The economics behind the awarding of terminals in seaports 233

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1 12 The economics behind the awarding of terminals in seaports: towards a research agenda* Christophe Theys, ** Theo E. Notteboom, Athanasios A. Pallis*** and Peter W De Langen 1 Introduction Port economic research has witnessed a strong surge in the last couple of years (see, for example, Cullinane and Talley, 2006). Seaports worldwide are confronted with scarcity of land and large, often global, infrastructure users. The awarding of terminals to these users is the prime task of landlord port authorities. Yet terminal concessions in seaports have only recently attracted academic attention (see, for example, Notteboom, 2007; Pallis et al., 2008). Issues such as the allocation mechanisms (to be) used for granting seaport concessions, the determination of the concession term and concession fees, and the inclusion of special clauses aimed at ensuring that the terminal operator will act in the interest of the port authority and the wider community (for example, throughput guarantees and environmental clauses), are interesting both academically and for the port industry. General economics literature on concessions and licences has a rich history (see, for example, seminal works ofdemsetz, 1968, and Williamson, 1976). Methodologies developed around auction theory have led to new applications, including the auction of spectrum licences for telecom operators (see, for example, Kwerel and Felker, 1985; Hazlett, 1998; Binmore and Klemperer, 2002). At the same time, the use of auctions in granting concessions has been challenged by the theory of negotiations. So far, insights from auction theory and other economic theories have rarely been applied to terminal concessions in seaports. Therefore, it remains to be seen which kind of awarding procedure would be best for which type of terminal concession to be granted. This chapter contributes towards that end by defining research challenges related to the application of economic theory to procedures to award terminal concessions. It does so by dividing and detailing the terminal awarding process in various phases and identifying issues and research 232

2 The economics behind the awarding of terminals in seaports 233 questions for each of these phases. Throughout the chapter, suggestions are made to apply mainstream economic theory to the ports industry, an application that remains an important challenge for the international port-related research community. This topic is increasingly important for port management strategies, as the operation of container terminals is today in private hands and market concentration is increasing; Drewry (2008) reported that private sector controlled terminals handled over 80 per cent of global throughput in 2007, up from 58 per cent in 1991, and global container operators will control over 58 per cent ofworjd container terminal capacity by The structure of the chapter is as follows. The next section gives an overview of the different steps in a typical terminal awarding process, after which relevant issues are discussed in detail in Sections 3-6. Section 7 concludes the chapter with suggestions for a future research agenda. 2 Process analysis of the awarding of seaport terminals A typical terminal awarding procedure consists of three phases: Pre-bidding phase: The awarding authority (typically a port authority or any other managing body of the port) makes the necessary preparations for the awarding taking into account prevailing regulatory conditions. The awarding authority has to decide on key issues related to the awarding procedure and make this information available to interested candidates. In this phase, the rules of the game are defined. Awarding phase: Candidates are screened, bids are evaluated and the most appropriate candidate is selected. The challenge for the awarding authority lies in making the right choice given the parameters set in the pre-bidding phase. Post-bidding phase: A legally binding contractual agreement is signed with the selected candidate and - in some cases - the company's performance is monitored during the contract term. If necessary, correcting measures are taken and disputes are settled. Figure 12.1 provides an overview of these three phases of the awarding procedure and indicates which issues typically arise in each of them. Issues to resolve during pre-bidding concern decisions on what to award and under which conditions the awarding will take place. These aspects will be dealt with in Section Pre-qualification is often (but not always) a first step in the awarding phase and consists of the selection of qualified companies out of the pool of interested candidates. It is based on a set of conditions developed by the awarding authority before the start of the

3 234 International handbook of maritime business Pre-bidding : I Pre-qualificationj Ql Selection ~I Auction based I ~I Negotiation based I j What to award? Figure 12.1 With How to monitor? t :... ;... : Schematic overview of awarding procedure and relevant issues awarding phase. Economic issues on pre-qualification will be discussed in detail in Section 4. Companies that have met these conditions are then allowed to enter one or more selection rounds in which the terminal concession is awarded. Awarding authorities can choose from a variety of different set-ups, but selection generally takes place on the basis of negotiations and/or auctionlike structures. Although the formal use of auctions is not common, many competitive selection procedures in seaports de facto use auctions because the terminal is assigned to the highest bidder - not necessarily in money terms but also with the highest 'score' on a number of criteria. Negotiations with the highest bidder after the (de facto or formal) auction are not rare and might even result in the reverse of the initial decision. 1 Issues concerning selection and, more particularly, the use of auctions and negotiations are treated extensively in Section 5. In academic literature on public-private partnerships (among which some are seaport terminals) and in practice distinctions are often made between various forms of contracts. TheW orld Bank's Private Participation in Infrastructure Database 2 categorises the different contracts primarily on the basis of the ownership, investment decisions and risk division. With management and lease contracts, the private partner operates governmentowned facilities for a pre-specified period. Management contracts thereby differ from leases in that in the former the public authority retains operational risk and pays the private partner a premium for its management services, while in the case of leases operational risk is transferred to the private entity which pays a (lease) fee to the public authority. In both cases, however, investment decisions remain the sole responsibility of the public partner. With concessions, on the other hand, private partners engage in substantial investments in existing or new facilities (referred to

4 The economics behind the awarding of terminals in seaports 235 by the World Bank as 'greenfield sites') and may transfer the facilities back to the government upon termination of the concession. Build-operatetransfer (BOT) projects are a well-known example of a greenfield project, but a vast range of public-private alternatives exist (see World Bank, 2007). The remainder of this chapter will focus on awarding procedures in the landlord port authority modep and refer to a terminal concession as 'a grant by a government or port authority to a (private) operator for providing specific port services, such as terminal operations' (Notteboom, 2007, p. 450). The discussion of the different phases of the terminal awarding procedure is associated with the rationale behind the use of concessions. Since the seminal work of Demsetz (1968), competition for the market - such as through the competitive process - has been proposed in cases where competition in the market fails. Hence, it is significant to analyse under which conditions competition for the terminal market is preferable to competition in the terminal market. 4 However, in the landlord model, port authorities use concessions regardless of the extent of competition in the market. For instance, in Rotterdam, concessions are granted for new container terminals, in a market (the Hamburg-Le Havre range) that is widely regarded as rather competitive. In this case, there is both competition for and competition in the market. In the remainder of the chapter the use of concessions is given and the focus is on the discussion of economic issues that might occur during their awarding procedures. 3 Issues during the pre-bidding phase Box 12.1 puts forward the main issues faced by awarding authorities when entering into a terminal awarding/concession trajectory, and will be discussed in detail in the next sections. First, once the decision has been taken to concession the operation of a (future) terminal, the awarding authority will have to describe the object of the concession. The port site that will be given in concession should be carefully delimited. Moreover, the technical and geological characteristics of the site and the physical, operative, commercial, judicial and labour aspects of the proposed concession have to be analysed and filed. Such information typically ends up in later documents related to the awarding procedure (public auctions/tender documents or requests for proposals in a competitive bidding process), in order to avoid information asymmetry in the awarding process. Given that the whole process might last for a considerable period of time, the stage of development of the terminal site to be awarded to a private operator also needs to be defined. The awarding authority might opt to award either (a) an undeveloped site where the operator will have to

5 236 International handbook of maritime business BOX 12.1 ISSUES RELATED TO THE PRE BIDDING PHASE What will be concessioned and under which conditions? Should the commodity to be handled be specified or should bidders have the freedom to identify what cargoes they wish to handle? What plots should be concessioned: one large plot or a number of smaller ones? What are key conditions of the concession and how to determine these? Duration, fees and fee structure? Performance targets, bonuses and penalties? Final asset compensation, right-to-end? What division of risk should there be between PA and TOC? What division of investment should there be between PA and TOC? What division of responsibility should there be (e.g., maintenance dredging)? develop infrastructure; (b) a greenfield site with infrastructure developed to site boundary; (c) an improved site with a quay line, paved yard but without buildings or handling equipment; (d) a site with all civil works completed, but where the operator supplies quay cranes and yard handling equipment; or (e) a fully developed site including quay cranes, but the operator supplies yard handling equipment. This decision is closely related to the financial and operational risk to be transferred to the winner of the concession and might influence the number of bidders. If the port authority does a poor job, candidates will have to verify the state of the premises and possibly perform surveys and/or field studies to prepare their bid. This incurs transaction costs and may reduce the number of bidders. In addition, any gaps left by the awarding authority during this stage provide the winner of the concession with opportunities for manoeuvring during the later stages and even after the finalisation of the process. Second, an awarding authority might want to decide on the main use of the terminal (multifunctional or dedicated) in the pre-bidding phase. Alternatively, the awarding authority might decide to just invite bids for a certain plot, rather than specifying how it should be used.

6 The economics behind the awarding of terminals in seaports 237 The port authority could decide to allow a wide range of commodities on the premises. The likely result is a multifunctional terminal which demands fewer dedicated investments from the terminal operator and allows for a flexible use. However, the multifunctional use of a facility might make the selection process more complex, as the port authority is likely to be confronted with candidates putting forward very different proposals in terms of the markets to be covered, the expected throughput volumes and required investments. If the awarding authority clearly defines the use of the terminal (for example, the plot to be used for container handling only), then the port authority will, later on in the process, have an easier task in evaluating the technical and economic proposals of the candidates on an equal footing. The level of facility dedication to one commodity or market segment is thus one of the key decisions to be taken by the awarding authority in the pre-bidding phase. 5 While the type of terminal use is a clear practical issue, with a lot depending on the specifics of the port/terminal, or even throughput orientation (for example, transhipment or not), the impact on the awarding process has never received attention in academic literature. Research has been done on multiversus single-user terminals. The question whether or not to allow single-user terminals forms an integral and crucial element in terminal leasing policy. Turner (2000) demonstrated that the position of terminal leasing policy as regards single-user terminals has a clear impact on system performance. Musso et al. (2001), Haralambides et al. (2002) and Cariou (2003) provide a more in-depth analysis of the concept, the pros and cons of dedicated/singleuser terminals, as well as issues of pricing. Market reality has made some world ports, which were previously reluctant to allow dedicated terminals, now embrace the concept in an effort to bind cargo to the port. 3.1 Splitting and phasing of the terminal site The size of a terminal site to be concessioned is a complex issue. In the prebidding phase, the port authority will have to make key decisions. Assume that a port authority has 200 ha of port land available for container terminal development. Is this site best concessioned as one terminal or should it be split into two or more sections, to be concessioned separately? In addition, the concession process can be phased. For example, the port authority could decide to award a first section of loo ha in year 1, 50 ha in year 3 and the remaining 50 ha in year 5. While the above strategic questions on splitting and phasing seem straightforward, the answers are not easy, given the far-reaching impact that these decisions may have on the competitive profile of the port concerned. Two key problems can be identified in this respect (Figure 12.2).

7 238 International handbook of maritime business Terminal sections One Two or more One point in time No phasing No splitting No phasing Splitting Tin 1ing of the con cessioning Spread over several moments/years Phasing Splitting Figure 12.2 Options related to the splitting and phasing of a terminal site The first problem relates to the way sections of a terminal plot are phased. A port authority could organise a separate competitive bidding procedure or auction process for each phase. Alternatively, a port authority might consider a second terminal phase as a mere extension of the initial terminal phase and decide to award the second phase to the incumbent terminal operator by direct appointment, thereby avoiding a competitive bidding process. Whether direct appointment is a viable option depends on (i) the relative dimensions of the phases and (ii) the level of inter-terminal competition in the port and between the port and neighbouring ports. If the second phase of the terminal represents a marginal extension of the first phase, then a competitive bidding process or auction for the second phase obviously does not make a lot of sense (at least when the incumbent terminal operator shows interest in also operating the second phase). In the case where the scale differences between the first terminal phase and subsequent terminal phases are small, then direct appointment to an existing operator is a less obvious choice. Port authorities who want to use direct appointment could opt for a gradual phasing of terminal extensions: the firm operating the first (larger) phase is given the chance to expand its facility berth by berth over time through direct appointment, so without having to face potential competitors through a competitive awarding process. Such a deliberate practice could emanate in collusive behaviour between the port authority and the incumbent terminal operator. The second problem connected to the phasing and splitting of a terminal plot relates to the dynamics in intra-port competition. Consider a port with a captive hinterland served by an existing container terminal of I 00

8 The economics behind the awarding of terminals in seaports 239 ha operated by an incumbent firm X. The port authority plans to concession an additional plot of 200 ha for container terminal development. If the port authority organises a competitive bidding procedure for the new plot and makes the incumbent firm eligible to compete for the terminal concession, then two outcomes are possible: The incumbent firm wins. The incumbent thus strengthens its monopoly position and can extract monopoly rents. Especially when an incumbent firm does not face regulatory problems it is most likely to win the bidding procedure, as it will bid the economic rent away in the bidding process. Eventually, the result is high revenues for the port authority, but high costs for port users. At the same time, the scale of the facilities is likely to generate economies of scale and scope, creating the potential for lowering the handling costs per unit for the operator. A new entrant is granted the concession, thereby introducing intraport competition. Given the scale differences between the existing and the new facility, the entrant in principle has a good starting position to outperform the incumbent firm. The port authority might also opt to split up the 200 ha plot into two separate sections: either the port authority then awards the two sections separately via a competitive process, or awards one section via a competitive process to allow new entrants (where the incumbent is excluded from the competitive bidding or auction) and assigns the other section to the incumbent firm (to allow growth). Consequently, port authorities have, in principle, some leverage in shaping the competitive process within the port. The example discussed here concerned a port with a captive hinterland. Things become much more complicated when the neighbouring ports are vying for the same cargo. The issues discussed above constitute the core of many legal disputes handled by competition authorities around the world. This inevitably raises further questions about the need/impact of intra-port competition and on the minimum efficient scale in terminal operations (see De Langen and Pallis, 2006). Hence, an evaluation of port authorities' practices in splitting and phasing of terminals demands more insight into the optimal/ minimum size of a terminal from an operational cost perspective and in the cost/benefit balance linked to allowing new entrants versus allowing incumbents to grow. As is illustrated in Figure 12.3 for a hypothetical container terminal, inappropriate splitting (for example, from 2Q to Q) could cause less efficient operations as a result of an increase in long-run average costs (ceteris paribus).

9 240 International handbook of maritime business ' ~--- -~--=--,.,-,._.., QL ~~----~ ~ Q MES 2Q TEU Annual throughout Figure 12.3 Illustrative minimum efficient scale for container terminals Port economic literature has addressed some of the above issues, to a limited extent and mostly in a qualitative manner. Defillipi (2004) focused on the benefits of turning mono-operator concession schemes into multioperator schemes via subsidies, with the ultimate target being lower prices paid by users, whereas Flor and Defillipi (2003) focus on the role of the regulator to enact an access mandate appropriate for reversing monopolistic situations (that is, by creating incentives to reach a Nash equilibrium) and the relevant basic principles to arrive at the optimal charge. However, quantitative approaches to the determination of the minimum efficient terminal scale and the shaping of intra- and inter-port competition remain largely unexplored territory. 3.2 The division of risks and investments between port authorities and terminal operating companies The infrastructure and superstructure investments linked to terminal development typically consist of: land reclamation works, capital dredging and maintenance dredgmg; quay-wall construction and maintenance; mooring equipment and fenders; investments in environmental mitigation and compensation (for

10 The economics behind the awarding of terminals in seaports 241 example, in the framework of the Bird and Habitat Directives of the European Commission); electric installations and wiring on the terminal; paving of the terminal; on-terminal rail facilities; roads on the terminal; warehouses and technical buildings; fencing and video surveillance (port security); investments in truck gates; office buildings; and terminal handling equipment (ship-to-shore cranes, yard equipment and so on.). The port authorities will have to decide on the division of risks and investments related to the object of the concession. The general principle is that risks should be allocated to the party that can best manage them. In the port industry, commercial risks can best be managed by private operators. Contrary to other infrastructure investments, such as roads, terminal operators do have a substantial influence on demand, as they generally compete with other terminal operators, either in the same port or in different ports. As private operators are generally well positioned to manage these risks, all investments in terminal equipment are best left to these private firms. For port infrastructure, this issue is more complex. In some cases, all risks are transferred to the private sector, and the awarding authority grants a concession to build and operate a terminal; the concessionaire has to make all the investments, and consequently bears all the risks. 6 This option is especially attractive when the terminal to be concessioned is not part of a larger port expansion project, but will need to be built standalone. However, when a port authority develops a larger port expansion project, with various sites to be concessioned, the port authority is better placed to bear these risks. 7 The awarding of a concession needs to address risk - as well as reward - factors in order to avoid unrealistic terms that may result in institutional entry barriers and a limited number of bids, or no bids at all. The type of risk and the hurdle rate of return needed for an operator to commit to a common user container terminal differ according to (a) the stage of development of terminal site leased (for example, undeveloped, greenfield, improved site, fully developed) and (b) the nature of the market (for example, established trade or not; type of trade; high or low entry barriers). The business case suggests that these situations (Table 12.1) determine whether, and under which conditions (that is, length of concession,

11 242 International handbook of maritime business Table 12.1 Potential conditions Risks involved for an operator: Key variables to be considered Stage of development of terminal site leased to private operator Undeveloped site to develop infrastructure Greenfield site with infrastructure developed to site boundary An improved site with a quay line, paved yard but without buildings or handling equipment A site with all civil works completed but supplies quay cranes and yard handling equipment A fully developed site including quay cranes but supplies yard handling equipment Variable Nature of the market No established regional trade; projections based on visionary cargo, or new free trade zone Established regional trade, substantial transhipment and lower barriers to entry Established hinterland general cargo trade but low container penetration factor Established regional and national container trade but open to competition from other terminal operators within the same or nearby port Established container trade, need for facilities and high entry barriers Sources: Based on Bayne (2006) and Drewry (2008). rates), private investments alone have the potential to be bankable or whether public funding is an essential means to generate the interest of potential bidders (Bayne, 2006). This issue, along with the discussed issue of minimum efficient scale for multi-operator schemes, is closely related to the public funding for infrastructure projects. Dooms and Verbeke (2006) demonstrated that major port development projects in European landlord ports benefit to some extent from public financing, especially in the realm of basic infrastructure provision, including land reclamation, maritime access improvement and the construction of quay walls. Such public financing may not be desirable from an economic point of view, but is common practice in most port expansion projects around the world. The relation between public financing and the division of investment and risks in the ports industry, and the

12 The economics behind the awarding of terminals in seaports 243 consequences of this relation for economic efficiency, are themes to be addressed in academic literature. 3.3 Duration, fees and fee structure The port authority will have to make decisions on the duration, fees and fee structure before starting the awarding process. In most cases the term of the concession is determined by the port authority or government agency. In many parts of the world, legislators have developed rough guidelines on concession durations in view of safeguarding free and fair competition in the port sector. There are hardly any rules of thumb on the concession duration, and attempts made by the European Commission to create relevant rules have not met with the agreement of all stakeholders (Pallis, 2007a). In general, the duration of the concession will vary with the amount of the initial investment required, the compliance with the development policy of the port and land lease and other easement rights. A port authority might opt for phased concession terms, with a base duration of, for example, 15 years and consecutive renewals (based on specific criteria) every five years. The port authority will also have to develop its views on a possible prolongation of the concession beyond the official term, before entering into the granting procedure. The duration of the agreement is of crucial importance both to terminal operators and port authorities. In general, long-term agreements allow private port operators to benefit from learning-by-doing processes and to achieve a reasonable return on investment (ROI). Port authorities try to find a balance between a reasonable payback period for the investments made by terminal operators on the one hand 8 and a maximum entry to potential newcomers on the other. As long-term agreements act as entry barriers (see De Langen and Pallis, 2007), intra-port competition will only take place among the existing local port operators. However, even when concession periods are long, new players can still enter the market, either through a merger with, or an acquisition of, a local operator or when a long-term concession or lease of a new terminal expansion is allocated to them (see Notteboom, 2002). While the importance of setting an optimal duration of a concession is well understood by academics and market players, it is highly remarkable that port-related academic literature does not offer any theories, guidelines and tools that can help in attaining an optimal concession term. The port authority will also have to decide on the fees and the fee structure it will use throughout the awarding procedure (see also Notteboom, 2007). The awarding body will likely opt for centring bidding or negotiations (at least partially) on concession fees- this will be discussed in detail in Section but also has the option to work with a fixed, non-negotiable

13 244 International handbook of maritime business fee structure. In setting the fees and fee structure, port authorities thus face a dilemma. On the one hand, port users demand a transparent, uniform and stable fee system. Such stability of the fee structure is important in view of the investment decisions of the terminal operator. On the other hand, port authorities are tempted to apply the market mechanism in setting the fees for the use of valuable port land. In the case where fees are determined by the market, differences in fees among terminals in the same port can be substantial. Cunl.:ession fees of two different container ierminals in the same port, even operated by the same terminal operator, may then have significantly different concession fees. Moreover, the fee level for a new concession will largely depend on the market situation at the moment of awarding and the number of potential interested parties. Granting authorities cannot really set a level playing field (in the sense of the same concession fees) as concessions can be, and are, sold. When the awarding authority grants a concession for a low price (in line with other concessions), the new owner may sell the terminal, and receive the rent of the low concession price. On the other hand, the mechanisms set by the awarding authority should avoid creating conditions for 'wildcat' operators, who might win at all costs and then renegotiate (see Section 6), or seek unforeseen post-award merging strategies. The discussion of the pros and cons related to concession fee levels and the mechanisms set by the port, or any other awarding authority, the fees and company strategies resulting from the competition between the bidding candidates (market mechanism) in order to win the concession, or any combination of these principles, all need to receive in-depth attention in port economic literature. 3.4 Performance targets, bonuses and penalties? Port authorities have to design strategies in the pre-bidding phase on how they will deal with performance targets. The most common indicator relates to cargo throughput. The port authority can indicate upfront a minimum throughput to be guaranteed by the concessionaire (especially in the case of existing berths/terminals). This should encourage the operator to market the port services to attract maritime trade and to optimise terminal and land usage. Where a terminal operator does not meet the objectives as set out in the concession agreement, it will either have to pay a penalty to the port authority (for example, a fixed amount per ton or twenty-foot equivalent unit (TEU) short) or, in the most extreme case, the concession will be retracted. In principle, throughput guarantees help to secure a reasonable level of land productivity, to reach high terminal utilisation rates and lower the entry barriers to newcomers (at least if the port authority follows a policy of retracting or reallocating certain parts of

14 The economics behind the awarding of terminals in seaports 245 the terminal due to underutilisation). A port authority might also consider rewarding terminal operators who are doing much more than expected. 3.5 Final asset compensation, right to end? Port authorities can follow different paths when it comes to dealing with the terminal superstructure at the end of the contract term. Although the decision on what to do with the superstructure is often made at the end of the concession term, it is useful for port authorities to develop views on this issue even as early as in the pre-bidding phase. Common approaches include the removavdestruction of the superstructure by the terminal operator at the end of the contract term or the transfer of the assets to the managing body of the port without any form of compensation. A port authority might opt for financial compensation of the terminal operator for the superstructure that was transferred at the end of the contract term. The design of this parameter of the awarding process has been neglected by research, even though it is vital for avoiding the deterioration of the investment climate, and consequently the competitiveness of the terminal, in the later years of the concessions. 4 Issues in the pre-qualification phase A port authority can decide to have a pre-qualification phase before entering the stage of competitive bidding or auctioning. The pre-qualification phase is aimed at reducing the number of potential candidates by developing criteria concerning company size, experience and financial strength. Box 12.2 puts forward the main issues faced by awarding authorities when designing a pre-qualification stage. 4.1 Excluding incumbent terminal operators from the awarding process An incumbent generally will have an edge over new entrants in additional bidding procedures. In the absence of competitors in a port, an incumbent firm that does not face tight price regulation, or any other barriers (regulatory or not), is likely to win a bidding procedure for an additional terminal. In that case it would generate some sort of market power that enables it to extract 'economic rents' vis-a-vis geographically, point-to-point, and asset-captured users facing limited other options. 9 This rent can be- at least partly - passed on to the port authority in a bid for the additional site to operate. A potential entrant cannot bid away any equal economic rent, as if it wins the concession it will be faced with a competitor in the same port. With the incumbent enjoying the benefits of past investments, business experience (that is, coordination with other actors involved in the port cluster) and marketing activities, any thoughts on the part of a newcomer for pricing well above marginal cost (plus some level of fixed

15 246 International handbook of maritime business BOX 12.2 ISSUES RELATED TO PRE QUALIFICATION Who qualifies as a concessionaire? Should the incumbent be allowed to bid? Should only terminal operators be allowed, or also other transport companies, such as shipping lines, logistics service providers (LSPs) and other transportation companies? Should potential bidders have a minimum company size? Should potential bidders have a minimum experience in the port industry, and if so: Local, regional or global? For the same cargo type? How are thresholds for pre-qualification set? Thresholds set via a benchmarking approach? Quantitative or qualitative thresholds? Requirements met at level of business unit or company as a whole? costs) will be highly unlikely. Thus, allowing the incumbent to participate in the bid will increase in the short term the expected revenue for the port authority but might also lead in the long term to higher costs for port users and a corresponding loss in allocative efficiency. The above reasoning is particularly valid in a case where there are no capacity constraints. In such a case, where the incumbent faces a newcomer and capacity on the existing facilities is highly utilised, the incumbent terminal operator will not have sufficient capacity in place to effectively compete for the newcomer's customers. Under these circumstances, the newcomer might be tempted to price higher than its marginal costs without fearing a significant loss of customers. The capacity situation in the relevant competitive port terminal range is thus an important element to consider. The welfare implications are not crystal clear as economies of scale, knowledge advantage, competitive vertical and/or horizontal integration and reduced transaction costs of organising the specific economic activity might give the incumbent firm competitive features that match the desires of a great number of stakeholders. Besides, the incumbent might be well positioned vis-a-vis powerful users (whether these are shipping alliances,

16 The economics behind the awarding of terminals in seaports 247 Table 12.2 Dimensions in the experience in terminal operations In same port Regional Global All terminal types Local/no specialisation Regional! no specialisation Global/no specialisation Specific types Local/specialisation Regional/specialisation Global/specialisation or multimodal transport operators or LSPs) generating traffic and additional economic activities beyond any minimum expectations or legal requirements. Apparently, port authorities can partially design the market structure. As port authorities may have other goals than maximising revenue and because creating intra-port competition may be beneficial for other revenue streams of port authorities (for example, leases to warehouse companies), port authorities may decide that incumbent operators are not allowed to hold more than one concession in the same port. Whether they can do so depends on the legal framework in place: the exclusion of potential candidates might be considered as anti-competitive by competition authorities. 10 There are also cases where regulation gives an advantage to localfdomestic players vis-a-vis foreign candidates (see Section 5.8). 4.2 Measuring experience and financial strength The experience of the candidate can be demonstrated by the management of facilities for similar cargo in the same or other ports. Candidates thus have to credit their experience in the activities related to the project by giving proof of specific antecedents in the exploitation of terminals. As illustrated in Table 12.2, defining relevant experience can take different forms depending on the geographical scope followed by the port authority (experience in the local port up to experience worldwide) and the terminal types considered (ranging from all types of terminals to a very specific terminal type, for example, a container terminal). Often these requirements are associated with a particular minimum handled throughput in these terminals, occasionally used as a means of minimising the number of bidders, due to a Gustified?) preference for global operators. 11 It might also be combined with the technical solvency of the bidder in the basic port handling services, 12 or the ability for 'filling capability gaps in logistics, broadening the geographical markets served and expanding terminal networks'. 13 Creative port authorities can design the required experience in such a way that certain terminal operators are well positioned to enter the selection phase. The bidding procedure typically contains thresholds on the financial

17 248 International handbook of maritime business strength of the bidders. For example, it can be stipulated that a certain percentage of the net worth of the bidder should at least equal the estimated project cost. Apart from the financial track record, financial solvency might also be associated with the capacity of the operator to maintain a specific level of reserves that match a considerable percentage of the total assets and/or fixed assets throughout the lifetime of the concession. 14 The reasoning and implications of the rules used to measure financial strength require some scrutiny. For example, the port authority will have to clearly define whether the combined net worth should relate to the terminal operating company or the mother company of which it is part. Enforcing a financial threshold becomes difficult in a situation where combinations of market players are formed (that is, consortia and/or partnerships between shipping lines and terminal operators). 5 Issues in the selection phase Box 12.3 presents the main issues related to the selection component of the awarding phase and concerns questions on how the concessionaire is selected. The following sections provide an in-depth analysis of these selection questions. 5.1 Choosing the right awarding procedure Figure 12.1 made clear that port authorities have ample choices in types of awarding procedures. Fundamental is the difference between the award of seaport terminal concessions using a direct appointing approach or via competitive procedures. In Europe, competitive awarding procedures constitute the large majority of terminal awarding processes. This category contains competitive bidding as well as the more restricted tender variant. Pallis et al. (2008) explain the difference by stating that in competitive bidding a preferred candidate is selected with whom negotiations are then conducted, while in the case of a tender all relevant contractual details are specified in advance after which the winner is selected on the basis of a certain (set of) objective(s), without further negotiations. Direct appointing approaches differ from the competitive bidding procedures in that they do not call for a variety of proposals, but immediately negotiate with one or a very limited number of operators. As is stated by Kerf (Kerf and World Bank, 1998), however, negotiations might also have a competitive character. Port authorities could design a competitive negotiation process by, for instance, inviting proposals from a large number of players, in order to stimulate competition. Next, one could create a pool of qualified players and start private negotiations with those candidates. The main difference between a direct appointing approach and competitive negotiations- and by extension all forms of competitive awarding

18 The economics behind the awarding of terminals in seaports 249 BOX 12.3 ISSUES RELATED TO SELECTION How is the concessionaire selected? Which type of awarding procedure? Competitive or direct? Pre-qualification or not? Which objectives and measures? Maximum revenue, throughput, added value, employment...? Minimum handling rate, concession duration...? Use of auction-based component? Which auction type? Which valuation type? Issue with collusion? Use of reserve price? Overbidding and use of bid bonds? Use of negotiation-based component? How many candidates allowed during negotiations? Negotiations on individual or collective base? How to deal with entry barriers? Favour small companies? Favour incumbents? procedures - is the intention of adopters of competitive processes to increase competition for the market, while this evidently is not the primary aim in direct appointment. Direct appointment could nevertheless be cost efficient for small-scale projects or extensions of existing concessions, but could also enhance competition in the market if explicitly chosen for strategic reasons of introducing (more) intra-port competition. On top of that, many European port authorities believe that they should be given the possibility to directly appoint terminal operators should they have strategic reasons to do so. The arguments in favour of or against either direct appointments or competitive awarding procedures need further underpinning by the application of economic theory specifically tailored to the characteristics of the seaport industry. Table 12.3 provides a detailed classification scheme for the various types of terminal awarding procedures that might unfold following the initial decision, along with their potential pitfalls. In the rest of the chapter, the analysis of issues related to the selection and post-bidding phases, along

19 Table 12.3 Direct and competitive types of terminal awarding procedures ~ V, a Direct A Competitive B c D Prebidding. ~. ~. Awarding procedure Post- Potential pitfalls bidding Pre- Selection qualification -Auction Negotiation based based.. ~.. ~... ~. ~. ~. Threat of substantial market power Likely to be subjective Potential problems with acceptance of decision by stakeholders 'Scoring' auction necessary (potentially subjective) Not all aspects easily quantifiable No 'personalisation' possible Threat of overbidding and collusion No 'personalisation' possible Threat of overbidding and collusion If many interested TOCs: time-consuming due to many negotiations If few interested TOCs: undermined market power for PA Potentially inefficient due to negotiation with inappropriate candidates Potentially subjective

20 E ~. ~. ~. If many interested TOCs: time-consuming (but better than D) If few interested TOCs: undermined market power for PA (more than D) Potentially subjective 1\.) F ~. ~. ~. 'Scoring' auction necessary (potentially V,... subjective) to reduce inefficiency risk of negotiation with inappropriate candidates Threat of compensating overbidding during auction with hard negotiations G ~. ~. ~. ~. Complex procedure Threat of compensating overbidding during auction with hard negotiations

21 252 International handbook of maritime business the lines of Box 12.3, will help to identify those procedures and pitfalls that have not already been addressed. It should be clear by now, however (for example, see the discussion in Section 2), that not all of the building blocks have to necessarily occur in a specific terminal awarding procedure. Pre-qualification phases might be included or omitted - a decision which impacts on the design of the selection phase - while selection can take place on the basis of auction-like structures, negotiation-based structures or a combination. Some procedures might contain an explicit pre-qualification component, while screening of the candidates' suitability in other procedures could implicitly take place during, for instance, negotiations or even in the pre-bidding phase. Similarly, at a later stage some awarding procedures will rely on auction techniques for the selection of the most appropriate candidate, while others will be entirely based on negotiations and yet others consist of an auction followed by a round of negotiations. 5.2 Objectives matter Irrespective of the type of selection procedure used and its different components, the aim remains to maximise a set of objectives that have been specified in advance. This means that the 'best' company - the one that should be awarded the terminal should a competitive procedure be in place- has to be the candidate performing best across the set of objectives. Objectives differ from the earlier discussed pre-qualification factors (see Box 12.2), in that the latter are minimum requirements that a market player has to fulfil in order to be eligible to bid as a concessionaire, while the objectives span a range of factors, on the basis of which the terminal will be awarded to the best company out of the pool of eligible candidates. Various potential objectives exist and the most appropriate terminal operator can be chosen on the basis of the optimisation of one or more of them. The choice of objectives is important and closely related to the strategies deployed by port authorities (see Brooks and Cullinane, 2007). Goss (1990) described quite extensively the price-bidding systems that can be used in the case of concession and lease agreements. The alternatives available range from (a) a given rent but minimal charges, to (b) a maximum rent and freedom for private operators to set their own charges. Given a set level of investment and quality requirements, the winner is either (i) the highest payer for the right to provide terminal services, or (ii) the bidder who is offering the lowest price to be paid by the terminal users. In the first option, the port authority or government agency aims at maximising the revenue. The payments are typically made as an annual payment. The second option focuses on the interest of the port users and ensures price minimisation rather than revenue maximisation. The concession fee under the first option is seldom renegotiated while the fee under the

22 The economics behind the awarding of terminals in seaports 253 second option could lead to pressure for renegotiation. The port authority can decide to go for a two-part payment system, combining a fixed concession fee and a variable royalty fee per ton or TEU. A system of royalty payments related to a minimum guaranteed throughput may be sensitive to renegotiation, as port authorities may be tempted to redefine the terms of the concession after a few years in order to gain more revenue. Occasionally, operators might also be awarded concessions on the basis of the maximum percentage of their revenue they are willing to transfer to the port authority. Juan et al. (2004) discuss a procedure for the Port of Valencia which, apart from the regular concession fees, also involves a one-off lump-sum goodwill payment in percentage terms of the expected net profit of one year. As far as the minimisation of tariffs is concerned, Engel et al. (2004) describe a procedure that was adopted in the Chilean ports of Valparaiso and San Antonio. A recent study by Notteboom (2008) for the European Sea Ports Organisation revealed that, also in Europe, terminals have been awarded on the basis of minimum cargo handling fees. However, the maximisation of concession fees is still the most common form of price bid in European awarding procedures. Naturally, one might wonder which is best: awarding on the basis of concession fees or user tariffs. The OECD (2007) proposed its preference for the former, if combined with an auction-like structure. The argument is based on experience regarding the inability of bidding on tariffs to adapt to a changing environment and the corresponding renegotiation threat. Still, a more in-depth analysis of which objectives are more suitable, under what circumstances and which awarding procedures remains a promising research avenue for the academic community. Equally interesting would be the design and use of other objectives. Here one might think of the minimisation of concession durations, the maximisation of value added, throughput or employment, and the combination of several objectives into one measure, for instance through the maximisation of the net present value of concession payments (that is, the sum of discounted products of expected throughput and a per unit (TEU) concession fee, given a certain. predefined concession duration). 5.3 The use of auctions Auction-like structures are often key constituents in the selection phase of an awarding procedure. They formalise the idea that the company performing best on the set of objectives is awarded the terminal. While the use of auctions is common in some sectors, for instance the agricultural sector, their application - not necessarily under the name 'auction' -in other economic branches is often less known. Vega-Redondo (2003 : 254), however, states in this respect: