Impacts ofExpanding Airport
Capacity on Competition
and Connectivity
The case of Gatwick and Heathrow

Country-Specific Policy Analysis

Impacts ofExpanding Airport
Capacity on 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
DISCLAIMER

This work is published under the responsibility of the Secretary-General of the International Transport
Forum. The opinions expressed and arguments employed herein do not necessarily reflect the official views ofInternational Transport Forum member countries.
This document and any map included herein are without prejudice to the status of or sovereignty over any
territory, to the delimitation 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, Jan Veldhuis, Thijs Boonekamp and Rogier Lieshout.
SEO Economic Research carries out independent applied economic research on behalf of the public andprivate 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 theintellectual 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 ..................................................................................................................... 9
1.

INTRODUCTION ......................................................................................................................... 13
Background and objective of the study.......................................................................................... 13
Our approach ................................................................................................................................. 13

2.

AIRLINE RESPONSES ................................................................................................................ 15
Airline responses and their likelihood ........................................................................................... 15
Description of the selected combinations of airline responses and aviation demand scenarios. ... 17

3.

METHODOLOGY ........................................................................................................................ 19
Principles of the approach ............................................................................................................. 19
Overview of the approach.............................................................................................................. 22
Growth rates in the Airports Commission’s aviation demand scenarios ....................................... 25
Assumptions on network expansion: aircraft size versus frequencies ........................................... 26
New destinations............................................................................................................................ 28
Definition of the four airline responses ......................................................................................... 28

4.

RESULTS: IMPACT ON CONNECTIVITY, COMPETITION AND SCARCITY RENTS ...... 33
Results of the quantitative impact assessment ............................................................................... 33

ANNEX A. METHODOLOGY TECHNICAL DESCRIPTION......................................................... 39
ANNEX B. CARRIER AND ROUTE CATEGORISATION ............................................................. 44
BIBLIOGRAPHY ................................................................................................................................. 46

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8 – TABLE OF CONTENTS

Figures1.

Total Passenger Benefits in 2030 ....................................................................................................... 11

3.1. Reduction of excess demand decreases ticket prices/ airline scarcity rents. Increase in charges
further reduces the airline rents ......................................................................................................... 21
3.2 Combining the Airports Commission aviation demand scenarios with the airline responses............ 25
3.4 Gives the breakdown of passenger numbers by airport following expansion of either Gatwick or
Heathrow for the different aviation demand scenarios as defined by the Airports Commission. ...... 26
4.1 Total Consumer Benefits in 2030 ....................................................................................................... 33
4.2 Business and Leisure Consumer Benefits in OD Markets in 2030 .................................................... 34
4.3 Consumer welfare impacts of airport expansion in 2030: Benefits to passengers travelling to andfrom the UK (bars) and to transfer passengers (dots) ........................................................................ 34

Tables
2.1 GDP growth rates in Airports Commission Scenarios ....................................................................... 16
3.1 Overview annual growth rates in passenger traffic in the different aviation scenarios used in thisstudy at the London airports (2011-2030) .......................................................................................... 26
3.2 On long-haul routes seat capacity increase is mainly delivered by increased frequency;
on short-haul routes aircraft size is the main driver. .......................................................................... 27
3.3 Assumptions on maximum aircraft size and frequency...................................................................... 27
3.4 Assumptions for definition of airline responses in combination with the relevant aviation
scenarios developed by the Airports Commission ............................................................................. 29
4.1 Impact analysis results for Heathrow expansion for the year 2030 .................................................... 35
4.2 Impact analysis results for Gatwick expansion for the year 2030 ...................................................... 36

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EXECUTIVE SUMMARY – 9

Executive Summary

The UK Airports Commission has short-listed three options for expanding airport capacity in the UK.
One option concerns expansion of Gatwick with an additional runway. The other options concern
expansion of runway capacity at Heathrow. The impacts of expansion on passenger and air freight user
welfare do not only depend on the macro-economic and aviation industry future, as defined by theaviation scenarios already developed by the Airports Commission, but also on the airline responses thatcan be expected as capacity comes on stream. This report assesses quantitatively the competition,
scarcity and connectivity impacts of different airline responses to expanding runway capacity at Gatwick
or Heathrow.

Airlines may react in different ways to expansion of capacity at Gatwick or Heathrow. The way
macro-economic conditions change, how business models develop over time and how new
aircraft (such as the Boeing 787 and Airbus A350) have an impact on the industry will affect thelikelihood of potential airline responses unfolding. An additional runway at Gatwick would most
likely see airlines responding either with development of Gatwick into a low-cost gateway or by
expanding conventional point-to-point services at Gatwick. Additional runway capacity at Heathrow
could be expected to be taken up predominantly by hub operations but in some circumstances could see
growth focused on an increase in point-to-point services at the airport.
These two pairs of airline responses can be considered as representative of the range of outcomes forcapacity expansion at Gatwick or Heathrow. The four responses combined with the most relevant
aviation demand scenarios developed by the Airports Commission are assessed in this report for the
impact on socio-economic welfare. The four airline response-scenario combinations (‘airline response
outcomes’ for short) are as follows.
Heathrow expansion
Airline response outcome 1: ‘Hub-carrier growth at Heathrow, point-to-point growth at
Gatwick’ combined with the Airports Commission ‘Assessment of Need’ scenario.

Airline response outcome 2: ‘Point-to-point growth at Heathrow and Gatwick, Heathrowremains the network hub’ combined with the Airports Commission scenario ‘Low-cost isKing’.

Gatwick expansion
Airline response outcome 3: ‘Partnerships: Gatwick becomes a low-cost gateway, Heathrowremains the network hub’ combined with the Airports Commission scenario ‘Low-cost isKing’.



Airline response outcome 4: ‘Gatwick point-to-point growth, Heathrow remains the network
hub’ combined with the Airports Commission scenario ‘Relative Decline of Europe’.

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We estimate the airline response outcomes in terms of connectivity gains, competition gains and gains
due to a reduction in scarcity rents to the benefit of passengers, all in comparison to a ‘do minimum’
scenario without any expansion of capacity in the London airports system.

Approach
The analysis of the airline response outcomes takes a medium-term perspective, examining impacts inthe year 2030. This choice is deliberate. Formulation of airline responses beyond 2030 would
significantly reduce credibility as uncertainty regarding future business models, financial performance of
the airline industry, cost levels and the survival of individual carriers becomes increasingly large. The
choice of the year of analysis does have implications for the results. Growth in demand is delayed under
the Relative Decline of Europe scenario and this results in benefits to passengers from capacity
expansion accruing mainly after 2035 under airline response outcome 4.
The airline response-aviation scenario combinations are evaluated in terms of passenger welfare impacts
related to connectivity gains (more flights and destinations), changes in competition levels (lower fares)
and reduction in airline scarcity rents (lower fares), compared to the do minimum scenario.
The system currently employed for allocating slots for take-off and landing in London airports, withmost slots allocated free of charge to incumbent airlines, means that rents accrue mainly to airlines.
Airline scarcity rents arise when potential demand exceeds the physical airport capacity to accommodate
airline seat supply, as is currently the case at Gatwick and Heathrow. Airline rents accrue as air ticket
prices increase to balance supply and demand and clear the market. Ticket prices are higher than theywould be if all demand was accommodated. Airport expansion will reduce airline scarcity rents, reflected
in lower airfares and lower airline revenues.
The welfare gains assessed arise mainly from the lower travel costs for UK and non-UK residents that
result from runway capacity expansion at either Gatwick or Heathrow and the airline responses that
unfold. The SEO Netcost model is used to estimate the effects for the year 2030 for the four airline
responses outcomes.

Results
We find that reductions in airline scarcity rents make up the majority of the consumer welfare gains. All
tested airline responses, including expansion of the hub operation at Heathrow, produce benefits forpassengers from competition. Welfare benefits for passengers in 2030 for each of the airline response
outcomes are summarised in figure 1.1.

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EXECUTIVE SUMMARY – 11

Figure 1. Total Passenger Benefits in 2030 (million GBP)LGW Relative Decline of Europe
LGW Low-cost is King
LHR Low-cost is KingLHR Assessment of Need01000

UK passengers

2000

3000

4000

5000

Non-UK passengers

Source: SEO Netcost

The outcomes are not directly comparable as they reflect different scenarios for the overall developmentof aviation and the global economy and are strongly affected by differences in the pattern of GDP growth
assumed. It should be noted that beyond 2030 the point-to-point airline response in the Relative Declineof Europe scenario following Gatwick expansion would be expected to begin to generate more
substantial welfare gains.
Based on our assessment, we conclude the following main points.
1. For each of the airline responses expansion of Gatwick and Heathrow produces welfare benefits forpassengers.
2. The reduction in airline scarcity rents is the most important element of the consumer welfare impactsof airport expansion for all airline response outcomes.
3. All tested airline responses produce benefits from competition, including those with an expanded hub
operation at Heathrow, and all produce connectivity benefits.
4. Around 55% of total welfare benefits accrue to UK residents in all airline responses. In the OD
market, leisure traffic accounts for about three quarters of the consumer welfare gains.
5. Total consumer benefits are highest in the scenario assuming point-to-point traffic growth at
Heathrow (airline response 2) and low-cost gateway development at Gatwick (airline response 3).
6. The lowest total consumer benefits are found in airline response 4, which assumes point-to-point
growth at an expanded Gatwick in the Relative Decline of Europe scenario.
7. An important factor in explaining the differences between airline responses is the fact that different
demand growth rates are used, depending on the Airports Commission scenario that applies for eachairline response. Until 2030, growth in the Low-cost is King scenario is higher than in theAssessment of Need scenario or the Relative Decline of Europe scenario. This difference between
the demand scenarios leads to higher overall welfare gains in airline responses 2 and 3 (which both

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12 – EXECUTIVE SUMMARY

assume a Low-cost is King scenario) compared to the Assessment of Need (airline response 1) and
Relative Decline of Europe scenarios (airline response 4).
8. The effects quantified relate to direct welfare benefits for passengers. Changes in surface transport
access conditions and the consequences of expansion in allowing passengers to switch to a moreconvenient airport in terms of access are not included. Similarly, wider economic effects from
improved connectivity of the London area have not been quantified.

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1- INTRODUCTION – 13

1. Introduction

UK Airports Commission has short-listed three options for expanding airport capacity in the UK. One
option concerns expansion of Gatwick with an additional runway. The other options concern expansionof runway capacity at Heathrow. The impacts of expansion on consumer welfare do not only depend on
the macro-economic and aviation industry future, as defined by the aviation scenarios already developedby the Airports Commission, but also on the airline responses that can be expected as capacity comes on
stream. This report assesses quantitatively the competition, scarcity and connectivity impacts of different
airline responses to expanding runway capacity at Gatwick or Heathrow.

Background and objective of the study
In December 2013 the UK Airports Commission short-listed three options for airport expansion in theUK, two at Heathrow and one at Gatwick1. A report with the Commission’s assessments of these options
was published for national consultation in the autumn of 2014.
Against this background, the Airports Commission asked the International Transport Forum and SEO
Economic Research to carry out a study to determine how each of the short-listed expansion options
might impact on the competitive nature of the London and UK-wide airport system. In a first study (ITF
2014)2, the factors that drive airline behaviour were identified. Probable airline responses were
formulated under a range of demand scenarios for the overall development of international aviation,
defined by the Airports Commission (Airports Commission 2014). The impacts on competition andconnectivity were outlined.
The present report provides a quantitative assessment of the impact of the most likely airline responses toexpansion of capacity at Gatwick or Heathrow on connectivity, competition and scarcity rents.

Our approach
Four combinations of aviation scenario and airline response to expanding airport capacity wereselected for quantitative impact assessment from the 30 potential combinations examined in the earlier
report, on the basis of their high likelihood. These four combinations are first described and the rationale
for choosing this set of responses outlined. The modelling framework used to assess the impacts of theairline responses under alternative airport expansion options is then discussed. Key assumptions
underlying the analysis are identified and finally the results of the impact analysis presented.

1

In September 2014, the Commission made the decision not to shortlist the Estuary option. More informationon this can be found here: https://www.gov.uk/government/publications/inner-thames-estuary-airportsummary-and-decision.

2

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/383331/expanding-airportcapacity-competition-_connectivity.pdf>

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14 – 1- INTRODUCTION

The two Heathrow expansion proposals short-listed by the Airports Commission have been grouped
together as one Heathrow expansion option for the purpose of this work. The alternatives have beengrouped together as they are very similar in the context of this study: they share the same location, thesame catchment area and provide the same peak-hour capacity. Only the terminal capacity is different, by
40 000 annual aircraft movements.
Note that surface access to the airports was excluded from the terms of reference for this study. Surface
access is clearly an important factor in determining choice of airport and flight options. It can be factored
into models of generalised travel cost but the focus for the current report is the response of airlines toexpansion of airport capacity.

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2- AIRLINE RESPONSES – 15

2. Airline Responses

Airlines may react in different ways to expansion of capacity at Gatwick or Heathrow. The way
macroeconomic conditions change and how business models develop over time will affect the likelihoodof potential airline responses unfolding. An additional runway at Gatwick would most likely see airlines
responding either with development of Gatwick into a low-cost gateway or by expanding conventional
point-to-point services at Gatwick. Additional runway capacity at Heathrow could be expected to betaken up predominantly by hub operations but in some circumstances could see growth focused on an
increase in point-to-point services at the airport. These two pairs of airline responses can be considered
as representative of the range of outcomes for capacity expansion at Gatwick or Heathrow. The four
responses combined with the most relevant aviation demand scenarios developed by the Airports
Commission will be used for the assessment in the chapters that follow.

Airline responses and their likelihood
Based on an analysis of the factors that drive airline behaviour and the characteristics of the London
airports system, SEO identified six different sets of airline responses to expansion of airport capacity at
Gatwick or Heathrow in the earlier analysis undertaken for the International Transport Forum and the
Airports Commission (ITF 2014). The airline responses have a varying impact on the traffic structure in
the London airport system as well as on connectivity, competition and reduction of airline scarcity rents
to the benefit of passengers and air freight users. We refer to ITF (2014) for an in-depth discussion ofeach of the identified airline responses3.
The way macroeconomic conditions develop over the long term will affect the likelihood of the airline
responses examined unfolding. Airline business models evolve, macro-economic conditions change, newaircraft technology is introduced and air-side airport charge (aero-charge) levels change. Some of theairline responses are unlikely under some future aviation demand scenarios, as developed by the Airports
Commission (Airports Commission 2014a). The six different sets of airline responses were therefore
assessed on their likelihood in each of the aviation demand scenarios (ITF 2014). Based on this analysis,four combinations of airline responses and aviation demand scenarios were selected for the quantitative
assessment in this study, as follows.
Heathrow expansion

3

Airline response outcome 1 ‘Hub-carrier growth at Heathrow, point-to-point growth at
Gatwick’ combined with the Airports Commission ‘Assessment of Need’ scenario.

Airline response outcome 2 ‘Point-to-point growth at Heathrow and Gatwick, Heathrowremains the network hub’ combined with the Airports Commission scenario ‘Low-cost isKing’.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/383331/expanding-airportcapacity-competition-_connectivity.pdf>

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16 –2- AIRLINE RESPONSES

Gatwick expansion
Airline response outcome 3 ‘Partnerships: Gatwick becomes a low-cost gateway, Heathrowremains the network hub’ combined with the Airports Commission scenario ‘Low-cost isKing’.



Airline response outcome 4 ‘Gatwick point-to-point growth, Heathrow remains the network
hub’ combined with the Airports Commission scenario ‘Relative Decline of Europe’.

The response-scenario combinations (‘airline responses outcomes’ in short) chosen for each expansion
option have the highest likelihood of realisation. As such, we can expect the future for an expanded
Gatwick to lie between airline responses 3 and 4, while an expanded Heathrow would see an outcome
between responses 1 and 2.
In the subsequent analysis we estimate the outcome of the airline responses in terms of connectivity
gains, competition gains and gains due to a reduction in scarcity rents to the benefit of passengers, all incomparison to a scenario without any expansion of airport capacity. Each of the four airline responses incombination with the Airports Commission demand scenarios is examined in section: Description of theselected combinations of airline responses and aviation demand scenarios.
Medium-term impact analysis focusing on 2030.
The analysis of the airline response outcomes takes a medium-term perspective, examining impacts inthe year 2030, while the aviation demand scenarios of the Airports Commission take a long-term
perspective (through 2050). The choice of a medium-term perspective is deliberate: formulation of airline
responses beyond 2030 would significantly reduce credibility as uncertainty regarding future businessmodels, financial performance of the airline industry, cost levels and the survival of individual carriers
becomes increasingly large.
The choice of the year of analysis does have implications for the results. Growth in demand is delayed
under the Relative Decline of Europe scenario and this results in consumer welfare benefits from
capacity expansion accruing mainly after 2035 under airline response 4 (see Airports Commission
2014b).
Table 2.1 GDP growth rates in Airports Commission Scenarios(Annual growth rates through 2030)
Scenario
Assessment of Need

UK
2.5%

Low-cost is King

3.0%

Relative Decline of Europe

2.5%

World
1.8% Western Europe
1.9% OECD
3.8% Newly Industrialised Countries
2.6% Less Developed Countries
2.3% Western Europe
2.4% OECD
5.8% Newly Industrialised Countries
4.6% Less Developed Countries
1.8% Western Europe
1.9% OECD
5.8% Newly Industrialised Countries
4.6% Less Developed Countries

Source: Airports Commission.

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2- AIRLINE RESPONSES – 17

Description of the selected combinations of airline responses and aviation demand
scenarios.
Heathrow expansion
Airline response outcome 1: Hub-carrier growth at Heathrow, point-to-point growth at Gatwickin the Assessment of Need scenario.
This airline response outcome following expansion of Heathrow unfolds in the context of the scenario
underpinning the Commission’s assessment of need for additional runway capacity in the London area.
In this scenario, future demand is primarily determined in relation to past trends and central data
projections. The development of oil prices and GDP growth are key among the main economic variables
taken into account.
The additional capacity at Heathrow enables the hub-carrier British Airways (and partners) to grow fromtoday’s constrained, sub-optimal hub-and-spoke system to an efficient fully developed hub operation
using a wave-system for coordinating arrivals and departures. Larger, more clearly defined banks ofarriving and departing flights will make it possible for many more transfer passengers to connect at
Heathrow. Other non-home-based network carriers such as American Airlines and Emirates also increase
flights from Heathrow to their own hubs, as do legacy point-to-point carriers such as Virgin Atlantic4.
Low-cost remains focused at Gatwick and the other London airports.
The expected increase of inbound long-haul traffic and growth of leisure demand from Asia may provide
opportunities for non-home based network carriers and long-haul low-cost carriers at Heathrow and at
Gatwick.
Airport charges will increase because of the costs involved in expanding Heathrow. This increase will
favour high capacity services into Heathrow and will discourage airlines from flying high frequency, lowcapacity services. For the hub-carrier this means that its feeder network into the UK and the rest ofEurope will grow but potentially without the same degree of penetration to small cities as at Amsterdam
or Frankfurt.

Airline response outcome 2 Point-to-point growth at Heathrow and Gatwick, Heathrow remains
the network hub in the Low-cost is King scenario.
Airline response outcome 2 develops under the Low-cost is King aviation demand scenario. This
scenario assumes a growing role for low-cost carriers as they enter long-haul markets and self-connecting
becomes more common for passengers. By 2040, charter and low-cost carriers take 50% of the market. It
also sees higher passenger demand from all world regions and lower operating costs. The importance ofhubs and network carriers declines throughout the world while liberalization of aviation markets
continues on a global scale. In this scenario low-cost carriers use new generation of aircraft such as the
Boeing 787 and Airbus A350 to enter long-haul point-to-point markets, while they generally refrain fromentering formal alliances.
The airline response assumes a saturating European low-cost, point-to-point market between secondary
airports. Low-cost carriers search for premium traffic at primary airports, including Heathrow. Despite
the increased airport charges at Heathrow, low-cost airlines establish a significant operational base at
4

The airline names mentioned are only indicative of the type of carrier that could respond to the expansion of
London’s airport capacity in the future.

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Heathrow to target the premium market, while keeping up their operations at Gatwick. Additional slots
are taken up by visiting network carriers and legacy point-to-point carriers.

Gatwick expansion
Airline response outcome 3 Partnerships – Gatwick becomes a low-cost “gateway”, Heathrowremains the network hub in the Low-cost is King scenario.
Airline response outcome 3 evolves under the Low-cost is King scenario (like airline response 2), but
assumes expansion of Gatwick. Legacy network carriers and/or low-cost carriers (of which some start tooperate in the long-haul market) partner to facilitate passenger connectivity. This could take place either
through a new alliance/codeshare formula or by an airport-led connection strategy. Low-cost airline
services, both short and long-haul, grow at Gatwick. The expected increase in airport charges could movecharges at Gatwick from the level of the other European gateways to the current aero-charges level of
Heathrow (PWC 2014). As a result, lower yield low-cost airlines may decide to move part of theiroperations to airports such as Luton and Stansted.
Long-haul low-cost flourishes at Gatwick given the large local OD market and strong expected growth in
the inbound long-haul leisure market, predominantly from Asia, as well as the potential for low-cost andsome full-service feed. The introduction of new generation long-haul aircraft (Boeing 787 and Airbus
A350) further contributes to the long-haul low-cost opportunities. Due to the nature of their businessmodel, low-cost operators can be expected to avoid the complexity of a wave-system structure forarrivals and departures. Hence, the share of transfer traffic will remain limited and will not reach thelevels of a typical hub airport. Non-Oneworld long-haul carriers increasingly focus network growth at
Gatwick, benefiting from 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 London
long-haul traffic is expected to grow faster than outbound traffic.

Airline response outcome 4 Gatwick point-to-point growth, Heathrow remains the network hub
in the Relative Decline of Europe scenario.
Instead of developing Gatwick into a low-cost gateway following capacity expansion (where point-topoint traffic is mixed with connecting traffic), this airline response option assumes that low-cost carriers
take up most of the capacity at Gatwick. However, they 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” andpartly migration of flights from Stansted and Luton to Gatwick, given Gatwick’s big catchment area forleisure traffic and increased availability of peak-time slots. But as aero-charges are expected to rise at
Gatwick after expansion, lower yield traffic is likely to continue to use Stansted and Luton.
A number of low-cost, long-haul destinations are assumed to be developed, based on the growing
inbound leisure market predominantly from Asia and the use of smaller, more fuel-efficient aircraft likethe Boeing 787 and Airbus A350. Over time, an increasing share of the additional capacity at Gatwick
will be used by carriers that currently operate at Heathrow but find more attractive options at Gatwick
when capacity becomes available. This may free-up some capacity at Heathrow, which can be used by
the hub carrier and other network carriers. Over time, as capacity shortages remain at Heathrow, thefocus at Heathrow will be on high-capacity flights to popular long-haul destinations reflected in an
increasing share of OD traffic. Crowding-out will take place with respect to short-haul flights andtransfer passengers at Heathrow in the long run.

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3. Methodology

The airline response-aviation scenario combinations are evaluated in terms of consumer welfare impacts
related to connectivity gains, changes in competition levels and reduction in airline scarcity rents,
compared to a scenario without any capacity expansion in the London airports system (‘do minimum’).
The SEO Netcost model is used to estimate these effects.

Principles of the approach
The impact of the selected airline response outcomes with expansion of Gatwick or Heathrow is assessedwith SEO’s generalised travel cost model, Netcost. Annex A provides a technical description of themodel.

The ‘Do minimum’ scenario (base case)Connectivity, competition and scarcity impacts in 2030 following airport capacity expansion at either
Gatwick or Heathrow are compared to a ‘do minimum’ scenario. The ‘do minimum’ scenario assumes no
new runway capacity in the future, but takes into account:

maximum use of existing infrastructure;

infrastructure schemes and changes to airport master-plans that are already in the planningpipeline and are to be delivered by 2020;

incremental growth to full potential long-term capacity by 2030;

terminal capacity increasing incrementally to service available runway capacity.

Growth rates per airport, destination region and airline category in the ‘do minimum scenario’ arederived from the Airports Commission ‘carbon traded’ constrained forecast. This forecast represents total
potential demand for UK aviation, but assumes that existing constraints on UK airport capacity persist
throughout the forecast period. The forecast assumes that carbon emissions from flights departing UK
airports are traded at the European level until 2030 and then as part of a liberal global carbon market.
Thus, the forecast assumes that any aviation emissions target can be met in part through buying credits
from other sectors of the economy.
Airside airport charges
The regulatory framework for aero-charges is assumed to remain as it is today. Under the do minimum
scenario they are unchanged. Under the expansion scenarios they rise to pay for the investment inrunway capacity. The change in aero-charges is incorporated in the airline responses and their impact onairline choice is captured. In relation to welfare impacts increased charges will be absorbed first by
airlines through a reduction in rents and competition will prevent airlines passing on much of the cost of

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higher charges to passengers. To 2030 the assumption in the modelling is that increases in charges do not
get passed on to passengers.
Estimation of benefits
Netcost estimates changes in benefits to passengers (consumer surplus) from changes in airport capacity
and airline services. The calculation of these ‘transport user benefits’ is based on conventional consumer
surplus theory where consumer surplus is defined as the benefit passengers enjoy in excess of the costs
they perceive (Airports Commission 2014). The benefits reflect reductions in ‘generalised travel costs’
associated with the better air travel options that arise after expansion of capacity at Gatwick or Heathrow.
Many of those benefits ripple through the rest of the economy and benefit parties outside the aviation
sector. Most of these secondary effects are captured by assessment of the direct benefits to passengers
but some may be additional. Such “wider economic impacts” are not, however, included in ourmodelling framework.
Benefits to the users of aviation can be divided into the following three categories.
1. Connectivity gains
Connectivity benefits are estimated based on the relative frequency increase. The total passenger benefits
are estimated by a utility function which depends on the frequency and generalised travel costs. The
connectivity benefits consist of the frequency component from this utility function. A complete technicaldescription is given in Annex A5.
2. Competition
Capacity expansion facilitates market entry and is generally likely to reduce market concentration.
Passengers benefit from the increasing downward pressure of competition on fares.
3. Reduction in airline scarcity rents
When potential demand exceeds the physical airport capacity to accommodate airline seat supply, airline
rents accrue as air ticket prices increase to balance supply and demand and clear the market (Figure3.1a). The system currently employed for allocating slots for take-off and landing in London airports,
with most slots allocated free of charge to incumbent airlines, means that rents accrue mainly to airlines.
In sufficiently competitive markets, airport expansion will reduce airline scarcity rents (figure 3.1),
reflected in lower airfares and lower airline revenues than would otherwise (figure 3.1) arise (although
not necessarily lower than today).
When capacity is added to either Heathrow or Gatwick, new airlines will enter the market and add newroutes. 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 3.1b). 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 the airlines. As Starkie (1998, p. 115) states: ‘Increasing theprice [of charging landed aircraft] (Figure 3.1c) would have the effect of reducing the scarcity rent
5

Welfare gains from more direct routings have not been quantified separately, as the gains are expected to berelatively limited given the modest growth in new direct routes in 2030. Yet, as we calculate first total welfare
gains based on the difference in network supply in the airline response with airport expansion compared to a
constrained scenario, any improvements in the network are taken into account into the overall reductions ingeneralised travel cost.

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3- METHODOLOGY – 21

enjoyed by the incumbent airline’. In other words, where there are airline scarcity rents, airfares areunlikely to increase simply because airline costs have increased through higher airport charges; instead
scarcity rents (and thus fares and yields will fall). This effect is accentuated if capacity increases because
competition would tend to drive fares down closer to a higher cost base. With sufficient airline
competition increased airport charges will erode rents before they affect ticket prices.
For this study, we assume that the remaining airline rents after expansion are larger than the increases inaero-charges and that airline do not pass through any further cost increases in a highly competitivemarket, but choose to absorb them.
Figure 3.1. Reduction of excess demand decreases ticket prices/ airline scarcity rents. Increase in charges
further reduces the airline rents

Source: ITF (2014) adapted from Starkie 1998.

In the do minimum scenario we have lower airport charges but persistent scarcity rents. In the expansion
scenarios we have higher airport charges but lower scarcity rents. Explicit modelling of this relationshipwas beyond the scope of the present report.
Airports Commission demand forecasts
The Airports Commission’s aviation demand forecasts provide an important basis for the impact
analysis. The Airports Commission provided passenger forecasts for 2030 for five different scenarios:
Assessment of Need, Global Growth, Relative Decline of Europe, Low-cost is King and Global

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Fragmentation6. Three of these forecasts (Assessment of Need, Low-cost is King and Relative Decline ofEurope) provide a basis for this analysis. Separate aviation demand forecasts are used for theunconstrained, constrained and airport expansion scenarios.
The unconstrained forecast represents total potential demand for UK aviation, in the absence of any
constraints on airport capacity or a cap on aviation emissions. Hence there are no scarcity rents at any
airport and passenger numbers grow in the range of 1-3 percent a year7. The unconstrained airport
scenarios are used solely for the calculation of scarcity rents.
The constrained forecast represents the baseline case without capacity expansion at any airport. In thisforecast the current airport capacity is fully utilised without building an extra runway. This forecast isalso referred to as the ‘do minimum’ scenario. The constrained forecast is used to determine scarcity
rents with respect to the unconstrained forecast.
The Heathrow or Gatwick expansion forecasts are used to determine the passenger benefits with respect
to the constrained scenario. These benefits are determined by the decrease in scarcity rents obtained by
the additional runway capacity.
The Airports Commission has developed two versions of the forecasts: carbon traded and carbon
capped8. In this analysis the carbon traded version is used. It assumes that aviation continues toparticipate in existing emissions trading schemes such as the EU Emissions Trading System (ETS), so
passengers face a carbon cost, but no specific emissions level is targeted.

Overview of the approach
Stepwise, the Netcost modelling framework was applied as follows.
1. Construction of unconstrained airline networks
2011 is the base year for the analysis. Using the growth figures in the applicable aviation scenario as
defined by the Airports Commission carbon traded forecast, the base network of 2011 was projected to
the year 2030 at the individual carrier-destination level by airport, taking into account any shifts of traffic
between airports foreseen in the aviation scenarios. An unconstrained network was projected for eachindividual airline response–scenario combination. For airline response 1 the growth rates in the Airports
Commission Assessment of Need scenario were used, for airline responses 2 and 3 the ‘Low-cost isKing’ scenario was used and for airline response 4 the ‘Relative Decline of Europe’ scenario was used,projecting networks by destination region and London airport.
Part of the seat capacity growth to 2030 translates into higher frequencies on existing routes, part intohigher frequencies on new routes and part of it is accommodated through the rising number of seats per
flight (larger aircraft). Section 3.4 describes the procedure followed in order to breakdown the seatcapacity growth into frequency growth, route growth and aircraft size growth.

6

A detailed description of these forecasts is given in : Airports Commission (November 2014), Strategic fit :forecasts.
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/374660/AC05forecasts.pdf

7Department for Transport (January 2013). UK Aviation Forecasts.
https://www.gov.uk/government/publications/uk-aviation-forecasts-2013

8

Ibid, pp. 51-52.

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3- METHODOLOGY – 23

2. Estimation of generalised travel costs in unconstrained airline networks
After the construction of the unconstrained airline networks for 2030, generalised travel costs andconsumer welfare values were estimated using the SEO Netcost model. The ticket price model of Netcost
uses flight time, frequency, competition level, type of connection (direct/indirect) and a dummy for lowcost carriers as independent variables to estimate average fare levels. The competition level depends on
both direct flights and indirect alternatives via other hubs, although on short-haul indirect alternatives areless relevant. Connectivity effects depend mainly on frequency growth following capacity expansion.
Next, airline networks and passenger numbers were assigned to destination and airline groups at asuitable level of detail for the definition of the airline responses (see Annex B). The level of detail waschosen so that competition within an airline group at a single destination region is as small as possible.
3. Projection of constrained airline networks in a ‘do minimum’ scenario and in a scenario with capacity
expansion
Similar to the methodology used in step 1, growth figures by destination region and London airport
derived from the Airports Commission’s aviation demand scenarios are used to construct a constrained
network for each of the London airports. The constrained scenarios exist for both the ‘do minimum’ andexpansion scenarios. Airline responses are developed for the expansion scenarios.
4. Estimation of generalised travel costs in constrained airline networks
Assuming constant load factors for the constrained scenarios, passenger numbers for each destination
region, London airport and carrier can be derived9. A reduction in passenger numbers compared to theunconstrained network implies an increase in generalised costs. Generalised costs for the ‘do minimum’and capacity expansion scenario are estimated using price elasticities taken from the literature (seeAnnex A).
5. Determination of airline scarcity rents
The differences in generalised costs between the ‘do minimum’ and capacity expansion scenarios equate
to scarcity rents that accrue to the airlines in the form of higher ticket prices.
6. Distinction between OD and transfer passengers
Transfer passengers are highly price-sensitive and so substitution elasticities in the transfer market aremuch higher than elasticities in the origin-destination market. For the transfer market, a conservative
substitution elasticity of -3 has been used10, although at other hub airports these elasticities can averagevalues of -4 to -7, with much higher values possible on individual OD markets (CPB 2011; Oum et al.
1993). This is an important notion as carriers focus on the higher yield OD-traffic when there is excess
demand, with lower yield transfer traffic is gradually crowded out. This is the assumption in theconstrained aviation demand scenarios. In balancing excess passenger demand with capacity in theconstrained scenarios, relatively small increases in ticket prices result in large decreases in transfer
9Note that it is possible that average load factors may further rise somewhat in the future, which could result inmarginally smaller increases in aircraft size and flight frequency.

10

Some transfer markets at Heathrow face a lot of competition (e.g. New York Vienna) others low competition(e.g. New York Leeds). For around 80% of the connecting markets via Heathrow passengers have analternative direct flight or hub to choose from (Lieshout and Burghouwt 2012). This is much higher than all
the other European hubs except Zurich. So BA is extremely exposed to competition in the connecting market.
This means that substitution elasticities in Heathrow’s transfer markets are expected to be very high.
Nevertheless, there may be reasons for passengers to travel with BA: loyalty programs play a part and there
are still markets where the hub carrier is dominant and passengers do not have an alternative. Hence, as anaverage a moderate substitution elasticity of -3 (rather than -4 to -10) was retained.

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passengers. To bring OD demand into line with available capacity ticket price increases need to berelatively high to achieve the same reduction in passenger demand, resulting in the bulk of airline
scarcity rents.
7. Determining consumer welfare impacts
Benefits to passengers from the airline responses following capacity expansion at Gatwick or Heathrow
are calculated by multiplying the expected reductions in generalised travel costs by the number ofpassengers in the expansion scenario/airline response and adding the benefit from reduction in excess
demand11 (difference in demand between constrained and unconstrained forecasts). The welfare benefits
arising from reducing excess demand is treated using the ‘rule of half’. Additional passengers ‘pay’ halfof the change in generalised travels (see box).
Box 1. The Rule of Half

Two categories of passengers benefit from capacity expansion. The first category are passengers
who would have travelled anyway in the absence of capacity expansion (i.e. in the constrained
forecast), the others are ‘new’ passengers able to travel at the lower prices consequent toexpansion of capacity. The first category benefits fully from the price decrease, the second
category is treated using the ‘rule of half’. This can be explained using the figure below. As aresult of capacity expansion ticket prices are reduced from P 0 to P1 and the number of passengers
increases from Q0 to Q1. The consumer benefits differ between the categories as follows.
There are Q0 passengers traveling in the constrained scenario. These passengers benefit from aprice reduction of P0-P1. The benefits for this category are represented by the surface of rectangle
A, which is equal to Q0*(P0-P1).
There are Q1-Q0 passengers not traveling in theconstrained scenario. This is the previously denied
demand as a result of capacity constraints. The
willingness to pay of these passengers is less thanP0. The first entrant to the market has a willingness
to pay of P0, resulting in a consumer benefit of P 0P1. The willingness to pay for the last additional
passenger is equal to P1 hence the consumer benefitof this passenger equals 0. The benefits for thiscategory are depicted by triangle B in the figure.
Thesurfaceof
thistriangleequals0.5*(Q1-Q0)*(P0-P1).

8. Break-down of effects
Consumer welfare is divided into competition, connectivity and scarcity components. The competition
component depends on the change in Herfindahl-Hirschmann concentration index (the sum of squared
market shares for each airline). The connectivity component is the change in generalised costs caused(mainly) by the increase in frequency of flights following capacity expansion. The remaining part of thewelfare impact consists of the reduction in airline scarcity rents, which benefit the passenger in the formof lower ticket prices.

11

In this exercise the assumption was made that these potential passengers did not travel rather than travelled by
one of the other London airports.

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3- METHODOLOGY – 25

In sum, the Netcost approach calculates the reductions in generalised travel costs as a result of capacity
expansion under the four airline response-scenario combinations and adds the welfare benefits of thepreviously denied demand.
Figure 3.2 Combining the Airports Commission aviation demand scenarios with the airline responses

2030

Macroeconomic
scenarios

Airportcapacity
scenarios

Airlineresponses

Unconstrained

Assesment of
Need

Constrained

Expansion LHR

Response 1

Unconstrained

Constrained
Networks 2030

Low-cost is King
Expansion LHR

Response 2

Expansion LGW

Response 3

Unconstrained

Relative Declineof Europe

Constrained

Expansion LGW

Response 4

Source: SEO

Growth rates in the Airports Commission’s aviation demand scenarios
The Airports Commission has forecast the number of passengers per London airport, by destination
region and for each scenario in 2030, as summarised in table 3.1. The growth rates applied in the various
airline responses are crucial to understanding the analysis: the higher the growth rate, the larger theexcess demand in a ‘do minimum’ scenario in 2030 and the larger the reductions in scarcity rents once
capacity is added to the London airports system. In particular the low growth rates in the scenario
Relative Decline of Europe in airline response 4 lead to much lower consumer welfare benefits incomparison to the other airline responses, where the scenarios Assessment of Need and Low-cost is King
apply.

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Table 3.1 Overview annual growth rates in passenger traffic in the different aviation scenarios used in thisstudy at the London airports (2011-2030)
Capacity expansion option

Unconstrained‘Do minimum’

LGW
expansion

Assessment of Need

2,45%

1,65%

Relative Decline of Europe

2,29%

1,62%

1,66%

Low-cost is King

2,59%

1,84%

2,43%

LHR
expansion
2,22%
2,49%

Source: Airports Commission.

Figure 3.4 gives the breakdown of passenger numbers by airport following expansion of either Gatwick or
Heathrow for the different aviation demand scenarios as defined by the Airports Commission.
250

200

23%
27%

24%
1%
150

1%

18%

17%

Other London
Airports OD

2%

LGW Transfer

9%

18%

100

29%

25%

18%

24%
LGW OD

10%9%
LHR Transfer

50
38%

42%
29%

36%

LHR OD

0
Expansion LHR Expansion LHR Expansion LGW Expansion LGWAssessment of Low cost is King Low cost is King Relative decline
Needs
of Europe

Source: Airports Commission’s forecasts; elaboration SEO

Assumptions on network expansion: aircraft size versus frequencies
Growth in seat capacity at the London airports can take place through use of larger aircraft, service tomore destinations and higher frequencies per route. For the extrapolation of the networks to 2030, we
made assumptions on how seat capacity growth on markets already served directly translates into use oflarger aircraft (more seats per flight) and more frequencies per route.

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3- METHODOLOGY – 27

For this purpose, flights schedules for all airlines serving the five airports in London12 as well as asample of other major EU hub airports were obtained from OAG airline schedules data for the period
2004 to 2014. Next, we analysed to what extent seat capacity growth at these airports has taken place via
increases in average aircraft size and via increases in frequencies. The annual growth rates derived aresummarized in table 3.2.
Table 3.2 On long-haul routes seat capacity increase is mainly delivered by increased frequency; on shorthaul routes aircraft size is the main driver.
Frequency growth

Aircraft size growthLong-haul

1,9%

0,1%

Short-haul

0,2%

1,7%

Source: OAG 2004-2014

From the historical analysis it follows that on average, network growth on long-haul markets can mostly
be attributed to frequency increases, while the main driver for total annual seat expansion on short-haulroutes has been the use of larger planes.
We have assumed that this development will continue through 2030 but expect convergence in the longer
run. Therefore we assume a maximum aircraft size threshold in the Netcost model. That is, once theaverage aircraft size for short-haul routes has grown to 120 seats for aircraft landing at London city, or to
240 seats for planes landing at the other London airports, we assume this number to remain stable until
2030. Consequently, we model all additional growth in this market as a result of frequency increases.
Table 3.3 summarizes the aircraft size thresholds used.
Table 3.3 Assumptions on maximum aircraft size and frequency
Maximum aircraft size
Long-haul

Short-haul

LHR

600

240

LGW

600

240

LTN

250

240

STN

600

240

LCY

120

120

Low-cost

275

240

To a certain extent, we use a similar reasoning for frequencies. As concluded in the previous report (ITF,
2014), scheduled airlines that are able to achieve the largest frequency share on a route may benefit froma disproportionately large market share on that route. Similarly, airlines operating a route 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
effect has especially proved to play a role on long-haul markets, where competition from low-costcarriers is generally limited or absent.

12

Southend was excluded from the analysis.

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Following the S-curve logic, further increases at already high frequency levels will not result in
substantial further increases in 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. Although we did not put an explicit maximum as to how many daily frequencies could be offered
to a certain destination, we did check and correct for any frequencies that appeared unrealistically high.

New destinations
To assess which new destinations might be served directly from one of the London airports, we relied on
adjusted passenger booking data for 201013. We analysed how many OD passengers travel indirectly totheir final destination via another hub airport. OD demand on these indirect connections was extrapolated
to 2030. Using minimum demand, capacity and frequency thresholds, we identified the destinations thatmight have enough demand potential for direct services to be added between now and 2030. These newdestinations have been added to the unconstrained network, for which generalised travel costs have been
calculated at the individual carrier-destination level.
As a level of service threshold, we assume a minimum required frequency of seven flights per week. In
addition, we assume that a new direct connection will stimulate demand (market generation) based on
IATA’s demand stimulation curve depending on the level of existing demand in the market (Sismanidou
et al., 2013). In addition, we assume that transfer passengers that now travel via other hubs will use thedirect flight. For short-haul and long-haul flights, we assume a minimum required average load factor of
90% and a minimum weekly frequency of seven. As a rule of thumb, we assume that at least a dailyfrequency is needed for a competitive service. In reality, on some routes and for some airlines lower
frequencies may apply. For long-haul, the minimum aircraft size threshold was set at 214 seats,
equivalent to the capacity of a Boeing 787 aircraft. For short haul, a new direct flight has a minimum
aircraft size of 160 seats.

Definition of the four airline responses
The four airline responses selected to estimate the impacts of airport capacity expansion on connectivity,
competition and reduction of scarcity rents are described in Chapter 2 in qualitative terms14. For the
impact assessment, the aviation scenarios developed by the Airports Commission and our projected
networks for 2030 are used to model the airline responses with the Netcost model. The airline names
mentioned are only indicative of the type of carrier that could respond to the expansion of London’s
airport capacity in the future.

13

The so-called MIDT (Marketing Information Data Tapes).

14

For an extensive discussion, refer to ITF (2014)

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Table 3.4 Assumptions for definition of airline responses in combination with the relevant aviation scenarios
developed by the Airports Commission
Airline response 1:
Hub-carrier growth
at Heathrow,point-to-point
growth at Gatwick

Aviation
scenario
Airportscenario
Traffic shift
between LHR
and LGW

Traffic shift
betweenairline groups

Transfertraffic

Aircraft size

Assessment of
Need
Expansion of
Heathrow
Oneworld traffic
moves from LGW
to LHR. Oneworld
flights at LGW are
replaced by higher
frequencies ofother carriers suchthat total seatcapacity at both
airports remains
unchanged.
Low-cost point-topoint (PtP) traffic ismoved from LHR to
LGW. If insufficient
to restore the seatcapacity at LGW,
non-Oneworld FSC
traffic is relocatedto LGW.
A BA point-to-point
subsidiary serves
remaining
Oneworld leisuretraffic at LGW.
Transfer traffic at
LHR increases.
Transfer traffic at
Gatwick almost
entirely limited to‘self hubbing’.
Oneworld at LHR:
60% transfer for
long-haul, 50% forshort-haul.

No additionalchanges in aircraft
size.

Airline response 2:
Point to point
growth at
Heathrow andGatwick,
Heathrow remains
the network hub
Low-cost is King

Airline response 3:
Partnerships:
Gatwick becomes a
low-cost gateway,
Heathrow remains
the network hub

Airline response 4:
low-cost: Gatwick
point-to pointgrowth,
Heathrow remains
the network hub

Low-cost is King

Expansion of
Heathrow
No traffic shift
between airports

Expansion of
Gatwick
No traffic shift
between airports

Relative Decline ofEuropeExpansion of
Gatwick
No traffic shift
between airports

Oneworld loses
market share at
LHR to LCCs such as
EasyJet andVueling. In long
haul markets Virginand leisure carriers
gain frequencies
with respect to
Oneworld.

Low-cost carriers
such as Norwegian,
EasyJet and Ryanair
replace legacy
carrier flights inboth long haul andshort haul markets
at LGW.

Capacity increaseat LGW is used by
PtP carriers.
Oneworld
frequencies do notchange withrespect to theconstrained growthscenario.

Share of transfer
traffic remains
stable for
Oneworld: at LHR
50% for long-haul,
45% for short-haul.
As share of
Oneworld declines
absolute number oftransfer passengers
decreases.

Transfer share of
Oneworld remains
the same.
Low-cost carriers
increasingly serve
the connecting
market with guided
connections(average of 10%transfer on lowcost flights at
Gatwick).
Low-cost carriers
carry more trafficin smaller long-haulaircraft such as 787
or A350.

Transfer traffic at
LGW almost
entirely limited to‘self-hubbing’.
Transfer share at
LHR remains stable.

No additionalchanges in aircraft
size.

Low-cost carriers
carry more trafficin smaller long-haulaircraft such as 787
or A350.

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30 – 3- METHODOLOGY

Airline response 1 ‘Hub-carrier growth at Heathrow, point-to-point growth at Gatwick’The share transfer traffic within the network of British Airways (and partners) at Heathrow
grows to 60% on long-haul and 50% on short-haul due to increased hubbing operations.



Oneworld will move all of its long-haul operations from Gatwick to Heathrow. The additional
capacity at Heathrow enables the hub-carrier British Airways (and partners) to grow from its
current constrained, sub-optimal hub-and-spoke system to an efficient fully developed wavesystem for coordinating arrivals and departures.

Full service carriers currently serving Gatwick will also move their operations to Heathrow

Other full service carriers that already serve Heathrow such as Emirates will increase flights totheir own hubs. Legacy point-to-point carriers such as Virgin Atlantic will also grow at
Heathrow.



British Airways (and partners) will give up some of their slots at Gatwick to low-cost carriersin the interests of consolidation and maximising hub economies at Heathrow while keeping asignificant part of their slots to be operated by the point-to-point subsidiaries in the airline
group.

Airline response 2 ‘Point-to-point growth at Heathrow and Gatwick, Heathrow remains the
network hub’The share of transfer passengers per airline group and per airport is in line with the Airports
Commissions forecasts but for Heathrow lower than under airline response 1.



Oneworld will move all of its long-haul operations from Gatwick to Heathrow. The additional
capacity at Heathrow enables the hub-carrier British Airways (and partners) to grow from its
current constrained, sub-optimal hub-and-spoke system to an efficient fully developed wavesystem for coordinating arrivals and departures.

Full service carriers currently serving Gatwick will also move their operations to Heathrow

Other full service carriers that already serve Heathrow such as Emirates will increase flights totheir own hubs. Legacy point-to-point carriers such as Virgin Atlantic increase flights at
Heathrow.



BA and partners will give up a large share of their slots at Gatwick to low-cost carriers.

Airline response 3 ‘Partnerships: Gatwick becomes a low-cost gateway, Heathrow remains the
network hub’

We assume that low-cost carriers operating from Gatwick will have a limited share of transfer
passengers on their flights, much less than that of BA and its partners at Heathrow.

BA and partners will keep the largest part of their long-haul operations at Heathrow, but will
increase stand-alone point-to-point services from Gatwick.

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3- METHODOLOGY – 31Long-haul low-cost and long-haul leisure services will increase from Gatwick. Airlines such as
Norwegian long-haul and Air Asia X will gain market share in the long-haul market, partly
driven by the growth of the inbound Asian leisure market and the use of smaller, more fuelefficient long-haul aircraft (Boeing 787 and Airbus A350).



Low-cost services from Stansted and Luton will increase. These will mainly be provided by
low-cost airlines, such as Ryanair and Wizz Air, that do not focus on premium markets. Other
low-cost carriers whose strategy would be to tap into premium markets, currently for example
the case for EasyJet, will increasingly move services from Luton to Gatwick and gain market
share in the business passenger market.

Airline response 4 ‘Gatwick point-to point growth, Heathrow remains the network hub’

We assume that low-cost carriers at Gatwick will stick to the more traditional low-cost carrierbusiness model, which means a continuing focus on point-to-point traffic.

Point-to-point legacy carriers at Heathrow such as Virgin Atlantic move some of theiroperations to the expanded Gatwick. Any slots that become available at Heathrow are taken up
by BA and partners at Heathrow.



Because of lower local airline industry growth rates in the Relative Decline of Europe scenario,
BA and partners consolidate operations at Heathrow. Available capacity at Gatwick is filled up
with point-to-point carriers.

Gatwick benefits from the introduction of the Boeing 787 and Airbus A350, which allows lowcost carriers to fly profitably on long-haul routes. As UK economic growth is modest in this
scenario, connectivity gains through 2030 are limited despite strong growth in Asia and otherparts of the world.

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4. Results: Impact on Connectivity, Competition and Scarcity Rents

This chapter summarises our findings on the impacts of runway capacity expansion on connectivity,
competition and reduction of airline scarcity rents, for four airline response outcomes following
expansion at Gatwick or Heathrow. We find that reductions in airline scarcity rents make up the majorityof the consumer welfare gains. All tested airline responses, including expansion of the hub operation at
Heathrow, produce benefits for passengers from competition. The analysis has a medium-term
perspective and does not look beyond the year 2030. It should be noted that beyond 2030 the point-topoint airline response in the Relative Decline of Europe scenario following Gatwick expansion would be
expected to begin to generate substantial welfare gains.

Results of the quantitative impact assessment
Figures 4.1 to 4.3 and the Tables in 4.1 and 4.2 summarise the results of the impact assessment on
connectivity, competition and reduction of airline scarcity rents. Before discussing the results, we notethat:
All results are in comparison to the same ‘do minimum’ scenario.

The airline response outcomes are not directly comparable as they reflect different scenarios forthe overall development of aviation and the global economy.

Benefits to passengers relate to the year 2030 only, therefore they need to be interpreted withcaution. That is especially the case for airline response 4, which unfolds in the Relative Declineof Europe scenario, as in this particular scenario the demand profile at Gatwick indicates thatwelfare benefits would mainly accrue after 2035.
Figure 4.1 Total Consumer Benefits in 2030 (million GBP)LGW Relative Decline of Europe
LGW Low-cost is King
LHR Low-cost is KingLHR Assessment of Need0
UK passengers

1000

2000

3000

4000

Non-UK passengers

Source: SEO Netcost

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34 – 4- RESULTS: IMPACT ON CONNECTIVITY, COMPETITION AND SCARCITY RENTS

Figure 4.2 Business and Leisure Consumer Benefits in OD Markets in 2030
(million GBP)LGW Relative Decline of Europe
LGW Low-cost is King
LHR Low-cost is KingLHR Assessment of Need0
Business passengers

1000

2000

3000

4000

Leisure passengers

Source: SEO Netcost

Consumer welfare benefit per passenger in 2030

Figure 4.3 Consumer welfare impacts of airport expansion in 2030: Benefits to passengers travelling to andfrom the UK (bars) and to transfer passengers (dots)(GBP per passenger)
35
30
25

scarcity

20
competition
15
connectivity

105Cons. Benefit /transfer passenger0
Hub carrier Point to
LGW
Point togrowth at Point growth becomes Point growth
LHR
at LHR and Low-Cost at LGW, LHR
LGW
Gatewayremains
network hub

Source: SEO Netcost

The results of the impact assessment for each of the airline responses are summarised in Table 4.1,
following Heathrow expansion, and Table 4.2, following Gatwick expansion. All results are presented interms of consumer welfare benefits; the reduction in travel costs for passengers following airport

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4- RESULTS: IMPACT ON CONNECTIVITY, COMPETITION AND SCARCITY RENTS – 35

capacity expansion through more flights and lower fares, in comparison to the do minimum scenario in
which capacity is not expanded.
Table 4.1 Impact analysis results for Heathrow expansion for the year 2030 in GBP(reference = do minimum scenario/no capacity expansion)
Heathrow Expansion
1. Assessment of NeedHub-carrier growth at LHR

2. Low-cost is King
Point-to-point growth at LHRand LGW£ 8.96£ 1.83£ 0.20£ 6.93£ 29.23£ 19.51£ 19.51
3.01
3.01£ 1.06
1.06£ 15.4415.13
15.44£ 15.13
15.13

Constrained
168,218 162,518
85,18738,376
4,561
10,897
29,197

Unconstrained
187,914 169,803
103,193
39,791
5,414
11,49428,022

Number of transfer passengers
LHR
LGW
LCY
LTN
STN

39,961
39,837124
0
0
0

29,971
29,493478
000

Total benefit to passengers (mln GBP)

2,649

UK
1,480

non-UK
1,169

Total benefit OD passengers (mln GBP)
OD passengers (connectivity) (mln GBP)
OD passengers (competition) (mln GBP)
OD passengers (scarcity) (mln GBP)

Business
1,481
367
303
33
1,145

Leisure
1,114

Benefit / OD passenger
connectivity
competition
scarcity
Benefit / transfer passenger

Number of OD passengers (x 1000)
LHR
LGW
LCY
LTN
STN

Total benefit Transfer passengers (mln
GBP)

1,168

23,19422,198

UK
2,162

non-UK
1,781

Business
3,490
882
539
189
2,762

Leisure
2,608

3,943

453

Source: SEO Netcost.

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36 – 4- RESULTS: IMPACT ON CONNECTIVITY, COMPETITION AND SCARCITY RENTS

Table 4.2 Impact analysis results for Gatwick expansion for the year 2030 in GBP(reference = do minimum scenario/no capacity expansion)
Gatwick expansion
3. Low-cost is King
4. Relative Decline of Europe
LGW becomes low-cost
Point-to-point growth at LGW,
gateway
LHR remains network hub
Benefit / OD passenger
connectivity
competition
scarcity
Benefit / transfer passenger£ 17.28£ 3.80£ 1.05£ 12.44£ 1.53

Number of OD passengers (x 1000)
LHR
LGW
LCY
LTN
STN

186,652
65,89569,624
6,778
15,01629,339Number of transfer passengers
LHR
LGW
LCY
LTN
STN

27,211
22,8244,387
0
00£ 1.54£ 0.12£ 0.33£ 1.09£ 0.38Constrained
169,803

22,198UK
Total benefit to passengers (mln GBP)

3,122 1,712

Total benefit OD passengers (mln GBP)
OD passengers (connectivity) (mln GBP)
OD passengers (competition) (mln GBP)
OD passengers (scarcity) (mln GBP)

3,081
678
187
2,216

Total benefit Transfer passengers(mln GBP)

42

non-UK
1,410

Business Leisure779 2,302

167,028
70,466
48,881
6,497
13,58327,601
19,412
19,412
0
0
0
0

264

256
21
55
180

Constrained
165,093

19,618

UK non-UK
150
113

Business Leisure
66
191

7

Source: SEO Netcost.

The first section of the table lists the consumer benefit per passenger. It shows the average benefit to theindividual OD (origin-destination) passenger, broken down by the benefits generated by reductions inairline scarcity rents (and thus lower fares), benefits of improved connectivity (more frequencies androutes) and benefits of more competition (lower fares). So in the case of airline response 3 (Gatwick
becomes a low-cost gateway under the Low-cost is King scenario), on average the individual O/D

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4- RESULTS: IMPACT ON CONNECTIVITY, COMPETITION AND SCARCITY RENTS – 37

passenger is 17 pounds better off with expansion of Gatwick. The majority of the welfare benefits perpassenger are generated by a reduction in fares because of a reduction in airline scarcity rents (12pounds), followed by a connectivity benefit of 4 pounds per passenger and a competition benefit throughlower fares of 1 pound. The same welfare benefits per passenger are given for transfer passengers,
totalling 1.5 pounds in case of airline response 3.
The second section presents the number of OD and transfer passengers at each of the London airports in
2030 for each airline response following capacity expansion. The section also lists the number ofpassengers in the London airports system if capacity is not expanded, the constrained case. The
difference between the number of passengers with and without capacity expansion already gives animpression of the extent to which airline scarcity rents can be reduced by expanding airport capacity. The
larger the difference, the higher the expected reductions in scarcity rents.
The third section presents total passenger welfare benefits, which include the total benefits of lower
travel costs for existing passengers and the total benefits for previously denied passenger demand. Incase of airline response 3, these benefits are over 3.1 billion pounds, benefiting a total of 186 000 OD
passengers and 27 000 transfer passengers. Part of these benefits accrues to UK residents (1.7 billion
pounds) and another part accrues to non-UK residents (1.4 billion pounds).
The final section breaks down the total passenger welfare benefits between OD passengers and transfer
passengers. For the OD passengers, we have estimated the total benefits through lower fares resulting
from a reduction in scarcity rents and from increased competition and through improved connectivity. In
case of airline response 3, the majority of the total benefits go to the OD passengers and only a small
portion to the transfer passenger. Again, a major part of the benefits result from reduced scarcity rents.
Based on the quantitative impact assessment, we conclude the following main points.
The reduction in airline scarcity rents is the most important element of the consumer welfare impacts of
airport expansion for all airline responses. All tested airline responses produce benefits from competition,
including those with an expanded hub operation at Heathrow.
Around 55% of total welfare benefits accrue to UK residents in all airline responses. In the OD (origindestination) market, leisure traffic accounts for about three quarters of the consumer welfare gains. On a
per passenger basis, transfer passengers benefit most in the airline responses to Heathrow expansion.
Total consumer benefits are highest in the scenario assuming point-to-point traffic growth at Heathrow(airline response 2) and low-cost gateway development at Gatwick (airline response 3), both of which are
based on the Low-cost is King demand scenario for. The lowest total consumer benefits are found inairline response 4, which assumes point-to-point growth at an expanded Gatwick in the Relative Declineof Europe scenario.
An important factor in explaining the differences between airline responses is the fact that different
demand growth rates are used, depending on the Airports Commission scenario that applies for eachairline response (see table 3.1). Until 2030, growth in the Low-cost is King scenario is higher than inboth the Assessment of Need scenario and the Relative Decline of Europe scenario. This difference in theaviation demand scenarios leads to higher overall welfare gains in airline responses 2 and 3 (which bothassume a Low-cost is King scenario) compared to the Assessment of Need (airline response 1) and
Relative Decline of Europe scenarios (airline response 4).

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We note that the deliberate choice for 2030 as the year of analysis is the main explanation for the very
low figures for airline response 4. According to the Airports Commission (2014b) benefits are expectedto accrue after 2035 in the Relative Decline of Europe scenario.
An important consideration in the total welfare effects is the change in the amount of transfer passengers.
Transfer passengers have a much higher price elasticity, given the many close substitutes available(direct flights, via other hubs) for a connection via Heathrow. As a result, welfare effects are much lower
when carriers use the additional capacity to a considerable extent to carry transfer traffic. For OD
passengers a price decrease of 10 percent leads to a 10 percent passenger increase on average. On theother hand, a 10 percent price decrease for transfer passengers leads to a 30 percent increase in passenger
numbers. Hence, for transfer passengers the additional capacity fills up sooner with a smaller pricedecrease. The gains for transfer passengers accrue to non-UK residents to a considerable extent.
The difference between OD and transfer passengers in terms of benefits from airline scarcity rent
reductions is most relevant for airline responses 1 and 3. In both responses, the number of transfer
passengers is expected to increase significantly once capacity becomes available at Heathrow or
Gatwick. In contrast, in airline response 2, not only growth rates are higher but capacity expansion mostbenefits the local OD passengers, resulting in larger welfare gains because of their much lower priceelasticities.
The effects quantified only relate to direct welfare benefits for passengers. Changes in surface transport
access conditions and the consequences of expansion in allowing passengers to switch to a moreconvenient airport in terms of access are not included. Similarly, wider economic effects from improved
connectivity of the London area have not been quantified.

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ANNEXES – 39

Annex A. Methodology Technical Description

The Netcost model serves as a basis for the methodology used for this study. This model uses OAG
schedule data for all direct and indirect alternatives to determine generalised costs and market shares forindividual markets. The Netcost model was first presented in Heemskerk and Veldhuis (2006a, 2006b)
and developed by Veldhuis and Lieshout (2009).
For the purpose of this study, the Netcost model has been applied on a more aggregate level. We quantify
consumer benefits for the London area depending on different airline responses. These responses
incorporate traffic shifts between airports and carrier groups, which are adjusted at a regional level.
Destination regions and carrier groups are defined such that we assume that destinations in one region
are perfect substitutes and there is no competition between carriers of the same carrier group.
Welfare effects for the four airline responses are determined using a 5-step approach:1.

Construct unconstrained, constrained and expansion-option airline networks for 2030 based on
OAG schedule data and passenger growth forecasts from the Airports Commission (2014a).

2.

Determine generalised travel costs and consumer utility using the Netcost price model.

3.

Calculate scarcity rents resulting in a demand increase or decrease to satisfy capacity
constraints.

4.

Include airline response scenarios by allocating frequencies over specific carriers.

5.

Divide the welfare effects between connectivity, competition and scarcity components. Breakdown results by UK/non-UK and OD/transfer passengers.

Construction of airline networks for 2030
Passenger forecasts provided by the Airports Commission were used to construct an airline network foreach scenario. For each, an unconstrained, constrained and LHR/LGW expansion a network is
determined. These networks are created by increasing the seat capacity offered in 2011 by annual
passenger growth rates from the Airports Commission forecasts. In total, 10 airline networks wereconstructed: 3 for the Assessment of Need and Relative Decline of Europe scenarios and 4 for the Lowcost is King scenario (as this scenario is considered for both expansion options).
The Netcost model also requires a ‘beyond-network’ for 2030 to determine indirect travel alternatives to
final destinations. This ‘beyond-network’ consists of all destinations that can be reached from London
with a connection at an intermediate hub airport. Direct and indirect travel alternatives are used todetermine the competition level in an OD market, which is an input variable for the fare model. Consider
for example the route LHR-SIN. British Airways and Singapore Airlines provide direct connections from
LHR. Besides this there are numerous indirect alternatives such as connections via Frankfurt or Dubai.
For this reason we construct airline networks for 2030 for Frankfurt, Dubai and other ‘onward hubs’. We

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40 – ANNEXES

project the 2011 network to 2030 by applying the average growth figures by destination region for all
airports given in the Airports Commission forecasts.

Calculating generalised travel costs and consumer value
The Netcost fare model determines generalised travel costs for an individual route alternative based on
travel time, competition level, carrier type and connection type. The fare model is estimated using
Ordinary Least Squares (OLS) and is defined as:
2ln( 𝑓𝑎𝑟𝑒) = 𝛽0 + 𝛽1 ⋅ 𝑡𝑛𝑜𝑛𝑠𝑡𝑜𝑝 + 𝛽2 ⋅ 𝑡𝑛𝑜𝑛𝑠𝑡𝑜𝑝+ 𝛽3 ⋅ ln(𝑓) + 𝛽4 ⋅ 𝐻𝐻𝐼 + 𝛽5 ⋅ 𝐷𝐿𝐶𝐶 + 𝛽6 ⋅ 𝐷𝑖𝑛𝑑𝑖𝑟𝑒𝑐𝑡

Where𝑡𝑛𝑜𝑛𝑠𝑡𝑜𝑝 = non-stop travel time
𝑓= weekly frequency
HHI = Hirschmann-Herfindahl concentration index (sum of squared market shares)
𝐷𝐿𝐶𝐶 = Dummy variable, equals 1 if the flight is operated by a Low Cost Carrier
𝐷𝑖𝑛𝑑𝑖𝑟𝑒𝑐𝑡 = Dummy variable, equals 1 if the flight is an indirect flight.
As we only consider direct routes in this analysis all dummy variables for indirect routes are set to 0.
The fare model is estimated using passenger booking data for 2010 and is specified by the following
parameter values:
t_nonstop

0.28873t_nonstop ²-0.00827ln(freq)0.03718HHI

0.30101

D_LCC-0.12801

D_indirect-0.11753

β03.95411R²

0.7663All variables are significant at 99.5% confidence level

As this analysis is done at regional level we assume there are no additional costs incorporated for theroute alternatives. Hence, the fare derived by the model defined above defines the generalised travel costof a route alternative.
After the generalised travel costs (GC) are derived, a utility function is used to determine the Consumer
Value (CV), having as base the frequency (f). A cost sensitivity parameter α is included. The consumer
value for route alternative i (CVi) is given by:

𝐶𝑉𝑖 = 𝑓 ⋅ 𝑒 −𝛼⋅𝐺𝐶𝑖

IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

ANNEXES – 41

The total consumer value for the connection between London and one of the world regions is determinedby adding up the consumer values for all independent route alternatives.
We consider the example of the route from LHR to North-East USA. Flights are offered by six different
carrier groups flying from three London airports. We suppose the amount of passengers is determined by
the seat capacity offered: load factors remain constant. The amount of OD-passengers is determined by
the load factor multiplied by the seat capacity, minus the number of transfer passengers. The welfare
effects for transfer passengers are calculated separately.

Market share

Generalised
costs (faremodel)

Consumer
value

Carrier_code

frequency

Ac. sizeseats

Load factor

ODpassengers

LCY

3

1

32

42

85%

35

0%

299

0.01

NA3

LGW

12

0

162

5

90%

5

0%

275

0.00

NA3

LHR

1

87

240

20929

85%

17790

17%

333

0.63

NA3

LHR

2

146

235

34222

85%

29089

28%

349

0.80

NA3

LHR

3

386

271

104558

85%

35550

34%

336

2.58

NA3

LHR

4

5

281

1468

85%

1248

1%

303

0.06

NA3
Total
NA3

LHR

5

88

293

25920

85%

22032

21%

325

0.70

105749100%

Region_dest

Airport_ori

NA3

714

187145

4.79

Before we can determine the scarcity rents in step 3 we need to adjust the generalised costs based on themarket share by the number of OD passengers. The consumer value is redistributed according to themarket shares. Adjusted generalised costs 𝐺𝐶𝑖′ are calculated by inverting the consumer value equation:

𝐺𝐶𝑖′ =ln(𝐶𝑉) − ln(𝑓)𝛼The generalised costs in the unconstrained (base) scenario are given by the multiplying the generalised
costs and the market shares:

𝐺𝐶 ′ = ∑ 𝐺𝐶𝑖′ ⋅ 𝑀𝑆𝑖
𝑖

These costs are required to determine the scarcity rents.

Calculating scarcity rents
As a result of capacity restrictions the seat capacity offered and resulting passenger numbers is lower in
the Constrained scenario:

IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

42 – ANNEXES

Region_dest Airport_ori Carrier_code frequency

Ac. size

seats

Load
ODfactor passengers

NA3

LCY

3

1

32

42

85%

36

NA3

LGW

12

0

162

5

90%

5

NA3

LHR

1

69

237

16463

85%

13994

NA3

LHR

2

116

232

26920

85%

22882

NA3

LHR

3

307

268

82247

85%

34955

NA3

LHR

4

4

278

1155

85%

982

NA3

LHR

5

70

290

20389

85%

17331

Totaal NA356914722290184

The OD demand decreased from 105 794 to 90 184, a 15% decrease. Assuming a price elasticity of -1,
this yields a GC increase of 17%: 0.85−1 = 1.17. The adjusted generalised costs (GC’) were equal to328. Hence a price reduction of $56 is needed to realise the desired demand reduction.
ODGC
DemandChangechange
NA3

0.85

1.17

GC’

Welfareeffect328-56.55The new generalised costs resulting from the calculation steps shown above can be used similarly todetermine the welfare effect for a capacity expansion scenario. This leads to the following result for the
Heathrow capacity expansion in the Assessment of Need scenario:
Region_dest Airport_ori Carrier_code frequency
NA3
LCY
3
1

Ac. size
32

seats
41

Load
factor85%

ODpassengers
35

NA3

LGW

12

0

162

5

90%

5

NA3

LHR

1

83

240

19921

85%

16933

NA3

LHR

2

139

234

32574

85%

27688

NA3

LHR

3

368

270

99522

85%

35102

NA3

LHR

4

5

280

1398

85%

1188

NA3

LHR

5

84

293

24672

85%

17910

Totaal NA3681

17813298861

In the fourth step of the model airline responses are applied.

Seeding the airline responses
Airline response 1 under the Assessment of Need scenario assumes hub-carrier growth at Heathrow. The
adjustments made for the US North-East region would be to assign some of the airline group 5
frequencies to Oneworld. In this case we would reduce airline group 5’s frequencies back to 70, its levelin the constrained case. Now all additional slot capacity at Heathrow is assigned to Oneworld.
As aircraft sizes differ for the various airline groups and total seat capacity remains unchanged for theairline responses, the total frequency might change. This leads to a change in welfare effects attributed toconnectivity. Changes in market shares lead to a change in competition level.

IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

ANNEXES – 43

Dividing welfare effects into connectivity, competition and scarcity components
In the third step we have determined a welfare effect of $-53 for the constrained scenario with respect tothe unconstrained scenario. In a similar way we can determine that the welfare effect of the LHR
expansion after incorporating the airline response equals $33. In this last step we divide this effect over aconnectivity, competition and scarcity component.

Frequency:
After the airline response scenario is applied, the frequency in the LHR expansion scenario equals 683
flights per week. A 20% increase with respect to the frequency of 569 flights in the constrained case. The
generalised cost change caused by this frequency increase can ∆GCfreq be calculated by:∆𝐺𝐶𝑓𝑟𝑒𝑞 = − ln (𝑓𝑒𝑥𝑝𝑎𝑛𝑠𝑖𝑜𝑛) /𝛼𝑓𝑟𝑒𝑠𝑡𝑟683
ln ()
569 = 12.16∆𝐺𝐶𝑓𝑟𝑒𝑞 = −−0.015Competition:
The competition level is determined by the HHI (sum of squared market shares). The HHI is an input
variable in the Netcost fare model. The fare increase attributed by the model to an absolute HHI increaseof 0.1 equals 0.0301%. Hence more market concentration yields a cost increase.
In the North-East US example the HHI changes from 0.31 to 0.30:

carrier
12345
MS restr 16% 25% 39% 1% 19%
MS expansion 17% 28% 36% 1% 18%
As we can observe the competition effect is very small. The corresponding welfare effect resulting fromthe competition increase equals $1.00 per passenger.

Scarcity:
The remaining welfare effect can be attributed to scarcity. In this case, this equals $32.61 - $12.16 –$1.00 = $19.45

Price elasticity
In this study two price elasticity values are used, one for O&D passengers and one for transfer
passengers. The values used are:


O&D passengers: -1Transfer passengers: -3

IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

44 – ANNEXES

These values were derived from various literature studies and earlier SEO studies. InterVistas finds
values between -0.48 and -1.23 on a national level in a price elasticity study prepared for IATA15.
Elasticities on intra-European routes as well as trans-Atlantic routes tend to be relatively high. Theseroutes contain the majority of traffic from London airports.
Transfer passengers are more price elastic than O&D passengers (CPB 2011; Oum et al. 1993). For mosttransfer routes many alternatives via other hubs are available, which are close substitutes. Particularly for
London there is fierce competition between transfer airports. More than 80 percent of the routes served
via London is also served via another hub airport.

Annex B. Carrier and Route Categorisation

Full service
carriers

Point-to-point

Leisure15

Carrier group Carrier group Name
1 SkyTeam
2 STAR
3 oneworld
4 independent full-service carriers
5 Virgin Atlantic
6 Regional carriers/full service PtP
7 EasyJet
8 Ryanair
9 Norwegian
10 Vueling
11 other Point-to-point (Low-cost)
12 leisure carriersInterVistas (2007) - Estimating Air Travel Demand Elasticities

IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

ANNEXES – 45

Continent

Regioncode

Region nameRegion SPASM

EuropeEU1

UK/Ireland

---

UK

Ireland

EU2

Scandinavia

516

NorwaySwedenFinlandDenmark

IcelandFaroesEU3

North-West Europe---

Germany

Netherlands

Belgium

Luxembourg

Switzerland

Austria

EU4

France/Italy---

FranceItaly

EU5

Iberian peninsula

514

Portugal

EU6South-East Europe

---

Spain
FormerYugoslavia

Albania

Bulgaria

GreeceRomania

TurkeyEU7

North-East Europe

518

Czech Rep.

Slovakia

PolandLithuania

LatviaEstonia

Belarus

UkraineMoldova

RussiaGeorgia

Armenia

Turkmenistan

Uzbekistan

Tajikistan

Kyrgyzstan

Kazakhstan

RussiaUAE

Bahrain

Qatar

Oman

Yemen

Saudi Arabia

JordanLebanon

Kuwait

Syria

Iraq

Iran

IsraelAfghanistan

Pakistan

BhutanTaiwanHong Kong

VietnamThailandHungary
EU8

CIS

518

Azerbaijan
Asia

Africa

AS1

India

524

India

Sri Lanka

Maldives

AS3

China

525

China

Nepal

AS4

Korea/Japan

525

North-Korea

Mongolia
SouthKorea

AS5South-East Asia

525

Bangladesh

MyanmarCambodia

Laos

AS6

Australia/New
Zealand

526

Australia

New
Zealand

AF1

North-Africa

515

MoroccoAlgeria

Libya

Tunesia

AF2

East-Africa

520

Egypt

Sudan

Eritrea

Ethiopia

Somalia

Kenya

Burundi

CAR

Congo

Tanzania

UgandaRwandaMozambique

Zimbabwe

Botswana

Namibia

S. Africa

Madagascar

AngolaZambiaGabon

Cameroon

Nigeria

Benin

Togo

Niger

Ivory Coast

Liberia

S. Leone

GuineaGambiaSenegalBurkina Faso

Ghana

C. Verde

AF4

MiddleAmerica
LatinAmerica

523

AS2

AF3

NorthAmerica

Middle-East

South-Africa

West-Africa

521

519

Japan

NA1

East-Canada

503

NS

NB

NL

QC

ON

NA2

West-Canada

502

BC

AL

SK

MB

YT

NA3

USA-northeast

513

Maine

Viriginia

Missouri

Minnesota

NA4

USA-southeast

513

N. Carolina

Florida

Texas

NA5

USA-northwest

512

Washington

OregonColorado

NA6

USA-southwest

512

California

New Mexico

MA1

Middle-America

522

MexicoPanamaMA2Carribean

522

LA1

Latin-America

522

Peru

EcuadorColombia

Venezuela

Guyana522

Argentina

Uruguay

Paraguay

Chile

Bolivia

IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

NT

Brazil46 – BIBLIOGRAPHY

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Airports
Commission(2014a).
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fit:
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IMPACTS OF EXPANDING AIRPORT CAPACITY ON COMPETITION AND CONNECTIVITY© OECD/ITF 2014

Impacts of Expanding Airport Capacity
on 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 timingof 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 term by 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 summarises a quantitative analysis of the likely responses from airlines in all segments of the market
building on a companion report that identifies the main drivers of airline behaviour and considers the possible
influence of changes to existing business models and the introduction of new types of aircraft, such as
the Boeing Dreamliner and Airbus A350.
Four sets of airline responses are modelled, two following expansion of Gatwick and two following expansion
of Heathrow, to test outcomes under a range of scenarios for the overall development of the global aviation
market. The analysis quantifies impacts on connectivity and potential benefits to the consumer through airline
competition and relieving congestion at airports and reducing the associated economic rents.

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2014-12 /Photo credit: Shutterstock - Lukas Rebec

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.