World's No.1 Footfall vs Struggling Rent... Duty-Free Shops Face a Critical Gamble

Incheon Airport, Trillion-Won Sales as a Variable for Duty-Free Industry
Economies of Scale and Brand Strengthening vs. Winner's Curse upon Entry
Cost Reduction and Investment Expansion vs. Losing Industry No.1 without Entry

Incheon International Airport Corporation has announced the first round of multiple operators for duty-free business rights, effectively finalizing the 10-year duty-free operator at Incheon Airport. Having suffered significant damage due to the unprecedented COVID-19 pandemic, the duty-free industry is now facing a demand for major changes in the business itself following the endemic (periodic outbreak of infectious diseases). The selection of operators at Incheon Airport this time is attracting attention as a potential turning point that could reshape the industry landscape.

According to Incheon International Airport Corporation, multiple candidates have been selected for the business rights available to large corporations: Shilla and Shinsegae Duty Free for DF1-2, which sell perfumes, cosmetics, liquor, and tobacco; Shilla and Shinsegae Duty Free for DF3-4, which handle fashion, accessories, and boutiques; and Shilla, Shinsegae, and Hyundai Department Store Duty Free for DF5, which deals exclusively with boutiques. The photo shows the duty-free shops located in the boarding terminal of Incheon International Airport on the 20th. Photo by Kang Jin-hyung aymsdream@

First Round Finalized...Shilla and Shinsegae Expected to Win Two Each, Hyundai One

According to the duty-free industry on the 21st, following the completion of the selection of multiple operators for each duty-free business right at Incheon Airport by Incheon International Airport Corporation on the 17th, DF1 and DF2 zones, which handle perfume·cosmetics, liquor·tobacco, and DF3 and DF4 zones, which handle fashion·accessories·boutiques, have been designated as preferred negotiators with Hotel Shilla (Shilla Duty Free) and Shinsegae DF (Shinsegae Duty Free) respectively. Shilla Duty Free offered the highest bid for DF1 and DF2, while Shinsegae Duty Free offered the highest bid for DF3, DF4, and DF5. For DF5, which handles boutiques, Shilla Duty Free, Shinsegae Duty Free, and Hyundai Department Store (Hyundai Department Store Duty Free) were selected as candidates. Although Lotte Duty Free submitted a higher bid than Hyundai Department Store Duty Free for zone 5, Hyundai Department Store Duty Free was selected as a candidate after the evaluation of business proposals.

Due to the rule prohibiting overlapping awards between Group 1 (DF1, 2) and Group 2 (DF3, 4, 5), Hyundai Department Store Duty Free is highly likely to win the bid for DF5. Shilla Duty Free and Shinsegae Duty Free are expected to divide the business rights between Group 1 and Group 2, operating perfume·cosmetics, liquor·tobacco, and fashion·accessories·boutiques respectively. Contrary to expectations of high bids that heightened concerns in the domestic duty-free industry, the Chinese state-owned duty-free group (CDFG) submitted a lower bid and was eliminated. Lotte Duty Free also failed to make the candidate list for both Group 1 and Group 2.

The 'Light and Shadow' of Incheon Airport's 10-Year Operator

Shilla Duty Free and Shinsegae Duty Free, both likely to win two locations each, view the 10-year duty-free business at Incheon Airport as having a positive impact not only in terms of expanding sales scale but also symbolically for growing into global duty-free operators. They have submitted bids with this perspective in mind. Both Shilla Duty Free and Shinsegae Duty Free expect sales exceeding 1 trillion KRW each at Incheon Airport once passenger numbers recover. Given the duty-free industry's characteristic of maintaining business through large-scale sales, sales in the trillion KRW range cannot be overlooked. Since its opening in 2001, Incheon Airport duty-free shops recorded sales of 2.8 trillion KRW in 2019 with an average annual growth rate of 6%.

The industry expects business conditions to improve visibly from the second quarter due to China's reopening. The ranking of domestic duty-free operators could also be reversed with Incheon Airport's entry. Shilla Duty Free and Shinsegae Duty Free, ranked second and third domestically in sales, could surpass Lotte Duty Free, the domestic leader. As of 2021, Lotte Duty Free's sales were 3.72 trillion KRW, while Shilla Duty Free's sales were 3.34 trillion KRW.

Incheon Airport holds significant symbolism as Korea's gateway and an Asian hub airport. The presence of major luxury brands is often influenced by whether they are located in global airports. Being present in major airports like Incheon Airport is also advantageous when expanding into overseas markets.

However, the burden of rent, which reached up to 170% of the minimum bid price, is a variable. Based on the highest bid rent and the number of international departing passengers in 2019 (about 35 million), the combined annual rent for DF1 to DF5 is approximately 878.7 billion KRW. Even considering that this is calculated only on the highest bid, it is around 870 billion KRW, about 87% of the 2019 rent of approximately 1 trillion KRW. Assuming sales recover to 2019 levels, rent would account for about 31% of sales. The key issue is how quickly recovery will occur. Generally, when rent reaches about 40%, it becomes difficult to make a profit.

High rental deposits also pose potential problems. If selected as the final tenant, the operator must pay the rental deposit (about nine months' worth) in cash at the time of contract. Based on the highest bid, DF1 and DF2 require deposits of approximately 190 billion KRW and 194 billion KRW respectively, and DF3 and DF4 require about 56 billion KRW and 53 billion KRW respectively. When bidding for two zones, this amount reaches around 240 to 250 billion KRW. This is difficult to recover in case of mid-term termination or other reasons.

Will Lotte's Unexpected Elimination Become a Blessing in Disguise?

Lotte Duty Free, submitting relatively conservative bids, failed to make the candidate list for Incheon Airport duty-free operators. Having experienced early withdrawal from some zones in 2018 due to inability to bear high rents at Incheon Airport, Lotte Duty Free took into account the 'winner's curse' and submitted appropriate prices near the break-even point (BEP). A Lotte Duty Free official said, "We submitted appropriate prices in this bid, but competitors made aggressive bets, resulting in a disappointing outcome," adding, "Sales from Incheon Airport duty-free shops account for less than 10% of total sales, so it is not a threat to overall performance." Lotte Duty Free plans to reinvest about 300 billion KRW saved from rent and operating costs into downtown stores, online, and overseas, thereby creating opportunities. The plan is to strengthen downtown duty-free and online sales, which account for 85% of total sales, to compensate for the sales lost from exiting Incheon Airport duty-free shops.

An industry insider said, "Each company's stance will change depending on the timing and level of passenger recovery and duty-free usage amid the changing duty-free industry environment," adding, "Changes after the selection of Incheon Airport operators should consider immediate recovery from the second half of this year, future customer lifestyles, and each company's innovation status."

Meanwhile, the Korea Customs Service plans to decide the final successful bidder among multiple operators through a license review in April. The new operators will begin operations in July.