There are four ways that airports set the rates and charges for airlines. Three utilize an agreement, and one is a non-agreement type. The airline rate-setting methodologies that use an agreement are Residual, Compensatory, and Hybrid. The non-agreement model is often called ordinance rate setting.
Historically speaking, the concepts that aviation uses to determine rates and charges are based on the foundation that use of aviation, pay for aviation. This was predominantly the case prior to deregulation in 1978 where the residual methodology was the king. In the 40 years since deregulation, some other options have increased in popularity, but the age old concept of the residual approach still holds true in many ways.
Laws, Regulations, and Policies Governing Rate-Setting
To understand the rate making methodology, you must first understand where the concepts come from.
USC
- Anti-Head Tax Act – 49 USC 40116 (e) (2)
- Airport and Airway Improvement Act of 1982 – 49 USC 47107
- Resolution of Airport-Air Carrier Disputes Concerning Airport Fees – 49 USC 47129
CFR
Grant Assurances
You will find that a lot of what is done in the US civil aviation system ties back to Grant Assurances.
Grant Assurance 22 – Economic Discrimination
Grant Assurance 24 – Fee and Rental Structure
Grant Assurance 25 – Revenue Diversion
Agreement Based Methodologies
Residual
In the residual approach to rate-setting, the simplest explanation is that the airlines bear the liability for the costs of the airport. The agreement means the airlines agree to cover any shortfalls in the airports non-aeronautical revenue. The non-aeronautical revenue is applied towards the “bill” of the airlines and the airlines cover the “residual” or left over amount through their rates & charges.
Pros of Residual
- Provides the airport with financial stability
- The investment community looks positive on the airlines carrying the burden of the financial responsibility
Cons of Residual
- Airlines maintain control of facilities and projects through Majority-in-Interest (MII) provisions
- Requires a written agreement between the airport and airlines
- Airport must give proceeds from non-aeronautical revenue to the airlines to offset their costs
Types of Residual
Airport Residual
The concept is based on factoring in the entire excess cost of operating the airport once non-aeronautical revenue has been applied towards the airlines’ costs. This is typically applicable to determining the landing fees to cover the leftover balance.
Cost Center Residual
In a cost center residual approach, breaks down the costs into applicable cost centers such as airfield, terminal, and apron/ramp. Once in the cost centers, the calculations are made to ensure that the costs break even after airline revenue.
Compensatory
In the compensatory rate-setting model, the airlines pay for what they use. The airport assumes the financial risks, but gets to retain the proceeds from non-aeronautical revenue.
Pros of Compensatory
- Airport retains proceeds from non-aeronautical.
- The airport has control over facilities and projects.
- The airport is incentivized to increase non-aeronautical revenue.
Cons of Compensatory
- Airport assumes all risk and liability for expenses
- Airports must have liquid cash and assets to continue operations
- In the event of an industry downturn, the airport is on the hook for the operational costs
Types of Compensatory
Compensatory Rental Rate
The main difference in Compensatory and Commercial Compensatory includes what space is included. In Compensatory Rental Rates, the useable space is used to determine the lease rate. Since the divisor is larger, the average rate is lower.
Commercial Compensatory Rental Rate
In a Commercial Compensatory Rental Rate, the leasable space is used to determine the rental rate. This reduces the divisor by not including public areas and will result in a higher average rental rate compared to Compensatory Rental Rate.
Hybrid
The hybrid rate-setting model is any combination of a residual and compensatory method. This is becoming more and more common with several airports remaining Residual for the airfield and transitioning their terminals and other areas to a Compensatory model. Typically a split model will allow non-aeronautical revenue sharing between both the airport and the airfield. The specific amount is based on the agreement between the airport and airlines.
Pros of Hybrid
- Allows the airport to retain some of the proceeds of non-aeronautical revenue.
- May allow the airport to perform capital projects in the terminal and non-airfield areas without airline approval.
- The airlines still retain some liability for the costs of the airport.
Cons of Hybrid
- The airport gives us some revenues as part of the cost sharing provisions.
- Still requires a written agreement between the airlines and airport.
Transitioning from Residual to Compensatory/Hybrid Method
Even with more and more airports considering the move from Residual to Compensatory, the trend is not easy to do. Airports operating under a Residual concept have limited cash on hand as they have historically handed the residual income over to the airlines under the agreement. Transitioning to a Compensatory or Hybrid model requires negotiation with the airlines, planning, and well thought out provisions that fit the specific airport.
Non-Agreement Based Methodology
Ordinance
If a non-agreement method is used, it is most likely done through an ordinance (also called the resolution, regulation, or tariff). This is done through a local government body such as a city council. The ordinance sets the rates for airlines and tenants. Caution should be taken as the US DOT has ruled that the airports must comply with the Policy Regarding Airport Rates and Charges if they do not have an agreement. [1]https://www.faa.gov/airports/airport_compliance/media/airports-rates-charges-policy-with-amendments.pdf
Airports that use the Ordinance method include:
- Phoenix Sky Harbor International Airport (PHX)
- Lexington Bluegrass Airport (LEX)
- Orlando International Airport (MCO)
Closing
In closing, the method used for setting the rates and charges for airlines will vary from airport to airport and must take into account the unique aspect of each airport. Factors will include the size of the airport, market served, hub versus O&D operations, and the debt service that must be covered. Do not just copy what another airport did.
References
| ↑1 | https://www.faa.gov/airports/airport_compliance/media/airports-rates-charges-policy-with-amendments.pdf |
1 thought on “Airline Rate-Setting Methodologies”