Aviation Economics & Finance Professor David Gillen...

Aviation Economics & Finance

Professor David Gillen (University of British Columbia )&Professor Tuba Toru-Delibasi (Bahcesehir University)

Module 18: 28 November 2015Istanbul Technical UniversityAir Transportation Management M.Sc. Program

OUTLINE

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• The impact of infrastructure charges (airport and air navigation) and airline costs

and competitiveness

– Airline and airport taxes & charges, a comparison

• Pricing policies: what carriers have to pay

– Residual pricing

– Compensatory pricing

– Funding agreements and efficiency

• Non-airside revenues

• Risk in the value chain

– Airport vs airline markets

– Comparing airport performance

– Assessing role of ownership and regulation in affecting performance

• Slots and Capacity

• Regulatory schemes

• Future Trends

OUTLINE – CONT.

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• Slots and capacity

• Regulation of prices– Rate-base rate of return

– Cost plus

– Price cap

– Other (consultation / monitoring / trigger regulation / arbitration /

contracts)

November 23-28 2015

IMPACTS OF CHARGES

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IMPACTS ON AIRLINES

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• Airport charges are a small portion of an airline’s operating costs in

North America but large in EU

– Small proportion for long-haul routes

• Charges have a larger effect on LCCs and short-haul routes

– LCCs have a smaller cost base than

legacy carriers

– Short-haul routes will pay a higher volume of charges

• Generally, the cost of airport charges will be less than the costs of

changing airports to avoid those costs

– The negative impact on demand would also contribute to

outweighing the airport charges

November 23-28 2015

AIRPORT CHARGES AS PROPORTION OF OPERATING COST - US

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AIRLINE FEES VERSUS AIRPORT FEES-EU

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CHARGES AND TAXES IMPOSED ON PASSENGERS BY AIRPORTS

OR GOVERNMENT AUTHORITIES VS. FEES LEVIED BY AIRLINES

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AIRLINE AND PASSENGER CHARGES

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COMPONENTS OF AIRLINE COSTS AT AN AIRPORT

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Source: ACI: All in Airport Costs Study 2013

USER CHARGES

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• Chicago Convention (1944), Article 15, Chapter 2:

• Uniform conditions for aircraft of all contracting states

• Non-discriminatory charges for international air services

• ICAO Policies on Charges for Airports and Air

Navigation Services (2009), Doc 9082/8:

• Users must bear their full and fair share of the cost

• Airports should maintain full financial records

• Full cost includes operating costs of airport and essential services, as well

as interest, depreciation, repairs and management

• No charges for facilities not used

• Non-discrimination between domestic and foreign carriers

• Non-aeronautical revenues can be used towards cost base

November 23-28 2015

AERONAUTICAL CHARGES

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• Landing fee (based on MTOW)

– Generally a fixed rate per tonne

– A main source of revenue for airports

• Terminal area navigation fee

• Aircraft parking and hangar fee

• Passenger service charges

– Another main source of revenue

• Security charges

November 23-28 2015

AERONAUTICAL CHARGES – CONT.

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• Noise and emission charges

• Cargo service charges

• Ground (ramp and traffic) handling charges

• Concession fees for aviation fuel & oil

November 23-28 2015

PASSENGER CHARGES

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• One of the main sources of revenue for an airport

• Commonly charged on departing passengers

• The level of charges varies across airports

– Some have lower charges for domestic pax

• Political reasons

– Some have additional fees for connecting pax

• Others remove this fee to attract connecting traffic

November 23-28 2015

LANDING CHARGES EXAMPLE: A320 (EU AIRPORTS)

16Source: Air Transport Research Society (2011)

These numbers should be treated with caution because different airports include different things in the airport charge

EXAMPLES OF TARIFF STRUCTURE (YVR-VANCOUVER CANADA 2015)

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November 23-28 2015

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November 23-28 2015

NON-AERONAUTICAL CHARGES

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Concession fees

Parking / car rentals Off-airport activities

Rentals of airport space/equipment

November 23-28 2015

NON-AIRSIDE REVENUE AS A PROPORTION OF TOTAL

REVENUE (2009 DATA)

21Source: Air Transport Research Society (2011)

AIRPORT CHARGES IN THE UNITED STATES

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• Residual agreements

– Under the residual method, after an airport deducts all non-airline

revenue from its total annual expenses, the airlines are responsible for

the remaining (residual) amount, and rates are set accordingly.

• Compensatory agreements

– Under the compensatory method, an airport is divided into various cost

centers (airfield, terminals, parking areas, etc.) & airlines pay a share of

those costs, based on the amount of space they occupy, planes they

land/depart and other measures of airline use.

November 23-28 2015

PASSENGER CHARGES IN THE U.S.

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• Airports are not legally allowed to charge passenger fees

• Passenger Facility Charge (PFC) can be used

– Funds generated go towards infrastructure projects

– Airlines do not have influence on how funds are allocated under

compensatory agreement, they have influence under residual

agreements

November 23-28 2015

FUNDING AGREEMENTS AND COST EFFICIENCY

• DEA Methodology

• Programming approach to

measure relative efficiency

of processes, firms and

institutions

• The efficiency of a DMU is

defined in terms of its position

relative to the efficient frontier.

For example, the efficiency of

DMU 3 is 0C'/0C and is efficient

if this ratio is = 1. Since OC'/OC

< 1 it illustrates that DMU 3

could use the same production

technology (stay on the same ray)

and produce at C' using fewer

inputs

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FUNDING AGREEMENTS AND COST EFFICIENCY

November 23-28 2015

Results of Tobit Regression

Variable Coefficient t Statistic

Structural/Environmental Variables

Number of Airlines Hubbing at Airport 0.0044 0.116

Land Area 0.0002 8.64

Number of Runways 0.2019 6.21 Total Number of Gates at Airport 0.0098 2.93

Proportion of Traffic International Pax 0.9717 0.569

Proportion of Traffic General Aviation 0.1729 1.03

Dummy Variable for 1989 0.0352 1.49

Dummy Variable for 1990 0.0001 0.004

Dummy Variable for 1991 -0.0363 -1.49

Dummy Variable for 1992 -0.0186 -2.76 Dummy MSP 3.9104 5.36

Dummy PHX 1.2765 5.01

Dummy SFO -3.4213 -6.32

Dummy ATL 1.5196 4.73

Dummy BOS -3.316 -5.93

Dummy CLT 0.6137 5.15

Dummy SEA -5.7217 -5.22

Managerial Variables

Airport with Residual Financing 0.1367 1.83

Airport with Compensatory Financing -0.1278 -1.81

Proportion of Gates Exclusive Use -0.3921 -3.57

Proportion of Gates Preferential Use 0.2424 1.39

Noise Strategy Variables

Rotational Runway 0.4309 4.84

Preferential Flight Path -0.1681 -3.07 Preferential Runway Approach -0.0107 -0.15

Limits to Number of Operations 0.9075 5.76

Limits to Stage II Aircraft 3.7090 6.11

Limits on Hours of Operation -3.1630 -5.19

Use of Noise Budget 0.3163 5.23

s 0.0746 12.5

REVENUE SOURCES FOR U.S. AIRPORTS

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RISK IN THE VALUE CHAIN

November 23-28 2015 27

AIRPORTS: OWNERSHIP MODELS

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• Public ownership

– Administrative (functionally dependent on national, regional or local

government)

– Corporatized (independent economic entity but shares are owned by

public authorities)

• Mixed ownership

– Independent economic entity

– Shares are owned by public and private investors

• Private ownership

– Independent economic entity

– Shares are owned by private investors

– Or by corporatized entities with mixed ownership

November 23-28 2015

AIRPORTS: OWNERSHIP AND EFFICIENCY

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• Government majority ownership airports and airports owned

by multi-level governments are less efficient than private

majority ownership airports

• Private majority ownership airports have significantly higher

operating profit margins; airports with government majority

and multi-level government ownership have the lowest

margins

Source: Albert Assaf, David Gillen (2012), “Measuring the Joint

Impact of Governance Form and Economic Regulation on Cost

Efficiency of Transportation Infrastructure”, European Journal of

Operational Research Volume 220, Issue 1, 1 July 2012, Pages 187–

198)

November 23-28 2015

AIRPORTS: OWNERSHIP AND EFFICIENCY

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• Private majority ownership airports have higher proportion of

non-aeronautical revenues and lower aeronautical fees

(excluding US airports)

• Airports with majority private ownership (including 100%

private ownership) do not achieve significantly higher

efficiency than the 100% government-owned airports, such as

those in the US Source: Albert Assaf, David Gillen (2012), “Measuring the Joint




198)

November 23-28 2015

MEASURING COST EFFICIENCY

• Differing methodologies: DEA, SFA, TFP, simple partial

productivity metrics

• Distinguish types of efficiencies:

– Technical inefficiency arises when, for a given set of inputs, output is less

than it could potentially be (the wrong place on the cost or production

function)

– Allocative inefficiency occurs when for a given output and set of input

prices, the input choices are sub-optimal (being on the wrong (higher) cost

function or (lower) production function

• Need to consider short run versus long run effects

• Need to account for presence of price regulation

November 23-28 2015 31

EFFICIENCY AND OWNERSHIP & PRICE REGULATION

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198)

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198)

BROAD VIEW OF PERFORMANCE METRICS

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Source: ACI: Guide to Airport Performance Measures (Prepared by Oliver Wyman, 2012)

BROAD VIEW OF PERFORMANCE METRICS

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Source: ACI: Guide to Airport Performance Measures (Prepared by Oliver Wyman, 2012)

CARE IN COMPARING FINANCIALS

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CARE IN COMPARING FINANCIALS

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AIRPORT RETURN ON CAPITAL ABOVE AIRLINES

38Source: IATA

November 23-28 2015

ECONOMIC PROFITS STRONGER THAN AIRLINES

39Source: IATA

November 23-28 2015

SLOTS AND CAPACITY

November 23-25 2015 40

CAPACITY AND AIRPORT SLOTS

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• Capacity is a major issue at many airports around the world

– Traffic is growing faster than additional capacity can be added

• To deal with capacity issues, varying practices for slot

allocation have been developed

• A slot is a time period for departure or arrival

– Could include runway, gate, customs flow, check-in counters

November 23-28 2015

SLOTS

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• International slots coordinated through IATA slot allocation

process

– Bi-annual conferences, with voluntary participation by airlines

– Set procedures for over capacity airports

• Grandfather rights

• Airport coordinator (often from national carrier)

• The EU has its own slot allocation regulations

– Similar to IATA but mandatory rather than voluntary

– Coordinator must be independent

November 23-28 2015

SLOTS – CONT.

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• Slots scarce at peak times at congested airports

– Tokyo Narita

– London Heathrow

– New York City: La Guardia, JFK, Newark

– Washington D.C. (control for different reasons)

• In the EU and United States, at slot-controlled airports, slots

can be traded, bought or sold

– LHR has a thin but active slot market

– Continental Europe has declined to embrace secondary markets

– Slot market in US is very thin, slots mostly traded

– Slots can be owned by banks and non-airline agents

November 23-28 2015

REGULATORY SCHEMES

November 23-25 2015 44

NEED FOR REGULATION

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• Airports are being commercialized and privatized

– Some have market power and could abuse this power

• Regulation aims to allow airports to:

– Receive an acceptable return on capital

– Have incentives towards efficient operations and investments

• BUT… SHOULD AIRPORTS BE REGULATED? WHY?

November 23-28 2015

REGULATION SCHEMES

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• Rate-of-return

– Airports fully recover costs

– And earn an allowed profit or reserve

– Used in the Netherlands, Germany (Dusseldorf), Italy

– Can lead to airports not being cost-effective and can lead to

overinvesting

• Price cap

– Incentives for cost-efficiencies while controlling price

– Used in the UK, Ireland, Germany (Hamburg), India, Chile

SOURCE: Gillen, David (2011), “The Evolution of Airport Governance and

Ownership”, Journal of Air Transport Management, 17, 3-13

November 23-28 2015

REGULATION SCHEMES – CONT.

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• Price Cap – cont.

– Formula for maximum price

– Price cap = CPI-X or RPI-X

• CPI = consumer price index; RPI = retail price index

• “X” factor reflects productivity gains

– Allows for unlimited profit levels

• Default Price Cap

– Option between a common set price cap

or a separate contract with the airport operator

• Must be agreement between the user and the operator

November 23-28 2015



REGULATION SCHEMES – CONT.

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• Trigger regulation

(price monitoring/“light-handed”)

– May trigger hard-handed regulation

– Used in Denmark, Australia and New Zealand

• Consultation / Arbitration



November 23-28 2015

ACCOUNTING METHODS FOR PRICE CAPS

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• Single-till

– Both aeronautical and non-aeronautical operations are included when

setting prices

– Commercial revenues can be used to reduce airport charges

• Dual-till

– Only aeronautical operations (revenues) are included when setting

prices

– Incentives towards increasing commercial revenues

• Will not cause airport charges to be lowered

November 23-28 2015



REGULATIONS - BENEFITS AND COSTS

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• Benefits

– Constrains exercise of market power

• (where do airports have market power?)

– Prevents airports from charging excessive prices

– Transparency and predictability of pricing

• Costs

– Administrative costs (staff, industry expertise, etc.)

– Monitoring costs (regular reporting, compliance verification)

– Intervention costs (airlines, airport tenants, etc.)

– Reduced efficiency

– Distorted investment incentives

– Reduced service quality in some cases (Single till)

November 23-28 2015

AIRPORT TRENDS

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FUTURE TRENDS

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• Global trend towards airport privatization to continue

• Just commencing in the U.S. (e.g. Chicago Midway)

• Lease or purchase

• Airports need to be financially self-sufficient

• Airports will pursue non-airside revenue with increased

efforts

• Governments will continue to divest airports, but

• increase regulatory rules & constraints

– security and safety issues

– political & regulatory matter

November 23-28 2015

FUTURE TRENDS – CONT.

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• Greater influence as a stakeholder

• Air policy, bilaterals, greater appreciation of role of airports

November 23-28 2015

END OF MODULE 17

November 23-28 2015 54

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