Expanding Airport
Capacity: Competition
and Connectivity
The case of Gatwick and Heathrow

Country-Specific Policy Analysis

Expanding Airport
Capacity: Competition
and Connectivity
The case of Gatwick and Heathrow

Country-Specific Policy Analysis

THE INTERNATIONAL TRANSPORT FORUM
The International Transport Forum at the OECD is an intergovernmental organisation with 54
member countries. It acts as a strategic think tank with the objective of helping shape the transport policy
agenda on a global level and ensuring that it contributes to economic growth, environmental protection,social inclusion and the preservation of human life and well-being. The International Transport Forumorganises an Annual Summit of ministers along with leading representatives from industry, civil society
and academia.
The International Transport Forum was created under a Declaration issued by the Council of
Ministers of the ECMT (European Conference of Ministers of Transport) at its Ministerial Session in
May 2006 under the legal authority of the Protocol of the ECMT, signed in Brussels on 17 October 1953,
and legal instruments of the OECD.
The Members of the Forum are: Albania, Armenia, Australia, Austria, Azerbaijan, Belarus,
Belgium, Bosnia and Herzegovina, Bulgaria, Canada, Chile, People’s Republic of China, Croatia, Czech
Republic, Denmark, Estonia, Finland, France, Former Yugoslav Republic of Macedonia, Georgia,
Germany, Greece, Hungary, Iceland, India, Ireland, Italy, Japan, Korea, Latvia, Liechtenstein, Lithuania,
Luxembourg, Malta, Mexico, Republic of Moldova, Montenegro, Netherlands, New Zealand, Norway,
Poland, Portugal, Romania, Russian Federation, Serbia, Slovak Republic, Slovenia, Spain, Sweden,
Switzerland, Turkey, Ukraine, United Kingdom and United States.
The International Transport Forum’s Research Centre gathers statistics and conducts co-operative
research programmes addressing all modes of transport. Its findings are widely disseminated and support
policy making in Member countries as well as contributing to the annual summit.

Further information about the International Transport Forum is available atwww.internationaltransportforum.org
This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to thedelimitation of international frontiers and boundaries and to the name of any territory, city or area.

Acknowledgement

The analysis for this report was undertaken by SEO Economic Research. The SEO team comprised Guillaume
Burghouwt, Joop Krul and Jan Veldhuis together with external advisors Jaap de Wit (University of Amsterdam)
and John Jamotta (former VP Network Planning at Southwest Airlines).
SEO Economic Research carries out independent applied economic research on behalf of the public and private
sectors. SEO Economic Research is affiliated to the University of Amsterdam, giving it access to the latest
scientific research tools. Operating on a not-for-profit basis, SEO continually invests in the intellectual capital of its
staff by arranging for them to pursue graduate studies, publish scientific papers and participate in academic
networks and conferences.

TABLE OF CONTENTS – 7

Table of contents

EXECUTIVE SUMMARY .........................................................................................................................11
Factors affecting airline behaviour ..............................................................................................11
Airline responses as a result of adding capacity at Gatwick or Heathrow ...................................12
Impact on the “competitive outcome”..........................................................................................14
Likelihood of the airline responses ..............................................................................................15
1. INTRODUCTION ..................................................................................................................................17
1.1
Background and objective of the study ........................................................................................17
1.2
Our approach ................................................................................................................................18
1.3
Follow up work ............................................................................................................................18
2. AIRLINE BUSINESS MODELS AND SEGMENTS ...........................................................................19
2.1
Business models for different airline segments ...........................................................................19
2.2
Legacy/ network carriers: the home-based hub carrier ................................................................20
2.3
Other legacy/ network carriers .....................................................................................................25
2.4
Low-cost carriers..........................................................................................................................27
2.5
Leisure carriers.............................................................................................................................31
2.6
Cargo operators ............................................................................................................................31
3. THE LONDON AIRPORTS SYSTEM .................................................................................................33
3.1
The London market ......................................................................................................................33
3.2
Heathrow ......................................................................................................................................37
3.3
Gatwick ........................................................................................................................................40
3.4
Stansted, Luton and Southend: low-cost, point-to-point leisure services ....................................41
3.5
City: point-to-point business services ..........................................................................................41
3.6
Future capacity requirements .......................................................................................................42
3.7
Key conclusions on the London airports system..........................................................................42
4. RELEVANT FACTORS IN AIRPORT CHOICE FOR AIRLINES AND OTHER USERS .................45
4.1
Factors driving airline behaviour .................................................................................................45
4.2
Market size ...................................................................................................................................45
4.3
Advantages of spatial concentration of the network ....................................................................47
4.4
Market access and airport capacity ..............................................................................................50
4.5
Visit costs .....................................................................................................................................51
4.6
Congestion costs ..........................................................................................................................54
4.7
Airport facilities and service level ...............................................................................................54
4.8
Summary of driving factors .........................................................................................................55
4.9
Positive feedback loop between connectivity growth and user behaviour...................................56
4.10 Performance of the London airports with respect to the airline drivers .......................................57
4.11 Key conclusions on factors that drive airline and user behaviour................................................59

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8 – TABLE OF CONTENTS

5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONS .............................61
5.1
Introduction ..................................................................................................................................61
5.2
Airline responses ..........................................................................................................................61
5.3
Expanding Heathrow....................................................................................................................63
5.4
Expanding Gatwick ......................................................................................................................69
5.5
Evaluating the competitive outcome of the options .....................................................................75
5.6
Key conclusions regarding airline responses and competitive outcome ......................................81
6. LIKELIHOOD OF AIRLINE RESPONSES .........................................................................................83
6.1
Introduction ..................................................................................................................................83
6.2
The Airports Commission forecast and scenarios ........................................................................83
6.3
Likelihood of the airline responses ..............................................................................................84
6.4
Key conclusions regarding the likelihood of the airline responses ..............................................88
BIBLIOGRAPHY .......................................................................................................................................91

Figures

2.1.

Legacy/ network carriers still important in intra-EU flights despite
growth of low-cost segment ............................................................................................................ 20
2.2. Paris enjoys a similar number of long-haul connections to London despitea smaller catchment area:. ............................................................................................................... 22
2.3 Distribution of flights of selected carriers by airline segment at the different London airports ..... 26
2.4 Share of low-cost flights in total number of flights is particularly high in the UK, ........................ 28
3.1. Overlap of airport catchment areas with 90 minutes access time ................................................... 34
3.2. Estimated share of passengers departing from the London airports with a reasonable alternative
departure airport .............................................................................................................................. 35
3.3. Gatwick largest airport in terms of scheduled destinations offered ................................................ 35
3.4. Share of airline market segments at the London airports in number of scheduled flights (2013)... 36
3.5. Heathrow ranks fourth in terms of the number of hub connections offered per week .................... 38
3.6. By 2040, London airports are predicted to be full .......................................................................... 42
4.1. The S-curve effect of frequency and market share.......................................................................... 48
4.2. Airport charges per turnaround ....................................................................................................... 51
4.3. Airport charges per departing passenger ......................................................................................... 52
5.1. Airline response 1: Hub carrier growth at Heathrow, point-to-point growth at Gatwick. .............. 66
5.2. Airline response 2: Two hubs at Heathrow, Gatwick point-to-point .............................................. 68
5.4. Peak-hour capacity versus number of connections via the hub per week in 2008 .......................... 70
5.5. Airline response 4: Hubs at Gatwick and Heathrow ....................................................................... 72
5.6. Airline response 5: Partnerships – Gatwick becomes a low-cost “gateway”, Heathrow remains the
network hub..................................................................................................................................... 73
5.7. Airline response 6: Gatwick point-to-point growth, Heathrow remains the network hub .............. 75
5.8. Excess demand increases ticket prices ............................................................................................ 78
5.9. Reduction of excess demand decreases ticket prices ...................................................................... 79
5.10. Impact on competitive outcome ...................................................................................................... 80
6.1. Likelihood of the airline responses under different aviation scenarios ........................................... 89

EXPANDING AIRPORT CAPACITY: COMPETITION AND CONNECTIVITY © OECD 2014

TABLE OF CONTENTS – 9

Tables

3.1.
3.2.
3.3.
4.1.
4.2
4.3.
4.4.

Key features of the London airports (2013) .................................................................................... 33
Shares of aggregated airline market segments at the London airports by number of flights .......... 35
Heathrow compared with other European hubs in terms of capacity and connectivity (2013)....... 39
Factors driving airline behaviour .................................................................................................... 45
Key driving factors for airline behaviour by airline segment ......................................................... 56
Key factors in choices made by air transport users ......................................................................... 57
Each London airport performs differently with respect to the factors driving airline behaviour .... 58

EXPANDING AIRPORT CAPACITY: COMPETITION AND CONNECTIVITY © OECD 2014

EXECUTIVE SUMMARY – 11

Executive summary

In December 2013 the UK Airports Commission short-listed three options for airport expansion in
the UK, two at Heathrow and one at Gatwick1. The Commission is currently in the process of assessingthese options. A report with the Commission’s assessments will be published for national consultation in
the autumn of 2014.
Against this background, UK Airports Commission and the International Transport Forum
requested SEO Economic Research to carry out a study to determine how each of the short-listed
expansion options may affect on the competitive nature of the London and UK-wide airport system.
The study is designed to answer the question what factors or combination of factors will drive - inthe context of additional capacity in the South East airports system - the most “competitive” outcome foreach of the expansion options. The study aims to provide the Airports Commission with an evidencebased assessment to scrutinise the airport capacity expansion options in regard to their competitive
outcomes, connectivity and overall user benefits. More specifically, the study answers the following
questions:
1.

Which factors affect decisions and behaviour of airlines in the UK airport system?

2.

How are airlines likely to respond as a result of adding additional capacity to either Gatwick or
Heathrow?

3.

What is the “competitive outcome” of the airline responses in terms of connectivity andcompetition to the benefit of aviation users?

4.

How likely are the airline responses in various future scenarios?

For the purpose of this work, the two Heathrow expansion proposals short-listed by the Airports
Commission have been grouped together as one “Heathrow” option.

Factors affecting airline behaviour
A multitude of factors drive airline behaviour in the London airport system but impacts on the financial
performance of airlines matter most.
Airlines try to maximize their financial return on invested capital and airline managers have to meetfinancial targets. Growth of the network is generally only possible when financial targets are being met.
Underlying factors that drive airline network behaviour and financial performance include size and1

At the time of writing of this report, the Commission had made the decision not to shortlist the Estuary option.
More information on this decision can be found here: https://www.gov.uk/government/news/airportscommission-announces-inner-thames-estuary-decision.

EXPANDING AIRPORT CAPACITY: COMPETITION AND CONNECTIVITY © OECD 2014

12 – EXECUTIVE SUMMARY

strength of the local market, airport visit costs, congestion costs, advantages of spatial concentration,
service levels and access to capacity.
Size and strength of the local market is of primary importance for all airline segments.
For all airline market segments, the size and strength (yield) of the local market is of primary
importance. The London local OD market is the largest and strongest in the world. Non-home based
network carriers, low-cost carriers, leisure/ charter carriers and home based legacy point-to-point carriers
fully depend on the size and strength of the local OD market from and to London. Only hub carriers like
British Airways and its partners at Heathrow are able to really ‘extend’ the local market by carrying
transfer traffic via their hub. Due to the specific user requirements of the hub carrier (peak-hour capacity,minimum connecting time) and characteristics of its business model, the hub carrier is currently captive
to the Heathrow location. This might change if Gatwick were to increase its capacity.
Low-cost, leisure and cargo traffic is sensitive to visit and congestion costs.
Low-cost, leisure carriers and all-cargo airlines are relatively sensitive to visit and congestion costs.
For them, the charges are a considerable part of their operating costs. Traffic rights, peak-hour capacity,
short connecting times and network concentration are less relevant to their airport choice behaviour.
Stansted, Luton and Gatwick are in particular attractive to low-cost and leisure carriers given their much
lower charges levels than City and Heathrow. The large local market for leisure traffic makes Gatwick inparticular attractive for leisure/ charter carriers, higher end low-cost carriers and legacy point-to-point
airlines.
Expansion of Heathrow or Gatwick will ultimately result in an increase in charges at the expanded
airport.
Airport charges are likely to increase following Heathrow or Gatwick expansion. At capacity
constrained airports with substantial excess demand, capacity expansion will result in a decrease inairline scarcity rents, with lower fares for consumers. Airlines are unlikely to increase airfares because ofhigher charges. Instead, higher charges will combine with the fall in scarcity rents to reduce airline
margins.
Carriers tend to spatially concentrate network growth.
The scale and scope economies of network concentration, including the effect of increased
frequencies more than proportionately increasing market share (the “S-curve” effect) are importantreasons why network carriers tend to concentrate network growth at a single location in cities served bymore than one airport. Network economies are the reason network carriers concentrate their network at ahub, but that does not imply that every network carrier operates only one hub in their network`. Therecan be reasons for a hub carrier to deviate from the single hub solution. Adding capacity to Gatwick
might allow for a secondary, competing hub operation but a split hub operation by British Airways atboth Heathrow and Gatwick is not likely to be an efficient network solution.

Airline responses as a result of adding capacity at Gatwick or Heathrow
Based on an analysis of the London airports system, key drivers for airline behaviour and theoptions for capacity expansion at either Gatwick or Heathrow, we have developed 6 different sets ofpotential airline responses, 3 for Gatwick and 3 for Heathrow. The airline responses have a varying
impact on the traffic structure in the London airport system as well as on connectivity, competition andreduction of airline scarcity rents to the benefit of consumers.

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EXECUTIVE SUMMARY – 13

Airline response 1: Hub carrier growth at Heathrow, point-to-point growth at Gatwick.
The first airline response assumes capacity expansion at Heathrow. The additional capacity enables
the hub carrier BA (and partners) to grow from today’s constrained, sub-optimal hub operation to a more
efficient wave system for coordinating arrivals and departures. Larger, more clearly defined banks ofarriving and departing flights will make it possible for a higher number of transfer passengers to connect
at Heathrow. Other non-home-based network carriers such as Delta and Emirates could also increaseconnections from Heathrow to their own hubs, as well as legacy point-to-point carriers such as Virgin
Atlantic. Low-cost remains focused at Gatwick and the other London airports.
Airline response 2: Two hub operations at Heathrow, point-to-point growth at Gatwick.
Again assuming Heathrow expansion, a competing network carrier develops a hub operation at
Heathrow besides BA and partners, benefiting from the strength of the London OD market. The new hub
operation is likely to be of a smaller size than that of the existing hub carrier. Establishing a competing
hub operation at Heathrow would be a risky strategy due to head-to-head competition with the incumbent
hub carrier, the expected rise in charges and the reduction in economic rents for airlines following
capacity expansion. In this airline response, the current hub carrier and partners expand their network
along the lines of airline response 1, albeit to a smaller extent. Existing or new non-home-based network
carriers increase long-haul and possibly short-haul services out of Heathrow. Low-cost and leisurecarriers, as under airline response 1, remain focussed at Gatwick and other London airports.
Airline response 3: Point-to-point growth at Heathrow and Gatwick, Heathrow remains the network hub.
A third possible airline response following Heathrow expansion is growth of point-to-point traffic at
both Heathrow and Gatwick. This assumes a saturating European low-cost, point-to-point market, where
low-cost carriers search for premium traffic at Heathrow. Despite the much higher charges at Heathrow,
low-cost airlines establish a significant operational base at Heathrow to target the premium market, while
keeping up their operations at Gatwick. Additional slots are taken up by visiting network carriers andlegacy point-to-point carriers.
Airline response 4: Hub operation at Heathrow and a competing hub operation at Gatwick.
As the London market is one of the largest and strongest aviation markets in the world, the Gatwick
capacity expansion option could trigger an incumbent, non-Oneworld UK carrier or a foreign network
carrier to use the new capacity to establish a hub operation at Gatwick. A hub operation at Gatwick could
potentially benefit from lower charges in comparison Heathrow charges. On the other hand, yields at
Gatwick are lower than at Heathrow and foreseen growth in peak capacity at Gatwick would most likely
be taken up by a smaller scale hub operation. BA and partners continue their hub operations from
Heathrow. The growing scarcity of capacity at Heathrow increases the opportunity costs of slots andresults in a continuation of the crowding out of short-haul and low yield flights from Heathrow. The
focus of Heathrow is increasingly on long haul, high capacity flights with a growing share of local OD
traffic. The legacy point-to-point segment at Gatwick is likely to grow modestly with more routes served.
Low-cost and leisure carriers continue to operate out of Gatwick and benefit from the increase incapacity
Airline response 5: Partnerships – Gatwick becomes a low-cost “gateway”, Heathrow remains the
network hub.
Again assuming Gatwick expansion, legacy network carriers and/ or low-cost carriers (of whichsome start to operate in the long-haul market) partner to facilitate passenger connectivity. This could take

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14 – EXECUTIVE SUMMARY

place either through a new alliance/ codeshare formula or by an airport-led connection strategy. Low-cost
grows significantly at Gatwick. Long-haul low-cost flourishes at Gatwick given the large local OD
market and strong growth in the inbound long-haul leisure market from Asia, as well as the potential for
low-cost and full-service feed. Due to the nature of the low-cost business model, such an airline response
will lead to relatively lower numbers of connecting passengers at the airport, as low-cost carriers will try
to avoid the complexity of a wave-system structure for arrivals and departures. Hence, the share oftransfer traffic will remain limited, in the range of 10-20% maximum, and will not reach the levels of atypical hub airport. The hub carrier and partners at Heathrow develop along the lines of airline response
4. Non-Oneworld long-haul carriers increasingly focus network growth at Gatwick, benefiting from feed
provided by low-cost carriers and availability of capacity.
Airline response 6: Gatwick point-to-point growth, Heathrow remains the network hub.
Instead of developing Gatwick into a low-cost gateway following capacity expansion at Gatwick,
where point-to-point traffic is mixed with connecting traffic, this airline response assumes that low-costcarriers take up most of the capacity at Gatwick but stick to a typical low-cost carrier business model
without a deliberate strategy to stimulate connecting traffic and achieve additional route density andconnectivity. The growth of low-cost carriers at Gatwick comprises partly “autonomous growth” and,depending on the future level of aero-charges, partly migration of flights from Stansted and Luton to
Gatwick. A number of low-cost, long-haul destinations are assumed to be developed, based on thegrowing inbound leisure market from Asia. Over time, an increasing share of the additional capacity at
Gatwick will be used by carriers that currently operate at Heathrow but find more cost effective options
at Gatwick when capacity becomes available. This may free-up some capacity at Heathrow, which can beused by the hub carrier and other network carriers. Over time, as capacity shortages remain at Heathrow,the focus at Heathrow will increasingly be on high-capacity flights to large long-haul destinations withincreasing shares of OD demand. Crowding out will take place with respect to short-haul flights at
Heathrow in the long run.

Impact on the “competitive outcome”
The different airline responses have varying impacts on the “competitive outcome” in terms ofconnectivity, competition and reduction of airline rents to the benefit of the consumer:Connectivity is expected to improve most when the hub carrier at Heathrow uses new capacity
to reinforce its hub system, as the possibility to generate long-haul route density on top of local
OD demand is largest. Multiple (competing) hub operations within the London airport system
would also stimulate connectivity but to a smaller extent, because of the multiplier-effect of
hub-and-spoke networks: one large hub delivers more connectivity than two hubs half the size.
Higher airport charges in the future resulting from airport expansion may reach levels thatmight prevent the hub carrier at Heathrow developing a hub operation with the same extensive
feeder network as, for example, at Frankfurt and Amsterdam. It remains to be seen to what
extent hub expansion at Gatwick or Heathrow would result in more capacity on existing routes
as opposed to adding new routes.

An airline response where network carriers and/ or low-cost carriers partner to facilitate
connectivity may increase connectivity as well (airline response 5), but this gain will be limited
based on current airline business models. This may change as airline business models evolve.

Not expanding Heathrow is likely to result in further crowding out of short-haul/ lower yieldflights at Heathrow as excess demand increases, as well as a further rise in air fares. Over time,

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EXECUTIVE SUMMARY – 15

short-haul/ lower yield flights are substituted with long haul, high capacity flights. The role ofGatwick, Stansted, Luton and City for short-haul connectivity will then increase.
Differences between the different sets of airline responses in terms of gains in short-haulconnectivity for the London airports system are likely to be much smaller than they are for long
haul connectivity. The relevance of connecting traffic to operating high frequency routes
profitably is small in the short-haul market and the overall size of the market for short-haulroutes is much larger.

In terms of reduction of scarcity rents and connectivity gains, a UK consumer is likely to gain
most by expanding Heathrow. With severe capacity constraints and high yield demand, thescarcity rents can be expected to be largest there. Hence, reduction of excess demand following
Heathrow expansion is likely to reduce fares more than following Gatwick expansion.
Furthermore, connectivity gains are likely to be highest for Heathrow expansion, with growthof the hub carrier.



Expansion of Gatwick is likely to have the strongest positive impacts on competition, with
benefits to the consumer due to the expected increase in low-cost carrier competition and a lessdominant position of a single alliance, resulting in more choice for the consumer and lower
fares.



However, it is not clear what the overall, combined impact on consumer welfare would be ofchanging scarcity rents, connectivity growth and changes in competition level as a result of
expanding Gatwick or Heathrow.

Likelihood of the airline responses
The way macroeconomic conditions develop over the long term will affect the likelihood of theairline responses examined unfolding. Some of the responses are unlikely under some scenarios. Airline
business models evolve, macro-economic conditions change and new aircraft technology will be on themarket when new capacity becomes available.
Confronting the six sets of airline responses with the future scenarios developed by the Airports
Commission, we draw the following main conclusions:Overall, hub carrier growth following Heathrow expansion and development of Gatwick into a
low-cost gateway following Gatwick expansion are the most likely airline responses under thevarious macroeconomic scenarios developed by the Airports Commission.

In the Assessment of Need scenario, hub carrier growth following Heathrow expansion andGatwick as a point-to-point gateway following Gatwick expansion seem to be most realistic
airline responses, although the other response options are each also moderately likely.

In the Global Growth scenario, most airline responses are likely except for an expanded
Heathrow with predominantly pure point-to-point, low-cost growth. Strong network carriers
may have a substantial interest in an expanded Gatwick in a high growth market, given thecapacity shortages at Heathrow. The multi-hub airline responses (2 and 4) seem only to berealistic in the Global Growth scenario.

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16 – EXECUTIVE SUMMARYIn the Relative Decline of Europe scenario, no multi-hub scenario is likely as the political willto accommodate hub operations from Middle East of Far East carriers will diminish as thesecarriers gain market share and put pressure on the European carriers. We expect the hub carrier
British Airways to focus on protecting its position at Heathrow as much as possible if
Heathrow is expanded but strong, non-European hub carriers will cannibalize its market.
Connections via non-EU hubs are likely to increase. In case of expansion of Gatwick, Middle
East and Asian carriers may team up with European low-cost carriers to organize feed for theirlong-haul flights.

The Low Cost is King scenario is likely to rule out multi-hub airline responses (responses 2 and
4). In case of expansion of Gatwick, a hybrid hub operation could be one of the realistic
futures, in which low-cost and legacy airlines partner to provide connectivity.



The Global Fragmentation scenario will most likely result in hub carriers rationalizing their
networks and focusing on their primary hubs. As the market stalls, the hub carrier may not beable to develop its hub network to the full extent made possible by expansion of Heathrow. In
the case of expansion of Gatwick, a point-to-point response is likely.

We note that airline response 2 (two hubs at Heathrow) may involve too much financial risk for the
new hub carrier and would not be realistic except possibly in the Global Growth scenario. The lower
yields at Gatwick and suboptimal peak-hour capacity also make the establishment of a competing hub
operation at Gatwick less likely (airline response 4)

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1. INTRODUCTION – 17

1. Introduction

Against the background of the assessment of the short-listed airport capacity expansion options of
the UK Airports Commission, this report analyses the potential consequences for airline behaviour incase one of the short-listed options would be implemented. In addition, the study discusses potential
implications of expansion at each airport for connectivity and competition to the benefit of the aviationuser. Finally, the study assesses the likelihood of different airline responses under the different scenarios
identified by the Airports Commission.

1.1

Background and objective of the study

In December 2013 the UK Airports Commission short-listed three options for airport expansion in
the UK, two at Heathrow and one at Gatwick2. The Commission is currently in the process of assessingthese options. A report with the Commission’s assessments will be sent out for national consultation in
the autumn of 2014.
Against this background, UK Airports Commission and the International Transport Forum
requested SEO Economic Research to carry out a study to determine how each of the short-listed
expansion options may impact on the competitive nature of the London and UK-wide airport system.
The study is designed to answer the question what factors or combination of factors will drive - inthe context of additional capacity in the South East airports system - the most “competitive” outcome foreach of the expansion options. The study aims to provide the Airports Commission with an evidencebased assessment to scrutinise the airport capacity expansion options in regard to their competitive
outcomes, connectivity and overall user benefits. More specifically, the study answers the following
questions:
1.

Which factors affect decisions and behaviour of passengers and airlines in the UK airport
system?

2.

How are airlines likely to respond as a result of adding additional capacity to either Gatwick or
Heathrow?

3.

What is the “competitive outcome” of the airline responses in terms of connectivity andcompetition to the benefit of aviation users?

4.

How likely are the airline responses in various future scenarios?

The Terms of Reference for this study indicated that the analysis of impacts should relate to thefollowing market segments:

2

At the time of writing of this report, the Commission had made the decision not to shortlist the Estuary option.
More information on this decision can be found here: https://www.gov.uk/ government/ news/ airportscommission-announces-inner-thames-estuary-decision.

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18 – 1. INTRODUCTION

Airlines - legacy long-haul, low-cost long-haul, legacy short-haul (including domestic), lowcost short-haul (including domestic) and charter;Passengers - business, leisure and visiting friends and relatives (VFR); inbound and outboundtraffic;

Freight users - belly hold and dedicated freighters.

The Terms of Reference also indicated that the driving factors identified should build on those set
out by the Airports Commission in Chapters 2 and 4 of the Commission’s Interim Report (Airports
Commission 2013).
The two Heathrow expansion proposals short-listed by the Airports Commission3 have beengrouped together as one Heathrow expansion option for the purpose of this work. The alternatives havebeen grouped together as they are very similar in the context of this study: they share the same location,
the same catchment area and provide the same peak-hour capacity. Only the terminal capacity isdifferent, by 40 000 annual aircraft movements (Air Traffic Movements, ATMs).
This study is qualitative in nature and will be published as part of the Commission’s national
consultation on the three short-listed options in November 2014.

1.2

Our approach

To address the objectives outlined above, we first set the scene by addressing the various airline andpassenger market segments used in this study, as well as the traffic and connectivity characteristics of the
London airports system. Next, based on review of literature and our expertise in the aviation sector, we
identify the main factors that drive airline and passenger behaviour in the different segments. This
information allows us to sketch the potential changes in airline (network) behaviour if additional capacity
were to be added either at Heathrow or at Gatwick. We then assess the implications of these airline
responses for connectivity, competition and reduction of airline scarcity rents. As not all airline
responses are likely in every future scenario, we assess the likelihood of the identified airline responses
for the different future scenarios defined by the Airports Commission.
The approach chosen in this study is of a qualitative nature, based on the available academic/
empirical literature and relevant material submitted to the Airports Commission by the three scheme
promoters: Gatwick Airport Ltd, Heathrow Airport Ltd and Heathrow Hub Ltd in May 2014.
This report has been reviewed by four external experts.

1.3

Follow up work

In November 2014, the Airports Commission commissioned a study to quantitatively model theoutcomes discussed in this study. The intention is to publish these results in December 2014.

3

The two alternatives are Heathrow Airport Ltd. (HAL) and Heathrow Hub Ltd. (HHL). HAL proposed one
new runway to the north west of the existing airport spaced sufficiently to permit a fully independent
operation. HHL proposed extension of the existing northern runway to the west to a length of at least 6 000m
to allow the extended runway to operate as two independent runways: one for departures and one for arrivals(Airports Commission 2013).

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2. AIRLINE BUSINESS MODELS AND SEGMENTS – 19

2. Airline business models and segments

Most airlines are focused on maximising profits and return on invested capital. The way they try toachieve this differs considerably depending on their business model. The different airline businessmodels and the potential evolution in these models is important for understanding possible airline
responses after expanding capacity at either Gatwick or Heathrow.

2.1

Business models for different airline segments

Before analysing any potential airline responses following expansion of capacity at either Heathrowor Gatwick and the consequences for competitive outcomes, we need to define relevant airline andpassenger market segments as the factors that drive behaviour following expansion of capacity differ
somewhat from segment to segment. In addition, we need to set out the current status of the London
airports in terms of market, connectivity and infrastructure characteristics as our point of departure forfurther analysis.
Network growth follows profitability
Most airlines are focused on maximising returns on their invested capital. Airline managers have tomeet financial targets. Growth of the network is generally only possible when financial targets are met.
Proposing growth in the context of sustained corporate losses is generally seen as far too risky a strategy.
The way airlines try to maximize financial returns varies considerably according to marketingtactics and business model. Airline business models differ strongly in their product and organizationalarchitecture (Mason & Morrison 2008), ranging from cost minimizing carriers, such as Ryanair, targeting
primarily the most price sensitive passengers, to more yield oriented carriers like British Airways, with astrong focus on premium passengers. This study distinguishes between legacy network carriers, low-costcarriers and charter/ leisure carriers.
Airline business models are evolving
We note that defining airline market segments/ business models is easier said than done as today’s
airline business models are increasingly blurring. As Mason & Morrison (2008, p.1) put it: “meaningfuldefinitions of and distinctions between airline business models are not easily formulated, particularly
when one considers the extremely dynamic nature of the industry”.
In response to increasing competition, lower yields and changing customer preferences, many socalled network/ legacy carriers have adopted (and are increasingly adopting) elements of low-cost carrierbusiness models, such as single class cabins and unbundling of the product (charging separately for
baggage for example). Many passengers traveling with European network carriers have to pay separately
for checking-in luggage and reserve their preferred seat. In response to market saturation, or in order tobenefit from serving specific market niches, many low-cost and leisure carriers have begun adopt to asmaller or larger extent characteristics of the network/ legacy carriers, ranging from assigned seating to
the marketing of connecting flights and codeshare agreements (Klophaus et al. 2012; Mason & Morrison

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20 – 2. AIRLINE BUSINESS MODELS AND SEGMENTS

2008). This should be kept in mind when assessing potential airline responses following expansion of
Gatwick or Heathrow, in particular when considering longer-term impacts.

2.2

Legacy/ network carriers: the home-based hub carrier

The share of the legacy/ network carriers has been declining since low-cost carrier growth took off
at the beginning of the century, and a few years prior to this in the UK. Yet, their share of intra-European
traffic is still substantial, as the figure below illustrates. For long-haul destinations, legacy/network
carriers are much more important, as their hub operations enable them to serve long-haul destinations
that are not profitable with origin-destination traffic alone. The share of low-cost/charter carriers in thismarket is still low, but that may change should new low-cost business models successfully evolve.

70%
60%
50%
40%
30%
20%
10%
0%
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Share of segment in number ofscheduled flights

Figure 2.1. Legacy/ network carriers still important in intra-EU flights despite growth of low-cost segment4

UK low-cost

Low-cost 8 EU countries

UK legacy/ network

Legacy/ network 8 EU countries

Source: OAG

Hubs allow network carriers to combine local and transfer demand to create route density.
Network carriers combine different origin-destination flows on a single route using their hubs as
consolidation points, which facilitate efficient transfers between different flights. Hubs are ‘factories’ tocreate route density. In general, hubs add value for an airline through beyond-market access and theability to fill planes and achieve a break-even load factor by carrying transfer traffic as well as origindestination (OD) traffic. Hence, by supplementing local demand with transfer traffic, the hub operationsof network carriers allow airports to grow their network of frequently served destinations far beyond
what the local OD-market would be able to support (Airports Commission 2013b).
Hub operations also generate ‘hub premiums’ in the local market for the hub carrier (Button 2002;
Gillen & Morrison 2005). The hub premium may reflect the ability to charge higher prices for passengers
that are willing to pay for flexible departure times as hubbing permits more frequent departures on the4

Legacy/ network carriers have been defined as the (former) flag carriers of each EU country. For aggregate
shares for 8 EU countries, the number of intra-EU flights departing from the UK, Ireland, Spain, Germany,
Italy, Belgium, the Netherlands and France has been used.

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2. AIRLINE BUSINESS MODELS AND SEGMENTS – 21routes served. In addition, hub premiums may reflect the higher cost of running a busy airport or the
scarcity rents at capacity constrained airports.
By differentiating their service levels and using the differences in willingness to pay/ time
sensitivity, network carriers are able to achieve a mix of business and leisure travellers on their flights.
As a rule of the thumb, network/legacy carriers carry 30% business passengers, which generate 60% of
their revenues. This means that leisure traffic still constitutes a considerable part of their revenues andtraffic and is essential to make their operations profitable. The same holds true for belly-hold freighttraffic to some extent: on long-haul flights, belly-hold cargo can make the difference between a profitable
and a non-profitable operation.
Hubs provide local consumers with a much wider set of directly and frequently served destinations
than would be possible based on local origin-destination demand alone. As such, hubs allow
metropolitan regions to enhance the accessibility of the region and lower time costs for local consumers.
This is in particular important for time-sensitive business passengers.
Hence, hubs are not goals in themselves but a means to optimize society’s global accessibility.
Hence, the key question is whether one large hub operation at Heathrow facilitated by expansion of
Heathrow would deliver more economic gains to UK society in terms of better connectivity and morecompetition than developments following an expansion of Gatwick, taking into account future changes in
the aviation market.
Local traffic is more defendable than transfer traffic and the hub carrier in London has a uniqueposition.
Local OD traffic is much more commercially defendable than connecting traffic using the hub, as
connecting traffic can often be served via a number of competing airline hub networks. In contrast, thelocal passenger has fewer alternatives and thus is likely to have a higher willingness to pay for services
departing the airport5. In this respect, London’s hub carrier, British Airways, is in the unique position ofoperating out the largest OD market in the world. This reduces its need to attract price sensitive transfer
passenger to fill its planes and allows it to operate at very high frequencies to its largest markets,
especially New York.
Peak-hour capacity is important for competitive position of hubs.
Among the many variables that influence the competitive position of hubs6, a highly reliable peakhour capacity is among the most important factors. By the nature of their operating model, network
carriers have to concentrate their flights and operations as much as possible in time and space by meansof a wave-system structure at a single hub airport. Such as wave-system structure ideally entails anairline schedule that connects all incoming flights at the hub to all outgoing flights within a reasonable
time window (Airports Commission 2013b; Bootsma 1997). This requires a high throughput capacity perhour. At major European hub airports such as Frankfurt, Paris Charles de Gaulle and Amsterdam, therespective hub carriers can use more than three runways at the same time, which delivers peak hourcapacities of over 120 movements per hour.

5

In its demand model, the Airports Commission considered different price elasticities for OD versus transfer
passengers. In addition, Amsterdam, Frankfurt, Paris CDG and Dubai have been included as competing hubs.

6

Size and strength of the local market, geographical location, minimum connecting time, peak-hour capacity,reliability of peak-hour capacity, bilateral traffic rights, strength of the home carrier(s)EXPANDING AIRPORT CAPACITY: COMPETITION AND CONNECTIVITY © OECD 2014

22 – 2. AIRLINE BUSINESS MODELS AND SEGMENTS

A strong local market supports connectivity
With 88 movements an hour at Heathrow and a relatively limited slot share in the total number ofslots compared to hub carriers at other European hub airports7, British Airways is not able to operate afully-fledged wave-system structure at Heathrow. As a result, the hub performance of Heathrow in termsof connections is poorer than that of most airports of similar catchment area size (Figure 2.2). The still
impressive network (both long-haul and short-haul) is mainly supported by Heathrow’s large and strong
local OD market.
This is not to say that the London airports system as a whole has a low connectivity performance.
Taking the direct long-haul flights of all London airports together, London is still the best directly
connected metropolitan area in Europe. Many lower yield flights tend to ‘spill-over’ to the other London
airports. Yet, relative to its catchment area, London’s long-haul network is only slightly smaller than
expected when compared to other large metropolitan areas with an airline hub.
Figure 2.2. Paris enjoys a similar number of long-haul connections to London despite a smaller catchment
area: number of unique long-haul connections versus the size of the local market within 100 km range for
hub airports in Europe.

Note: Horizontal axis: gross domestic product produced in a radius of 100 km of the airport or city centre.
Source: OAG; SEO catchment area database; long-haul destinations: destinations >3450km

7

52% in the total number of scheduled flights in 2013 as reported by OAG.

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2. AIRLINE BUSINESS MODELS AND SEGMENTS – 23

Home-based hub carrier dominant at most hub airports.
The network is only able to benefit from a high peak-hour capacity at the hub airport when it holds
the majority of the slots in the peaks. At most of the major hub airports around the world, the hub carrier
dominates the hub airports in terms of slot share.
British Airways dominates Heathrow’s hub function8, but to a lesser extent than legacy carriers atcompeting hubs elsewhere in Europe. The relatively low slot share of British Airways should be seen in
an historical context. In the bilateral era (before liberalization of the intra-EU market), the UK
government usually designated multiple carriers in the bilateral air service agreements. This means that
British Airways was left with 35% of the capacity on the routes covered by the bilateral and 15% was
taken up by other UK carriers, in contrast to the flag carriers of other UK countries that generally held
50% of the international capacity. In addition, BA’s UK domestic network is smaller than that of the flag
carriers in for example France and Germany. The flag carriers of those countries could top up their 50%
share of capacity at the national airport under bilateral agreements with a significant amount of domestic
traffic. Finally, foreign carriers have always exercised the great majority of traffic rights to London
allocated in bilateral agreements because of the strength of the London market. In other European
countries, this was not always the case, leading to a more dominant position of the flag carriers of thosecountries in their home airports.
The only way to expand the hub operations at Heathrow is by buying slots from other airlines, as far
as they are willing to sell them, or by taking-over other airlines (e.g. bmi).
Hub-and-spoke operations incentivise network carriers to concentrate the network on a single location.
The nature of hub-and-spoke networks gives airlines a strong incentive to concentrate the network
at a single location: the number of connected city pairs via the hub (and thus the potential to generateconnecting traffic) rises exponentially as more flights are added to the network. In other words, one large
hub delivers more connections via the hub and more potential to attract transfer traffic than two hubs half
the size.
However, a clear advantage in the O&D market, capacity constraints or limits imposed by bilateral
air service agreements (more broadly the ‘aero-political environment’) may warrant deviation from thesingle hub solution (Burghouwt 2014)9. Deviating from the single hub solution means a loss ofconnectivity and thus reduction in the network economies associated with the hub-and-spoke system10.
Hub carrier British Airways operates about 10% of its flights as stand-alone operations and these are outof Gatwick, supported by the large local (leisure) demand base.
Home-based hub carrier ‘capture’.
The business model of the legacy network carrier makes it relatively captive to its home baseairport. The connectivity between flights necessary for achieving route density, sunk costs, aero-politicalconstraints and the lack of large-scale airport capacity elsewhere in Europe ties the hub carriers to their
8

About 50% of the passengers of British Airways and its partners within the Oneworld-alliance are transfer
passengers (Airports Commission 2013b, p. 50).

9‘Points’ and output restrictions defined in bilateral air service agreements may limit a hub carrier in its
operations to certain destinations, whereas opportunities may exist from a secondary hub.

10

We will come back to the single hub and multihub discussion when discussion airline driving factors in
Chapter 4.

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24 – 2. AIRLINE BUSINESS MODELS AND SEGMENTS

hubs. Switching hub operations between airports is unlikely, in particular with regards to long-haul
flights. Dependency on a single hub airport is somewhat smaller for short-haul flights, given the larger
local traffic volumes and absence of aero-political constraints for domestic and European traffic, whichmakes it more feasible to operate stand-alone short-haul, point-to-point flights out of alternative airports.
Network carrier business model under pressure.
European legacy network carriers face difficult times. Since liberalization of the European market,
network carriers have experienced a rise in (low-cost) competition with their short-haul feeder networks(Burghouwt et al. 2014). Since the early 2000s, also competition on long-haul flights has been growing.
As a consequence, fares and revenues have declined substantially since the 1990s.
In the short-haul market, low-cost carriers have not only generated new demand but have also
cannibalized network carriers’ market shares and brought down fare levels. However, short haul feeder
routes are more or less indispensable for network carriers, because they contribute to the volume needed
to support their profitable intercontinental network. Hence, European legacy network carriers search forways to reduce the costs of their short-haul network, by reducing frills and labour costs, but also by using
low-cost (subsidiary) carriers to operate part of their short-haul feeder network. Iberia Express andTransavia are examples of the feeder role low-cost subsidiaries play for Iberia and KLM respectively.
Yet, reduction of costs by setting up low-cost subsidiaries is not easy to realize, as the many failed
attempts of networks carriers have shown (e.g. Go, Buzz, Snowflake).
In the long-haul market, a new generation network carriers from the Middle East and Turkey has
gained considerable market share at the expense of the European legacy network carriers (Copenhagen
Economics 2012; Grosche & Klophaus 2013).
London’s connecting market is heavily contested.
In the transfer market at Heathrow, competition is fierce: on 85% of routes offered between city
pairs with a transfer at Heathrow, hub carrier British Airways and partners face competition from at least
one other hub. This is because capacity constraints force the airline to focus on the largest markets,
markets in which most other hub carriers also provide connections. This number of contested connecting
markets is among the highest of all European hubs and contrasts sharply with Paris CDG (72%),
Amsterdam (71%), Madrid (65%) and Helsinki (50%). The heavy competition in the connecting market
is counterbalanced by a very large local OD market.
Will new aircraft technology undermine the hub-and-spoke network model?
It is frequently argued that the introduction of a new generation of aircraft (Boeing 787 and Airbus
A350) may further undermine the position of the European network carrier. These efficient long-haulaircraft with their lower operating costs will allow competing carriers (either point-to-point or network)
to bypass the European hub airports, as more OD-markets can be served directly.
Although a certain level of hub-bypassing may indeed take place, the actual impact of new aircraft
technology will be much more nuanced. First, the number of OD-markets that can be served with a direct
service will remain limited, compared to the vast number of markets with little OD-demand that needvia-the-hub services to be connected. Secondly, the European hub carriers will also be able to use newaircraft technology in order to serve more secondary destinations in a profitable way. In other words,
new aircraft technology is likely to result in both a reinforcement of hub systems as well as more hubbypassing.

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2. AIRLINE BUSINESS MODELS AND SEGMENTS – 25

2.3

Other legacy/ network carriers

Hub carrier partners within the Oneworld alliance.
Hub carrier partners within the Oneworld alliance (such as American Airlines, Iberia, Finnair)
operate the network model as described in the previous section. However, they operate out of their own,
non-UK home base. Nevertheless, they will try to concentrate their networks at Heathrow in order tomaximize connectivity with flights operated by other Oneworld airlines to achieve route density
advantages themselves. Apart from certain short-haul flights, which have sufficient OD demand forstand-alone service, to Gatwick and City airports for example, Oneworld airlines will aim to concentrate
network growth at Heathrow.
Figure 2.3 shows that the Oneworld alliance partners indeed operate the majority of their flights out
of Heathrow, with hybrid low-cost/ leisure carrier Air Berlin as the main exception.

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Source: OAG

easyJetRyanair
Wizz Air
Norwegian Air Shuttle
germanwings

Homebased hubcarrier+partners
Non-homebased legacy/network
Homebasedother legacy ptp
Low-cost

100%
18000090%16000080%70%14000060%12000050%

100000

40%
80000

30%
60000

20%
40000

10%
20000

0%
0

Leisure/charter

Number of scheduled departures per weekThomson Airways
Monarch Airlines
Thomas Cook Airlines

Virgin Atlantic Airways
City Jet
Aer Lingus
Lufthansa German Airlines
Swiss/Crossair
SAS Scandinavian Airlines
United Airlines
Air France
KLM-Royal Dutch Airlines
TAP Portugal
Delta Air Lines
Air Canada
Turkish Airlines
Emirates

British Airways
American Airlines
Qatar Airways
Cathay Pacific Airways
Finnair
Qantas Airways
TAM Linhas Aereas
Air Berlin
Royal JordanianJapan Airlines

Share of airport in number of departures

Figure 2.3 % distribution of flights of selected carriers by airline segment at the different London airports

Stansted

Luton

Heathrow

Gatwick

City

Total

2. AIRLINE BUSINESS MODELS AND SEGMENTS – 27

Home-based legacy carriers (outbound).
In London Virgin Atlantic operates flights from both Gatwick and Heathrow. It primarily carries
local traffic from and to London. According to the Airports Commission (2013b), the share of connecting
traffic of Virgin Atlantic at Heathrow is 20%, with 80% being local OD traffic. Virgin’s unit cost andyield levels are both higher than for low-cost carriers.
Non-home based legacy/ network carriers (inbound).
Many network carriers (allied/ non-allied) serving London operate a hub elsewhere in the world andserve the London market as an ‘outstation’. They follow the network model to a larger or smaller extent
as described in the previous section. For non-EU carriers, a main constraint to their potential expansion
in the UK market, apart from any capacity issues, may be the availability of traffic rights to serve theLondon airports.
Legacy network carriers are mainly attracted to London by the size and strength (yield) of the local
OD market, which Gatwick and Heathrow are both well suited to serve. City is very well placed forshort-haul business flights, given its inner city location (Table 3.2). The high-yield profile of Heathrow isanother reason that most of the other legacy/ network carriers operate out of Heathrow, at least as far as
long-haul traffic is concerned.
Nevertheless, a number of legacy network carriers operate out of Gatwick, including Emirates,
Turkish Airlines and Vietnam Airlines. The main reasons are (1) the fact that Heathrow capacity
shortages prevent them from starting operations or growing their operations further and (2) theavailability of a large catchment area for leisure traffic (3) substantially lower airport charges and (4) insome cases constraints in bilateral air service agreements. Future growth in inbound leisure demand as aresult of the quickly growing middle class in Asia may increase the attractiveness of Gatwick for
inbound network carriers from Asia.
The characteristics of Stansted and Luton do not meet the user requirements of most of legacy/
network carriers, although Stansted does have the facilities to serve legacy carriers. The longer landsideaccess times would require them to accept much lower fares and achieve a much lower cost base,comparable to the point-to-point low-cost carriers. In addition, the longer access times from London city
centre make Stansted and Luton less attractive for business passengers11. In addition, runway length at
Luton currently does not allow for long-haul operations with wide-body aircraft.

2.4

Low-cost carriers

The importance of low-cost carriers for the UK market.
The role of the low-cost segment for providing connectivity in the London airports system and in
the UK as a whole should not be underestimated. In Europe, the low-cost model was pioneered by
Ryanair in Ireland and the UK in the 1990s. During these years, the low-cost business model did nothave any significant market share in Europe apart from the UK and Ireland. A small group of low-costcarriers now account for over 30% of the short-haul scheduled market from and to the UK within
11This is not to say that low-cost, point-to-point carriers as such are not attractive to business passengers: agrowing share of business passengers use low-cost carriers on short-haul trips as they value the core
proposition of low-cost carriers once they are familiar with the product (high value-price ratio and reliability).

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28 – 2. AIRLINE BUSINESS MODELS AND SEGMENTS

Europe. This is above the EU average and substantially more than the share in a number of other EU
countries including Germany, the Netherlands and France (Figure 2.4). Within the UK, 37% of the seatcapacity was provided by low-cost carriers in 2012 (Dobruszkes 2013). Not only is the UK’s low-costconnectivity increasingly relevant for leisure trips and passengers visiting family and relatives, but also
to business passengers.
Figure 2.4 Share of low-cost flights in total number of flights is particularly high in the UK, Ireland, Spainand Italy

Low-cost share in number of flights

45%
40%
35%
30%
25%
20%
15%
10%
5%

UK

IrelandSpain

Germany

Belgium

Netherlands

Franceaverage EU

Source: OAG; SEO analysis; Note: intra-EU flights

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0%

Italy

12

Low-cost carrier growth has had different effects on the welfare of UK consumers. Low-fares havestimulated the market and created a group of travellers that would otherwise not have travelled by air.
Low-cost carriers have brought down fares for existing travellers. It is generally acknowledged that thepresence of a low-cost carrier is one of the most important determinants of fare levels. Furthermore, lowcost carriers have established numerous new services to new, short-haul destinations from the UK
airports. Finally, since low-cost carriers tend to be more footloose and dynamic, they have stimulatedcompetition between airports in the UK in the market for airline services.
Short-haul low-cost carriers.
Although there is no single low-cost carrier model (Klophaus 2012; Mason & Morrison 2008), lowcost carriers generally focus on short-haul, point-to-point destinations and strive for profit maximization
on each route. If the flight is not profitable, they exchange the route or even give up the airport, for a
12

For the purpose of a consistent comparison over the years, the EU area covers “EU15+2”: Belgium, Germany,
Denmark, Finland, France, Greece, Ireland, Italy, Luxemburg, Netherlands, Austria, Portugal, Spain, United
Kingdom Sweden+ Norway and Switzerland. A conservative selection of low-cost carriers has been used, of
which EasyJet, Ryanair, Vueling and Norwegian are the most important. A wider selection of low-costcarriers will result in larger low-cost shares.

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2. AIRLINE BUSINESS MODELS AND SEGMENTS – 29

more profitable one. This makes them much more footloose and independent of any airport than network
carriers, which have to consider the impact of each route on their overall network profitability. In
addition, the focus on intra-European operations (and consequent lack of aero-political constraints)13 as
well as lower sunk costs further contributes to their freedom to reconfigure operations. Annual route
churn and the seasonality of the connections offered are considerably higher than those of the legacy/
network carriers.
Being able to operate at lowest cost relative to its competitors is crucial for the success of a low-costcarrier. To win market share and create new markets their major tool is to offer lower fares on theseroutes than competitors. Both the use of underserved, secondary airports as well as low fares enables thecarriers to create new markets, generate new market demand (market stimulation), expand the catchment
area by exchanging longer access times for lower fares (catchment area expansion) and gain market sharefrom incumbent carriers (cannibalization). Keeping fares low, means competing at the lowest costpossible. Especially on short haul routes the cost per seat/mile of a point-to-point carrier can be 30-50%
lower than the operating cost of a legacy carrier at the same route.
Operations and services are completely dedicated to reaching the lowest cost possible on every linkof the operating process. This means high productivity by efficient use of airplanes and fast aircraft
turnarounds, operating from uncongested secondary airports with lower landing fees, and lower cost of
staff with less services on the ground (no busses, no bridges) and in the aircraft. For additional services
passengers have to pay (unbundling).
Low-cost airlines mainly focus on leisure passenger markets, which are more price-sensitive andaccept longer access and egress times in return for lower fares. By focusing on trips from London toEuropean cities with very low fares, they created new and fast growing markets.
Long-haul low-cost airlines.
The low-cost business model is especially competitive on short-haul flights. Here, the efficiency
gains through maximising aircraft utilization and cost advantages of operating out of secondary airports
are highest. On long-haul routes low-cost carriers have to compete with already long established network
carriers. The conventional view is that this is far more difficult than on short-haul routes because theefficiency gains that can be achieved are much smaller. Aircraft on long-haul routes already up to operate
20 hours a day. Furthermore, the possibilities for reducing frills (seat pitch, catering, entertainment, etc.)
and labour costs on long-haul flights are more limited (Francis et al. 2007; Morrell 2008; Wensveen andLeick 2009). Cross-subsidization of economy fares with the premium fares becomes impossible in asingle class cabin. Finally, the infrastructure of many secondary airports that host low-cost flights is notsuitable for long-haul flights. The main opportunity for long-haul low-cost operations lies in lower
labour costs and the use of a new generation, fuel efficient aircraft (Boeing 787 and Airbus A350).
The common opinion among experts is that the long-haul low-cost network will be initiallyrestricted to destinations with sufficient volume to set up direct flights. This is supported by the long-haul
low-cost operations of Norwegian Air Shuttle and AirAsia X. The notion that low-cost operations will belimited to ‘thick’ long-haul markets is rooted in the fact that setting up a short-haul network to feed thelong-haul flights is generally considered to result in too much complexity and raise unit costs too high for
low-cost carriers. If long-haul low-cost carriers are to acquire a significant share of the long-haul market,
they will need to feed the long-haul routes with short-haul feeder services, but without jeopardizing
13

This holds true for the majority of the low-cost operations in Europe, although a small share of them is being
operated to destinations outside the common aviation market (e.g. EasyJet to Moscow and Turkey).

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30 – 2. AIRLINE BUSINESS MODELS AND SEGMENTS

aircraft utilization rates or creating network complexity. Norwegian Air Shuttle is trying to develop sucha model through its Oslo, Stockholm, Copenhagen and Gatwick bases, while AirAsia X operates asimilar model out of Kuala Lumpur.
New aircraft technologies, now being introduced in the Boeing 787 and Airbus A350, make itpossible to serve less dense long-haul routes on a profitable basis. These new aircraft are likely toincrease the opportunities for the long-haul low-cost business model.
Low-cost operations in the London airports system.
In the London airports system, low-cost service is concentrated at Gatwick, Luton, Stansted andSouthend. Gatwick is more expensive to operate from, but fits into the business model of low-costcarriers searching for markets that are able to deliver higher yields; carriers such as EasyJet or
Norwegian Air Shuttle. As such, Gatwick is more comparable in terms of low-cost traffic profile toairports such as Orly and Amsterdam than it is to Stansted and Luton. Stansted and Luton are more
attractive for ultra-low-cost carriers such as Ryanair and Wizzair14.
The changing low-cost carrier business model
In the past two decades low-cost carriers realised double-digit growth figures, but this market
appears to be nearing saturation, in particular in the UK (De Wit & Zuidberg 2012; Burghouwt et al.
2014). Growth levels are beginning to reflect generic market growth more and more closely and thepotential for new market generation is diminishing. For this reason low-cost carriers have to look for newmarkets. They increasingly fly longer routes, fly more low frequency routes and fly more routes to theprimary European airports, which gives them access to premium demand. Like the business models of
network carriers, the low-cost business model is becoming increasingly hybrid. Vueling offers
connecting flights through its home base, Barcelona, but without operating a complex wave-system
structure for arrivals and departures. Connecting traffic is not a primary objective for the carrier but auseful addition. In their pursuit of business travellers and higher yields, EasyJet operates from bigger hub
airports with higher premium markets. Even Ryanair is increasingly entering primary airports andtargeting the business passenger15. This may put low-cost carriers potentially in a position to feed hubcarrier long-haul flights.
Low-cost feeding the hub carrier’s long-haul flights?
It is not unthinkable that low-cost carriers will increasingly take over the short-haul flights of
network carriers in the future, a development that may already have started as network carriers are setting
up low-cost subsidiaries to take over part of their short-haul operations (Transavia for Air France-KLM,
Germanwings for Lufthansa, Iberia Express and Vueling for Iberia). Yet, there is essentially a limit to theextent to which this is possible and likely: hub scheduling and baggage transfers involve costs that
undermine the core competitive advantage of low-cost carriers: a simple and cost efficient operation.

14

Few low-cost airlines operate into Heathrow. Exceptions are Vueling and Germanwings. Lufthansa’s low-cost
subsidiary Germanwings operates into Heathrow, after it took over the short-haul services from Lufthansa notstarting or finishing in Frankfurt or Munich.

15

Ryanair announced its BusinessPlus programme in September 2014.

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2. AIRLINE BUSINESS MODELS AND SEGMENTS – 31

2.5

Leisure carriers

Full leisure carriers – also known as charter airlines – focus on point-to-point traffic, mostly as nonscheduled flights that are part of package tours. Until recently they operated mainly in the business-tobusiness (charter) market in which the distribution of seats is dominated by tour operators. Some of thelarge tour operators run their own airlines (Thomson/ TUI, Thomas Cook/ Condor).
Since the liberalization of the EU market at the end of the 1980s, the leisure/ charter business model
has become more hybrid. New distribution models and changing consumer preferences have altered themarket. Helped by the Internet revolution and a growing low-cost offer to holiday destinations,individual travellers increasingly arrange their holiday accommodation and travel separately. Low-costcarriers have gained market share in particular on the Mediterranean leisure market. In response, thelarge leisure airlines nowadays also sell seat only tickets, while others have converted (e.g. Transavia)
themselves into low-cost operators. Some charter airlines have been taken over by network carriers andcompete with low-cost carriers at European feeder destinations (such as Transavia for KLM). In suchcases, their operations are closely connected with the operation of the network carrier at its hub. The
remaining leisure/charter airlines have strongly consolidated over the years, with TUI Travel and Thomas
Cook with their respective airline brands being the main conglomerates.
Because their margins on tickets are very small, most leisure/charter carriers are very sensitive to
airport charges. In the London airport system, leisure/charter traffic is mainly concentrated at Gatwick
and to a lesser extent at Luton and Stansted. Due to runway requirements, long-haul leisure traffic cannot
use Luton, whereas Heathrow is too expensive.

2.6

Cargo operators

Cargo operators are active in three main markets: belly cargo, full freighter (maindeck) andintegrator/ express markets. The focus for air cargo carriers is on high value, light and/ or perishable
goods such as electronics, fast fashion, flowers and pharmaceuticals. Globally, roughly half of all cargovolume is carried on scheduled flights in the belly of wide body aircraft. Scheduled and non-scheduled
full freighter operators and integrators that operate in the 24 hour express parcel market transport theother half of the total air cargo volume.
Belly cargo on intercontinental routes accounts for 10-15% of the total revenues of the average
flight, which may be decisive for route profitability. This cargo segment is concentrated at hub airports
with scheduled intercontinental connections. Although Heathrow does not have room for full freightersand has formal restrictions on full freighter operations, it is still one of the biggest cargo hubs in Europe
because of the belly freight transported. As belly cargo requires the availability of scheduled long-haul,wide body capacity, within the London airports system cargo traffic is concentrated at Heathrow.
Elsewhere in the UK, East Midlands is an important marketplace for cargo. A competitive cargomarketplace means a strong regional cargo market, presence of global forwarders, high quality handlers
and choice of handlers, road feeder services, availability of night capacity and attractive visit costs.
Congestion costs and slot values, the small margins on full freighter services as well as the applicabletraffic distribution rules have resulted in absence of full freighter flights at both Heathrow and Gatwick.
On a European scale, most cargo operators are highly footloose and freight is trucked over long
distances to airports. Full freighter operators mostly concentrate at hub airports or dedicated cargo
airports with a competitive cargo marketplace.

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Integrators such as FedEx, UPS, Danzas and TNT mostly operate in the parcel market and take careof the total door-to-door chain. They run their own planes and prefer airports with sufficient (night) andpeak capacity for their hub operations. They do not need a competitive handling market and presence of
forwarders, as they run their own facilities as stand-alone operations. Because of globalization and online
shopping, it is expected that the share of integrators will increase in the future. Currently, the London
airports have no room integrators hubs due to the lack of peak hour and night capacity (although some
integrator flights operate into the London airports).

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3. THE LONDON AIRPORTS SYSTEM – 33

3. The London airports system

The London aviation market is the largest in the world in terms of passenger numbers. It issegmented over a constellation of different airports. Each shows a clear specialization in terms ofairlines and passengers market segments served. This reflects capacity constraints, geographicallocation and infrastructure characteristics and has evolved over time as the privatized airports develop
in a market oriented regulatory framework.

3.1

The London market

London is the largest OD market in the world.
The London market is the biggest and strongest aviation market in global air transport in terms of
local passenger numbers. In 2013 the total London OD market reached 110 million OD passengers per
year,16 served by six different airports.
The London airport system consists of Heathrow (LHR), Gatwick (LGW), Stansted (STN), Luton(LTN), City (LCY) and Southend (SEN). Although the number of aircraft movements has remained
stable over the last ten years, passenger numbers have grown by 1.5% per annum, mainly due to increasein aircraft’s size (Table 3.1)17.
Table 3.1. Key features of the London airports (2013)
Heathrow

Gatwick

Stansted

Luton

City

Southend

Total

Passenger movements (mln)Absolute
Annual growth (’03-’13)

72.3
1.4%

35.4
1.7%

17.8
-0.5%

9.7
3.6%

3.4
8.7%

1.0

139.7
1.5%

Transfer share
Business share

37%
30%

7%
15%

4%
15%

2%
16%

2%
54%

NA
NA

Freight and mail (x1,000 ton)Absolute
Annual growth (’03-’12)

1,515
1.5%

101
-8.0%

237
1.6%

29
2.4%

0
-

1

1,882
0.7%

Aircraft movements (x1,000)
Absolute
Annual growth (’03-’13)

472
0.2%

251
0.3%

146
-2.4%

96
1.2%

74
3.4%

29

1,068
-0.1%

Scheduled seat capacity (mln)*
Absolute
Annual growth (’03-’13)

92.0
0.6%

41.1
4.2%

21.7
-1.4%

11.8
4.2%

5.3
6.4%

1.3

173.1
1.5%

LCC share
Average delay (mins)

1%
13.6

64%
13.9

99%
9.5

99%
10.8

1%
6.9

92%
NA

VolumeCapacity* Excludes non-scheduled flights
Sources: CAA, OAG

16
17

See Airports Commission (2013), p.59.
Southampton may serve some traffic from the edge of the London metropolitan area but is not considered as aLondon airport here.

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34 – 3. THE LONDON AIRPORTS SYSTEM

The local population is characterized by a very high propensity to fly. The catchment area of the
London airports significantly overlaps when looking solely at access times to the airports (Figure 3.1).
The overlaps are especially pronounced for the Greater London districts, which are also the most densely
populated districts. This means that there is substantial potential for competition between the London
airports, although it is likely to be more limited than the isochrones may suggest as each London airport
offers a different combination of available destinations. Moreover, different passenger segments(business/ leisure; long-haul/ short-haul) value access time differently.
Figure 3.1. Overlap of airport catchment areas with 90 minutes access time

Source: CAA (2011)

Competition for local long-haul passengers is weakest.
Actual competition depends on the extent to which the airports offer services that are a reasonable
substitutes for passengers. Against this background, (Figure 3.2) shows the estimated share of passengers
departing from the London airports that have a reasonable substitute departure airport at their disposal.
Generally speaking, it is the passenger at Luton, Gatwick and City that has most reasonable substitutes interms of destinations offered, whereas at Heathrow and Stansted there are fewer alternatives. At
Heathrow and Gatwick, passengers travelling to short-haul destinations have more choice thanpassengers travelling to long-haul destinations. In particular Heathrow offers a lot of exclusively served
long-haul destinations.

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3. THE LONDON AIRPORTS SYSTEM – 35

Figure 3.2. Estimated share of passengers departing from the London airports with a reasonable alternative
departure airport

Source: SEO catchment area model; 2012 data; Note: includes both direct and indirect travel options; shares do not giveinformation about the absolute size of the passenger flows; transfer passengers are excluded

Long-haul traffic is rather concentrated
As Table 3.2. shows, the majority of the long-haul network is concentrated at Heathrow with 84%
of the scheduled long-haul flights. Heathrow serves over 60% of the scheduled long-haul destinations
exclusively in the local OD-market. Gatwick is the second long-haul airport with 14% of the scheduled
flights. Yet Gatwick’s network scope is relatively large: it served over 50 long-haul destinations in 2013
versus 90 at Heathrow. This reflects an average frequency per destination that is much lower than at
Heathrow.
Table 3.2. Shares of aggregated airline market segments at the London airports by number of flights

Heathrow

Gatwick

City

Stansted

Luton

Total

Long haul

84%

14%

0%

1%

2%

100%

Short haul

39%

29%

9%

15%

9%

100%

Home based hub
carrier + alliancepartners

79%

12%

9%

0%

0%

100%

Legacy PtP carriers

86%

14%

0%

0%

0%

100%

Other non69%
homebased network
carriers
Low-Cost carriers
3%

14%

15%

2%

1%

100%

44%

1%

33%

19%

100%

Leisure/ charter

74%

0%

8%

18%

100%

0%

Source: OAG; note: other non-home-based network carriers are those carriers that do not belong to the Oneworld alliance andoperate a hub outside the UK.

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36 – 3. THE LONDON AIRPORTS SYSTEM

Figure 3.3. Gatwick largest airport in terms of scheduled destinations offered

Number of destinations

250
200
150

Long haul (ICA)
Short haul international

100

Domestic
50
0
LCY

LGW

LHR

LTN

STN

Source: OAG; 3rd week of September 2013TF, 2013.

High-yield traffic is concentrated at Heathrow, lower yield and leisure traffic at Gatwick.
An important difference between the Gatwick and Heathrow market is the fact that the high-yieldsegment, predominately served by legacy carriers, is concentrated at Heathrow, while the lower yield/
leisure segment is more concentrated at Gatwick, mainly served by point-to-point carriers (low-cost andleisure). This is also reflected in the number of business passengers from London’s central business
district that use Heathrow. Carriers such as British Airways, Emirates and Vietnam Airlines also servelong-haul destinations from Gatwick, but these flights are operating in a lower yield segment than thoseat Heathrow. Stansted and Luton serve only 46 long-haul flights a week, nearly exclusively in the pointto-point leisure markets (Caribbean and North Africa). London City airport does not serve long haul
traffic, due to runway restrictions, except for an all business class, narrow body service to New York.
Figure 3.4. Share of airline market segments at the London airports in number of scheduled flights (2013)

Luton
Stansted
City
Gatwick
Heathrow
0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Share in number of scheduled flights
Home based hub carrier + alliance partners Short-haulHome based hub carrier + alliance partners Long-haul

Non homebased network carriers Short-haul

Non homebased network carriers Long-haulLegacy PtP carriers Short-haulLegacy PtP carriers Long-haul

Low-cost carriers Short-haul

Low-cost carriers Long-haul

Leisure/charter carriers Short-haul

Leisure/charter carriers Long-haul

Source: OAG.

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3. THE LONDON AIRPORTS SYSTEM – 37

Short-haul dispersed over the different airports
The short-haul market is reasonably distributed over the London airports in terms of the number offlights. In the short-haul market, Heathrow is, with almost 40% of the scheduled flights, far lessdominant than in the long-haul segment. With 29% scheduled flight share, Gatwick takes a significant
share in this market. The other London airports together take a share of around 33%. However, in thehigher yield segment Heathrow and City are the main airports. With over 600 flights a week executed by
British Airways and other legacy carriers, Gatwick also takes a significant share in the more premium
short haul market. Gatwick dominates the point-to-point low-cost market with 44% of flights andaccounts for 74% of scheduled flights in the leisure/ charter segment. The other London airports, Lutonand Stansted, which account for 24% of scheduled flights in the short haul market, focus nearlyexclusively on the low yield segment served by low cost and leisure/ charter carriers.

3.2

Heathrow

Heathrow operating at full capacity.
Heathrow is by far the largest of the London airports in terms of passenger movements (72.3
million) and the second largest in terms of destinations offered. Aircraft movements only increased by
0.2% per annum over the last decade. Passenger growth was realised with larger aircraft and higher loadfactors. Heathrow also processes the majority of cargo in the London airport system. All freight and mailis carried in the belly hold of passenger aircraft, no main deck cargo capacity is available at Heathrow.
The airport has been heavily congested for years, which is not only reflected in capacity shortages
but also in high average flight delays. The airport’s two runways currently operate at around 99%
capacity for most of the time. Annual air traffic movements are currently restricted to 480 000. Switching
to mixed mode to increase capacity is not allowed. Carriers willing to expand operations at Heathrow
therefore must either purchase very expensive slots from other carriers, take over other airlines (e.g. bmi
by British Airways) or increase the size of their aircraft even further18 Due to restricted runway capacity
there is an imbalance between airside and landside capacity: passenger movements are therefore well
below the terminal capacity of 90 million passengers per annum.
Heathrow is an important transfer point but not a ‘classic’ hub.
Heathrow is the only hub in the London airports system. It has a 37% transfer share, although it is
not a hub in a classic sense. It is the fourth airport in Europe in terms of the number of hub connections
offered (Figure 3.5). However, the transfer share is small compared to the other large but less congested
hubs in Europe, such as Frankfurt and Amsterdam. In addition, its feeder value19 is lower than at
Frankfurt, Amsterdam, Paris CDG, Munich and Istanbul, which indicates a weaker hub operation. British
Airways has the largest hub operation at the airport with many short-haul flights connecting to long-haulintercontinental flights

18

Yet, a number of spare slots is available in the winter season.

19

The number of online, onward connections per arriving flight at the hub.

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38 – 3. THE LONDON AIRPORTS SYSTEM

80 0001670 0001460 0001250 0001040 000830 000620 000

4
2

10 00000Number of hubconnections

18

Frankfurt
Paris Charles de Gaulle
Amsterdam
London Heathrowİstanbul Atatürk
MunichMadrid Barajas
ZürichMoscow
ViennaRome Fiumicino
Helsinki-Vantaa
Brussels
Copenhagen
Lisbon (Mainland)
Oslo-Gardemoen
Düsseldorf
Barcelona
Stockholm-Arlanda
Berlin Tegel
Istanbul Sabiha Gökçen
Moscow
AthensDublinPragueGenèveParis-Orly
London Gatwick

Number of hub connections by inbound flight

Figure 3.5. Heathrow ranks fourth in terms of the number of hub connections offered per week

Hub connectivity

Feeder value

Note: Number of online connections offered via the hub per week, weighted by transfer time and detour time.
Source: ACI Europe & SEO 2014; SEO Netscan.

Peak-hour capacity is lower than at other European hub airports.
As a result of the capacity constraints of the runway system, peak hour capacity is far lower than at
the other European main hubs, which limits the operation of a wave system for arrivals and departuresthat characterizes classic hubs such as Frankfurt and Amsterdam and limits the size of the feeder
network. The share of British Airways in total air traffic is also lower than that of home carriers at theother hubs, although it increased considerably in recent years because of slot and airline acquisitions.
Consequently, Heathrow lags behind the major European hubs in terms of connectivity provided in theconnecting market.
In its Interim Report, the Airports Commission indeed finds that a concentrated airport model (withhub capacity concentrated at one of the London airports) would deliver better connectivity results thanspreading hub capacity over two, two-runway airports (Airports Commission 2013, p. 130). Yet, thedifference is less marked than it would be for other cities in the world because of the large local market,
which also supports high levels of connectivity under a dispersed model.

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3. THE LONDON AIRPORTS SYSTEM – 39

Strong local market.
Heathrow is in a different position than other hubs as, thanks to the big London market for longhaul traffic and a well-functioning slot market, the number of intercontinental destinations is still high.
The secondary slot market at Heathrow has enabled airlines with a high willingness to pay to buy scarce
Heathrow slots and use them for long-haul flights. The yields that can be achieved at Heathrow arehigher than at other London airports: according to the Airports Commission (2013, p.62), airlines
operating out of Heathrow in 2012 earned 21 US cents per passenger mile on average versus 15 and 10
cents at Stansted and Gatwick respectively.
Table 3.3. Heathrow compared with other European hubs in terms of capacity and connectivity (2013)

Source: ACI Europe & SEO (2014); OAG; SEO Netscan; individual airport data
Note: feeder value indicates the number of onward hub connections per arriving flight

Expansion could raise capacity up to 700-740 000 movements per year.
A third runway at Heathrow, or extending the northern runway to the west, could raise yearly
capacity up to 740 000 (HAL) or 700 000 (HHL) movements20 respectively at a peak hour capacity of
128 movements. That would make Heathrow comparable to the potential capacity of Frankfurt and Paris
CDG. A new 6th terminal at a new land extension could raise the potential capacity of the airport to 120
million passengers per annum.
Increase in charges.
Aero charges at Heathrow are expected to rise should the airport be allowed to expand as the projectwill ultimately be financed by the airlines.
In case of Heathrow expansion, airlines would be less sensitive to a rise of charges than they would
be in the case of an equivalent increase at Gatwick because Heathrow is predominantly used by legacy
carriers, which are less sensitive to costs than low-cost carriers. The airport handles a relatively large
share of business passengers (30%). These passengers are less sensitive to the relatively high airfares at
20

The difference in annual capacity between the two options is due to operational constraints during the earlymorning and late evening period under the Heathrow HUB option that would have to be introduced to provide
local communities with respite.

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40 – 3. THE LONDON AIRPORTS SYSTEM

Heathrow, which are partly the result of the capacity shortage at the airport. And as most long-haul
flights are offered from Heathrow, business passengers often have no other choice than to use the airport.
Heathrow is less attractive to low-cost and leisure carriers due to congestion, the high slot prices andhigh airport charges. The same holds true for regional carriers.
At the moment, airlines at Heathrow extract considerable scarcity rents due to excess demand at
Heathrow and price-capping of airport charges, charging fares substantially higher than marginal costs.

3.3

Gatwick

Gatwick is the busiest point-to-point airport in Europe.
Gatwick is the second largest UK airport and the busiest point-to-point airport in Europe and usedby many legacy network carriers as well as low-cost carriers. It offers more destinations than any of theother London airports and is particularly strong on short-haul routes.
The main carrier by scheduled seat capacity is EasyJet. The airport has a large share of low-cost
capacity (64%), which can be explained by the large catchment area for leisure traffic, excellent surface
accessibility21 including to Central London/ Westminster and availability and price of capacity in relation
to Heathrow. In 2013, 85% of its passengers travelled for leisure purposes. Gatwick contributes
significantly to the short-haul connectivity (international and domestic) of the London airports system: it
accounts for about one third of the short-haul flights in the London airports system. Yields that can beachieved at Gatwick are lower than at Heathrow but airline costs to operate out of Gatwick aresubstantially lower.
British Airways is the second largest carrier. Its operation at Gatwick is more focused on pricesensitive OD passengers, providing direct competition to EasyJet and other low cost carriers. The carrieralso has a significant long-haul operation at the airport, competing with Virgin Atlantic in the long-haulleisure market. With 93% local OD traffic and 7% transfer traffic, the airport mostly serves the OD
market, and some interlining passengers22.
Gatwick nearing capacity limits as a single runway airport.
Due to the capacity constraints of a single runway system, flight movements showed hardly any
growth over the last decade. Just like at Heathrow, growth in passenger movements was achieved mainlyby the operation of larger aircraft.
With a maximum peak hour capacity of around 55 movements an hour, Gatwick has already themost intensively used single runway system in the world. Without a second runway, this number canhardly increase. However, modest future growth in aircraft movements and passengers is expected to bepossible using off-peak hours and larger aircraft. Due to noise constraints, extension of operating hours is
not a realistic option. By optimizing the taxiways system and the construction of a midfield pier the
airport can be developed for 45 million passengers without a second runway compared to 35 million
today.

21

2.5 million people within 30 minute travel time (Gatwick Airport Limited 2013).

22

British Airways tried to implement a split hub operation at Heathrow and Gatwick in the second half of the
1990s but abandoned the Gatwick hub in 2001 as it was not profitable.

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3. THE LONDON AIRPORTS SYSTEM – 41

However, the current hourly capacity of a single runway system is far too small for significant
growth of aircraft movements or setting up a hub with a fully-fledged wave system structure. Only
investment in a second runway can raise capacity substantially, to around 560 000 movements per year
and 98 movements an hour. Such capacity expansion in combination with additional terminal capacity
would give the necessary room for significant growth of point-to-point operations at the airport. The
growth in peak-hour capacity could potentially be used for some form of hub operation (see chapter 5).
Increase in charges.
Aero charges at Gatwick are expected to rise should the airport be allowed to expand as the projectwill be ultimately financed by the airlines.
In case of Gatwick expansion, airlines would be more sensitive to a rise of charges than they would
be in the case of an equivalent increase at Heathrow as Gatwick has a large share of low-cost airlines,
which are more cost-sensitive than legacy carriers. Compared to Heathrow, the airport handles a larger
share of leisure passengers. These passengers are highly sensitive to the higher fares that would result if
higher aero charges are passed on to the consumer.

3.4

Stansted, Luton and Southend: low-cost, point-to-point leisure services

Stansted
Stansted is the fourth airport in the UK by passenger numbers and is predominantly used by lowcost carriers. After Gatwick, it is the main low-cost airport in the London airports system. The twolargest European low cost carriers Ryanair and EasyJet are its main operators. As a result, most of its
connections are intra-European. Annual passenger growth at the airport has been negative over the last
decade. This was mainly due to Ryanair’s decision to decrease capacity at the airport after the airport
raised its charges. The airport and Ryanair recently reached a deal in which Ryanair promised to grow its
capacity at Stansted in exchange for lower airport charges and better facilities. The same holds true for
EasyJet.
Luton
Luton, although around half the size of Stansted, runs a similar low-cost operation. The airport
functions as a main operational base of EasyJet, but is also used by other low cost carriers such as
Ryanair and Wizzair, resulting in a large share of leisure travellers (84%) and a network which isprimarily focused on Europe. The airport also handles a large number of business jets. Aircraft
movements increased slightly over the last decade with 1.2% per annum.
Southend
Until the end of the 1970’s Southend was the third London airport. Currently it is the smallest of the
London airports, handling just under 1 million passengers in 2013. EasyJet started operations at the
airport in 2012, which resulted in a large influx of passengers. As a result most scheduled capacity isoffered by EasyJet (92%). The airport operator expects passenger numbers to increase to 2 million in
2020.

3.5

City: point-to-point business services

City airport is located close to London’s financial district and is therefore the preferred airport for
many time-sensitive business travellers, which is reflected by the high share of business travellers using

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42 – 3. THE LONDON AIRPORTS SYSTEM

the airport (54%). The airport primarily operates routes to the rest of the UK and Northern Europe. Dueto its short runway, steep glide slope and noise restrictions, it is primarily used by smaller aircraft.
Passenger growth has been substantial over the past decade, averaging 8.7% per annum. This growth wasrealised by both an increase in flight movements and the operation of larger aircraft.

3.6

Future capacity requirements

We note that the London airports together currently have 40-50% spare capacity available, mainly at
Stansted, Luton and Southend, with early morning capacity being most scarce at Luton and Stansted23.
By 2040 there will be hardly any capacity left in the London airport system, however, as Figure 3.6
shows (Airports Commission 2013).
Figure 3.6. By 2040, London airports are predicted to be full

Source: Airports Commission 2013, p. 11

3.7

23

Key conclusions on the London airports system

The London aviation market is segmented over a constellation of different airports. The
capacity constraints at various airports, the market oriented approach of its (privatized) airports
and the different geographical and infrastructure characteristics of the airports have over time
resulted in a clear specialization of the London airports in terms of airline and passenger market
segments.



Heathrow serves the long haul premium market of business travellers, although in absoluteterms most of its passengers travel for leisure. It serves many unique destinations for which
consumers do not have a reasonable alternative. Heathrow is the only hub in the system, but its
lack of peak-hour capacity and the relatively limited slot share of the hub carrier does not allow
BA to operate a fully-fledged wave-system for arrivals and departures, resulting in aconnectivity deficit relative to hub airports of a similar size elsewhere. This is in particularimportant as BA competes in the transfer market at Heathrow with hubs inside and outside
Europe, such as Frankfurt, Amsterdam, Paris CDG, Dubai, Istanbul and Atlanta.

Gatwick serves the long haul market as well, with a focus on leisure/ lower yielding traffic. Its
strength is mainly in the short-haul international and domestic market in which it provides athird of London’s connections. Low-cost has a major share at Gatwick, delivering low airfares
to UK consumers. The airport is well located: it is the best-connected London airport by surface
access: 2.5 million people live within 30 minutes travel time and the airport has an extensive
rail network.

Reports/Statistics on Stansted, Luton and City from Airport Coordination Ltd..

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3. THE LONDON AIRPORTS SYSTEM – 43

The short haul market is more segmented. The lower yield segment is primarily served from
Gatwick, Luton, Southend and Stansted. Low-cost and leisure carriers have only very limited
operations at Heathrow and none at City.



Competition between airports is strongest in the short-haul leisure segment. The offer of shorthaul services is more equally distributed over the airports and leisure passengers are prepared toaccept longer airport access times due to their lower travel time sensitivity. Competition
between the London airports in the local OD-market is smallest in the long-haul businesssegment, for which Heathrow is the only alternative for 60% of the long-haul destinations. In
contrast, in the long-haul transfer market of Heathrow, airport competition levels are very high.



In absolute terms, most passengers have reasonable alternative departure airports to fly to theshort-haul destination served by Heathrow and Gatwick. Given the structure of the catchment
area, growth of air service supply at Gatwick will most likely result in more airline competition
with services provided at Heathrow and City and to a lesser extent with those provided at
Stansted and Luton. Increase in supply at Heathrow will most likely affect competition with
Gatwick, City and Luton and to a lesser extent with Stansted, as far as the short-haul market isconcerned.

Overall, we conclude that the airports in the London market show distinct profiles in terms of
the airline and passenger market segments they serve. The low cost /point-to-point segment has
the best opportunities for growth, given the flexibility of carriers to switch between London
airports, the lower sensitivity for access time of non-business passengers and the fact that
Stansted, Luton and Southend are together operating at only 40-50% of their total capacity. The
market for the hub operator and legacy carriers is mostly restricted to Heathrow. The same
holds true for cargo, which requires the long-haul belly capacity at Heathrow. The hub carrier
and partners are captive to Heathrow in the current capacity environment. Gatwick plays animportant role for short-haul, point-to-point connectivity and also has a share in the long-haulmarket, mainly in the lower yield and leisure passenger segment.

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4. RELEVANT FACTORS IN AIRPORT CHOICE BY AIRLINES AND OTHER USERS – 45

4. Relevant factors in airport choice for airlines and other users

In the context of the available airport capacity in the South East of the UK, airline supply
characteristics and the options for airport capacity expansion at either Heathrow or Gatwick, thequestion now is what factors will drive airline behaviour. This section brings forward market size
factors, market access factors, advantages of spatial concentration, visit costs and airport service levels
as important airline choice variables. It also explores the positive feedback mechanism that exists
between increased connectivity, passenger choices and airline behaviour.

4.1

Factors driving airline behaviour

The decision of an airline to start or expand routes from an airport, new or existing depends on the
result of the following drivers:
Table 4.1. Factors driving airline behaviour
Drivers

Question

Demand and yieldpotential

Is there sufficient demand and willingness to pay in the market to achieve a breakeven yield?

Advantages of spatialconcentration

When more than one airport is available in the conurbation, which airport(s) to use?

Market accessIs it possible to get access to this market?

Airport capacity

Is there sufficient capacity for (growth of) the operation?

Visit costs

What will be the cost of serving this market?

Service level and facilities Are the services and facilities at the airport suitable for the intended operation?

Airline network decisions are a function of profitability.
It is important to note that in the end these questions are part of the airline’s financial equation
regarding network development, as the airline will try to maximize returns on the invested capital.
Network growth in the face of airline losses is seen in the industry as far too risky, no matter the strategic
reasons for network expansion. Network growth is a function of profitability.

4.2

Market size

Size and characteristics of the OD-market.
The attractiveness of a market to an airline depends first and foremost on the volume and the size ofthe local market and in the second place on the yield that can be achieved.
Size and strength of local OD market crucial for point-to-point carriers.
A point-to-point carrier (be it low-cost or full-service) almost fully depends on the OD market. In
contrast, a hub carrier can extend the home market by adding transfer passengers. A large local market

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gives the hub carrier a largely captive and stable passenger demand base that is prepared to pay a
premium for the scope of direct, non-stop services out of the hub airport (Starkie 2006). In contrast,
transfer traffic is much more price elastic and footloose in terms of the choice of alternative routings. It
therefore delivers lower yields than local OD traffic. A large local OD market eases the hub carrier’sroute density problem. According to Levine (2009), the strength of the local market is the single mostimportant hub airport success factor, because a large local market eases the route density problem. In thisrespect, London is a special case: it has the biggest local OD market in the world, which in theory should
allow a hub carrier to establish a hub operation at one of the London airports that outperforms other
European hubs. For the same reason, it is a very attractive market for point-to-point carriers.
Expected future growth in particular the inbound leisure market from Asia may increase the scopefor long-haul services in the London market. An important question is if this would give Asian carriers acompetitive advantage to European carriers, as inbound leisure travellers from Asia may show apreference for Asian carriers.
Business and leisure passengers value travel time differently.
A related question is how far passengers are willing to travel over land to and from the airport.
Business travellers generally dislike long distances, not only with respect to the travel time involved but
also with respect to the reliability of landside access times (Koster et al. 2011). Hence for airlines
focusing particularly on the business segment, the catchment area is relatively small and so the airport
location relative to the main population and economic centres is critical. With easy and fast access toCentral London, Heathrow, Gatwick and City Airports are more attractive for business travellers, than
Stansted, Luton and Southend, which lie further from the city centre.
Leisure passengers are generally willing to travel longer distances over land in return for lower
fares. As a consequence, the catchment area of leisure/charter and low-cost carriers is larger and thelocation of the airport is less critical than for other types of passenger. As a result, low-cost carriers are
more willing to use Stansted or Luton than legacy carriers. Passengers evaluate the time and monetary
costs involved of the entire trip chain (e.g. Lieshout 2012) in choosing airports and airlines. This meansthat carriers can compensate longer surface access times/costs with lower airfares. For package tour
passengers, airport and airline choice is less dependent on the passenger as the tour operator influences oreven determines the departure airport and the airfare may not be a visible element in the package.
We note that the neat segmentation of business/time sensitive/price inelastic and leisure/price elastic
passengers is much more nuanced in practice. The price inelastic business passenger is mostly found inlarger companies, whereas the price sensitivity for small companies is on average higher. But also theother way around, certain leisure passengers and travellers visiting family or relatives may be priceinelastic and time sensitive (for example, they may be premium leisure passengers or have no otheralternative transport options/ no schedule flexibility).

Yield to achieve and competition level.
Heathrow is a higher yield market than Gatwick, Luton and Stansted. For this reason, it is thepreferred airport for many legacy network carriers and legacy point-to-point carriers that operate at
higher cost levels. The same holds true for the ultra-high yield market at London City Airport. For low
cost and leisure carriers, which focus on high volume markets with lower fares at competing costs, theairport choice is more determined by visit cost and less critical from the yield point of view. Hence, lowcost and leisure carriers prefer Gatwick, Luton and Stansted at which airport charges for a typical lowcost turnaround are much lower than at Heathrow. Given scarcity in airport capacity and congestion costs

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at Gatwick, the airport is less attractive for ultra-low-cost carriers such as Ryanair and Wizzair. As
capacity expansion at Gatwick may increase charges, the attractiveness of Stansted and Luton in the lowcost segment may increase as far as visit cost levels are concerned.
Legacy carriers are less able to adopt a low-cost, low-fare strategy, and have to focus more
predominantly on Heathrow where they can generate higher yields. As costs for operating at Heathrow
are high, reflecting the high opportunity costs of the slots, regional carriers and regional operations havebeen gradually pushed out of Heathrow.
Recently, legacy network carriers have started to establish their own low-cost subsidiaries in orderto bring down costs and compete effectively with low-cost carriers. Examples are Iberia Express,
Transavia (KLM) and Germanwings (Lufthansa). This could eventually result in a larger (indirect) roleof the legacy carriers at in particular Gatwick and to a lesser extent Stansted and Luton. Yet, the question
is if these strategies will be successful in the long-run due to the strong position of labour unions.

Cargo marketplace.
Airfreight depends on a local ecosystem of cargo airlines, storage facilities, forwarders and groundhandlers.
Cargo operators need a “cargo marketplace” of dedicated cargo facilities freight forwarders, groundhandling companies and road transport companies located at and around the airport. There is a mutual
relationship between the forwarders, cargo facility operators, ground handling companies and cargo
operators. Cargo airlines favour airports with a strong presence of global forwarders (Kupfer 2012), a
competitive ground handling market and dedicated cargo facilities. Forwarders favour airports with astrong cargo network and the flexibility to use both main-deck and belly hold cargo. There is a strong
tendency to concentrate cargo.
For belly-hold cargo the schedule of passenger flights is important. Full freighter operators preferairports with the ability to operate 24 hours a day, so for them night capacity is important.
The integrator segment does not use London as a hub.
The integrator segment (including operators such as DHL, UPS and Fedex) does not currently use
any of the London airports as a hub (but they do fly some services to Stansted). They run stand-alone
operations and do not need the kind of cargo marketplace described above. The airport is mainly selected
for sufficient night capacity needed for 24 hour a day operation.

4.3

Advantages of spatial concentration of the network

Concentration brings cost advantages.
In particular legacy airlines can achieve cost advantages by concentrating their network on a single
operational base. This is because of (1) less complex aircraft scheduling, maintenance and crew planning,(2) lower average costs for handling, maintenance and other service and (3) more intensive use of capital(Reynolds-Feighan 2001; Burghouwt 2007). Hence, all other market and capacity factors being equal,
airlines have a cost incentive to concentrate their operational base at a single location and avoid split
operations.

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Non-linear supply reactions or the “S-curve” effect.
Scheduled airlines that are able to achieve the largest frequency share on a route may benefit from adisproportionately large market share on that route (De Neufville 2005). Similarly, airlines operating aroute with a low share in frequency of service may experience a disproportionate drop in market share.
This “S-curve effect” triggers legacy airlines to increase frequencies and concentrate services at a single
airport. The “S-curve effect” is in particular present where legacy carriers compete and weaker when
low-cost competition is involved, as in the latter case price is a more important factor in competition thanfrequency (Figure 4.1) i1llustrates the S-curve for US city-pair markets, confirming that airlines with the
majority of flights in a market benefit from a disproportionate market share of passengers.
Figure 4.1. The S-curve effect of frequency and market share

Source: InterVISTAS 2013.

Diminishing returns on frequency growth at the route level.
Following the S-curve phenomenon, further increases in already high frequency levels will not
result in further increases in substantial market share or additional market generation. Hence, market
saturation can be a reason for airlines to develop new routes or additional frequencies at other airports on
a parallel route (De Neufville 2000).

Network economies: the single hub versus the multi-hub solution.
Hubs are factories to create route density.
The network economies associated with hub-and-spoke operations stimulate hub carriers toconcentrate network growth on a single hub in each region. Hubbing advantages become
disproportionally larger with a growing network (Burghouwt 2014). For the hub carrier, operating a
concentrated hub-and-spoke system is one of the main elements of its business concept. It needs a basewhere it can operate such a system, which implies concentrations of as many flights as possible at one
single airport. This enables the hub carrier to create maximum hub connectivity and to attract additional
connecting traffic, higher load factors to its flights, more frequencies on existing destinations and/ or todevelop new destinations. Hubs allow network carriers to create route density. Further growth of the
network of the hub carrier will result in a non-linear increase of connections via the hub, triggering again
more demand, higher load factors, new destinations and higher frequencies. Similar considerations may
exist for alliance partners of the hub-carrier (American Airlines and Cathay Pacific in the London

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context). Also for them, operating flights at the alliance partner’s hub has this additional value as theirflights connect to the flights of the hub carrier.
A single hub is optimal from a theoretical point of view.
For the hub carrier, deviating from the single hub solution is not optimal, at least not from atheoretical point of view. Each additional hub in the network reduces economies of density. Furthermore,
additional hubs bring cost in dealing with complexity (Duedden 2006; Wojahn 2001a&b). History showsthat many secondary hubs24 (e.g. Milan Malpensa, Raleigh-Durham, Barcelona, Gatwick) have beenclosed by their respective hub carriers (Redondi et al. 2012).
Reasons to deviate from the single hub solution.
The theoretical arguments for the single hub solution ‘do not leave room for the kind of multi-hub
networks that many major carriers operate’ as Wojahn states (2001, p. 268). Indeed, various European
carriers operate multi-hub systems in the same geographical region, including Air France-KLM at Paris
CDG and Amsterdam and the Lufthansa Group at Frankfurt, Munich, Zurich, Brussels and Vienna.
There are reasons for hub airlines to deviate from the single hub solution in practice. These include theuse of multiple hubs to achieve spatial network coverage, the level of demand on certain routes, capacity
shortages at primary hubs, strategic positioning and entry deterrence and aero-political restrictions thatcan be circumvented by operating out of a secondary hub. Despite major steps in air transport
liberalization, bilateralism still plays a major role in the development of international airline networks.
As a consequence the hub carrier can only benefit from traffic rights accorded under bilateral agreements
if its hub is located in its country of registration and nationality clauses still apply. Continuation of asecondary hub may also be a temporary solution after a merger or take-over but before the airline decides
to rationalize the network.
Specialization in airline multi-hub networks: total market size and local OD demand.
An exploratory study of multi-hub systems operated by European airlines shows that only in large
markets can hub carriers serve long-haul destinations from multiple hubs, while smaller markets are only
served from a single hub (Burghouwt 2014). Within the Air France-KLM system, a clear specialization
pattern between Amsterdam and Paris CDG is present: large long-haul destinations are served from bothhubs (e.g. New York, Singapore), whereas smaller long-haul destinations are exclusively served from asingle hub in the system, with the choice of hub dependent on which hub has the advantage in the local
OD market. Generally speaking, Paris CDG has a larger local OD market than Amsterdam and thus
serves most of the smaller destinations. However, on a number of smaller destinations, the local marketof Amsterdam is larger than in Paris, resulting in unique service of destinations such as Manila andJakarta from Amsterdam. The unique position of Amsterdam in certain markets relates to historical ties
(Paramaribo, Jakarta, Curacao) or specific economic relations (Manila, West-Africa). In addition, aeropolitical constraints influence the allocation of long-haul destinations over the hubs.
Multi-hub airline strategies versus multiple hubs in the same metropolitan area.
In sum, the multiplier effect of hubbing stimulates hub carriers to concentrate hub operations on asingle airport. There can, however, be reasons to deviate from the single hub solution, in particular in24

By secondary hubs we mean that the hub is smaller in size that the primary hub in the system. BA’s operation
at Gatwick during the 1990s was always smaller than at Heathrow, both in terms of European as well asintercontinental flights.

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large markets or where clear advantages for secondary hubs in the local OD market exist. This is not to
say that carriers would favour a split hub operation over two airports within the same metropolitan area.
In airport systems with multiple large airports (New York, Paris, Moscow, Tokyo), we see that airports
perform different roles, either hosting competing hub carriers, or comprising one hub airport
complemented with one or more airports hosting point-to-point services.

4.4

Market access and airport capacity

Availability of sufficient route density and attractive yields are of little use if a carrier cannot enter
the market. Various factors determine market access.

Access to slots at convenient times.
The availability of large peak hour capacity is particularly relevant for the hub carrier and its
alliance partners and other carriers wishing to connect to its hub-and-spoke system. The schedulerequirements of other legacy carriers are mainly determined by the wave systems at their own hubs. But
also on short-haul, point-to-point destinations, most legacy carriers prefer flying in the morning andevening peaks in order to serve the premium/ business market. Carriers that are less dependent on peak
operations (point-to-point low-cost, leisure, full freighters) may prefer airports, which allow for lower
peak-hour capacities.
Passengers dislike waiting at the hub; therefore hub carriers try to minimize transfer time at the
airport. Minimum connecting time is a crucial decision factor in the transfer market, so hubs competewith each other on minimum connecting time. In this sense it is closely coupled with peak hour capacity.
The future minimum connecting time at Gatwick or Heathrow in case of capacity expansion will be an
important factor for its competitive position in the connecting market.

Night capacity.
The availability of night time capacity may be relevant for all airlines. However for some airlines,
opening hours during the night, early morning and late evening are more critical than for others.
Generally speaking, night capacity is important for home-based carriers, which in case of delayed
arriving flights, must have the possibility to land at their home base. Most airports deliver night opening
for these exceptions. Early morning capacity might be relevant for the hub airline, in case it has aconnecting wave between early morning long haul arrivals (particularly from Asia before 6 am) andsubsequent departures into Europe.
Availability of early morning and late evening slots important for low-cost and leisure.
Early morning and late evening capacity is important for home based leisure and low cost carriers.
To optimize aircraft utilization they need to make two or three returns a day. For this reason home based
leisure and low-cost carriers prefer bases and destinations with extended opening hours. Anotherargument is found on the demand side: contrary to business travellers these holiday makers are more
willing to accept late and early arrivals/ departures in return for lower fares. Finally, there is the potentialcargo integrator segment, which today does not use any of the London airports as a base.

Traffic rights.
A large market and sufficient capacity are of little use if traffic rights for operating international
flights are restricted, making it difficult to provide direct routes. Hence, the portfolio of traffic rights is a

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critical and indispensable success factor for hub airports, especially with regard to the intercontinental
market. For the liberalized European and North-American markets, traffic rights are not an issue in the
UK context. However, they are of some relevance to long-haul connections to Africa, Latin America, theMiddle East and Asia (to a larger or smaller extent)25.

4.5

Visit costs

Visit costs are all costs the airline directly or indirectly faces when providing a flight to a particular
airport. There may be differences in visit costs between distinct types of airlines, but such differences
mostly reflect differences in service of the airport to the airlines. Visit costs include landing charges,
parking charges, ground handling fees, passenger charges, security charges, fuel costs, government taxes
and air traffic management costs.

Airport charges.
City and Heathrow have highest charges per passenger.
Figures 4.2 and 4.3 compare the charges per turnaround for three representative aircraft types for the
London airports. Heathrow and City are clearly the most expensive airports to operate from. Gatwick,
Luton and Stansted are roughly at the same level for all aircraft types, with Stansted charging the lowest
fees on short-haul. Note that this figure does not include any specific airline-airport arrangements: a large
share of the Gatwick and Stansted fees are negotiated in airline-airport contracts and will differ from theofficial charges.
Figure 4.2. Airport charges per turnaround

Airport charges per turnaround(including LTO, passenger (+PRM),
security and parking charges)£10,000£9,000£8,000£7,000London Heathrow£6,000London Gatwick£5,000£4,000London Stansted£3,000London Luton£2,000London City

£1,000£Embraer 195

Airbus A320200

Boeing 777200ER

Source: IATA airport charges manual; analysis SEO; Notes: LTO are landing and take-off charges; PRM charges are charges tofund needs for people with reduced mobility. Assumptions have been made on OD share (100%), representative parking time foreach aircraft type and time of day/season.

25

See also Airports Commission Interim Report, section 5.9

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Airport charges per passenger(including LTO, passenger(+PRM), security and parking
charges)Figure 4.3. Airport charges per departing passenger
£,45
£,40
£,35
£,30
£,25
£,20
£,15
£,10
£,5
£-

London Heathrow
London Gatwick
London Stansted
London Luton
London City
Embraer 195

Airbus A320200

Boeing 777200ER

Source: IATA airport charges manual; analysis SEO. Notes: LTO are landing and take-off charges; PRM charges are charges tofund needs for people with reduced mobility. Assumptions have been made on OD share (100%), representative parking time foreach aircraft type and time of day/season. Charges are per departing passenger.

Relevance of visit costs to airlines.
Although airport visit costs generally represent a limited share of an airline’s total operational costs,
this share can be more significant for short haul flights as well as for low fare airlines. Typical examplesof airlines with high shares of visit costs are Ryanair and EasyJet. These high shares do not result from
relatively higher airport charges, but rather from minimising other operating costs, such as staff costs.
Visit costs may heavily affect carriers with a large share of flights at an airport with high charges.
Airport expansion will result in an increase in charges.
Expansion is expected to result in increased charges at the expanded airport. As discussed in theprevious chapter, airlines would be less sensitive to a rise of charges at Heathrow than in the case of anequivalent increase at Gatwick. This is because Heathrow is predominantly used by legacy carriers,
which are less cost-sensitive that low-cost and leisure carriers. Heathrow airport handles a relatively
large share of business passengers (30%), who are less sensitive to the relatively high airfares forservices using Heathrow. Heathrow is less attractive to low cost and leisure carriers due to congestion,
the high slot prices and high airport charges. The same holds true for regional carriers. At the same time,
if passed through to the passenger, higher aero charges may negatively affect the potential in the transfer
segment given the high cross-price elasticity of connecting passengers.
In the case of Gatwick expansion, airlines would be more sensitive to a rise of charges than theywould be in the case of an equivalent increase at Heathrow because Gatwick has a large share of low-costairlines, which are more cost-sensitive than legacy carriers. Compared to Heathrow, the airport handles alarger share of leisure passengers. These passengers are more sensitive to higher fares, assuming airport
charges would be passed on to the consumer.
How will higher airport charges impact fares and airline behaviour?
As the competitive pressure on hub airlines increases, the factor of competitive visit costs becomes
more important. Airport visit costs (and increases in these costs) cannot always be passed on to

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passengers in the form of higher airfares, at least not in the short-run. Particularly if high competitionlevels exist with a high (substitution) price elasticity, these charges are absorbed by the airlines. Withlimited profit margins, the effects of an increase in airport charges can be significant.
Absorption of (increased) airport charges is likely to be a short-term reaction, while in the longer
run in a competitive market airlines are expected to pass on higher cost to the passengers if all airlines
are faced with the cost increase. In the long run, in the absence of alternatives, higher airport charges
may either affect the connectivity on offer at a hub airport or negatively influence the airline’s bottom
line. Increases in airport charges (even if small) that are passed on to the passenger will influence
behaviour of the marginal passenger, in particular in the price-elastic transfer passengers and in local OD
markets where the passenger has a choice between different departure airports. Alternatively, the carrier
may – as a result of declining load factors – decide to reduce its supply in the market (smaller aircraft,
lower frequencies).
However, at a constrained airport such as Heathrow with substantial excess demand and airline
scarcity rents (see also section 5.5), the impact is different: increases in airport charges result in a fall inairline scarcity rents/ airline margins, instead of a rise in fare levels. This fall will further be accentuatedif capacity would be increased, because competition will drive down fares to a (higher) cost base.
The fact that yields at Heathrow (25 US cents per passenger mile in 2012) are substantially higher
than at Gatwick (10 US cents per passenger mile in 2012) (Airports Commission 2013, p.62) may be areflection of the larger excess demand and airline economic rents at Heathrow.

Airport-airline contracts.
We observe that the cost of access to airport infrastructure is increasingly subject to airport-airline
contracts in the current liberalized European aviation market where airport competition is intensifying
and airports are increasingly acting as commercial enterprises (Copenhagen Economics 2012; Starkie2012). In particular in the UK, airport-airline contracts play an important role where airports attract newservices by offering airlines discounted charges in return for long term commercial guarantees from theairlines. Under its current airport license, the UK regulator has allowed Gatwick to negotiate contracts
with individual airlines. Airport-airline contracts are likely to increase competition between airports inthe market for airline services.

Slot prices.
Slot trading has brought the opportunity costs of slots into the airline’s financial equations.
Heathrow and Gatwick airports have the most developed and transparent secondary slot trading
market in Europe, which has brought the opportunity costs of slots into the airlines’ financial equations(Bush 2014). Slots are traded for substantial amounts of money, particularly Heathrow peak-slots,
reflecting high-yield opportunities at the airport. The capacity constraints at both airports have driven up
slot prices. Slots traded are generally used for longer haul and higher capacity flights, which indicatesthat secondary slot trading creates a situation in which slots at the congested airports are used by thosecarriers with the highest willingness to pay. Buying carriers are generally the hub carrier and other large
network carriers, which are able to utilize slots better in their networks, not only on the flights using theslots but also on the connections they enable. Selling airlines tend to be financially weak network
airlines, regional point-to-point airlines and carriers that have an alternative elsewhere in the airports
system.

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In addition to capacity constraints that tend to crowd-out short-haul, low-yield flights over time, thesecondary market further stimulates a concentration of long haul, high capacity traffic at congested
airports.
Impacts on slot prices are probably modest if capacity is added gradually.
Expanding Heathrow or Gatwick could put downward pressure on slot prices in the secondary
market, in particular if large amounts of slots become available in the same season. Such a development
could also jeopardize the liquidity of the market before the capacity becomes available, as airlines will
not buy expensive slots when they know slots will become available through the regular allocation
procedure at no cost. If capacity were to be added only gradually, effects on slot prices and the secondary
market would be smaller.

Sunk costs
Sunk costs are an important factor in anchoring carriers to an airport. Sunk costs include
investments in special passenger facilities, offices, maintenance facilities, brand building and staff.
Especially for home based carriers that already operate from the airport for many years, it can be abarrier to exit the market at that airport and start up an operation elsewhere. This explains the general
reluctance of low-cost carriers to invest in their own facilities at airports. Legacy carriers have in contrast
relatively recently invested in Terminal 2 and Terminal 5 at Heathrow, which may inhibit them frommoving their operations elsewhere. The same applies to non-UK carriers that would like to start-up a
substantial operation at one of the London airports: they would have to invest heavily in branding to
attract passengers.

4.6

Congestion costs

Airport congestion, in the form of delays, holding times and lengthy taxiing times, increases
operating costs for airlines. In particular low-cost carriers try to avoid congested airports in order toachieve a cost efficient operation. Delays at Gatwick and Heathrow are expected to decrease after adding
capacity26.

4.7

Airport facilities and service level

Availability of maintenance facilities
Home carriers may heavily invest in maintenance facilities at the home base. These investments also
involve substantial sunk costs in facilities and staff, which may be an important reason for staying at an
airport. For non-home based carriers facilities for line maintenance are important, but not a decisive
factor in airport choice.

26

As a rule of thumb, airports with six runways or more can be expected to suffer from inefficiencies in the
airport operation (long taxiing times, runway crossings etc.). However, with expansion of Heathrow or
Gatwick, is simple threshold is still far away.

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Service level and passenger experience.
Dissatisfiers and satisfiers.
For keeping and attracting passengers, airlines compete with services that improve the passenger
experience. The airport plays an important role in providing these services. The most important factors
are those dissatisfiers that drive passengers to use other airports. Mostly they concern walking distances
and waiting times for security, immigration and luggage. Satisfiers also contribute to a better passenger
experience. They are mostly related to the layout of terminals, shopping facilities, atmosphere and space,cleanliness, friendliness of staff and availability of dedicated lounges. Together they determine the imageof an airport and its perceived value by passengers.
We note that part of the service level is actually outside the airport’s sphere of influence, as thegovernment largely determines service factors such as border controls.

4.8

Summary of driving factors

Table 4.2 summarizes the key factors that are likely to be affect the behaviour of airlines within the
London airport system. The importance of the factors that drive the airline’s choice of airport and its
subsequent network development at the airport are different for each of the airline segments. Some ofthese factors can be categorized as ‘deterrence’ factors: they incentivize airlines to search for substituteairports, such as high airport charges. The majority of them are ‘pull’ factors: they incentivize airlines toconcentrate services at a certain airport, such as a large OD market or high sunk costs

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Table 4.2 Key driving factors for airline behaviour by airline segment
Hub Carrier andpartners

Driving factors

Other
Legacy*LCC Point-toPoint

LeisureDedicated Full
Freighter

Integrators

Market size
OD-market size

+++

+++

++

+++

+++

+

Yield and competition level

+++

+++

+

+

+

+

Cargo marketplace

+++

++

+++

+

+++

++

+

+++

++

++

Network concentration
advantages
Cost advantages
Non-linear supply effects

+

+

+++

Network economies
Market access
Availability of (peak hour)capacity

+++

+

++

Night capacity

+

+++

++

++

+++

+

++

+++

+++

++

++

++

Airport charges and taxes ¶

+

+

+++

+++

+++

++

Slot prices ¶

+

+

+++

+++

+++

++

Sunk costs

+++

++

+

+

+

++

Maintenance facilities

+++

+

+

Service level

++

++

+

+

+

Congestion costs ¶Traffic rights

+++
++

Costs

Airport facilities and service
level

Key: +++ very important for airport choice, ++ important in airport.
Notes: * Including non-home based network carriers and homebased legacy point-to-point carriers; deterrence factors have beenmarked with ¶.

4.9

Positive feedback loop between connectivity growth and user behaviour

The mutual relationship between airport connectivity and passenger/ user behaviour.
The connectivity offered in the London airports system interacts with passenger behaviour.
According to Hansen (1995), there is a positive feedback mechanism between airport choice and network
development by the airline and passenger/ user behaviour. Growth in the network on offer will decrease
travel costs for consumers/ users due to higher frequencies, more destinations and more competition/
lower fares. Hence, the airport will attract more demand from and to its hinterland, which increases the

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likelihood of further connectivity growth by the airline. In other words, growth of the network at a
certain airport within a multi-airport system tends to reinforce itself over time. This results in a dominantrole for a single airport within the multi-airport system, until capacity constraints arise and/or the OD
market reaches a certain level (as in the case of London).
Availability, air fares, access time, frequency and loyalty schemes most important choice variables.
Regarding passenger choice itself, many empirical studies have identified the most importantvariables. Generally speaking, the literature brings forward the availability of destinations, ticket price,access time, frequency and loyalty programmes as the most important choice variables. Their importancediffers by passenger segment. We have summarized the factors for aviation users below. The passenger
choice factors need to be considered in order to assess the competitive outcome of different airline
response scenarios in the next chapter.
Table 4.3. Key factors in choices made by air transport users

Segment

Determining factors

Business

Frequency (availability of flights)
Elapsed travel time (access, flight and connecting)Reliability of landside access
AirfareShopping facilities
Frequent Flyer Programmes
Corporate contracts
Airport/ airline awareness and past use

LeisureAirfareAvailability of flights
Shopping facilities
Reliable land access
Elapsed travel time (access, flight, connecting)
Airport/ airline awareness and past use

Visiting Friends and Relatives

Similar to leisure segment
Destination is critical
Frequent Flyer Programmes
Airport awareness and past use

Cargo forwarders

Scheduled (long haul) belly capacity(Scheduled) full freighter capacity
Available handling facilities
Competitive cargo markets (fares)
Reliable land access

4.10

Performance of the London airports with respect to the airline drivers

London airports perform differently on driving factors
Because of the differences in infrastructure, location, traffic and regulatory environment, theLondon airports perform differently on airport driving factors. These differences partly explain (but arealso the result of) the current specialization within the system as described in chapter 3.

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Table 4.4 Each London airport performs differently with respect to the factors driving airline behaviour

Driving factors

Heathrow

Gatwick

City

Stansted

Luton

Catchment area size:
number of inhabitants
within 100km

18.5 mln

16.9 mln

17.6 mln

16.7 mln

17.7 mln

Yield

High

Low

High

Low

Low

Cargo marketplace

StrongWeak

AbsentWeak

Very weak

Relevance of costadvantages of network
concentration

Strong for homecarriers

Strong for homecarriers

Weak(nichemarket)Present forhome carriers

Present forhomecarriers

Relevance of non-linear
supply effects

StrongMediumStrongWeak

Weak

Relevance of network
economies related to
hub-and-spoke network

Strong for hub
carrier

Weak

AbsentAbsentAbsentDeclared (peak hour)capacity

88/hr.

55/hr.

N.a.

29/hr.

42/hr.

Night capacity

3 250(mvt limit S15)
4 080
(noise limit S14)

11 200(mvt limit S15)
6 200
(noise limit S15)

0

7 000
(mvt limit S15)
4 650
(noise limit S15)

Regulatedby noisecontours

Congestion costs

High

High

High

Low

Low

Relevance of availabilityof traffic rights

Very relevant

Relevant

Not
relevant

Small relevance

Small
relevance

Airport charges and
taxes

High

Low

High

Low

Low

Slot prices

High

Low

N.a.

N.a.

N.a.

Sunk costs

Very relevant forhome based
carriers

Very relevant forhome based
carriers

Relevant for home based carriers

Maintenance facilities

UnclearUnclearVery limited

UnclearUnclearService level

High

High

High

MediumMediumMarket size

Network concentration
advantages

Market access

Costs

Airport facilities andservice level

Source: Airport Coordination Limited.

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Capacity expansion will alter performance of London airports regarding the driving
factors
Adding capacity to either Heathrow or Gatwick will change the (relative) performance of the
facilities with respect to the following drivers:
Declared peak-hour capacity at Gatwick and Heathrow would rise to about 98 and 128
movements per hour respectively

Airport charges will rise following Heathrow or Gatwick expansion. At capacity constrained
airports with substantial excess demand, capacity expansion will result in a decrease in airline
scarcity rents and thus lower fares for the consumer. Higher charges will lead to a further fall inscarcity rents/ airline margins.

Capacity expansion will have a moderating effect on the increase in slot prices or may evenlead to lower slot prices, depending how capacity is added to the market.

Congestion costs will most likely go down, as both airports will not operate at full capacity
anymore.



Adding capacity at both Gatwick and Heathrow will give more opportunities to develop or
strengthen the cargo marketplace, not least because of the expected increase in belly holdfreight capacity.

4.11

Key conclusions on factors that drive airline and user behaviour

A multitude of factors drive airline behaviour in the London airport system but impacts on the financial
performance of airlines matter most.
Airlines try to maximize their financial return on invested capital and airline managers have to meetfinancial targets. Growth of the network is generally only possible when financial targets are being met.
Proposed growth in the context of corporate losses is seen as far too risky. Network growth is a functionof profitability. Underlying factors that drive airline network behaviour and financial performance
include size of the local market, airport visit costs, congestion costs, advantages of spatial concentration,
service levels and access to capacity.
Size and strength of the local market is of primary importance for all airline segments.
For all airline market segments, the size and strength (yield) of the local market is of primary
importance. The London local OD market is the largest and strongest in the world. Non-home based
network carriers, low-cost carriers, leisure/ charter carriers and home based legacy point-to-point carriers
fully depend on the size and strength of the local OD market from and to London. Only the hub carrier
British Airways and partners are able to really ‘extend’ the local market by carrying transfer traffic via
their hub. Also other carriers can benefit from the hub carrier’s connectivity as passengers may interline
or self-hub although these self-connect and interline volumes are relatively limited. Due to the specificuser requirements of the hub carrier (peak-hour capacity, minimum connecting time) and characteristics
of its business model, the hub carrier is currently captive to the Heathrow location. This might change if
Gatwick were to increase its capacity.

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Low-cost, leisure and cargo traffic is sensitive to visit and congestion costs.
Low-cost, leisure carriers and all-cargo airlines are relatively sensitive to visit and congestion costs.
For them, the charges are a considerable part of their operating costs.
For passenger carriers, the lumpiness of seat capacity leverages elasticity in relation to airport
charges. Traffic rights, peak-hour capacity, short connecting times and network concentration are lessrelevant to their airport choice behaviour. Stansted, Luton and Gatwick are in particular attractive to lowcost and leisure carriers given their much lower charges levels than City and Heathrow. The large local
market for leisure traffic and excellent surface access makes Gatwick in particular attractive for leisure/charter carriers, higher end low-cost carriers and legacy point-to-point airlines.
Expansion of Gatwick or Heathrow will ultimately result in an increase in charges at the expanded
airport.
Airport charges are likely to increase following Gatwick or Heathrow expansion. At capacityconstrained airports with substantial excess demand, expansion will result in a decrease in airline scarcity
rents, with potentially lower fares for consumers. Fare levels may not decline overall, however, as thelevel of aero charges will go up at the same time. On balance Airlines are unlikely to increase airfares.
Instead, higher charges will lead to a fall in scarcity rents/ airline margins. In other words, the increase inairport charges following expansion leads to a further reduction in airline margins, as competition brings
fares closer to a (higher) cost base.
Carriers tend to spatially concentrate network growth.
The scale and scope economies of network concentration, the “S-curve” effect and network
economies are important reasons why carriers tend to concentrate network growth on a single location in
the same city. These factors are stronger for legacy carriers than for low-cost carriers and stronger for
growing markets than for maturing markets. Network economies are the reason hub carriers concentrate
their network at a single airport.
There are reasons for some network carriers to have more than one hub.
From a theoretical point of view, network carriers prefer a single hub network. However, there canbe reasons for a hub carrier to deviate from the single hub solution. Adding capacity to Gatwick mightallow for a secondary hub operation by a competing hub carrier. A split hub operation by British
Airways at both Heathrow and Gatwick is not likely to be an efficient network solution.
Capacity expansion will change the performance of the London airports with respect to drivers of airline
behaviour.
Adding capacity to either Heathrow or Gatwick will change the (relative) performance of the
airports in the London system. These changes relate primarily to (peak-) hour capacity, visit costs/
charges, congestion costs, slot prices, service levels and the cargo marketplace.

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5. Airline response for different capacity expansion options

Based on an analysis of the London airports system, key drivers for airline behaviour and theoptions for capacity expansion at either Gatwick or Heathrow, we have developed 6 different airline
responses. The airline responses have different impacts on the structure of traffic in the London airport
system as well as on connectivity, competition and reduction of airline rents to the benefit of theconsumer.

5.1

Introduction

This chapter addresses the potential implications of capacity increases at Heathrow and Gatwick on
airline behaviour. Firstly, we address the extent to which airline behaviour may change, taking into
consideration the driving factors for each airline segment and the characteristics of London airports. We
do this by elaborating a number of airline response scenarios for each airport capacity expansion option.
Secondly, we qualitatively assess the potential effects on connectivity, competition and reduction ofairline economic rents to the benefit of the aviation users.

5.2

Airline responses

We foresee the following airline responses for the London airports system:
Heathrow expansion optionAirline response 1:

Hub carrier growth at Heathrow, point-to-point growth at Gatwick.

Airline response 2:

Two hub operations at Heathrow, point-to-point growth at Gatwick.

Airline response 3:

Point-to-point growth at Heathrow and Gatwick, Heathrow remains
network hub.

Gatwick expansion optionAirline response 4:

Hub operation at Heathrow and a competing hub operation at
Gatwick.

Airline response 5:

Partnerships – Gatwick becomes a low-cost “gateway”, Heathrowremains the network hub.

Airline response 6:

Gatwick point-to-point growth, Heathrow remains the network hub.

For each airline response, we will discuss the assumed airline responses to capacity expansion, as
well as first notions on the possible implications for connectivity, competition and consumers. The
airline responses will then be assessed for competitive impacts.

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62 – 5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONSRegulatory framework.
The CAA is responsible for the economic regulation of UK airports. It has recently published adraft policy statement on the regulation of new airport capacity27 that sets out the principles that it will
apply under any future regulatory regime as follows.
“Risk should be allocated to those parties who can best manage it. This approach is most
likely to protect users' interests (that is, the interests of passengers and those with abeneficial interest in freight), by producing the lowest expected out-turn cost (as incentives
to manage the cost are maintained) and by revealing information about parties' valuation ofrisk”.

“Commercial negotiations should be encouraged. If a commercial agreement to underpin
expansion is possible, it could incentivise efficiency, ensure that risks are borne by thosebest able to manage them, reveal information about parties' valuation of risk, and avoid any
unnecessary regulatory intervention”.

“Capacity can be paid for both before and after it opens. Whether pre-funding arises
through the natural operation of a market or through regulatory intervention, some measureof pre-funding may be in users' interests”.

Whilst the draft policy statement does not constitute a detailed regulatory regime, the Airports
Commission does not consider that the application of the above principles would be likely to create
significantly different impacts in any of the scenarios for airline industry development.
In developing the airline responses, we thus assume no substantial changes in the regulatory
framework for the London airports in the future.
The airline industry is highly dynamic.
The airline industry is dynamic and has shown remarkable changes since the start of EU
liberalization in the early 1990s, including the rise of new business models and adaptation of existing
ones. As it will take another 10 years before new runway capacity becomes available in the London
airports system28, the possibility of future developments in the aviation market that result in paradigm
shifts in airline business models should be taken into account.
Likelihood of each airline response depends on how the aviation sector will develop.
Therefore, in this chapter we describe the possible airline responses and how they would impact onconnectivity, competition and reduction of airline rents to the benefit of aviation users. As not all airline
responses are likely in every macro-economic future, we also need to assess the likelihood of the airline
responses. Chapter 6 discusses the likelihood of the airline responses by considering a number ofpossible developments in airline business models and macro-economic conditions, based on the Airports
Commission scenarios.

27

http://www.caa.co.uk/docs/2888/CAP1221.pdf

28

The proposals submitted to the Airports Commission by GAL, HHL and HAL indicate that it would bepossible to open the second runway at Gatwick in 2025, and either of the two capacity expansion proposals at
Heathrow could be operational in 2026.

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5.3

Expanding Heathrow

Airline response 1: Hub carrier growth at Heathrow, Gatwick point-to-point growth.
A capacity increase at Heathrow implies the construction of a third parallel runway or extension of
the north runway to the west. This could raise yearly capacity to 700-740 000 movements at a peak-hourcapacity of 128 movements per hour. Once the new runway is opened, it will most likely not lead to an
immediate increase of the peak hour capacity, measured in number of hourly aircraft movements.
Stepwise capacity increases are more likely. Currently, terminal and runway capacity is unbalanced.
Terminal 5 and Terminal 2 have led to a significant increase in terminal capacity, while the runway
capacity has been kept unchanged. With the third runway at Heathrow or expanding the north runway to
the west, the two capacity items will become more balanced.
Hub carrier and alliance partners show strong growth.
The ability of the hub carrier to operate a hub-and-spoke system will improve once a third runway isoperational. We would expect the hub carrier to acquire slots through the regular slot allocation
procedure first, before buying slots from incumbents or new entrants. However, when the new capacity
also reaches its limits, the hub carrier and other legacy long haul carriers are likely to be net buyers of
traded slots.
The additional capacity enables the hub carrier to shift the sub-optimal hub-and-spoke system oftoday into a more efficient wave-system with clearly defined arrival and departure waves. Due to scarcity
at Heathrow BA has also allocated 13% of its long haul flight seats to Gatwick. Hence, in this scenario
the current Gatwick flights of the hub carrier, both long and short-haul would move to Heathrow. This
corresponds to some 60 additional flights per day of the hub carrier possible at Heathrow. On top of this,
we would expect the hub carrier to further develop its network at Heathrow. In a maximum scenario of acapacity of 700 000-740 000 movements per year, assuming that capacity will be allocated 50% to newentrants and that British Airways will have a share of 52% in the remaining new slots, this number could
rise to 80-90 hub departures per day.
Another possibility is that British Airways will keep using its Gatwick slots for its own (low cost)
flights as it currently operates a rather profitable short-haul operation out of Gatwick with lower yieldflights, which it may not want to abandon fully. Transfer to a low cost subsidiary/ partner (such as
Vueling) may be an option.
Connectivity growth and the hub carrier’s financial performance.
It is difficult to foresee to what extent the hub carrier will use the additional capacity at Heathrow toincrease frequencies/ capacity in existing markets or focus network growth on new destinations. Bothstrategies enhance connectivity (see section 5.5) on the concept of connectivity) but in different ways andwith different broader economic value. British Airway’s network portfolio in an expanded Heathrow will
track to financials. If expanding capacity in existing markets would be seen as producing greater returns
than developing new markets, then that would be the first order of priority, and vice versa. Which ismost profitable will depend amongst other things on the level of latent demand in the current restricted
capacity environment that cannot be served, as well as the extent to which the high Heathrow
aerocharges can be passed through in the OD and transfer segments.

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64 – 5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONSExpected charges increase impacts on hub performance.
Airport charges will increase because of the costs involved in expanding Heathrow. This increase
will favour high capacity services into the UK domestic airports and will discourage airlines from flying
high frequency, low capacity services to tertiary points in the UK and elsewhere in Europe. For the hub
carrier this means that its feeder network into the UK and the rest of Europe will grow, but without thesame degree of penetration to small cities as at Amsterdam or Frankfurt. Given the severe competition in
the transfer market, it is unlikely that the hub carrier will pass through higher charges to transfer
passengers on existing destinations, as it would face significant declines in market share. A stronger
differentiation in passenger charges (transfer versus OD) than is currently the case at Heathrow might bea way to compensate for the expected stronger effects in the transfer market. All in all, a further increasein charges together with a reduction in airline economic rents at Heathrow may jeopardize developmentof lower yield, short-haul feeder flights at Heathrow.
With respect to the development of new routes, the carrier may focus on routes with relatively highlevels of OD demand, which provide the carrier with more opportunities to pass through higher charges
to its passengers.
Point-to-point legacy, non-home-based network carriers.
Other non-home-based network carriers such as Delta and Emirates are also likely to benefit fromthe increase in capacity at Heathrow and can be expected to grow their network at Heathrow and increase
flights from Heathrow to their own hubs. Also a legacy point-to-point carrier such as Virgin Atlantic canbe expected to increase its slot share. In particular network carriers from Asia may disproportionately
benefit from brand loyalty in their own home market as inbound long-haul traffic is expected to growfaster than outbound traffic. Certain network carriers with a larger share of low yield traffic may
increasingly prefer Gatwick to Heathrow as Heathrow charges are expected to increase.
Low-cost and leisure carriers are not likely to take up Heathrow slots.
There is little expectation that low-cost or leisure carriers will acquire Heathrow slots through thesecondary slot market. Apart from the slots they may acquire through the regular slot allocation
procedure, they may prefer operating at Gatwick, as soon as more capacity becomes available at Gatwick
after a possible migration of the hub carrier and other legacy operations to Heathrow.
Opportunities in the cargo marketplace.
Growth in long-haul belly capacity at Heathrow is expected to further strengthen Heathrow’s role asa cargo marketplace. But it is not likely that the full-freighter segment will flourish at any significant
scale, given its low yield character.
Connectivity impacts.
With implementation of a fully-fledged wave system for arrivals and departures, the number ofconnections via Heathrow and the number of transfer passengers using Heathrow can be expected to
grow considerably. Connections with a transfer at Heathrow could increase substantially, taking into
account the hub multiplier effect (measuring connectivity in terms of number of destinations andfrequencies is outside the scope of the paper and the Airports Commission is looking into these impacts
using its own aviation demand model). This would give Heathrow a stronger position in the connecting
market and strengthen the customer base, allowing it to surpass the threshold for adding a range of newlong haul and short-haul routes. It is, however, difficult to predict exactly what balance the hub carrier

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will strike in the use of additional capacity between increasing capacity (aircraft size/frequencies) on
existing routes and developing new destinations. Non-home-based network carriers will further
contribute to the connectivity growth at Heathrow. Connectivity from/ to the domestic UK airports via
Heathrow may increase, decreasing the role of foreign hub airports such as Amsterdam in the UK
market. At the same time, the high charges at Heathrow will limit the degree of penetration into theEuropean and UK feeder market and this is likely to remain smaller than that of hub airports such as
Frankfurt and Amsterdam29.
Impacts for Gatwick and the other London airports: inbound leisure demand from Asia.
In this scenario, Heathrow expansion results in a cascade effect in the London airport system: thegrowth of the hub operator and partners at Heathrow will free up capacity for non-legacy carriers at
Gatwick or for a (new) British Airways low-cost subsidiary, to which BA is entitled to hand over slots
for free according to the existing slot allocation rules, leading to a more pronounced role of Gatwick as apoint-to-point low-cost and leisure airport. Such a development could relatively weaken the role ofStansted and Luton in this particular market. The expected increase of inbound versus outbound longhaul traffic and growth of leisure demand from Asia may also provide opportunities for non-home based
network carriers and long-haul low-cost carriers at Gatwick as well.
Impact for competition and consumers: better connectivity to the hinterland.
From the point of view of the consumer one can expect a better access through a more extensive
British Airways network to the domestic and European hinterland by air. However, the expected higher
airport charges will discourage high frequency, low capacity feeder flights into Heathrow. The
probability of new long-haul direct flights from UK regional airports will also diminish.
From the point of view of the airlines, the connectivity of the British Airways network and its
alliance partners will improve with regard to intercontinental as well as European routes. Competition
with other hubs in Europe will intensify to the benefit of British Airways and Heathrow. On the other
hand, long-haul non-Oneworld hub carriers from other continents will intensify competition with British
Airways by redirecting lower yield passengers through their own hubs after intensifying their frequencies
of service at Heathrow or Gatwick. BA and Oneworld partners will have a more dominant position, inparticular regarding long-haul flights, further enforced by loyalty programmes and contracts with large
corporations.
Short-haul competition in the local market may increase.
Short-haul competition in the OD market may increase, in particular at Gatwick and City airports as
BA moves some of its flights there to Heathrow. Airlines at Heathrow will face increasing competition
from low-cost carriers at Gatwick.

29

Although some domestic routes may be designated as Public Service Obligations.

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Figure 5.1. Summary of airline response 1: Hub carrier growth at Heathrow, point-to-point growth at
Gatwick.
 Increase in flights
 Decrease in flights

Heathrow

Gatwick

Other London
Airports

Hub carrier and partners







Other non-home-based
network carriers







Point-to-point legacy







Low-costCharter







Cargo







Airline response 2: Two hub operations at Heathrow, point-to-point growth at Gatwick
Competing hub carrier enters the Heathrow market.
A second airline response is the development of a dual, competing hub operation at Heathrow.
Given the exceptional strength of the London OD market and on-going liberalization of aviation markets,a second alliance or non-allied carrier could consolidate at Heathrow by acquiring slots through theregular slot allocation procedure and the secondary slot market or by taking over/ cooperating withcarriers that already have a substantial presence at Heathrow.
Although such a scenario may seem unlikely at first glance, today’s industry gives various examples
of how this could manifest itself. Jet Airways India operates a stand-alone scissor30 hub at Brussels(besides the hub operation of Brussels Airlines) to connect India with the US, using a portfolio of 5th
freedom traffic rights. Hence, the availability of 5th freedom rights from Asia via Heathrow to North
America could be a stimulus for such a hub operation. Etihad is acquiring equity shares in various
airlines around the world to build its global network and generate feeder on endpoints in their own
network. A similar step could be envisaged in the UK market, which provides an opportunity to build up
a network out of Heathrow, backed by a financially strong foreign carrier. The same network
development could be envisaged for Gatwick (see section 5.4). Another possibility could be thetransformation of the business model of an existing long haul, home-based legacy point-to-point carriersuch as Virgin Atlantic into a business model that includes a dedicated short-haul feeder network.
Hub carrier and partners.
The current hub carrier and partners will expand their network along the lines of airline response 1,
albeit to a smaller extent, but the alliance could become less dominant as the second hub carrier takes up
a significant share of the slots.
30

Using 5th freedom rights, Jet Airways flies into Brussels airport from multiple origins in India within a single
time window, using wide-body aircraft. Passengers change planes at Brussels and the aircraft depart within asingle time window to various destinations in North America.

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Other network carriers and point-to-point legacy carriers.
Existing or new non-home-based network carriers will expand long-haul and possibly short-haul
services out of Heathrow. In particular network carriers from Asia may disproportionately benefit frombrand loyalty in their own home market as in the future inbound long-haul traffic is expected to growfaster than outbound traffic.
The new hub operation is likely to be of a smaller size than that of the existing hub carrier but
depending on its scale, the development of a second hub operation may leave less room for othercompeting non-home-based network carriers at Heathrow.
The move into Heathrow would be a risky strategy for the new hub carrier, due to the expected head
to head competition with the incumbent hub carrier, the expected rise in charges as well as the reduction
in airline economic rents following expansion of capacity.
Low-cost and leisure carriers
Low-cost and leisure will develop along the same lines as under airline response 1.
Cargo
Cargo will develop along the same line as under airline response 1
Connectivity impacts and impact on consumers.
From a connectivity perspective, such an airline response seems to be less effective: the sharing ofscarce hub airport capacity between competing airlines will result in a suboptimal level of connectivity
provided via Heathrow because competing hub carriers will not sell connections between each other’s
flights. The sum of connections of two separate hub operations is lower than one single hub operations of
the combined size. Hence the opportunities to achieve sufficient route density for new destinations andfrequencies may be lower than under scenario 1.
On the other hand, a second hub operation at Heathrow will lead to an increase in competition bothin the OD market and transfer market, with more choice and lower fares for the consumer as a resultcompared to airline response 1, depending on the extent to which the network of the two hub carriers
overlaps. The new hub carrier may search for new markets so as to avoid direct head-to-head competition
with the existing hub carrier. This would add to the connectivity profile of London in terms ofdestinations served.
Impacts on Gatwick and the other London airports: capacity at Gatwick unaffected.
The growth of the second hub carrier at Heathrow could well be “autonomous” growth, albeit at asmaller scale than the incumbent hub carrier, thus not involve any migration of capacity from elsewherein the London airports system to Heathrow. This means that the capacity at Gatwick remains relatively
unaffected, although competition to the Gatwick short-haul and long haul services will increase. Hence,no further cascade-effects in the rest of the London airport system are assumed.

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Figure 5.2. Summary of airline response 2: Two hubs at Heathrow, Gatwick point-to-point Increase in flights
 Decrease in flights

Heathrow

Gatwick

Other London
Airports

Hub carrier and partners







Other non-home-based
network carriers







Point-to-point legacy







Low-costCharter







Cargo







Airline response 3: point-to-point growth at Heathrow and Gatwick. Heathrowremains network hub
A third possible airline response following Heathrow expansion is growth of point-to-point traffic at
both Heathrow and Gatwick. This assumes a saturating European low-cost, point-to-point market. As thenumber of short-haul OD-markets that European low-cost carriers can serve is essentially limited, lowcost carriers serve longer routes, ‘thinner’ routes at lower frequency and search for premium traffic at
primary airports. Despite the much higher charges at Heathrow, low-cost airlines establish a significant
operational base at Heathrow to target the premium market, while keeping up their operations at
Gatwick. Furthermore, additional slots are taken up by visiting network carriers and legacy point-to-point
carriers.
Home-based hub carrier and partners: limited growth.
BA and partners will maintain their operations from Heathrow. As the network business model isunder pressure from low-cost carriers on the short-haul market and non-EU network carriers on longhaul, the hub carrier is not able to benefit from the increased capacity and grow its hub operation. Directcompetition to the hub carrier increases substantially on the short-haul market and to a lesser extent on
the long-haul market.
Other network carriers and point-to-point legacy carriers.
Home-based point-to-point legacy carriers such as Virgin Atlantic expand their operations at
Heathrow. In addition, the share of visiting network carriers at Heathrow, both on short-haul and longhaul markets increases. In particular visiting network carriers from Asia may disproportionately benefit
from brand loyalty in their own home market as inbound long-haul traffic grows faster than outboundtraffic. Network carriers at Gatwick shift part of their operations to Heathrow.
Low-cost and leisure carriers.
Low-cost carriers focus network growth at Heathrow but maintain operations at Gatwick. The
Heathrow opportunity may come to the detriment of low-cost operations at Stansted and Luton.

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Opportunities in the cargo marketplace.
Growth in long-haul belly capacity at Heathrow is expected to further strengthen Heathrow’s role asa cargo marketplace, but to a lesser extent than under airline responses 1 and 2 given the increased role ofthe low-cost segment. In addition, it is not likely that the full-freighter segment will flourish at any
significant scale, given its low yield character.
Connectivity impacts and impact on consumers.
Point-to-point, low-cost competition at Heathrow, together with reduction of scarcity rents/excess
demand and a declining market share of the hub carrier, translates into lower fares for consumers.
Connectivity will increase in both short-haul and long-haul markets. In comparison to airline responses 1
and 2, long-haul connectivity growth is smaller as no/only modest growth of the hub operation isforeseen for this airline response.
Figure 5.3. Summary of airline response 3: point-to-point growth at Heathrow and Gatwick,
Heathrow remains network hub
 Increase in flights
 Decrease in flights

5.4

Heathrow

Gatwick

Other London
Airports

Hub carrier and partners







Other non-home-based
network carriers







Point-to-point legacy







Low-costCharter







Cargo







Expanding Gatwick

Airline response 4: hub operation at Gatwick and hub operation at Heathrow
Expansion of Gatwick with a second parallel runway could increase peak-hour capacity from 50 to
98 movements per hour and 560 000 aircraft movements per year. As the London market is one of thelargest and strongest aviation markets in the world, the Gatwick capacity expansion option could trigger
an incumbent, non-Oneworld UK carrier or a foreign network carrier to use the new capacity to establish
a hub operation at Gatwick. This might be a traditional, stand-alone hub operation of an EU or US hub
carrier, facilitated by the open skies agreement between the US and Europe. Another option is a
Brussels-like scissor hub between Asia and the US based on 5th freedom traffic rights. We note that thepeak capacity of 98 movements per hour would enable only a smaller scale hub operation. Such peakhour capacity would enable Gatwick to theoretically have the same scale of hub operations as
Copenhagen, Madrid, Rome or Heathrow today (Figure 5.4)

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Figure 5.4. Peak-hour capacity versus number of connections via the hub per week in 2008 31

Source: SEO Netscan; individual airport data

Home-based hub carrier and partners
BA and partners will continue their hub operations from Heathrow. The growing scarcity ofcapacity at Heathrow will increase the opportunity costs of slots and will result in a continuation of
crowding out of short-haul and lower capacity/ low yield flights, higher airline economic rents andhigher ticket prices. The focus of Heathrow will be increasingly on long haul, high capacity flights with agrowing share of local OD traffic. BA and partners at Heathrow will face more competition in both theshort and long haul network from the new hub operation at Gatwick, assuming that investments insurface access make Gatwick equally attractive to the business community.
Other legacy network and legacy point-to-point carriers: shift from Heathrow to Gatwick.
A non-Oneworld carrier establishes the hub operation at Gatwick. If this is a competing network
carrier currently operating out of Heathrow, this could involve a shift of capacity from Heathrow to
Gatwick, leaving more room for Oneworld carriers at Heathrow. The new hub carrier at Gatwick would
most likely benefit from lower charges in comparison to the hub carrier at Heathrow. On the other hand,yields at Gatwick are lower than at Heathrow, which may put the competing hub carrier at a competitive
disadvantage.
The legacy point-to-point segment at Gatwick is likely to continue and modestly grow its network,
potentially cherry picking on the transfer demand of the new hub operation. As inbound long-haul traffic
is expected increase relative to outbound traffic with growth in leisure demand from Asia, Gatwick may
become the preferred platform for network growth for certain Asian carriers – a tendency that would be
reinforced by the increasing scarcity of capacity at Heathrow.
Low-cost and leisure carriers continue to operate out of Gatwick.
Low-cost and leisure carriers will continue to operate out of Gatwick and benefit from the increasein capacity, in particular if the increases in airport charges are modest, as currently expected. Over the31

The hub connectivity at Frankfurt is exceptional because of its efficient connections and high share of the hub
carrier in the total number of flights

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5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONS – 71

longer term, when Gatwick again nears capacity limits and slot prices increase, low-cost carriers may
search for alternatives for their network growth at Stansted and Luton.
Opportunity to develop Gatwick into a cargo marketplace.
Establishment of a hub operation at Gatwick including growth of long-haul services would provide
the opportunity to develop Gatwick into a cargo marketplace alongside Heathrow. With the modest
increase in charges, capacity expansion could provide opportunities for full-freighter operations as well.
Impact on connectivity and consumers
This scenario would result in a substantial increase in competition between British Airways (andpartners) and the new hub operation at Gatwick, both in the local and the connecting markets, to thebenefit of the consumer in London (local OD market), consumers in the rest of the UK (local andconnecting market) and consumers outside the UK (connecting market). As in scenario 2, this scenario is
suboptimal in connectivity terms: spreading two hub operations over two airports with essentially limited
peak-hour capacity results in a lower number of connecting opportunities via the hubs, lower connecting
traffic volumes and less airport connectivity than would be the case if peak-hour capacity growth wereconcentrated at a single location. However, the hub carrier at Gatwick may also add to the destination
portfolio of London if it benefitted from the much lower visit costs at Gatwick, which may allow it toserve thinner European routes with smaller aircraft in a profitable way. On long-haul routes, it may
search for markets currently not served by the hub carrier at Heathrow so as to avoid head-to-headcompetition.
Consumers in certain parts of London will benefit from connectivity growth closer to their home
and work locations. A careful analysis would be needed to answer the question if decreases in accesscosts would compensate for the suboptimal connectivity gains for London as a whole in comparison toscenario 1.
In the longer run, competition could also result in low profitability for both hub operations. It may
even force the hub airlines to reposition their networks, for example by de-hubbing Gatwick, withadverse effects on the connectivity available to the UK consumer.
Crowding-out effects at Heathrow and Gatwick.
The development of Gatwick into a competing hub will require the carrier(s) involved to acquire asubstantial amount of slots through the regular slot allocation procedure as well as through the secondary
slot market or by taking-over other airlines holding slots at Gatwick. It is assumed that current loweryield operations (low-cost and leisure) at Gatwick are gradually crowded out to Stansted and Luton in thelong-run. If the new hub carrier operation at Gatwick involves carriers currently operating at Heathrow,some capacity may become available at Heathrow, which is likely to be acquired by the incumbent hub
carrier and other legacy carriers. In the long-run however, as capacity shortages remain at Heathrow, thefocus at Heathrow will be increasingly on high capacity flights to large long-haul destinations withincreasing shares of OD demand. Crowding-out may take place with respect to short haul flights at
Heathrow in the long-run.

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Figure 5.5. Summary of scenario 4: Hubs at Gatwick and Heathrow Increase in flights
 Decrease in flights

Heathrow

Gatwick

Other London
Airports

Hub carrier and partners







Other non-home-based
network carriers







Point-to-point legacy







Low-cost







Charter







Cargo







Airline response 5: Partnerships – Gatwick becomes a low-cost “gateway”, Heathrowremains the network hub.
This airline response envisions the partnering of legacy network carriers and/ or low-cost carriers(of which some start to operate in the long-haul market), to facilitate passenger connectivity. This could
take place either through a new alliance/ codeshare formula or by an airport-led connect strategy32, where
the airport takes care of baggage transfers and arranges a smooth interline transfers, including an
insurance for passengers to catch a later flight in case of missed connections.
Low-cost and leisure carriers grow significantly at Gatwick, hub carrier and partners continue at
Heathrow.
Low-cost grows significantly at Gatwick as part of this airline response. Low-cost carriers partnerwith each other and with full-service carriers, without adding too much complexity to their schedule.
Long-haul low-cost is assumed to flourish at Gatwick given the large local OD market and strong growthin the inbound long-haul leisure market as well as the potential for low-cost and full-service feed. The
hub carrier and partners at Heathrow develop along the lines of airline response 4, with over time further
crowding out of short-haul and lower yield flights to Gatwick.
Non-home-based network carriers and legacy point-to-point carriers focus growth on Gatwick
Non-Oneworld long-haul carriers will increasingly focus network growth at Gatwick, benefitingfrom feed provided by low-cost carriers and availability of capacity. In particular network carriers from
Asia benefit from brand loyalty in their own home market as inbound long-haul traffic is expected to
grow faster than outbound traffic.

32

Such as Gatwick Connect, ViaMilano or iChangi Connect.

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5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONS – 73

Growth of cargo at Gatwick.
As in airline response 4, the growth of long-haul connections at Gatwick facilitating belly-holdfreight transport, potential development of full-freighter services and excellent surface accessibility may
provide the opportunity to develop a role for Gatwick as a marketplace for cargo alongside Heathrow.
Impact on connectivity and consumers
The growth of low-cost carriers is assumed to result in significant increase in short-haulconnectivity. Due to the nature of the low-cost business model, such a scenario will lead to suboptimalschedule design for transfer passengers, as low-cost carriers will try to avoid the complexity of a wavesystem structure. Hence, the share of transfer traffic will remain limited, in the range of 10-20%
maximum, and will not reach the levels of a typical hub airport. Long-haul growth takes place because ofentry of non-home-based network carriers and long-haul, low-cost carriers, but the range and frequencyof long-haul destinations will be more limited than in airline response 4. The strong presence of low-costcarriers may benefit both local and connecting passengers in terms of choice and ticket prices.
Impact on Heathrow and the other London airports.
Over time, as capacity shortages remain at Heathrow, the focus at Heathrow will be increasingly onhigh capacity flights to large long-haul destinations with increasing shares of OD demand. Crowding out
will take place with respect to short-haul flights at Heathrow in the long-run. As capacity is available at
Gatwick and charges are expected to rise only modestly, a relative shift of low-cost carrier growth from
Stansted/ Luton to Gatwick can be expected.
Figure 5.6. Summary of airline response 5: Partnerships – Gatwick becomes a low-cost “gateway”,
Heathrow remains the network hub
 Increase in flights
 Decrease in flights

Heathrow

Gatwick

Other London
Airports

Hub carrier and partners







Other non-home-based
network carriers







Point-to-point legacy







Low-costCharter







Cargo







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74 – 5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONSAirline response 6: Gatwick point-to-point growth, Heathrow remains the networkhub.
Growth of low-cost and charter carriers.
Instead of developing Gatwick into a low-cost gateway, where point-to-point traffic is mixed withconnecting traffic, this response assumes that low-cost carriers take up most of the capacity at Gatwick
but stick to a typical low-cost carrier business model without a deliberate strategy to stimulate connecting
traffic and achieve additional route density and connectivity. The central assumption is that classic lowcost carrier business model focus on cost minimization, which excludes facilitating connecting traffic.
The growth of these carriers at Gatwick comprises partly “autonomous growth” and partly migration offlights from Stansted and Luton to Gatwick. A number of low-cost, long-haul destinations are assumed to
be developed, based on the large local market for leisure and visiting friends and relatives.
Hub carrier and partners, non-home-based network carriers and legacy point-to-point carriers.
Over time, an increasing share of the additional capacity at Gatwick will be used by carriers thatcurrently operate at Heathrow but find more cost effective options at Gatwick when capacity becomes
available. This may free-up some capacity at Heathrow, which can be used by the hub carrier and othernetwork carriers. Over time, as capacity shortages remain at Heathrow, the focus at Heathrow will
increasingly be on high-capacity flights to large long-haul destinations with increasing shares of OD
demand. Crowding out will take place with respect to short-haul flights at Heathrow in the long run.
Non-home-based network carriers and point-to-point legacy airlines such as Virgin Atlantic can be
expected to use Gatwick increasingly, resulting in more full-service short and long-haul flights at
Gatwick.
Modest cargo growth at Gatwick.
Capacity growth at Gatwick provides opportunities for dedicated full-freighter service at Gatwick.
As long-haul passenger flight development is limited, however, and low-cost carriers avoid thecomplexities of handling belly-hold cargo, the development of Gatwick as a marketplace for cargo ismodest in comparison to airline response 4.
Impact on connectivity and consumers and impact on Heathrow and the other London airports.
Short-haul connectivity at Gatwick will rise substantially at Gatwick. Average fares will go down asa result of both lower scarcity rents and more competition in the local OD market, to the benefit of theconsumer. Long-haul connectivity at Gatwick only grows as far as long-haul, low-cost carriers are able
to set up operations and legacy carriers prefer Gatwick over Heathrow when capacity shortages at
Heathrow remain/ worsen. It remains to be seen to what extent the gain in short-haul connectivity is a net
gain for the London airport system or just a redistribution of supply within the airports system, at theexpense of Stansted and Luton.

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Figure 5.7. Summary of airline response 6: Gatwick point-to-point growth, Heathrow remains the network
hub.

5.5

 Increase in flights
 Decrease in flights

Heathrow

Gatwick

Other London
Airports

Hub carrier and partners







Other non-home-based
network carriers







Point-to-point legacy







Low-costCharter







Cargo







Evaluating the competitive outcome of the options

The central question to be answered in this study is how airline responses following expansion ofeither Heathrow or Gatwick are expected to determine the “competitive outcome” of runway capacity
expansion in the London airport system. The factors of most interest in the “competitive outcome” are set
out in the Airports Commission’s Appraisal Framework33. In this study we give a qualitative analysis of
the “competitive outcome” along the following lines:Impacts on connectivity: how does each of the options facilitate connectivity and what kinds ofconnectivity will be enhanced against the background of maintaining the UK’s status asEurope’s most important hub for aviation.

Impacts on competition to the benefit of the aviation user: the UK aviation sector provides
individuals and businesses with a wide choice of travelling options. Increasing competition
within the sector has delivered significant benefits for users of aviation (business and leisure
passengers and the freight sector) and the broader economy through making air travel more
affordable and accessible. Hence, how does each of the options under consideration maximize
the benefits of competition, both between airports and airlines, and lead to improvements in
consumer welfare?

Impact on airline economic rents: when demand exceeds supply at congested airports such as
Heathrow and Gatwick, passengers pay a premium on their ticket price (Starkie 1998, p.112).
Reduction of excess demand by supplying more airport capacity will lead to a transfer of these
economic rents from the airlines to the users of aviation through lower ticket prices.

Before describing the impacts for these three items, we first discuss in more detail how we define
connectivity, competition and benefits to aviation users due to the reduction of excess demand in thefollowing sections.

33

Airports Commission (2014). Airports Commission: Appraisal Framework, pp. 27-32.

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76 – 5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONSWhat is connectivity?
Connectivity growth is widely acknowledged to result in direct consumer welfare gains and deliverwider (external) economic effects. Although its economic importance is clear, its definition ranges
widely.
We define connectivity as the extent to which consumers can reach their desired destination atminimum time and monetary costs. This means that connectivity is not only about the availability ofdestinations to and from London, but also about variables such as frequency, transfer times, in-flighttimes, ticket prices, reliability and access times.
Connectivity is a multidimensional concept.
Connectivity is a multidimensional concept. Connectivity starts with the availability of a flightconnection to the desired destination. This does not only include directly served, non-stop destinations,but also any indirect travel opportunities via intermediate hub airports; the more destinations, the betterthe connectivity. Indirect connections are generally perceived as being of lower quality than directconnections, as they involve longer in-flight times (detours) and transfer time at the intermediate hub
airport. In particular business passengers, with on average higher values of time, dislike indirectconnections when direct flights are available. Hence, short air travel times mean good connectivity, allother things being equal. In addition, connectivity can be provided out of multiple airports serving thesame geographical region.
The higher the daily frequency of the connection, the more flexibility a consumer has to choose thedesired time for departure and arrival. The shorter the time between the actual and desired time ofdeparture/ arrival – called the interval time or schedule delay – the better connected a city is. Again, inparticular for the time sensitive passengers, the frequency variable is important.
Finally, access time is important. Connections at a large distance from the base location (office,home) are of less value to the consumer than the ones close by. Ultimately, connectivity is about thepassenger experience of door-to-door travel times.
Competition.
It is not only availability and the characteristics of the connection that are important to connectivity
but also about the price of the connection. Less time-sensitive passengers may be prepared to accept
longer travel times (or in other words, lower quality connectivity) for a lower airfare. This explains partly
the success of low-cost carriers, which are able to expand their local OD market with low fares. The
other way around, time-sensitive business passenger may choose a better connection and pay a higher
fare.
Hence, connectivity is not only about the availability and quality of connections in all dimensions
but also about the costs of using the connection and how consumers perceive the availability andaffordability of connections. Here, competition comes in, as competitive markets tend to have lower
ticket prices than markets with one airline, all other things being equal. Furthermore, in particular entry
of a low-cost carrier in markets where legacy carriers operate has a strong downward pressure on air
fares.
Both variables and the interplay between them determine the utility of a certain connection for the
consumer. Improvements in one of the dimensions of connectivity may result in consumer welfare gains
and eventually have wider economic effects at the national level.

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5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONS – 77

In sum, connectivity is a multidimensional concept. Connectivity is not only about the availabilityof a connection, the time involved and the frequency of connections, but also about the costs involved forthe passenger and the extent to which passengers value the time and monetary costs of using thatparticular connection.
Diminishing returns to connectivity improvements.
Connectivity growth in a single air transport market is characterised by diminishing economic
returns. A once-a-day flight to a new destination that is currently not, or very poorly, served (for example
with a double transfer connection) with a lot of underlying passenger demand will result in substantial
direct consumer welfare gains and possibly wider economic effects. In case different carriers alreadyserve the same destination three times a day, the same additional daily flight will have significantly lesseconomic value. It is like adding a 10th shoe shop in the main street if they all sell the same range of
products. The same holds true if many indirect and efficient travel opportunities already exist in the same
market.
These diminishing returns of connectivity growth do not only apply at the individual market level,
but also to the airport and city level. Airlines develop their route networks in line with market demand.
This means that economic centres with a lot of local demand tend to be already well served. Additional
destinations added from/ to already well-connected destinations tend to generate lower economic returns
than the ones already served from/ to the airports in the metropolitan area.
Hubs enhance connectivity.
Airline hub operations add transfer traffic to local OD demand in order to achieve the necessaryroute density to operate routes without sufficient local OD demand profitably and achieve network
economies. The connections that hub carriers provide via the hub (so-called hub connectivity) and theconnecting traffic that uses these hub connections are not a goal in themselves from a wider economic
perspective, but a means to enhance the connectivity performance of the city served. As pointed out inthis study, London faces the unique situation of having the largest OD market in the world, which
reduces the need for transfer traffic at its hub airport compared to ‘classic’ hubs such as Frankfurt andAmsterdam. This explains its impressive connectivity performance without a fully-fledged hub
operation.
Measuring connectivity.
Many indicators are available to measure connectivity (for an overview see Burghouwt & Redondi
2014; Airports Commission 2013c). Yet, it is difficult to capture the multidimensional character ofconnectivity with one single measure. Probably closest come those measures that calculate direct
consumer welfare gains as a result of improvements in certain dimensions of connectivity, such as morecompetition/ lower fares, shorter travel times, higher frequencies and more direct instead of indirectflights. Such measures are also able to take into account the value consumers attach to the time aspects of
their journey and integrate existing demand and demand generation into the welfare calculation34. For an
overview see Burghouwt et al. (2007) and Veldhuis (2013).

34

We note that such measures take into account direct welfare impacts for consumers but not any additional
wider (external) economic effects.

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Benefits for aviation users from a reduction in excess demand.
If demand for airport capacity is larger than supply and prices for using that capacity for airlines arelower than the market clearing price, excess capacity produces an economic rent. This is the ‘potential
for earning a return in excess of the average cost of supplying runway service’ (Starkie 1998, p.112).
These excess returns cannot be captured entirely by airports such as Heathrow and Gatwick under thecurrent regulatory framework as their prices are capped. The airlines, however, will charge thepassengers what the market can bear in matching demand with available seats and hence, the airlines
capture the economic rent, as Figure 5.8 shows. The extent to which ticket prices are higher thanmarginal costs at capacity-constrained airports will depend on the level of excess demand andcompetition from other airports in the catchment area that provide realistic alternatives to the passenger.
Figure 5.8. Excess demand increases ticket prices

Cost

DemandTicket price P1
Average costof supply Pc

Economicrent
Declared
capacity C1
Excessdemandat Pc

Runway output

Source: adapted from Starkie (1998).

When capacity is added to either Heathrow or Gatwick, new airlines will enter the market and add
new routes. Because of the increased contestability of the market, ticket prices will fall, reducing the
economic rent for the airlines to the benefit of the consumer (Figure 5.9). Benefits in terms of ticket
prices are likely to be highest when capacity is expanded at the airport with the largest excess demand. If
airport charges rise as a result of capacity expansion, the average cost of supply will rise, further
reducing the economic rents accruing to airlines.

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Figure 5.9. Reduction of excess demand decreases ticket prices

Cost

DemandTicket price P1
Ticket price P2
Average costof supply Pc

Economic rent

Capacity
increase

Runway output

Source: adapted from Starkie (1998)

Impact on the competitive outcome.
About the impact assessment.
In the remainder of this chapter, we assess qualitatively the impact of the airline responses in thevarious scenarios on the main dimensions of connectivity: benefits of increased competition for
consumers in the form of lower fares and improved availability of connections (more destinations, higher
frequencies, shorter travel times). At this stage of the analysis, we indicate the expected direction of theeffects, but not their magnitude.
Impacts on connectivity.
Benefits in terms of connectivity gains in the short-haul and long-haul markets are expected to belargest in airline response 1- where substantial growth of the hub operation takes place at a single
location - as the route density achieved by an expanded hub operation will facilitate serving an increasing
number of markets, both short-and long-haul, directly (Figure 5.10). This not only benefits the local
London consumers but also other UK consumers as they are provided with increased connectivity via atransfer at Heathrow. Because of higher airport charges at expanded Gatwick or Heathrow, coverage of
the European feeder market may remain limited, and restricted to the larger European markets.
The strong network at Heathrow may come to the detriment of long-haul direct flights to other UK
cities. Short-haul connectivity is likely to grow in any of the scenarios, as other UK airports will benefit
from increased connectivity with one or more of the London airports. Connectivity available for cargo
will grow as a result of the increase in long-haul flights at Heathrow. As the hub carrier moves part of its
flights back to Heathrow, Gatwick’s full-service connectivity may partly be substituted with low-costservices and connections offered by legacy point-to-point carriers.

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80 – 5. AIRLINE RESPONSE FOR DIFFERENT CAPACITY EXPANSION OPTIONSAirline responses 2 and 4 basically produce the same type of effects, but to a lesser extent as two
hub operations side by side generate less connectivity than one large hub operation. On the other hand,the strong presence and modest growth of low-cost/ leisure carriers at Gatwick in airline response 4 islikely to offer more choice, competition and lower fares to the market, in comparison to airline responses
1 and 2.
In the case of a low-cost hub/ gateway at Gatwick (airline response 5) as well as point-to-point
growth at Heathrow and Gatwick (airline response 3), short-haul connectivity will increase and to alesser extent long-haul connectivity, depending on the success of long-haul, low-cost business models
and the partnering of low-cost and network carriers under airline response 5. In case the role of Gatwick
becomes an expanded point-to-point airport (airline responses 5 and 6), connectivity gains would
primarily be realized in the short-haul market under current market conditions. The growth in low-costoffer in airline responses 3, 5 and 6 is likely to have positive impacts on competition levels and thus
result in lower airfares for consumers.
Figure 5.10. Impact on competitive outcome

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Benefits of competition for passengers and other aviation users.
Airline response 1 will lead to a more dominant position of the hub carrier and partners at
Heathrow, but with improved connectivity. For leisure passengers, who are less time-sensitive, realistic
direct and indirect substitutes are available. Transfer passengers will benefit from the larger hub
operation at Heathrow in airline response 1 in the long-haul market, as the new connections provided via
Heathrow will increase competition with existing connections via other EU and non-EU hubs in themarket. In particular the price elastic leisure passenger will benefit from increased competition in theconnecting market.
For other airline responses (2 to 6), the hub carrier within the London airport system is likely to
become less dominant. As mainly low-cost carriers are expected to benefit in scenarios 3, 5 and 6, we
expect a substantial downward pressure on fares, enhancing consumer welfare. In particular the growthof long-haul, low-cost in combination with growth of short-haul, low-cost at Gatwick under airline
response 5 will result in increased competition to the benefit of the local consumer. As the connectivity
gains are less pronounced compared to scenario 1, consumers elsewhere in the UK will not benefit fromthe same rise in indirect travel options through the London airports as an alternative to already existing
indirect travel options.
Reduction of airline economic rents to the benefit of aviation users.
A major benefit of expanding airport capacity is the reduction of excess demand. Reduction inexcess demand will result in a transfer of economic rents from airlines to passengers with downward
pressure on fares (section 5.5) As excess demand is larger at Heathrow than at Gatwick, these consumer
welfare gains will be larger for expansion at Heathrow (airline responses 1-3) than for expansion at
Gatwick (airline responses 4-6).

5.6

Key conclusions regarding airline responses and competitive outcome

Based on an analysis of the London airports system, key drivers for airline behaviour and theoptions for capacity expansion at either Gatwick or Heathrow, we have developed 6 different
airline responses. The airline responses have a varying impact on the traffic structure in the
London airport system as well as on competitive outcomes.

Connectivity is expected to improve most when the hub carrier at Heathrow uses new capacity
to reinforce its hub system, as the possibility to generate long-haul route density on top of local
OD demand is largest. Multiple (competing) hub operations within the London airport system
will also stimulate connectivity but to a smaller extent, as the connectivity gain of one large
hub operation is larger than the sum of two smaller hub operations, because of the multipliereffect of hub-and-spoke networks. However, a high increase in charges might prevent the hub
carrier at Heathrow developing a hub operation with the same extensive feeder network as forexample at Frankfurt or Amsterdam, potentially in contrast to a hub operation at Gatwick if
charges at Gatwick prove lower than at Heathrow (airline response 4). It remains to be seen towhat extent hub expansion at Heathrow will result in more capacity on existing routes as
opposed to adding new routes.

An airline response where network carriers and/ or low-cost carriers partner to facilitate
connectivity may increase connectivity as well (airline response 5), but this gain will be limited
based on current airline business models. However, this may change as airline business models
evolve further.

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35



Not expanding Heathrow is likely to result in further crowding out of short-haul/ lower yieldflights at Heathrow as excess demand increases, as well as a further rise in air fares. Over time,short-haul/ lower yield flights are substituted with long haul, high capacity flights. The role ofGatwick, Stansted, Luton and City for short-haul connectivity will increase.

Differences in terms of gains in short-haul connectivity for the London airports system arelikely to be much smaller for the different airline responses, as the relevance of connecting
traffic to operating high frequency routes profitably is smaller and the market for short-haulroutes is much larger35. We note that the expected increase in charges after expanding
Heathrow may come at the detriment of high frequency, low capacity feeder services tosecondary and tertiary cities in the UK and elsewhere in Europe.

In terms of reduction of scarcity rents and connectivity gains, a UK consumer is likely to gain
most by expanding Heathrow. With severe capacity constraints and high yield demand, thescarcity rents can be expected to be largest there. Hence, reduction of excess demand following
Heathrow expansion is likely to reduce fares more than following Gatwick expansion.
Furthermore, connectivity gains are likely to be highest for Heathrow expansion and growth of
the hub carrier.



Expansion of Gatwick is likely to have the strongest positive impacts on competition, with
benefits to the consumer due to the expected increase in low-cost carrier competition and a lessdominant position of a single alliance, resulting in more choice for the consumer and lower
fares.



However, it is not clear what the overall impact will be on consumer welfare of chancing
scarcity rents, connectivity growth and changes in competition level as a result of expanding
either Gatwick or Heathrow.

80% of passenger traffic at EU airports concerns intra-EU destinations.

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6. Likelihood of airline responses

The way macroeconomic conditions develop over the long term will affect the likelihood of theairline responses examined unfolding. Some of the responses are unlikely under some scenarios. Airline
business models evolve, macro-economic conditions change, new aircraft technology will be on themarket when new capacity becomes available. Overall, hub carrier growth in case of Heathrow
expansion and the development of Gatwick into a low-cost gateway are the most likely airline responses
under the various macroeconomic scenarios developed by the Airports Commission.

6.1

Introduction

The airline responses presented in the previous chapter are based on a business-as-usual assumption
regarding macro-economic development as well as the structure of the airline industry and airline
business models. As stated in the introduction to chapter 4, the airline industry is highly dynamic and its
performance is closely related to macro-economic, technological and aero-political conditions. Hence,the question is to what extent the airline responses developed in chapter 4 are robust in relation topotential long-term changes inside and outside the industry.
In this chapter, we will address the likelihood of the different airline response scenarios by
confronting them with the five macroeconomic sensitivity scenarios developed by the Airports
Commission (Airports Commission 2013).

6.2

The Airports Commission forecast and scenarios

Baseline forecast.
In its Interim Report (Airports Commission 2013), the Commission reported its forecast for aviation
demand in the UK in 2050. Its unconstrained forecast yielded a median of 450 million terminal
passengers in 2050, in a range of 380-550 million passengers per annum. Based on this baseline forecast,
the Commission concluded that in 2040 all London and South East airports will be full, even with acarbon cap in place, and that 90% of the available capacity in London and the South East will be used by
2030. Based on these demand forecasts, the Commission points to the need for one additional runway in
the South East by 2030 across a range of scenarios. The Commission also indicated that it is likely that
there will be a need for a second additional runway by 2050.
Scenarios.
The future of the aviation industry is difficult to predict. To ensure that its forecast sufficiently takes
into account uncertainties in the market, the Commission developed alternative scenarios for the future of
the aviation sector, besides the baseline/ assessment of need scenario. Each scenario has different
implications for the respective market shares of hub-and-spoke and point-to-point networks and for theparticipation of UK airports in global route networks. The Commission uses the following four,
qualitative scenarios to compare with its baseline forecast (Airports Commission 2013).

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Assessment of need scenario.
This baseline scenario is consistent with the forecasts underpinning the Commission’s assessment ofneed. In this scenario, future demand is primarily determined in relation to past trends and central data
projections (for example, on GDP, global oil prices etc.).
B. Global growth.
This scenario is characterised by strong economic growth and increasing globalisation of theeconomy. The role of major aviation hubs and alliances around the world is strengthened. Liberalisationof aviation markets continues. Continued growth of the middle class leads to strong demand growth andstrengthening of Middle East carriers. Global airline alliances further strengthen the global hub network,
benefiting from a new generation of fuel-efficient aircraft.
C. Relative decline of Europe.
This scenario also shows strong economic growth and increasing globalisation. However, it assumes
aggressive competition between the legacy carriers and new market entrants from emerging economies.
This results in a decline in the importance of the European aviation hubs as European airlines are
frequently out-competed by Middle Eastern and Asian carriers. Middle Eastern carriers use new aircraft
technology to by-pass the major European hubs and fly directly into secondary European cities. The roleof global alliances declines.
D. Low cost is king.
Scenario C assumes a growing role for low-cost carriers as they enter long-haul markets and selfconnecting becomes more common for passengers. By 2040, charter and low-cost carriers take 50% of
the market. The importance of hubs and network carriers declines throughout the world. Liberalization ofaviation markets worldwide continues. Low-cost carriers use new aircraft technology such as Boeing 787
and Airbus A350 to enter long-haul point-to-point markets. The low-cost carriers have little incentive toenter into formal alliances.
E. Global fragmentation.
Scenario D assumes a decline in global economic and aviation growth. The world economy
fragments and liberalisation stalls. Countries turn inward, adopting protectionist and interventionist
policies. Global aviation markets suffer from protectionism and a slowdown of growth in Asia. Airlines
compete aggressively for a relatively small pool of passengers, resulting in a partial break-up ofalliances. New long-range aircraft enable more markets to be served point-to-point.

6.3

Likelihood of the airline responses

We have confronted the airline responses with the qualitative scenarios of the Airports Commission(A-E) as they described above. Regarding the robustness/ likelihood of the airline responses, we candraw the following conclusions.

Airline response 1: Hub carrier growth at Heathrow, point-to-point growth at Gatwick.
 Assessment of Need (A): Continuing importance of alliances and hubs as well as traffic growth
makes hub capacity in particular in demand in the Assessment of Need scenario. New aircraft

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technology is used to enhance hub performance. Hence, the likelihood of the expected airline
responses is high.
 Global Growth (B): Continuing importance of alliances and hubs as well as traffic growth makes
hub capacity in particular in demand in the Global Growth scenario. New aircraft technology isused to enhance hub performance. Hence, the likelihood of the expected airline responses is high.
 Relative Decline of Europe (C): Aggressive hub competition from outside Europe leads to a
relative decline of the Heathrow hub in the international-to-international connecting market. The
share of hub carrier at Heathrow will be smaller. In that case, it might be less likely that the hub
carrier is able to build up a hub operation at the envisioned scale. The likelihood of the airline
response is moderate.
 Low-cost is King (D): Strong low-cost growth cannibalizes the short-haul but also the long-haulmarket. The hub model is under pressure. The hub operation at Heathrow will not reach its
envisioned scale. Gatwick grows as far as capacity permits as a point-to-point airport, including
long haul low-cost. The likelihood of the airline response scenario is moderate to small.
 Global Fragmentation (E): As the market is in decline, single hub operations become more
important to connect small markets with an intermediate transfer. A less liberal aviation market
restricts the further growth of the low-cost sector. If global fragmentation was severe enough toresult in the demise of the hub carrier, this airline response is not plausible. Otherwise thelikelihood of the airline response under this scenario is moderate to high.

Airline response 2: Two hub operations at Heathrow, point-to-point growth at
Gatwick.
 Assessment of Need (A): Network carriers and alliances remain important, besides a large share of
low-cost carriers in the short-haul market. Lower economic growth than under the Global Growthscenario (B) makes a second hub operation in competition with BA and partners less likely. Hence,
the likelihood of the expected airline responses is somewhat less than moderate.
 Global Growth (B): Benefiting from strong market growth and global open skies, a competingalliance establishes a second hub operation at Heathrow. The question is to what extent a second
hub operation will be viable in the long run, given the fierce competition at the home base and theincumbent’s advantages. From a financial point of view, building a competing hub operation at
Heathrow will be a risky undertaking. The likelihood of the airline response in this scenario ismoderate.
 Relative Decline of Europe (C): Growing competition from Far East and Middle East carriers will
result in a less liberal approach from EU governments towards these carriers. Hence, it is unlikelythat a non-EU carrier will establish a hub operation at Heathrow in this scenario. As the European
hub model itself is under pressure from increased competition in the both the short-haul and long
haul market, establishing a second hub in London is not likely. The likelihood of the airline
response in this scenario is low.
 Low-cost is King (D): Strong low-cost growth cannibalizes the short-haul but also the long-haulmarket. The hub model is under pressure. Competing hub carriers retreat at their primary hubs.
The likelihood of the envisioned airline response in this scenario is low.

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 Global Fragmentation (E): Hub carriers rationalize their networks and focus on their primary hubs;
secondary hubs are dismantled. Airport capacity for an additional secondary hub operation at
Heathrow is not in demand. The likelihood of the envisioned airline response under this scenario is
low.

Airline response 3: Point-to-point growth at Heathrow and Gatwick, Heathrowremains network hub.
 Assessment of Need (A): Network carriers and alliances remain important, besides a large share of
low-cost carriers in the short-haul market. The current trend in the market continues and low-costcarriers increasingly search for new market opportunities and premium demand. As part of their
evolving business model, they may start operating some services out of Heathrow. Yet, theirmarket share remains limited, partly because of the high aero-charges. The likelihood of the airline
response in this scenario is moderate.
 Global Growth (B): On-going liberalization, demand growth and new aircraft may facilitate
operations of low-cost at Heathrow both on long-haul and short-haul. Low-cost carriers benefit
from new aircraft technology. Yet, network carriers remain very strong players at Heathrow in this
scenario. Hence, the operations of low-cost carriers at Heathrow will not increase to any large
extent. The likelihood of the airline response in this scenario is low.
 Relative Decline of Europe (C): As the European hub carrier model is under pressure fromincreased competition, low-cost carriers start to play a more important role in connecting London
with the rest of Europe through point-to-point connections in short-haul and selected long-haulmarkets. Long-haul growth is supported by high growth figures in the Asian inbound (leisure)market. Yet, Heathrow remains expensive for low-cost carriers to operate from. The likelihood of
the airline response in this scenario is moderate to high.
 Low-cost is King (D): Low-cost carriers search for new opportunities as the European market issaturating. One of their strategies is to target the premium passenger by entering the primary
airports such as Heathrow as well as the long-haul market. They benefit from new aircraft
technology and further liberalization. The hub model is under pressure, which makes large-scale
hub capacity less in demand. The likelihood of the airline response under this scenario is high.
 Global Fragmentation (E): as the economy, aviation demand growth and liberalization stall, pointto-point carriers may want to avoid operating out Heathrow with its high aerocharges and highcompetition levels. Instead, they target the price sensitive passenger out of Gatwick, Stansted andLuton and focus on markets with fewer competitors. The likelihood of the airline response in this
scenario is low, assuming that the hub carrier survives.

Airline response 4: Hub operation at Heathrow and competing hub operation at
Gatwick.
 Assessment of Need (A): Network carriers and alliances remain important, besides a large share of
low-cost carriers in the short-haul market. Lower economic growth than under the Global Growthscenario (B) makes a second hub operation in competition with BA and partners less likely. Hence,
the likelihood of the expected airline response is moderate.

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6. LIKELIHOOD OF AIRLINE RESPONSES – 87

 Global Growth (B): Continuing importance of alliances and hubs and traffic growth makes hub
capacity in particular in demand, including for a secondary hub operation at Gatwick. The
likelihood of the airline response in this scenario is high.
 Relative Decline of Europe (C): Growing competition from Far East and Middle East carriers
results in a less liberal approach from EU governments towards these carriers. Hence, it is unlikelythat a non-EU carrier will establish a hub operation at Gatwick in this scenario. The likelihood of
the airline response in this scenario is low.
 Low-cost is king (D): Strong low-cost growth cannibalizes the short-haul but also the long-haulmarket. The hub model is under pressure. Competing hub carriers retreat at their primary hubs.
The likelihood of the envisioned airline response in this scenario is low.
 Global fragmentation (E): Hub carriers rationalize their networks and focus on their primary hubs;
secondary hubs are dismantled. Airport capacity for an additional secondary hub operation at
Gatwick is not in demand. The likelihood of the envisioned airline response under this scenario is
low.

Airline response 5: Partnerships – Gatwick becomes a low-cost gateway, Heathrowremains the network hub.
 Assessment of Need (A): On-going liberalization, demand growth and new aircraft facilitate
further growth of low-cost at Gatwick both in long-haul and short-haul, local and (self) connecting
market. Low-cost carriers benefit from new aircraft technology. The likelihood of the airline
response in this scenario is high.
 Global Growth (B): As in the Assessment of Need scenario (A), on-going liberalization, demand
growth and new aircraft facilitate strong growth of low-cost at Gatwick both in long-haul andshort-haul, local and (self) connecting market. Low-cost carriers benefit from new aircraft
technology. The likelihood of the airline response in this scenario is high.
 Relative Decline of Europe (C): Middle East and Far East carriers partner with short- and longhaul low-cost carrier to create connectivity at Gatwick. Low-cost carriers benefit from new aircraft
technology. The European hub model is under pressure. The likelihood of the airline response
under this scenario is high.
 Low-cost is King (D): Low-cost carriers and full-service carriers at Gatwick partner together (andwith the airport) to facilitate connections, both on the short-haul and long haul market. They
benefit from new aircraft technology and further liberalization. The hub model is under pressure,which makes large-scale hub capacity less in demand. The likelihood of the airline response under
this scenario is high.
 Global Fragmentation (E): In adverse economic conditions passengers are very price sensitive;
self-connect traffic is on the rise even on short-haul routes. However, low-cost growth is restrictedby restrictive aero-political policies. Demand for long-haul low-cost is modest as globalization
stalls. The likelihood of the airline response in this scenario is moderate.

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88 – 6. LIKELIHOOD OF AIRLINE RESPONSES

Airline response 6: Gatwick point-to-point growth, Heathrow remains the networkhub.
 Assessment of Need (A): Low-cost carriers continue growth at the Gatwick location. As Heathrowremains capacity restricted, legacy point-to-point carriers and lower yield network carriers focus
growth on Gatwick. In order for low-cost carriers to grow further in a maturing market, they willneed to adapt their business models. The question is if this can be done without targeting the (self)connecting market or the premium passenger market at Heathrow. The likelihood of the airline
response in this scenario is moderate.
 Global Growth (B): Strong alliances and network carriers may try to get a strong foothold at
Gatwick in order to create room for growth. Independent low-cost growth at Gatwick is modest.
Yet, the hub carrier may set up a subsidiary to compete out of Gatwick Hence, the likelihood of
the airline response in this scenario is moderate.
 Relative Decline of Europe (C): As the European hub carrier model is under pressure fromincreased competition, low-cost carriers start to play a more important role in connecting London
with the rest of Europe through point-to-point connections in short-haul and selected long-haulmarkets. Long-haul growth is supported by high growth figures in the Asian (leisure) market. The
likelihood of the airline response in this scenario is high.
 Low-cost is King (D): In order for low-cost carriers to grow further in a maturing market, they willneed to adapt their business models. The question is if this can be done without targeting the (self)connecting market. The likelihood of the airline response in this this scenario is moderate.
 Global Fragmentation (E): Low-cost hubbing/ self-connecting traffic does not take off. There islittle demand from network carriers to use Gatwick for hubbing activities as they retreat to theirprimary hubs. Gatwick retains short-haul point-to-point services with limited long-haul traffic. The
likelihood of the airline response in this scenario is high.

6.4

Key conclusions regarding the likelihood of the airline responses.

A variety of airline responses can be envisioned for different futures of the aviation industry as awhole. However, not all airline responses are realistic for each of the future scenarios developed by theCommission (see figure): In the Assessment of Need scenario (A) or ‘business-as-usual scenario’, hub carrier growthfollowing Heathrow expansion and Gatwick as a point-to-point gateway following Gatwick
expansion seem to be most realistic airline responses, although there is a moderate likelihood of
the other responses as well.
 In the Global Growth scenario (B), most airline responses are likely except for an expanded
Heathrow with predominantly pure point-to-point, low-cost growth. Strong network carriers may
have a substantial interest in an expanded Gatwick in a high growth market, given the capacity
shortages at Heathrow. The multi-hub airline responses (2 and 4) seem only to be realistic in caseof Global Growth.
 In the Relative Decline of Europe scenario (C), no multi-hub airline response is likely as thepolitical will to accommodate hub operations from Middle East of Far East carriers will diminish
as these carriers gain market share and put pressure on the European carriers. We expect the hub

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6. LIKELIHOOD OF AIRLINE RESPONSES – 89

carrier British Airways to focus on protecting its position at Heathrow as much as possible if
Heathrow is expanded but strong, non-European hub carriers will cannibalize its market.
Connections via non-EU hubs are likely to increase. In case of expansion of Gatwick, Middle East
and Asian carriers may team up with European low-cost carriers to organize feed for their longhaul flights.
 The Low Cost is King scenario (D) is likely to rule out multi-hub airline responses (2 and 4). In
case of expansion of Heathrow, low-cost entry at Heathrow is likely. In case of expansion of
Gatwick, a hybrid hub operation could be one of the realistic futures, in which low-cost and legacy
airlines partner to provide connectivity.
 The Global Fragmentation scenario (E) will most likely result in hub carriers rationalizing their
networks and focusing on their primary hubs. As the market stalls, the hub carrier may not be able
to develop its hub network to the full extent made possible by expansion of Heathrow. In the caseof expansion of Gatwick, a point-to-point response is likely in this scenario.

Figure 6.1. Likelihood of the airline responses under different aviation scenarios as defined by the Airports
Commission
Heathrow Option
Response 1
Response 2
Response 3

Response 4

Hub carrier
growth at
Heathrow,
point-to-point
growth at
Gatwick.

Two hub
operations at
Heathrow,
point-to-point
growth at
Gatwick.

Point-to-point
growth at
Heathrow andGatwick,
Heathrow
remains
network hub.

Hub
operation at
Heathrow anda competing
hub operation
at Gatwick.

Partnerships –Gatwick becomes a low-cost“gateway”,
Heathrow
remains the
network hub.

Gatwick
point-to-point
growth,Heathrow
remains the
network hub.

+

o

o

o

+

o

+

o

–

+

+

o

o

–

o+

–

+

+

–o

–

+

–

+

o

o+

–

–

–

o

+

+

–

–o

–

+

+

Scenarios:
A Assessment ofNeed
B Global Growth
C Relative Declineof Europe
D Low-Cost is KingE Global
Fragmentation
Overall likelihoodof airline response
across scenarios
Key:+ High likelihoodo Moderate likelihood– Low likelihood

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Gatwick Option
Response 5
Response 6

90 – 6. LIKELIHOOD OF AIRLINE RESPONSES

Further quantification of the competitive effects of the airline responses.
Confronting the scenarios of the Airports Commission with the airline responses brings forward
which combination of scenarios are useful, in terms of their likelihood, to be considered in further
quantitative impact analysis to be carried out by the Airports Commission. The most realistic
combinations of scenarios and airline responses are:
 Assessment of Need with airline responses 1 and 5
 Global Growth with airline responses scenarios 1, 4 and 5
 European Decline with airline responses 3, 5 and 6;
 Low-cost is King with airline responses 3 and 5;
 Global Fragmentation with airline responses 1 and 6.
Taking into account the overall likelihood of the airline responses in all scenarios, any further
quantitative impact analysis may most usefully consider airline responses 1, 5 and 6.
We note that airline response 2 (two hubs at Heathrow) may involve too much financial risk for the
new hub carrier and would not be realistic except possibly in the Global Growth scenario. The lower
yields at Gatwick and suboptimal peak-hour capacity also make the establishment of a competing hub
operation at Gatwick less likely (airline response 4).

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BIBLIOGRAPHY – 91

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Expanding Airport Capacity: Competition and Connectivity
The case of Gatwick and Heathrow
The Airports Commission was set up by the Government of the United Kingdom in 2012 to take an
independent look at the UK’s future airport capacity needs. It has been tasked with setting out the nature,scale, and timing of steps needed to maintain the UK’s status as an international hub for aviation,
alongside recommendations for making better use of the UK’s existing runway capacity by the end of 2013;
and setting out recommendations on how to meet any need for additional airport capacity in the longer-termby the summer of 2015.
In December 2013 the Commission published its Interim Report, which included a shortlist of three options
for increasing the UK’s aviation capacity in the long term: two at Heathrow and one at Gatwick. To determine
which alternative would provide the largest benefits to passengers, freight businesses and the UK economy
overall it is important to understand how airlines are likely to respond to increased runway capacity.

This report is part of the International Transport Forum’s Country-Specific Policy Analysis (CSPA) series.
These are topical studies on specific transport policy issues of concern to a country carried out by ITF
on request.

International Transport Forum
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Web: www.internationaltransportforum.org

2014-10 /Photo credit: Shutterstock - Thor Jorgen UdvangThis report examines the likely responses from airlines in all segments of the market: the local hub carrier,BA, other network airlines, short and long-haul low-cost carriers and charter airlines. It identifies
the main drivers of airline behaviour and considers the possible influence of changes to existing businessmodels and the introduction of new types of aircraft, such as the Boeing Dreamliner and Airbus A350.
The report develops six sets of responses, three following expansion of Gatwick and three following
expansion of Heathrow, to test the likely evolution of the market. As the future of the highly dynamic
aviation market is uncertain, it checks the resilience of each across five different scenarios of how the global
aviation sector may develop in the future. The analysis maps the implications for connectivity andpotential benefits to the consumer through airline competition and relieving congestion at airports
and reducing the associated economic rents.