JOINT TRANSPORT RESEARCH CENTRE

Discussion Paper No. 2008-17
September 2008
Impacts of Airports on Airline
Competition: Focus on Airport
Performance and AirportAirline Vertical Relations
Tae H. OUM
The Air Transport Research Society (ATRS) andUniversity of British Columbia, Canada
Xiaowen FU
Hong Kong Polytechnic University
Hong Kong, China

JOINT TRANSPORT RESEARCH CENTRE

Discussion Paper No. 2008-17

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

Draft of 10 September 2008
Not to be quoted without the authors’ permission. Comments Welcome.
Impacts of Airports on Airline Competition:
Focus on Airport Performance and Airport-Airline Vertical Relations

Tae H. Oum,
The Air Transport Research Society (ATRS) andUniversity of British Columbia, Canada
Tae.oum@ubc.caAnd
Xiaowen Fu,
Hong Kong Polytechnic University
Hong Kong, China
lgtxfu@polyu.edu.hk

September 2008

The views expressed in this paper are those of the authors and do not necessarily
represent positions of the University of British Columbia andHong Kong Polytechnic University, the OECDor the International Transport Forum.

TABLE OF CONTENTS

ABSTRACT .............................................................................................................................. 5
1.

INTRODUCTION ...............................................................................................................62.

AIRPORT REVENUE STRUCTURE, REGULATION AND PRICING ............................... 83.

AIRPORT’S MARKET POWER ....................................................................................... 11
3.1. Airport capacity and demand for that capacity.......................................................... 11
3.2.Low cost carrier airports ............................................................................................ 123.3. Airline market structure and competition .................................................................. 123.4. Share of connecting passengers .............................................................................. 13
3.5. Intermodal competition, especially between airlines and high speed rail ................. 13
3.6. Competition among airports in the same metropolitan region .................................. 14

4.

AIRPORT DOMINANCE AND AIRLINE HUB PREMIUM, AND IMPLICATIONSFOR AIRLINE-AIRPORT COOPERATION ..................................................................... 15

5.

AIRPORT-AIRLINE VERTICAL RELATIONSHIP ........................................................... 18
5.1. The costs and benefits of airport-airline integration .................................................. 19

6.

SUMMARY AND CONCLUSION .................................................................................... 22

NOTES ................................................................................................................................... 24
REFERENCES ....................................................................................................................... 27
Appendix A. Alternative forms of economic regulation of airports ......................................... 33
Appendix B. Forms of government ownership and private ownership .................................. 35
Appendix C. US Airline Industry Consolidation within a Decade after 1978 Deregulation .... 37
Vancouver/Hong Kong, September 2008

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 20083

ABSTRACTThis paper examines revenue structure, regulation, and market power of airports, andhow they affect airport’s services to airlines and influence the form of vertical relationshipbetween airport and airlines, and thus, eventually on competition in airline markets. In
addition, we also examine the competitive consequences of common ownership,
coordination or alliance among multiple airports in a region.
The key findings are:•••Concession revenues are of increasing importance to airports. The positive
externality of air traffic on the demand for non-aeronautical services, along withcompetition among both airlines and airports, induces a vertical cooperation
between airports and the dominant carrier at the airport.
Airports have substantial market power due to the low price elasticity of theiraeronautical services. However, such airports’ market power is moderated bycompetition in both the airline and airport markets.
There are benefits for both airports and airlines from entering into long term
relationships. Airports can obtain financial support and secure business volume,
which are important for daily operation as well as for long term expansion. Airlines
can secure key airport facilities on favorable terms, essential for making long term
commitments/investment at an airport. This along with the positive externality of thedemand for airport’s aeronautical services on commercial services provides
incentives for the airport and the dominant carrier to strike exclusive deals, harming
competition in the downstream airline market if unchecked. Such airport dominanceallows an airline to obtain a substantial hub premium. On the other hand,cooperation between a hub airport and the dominant carrier may enhance thecompetition between airline networks formed by different airport-dominant carrier
combinations. In other words, airport-airline coordination or alliance is a doubleedged sword for downstream airline competition, there is a need for careful further
examination on the issue in order to design an effective regulatory oversight.

The issue of cooperation or alliance between two or more hub airports in a region needs
more careful analysis because, while cooperation and coordination may improve customer
service and efficiency, it is also likely to reduce competition not only between airports in theregion but also between carriers in the downstream airline market.

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 20085

1. INTRODUCTION

In recent years, airports have been under growing pressure to be more financially selfsufficient and less reliant on government support. Many airports around the world have beencommercialized and/or privatized so that airports are operated more like a business (Carneyand Mew, 2003; IATA, 1997). Most countries have created regulatory agencies separatelyfrom airport operators. These changes introduced strong incentives for airport managers toincrease revenue and reduce costs. The changing objective and strategy of airports,
together with the evolving regulatory policies and governance structures influence airports’
performance and their services to airlines. These changes are posing new challenges toairport managers and regulation system. In order to design a proper regulatory system, it isimportant to examine the determinant factors of airport performance, and the effects on thecompetition in downstream airline markets.
This paper seeks contributions in the following two areas: First, we review the key
determinant factors for airport performance, and how they affect airport pricing and services
to airlines. The issues reviewed include revenue structure, market power and regulatory
regimes on airports. We then examine how airport services and business strategies
influence competition in the downstream airline market, and the interactive effects between
airline-airport vertical relations and the horizontal competition in airline and airport markets.
This paper is organized as follows: In Section 2, we study the revenue structure of airports,
and its interactive effects with regulatory regime. This allows us to study airport pricing andservices to airlines which affect airline performance. Section 3 discusses sources of airport
market power, and how such market power is affected by the types of airlines using the
airport, as well as by the airline and airport market structures. Section 4 examines evidenceon airline hub premium, and how the existence of high hub premium may promote
cooperative relations between a dominant airline and the airport. Section 5 reviews thealternative types of vertical relations between airlines and airports, and how they influencecompetition in the airline and airport markets. The last section concludes and summarizes
the paper.

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Figure 1. Percentage of Non-aeronautical Revenue , 200690%

% Non-aeronautical Revenue 2006

80%

70%

North America
EuropeSource: The Air Transport Research Society (ATRS, 2006)

Asia Pacific

60%

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7

2. AIRPORT REVENUE STRUCTURE, REGULATION AND PRICING

An airport derives its revenues from two sources: charges for aeronautical services suchas aircraft landing (take-off) fees, aircraft parking and taxiway charges, passenger terminal
and facility charges, etc, and the revenue from non-aeronautical sources such asconcessions and other commercial services, car parking, office rentals, and other income
from airport buildings and development of airport lands. As aeronautical charges are usually
regulated, airports rely on commercial and other non-aeronautical services to bring in an
increasing portion of their total revenues. For example, the Air Transport Research Society’
global airport performance benchmarking project (ATRS, 2006) reports that most of the
major airports around the world generate anywhere between 45% and 80% of their total
revenues from non-aeronautical services, a major portion of which is concession revenue.
The unsatisfactory outcome of deregulation/light-handed regulation in New Zealand andAustralia is likely due to the lack of competition among airports. In these two countries,
population is concentrated around several major cities, with airports separated by long
distances. The fact that Virgin Blue enters into expensive litigation with airports indicatesthat the carrier, despite being the second largest airline in Australia, has very limited
countervailing power. As Forsyth (2006) points out, “there is no viable alternative airport
within 150 km- the airline simply has no alternatives”. Zhang and Zhang (2003) and Oum,
Zhang and Zhang (2004) have shown that the presence of concession revenue does
alleviate an airport’s incentive to increase aeronautical service charges. However, Oum,
Zhang and Zhang also concluded that an unregulated profit-maximizing airport, when notunder competitive pressure from other airports, would have incentive to charge a pricehigher than the socially optimal level, and even higher than the price that publicly owned
airport under breakeven financial performance requirement would charge. These findings do
not necessarily reject Starkie’s (2001) conclusion as he considered mainly the cases ofWestern European cities, where many airports compete with each other for airlines’ businessas well as competing with high-speed passenger railways. Instead, our investigation in thefollowing section will show that the effects of an airport’s concession revenue on airside
service pricing are moderated by airline market structure, competition among airports as wellas the vertical relationships between airline(s) and airport(s).
The form of regulation influences pricing behavior and performance of an airport
significantly. Although various forms of airport regulations have been adopted by different
countries around the world, the most widely used regulatory regimes are: (a) single-till pricecap regulation, (2) Dual-till price-cap regulation, (c) Rate of return regulation, and (d) lighthanded regulation (usually price and performance monitoring along with threat of regulation).
A detailed discussion on the application of these regulations in various countries is available
in appendix A.
Many studies have compared the performance of these regulatory regimes. A key issue
in the debates on airport regulation has been on the merits of single-till versus dual-till pricecap regulation. The advantages and disadvantages of each approach are discussed in
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Starkie and Yarrow (2000), Australian Productivity Commission (2002), UK CAA (2000 and2003), and Niemeier (2002). Beesley (1999) questioned the appropriateness of single-tillregulation. He argued that regulation should concentrate on activities that are characterized
by a natural monopoly, and therefore, should not involve commercial activities. At the sametime, since he doubts that it is possible to isolate the aeronautical activities from other airport
activities, he generally rejects the applicability of price cap regulation on airports. Starkie
and Yarrow (2000) suggest that the adoption of the single-till approach results ininefficiencies at capacity constrained airports, because non-aeronautical revenues keep
aeronautical charges at a low level, and subsequently excess demand is artificially stimulated. They propose that a better outcome would be for aeronautical charges to be set at thelevel that provides a clear signal to enable resources to be efficiently allocated. Lu andPagliari (2004) argue that the dual-till approach is desirable when an airport’s aeronautical
capacity is fully or over-utilized, while the single-till approach is preferable in the presence ofexcess capacity. In principle, under the dual-till system, the possible (excess) profits earnedby airports from non-aeronautical services can be utilized to expand capacity and improve
service quality. However, there is no easy answer to how to provide incentives for airports to
do so. Czerny (2006) shows that an unregulated airport with excess capacity would tend to
reduce charges for commercial services and raise aeronautical charges.. The intuition is thatprice elasticity of demand for commercial services higher than the price elasticity of thedemand for airside services. Czerny further points out that single-till regulation dominates
dual-till regulation at non-congested airports, in the sense that single-till regulation comescloser to maximizing welfare than dual-till regulation.
Overall, single till regulation appears to be superior to other regimes in terms of setting
appropriate prices. The notion of regulating only the monopoly services (aviation services) is
appealing in theory. However, dual-till regulation ignores the economies of scope for airports
in providing aviation and concession services jointly. More importantly, dual till regulation
does not internalize the demand complementarity between aviation and commercial
services. As airlines who bring passengers to the airport may not benefit from directly fromthe concession sales, they may ignore such positive demand externality in their decisions.
On the other hand, under a single till regulation, concession revenue may be used to crosssubsidize aeronautical charges.
For congested airports, Starkie and Yarrow’s (2000) recommendation of dual-tillregulation appears to be reasonable. However, the best remedy for capacity utilization may
be peak-load pricing, or some sort of congestion pricing of the facilities such as slots,
checking counter and bridges etc. The extra revenue generated from such a pricing may be
used for capacity investments. In practice, however, such policy changes may be difficult
due to influence of vested interests.1
While firms under rate-of-return regulation tend to over-capitalize their asset bases(Averch-Johnson effect ) a major problem with price-cap regulation, either single till or dual
till, is that airports in the long run tend to under-invest in airport capacity. Oum, Zhang andZhang (2004), using a econometric analysis of the ATRS (Air Transport Research Society)global airport efficiency benchmarking data, conclude that after controlling for the effects offactors beyond management control, airports under price-cap regulation tend to under-invest
on capacity.

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Although all regulatory schemes discussed may be applied to any airport, actual
regulation and intervention tend to be less strict nor explicit for government owned andoperated airports.2 For example, many airports in the United States are owned by municipal
governments and are operated by the city aviation departments. In principle, the Federal
Aviation Act requires that airside fees cover only the costs associated with providing
aeronautical services. The Federal Aviation Administration (FAA) was awarded the power toregulate the prices of U.S. airports. In practice, however, FAA has rarely exercised thesepowers as there is little to be gained by regulating a government undertaking which operates
as a not-for-profit entity, lacking incentives to set unfair prices (Graham, 2004).
While an airport’s aeronautical charges become an input price to airlines, the effect of
airport capacity is a more complex matter. A capacity shortage will lead to airport congestion,
implying a reduction of service quality to all carriers and passengers. On the other hand,capacity constraints could have differential impacts on different airlines using the same
airport. A dominant carrier at an airport usually controls a significant proportion of key
resources such as landing slots, check-in counters and gates. Capacity shortage at the
airport may help the dominant firm to keep potential competitors out of the market.
Therefore, it is not clear from the current literature as to what is the best way of allocatingsuch precious resources, especially between incumbents and entrant airlines.
Airport pricing and services directly influence the performances of airlines. Our review of
the revenue structure, regulatory regimes and pricing behavior of airports suggests thefollowing:•••

Concession and other non-aeronautical revenues are of increasing importance toairports. The positive externality effects of the demand for aviation services on the
demand for commercial services reduces an airport’s incentive to exploit its market
power, and set high aeronautical charges. However, absent competitive pressureand explicit regulation, airports will increase their aviation service charges above thesocial optimal level, given the very low price elasticity of the demand for airport
services.
The regulatory and governance structure of airports is very complex and diverse.
Single-till price-cap regulation appears to perform better than other approaches as itprovides incentives for an airport to internalize the demand complementarity
between aviation services and commercial services. However, in the long run,
airports under price cap regulation tend to under-invest in capacity expansion. This
may increase congestion and thus reduce service quality, as well as providing more
opportunities for a dominant airline to prevent competitive entry.
The actual pricing and performance of an airport are subject to a combined effect ofmany factors, some of which are beyond management control. Therefore, it isimportant to identify those true determinant factors in order make proper policy
choice.

Another issue not addressed in the literature on airport regulation is the effect of thetiming of changes in the regulatory regime. Suppose a country changes regulation of a
privatized airport from single-till to dual-till price-cap regulation after the airport has alreadybeen privatized. Then it would create windfall gains for the owners of the airport, because
theoretically the value of the airport will increase by the present value of the stream ofincreased future profits from the non-aeronautical business. Such a windfall gain would
create inefficiency. But, if the decision on dual-till price cap regulation is made at the time
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the airport is privatized, then the future airport owners should not be able to make a windfall
gain because the bid prices on the airport would reflect a larger amount of the future profits
to be made from non-aeronautical services under the dual-till than under the single-till pricecap regulation.

3. AIRPORT MARKET POWER

In the past, most airports were owned and operated by government branches, public
sector agencies or corporations, probably because airports were regarded as a natural
monopoly characterized by substantial economies of scale. Such a belief has now beendisputed widely. Doganis (1992) states that economies of scale are probably exhausted at
an annual output of about three million passengers. Jeong (2005) shows empirically that a
constant returns to scale sets in at US airports at about three to five million passengers.
Starkie (2001) even suggested that an airport’s long run unit cost may be an increasing
function of output.3 Since the natural monopoly argument for economic regulation may nothold in the case of airports, their market power is likely to come from the fact that it takes
several decades to plan, environmentallyreview, and construct a new airport especially neara major metropolitan area. The rapid growth of air traffic often creates capacity shortage,
which in turn gives airport pricing power.
Major airports have substantial market power for their airside services, because theprice elasticity of the demand for airside services is very low since airport charges accountfor a relatively small portion of an airline’s total cost. Gillen, Oum and Tretheway (1988)
conclude that the price elasticity ranges between -0.01 and -0.1 depending on aircraft
size/payload. This implies that airports can increase their aeronautical charges substantiallywithout losing much traffic. Therefore, in the absence of regulation, a profit maximizing
airport may be able to even double its aeronautical charges without losing much traffic (Fu,
Lijesen, and Oum, 2006). However, the actual market power of an airport depends largely on
the following factors:
•
•
•
•
•

Airport capacity available in the region as compared to the rising demand for thecapacity
Airline market structure and competition at the airport and in the region;
Share of Connecting Passengers;
Inter-modal competition, especially between airlines and high speed rail;
The extent and nature of competition with other airports, whose traffic catchments
areas overlap significantly with the airport under consideration.

3.1. Airport Capacity and Demand for that Capacity
In a majority of the major metropolitan areas in Europe, U.S., and Asia, current capacityand future expansion plans are generally not sufficient to meet the rising demand forcapacity since air passenger and freight transport demands increase at the average rates of
4-5% and 5-6% per year, respectively. Congested airports have an even greater incentive to
Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 200811

raise airside prices since a reduction in traffic would lead to service quality improvement.
Naturally these factors increase the market power of most airports in major metropolitan
regions.
3.2. Low Cost Carrier Airports
On average, the average per-seat cost of EasyJet was £40.48 during the first half of2008. Airport and ground handling costs added up to £11.14, more than 25% of the total
cost.4 Clearly, LCCs specializing on short-haul markets will be far more sensitive to airport
charges. Also, since LCCs utilize point-to-point networks without doing connecting services,
it is less costly for them to switch airports if things do not work out with an airport. This
reduces the market power of airports. Since LCC airports attempt to attract passengers inorder to capitalize on the positive externality of air traffic on commercial services, LCC(s) has
substantial bargaining power in negotiating fees with these airports.
Since major LCCs tend to have wider catchment areas than Full Service Airlines(FSAs), their choice of an airport in a region is quite flexible, and as such, can be largely
influenced by the deals on aeronautical charges and what they can extract from the airport
and/or the community, in exchange for bringing new business to the airport and community.
For example, after the cold war, many military airports in Western Europe werecommercialized. This introduced competition among airports whose catchment areas
overlap. On the other hand, Ryanair and EasyJet have emerged as the two dominant LCCs
in Europe. This allows them to negotiate good deals with competing airports. Ryanair paid,
on average, $1 or less per passenger to eight provincial UK airports during the 1998 – 2000
period when the average aeronautical revenue at major airports in Europe were more than
$8 per passenger (Barrett, 2004). Furthermore, these LCCs were able to use their market
power (as a big buyer) even to attract subsidies from airports. The European Commission
have opened investigations on the possible state subsidy offered to EasyJet and Ryanair bysome airports such as Belgium’s Charleroi airport, Berlin Schoenefeld and Luebeck
Blankensee airports in Germany, and Tampere Pirkkala in Finland. In the United States,
some community airports heavily depend on a couple of Full Service Airlines (FSA) to link
their airports to major carriers’ hubs. In such case, airports offer favorable prices to thesecarriers to ensure connectivity to major airline networks.
3.3. Airline market structure and competition.
Since a primary hub airport for full service airlines provides very different services
compared to a secondary airport targeting LCC services,5 the substitution effects between
these airports, such as the case of Heathrow and Luton airports in the London area, are notas strong as the case when similar airports compete each other.
The market power of even a monopoly airport would be curtailed when one airline gets todominate this airport. The dominant carrier can turn the airport-airline relation into one ofbilateral-monopoly (monopoly-monpsony). Each side, namely the dominant airline and the
airport, commands market power. In such case, the negotiated outcome between equally
powered buyer and seller is usually socially efficient. The market outcome dictated by one
dominant party (airport or airline) is inefficient.

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In reality, it is more likely that a monopoly airport may take advantage of the hub
carrier’s inability to move away from a natural hub airport. It is difficult and expensive for an
FSA to move away from existing hubs. The UK Office of Fair Trading (OFT 2007) states“Carriers offering extensive long haul services, particularly those serving the US market, saw
limited scope for substitution away from Heathrow” for the following reasons:
•

•
•
•

Airlines in alliances, which schedule their flights to allow interconnection with otherairlines in the alliance group, can not realistically switch airports independently ofother alliance members: 21 of the top 30 airlines (by airport revenue) at Heathrow
are members of Star Alliance, Oneworld Alliance or SkyTeam Alliance.
Only Heathrow has the infrastructure to support hub activities.
Heathrow is close to the large, wealthy population living along the M4 corridor, innorth-west London and Buckinghamshire.
In many circumstance, switching airports on international services is restricted by airservices agreements (ASA).

As a result, a major airport tends to have more power over FSAs even if the airline is thedominant carrier at the airport.6 The monopoly power of an airport gets much larger when amajor airport has no apparent hub carrier, with market shares at the airport being sharedalmost equally among a number of carriers. A good example is Los Angeles International
Airport (LAX) which is almost equally shared among major US carriers.
3.4. Share of Connecting Passengers
When a high proportion of an airport’s traffic is connecting traffic, monopoly power ofboth airlines and airports are limited on connecting traffic. This is because connecting
passengers have choices to travel via different hubs. As a result they constrain the market
power of airlines and airports. FedEx, for example, had established its Asian hub in SubicBay. Since there is little local traffic, the carrier didn’t experience much business loss when it
decided to relocate the hub to Guang Zhou. Another extreme example is the Honolulu andAnchorage airports. Historically, these two airports had been major transit hubs since transPacific flights needed to do technical stops there. However, its importance quickly diminishedwhen non-stop flights became possible. Because of this market power differential, we often
find that it is considerably cheaper to fly, say, from Vancouver to Berlin via London than
Vancouver to London. Similar examples on the pacific market would be that Vancouver toShanghai via Tokyo is often considerably cheaper than Vancouver to Tokyo. Since both
airlines and airports share a common objective of attracting more connecting passengers,
the higher the proportion of connecting passengers (in a major airline’s hub airport) the
higher is the incentive for both the airport and airlines to cooperate with each other. Thisissue will be taken up further in the next section when we discuss airport-airline vertical
relations.
3.5. Inter-modal competition, especially between airlines and high speed rail
The relationship between airlines and railway services can be competitive as well ascomplementary. It is likely that high speed rail (HSR) poses more competition to airlines inshort-haul markets (e.g., Amsterdam-Paris; Brussels-Paris) than being complementary. As
such, an increase in HSR services would reduce the market power of airlines and airports.
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3.6. Competition among Airports in the Same Metropolitan Region
Obviously, common ownership of several airports located in a metropolitan area or aregion is likely to increase market power of those airports collectively. UK Competition
Commission decided to order BAA plc. to divest Gatwick and Stansted, and either Edinburghor Glasgow. This is consistent with its effort to reduce BAA airports’ market power in these
two regions.7 City of Chicago’s plan to privatize Midway Airport (MDW) is certain to
introduce competition with Chicago O’Hare airport (ORD), although the main motivation forthis privatization came from the city’s financial reasons. Since no substantial economy ofscope has been observed for putting more than one airport in the same region under acommon ownership,8 it appears more socially efficient to place each airport under separate
ownership and management.
Presence of alternative airports under different ownerships can reduce airports’ market
power in the following way. Due to the competition among airports, the (firm-specific) priceelasticity of demand faced by each airport, ε i , is determined by the formula of

εi =

ε

, where ε is the price elasticity of market demand for airport services in the

S i (1 + vi )region, S i is airport’s i’s market share, and vi is the conduct parameter which measures thenature of competition between airports. When vi takes values 0, -1, and 1, the competition
among airports are of Cournot, Bertrand and collusive behavior types (Oum, Zhang andZhang, 1993). Although empirical verification is necessary, the fact that airports competewith limited capacities suggests that they are likely to compete in Cournot fashion.9 Thisimplies that when three symmetric airports compete with each other when the price elasticityof the market demand ranges -0.01 and -0.1, each airport will face a firm-specific priceelasticity in the range of -0.03 to -0.3 for their aeronautical services. This level of very low
price elasticity would still allow these airports to increase prices significantly without losing
much traffic.
When alternative airports are owned by the same (private) company, these airports will
behave collusively such that vi approaches 1, making airport specific elasticity approachclose to the market elasticity. This allows airports under common ownership to retain market
power. Therefore, the recent move by the UK Competition Commission on BAA’s ownershipof the London area and Scotland airports are pro-competitive. The common ownership andmanagement of the three major airports in New York & New Jersey metropolitan area (JohnF. Kennedy (JFK), Newark (EWR) and LaGuardia (LGA)) has caused similar problems for
the US Department of Transportation (Oum, Yan and Yu, 2008).
An interesting and relevant question is, without government intervention, will adjacent
airports under separate ownerships behave competitively, or they would rather to collude or
to form alliance? If airports would prefer to work together with each other, even in an area
being served by multiple independently owned airports, there may be needs for regulation.
Studies on merger and alliance formation (Stigler, 1950; Salant et al. 1983; Rodrigues, 2001;
Horn and Persson, 2001) suggest that the actual outcome depends on many factors, suchas whether firms produce substitutes or complements, whether there are significant
economies of scale in production, whether firms provide homogenous or differentiated14

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services, conduct of competitors, structures of the upstream and downstream markets, etc.
Without a detailed and country-specific study, it is difficult to predict competing airports’behavior. Other than the possible incentive of collusion, airports’ alliance/ cooperation may
lead to some synergy. Cooperation between two or more of nearby airports is likely to help
allocate traffic more efficiently between those airports. Tokyo’s Haneda airport focuses on
intra-Japan flights while Narita airport focuses on international flights. Seoul’s Gimpo(domestic) and Incheon (international) airports, and Shanghai’s Hong Qiao (domestic) and
Pudong (international) airports are similar cases. There is a recent proposal to link the Hong
Kong International Airport with the Shen Zhen airport in southern China via a high speed rail
for a similar division of flights.10
Therefore, the relations among airports in the same region need to be analyzed
carefully. While coordination may improve customer services and operational efficiency ofthe combined airport group, it will reduce competition not only between airports in the region
but also reduce competition in the downstream airline markets. In short, the strategic
behavior of airlines will need to be considered when examining full impacts of allowing (ordisallowing) competing airports to form alliance or merge with each other.
Airports derive two types of revenues: revenues from aeronautical charges andcommercial and other non-aeronautical revenues. As most previous studies, we haven’t
discussed airports’ market power on commercial operations since this is likely to be an
empirical question. Concession services at airports are imperfect substitutes to similar
services offered in the city. Therefore, airport and concession service providers may havesome market power. Certain developing countries allow airports to charge a premium forconcession services, probably with the perception that those services are usually consumedby high-income and/or business travelers whose price elasticities tend to be low. Even inthese markets, however, market power tends to be unsustainable in the long run. Prices
have to be reduced in order to stimulate concession consumption. Shanghai Pudong
International Airport has recently decided to reduce concession prices, in the hope that the
airport can derive a higher proportion of revenues from non-aeronautical services in the
future.

4. AIRPORT DOMINANCE, AIRLINE HUB PREMIUM, AND IMPLICATIONS FORAIRLINE-AIRPORT COOPERATION

Since the deregulation of the US domestic market, airlines were given the freedom to
optimize their route structures. As a result, hub-and-spoke networks have been expanded
extensively by major network carriers. Such a change is accompanied by major shake-ups inthe industry. Massive mergers, acquisitions, and liquidations occurred in the industry during
the first 10 years after the 1978 deregulation as surviving major carriers were trying tostrengthen their dominance in existing hubs and to expand continental market coverage. For
example, many airlines based in Central and Eastern United States acquired carriers basedin Western United States.11

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15

Dominance at an airport allows a carrier to achieve substantially higher mark-up above
costs. Such a benefit to the dominant carrier is referred as the “hub premium” in theliterature. Borenstein (1989) studied airline pricing for local traffic to/from major US hubs in
1987. He found that dominance of major airports by one or two carriers would result in higher
fares for consumers who want to fly to or from these airports. Such strongholds insulate thedominant carrier from competition12. This phenomenon has been confirmed by subsequentstudies, albeit with varying magnitudes of hub premium ranging from well below 10%((Dresner and Windle 1992; Morrison and Winston 1995; Lee and Prado 2005) to around
20% (GAO 1989, 1990; Lijesen, Rietveld and Nijkamp 2004). Other than market power,
alternative sources of hub premium, such as Frequent Flier Program (FFP), passenger mix
and product differentiation (Lederman, 2008; Lee and Prado, 2005; Berry, 1990) areproposed over the years. US Department of Transportation (DOT, 2001), however, believes
that these rationales commonly used to explain high fares in hub markets only apply if pricecompetition is not present.13 It is the lack of price competition, not these rationales, that
explain high prices at hub markets. DOT (2001)14 concluded that “from a consumer
perspective, the primary disadvantage of network hubs is the level of market power that the
hub carrier is capable of amassing and the higher prices consumers pay as a result. This
stems from the fact that no airline with a similar cost structure can compete effectively at
another airline’s hub. DOT and others have reported on the prevalence of high fares paid bypassengers at hub airports dominated by a network carrier; indeed, “no credible study
concludes otherwise.”
Regardless of the source of hub premium, such a benefit gives airlines strong incentive
to dominate an airport. As shown in Table 1, except for Chicago O’Hare airport, virtually nomajor airlines share their hubs with others.15

Table 1. Share of Enplanements of the Dominant Carrierat Concentrated Hub Airports, 1978, 1993
1978
AirportAtlanta
Charlotte
Cincinnati
DaytonDenverDetroitGreensboro
MemphisMinneapolis-St.
Paul
Nashville
Pittsburgh
Raleigh-Durham
St. Louis
Salt Lake City
Syracuse

1993

Share
49.7
74.8
35.1
35.3
32.0
21.7
64.5
42.2
31.7

Carrier
Delta
Eastern
Delta
TWA
UnitedAmericanEastern
Delta
Northwest

Share
83.5
94.6
89.8
40.5
51.8
74.8
44.9
76.3
80.6

Carrier
Delta
USAir
Delta
USAir
UnitedNorthwest
USAir
Northwest
Northwest

28.5
46.7
74.2
39.4
39.6
40.5

AmericanAllegheny
Eastern
TAW
Western
Allegheny

69.8
88.9
80.4
60.4
71.4
49.5

AmericanUSAir
American
TWA
Delta
USAir

Source: Morrison and Winston (1995).
16

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Meanwhile, while an airline often utilizes multiple hubs overall, they can not afford tohave more than one hub in a region. Airneth (2005) observed that the closest distance
between two major hubs in a successful dual-hub system is 900km, the case of Northwest’sMinneapolis-St. Paul and Detroit. British Airways attempted to share hub functions of
London-Heathrow airport with Gatwick airport, mainly to relieve congested Heathrow airport.
However, they soon realized that it was not a winning game, and as a result, they decided tode-hub Gatwick (O’Connell, 2008). BA found that long-haul routes could be much more
profitable by moving them to Heathrow, and duplicating a short-haul feed network from
Gatwick was costly. It is an example of the failure of duplicating hubs in the same city. When
Air France and KLM applied for merger, the Dutch Government was concerned since it might
be of the merged airline’s interest to reduce hub functions in Amsterdam (AMS). AMS is too
close to Paris to be successful as a dual hub as shown in figure 2. In addition, Paris-CDG
has much larger population base to support a Super-hub of the combined carrier. Therefore,
Dutch government imposed the condition that the combined AF-KLM should maintainminimal of 42 major international key destinations from Amsterdam at least for the next 5
years. Consequently, the combined AF-KLM will not be able to make any major network
restructuring involving international destinations or connecting services until 2010.

Figure 2. Air France and KLM Merged Network:
Paris and Amsterdam

In summary, airport dominance allows a carrier to achieve hub premium and enjoy otherrelated advantages.16 An airline prefers to have its own exclusive hub rather than to share asame airport with other carrier’s hub function. While a carrier may set up an optimal multiple
hub network for continental coverage, it can not afford to have more than one hub within aregion. All of these factors indicate the following:
Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 2008

17

•

•

Network carriers will be competing in each of the major markets by setting up theirhubs in different airports in each major market of the continent. These airports ineach region will have substantially overlapping catchment areas. Some airports
may be in the same city.
The above provides a strong incentive for airports and their respective dominant
airlines to cooperate with each other (vertical cooperation between airports andairlines) in order to compete successfully with other airport – hub airline
combinations in the region.

5. AIRPORT-AIRLINE VERTICAL RELATIONSHIP

Despite some conflicting interests, especially with regard to aeronautical service
charges, many airports have developed close relationships with airlines. The following typesof relationship are often observed in practice:18•

Signatory airlines. Many governments now require airports to be financiallyindependent. Since those airports are free from government subsidy, many havechosen to work with airlines. Carriers who signa master use-and-lease agreement
are awarded so-called signatory airline status. Those airlines become eventual
guarantors of the airport’s finance. In the case of ‘residual’ agreement, the signatory
airlines pledge to cover the full cost of airport operations required for the airport tobreakeven. The aeronautical service charges are determined by the ‘residual cost’remained, after the revenues from non-signatory airlines and non-aviation sources
have been deducted from the airport’s total costs (debt service, interest, andoperating expenses). In other cases, the main contribution from signatory airlines isservice guarantee and usage commitment. This reduces uncertainty over future
airport revenue, and thereby allows the airport to reduce financing costs whensecuring long term bank loans. In return, signatory airlines are given varying
degrees of influence over airport planning and operations including slot allocation,
terminal usage, capacity expansion projects, and exclusive or preferential facility
usage.

•

Airlines own or control airport facilities. Some airlines hold shares in airports ordirectly control airport facilities. For example, terminal 2 of Munich airport is a joint
investment by the airport operating company FMG (60%) and Lufthansa (40%), thedominant airline at the airport. Lufthansa has also invested in Frankfurt airport, andholds a 29% share of Shanghai Pudong International Airport Cargo Terminal. By
2006, Thai Airways had invested over US$400 million at the new Bangkok
International Airport.17•

Long term usage contract. There are many cases where airlines and airports
secure their cooperation via long term contracts. In recent years, the Low Cost
Carriers (LCCs) have organized this type of long term contract with airports. Many
Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 2008

secondary airports offer LCCs favorable usage terms in order to attract their traffic.
However, once an airline incurs sunk costs in establishing its services out of the
airport, the airline loses bargaining power because of the high cost of switching to a
new base. Therefore, many LCCs choose to sign up long term contracts with
airports in order to lock in the favorable terms. Long term contracts can also be
helpful to airports. It encourages an airline to make long term investment to develop
a more extensive network, securing airport traffic in the long run. Therefore, most
airports are willing to sign such long term contracts. For example, in 2002
Melbourne airport and Virgin Blue reached a 10-year agreement for the airline tooperate from the former Ansett/Southern Domestic Terminal.
•

Airport revenue bonds. Many airports now choose to issue Special Facility
Revenue Bonds (SFRB) to finance specific capital improvement programs18 (e.g.,fuel farms, maintenance facilities, terminals, etc.). In these project financing
arrangements, airports retain asset ownership but transfer the right for exclusive
usage to the project sponsor under long-term lease agreements. The tax-exempt
SFRBs are exclusively secured by the specific project’s revenue stream, which isguaranteed by the project sponsor. The airport is without any obligation to SFRB
bondholders in case of default. Therefore, much of the risk associated with the
project is transferred from airports to airlines. In turn, SFRB gives airlines
preferential or exclusive rights over key airport facilities.

5.1 The costs and benefits of airport-airline integration
The effects of vertical relationships between firms have been studied extensively in theeconomic literature. For example, vertical cooperation/integration may have positive
efficiency effects such as the removal of double-marginalization (Tirole 1988), coordinationof optimal production and inventory in supply chains (Cachon and Lariviere 2005, Dana andSpier 2001), etc. Vertical integration among firms may also bring negative effects oncompetition, such as market foreclosure and price squeeze (Greenhut and Hiroshi 1979,
Salinger 1988, 1989, Schmalensee 1973), etc. However, vertical relations between airlines
and airports have received little attention in the literature thus far. This is probably due to thefact price discrimination on aviation services is prohibited by the International Air Transport
Association (IATA) rules. That is, an airport is required to charge all airlines the same pricefor identical services. Such a restriction, together with the historical public utility status of
most airports, has often excluded airports from the lists of anti-trust investigation until the
recent privatization wave. Nevertheless, as airports provide an essential input to airlines,
such airline-airport cooperation, especially those offering exclusive deals to specific airlines,
raises anticompetitive concerns.
In general, inter-firm relationships can be complex when one considers an upstream(airport) market and a downstream (airline) market jointly. Several studies model passenger
travel choice over a region being served by multiple airports. In such a case, passengers
choose a combination of airports and airlines, rather than airline services only (Ashford andBencheman, 1987; Caves, Ndoh and Pietfield, 1991; Pels, Nijkamp and Rietveld, 2000,
2001, 2003b). Pels, Nijkamp and Rietveld (2001) point out that an airline faces two types ofcompetitors: competitors operating from the same airport; and competitors operating fromother airports. The airlines operating from the same airport may have conflicting interests aseach tries to expand its market. But as opposed to the airlines operating from other airports,
Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 200819

they may also have the same interest of making the airport attractive in order to attract morepassengers to route their travel via the airport, and divide up those traffic among themselves.
While the above studies investigated competition among airline-airport combinations,
there have not been much studies on the endogenous formation of airport-airline
combination mechanism (i.e. the process during which airlines choose particular airports toserve, or the process during which airports attract particular airlines to establish homebases). As discussed in Section 4, airports do have incentives to ally with a particular airline.
When an airport faces competition from other airports, either an adjacent airport sharing thesame catchment area, or another major airport competing for connecting traffic, it is in each
airport’s interest to ally with one airline, normally the dominant carrier. The airport cansecure its future traffic and revenue once a major carrier has decided to establish its hub
there, a much needed commitment to an airport facing competitive and financial challenges.
It does not help much for an airport to treat other carriers equally well, since the existence ofa hub premium discourages airlines from sharing their own hubs with competitors.
On the other hand, airlines also have strong incentive to ally with an airport. The support
and preferential treatments from airports allow a dominant carrier to secure the key
resources needed for operation, and to gain competitive advantage over other carriers.
Thus, when there are competitive pressures in both the airline market and airport
market, both airports and airlines have incentives to form vertical alliances. Such verticalcooperation, or possible tacit collusion, would further strengthen the dominant carriers’
market power at the airport. This has raised some competitive concerns. In 2004, forinstance, the European Commission ruled against the agreement between Belgium’s
Charleroi airport and Ryanair, claiming that the favorable terms offered by the airport
constituted an illegal state aid.
Morrison and Winston (2000) and Dresner, Windle and Yao (2002), among others,
found empirical evidence that a dominant airline’s control over key airport facilities, such as
slots and gates, is likely to impose significant entry barriers to other potential competitors.
Gonenc and Nicoletti (2000) studied 102 air routes connecting 14 major international
airports. They found in a large number of international airports, congestion phenomena arereported to exist and a single airline controls more than half of the available slots. Thisimplies that dominant carriers are frequently in a position to use slot dominance at congested
airports to close out competitors or raise costs for rivals costs on certain routes. As a result,few international routes are truly open to competition.
In the United States, the Charlotte/Douglas airport authority believed that it had
benefited from having a single dominant carrier (US Airways) – the carrier was regarded as a“partner” of the airport. The U.S. Federal Aviation Administration (FAA), however, expressed
concern that US Airways exercised too much control over airport facility and operations suchas landing slot allocation and passenger terminal usage. The mayor of Charlotte appointed atask force to address the issues of airline competition. Additionally, the Aviation Department,
pursuant to a directive from the City’s Advisory Committee, hired a consultant to evaluate thecompetitive situation at Charlotte and to develop strategies for improvement (FAA 1999).
In general, FAA is concerned about an airport offering exclusive deals to a particular
airline, because such special treatment may harm competition in downstream airline
markets. Specifically, FAA is against airports’ practice of giving exclusive or preferential
20

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 2008

facility usage to particular airlines. FAA suggests airports recover exclusive facilities for
public usage. Airports are allowed to levy a Passenger Facility Charge (PFC) to finance nonexclusive facilities. In order to fully benefit from such revenue, large airports with a“dominant” carrier must submit to the U.S. Department of Transportation (DOT) a plan on
how they intend to promote airport access, entry and competition (FAA, 1999). The
requirement of submitting a competition plan was incorporated into the “Wendell H. Ford
Aviation Investment and Reform Act for the 21st Century”, legislated in 2000. According tothis Act, large and medium airports that exceed a certain threshold of concentration are
required to submit competition plans.
With growing pressures for airports to improve their financial performances, newpatterns of airport-airline relations emerge. For example, since concession revenue isincreasingly important, airports and airlines now use various agreements to internalize thepositive demand externality between aviation services and concession services. Since
2000, Tampa International Airport has been sharing concession revenues with its signatory
airlines. On the airline side, Ryanair identified airport car parking as one of its major business
opportunities and cooperates with the leading airport parking company BCP (Ryanair, 2005;
Davy Securities, 2006). In its negotiation with some airports, Ryanair asked for sharing
parking revenue as a condition to initiate services at these airports.19 Fu and Zhang (2008)
studied analytically various forms of concession revenue sharing arrangements. One of theirfindings is that when a carrier has significant competitive advantages over other carriers, a
price regulated airport can enhance its own profit by cooperating with the dominant airline.
This allows the dominant airline to strengthen its market power in terms of increased market
share and profit at the expense of its competitors. The intuition is that concession revenue
sharing provides competitive advantage to a sharing airline, who can internalize demand
externality, and benefits from its competitors’ output expansion in terms of getting moreconcession revenue. Since dominant carriers can exploits such competitive advantage more,an airport is more likely to work with them. Overall, Fu and Zhang (2008) found thatcooperation between airlines and airports, such as the case of revenue sharing, may be asource of welfare gains. However, it may have negative effects on airline competition. In
some cases, the airport and dominant airlines have incentives to collude each other at theexpenses of other carriers.
In recent years, airlines and airports have developed various forms of vertical relations
in order to reduce risk, internalize demand externalities and gain competitive advantages
over other airlines/airports. Cooperation between an airport and an airline, however, may
harm competition. The effects of these vertical relations are two-sided, which warrant further
investigation. Imposing strict regulations at the current stage is likely to hinder innovation andreduce dynamic efficiency in the long run. Therefore, probably the best choice for regulators
is to intervene only when there is clear evidence of negative effects. A simple and effective
way to deter bad behaviors is to require disclosure of exclusive contracts between airports
and airlines. Transparency and public scrutiny are cost-effective alternatives to “immature”
regulation.

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 200821

6. SUMMARY AND CONCLUSION

In recent years, airports have been under growing pressure to be more financially selfsufficient and less reliant on government support. The process of privatization andcommercialization strengthens managers’ desire to enhance airport performance, while
requiring a streamlined, cost effective regulatory system. Since airports provide essential
inputs to airlines, performance in the airport market will have important impacts on thedownstream airline market. In this paper, we attempted to achieve two main objectives:
First, we study the key determinant factors for airport performance, and how they affectairport pricing and services to airlines. Three key factors are reviewed, namely revenue
structure, regulatory regimes, and market power of airports. Secondly, this paper reviews
how airport services, business strategies and airport-airline vertical relations influence
downstream airline competition.
Our investigations lead to the following conclusions:22•

Airport revenue structure: Concession and other non-aeronautical revenues areof increasing importance to airports. There is economy of scope to produce
aeronautical and non-aviation services jointly. Airports expanding concession andother non-aeronautical service activities are likely to achieve higher efficiency andbetter financial performance, and thus, allow them to reduce aviation user charges
to airlines and passengers. In addition, the positive externality of the demand foraviation services on the demand for concession services reduces an airport’s
incentive to exploit its market power vis-à-vis airlines. However, absent competitive
pressure and explicit regulation, airports will still increase their service charges
above socially optimal levels.

•

Airport regulation: The regulatory and governance structure in the airport industry
is very complex and diverse. In terms of pricing, single-till price regulation appears
to perform better than the alternatives, since it mandates airports to internalize thedemand complementarity between aviation services and commercial services. Dualtill regulation can be more efficient by pricing air services separately in congested
airports. However, in the long run, airports under any kind of price cap regulation
tend to under-invest in capacity. This may reduce airport service quality, andfacilitate a dominant airline to close out competition from potential entrants.

•

Airport market power: In general, airports possess substantial market power overaviation services due to the extremely low price elasticity. The availability ofalternative airports will reduce airport market power, but not in the case of common
ownership. However, the market power of airports is substantially reduced in thecase of short haul markets served by LCCs, or airports dominated by one or only a
few airlines.

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 2008

•

Airport – airline vertical relation: There are benefits for both airports and airlines
from entering into long term relationships: Airports can obtain financial support andsecure business volume, which are important for daily operation as well as for longterm expansion. For airlines, they can secure key airport facilities on favorable
terms, which are essential conditions for them to make long term
commitment/investment at an airport. This provides incentives for the airport andthe dominant carrier to strike exclusive deals, harming competition in thedownstream airline market if unchecked. Such a dominance of one airline at an
airport allows the airline to obtain a substantial hub premium.

•

Cooperation and competition between two or more airports in a region:
Cooperation between two or more airports is likely to help allocate traffic more
efficiently between those airports. This issue needs more careful analysis because
while the cooperation and coordination may improve customer services and theoperational efficiency of the airports, it is likely to reduce competition not only
between airports in the region but also between carriers in the downstream airline
markets.

In summary, our findings suggest that the airport industry and its relations with airlines
are experiencing major changes, which have important implications for airport management
and regulatory policies. While the performance of airports directly determines their pricing
and services to airlines, there are also interactive impacts between the two markets asevidenced by the vertical relations between airlines and airports. Therefore, there is a needto recognize the upstream - downstream relations between airports and airlines when one
evaluates airport performance, or designs regulatory policies for airports and airlines.

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 200823

NOTES1.

For example, the US Department of Transportation (DOT) announced its plans to
auction some slots of the three airports in NY-NJ Metropolitan area, in the hope that thiswill encourage entry of competing airlines and generate revenue to upgrade air traffic
control systems. However, this plan has received strong opposition from the airport
management and the Ports Authority of New York and New Jersey, the owner of the
airports, who threaten to file law suit to stop the Federal Government from selling“something it does not own”. In reality, a resource allocation model must be in line withstate laws as well as being consistent with economic intuition.

2.

There are alternative forms of government ownership and control over airports. A briefsummary is available in appendix B.

3.

The majority of the empirical studies on airport cost functions can not be relied formeasuring economies of scale because of one or more of the following problems: (a)ignores non-aeronautical services outputs which account for 40-80% of total revenues ofan airport; (b) separate artificially airside services output from terminal services; and (c)use of unrealistically simple capital input calculation.

4.

EasyJet 2008 Interim report, no breakdown of airport service charges and handlingcosts was available at
http://www.easyjet.com/EN/Investor/investorrelations_financialreports.html .

5.

For a discussion of the different requirements for airport services by FSAs and LCCs,
see Gillen and Morrison (2003)

6.

One former chief executive of a major Canadian airport stated openly in an academic
conference in United States that there is no need to consult with airlines when planning
airport capacity. There is no need for airport management listen to what airlines say.
This may be an extreme example, but it illustrates that major airports have market powerover even the dominant hub airlines.

7.

The UK’s Office of Fair Trading (OFT 2007) pointed out that “Carriers offering extensive
long haul services, particularly those serving the US market, saw limited scope for
substitution away from Heathrow”. Even after considering alternative remedies for
BAA’s jointly ownership in the London area, OFT (2007) believes that “Heathrow would
retain market power due to its hub status (and possibly other factors including its size,
reputation and good surface access from central London).

8.

We have not seen any empirical estimates on the economies of scope for an agency orfirm to operate multiple airports in a metropolitan region. However, it appears that the24

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 2008

negative effects of monopoly power of an agency owning multiple airports in the region
is likely to exceed whatever the positive effect on society of allowing a monopolist tooperate multiple airports in a region.
9.

Kreps and Scheinkman (1983) proved that if firms first make pre-commitment of
quantity, and then compete with price, the equilibrium outcome will be equivalent toCounot competition.

10. There are five adjacent airports near Hong Kong: Hong Kong (HKG), Guang Zhou
(CAN), Shen Zhen (SZX), Macau (MFM) and Zhuhai (ZUH). In 2006, Hong Kong Airport
Authority (HKAA) acquired 55% of the Zhu Hai Airport for a price of US$24.75 million
HKAA’s control over the two airports is achieved via the ownership of the Zhuhai-Hong
Kong Airport Management Company Ltd, which a joint venture formed by HK Airport
Authority and the state owner of Zhu Hai airport. The joint venture will manage andoperate Zhu Hai airport for 20 years.
11. For example, Delta acquired Western Airlines in order to expand their market coverage
in western United States and to secure Salt Lake City as its western hub while American
Airlines strengthened its Dallas –Ft Worth hub and acquired Air California. US Air
acquired Piedmont and Pacific Southwest. On the other hand, Northwest acquired
Republic in order to increase dominance of its Minneapolis-St. Paul hub and surrounding
markets. Appendix C summarizes the consolidation process of the US airline industry.
12. Borenstein (1989) found, ceteris parabus, a dominant airline on a route with a 70%
share of the traffic might be able to charge from 2% to 12% higher prices than its rivals
which only have 10% shares. Hub premium is even more evident for flights connecting
two hubs of the same carriers. An airline with 50% of the traffic at each endpoint of aroute is estimated to charge high-end prices about 12% above those of a competitor with
10% of the traffic at each endpoint.
13. DOT (2001) concludes that “In dominated hubs as a whole, 24.7 million passengers pay
on average 41% more than do their counterparts flying in hub markets with low-farecompetition.”
14. http://ostpxweb.dot.gov/aviation/domestic-competition/hubpaper.pdf
15. AirTran maintain a hub at Atlanta, but its market power is not comparable to Delta, who
has established its super-hub at the same airport.
16. Other researchers studied the effects of hub-and-spoke networks in general, andconcluded that such a network would indeed allow hub carriers to price and compete
more strategically (Spiller 1989, Berry 1990, Bittlingmayer 1990, Brueckner and Spiller
1991, Brueckner et al 1992, Zhang and Wei 1993, Oum et al. 1995, Zhang 1996, andHendricks et al. 1997)
17. Many other airlines control or own airport facilities, especially in their domestic hubs.
Qantas owns terminals in both Sydney airport and Melbourne airport. LAPA Airways
holds minority share in Airport Aeropuertos Argentina. In 1994, a consortium of four

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 200825

international airlines (Air France, Japan Airlines, Korean Air, and Lufthansa) invested interminal 1 of JFK International Airport in New York.
18. In general, there are three types of revenue bonds: general airport revenue bonds(GARBS), special facility revenue bonds (SFRBs), and PFC-backed bonds.
19. In other cases, revenue sharing is in effect when airlines hold shares in airports ordirectly control airport facilities. For example, terminal 2 of Munich airport has about 110
stores and restaurants. Profits generated from it, including those from the lease of areas
for catering and retail, are shared by FMG and Lufthansa (Kuchinke and Sickmann,2005).

26

Oum/Fu — Discussion Paper 2008-17 — © OECD/ITF, 2008

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APPENDIX A. ALTERNATIVE FORMS OF ECONOMIC REGULATION OF AIRPORTS

Single-till Price regulation: Price regulation usually takes the form of a price-cap applied torevenues deriving from airport charges per passenger. With single till price regulation, pricecap is applied only to aviation services. However, both aeronautical and commercial
revenues and costs are considered in determining the level of aeronautical charges. Thereis, therefore, a cross subsidy for aeronautical services with revenues arising fromcommercial activities.
The single-till principle was recommended by ICAO and has been widely used inEurope, including UK, Austria, France, Ireland, Norway, Spain, Portugal, Sweden, and most
airports in Germany. In the UK, the Civil Aviation Authority (CAA) sets price caps on airport
charges every five years at airports designated by the Secretary of State, using the RPI-X
formula. Price cap regulation outside the UK is generally based on the CPI – X formula, andthe regulatory review periods vary between 3 to 5 years.
With single till price regulation, air carriers would share part of the airport’s commercial
revenues by paying lower aeronautical charges because of the cross-subsidization of
aeronautical services from commercial services. This is a major reason why single-till pricecap regulations are widely supported by airlines. However, this leaves aeronautical service
prices below provision costs, which poses a problem, especially at a congested airport.
Dual-till Price Regulation separates aeronautical functions from non-aeronautical ones. It
determines the level of aeronautical charges by considering aeronautical revenues and costs
only. Consequently, the corresponding asset base includes aeronautical assets only.
Aeronautical charges will be likely to be set at a higher level under a dual–till approach,especially at a congested airport, than under a single-till approach where cross-subsidizationfrom non-aeronautical revenues will help off-set some of the costs of the aeronauticalservices.
The price cap for Hamburg Airport was the first to be set on a dual-till in 2000 on theargument that regulation should be confined to the monopolistic bottleneck and incentives fordeveloping the non-aviation business should not be stifled (Niemeier, 2002). Other airports
adopted dual-till regulation are Frankfurt, Copenhagen, Malta and Budapest.
Rate of Return regulation benchmark the profitability of regulated activities to the averageof reference airports or businesses. It tends to be complex, unresponsive and expensive toadminister due to the lengthy regulatory hearings involved. Currently, it is used in Belgium
and Netherlands.
It should be noted that the operator of Amsterdam Airport, Schiphol Group's shares areheld by the State of the Netherlands, the City of Amsterdam and the City of Rotterdam.
However, Schiphol Group is a financially independent, commercial company that is subject
to corporation tax effective from 1 January 2002. The fact that Schiphol Group is government
owned may alleviate the complexity and interests conflicts in implementing the rate-of-return
regulation.
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Price Monitoring and Threat of Regulation is currently implemented in Australia and New
Zealand. The regulators use a trigger or "grim strategy" regulation where a light-handed formof regulation is used until the subject firm sets prices or earns profits or reduces quality
beyond some point and thus, triggers a long-term commitment to intruding regulation.
Australia initially imposed dual-till price cap regulation on all privatized airports. Primarily
based on the recommendation of the Productivity Commission (2001), on 1 July, 2002 thegovernment ended the price-cap regulation on all privatized airports for a period of five years(Fu, Lijesen and Oum, 2006). The larger airports, including Sydney, are now subject to pricemonitoring, and the smaller airports are not subject to any controls.
New Zealand does not subject its privatized airports to formal price regulation. Airlines
have been very critical of the pricing policies at some regulated airports (Productivity
Commission, 2006, Bisignani, 2006).
In UK, a system of light-handed regulation applies to airports at which annual turnover
has exceeded £1 million pounds in two of the previous three financial years, excluding those
airports designated for price cap regulation in London and Scotland.

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APPENDIX B. FORMS OF GOVERNMENT OWNERSHIP AND PRIVATE OWNERSHIPIn practice, following forms of government ownership and control have been mostfrequently observed in the airport industry:• Owned and operated by national government – as both regulator and operator
Examples: Spain (Aeropuertos Españoles y Navegación Aérea (AENA) is in charge of 48
airports (McCarthy and McDonnell, 2006) as well as the Air Traffic Control system.);Singapore (Singapore Changi Airport is owned and operated by the Civil Aviation Authorityof Singapore (CAAS). CAAS acts as both the regulator and operator of Changi Airport.)• Owned and operated by national government – Separate regulator and operator
Examples: Finland (regulator: Finnish Civil Aviation Authority; Operator: the former Finnish
Civil Aviation Administration, renamed as Finavia); Sweden (Regulator: Swedish Civil
Aviation Authority; Operator: Luftfartsverket – LFV Group)• Owned and operated by local government departments
Examples: In the United States, many airports are owned by the local governments. In
general, these airports rely heavily on private sector contracting as well as airline
investments in the operation and financing of infrastructure. FAA has the authority toregulate at federal level.
• 100% Government Corporation
Examples: The Norwegian state through the Ministry of Transport and Communications
controls 100% of the share of Avinor, which owns and operates 46 airports in Norway. Hong
Kong International Airport is operated by Airport Authority Hong Kong (AA), wholly owned by
the Government of the Hong Kong Special Administrative Region (HKSAR). The authority
has, for all practical purposes, operated as a government corporation (Cheung, 2006). Other
examples include the Incheon International Airport Corporation (IIAC) and Dublin Airport
Authority (DAA).
• Not-for-Profit Airport Authority
Example: Canada and the US. The term “airport authority” is not clearly defined. In Canada,
it refers to a not-for-profit private sector entity that operates airports under long term lease
contract. In the United States, in generally is used to mean a quasi-government agency that
operates airports at arm’s length from a municipal or county government (Tretheway, 2001).
• Multi--government ownership
Example: Germany, New Zealand, Japan, and the Netherlands. Munich Airport is operatedby Flughafen München GmbH that is jointly owned by the Free State of Bavaria (51%), theFederal Republic of Germany (26%), and the city of Munich (23%).

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In recent years, some countries have fully / partially privatized their airports. An
incomplete list of these airports is provided below:• Fully-privatized:
Example: Most airports in UK, except the Manchester Group, Newcastle (49% privateinterest) and Luton (30-years concession contract), Australia (most of the medium to large
airports are privately owned, smaller airports are owned by local governments), Italy (Rome).
Fully privatized airports refer to those where governments no longer have any ownershipinterest in the airports. The airports may be fully traded on the stock markets or fully owned
by a private group or consortium.
• Mixed ownership with private majority:
Example: Belgium, Denmark, Austria, New Zealand (Wellington and Auckland), Switzerland(Zurich). In many countries, full privatization is restricted as the former public owners (i.e.
national governments) want to secure certain public interests to be guaranteed by a golden
share or a wide ownership clause.
• Mixed ownership with government majority:
Example: Germany (Frankfurt, Hamburg), France (de Gaulle and Orly), China (Beijing andShanghai), Japan (Kansai International) . In most cases, governments retain a majority stakein privatizing their airports. This is the most prevalent ownership form outside UK, Australia,
and New Zealand.

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APPENDIX C. US AIRLINE INDUSTRY CONSOLIDATION WITHIN A DECADE AFTER
1978 DEREGULATION

Source: Morrison and Winston (1989).

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