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CHAPTER 8 Selecting Appropriate Techniques for Air Service Development There are several types of incentives that airports and communities can offer air carriers dur- ing air service development negotiations. This chapter discusses techniques that various small communities have successfully applied and describes their advantages and disadvantages. It also includes a brief discussion on FAA's oversight of matters relating to airport rates, charges, and incentives. Finally, it discusses the conditions under which different types of ASD techniques may be appropriate. When air carriers are deciding whether to serve a particular community, they are making business decisions about whether to commit literally millions of dollars worth of human and capital resources to a market. Decisions of that magnitude are not taken lightly. With airlines financially strained since 2001 and with the U.S. economy having been stressed by high energy costs, problems on Wall Street, and a recession, airline managements are naturally risk averse. Communities and the airports they serve can help mitigate an airline's risk of introducing Except in unusual new service through various ASD techniques that either provide an assurance to the carrier that they will generate a certain level of revenue or significantly reduce some of the start-up circumstances, all costs involved with entering a new market or increasing the level of service at a market. Except smaller communi- in unusual circumstances, all smaller communities need to provide some sort of risk mitiga- ties will need to tion to attract new or enhanced service. Airlines and communities increasingly recognize that expanding the service in their market requires a partnership in which both partners share in provide some sort the risk, at least initially. of risk mitigation ASD techniques can generally be divided into two broad categories: those designed to boost a to attract new or carrier's revenue through promoting passenger demand and those designed to induce carriers enhanced service. to supply air service by reducing their costs. Although both can produce the same result in the carrier's bottom line, different carriers have expressed clear preferences for different types of incentives. Airports may also decide that they want to use both revenue-boosting and cost- reducing options. What revenue-related ASD techniques are available? Revenue-related techniques seek to ensure either that carriers generate a sufficient amount of passenger demand or that the revenue generated from the operations hits a minimum threshold. Minimum Revenue Guarantees Revenue guarantees are agreements that establish a target amount of revenue that a carrier will receive for operating a particular service to a particular destination over a given length of time. They may be expressed as a minimum amount that will be generated from passengers (ticket sales), 104
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Selecting Appropriate Techniques for Air Service Development 105 provided that the carrier meets certain operating requirements (e.g., completing 92 percent of their operations, with an on-time departure or arrival record of x percent). The guarantees are only paid out if passenger demand--and associated target revenues--do not materialize. The amount paid is equal to the shortfall. If the target is met, no funds are drawn down, which may actually be an indication of project success. The timing of the payouts can vary widely--monthly, quarterly, semi-annually, or annually. Revenue guarantees should contain performance requirements on the part of the carrier. For example, while the airport or community may be ensuring that they will meet traffic and revenue targets, they in turn need some assurance from the carrier that it will meet performance and reli- ability requirements such as mutually agreed upon completion rates and on-time performance requirements. Over the last few years, airports have increased the amount of revenue guarantees that they have awarded. As carriers increasingly drop service at many communities because of their ongoing financial hardships, more communities are competing to attract (and retain) air service, so the amount of revenue offered as incentives has increased. Revenues are generally stated as a set target. For example, Rhinelander-Oneida County (Wisconsin) Airport used a SCASDP grant to provide a revenue guarantee of $492,000 to sup- port nonstop service to Minneapolis. Rhinelander convinced Northwest Airlink to convert three of its four daily one-stops (via Eau Claire, Wisconsin) to nonstops. Because the service generated more revenue for the airline than had been expected, the airport was able to return nearly half of the revenue guarantee to U.S.DOT. In the survey, several airports reported using some form of revenue guarantee. Few were undertaken as the only type of incentive. That is, the revenue guarantees were usually combined with other forms of incentives, such as cost or fee waivers. Federal funds were often used to support the minimum revenue guarantees, thus effectively shifting the risk of the service's possible failure to the federal government. The amounts of the guarantees ranged from $250,000 to $1.6 million. With fuel costs rising and passenger demand slipping, the study team would not be surprised if average revenue guarantees would approach $1 million. Advantages of Revenue Guarantees 1. Carriers like them: In the survey of carriers, five out of six carriers reported that revenue guar- antees were an effective means for attracting service. 2. Potentially low costs: If the project is successful, minimum revenue guarantees (MRGs) cost little or nothing. The airport serving Redmond/Bend, Oregon, won a $500,000 SCASDP grant to provide a revenue guarantee for Delta's new service to Salt Lake City, but load factors remained so high following the first 12 months of service that the airport returned the entire SCASDP grant to U.S.DOT. 3. Cash flow: Depending on how they are structured, MRGs can be paid at various times dur- ing the target period, and these pay dates can be negotiated in ways that can be more or less advantageous for a small community's cash flow. They may be paid only at the end of the agreed-upon period of air service, thus requiring no initial cash outlay. 4. Administrative ease with low administrative costs: The revenues that the contracted airline generated during the period are relatively easy to track. Risks or Disadvantages of Revenue Guarantees 1. Despite a community's best efforts to estimate how passenger traffic will respond to new service, there are no guarantees--the airport/community can lose the entire amount. Also, depending on the source of the revenue guarantee, it may not motivate the community to use the service. The U.S.DOT Inspector General's office reported the example of a community that attracted
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106 Passenger Air Service Development Techniques new air service during the period of its SCASDP grant, but Pensacola's travel bank traffic was lighter than expected, and the carrier providing that service abandoned the market as soon as the funds Pensacola's travel bank was the product of a were expended. large community effort involving support from 2. Carriers can be wary of them, particularly in certain mar- numerous community stakeholders. The Chamber kets. An official from one major legacy network carrier's of Commerce, Pensacola city officials, and airport regional affiliate told an air service conference in 2008 that officials conducted intensive outreach to the local it was not entirely supportive of MRGs for the following community and persuaded 319 businesses to reason: if the carrier used all of the revenue guarantee, yet contribute $2.1 million for two years' worth of pulled out because the service was not profitable, leaving prepaid travel on AirTran Airways. The local bank the market would create a negative brand image that would involved issued each participating business a debit be difficult to overcome, especially if the carrier still serves card to draw funds toward the purchase of AirTran the market to another hub. airline tickets. Using their debit card accounts, 3. The changing economics of the regional industry may businesses could purchase tickets from travel agents, make some efforts simply not cost effective. New Haven, the Internet, and other distribution channels. If Connecticut, had the unfortunate experience of exhaust- the businesses did not spend the funds they had ing the $1.6 million revenue guarantee it had assembled allocated to the account within the two-year period, with the help of Yale University and other community the remaining funds were transferred to AirTran, partners. Delta accepted the revenue guarantee for RJ and the businesses received AirTran vouchers operations into Cincinnati. However, because of issues redeemable within one year. While Pensacola with New Haven's primary runway (its 5,600-foot length passengers can fly to any of AirTran's destinations and airfield obstructions), Delta experienced greater than (via Atlanta), AirTran determines the flight sched- expected payload restriction that forced its CRJ-200s to ule. The initial agreement stipulated that if AirTran operate with less than full passenger loads. Coupled with reduced its flights to fewer than three per day, rising fuel costs, the carrier simply could not generate the filed for bankruptcy, or sold more than 50 percent revenue it needed to make the route profitable and dis- of its stock, then businesses participating in the continued service in January 2006. travel bank could be released from the agreement. 4. Several of the surveyed airports that tried revenue guar- AirTran increased its flights from three to four in antees commented that they seriously underestimated how 2003. Airport officials credited the 50 percent drop difficult it would be to raise money from local sources. in airfares along AirTran's routes for the 26 percent The concept of a revenue guarantee is attractive; however, increase in traffic in May 2002. convincing local businesses, governments, and individuals In the survey of airports, few airports used some to contribute funds can be a major challenge. form of travel bank. When travel banks were used, they were usually combined with other forms of Guaranteed Ticket Purchases incentives, such as cost or fee waivers. Typical sizes ("Travel Trusts" or "Travel Banks") of travel banks at the airports surveyed ranged Guaranteed ticket purchase programs effectively ensure from $500,000 to $700,000. However, as shown in that the target airline will have passenger traffic worth a certain the Pensacola example and elsewhere, travel banks volume of revenue, thus helping to mitigate some of the risk can involve considerably more than $1 million. associated with attracting passengers to new or expanded service. Businesses or individuals deposit funds in a bank account that can be used only for purchasing tickets on the target airline during a given period of time. Advantages of a Travel Bank 1. A travel bank provides an undeniable indicator to the airline of the community's commit- ment to use the proposed service. It is especially a commitment indicator of the business com- munity, which often provides the greatest source of funds to the travel bank and the poten- tial clients of greatest interest to the airlines. It is a sure sign of the underlying demand for travel from a community.