SINGAPORE CHANGI AIRPORT – A CASE STUDY OF ITS DEVELOPMENT

2008
Article touches on: Attractions of Airports, Problems and Issues, Revenue Regulation, CHANGI AS A BUSINESS CASE STUDY, Revenue Components, DEVELOPMENT OF CHANGI AIRPORT
http://www.myscl.org/publications_7_1_10.pdf

CHOW KOK FONG
M.B.A, LL.B.(HONS), B.SC.(HONS)
F.C.I.ARB., F.R.I.C.S, F.C.I.S., F.S.I.ARB.
Chartered Arbitrator
Formerly Chief Executive Officer, Changi Airports International
Past Chairman, Society of Construction Law, Singapore

At first instance, this must appear a torrid time to be writing about airports and
infrastructure. Few could have imagined that the world of high finance which had
been so confidently buoyant 18 months ago could descend to its present state.
Nevertheless, the case for airports is not just built on expectations of asset
valuations. It forms an integral part of that crucial infrastructure which is needed to
sustain the flow of commerce that will be pivotal for any eventual recovery. It is still
the only way by which large swathes of China, Russia, India and, indeed, the bulk of
Africa can interface with the rest of the world.
My presentation will be divided into three parts. The first considers airports as a
class of assets. Before the current difficulties with the financial markets the industry
has started to attract a rising tide of interest from the large pension funds and
lenders. There are good reasons for this and these will be readily appreciated from a
comparison of the business dynamics of airports with that of utilities and real estate.
The presentation then moves from this to discuss Singapore Changi Airport as a
case study to demonstrate some of the payoffs and the problems unique to this
asset class. Finally, we will draw everything together to show how the points
deliberated distill into a development track for a major airport which is one of the
leading airports in the world.

AIRPORTS AS AN ASSET CLASS
Attractions of Airports

The most attractive thing about airports as an asset class is their growth story.
Despite the current difficulties of high oil prices and the spreading contagion of
airlines going into liquidation, airports retain a compelling growth story. Over the
past 7 years, passenger growth has averaged 5.9%, more than 150 basis points
above the underlying economic growth rate. This has to do as much with the
increasing affordability of air travel but it also stems from the fact that many parts of
our world has become increasingly accessible. Even allowing for the control of
carbon footprints, this development will be difficult to suppress.
An airport is a virtual monopoly. While some competition may exist between airports
in a locality, few have actually competed aggressively. Ironically one of the few
situations of competition amongst airports is encountered in Moscow. It has three
airports and the two largest, Domodedovo and Sheremetyevo, do go after each
other’s business aggressively. Apart from this and a few other instances, airports do
by and large enjoy the considerable pricing power befitting near monopolies.
Airports owe their monopolistic attributes to the high barriers of entry in the business.
Any entrant has to grapple with the complex process for developing a major facility
and the development of an airport itself is not only a major capital project but
extremely complex. For example, the construction of Terminal 3 in Changi involves
no fewer than 200 different contractors, sub-contractors, suppliers and consultants
with a construction programme that has to monitor over 5,000 activities. In addition,
in many parts of the world, any airport expansion or development has to grapple with
a host of environmental and planning issues, including concerns raised by residents
in the locality. These inquiries and evaluations are drawn out processes and, quite
frequently, after years of debate nothing ensues. An example is the New Lisbon
Airport. Since 1989, successive Portuguese governments have changed the
program, scope and site of the new airport and last year a decision was made on a
new site at Alochete.
Because of the underlying economics and its inherent characteristics, airports are
blessed with consistent cash flows which rise gradually over time. This makes
airports ideal as investments for pension funds and insurance companies. The basic
deal is an asset which is reasonably insulated from the vagaries of the business
cycle so that even in the doldrums, it can generate a respectable yield. An important
dimension to an airport’s cash flow is that we are still some distance away from
optimizing revenue generation from this asset class, particularly non aeronautical
revenue from retail and commercial operations. In the years ahead, this aspect of
the business is likely to attract considerably more attention and will be the focus of
creative retail plays.

Problems and Issues
Against these positive factors, the airport business is a highly regulated one. There
are regulations on revenues through revenue caps, environmental and planning
restrictions and, more critically, a complex web of aviation safety regulations. The
business of an airport depends critically on a country’s air rights. Airports have to
rely on the various agencies of national governments in the negotiation and defence
of these rights.
An inescapable aspect of airports is their political visibility. There are many
examples where local constituencies see airports as an extension of some notion of
national sovereignty and are reluctant to allow foreign entities to operate or own
these assets. These sentiments may exact extortionate levels of concessions or,
worse, prevent the relevant state agency from delivering on its obligations. For this
reason it is difficult to get one’s hands on the good quality airport assets, particularly,
airports which serve as major gateways to a region or country. Hence, notwithstanding the difficulties with the debt market at present, interest on the sale of
Gatwick, for example, is likely to remain strong.

Revenue Regulation
Because of their political visibility and their propensity for monopolistic behaviour,
airports are perhaps the most regulated of infrastructure assets. They raise
inevitable policy concerns that users – especially passengers – may be unfairly
exploited. However, the strongest advocates for the regulation of airports are the
airlines. The general argument seems to be that while many airports are
monopolies, airlines are not and, indeed, are subject to the disciplines of
competition, particularly for international routes and passengers. This thesis seems
to be supported from a comparison of the IRRs of airports and airlines. Respectable
airports should earn IRRs of at least the mid-teens (i.e. between 14 to 17%) but the
average for a cohort of well managed airlines is around 9 to 12%. However, from an
airport vantage this argument overlooks the fact that the two sectors are really quite
separate. One is location bound, driven as much by the need to get to the place as
by the capacity of the airport to manage transfer passenger volumes. The other is
truly air bound – airlines in theory need not owe allegiance to any place. Thus an
airline like Lufthansa could just as well site its headquarters in Munich as it could
currently in Frankfurt.

Be that as it may, the case for any regulation has to do with much more than pricing.
It has to address the delivery of service, efficiency and safety standards and the
maintenance of sufficient levels of investment. In the United Kingdom, section 40 of
the Airports Act 1986 provides for the Civil Aviation Authority to impose price caps on
airports which are designated for such controls under the Act. The price caps are
applied to specified airport charges, principally those which are levied on (a) the
landing, take-off and parking of aircraft and (b) the handling of passengers through
the terminal buildings. Under what is commonly known as a single-till structure, the
total revenue from these airport charges (frequently called “aeronautical income”) are
pooled with the revenue generated by retail, property rentals and income from
concessions such as those relating to airport service providers and car-park
operators (termed “non-aeronautical income”). The regulator then determines the
level of total airport revenue which the airport owner is entitled to receive, taking into
account the need to provide the owner with a return on the investments needed for
the upgrading, expansion and improvement of the airport. The total airport revenue
is often determined as a percentage of the assets which qualify for this purpose.
These designated assets make up collectively the “regulated asset base”. Subject to
the total airport revenue permitted, the owner or operator may then determine the
quantum of individual charges to be imposed on users of the airport. An example of
an airport with a single till revenue structure is Heathrow.

A single till structure is an approach borrowed from the conceptual framework used
to regulate the pricing of utilities. It could be argued that it is not appropriate for
airports because unlike utilities, the market for airports is subject to considerable
barriers of entry, principally because of the complications of bilateral air service
agreements. Moreover, in a congested airport this revenue structure prevents
differentiated pricing of airport charges which could have been used to alleviate
congestion at peak hours. Different charges, for example, could have been applied
to different routes, type of traffic (e.g. chartered or scheduled) and transfer or
originating traffic. For this reason, few airports outside the United Kingdom and
France have adopted the single till structure. The alternative to the single till is the
“dual till” where the aeronautical and non-aeronautical revenues are regulated
separately. The regulator may prescribe the maximum charges which may be
imposed for the users of the airport, namely the passenger facilitation charges and
the landing charge.

Changi Airport is undergoing a process of corporatisation. The development of an
appropriate revenue regulation structure will be an important matter which has to be
resolved in this process. Like any other airport, the ultimate choice of the structure
will be a balance between (a) sustaining the operational performance of the airport
as a critical infrastructure facility and (b) ensuring that the airport team is motivated
to innovate and to deliver the returns consistent with the airport as an investment
asset.

CHANGI AS A BUSINESS CASE STUDY
Constituents

Changi has a strong branding in terms of passenger experience. It has been voted
by business travelers as the best airport in the world for 20 successive years. In
reality, however, it is not a viable model for an airport to just focus on passengers – it
has to cater to both airlines and passengers.
The selling pitch to airlines is Changi’s capacity to accommodate their growth, built
on a progressive air rights policy and a record of sustained process innovation.
Changi serves as a hub for a number of airlines apart from Singapore Airlines. The
Australian carrier Qantas, for example, uses Changi to hub its kangaroo routes from
Australia to Europe. Changi has in place stringent performance targets including
aircraft turnaround times and baggage delivery. The outsourcing non-core activities
is intended to provide airlines with a choice of competing service providers thereby
maintaining some form of pricing discipline for services such as ground handling and
MRO work.

The airport’s passenger branding is built on two pillars. The first is the connectivity of
the airport. The airport serves 4,200 weekly flights to 185 cities. Secondly, Changi
distinguishes itself from the other mega-airports by a combination of a strong retail
and recreational program with a generous infrastructure of passenger facilities and
amenities. There is retail activity round the clock. Thirdly there are a number of
Changi service hallmarks. Taxi and public transport transfers are located within an
in-door climate controlled environment. Loading passengers can expect first
baggage within 12 minutes from the docking of an aircraft and in 95% of the
situations, a passenger should be able to disembark from a plane and get on to a
taxi within 20 minutes.


Revenue Components
The airport derives 60% of its total annual revenue (over US$500 million) from nonaeronautical
sources, particularly commercial and retail activities. Until this year, the
strong revenue flows from commercial and retail enables the airport to largely retain
its passenger facility charges and landing fees at the levels of 1990. This year saw
an increase in these charges but on the whole the charges remain highly competitive
amongst airports in the region.

The airport manages to achieve a consistent EBITDA margin of between 45 and
50% of revenue. Annual revenue is in the region of S$1 billion (US$700 million). In
2006, the airport returned S$2 billion (US$1.4 billion) to the state coffers in addition
to the tax it pays. The strong cash flow also enables all the capital expenditure of
the airport including the development of Terminal 3 and the extensive upgrading
work of T1 and T2 to be financed entirely out of retained earnings.

DEVELOPMENT OF CHANGI AIRPORT
Site Selection

Prior to the development of Changi Airport, Singapore was served from an airport at
Paya Lebar. In February 1972, to cater for rising travel demand, the cabinet had
originally agreed to simply expand this airport by building a second runway there. It
would have meant a shorter construction period and lower land acquisition costs.
The problem is that an increased number of flights over the city and large tracts of
residential areas would have burdened Singapore with perpetual noise and emission
problems. In 1975, after a series of reviews, the cabinet changed its earlier decision
and decided to plumb for a new airport in Changi. It was budgeted then to cost
several times more than would have been spent on the Paya Lebar scheme and that
did not take into account the construction of new access roads to connect the new
airport to the city. Up to 1,300 Ha of land was set aside for the airport, 70% of which
had to be re-claimed from the sea.

Master Plan
The airport master plan as drawn up in 1977 envisaged the eventual airport to
consist of four main terminals and three runways. The first two runways were spaced
1.6 km apart and the first three terminal buildings and surface approach were set out
in a H-formation in the area girded between the two runways. Terminal 1 was
completed in 1981. Paya Lebar had a capacity then of around 12 mppa, and
Terminal 1 almost doubled that capacity to 22 mppa. With the completion of
Terminal 2 in 1990, the capacity doubled yet again to 46 mppa. Shortly following the
T2 completion, a massive program was undertaken to upgrade T1 and to raise its
operational capability to that of T2. The completion of T2 was a defining moment for
Changi, because it propelled Changi to the ranks of major airports in the world.
However, it also meant that both its development strategy and approach were widely
studied. Many of Changi’s elements found their way into the development
programmes of other major airports in Asia and the Middle East, each aspiring to be
larger and better than Changi.

Terminal 3
Plans to develop Terminal 3 were made in the late 1990s. By then it was evident
that the landscape of the industry has changed. Several competitors have emerged
in Changi’s space – Dubai and Kuala Lumpur posed the threats for the kangaroo
route while Bangkok has staged its claim to be an alternative hub for traffic between
Europe and Asia. The question is how does Changi differentiate to maintain its lead
in the face of these changes and how can the Terminal 3 development be used
towards this differentiation?
The first premise for the Terminal 3 development brief was to ensure that the airport
maintains its premium as an uncluttered, anxiety-free hub, maintaining a layout
known for its directional clarity even for the first time user. This is more ambitious
than it sounds. Spatially it calls for more floor area than conventional layouts. At the
same time, the layout has to generate a sufficient sense of buzz and interest to
support the retail program against a relatively over sized space.
The second premise was to accommodate the A380. Singapore Airlines became the
first airline to place a substantial order of 19 of these planes with Airbus and sought
the right to be the first airline to put the A380 into service. Changi Airport was to be
to be the first to develop the facilities for handling the A380. A total of 8 special gate
holds in Terminal 3 were customized for the A380. At the same time 11 other gate
holds in Terminals 1 and 2 were upgraded to service the A380s. The central feature
of the A380 gates is that they have to be sited in locations which allow more apron
space for the parking of these large planes. The customized passenger loading
bridges operate from enlarged gate hold rooms. Each PLB has three arms instead of
the conventional two arms – these enable passengers to get into the upper cabins of
the plane directly from the gate hold rooms. Upon arrival, the A380s load their
baggage on to 90 m carousels – 20 m longer than the conventional carousels. The
objective is to ensure that the times for embarkation and disembarkation of
passengers are no longer than those for the 747-400s.
The third was to position Terminal 3 as an environmentally sustainable building.
This was prompted not so much by a sense of political correctness as sheer
necessity. In order to avoid misunderstandings in bilateral relations with our
neighbours, Singapore sought to become self-sufficient in terms of water through
conservation, recycling and expansion of water catchments. Changi had to follow in
the train of this national effort. Singapore also relies on imported oil and natural gas
for all her energy needs. Building codes were already in place in the 1980s to stem
energy consumption but these were passive prescriptions. At the time when
Terminal 3 was planned, the shift had moved imperceptibly towards more dynamic
approaches of sustainability.
Finally, the airport must be able to have the reserve to meet all contingencies. By
the time the project commenced, there were already the fall outs of the September
11 attacks and the SARs pandemic. Both these events vindicated the need for
flexible layouts which allow internal spaces to be re-configured at short notice to deal
with new processing requirements for security and health inspection. In the midst of
all these, the airport has to be able to function with its characteristic reliability and
this functional capability had to be built into Terminal 3.

THE CONTRACT FOR TERMINAL 3
Project Particulars

The main contract was awarded in December 2002 at a contract sum of S$960
million (US$680 million). The building as designed has a gross floor area of 380,000
sq meters within the main building and another 170,000 sq metres of car parks,
making a total floor area of 550,000 sq metres. It added a further capacity of 22
mppa to the existing Terminals 1 and 2 and is serviced by 28 passenger loading
bridges of which 8 are provided with special facilities to service the A380.
The contract itself was placed on the basis of the Singapore Public Sector Standard
Conditions of Contract, a standard form of contract modeled at least in concept after
the New Engineering Contract. It was evident from the beginning that specialist
systems and packages would form a large part of the contract. These accounted for
$410 million or 45% of the contract sum. The largest component is the Baggage
Handling System which had to integrate the operations of all the three terminal
buildings. In addition, there were direct contracts for the People Mover System and
for work relating to the extension and upgrading of runways, taxiways and aprons.
The aggregate value of all these contracts came to S$1.65 billion (US$1.16 billion).
The contract period for the main contract was 33 months but a further 6 months was
scheduled for the completion of the baggage handling system. In essence there
were three important milestones: the completion of the main contract minus the
baggage handling system, the completion of the baggage handling system and the
completion of operational readiness and testing (ORAT) programme.

The Impact of SARS
Shortly after the award of the main contract, Asia was struck by the outbreak of
SARS (severe acute respiratory syndrome). Between November 2002 and June
2003, all the regional economies were hit, particularly China and Hong Kong, two of
the most important aviation markets in the region. Passenger traffic plummeted. The
fallout from the contagion continued to be felt months after the pandemic was finally
arrested. It was thereupon decided to defer the T3 project by 9 months initially and
subsequently by 24 months.

In late 2004, conditions finally permitted the construction programme to resume at
the regular momentum. The programme had to be re-configured extensively
because the schedules of materials, equipment and system supplies had to be
altered in the light of the number of new airports being developed throughout Asia.
Concurrently with T3, the 10 year renewal and upgrading program of T2 was also
proceeding. This was a substantial undertaking in its own right, costing around
S$280 million.

The deferment allowed the main contract works to be completed together with the
baggage handling system. Other than the deferment, everything else went largely
as planned. All the main contract works and systems were completed on 28
February 2007. This permitted almost 10 months for the ORAT programme. It also
allowed the airport to work with Airbus on the trial dockings of the A380 before its
delivery to Singapore Airlines in October 2007. Despite the events which threatened
to derail the project, T3 went into operation on 8 January 2008 and was officially
opened eight months later.

Some Observations
A striking aspect of the T3 project was that the whole procurement approach was
very conventional in character. The final accounts for all the contracts are expected
to come in at S$1.8 billion or US$1.26 billion. A large part of this was due to a
change in the design to allow for an increase the floor to ceiling heights of the
departure area. The thing going for the T3 contract was that it was placed at a time
when market conditions were relatively soft. Notwithstanding the pick-up in activity
at the time when construction resumed in 2004, the market conditions were still
favourable and most of the subcontractors and suppliers held on to their original
pricing commitments.

CHOW KOK FONG
1 July 2008