Anchorage International Airport Duty Free/General Merchandise Concession

Background:

The duty free/general merchandise concession (DF/GM concession) at the North Terminal of Anchorage International Airport (AIA) is operated by the David Green Group, J.V. (DGG) until its agreement termination in July 2000. DGG is requesting that the State grant an term extension of 40 months to facilitate the expansion and improvement of the retail spaces.

The AIA DF/GM concession at one time produced one of the world's highest revenue per passenger airport operations resulting in an extremely valuable State asset that generated significant revenues for the airport and its operators. In 1988, transit passengers totaled 1.5 million passengers and concession retail sales exceeded $100 million per year with fees paid to the State approaching $19 million annually. However, with the opening of Soviet air space and a new generation of long-haul jets coming on-line the market drastically declined by 75% in the number of transit passengers with annual sales plummeting to a low of $7 million and concession fees to $1 million (See attached Charts A through C for passenger traffic, airport concession fees and gross revenue history).

DFS Ltd., the world's largest duty free operator and incumbent AIA concessionaire, did not even submit a bid to the State to retain the concession that it operated for 25 years. It was deemed to have eroded in the value to the point of not worth the effort. In fact, DOTPF had to put the bid proposal out for a fourth time before it even got any interested bidders. At that point, the successful bidder was the David Green Group (DGG).

The DGG was awarded the concession for a term of five years beginning on August 1, 1995. During their first year of operation they increased sales by 50% to over $10 million with expectations that there will be an additional 50% sales growth in the second year. This has been the result of local management control, a focused marketing strategy, hard work, passenger growth and appropriate investment. The recent increases in international transit passengers present a narrow window of opportunity to revitalize the standing of the DF/GM concession. The increase enhances the credibility of the DF/GM concession opportunity, so that it is once again to viably market the facility to high-end merchandise suppliers. Many of these suppliers expect the surrounding company of other prestige brands. World class brands such as Hermes, Cartier, Coach and Christian Dior have expressed renewed interest in Anchorage, but only if a high-end retail environment is created. Because of the highly competitive nature of the duty free business globally and the changes occurring in the Asian, European and North American economic market, airports and concessionaires are making significant investments to attract retail sales growth. Consequently, if AIA is to maintain their position in the marketplace or to expect any growth it is essential that the necessary investment(s) be made to insure a competitive presence. DGG believes that additional investment in the infrastructure of their concession would yield a significant increase in retail sales and fees to AIA. However, not enough time remains under the current concession agreement to adequately amortize the investment.

The State directs the airport and its AIA Revenue Fund to be self-sustaining to maximize revenue opportunities where feasible, as is the case with most airports in he world. There is a limit on the amount airports can derive through increased landing fees before discouraging air carriers using their facilities. Increasing competition between airlines has meant that airports have turned to retailing as an alternative source of revenue. A London Financial Times study stated, "the portion of income derived from landing fees fell from 27% in 1983 to 25% in 1993. This reflects pressures from both airlines and regulatory bodies to keep these charges low." In the case of AIA, the State fees derived from the DF/GM concession sales enhances the attractiveness for the international terminal, better serves the traveling public and enables the State to mitigate other operational costs currently borne by the air carriers. While DGG certainly intends to work aggressively to enhance the duty-free concession to the extend economically prudent under the existing agreement, the regrettable reality is that it is not commercially feasible for DGG to undertake the necessary proposed scope of investments under the current contract term.

Other Airport Duty Free Concessions:

AIA competes with selected major Asian and North American airports for the discretionary spending of both transit and destination travelers. This international competition for the sale of duty-free/general merchandise has entered a new era of competition, particularly in these airports across the Pacific Rim (See Chart D from trade press, Datamonitor). Other existing airports, such as Los Angeles, New York and Vancouver are also investing capital to improve their passenger facilities. The retail opportunities available to the international travelers are thus being continually elevated. Progressive leasing authorities recognize that to remain competitive they must work with their concessionaire(s) to viably compete for discretionary travel retail sales. For example, at JFK in New York, a group of four major international airlines, i.e., Korean Air, JAL, Lufthansa and Air France, are constructing a world class terminal facility by 1998 to complement the high standard level of passenger service expected for them. This competing facility will contain over 17,000 square feet of retail space, as compared to AIA's current 8,000 sq. ft. of retail space. This is a significant increase of their existing retail areas and improves their competitiveness for air travelers spending on this major route transiting Anchorage.

Examples of Asian airport investments are noted in Chard D (attached) through the year 2000 for new or improved airport operating and retail facilities. The new Chek Lap Kok Airport opening in 1997 will dramatically increase retail shopping space by 15,000 sq. ft. over the current congested facility in Hong Kong. Many of these airports are direct competitors to AIA and its international merchandise concession.

Major international airports in the U.S., such as Sea-Tac, Portland and Las Vegas work with their concessionaires to grant them term extensions when substantial investments and efforts are made to improve merchandise facilities. The airports recognize the necessity to compete for customer pending in order to receive additional fees from cooperative concession agreements as this to operate and upgrade their facilities for expected future growth.

Legislative Need:

Conversations with the AIA's staff demonstrate a recognition of the competitive nature of the retail business and a belief that additional investment(s) would yield greater financial and competitive returns. However, they feel that they need the broadened authority under existing statutes to extend the term of the agreement for the benefit of the airport.

The introduction of the proposed amendment would allow the State and DOTPF to extend the term of the duty free concession agreement for 40 months if deemed to be in the best interest of the State and designed to improve AIA's competitive position in the marketplace. Absent this amendment, AIA would be constrained from having the flexibility to react to the already changing competitive environment. Giving DOTPF this flexibility both enhances the value for the concession and the State asset by generating additional fees to AIA, lowers operating costs and rates which would attract further new international air carriers to this airport.

It is estimated that spending on airport infrastructure in Asia will amount to $75bn by the end of the century, with the new airports in Hong Kong, Seoul and Kuala Lumpur accounting for half of this, and China for a further $10bn. Development is also taking place in the developed countries of the region: in 1995, the new Osaka/Kansai airport was opened in Japan. The region's major airport investment programs for the rest of the decade are shown in Table 4.4. Beyond this, perhaps another $50bn of investment will be needed in the period 2000-10.

There is also evidence that growth is not only occurring in these large regional airports, but is also spreading to a host of secondary cities such as Kota Kinabalu (Malaysia) and Cebu (Philippines). This growth is being driven by tourism and government programs to reduce congestion in the largest cities and spread the benfits of industrialization to other parts of the country. The key countries experiencing this growth are China, India, Indonesia, Malaysia, the Philippines, South Korea, Taiwan, and Thailand. A third phase of development will occur later in Cambodia, Laos, Mongolia and Vietnam.

China's airports:

This section focuses on China, one of the key growth areas on the continent. Not only is China a rapidly expanding air travel market, it has a hugh airport expansion program and has been a major destination for foreigh retailers over recent years. Over the 25-year period to 1993, the growth in air passengers in China averaged 21% per annum to reach 53 m passengers.