Airports need to develop business models that plan for uncertainty and prepare for change to succeed in today’s operating environment, writes LeighFisher’s Andy Carlisle.
In recent years the global economy has been subject to almost unprecedented turbulence, which has resulted in a climate of uncertainty, and the aviation industry has proved particularly vulnerable to external events such as terrorism, pandemics, and extreme weather.
Indeed, rapid change in consumer markets and technologies is creating a situation in which businesses should increasingly expect future disruptive factors to challenge ‘business as usual’ models.
While often perceived as an operational issue, resilience is an increasing feature of airport business management, and shapes how business models evolve to meet new challenges.
Airlines have become more cost-sensitive; alliances are expanding; many Middle Eastern carriers are aggressively growing; growth is becoming more centred on emerging markets; new aircraft offer market opportunities; and the private sector is taking an increasing role in the global industry.
In this context, resilience means managing risk and capitalising on opportunities. It involves preparing and organising for change. No one can predict the future, but certain strategies can build a more resilient business model that can better cope with change. No one wants to think about what might go wrong, but avoiding the issue is not a sustainable strategy.
A number of interdependent variables drive airport business performance and, although traffic – passenger and cargo – is just one element of an airport’s business plan, it directly drives an airport’s revenue and costs, and influences every part of the business and its operations.
Exploring the potential variability of demand enables assessment of the likely impact on cost, revenue, and capital investment needs – which in turn influence the planning of facilities and operations.
This provides a foundation for looking at ways to offset the financial impact that results from lower traffic levels, such as revenue enhancement or cost-reduction measures.
However, in contrast to many other businesses, airports have a high proportion of fixed costs and the long-term nature of airport planning means that investment decisions are hugely reliant on the assessment of future demand.
These decisions have to be made without certainty of the future, but there are, nevertheless, a number of strategies that airports can adopt to improve business resilience, as Budapest Airport discovered when it had to completely re-think its business strategy following the February 2012 collapse of its main carrier, Malév Hungarian Airlines.
The Budapest experience
It is difficult not to overstate the former importance of Malév to Budapest Airport as, at the time of its demise, it accounted for 37% of the gateway’s passengers and generated almost 50% of its income.
The airport’s management team responded by initiating a series of co-ordinated actions to rebuild the traffic base and mitigate the financial impacts of the Malév collapse and, arguably, was so successful in its efforts that by the end of 2012 the year-on-year fall in total passenger numbers was only 4.7%.
Although many network carriers ramped up their services to help compensate for the loss of Malév’s operations, it was the low-cost sector – primarily Ryanair and Wizz Air – that really took advantage of the situation by filling the void.
Recognising the strategic opportunity that had been created by the demise of Malév, on the day of its bankruptcy both Wizz Air and Ryanair announced the launch of nearly 40 new routes. This had knock-on impacts for other European airports, as aircraft were quickly redeployed to provide the capacity to aggressively target the vacant Budapest slots.
Many other airlines also reacted to the situation by increasing the frequency of existing flights or expanding their capacity by using larger aircraft to serve Budapest. Consequently, load factors improved significantly, but the number of aircraft movements fell by around 23,000.
While management was very proactive in its response to the collapse of Malév, it is also true that many airlines had been anticipating the situation and rapidly adjusted their networks to take full advantage. They recognised the strategic opportunity to grab market share: quickly moving capacity from lesser performing routes.
Low-cost carriers increased their market share at Budapest from 26% in 2011 to 52% in 2012. To meet the new requirements of full-service and low-cost carriers within a single terminal building, the airport offered different service standards and created separate areas on the apron.
Airlines can now choose between different products, with associated differences in cost, that are in line with their needs. The airport, for example, has introduced a differentiated gate boarding product.
There are two aspects to note in the Malév collapse. Firstly, the underlying strength of the Budapest market, which had been growing strongly before the collapse, was attractive to airlines. Activity had been constrained in the years leading up to the crisis by the dominance and financial weakness of Malév.
The rebuilding of the traffic base therefore did not significantly dilute aeronautical revenue yields as one might have expected.
Secondly, Budapest Airport had an organised air service marketing team that had prepared for the eventuality of a Malév collapse and may have already had draft agreements in place with other carriers. It was therefore able to immediately respond to the opportunities that quickly emerged.
Management took a number of immediate actions to reduce the direct costs of operations. Firstly, they closed the old Terminal 1 and concentrated all operations at Terminal 2. This not only immediately reduced operating and maintenance costs, but optimised commercial revenue as T2 included a recently enhanced commercial offering, known as SkyCourt. In time, the T2 retail mix was fine-tuned to reflect the new passenger profile.
The old Terminal 1 re-opened in 2012 as a conference and event venue providing new commercial opportunities. This highlights the benefits of having flexible infrastructure that can be adapted as market conditions change.
In addition, the airport accelerated a planned cost-reduction programme. Wages were frozen, the headcount of airport staff was reduced by 25%, and new working practices and shift patterns were introduced.
Given that Malév was the main cargo customer, a planned cargo city development was deferred, and instead some existing buildings were refurbished to be let to new customers.
The airport was certainly under no illusion about the importance of developing a diverse new range of revenues to compensate for the loss of Malév’s income, which included a significant amount of rent from buildings across the airport site. Planning for the development of a new business park continued as planned for a while, although final development was put on hold.
Collectively these responses meant that Budapest Airport’s EBITDA fell from €104 million in 2011 to €100 million in 2012, so profitability fell proportionately less than traffic.
This demonstrates that in replacing the Malév traffic, the airport had not significantly diluted its yields, and that its aggressive cost control and efficiency measures had successfully mitigated the inevitable short-term drop in commercial and property income.
Lessons learnt from Budapest
The overall lesson learnt from the Budapest Airport/Malév episode is that the airport’s management team had prepared well for the potential collapse of its largest customer. The risk had been present for several years so they had already fully analysed the potential repercussions, understood the business risks, and prepared business contingency plans.
Choosing not to simply focus on traffic replacement or emergency cost reduction, they also took a series of co-ordinated actions that ultimately minimised the negative impact on profitability.
The extent to which the private ownership and operation of Budapest Airport both allowed – and indeed required – it to plan for and respond to the events in the way it did would be interesting to find out.
Whatever the answer, the undeniable fact is that traffic has continued to grow at Budapest Airport since 2012. Indeed, its annual throughput exceeded 9mppa for the first time last year when 9.1 million passengers (+10.6%) passed through its facilities.
The airport also successfully closed a €1.3 billion refinancing in September 2014, during which the resilience of the airport’s business model was a key focus. LeighFisher advised the lenders on the transaction.
Airports are typically resilient businesses. Research by LeighFisher indicates that from 2000-2012 EBITDA as a percentage of turnover rose at a compound annual growth rate of 1.1% across a basket of fifty airports worldwide, as illustrated in the graph above.
There are few examples of a commercial service airport closing (unless it is being replaced by a new greenfield airport in the same region), whereas there have been many airline bankruptcies, especially in the deregulated era.
That in itself creates risk for airports given an airport’s revenue is vulnerable to traffic fluctuations. However, airports can counteract their vulnerabilities with commercial activity to enhance long-term revenue resilience more effectively than many other types of infrastructure.
Privatisation over the past 25 years has brought a greater focus on airports’ financial performance. Airports already have many resilient features, but contingency planning, risk profiling, and managing dependencies can improve resilience.
Regular strategic planning exercises can be useful to identify the future challenges and develop strategies that can respond to change and capitalise on opportunity. One cannot predict what lies round the corner with certainty, so it is necessary to look ahead, since to plan for only one possible future is inconsistent with enhancing business resiliency.
Airports will need to be, and remain, alert to the rapid changes now taking place on every front. Regulation and business priorities will, increasingly, converge on improving the passenger experience, but within the context of a constrained operating and infrastructure footprint.
Managing the risk of market, regulatory, and environmental disruption is only one aspect of building resilience. On the positive side, new and potentially disruptive technology has the ability to deliver greater profitability from enhanced revenue, processing efficiency, and more efficient use of airport capacity.