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The joy of flying: efficient PPP airport concession contracts

Learn about efficient Public-Private Partnership (PPP) airport concession contracts and three organizational forms to provide infrastructure. Understand the importance of non-aviation revenues, cost reduction strategies, and optimal risk-sharing mechanisms. Discover how competitive auctions can enhance contract implementation.

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The joy of flying: efficient PPP airport concession contracts

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  1. The joy of flying: efficient PPP airport concession contracts Eduardo Engel, Ronald Fischer and Alexander Galetovic U. de Chile, U de Chile, U. de los Andes

  2. Three organizational forms to provide infrastructure • Public/traditional • Government plans and owns the infrastructure • Government invests, operates and runs the infrastructure, many times subcontracting tasks, mostly in unbundled fashion • Direct link with budget • Public-private partnership (PPP) • Government plans and owns the infrastructure • Private firm invests, builds, operates, runs and then transfers the infrastructure back to the government (bundled contract) • Direct (if opaque) link with budget • Privatization • Private firm plans and owns the infrastructure • Private firm invests, builds, operates and runs the infrastructure • No link with budget

  3. Many airports are privately run Privatization • Europe: Heathrow, Rome, Vienna, Copenhagen, Manchester, …. PPPs • PPIAF database: 141 airports in low & middle income countries are PPPs; 110 involve investment & operation • 20-50 years; 30 on average • Greece, Zagreb, Belgrade, Mynamar, Cuzco • San Juan, (Kennedy), (La Guardia), Madrid, Sydney, Kansai, Osaka, 22 smaller airports in France, …

  4. Variable, exogenous demand

  5. Non-aviation revenues • Airports have two revenue sources • Aviation revenue(e.g. passenger charges, landing fees, terminal rentals) • Non-aviation revenue (e.g. retail concessions, car parking, real estate rents) • Non-aviation revenue is a function of • The exogenous demand for travel • Effort, investment & effort of the operator • Non-aviation revenue is important

  6. Global airport revenues & costs (2012)

  7. The problem Design a PPP contract that: • Reduces or eliminates costly exogenous, (aviation-related) demand risk • Provides incentives to exert efficient effort to increase non-aviation revenues • Can be awarded in a competitive auction → Exploit correlation between aviation and non-aviation revenue

  8. The model • Infrastructure • Costs I • Does not depreciate • Exogenous demand risk (aviation revenue) • PV of user fees: v, p.d.f. f(.) • Corresponds to willingness to pay • I

  9. The model II • Endogenous risk (non-aviation revenue) • Concessionaire exerts non-contractible “effort” (investment) e ≥ 0before operation • With probability p(e) generates value v • With probability 1 − p(e) generates no value • p(0) ≥0; p(e) < 1; p’ > 0; p” < 0; p’() = 0 • Risk-neutral planner • Many risk averse firms • VNM utility U(y,e)= u(y) ─ ke • Outside option U(0,0)= u(0)

  10. The model III Principal chooses payment schedules which depend on v and failure (f) or success (s) of non-aviation project: {Rf(v);Rs(v)}, with and effort e

  11. Principal’s problem

  12. Result 1: concessionaire bears no exogenous risk Take any {Rf(v);Rs(v)} that solves the principal’s problem and replace it by {Rf; Rs} such that Then both the PC and the ICC hold by construction but

  13. Reformulated principal’s problem

  14. Result 2: some effort increases welfare Let . If there exists a contract of the form with and such that the principal improves upon the contract

  15. Result 3: cross-subsidy from non-aviation to aviation business Losses in both states Profits in both states

  16. Result 4: smaller Rf, more effort Define e(Rf) via Because p’’< 0, to have e(Rf) decreasing, we need decreasing in Rf

  17. Result 4: smaller Rf, more effort Defining , the condition for e(Rf ) decreasing in Rf holds for all αθ> 0 if Sufficient condition: Economics: when condition holds and aviation revenues are smaller, larger marginal return to effort

  18. Result 5: monotonicity Now the principal’s objective function is decreasing in Rf; and the concessionaire’s PC is increasing inRf,

  19. Result 5: monotonicity

  20. Result 6: an PVR auction bidding on Rf implements the contract • Given α, firmsbidonRf • Lowestbidwins • Concessionlastsuntilwinningbidiscollected in aviationrevenues • Concessionairecollects in non-aviationrevenueifprojectissuccessful • Competitionforces to bid • Works evenif principal doesnot observe ancillaryrevenue and

  21. “Result” 7: optimal risk sharing (α)

  22. Summary • Efficient PPP contract implementable with a PVR auction on aviation revenue only • concessionaire loses money in aviation business • Concessionaire earns money in non-aviation business; cross subsidy from non-aviation business • Concessionaire is shielded against exogenous demand risk in both businesses • Fixed-term concession is not optimal • Competition takes care of rent-extraction • Works even if principal does not observe ancillary revenue (value)

  23. Thank you

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