Chapter 6

AIRPORT FINANCIALMANAGEMENT AND PRICING

Photo credit: Federal Aviation Administration

Contents

PageApproaches to Financial Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , . 125

The Residual-Cost Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125The Compensatory Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126Comparison of Residual-Cost and Compensatory Approaches . . . . . . . . . . . . . 127Pricing of Airport Facilities and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129Structure and Control of Airport Charges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131Variation in the Source of Operating Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 133

Trends in Airport Management Since Deregulation . . . . . . . . . . . . . . . . . . . . . . . . . 135Shorter Term Contracts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135Modifications of Residual-Cost Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136Maximization of Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136

List of TablesTable No. Page18.19.

20.

21.22.23.

Financial Management of Commercial Airports, 1983 . . . . . . . . . . . . . . . . . . . 126Comparison of Residual-Cost and Compensatory Methods ofCalculating Airport Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127Role of Airlines in Approving Capital Projects atCommercial Airports, 1983 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128Term of Airport Use Agreements at Commercial Airports, 1983 . . . . . . . . . . 130Profile of Landing Fees at Four Major Airports, 1982 . . . . . . . . . . . . . . . . . . . 132Average 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, U.S. commercial airports are typicallyowned and managed by local governments orother non-Federal public authorities. Although themanagement approach varies, major U.S. 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 patrons.This 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 process.

On the basis of a survey conducted by the Con-gressional Budget Office (CBO) in 1983 (app. 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 1978.Brief attention is also given to management andfinancing practices of smaller airports, includingpublicly owned general aviation (GA) airports.

APPROACHES TO FINANCIAL MANAGEMENT

At 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 shared.These contracts, commonly termed “airport useagreements, ” establish the terms and conditionsgoverning the airlines’ use of the airport.2 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 projects.

Although 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 U.S. Airports in the1980s, April 1984. 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 ordinance.

port-airline 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 revenue.The 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 use.

The Residual-Cost Approach

A 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). Under this ap-proach, the airlines collectively assume significant

125.

126 . Airport System Development

financial 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

Large MediumApproach Number Percent Number Percent

SOURCE: Congressional Budget Office, 1963 Survey.

lustrate 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 center.3

The residual between costs and revenues wouldthen provide the basis for calculating the ratescharged the airlines for their use of facilities withinthe cost center. Any surplus revenues would becredited to the airlines and any deficit charged tothem in calculating airline landing fees or otherrates for the following year.4

The Compensatory Approach

Under 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 and

3Debt 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 1.25 to 1.40 times debt service, thereby pro-viding a substantial cushion that enhances the security of the bonds.This is discussed further in ch. 7.

4Haro1d B. Kluckholn, “Security for Tax-Exempt Airport RevenueBonds,” summary of remarks presented at the New York Law JournalSeminar on Tax-exempt Financing for Airports, 1980.

Ch. 6—Airport Financial Management and Pricing . 127

rents will suffice to allow the airport to meet itsannual operating and debt service requirements.A compensatory approach is currently in use at10 of the 24 large commercial airports and 15 ofthe 36 medium airports surveyed by CBO.

Although 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. 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 airlines.

Comparison of Residual-Cost andCompensatory Approaches

These 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:

●

●

●

an 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 operator.

These differences, examined below, can havean important bearing on an airport’s performancein the municipal bond market, as will be discussedin chapter 7.

Retention of Earnings

Although 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. It canalso provide an alternative to issuing debt for the

128 Airport System Development

financing of some portion of capital development.Residual-cost 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 costs.5

By 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. 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 nonairlinerevenues. b

Because 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 airports.

costs, residual-cost airports, as a group, tend toretain considerably smaller percentages of theirgross revenues than do compensatory airports.A few residual-cost airports, however, have mod-ified the approach to permit accumulation of siz-able retained earnings for use in capital projects.At 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 projects.

Majority=in-interest

In 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. These powers are embodiedin so-called majority-in-interest clauses, which area much more common feature of airport useagreements at residual-cost airports than at air-ports using a compensatory approach (see table20). At present, more than three-quarters of thelarge commercial airports using a residual cost ap-proach have some form of majority-in-interestclause in their use agreements with the airlines,and two-thirds of the medium residual-cost air-ports have such clauses. Of the airports surveyed,only one-tenth of the large and one-third of me-dium commercial airports that use a compen-satory approach to financial management havemajority-in-interest clauses in their use agreements.

Table 20.—Role of Airlines in Approving Capitai Projects atCommercial Airports, 1983°

Large MediumAirline role Number Percent Number PercentResidual costMajority-in-Interest clause . . . . . . . . . . . . 11 79 14 67No formal requirement of

airline approval . . . . . . . . . . . . . . . . . . . 3 21 7 33Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 100 21 100

CompensatoryMajority-in-Interest clause . . . . . . . . . . . . 1 10 5 33No formal requirement of

airline approval . . . . . . . . . . . . . . . . . . . 9 90 10 67Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 100 15 100

Grand total . . . . . . . . . . . . . . . . . . . . . 24 — 36 —

Ch. 6—Airport Financial Management and Pricing 129

Majority-in-interest clauses give the airlinesaccounting for a majority of traffic at an airportthe opportunity to review and approve or vetocapital projects that would entail significant in-creases in the rates and fees they pay for the useof airport facilities. 7 This arrangement providesprotection for the airlines that have assumed fi-nancial risk under a residual-cost agreement byguaranteeing payment of all airport costs not cov-ered by nonairline sources of revenue. For in-stance, without some form of majority-in-interestclause, the airlines at a residual-cost airport couldbe obligating themselves to pay the costs of as-yet-undefined facilities that might be proposed inthe 15th or 20th year of a 30-year use agreement.Under a compensatory approach, where the air-port operator assumes the major financial risk ofrunning the facility, the operator is generally freerto undertake capital development projects with-out consent of the airlines that account for a ma-jority of the traffic. Even so, airport operatorsrarely embark on major projects without con-sulting the airlines that serve the airport. Poten-tial investors in airport revenue bonds would bewary of a bond issue for a project lacking the air-lines’ approval.

Specific provisions of majority-in-interest clausesvary considerably. At some airports, the airlinesthat account for a majority of traffic can approveor disapprove all major capital developmentprojects—e.g., any project costing more than$100,000. At others, projects can only be deferredfor a certain period of time (generally 6 monthsto 2 years). Although most airports have at leasta small discretionary fund for capital improve-ments that is not subject to majority-in-interestapproval, the general effect of majority-in-interestprovisions is to limit the ability of the public air-port owner to proceed with any major project op-posed by the airlines. Sometimes, a group of justtwo or three major carriers can exercise suchcontrol.

The combination of airlines that can exercise majority-in-interestpowers varies. A typical formulation would give majority-in-interestpowers to any combination of “more than so percent of the scheduledairlines that landed more than 50 percent of the aggregate revenueaircraft weight during the preceding fiscal year” (standard documentwording).

Term of Use Agreement

At the airports examined in the CBO study,residual-cost airports typically have longer termuse agreements than do compensatory airports.This is because residual-cost agreements histori-cally have been drawn up to provide security forlong-term airport revenue bond issues; and theterm of the use agreement, with its airline guar-antee of debt service, has generally coincided withthe term of the revenue bonds. More than 90 per-cent of the large and 75 percent of the mediumresidual-cost airports surveyed by CBO have useagreements with terms of 20 or more years (seetable 21). Terms of 30 years or longer are not un-common.

By contrast, about 60 percent of the large and40 percent of the medium compensatory airportssurveyed have use agreements running for 20years or more. Four of the compensatory airportssurveyed have no contractual agreements what-ever with the airlines. At these airports, rates andcharges are established by local ordinance orresolution. This arrangement gives airport oper-ators maximum flexibility to adjust their pricingand investment practices unilaterally, without theconstraints imposed by a formal agreement ne-gotiated with the airlines, but it lacks the secu-rity provided by contractual agreements.

Pricing of Airport Facilitiesand Services

Major commercial airports are diversified enter-prises - that provide a wide range of facilities andservices for which fees, rents, or other user chargesare assessed. Most commercial airports, regardlessof size, type, or locale, offer four major types offacilities and services:

• airfield facilities, made up of runways, tax-iways, aprons, and parking ramps for use bycommercial and general aviation;

● terminal area facilities and services providedto concessionaires and consumers, includingauto parking and ground transportation,restaurants and snack bars, specialty stores(e.g., newsstands and duty-free shops), carrental companies, passenger convenience fa-cilities (e.g., porter service, restrooms, tele-phones, and vending machines), personal

.

130 . Airport System Development

Table 21.–Term of Airport Use Agreements at Commercial Airports, 1983

Large Medium

Length of term Number Percent Number Percent

Residual cost20 years or more. . . . . . . . . . . . . . . . . . . . 13 93 16 7611-19 years. . . . . . . . . . . . . . . . . . . . . . . . . 0 0 2 106-10 years . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 55 years or less. . . . . . . . . . . . . . . . . . . . . . 1 7 : oNegotiations in process . . . . . . . . . . . . . 0 0 2 10

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 100 21 100

compensatory20 years or more . . . . . . . . . . . . . . . . . . . . 6 60 6 4011-19 years.... . . . . . . . . . . . . . . . . . . . . . o 0 2 136-10 years . . . . . . . . . . . . . . . . . . . . . . . . . . 1 10 2 135 years or less..... . . . . . . . . . . . . . . . . . 0 0 3 20No use agreements . . . . . . . . . . . . . . . . . 3 30 1 7Negotiations in process . . . . . . . . . . . . . 0 0 1 7

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 100 15 100

Grand total . . . . . . . . . . . . . . . . . . . . . 24a — 36b —

‘Ground rentals are leases of land in which the lessee pays thecost of constructing any facilities, such as terminals, upon it.

9Fixed base operators are private concerns that lease aircraft andoffer aviation services, such as fuel sale, flight instruction, and air-craft maintenance.

ports decrease in size, and many of the smallest

do not generate sufficient revenue to cover their

o p e r a t i n g c o s t s , m u c h l e s s c a p i t a l i n v e s t m e n t .

Among GA a i rpor t s , those tha t l ease l and or fa -

cil it ies for industrial use generally have a betterchance o f cover ing the i r cos t s o f opera t ion thando those providing only aviation-related services

and fac i l i t i es . l”

T h e c o m b i n a t i o n o f p u b l i c m a n a g e m e n t a n d

pr iva te enterpr i se un ique ly charac ter i s t i c o f the

f i n a n c i a l o p e r a t i o n o f c o m m e r c i a l a i r p o r t s i s

reflected in the divergent pricing of airport facil-ities and services. The private enterprise aspectsof airport operation—the services and facilitiesfurnished for nonaeronautical use—generally arepriced on a market pricing basis. On the otherhand, the pricing of facilities and services for air-lines and other aeronautical users is on a cost-recovery basis, either recovery of the actual costsof the facilities and services provided (the com-pensatory approach) or recovery of the residualcosts of airport operation not covered by nonair-Iine sources of revenue. This mix of market pric-

‘OSee Joel Crenshaw and Edmund Dickinson, “Investment Needsand Self-Financing Capabilities: U.S. Airports, Fiscal Years 1981-1990,” report prepared for the U.S. Department of Transportation,July 1978, pp. 12, 45; and Laurence E. Gesell, The Administrationof Public Airports, Coast Aire Publications, 1981, pp. VI 6-13.

Ch. 6—Airport Financial Management and Pricing 131

ing and cost-recovery pricing has important imp-lications for airport financing, especially withregard to the structure and control of airportcharges and the distribution of operating revenues,

Structure and Control ofAirport Charges

At major commercial airports, the structure andcontrol of fees, rents, and other charges for facil-ities and services are governed largely by a vari-ety of long- and short-term contracts, includingairport use agreements with the airlines, leases,and concession and management contracts. Foreach of the four major groups of facilities andservices outlined above, the basic kinds of chargesassessed at residual-cost and compensatory air-ports can be compared in terms of:

● method of calculation,● term of agreement, and● frequency of adjustment.

Airfield Area

The major fees assessed for use of airfield fa-cilities are landing or flight fees for commercialairlines and GA aircraft. Some airports also levyother airfield fees such as charges for the use ofaircraft parking ramps or aprons. In lieu of land-ing fees, many smaller airports, especially GA air-ports, collect fuel “flowage” fees, which are leviedper gallon of aviation gasoline and jet fuel soldat the airport.

At residual-cost airports, the landing fee for air-lines is typically the item that balances the budget,making up the projected difference between allother anticipated revenues and the total annualcosts of administration, operations and mainte-nance, and debt service (including coverage).Landing fees differ widely among residual-cost air-ports, depending on the extent of the revenuesderived from airline terminal rentals and conces-sions such as restaurants, car rental companies,and automobile parking lots. If the nonairlinerevenues are high in a given year, the landing feefor the airlines may be quite low. In recent years,several airports—including Los Angeles and Hon-olulu International—have approached a “nega-tive” landing fee. At some residual-cost airports,

the landing fee is the budget-balancing item forthe airfield cost center only. At such airports, thesurplus or deficit in the terminal cost center hasno influence on airline landing fees, and terminalrental rates for the airlines may be set on a resid-ual-cost or a compensatory basis.

The method of calculating landing fees at re-sidual-cost airports is established in the airportuse agreement and continues for the full term ofthe agreement. To reflect changes in operatingcosts or revenues, landing fees are typically ad-justed at specified intervals ranging from 6 monthsto 3 years. At some airports, fees maybe adjustedmore often if revenues are significantly lower orhigher than anticipated. Often, the nonsignatoryairlines (those not party to the basic use agree-ment) pay higher landing fees than the signatorycarriers. General aviation landing fees vary greatlyfrom airport to airport, ranging from chargesequal to those paid by the commercial airlines tonone at all. Most landing fees are assessed on thebasis of certificated gross landing weight. ”

At compensatory airports, airline landing feesare based on calculation of the average actualcosts of airfield facilities used by the airlines (seetable 22). As in the case of residual-cost airports,each airline’s share of these costs is based onits share of total projected airline gross landingweights (or, in a few cases, gross takeoff weight).In addition to fees determined by this weight-based measure, three compensatory airports—Boston Logan International and John F. Kennedyand La Guardia airports in New York—assess asurcharge on GA aircraft during hours of peakdemand. At present, however, no major airports

“This practice of basing landing fees on aircraft weight tends topromote use of commercial airports by general aviation. Since mostGA aircraft are relatively light (under 10,000 lb), they pay very lowlanding fees at most commercial airports-typically $10 or less. Thesmallest GA aircraft (under 2,500 lb) often pay no fee. Among theairports surveyed by CBO there is no clear indication that landingfees for GA differ systematically as a function of pricing policy.Residual-cost and compensatory airports alike have landing fees forGA that are so small as to be a negligible, either as a source ofrevenue to the airport or as a deterrent to use of congested facilities.

132 Airporf System Development

Table 22.–Profiie of Landing Fees at Four Major Airports, 1982

Airline Iandina fee

Basis of fee Method of calculation Feea General aviation landing fee

Fee = public aircraft facilities costsdivided by total projected scheduledairline landing weights; adjustedannually

Fee = airfield cost center expensesdivided by total projected airlinelanding weights; adjusted annually

Fee = residual cost divided byestimated total landing weights ofall airlines; adjusted semiannually

Fee = residual cost divided byestimated total landing weights ofall airlines; adjusted every 3 years

$1.24

$0.34

$0.75’

$0.23

Depafiments, August 1982.

impose such peak-hour surcharges on commer-cial airlines to help ease congestion problems.12

Landing fees at compensatory airports are es-tablished either in airport use agreements with theairlines or by local ordinance or resolution. Thefrequency of adjustment of the fees is compara-ble to that at residual-cost airports.

Terminal Area

The structure of terminal concession and serv-ice contract fees is similar under both pricing ap-proaches. Concession contracts typically providethe airport operator with a guaranteed annualminimum payment or a specified percentage of

the concessionaire’s gross revenues, whichever isgreater. Restaurants, snack bars, gift shops, news-stands, duty-free shops, hotels, and rental caroperations usually have contracts of this type.Terminal concession contracts are often bid com-petitively, and they range in term from month-to-month agreements to contracts of 10 to 15years’ duration. (Hotel agreements generally havemuch longer terms, often running for 40 years ormore. ) Airport parking facilities may be operatedas concessions; they may be run by the airportdirectly; or they may be managed by a contrac-tor for either a flat fee or a percentage of revenues.

Airline Leased Areas

At both residual-cost and compensatory air-ports, airlines pay rent to the airport operator forthe right to occupy various facilities (terminalspace, hangars, cargo terminals, and land). Rentalrates are established in the airport use agreements,in separate leases, or by local ordinance or resolu-tion. Terminal space may be assigned on an ex-clusive-use basis (to a single airline), a preferential-

Ch. 6—Airport Financial Management and Pricing ● 133

use basis (if a certain level of activity is not main-tained, the airline must share the space), or ona joint-use basis (space used in common by sev-eral airlines). Most major commercial airports usea combination of these methods. In addition, air-ports may charge the airlines a fee for use of anyairport-controlled gate space and for the provi-sion of Federal inspection facilities required at air-ports serving international traffic. Some airportshave long-term ground leases with individual air-lines that allow the airlines to finance and con-struct their own passenger terminal facilities onland leased from the airport.

Among residual-cost airports, the method ofcalculating airline terminal rental rates varies con-siderably. If airline fees and charges are calculatedon a residual-cost basis within each cost center,the method of calculating rental rates resemblesthat of the simplified example shown in table 19.To arrive at the airline fee, total nonairline rev-enues generated within the terminal cost centerare subtracted from the total costs of the center(administration, operations and maintenance, anddebt service). Each airline’s share is based on thesquare footage it occupies, with proration ofjointly used space.

On the other hand, at residual-cost airportswhere receipts from airline landing fees alone areused to balance the airport budget, the terminalrental rates for the airlines may be set in variousways—on a compensatory basis (recovering theaverage actual costs of the facilities used), by anoutside appraisal of the property value, or by ne-gotiation with the airlines. In all cases, each air-line’s share of costs is based on its proportionateuse of the facilities. Rental rates may be uniformfor all types of space leased to the airlines, or theymay differ according to the type of space pro-vided—for example, they may be significantlyhigher for leases of ticket counters or office spacethan for rental of gate or baggage claim areas.

At residual-cost airports, the rental term for air-line leased areas generally coincides with the termof the airport use agreement with the airlines. Thefrequency of adjustment of terminal rental ratesranges considerably—annually at many airports,but up to 3 to 5 years at others.

At compensatory airports, the method of cal-culating terminal rental rates for the airlines isbased on recovery of the average actual costs ofthe space occupied. Each airline’s share of the totalcosts is based on the square footage leased. Typi-cally, rates differ according to the type of spaceand whether it is leased on an exclusive, preferen-tial, or joint-use basis. The rental term for air-line leased areas often coincides with that of theairport use agreement. (It is set by ordinance atairports that operate without agreements. ) Ratesare typically adjusted annually at compensatoryairports.

Other Leased Areas

A wide variety of arrangements are employedfor other leased areas at an airport, which mayinclude agricultural land, fixed base operations,cargo terminals, and industrial parks. The meth-ods of calculating rental rates and the frequencyof adjustment differ according to the type of fa-cility and the nature of use. What these disparaterentals have in common is that, like terminal con-cessions and services, they are generally pricedon a market basis; and the airport managers haveconsiderable flexibility in setting rates and chargesin the context of market constraints and their ownpolicy objectives.

Variation in the Source ofOperating Revenues

1n general, revenue diversification enhances thefinancial stability of an airport. In addition, thespecific mix of revenues may influence year-to-year financial performance. Some of the majorsources of airport revenue (notably landing feesand terminal concessions) are affected by changesin the volume of air passenger traffic, while others(e.g., airline terminal rentals and ground leases)are essentially immune to fluctuations in airtraffic.

The distribution of operating revenues differswidely according to factors such as passengerenplanements, the nature of the market served,and the specific objectives and features of the air-port’s approach to pricing and financial manage-ment. Airport size generally has a strong influ-ence on the distribution of revenues. The larger

134 ● Airport System Development

commercial airports typically have a more diver-sified revenue base than smaller airports. For ex-ample, they tend to have a wider array of income-producing facilities and services in the passengerterminal complex. In general, terminal concessionscan be expected to generate a greater percentageof total operating revenues as passenger enplane-ments increase. On average, concessions accountfor at least one-third of total operating revenuesat large, medium, and small commercial airports,compared to about one-fifth at very small (nonhub)commercial airports and a smaller fraction stillat GA airports (see table 23).

Factors other than airport size also affect dis-tribution of operating revenues. At commercialairports, for example, parking facilities generallyprovide the largest single source of nonairlinerevenues in the terminal area. Airports that havea high proportion of connecting traffic may, how-ever, derive a smaller percentage of their operat-ing income from parking revenues than do so-called “origin and destination” airports. Other fac-tors that may affect parking revenues includeavailability of space for parking, the volume ofair passenger traffic, the airport pricing policy,availability and cost of alternatives to driving tothe airport (e.g., mass transit and taxicab serv-

ice), and the presence of private competitors pro-viding parking facilities at nearby locations offthe airport property.

The approach to financial management, be-cause it governs the pricing of facilities and serv-ices provided to airlines, significantly affects thedistribution of operating revenues. Since so manyother factors play an important role in determin-ing revenue distribution, however, the mix ofoperating revenues at an airport cannot be pre-dicted on the basis of whether the airport employsa residual-cost or a compensatory approach. Themix of revenues varies widely among residual-costairports. With airline landing fees characteris-tically picking up the difference between airportcosts and other revenues at residual-cost airports,airfield area income differs markedly accordingto the extent of the airport’s financial obligations,the magnitude of terminal concession income andother nonairline revenues, and the volume of airtraffic. In 1982, for example, airfield area revenuesprovided anywhere from 10 percent (Tampa In-ternational) to more than 50 percent (ChicagoO’Hare International) of total operating revenuesat residual-cost airports. By contrast, compen-satory airports show a considerably smaller rangeof variation in the distribution of revenues.

Table 23.–Average Operating Revenue by Revenue Source, Commercial and Generai Aviation Airports, 1975-76

Ch. 6—Airport Financial Management and Pricing 135

TRENDS IN AIRPORT MANAGEMENT SINCE DEREGULATION

FederaI deregulation of the airline industry hasradically changed the market in which airlines—and airports—operate. Once subject to strict reg-ulation of routes and fares, commercial air car-riers are now free to revise routes, adjust fares,and introduce or terminate service to particularairports as market conditions seem to warrant.This new freedom from Federal intervention hashad pronounced effects on the airline industry.It has spurred intense competition and even pricewars among the airlines, led to reconfigurationof the route system, and encouraged the startupof new carriers. For some of the established air-lines, serious financial difficulties have ensued. Al-though deregulation has not caused radical changesin the financial management of airports, recenttrends do reflect the uncertainties of a new, openmarket. Deregulation also appears to have ac-celerated certain shifts in management policy andpractice that were under way before deregulation.

Since the early days of commercial air travel,would-be investors in airport revenue bonds haveheld long-term use agreements in high regard, con-sidering them evidence of the airlines’ commitmentto serve an airport for long periods—spans usu-ally coincident with the terms of bond issues. Asthe industry has matured, however, investors andanalysts have increasingly recognized that an air-port’s financial stability—hence its capacity togenerate a stream of revenue adequate to securerevenue bond issues—depends more on the under-lying strength of the local air travel market thanon long-term use agreements.

Deregulation has reinforced this shift, as thestrength of the airlines’ financial commitment toan airport is significantly diluted by their new flex-ibility to withdraw from a market virtually at will.Confidence has also been shaken by the financialproblems now plaguing many airlines. Althoughchanges in airport financial management occurvery slowly (many standing use agreements runthrough the 1990s or later), three important trendsin financial management are now emerging at ma-jor commercial airports:

● shorter term contracts—shorter terms for air-port use agreements, nonairline leases, and

●

●

concessionaires’ contracts, and more frequentadjustment of rates and charges;modification of residual-cost approach—modification of residual-cost ratemaking andmajority-in-interest provisions, with move-ment in the direction of more compensatoryforms of financial management; andmaximization of revenues—concerted effortby airport managers to maximize revenuesby means of a variety of strategies intendedto strengthen and diversify the revenue baseof the airport.

Shorter Term Contracts

Deregulation appears to have hastened a trendtoward shorter term airport use agreements thatwas already under way prior to 1978. Shorterterm contracts give airport operators greater flex-ibility to adjust pricing, investment policies, andspace allocation to meet shifting needs in a de-regulated environment. For example, several air-ports with long-term use agreements in force havegiven much shorter term agreements to air car-riers that have begun serving the airport since1978. Contracts for such recent entrants often runfor 5 years or less, and they may take the formof yearly or even month-to-month operatingagreements (similar to those used for air taxi andcommuter operators). At least 15 percent of thelarge and medium airports surveyed by CBO havegranted new carriers such relatively short-termterminal leases and/or use agreements. Moreover,as existing long-term use agreements expire, manyairport operators indicate an intention to negoti-ate shorter term use agreements with all carriersserving the airport. At least a dozen of the air-ports surveyed by CBO either have recently con-cluded shorter term agreements or anticipate thatnew use agreements (planned or in negotiation)will be significantly shorter than ones now stand-ing. In part, this reflects the fact that many post-deregulation agreements have not involved ma-jor capital development programs requiring long-term bond financing.

Many airports also report that, as old contractsexpire, they are routinely shortening the terms ofnonairline leases and contracts with concession-

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136 ● Airport System Development

aires. Some are also moving to more frequent ad-justment of rates and charges under existing agree-ments to meet the escalating costs of airportoperation.

Modifications of Residual=

better able to assume the financial risks of airportoperation without relying on “break-even” guar-antees by the airlines, and they may maximizerevenues by adopting a compensatory approach.

Maximization of Revenues

No matter how they approach financial man-agement, many commercial airports are now seek-ing to increase and diversify their revenues by avariety of strategies. These include raising existingfees and rental rates, seeking more frequent ad-justment of charges, using competitive bidding forconcessionaires’ contracts, increasing the airport’spercentage of gross profits, and exploiting newor untapped sources of revenue—e.g., videogamerooms, industrial park development, and leasingof unused airport property. Some airports arelooking to future possibilities, as well. For exam-ple, two large airports that recently renegotiatedairport use agreements—Chicago O’Hare andGreater Pittsburgh International-included clausesin the new contracts protecting the airport’s rightto levy a passenger facility charge (or head tax)if and when Federal law permits. In general, thiseffort to diversify and expand revenue sourcesreflects the paramount importance of a guaranteedstream of income to assure an airport’s financialsuccess.