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ECONOMICS Last modified on June 20, 2013

Airport profitability

Despite the sizeable commercial profits of some of the world’s biggest gateways, the majority of airports lose money. Graham Newton asks why and if anything can be done to reverse the trend.

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.

North American challenges
An ACI North America capital needs survey estimates that US airports need $71.3 billion for infrastructure development over the next five years.

“If we don’t get the changes we need in the federal system then it is going to be extremely challenging to fund these developments in a sustainable way,” says Deborah McElroy, ACI-NA’s executive vice president for policy and external affairs.

A key method for airport development funding in the United States, the Passenger Facility Charge (PFC), hasn’t gone up for 13 years and so has lost half of its purchasing power. That puts a lot of pressure on airports to access capital through bonds.

While many US airports have excellent credit ratings thanks to prudent financial management, the amount of debt being taken on is huge.

“The concern then switches to how will airports find the revenue streams that will pay off these debts?” says McElroy.

“We recommend that the PFC is increased to at least restore its purchasing power. Even that would only increase it to $8.50 – which still compares favourably with the fees charged by some airlines for ancillary services, such as hold baggage.”

McElroy states the various airport charges paid by airlines are a small percentage of their overall operating cost. Although accepting that it is a tough environment for all stakeholders in the aviation value chain, she says there does need to be an increase in airport fees.

“We agree there needs to be transparency and consultation so we can build a sustainable system in conjunction with airline partners,” she says.

Greater local control is the second vital element in ensuring sustainability for US airports. The federal government is understandably ponderous, and so greater control on a local level will give airports some much needed flexibility in their business and financing strategy.

“This will ensure airports can help airlines operate efficiently and provide passengers with a pleasant travelling experience,” says McElroy.

The green shoots of privatisation are also taking hold in the United States. San Juan in Puerto Rico has been privatised and Chicago Midway and a smaller airport in Georgia are going through the process. While McElroy stresses that this won’t change the fundamental issues or the rules, it is a positive development.

“It isn’t about being pro or anti-privatisation,” she says. “It is about airports having the option. It worked for Puerto Rico, so other airports should have the same opportunity.

“I’m confident that airports will continue to serve airline and passenger needs,” she concludes. “Airports have shown great creativity in the past in generating new revenue streams and I am sure we will see more great innovation in the future.”

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.


Rethinking regulation

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.

Competitive pressures in Europe
“In 2011, in Europe, the average Return on Capital Employed (ROCE) was just 4.3%,” informs Donagh Cagney, economics manager, ACI Europe.

“Wider commentary and regulatory decisions about the airport business imply that a ROCE of circa 6-7% is the minimum threshold for sustainability. Below this point airports are competing with interest rates, as investors can consider it more advantageous to save their capital rather than invest it in airports, in light of the associated risks.”

European airports have been working hard to rectify that situation, successfully reducing operating costs per passenger over the last two years.

This kept overall operating expenditure flat in 2010, despite the 4.2% growth in traffic. And in 2011, overall operating expenses grew 6% – less than the 7.3% increase in traffic.

“This represents a considerable response to prevailing market demand, given the proportion of costs which could not be avoided,” notes Cagney.

Since 2009, there has been a substantial (29%) increase in capital costs – that’s €2.09 billion. Interest on this kind of finance has soared to an eye-watering 45%.

Airports haven’t squeezed the airlines to overcome any revenue shortfall either. In 2012, 65% of European airports either froze or reduced their aeronautical charges.

It’s a reflection of the market reality in Europe, where competitive pressures are huge. Aside from the majority of local passengers enjoying a choice of departure airports, some 62% of passengers transferring through a European hub airport now have a choice of transfer airport options too.

“There are no easy solutions to the problem of airport profitability,” says Cagney. “Demand-side pressures are strong due to competition and the weak economic climate. Similarly, the fixed cost nature of airports removes the flexibility to respond. This squeezes airport margins.

“The prospects for individual airports depend on what factors can be controlled and what cannot be controlled,” he adds.

“A combination of cost efficiency and choosing and implementing the right business model will help airport profitability. However, it is not reasonable to expect this to work for smaller airports facing considerable competitive pressures in areas with a limited demand for air travel.”

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.

Asia-Pacific on the rise
Based on the preliminary ACI results, Asia-Pacific airports finished 2012 with a strong 7.1% increase in passenger numbers while the Middle East, led by Dubai and Abu Dhabi, recorded even more remarkable growth of 12.1% when compared with 2011.

Many airports in the region, most of them major hub airports, have recorded double-digit growth rates in 2012 due to the robust economic growth in their own countries and the rising propensity to travel in the region.

Even so, “numerous airports are still operating at a loss partly due to the fact that the revenue generated does not match up with the high operating costs,” explains ACI Asia-Pacific’s regional director, Patti Chau.

Strong traffic growth comes at a cost. Last year’s traffic results also showed that among the top 20 busiest airports in the world, nine are in the Asia-Pacific region. And many of the airports in the region are already operating beyond their design capacity.

According to the 2011 ACI Economic Survey, capital expenditure in Asia-Pacific will be increased to $42 billion during the years 2013-2016, compared with $5.8 billion in 2012.

While government ownership is the norm, the regulatory regimes differ wildly. ACI members are spread over 43 countries. “The region is unique in that it has the most advanced economies and, at the same time, some of the least developed,” says Chau. “This makes common goals and objectives hard to identify.”

This is especially true for economic regulations. Some governments operate a light-touch regime, while others support more rigid controls. ACI has been advocating a light-touch economic regulation model at ICAO and other forums, to ensure that airports are not labelled as monopolies and are able to operate as much as possible as commercial entities.

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