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CHAPTER 2 Concession Agreements Terminal concessions (e.g., food and beverage, news and gift, and passenger services of various kinds) and landside concessions (e.g., parking and rental cars) can provide important revenue to airports. Airport concession agreements represent an important mix of revenue generation and passenger service. Such agreements enable airports to earn revenues based on "market value" rather than just cost-recovery. As airports work to enhance the entire passenger experience, the overall concession program design as well as the service standards incorporated in the concession agree- ment are important tools in that effort. Airport concessions have been experiencing significant changes in all aspects of operations. Many of these changes are reflected in the make-up of the con- tracts under which they operate. Many contractual changes have been made as airport managers seek to increase concession revenues while optimizing use of land and facilities. Critical issues in concession agreements are as follows: Financial terms Rent structures Defining gross revenues Solicitation Term Improvements provided by airport Improvements provided by concessionaire Monthly reporting Audit Service and operational terms Exclusivity of concession rights granted Hours of operation Personnel and on-site manager requirements Street pricing Maintenance of and title to improvements Recapture or relocation of premises Materials handling 2.1 Financial Terms Airports receive a significant amount of rent revenue and other fees from concessions. Unlike aeronautical rents which are geared toward the recovery of costs, concession revenues are estab- lished based on "market rent" principles and are designed to reflect the value of the privilege of doing business at the airports. Airport rents are typically much higher than their counterparts at "street" (local community) locations. This reflects that airport passengers provide concessionaires 15

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16 Guidebook for Developing and Managing Airport Contracts a solid customer base at their location, thereby providing a greater sales penetration and lower marketing requirements. 2.1.1 Rent Structures Most rent from concession operations is received through a revenue-sharing structure where the airport receives a percentage of the gross revenues from the concession, with a minimum annual guarantee (MAG) to protect the airport from a reduction in revenues. Some airports also charge separate cost recovery fees, such as utilities reimbursement, common area maintenance charges (for the cleaning and maintenance of food court seating, for example), or distribution and delivery charges. Many structures in use at U.S. airports today would be reasonable choices on which to model an article for a new contract. Concession managers must frequently balance maximizing the rental rates and cost recovery with the financial pressures on concessionaires to pay labor and other costs. Ideally, utilities should be paid by tenants proportionately. If possible, spaces should be metered individually. If that is not possible, a system that either allocates utility costs according to the util- ity loads of a tenant's equipment or allocates according to sales levels should be used. It is possible to calculate the inclusion of utilities in a percentage rent structure; however, doing so exposes the sponsor to a loss of income if the market's determination of percentage rent goes down. See CRP-CD-81 (enclosed herein), Appendix to Chapter 2, Concession Agreements, for an excerpt from the OAK concession agreement for a description of minimum guarantee and per- centage rent and an excerpt from the DFW concession agreement template for an example of concession rents. 2.1.2 Definition and Calculation of MAG The Minimum Annual Guarantee (MAG) is the total annual amount that the concessionaire agrees to pay at a minimum as rent under the concession agreement. The MAG may be estab- lished by the airport operator or may be bid by the concessionaire as part of its proposal. MAGs are stated in annual amounts and should be tied to the Contract Year, Lease Year, or other term defined in the agreement. These annual amounts should be further defined as required monthly payments equal to one-twelfth of the annual amount paid at the beginning of each month. MAGs may be defined so that they increase as the concessionaire's business increases. Some air- ports define MAGs so that MAGs increase with enplanements. Many airports take an approach that the MAG is adjusted to a level that is close to, but less than the most recent year's rent (e.g., MAGs may be set at 85% of the prior year's total rent paid). The agreement should also stipulate that the MAG can never fall below its initial annual level. MAGs for terminal concessions may be established on a contract basis or on a per location basis. Establishing MAGs on a per location basis is useful if each location is viewed as likely to be prof- itable and/or if there are many operators. Single MAGs covering entire contracts are useful to ensure required revenue levels or if there is reason to believe that one or more locations under the contract may not be as profitable as the rest. In any case, MAGs should ensure that an adequate rate of return is earned. At the same time, they should support the established rent percentages to be paid. Airports should also consider the inclusion of a "catastrophe clause" in their agreements. These clauses stipulate the terms, when traffic declines by a specified percentage at an airport, under which rent can be proportionately reduced.

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Concession Agreements 17 Terminal concession contracts may also include temporary reductions in the MAG that may be granted in the case of construction in the immediate vicinity of the concession directly impacting exposure to passengers and sales. 2.1.3 Percentage Rents Concession agreements almost always contain provisions for the payment of additional rents on a percentage basis. The percentage rents are calculated by multiplying the rental rate by the sales defined as Gross Revenues or Receipts for the locations. See CRP-CD-81 (enclosed herein), Appendix to Chapter 2, Concession Agreements, for an excerpt from the DFW Concession Agreement template for an example definition of Gross Receipts. Some contracts will apply different percentages for different levels of sales, as shown in Table 2-1. The contract may also provide a lower level of percentage rents for branded concepts to recog- nize the franchise fees that must be paid to the franchisor. 2.1.4 Term As with many types of airport contract, the trend is toward terms shorter than the 30-year agree- ments of the past. The range of the sample agreements for terminal concessions was 5 to 2 years, and for rental cars, 2 to 6 years. The amount of required investment in facilities affects the term length--an airport's development of pro forma income statements is essential to establishing term length. The larger the capital investment, the more time required to amortize the investment. If the capital investment is minimal, then it is better to have flexibility to introduce new concepts or new entrants, update the contract provisions, and possibly increase revenue more frequently. See CRP-CD-81 (enclosed herein), Appendix to Chapter 2, Concession Agreements, for an excerpt from the DFW Concession Agreement template. 2.1.5 Solicitation Depending on local purchasing requirements, airports may be able to renegotiate concession agreements without having to make requests for proposals (RFP). An airport operator may choose to negotiate a new agreement with an existing operator in order to reward an existing operator for great performance. An airport operator may also find it preferable to negotiate an agreement to bring in specified brands or concepts. An airport operator may also find that the extension of an existing agreement is appropriate when the concessionaire has made a recent reinvestment in facilities. A negotiated agreement approach may also be very appropriate at a small airport where it is difficult to attract new operators and renegotiating with the existing operator may result in more favorable terms than a bidding process would produce. However, in most instances, the Table 2-1. Percentages for different levels of sales. $0 to $1,000,001 to Greater than Category $1,000,000 $2,000,000 $2,000,000 Casual dining/bar 10% 12% 14% Quick-serve 12% 14% 16% Fast food 10% 12% 14% Specialty coffee 14% 16% 18% Caf 12% 14% 16% Newsstand - Category 1 12% 12% 12% Newsstand - Category 2 16% 16% 16%

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18 Guidebook for Developing and Managing Airport Contracts competitive solicitation of concessions will result in higher percentage rents and/or MAGs and a broader array of new or additional brands to choose from in a terminal retail program. This process may also be used to assign more favorable operating locations to the highest bidder in rental car processes. 2.1.6 Improvements Provided by Airport The contract should specify what facilities and improvements are being provided by the airport. The costs of facilities and improvements that the airport provides should be recovered in the space lease portion of the contract. In instances where the airport is investing a significant sum, it may be prudent for the agreement to have a net book value (NBV) provision whereby the tenant would have to pay the airport the unamortized portion of that investment if the agreement is terminated early. 2.1.7 Improvements Provided by Concessionaire Concession agreements have become increasingly clear with regard to defining not only the improvements permitted, but their value and amortization/depreciation schedule. Airports are encouraged to ensure that agreements spell out required investment levels and the schedule that will determine the net book value of those improvements throughout the term of agreement. Airports have also been successful in protecting the integrity of their asset(s) by including refur- bishment clauses. These clauses require tenants to re-invest in the assigned premises at regular intervals, thereby preserving a "like new" condition for the duration of the term. Some airports require major refurbishment at a midpoint of the term. Others require ongoing refurbishment. See CRP-CD-81 (enclosed herein), Appendix to Chapter 2, Concession Agreements, for an excerpt from the PVD concession agreement requiring refurbishment of the premises annually commencing during the midpoint of the agreement. Under some car rental agreements, the car rental company will construct the ready/return area and/or the service center. In this case, the airport may lease the land in an underlying ground lease at an appropriate land lease rate. The agreement should specify if the airport owns all improve- ments at the end of the lease. Additionally, there should be a procedure for valuation and buy out of facilities if the contract is terminated prior to its expiration or if the airport has to relocate the car rental operation for airport expansion or other valid reasons. 2.1.8 Monthly Reporting The format for reporting transactions and remittances of monthly payments should be provided in the agreement. Detailed items required for monthly reporting include the following: Gross revenues Breakdowns by concession location (each space) and product type (food vs. alcohol, or sundries vs. gifts) Concessions fees/percentage rents/MAGs remitted Customer Facility Charges (CFC) collections Airport Concession Disadvantaged Business Enterprise (ACDBE) Reports See CRP-CD-81 (enclosed herein), Appendix to Chapter 2, Concession Agreements, for an excerpt from the MSP Concessions General Terms & Conditions. Transaction days and amounts for each car rental should be treated as confidential informa- tion when collecting monthly transaction information for rental car concessions, while the retail concessions reports generally will not require this.