The multiplier effect and positive externalities airports generate through employment and contributions to local economies are significant. Commerce, tourism, and an intricate supply chain of businesses thrive and depend on passenger and cargo traffic within the aviation ecosystem and beyond.

These benefits do not come without costs. Airports are capital-intensive irrespective of their ownership and financing model. The large capital outlay and the complexities involved in airport planning, approvals, and constructing new infrastructure mean that there is risk associated with the long-time horizon of these investments.

In other words, capital investments tend to be lumpy over the short-term whereas cash flows and an expected return on invested capital (ROIC) are only sufficiently realized over a longer period. Moreover, a critical mass of traffic is required before airport operators or other stakeholders can start recovering costs.

In the era of high government debt following the pandemic, where drawing on the public purse is not always feasible, there are questions as to the policy options to finance airport infrastructure and manage operations over the long-term.

Historically, the private sector—mainly through public-private partnerships (PPPs)—has been attracted to larger high-traffic airports. But can different forms of private sector participation be extended to smaller, low-traffic airports?

Economies of Scale, Scope, and Size

On a distributional basis, the majority of global airports are small, with low passenger and cargo traffic volumes. During pre-pandemic times, based on analyses from ACI World (in its ACI Airport Economics Report), more than 90% of all airports processed fewer than five million passengers annually.

Through the lens of profitability, as much as 68% of these gateways are estimated to be operating at a net loss. Interestingly, of that 68%, almost all (97%) have fewer than one million passengers.

Airports serving the smallest markets tend to have higher overall costs on a per-passenger basis because they do not have sufficient scale. Average total costs decline with an increase in market size because fixed costs such as depreciation, interest expenses, and other capital costs, are spread across traffic throughput.

The chart below shows average unit costs across various size categories of airports. Although what’s shown is not an actual cost curve, the significant decrease in unit costs beyond those airports with fewer than one million passengers is indicative of economies of scale.

At some point, airports achieve a level of minimum efficiency. There may even be diseconomies of scale in the traffic development continuum when airports need more CAPEX to meet current and future demand. The extra costs and potential excess capacity in the near-term result in what economists refer to as diseconomies of scale.

Policy Levers and Financing Mechanisms

If the majority of small airports are loss-making, why are they kept open for business? The answer hinges on their contribution to the local, social, and economic development of their surrounding communities.

There are several financing and funding tools that can be considered for smaller airports. Because of the positive externalities they generate, there is often government intervention through subsidies or grants to help cover shortfalls or deficits. In the case of major airport networks—perhaps a portfolio under a single operator in a given jurisdiction—profitable gateways tend to compensate for the net losses of smaller airports in the group.

While there are always exceptions, when it comes to overall financial performance, size does matter. The probability of making a loss increases with lower traffic volumes because the overall market becomes smaller as shown in the chart below. Again, if net profit margins are analyzed, and different forms and grants and subsidies are excluded, the smallest airports have either negative margins or very thin ones.

Governments continue to find alternatives to the financing conundrum. Recognizing the important role these smaller airports play in terms of socio-economic development and connectivity, the European Commission’s Aviation State Aid Guidelines have historically viewed airports with fewer than three million passengers per year as eligible for state aid.

However, these subsidies are deemed time-bound and temporary until 2027. Thereafter, smaller airports are expected to achieve financial viability by raising airport charges, developing traffic, and achieving cost efficiencies.

While some of these tools may slightly improve traffic and the bottom line, there is no denying the underlying economics. A recent report by ACI EUROPE in collaboration with Oxera revealed that airports with fewer than one million passengers have a high likelihood of operating at a loss irrespective of the measures they take. That is, the underlying economics linked to economies of scale remain the same.

Thus, there are strong arguments recognizing that state aid is still a critical safeguard in covering the financial shortfall beyond 2027.

Given that many small airports operate at a loss, can a case be made for private-sector participation? What possible factors are at play to incentivize such an investment? In Part 2 of this article, we will review these questions and dissect the possibilities with regard to small-scale airport public-private partnership (SSPPP) projects. It will be published on November 27.

[1. Patrick Lucas is the Principal and Founder of Airport Economics Consulting. He has held various posts at ACI World, rising to Vice President and Chief Economist. The author notes that this article draws from earlier work and contributions from the Airport Chapter of the World Association of PPP Units (WAPPP), in particular Jacques Follain, Curtis Grad (Modalis), and Rodolfo Echeverria. Special thanks also to ACI for its data, and to Andrew O’Brian (Centerline Airport Partners), Pierre-Hugues Schmidt (VINCI Airports), Jorge Roberts (AvPorts), Alexandre Leigh (IFC PPP Transaction Advisory), and Rogerio Prado (Pax Aeroportos) for their insights. 2. This article is modified from the original in Airport World, the magazine of Airports Council International.]