Paul Kehoe is the managing director of Belfast International Airport which is a subsidiary of TBI plc in the UK. He is has spent the majority of his career in airport operations and privatisation programmes in the UK, Australia and the USA. This article reviews the airport operation as a business and looks at the aspects of financing future growth
Airport directors love to disguise their businesses as highly complex activities that require years of experience to even fathom the most simplest of tasks. Some of that apparent complexity may stem from the fact that airports are large places that act as a multi-modal interchange between air and surface transport. Many will argue that their airport must have more steel, glass and marble because the airport is a statement of national and local, if not personal pride. Some communities feel that they have to have an airport because they have a railway terminus, an opera house and a cathedral.
Airports are, in fact, very simple businesses and only require a few elements to make them work: a strip of concrete, a passenger processing building and a licence to operate. Many of the rural airports in Ireland have just that. However, many of us are used to a few more luxuries than this. We expect passenger lounges and shops to while away the hours before the flight and more technical facilities such as Secondary Surveillance Radar and Instrument Landing Systems so that our flights can arrive and depart on time and all weathers. However, Europe’s new breed of low cost carriers would probably prefer the former description whist the national flag carriers might expect first class facilities. However both would want to pay no more than the thought fit.
Ultimately, of course, the passenger has to pay. The recent decision by airlines to show the passenger service charge as a separate item on the ticket is part of plan to highlight airport charges.
There are differences around the world, the operating structure of airports in the US and Europe is very different. In the US, privatisation is not in vogue with the states and cities which own and operate airports. They operate almost as not for profit organisations where any surplus funds are ploughed back into facility development or are returned to the airlines in the form of rebates. In Europe, airports are run as businesses and do make profits if they are able. The move towards the profit motive service provider rather than public utility has come about because of airport privatisation. Airport managers have become more commercially aware as they strive to improve profit whilst attempting to increase airline traffic through offering incentives on charges.
Commercial acumen is going to be needed in spades over the next few years as a principal element of the commercial activity is removed at the end of June 1999. The loss of Intra EU Duty Free will challenge all airports that relied on the sale of those goods to offset increases in aircraft charges. It has been estimated that Aer Rianta could lose around IR£30m revenue from the loss of Duty Free. At Belfast the estimate is significantly lower because of the already high number of passengers on domestic flights: the impact should be no more than £500,000.
Airport Charges
So how do airports work financially? Essentially, as was indicated earlier, they are very simple businesses dressed up in a large amount of technospeak. They are simple in structure and simple to finance. They are fixed cost operations that can work at well beyond their design capacities. It is probably one of the few industries where you can get a quart into a pint pot. For example, the original design capacity of Heathrow was supposed to be around 2m passengers a year ‑ at least to the planners in the 1940s and 50s. They didn’t believe that there would be a market for more than that. In 1998 Heathrow handled 60m passengers.
The origins of airport charging derive from the 1944 Chicago Convention on International Civil Aviation to which most countries are signatories. The convention decreed that airport facilities should be available to all users and that there should be no undue discrimination against them. The initial charging mechanisms were based on cost recovery and, with non discrimination as a guiding principal it led to the averaging out of costs irrespective of the particular users requirements from that airport. Of course, this system did not take into account the need to build particular facilities for certain users. Why should the owner of a small turbo-prop pay the same fees as the Boeing 747 operator for whom the airport has lengthened and strengthened the runway.
Airport charges are broken down into two basic forms; the first is based on the weight of the aircraft ‑ a charge per tonne, the second is a per capita passenger charge. There are variations on this theme. With some airports offering various discounts to smaller aircraft, quieter aircraft and peak and off-peak charges.
As airports are fixed cost operations and therefore at an airport with excess capacity the marginal cost increase of handling additional passenger traffic is practically zero. This being the case then why can’t the new traffic to the airport have their prices based on that marginal cost. The capital costs for building the facility are largely ignored in this short run marginal cost pricing methodology. This approach would delight the low cost carriers such as Ryanair and easyJet who believe that they are bringing extra traffic to the airports because of their own pricing policies and therefore should only pay charges based on the short run cost basis. Alternatively, Ryanair might argue what they are looking for is a “bus-stop” for their operations and don’t require all the other paraphernalia attached to the airport. The problem is that like the premium carriers they still need apron space, runways and radar.
Given the International Civil Aviation Organisation (ICAO) principles that there should be no discrimination between users, how can airline A pay full cost recovery and airline B marginal pricing? They shouldn’t, of course, but for many airports around Europe the prize of having an air link to London or another major centre is worth having a marginal offering. However, in the past the airport may have been able to justify the lower charge because of the opportunity to sell duty free ‑ but that door has just closed.
It is difficult to operate a marginal pricing mechanism in the UK because the 1986 Airports Act enshrines the ICAO philosophy in law. In Ireland, the situation has been somewhat different; Aer Rianta being a state run organisation has been mandated by Government to encourage growth at three airports by offering incentives based on a marginal pricing approach. In the UK, the principle of marginal pricing typically applies to new routes of a relatively short time frame after which the charges reverts to full cost recovery model.
Economies of Scale
Research undertaken by Rigas Doganis, Professor of air transport at Cranfield University and BAA plc has shown that airports do exhibit significant economies of scale (and indeed scope). The graph below shows this effect.
The important feature of the graph is the significant change of slope as airport approaches three to four million passengers. Smaller airports will have high unit costs and consequently, as Doganis points out, in planning terms it would make sense to concentrate air traffic within a region at one location rather than spreading the services out to smaller airports. An important issue is the drive toward the three million passenger mark; at this point, based around the right facilities, airports become significant cash generators and commercially attractive to the retail providers. Airports can offer good return on sales and reasonable returns on capital. However, if they are too successful from their aeronautical charges, there are negotiating mechanisms which can be applied.
The growth in traffic plus the charging methodology has led many to consider that airports are good investments. One only has to look at the BAA plc and other privatised airports to see that being the case. Once the initial investment is made the airport can grow and take a return on its investment until the next lump of capital is required.
Given the move of state bodies to divest themselves of airport assets more privatisations will occur and for the investor it seems it’s a good time to buy. |
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| Article appeared in the July 1999 issue.
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