Air Baltic and Estonian Air have similar strategies, but is there room for both?
One of the few promising airlines in Eastern Europe until its near-collapse last year, Air Baltic is slowly returning to financial stability and rebuilding its strategy—and now it faces new competition from Estonian Air.
Both Air Baltic and Estonian in turn are challenged by low-fare airlines, although their exposure is still below the European average. And they are squeezed between much larger carriers such as their former parent SAS Group, as well as Finnair and LOT Polish Airlines, which are trying to feed their hubs with traffic originating in the fast-growing Baltic economies.
When former Malev Hungarian Airlines CEO Martin Gauss joined Air Baltic as interim CEO last year, he put the company through a fast-track analysis and came up with a number of options: immediate closure, doubling of the fleet or consolidating. Latvia’s government did not like the first two options, but wanted to retain a local airline, even if it meant more losses would accumulate before a turnaround could be accomplished. The decision to step in as a majority shareholder and rescue the airline from imminent demise is expected to pay off in the long term.
The Latvian government had long been in a dispute with minority shareholder Baltic Aviation Systems (BAS), a financial vehicle set up by former CEO Berthold Flick. In spite of its minority-shareholder status, BAS effectively had full management control. But when it could not participate in a desperately needed capital increase, its stake fell back to the government.
Air Baltic has not only been one of the few promising carriers in the region, it is also one of the few that was set up (in 1995) after the fall of the Soviet Union. It did not have links to Aeroflot, which forms the basis for many of today’s national carriers in the region. While Air Baltic initially focused on local traffic, it changed its strategy fundamentally in 2008, when the Latvian economy collapsed overnight.
In order to maintain its size and even expand, Air Baltic turned its focus to connecting traffic through Riga, building the airport into a hub for the Baltic region and Eastern Europe. But with local demand dwindling, the carrier had to buy itself into new markets with low fares. «Routes were opened without proper analysis. It was a period of wild expansion,» says Gauss.
He launched a restructuring aimed at bringing the airline back to profitability by 2014. The plan calls for some deep cuts, including a 15% reduction of Air Baltic’s workforce and paring its fleet to 22 aircraft next winter from the current 34. These steps mean the carrier will grow only marginally in the next five years. Annual capacity will rise 3.4% at a time when analysts expect the Baltic aviation market to increase 7% annually, the highest growth rate in Europe.
«We will intentionally give up market share,» Gauss says. The connecting model is not being abandoned, but priorities are shifting. Forty percent of Air Baltic’s passengers will connect in the future and 60% will board locally. Ten of its 70 routes have been discontinued.
The airline’s fleet, comprised of four aging types, will undergo significant changes. All 10 Fokker 50s will be permanently parked at the end of the summer, even though some leases continue into 2014. Gauss calls them «our bad bank.» Bombardier Q400s will replace the Fokkers, and three more Q400s will be purchased directly from the manufacturer or leased.
Air Baltic has leased out its two Boeing 757s and is weighing how to replace its Boeing 737 Classics—the board of directors will choose between the Boeing 737-700 and Airbus A319. Gauss remarks that A319 availability is very good now and lease rates are affordable, as Easy Jet and Air Berlin are putting many relatively young used aircraft on the market.
Aside from its financial problems and shareholder struggles, Air Baltic has been one of the most creative airlines in terms of increasing product and ancillary revenues. From their seats, passengers can buy vouchers to purchase cars or order flowers. Food available in flight is organic and sourced locally. In addition, Air Baltic has deployed a fleet of rental bikes in Riga and helped launch another taxi franchise to improve the local service. Gauss says he supports that creativity, but adds, «I’m also the one who tells people that at the end of the day it’s [earnings before interest and taxes] that counts.»
Air Baltic’s only local competitor in the Baltic states is based in Tallinn, Estonia, just a 30-min. flight away. Estonian Air hired Air Baltic’s former chief commercial officer, Tero Taskila, as CEO in 2011 with the expectation that he would help improve the local air transport infrastructure.
«Estonian Air is now like Air Baltic in 2004,» says Taskila. «We are running behind.» But if his business plan works, the airline will grow close to the size of its competitor. Estonian wants to operate a fleet of about 20 aircraft by 2020, not many fewer than Air Baltic.
However, unlike its Latvian rival, Estonian Air is phasing out narrow bodies in favor of Embraer 175s and 190s. The airline is also considering ordering Bombardier Q400 or ATR42/72 family aircraft.
Taskila says it is «a clear shareholder objective» to achieve a sizeable network to promote business and tourism in the country. The Estonian government has been willing to invest in that growth. According to European Union legislation, governments can fund airlines, but they have to behave like a private investor would. The SAS Group retains a small stake in Estonian that is expected to be sold when the airline is eventually privatized.
Despite the domestic goals, the new CEO has rearranged the network to refocus on higher-frequency point-to-point services to European capitals. The share of connecting passengers is planned not to exceed 35%, far less than at Air Baltic.
Estonian has offered low fares, such as €39 ($48) for services to Stockholm or Helsinki. Taskila defends that approach, saying that the very low fares mainly apply to routes with competition from FlyBE Nordic and Ryanair.
The carrier’s current business plan projects that it will break even next year and achieve «a healthy profit» in 2014. However, Taskila admits that many uncertainties linger—such as high fuel prices and the weakening euro—that are affecting yields. If negative trends continue, profitability might not be reached for another several years. In theory, the airline will be privatized once it is firmly established, but the Estonian government has not given any clear guidance yet. Taskila says, «we need to get pretty before we can get married.»