Aviation economic sustenance agreements

The pandemic came with many lessons for us all. For stakeholders in aviation, one of the lessons is an alternative outlook on how to structure commercial contracts between airports and concessionaires. The agreements should mirror current and future uncertainty around passenger profiles and traffic volumes.

The pandemic may be over but the applicability of the white paper by Airports Council International (the voice of the world’s airports) still applies to aviation in Africa in particular and SMALL and MEDIUM sized airports in general. This white paper titled: “Airport Concession Agreements: Fixed Vs Variable Minimum Annual Guarantee” can be downloaded from the aci store (store.aci.aero). Yours truly took part in the production of this document.

Where there are leases incorporating a Minimum Annual Guarantee framework or fixed rent clauses, taking a look at alternative outlook for concession agreements is important. Contracts usually include a force majeure clause, but it may not cover pandemic scenarios and it may not have a formal agreement in place to review commercial terms when such events occur. This white paper aims to secure a Win-Win for all stakeholders when there is a disruption to business of the airport.

The white paper reasserts that airports are expensive to build, maintain and operate. Their capital expenditures and operating expenses far exceed those of concessionaires. No matter the volume of traffic or the passenger demographics, both the airport and concessionaire have multiple fixed and variable costs that must  be paid. Airports have also been going through changes in ownership and business models which put a lot of demand on airports and concessionaires in their bid to serve the customer and at the same time grow their balance sheets.

The MAG model (Minimum Annual Guarantee) for rent has traditionally been an effective tool for airports to hold concession partners to a minimum level of performance. It is usually combined with a revenue share and/or tiered revenue share model, where the MAG is the minimum rent paid, but is often exceeded by the percentage rent, so it becomes void beyond a minimum standard payment.

One good strategy is to negotiate a MAG which is challenging but achievable and sustainable with an expectation that it will be exceeded year after year. The downside is that it may not be feasible or pragmatic to impose a MAG in case of a hardship event, which is, an unpredictable event or a predictable event but with a significant and uncertain magnitude and duration,  and beyond the control of the affected party.

One way to mitigate this risk is to have a predefined contract adjustment mechanism that will recognise the hardship event and allow for proper adjustments of the concession agreement. So whatever firm commitments are made by the concessionaire can be converted into service level agreements that can be incorporated within the framework of the contract so that both airport operator and concessionaire work collaboratively towards a common objective.

The white paper  states further that the level of MAG may be appropriate but where there is a substantial negative shock to the travel market of the magnitude of the COVID-19 pandemic (outbreak of hostilities in parts of Africa like the recent one in Sudan is another example) among others, then both the airport and concessionaire will need to work together and negotiate appropriate mitigation issues that arise from the need to fulfil lease obligations. The process of such a negotiation can be included in concession agreements to formally provide a jointly agreed framework for such situations.

Concessionaires have, as a result of the prolonged length and fall-out from the COVID-19 pandemic, been pushing for a switch from traditional MAG contracts to a variable MAG model. However, that does not take cognisance of the fact that during periods of substantial reduction in traffic volumes, an airport must still pay considerable fixed costs.

The white paper suggests an approach when discussing rent abatement – an approach that shares the pain as parties consider reducing the MAG or introducing a hybrid model that adds an element of variability to the MAG based on traffic and/or passenger profile until certain thresholds are met.

Airport operators will require a certain level of security of income from the retail and other commercial spaces which they award to concessionaires. They need to recover from shocks such as the COVID-19 pandemic to offer protection against poor performance from concessionaires. Recall they have taken a risk in financing, building and operation of the airport.

At the same time, concessionaires will also have invested in the design, construction and fit-out of the stores as well as the recruitment, training and development of their personnel. They will typically have between five and seven years to recover their investment. But concessionaires will have limited opportunity to promote traffic to their stores when there is a material reduction in passenger numbers. The captive customer base would have been eliminated. So an unsustainable MAG structure can lead to severe losses that are not recoverable through the remaining term of the contract.

The importance of ensuring that airport operators and business partners have a regular and open and transparent dialogue, and, also, maintain those cooperative and synergetic relationships that have been developed over many years, such that both airport operator and concessionaire can jointly sail through any present and future challenges to the aviation industry,  is to be uppermost in the minds of all, says the white paper.

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