Week in Review
Duty free: when the tide goes out
Looking for the most seriously stuffed business model in a Covid-infected world? Airport duty free shopping must be right up there. But don’t waste too much sympathy, says business editor Nikki Mandow. She’s betting duty-free is so potentially lucrative it isn't going anywhere.
Duty free shopping basically should not exist. Not because it separates so many of us from our hard-earned dollars in impulse purchases for stuff a Consumer.co.nz survey suggests we can often buy cheaper outside the airport.
But because it’s a bizarre anomaly.
Duty free was dreamed up by a quick-thinking Irish former barman who worked at Shannon Airport in the late 1940s. He exploited a centuries-old British tax loophole that allowed sailors to take rum and whiskey onto their ships without paying duties.
He argued to the Irish government that if it was legal for sailors to take booze out of the country on boats without paying tax, why not passengers on planes? And if you could do it for alcohol, why not cigarettes, perfume, Toblerone?
The government agreed, against the odds (what regime agrees to get less tax?) and the first airport duty-free shop was born in Shannon in 1947. It was so successful other airports copied the idea.
By February 2020, duty free was a US$80 billion-a-year industry worldwide.
And then Covid struck.
Now it’s a nearly nothing industry.
Negligible international passengers means there is almost no one to buy duty free stuff. And that’s not going to change for a while, certainly not in New Zealand.
Because the duty free model only exists alongside overseas travel, and because most duty free stores are stuck inside virtually empty international airport terminals, there’s nothing duty-free store owners can do to change their fortunes.
“While our borders remain closed, so do our stores,” says a voicemail message at Aelia Duty Free.
Same with online purchases.
The Loop is the other duty free chain at Auckland International Airport. It reopened its smaller store at the international terminal at lockdown Level 1, and had a departures-only 'click and collect' service available when Auckland went back to Level 3.
Everything else, including the duty free area in the arrivals area has been closed since March.
"Some of the commentary points to a full international recovery in 2023, but we think it could take longer."
Reopening isn't likely until the Government approves safe air corridors, says Auckland International Airport head of retail Lucy Thomas. And who knows when that might be?
"There is a huge amount of uncertainty in terms of when and how the international recovery will unfold," Thomas says. "Some of the commentary points to a full international recovery in 2023, but we think it could take longer.
"At our 2020 full year financial results announcement two weeks ago we signalled that we were hopeful short-haul Tasman and Pacific Island travel will resume sometime in 2021, with a full recovery of both these markets occurring before long-haul international travel returns to normal."
So will duty free stores survive?
Przemek Lesniak, chief executive of Lagardère Travel Retail Pacific, which owns Aelia Duty Free, says they will.
“Our focus throughout this difficult period has been on supporting our impacted team members and this continues to be our priority as we slowly and cautiously reopen our network of New Zealand stores.
"We are committed to continuing our operations in the market for the long term and appreciate the support of our airport partners as we continue to rebuild stronger together."
Commentator Chris Wilkinson, managing director of Wellington-based retail strategists First Retail Group, reckons the industry can hold out.
“We are watching it closely. The companies say there have been tough times in the past. They have looked at it philosophically, and say ‘We will come through; we are here for the long haul.”
But how is it possible to survive no sales - possibly for a long time?
One reason is most duty free companies, including in New Zealand, are part of big international chains. Paris-based Lagardère Travel Retail had worldwide sales of around $10 billion in 2019, and 4800 stores in 39 countries. In New Zealand Aelia doesn't just run duty free stores (in Auckland, Christchurch, Dunedin (as DFC) and Queenstown).
When it won an eight-year concession at Christchurch Airport in 2018, it also announced it was opening a Relay convenience store; a TikiTour souvenir shop, a So Chocolate confectionery outlet, and a Natural Fibre store offering wool, leather and active leisure wear.
It’s got skin in the game.
Meanwhile Loop Duty Free is owned by Ireland’s Aer Rianta International, “one of the largest and most significant players in the global travel retail industry” and the same company that opened that first duty free shop in Shannon. ARI turnover is around $1 billion a year.
Pre-Covid, duty free was pretty lucrative, certainly in comparison with other, often struggling, bricks-and-mortar retail chains. According to the World Duty Free Council, the duty free sector has grown at more than 8 percent a year since 2000. This makes it the second-fastest-growing global sales channel after online.
Short term pain
Still, Covid-19 means the short-to-medium term financial outlook is dire. Lagardère Travel Retail worldwide revenue fell 54 percent in March year-on-year. Announcing the result, it said it was expecting a 90 percent drop in April.
At Gatwick Airport, which breaks out its different retail streams, duty and tax-free income slumped in the six months to June 30 to a third of what it had been in 2019.
And at Auckland International Airport, retail income for the first six months of the year was a quarter of what it had been the year before - $28 million, as against $115 million.
“This whole situation is a disaster for duty free,” says Greg Harford, chief executive of Retail NZ. “The numbers of people coming in are tiny and duty free is the last thing on their minds.
“There have been lots of job losses.”
The future for the duty free industry
It’s possible stores will close permanently in New Zealand, but much more likely they won’t, Wilkinson says.
Instead they will stay in “hibernation”, make behind-closed-doors agreements with the airport companies about rent and costs, and just wait until the international traffic returns.
That might not be the same for non-airport-based duty-free stores, which are as much at risk as any other retailer, Wilkinson says - possibly more, given the reliance on international travellers.
But what’s different for duty free shops at the airport is the symbiotic - even co-dependent - relationship between airport and store.
In the good times, both make good money. Shoppers are trapped in this other-worldly zone between passport control and flight gate. They have free time, they are potentially in a holiday spending mentality, there lots of glitzy outlets to choose from, and (despite evidence to the contrary) many have a feeling they are getting a bargain.
And while normal landlords don't get more (or less) money if their renters do well (or badly), that’s not how it works at airports, Wilkinson says.
There, stores pay an (often sizeable) annual rental to the airport for their space. But on top of that, they give the airport a percentage of sales, using a sliding scale depending on how profitable a particular item is.
The airport might get a bigger percentage on chocolate sales, for example, because the profit margin is high; less on tobacco, where it’s lower.
Exactly what that percentage is is a commercial secret but Newsroom understands it's not to be sneezed at. Perhaps 10-20 percent.
The Duty Free World Council says revenues from duty free & travel retail sales are “the number one source of non-aeronautical revenues earned by airports world-wide and on average account for over 40 percent of such revenue”.
Keith Spinks, Secretary General of the European Travel Retail Confederation, estimated in 2016 that around 40 percent of global airport revenues derive from non-aeronautical streams and duty-free and travel retail usually make up the biggest share.
And in New Zealand, Auckland International Airport's 2019 annual result, the last one pre-Covid, shows its retail income was $225 million. That's 30 percent of total airport revenue, Thomas says, although the company doesn't break out duty free sales.
Until the pandemic, the sector was booming.
"Retail income has grown at the airport over the last 10 years as we have expanded the retail proposition to meet customer demands. Duty free as a category within retail has similarly grown as the retailers have expanded their product range and depth."
And it's not just in-airport traffic. In 2018 Auckland Airport launched an online multi-retailer shopping channel called The Mall where travellers can browse and buy online and then pick up their purchases at the airport.
It also has a WeChat mini online store targeted at Chinese-speaking customers, and a digital rewards programme, Strata Club, that works through the Auckland Airport app and has 45 retailers involved, including duty free stores.
Actually, the whole pandemic lockdown sales disaster could have a silver lining in the future for the airport's e-commerce duty free sales, Thomas says.
"We are anticipating an acceleration of the online shopping trend, as people have become more familiar with browsing online and click and collect during the Covid-19 outbreak. We expect to see more people browsing and buying ahead of travel."
Of course, no one ever imagined a time when airports would be virtually empty and duty free sales pretty much zero. But because of the way the concessions are structured, duty free shop and airport are in this Covid-induced mess together.
"Retail rent income was well down in FY20 and rent abatements totalled just over $60 million, so we’re all sharing the pain." Auckland Airport
“It’s a very uncertain time,” Wilkinson says, but airports don’t have much choice. The likelihood of being able to replace an airport tenant which doesn't pay its rent is very small. Who is going to take on a lease in an empty international terminal?
“Airports don’t have many options” - other than drop or delay rent and other payments and allow the duty free stores to hibernate.
Auckland Airport is working with all its retailers, including duty free shops, "on a case-by-case basis to help where we can", Thomas says.
"Retail rent income was well down in the 2020 financial year and rent abatements totalled just over $60 million, so we’re all sharing the pain of the sudden downturn."
Moreover, at some stage, airport management companies are going to want a busy shopping environment back, so newly-freed travellers can go back to spending.
“It’s in everyone’s best interest to maintain vibrancy,” Wilkinson says. "Customers might return in a different way, stores might not need the same scale, but they will want a balanced offer for their audience.”
And these big international companies are the experts at getting travellers to part with maximum dollars.
Duty free is “cutting edge retail”, Wilkinson says. Stores use digital advertising and signage to change the message and which products being promoted, depending on which flights are due in at any particular time.
The duty free ads you see if you are on a flight to or from China might be different to the ones you see if you are going in or out of the US. Which products are most prominently on display can change too; even the languages spoken by staff manning the desks.
“There’s huge science behind it - understanding what their customer is looking for,” Wilkinson says. And the airports don’t want to lose that expertise.
“They are going to need to develop new models, but I don’t see airports wanting these airport stores to go out of business. They want to see them continue.”
"For New Zealanders, the experience of shopping duty free, whether it’s purchasing a new perfume or stocking up the liquor cabinet, is strongly associated with the excitement of travel. We don’t think that this will change."
More cooperation to boost customer spending
What might change, says Peter Mohn, CEO of Swiss-based travel research company m1nd-set, is the way airlines, airports and stores work together.
“While data-sharing has been a taboo among travel retail stakeholders until now, the coronavirus has forced all companies across the industry into a corner,” he told travel retail news website TR Business last week.
“The current pandemic may be the catalyst to a more collaborative approach and real partnership model where airlines and airports — and more importantly, their commercial partners — finally start working together to drive travel retail revenues, where all parties benefit.”
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