INDUSTRY AT A CROSSROADS

Today the airport concessions industry is at a crossroads. The current situation is not good; the status quo has many challenges; change in the business framework – the model – is needed. And we – airports and concessionaires – have choices: there is more than one way to change the model, to make the business more sustainable, more resilient, more equitable. Change may be fixing the model to continue with the industry we have all come to know. Change may be acknowledging the challenges and accepting a different offer. Change may be something completely out of the box, a change that no one is even thinking about yet. Whichever way we go, it’s a choice that we need to make together – airports and concessionaires together, the industry as a whole. It’s a choice that will affect not just us but our customers, the traveling public, and the experience they enjoy as they travel through our facilities.
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But why must we choose? Let’s just face facts: the current situation is not sustainable. Why? Consider four facts.

• Labor costs keep climbing. The labor market has evolved to be vastly different than before the pandemic, an evolution we believe is a permanent change.
• Construction costs have soared beyond anything anyone contemplated.
• Interest rates are back to normal. And it’s not what we all think “normal” is!
• Sales per enplanement growth has stalled. Sales have not kept pace with costs.

Allow us to explain in four charts and a table.

1. Labor

The labor market has changed, particularly in the lower-wage segment of the economy. This is likely a permanent change, partially because of how industry and the labor market have evolved, and partially because, in the case of wages, what has been given cannot be easily taken back. These workers – who not just airport restaurants and retail, but street side food service, retail, health care, elder care, and many other service industries rely on – have moved on. And also dropped out. We have seen a decline in participation, for a variety of reasons, but generally related to low wages and the personal costs of earning low wages (e.g., the cost of childcare taking a large proportion of one’s own wages). Perhaps more important, these workers now have alternatives: for example, the growing number of well-paying jobs in logistics. Logistics companies – e.g., Amazon – now set the wages for many service industries. (Remember Amazon built a complete delivery system, and the three that were in place did not 2 retract much.) The consequence of this shift is increasing labor costs for all companies that compete in this labor market. 

Concessionaires are not immune to wage pressures. An ARRA survey of its members showed a 38% increase in associates’ hourly wage rates from 2022 through 2023 (Chart 1). During this same period, average hourly earnings in the overall nationwide leisure and hospitality industry increased only 13%. 1 Moreover, a company cannot just raise its associates’ wages: these increases trickle through the company’s whole labor system, its whole P&L. This level of cost increase presents a significant challenge. With widespread pricing constraints in the airport concessions industry, recovery of these extraordinary costs is nearly impossible, and as a consequence, profitability vanishes.

2. Construction

We all know about construction costs. The ARRA survey of its members (representing more than 80% of the US concessions industry) shows a weighted average 37% increase in construction costs since the beginning of the pandemic (Chart 2). During the same period, economy-wide nonresidential construction costs increased 22%.2 No one reading this should be surprised by the finding. But let us mix in the other half of our industry’s capital situation – interest rates​...

3. Interest Rates

The concessions industry – and everybody in the economy – is also experiencing a substantial increase in interest rates. Certainly expected, given central banks’ efforts to control inflation. But, let us suggest, current rates won’t fall back to what we have come to think of as “normal” – that is, pre-pandemic levels. Rather, interest rates have now returned to normal.

Consider a long-term perspective: until the recent run-up in interest rates, our economy enjoyed a long streak of very low interest rates (Chart 3). Frankly, unprecedented. If we look at interest rates over a longer time span – in this case, a benchmark 10-year Treasuries – we see that current interest rates are similar to levels before the 2008-2009 financial crisis. With central banks working to maintain liquidity and economic stability in response to the financial crisis, the low rates we enjoyed between the financial crisis and the pandemic may be the exception, not the rule.

​So, it should not be a surprise if interest rates do not return to their pre-pandemic levels. Are we back to normal? In this case, it depends on how you define normal. Unfortunately, what we have come to expect, is probably not normal.

Which implies that our industry – our economy – should adapt to higher rates as a long-term reality rather than expecting a return to the unusually low rates of the recent past. Looking at the impact of higher interest rates from a concessionaire’s point of view: baseline interest rates that drive borrowing costs for concessions buildout loans (Secured Overnight Funding Rate, the successor to LIBOR) are now about 5.3%. Before the pandemic, SOFR hovered around 2.5%. Moreover, the margin above SOFR that lenders charge concessionaires has also increased: pre-pandemic, the margin was generally 5%. Today, the margin is 8%. Total borrowing cost: pre-pandemic, about 7.5%. Today, about 13.3%.

Obviously, this is a significant hit to a concessionaire’s bottom line. Combine higher interest rates with higher construction costs and an airport operator’s debt service on a typical sevenyear loan is now 63% higher than before the pandemic.

4. Sales

But sales have recovered, yes? Well … no.

Consider average sales per enplanement as reported in ACI-NA’s annual concessions benchmarking survey (Chart 4. Note these are not necessarily the same airports from year to year, but an annual sample of ~70 airports). Sales per enplanement increased steadily from 2009 to 2014 to approximately $10.00 per enplaned passenger (including duty free), but then, essentially plateaus.

​Although there has been some growth coming out of the pandemic, on the whole, sales rates are lagging inflation by a substantial amount. If sales rates had kept pace with inflation from 2018 (the last year reported prior to the pandemic), the industry could have achieved an additional $1.00 in revenue per enplanement. With 2023 total enplanements recovering to 946 million,3 falling behind inflation has cost concessionaires $946 million in the aggregate. In light of rapidly rising operating and capital costs, this revenue shortfall is a staggering blow to the industry.

It’s a Big Deal!

​What does this all mean? Well … it’s a big deal. The impact on concessionaires is dramatic!

​Keep in mind that airport concessions (as well as street side restaurant and retail businesses) are low margin businesses. As we can see in the nearby table, prior to the pandemic, a representative free cash flow return on sales was about 10.5% (the orange circle). This is the cash available to pay investors. Today, considering the impact of the four facts just discussed – as well as other changes we didn’t highlight such as increasing costs of goods – the return is now zero (the red circle). The bottom line: concessions contracts starting today earn no return on equity, nor return of equity. This is not the picture of a sustainable business model … for anybody, for any business. 

We have arrived at an urgent situation where airports and concessionaires must together make a choice about how to go forward. Do we change our model, or do we keep our model? Either way, there are consequences. If we evolve the model to meet the new business environment, then we can maintain the service levels that we’ve all come to expect, that our customers have come to expect: great looking stores and restaurants, recognized brands, and exceptional hospitality. If we don’t change the model, we will likely regress as an industry. Back to an era of limited offerings and generic concepts. As the industry moves into this critical period, the choices we together make today will shape not only the future of airport concessions but also the broader passenger experience for years to come.

​Let’s begin the conversation. We must decide. Before others make the choice for us!

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1 U.S. Bureau of Labor Statistics, “Average Hourly Earnings of Production and Nonsupervisory Employees, Leisure and Hospitality” reported by the Federal Reserve Bank of St. Louis. Comparison period is January 2022 to January 2024.

2 Turner Construction Building Cost Index for 2024Q1 vs. 2019 annual average.
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3 U.S. Bureau of Transportation Statistics
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Issued: September 6, 2024​