JOINT TRANSPORT RESEARCH CENTRE

Discussion Paper No. 2008-15
July 2008

The Airport Industry in aCompetitive Environment:
A United Kingdom Perspective
David STARKIE
Economics-Plus Ltd
London, United Kingdom

JOINT TRANSPORT RESEARCH CENTRE

Discussion Paper No. 2008-15

Prepared for the Round Table of 2-3 October 2008 on
Airline Competition, Systems of Airports
and Intermodal Connections

THE AIRPORT INDUSTRY IN A COMPETITIVE ENVIRONMENT:A UNITED KINGDOM PERSPECTIVEDavid STARKIE
Economics-Plus Ltd
LondonUnited Kingdom

July 2008

The views expressed in this paper are those of the authors and do not necessarily
represent positions of Economics-Plus Ltd, the OECDor the International Transport Forum.

TABLE OF CONTENTS

1.

INTRODUCTION ...............................................................................................................52.

SIZE AND DIVERSITY ...................................................................................................... 63.

OWNERSHIP AND CAPITAL MARKETS ......................................................................... 7

4.

COMPETITION FOR CONTRACTS .................................................................................. 85.

COMPETITIVE HINTERLANDS ...................................................................................... 12

6.

FINANCIAL PERFORMANCE ......................................................................................... 15

7.

CONCLUSIONS .............................................................................................................. 17

NOTES ................................................................................................................................... 19
TABLES AND FIGURES ........................................................................................................ 22

London, July 2008

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1. INTRODUCTION

The paper provides an overview of UK airports from the perspective of a businessenterprise. Its object is to show, through the medium of the UK industry, that effective
competition between airports is possible and that a competitive industry can be financially
viable. In the UK case viability is achieved at all levels of output, thus refuting the suggestionthat high fixed costs are a significant barrier to positive returns, particularly for airports oflimited output. This viable industry operates for the most part in the private sector of theeconomy and it has evolved without the imposition of a strategic plan. It is competition thathas driven the dynamics of the industry, an industry that in its symbiotic relationship with theairline industry has been an economic success story helping to produce strong economic
growth in the service sector of the UK economy.
The structure of the paper is as follows: the following section provides a snapshot of the
UK airports industry from which it is evident that economies of scope are important1. This isfollowed by a section on the ownership structure of the industry, drawing attention therein to
the market for corporate control (with its implications for productive efficiency). Section 3
outlines the relationship between airports and airlines stressing the recent development oflong-term contracts which are important for understanding the current nature of competition.
Section 4 places competition in a spatial setting by summarising recent analyses ofhinterlands or catchments from which the individual airports attract traffic; it is shown thatmost of these catchments overlap to form a chain of competition. Section 5 analyses thefinancial performance of the industry; its conclusion is that airports at all levels can operate
without subsidy and, overall, the industry’s profitability is similar to that for the non-financial
sector of the UK economy. Section 6 concludes the paper by arguing that governments
should encourage competition in the market for basic airport services, if necessary by
restructuring and by unbundling concentrated ownership. Economic regulation, even whenwell designed, is very much a second-best solution.

2. SIZE AND DIVERSITYIn spite of its relatively small area, the UK in general, and England in particular, have asurprisingly large number of airports with scheduled passenger services; in 2007 there wereabout 40 such airports. Their size distribution, with reference to passenger numbers, is bimodal with four large airports with numbers in excess of 20 million and the remainder withless than 10 million passengers. There is one major transfer (connecting) hub, London
Heathrow, which of course is a supreme example of its genre. I could continue to cut andStarkie — Discussion Paper 2008-15 — © OECD/ITF, 20085

slice the data on UK airports countless ways and possibly bore you in the process. Instead,can I refer you to the comprehensive airport data on the UK Civil Aviation Authority’s
website.2 I am more interested in the ‘airport’ as a business entity, or enterprise, operating
as the UK airports do within a competitive market economy with economic regulation limited
to three co-owned London airports; this gives the analysis of the data a particular slant.
I have already referred to passenger numbers and it is a common practice to use this as
the defining characteristic of an airport’s size, but to do so tends to diminish the fact that
airports are in most cases multi-product entities supplying to the market a bundled group ofservices (OFT, 2006). Apart from handling passenger traffic, other activities include shipping
airfreight (including mail), providing for air-taxi services and general aviation, acting as abase for flying training, aircraft maintenance, flight testing and corporate jet activity, andproviding for a large number of other specialist aviation services. Further complexity is added
because the activities of the airport company can extend beyond the supply of airport
services per se. The property assets within the airfield boundary might also serve nonaviation-related activities. At the smaller airfields, it is not unusual to find former hangars andsimilar obsolete or stranded assets used for storage or as units for light industry.
Looked at in business terms, a more appropriate measure of firm size is turnover. Table
1 ranks selected UK airports by turnover in 2005/6. (There are probably another dozen
relatively small airports exceeding the minimum turnover threshold shown, £5mn, for which
financial data are not readily available). The range of turnover is huge, as one might expect,
and, although there is a high correlation between this statistic and passenger numbers for
medium and large airports, there are, nevertheless, cases where financial turnover relative topassengers is disproportionately high; Nottingham East Midlands, Cardiff and London City
are examples. For small airports the relationship between passengers numbers and turnoveris less close3 and a further indication of this is the relative proportion of Air Transport
Movements, those with a passenger focus, to total aircraft movements which for these
airports is often less than half (see Table 1, columns 3 and 4).
But, small airports are of greater significance than their size suggest. In a competitive
airport environment (about which I will more to say later) they are a source of competition forthe larger airports. The industry is dynamic and rapid growth from a small base is notuncommon; Liverpool, for example has experienced exceptional growth during the last
decade which has had repercussions for other airports in its region. A competitive challenge
has also come from newly established civil operations at former military bases using thestranded assets of the defence ‘industry’ (Doncaster, Newquay, Manston) and at airfields
located alongside aircraft manufacturing plants (Belfast City), as well as from the occasional
new airport on a greenfield site, such as London City and Sheffield City. But there has been
exit from the industry as well and the latter example is a case in point.

3. OWNERSHIP AND CAPITAL MARKETS

Until little more than 20 years ago, virtually all runway and terminal assets at UK airports
were owned by the public sector, (although the private sector often played a major role,
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through concession agreements in the running of the airports or, more typically, parts ofthem). The transfer in 1987 to the private sector of all the share capital of the British Airports
Authority, a corporate enterprise owned by central government, was the first importantchange of ownership in the UK industry. This transfer, by flotation of shares on the London
stock exchange, established BAA plc, (confusingly referred to as a public quoted company)
with a substantial capitalisation. Between 1993 and 1999 many local government owned
airport assets were also sold. This was a period when strict controls were imposed on local
government spending on airport assets so that, to expand such airports, private capital wasneeded, but further privatisations have occurred since removal of the capital spending
constraints (See Table 2). Unlike the public flotation of BAA, disposals by local governments
to the private sector took the form of trade sales, that is, sales to existing trading entities.
The majority of the financial transactions have been outright sales to the private sector
but with some exceptions. Local government retains a majority share in Newcastle-uponTyne airport; a minority share in Birmingham airport and a tiny share in Blackpool airport;
whilst London Luton airport is a 30 year concession agreement. The latter commenced in1998 and recent events suggest that this approach is not without its problems. The
concession holder, ACDL, has now decided not to pursue earlier plans for major investment
citing as a reason the limited period remaining before the end of the concession agreement,(although central government’s support for, arguably, premature expansion of near-by
London Stansted has probably complicated matters). Not all airports have been sold to theprivate sector or introduced private equity capital. Manchester (UK’s fourth largest) which
belongs to a consortium of local governments in North West England is a significant
exception. The UK airport industry is thus a mixed private-public sector industry but one
currently dominated by the private ownership of assets.
An important feature of the market in UK airport assets (and indeed the assets of theprivatised utility industries in general in the UK) is that it is a market with a global reach, thefinal impediments to which disappeared in 2006: when BAA was privatised the government
capped the amount of shares that any one shareholder could hold to 15 per cent but,following a ruling by the European Court of Justice that this restriction impeded the freemovement of capital in the European Union, it was removed. The take-over of BAA soon
followed when a consortium led by Ferrovial, the Spanish construction, infrastructure andservices group4, outbid Goldman Sachs, the US investment bank. Another Spanish led
consortium has an interest in Belfast International and Cardiff airports as well as holding the
Luton airport concession; Macquarie Airports, an investment trust which is part of theAustralian bank of that name, owns Bristol airport; a New Zealand investment group has aninterest in two smaller airports; Copenhagen airport (in which Macquarie also has an interest)
holds the minority stake in Newcastle airport and private equity groups have been involved in
the two most recent privatisations of local government airports, Leeds Bradford and Exeter.
Both these latter sales took place at a price of about 30 times earnings (before allowing forinterest, tax, depreciation and amortization). This suggests high expectations by thepurchaser that substantial cost efficiencies can be achieved and/or strong market growth isattainable.
The market for corporate control generally in the UK is a very active one and thischaracteristic applies equally to the market in airport assets. Ownership by unquoted privatecompanies (BAA plc was the exception) has not prevented several of the airports changing
hands since they were first transferred to the private sector, some several times (see Table2). It would be reasonable to suppose, therefore, that as a consequence much of the industry
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is subject to capital market disciplines which bear in particular upon its productive efficiency:
the acquiring firm will aim to increase the profitability of the airport taken over, securing agood investment return by improving the airport’s operational efficiency. And, in so far as theremaining (corporatised) public sector airports find themselves competing in the market for
air transport services with (for-profit) private sector airports, competition for private sector
airport assets in the global capital markets will have had the effect of increasing the
productive efficiency of the sector as a whole.

4. COMPETITION FOR CONTRACTS

It was expected that liberalisation of European air transport, the final phase of which wascompleted in 1997, would lead to a much more competitive air transport market throughout
Europe. Not anticipated was the role that the Low Cost Carrier (LCC) would play in driving
these market reforms, nor the profound effect the carriers would have on the airports
industry. The consequence has been to greatly increase competition between airports and toincrease the bargaining power of the airlines. The catalyst in this transforming process has
been the introduction of formal, specific (long-term) contracts between the airport anddownstream airline customers. These vertical supply contracts, arguably, should rank
alongside the use of on-line internet booking systems and the introduction of cheap one-way
fares (which undermine the ability of the legacy carriers to price discriminate), as a majorinnovation in contemporary civil aviation. The privatised UK airport industry has played a keyrole in their introduction.
Vertical supply contracts between airport and airline have long been a familiar feature ofcivil aviation in other parts of the world, such as in Australia (long term leases on terminals)
and, especially, in the United States (gate leases and ‘majority-in-interest’ clauses giving
airlines some control over capital expenditure). But the focus of contractual developments in
Europe since liberalisation, initially in the UK and then more generally, is novel; it has been afocus on negotiated charges for the long-term use of basic airport infrastructure.
The traditional relationship between airport and airline user has had at its core a posted
tariff of charges (the most important of which are generally structured to reflect aircraft
weight) together with associated ‘conditions of use’. The interesting feature of this traditional
approach is its informality: users do not need a contract with the airport but in paying the
published tariff they also accept the ‘conditions of use’ (Condie, 2004, Graham, 2001). Under
this arrangement the airport is, in effect, assuming the long-term traffic risk. This was not ofconcern to airport owners when air services were subject to general regulatory controls onroute entry and thus operated in a less competitive, stable, environment. But liberalization ofaviation has increased the risk of airport assets being stranded by the opportunistic
behaviour of airlines that are now free to change routes and switch airports at will.
Consequently, there is now an incentive for the airport to establish with its downstream
airline customers negotiated long-term5 contracts for supply that achieve a better balance ofrisks. These contracts are not dissimilar to those that exist in other industrial sectors facedwith similar economic circumstances; the shipping and ports industry for example6.
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Besides specifying charges, the negotiated contract usually covers issues such as thequality of service the airport is to provide, for example minimum turn-round times; the amountof marketing support the airline is to receive; and a commitment by the airport to future
investment, the nature of which is sometimes specified in detail. Conversely, as part of theagreement the airline commits to basing a certain number of aircraft at the airport; to roll out,
per schedule, a route network; and sometimes to guarantee a minimum level of traffic,
effectively take-or-pay contracts7. The average charge paid by the airline in these contracts is
usually much less than the average that would result from the use of the published tariff.
Payments are also structured in such a way that traffic risks are shared, for example by using
a per passenger charge only. The published tariff is, of course, still used for charging thoseairlines for which a negotiated contract is less suitable or inappropriate.
The negotiated contract has led to a fundamental change in the nature and intensity ofcompetition between most UK airports. Although airports still compete to attract linking air
services provided by airlines based at other airports, the prime competitive focus has shiftedto encouraging airlines (and associated entities such as express freight carriers) to establish
an operating base at which aircraft would be positioned overnight, and to develop from thisbase a route network. The effect of this has been to greatly increase the bargaining power ofmany airlines vis a vis the airports.
Prior to liberalization, those airlines now commonly referred to as ‘legacy’ airlines tended
to focus their base operations on a specific geographical market. This was especially true ofthe so-called flag carrying airlines with their capital-city focus. If they had been required tonegotiate commercial contracts with their base airport, and generally the issue did not arise
because of the symbiotic relationship between what were usually two public sector entities,
the airline(s) would have had little countervailing power unless the city happened to beserved by multiple airports with different owners. In contrast, LCCs have no specific interestin a particular geographical market; their objective is to choose locations across Europe thatmaximize the return on their capital (aircraft) assets. The effect is to increase considerably
the countervailing power of such airlines in negotiations; the airline can credibly threaten to
take their ‘capital on wings’ to a different location. The point is exemplified by Ryanair’s
frequent practice of announcing a short list of airports at which it might base its next trancheof aircraft and then to hold a ‘beauty parade’ in order to secure best terms. Thus, competition
between airports is no longer simply and only a matter of competition between spatiallyadjacent airports; competition in the new regime takes place over a very wide geographic
market which reflects, in particular, the willingness of the LCCs to open new bases
throughout Europe.
Once such a base has been established, the airline will have sunk a certain amount ofcosts but, until at least until the end of its contract period, it will be protected from the airport
behaving opportunistically and, as already mentioned, these contracts are usually of long
duration. It is also likely that the airport will wish to compete against rivals to attract thebasing of future increments of capacity (not already prescribed in an existing contract) andthis too will constrain its behaviour. Of course, at the end of the contract period the airline will
be in a different position and will face switching costs, but it will have a stable and known
environment prior to the contract termination date in which to negotiate a replacement
contract or to make other arrangements; this in itself should reduce transitional costs8.
Equally, at the end of the contract the airport also faces losing a chunk, possibly a large
chunk, of its business in circumstances where most likely it is faced with a level of fixed costs
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much higher than the (location specific) fixed costs faced by the airline. There will be
incentives for both parties, therefore, to negotiate new contact terms and it is not immediately
obvious that either the airport or the airline will have the upper hand; the most likely outcome
is that the bargaining positions will be reasonably balanced.
In contrast, airlines that established operating bases at a time when negotiated contracts
were not available and operate essentially by reference to the published tariff and associatedconditions of use, appear more vulnerable to increases in posted charges or other forms ofopportunistic behaviour on the part of the airport and there has recently been muchdiscussion between airlines and regulators concerning the size of the switching costs thatmight be involved in moving flight operations between airports. But what is to be emphasizedis that it is the net cost of switching that is the important factor and financial inducements,
such as marketing support by competing airports which reduce this net cost, should be taken
into account. There is no reason to suppose that base airlines currently paying the publishedtariff and thus supposedly stranded by their switching costs would not be subject toinducements from rival airports. Thus, in so far as those airports strongly associated with‘legacy’ airlines find themselves competing with (low cost) airports willing to enter into longterm contracts with airlines, they too have to respond to competition by adjusting prices fortheir established airline customers.
Manchester airport provides a very good example of this. It is an airport now of very
similar size to London Stansted having been in the past much larger than the latter: it also
used to be head and shoulders above other airports in its North West region; that is nolonger the case. For a time, Manchester shunned the LCCs and declined to enter into
negotiated contracts with them. It preferred to continue to focus on serving the legacy airlines(British Airways had a base there) and, in this capacity, it served some long-haul routes aswell as many European and domestic services (the latter including an important shuttle
service to and from London Heathrow); it was also an important base for inclusive tour
(charter) traffic9. But in the last 10 years or so it has faced increasing competitive pressuresfrom, first, Liverpool and then more recently from Leeds-Bradford and the new SheffieldDoncaster airports, so that its growth rate slowed and its overall share of UK passenger
traffic stagnated (at around 10 per cent). It was forced to respond and it did so by selectively
supporting a large number of airlines in the form of either a reduction in airport charges (orrebates), or by making large contributions to joint marketing campaigns. Between 1998 and2003, for example, about 75 different airlines received support although this was highly
skewed with 20 airlines receiving over 90 per cent of the expenditure. Importantly, to prevent
reductions in services, it provided support (to the extent of nearly one-quarter of the total
support budget in 2002-3) to airlines (and charter carriers) “…that would otherwise haveceased or reduced services…”10
Because the UK was at the vanguard of air services liberalization and the synergistic
LCC revolution, competition between airports to attract airline operating bases soon followed
and today there are a large number of such bases in the UK. Table 3 shows the UK
operating bases for four non-legacy11 airlines, easyjet, Ryanair, Flybe and Jet2 in thesummer of 2008. These four airlines have, between them, 32 bases in total spread across 19
airports. It is not an exhaustive list of operating bases in the UK: bmibaby, another quasiLCC, currently has four, VLM bases aircraft at London City airport, Aer Lingus has justopened a base at Belfast International and, of course, British Airways has a number ofbases, but the Table shows those bases most likely subject to negotiated long-term contracts
along the lines described above; Gatwick and Stansted are known exceptions as BAA
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currently declines to enter into such contracts. The list also indicates that the use of longterm negotiated contracts now extends beyond the type of airline that essentially pioneered
the approach.

5. COMPETITIVE HINTERLANDS

The attractiveness of an airport to an airline and thus the contractual terms an airline isprepared to accept in order to establish at it an operating base (or serve it as an end point on
a network the hub of which is located elsewhere) depends on a number of factors including
those that could affect operating performance and those that bear upon the anticipatedaverage fare yield. The airline will be cognizant of the airport’s infrastructure (its runway
length, the standard (‘category’) of its instrument landing system (ILS), terminal facilities),
how much spare capacity the airport has, its potential for future expansion and its freedom
from operating restrictions. The fare yield will depend upon the presence of potential
competitors already at the airport or at a nearby airport, and, of course, upon its perceived
attractiveness to potential passengers. This latter, in turn, depends foremost upon the
airport’s location in relation to a market demand, the extent and depth of which is determinedby factors such as population density, income levels, business activity, international trade
links, tourism potential and the quality of the transport links, particularly of the regional road
network, which will determine airport access times.
Access times are important in determining the overall size of the regional market and the
UK CAA has suggested that a significant number of leisure passengers are, in general,
willing to tolerate access times of around 2.0 hours to reach a chosen airport (CAA, 2006,
22.17), although, for business travel, 1.0 to 1.5 hours is thought to be more appropriate. Its
analysis indicates that a two-hour drive time accounts for around 80 to 90 per cent ofpassengers using an airport12. These statistics are derived from data for the larger (and moreleisure oriented) airports in the UK each of which serve a large number of destinations.
Consequently, they might draw from a larger than average area of ‘catchment’. On the other
hand, airports with a smaller volume of passenger traffic might draw most of it from a more
restricted catchment, perhaps within 1.0 to 1.5 hours drive time of the airport.
From a competitive viewpoint, the issue is whether and to what extent the catchments ofdifferent airports overlap. I have previously pointed out (Starkie, 2002) that airports (andairlines) cannot segment their customer base by residential/business location; that is to saythat they do not have the ability to price discriminate between customers according to where
the latter are located with respect to the airport. The consequence of this is that even a small
degree of catchment overlap might have a potent effect on prices. The point is illustrated in
Figure 1. This shows stylized catchments for two airports (A and B), that overlap in theshaded area. Within this latter area, air services from the two airports compete directly forcustomers. However, passengers located at point z (well outside the catchment of airport A
and thus captive to airport B) are potential beneficiaries of the price set for customers locatedin the area of direct competition. Unless it is possible to separate passengers at z into amarket separate from those in the overlapping zone, the former passengers when using
airport B will also benefit from the competitive price offered to passengers in the overlappingcatchment.
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11

The CAA has undertaken detailed analysis of the degree to which airport catchments
overlap in both the London and North West (Manchester) regions of the UK. The analysis,
based on driving times, reveals that there are extensive overlaps between the various
London airports for both the one and two hour ‘isochrones’ and, for the latter, overlaps with
airports outside the London region, particularly with airports located to the north and west. In
the case of the North West region, again there is a strong overlap. Manchester is by far thelargest airport in this region with a turnover about ten fold that of nearby Liverpool (see Table1) but the overlap of its catchment with those of other airports is considerable and thisremained generally the case when the analysis was repeated for different market segments(domestic, long-haul etc.).
The UK Competition Commission (‘CC’) has also conducted a broadly similar analysis of
the London and Scottish airports in relation to its Emerging Thinking Report (Competition
Commission, 2008)13. However it made use of a different methodology and, in particular, it
did not depend upon the analysis of driving times but used instead the results of passenger
surveys. The CC’s starting point was to assume that if a significant percentage ofpassengers originating from a district used a particular airport, then it could be inferred thatall passengers in that district were potential customers of airlines operating from that airport.
For the initial analysis the threshold of significance was set at 20 per cent. Therefore, the CC
measured the degree of catchment area overlap by measuring the percentage of an airport’s
passengers that came from local authority areas where another airport accounted for 20
percent or more of its passengers. In terms of Figure 1, one would calculate for Airport A, thepercentage of its passengers from the shaded area when Airport B attracted at least 20
percent of the shaded areas passengers.
Subject to the availability of survey data, this analysis can be refined further. For
example, it can be repeated for different market segments, leisure, business etc and the CC
did do this (although when judging whether such a disaggregated approach is reallynecessary again one should be mindful of constraints on the ability of airports and airlines tosegment and thus price discriminate in spatial sub-markets). The CC also carried out a yet
more stringent examination deriving catchment areas only for those passengers travelling on
air routes served from more than one airport. However, my own view is that this approach is
too stringent. For (short-haul) leisure passengers it ignores the issue that many suchpassengers are purchasing a commodity with certain attributes so that an airline route todestination X is a substitute for a route to destination Y. There are also market dynamics toconsider: that in a liberalized, competitive airline market, airlines are free to enter in responseto perceived opportunities so that the picture regarding parallel route competition is fluid.
And, in the longer term, improvements in transport infrastructure also change the shape andsize of catchment areas.
The initial conclusions of the CC following its analysis of the London region airports
match, in large measure, those of the CAA: that in the regions analysed there should besignificant potential for airport competition (para. 167), although the common ownership of
three London airports by BAA is likely to adversely affect competition between them. With
respect to the Scottish airports, the CC’s current view is that there is potential for competition
between Glasgow and Edinburgh (para. 274) and probably also between them and
Aberdeen, but again joint ownership of these three airports by BAA is a feature thatadversely affects competition.

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The analyses of both the CAA and the CC have a particular regional focus (London,
North West England and Scotland) because each was serving a particular purpose. In order
to examine the potential for competition between airports more generally, I have carried out
an analysis of driving times between significant airports across England and Wales as awhole (Starkie, 2008). Table 4 shows driving times between proximate English/Welsh
airports14. Included in the data base are all those airports with scheduled passenger services
and with more than 400,000 passengers in 2005/6; a total of 21. The entries in the Table
show times between those airports that are within 2.0 hours drive of each other (unless thenearest neighbouring airport exceeded 2.0 hours drive time). For this purpose, driving times
are taken from the RAC’s Route Planner and are based on assumed speeds of 60mph(96kph) for motorways (the national speed limit is 70mph (112kph)) and 30mph (48kph) for
all other roads; times, therefore, are derived from very conservative speed estimates.
In spite of this conservative estimate of travel times, many airports are in surprisingly
close proximity to at least one other airport (although, as noted, in south east England as wellas in Scotland, most proximate airports are owned by BAA); bear in mind that, for example, adriving time of up to 2.0 hours between two airports implies that residents located halfway (interms of driving time) can get by car to either airport within one hour. There is, in fact, only
one airport, Norwich, lying more than 2.0 hours from its closest neighbour; all of theremaining 20 airports lie within 1.5 hours of at least one other airport (and, in some cases,
several airports), The average driving time beween airports is slightly more than 1.0 hour
implying an average journey time of about 0.5 hours for passengers located at the half way
point on the fastest routes. This, of course, is well within the time criteria set by the CAA.
Overall, the results of these three separate analyses of airport hinterlands suggest thatin the UK there is a large degree of overlap of general catchments for passenger traffic andin this context the airports industry appears to have a potentially competitive structure (which
will limit the average fare yield that the airlines can expect and, in turn, will influence
negotiated contact prices). There will of course be a degree of differentiation in the market:
not all airports have the infrastructure to serve long-haul destinations (although a surprisingnumber do have this capability), for environmental reasons some have restrictions on theirhours of operations, and the market for freighter operations is concentrated on only a few
airports15. But, on the whole, the market for the provision of airport services in the UK
appears to be strongly, if imperfectly, competitive; the one possible exception is the submarket for international connecting traffics in which London Heathrow has carved out foritself a national dominance16.

6. FINANCIAL PERFORMANCE

If the structure of the UK’s airport industry is strongly competitive (at least outside theLondon region and Scotland where BAA is dominant), individual airports will have limited
market power and are more likely to be price takers, especially when it comes to negotiating
contracts to attract new business. But if, as received wisdom will have us believe, airports
are subject to very high fixed costs and thus pronounced economies of density (as well as
supposed economies of scale), such competition can be expected to result in airports with
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small traffic volumes, and perhaps even not-so-small airports, generating financial losses. In
part of mainland Europe it is this belief that competition will lead to average prices below
average costs for many airports, that has encouraged a planned rather than market-led
approach to the development of the airport industry.
To examine whether airports in a competitive environment are generally loss making, (orwhether airports are so differentiated and competition so imperfect that profits areexcessive), I have used summary statistics on the financial performance of UK airports
compiled by the Centre for Regulated Industries at the University of Bath. These data havethe great advantage that they are subject to consistent (UK) accounting standards, but,nevertheless, their use is not without its problems. First, in spite of the data being compiled
on an annual basis, comparison between years is difficult because of changes in accounting
standards17. Second, and more importantly, airports have often reported year-by-year resultscovering different periods of time, either: 9 months, 12 months or 15 months. Third, different
airports have different depreciation policies. Finally, there are two sets of accounts available,
one based on Company House returns and the other based on returns to the CAA for
regulatory purposes; the two sets are, for the most part, the same but there are a few
differences. The following analysis focuses on Company House data for 2005/6 which has
the virtue that all airports are reporting 12 months results.
There are 27 individual airports reporting financial data in the series, ranging fromSouthend to the east of London with a turnover of just less than £5m at one extreme, toLondon Heathrow with in excess of £1bn of annual sales18. But, there is a discontinuity inthe size range: the four airports, Heathrow, Gatwick, Stansted and Manchester, are verymuch larger than the remaining 23; because of this, the fact that the financial performance of
medium sized and small airports is of more interest and especially because in 2005/6 all fourof these airports were subject to price controls19, they have been excluded from the following
analysis. This gives a range of turnover for the remaining airports of between £5m to £111m.
Pertinent data for the 23 airports are shown in Table 5. Listed are: turnover, operating
profit/loss (after allowing for depreciation), net profit/loss (after allowing additionally for tax
and interest), operating profit as a percentage of turnover, and operating profit as apercentage of fixed assets (except for Coventry which was excluded because of anomalies inthe data). These data refer to all the activities engaged in by the respective airports,
including what the economic regulatory accounts refer to as non-operational activities.
The data show that, in 2005/6, of the 23 airports nearly all were profitable; only two,Blackpool, with a turnover of £6.3m, and Durham Tees Valley, with a turnover of £10.8m,
made an operating loss and a net loss overall.20 Coventry, with a turnover of £14.1m, also
made an operating loss but recorded a net profit, whilst Cardiff, with a turnover of £22.1m,
made an operating profit, large in relation to turnover, but an overall net loss.21 Humberside
also recorded a net loss on a more modest turnover of £10.9m.22
Although the few airports recording losses of one sort or another are among the smaller
airports in the group examined, there are seven other airports falling within a similar range ofturnover (up to £22mn.) that made both an operating profit and a net profit. These include
the smallest airport, Southend; a small turnover per se does not appear to be an impedimentto profitability. On the other hand, the margin of profit does appear to increase with turnover,but so too does the ratio of fixed assets to turnover; consequently operating profits

14

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

expressed as a percentage of fixed assets, a broad indication of the return on capital
employed, do not show such a strong association with turnover (see Figure 2).
Generally speaking, the better return on fixed assets were produced by airports
occupying the middle range of turnover but, overall, the performance measure in Figure 2
does not suggest an inability of small to medium sized airports to make a decent return on
fixed assets; the ratio of operating profits to fixed assets was over 32 per cent for the
relatively small Biggin Hill for example. Most probably the ability of such airports to perform
well is assisted by the multi-product nature of the industry and associated economies ofscope.
Nor do the performance measures suggest, as do proponents of the ‘airports are natural
monopolies’ school, that if no price controls are imposed the industry will make excessive
returns. The average return (operating profits as a percentage of fixed assets) for the 22
airports is 15.3 (or 10.9 if we exclude the single most positive and negative outlier). This isvery similar to the overall return for the non-financial sector in the UK in 2005 and 2006. To
extend the comparison, non-financial service sector companies in the UK made an average
net return of 17.9 per cent in 2005 and 19.5 per cent in 2006, whilst the corresponding
returns for the manufacturing sector were 9.1 and 7.8; the return in the UK airports’ industry
falls neatly between the two (Table 6). Competition appears to be a most effective
regulator23.

7. CONCLUSIONS

On the basis of the foregoing evidence, I would argue that a competitive framework is anachievable objective for a national airports policy. It is by no means evident that the industry
is inherently a natural monopoly industry and thus requires regulation of prices or financial
returns. On the contrary, the UK illustrates the ability of an airports industry to evolve a
competitive structure whereby competition is an effective regulator of what the airport cancharge the airline. Where there have been problems it is because of the failure to break-up
the state enterprise, the British Airports Authority, when it was privatised in the mid-1980s sothat proximate airports in two UK regions, London and Scotland, continue in common
ownership. The lesson to be drawn is clearly apparent.
And yet, in those countries where privatisation or corporatisation of the airports industry
is on the policy agenda, as is currently the case in Spain and Portugal, it appears that
economic regulation is considered the natural adjunct of such a policy, a necessary
appendage24. The alternative approach, of restructuring ownership to provide a lessconcentrated, more competitive industry structure and then allowing competition to drive theindustry forward, does not appear on the radar screen. I suspect that one of the reasons forthis is that unless the national administrations are familiar with the processes, thefundamental problems associated with even well designed economic regulation25 will not be
fully appreciated (and there will be an army of advisers with a vested interest in a regulated
solution; the consulting industry, for example, does well out of offering solutions to regulatory
problems).
Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

15

The most important of these perceived problems is that the price control approach could
discourage investment, the so-called ‘hold-up’ problem, and encourage the under supply ofservice quality. In the former case, because the regulator can commit to a regulatory
settlement for only a limited period of time (usually 5 years) but investments are amortisedover much longer periods, the regulated firm is faced with the risk that (future) regulators
might renege on the regulatory settlement, thus reducing incentives to invest26. In the case ofservice quality the price regulated firm can save costs and increase its return by skimping on
quality but the regulator finds the problem difficult to address because of the difficulty of
judging an optimal level of service quality.
And yet the irony of this situation is that, as we have seen, the unregulated airports
industry reaches its own solution to these problems: it establishes long-term vertical supply
contracts with its airline customers. The long-term nature of the contract provides the security
that the airport needs to sink costs in additional infrastructure, thus avoiding the hold-up
problem and the terms of the contract stipulate the quality of service that the airline expects
from the airport. It is, after all, the way in which similar issues are resolved in much of themarket economy27. In contrast, the effect of regulation can be to crowd out the efficientsolution28.
It would be better, therefore, if policy makers when undertaking industry reviews, insteadof reaching first for the regulatory tool-box, pose the question: is the structure of the industry
such that a reasonably competitive outcome is likely? If not, can the industry be restructured
to make it more competitive? For the UK’s airport industry, as I have tried to show,competition appears to have worked well and led to a dynamic industry, free of subsidy29, yet
profitable for both small and large airports, with an overall level of profit similar to that for the
non-financial sector of the UK economy: a most satisfactory state of affairs.

16

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

NOTES1.

For a recent excellent general overview of the UK industry, see Graham (2008).

2.

At www.caa.co.uk/airportstatistics

3.

For UK airports with under £30mn turnover (n=13), total passenger numbers
explained two-thirds of the variance in turnover.

4.

BAA is owned by Airport Development and Investment Limited (ADI), in turn wholly
owned subsidiary of SGP Topco Limited, in which Groupo Ferrrovial SA holds 61.06
per cent of the ordinary shares through two of its subsidiaries. The other two
shareholders are Airport Infrastructure Fund LP, which is managed by Caisse deDépôt et Placement du Québec which has 28.9 per cent of the ordinary shares andBaker Street Investment PTE Limited, a subsidiary of GIC Special Investments PTE
Limited which holds the remaining 10 per cent.

5.

Some have been written with 20 year terms.

6.

For a review of similar arrangements in the electricity supply industry, see Littlechild(2007).

7.

This description of contract terms is based on those in two contracts details of which
are known to the author.

8.

Note that the airline is not necessarily dependent upon the existence of a potentiallycompeting airport in the same region. It is to be stressed again that the airline will belooking for the best return on its airline capital across a wider European market.

9.

It is also one of the UK’s major centres for air freight.

10.

Competition Commission, 2002, Appendix 7.5.

11.

I have refered to this group as ‘non-legacy’ airlines rather than LCC’s because only
easyjet and Ryanair maintain the essential characteristics that define the original
LCC brand.

12.

For London Stansted the figure was about 80 per cent but closer to 90 percent in thecase of London Luton and London Gatwick. This difference between Stansted andthe two other airports might reflect the fact that Stansted is dominated by Ryanair
which has a lower average fare yield than the low cost airlines that are relatively

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 200817

more important at Gatwick and Luton; thus passengers might be driving longer
distances to benefit from lower fares.
13.

One of the UK’s two competition agencies, the Office of Fair Trading (OFT)
conducted in 2005/6 an investigation of UK airports (OFT, 2006). This led to areferral to the second agency, the Competition Commission, with the request that it
carry out a market investigation into the supply of airport services by BAA, thedominant airport operator in two regions of the UK, with a view to increasing
competition in this part of the market. This inquiry is ongoing but in April of this year
the Commission published its Emerging Thinking report13. The Commission plans topublish its interim conclusions in August 2008 and its final report in March 2009.
Unfortunately, the stipulated timetable for completion of this written paper precedes
the publication of the CC interim conclusions.

14.

Cardiff International is the only significant airport in Wales.

15.

The sunk costs associated with the specialized facilities required for freight
operations are also protected in a number of cases by long-term contracts.

16.

In this part of the market, London Heathrow competes with Mainland European
hubs.

17.

The most recent examples are FR17 and FR 21.

18.

Also included in the series, but in aggregate form only, are the results for theHighland and Island group of airports controlled by the Scottish Executive. Becauseof the aggregation, these are excluded from this analysis.

19.

Manchester was de-designated in 2008 thus removing price controls.

20.

Blackpool’s operating loss and net loss were virtually identical, recording no
movement on the tax account and virtually zero movement on the interest account.

21.

Cardiff’s net loss is the result of an exceptionally large tax charge.

22.

Humberside’s net loss is the result of a large interest payment.

23.

It is perhaps useful to note that a survey of 50 European airports, most of whichwere in the public sector, by SH&E (2006) found that the average return on capital
was 4.6 percent.

24.

For a very good overview of the European industry see Gillen and Niemeier, 2008.

25.

In the case of the UK utility industries has taken the form of the price control model‘RPI-/+X’ developed during the 1980s and, because this model provides incentives
for economic efficiency, (particularly because of its forward looking approach) it isgenerally considered to be superior to rate base (rate of return) regulation which
preceded it. The generic model has a number of key features: a periodic review
process, a building blocks approach focused around a Regulatory Assets Base
(RAB) which integrates (depreciated) past and planned investments, and a process

18

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

for deciding upon an allowable return on the RAB: the RAB, allowable return andefficient operating costs then form the basis for determining future allowable prices,
usually for a period of 5 years, benchmarked against the Retail (Consumer) Price
Index, hence the RPI-/+X formula. There are different variants of the approachbased on this core with a different emphasis given to different components at
different times and according to the industry concerned, (for example, applied to the
airports’ industry there can be commercial revenues from retailing to take into
account).
26.

There are counter arguments that suggest that price controlled airports might overinvest. Furthermore, there is also the issue of a suitable cost of capital. It is argued
that the standard approach, deriving the weighted average cost of capital (WACC)
with reference to a partly debt financed RAB and an equity-based capital
expenditure programme, does not provide enough incentive for equity capital(particularly in circumstances where there are, as is probably the case with large
airports like Heathrow, decreasing returns to scale).

27.

By co-incidence at the time I was writing this paper, the following example appearedin the Financial Times (3rd July, 2008): “Scottish Coal has agreed to sell about 2
million tonnes of coal a year - half its current output - to Scottish Power to feed its
two coal-fired power stations…The coal will be sold at an undisclosed fixed price,which Scottish coal said gave both parties the certainty they need to invest in newmines and power generation equipment.”

28.

London Luton airport provides an interesting footnote on this point. EasyJet, an
important customer of Luton, attempted in its earlier days at the airport, to get the
airport subject to price control. It failed to do so but it then reached a negotiatedlong-term contract with the airport which, when judged against the published tariff,
was on terms most favourable to the airline.

29.

The exceptions are the Highland and Island airports subsidized by the Scottish
Executive for social reasons.

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

19

TABLES AND FIGURES

Table 1
Selected Financial and Operating Data for UK Airports, 2005–06
Turnover(£000)
1,195,400
361,500
290,553
176,500
111,10982,61577,381
77,021
51,36050,566

ATMsa

Other
movementsb
5,981
9,058
16,421
15,465
9,731
13,296
9,808
20,203
23,79824,490London Heathrow
472,954
London Gatwick
254,004
Manchester
217,396
London Stansted
180,729
Birmingham
113,668
Glasgow
97,610
Edinburgh
117,312
London Luton
87,690
Newcastle
55,164
Nottingham East
56,224
Midlands
Bristol
49,61959,854
20,670London City
40,18061,179
9,733
Aberdeen
33,954
94,665
17,851
Belfast International
31,20643,78037,093
Liverpool
28,79943,312
37,347
Cardiff
22,103
20,68922,337
Southampton
22,02245,10913,351
Leeds Bradford
21,02336,33031,641
Exeter
17,707
14,481
40,572
Bournemouth
14,44014,041
69,600Coventry
14,123
13,951
54,134
Norwich12,08920,89430,145
Humberside
10,934
11,34225,996
Durham Tees Valley
10,83453,53252
London Biggin Hill
6,892
4,834
62,666
Blackpool
6,333
13,02861,985Southend
4,973
1,548
47,798Source: Centre for Regulated Industries, Airport Statistics 2005/6, Appendices D1 and B2.
aMovements of aircraft engaged in the transport of passengers, cargo or mail oncommercial terms.
b20

Includes test and training flights, aero club movements, military movements and private
flights.

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

Table 2
Ownership Patterns at Main Airports in the United Kingdom, 2007
Present ownership

Aberdeen
Belfast City
Belfast International
Birmingham

Bristol
Cardiff
Edinburgh
Glasgow
Leeds Bradford
Liverpool
London City
London Gatwick
London Heathrowb
London Luton
London Stansted
Manchester
Newcastle
Nottingham East
Midlands
PrestwickSouthampton

ADI (BAA)
Ferrovial
ACDL
Local authorities / Dublin
Airport Authority /Macquarie Airports /Employees
Ferrovial / Macquarie
Airports
ACDL
ADI (BAA)ADI (BAA)
Bridgepoint
Peel Holdings
AIG / GE / Credit Suisse
ADI (BAA)ADI (BAA)ACDLADI (BAA)
Local authorities
Copenhagen Airport
Manchester Airport Group

Privateinterest(percent
)
100
100
100
51

Infratil Ltd
ADI (BAA)

Privatization
Date Re-salesa

1987
n.a.
1994
1997

1
1
2

100

1997

100
100
100
100
100
100
100
100
100
100
0
49
0

1995
1987
1987
2007
1990
n.a.
1987
1987
1998
1987
n.a.
2001
1993

1

100
100

1987
1961

2
2

1
2

2
1
1
1
1

Source: Adapted from Graham, 2008. All airports in the United Kingdom with more than one
million annual passengers in 2005.
n.a. = Not applicable.
a‘Re-sales’ indicates the number of changes of owner since the first privatization or initialsale in the case of Belfast City and London City.
b
30-year concession contract. Ownership remains with the local authorities.

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 200821

Table 3
UK Operating Bases for Four Non-Legacy Airlines, Summer 2008
easyJetBelfast- Belfast City
- Belfast International
Birmingham
Blackpool
Bournemouth
Bristol
Edinburgh
ExeterGlasgow- Prestwick- Renfrew
Leeds Bradford
Liverpool
London- Gatwick- Luton- Stansted
Manchester
Newcastle
Nottingham East
Midlands
Southampton

22

Flybe

Ryanair

●

●

●

●

●

Jet 2
●
●

●
●
●

●
●

●

●
●
●
●
●
●
●
●
●
●
●

●
●
●
●

●
●
●

●

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

Starkie — Discussion Paer 2008-15 — © OECD/ITF, 2008

Table 4
Driving Times between Adjacent Airports (hours.minutes)
BHX BLK BOH BRS CWL DSA EMA EXT HUY LBA LCY LGW LHR LPL LTN MAN MME NCL NWI SOU STN
BHX
0.48
1.26 1.34
BLK
1.44
1.14
1.01
BOH
0.42
BRS
1.23
1.17
CWL
1.23
DSA
1.22
0.48 1.20
1.44
EMA 0.48
1.22
EXT
1.17
HUY
0.48
1.32
LBA
1.44
1.20
1.32
1.06 1.29
LCY
1.01 0.44
0.47
LGW
1.01
0.44
1.14
1.28 1.19
LHR
0.44 0.44
0.40
1.08 1.09
LPL
1.14
0.44
LTN 1.26
1.14 0.40
1.37 1.01
MAN 1.34 1.01
1.44
1.06
0.44
MME
1.29
1.04
NCL
1.04
NWI
2.12
SOU
0.42
1.28 1.08
1.37
STN
0.47 1.19 1.09
1.01
2.12
BHX: Birmingham BLK: Blackpool
BOH: Bournemouth
BRS: Bristol
CWL: Cardiff
DSA: Doncaster
EMA: Nottingham
EXT: Exeter
HUY: Humberside LBA: Leeds Bradford LCY: London City LGW: Gatwick
LHR: Heathrow
LPL: Liverpool
LTN: Luton
MAN: Manchester MME: Durham Tees
NCL: Newcastle
NWI: Norwich
SOU: SouthamptonSTN: Stansted
Valley23

Table 5
Financial Data for the Smaller UK Airports, 2005–06
Turnover(£000)

Birmingham
Glasgow
Edinburgh
London Luton
Newcastle
Nottingham East Midlands
BristolLondon City
Aberdeen
Belfast International
Liverpool
Cardiff
Southampton
Leeds Bradford
ExeterBournemouth
Coventry
NorwichHumberside
Durham Tees Valley
London Biggin Hill
BlackpoolSouthend

111,10982,61577,381
77,021
51,36050,566
49,61940,18033,954
31,206
28,79922,10322,022
21,023
17,707
14,44014,12312,08910,934
10,834
6,892
6,333
4,973

Operatingprofit/loss(£000)
35,47725,78931,381
12,87819,07215,80425,344
7,587
10,944
9,436
18,336
5,953
8,791
1,357
1,019
2,951
-1,739563
642-2,715391-2,953137

Net profit/
loss(£000)

Operatingprofit as % ofturnoverOperatingprofit as % of
fixed assets

19,45815,153
18,335
5,643
15,3097,433
23,465
6,024
8,715
4,700
20,606-2,188
5,941
571
32
1,513
1,415
71
-751
-1,242246-2,952
118

31.9
31.2
40.6
16.7
37.1
31.3
51.1
18.9
32.2
30.2
63.7
26.9
39.9
6.5
5.8
20.4
-12.3
4.7
5.9
-25.1
5.7
-46.6
2.8

9.9
10.0
12.1
13.5
10.9
25.8
33.7
164.8
11.1
7.9
17.7
7.8
9.6
2.9
6.1
5.6
N.A.
2.3
2.2
-9.8
32.1
-46.4
7.1

Source: Centre for Regulated Industries, Airport Statistics 2005/6, Appendix D.
N.A. = Not available.
Note: There is some variability in depreciation policies which might have an effect on the
figures for operating profits as a percentage of fixed assets.

24

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

Table 6
Net Return (%), Airports and UK Private Non-Financial Sector 2005–06
2005–06
Airportsa

15.2 (10.9b)
2005

2006

Non-financial service sector

17.9

19.5

Manufacturing sector

9.1

7.8

All private non-financial
corporations

14.0

14.5

Source: National Statistics and author’s calculations.
aAirports listed in Table 5.
b
Excluding outliers.

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 200825

Figure 1
Competition and Catchment Areas

Figure 2
Operating Profit as % of Fixed Assets v Turnover (£000)
Operating profits as % of fixed assets
Op. Profits % Fixed Assets
200.0%

150.0%

100.0%

50.0%

0.0%
0

20,00040,00060,00080,000100,000

120,000-50.0%-100.0%Turnover26

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 2008

REFERENCES

Civil Aviation Authority (2006) Airport Regulation: Price Control Reviews – Initial Proposals
for Heathrow, Gatwick and Stansted Airports, December, CAA, London.
Competition Commission (2002) Manchester Airport PLC: A Report on the Economic
Regulation of Manchester Airport PLC, CC, London.
Competition Commission (2008) BAA Market Investigation: Emerging Thinking (April), CC,
London.
Condie, S., (2004) Powerful Customers: Working with the Airlines in Vass, P. (Ed), The
Development of Airports Regulation-A Collection of Reviews, CRI, School of Management,
University of Bath.
CRI, (2006) Statistical Series: The UK Airports Industry, Airport Statistics 2005/6, CRI,
School of Management, University of Bath.
Gillen, D. and Niemeier, H-M. (2008) ‘The European Union: Evolution of Privatisation,
Regulation, and Slot Reform’ in C. Winston and G. De Rus, Aviation Infrastructure
Performance: A Study in Comparative Political Economy, Brookings Institute, Washington
DC.
Graham, A., (2001) Managing Airports: an International Perspective, Butterworth
Heinemann, Oxford.
Graham, A., (2008) ‘Airport Planning and Regulation in the United Kingdom’ in C. Winston
and G. De Rus, Aviation Infrastructure Performance: A Study in Comparative Political
Economy, Brookings, Washington DC.
Littlechild, S. C., (2007) Beyond Regulation in C. Robinson (ed), Utility Regulation andCompetitive Markets, Edward Elgar, Cheltenham.
Office of Fair Trading (2006) ‘UK Airports: Report on the Market Study and Proposed
Decision to Make a Market Investigation Reference’, OFT 882, London.
Starkie, D. (2002) ‘Airport Regulation and Competition’, Journal of Air Transport
Management, 8, 63-72.
Starkie, D. (2008) Aviation Markets: Studies in Competition and Regulatory Reform, Ashgate,
Aldershot/IEA, London.

Starkie — Discussion Paper 2008-15 — © OECD/ITF, 200827