SAN JOSE CAPITAL OF SILICON VALLEY

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Meghan Curtis
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1 COUNCIL AGENDA: 09/13/16 ITEM: 6.1 CITY OF SAN JOSE CAPITAL OF SILICON VALLEY TO: HONORABLE MAYOR AND CITY COUNCIL Memorandum FROM: Kimberly J. Becker SUBJECT: CONFIRMATION OF AIR DATE: SERVICE SUPPORT PROGRAM Approved RECOMMENDATION I Date Review and reconfirm modifications previously made to the Norman Y. Mineta San Jose International Airport (SJC) Air Service Support Program by City Council action on December 15, 2015 (ResolutionNo ). OUTCOME Recognizing the opportunity to elevate Norman Y. Mineta San Jose International Airport and the City of San Jose's (City) global status, Council approved Resolution No at the December 2015 meeting to make modifications to the Airport's support program for new air service. By taking such action, the Council elected to take a proactive position. -Reconfirmation of that action would further acknowledge the essential need for the Air Service Support Program* EXECUTIVE SUMMARY As part of the December 15, 2015 proceedings, the Honorable Mayor requested another review of the Air Service Support Program following the initialflight launches-of new international carriers. Within the last eighteen months, SJC's air service initiatives, which include the airline support program, have yielded results; overall year-to-year-airline capacity growth for 2016 is currently in the range of 12-15%, five new international airlines have launched or announced service, and the Airport is in a position to add-as many as one million-total passengers in calendar year With marketing support from our program/hainan has carried over-90,000 passengers and is seeing 1-1% year-year growth since its June 2015~launch; British Airways has achieved a loadfactor of over 80% based on airport statistics, and Lufthansa's early results indicate approximately 20,000 passengers already carried with strongtj.s. point of sale results.

2 Page 2 Although domestic increases account for 77% of the total capacity growth, it is clear that the high-profile international routes have taken SJC and the City of San Jose to a new level of global recognition and connectivity. The Airport's program, consistent with FAA policy, is not a subsidy to any airline, and remains revenue positive during temporary fee waiver periods due to the ongoing collection of non-waived fees such as offices, baggage space, FIS international arrivals facility fees, and other exclusive use space rents. Other positive revenue generation sources related to the flight also include Passenger Facility Charges, Customer Facility Charges, and revenues from concessions, parking, and car rentals. The program waives future fees and does not reduce current revenues or place added costs on others. Given the net positive revenue impact of new airline services, no further changes to the program are recommended at this time. From a fiscal perspective, however, the existing program continues to stipulate that any award of marketing dollars remains subject to the City Council's overall allocation of budgeted funds. BACKGROUND Mineta San Jose International Airport is a strategic asset for achieving the City's economic development goals. Air service provides an essential link to support and sustain Silicon Valley's quality of life by moving people and products between San Jose and destinations, both domestically and globally. Gaining better access to national and international markets and technology centers has long been a priority of the region's businesses. Community and business leaders and travelers have clearly expressed their strong desire to the Airport for improved access between San Jose and key domestic and international cities. Recognizing the substantial airline investment and startup costs associated with new commercial air service, SJC initiated an incentive/support program in Like airports across the-nation, SJC has continued to make periodic modifications to. take into account the competitive landscape and changes in the aviation industry. The Airport's program to support new service is an effective-element of the overall development and recruitment_program, and the new routes receiving this assistance are consistent with City Council direction and Federal Aviation Administration (FAA) guidance. Over the past eighteen months, SJC and the City have seen a considerable amount of new airline services announced. Although new domestic routes and additional capacity have-been taking place, there has been significant public interest in the international sector. To date, SJC and the City's citizens have benefitted.from several recent additions: Hainan Airlines (HU) recently completed its first full year of operations on.the Beijing-route, and has carried approximately 90,000 total passengers. Overall volume has-been strong^ with the carrier planning to integrate a higher capacity version of the Boeing 787 Dreamliner aircraft on periodic operations to accommodate demand. Hainan competes with Air China and-united from SFO to Beijing.

3 Page 3 British Airways (BA) launched daily Boeing service to London on May 4, Based on operations data, the carrier has already carried approximately 40,000 passengers and overall loads are well balanced. BA also offers two daily SFO-LHR flights, in addition to two from United and two from Virgin Atlantic, all of which compete with the new S JC service. Air Canada (AC) began two daily CRJ-700 round trips to Vancouver on May 9, Reports from the airline's team indicated that SJC's re-entry into the Canadian market after an absence of 15 years has been on par with expectations. Air Canada, United, and WestJet operate to Vancouver from SFO. Lufthansa Airlines (LH) launched its Frankfurt service on July 1, 2016 using a 298 seat Airbus A aircraft, which represents the largest scheduled commercial aircraft in SJC's history. As of this report, results are very preliminary but approximately 20,000 passengers have already used the service. Lufthansa flies from SFO to Frankfurt and Munich, and United operates two daily SFO-Frankfurt flight services. Air China (CA) begins its nonstop flights to Shanghai on September 1, 2016 using an Airbus A aircraft. This new SJC flight will compete with China Eastern and United, both operating daily round trips from SFO. ANALYSIS The terms of the Air Service Support Program are outlined in the summary table below. Airlines whose service qualifies need to apply for the support program to be eligible to receive fee waivers and marketing funds. New Unserved Short-Haul Domestic 100% for 12 months n/a Up to $25,000 Any New or Added Long-Haul Domestic 100% for 18 months n/a Up to $5 LD00 Any New International within North America 100% for 18 months n/a Up to $50, % for first 18 months; Any New International outside North America 50% for next 12 months New Entrant Carrier As above. n/a Same duration as-100% Landing Fee Waiver Up to-$500,000 As above + Up to $100,000 Consistent-with extensive and periodically updated direction from the FAA, the SJC program has continued to offer fee waivers ONLY for initial periods of time and dedicated marketing funds to be exclusively used to promote new services that meet the program's qualifications.

4 Page 4 The key elements of the changes made in December 2015 were primarily directed toward longhaul international flights, with the concurrent Public Hearing specifically addressing multiple domestic and international applications from qualifying airlines. The significant changes were as follows: 1. Marketing support for new long-haul international service (outside of North America) was increased from $250,000 to a maximum of $500,000, in recognition of the magnitude of risk associated with large aircraft and long range missions; 2. Marketing support for a new entrant carrier was increased from $50,000 to a maximum of $100,000, acknowledging the costs of promoting a new brand and breaking into a new market; 3. Previous requirements for a qualifying airline to match SJC's marketing funds were removed, in recognition of the multi-million dollar investment the airline would already be making by dedicating the aircraft, flight and ground crews, and operational resources to SJC's route. Support programs, including SJC's, are extremely widespread in the aviation industry, with so many programs nationwide that they fall under strict FAA guidelines: A SJC would be at a competitive disadvantage without a robust program. Some communities also supplement their airport's program with aggressive financial packages funded by non-airport revenue, including ticket/revenue guarantees; A Competition for high-profile international services is global, as valuable aircraft assets can be deployed-throughout the world; A Competitien-also remains fierce in the domestic U.S. market, amplified by mergers and con-solidatiomof-the industry in recent years; A SJC's program is-designed to he-revenue positive even during defined/temporary periods of fee waivers (for example, Air China's Council-approved program was projected to produce $1.3 million of net impact to the Airport during the initial support period of service to Shanghai, with an annual economic impact of $65 million); A In alignment with FAA federal policy, SJC's Air Service Support Program is NOT a subsidy. The program is designed specifically to help an airline strengthen its marketing impact and (for new entrants) mitigate start-up costs during the critical initial period of launch of new service; A Ultimately, the program is designed to help an airline achieve multi-year sustainability in light of enormous investments. For example, from Hainan Airlines' official application to the US-Department of Transportation, Exhibit C-l showed a total annual operating cost of "the SJC-Beijing route to be $75.3Tnillion (more than $300,000 per round trip), which is in addition to the approximately $250 million cost of acquiring a single long-haul aircraft to fly the route. Even during the initial period of fee waivers andmarketing funding, the total financial impact of new services remains-positive. The qualifying airline is required to pay for offices and baggage/shared infrastructure facilities, passenger spending strengthens revenue flows for food,

5 Page 5 beverage, news/gifts, parking, car rentals, and other concessions, and SJC's contractual shares of those revenues flow back to the Airport. Passenger Facility Charges (PFCs) are collected, beginning with the first operational flight, and Customer Facility Charges (CFCs) are collected by the rental car companies from their customers from the new flights, with those funds also flowing to the Airport. The program waives future fees and does not reduce current revenues or place added costs on others. Finally, the Office of Economic Development (OED) calculates the overall economic impact of new service; for long-haul international routes, OED's estimates are consistently within range of the traditional national estimates of approximately $100 million per year. EVALUATION AND FOLLOW-UP Consistent with past practices, Airport staff will continue to monitor FAA directives and trends in the commercial airline industry to recommend future changes to the program as appropriate. Staff also commits to development of performance measures that track the effectiveness of marketing funds and increases in passengers, recognizing that direct correlations are dependent on available data. POLICY ALTERNATIVES Alternative #1: The City Council chooses to not reconfirm changes made to SJC's program in December Eros: None. Cons: The ability to compete with other airports and their respective cities and the chances" of financial success of any future qualifying routes may be placed in jeopardy. Simply put, airlines may choose to place their aircraft In other markets rather than expand in San Jose. Reason for not recommending: Cities around the United States and the globe are competing aggressively Tor the business, tourism, and economic impact resulting from expanded airline service. Within Federal Aviation Administration guidelines, the City Council implemented San Jose International's support program and has continued to modify that program to meet changing industry conditions. New service that Is sustained over a period of years has a significant impact on the Airport and the community, and revenues generated by airport fees and passenger spending at SJC outweigh the short-term fee waivers and marketing funds designed to help a qualifying service during its initial period of operations.

6 Page 6 Modifications made by the City Council in December 2015 were entirely consistent with the evolution of the program, remain within strict FAA guidelines, and allow SJC and the City to remain competitive for new service. PUBLIC OUTREACH This memorandum will be posted on both the Airport's website and on the City's Council Agenda website for the September 13, 2016 Council meeting. COORDINATION This memorandum was coordinated with the City Attorney's Office and the City Manager's Budget Office. COMMISSION RECOMMENDATION/INPUT This item does not have input from the Airport Commission. FISCAL/POLICY ALIGNMENT This project-aligns with the City's-Economic Development Strategy #9, "Keep Developing a Competitive,'World Class-Airport, andlattract New Air Service." This item contains no specific air carrier application for the-air Service Support Program, and therefore, no-impact has been estimated by the Office of Economic Development. CEO A Resolutions NOST and , File No. PP y's t KIMBERLY J. BECKER Director of Aviation For questions, please contact Kimberly Becker, Director of Aviation, at (408)

SAN JOSE CAPITAL OF SILICON VALLEY

CITY OF *% CcT SAN JOSE CAPITAL OF SILICON VALLEY TO: HONORABLE MAYOR AND CITY COUNCIL SUBJECT: SEE BELOW COUNCIL AGENDA: 04/19/16 ITEM: ^ Memorandum FROM: Kimberly J. Becker DATE: April 6, 2016 Approved