Chapter 6 AIRPORT FINANCIAL MANAGEMENT …

1 Chapter 6 AIRPORT FINANCIALMANAGEMENT AND PRICINGP hoto credit: Federal Aviation AdministrationContentsPageApproaches to FINANCIAL MANAGEMENT .. , . 125 The Residual-Cost Approach .. 125 The Compensatory Approach .. 126 Comparison of Residual-Cost and Compensatory Approaches .. 127 Pricing of AIRPORT Facilities and Services .. 129 Structure and Control of AIRPORT Charges.. 131 Variation in the Source of Operating Revenues .. 133 Trends in AIRPORT MANAGEMENT Since Deregulation .. 135 Shorter Term Contracts.. 135 Modifications of Residual-Cost Approach .. 136 Maximization of Revenues .. 136 List of TablesTable MANAGEMENT of Commercial Airports, 1983 .. 126 Comparison of Residual-Cost and Compensatory Methods ofCalculating AIRPORT Fees .. 127 Role of Airlines in Approving Capital Projects atCommercial Airports, 1983 .. 128 Term of AIRPORT Use Agreements at Commercial Airports, 1983 .. 130 Profile of Landing Fees at Four Major Airports, 1982.

2 132 Average Operating Revenue by Revenue Source, Commercial andGeneral Aviation Airports, 1975-76 .. 134 Chapter 6 AIRPORT FINANCIALMANAGEMENT AND PRICING1 Unlike airports in other countries, many ofwhich are owned and run by national govern-ments, commercial airports are typicallyowned and managed by local governments orother non-Federal public authorities. Although themanagement approach varies, major com-mercial airports function as mature enterprises,applying up-to-date techniques of FINANCIAL man-agement and administration. These publicly ownedand managed facilities are operated in conjunc-tion with private industry-the commercial air-lines, which are the airports link to their peculiar public-private character distinguishesthe FINANCIAL operation of commercial airportsfrom that of wholly public or private enterprises,distinctly shaping AIRPORT MANAGEMENT practices,the pricing of facilities and services, and the in-vestment planning the basis of a survey conducted by the Con-gressional Budget Office (CBO) in 1983 (app.)

3 B),this Chapter develops a profile of FINANCIAL pol-icies and practices now followed at 60 of the Na-tion s larger commercial airports and assessestrends in AIRPORT FINANCIAL MANAGEMENT since Fed-eral deregulation of the airline industry in attention is also given to MANAGEMENT andfinancing practices of smaller airports, includingpublicly owned general aviation (GA) TO FINANCIAL MANAGEMENTAt most commercial airports, the FINANCIAL andoperational relationship between the AIRPORT oper-ator and the airlines is defined in legally bindingagreements that specify how the risks and respon-sibilities of running the AIRPORT are to be contracts, commonly termed AIRPORT useagreements, establish the terms and conditionsgoverning the airlines use of the Theyalso specify the methods for calculating rates air-lines must pay for use of AIRPORT facilities and serv-ices; and they identify the airlines rights andprivileges, sometimes including the right to ap-prove or disapprove any major proposed airportcapital development FINANCIAL MANAGEMENT practices dif-fer greatly among commercial airports, the air- IThis Chapter was prepared by the Congressional Budget Officeand appears in unabridged form in Financing Airports in the1980s, April 1984.

4 The version here has been condensed and editedto conform to the OTA report format. AIRPORT use agreement is used generically hereto include bothlegal contracts for the airlines use of airfield facilities and leasesfor use of terminal facilities. At many airports, both are combinedin a single document. A few commercial airports do not negotiateairport use agreements with the airlines, but instead charge ratesand fees set by local relationship at major airports typicallytakes one of two very different forms, with im-portant implications for AIRPORT pricing and in-vestment:The residual-cost approach, under which theairlines collectively assume significant finan-cial risk by agreeing to pay any costs of run-ning the AIRPORT that are not allocated toother users or covered by nonairline sourcesof compensatory approach, under whichthe AIRPORT operator assumes the major finan-cial risk of running the AIRPORT and chargesthe airlines fees and rental rates set so as torecover the actual costs of the facilities andservices that they Residual-Cost ApproachA majority of the Nation s major commercialairports surveyed by CBO 14 out of 24 large air-ports and 21 of 36 medium airports have someform of residual-cost approach to FINANCIAL man-agement (see box A and table 18).

5 Under this ap-proach, the airlines collectively assume . AIRPORT System Developmentfinancial risk. They agree to keep the airportfinancially self-sustaining by making up any defi-cit the residual cost remaining after the costsidentified for all AIRPORT users have been offset bynonairline sources of revenue (automobile park-ing and terminal concessions such as restaurants,newsstands, snack bars, and the like).Although applications of the residual-cost ap-proach vary widely, a simplified example can il-Table 18. FINANCIAL MANAGEMENT ofCommercial Airports, 1983 LargeMediumApproachNumber Percent Number PercentSOURCE: Congressional Budget Office, 1963 the basic approach (see table 19). Mostairports have a number of different cost centers,such as terminal buildings, the airfield, roads andgrounds, and the air freight area. At a residual-cost AIRPORT , the total annual costs includingadministration, maintenance, operations, anddebt service (including coverage) could be cal-culated for each cost center, and offset by allnonairline revenues anticipated for that residual between costs and revenues wouldthen provide the basis for calculating the ratescharged the airlines for their use of facilities withinthe cost center.

6 Any surplus revenues would becredited to the airlines and any deficit charged tothem in calculating airline landing fees or otherrates for the following Compensatory ApproachUnder a compensatory approach, the airportoperator assumes the FINANCIAL risk of AIRPORT oper-ation, and airlines pay rates and charges equal tothe costs of the facilities they use as determinedby cost accounting. In contrast to the situationat residual-cost airports, the airlines at a compen-satory AIRPORT provide no guarantee that fees and3 Debt service coverage is the requirement that the AIRPORT s rev-enues, net of operating and maintenance expenses, be equal to aspecified percentage in excess of the annual debt service (principaland interest payments) for revenue bond issues. The coverage re-quired is generally from to times debt service, thereby pro-viding a substantial cushion that enhances thesecurity of the is discussed further in ch.

7 B. Kluckholn, Security for Tax-Exempt AIRPORT RevenueBonds, summary of remarks presented at the New York Law JournalSeminar on Tax-exempt Financing for Airports, 6 AIRPORT FINANCIAL MANAGEMENT and Pricing . 127rents will suffice to allow the AIRPORT to meet itsannual operating and debt service compensatory approach is currently in use at10 of the 24 large commercial airports and 15 ofthe 36 medium airports surveyed by individual airports have adoptedmany versions of the compensatory approach, thesimplified example set out in table 19 illustratesthe basics. First, for each cost center a calcula-tion would be made of the total annual expenseof running the center, including administration,maintenance, operations, and debt service (withcoverage). The airlines shares of these costs wouldthen be based on the extent of their actual use offacilities within each cost center.

8 The airlineswould not be charged for the costs of public space,such as terminal lobbies. Nor would they receiveany credit for nonairline revenues, which offsetexpenses in the residual-cost approach but are dis-regarded under a compensatory approach in cal-culating rates and charges to the of Residual-Cost andCompensatory ApproachesThese two major approaches to FINANCIAL man-agement of major commercial airports have sig-nificantly different implications for pricing andinvestment practices. In particular, they help de-termine:lllan AIRPORT s potentiaI for accumulating re-tained earnings usable for capital devel-opment;the nature and extent of the airlines role inmaking AIRPORT capital investment decisions,which may be formally defined in majority-in-interest clauses included in AIRPORT useagreements with the airlines; andthe length of term of the use agreement be-tween the airlines and the AIRPORT differences, examined below, can havean important bearing on an AIRPORT s performancein the municipal bond market, as will be discussedin Chapter of EarningsAlthough large and medium commercial air-ports generally must rely on the issuance of debtto finance major capital development projects, theavailability of substantial revenues generated inexcess of costs can strengthen the performance ofan AIRPORT in the municipal bond market.

9 It canalso provide an alternative to issuing debt for the128 AIRPORT System Developmentfinancing of some portion of capital financing guarantees that an airportwill always break even thereby assuring serv-ice without resort to supplemental local tax sup-port but it precludes the AIRPORT from generat-ing earnings substantially in excess of contrast, an AIRPORT using a compensatoryapproach lacks the built-in security afforded bythe airlines guarantee that the AIRPORT will breakeven every year. The public operator undertakesthe risk that revenues generated by AIRPORT feesand charges may not be adequate to allow the air-port to meet its annual operating costs and debtservice obligations. On the other hand, becausetotal revenues are not constrained to the amountneeded to break even, and because surplus rev-enues are not used to reduce airline rates andcharges, compensatory airports may earn and re-tain a substantial surplus, which can later be usedfor capital development.

10 Since the pricing of air-port concessions and consumer services need notbe limited to the recovery of actual costs, theextent of such retained earnings generally dependson the magnitude of the AIRPORT s the residual-cost approach is not de-signed to yield substantial revenues in excess of.. -- Peat, Marwick, Mitchell & Co., Comparative Rate Analysis:Dade County Aviation and Seaport Departments, August 1982,p. 3. Market pricing of concessions and other nonairline sources ofrevenue is a feature of both residualcost and compensatory , residual-cost airports, as a group, tend toretain considerably smaller percentages of theirgross revenues than do compensatory few residual-cost airports, however, have mod-ified the approach to permit accumulation of siz-able retained earnings for use in capital Miami and Reno International Airports, forexample, certain AIRPORT -generated revenues areexcluded from the revenue base used in calculat-ing the residual cost payable by the airlines; therevenues flow instead into a discretionary fundthat can finance capital development exchange for the guarantee of solvency, air-lines that are signatory to a residual-cost useagreement often exercise a significant measure ofcontrol over AIRPORT investment decisions andrelated pricing policy.