Airline Volatility and Airport Revenues

Airline Volatility and Airport Revenues by Nikin Shah, Kenan-Flagler BSBA '05

for Boeing Corporation September 2004

TABLE OF CONTENTS Executive Summary

2

1.

Introduction

5

Research Objective

6

Industry Backgrounds

6

2.

2.1.

6

History

6

Current Trends

9

Structure of the Industry

10

Corporate Strategy

13

2.2. 3.

Air Carrier Industry Background

Airport Industry Background

Airports and the Volatility of the Airline Industry

15 20

3.1.

Relationship of air carriers to airports

20

3.2.

Hub-and-Spoke versus point-to-point

21

4.

Recommendations

27

5.

Conclusion

30

Endnotes

31

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Executive Summary Aviation is one of the most important forms of transportation today. We need aviation to transport passengers, mail, and freight quickly from one place to another. Since 2000, however, the airline industry has declined and has not been able to fully recover. Several reasons have factored into the drought of the industry, some of which have changed the industry’s future. The instability of the airline industry started when the U.S. economy went into a recession early 2001. With the entrance of low-cost carriers and reduction in business travelers, several traditional airlines began to see a reduction in revenues and profit. The discount carriers began to enter and gain more market share as they imposed their low costs and fares. To further escalate the troubles of the traditional airlines, the attacks of September 11, 2001 put a burden on the entire industry as passengers hesitated to fly, but more so, flying was more a hassle than a convenience. Recent increases in fuel and labor costs have kept many airlines from generating profits and staying competitive. All these downturns in the airline industry, causing the majority of the airlines to lose money, has had a direct effect on airport aeronautical and nonaeronautical revenues. Airports receive two types of operating revenues, aeronautical and nonaeronautical. Their aeronautical revenues are generated by airlines primarily through rental and landing fees. However, due to the continued loss in profits many airlines are facing, airports have temporarily reduced some of their aerona utical charges to accommodate as many airlines and flights as possible. Traditional non-aeronautical revenues are generated through parking, rental cars, and concessions, but with the decrease in passengers, some airports have had the lowest non-aeronautical revenues since 1996. Airports have also been affected as several financially weak airlines have decided to adopt the point-to-point network and abandon some of their hubs. The pointto-point system compares to the hub-and-spoke network is viewed to be more cost Page 3 of 33

efficient as it requires less staff and equipment. In addition, airports which are 50 percent or more dominated domestically by only one carrier, are realizing they are in trouble at if they do not begin to diversify. This is not only to generate more cash flow, but to secure themselves from the instability within majority of the airlines. As the airline industry continues to struggle and remain unprofitable, airports need to restructure their business plan in order to cope with the changes volatility of the industry. Airports should exist as an independent business enterprise in which it does not rely on any single factor. More so, airports ought to diversify their business strategy to ensure stability, while maintaining their primary goal, beyond survival, to generate profit and growth. Through diversification airports can become more integrated within the region they exist, to serve as a mechanism of economic and regional development, nor just an airfield. To ease the over-reliance on traditiona l aeronautical revenue streams, airports have been diversifying their funding through increasing their sources of nonaeronautical revenues. With the airports changing their business model to focus on nonaeronautical revenue sources, we can observe how airports make themselves a center hub for cities and regional development. Dr. Jack Kasarda, director of the Kenan Institute of Private Enterprise at the University of North Carolina, has coined the term ‘aerotropolis’ to define how airports are the core driver to urban development as they promote various airport-linked business to serve as employment, as well as, “global production, commercial systems, and engines of economic development.” 1 With this idea, some airports are banking on the fact that terminal passengers, businesses, and other activity will drive this new source of revenue to improve airports, cities, and regions around them.

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1. Introduction Aviation is one of the most important forms of transportation today. We need aviation to transport passengers, mail, and freight quickly from one place to another. Since 2000, however, the airline industry has declined and has not been able to fully recover. Several reasons have factored into the drought of the industry, some of which have changed the industry’s future. The volatility of the airline industry has greatly affected airport revenues, primarily due to a decrease in passengers and airline traffic. Many believe that airlines began losing money due to September 11 and the war on terrorism, however, the saturation and the decline of the airline industry occurred before these events. During 2000 and 2001, several low-cost carriers such as Southwest and Air Tran began to offer cheaper tickets causing the large carriers to lose market share and money, due to their high-cost structures. The pressure to lower ticket prices increased even more after the events of September 11, the outbreak of SARS, the Iraq war. More so, the recent increase in fuel prices has further affected carrier bottom lines. The industry has changed as passengers have become more price-sensitive and less loyal to a particular airline. All these downturns in the airline industry, causing a majority of the airlines to lose money, have had a direct effect on the revenues airports are receivi ng. With less passengers traveling and a reduction in the number of flights, aeronautical and non-aeronautical revenues in 2003, for all-hub airports, have been the lowest since 1999 and 1996, respectively2. Due to the continued loss in profits many airlines are facing, airports have temporarily reduced some of their terminal rental fees to accommodate as many airlines and flights as possible. However, many of those airports, which were considered hub ports for the large carriers, have not been able to make as much money due to their hub airlines becoming financially weak and

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retrenching service.∗ All of these circumstances lead to the question how is the volatility of airline industry affecting airport revenues? Research Objective I plan to answer the research question proposed from an airline industry perspective, discussing alternative growth strategies for airport development (i.e. nonaeronautical revenues as opposed to aeronautical revenues). I will be looking at existing data, research, and articles and draw conclusions on the key factors causing this volatility and decline in airline/airport revenues. More so, I plan to offer an insight into how airports might generate new revenue streams.

2. Industry Backgrounds For the purpose of this paper, industry background will only be provided for public air carriers and commercial service airports within the United States. 2.1.

Air Carrier Industry Background

History The air carrier industry began about a century ago, when Wilbur and Orville Wright took flight for about 12 seconds in Kitty Hawk, North Carolina on December 17, 1903. Since then, the industry has changed immensely. Before 1978, the air carrier industry was regulated and overseen by a government agency, the Civil Aeronautics Board (CAB). The CAB determined each route for the airlines and set the prices to regulate competition. However, on October 24, 1978, Congress approved the Airline Deregulation Act allowing the industry to become a market-driven industry, with

∗

One example of this is Pittsburgh airport where financially weak US Airways decided to downgrade their

hub status to a “focus city” and cut one-third of their nonstop flights.

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customer demand determining the levels of service and price. After this approval, the CAB slowly dissolved as the industry functioned freely. Yet there are still certain aspects of the industry, such as safety and antitrust laws, regulated by government agencies, such as the Federal Aviation Administration (FAA). After the Airline Deregulation Act of 1978, the industry transformed structurally. There was an increase in carriers, competition, and travelers. Deregulation not only spurred competition amongst the existing carriers, but also from new entrants into the market. The carriers began to respond more to consumers’ needs as they improved and became efficient in all areas such as marketing, technology, and service. During the next two decades, there were two recessions, in 1981 and 1990. However, in each case, the economy recovered to normal within a year and the industry began expanding once again [See Chart 1]. It was not until April 2001, the beginning of an economic recession, that the10-year expansion of the U.S. economy ended 3. The recession in 2001 caused airline revenues and profits to slowly dwindle due to decrease in business travelers and airline prices, and a rise in labor and fuel cost. Observing in Chart 1, the decline in available seat miles reflects on airlines cutting capacity to control their high fixed costs and minimize their operating losses. Business travelers began to become more price-sensitive and preferred to either fly economy or not travel at all. This hurt the airlines greatly because they did not have their regular flow of travelers paying premium prices. In addition, low-cost carriers such as Southwest and Air Tran began to increase market share as they entered competitive markets, decreased prices, and offered friendlier service. More so, these discount airlines focused on quick turn around by flying point-to-point ,thus having fewer delays and customers that are more content. With the pressure to decrease costs and prices from the low-cost carriers, many legacy carriers began to crumble as labor and fuel costs were on a steady rise (at about 9.7 percent and 8.9 percent, respectively) 4.

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Chart 1 ∗ Airline Industry Available Seat Miles Growth, 1974-2003 Percentage 0.25

0.2

0.15

0.1

0.05

0 1974

1976 1978 1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000 2002

2004

-0.05

Source: www.bts.gov

To further escalate the downturn in the economy, the catastrophic events of September 11, 2001 caused the aviation industry to take its biggest hit. The harshest impact the events had on the airline industry was that it caused passenger traffic to go down as much as 30 percent primarily due to lowered confidence and increased hassle to fly due to security5. Along with this, airlines immediately layed-off 15-20 percent of staff and reduced just as many flights 6. After the attacks, as the air carrier industry plummeted, many attributed all the struggles of the industry to the events of 9 -11. However, the industry was already crumbling and the events just escalated the effect.

∗

“Available seat miles (ASM) are the total number of seats in the active fleet, multiplied by the number of

miles flown. Changes in ASMs are influenced by the net addition of aircraft to the fleet, by the pitch and mix of aircraft seats, the average length of flights, and by how quickly the airline (or industry) turns around its aircraft between flights (Standard & Poor’s, Industry Surveys: Airlines, 2004)”

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Current Trends Adding to their difficulties, recent increases in fuel and labor costs coupled with the competition from low-cost carriers have put many legacy carriers at the verge of bankruptcy, not to say, some have already been in or are still struggling to get out of bankruptcy. The airline industry is very labor and capital intensive. Due to its labor intensity and the fact that the industry is highly unionized, many of the legacy carriers struggle to lower costs, while maintaining sufficient labor forces. Current situations of airlines on the verge of bankruptcy are causing airlines to continually discuss ways of lowering labor costs. For example, Delta Airlines has one o f the highest labor costs in the industry, accounting for about 40 percent of their total expense 7. Even after Delta’s pilot union recently proposed a 23 percent wage reduction, Delta’s CEO warned the union that they needed to cut wages even more to remain competitive and avoid bankruptcy8. Along with the high labor costs, fuel costs are increasing as the US continues to have troubles with the Middle East. Oil prices have risen tremendously, from $26 a barrel in 2002 to approximately $31 a barrel in 2003. Prices are expected to exceed an average of $38 a barrel through 2004. “The expected $7 increase from 2003-2004 amounts to $3 billion in additional expense to the industry, on top of an unprecedented and expanding national security/aviation security burden!”9 The only buffer that some airlines have is they already have hedged their fuel costs at a prior time∗ . After the September 11 attacks, government began to re-regulate some of the aspects that it once allowed the market and the airlines to control. The government imposed national and aviation security measures on the airlines, which created a severe burden to the carriers as they were already struggling with rising labor and fuels costs.

∗

Airlines hedge their fuel at a set price and period of time with a supplier to protect them from price

escalations in the market. Hedging can be done directly with a supplier or by trading on the future market.

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United Airlines went bankrupt in December 2002 and they still struggle to restructure and recover. One of the main reasons for United’s slow recovery is due to the security burden imposed by the government and the government’s belief that the airlines should be able to pay the costs of security. Traditional carriers, such as American, Delta, and US Airways, have also been struggling to remain competitive as the number of low-cost carriers has increased. These new airlines have created a new image for the industry in which “air transportation has become much more of a commodity with price being the key driver” 10 Not only have these airlines create a more saturated and competitive market, but they have also put a burden on the traditional carriers to lower fares. This, when coupled with higher costs, leads to decreasing revenues and profits. “No single expense has escaped the watchful eye of airline management, as carriers have deferred aircraft orders, reduced passenger food costs, parked aircraft, simplified fleet plans, and cut booking fees, to name a few initiatives.” 11 Airlines, such as American Airlines, the largest carrier in the United States, now realize they cannot reduce their costs to the level of discount carriers, thus they are hoping that their “corporate clients who still pay more than vacationers, will maintain their loyalty in return for international service, firstclass seats, airport clubs, and frequent-flier miles.” 12 The external factors, which the airlines themselves cannot fix or control, are causing continued loss in revenue/profit. Factors such as security costs and lack of government funding for security mandates, have caused airlines to focus on cost reduction and survival, rather than profitability and growth. Structure of the Industry Air carriers are classified by the government based on the amount of revenues each carrier earns on operations a year. They are classified as majors, national, regional (large, medium, and small), or all-cargo. The major airlines generate operating revenues of more than $1 billion annually. In 2003, there were 13 major passenger airlines, which include carriers such as American Airlines, Delta Airlines, Southwest, United Airlines, and US Airways. These airlines service the entire country and all but Page 10 of 33

Southwest serve international markets. Looking at Table 1 on the following page, since 2000, the major carriers have lost close to $22 billion13. The national and regional classes of carriers are the smaller airlines, which primarily service particular regions of the country. National carriers have operating revenues between $100 million and $1 billion and regional carriers have revenues under $100 million. The number of carriers in these two classes has risen significantly since about 1990; and the survivors of hundreds of startup airlines trying to enter the market since Deregulation in 1978. The last class of carriers is the air cargo carriers that exclusively ship freight and mail. As economies and companies have been globalizing and remaining competitive, the air cargo industry has risen. “The huge volume of high-value, time-critical products traversing national boundaries by air annually has resulted in air cargo accounting for 40 percent of the value of today’s world trade (vs. under 2% by weight).” Although the recession and the events of September 11 greatly affected the airline industry, the air cargo industry quickly bounced back and remains profitable as a global growth sector.14

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Corporate Strategy There are two main types of carriers within the United States, full-service carriers and niche-market carriers. The full-service carriers, also known as traditional or legacy carriers are those which serve the entire country and practice the hub-and -spoke concept. They focus on expanding their brand by forming alliances with smaller regional airlines and larger international airlines. At present, there are three main alliances within the US airlines industry, Delta’s Sky Team, American’s Oneworld Alliance, and United’s Star Alliance. [See Table 2 on next page] The primary benefit for these alliances is for the airlines to gain access to every possible market, thus increasing their chances to grow and passengers and revenue. The other types of airlines are niche-market carriers, which focus on a particular region or market. The most well-known niche-market carriers are the low-cost airlines, such as Southwest and Jet Blue, which emphasize low-costs and low fares. Primarily, these airlines fly point-to-point allowing them to offer quick turn around and more direct service from city- to-city. Over the last few years, the low-cost airlines have been gaining market share as they offer low fares to their customers, while still making a profit. Southwest is the first low-cost carrier to achieve “major carrier” status. Observing that the low-cost carriers are some of the only airlines making money, many traditional carriers have begun to introduce their own low-cost carrier in attempt to compete. Not only are many legacy airlines abandoning their strategy of the hub-spoke system, but also they are attempting to adopt the point-to-point strategy which has already been mastered by other carriers. 15 As these traditional carriers carry an optimistic outlook of their new spin-off airlines, many experts and researcher doubt that the sub-brand strategies will work. The reasoning is, on one hand airlines are trying to improve on efficiency, costs, and service to increase customers’ awareness and loyalty; while on the other hand, as these big companies trying to start and manage brand new airlines and images, they will impose “big-company overheads, processes, point of views, and other costs.” 16

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Table 2 World Airline Alliances Alliance

Members Founding members: American Airlines, British Airways, Canadian Airlines, Cathay Pacific Airways and Qantas Airways (1 February 1999). Additional members: Finnair and Iberia (September 1999), Aero Lingus and LAN Chile (May 2000).

Oneworld (8 member airlines)

Former members: Canadian Airlines, after being purchased by Air Canada, withdrew from the alliance in June 2000 Founding members: United Airlines, Air Canada, Lufthansa, Thai Airways International and SAS-Scandinavian Airlines (14 May 1997).

Star Alliance (15 member airlines)

Additional members: VARIG Brazilian Airlines (October 1997), Air New Zealand (March 1999), All Nippon Airways (October 1999), Austrian Airlines Group (March 2000), Singapore Airlines (April 2000), BMI British midland, (July 2000), Asiana Airlines (March 2003), Spanair (April 2003), LOT Polish Airlines (October 2003), US Airways (May 2004). Former members: Ansett Airlines (joined March 1999, failed in 2001), Mexicana Airlines (joined July 2000, ended March 2004). Future members: South African Airways (SAA), TAP Air Portugal and the first Star Alliance regional member airline, Blue1, have had membership approved. Founding members: Air France, Delta, AeroMexico and Korean Airlines (June 2000). Additional members: CSA Czech Airlines (March 2001) and Alitalia (July 2001) Former members:-

SkyTeam (6 member airline s)

Future members: KLM, Continental Airlines and Northwest Airlines to join in 2004; Aeroflot has applied for membership.

17 Source: Tourism Futures International, Updated June 2004

One of the major changes to the industry after Deregulation was the implementation of the hub -and-spoke concept. Prior to Deregulation, most carriers operated point-to-point networks, as they traveled from one city to another without making any stops. After Deregulation, most carriers thought they could gain access to smaller regions b y offering smaller flights to one main destination, exchange passengers, and then depart to various other destinations with larger flights. The major carriers adopted the hub-and-spoke concept to reduce wait times as they synchronized planes to come in and out of the hub airport during close timeframes 18. The advent of a

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hub-and-spoke network was the increase in the number of city pairs carriers could serve with a given number of flights 19. Within the hub-and-spoke system, airlines can carry a greater number of passengers on a single route more frequently, compared to point-topoint systems making smaller routes of fewer passengers less frequently. The hub increases its significance as it serves more cities (spokes), thus increasing the number of passengers, both local and connecting. The point-to-point concept, which existed prior to Deregulation, has recently become more successful, especially amongst the low-cost carriers. In general, these carriers focus on serving fewer larger markets, rather than a greater number of smaller markets. Compared with the hub -and-spoke network, the point-to-point concept is favored because of its low-cost, direct travel between two points. Additionally, the huband-spoke system is more expensive to implement because, as it requires flights to be synchronized, more staff and ground equipment are needed to ensure time-sensitive services and ideally, this concept would prove to work efficiently if planes arrived and departed as scheduled. But in reality, a domino-effect is created when planes and carriers are delayed, causing more delays and disgruntled passengers. 2.2.

Airport Industry Background In the United States, there are more than 18,000 airports ranging anywhere from

commercial service airports, those serving regularly schedules airline traffic, to private or general aviation airports, those primarily for personal or corporate planes. Commercial service airports are classified based on the percentage of the total enplaned passengers per year within the 50 states, the District of Columbia, and other U.S. areas. The four classifications for these airports are: •

Large hub, 1 percent or more of total U.S. enplaned passengers

•

Medium hub, 0.25 to 0.999 percent of total U.S. enplaned passengers

•

Small hub, .05 to .249 percent of total U.S. enplaned passengers, and

•

Non-hub, less than .05 percent of total U.S. enplaned passengers.

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These classifications of hubs should not be confused with the definition used by airlines in describing their “hub-and-spoke” route structures. 20 Adapted from a presentation by David Z. Plavin, President of Airports Council International-North America 21, are some myths about airports which could cause misinterpretation in analyzing airports. Airports are developed, owned, and regulated by the public sector (governmental body). The public sector includes local and state governments, Port authorities, and Airport authorities. These authorities are created for the sole purpose of managing and developing airports, sometime even sea ports. In addition, since airports are involved with air traffic, they are regulated by the FAA to ensure a safe and efficient aerospace environment. Although the public sector handles the overall operations of the airport, the private sector (airlines, concessionaries, and contractors) play a significant role in the day-to-day operating and financing, accounting for 90 percent of all employees at the nation’s airports 22. Similar to the airlines, airports are capital and labor intensive, thus they have very large fixed costs. Airports are a closed system meaning they generate majority of their revenues through their users, airlines and passengers, and only a small amount from the public sector. The only money which the government allocates to airports is for capital related projects or to small airports that cannot afford the high fixed costs. Airport revenue is broken up into two main categories: operating and non-operating; and then their operating revenue is further divided into aeronautical and non-aeronautical revenues. Aeronautical revenue’s consists primarily of airline rental and landing fees, which are paid by the airlines which service the airport. Rental fees are most often based upon the rate per square foot, and the landing fees are based on weight and charged every time a planes lands at its destination. An airport’s non-aeronautical revenue consists of parking, rental cars, concession/ terminal fees, land rental/non-terminal facilities, and other (which consist of all other non-aeronautical operating revenue earned from the non-aeronautical use of the airport). Over the years, airports have been increasing their traditional nonaeronautical revenue sources to diversify their revenue streams. Interestingly, however, Page 16 of 33

from 1996 to 2003, the other non-aeronautical revenue source increased percentage from 6 percent to 18 percent. To some degree this increase is a result to various nontraditional revenue streams such as hotels, office buildings, and ground transportation.

Chart 2 Non-Aeronautical Revenue Mix for Large Hub Airports, 1996 and 2003 1996 5. Misc. 2%

6. Other 6%

2003

1. Land and non-terminal facilities 10%

6. Other 18% 5. Misc. 3%

4. Parking 34%

2. Terminal Total 31%

3. Rental cars 17% L_1996 Nonaeronautical Operating Revenue 1. Land and non-terminal facilities $234,577,324 2. Terminal Total $739,216,300 3. Rental cars $396,433,543 4. Parking $810,818,319 5. Misc. $56,689,197 6. Other $150,400,945 Total $2,388,135,628

Percent of Total 9.8% 31.0% 16.6% 34.0% 2.4% 6.3% 100.0%

4. Parking 31%

1. Land and non-terminal facilities 7% 2. Terminal Total 22%

3. Rental cars 19%

L_2003 Nonaeronautical Operating Revenue 1. Land and non-terminal facilities $175,133,806 2. Terminal Total $512,359,420 3. Rental cars $446,560,661 4. Parking $730,028,935 5. Misc. $60,540,837 6. Other $424,995,029 Total $2,349,618,688

Percent of Total 7.5% 21.8% 19.0% 31.1% 2.6% 18.1% 100.0%

Source: www.faa.gov

The non-operating revenue for airports is generally everything that does not relate to the daily operation of airports such as interest income, grant receipts, and passenger facility charges. The majority of the grants which airports receive are from the Airport Improvement Program, a program designed to aid airports in improving aviation related projects, such as airport safety, capacity, security, and environmental concern. Passenger Facility Charges (PFC) are fees billed to the airline, for airline’s passengers to use the airport’s facilities. PFCs are, in turn, passed on to passengers through their ticket costs. Although the PFCs are not a grant from the government, the FAA requires the revenue earned from PFC are only used for capital improvement projects. 23 Airports within the US have a significant role to the area in which they are located, especially as they are a means of transporting passengers and cargo. For Page 17 of 33

example, a 2002 Economic Impact study of U.S. airports by Airports Council International North America 24 found there were a total of 6.7 million U.S. airport-related jobs with total earnings of about $190 billion. Relatedly, however, since airports are highly labor and capital intensive, and they service a great amount of debt. Airports service their debt primarily through revenue bonds called general airport revenue bonds (GARBS). These revenue bonds are secured by an airport’s future revenue stream. As these bonds are bought and sold on the open market, credit agencies such as Standard and Poor’s rate the credit of the airports based on several of factors including available cash, airline strength, cost structure, and the vitality of the region’s economy. The higher the credit rating of an airport, the easier it is for that airport to finance and pay for improvements and/or expansions. Looking at the current bond ratings by Standard & Poor’s, Table 3 , Pittsburgh’s Airport (PIT) is as a BBB and their outlook is negative. Most likely Pittsburgh Airport will have a tough time generating cash flow, thus they will have a tougher time trying to finance their various projects. On the other hand , an airport similar to Los Angeles International (LAX) will be able to fund their developments much easier since their rating is a stable AA.

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Table 3 Large Hub Airport Bond Ratings, Updated June 15, 2004 LongTerm Rating A+

Obligor Airport ATL Hartsfield Atlanta International Airport

Issuer Atlanta Department of Aviation

U.S. State/ Province Georgia

BOS CLT

Boston Logan International Airport Charlotte/Douglas International Airport

Massachusetts Port Authority Charlotte Aviation Department

Massachusetts A+ North Carolina A

Stable Negative

CVG

Cincinnati/Northern Kentucky International Airport Washington Dulles International Airport and Reagan National Airport Denver International Airport Dallas-Fort Worth International Airport Detroit Metro Wayne County Airport Port Authority of New York & New Jersey (JFK International, La Guardia Airport, & Newark International) Fort Lauderdale-Hollywood International Airport

Kenton County Airport Board

Ohio Washington, D.C. Colorado Texas Michigan

A

Stable

A+ A A+ A-

Stable Stable Stable Stable

Port Authority of New York & New Jersey New York Broward County Department of Aviation Florida Hawaii Department of Transportation (Hawaii Airport System) Hawaii Washington, Metropolitan Washington Airport Authority D.C.

AAA+

Stable Stable

A-

Negative

A+

Stable

Port Authority of New York & New Jersey Clark County Department of Aviation

New York Nevada

Stable Stable

Clark County Department of Aviation Los Angeles Department of Aviation

Nevada California

LGA MCO MIA MSP

Las Vegas-McCarran International Airport* Los Angeles International Airport Port Authority of New York & New Jersey (JFK International, La Guardia Airport, & Newark International) Orlando International Airport Miami International Airport Minneapolis-St. Paul International Airport

AAAAA+*(2nd lien) AA

Port Authority of New York & New Jersey Greater Orlando Aviation Authority Dade County Aviation Department Minneapolis-St. Paul Metro Airports Commission

New York Florida Florida Minnesota

Stable Stable Stable Stable

MSP ORD

Minneapolis-St. Paul International Airport* O'Hare International Airport

Minneapolis-St. Paul Metro Airports Commission Chicago Department of Aviation

Minnesota Illinois

ORD

O'Hare International Airport*

Chicago Department of Aviation

Illinois

ORD PHL PHX

O'Hare International Airport* Philadelphia International Airport Sky Harbor International Airport

Chicago Department of Aviation Philadelphia Department of Aviation Phoenix Aviation Department

Illinois Pennsylvania Arizona

PHX

Sky Harbor International Airport*

Phoenix Aviation Department

Arizona

AAA+ AAAA*(2nd lien) A+ A-*(3rd lien) A*(2nd lien) A AAA*(2nd lien)

PIT SAN

Pittsburgh International Airport San Diego International Airport Port of Seattle (Seattle-Tacoma International Airport) Port of Seattle (Seattle-Tacoma International Airport)* San Francisco International Airport Lambert-St. Louis International Airport Tampa International Airport *Subordinate lien

AllegheNew York County Airport Authority California Maritime Infrastructure Authority

Pennsylvania California

BBB A+

WatchNeg Stable

Port of Seattle

Washington

Stable

Port of Seattle San Francisco Airports Commission St. Louis Hillsborough County Aviation Authority

Washington California Missouri Florida

AAA-*(2nd lien) A BBB+ A+

DCA DEN DFW DTW

EWR FLL HNL IAD

JFK LAS LAS LAX

SEA SEA SFO STL TPA

Honolulu International Airport Washington Dulles International Airport and Reagan National Airport Port Authority of New York & New Jersey (JFK International, La Guardia Airport, & Newark International) Las Vegas-McCarran International Airport

Metropolitan Washington Airport Authority Denver Department of Aviation Dallas-Fort Worth Airport Board Wayne Cnty Airport Authority

Outlook Stable

Stable Stable

Stable Stable Stable Stable Stable Stable Stable

Stable Negative Stable Stable

Source: Standard & Poor’s: Ratings Direct ∗ Insurer Financial Strength Ratings An insurer rated ‘BBB’ or higher is regarded as having financial security characteristics that outweigh any vulnerability, and is highly likely to have the ability to meet financial commitments. An insurer rated ‘BB’ or lower is regarded as having vulnerable characteristics that may outweigh its strengths. ‘BB’ indicates the least degree of vulnerability within the range; ‘CC’ the highest. Plus (+) or minus (-) signs following ratings from ‘AA’ to ‘CCC’ show relative standing within the major rating categories.

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3. Airports and the Volatility of the Airline Industry 3.1.

Relationship of air carriers to airports Although airports are not on the verge of bankruptcy, they have been greatly

affected by the volatility of the airline industry. In their efforts to constantly cut costs, airlines have been experiencing various pressures from the government, suppliers, and passengers, which in turn, have made the industry very unstable. Likewise, decrease in airline movements and passengers have led to decreases in aeronautical and nonaeronautical revenues of airlines. From 2000 to 2003, there has been a 6 percent decline i n available seat miles and 15 percent decline in passenger traffic 25. With fewer flights, airports received less revenue from landing fees. More so, the decrease in passengers has led to a loss in non-aeronautical revenues like parking fees, terminal concessions, and rental cars. As the airlines continue to lose money, airports have temporarily reduced some of their terminal rental fees and landing fees to accommodate as many airlines and flights as possible. In the past, airports have based about two -thirds of their revenue on aeronautical sources. However, as airports are beginning to reduce aeronautical charges, they are scrambling to find ways to buffer the change and remain profitable. An October 2001 study by the ATA shows that within the last two decades airport charges have shifted from the airlines to the passengers, in the form of passenger facility charges. Although airports have found a possible solution for lower aeronautical revenues, credit analysts view PFCs and other special facility bonds under scrutiny because they are based on passenger traffic levels 26. Thus, as passenger traffic levels are still down and airlines are on the verge of bankruptcy, these forms of revenue are viewed as risky. And, as consumers are becoming more price-sensiti ve, at a certain PFC level, passengers will decide airline ticket prices are too high and opt to not travel.

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Chart 3 Airport Charges

27 Source: Air Transport Association of America, October 2001

The instability of the industry is also affecting airports’ long-run forecasts. As experts and analysts forecast passenger traffic to be on the rise, airports cannot take for granted they will see a rise in revenue and not have to worry about the future. Similar to the September 11 attacks, another catastrophic or unexpected event could occur causing the industry to go under once again. The primary reason for U.S. airline industry downturn was the U.S. economic recession beginning in early 2001. But, the attacks of September 11, 2001 could have affected the industry regardless if the US economy was in a recession or in a boom period. Thus, US airports need to find a method to buffer the effects of these extraneous events to ensure stability. 3.2.

Hub-and-Spoke versus point-to-point One of the most common connections of airlines to airports is through the hub-

and-spoke model. When airlines decide to establish a hub at a particular airport, they tend to guarantee a certain percentage of flights and passengers to the airports, in order for the airport to generate cash flow from aeronautical and non-aeronautical revenue Page 21 of 33

sources. However, due to airlines questioning bankruptcy and recent trends of the pointto-point network, major hub airports are starting to worry about their future, as financially weak airlines begin to retrench. The main concern is for airports which are over 50 percent domestically served by only one major airline [See Table 4 and 5]. “Airports dominated by one carrier are more vulnerable to economic downturns, and are thus inherently riskier, than are airports that have many competing airlines with more balanced market shares.” 28 Airports which are serviced primarily by major airlines need to be careful because at present few major airlines that are financially stable.

Page 22 of 33

Table 4 Carrier Mix of Major Domestic U.S. Carriers at Large Hubs, 2003 (Based on passengers) Codes AS HP AA MQ

Major Carriers Alaska Airlines, Inc. America West Airlines, Inc. American Airlines, Inc. American Eagle Airlines, Inc.

Codes TZ ATA CO DL

Major Carriers American Trans Air, Inc. Ata Airlines d/b/a Ata. Continental Airline, Inc. Delta Airlines, Inc.

Codes NW WN UA US

Major Carriers Northwest Airlines, Inc. Southwest Airlines, Inc. United Airlines, Inc. US Airways, Inc.

ATL 38,851,476 % of Total

Total Major 28,504,895 73.4%

DL AA 26,135,848 733,521 67.3% 1.9%

UA 393,708 1.0%

NW 382,513 1.0%

US 272,425 0.7%

HP 197,008 0.5%

ATA 278 0.0%

TZ 54 0.0%

AS 0 0.0%

MQ 0 0.0%

WN 0 0.0%

BOS 11,082,633 % of Total

Total Major 8,678,951 78.3%

DL 2,097,564 18.9%

AA 1,970,464 17.8%

US UA NW 1,506,970 1,030,515 594,537 13.6% 9.3% 5.4%

MQ 544,705 4.9%

CO 505,612 4.6%

HP 216,746 2.0%

ATA 138,404 1.2%

AS 53,918 0.5%

TZ 19,516 0.2%

WN 0 0.0%

BWI 9,669,220 % of Total

Total Major 8,312,880 86.0%

WN 4,623,047 47.8%

AA 703,462 7.3%

UA 684,451 7.1%

DL 678,076 7.0%

US 518,815 5.4%

NW 410,788 4.2%

CO 380,679 3.9%

HP 239,928 2.5%

MQ 73,603 0.8%

TZ 31 0.0%

AS 0 0.0%

ATA 0 0.0%

CLT 11,351,310 % of Total

Total Major 9,268,996 81.7%

US 8,444,628 74.4%

UA 184,794 1.6%

DL 162,340 1.4%

AA 161,476 1.4%

NW 136,660 1.2%

ATA 113,434 1.0%

MQ 30,528 0.3%

CO 17,624 0.2%

TZ 17,184 0.2%

HP 328 0.0%

AS 0 0.0%

WN 0 0.0%

CVG 10,436,811 % of Total

Total Major 5,649,453 54.1%

DL 5,475,076 52.5%

MQ 88,532 0.8%

UA 71,401 0.7%

NW 13,195 0.1%

CO 761 0.0%

WN 265 0.0%

US 114 0.0%

AA 109 0.0%

AS 0 0.0%

HP 0 0.0%

TZ 0 0.0%

ATA 0 0.0%

DCA 6,795,620 % of Total

Total Major 5,469,013 80.5%

US 1,826,499 26.9%

DL 1,011,288 14.9%

AA 914,993 13.5%

NW 569,952 8.4%

UA 386,657 5.7%

CO 285,659 4.2%

MQ 190,067 2.8%

HP 128,292 1.9%

ATA 108,515 1.6%

AS 32,671 0.5%

TZ 14,420 0.2%

WN 0 0.0%

DEN 17,968,661 % of Total

Total Major 12,670,368 70.5%

UA 9,172,577 51.0%

AA 830,277 4.6%

DL 698,402 3.9%

NW 506,574 2.8%

CO 466,989 2.6%

US 353,339 2.0%

HP 326,363 1.8%

AS 152,760 0.9%

ATA 141,131 0.8%

TZ 21,834 0.1%

WN 122 0.0%

MQ 0 0.0%

DFW 24,972,535 % of Total

Total Major 22,084,722 88.4%

AA DL 15,771,012 2,426,539 63.2% 9.7%

MQ UA 1,992,301 494,065 8.0% 2.0%

HP 359,840 1.4%

NW 303,753 1.2%

CO 265,624 1.1%

US 264,371 1.1%

ATA 178,206 0.7%

TZ 29,011 0.1%

WN 0 0.0%

AS 0 0.0%

DTW 15,752,605 % of Total

Total Major 12,563,737 79.8%

NW AA 10,425,779 482,462 66.2% 3.1%

WN 415,145 2.6%

UA 342,272 2.2%

DL 244,606 1.6%

CO 242,046 1.5%

HP 215,734 1.4%

US 100,920 0.6%

ATA 46,275 0.3%

MQ 36,529 0.2%

TZ 11,969 0.1%

AS 0 0.0%

EWR 14,625,547 % of Total

Total Major 11,160,102 76.3%

CO 7,338,137 50.2%

AA 976,764 6.7%

DL 813,075 5.6%

UA 776,968 5.3%

NW 450,052 3.1%

US 283,519 1.9%

HP 241,181 1.6%

ATA 146,681 1.0%

MQ 60,492 0.4%

AS 50,513 0.3%

TZ 22,234 0.2%

WN 486 0.0%

FLL 8,678,833 % of Total

Total Major 5,960,579 68.7%

DL 1,846,988 21.3%

WN 1,047,388 12.1%

AA 974,636 11.2%

US 805,661 9.3%

CO 635,048 7.3%

NW 214,205 2.5%

ATA 167,056 1.9%

UA 126,170 1.5%

HP 105,044 1.2%

TZ 38,056 0.4%

MQ 327 0.0%

AS 0 0.0%

HNL 8,894,956 % of Total

Total Major 2,903,246 32.6%

UA 852,967 9.6%

NW 626,944 7.0%

AA 558,957 6.3%

DL 375,331 4.2%

CO 301,120 3.4%

ATA 165,342 1.9%

TZ 22,585 0.3%

AS 0 0.0%

HP 0 0.0%

MQ 0 0.0%

WN 0 0.0%

US 0 0.0%

IAD 8,044,476 % of Total

Total Major 4,555,107 56.6%

UA 3,075,147 38.2%

DL 522,470 6.5%

AA 421,130 5.2%

NW 193,099 2.4%

US 113,303 1.4%

HP 83,088 1.0%

AS 59,669 0.7%

MQ 49,260 0.6%

CO 37,941 0.5%

TZ 0 0.0%

ATA 0 0.0%

WN 0 0.0%

IAH 16,134,347 % of Total

Total Major 12,672,466 78.5%

CO AA 10,883,006 377,619 67.5% 2.3%

UA 326,960 2.0%

NW 323,152 2.0%

DL 241,024 1.5%

US 216,891 1.3%

HP 184,302 1.1%

WN 99,773 0.6%

MQ 11,480 0.1%

ATA 8,259 0.1%

AS 0 0.0%

TZ 0 0.0%

JFK 15,653,375 % of Total

Total Major 6,713,325 42.9%

AA 3,374,077 21.6%

DL 1,958,454 12.5%

UA 665,721 4.3%

HP 324,765 2.1%

MQ 187,028 1.2%

NW 180,513 1.2%

CO 22,767 0.1%

AS 0 0.0%

TZ 0 0.0%

ATA 0 0.0%

WN 0 0.0%

US 0 0.0%

LAS 17,089,805 % of Total

Total Major 15,301,050 89.5%

WN 5,718,825 33.5%

HP 2,906,144 17.0%

UA DL AA CO 1,314,339 1,270,682 1,116,674 848,883 7.7% 7.4% 6.5% 5.0%

NW 632,738 3.7%

AS 529,475 3.1%

US 492,458 2.9%

ATA 396,182 2.3%

TZ 74,650 0.4%

MQ 0 0.0%

CO 389,540 1.0%

Source: www.bts.gov

Page 23 of 33

Table 4, continued Carrier Mix of Major Domestic U.S. Carriers at Large Hubs, 2003 (Based on passengers) Codes AS HP AA MQ

Major Carriers Alaska Airlines, Inc. America West Airlines, Inc. American Airlines, Inc. American Eagle Airlines, Inc.

Codes TZ ATA CO DL

Major Carriers American Trans Air, Inc. Ata Airlines d/b/a Ata. Continental Airline, Inc. Delta Airlines, Inc.

Codes NW WN UA US

Major Carriers Northwest Airlines, Inc. Southwest Airlines, Inc. United Airlines, Inc. US Airways, Inc.

LAX 26,225,733 % of Total

Total Major 18,868,884 71.9%

UA 4,647,833 17.7%

AA 3,709,899 14.1%

WN DL AS NW 3,221,367 2,008,510 1,183,087 969,864 12.3% 7.7% 4.5% 3.7%

CO 880,055 3.4%

HP 677,600 2.6%

MQ 524,986 2.0%

US 514,738 2.0%

ATA 468,478 1.8%

TZ 62,467 0.2%

LGA 11,365,887 % of Total

Total Major 8,536,309 75.1%

DL 2,501,713 22.0%

AA 2,321,229 20.4%

US UA 1,266,935 740,395 11.1% 6.5%

NW 709,441 6.2%

MQ 338,278 3.0%

ATA 312,593 2.8%

CO 306,012 2.7%

TZ 39,713 0.3%

AS

HP

WN

MCO 13,374,685 % of Total

Total Major 10,024,578 75.0%

DL 2,509,714 18.8%

WN 1,998,632 14.9%

AA US CO 1,413,513 1,170,185 792,338 10.6% 8.7% 5.9%

UA 770,429 5.8%

0.0%

0.0%

0.0%

NW 734,201 5.5%

ATA 368,045 2.8%

HP 161,742 1.2%

TZ 65,938 0.5%

AS 38,668 0.3%

MQ 1,173 0.0%

MIA 14,159,042 % of Total

Total Major 10,186,883 71.9%

AA 7,661,527 54.1%

DL 640,853 4.5%

UA 513,783 3.6%

CO 490,097 3.5%

US 400,442 2.8%

NW 242,348 1.7%

HP 99,922 0.7%

ATA 78,037 0.6%

AS 34,649 0.2%

TZ 20,663 0.1%

MQ 4,562 0.0%

WN 0 0.0%

MSP 16,020,898 % of Total

Total Major 13,314,742 83.1%

NW UA 11,265,638 517,067 70.3% 3.2%

AA 408,179 2.5%

DL 330,001 2.1%

HP 228,485 1.4%

ATA 190,595 1.2%

CO 181,416 1.1%

US 161,343 1.0%

TZ 32,018 0.2%

AS 0 0.0%

MQ 0 0.0%

WN 0 0.0%

ORD 32,918,999 % of Total

Total Major 26,852,173 81.6%

UA AA 13,202,541 9,146,636 40.1% 27.8%

MQ DL 2,171,208 584,944 6.6% 1.8%

NW 510,553 1.6%

US 447,160 1.4%

CO 410,006 1.2%

HP 332,223 1.0%

AS 30,838 0.1%

TZ 8,058 0.0%

ATA 8,006 0.0%

WN 0 0.0%

PHL 11,841,247 % of Total

Total Major 9,574,726 80.9%

US 6,780,032 57.3%

AA 683,018 5.8%

UA 629,456 5.3%

DL 576,861 4.9%

NW 354,407 3.0%

HP 201,837 1.7%

CO 157,611 1.3%

ATA 111,064 0.9%

MQ 63,802 0.5%

TZ 16,638 0.1%

AS 0 0.0%

WN 0 0.0%

PHX 18,252,290 % of Total

Total Major 16,082,134 88.1%

HP 7,368,773 40.4%

WN 5,068,654 27.8%

AA 671,182 3.7%

UA 642,077 3.5%

NW 569,797 3.1%

CO 440,915 2.4%

DL 432,748 2.4%

AS 360,170 2.0%

US 321,056 1.8%

ATA 174,390 1.0%

TZ 32,372 0.2%

MQ 0 0.0%

PIT 7,098,805 % of Total

Total Major 5,042,593 71.0%

US 4,190,771 59.0%

DL 255,392 3.6%

UA 164,681 2.3%

NW 102,160 1.4%

AA 80,603 1.1%

MQ 72,616 1.0%

HP 66,842 0.9%

ATA 58,126 0.8%

CO 51,402 0.7%

AS 0 0.0%

TZ 0 0.0%

WN 0 0.0%

SAN 7,563,778 % of Total

Total Major 6,939,124 91.7%

WN 2,632,658 34.8%

UA 861,715 11.4%

AA 759,411 10.0%

DL 693,950 9.2%

AS 431,435 5.7%

HP 415,922 5.5%

CO 343,694 4.5%

NW 307,623 4.1%

MQ 252,936 3.3%

US 239,653 3.2%

TZ 127 0.0%

ATA 0 0.0%

SEA 13,068,573 % of Total

Total Major 10,696,253 81.8%

AS 4,453,171 34.1%

UA 1,554,732 11.9%

WN NW 1,079,994 951,046 8.3% 7.3%

DL 787,997 6.0%

AA 737,753 5.6%

CO 433,701 3.3%

HP 340,532 2.6%

US 229,322 1.8%

ATA 115,387 0.9%

TZ 12,618 0.1%

MQ 0 0.0%

SFO 14,078,694 % of Total

Total Major 11,093,002 78.8%

UA 6,225,750 44.2%

AA 1,251,898 8.9%

DL 725,599 5.2%

NW 562,059 4.0%

AS 553,355 3.9%

CO 494,934 3.5%

HP 425,932 3.0%

ATA 385,719 2.7%

US 385,354 2.7%

MQ 41,981 0.3%

TZ 40,421 0.3%

WN 0 0.0%

SLC 8,955,940 % of Total

Total Major 6,717,119 75.0%

DL 4,713,568 52.6%

WN 1,002,301 11.2%

UA 331,268 3.7%

AA 273,971 3.1%

HP 151,848 1.7%

NW 126,571 1.4%

CO 116,723 1.3%

ATA 734 0.0%

AS 135 0.0%

MQ 0 0.0%

TZ 0 0.0%

US 0 0.0%

STL 9,922,315 % of Total

Total Major 7,933,149 80.0%

AA 5,899,419 59.5%

WN 1,285,042 13.0%

NW 231,363 2.3%

UA 222,364 2.2%

DL 185,078 1.9%

HP 87,791 0.9%

CO 11,740 0.1%

US 5,087 0.1%

MQ 4,832 0.0%

ATA 433 0.0%

AS 0 0.0%

TZ 0 0.0%

TPA 7,672,398 % of Total

Total Major 6,273,847 81.8%

DL 1,632,555 21.3%

WN 1,581,912 20.6%

US 876,559 11.4%

AA 708,167 9.2%

CO 515,868 6.7%

NW 454,944 5.9%

UA 395,579 5.2%

HP 108,263 1.4%

AS 0 0.0%

MQ 0 0.0%

TZ 0 0.0%

ATA 0 0.0%

Air Carrier Totals

AS 7,964,514

HP AA MQ TZ 16,196,475 65,094,038 6,741,226 602,577

ATA CO DL NW WN UA US Total Major 3,881,370 28,247,948 64,537,246 34,056,469 29,775,611 51,318,382 32,188,550 340,604,406

Source: www.bts.gov

Page 24 of 33

Table 5 Passengers at U.S. Large Hub Airports by Carrier Group, 2003 (Ranked by Major-Passenger) Carrier Group International ORIGIN SAN LAS DFW MDW PHX BWI MSP SEA TPA CLT ORD PHL DCA STL DTW SFO IAH BOS EWR LGA SLC MCO ATL LAX MIA PIT DEN FLL IAD CVG JFK HNL Grand Total

98,810 395,833 279,031 5,715 204,703 220,792 59,735 311,470 149,514 19,478 2,091,700 338,151 77,784 11,932 181,478 1,847,628 557,572 1,190,091 1,476,389 317,932 25,421 804,134 638,108 5,322,449 2,860,240 12,473 250,520 402,619 1,090,755 41,917 4,838,704 1,243,821 57,637,381

Percentage 1.3% 2.3% 1.1% 0.1% 1.1% 2.3% 0.4% 2.4% 1.9% 0.2% 6.4% 2.9% 1.1% 0.1% 1.2% 13.1% 3.5% 10.7% 10.1% 2.8% 0.3% 6.0% 1.6% 20.3% 20.2% 0.2% 1.4% 4.6% 13.6% 0.4% 30.9% 14.0% 8.1%

Domestic Regional National Major Total Percentage Percentage Percentage 71,588 0.9% 454,256 6.0% 6,939,124 91.7% 7,563,778 445,805 2.6% 947,117 5.5% 15,301,050 89.5% 17,089,805 260,317 1.0% 2,348,465 9.4% 22,084,722 88.4% 24,972,535 570,890 6.6% 427,886 4.9% 7,679,408 88.4% 8,683,899 1,429,252 7.8% 536,201 2.9% 16,082,134 88.1% 18,252,290 173,837 1.8% 961,711 9.9% 8,312,880 86.0% 9,669,220 1,011,619 6.3% 1,634,802 10.2% 13,314,742 83.1% 16,020,898 42,986 0.3% 2,017,864 15.4% 10,696,253 81.8% 13,068,573 201,773 2.6% 1,047,264 13.6% 6,273,847 81.8% 7,672,398 1,787,929 15.8% 274,907 2.4% 9,268,996 81.7% 11,351,310 57,793 0.2% 3,917,333 11.9% 26,852,173 81.6% 32,918,999 1,335,108 11.3% 593,262 5.0% 9,574,726 80.9% 11,841,247 647,156 9.5% 601,667 8.9% 5,469,013 80.5% 6,795,620 651,114 6.6% 1,326,120 13.4% 7,933,149 80.0% 9,922,315 938,494 6.0% 2,068,896 13.1% 12,563,737 79.8% 15,752,605 10,076 0.1% 1,127,988 8.0% 11,093,002 78.8% 14,078,694 33,628 0.2% 2,870,681 17.8% 12,672,466 78.5% 16,134,347 378,025 3.4% 835,566 7.5% 8,678,951 78.3% 11,082,633 123,133 0.8% 1,865,923 12.8% 11,160,102 76.3% 14,625,547 899,774 7.9% 1,611,872 14.2% 8,536,309 75.1% 11,365,887 73,220 0.8% 2,140,180 23.9% 6,717,119 75.0% 8,955,940 602,381 4.5% 1,943,592 14.5% 10,024,578 75.0% 13,374,685 224,905 0.6% 9,483,568 24.4% 28,504,895 73.4% 38,851,476 122,062 0.5% 1,912,338 7.3% 18,868,884 71.9% 26,225,733 393,303 2.8% 718,616 5.1% 10,186,883 71.9% 14,159,042 1,260,983 17.8% 782,756 11.0% 5,042,593 71.0% 7,098,805 553,640 3.1% 4,494,133 25.0% 12,670,368 70.5% 17,968,661 328,452 3.8% 1,987,183 22.9% 5,960,579 68.7% 8,678,833 30,161 0.4% 2,368,453 29.4% 4,555,107 56.6% 8,044,476 176,866 1.7% 4,568,575 43.8% 5,649,453 54.1% 10,436,811 90,575 0.6% 4,010,771 25.6% 6,713,325 42.9% 15,653,375 272,215 3.1% 4,475,674 50.3% 2,903,246 32.6% 8,894,956 33,891,462 4.8% 117,844,168 16.6% 499,509,488 70.5% 708,882,499

Source: www.bts.gov

For example, Pittsburgh airport, a former hub of US Airways, still relies heavily on the airline, as it serves 59 percent of its domestic market29. US Airways has been struggling since it came out of bankruptcy, on March 31, 2003, and is still trying to avoid it once again. As US Airways decided to downgrade Pittsburgh from secondary hub to “focus city” status and cut one-third of its flights, on July 23, 2004, the Pittsburgh airport is now under pressure to find ways it can pay for its high costs; costs associated with once being a primary hub for US Airways. Not only has the airline put Pittsburgh in turmoil, but credit agencies have downgraded Pittsburgh’s bond ratings to a BBB

Page 25 of 33

negative, one level above a speculative grade (S&P). Lower credit ratings only make it harder for Pittsburgh to finance its current debt and make improvements to the airport. As the structure of the market is changing with the increasing number of low-cost carriers, several traditional carriers have realized they need to restructure their business strategy or else they will be squeezed out of the industry. Already having cut costs and flights, some airlines have begun to implement the point-to-point network practiced by the several of the discount carriers. The reason airlines have been switching to the point-to-point system is due to its cost-efficiency compared to the hub-and -spoke network. The traditional carriers realize that the hub-and-spoke network is complex, inefficient, and in many cases not profitable. As more airlines are retrenching, abandoning unprofitable routes and the hub-and spoke concept, several airports face a troubled future with fewer flights and passengers. This turbulence within the industry is expected to last for a few more years until all airlines adjust to the marketplace and find their niche, or fall out. In the end, experts believe the turbulence will, “lead to fewer jobs, fewer hubs, and ultimately, airlines that bear little resemblance to those of today. ” 30 As a result, airports should begin their own restructuring before the airlines have to restructure the airports themselves.

Page 26 of 33

4. Recommendations As the airline industry continues to struggle and remain unprofitable, airports need to restructure their business plan in order to cope with the changes and instability of the industry. Airports should exist as an independent business enterprise in which it does not rely on any single factor. More so, airports ought to diversify their business strategy to ensure stability, while maintaining their primary goal, beyond survival, to generate profit and growth. Through diversification airports can become more integrated within the region they exist, to serve as a mechanism of economic and regional development, nor just an airfield. Traditionally airports have generated the majority of their revenues from aeronautical sources. Airports were viewed as parking lots for airlines to operate aircraft and directly serve passengers and cargo. However, more recently, airports are realizing their need to generate other ways to fund their airports costs. Already airports have been increasing PFCs and other bonds to increase their revenues. Unfortunately, these bonds are similar to the Airport Improvement Plan in that they are only for capital budget improvements and additions for aeronautical purposes. But, as one researcher observes, “airports can’t raise aeronautical fees to whatever their revenue needs might be. Airports play in a competitive arena to capture airline service, and aeronautical fees play a role.” 31 To ease the over-reliance on traditional aeronautical revenue streams, airports have been diversifying their funding through increasing their sources of nonaeronautical revenues. Airports have increased their non-aeronautical revenues through airside and landside facilities, serving not only passengers and airline employees, but also the local market surrounding the airport. Such facilities are 32:

Page 27 of 33

•

Retail shopping centers

•

Business office complexes

•

Hotel and entertainment facilities

•

Conference and exhibition centers, and

•

Logistics and free trade zones

Through the increase of non-aeronautical revenues, airports will find it easier to finance and improve their facilities, while at the same time, remain competitive and selfsustaining. Another form of diversification, which was implemented by Raleigh-Durham International Airport and several other US airports, is to balance ones airline mix over a number of carriers. In the July 4, 2004 issue of the Charlotte Observer, Ted Reed wrote an article regarding how Raleigh-Durham Airport has prospered even though it has not had a hub -airline since 1995 when American Airlines closed its hub.∗ Nonetheless, RDU still remains profitable, as it increased the number of low-cost carriers and the number of flights from its existing airlines. One of the major additions to RDU occurred when low-cost carrier giant Southwest started servicing RDU in 1999. Reed mentions in 2003, “7.4 million passengers originated or ended travel here, twice as many as in 1992, when American’s hub was at its peak.” 33 Clearly, this demonstrates that airports do not need a hub airline to function successfully. As airports begin to expand and diversify they become a center hub for cities, enhancing regional and economic development. In a statement by Dr. John D. Kasarda, director of the Kenan Institute of Private Enterprise at the University of North Carolina, he comments on how there are four common drivers for airport development:

∗

Midway Airlines switched its headquarters to RDU in 1995 and remained the primary carrier until going

bankrupt in 2003. However, Midway was only able to achieve a 30 percent market share during its service at RDU and was never at the level of a major airline. Thus, although Midway was hubbed at RDU, it was not the same as when American had its hub at RDU.

Page 28 of 33

•

New non-aeronautical revenue sources-To compete and to better serve their traditional aviation functions

•

Affordable, accessible land - For commercial development

•

Gateway passengers and cargo traffic, and

•

Landside business development- Airports serving as a cata lyst and magnet34.

Through the growth of the airports, policy-makers should bear in mind that airports need to provide not only for traveling passengers, but to the local community as well. However, in restructuring their business plan, airports must meet three basic requirements: •

Sufficient local consumer demand

•

Good geographic location, and

•

The necessary infrastructure to support high-volume traffic 35.

Further, airports themselves should emulate a city, as they become a center for businesses, residential communities, and entertainment facilities. Dr. Kasarda has coined the term ‘Aerotropolis’ to define how airports are the core driver to urban development as they promote various airport-linked business to serve as employment, as well as, “global production, commercial systems, and engines of economic development.” The concept of the Aerotropolis exists as “emerging corridors, clusters, and spines of airport-related businesses are creating new urban forms as much as 15 miles from major airports.” With this idea, some airports are banking on the fact that terminal passengers, businesses, and other activity will drive new sources of revenue to improve airports, cities, and regions around them. 36 A prime example of the ‘Aerotropolis’ is Amsterdam’s Schiphol Airport. Schiphol employs over 54,000 people and is a major contributor to the economic and regional development of The Netherlands itself. By 1997, “the airport accounted for 1.9 percent of The Netherlands’ gross domestic product and this is forecast to grow to 2.8 percent, or $14 billion, by 2015.” 37 Schiphol Airport resembles a mall in that it offers retail shops, entertainment facilities, and restaurants to both in-transit passengers and the general

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public. Also, adjacent to the airport, there are business and meeting facilities and two five-star ho tels. Not to mention, below the airport there is a train station connection to the city, the rest of The Netherlands, and various parts of Western Europe. In general, Schiphol airport is a city i n itself as it drives the local and national economy of Amsterdam and The Netherlands.

5. Conclusion The aviation industry is a vital part of today’s global economy and its growth. However, due to the recession in early 2001, and the tragic events of September 11, the U.S. airline industry has been very volatile and has had a slow recovery. With the increasing number of low-cost carriers and the rising of fuel and labor costs, several airlines have struggled to stay competitive. In addition, due to the decrease number in passengers and airline traffic over the last few years, airlines have not been able to maintain a steady profit to fund their high fixed costs. Several of the traditional airlines have debated the idea of bankruptcy as they continue to explore cost-cutting measures to make a profit. Overall, the volatility in the airline industry has greatly affected airport aeronautical and non-aeronautical revenues. As airlines realize they need to restructure their business strategy, they are putting airports in a tight position. Currently, airports have temporarily reduced some of their aeronautical charges to airlines to help them with their situations. However, as airlines cut back on unprofitable routes and abandon the hub-and-spoke network, airports are not guaranteed passengers and air traffic to fund their high fixed costs. Airports should realize tha t if they are not a primary hub , then “they are more vulnerable because their operations are more easily reduced or eliminated by hubbing carriers during periods of retrenchment.” 38 Airports have several strategic options. They can re-structure themselves as a dominant hub allowing airlines to come to airports rather than airports go to the airlines. But they put themselves at the mercy of their dominant carrier. On the o ther hand airports can restructure themselves and exist as an integrated business enterprise. Page 30 of 33

They can diversify their various revenue streams, not over relying on any one airline or source of revenue. One method of restructuring , which some airports have already implemented, is increasing airport non-aeronautical revenue. Airports should not only increase their traditional non-aeronautical revenue, such as parking, concessions, and rentals cars, but also they should develop new sources of non-aeronautical revenue, such as hotels, entertainment facilities, and business development. This way, airports will be a primary source of growth for its local economy as it employs and serves both passengers, local residents, and their surrounding region.

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Endnotes

1

Kasarda, John. “From Airport City to Aerotropolis.” Airport World. August-September 2001. Volume 6 Issue 4. Pg 42-45.

2

Federal Aviation Association Financial Statistics, 2004, www.faa.gov

3

Lin, Ta -Win and Jim Schmidt. “Economic Conditions During The 2001Recession (Part 1)” Washington State Office of Financial Management: Washington Economic Trends. July 2002. Research Brief No. 15.

4

“The Airline Industry and Current Challenges.” MIT, Global Airline Industry Program. Updated October 8, 2003. Online. http://web.mit.edu/airlines. June 16, 2004.

5

Bureau of Transportation Statistics, 2004, www.bts.gov

6

Chambers, Charles. “Status of the Airline and Airport Industry.” Presentation to Airport Niche Market Workshop and Clean Cities Washington Day. Global Aviation Associates, Ltd. 12 March 2002. March 12, 2002

7

Associated Press. “Salt Lake braces for possible Delta Bankruptcy.” USA Today. 12 May 2004. Online. www.usatoday.com. July 29, 2004.

8

Maynard, Micheline. “Delta Talks to Start as Pilots Offer Big Wage Cut.” New York Times. 21 July 2004. Online. www.nytimes.com. July 29, 2004.

9

Air Transport Association, Inc. “Statement on the State of the Airline Industry.” 3 June 2004. www.airtransport.org. June 17, 2004.

10

IBID.

11

IBID.

12

McCartney, Scott. “Hot Hard by Low-Cost Airlines, AMR Tries Behaving Like One.” The Wall Street Journal Online. 7 June 2004. Online. http://online.wsj.com. June 7, 2004.

13

Bureau of Transportation Statistics, 2004, www.bts.gov

14

Kasarda John D. and Jonathan Green and David Sullivan. “Air Cargo: Engine of Economic Development.” Center for Air Commerce, Kenan Institute of Private Enterprise, Kenan-Flagler Business School, University of North Carolina Chapel Hill, USA. July 2004.

15

“Fare Wars: The ‘The Friendly Skies’ are More Cutthroat than Ever.” Knowledge@Wharton: Strategic Management. 2 June 2004. http://knowledge.wharton.upenn.edu. June 4, 2004.

16

“A Sweet Song? Delta Aims at the Low-Fare Market.” Knowledge@Wharton: Strategic Management. 12 February 2003. http://knowledge.wharton.upenn.edu. June 4, 2004.

17

Tourism Futures International. June 2004. Online. www.tourismfuturesintl.com. July 29, 2004.

18

The Emerging Airline Industry. A.T. Kearney and the Society of British Aerospace Companies. 2003.

19

Roberts Roach & Associates, Transportation Management Consultants. Online Studies. http://r2ainc.com/index.htm. June 7, 2004.

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20

Corridore, Jim. Industry Surveys Airlines. Standard & Poor’s Industry Surveys. 20 May 2004. The McGraw-Hill Companies.

21

Plavin, David Z. “Top Ten Myths about Airports: The North American Experience.” Airports Council International of North America. 15 April 2004.

22

Airline Handbook Online Version Chapters 3, 4, 7, and 9. Air Transport Association. Revised 2001. www.airlines.org/publications. June 11, 2004.

23

IBID.

24

“The Economic Impact of U.S. Airports.” Airports Council International North America. 2002.

25

Bureau of Transportation Statistics, 2004, www.bts.gov

26

“Impact of Air Carriers Emerging from Bankruptcy on Hub Airports, Airport Systems and U.S. Capital Markets.” U.S. Department of Transportation December 2003.

27

Golaszewski, Richard. “Airport Capacity and Financing: Threats, Opportunities and Solutions.” 5 Hamburg Airport Conference: Airport Financial Exposure to Traffic Declines. 13-15 February 2002. http://www.hamburg-aviation-conference.de/pdf/session2/Golaszewski2.pdf. June 16, 2004.

28

IBID.

29

Bureau of Transportation Statistics, 2004, www.bts.gov

30

Maynard, Micheline. “Get Out the Glue for a New Business Model. New York Times. 11 July 2004. Online. www.nytimes.com. July 12, 2004.

31

Kasarda, John D. “Statement of Dr. John D. Kasarda.” 16 June 2004.

32

IBID.

33

Reed, Ted. “What’s the hub-bub about hubs?” Charlotte Observer. 4 July 2004. Online. www.charlotte.com. July 6, 2004.

34

Kasarda, John D. “Statement of Dr. John D. Kasarda.” 16 June 2004.

35

Freidheim, Cyrus F. and B. Thomas Hansson. “Airports as Engines of Economic Development: Great Airports are Critical for a Region.” Strategy+business. Third Quarter 1999. www.strategybusiness.com/press/article. June 9, 2004.

36

Kasarda, John. “From Airport City to Aerotropolis.” Airport World. August-September 2001. Volume6 Issue 4. Pg 42-45.

37

Kasarda, John D. “Planning the ‘aerotropolis’.” Airport World. October-November 2000. Vol.5 No 5. Pg 52-53.

38

“Impact of Air Carriers Emerging from Bankruptcy on Hub Airports, Airport Systems and U.S. Capital Markets.” U.S. Department of Transportation December 2003.

th

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