It all looks so promising. Air connectivity has become the heartbeat of the global village, and by 2030, airports will handle some 10 billion passengers. There is strong growth in every region apart from the mature markets of North America and Europe, where high traffic levels already exist.
But in the shadows of the bright light of a booming business, lurks a disturbing truth – 70% of airports lose money.
Somewhat perversely, the key problem is that to make money, an airport must first spend huge sums to satisfy the increasing demand for its product.
For many, it’s a high-risk strategy. Airport assets are geographically fixed, need long-term viability to pay back investment and have no real alternative use.
Moreover, the demand for an airport’s product is largely outside of its control, depending instead on airline customers that operate very much in the short term. Business can disappear in the blink of an eye. About 20% of Europe’s active air routes change regularly, for example.
When coupled with the fact that 84% of European airports have a dominant carrier with over 40% of available capacity, it seems hardly surprising that the majority of airports never turn a significant profit.
“Airports are asset-intensive businesses that require large minimum investments just to accommodate a single landing,” notes ACI World’s economic director, Dr Rafael Echevarne.
“A single-runway airport can accommodate from one to over 30 million passengers. Thus, there is a critical mass that must be achieved before airports can start recovering the large operating costs and the infrastructure investments.”
With achieving critical mass a key factor, it follows that the profits that do exist are concentrated in the major hubs. Indeed, some 60% of airports worldwide handle less than one million passengers and it is rare for them to make money.
Squeezed from all sides, these smaller gateways have neither the economies of scale to drive down costs nor sufficient traffic to generate significant aeronautical revenue or commercial opportunities.
And, with increasingly tough regulatory and environmental pressures, they may not be able to grow their facilities, even if airline demand warrants it. Expansion approval is hard won.
By contrast, the major hubs tend to be a magnet for airline business, increasing airline charges and commercial potential.
But while “bigger is better” goes some way to explaining why the majority of airports are not in a position to make money, it doesn’t fully address the fundamental challenges that all airports face. The struggle to deliver sustainable airport profits runs much deeper.
Give and take
In simple terms, making money requires a two-fold approach: cutting costs and increasing income.
Trying to compare airport costs between gateways is almost impossible due to the many different operating models. Some airports provide ground handling, for example, others do not. Some lease terminal facilities to airlines while others do all the work themselves. And, some need to spend substantial sums on winter equipment and supplies, which is an alien concept to those operating in sunnier climes.
But as a guide, the UK Competition Commission assesses that approximately 82.5% of total airport costs are fixed. Much of this is tied up in capital costs – the building and equipping of new terminals, aprons and runways.
There are also the fixed costs of meeting regulatory requirements, such as safety and security. “There are a large proportion of costs that are not really controllable in that they are imposed by the very nature of the business,” confirms Echevarne.
Those costs that are controllable – operating expenses – are already being reduced as part of airports’ good business practise.
But, in a tough economic environment, airports must continue to work hard. Throughout the world, the largest component of operating expenses is personnel costs, followed by contracted services.
As for income, this comes from two main sources: aeronautical revenue and non-aeronautical revenue. Globally, some 53% of airport revenue is derived from aeronautical sources. A significant trend is the growth of passenger-based charges, which now comprise more than 60% of total aeronautical revenues.
In effect, this enables airports to share some of the investment risks with their airline customers as their income stream becomes increasingly traffic reliant.
But, airlines can respond quickly to a volatile market. Airports are not nearly so mobile, which makes the trend toward passenger-based charges particularly dangerous for sustained profitability.
In 2011, airlines in Europe opened up 2,491 new routes and closed 1,936. A sizeable chunk of an airport’s annual income has the potential to become a question mark in the ledger.
Even if this challenge could be overcome, as Echevarne points out, if an airport were to attempt to recover all its costs purely from aeronautical activities, in many cases it would be a prohibitively expensive place to land.
This is why developing non-aeronautical revenue is now a key strategy for airports large and small on every continent. Certainly, many airports have been innovative in discovering and developing new non-aeronautical revenue streams.
These commercial projects have come in a vast range of shapes and sizes, such as office developments, business and industrial parks, logistics hubs, hotels, parking, rail and transport infrastructure, and retail developments. ‘Airport city’ developments, such as Seoul Incheon, have been particularly successful.
It will be important for airports to continue to innovate in a broad portfolio of commercial activity. Not only can profits generated be reinvested into the broader airport infrastructure, but also may improve the organisation’s credit rating, in turn lowering the cost of borrowing for future projects.
The framework that underpins the airport business is an important factor in how far airports can go in reducing costs and boosting revenue.
For a start, it’s a very competitive market. Airports in overlapping catchment areas compete for passengers. Around 63% of European citizens live within two hours of at least two airports, for example. And where rail connections exist, 50% of passengers on routes of less than four hours are taking the train rather than flying.
Airline buyer power places further pressure on airport margins. It is normal business practice for an airport to largely rely on a single carrier. And among bigger hubs, airlines and airline groups are increasingly moving towards a multi-gateway model, allowing them to switch capacity or at least threaten to switch capacity.
For airports to secure a more sustainable future, there needs to be a regulatory regime that takes account of the competitive environment in which airports operate.
At least part of the problem comes down, again, to the mismatch between timeframes. Many regulatory regimes feature short-term thinking – often looking no further than the next government elections – while airport investments need longer-term awareness.
Given the perils involved in delivering such major capital projects, future regulations must look to provide greater certainty and so help to reduce investment risk.
“On the one hand, the regulatory authorities determine the minimum requirements an airport must have to operate and how the associated investments can be recovered,” says Echevarne.
“Then, the regulator has a key role to play in terms of those taxes imposed on airports and air transport in general, which are not necessarily reinvested in the industry. Obviously this unnecessarily penalises demand and the financial sustainability of airports.
“On the other hand, limiting the returns airports can attain from non-core activities, like shopping, is a disincentive for investors and ultimately goes against attracting much needed infrastructure investments,” he adds.
Horses for courses
The drive for profits has seen a number of different airport business models, from full privatisation to 100% state ownership.
Privatisation is usually touted as the game-changer. It is a trend that began with the privatisation of BAA in 1986. This is seen as a watershed moment because, until then, nearly every airport in the world was government-run and had the management style and economics to match.
According to ACI, there are roughly 450 airports worldwide with some form of private sector participation. Europe and Latin America lead the way. Africa and the United States are showing some interest while in Asia-Pacific airports are mostly government-owned.
The evidence to date suggests there is actually no right or wrong answer in terms of ownership. More important is the management mindset.
Get this right, Echevarne believes, and the possibility of profit looms large. Successful airports can hit on a winning formula regardless of infrastructure ownership.
“Airports have evolved from being simply public-sector infrastructure providers into sophisticated, business-oriented service providers,” he says.
“This transformation has occurred mainly as a result of the realisation by governments around the world that airports are major engines of socioeconomic growth for the territories they serve and that, with the right management in place, they can be run efficiently and in many instances can be self-sufficient.”
So, while an airport is always likely to be asset intensive, gateways can and do adapt their chosen business model to suit their specific circumstances and the nature of the market dynamic within which they operate.
They can be O&D airports, alliance anchor hubs, low-cost carrier bases or intermodal gateways. They can create airport cities, focus on business travel or freight, provide top-level retail experiences or invest in specific features or service qualities, such as fast processing times.
In other words, airports can be chameleons, adapting to their environment be it increasing traffic, competition or new management and operational techniques. So, while there is no one-size fits all formula and no magic wand for success, airport profits may yet find a way out of the shadows.