Sky-high rents cost duty free dear

14 December, 2017

One of the biggest bugbears for any liquor brand wanting to build a presence in duty free is the high cost of entry.

The revered shop-window effect of travel retail is all well and good, but the challenge of living with very low profit margins is daunting for smaller to medium-sized suppliers. It also puts off others from ever considering the channel as a potential place to do business.

The root cause of this lack of profitability is the oft-reviled airport retail concession model. Competing operators bid for fixed-term contracts in an auction-style tender process and offer the airport authority a minimum annual guarantee (MAG). With airport authorities keen to generate as much retail revenue as possible to keep landing fees low, the highest MAG invariably wins the day.

Now, the level of MAG paid to the airport can be eye-watering in the case of major international hubs and often rises over the course of the contract. Suppliers are routinely squeezed so retailers can maximise their profits. Throw in added costs for suppliers such as staging and funding promotions and there is often precious little profit left, especially when it comes to standard-priced spirits.

The MAG-based system comes under further pressure if, for whatever reason, passenger numbers or spending levels fall below the levels predicted by the retailer during the bidding process.

This nightmare scenario is exactly what has happened at Seoul Incheon recently – an important airport for blended premium and super-premium scotch and cognac. Sales of brands such as Ballantine’s, Johnnie Walker and Hennessy are some of the highest anywhere in Asian duty free.

In happier times, Incheon used to vie with Dubai airport for the title of the single biggest duty free location in the world. However, a year-long diplomatic row between China and South Korea over the latter’s planned deployment of a US anti-missile defence system has led to a disastrous drop in the number of high-spending Chinese travellers visiting the country.

According to the Korea Tourism Organisation, Chinese tourists used to account for about a half of all visitors to South Korea, but over the first seven months of 2017 numbers halved. Consequently, Lotte Duty Free, one of Incheon’s biggest retailers, has repeatedly tried to renegotiate its original contract with airport authority IIAC, but to no avail. Facing a hefty penalty if it withdraws early from the contract, Lotte has now complained to the country’s Fair Trade Commission over the situation.

Lotte shares the liquor and tobacco concession at Incheon with rival Korean operator Shilla Duty Free and earlier this year won a tender to run a further eight liquor and tobacco stores in the airport’s new Terminal 2.

It is set to open in January in time for the 2018 Pyeongchang Olympic Games. A question mark must now hang over Lotte’s long-term commitment to Incheon, however. It is to be hoped a decision in late October by China and South Korea to move beyond the THAAD decision and restore closer ties will lead to a return of Chinese travellers to the country and ultimately resolve the dispute between Lotte and IIAC.

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