Privatisation and Business Management of European Airports - Case Study Example

Privatisation and Business Management of European Airports By: Your Name here Name of University March 18,2009 Abstract After a conversation on privatisation in the sector, this paper reviews working and financial performance of European commercial airports by evaluating these in mixed public-private and fully private ownership to those in public control. The results of partial factor productivity (PFP), financial ratio (FRA) and data development analysis (DEA) are overview for this purpose to further explore divergences and their attribute to the degree of privatisation. It also includes the reviews on performance changes and changes in ownership. Final perspective is privatisation of airports and its impact on both management and business. There are significant differences between private and public owned airports. Public group is not homogeneous and presents structural variations between fully and partially privatised companies. Mainly we can see that difference is in operational management, utilization of assets and capital. Privately managed or owned airports are more cost effective whereas publicly owned airports generally produce more revenue that makes these airports obviously stronger in financial presentation. “Liberalisation, deregulation and privatisation have been in the limelight of economic discussion for more than a quarter of a century. The aviation industry has been sharply impacted, including airports. In Europe, the final stage of air transport liberalisation came into effect on April 1st, 1997. But this freedom could be meaningless until slot allocation and air traffic control problems are resolved. Accommodating the projected traffic growth demands substantial additional investment, which in turn requires considerable private sector capital.” (Button) Methods of Privatizing Airports There are several techniques, approaches or methods of privatization that have not only been proposed but had been implemented. Some of them are discussed hereunder: Stocks Floatation: The public offering of different shares or stocks flotation as a secondary or initial offering is considered as the most common and popular technique of privatizing airports. This can be practiced either in the international or domestic capital market or through both of them. Stock floatation or public offering of shares could include the sale of partial or full shares from existing shares or through issuing of new shares. The overall reduction of large industrial unites and the control certain units could be the result of this technique. It is preferable technique for accomplishing wider ownership of share as well as for encouraging and promoting specifically the capital market while delivering precision in its process. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) Direct Placement: Direct placement is also called as private placement, trade sale and strategic sale or negotiated sale. Under this method, a government sells its entire or partial stake to carefully selected purchaser. Moreover this technique is utilized to meet the needs of company. For example it a company requires management expertise, broader market and advance technology then a purchaser may be selected on the basis of particular need. A strategic coalition is generally the outcome of this method. (Scott S, 2005) Management/Employee Buy-out: MBO is related with the acquisition or purchase of a controlling shareholding in a firm by relatively a small mangers’ group. In some cases, however, the acquisition is performed by a employees or by a combination of employees and managers. The latter technique is known as an MEBO or management and employee buy out. In this kind of transaction, there is a probability that a consortium including employees, managers and venture capital or investment banking is formed. The other variants of this technique are Leverage Management employee buy out or Leverage Management Buy out and Employee Stock Ownership Plan. (DeCastro, J., & Uhlenbruck, N. 2004) Outsourcing or Contracting out: Outsourcing or contracting out is a technique in which the operation of business is outsourced to other parties. This method has recently become too common in private firms as well as in the airports. The practice of this concept could be found in different services like waste management, auditing, street cleaning, cleaning and laundry in public hospitals, catering, refuse collection, security services and software maintenance and development. There is not ownership transfer of airports to private sector in this technique, although operational control or management of the activities under this particular agreement will be fully organized by the contractor. (Baumol, W. J, 1996) Sale of Assets: As an entity a large industrial unit often confronts considerable complexities that are not resolved instantly. As such under the monetary, tax or legal consideration, the government may sell the asset of the industrial units exclusively from the entire company. This technique can be used to discard unproductive assets that ultimately lead to the undesirable downsizing of the industrial unit. For instance port or Railway enterprises often possess unproductive assets like land that are difficult to dispose. Another distinctive approach adopted for the sale of assets is known as ‘liquidation’. This method can be used for selling entire assets of the industrial unit as it is not workable to sales its shares. The concept of liquidation is mostly based on the law of insolvency. (Baumol, W. J, 1996) Concession, Leasing and Management Contract: Concession, Leasing and management contract are similar to outsourcing in a way that they are involved with ownership transfer or assets disposal. Leasing has been viewed as a technique of financing and can be defined as ‘contractual agreement executed between a lessee and lessor that gives the right to lessee to use specific property that is owned by lessor for a particular period of time in return for predetermined and normally periodic payments of cash. (Baumol, W. J, 1996) Under the agreement of lease the lessee normally leases assets or different facilities between four and vie years and the lessor in turn received the lease payment as a form of compensation. There are different classifications of leases such financial or capital, arrangement of sale and leaseback and a variety of combination leases. The lessee under a capital lease has ample opportunity to purchase asset when the lease contract is terminated. On the other hand no such choice is available in operating lease. The government receives some payment in this arrangement throughout the period of lease. (DeCastro, J., & Uhlenbruck, N. 2004) The next method is management contract. This is a technique that is used for increasing the efficiency and other methods of the industrial project by hiring a management contractor. The contractor assumes overall responsibility in the control and management of the airports based on a particular contract. It has complete control of the company. (Acs, Z., & Audretsch. D. 2003) The reward received by the contractor is the compensation that is mostly based on the company’s profitability and different other measures that are stipulated in the contract. No ownership transfer occurs; hence all risks in business are the responsibility of the state or the original owner. The contract may increase additional monetary burden particularly for the compensation of contractor; although establishing of outsiders could enhance the performance of airports. (Baumol, W. J, 1996) The next technique is a concession that normally is an arrangement on long term bases ranging from twenty five to thirty years. Under this specific arrangement, a concession is provided to the private sector in organizing or managing assets or some part of business of industrial units within the prescribed period. There is not ownership transfer in this technique. (Mowery, D. C., & Oxley, J. E, 2003) Build Operate and Transfer: It is very popular technique use for supporting the private sector to participate in the activities of public service. For example in some countries the highways are built through this approach. This method requires the state to appoint private firm in building infrastructure and subsequently operating as a reward or compensation. At the expiry of contract the transfer of infrastructure is affected. (Scott S, 2005) Voucher Scheme: are normally part of mass privatization plan that have been employed in Eastern and Central Europe. These programs have also been implemented in the former Soviet Union. The bottom line of this particular program of mass privatization is to initiate the market forces into that economy and swiftly privatize the large industrial projects on a large scale level. In most of the cases the program of mass privatization is inclusive of voucher distribution for discounted or free prices to the people of the related countries. The voucher can be used to purchase shares of large industrial projects in an auction. (Jackson, P., & Price, C, 2003) Basically there are two main concepts in the privatization of large industrial projects. The first are techniques that include the ownership transfer to private sector from. Other concepts focus on the ultimate transfer of operational or management control for example outsourcing, concessions, leasing, contracting and management control. The technique of ‘Build operate and transfer’ can be viewed as an alternative of the management contract. Although ownership transfer and the overall control of airports, the above-mentioned exposition proposes that a variety of measures in privatization of airports could have taken place. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) Privatisation is considered as the change of ownership and shift of property from a public official control to private investors. In this framework, the traits of mixed ownership sculpt or restricted transfer of ownership rights signify an interesting mingle. Hybrid partnership in public and private sectors can provide an opportunity for superior benefits and qualities. “Moreover, governments often pursue large-scale privatisation programmes and their credibility as a seller matters in realizing the fair value of an asset. Especially when the subsequent performance and value of a firm is influenced via regulation, as it is the case regarding airports. Weak post-privatisation performance attributable to government opportunism may result in reduced interest in future projects.” (Advani, 1998;Backx et al, 2002; De Neufville & Odoni, 2003) The understanding in transferring airports from the public to the private sector increase in the United Kingdom, Australia and in a different places show that the complication of the procedure does not permit for a solitary loom of privatising airport operations in the effort to convene the prospects of all involved stakeholders. Some views on privatisation are also misleading regarding the management of airports. Mainly privatisation of big airports does not involve the physical sale of the property, whereas there are some exceptions like former British Airports Authority. Airport privatisation typically engross only the transfer of few ownership rights (Dempsey, 2000) Sample Airports The importance of privatization for governments can be viewed from the phenomenon that it has been applied in more than eighty countries all over the world and was anticipated to raise more than six hundred and fifty billion United States Dollars every year for the concerned governments by the end of decade 2000. The four selected airports are Aerports de Paris of France (ADP), Amsterdam Netherlands (AMS), Aer Rianta Group Ireland (ARI) and Berlin Group Germany (BER) While financial and economic viability was mostly viewed as one significant driver, privatization has also been promoted aggressively by global lending agencies such as the IMF, World Bank and ADB as a specific remedy for economic complexities in developing countries through a bulk of structural adjustment and liberalization programs that have been associated with the loans given by these agencies. (Covin, J. G., & Miles, M. P, 2002) It is not surprising that the element of privatization has been carefully selected as a ‘favored policy’ in most of the economies concurrently with general agreement for a monetary loan from the International Monetary Fund. Besides the increasing acceptance of the criticism, acceptance of program and opposition has generally been evolving in the countries that have specifically implemented the policy. (DeCastro, J., & Uhlenbruck, N. 2004) Privatization can be narrated in broad and narrow sense. Different definitions show that as an exclusive process the theme of privatization has many shapes. Privatization action mostly enhances the private sector role in the economy. In this sense such activities that constitute privatization include the scale of deregulation, public assets, opening government monopolies to somewhat greater competition along with contracting out, specific private provision of public services, combined capital projects that use private and public finance introducing and increasing user charges. From a narrow sense, privatization is simple action that transfers entire or partial ownership along with government controlled organizations to private sector. Another narrow form of definition of privatization is stated as the transfer of decision making authority and ownership from state or federal governments to private investors. The potential impact of broad and narrow types of privatization mostly provides a significant research question. Allocation of exclusive ownership rights is just another primary dimension in understanding of the theme of privatization. Ownership rights mostly refer to the core of authority for making particular strategic choices. These exclusive rights happen on a continuum that range from public to private. Owners have the authority to decide the strategic goals and develop strategy for competition along with allocating resources. Specifically this is the main case when ownership is held by private parties. (Shaker A. Zahra, S. Duane, R. Gutierrez, I, 2006) “Statistically significant differences have been measured for twelve key ratios such as inflation-adjusted total unit costs, operating unit costs adjusted for inflation, asset utilisation in terms of WLU/total assets, total asset turnover, total unit revenues, aeronautical unit revenues, the revenue/expenditure ratio, return on assets, operating (EBIT) margin, EBITDA margin, return on sales and cash flow in percent of total revenue. Operating and total unit costs, cash flow in percent of total revenue, operating and EBITDA margin, the revenue/expenditure ratio, return on assets and return on sales, all have significantly improved after partial or full privatisation. Structural changes appear to produce improvements in operating efficiency and profitability. The revenue-generating ability regarding total unit revenues as well as aeronautical unit revenues, however, appears to be reduced in contrast to the period before partial or full privatisation, which is in line with the findings of financial ratio analysis and the independent t-tests.” (Aviation Research Journal 1998) The model of European airports represents a cross-section, from Europe’s main London Heathrow to minor ones like Basel and Cardiff. It comprises private airports like Glasgow, partially privatised airports like Dusseldorf, and public set-ups like Copenhagen and Vienna. Publicly owned but independently working airports of Cologne and Geneva. These airports are similarly scattered over the Britain and continental Europe. Table 1 Total Sample of European Airports: Source: Airports Council International (ACI) Thirty one airports and four airport systems measured in this swot are a dissimilar group in provisions of traffic and make-up, management of operations, location and geography, regulatory governance and controlling attributes. There are two basic performance measures financial metrics and productivity. Financial metrics concentrate on profitability or rate of return. Productivity is the affiliation between inputs and outputs where the indispensable belief of contributing more outputs by using little inputs. “Based on the concepts of performance indicators and financial ratio analysis, comparisons are made by working out indices and ratios for the individual sample airports as well as the mean value of the sub groupings of publicly owned and privatised airports. This includes measures of aggregate and disaggregate cost and revenues, capital productivity, revenue generation and commercial performance, and ultimately profitability as summarised in Table 2.” (Coelli,1998). Table 2 Financial Ratios and Performance Indicators When we compare the top four Eurpean public owned airports Aerports de Paris of France (ADP), Amsterdam Netherlands (AMS), Aer Rianta Group Ireland (ARI) and Berlin Group Germany (BER) we find almost similar financial trends in their performance. We can see the huge capital involved in the management of airports with strong logistic support and human resource involvement. ADP and AMS have the most strong and visible share of cargo in European market. When we try to communicate the link between these two leading airports with smaller ARI and BER the load of cargo seems many times less for the lateral airports. Table 3 Results of Independent Means t-Tests As analysed in Table 3, the major performance indicators that are 20 to 28% and different financial ratios tested appreciably are significantly different for privatised against public sector airports. No major difference was found statistically in relation to the non aeronautical share of aggregate revenue, return on investment, return on business equity, cash flow contribution in percent of total revenue, investment coverage ratio, and capital expenditure on each terminal passenger and capital expenditures in relation to the revenue. “Partially and fully privatised airports show improved ratios in the majority of cases. Publicly owned companies, however, are significantly more economical or successful regarding capital productivity or asset utilisation (WLU/total assets), total asset turnover, fixed asset turnover, revenue generation in terms of total as well as aeronautical unit revenues, commercial revenue per terminal passenger, return on net assets before interest and taxes, total revenue per currency unit of shareholdersf funds and the capital expenditure to depreciation ratio. It needs to be emphasised that especially when ratios involving balance sheet items are being considered, the test reveals distinct differences, confirming a different capital structure and capital productivity of sample airports, and a different way of financing the productive assets. Partially privatised airports assume an outstanding position within the group of privatised entities in this respect. Differentiating between partially and fully privatised businesses clearly shows that privatised airports do not constitute a homogeneous group but reveals distinct differences amongst them. Most markedly regarding unit costs, revenue generation and total revenue per currency unit of shareholdersf funds, total asset turnover, debt ratio, gearing and financial leverage, return on capital employed, net assets in percent of total assets, return on net assets (before interest and taxes), return on assets and return on equity. Partially privatised and publicly owned airports appear to generate comparatively high unit revenues. This may be attributable to different regulatory regimes (quasi-monopolies) and possibly a different customer base (lower share of . at the time . upcoming no frills low-cost carriers).” Impact of Privatization on airports: The process of privatization of large industrial projects is related to the selected technique or method of privatization. The process of privatization through step-by-step is different in each method; however in general the process can be distinguished into three primary steps: stage of pre-privatization, implementation and the last stage of post-privatization. (Baumol, W. J, 1996) Stage of Pre-Privatization: The planning stage is vital for the overall success of privatization due to the comprehensive matters of privatization have to be established at this stage. Most of the elements are considered at this stage like level of future ownership by the previous owner or state, employment issues, cost of privatization, financing and resource mobilization. A government should ensure to establish the right management and organization and also to publish a complete plan of privatization which will possibly contribute to the overall success of privatization. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) Stage of Implementation: Unambiguous rules, transparency, pricing and valuation are amongst elements that must be taken into consideration for this phase. The transparency should be given ample opportunity in the first place aimed at the investors and it can ensure to prevent the abuse of associated power from the officials of state. Usually the benefits of privatization are taken by the inner circles of officials and policy makers. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) Collusion, nepotism and corruption are mostly inherent in privatization. As such the element of transparency is considered a prerequisite in the process of implementation to avoid such exercises and also to enhance the accountability notion. The unambiguous rules are essential to ensure fair processes like pre-qualification of buyers, pricing valuation and tender. The ultimate objective of this process is in assuring an orderly nature, to maximize the overall returns to government, to preserve a reasonable process for the public and to ensure that the buyer is qualified enough to operate the acquired unit productively. (DeCastro, J., & Uhlenbruck, N. 2004) Stage of Post-Privatization: Government should have a mechanism to ensure that objectives of privatization are achieved. For example an independent audit is a significant measure that is to be implemented. It is also to assure that a complete image of privatization can be achieved and all controversies are minimized. For the purpose of gaining optimum results the audit should cover all relevant monetary aspects and other relevant factors of the privatization. Besides an autonomous audit, different aspects should also be integrated and planned in the related documents. (Jackson, P., & Price, C, 2003) Conceptually the entire aspect of privatization should be placed accordingly prior to implementation of policy. The experience, however, had shown otherwise, for example in the prior days of privatization in Britain, it did not exhibit the formal policy of government but as a short commitment to denationalize some of the state owned enterprises. Catalysts and Channels in Privatization of Airports Although the rise in concept of neo-liberalism is often claimed as the basic channel and catalyst of privatization, low level of financial performance of airports, difficulties relating to finances faced by them, pressure exerted by agencies of international lending and political elements are generally recognized as the elements that have ultimately induced the policy. These elements are discussed hereunder: (Baumol, W. J, 1996) Poor Performance of Airports: Allegations of poor monetary performance have always been presented as strong premises in favor of privatization, although proof such kind of claims are mixed. Empirical evidence reveals that most of the private sector is efficient as compared with the public sector. There is no methodical evidence available that public units are less cost conscious than private firms, there exist world class, super quality state owned industrial project like Pohang Steel Company, The Ethiopian Telecommunications Authority, Singapore Telecom and the Guma Valley Water Company of Sierra Leone. (Jackson, P., & Price, C, 2003) As such the generalization that low level or poor performance is the main reason of privatization of industrial projects is not justifiable but rather a study based on case-to-case basis would be more suitable. In the United Kingdom most of the profitable companies have already been privatized and the rest of the world, specifically the developing countries, is following the pursuit. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) It is pertinent to mention that the reason of poor performance of the state owned enterprises as far as United Kingdom is concerned and as claimed by some researchers and experts was the government failure instead of public enterprises themselves. The government was not successful in establishing the unambiguous aims and objectives and the poor level of performance measurements. (Scott S, 2005) Large industrial projects have many objectives obligated on them such as maintenance of employment, adequacy of supply, support for the local development, and stable and low prices. As such they cannot concentrate on just achieving a fair financial performance. But the performance of large industrial projects is primarily measured on their monetary returns as the case is in private enterprises. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) As such the financial performance of the industrial projects is not termed mostly as better when compared with private firms. The state is also not successful in providing the required level of independence to the industrial projects in different aspects, for instance in the terms of strategic decision making. However besides these kinds of complexities the element of mismanagement of these industrial projects is also viewed as another significance cause of poor performance of these projects. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) These kinds of indication also led to search for information related to the question that ownership or other specific factors such as ambiguous goals, competition etc drove the overall performance of enterprises. Empirical evidence reveals that reforming organizations and promoting competition have been more significant than changing ownership. (Scott S, 2005) The Financial Difficulties faced by the State: The second basic premise that has induced privatization of large industrial projects is financial difficulties such as debt and budget deficit faced by the owners of the projects. This can be viewed from the experience of many nations including United Kingdom. Prior to the implementation of privatization policy in United Kingdom the budge deficit was on gigantic rise and in response it increased the overall level of need for a borrowing requirement by public sector. The borrowing by public sector rose to peak in the year 1975 for about 10.75% of Gross Domestic Product. (GDP) (Baumol, W. J, 1996) In confronting with such kind of complexities the privatization of large industrial projects is viewed economically and politically as most suitable choice. During a monetary crisis increase in tax is also considered economically improbable as both the state owned enterprises and private sector are said to be in trouble. As such when the rhetoric for enhancing performance of the industrial projects is in place, the prominent motives considered suitable for privatization are repaying debt and reducing the level of budget deficit in those countries that are facing crisis. (Hart, O, 2005) This exercise will result in transfer of ownership to the private sector and the sate could reduce subsidies and successful in eliminating capital participation of government in the industrial projects owned by it. This is termed as reasonable by most of the experts, even though evidence reveals that privatization can be a source of giving subsidies to rich at the cost of general public. (Hitt, M. A., Nixon, R. D., Hoskisson, R. E., & Kochhar, R, 2000) The International Pressure: The powerful players in the promotion of the concept of privatization particularly in developing countries are the international lending agencies such as the World Bank, The IMF and the ADB. It has been agreed by some researchers that the role played by the Word Bank and the IMF is essential for the purpose of sponsoring this policy all over the world. The government of United States has remained the prime player behind the agenda of the World Bank and the International Monetary Fund. Besides the US government the main architects of this policy are the experts of the private economy, primarily huge firms that control most of the international economy. Resultantly it is easy to imagine the beneficiary of such policy. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) The pressure exerted on developing countries has been combined together with conditions required for loan that generally come under structural adjustment and economic reform. Developing countries that need loan from the international lending agencies have no option but to accept and ultimately implement specific programs, although those have mostly been criticized as excessive and do not have focus as to the exact inherent complexities as such. The IMF and the World Bank not only assumes a prominent role to encourage the concept of privatization as a liberalism and neo-liberalism element but they also aggressively sponsor the ideology of interventionist. (Hitt, M. A., Ireland, R. D., & Hoskisson, R. E, 2006) The Political Factor: Another element that induces the concept of privatization is political situation. In mass privatization in Eastern and Central Europe and also in the former Soviet Union, the theme of privatization had been utilized to attract political support from the public. Even though most of the measures that have been adopted in the policy of mass privatization such as special arrangement made for management employee buy out and high discount prices etc, the technique of distribution of vouchers either at a minimum price or for free is considered as the most suitable choice for promoting a broader share of ownership and considered successful in attracting political support. In United Kingdom a political motive had been also recorded behind the fundamental policy practiced by the conservative government for privatizing most of its state owned enterprises. (Baumol, W. J, 1996) Summary The concept of privatization has been narrated in many ways and although it is not possible to avoid most of the interpretations, it can be observed from macro and micro perspectives. In a macro perspective the concept of privatization can be defined as a strategy to change the government role in the economy. (Hart, O, 2005) In the micro view the privatization is synonyms to transferring control and/or ownership to the private sector from airports. In the background of centrally planned economies, the idea of privatization is viewed as transformation or diversion of state-driven economy to market-driven economy. It is pertinent to mention that transformation is inclusive of ownership and control of considerable number of industrial projects to private sector. (Hitt, M. A., Nixon, R. D., Hoskisson, R. E., & Kochhar, R, 2000) Concept of privatization is established on the capitalistic ideology as it has been built on the principles of capitalism specifically private property. Under this specific principle the private control and ownership is claimed to surpass ownership of state for different reasons by the basic nature of debate could be narrated as ‘if private property is a pre-requisite of capitalism, no industrial project qualify as a particular capitalist institution and state capitalism is considered self contradictory phrase. A new momentum was gained by privatization following the failure of government in the decade of 1970s. Privatization in United Kingdom that commenced in the later second half of 1970s was regarded as the re-birth of this specific policy. Many other countries over the world followed the pursuit, either under stress and direction of international lending agencies or independently. (Galal, A., Jones, L., Tandon, P., & Vogelsang, I, 2002) The fundamental aim of privatization is to enhance and improve their efficiency. Other primary objectives of privatization have also been followed as those designed for enhancing a significant share of ownership, reducing the financial burden of state and achieve political advantage. The first are techniques that involve the transformation of ownership to private sector from state such as direct placement or public offering etc. (Jackson, P., & Price, C, 2003) The other concepts concentrate on transferring operational control or transfer of management, for example leasing, contracting and management contract. As such although the transfer of control and ownership of state owned enterprises are the prime issues of privatization, the above-mentioned exposition propose that there are different measure that could be adopted in privatization of state owned enterprises. Hitt, M. A., Ireland, R. D., & Hoskisson, R. E, 2006) In implementing this policy there are mainly three strategic phases; planning, implementation and the post-implementation phase. The poor performance of large industrial projects has also been considered as the prime catalyst of privatization, there are a different aspect that seems to drive the policy specifically the financial complexities confronted by the state, the political motives and the international pressures. By advancing awareness of the experience of privatization in some countries, the comprehension of the expression of privatization will be best accomplished. (Hart, O, 2005) References Advani, A., 1998. Market orientation . The case of airport privatization. PhD thesis. Oxford: University (Bodleian D203268). Airline Business, 2003. The airline industry guide 2003/04. Sutton: Reed Business Information. Airports Council International, ACI Europe, 2003. Airport charges in Europe. Brussels: ACI. Airports Council International, ACI Europe, 2004. The social and economic impact of airports in Europe. Brussels: ACI/York consulting. Airports Council International, ACI Europe, 2005. 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