« FINANCING THE AIRPORT SYSTEM SHOULD REFLECT A CHANGING NETWORK ARCHITECTURE »

Note:  I was asked by Barbara Cook, Editor of AAAE’s Airport Magazine to write an article on financing the airport system.   I always appreciate Barbara asking me to write on such non-controversial subjects.  That said, I agreed all the while appreciating that there are fewer answers in the immediate term than there are questions.  I agreed all the while appreciating that all airlines and all airports are not on the same page regarding the subject.  My attempt is less about having the final answer and more about appreciating that the airline, and thus the airport, system is being forever changed as a result of consolidation of the US domestic network architecture.  Somehow I am confident that neither the airline sector nor the airport sector will like all of what I have to say.  Nonetheless it is time to seriously think about what the airline/airport grid looks like tomorrow and where investment makes sense while keeping the air travel consumer at the forefront of the thinking.

ARTICLE

The macro view says that airport financing will be different five years from now than the current decades-old practice.  The days of simply going to the capital markets to fund airport infrastructure projects is also likely to change as debt amortization will result in increased enplanement costs as growth in the North American market slows.  At the same time, limited government funding for such infrastructure projects are a surety given the political realities in Washington.  In some circumstances where shortfalls in funding exist, the time may be right to explore public-private partnerships in order to ensure that capital projects necessary to keep an airport an economic catalyst are instituted.

The micro view begins and ends with an industry that has consolidated around four major domestic carriers.  American/US Airways, United, Delta and Southwest will control 87 percent of the enplanements.  A close analysis of those airlines reveals an industry de-fragmenting their respective networks.  Look at major metropolitan areas with multiple airports and you will see services being centered on one or two airports, not three or four, while many secondary and tertiary hubs are dismantled to remove duplicate services.

An airline industry that managed to lose more than $60 billion over ten years would hardly seem a model for other businesses. But airlines, which lost more than 17 cents on every dollar of revenue in 2008, are today making a marginal profit.  While the industry has to do better than marginal, any business that demonstrates an 18 point profit margin improvement in four short years deserves a look.  As Delta Air Lines’ CEO Richard Anderson told analysts on a conference call in 2012: Today’s airline industry “is not a hobby.”

The new airline industry vernacular offers a blueprint for the airport community.  By diversifying revenue (finding sources of revenue other than passenger fares); de-leveraging the balance sheet (using excess cash on the balance sheet to pay down expensive long-term debt); driving profitability across the entire economic cycle (making money during downturns as well as good times); and earning an adequate return on invested capital (investing only in projects that promise a financial return relative to the capital expended to fund the project), the airlines have turned around a decade of underperformance.

This new approach can work in a consolidated environment even as it did not, and could not, work in an industry that was highly fragmented.  The days of growth for growth’s sake are over.  This fact is both a problem and an opportunity. 

The problem is that yesterday’s model was driven by a market share mentality that resulted in unprofitable growth that commoditized the airline product.  Under the old model, if marginal revenue exceeded marginal cost then added capacity could be justified.  Growth increased the unit cost denominator making the calculation of marginal revenue exceeding marginal cost an easier one.  But when the fully allocated cost model turned into religion, it became painfully clear that the industry had grown too big to generate profitable revenue generation capabilities.

What does this evolution mean for airports? In theory, it should be easier for airports to finance projects in a more stable industry environment.  Yet it is troubling that the airline side of the industry rarely mentions airports as stakeholders that will benefit from consolidation. The airport winners and losers in the airline consolidation process have yet to be fully identified. Until that process plays out, understanding how airports fund necessary projects will be hard to define given the volatile environment we are in.

Putting the System into Perspective

Large Hub Airports:  6.3 percent of all commercial air service airports (29) enplane 70 percent of all passengers; handle 59.4 percent of all departures; and are served by 66.4 percent of the commercial air service seats;

Medium Hub Airports:  7.6 percent of all commercial air service airports (35) enplane 18 percent of all passengers; handle 19.1 percent of all departures; and are served by 20 percent of the commercial air service seats;

     Large and Medium Hub Airports:  14 percent of all commercial air service airports (64) enplane 88 percent of all passengers; handle 78.5 percent of all departures; and are served by 86.4 percent of the commercial air service seats;

Small Hub Airports:  16 percent of all commercial air service airports (74) enplane 8.4 percent of all passengers; handle 11.7 percent of all departures; and are served by 9.4 percent of all commercial air service seats;

     Large, Medium and Small Hub Airports:  30 percent of all commercial air service airports (138) enplane 96.4 percent of all passengers; handle 90.2 percent of all departures; and are served by 95.8 percent of commercial air service seats;

Non Hub Airports:  44.4 percent of all commercial air service airports (205) enplane 3.1 percent all passengers; handle 8.3 percent of all departures; and are served by 3.8 percent of commercial air service seats;

Essential Air Service Airports:  25.8 percent of all commercial air service airports (119) enplane .2 percent of all passengers; handle 1.5 percent of all departures; and are served by .4 percent of commercial air service seats.

After All, It Is a System

Capacity cuts since 2008 have gone a long way toward identifying airport markets that will likely survive assuming no additional exogenous shocks like $150 - 200 per barrel of oil.  Even with capacity cuts and consolidation, significant competition remains at the nation’s commercial air service airports – particularly at the large, medium and small hub airports. In 2012 there was an average of 11 competitors at the nation’s large hub airports; 9 competitors at the nation’s medium hub airports; and 6 competitors at the small hub airports.  That is robust competition at these respective enplanement levels and assures that each airport will remain a node on the airline service grid for years to come.

Given this, it is time to rethink Passenger Facility Charges (PFCs). These per passenger charges should be allowed to be increased up to some arbitrary number like $9 and scaled back to account for the relationship of O&D traffic as a percent of total enplaned traffic.  In other words, a market like Atlanta would be able to charge the maximum PFC amount because it facilitates traffic to points large and small, whereas a market like San Diego accommodates mostly local demand to other large markets and therefore has less non-local demand on the SAN infrastructure.

In a consolidated arena like the U.S., the PFC doesn’t really act as a tax or a fee as it might have just a few years ago. Given robust levels of competition in the largest 138 markets, price elasticity is also somewhat less an issue where multiple airlines offer similar base fares competing for the same passenger.  Airports like Nashville dominated by a so-called LCC, and I include Southwest in that category for discussion, would be unable to charge the same PFC as Atlanta. While carriers operating at Nashville typically serve only the largest markets, there would need to be an accounting of the fact that Southwest utilizes the airport as an omni-directional connecting point on its system.

Some cross-subsidization of non-hub markets by larger markets will likely be necessary if government support continues to decline. However, passenger hubs in the Southeast should only subsidize airports that they facilitate and not contribute to one pool to be divided by political whim or prejudice.  Likewise, LAX should not cross subsidize Valdosta, GA.  As in any business, projects should be prioritized where returns on capital warrant but that seems to be the exception rather than the rule when it comes to investing in airport projects today.

Conclusion:  After Evolving and Adapting Comes the Thriving

Airlines today are finally focusing on the customer.  Airlines today recognize that stability in the industry will permit them to finally invest in the customer – the ultimate user of the system - rather than focus solely on their survival.  That’s a positive change. But the customer in Jacksonville, NC should be as important as the customer in New York.  With a customer’s journey beginning and ending at an airport regardless of size, amenities and service should be prioritized between the airline and the airport to make the travel experience feel seamless to that passenger.

To fund the airport system of tomorrow we need to get airline and airport leadership on the same page.  Leadership in each industry needs to understand that neither can achieve its goals in a consolidated environment without the active partnership of the other.  Airports need to accept that the airline industry architecture/mindset has fundamentally changed, while airlines need to accept the fact that airports are a vital part of the customer experience and should not be ignored when discussing policy or whether or not certain infrastructure projects should be considered.

A slow growth environment means retaining the customers you have.  The total travel experience versus cheap travel should be the value proposition going forward.