,' he says. Before, Transaero was seen as expensive. 'We believe that the market will start growing strongly in two years and we want to be prepared to catch it,' he adds.
Though stimulating the market through discounting has a commercial logic, in the stagnant domestic sector it has its risks. Transaero's motivation stems from its call on a domestic economic recovery married to its own capacity increases. Load factors on domestic routes run between 60 and 70 per cent.
Pleshnakov believes there is pent-up demand in the country to fill the current capacity but not at current prices. 'We were the first carrier in Russia to offer more than one economy fare and we now have 12-15 different fares. We are trying to evolve rates to increase volume.' Fare groups have been expanded to include tariffs for children, the elderly and newly-weds.
The Novosibirsk experiment has led to a McDonnell Douglas DC-10 replacing a B737-200 on the route. Head of marketing Sergey Gratchev argues that the potential remains in the system to add substantial capacity on routes which have withered since the economy has plunged into freefall, losing 50 per cent of GDP since 1991. Gratchev points to an old Aeroflot timetable as a reminder that the former Soviet Union supported a large number of sectors on which 250-seat aircraft operated three or four daily services. Few need reminding that Aeroflot didn't make any money from these operations. 'The market is in transition,' argues Gratchev. 'First half data shows that it has stabilised and the experience on Moscow-Novosibirsk shows that real and potential demand are very different.'
Gratchev says attempts to expand the revenue base include targeting the corporate market. An agreement with Norilsk Nickel, the recently privatised metals giant, illustrates the potential to capture higher-yielding business traffic through Frankfurt, one of Transaero's main overseas destinations. Deals are also being discussed with the European Bank for Reconstruction and Development and other European or US companies.
Pleshnakov declines to identify the impact of the revised fares on domestic yields. But insiders argue Transaero has sufficient computer support to model and manage the changes. As yet it has no formal yield management system though this may come, says Gratchev. The parameters of the system have been set up but the airline will seek to build its own system rather than purchasing a custom-built package, he says.
The domestic focus is one of four strands in the Transaero strategic manual alongside fleet restructuring, strengthening the balance sheet and securing alliance partners. Pleshnakov has made little secret of his desire to build up the fleet rapidly and announced, a little prematurely, a planned $1 billion restructuring in early 1996. Eighteen months later the statement carries a little more weight. The current fleet includes three owned B737-200Advs, three B757-200ERs (leased from ILFC), three owned DC-10-30s and a single Ilyushin Il-86. He aims to standardise the fleet around Boeing equipment with the possible addition of the Il-96.
The first step is a contract to lease two B737-700s from Germany's Bavaria Leasing for eight years from January 1998. A B767-300ER is due to arrive from ILFC in March on an eight-year lease followed by a second in November. These will be used primarily for long-haul domestic services and will replace the DC-10s within two years.
The B737-200s will be phased out, probably by the end of 1999, and up to four more B737-700s may be leased in the next two years. The -700 market is a lessee's domain at present owing to the speculative orders from a range of lessors including Pembroke Capital in Dublin and GATX, both of which are talking with Transaero. These aircraft will be introduced on medium-range sectors including Irkutsk, Omsk, Ekaterinburg, Alma Ata, Tel Aviv and Berlin.
The second phase of the restructuring includes the purchase of 20 more aircraft: four new generation B737s and four B767s in 2000 with four more B757s and two B767s the following year. The letter of intent to take six Il-96Ms, two a year from 2001, looks more flexible. Pleshnakov says the final decision will be based on the experience of Aeroflot RIA with the aircraft in terms of performance and financing and no decision is expected to be made before 1999. Aeroflot is already working with Citibank to arrange western funding.
Pleshnakov is committed to rebuilding the Transaero balance sheet by purchasing rather then leasing the second phase aircraft. He says negotiations are continuing with a consortium of banks, including five of the largest Moscow banks, to cover initial downpayments. Finance charges are going down. Average annual interest on foreign currency borrowings was 107 per cent in 1994, 35 per cent last year and 18 per cent this year. Though no formal application has been made, Pleshnakov aims to secure guarantees for $60-70 million from the US Eximbank.
Pleshnakov says long-term debt is around $30 million (and falling) and is covered by paid-up share capital of just $20 million, though the former does not include capitalised operating leases. Earlier this year the airline aborted a planned $150 million private placement which would have given an unidentified investor a stake of up to one-third in the carrier. Pleshnakov says he was almost burned by the experience and is cooling off. He says the carrier will launch a small initial public offering in the domestic market next year and will also evaluate international investors through eurobonds or American depositary shares. Transaero's ownership is split 70:30 between personal and corporate investors with Pleshnakov holding the largest stake, believed to be 40 per cent.
Transaero's attraction to investors will be boosted by its financial performance. Sales in the first half of 1997 climbed 56 per cent to R1,194 billion ($203.1 million) while operating profits quadrupled to R214 billion ($37.5 million) bringing a net surplus of $18.8 million.
Pleshnakov says annualised sales are forecast to reach $315 billion this year compared with $249.2 million in 1996. Net profits reached $19 million last year and $4 million in 1995 and are forecast to total $57 million for 1997. Pleshnakov says the carrier aims to add $120-130 million a year to sales in each of the next three years with a target of exceeding $1 billion by 2003.
Passenger numbers are expected to reach between 1.6 and 1.7 million for the full year, compared with 1.48 million in 1996. In the eight months to 30 July passenger numbers rose 9 per cent to just over 1 million. Scheduled traffic accounted for almost 90 per cent of passenger numbers and departures climbed 26 per cent. Meanwhile charter flights were cut by 41 per cent in the first half.
The second strand of the domestic strategy is the creation of a feeder network to four planned hubs through a wholly owned subsidiary, Transaero Express. The company currently operates executive charters but would be re-equipped with two Il-114s and, perhaps An-140s. Western aircraft are also being looked at to operate 200-400 mile sectors.
The current network splits evenly between domestic and international sectors, including those in the former CIS. To the west it operates to Frankfurt and, using the traffic rights of its Latvian affiliate Riga Air, to Paris and London. Plans for a Manchester service were dropped earlier this year but Transaero expected to open Strasbourg direct in October. Its single weekly US route to Los Angeles, operated over the Pole with a DC-10, broke even in July and the next summer schedule may increase services to three a week. A New York route via London/Stansted is being evaluated but remains caught in the bilateral stalemate between the UK and US.
The intense competition from western carriers has slowed attempts to forge alliances and the folder so far includes just a preliminary memorandum of understanding with American Airlines on the LA route.
Transaero still lacks designation to the UK, requiring the Riga changeover. The US refuses to designate a second Russian carrier to New York following Russia's reluctance to allow United to codeshare with partner Lufthansa through Frankfurt to Moscow, and a simmering dispute concerning overflight rights and charges in the Russian Far East.
The bilateral situation has led to an agreement to take a 30 per cent stake in privately owned Riga Air for a nominal $10,000. Transaero has already invested $5 million in the carrier, which it hopes to restructure into a regional operator when the bilateral obstacles to its own expansion are lifted. Route analyses with the Canadair RJ and Fokker 100 have already been undertaken to study the use of Riga and its modern, but underused, airport as a hub for services to Scandinavia, central Europe and Russia. However the Baltic market is already crowded with SAS, its affiliate Air Baltic and Finnair up against indigenous Estonian Air, Air Lithuania and Lithuanian Airlines.
To the east Transaero operates once a week to Hong Kong and has authority to Taipei, though this is unlikely to be used before the end of next year. Beijing and Shanghai are also being considered. Aside from the fleet modernisation, Transaero's main competitive advantage is the centralisation of its operations at Moscow/Sheremetyevo airport, allowing connections between domestic and international services. Aeroflot RIA still splits most domestic flights into Domodedovo and Vnukovo, both a 60km hop from Sheremetyevo.
Transaero is already working with the airport authority, control of which has passed from the state to Moscow city, to streamline customs processing and hopefully achieve a similar reform of passport formalities. The first phase of reconstruction - the departure area - was completed in July.
While all the building blocks are in place for Transaero to pursue its $1 billion annual sales target, the hoped for rebound in the domestic market remains a gamble. The only certainty is that the domestic business is heading for further consolidation as capacity continues to leave the market.
'In two to five years I feel we will have three to five big airlines with wide domestic networks plus scheduled international routes,' says Pleshnakov. He says the first tier will average 1.5-2 million passengers a year followed by a tail of 10-20 mid-sized, mainly regional, airlines. 'These two groups will represent 85-90 per cent of all traffic.' Pleshnakov has little doubt that Transaero will be in that first tier, alongside Aria and domestic carrier Vnukovo. His confidence is beguiling. But Transaero insiders insist that the TWA bid (which was never formalised) held little sway with the new chairman. This is just as encouraging.
'In two to five years I feel we will have three to five big airlines with wide domestic networks plus scheduled international routes,' says Pleshnakov. He says the first tier will average 1.5-2 million passengers a year followed by a tail of 10-20 mid-sized, mainly regional, airlines. 'These two groups will represent 85-90 per cent of all traffic.' Pleshnakov has little doubt that Transaero will be in that first tier, alongside Aria and domestic carrier Vnukovo. His confidence is beguiling. But Transaero insiders insist that the TWA bid (which was never formalised) held little sway with the new chairman. This is just as encouraging.
Source: Airline Business
