Leading the way out of crisis
Airport concession fee strategies in the coronavirus era
ICF Senior Manager Alan Gluck has over 25 of experience in commercial and concessions management, commercial planning, financial analysis and government procurement. In the airports industry, Alan has developed commercial plans, prepared solicitation documents and served both on and as a SME for selection panels for food service and retail concessions. He is also a judge for the Airport Food & Beverage Awards, organised by The Moodie Davitt Report. In this White Paper, he explores possible responses to the COVID-19 crisis from the view of airport concessionaires, and in particular how they can manage the challenge of rental payments.
With the fallout from the Novel Coronavirus (COVID-19), airports worldwide are faced with many unique challenges that had never been contemplated, writes Alan Gluck. This pandemic has brought traffic to a crawl, resulting in airports and their concessionaires being put into a situation where existing rent structures and payments are no longer viable: most commercial space leases do not contemplate a complete breakdown of the commercial aviation system.
This paper explores alternatives for how airports and their retail (food service, convenience and speciality merchandise) concessionaires can deal with rent payments at a time of extreme uncertainty and little or no traffic. While the paper is centred around the recent Federal Aviation Administration (FAA) guidance for US airports, these recommendations are broadly applicable to airports and their commercial concessionaires everywhere, subject to nuances of specific concession contracts or regulatory environments.
ICF Senior Manager Alan Gluck: Exploring the options for airports and their partners
Just as airports are seeking relief and assistance from their national governments, so too are concessionaires seeking help in a situation that is not of their making. The FAA guidance of 28 March 2020 allows for closure of concessions (although there may be impacts on the ability of an airport to meet its Airport Concession Disadvantaged Business Enterprise/ACDBE goals, a focus in US airports that is not applicable in the rest of the world).
While certainly many concession locations should be temporarily shut down when there is little or no passenger traffic, simply closing all concessions is probably not a successful strategy for airports or concessionaires.
While such closures do not violate grant assurances for US airports, it would be better to come up with a way to keep businesses financially viable while maintaining some level of service, and ensuring concessions (and staff) are in place once traffic begins to recover. According to the FAA, collection of rents may be put off: “Deferral of rental payments and or fees, if adequately justified, is not likely to violate FAA’s grant assurances...” but not waived: “...In general, there is no authority that would allow an airport to waive landing fees and terminal rents...” However, is this realistic in the current environment?
Concessionaires are, in general, seeking some manner of rent relief from their airport partners. Airports are left with four basic responses: (i) do nothing, (ii) suspend minimum annual guarantees (MAG), (iii) defer rent or (iv) rent abatement. Let us look at strengths and weaknesses of each alternative.
Creative responses are required that work for both concessionaires and airports, says Alan Gluck (3Sixty Duty Free at Dallas Fort Worth Airport pictured)
i. Do nothing
The first option is to do nothing and enforce existing contracts. This has been the option taken by some US airports, which have even gone so far as to issue Notices of Default (likely for failure to maintain/operate required open hours). While this option will certainly keep the airport in line with FAA recommendations, this is equally likely to cause concessionaires to consider abandoning airport contracts. With little or no concession sales, maintaining and collecting the contractual MAGs is just not practical.
The “do nothing” approach will have an even greater impact on small business owners and ACDBEs with only one or two locations. Larger operators may have busier locations that can help support less-active locations for a very short period. Single store operators do not have this luxury. Simply put, if passenger traffic does not pass their shop, they will have no sales, and with no sales, or sales below a certain level, the concessions become no longer viable. Individual business owners will be forced to close permanently, and larger concessionaires will more closely have to consider that option and walking away from their contracts with airports.
Enforcing concession contracts “as-is” is a virtual guarantee of business failure. And such failures, if enforced as breaches of contracts, will result in there being no concessions to serve passengers when they do eventually return. So, while the “do nothing” strategy sounds good to airports on paper, unless there is an immediate return to normalcy and the passenger growth rates of the past, the likely result is that concessionaires will default, and locations will close.
ii. Minimum Annual Guarantee (MAG) suspension
One of the most evident means of aid would be to relieve concessionaires of the obligation to pay the contractual MAG. This seems like a reasonable solution, as MAGs are developed, generally, on past (or expected) performance. In either case, with few, if any customers, almost every current MAG will be irrelevant as it was established based on a passenger flow level that is no longer achievable in the near term. Suspension of MAGs seems fair and reasonable as concessionaires would then only be responsible for paying a percentage of their actual sales as rent.
However, from the point of view of the concessionaire, this still presents a significant problem. While many of the variable costs incurred by concessionaires can be minimised, fixed costs, such as other airport charges and insurance cannot be changed. Plus, with stores remaining open, regardless of the passenger numbers, various variable costs including personnel, utilities, percentage or rent are not supported by the traffic.
Keeping fixed expenses largely unchanged while sales decrease results in severe cuts to tenant profitability and in most cases, no profit at all. Again, this impact is felt more strongly by single store operators. So, even if MAGs are eliminated, store sales most likely cannot support continued operations.
Duty Free Americas at Miami International: One of many retailers whose stores are closed at the major US airports
iii. Rent deferral
Another option which appears to be acceptable to the FAA under the 28 March guidance, would be for an airport to postpone rent collection for several months. This would allow operators to conserve cash for operations during lean times, allowing concessionaires to repay the airports once there is a return to normality. Note that FAA rules require that this option, if chosen, would need to be offered to all airport tenants equally.
However, there are a few issues with this strategy. First, nobody can determine with any exactness when “normal” will return. Is it three months, twelve months or more? Secondly, it is impossible to know what the new “normal” will be. What is certain is that passenger levels will take time to recover. Just as after other shocks to the system, such as September 11, traffic may take years to recover. That means that the deferred rents will need to be paid back (with interest) based on revenue from sales that may be lower than were originally projected.
In theory, this option would allow concessionaires to continue to operate until the COVID- 19 pandemic ends. However, concessionaires may not be able to continue their businesses, even though their operating expenses are temporarily reduced.
Other expenses, particularly labour (and benefits and taxes), may not be supportable, even if the business is not immediately required to pay rents to the airport. Each business has some calculable level of sales below which the vendor will lose money regardless of the rent deferral. Even if there is a way for the vendor to sustain current operations with deferred rent, as previously stated, once back rents must be paid back, vendor expenses may well exceed their ability to repay them.
iv. Rent abatement
Lastly, rent abatement, or simply not requiring vendors to pay any rent for a period, is the most extreme strategy available. This methodology clearly violates the FAA 28 March guidance as this would be a waiver of terminal rents. This option means that concessionaires would be given their space “for free” and the airport would receive nothing from whatever limited revenue that the operations produce.
The benefits of this option would be that it gives concessionaires the most potential to sustain some level of service while the pandemic continues and will put vendors in the best position to resume operations as passenger traffic increases. A combination of rent abatement and temporary closure of most of the concession units should help the airport to ensure that there is some level of concession services for passengers now. This option should also help to minimise or avoid concessionaire negative cash flow problems that might stem from requiring repayment of the avoided rents.
The problems of this option are many. From the concessionaire’s point of view, even if there is no rent charged and no expectation of repayment, concession operations still may not be financially sustainable in the short term.
From the airport’s point of view, without this non-aviation revenue, airports may find themselves unable to sustain themselves. This problem becomes more acute because, if rents are abated for concessionaires, other airport tenants are going to expect similar treatment, which is a requirement under FAA guidelines.
Unless the airport is shuttered, which can only be done with permission of the FAA, the airport will have bills to pay and no revenue with which to pay them. A failure to collect rents may also violate bond covenants on the financial offerings that have been previously used to finance airport construction. A default on bonds would have long-term consequences. At a minimum, a failure to make required bond payments would have a negative impact on bond ratings currently and in the future. This will limit the airport’s ability to improve its facilities when it eventually becomes necessary.
A combination of rent deferral, flexibility of operations and new lease agreements could be among the solutions to the concession fee challenge
One possible solution
At the risk of stating the obvious, there is no easy solution to this situation. The options that will work best for the airport, and which are permitted by the FAA (US) or respective regulatory agency, may not work for concessionaires. Concessionaires may not be able to support the solutions that work best for the airport. It will be necessary to determine a creative response to this problem.
While it is impossible to create a potential solution without a further investigation into the finances of concessionaires and airports, and a “one size fits all” solution may not be practical, one such answer may be a combination of rent deferral, closure of select concession locations during the pandemic and a change in other lease terms over the long term. We acknowledge that any of these ideas must be balanced against the airport’s commitments and its use and lease agreement as well as the financial condition of the concessionaire.
Generally, airports might consider providing a lease extension to give concessionaires a longer time to recoup their lost revenue. The lease extension can be predicated on the vendor continuing to operate in a manner to maximise revenue by providing outstanding customer service and ensuring the concession locations are well maintained and meeting all other lease conditions.
The delayed rent repayment should be made over an extended period (years, not months); should incur interest as allowed or required by law (e.g. Treasury note interest rates as per FAA’s 28 March guidance); and repayment should not start until there has been a return to normality (so a level of flexibility as to when repayment begins must be included in such extension).
In addition, MAGs should be reduced to levels that are more practical given current (and future expected) conditions, which may result in a separate MAG level during the pandemic and thereafter, or they can be eliminated completely until recovery begins.
For airports that continue MAGs during the pandemic, they should consider utilising a per-passenger MAG methodology. Percentage rents should also be reduced, at least during the pandemic. The airport should carefully consider the necessity of other charges that it levies and their reasonableness.
All these recommended changes will require negotiation, and both parties must be willing to give a bit so that a mutually agreeable solution can be reached. No one is going to “win” these negotiations, but both sides must come together for mutual benefit and the benefit of the travelling public.
Conclusion
Life in the immediate future will be different. Concessionaires may no longer earn profits at their pre-crisis level for a while, but the business opportunities still need to result in positive cash flows for them. Airports must continue to be self-sustaining, serving the public with facilities that provide outstanding customer experiences. The balance that allows for these imperatives needs to be recast for each individual airport in these new, uncertain times.
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The Moodie Davitt eZine
Issue 278 | 7 April 2020
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