The AiRUnion airline alliance led by the country's fourth largest carrier, Krasnoyarsk Airline (KrasAir), is largely composed of airlines in which KrasAir's senior management, twin brothers Boris and Alexander Abramovich, exercise either control or influence through stakes held by associated investors. Although of late, the alliance that includes KrasAir, Domodedovo Airlines, Samara Airlines, Omskavia and Sibaviatrans, has begun to add to a number of regional airlines in which the brothers do not exercise particular influence, including Bashkir Airlines and Far Eastern carrier Sakhalin Airlines, which have announced their membership of AiRUnion over the last few weeks.

The new alliance represents a substantial and growing share of the Russian airline market carrying well over 1.25m passengers in H12005 (3.48m 2004), out of the 14.7m carried overall in the first half of 2005 by Russian carriers. The largest carrier in terms of combined domestic and international traffic being Aeroflot, which carried 3.74m passengers in H12005 (6.64m 2004), struggling against a background of slowing traffic in the domestic market in particular, as fare hikes driven by increased fuel costs dissuaded Russians from travelling with a commensurate impact of the carrier's first half earning that fell by over 20%. The soft market encouraging the Russian Government to continue to push for the consolidation of the sector on the grounds in an effort to remove the unviable or in may cases terminally ill among Russia's medium sized carriers.

The larger national players (Aeroflot, Sibir, KrasAir, Pulkovo Airlines), with access to Western aircraft, have rendered the regional carriers increasingly uncompetitive after years of inadequate investment in both infrastructure and efficient fleets. The lack of efficient aircraft having become particularly evident over the last 12 months as aging fleets of Soviet era aircraft have exacerbated the impact of massive increases in fuel on carrier' costs. In some cases lifting fuel as a proportion of carrier's operating costs to over 70%. The lack of access to modern aircraft leaving carriers severely handicapped in addressing the issue of costs, when a maturing market is bringing them into head to head competition with larger national carriers. The latter airlines expanding out of their traditional markets and looking for increased coverage in a Russian market that in H12005 looked stalled with growth of only 1.8%.

Despite a decline in passenger numbers of 8% in the first half of 2005, AiRUnion reports that its central management of the alliance's combined fleet of over 104 aircraft and helicopters has allowed both a substantial improvement in utilisation of the fleet and significant reductions in costs. Aircraft resources says the alliance, are being more efficiently employed, with routes previously serviced by aircraft that were either too large or too inefficient for the task, replaced with more appropriate aircraft. The changes having resulted in the virtual elimination of the notoriously thirsty Il-62s and with it the closure of some routes serviced by the aircraft. Sacrificing, according to AiRUnion, previously loss-making traffic in favour of profits. The centralising of fleet planning, argues AirUnion, generating savings of Rb 1billion ($35.7m) in operating costs in H12005 alone.

While the alliance says that as a whole it has reaped benefits from the changes, the impact of the changes on individual carriers in terms of traffic, has been marked, with routes either abandoned or reassigned to other alliance members. With DAL, the alliance's predominantly domestic long haul carrier, seeing its traffic fall by 16.83% in the first six months of the year as loss making routes operating the Il-62 were either dropped or transferred to other carrier to be flown by more appropriate aircraft. A similar situation was recorded at Samara Airlines where volumes fall by 13.98%.

The alliance argues, as has Aeroflot in the past, that it is no longer concerned with the simple protection of market share at any cost, and if it does not have the appropriate equipment it is prepared to drop unprofitable routes or reduce services while building a sustainable network based on the development of its three hub based strategy around airports in Moscow, Krasnoyarsk and Samara. The decision to go for the three hubs is in itself a departure from conventional wisdom of the two major carriers that have focussed operations on Moscow, Sibir having establish the city at the centre of its network over its historical base in the Siberian city of Novosibirsk. The strategy has however, been questioned by some commentators who see it as a potential dilution of traffic and loss of mass, but given the gathering breadth of the AiRUnion network as new members join, and its improved ability to capture passengers at point of departure. Linked with the government's plans to given substantial direct assistance to the development of a number of key hubs including those chosen by AiRUnion. It does on a top line assessment appear to pose a competitive threat to those carriers that have previously focused on carrying the bulk of their regional passengers through Moscow to destinations both domestic and international.

The question remains however, how does the alliance, as presently constituted, continue to develop and address the two key issues of structure and finance. The AiRUnion alliance as presently constituted, poses a series of challenges under current Russian corporate law and civil aviation licensing. The alliance says that it is therefore examining the merging of the various airlines without risking their route licences, but removing the alliance's members from the Byzantine and inflexible system that governs the operation of those licences in Russia. A merger of at least the airlines where the Abramovich brothers hold sway into a single entity, in theory would see the state as a major shareholder in a new venture, given its holdings in KrasAir (51%), DAL (50.04%) and Samara (46.9%). But according to reports, AiRUnion management would rather see it as a blocking shareholder with a 25% + holding, as opposed to the control it would exercise if the state owned airlines alone were merged as had been proposed. A state controlled airline generally viewed as being unacceptable to those involved, given it is considered to be a deterrent to attracting investors rather than an encouragement. In August 2005 Boris Abramovich sent a letter to the Ministry of Transportation requesting the merger of KrasAir, Omskavia, Samara and DAL into a single entity, arguing the airline existed de facto and therefore should do so de jure. The Ministry is reported to be reviewing the proposal, but there are reported to be concerns within Government, as with so many other Russian partial privatisations, that restructuring would dilute the state's interest.

While the issues of ownership remain in negotiation and under review by the Russian Government. AiRUnion's infrastructure is operating as a single carrier with its ticketing, sales and booking operating through the Sirena 2.3 booking system previously used by KrasAir and now used by all the carriers in the alliance. The latter group having moved from the previously used Sirena 2000 for reservations with a common tariff structure. The alliance to Russian customers at say management, feeling like a single carrier despite the differing codes, although it is accepted that continued separation between carriers poses a problem internationally were each airline in the alliance is regard as independent and dealt with accordingly.

For many market observers however, the major question is not whether the alliance can move from alliance to single entity, but whether the alliance has the resources to fund and manage such a development. The Abramovich brothers have proved capable in the past of mustering sufficient finance to acquire stakes in carriers and have recently surprised many by being prepared to take on a large section of Hungarian flag carrier Malev's debt in the ill fated privatisation tender. The airline is politically well connected and Boris Abramovich is reported to have strong links with the financially liquid metals producers in the Krasnoyarsk region, as well a growing reputation with the Western sources of finance such as the EBRD. So on the limited information available, which for investors must be a concern, finance does not appear to be an issue. Leaving the key element in the creation of a viable entity, an expensive fleet renewal, well in hand. With reports suggesting that Western lessors are already beating a path to the carrier's door as it reveals plans to seek fund for the acquisition of new Western aircraft to add to the 12 737s and additional 767s already planned.

Perhaps the major issue outstanding for most commentators is can AiRUnion manage the merger of so many diverse elements over a relatively short time period? With the exception of KrasAir, none of the airlines being incorporated into the new structure are what could be described as outstanding and in some cases, the uncharitable would argue the alliance has saved them from disappearance through slow decline or more rapid bankruptcy. Can the Abramovich management stitch these carriers into a single entity capable of competing against two well-honed competitors in the form of Aeroflot and Sibir? The challenge significantly different to that of Sibir as it rose to prominence in the sector. Sibir having simply cherry picked the assets and staff from the crumbling remnants of Aeroflot leaving behind the structures and obligations following the break up of Soviet Aeroflot in the mid 1990s, to build its fleet and network and its current position of the largest domestic carrier.

To date the alliance, not unsurprisingly, reports that the process of merger has been relatively smooth. But as it absorbs carriers where KrasAir has no direct equity leverage, the task may prove to be more difficult. Management have yet to prove their ability to make the whole show work as one particularly with large numbers of expensive Western aircraft. The first six months of 2005 appear to have offered some sense of a management team with at least a first phase of an operational strategy. Others in frequent contact with the management of KrasAir however, have less confidence in their ability to manage the process. Pointing in particular to the recent Malev involvement as an example of tendency of the airline's management to overstretch itself and be easily distracted from the task of consolidating what it has already acquired.