Falling prey to the winner’s curse Lotte Duty Free won its current five-year contract at Incheon International Airport’s main terminal building in February 2015 after an extraordinarily aggressive bid to secure its dominant position at the Korean gateway. It snapped up four of the eight contract packages available to bigger companies (SMEs bid separately). The contracts ran for five years from September 2015. Lotte outbid arch-rival Shilla by more than +60% across all eight packages (winning four), offering a staggering KRW6.425 trillion (US$5.8 billion) over five years (for all eight) compared with Shilla’s KRW3.914 trillion (US$3.5 billion). Lotte had to pay around US$3.6 billion for the four packages it won over the five-year annually. Shilla offered KRW1.325 trillion (US$1.19 billion) over five years or KRW260 billion (US$234 million) annually for its three packages. Lotte’s annual guaranteed concession fee for each of the five years was as follows: Year 1: KW500 billion Noting the extremely aggressive bid in February 2015, The Korea Times headlined an article, ‘Lotte may fall victim to winner’s curse’. Thanks to THAAD and, arguably, a bid that looked to many observers as overly aggressive whatever the conditions, that headline has proven prophetic. |
SOUTH KOREA. Lotte Duty Free announced today that it has filed an unfair trade practice complaint with the Fair Trade Commission over the company’s duty free concession at Incheon International Airport.
The dramatic move has major repercussions for Korean duty free and will also be watched closely by retailers and airports in other markets. The unprecedented complaint follows Lotte Duty Free’s repeatedly unsuccessful efforts to renegotiate its contract in the wake of a disastrous slump in Chinese tourism since the THAAD dispute with China began in March. The Fair Trade Action has been filed despite the Seoul and Beijing authorities agreeing last week to end their dispute over South Korea’s deployment of the US anti-missile system.
A Lotte Duty Free spokesman said: “We negotiated three times with Incheon International Airport Corporation but have failed to find a settlement point and therefore filed a complaint with the Fair Trade Commission about unfair trade. We hope to find a consensus on the negotiations.”
However, an Incheon International Airport Corporation spokesman told The Moodie Davitt Report: “IIAC thinks the withdrawal [contract termination] conditions do not violate the Fair Trade Act and Lotte also agreed [with the concession terms] when they made the contract. We are sorry to hear Lotte’s decision but IIAC should keep the contract [as is] without exception.”
In September, Lotte threatened to withdraw from Incheon because of the financial losses it was incurring under its onerous minimum annual guarantee-based (MAG) contract. The retailer’s pleas for rent relief were in vain with Incheon International Airport Corporation (IIAC) telling The Moodie Davitt Report that airport concessions fees were not solely to blame for Lotte’s woes. IIAC also highlighted the retailer’s heavy cost base and falling downtown sales as another factor.
Lotte Duty Free Co said today that the concession conditions unfairly disadvantage duty free shop retailers under the terms of the Monopoly Regulation and Fair Trade Act (‘Fair Trade Act’).
The retailer highlighted two key areas of alleged unfairness. Firstly, there is no room for rent renegotiation due to special conditions. Secondly, there are excessive termination penalties and conditions.
Lotte Duty Free said that due to the nature of the business, duty free retailers are inevitably affected by changes in international conditions and government policies [in this case the South Korean government’s decision to deploy THAAD -Ed]. However, IIAC has refused to renegotiate rental terms despite the extreme change in the operating environment and a corresponding slump in sales, Lotte said.
Lotte Duty Free’s complaint this week alleges that the contracting party (IIAC) should adjust concession rents and deposits in the case of changes to the business environment caused by extreme external factors.
Noting that the concession carries “excessive contract termination conditions and penalties”, Lotte Duty Free noted: “The contract termination condition is unilaterally disadvantageous to the duty free retailer.” Under the concession terms, a retailer cannot demand termination unless half of the five-year contract duration has passed. Additionally, even if that point in the contract has been reached, a mandatory four-month cancellation notice period is required.
Lotte Duty Free contrasted the Incheon International Airport contract with that of Korea Airport Corporation’s concessions at Seoul Gimpo Airport. At the latter, retailers can terminate the contract more freely with much less onerous penalties, Lotte said.
At Incheon, Lotte must pay a penalty equal to 25% of the MAG in the final year of the contract if it walks away. At Gimpo the penalty is 5% of the MAG applicable to the year the retailer terminates.
Bid too high in the first place?
But some sources believe that Lotte has become a victim of its own overly aggressive bid, one that the THAAD crisis accentuated to a disastrous degree.
One Korean industry veteran told The Moodie Davitt Report: “Almost everybody in the industry understood that the amount was too high for Lotte to sustain for five years, even difficult to cope with for two. Now, Lotte is paying more than 60% of sales revenue to IIAC as a concession fee and it will be much higher in the next term (from September 2018) and then even more in the next.”
Another, non-Korean, retailer said: “This is of course the challenge of airport retail. There is unfortunately no perfect formula. Pax modifiers can help or as in the case of HKIA [where during DFS’s term passenger numbers rose but spending fell] can be quite detrimental. Every sword has two edges as they say and there is no replacement for pragmatic negotiations recognising the current market conditions.”
Footnote: In 2009, IIAC offered a -10% reduction its its concession fees in order to assist retailers hit by the global financial crisis. However that initiative resulted in a charge of tax evasion (by deliberately reducing profit) from the National Tax Service and a heavy fine that is still being contested.
