INSIGHT: Why Russian carriers curtail business-class

The ongoing economic crisis, which shows no signs of abating, has seen the demand for premium air travel services plummet. Russian carriers are now attempting to mitigate the noticeable disparity between their economy- and business-class passenger numbers. The so-called intra-Europe business class concept has failed to catch on in Russia, devoiding carriers of operational flexibility and forcing them to overhaul their cabin layouts. The low demand has seen the total number of business-class seats in the country shrink 20% in the past 1.5 years, and many airlines are discontinuing the class completely on short-haul routes with flight times of up to two or three hours).

By Alexey Sinitsky and Andrey Kramarenko

As is always the case with economic crises, this current one hit business-class air travel particularly hard. Commercial customers and government agencies have been cutting back on travel expenses, restricting business-class entitlements to more senior employees and going with economy tickets on shorter-haul routes. The previous crisis, of 2008-09, turned out to be short-lived; the demand for premium air travel quickly rebounded on the back of the rapid 2010 economic growth. The primary difference of the current crisis is that it is more profound and longer lasting: nearly two years on, it is still unclear whether or not the recession has reached its nadir yet. The continuing imbalance in the demand for economy and business-class services is prompting carriers to take radical measures, such as reducing the count of premium seats or discontinuing business-class services altogether on short-haul routes.

In between the two crises, the Russian carriers observed an uneven growth of demand for economy and business-class travel. The majority of new passengers were tourists; as a result, after several years of expansive growth in passenger numbers, the economy-to-business ratio changed significantly. As the new crisis began, many corporate clients warmed to the idea that their employees might just as well fly economy on short-haul routes. This caused a further decline in demand for premium services on flights lasting up to two or three hours.

The industry reacted in a radical way. After Transaero Airlines folded, and its capacity left the market, the combined total of available business-class seats for the country’s top six airlines (including Transaero) shrank 20% compared to November 2014. Within a period of 1.5 years, all the major carriers reduced the number of business seats offered, and the continuing searches for a new balance in cabin layouts indicate that Transaero’s passengers have not switched to the remaining leading market players in any noticeable way. The combined share of business-class seats for the five largest operators (for the exception of Transaero) has declined from 8.1% to 7.1% of their total combined seats (see Fig. 1). In fact, all Russian airlines without exception have reduced their business-class seat count to this or that extent.

(Fig. 1) Change in the share of business-class seats in top-5 Russian airlines’ capacity from November 2014 to May 2016

The main factor behind the shrinking premium demand is the economic crisis, which is making corporations cut down on the more obvious expenses (after all, as the old joke goes, first- and third-class passengers arrive at their destination at the same time). Seeing as there are no signs of the macroeconomic situation improving any time soon, carriers have no illusions about the premium demand restoring back to normal in the foreseeable future. One important contributing factor here is that Russian government agencies and public service organizations have been restricting their employees’ access to premium air tickets when traveling on business.

Back in the mid-2000s, Aeroflot – Russian Airlines, a strong leader on the premium market, would have its new airliners delivered with more business-class seats than the global average, which stood at around 8% of all seats at the time. Aeroflot’s Airbus A319s and A321s had 17% business-class seats, and its Airbus A320s and A330-200s, 14%. The carrier would use its empty business-class seats to upgrade loyalty program members from overbooked economy. In Aeroflot’s recently delivered airliners, the share of business-class seats is considerably lower: 14% for the Sukhoi Superjet 100s, 13% for the Boeing 737-800s, 9% for the Airbus A321s, 7.5% for the Boeing 777-300s (plus 12% premium economy seats), and just 5% for the Airbus A320s. The airline has passed its Airbus A319s on to subsidiaries Rossiya and Avrora, which operate them with just 6% business-class seats. S7 Airlines, for its part, has converted all its A319s to all-economy, and its new Boeing 737-800s have 4.7% business-class seats, against 7.2% previously.

In effect, Aeroflot remains the only Russian carrier whose business-class capacity represents a noticeable slice of all seats available (11.2%, against 12.4% at the time the current crisis struck). For the other four of the five largest airlines, the figure varies between 1.7% and 4.1% (see Fig. 2).

(Fig. 2) Top-5 Russian airlines’ capacities by service class at May1, 2016

Unfortunately, the so-called intra-Europe business class model has failed to take root in Russia. The idea of the model is to attach premium status to standard blocks of economy-class seats, in which the middle seat’s functionality is disabled (with sliding armrests and more legroom the only available perks if you are lucky). This concept is extremely convenient for airlines, allowing them to reconfigure the cabin with nothing more than a moveable class divider, but passengers do not appreciate the idea at all. The level of business-class services in Russia is set by Aeroflot, and the other carriers are having to count with that. Following failed intra-Europe experiments, they are now either reintroducing wide, comfortable premium seats or abandoning the business class altogether.

Pavel Permyakov, CCO at UTair – Passenger Airlines, says the intra-Europe concept has not been popular with passengers: “We believe this is because of the business-class policy adopted by the largest domestic market player [Aeroflot], which currently offers a certain level of services, thus setting a standard in the premium class. Passengers expect a similar level of service from the other carriers. We have set course towards developing a new business-class offering by installing more comfortable seats on 10 of our 737-500s, and this is only the beginning.”

S7 Airlines in April this year fully discontinued business-class services on its Airbus A319s, which mostly fly short-haul (up to 2.5 hours in the air) between Moscow and destinations in European Russia and the CIS. The operator explains the decision not just by the changing business travel policies of many commercial customers but also by the growing demand for economy tickets caused by the carrier’s transition to a new pricing system. Doing away with the two coat stowages and two business-class seat rows allowed S7 to add three rows of economy seats, increasing the total A319 seating capacity from 136 to 144. It is worth noting that S7’s single-class layout does not imply intra-Europe business-class seats.

Ural Airlines’ 11-ship Airbus A321 fleet is in all-economy, 220-seat configuration; two of the carrier’s 19 A320s seat 160 all-economy passengers (the remaining 17 airliners have two-class cabins). Ural Airlines uses its A321s on scheduled routes, which generate significant tourist flows, so all-economy cabins are fairly justified there (apparently, the two all-economy A320s are required for more flexibility in redistributing capacity among the different routes depending on demand). The carrier’s two-class airliners serve city pairs with a more sizeable share of business travelers.

The slumping premium demand is not the only problem facing the carriers. According to our estimates, Russian regional airports in 2015 earned some 2 billion rubles ($28.7 at the current exchange rate) serving business travelers on domestic routes, and a further 0.3 billion rubles serving them on international routes. Carriers justly believe that the prices charged by regional airports’ business lounges are excessively high prices. Business travelers have turned into milking cows for airport operators, who are using them for maximum profit with minimum costs involved. In 2014, the average bill lounges exceeded 3,200 rubles – twice the sum charged at European airports, even at the current exchange rate.

Since the crisis hit, prices at many airports’ business lounges have grown 20-25%, making many business-class fares unprofitable for carriers. One more factor here are frequent flier programs, whose gold and platinum members are allowed into airport business lounges (and may bring one guest along free of charge). The number of such passengers passing through regional business lounges is roughly double of the number of business-class passengers. This boosts lounge operators’ profits while taxing the budgets of the airlines, which are left to pick up the tab. In response, first Transaero and then S7 Airlines introduced business-class fares which did not include access to business lounges. It is possible that in the future, members of frequent flyer programs may also be denied business lounge services at the most expensive airports.