TERMINAL COMPETITION AT
HEATHROW AIRPORT
REPORT PREPARED FOR
HEATHROW-WEST LIMITED
Final Report
24 October 2019
Terminal Competition at Heathrow Airport
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About this Report
This report ("Report") was prepared by AlixPartners UK LLP ("AlixPartners") exclusively on instructions from and for the sole benefit and use of Heathrow West in respect of its engagement with stakeholders
concerning expansion of terminal capacity at Heathrow Airport.
The Report is not intended by AlixPartners to be used by any other party than Heathrow West or for any other purpose. Any parties other than Heathrow West that have access to the Report should make their
own investigation, analysis and decisions in relation to the subject matter of the Report. Accordingly, no
liability or responsibility whatsoever is accepted by AlixPartners or its employees, partners or affiliates for any loss whatsoever arising from or in connection with any use of the Report, or any part of the Report,
by anyone other than Heathrow West.
The information in the Report reflects conditions and the views of AlixPartners as of this date, all of which
are subject to change. AlixPartners undertakes no obligation to update or provide any revisions to the
Report to reflect events, circumstances or changes that occur after the date the Report was prepared.
The Report includes discussion of how competition between terminal operators may evolve in the event
that terminal expansion is carried out by a third party. Actual developments may differ from those
projected or forecast. Those differences may be material.
Terminal Competition at Heathrow Airport
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Contents
1 Executive Summary ............................................................................................................ 6
1.1 Background ................................................................................................................ 6
1.2 Plans for terminal expansion ......................................................................................... 6
1.3 Competitive scenarios .................................................................................................. 7
1.3.1 Competition in design..................................................................................... 8
1.3.2 Competition in financing ................................................................................. 8
1.3.3 Competition in construction ............................................................................ 8
1.3.4 Competition in operation ................................................................................ 9
1.4 Conclusion ................................................................................................................ 10
2 Introduction ..................................................................................................................... 11
2.1 Background .............................................................................................................. 11
2.2 Purpose of this report ................................................................................................ 15
2.3 Structure of this report .............................................................................................. 16
3 Alternative terminal expansion proposals ............................................................................ 16
3.1 Introduction .............................................................................................................. 16
3.2 Passenger forecasts for Heathrow ............................................................................... 16
3.3 HAL’s plan for terminal expansion ............................................................................... 18
3.4 Heathrow West’s plans ............................................................................................... 20
3.5 Comparison of the two plans....................................................................................... 21
3.6 Coordination between Heathrow West and HAL ............................................................. 23
4 Competitive scenarios ....................................................................................................... 24
4.1 Introduction .............................................................................................................. 24
4.2 Competition in terminal design .................................................................................... 25
4.3 Competition in financing ............................................................................................. 27
4.4 Competition in build ................................................................................................... 28
4.5 Competition in terminal operation: available capacity .................................................... 28
4.5.1 Expansion phase .......................................................................................... 28
4.5.2 Runway constrained phase ........................................................................... 29
4.6 Competition in terminal operation: example scenarios ................................................... 31
4.7 Slots ........................................................................................................................ 34
5 Costs and benefits of terminal competition .......................................................................... 35
5.1 Introduction .............................................................................................................. 35
5.2 Problems with HAL’s current regulatory framework ....................................................... 36
5.3 Cost and benefits of competition ................................................................................. 38
5.3.1 Competition in design................................................................................... 39
5.3.2 Competition in finance .................................................................................. 42
5.3.3 Competition in build ..................................................................................... 43
5.3.4 Competition in operation .............................................................................. 44
5.3.5 Effect on regulatory burden .......................................................................... 52
5.4 Summary ................................................................................................................. 53
6 Conclusion ....................................................................................................................... 54
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Appendices
A1 How the regulatory framework could operate ...................................................................... 56
A1.1 Introduction .............................................................................................................. 56
A1.2 Regulating the new terminal operator .......................................................................... 56
A1.3 Regulating the HAL terminals ...................................................................................... 57
A1.4 Airfield regulation ...................................................................................................... 59
A2 Case studies .................................................................................................................... 63
A2.1 Introduction .............................................................................................................. 63
A2.2 Separate ownership of airport terminals ....................................................................... 63
A2.3 Competition in Ground Handling .................................................................................. 67
A2.4 Competition between airports ..................................................................................... 68
A2.5 Other sectors ............................................................................................................ 69
A2.6 Conclusion from case studies ...................................................................................... 73
Terminal Competition at Heathrow Airport
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Exhibits
Figures
Figure 1: Instances of terminal competition ...................................................................................... 7
Figure 2: Aero revenue per passenger for different airports, 2014 ..................................................... 12
Figure 3: DfT and AC forecasts of passenger demand at Heathrow with NW runway ............................ 17
Figure 4: Overview of HAL expansion plans ..................................................................................... 19
Figure 5: HAL’s Heathrow expansion plan after 2050 ........................................................................ 19
Figure 6: Heathrow West’s options for expansion of Heathrow terminal capacity ................................. 20
Figure 7: Comparison of Heathrow West expansion plans and demand forecasts ................................. 22
Figure 8: HAL expansion plans ....................................................................................................... 22
Figure 9: Instances of terminal competition .................................................................................... 24
Figure 10: Ofgem’s description of typical project process .................................................................. 25
Figure 11: Spare capacity required to facilitate competition in stylised model ..................................... 30
Figure 12: Illustrative example scenarios for airline distribution across terminals ................................ 33
Figure 13: HAL’s actual vs. regulated return on RAB (pre-tax) .......................................................... 38
Figure 14: Airport Service Quality performance improvements for HAL (left) and GAL (right), against
average of European competitors ................................................................................................... 46
Figure 15: Relationship between HAL and Heathrow West in respect of the airfield .............................. 59
Figure 16: Comparison of regulatory accounting challengers in HAL vs. BT/Openreach ........................ 61
Terminal Competition at Heathrow Airport
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1 Executive Summary
1.1 Background
In July 2015 the Government-appointed Airports Commission (“AC”), investigating measures
needed to preserve the UK’s position as a global aviation hub, published its final report. To provide
additional capacity1, it recommended expanding Heathrow through a new full-length runway to
the northwest of the existing two runways. The recommendation was endorsed in the
Government’s Airport National Policy Statement (“ANPS”) in June 2018, which was subsequently
passed through a parliamentary vote.
The ANPS makes no explicit assumption that Heathrow Airport Holdings Limited (“HAL”) should
perform all elements of the airport expansion. Indeed, an alternative operator – Heathrow West
Limited (“Heathrow West”) – has already put forward its own plans to develop the terminal
capacity required to match increased runway capacity. We have been commissioned by Heathrow
West to consider the cost and benefits of introducing competition in the provision of additional
terminal capacity at Heathrow Airport.
This idea of terminal competition is by no means new. The involvement of parties other than HAL
in the expansion process through Separate Terminal Operation and Development (“STOD”) or
Terminal Development Tendering (“TDT”) was already considered in the Competition
Commission’s (“CC”) 2009 investigation of BAA. The Civil Aviation Act (2012), which took up the
idea, was drafted in such a way as to allow more than one operator of terminals at an airport.
.
1.2 Plans for terminal expansion
HAL’s plans for terminal capacity expansion, as described in its June 2019 consultation, are spread
over four phases. The planned development would provide terminal capacity for 130-135 million
passengers per annum (“mppa”) by 2050. However, terminal capacity would trail runway capacity
until at least 2050.
HAL’s most recent total capital cost estimate for opening a new runway in 2026 is in the region
of £14 billion (excluding material expenditure on new terminal capacity), with a total expansion
capital cost of around £32.5 billion up to 2050 (in 2014 prices). No detailed breakdown of these
costs is available at present.
Heathrow West, a subsidiary of the Arora Group (which already manages hotel and business
facilities at Heathrow Airport and is one of the most significant land owners on the site marked
for expansion) has developed alternative plans for development and operation of additional
terminal capacity.2 At the time of writing, Heathrow West’s plans are less developed than those
of HAL. For the purposes of this report we assume that Heathrow West plans a single terminal
1 To raise runway capacity from the current cap of 480,000 Air Traffic Movements (“ATM”) to at least 740,000
ATMs. 2 Heathrow West takes HAL’s plans for the north west runway and other necessary and consequential
investments in the airfield as given and expect that they would be implemented by HAL itself. Heathrow West’s
plans deal solely with the development of the necessary passenger terminal capacity required to enable
Heathrow expansion. This includes associated aprons and taxiways required by aircraft for access to the new
terminal buildings.
Terminal Competition at Heathrow Airport
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development (T6), which can deliver an additional 40 mppa by 2032 with a first phase being ready
for 2026. We also assume that this plan can meet the environmental requirements of the ANPS.
The main differences between the two competing passenger terminal expansion proposal relate
to:
(a) Scope of alterations to existing terminal capacity: While HAL plans to develop two new sites
(T5X and T5XN) and various alterations to existing terminals, Heathrow West plans a single
new terminal (T6). Heathrow West’s plan could thus reduce interference with the operation
of the rest of the airport during construction, limit the use of land, and eliminate the need
for additional transfer infrastructure between terminals.
(b) Timing of capacity development: While HAL plans to phase terminal expansion, leading to
a capacity shortfall until at least 2050 (based on DfT passenger forecasts), Heathrow West
plans to expand capacity at a much earlier stage.
1.3 Competitive scenarios
In this report, we consider the costs and benefits under a scenario where an independent company
(Heathrow West) proposes to design, finance, build and operate a new terminal. Under this
configuration there are two potential instances of competition between the alternative providers,
as illustrated in Figure 1.
Figure 1: Instances of terminal competition
Source: AlixPartners.
Competition can take place during the selection process, where alternative providers put forward
their plans. Competition at this stage could affect incentives and outcomes with regards to
terminal design, financing and building. Competition in operation could ensue after the selection
process, provided that a party other than HAL is selected. In the following Section, we provide an
overview of how competition may work at each of these stages and analyse the costs and benefits
to airlines and passengers.
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How competition would work in practice would depend on the regulatory regime that is adopted.
This issue is beyond the scope of our report. Nevertheless, we note that there exist a range of
potential regulatory options that the Civil Aviation Authority (“CAA”) would have at its disposal.
These range from limited regulatory oversight to full Regulatory Asset Base (“RAB”)-based price
regulation – the appropriateness of which would depend on the intensity of competition between
terminal operators. Further, we believe that the airfield – an essential facility for both terminal
operators – would need to be separately regulated to ensure that HAL and an alternative operator
can compete on an equal footing.
1.3.1 Competition in design
Competing terminal developers would have to – and have done so already – put forward cost-
efficient proposals that are in the interest of all stakeholders. Proposals can differ along two main
dimensions:
● design functionality: what airline and passenger requirements will be met by the design,
and what levels of service can be expected?
● competition in design cost efficiency: for any given functionality, what are the resource
costs?
Our assessment shows that competition in terminal design is likely to lead to design functionality
that better suit the needs of passengers, airlines and other stakeholders. This is because an
independent airport operator, who is under pressure to attract airlines, has strong incentives to
design a terminal that allows it to compete – inter alia for Low Cost Carriers (“LCCs”). HAL, in the
absence of competition, would be incentivised to specify functionalities that are not required by
all airlines (in particular LCCs), as it could recover its costs through its RAB nevertheless.
Further, we find that competition by a non-RAB regulated entrant would lead to terminal design
that is more cost efficient. This is because it avoids the gold-plating incentives that are inherent
in the current regulatory framework. An independent operator – unlike HAL – would have the
economic incentives to limit capital expenditure; HAL on the other hand, would have strong
incentives to build an excessively costly terminal in so far as its allowed return exceeds its actual
cost of capital.
1.3.2 Competition in financing
Competition in financing could be introduced if both developers were required to commit either to
a fixed price or revenue cap for the first years of operation, or more likely a contract where the
risk of overspend is shared between the developer and any future RAB. For the latter, either the
developers could submit the regulated Weighted Average Cost of Capital (“WACC”) they would
be prepared to accept as part of the bidding process, or the regulator could state a WACC that
would apply during the development period (or beyond) in any future RAB-based regulation.
1.3.3 Competition in construction
Before the start of the construction stage, one of the parties would have been selected – there
would thus not be any competition between the parties as such. However, the choice of the
provider at the selection stage may affect outcomes during the construction phase to the extent
that an independent terminal operator would have different incentives.
Our analysis shows that an independent operator would have the incentive to release terminal
capacity at an earlier stage as it would be able to steal business from HAL. This appears
particularly likely if the new operator does not benefit from RAB remuneration of assets in the
Terminal Competition at Heathrow Airport
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course of construction (“AICC”). As a result, passengers and airlines, as well as the UK economy
as a whole, could benefit from the expanded runway capacity at an earlier stage.
1.3.4 Competition in operation
Supposing that an alternative provider has been selected to provide the terminal expansion, it
would compete in operation with HAL to attract airlines and passengers. This competition would
be in two phases:
● In the expansion phase: the new terminal operator would aim to acquire business from new
entrants, established airlines who want to expand their presence at Heathrow, or established
network carriers who may want to switch from existing HAL terminals. Competition between
operators would be intense in this phase;
● In the runway constrained phase: airlines may still switch between terminals once the
enlarged runway capacity at Heathrow is exhausted. While competition between operators may
be less intense than in the expansion phase, we have strong reasons to believe that it would
continue to be effective. Provided that terminal operators carry a margin of spare capacity – a
scenario that we believe is likely – switching could still occur. Further, operators could compete
to attract airlines with attractive features such as a steady load profile of passengers; a high
ratio of passengers per flight; quick and efficient plane turn; and a high level of retail spending
per passenger.
We expect that terminal competition would generate substantial benefits for passengers and
airlines during the expansion phase and beyond.
As noted above, terminal competition would incentivise operators to bring capacity on stream
more quickly to gain revenues and market share. We would expect strong competitive pressure
during this expansion phase, as the new entrant would need to attract airlines. We also note that
– if one were to believe that HAL’s passenger forecasts were correct – this expansion phase would
last for 24 years (until 2050), i.e. competition between terminal operators could be strong for a
prolonged period of time, and would be front-loaded (i.e. stronger in the earlier years).
The competitive pressure during this phase would force both terminal operators to improve their
operational efficiency and to be more responsive to customer requirements. While these issues
are partially addressed through the current regulatory framework, we believe that the latter is
imperfect and that competition would lead to superior outcomes.
The benefits of competition at the operations stage would expand beyond operational cost
savings. We expect to see an increased use of commercial deals between terminal operators and
airlines. A competitor terminal would provide a yardstick against which airlines could compare the
pricing and service offering terms of HAL to enable better contractual negotiation in a competitive
context. Further, entry by airlines with different business models (i.e. LCCs) could further
stimulate competition between airlines and thus drive further benefits for passengers and the UK
economy as a whole.3
Our findings are supported by experiences in other cases of intervention in the airports sector and
other industries. The break-up of the former BAA, as well as the introduction of competition in
specialised airport services such as baggage handling both led to substantial passenger and
3 The AC’s Final Report was based around five scenarios for the future development of aviation, one of which -
‘low cost is king’ - specifically focused on the case where low-cost carriers strengthen their position in the short-
haul market and capture a substantial share of the long-haul market.
Terminal Competition at Heathrow Airport
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airlines benefits. Similarly, liberalisation in telecoms and postal services stimulated innovation
and led to cost savings.
While some commentators have raised concerns relating to the practical or cost implications of
terminal competition, in our view these are overstated. The separation between terminal and
airfield operations and the presence of multiple terminal operators in airports across the globe
shows that independent terminal operation is feasible. The additional regulatory burden – a
requirement to impose separate regulation on the airfield – appears to be limited, and indeed
light compared to other regulated industries. Further, any such regulatory costs should be
considered alongside the enhanced effectiveness of regulation arising from benchmarking, and
any savings associated with the potential scaling-back of terminal regulation.
1.4 Conclusion
Overall, we find that the introduction of competition in terminal development and operation is
likely to generate substantial benefits for passengers, airlines and other stakeholders. Arguments
put forward against competition, which emphasise potential risks, appear to be overstated, as
demonstrated by examples of structural separation between terminal and airfield operators across
the globe.
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2 Introduction
2.1 Background
Heathrow airport
Heathrow airport, which started operations in 1930, is the UK’s main hub airport.4 At around 80
million passengers per annum (“mppa”) in 2018, it accounted for 27% of air passengers in the
UK and 46% in London.5 In addition, the airport handled around 64% of the UK’s air cargo.6 As
such, it is of strategic importance for London and the UK economy as a whole.
Since the closure of Terminal 1 in 2015, the airport currently has 4 operational terminals.
Additional facilities include three rail stations, the stations on the London Underground, a
motorway system that connects it to the London area and car parks that provide over 22,900
spaces. 7
The airport is currently owned by Heathrow Airport Holdings Limited (“HAL”), whose shareholders
include FGP Topco Limited (Ferrovial S.A.), Qatar Holding, Caisse de dépôt et placement du
Québec, the Government of Singapore and others.8
Heathrow is not only one of the busiest airports in the world – it is also one of the most expensive.
A study prepared for the CAA by PA Consulting shows that HAL’s aeronautical revenues in 2014
were significantly higher than those of its European peers considered in the study (see Figure 2
below).9 Based on an alternative measure proposed by the authors (revenue per work load unit),
which takes account of cargo movements, HAL is second to none even when compared to the
largest airports in South Korea and Japan.10
4 CAA, Market power determination in relation to Heathrow Airport - statement of reasons (CAP1133), Appendix
C: The business of Heathrow Airport Limited, January 2014. 5 CAA Airport data 2018, available here: https://www.caa.co.uk/Data-and-analysis/UK-aviation-
market/Airports/Datasets/UK-Airport-data/Airport-data-2018/. 6 CAA Airport data 2018, available here: https://www.caa.co.uk/Data-and-analysis/UK-aviation-
market/Airports/Datasets/UK-Airport-data/Airport-data-2018/. 7 CAA, Market power determination in relation to Heathrow Airport - statement of reasons (CAP1133), Appendix
C: The business of Heathrow Airport Limited, January 2014. 8 CAA, Market power determination in relation to Heathrow Airport - statement of reasons (CAP1133), Appendix
C: The business of Heathrow Airport Limited, January 2014. 9 CAA, Benchmarking of High Level Economic and Financial Metrics of Heathrow Airport, PA Consulting
(CAP1563d). 13 June 2017, Figure 20. 10 CAA, Benchmarking of High Level Economic and Financial Metrics of Heathrow Airport, PA Consulting
(CAP1563d). 13 June 2017, Figure 22.
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Figure 2: Aero revenue per passenger for different airports, 2014
Group average shown by orange line.
Source: CAA, Benchmarking of High Level Economic and Financial Metrics of Heathrow Airport, PA
Consulting (CAP1563d). 13 June 2017, Figure 20.
These unusually high revenues are required to cover HAL’s above average operational expenditure
(“opex”), which is the highest of the European airport considered in the study on a per passenger
and per Air Transport Movement (“ATM”) metric.11 A study by the European Commission ranks
Heathrow as the second least efficient – measured as unit cost per passenger – in the group of
30+ mppa airports in 2015.12 Beyond this, the high revenues are reflected in HAL’s profitability
(measured as EBITDA per passenger), which exceeds that of all but one airport in the study.13
Heathrow expansion
In July 2015 the Government appointed Airports Commission (“AC”), investigating measures
needed to preserve the UK’s position as a global aviation hub, published its final report. Heathrow
Airport’s existing capacity was effectively fully utilised, and Gatwick’s capacity was anticipated to
be fully utilised within a short period of time. With growing demand for aviation, more airport
capacity was needed in South East England, and in particular at London’s global hub airport. The
AC recommended that expanding Heathrow through a new full-length14 runway to the northwest
11 CAA, Benchmarking of High Level Economic and Financial Metrics of Heathrow Airport, PA Consulting
(CAP1563d). 13 June 2017, Figure 9 and 11. 12 European Commission, “Support study to the Ex-post evaluation of Directive 2009/12/EC on Airport Charges,
Final Report, Steer Davies Gleave”, 19 December 2017, Figure 4.29. 13 CAA, Benchmarking of High Level Economic and Financial Metrics of Heathrow Airport, PA Consulting
(CAP1563d). 13 June 2017, Figure 26. 14 Proposed by Heathrow to be 3,500m in length.
Terminal Competition at Heathrow Airport
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of the existing two runways was the best option to meet the UK’s requirements for new airport
capacity, subject to measures to mitigate environmental and local community impacts.15
The additional runway capacity would allow Heathrow to operate at least 740,000 ATMs per
annum, whilst still meeting constraints on hours of night time operation and noise respite for local
residents.16 This number of ATMs would allow the airport to meet demand of over 130 mppa,
provided sufficient terminal capacity were available.17
The Government, after carrying out additional work on the economic and environmental impacts,
published an Airport National Policy Statement (“ANPS”) in June 2018 which was subsequently
passed overwhelmingly in a parliamentary vote on 25 June 2018.18 This accepted the AC’s
recommendation that the required new capacity was best provided by a new full-length northwest
runway at Heathrow.19
In parallel HAL has developed plans and began public consultations on construction of both the
new runway and associated passenger terminal capacity, with a view to apply for a Development
Consent Order (“DCO”) in 2020.20 However, it is significant that the ANPS makes no explicit
assumption that HAL will perform all elements of airport expansion. Further, it is worth noting
that in any event surface access requirements will be met by rail and road authorities (albeit in
part financed by the airport).
The Civil Aviation Act
The Competition Commission’s (“CC”) 2009 investigation of BAA, as well as recommending
divestments of airports within the group, also looked at the possibility of Separate Terminal
Operation and Development (“STOD”) and Terminal Development Tendering (“TDT”). In part,
this was prompted by a paper submitted to the commission by Frontier Economics (“Frontier”),
supporting STOD for Stansted Airport.21 Although Frontier’s report was framed in the context of
Stansted Airport, Frontier stated:
“For simplicity, and given the context in which this report is being prepared, the report is
addressed specifically to the question of regulation at Stansted Airport. However, it is our
view that the ideas presented here are generally applicable and beneficial to any airport
with market power, provided the relevant authorities have the will to implement the
necessary structural and legal changes that may be required.” 22
15 Airports Commission, Final Report, July 2015,
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/440316
/airports-commission-final-report.pdf. 16 Airport Commission, op. cit., para. 5.10. 17 Airport Commission, op. cit., para. 13.17. 18 In the House of Commons with 415 “ayes” versus 119 “noes”. 19 Department for Transport, “Airports National Policy Statement: new runway capacity and infrastructure at
airports in the South East of England”, June 2018,
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/714106
/airports-nps-new-runway-capacity-and-infrastructure-at-airports-in-the-south-east-of-england-web-
version.pdf. 20
https://aec.heathrowconsultation.com/?gclid=EAIaIQobChMI4MPsod2g4wIVmpntCh0sTwnJEAAYASAAEgKJw
fD_BwE&gclsrc=aw.ds. 21 Frontier Economics, ‘Regulation of capacity investment at Stansted Airport’, March 2008, (“Frontier
(2008)”).
22 Frontier (2008), op. cit., para. 7.
Terminal Competition at Heathrow Airport
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The CC looked at the case for STOD at each of BAA’s three London airports and concluded that in
principle there was no reason why separate terminal operation should not be considered in future.
In respect to Heathrow the CC concluded:
“We agree that the integrated nature of Heathrow and, in particular, the complex air-line
moves between terminals—which will be necessary over the next few years as part of the
redevelopment of the airport—limit the prospects for STOD at Heathrow in the short term.
However, if a sixth terminal were to be built, as currently envisaged by BAA, there would
appear to be no reason in principle why this could not be funded and operated separately
from the other terminals. A STOD or TDT remedy relating to Heathrow Terminal 6 could be
implemented only after a careful analysis of its costs and benefits. This could only be carried
out once there was more certainty about this development and would be best handled by
the CAA. We note that the large excess demand at Heathrow and resulting persistent
capacity constraints suggest that STOD for Terminal 6 (or any of the other terminals) may
not result in effective competition. We also note that this terminal will be located on land
which is currently not owned by BAA and in all likelihood would need to be purchased using
CPO powers. This might raise substantial practical and legal difficulties if the building of the
terminal were put out to tender by the CAA.” 23
In short, the CC explicitly mentioned the possibility of a separately operated Terminal 6 at
Heathrow, if expansion was to go ahead, whilst acknowledging that such a careful cost-benefit
analysis would be required. The idea that HAL would construct and operate the terminal was never
a foregone conclusion. It is worth noting that in the current context where both HAL and Heathrow
West will submit DCOs, the winning submission would have Compulsory Purchase Order (“CPO”)
powers, thus simplifying the legal difficulties referenced by the CC.
As a result, the Civil Aviation Act (2012) was drafted with the explicit idea that in future there
may be different operators of different ‘areas’ of an airport. The explanatory notes for the Act
explain:
“[Section 5] introduces the concept of an ‘airport area’ (and therefore a ‘dominant airport
area’) to allow for the possibility of there being more than one operator at an individual
airport. This could be the case, for example, if an airline acquired or leased a terminal
building.”24
The Act therefore envisages the possibility of more than one operator of terminals at an airport.
Given the need to build and operate new terminal capacity for Heathrow expansion, the question
of who could or should operate the additional capacity is relevant, i.e. whether it is HAL or another
operator.
Published reports on separate terminal operation at Heathrow
Since the original Frontier report from 2008, other published reports have investigated the
benefits of terminal competition at Heathrow. These, as well as the original Frontier report, are
summarised in Table 1.
23 CC, ‘Introducing terminal competition at BAA’s UK airports’, Appendix 10.11 to main report ‘BAA airports
market investigation’, 2009, para. 67. 24 DfT, ‘Explanatory Notes: Civil Aviation Act (2012)’, para. 45.
Terminal Competition at Heathrow Airport
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Table 1: Published reports on separate terminal operation at Heathrow
Author Synopsis
Frontier (2008)
Commissioned by easyJet
Proposes that the monopoly elements of an airport (e.g. runway) are separated from those that can be opened to
competition (i.e. terminal tendering, building and
operation). Frontier conclude that this is operationally feasible, with benefits of competition to airlines and
passenger, whilst simplifying the way in which price
regulation is applied.
Competition Commission25
Recommended that separate terminal operation and
development be considered in future expansions of
Stansted, Gatwick and Heathrow.
Adam Smith Institute26 Discusses benefits of an independent process to assess
competing DCO applications for the Heathrow Airport
expansion, with a view to the potential benefits provided
by terminal competition.
Compass Lexecon27
Commissioned by Arora
Reviews evidence on whether separate ownership and
operation of a new Heathrow Terminal 6 might be
beneficial. Concludes benefits of competition are likely to outweigh any disadvantages caused by the need to
coordinate operations between terminals and between
terminals and the runways.
Walbrook Economics28 Finds that terminal competition will improve efficiency,
increase choice and drive down prices.
Frontier (2018)29
Commissioned by HAL
Focus on the operational difficulties of separate terminal
operation. The conclusions of this report appear at odds
with Frontier’s previous 2008 report on behalf of easyJet
Source: AlixPartners literature review.
The Arora Group’s plans for Heathrow West
The Arora Group (which already manages hotel and business facilities at Heathrow Airport and is
one of the most significant land owners on the site marked for expansion30) has published
separate plans – Heathrow West – for development and operation of the additional terminal
capacity required to meet passenger demand following the building of the third runway at
Heathrow. Heathrow West intends to submit these in an application for an alternative DCO in
respect of the passenger terminal capacity.
2.2 Purpose of this report
Passenger terminal capacity at Heathrow would need to be expanded to meet the passenger and
airline demand resulting from expanded runway capacity at Heathrow. We have been
commissioned by Heathrow West to consider the cost and benefits of introducing competition in
25 CC, ‘Introducing terminal competition at BAA’s UK airports’, Appendix 10.11 to main report ‘BAA airports
market investigation’, 2009. 26 Matthew Lesh, Adam Smith Institute, ‘Ready for takeoff – building competition in the aviation industry’,
available here: https://www.adamsmith.org/research/ready-for-takeoff (accessed 9 July 2019). 27 Compass Lexecon, ‘The potential for competition between Heathrow terminals’, May 2017. 28 Walbrook Economics, ‘‘You can go to any airport terminal you like so long as it is grey’ But why?’, 11th July
2019. 29 Frontier Economics, ‘Economic regulation of terminal expansion’, December 2018 (“Frontier (2018)”). 30 Heathrow West, Stage 1: Main Consultation Document, April 2019, page 12. Available here: http://heathrow-
westconsultation.consultationonline.co.uk/wp-
content/uploads/sites/78/2019/04/Heathrow_W_MAIN_Stg1_FULL_Spreads.pdf.
Terminal Competition at Heathrow Airport
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terminal provision at Heathrow and to conclude on the implications for design, construction and
operation of terminal capacity to meet this demand. Specifically, this report looks at the effect of
competition on the incentives of HAL and those of alternative designers and independent operators
such as Heathrow West, to work in the airline and passenger interests. Finally, the report deals
with complications that may result from the separation between airfield and terminal operator,
and the presence of multiple terminal operators at the airfield.
In doing so, the report draws on the experience of many global major airports, where development
and operation of passenger terminals is carried out by a separate entity to development and
operation of the runway and airport.
Although not directly in the scope of this report, it also comments on options for the regulatory
mechanisms that would need to be put in place to enable competition between terminal operators,
and consequentially any positive or negative impacts on consumer interest.
2.3 Structure of this report
The remainder of this report is structured as follows:
● Chapter 3 provides a more detailed description of the expansion plans put forward by HAL and
Heathrow West;
● Chapter 4 describes how competition between terminal operators for airlines could operate;
● Chapter 5 weighs up the costs and benefits of competition between terminal operators;
● Chapter 6 concludes.
● Appendix A1 considers options for a regulatory framework that would enable competition;
● Appendix A2 discusses case studies of structural separation between terminal and airfield
operations;
3 Alternative terminal expansion proposals
3.1 Introduction
This chapter describes and contrasts the plans of HAL and Heathrow West to build the additional
terminal capacity required to meet the annual 130-135 mppa expected from the more than
740,000 ATMs allowed annually in a three runway Heathrow Airport. We show critical differences
between the plans – particularly the timing of release of new capacity - that are important for
understanding the outcomes of competition at the proposal development and operation stages.
First, however, we discuss the passenger forecasts that provide the basis for this expansion.
3.2 Passenger forecasts for Heathrow
Since the Airport Commission (“AC”) published its final report, passenger demand at Heathrow
has grown significantly above the levels forecast by the AC for the existing 2 runway airport. The
Department for Transport’s (“DfT”) updated forecasts that informed the ANPS, as well as the AC’s
forecasts are shown in Figure 3 below. Whilst one may view the DfT growth rates to be optimistic
(particularly in relation to the large increase in passenger demand as soon as the capacity
Terminal Competition at Heathrow Airport
17
becomes available), the forecasts suggest scope for significant increase in passenger demand
once a new runway is in operation.
Figure 3: DfT and AC forecasts of passenger demand at Heathrow with NW runway
Source: DfT, Updated Appraisal Report: Airport Capacity in the South East, October 2017, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/653879
/updated-appraisal-report-airport-capacity-in-the-south-east.pdf.
The DfT explains:
“Under the LHR Northwest Runway scheme, Heathrow airport is expected to be full by 2028,
compared to 2035 in the AC’s assessment of need, carbon traded forecasts. This assumes
no phasing of additional capacity, and no barriers to airlines making use of this capacity as
soon as it becomes available.”31
The DfT clearly expects any available capacity at Heathrow, through terminal and slot availability,
to be filled quickly, up to the available runway capacity. This view is echoed by independent
analysis conducted by OAG on the potential use of new slots created by a third runway at
Heathrow:
“In our cautious assessment of the opportunities, we project that over half of the new
capacity could be used within two years from opening, if not faster allowing for existing
carrier expansion. For such a large capacity increase to be absorbed so quickly it highlights
the case for new runway capacity in London and the South East.” 32
HAL’s own forecasts for the purposes of the DCO show a slower rate of growth, although it is
notable that HAL assumes that the current 480,000 ATM cap is lifted prior to opening of the third
runway – see Table 2.
31 DfT, Updated Appraisal Report: Airport Capacity in the South East, October 2017, para 2.19,
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/653879
/updated-appraisal-report-airport-capacity-in-the-south-east.pdf. 32 OAG, The Heathrow Forecast: Growth, Expansion and New Markets, August 2018, pp.19,
https://www.oag.com/the-heathrow-forecast.
Terminal Competition at Heathrow Airport
18
Table 2: HAL’s “Assessment Case” forecasts, compared to the DfT
Source: HAL, Future Runway Operations, June 2019, Table B1, https://aec.heathrowconsultation.com/wp-
content/uploads/sites/5/2019/06/Future-Runway-Operations.pdf.
HAL’s forecasts appear to lag those of the DfT because of an additional constraint imposed by the
phased opening of the new terminal capacity (outlined in Section 3.3). HAL estimates that, under
its own plans, at the time of runway opening terminal capacity would be only 105 mppa with
additional terminal capacity delivered on a phased basis from 2028 onwards. HAL also raises a
concern about the environmental impact of faster passenger growth and describe their approach
as “environmentally managed growth”. According to HAL, it identifies the environmental criteria
within the ANPS (particularly noise) and expresses these as limits which the growth of Heathrow
cannot exceed. This, according to HAL, ensures that expansion always remains within the
environmental limits set by the ANPS.33
3.3 HAL’s plans for terminal expansion
HAL’s plans for additional terminal capacity, as described in its June 2019 consultation,34 are
spread over four phases. Figure 4 below summarises these.
33 HAL, Future Runway Operations, June 2019, Table B2, https://aec.heathrowconsultation.com/wp-
content/uploads/sites/5/2019/06/Future-Runway-Operations.pdf. 34 See https://aec.heathrowconsultation.com/plans/.
Terminal Competition at Heathrow Airport
19
Figure 4: Overview of HAL expansion plans
Source: AlixPartners illustration based on HAL June 2019 consultation.
It is anticipated that these developments would provide the required terminal capacity for 130-
135 mppa. However, terminal capacity would trail runway capacity until at least 2050.
Figure 5 illustrates HAL’s plan for an expanded Heathrow sometime after 2050.
Figure 5: HAL’s Heathrow expansion plan after 2050
Source: HAL, Airport Expansion Consultation, https://aec.heathrowconsultation.com/topics/airfield/.
Terminal Competition at Heathrow Airport
20
3.4 Heathrow West’s plans
Heathrow West takes it as given that HAL’s plans for the north west runway and other necessary
and consequential investments in the airfield would take place, and that they would be
implemented by HAL itself. Heathrow West’s plans deal solely with the development of the
necessary passenger terminal capacity required to enable Heathrow expansion. This includes
associated aprons and taxiways required by aircraft for access to the new terminal buildings.
At the time of writing Heathrow West’s plans are less developed than those of Heathrow, having
reached Stage 1 Consultation in April 2019. This presented four options for the provision of over
40 mppa of passenger terminal capacity. In three of these options, capacity is provided by a single
terminal development with satellites, to the west of T5. This would double the capacity already
provided by T5 in the western campus of the airport. In all options it is important that the
relationship between T5 and T6 allows full interworking from the perspective of airlines (e.g.
transfer passengers and baggage).35 Figure 6 summarises Heathrow West’s four options for
consultation.
Figure 6: Heathrow West’s options for expansion of Heathrow terminal capacity
Source: Heathrow West, Stage 1: Man Consultation Document, April 2019, http://heathrow-westconsultation.consultationonline.co.uk/wp-
content/uploads/sites/78/2019/04/Heathrow_W_MAIN_Stg1_FULL_Spreads.pdf.
For the purposes of this report we assume that Heathrow West plans a single terminal
development (T6) with satellite terminals directly to the west of T5, with a common check-in
concourse with T5. We assume the plan has the capability of delivering a full additional 40 mppa
35 See, for example, IAG submission on “Arora Group Consultation on Initial Plans for Heathrow West”, paragraph
2.1.5.
Terminal Competition at Heathrow Airport
21
by 2032 with the first phase being ready by 2026. We also assume that this plan can meet the
environmental requirements of the ANPS.36
In addition to the development of a new terminal, Heathrow West’s plans include proposals to
change existing roads, upgrade public transport infrastructure, realign rivers, manage the
ecological impact, and build other facilities such as car parking and other ancillary facilities.37
3.5 Comparison of the two plans
The main differences between the two competing passenger terminal expansion are in respect to:
(a) Scope of alterations to existing terminal capacity:
(i) Heathrow West plans a single new terminal site to the west of T5 (T6). The
Heathrow West plan, therefore, aims to limit construction to only one terminal
site. It expects that this would require less land than HAL’s plans38 and result in
lower costs and reduced interference with the operation of the rest of the airport
during construction. Once operational it will allow better connectivity for transfer
passengers within the whole T5/T6 western campus, simpler interfacing between
T5 and T6 and lower costs;
(ii) HAL’s plans involve two new sites (T5X and T5XN) – with the consequential need
to bus passengers between the two sites (or invest in a track transit system
currently not included in the costs), incremental building at an existing site (T2A),
demolition (T3), and two new satellites (T2C and T2D). T3 demolition and
development of T2A, T2C and T2D occurs in the centre of the operational airfield;
(b) Timing of capacity development:
(i) Heathrow West’s plans, concentrated on one site, have the potential to expand
terminal capacity by up to 40 mppa in time for the increase in runway capacity.
This plan provides for terminal capacity to be provided earlier than under HAL’s
plans, which increases the scope for stimulating terminal competition as discussed
in Section 4.5;
(ii) HAL’s plans, which involve incremental build, would see terminal capacity trail
runway capacity until at least 2050 under the DfT passenger forecast.
Figure 7 and Figure 8 below illustrate the timing of passenger terminal capacity expansion under
the two proposals and compares them against the DfT and AC demand forecasts. As mentioned
above, Heathrow West (Figure 7) plans to expand terminal capacity through a one-off project that
would increase capacity by 40 mppa (with a first phase completed by 2026).
HAL’s plans, on the other hand, foresee a gradual release of terminal capacity until 2050.39, Under
HAL plans (Figure 8) there is a pattern of capacity exhausted in roughly a year of each new
36 Including carbon footprint, air quality, noise and biodiversity. 37 Heathrow West, Stage 1: Main Consultation Document, April 2019, page 22. Available here: http://heathrow-
westconsultation.consultationonline.co.uk/wp-
content/uploads/sites/78/2019/04/Heathrow_W_MAIN_Stg1_FULL_Spreads.pdf. 38 Heathrow West, Stage 1: Main Consultation Document, April 2019, page 26. Available here: http://heathrow-
westconsultation.consultationonline.co.uk/wp-
content/uploads/sites/78/2019/04/Heathrow_W_MAIN_Stg1_FULL_Spreads.pdf. 39 See Figure 4 above.
Terminal Competition at Heathrow Airport
22
tranche of terminal capacity being opened. Terminal capacity will trail runway capacity and
demand (as forecasted by DfT and AC) until at least 2050 if HAL were to go ahead with its plans.
Figure 7: Comparison of Heathrow West expansion plans and demand forecasts
Source: DfT, AC, Heathrow West.
Figure 8: HAL expansion plans
Source: AlixPartners assessment based on historic CAA data, AC and DfT forecasts.
Table 3 summarises the “end-point” capacity that would be available at Heathrow under the
schemes proposed by HAL and Heathrow West. In the case of HAL, this end-point would not be
reached until sometime after 2050. Under the Heathrow West plan the additional terminal capacity
is all concentrated in one single development site to the west of T5. HAL would be free to develop
the eastern campus of the airport (T2 and T3) and T4 and T5 as it sees fit.
Terminal Competition at Heathrow Airport
23
Table 3: Comparison of capacity expansion plans
Existing HAL
(mppa/year)
HAL with
redevelopment
of central
campus
(mppa/year)
HAL with
redevelopment
of central campus +
Heathrow West
(mppa/year)
HAL without
redevelopment
of central campus +
Heathrow West
(mppa/year)
T2 20 52 52 25
T3 20 - - 20
T4 10 10 10 10
T5 33 40 40 40
HAL: T5X & T5XN
Heathrow West: T6
40 40 40
Total 83 142 142 135
Source: based on Heathrow West & HAL plans (https://aec.heathrowconsultation.com/topics/airfield).
In Section 4.2 we discuss how allowing two competing plans to go forward for DCO application
would introduce competition in airport expansion design.
3.6 Coordination between Heathrow West and HAL
In Chapter 5 we discuss the potential costs and benefits of terminal operator competition brought
by independent operation of Heathrow West’s T6. As we explain, the new operator would likely
bring innovation in passenger and airline service, as well as a different approach to commercial
pricing and contracts with airlines.
At this stage, we only note that Heathrow West’s T6 would need to work in close cooperation with
the rest of Heathrow, and particularly with T5. There are possible scenarios (Example scenario 1
and 2 in Chapter 4) in which one airline group would operate from both T5 and T6, and so efficient
handling of transfer passengers between the two terminals would be important and, once
established, mutually beneficial to both operators.40 This would include full sharing of flight and
gating information so that connecting passengers are kept informed to the same extent as if the
terminals were jointly operated. This should not present any additional difficulties because flight
information is already shared between the multiple independent operators that already work at
Heathrow.
It is also possible that T5 and T6 would share some elements of a common infrastructure. This
will include a common check-in area. They may also share a common baggage system - this would
be subject to subsequent negotiations and agreement between the two operators.
40 In Section A1.3.3 we do consider the possibility that initially one operator may consider it advantageous to its
own interests to degrade transfer passenger service to minimise loss of airlines to the competing terminal.
Analogous situations arise in other regulated sectors and are generally addressed through operator licence
obligations.
Terminal Competition at Heathrow Airport
24
4 Competitive scenarios
4.1 Introduction
In this chapter we provide an overview of how competition may work in the provision of terminal
capacity at Heathrow, before we look at the costs and benefits to airlines and passengers in later
chapters.
Competition between HAL and an alternative party could be introduced at different stages of the
expansion process. We are considering the scenario where an independent company (Heathrow
West) proposes to design, finance, build and operate a new terminal. This is illustrated in Figure
9 below.
Figure 9: Instances of terminal competition
Source: AlixPartners.
Competition can take place during the selection phase, where alternative providers must put
forward their plans. Full competition can continue after the selection process, in operation of the
terminals, if there is separate ownership (other than HAL). If ownership of the new terminal
remains with HAL, the possibility for competition is limited to the option of franchising out the
operation of the terminal under a competitive tender (for example the five-year contract for
management of Riyadh Airport’s Terminal 5 awarded to DAA International, discussed in Appendix
A2). In this case the extent of competition will be limited by the terms of the franchise that may
restrict the breath of competitive activities in which the franchisee may engage.41
The resulting competition can affect incentives and outcomes at the four stages of the expansion
process:
41 There will be an incentive on the airport owner to restrict the extent to which the franchisee can compete with
the existing terminals.
Terminal Competition at Heathrow Airport
25
(a) design of the new terminal capacity;
(b) financing of the new terminal capacity;
(c) building of the new terminal capacity; and
(d) operation of the new terminal capacity.
In this Chapter we aim to provide an overview of how competition could work at each of these
levels. In Chapter 5 we look more closely at the benefits and costs of each of these levels of
competition.
4.2 Competition in terminal design
Competition in design could be introduced at the developer selection stage. Such an approach is
being pioneered by Ofgem through the current regulatory review of RIIO-2, described by Ofgem
as ‘Early Competition’:
“Early Competition can be described as competition run prior to the project design process
to reveal the best idea to meet a system need, and could reveal non-network (and
flexibility) solutions. We identified two high level approaches to early competition, the first
is where the competition for ideas and delivery are separated into two stages; the second
is where one competition process is run for both idea and delivery.” 42
Figure 10, reproduced from Ofgem’s RIIO methodology consultation, shows the stages that Ofgem
believe can potentially be open to competition.
Figure 10: Ofgem’s description of typical project process
Source: Ofgem, ‘Consultation: RIIO2 Specific Methodology’, 18 December 2018, Figure 5.
In the accompanying text Ofgem state:
“We consider that early competitions could produce benefits for consumers by revealing
new or innovative ways of solving network problems …” 43
In the subsequent May 2019 decision on RIIO-2 methodology Ofgem confirmed its decision to:
42 Ofgem,’RIIO-2 Decision: Sector Specific Methodology – Core document’, 24 May 2019, para 10.104. 43 Ofgem, Op. cit., para 8.72.
Terminal Competition at Heathrow Airport
26
‘Ensure RIIO-2 is capable of delivering some form of early competition, and require network
companies to identify projects which are potentially suitable for such competition.’ 44
Ofgem’s criteria for projects to which early competition may be appropriate are as follows:
“Network companies will be required to identify projects which have a value of over £50m
and which are contestable (that is, there is the potential for alternative solutions) as being
possibly suitable for early competition.” 45
While of course the Ofgem criteria relate to energy infrastructure, the focus on larger projects for
which alternative solutions may be developed is consistent with the Heathrow terminal expansion
context.
The previous Chapter compared and contrasted plans by HAL and Heathrow West, indicating
significant differences in approach. Comparative evaluation of these plans is beyond the scope of
this report, but the fact that two distinct plans have been made shows the scope for competition
in terminal design.
It is worth noting that HAL has already adjusted its cost estimate from £16.5 to £14.0 billion in
December 2017. The CAA commented:
“The process for airport and airline engagement has allowed airlines to influence HAL’s
overall scheme design so that it is fit for purpose (including properly protecting consumers),
efficient and affordable. Our reports to date have shown that the process of airport-airline
engagement at Heathrow has had significant advantages for consumers, with airlines being
able to input into the process for overall scheme design and make clear their priorities and
share their expertise. HAL has responded positively by reducing the baseline costs of its
draft design by £2.5 billion compared to its submissions to the Airports Commission.
Nonetheless, this engagement process has revealed that much remains to be done to secure
the delivery of capacity expansion in a way that is in the interests of consumers, is
affordable and financeable.” (emphasis added)46
While it is not clear that the costs referred to in the preceding passage relate to a comparable
scope for the expansion, it does tend to indicate a broader concern regarding the overall costs
associated with HAL’s expansion plans. It would be expected that an increase in the competitive
process associated with the development of competing plans for terminal expansion would help
to promote efficiency and affordability.
Clearly both plans cannot proceed to construction, and so the appropriate forum for the
“competition” to take place is either (i) during the DCO planning enquiry stage; or (ii) by some
government or appointed body post planning inquiry in the event that both plans are approved.
Either way, competition in design would occur.
Competition in design can happen in two broad ways:
● competition in design functionality: what airline and passenger requirements will be met
by the design, and what levels of service can be expected?
44 Ofgem,’RIIO-2 Decision: Sector Specific Methodology – Core document’, 24 May 2019, pp. 89. 45 Ofgem, Op. Cit., para 10.110. 46 CAA, ‘Economic regulation of capacity expansion at Heathrow: policy update and consultation’ CAP 1658,
April 2018, para. 7.
Terminal Competition at Heathrow Airport
27
● competition in design cost efficiency: for any given functionality, what are the resource
costs?
The possibility of competition in design for new terminal capacity at Heathrow – both functionality
and cost efficiency – is demonstrated by the respective plans put forward by Heathrow West and
HAL. We discuss the potential benefits of this type of competition in Chapter 5.
Finally, we note that competition would not be limited to the terminal as such. Other elements of
the design process, such as the integration of the new terminal with existing transport links,
engagement with communities, management of environmental impacts would be affected by the
competitive pressure. Competition could not only lead to a better terminal as such – it could also
yield alternative, innovative and more cost efficient and sustainable ideas regarding the wider
expansion process.
4.3 Competition in financing
Recent regulatory initiatives have led to various financing models being developed for specific
projects in the regulated water and energy sectors. In the case of Thames Tideway Tunnel (“TTT”)
and Offshore Transmission Operators (“OFTO”) the government or regulator has invited
alternative providers to bid to finance terminal expansion once the design and core build
contractors have been agreed. The experience of TTT demonstrates that different forms of
financing solutions may be developed, although this does not in itself demonstrate that
maintaining competition in project delivery may yield substantial financing benefits.47
A similar process could in principle be developed for funding of new terminal capacity at Heathrow.
However, there may be additional complexities from the likelihood of post-design changes to the
specification flowing from the needs of the market (e.g. changes to the forecast mix of narrow
body vs. wide body planes). Furthermore, any competitive funding tender would need to ensure
that all participants competed for the same revenue stream. Since Heathrow currently receives
revenues in respect of assets in the course of construction (“AICC”), the same arrangements
would need to be put in place for any winner of the funding contest. Furthermore, it would be
important to ensure that the incremental financing costs associated with competing terminal
capacity are considered, rather than comparing one case in which costs are averaged out over
both new and existing capacity against another project which consists of incremental new
capacity. In view of these complications, and since the benefits of this type of arrangement are
unclear in the case of Heathrow Airport expansion, we do not consider this further in this report.
Alternatively, however, competition in funding would be implicit if both developers were required
to commit either to a fixed price or revenue cap for the first years of operation (which seems
unlikely given the risk and possibility of scope change), or more likely a contract where the risk
of overspend is shared between the developer and any future Regulatory Asset Base (“RAB”). For
the latter, either the developers could submit the WACC they would be prepared to accept as part
of the bidding process, or the regulator could state a WACC that would apply during the
development period (or beyond) in any future RAB-based regulation.
47 Oxera, ‘The Thames Tideway Tunnel: returns underwater?’, September 2015,
https://www.oxera.com/agenda/the-thames-tideway-tunnel-returns-underwater/.
Terminal Competition at Heathrow Airport
28
4.4 Competition in build
Before the start of the construction stage one of the parties would have been selected to provide
the expansion capacity. There would thus be no competition between the parties as such. Further,
either of the potential providers would outsource the actual construction work to a third party.
However, the choice of the provider at the selection stage may affect the outcomes during the
build stage. This is because the incentives to manage the construction process in the interest of
airlines and passengers and to minimise cost overruns, may not be the same for HAL and an
independent provider. We explore these issues in Section 5.3.3.
4.5 Competition in terminal operation: available capacity
Supposing that an alternative provider has been selected to provide the terminal expansion, it
would compete with HAL to attract airlines and passengers. This competition would be in two
phases:
● In the expansion phase: the new terminal operator would aim to acquire business from new
entrants and/or established airlines who want to expand their presence at Heathrow as quickly
as possible. The operator could further try to convince established network carriers to switch
from existing HAL terminals to the new independently operated T6;
● In the runway constrained phase: Airlines may switch between terminals once the enlarged
runway capacity at Heathrow has been exhausted. As we discuss below, this may require
terminal operators to carry a margin of spare capacity to facilitate this switching.
4.5.1 Expansion phase
The forecasts made by DfT, and independently by OAG, show that demand for the new capacity
at Heathrow is expected to be strong and likely to match runway capacity within a few years of
opening. Nevertheless, as noted in Section 3.3, it appears that HAL plans to release terminal
capacity gradually over a period of 24 years after the opening of the new runway.48 This would
limit the amount of spare capacity at any point in time, or even lead to excess demand for terminal
capacity. This is in stark contrast to Heathrow West’s plans, which foresee the potential release
of large blocks of terminal capacity at an earlier stage, allowing a competitive market to develop
between terminals.
In general, we expect that terminal competition would incentivise operators to bring capacity on
stream more quickly to gain revenues and market share (i.e. competing to win business from HAL
where total terminal capacity exceeds total demand). This appear particularly likely if the new
operator does not benefit from RAB remuneration of assets in the course of construction (AICC).
Therefore, we would expect strong competitive pressure from the newly built terminal during the
expansion phase. We also note that – if one were to believe that HAL’s passenger forecasts were
correct – this expansion phase would last for 24 years (until 2050), i.e. competition between
terminal operators could be strong for a prolonged period of time, and be front loaded (in the
sense of being strongest in the earlier years) giving greater weight in a discounted value
calculation.
We note that these outcomes are in stark contrast with a scenario in which HAL is selected for
the expansion without going through a competitive process. HAL does benefit from AICC and, in
the absence of competition, has less incentive to build excess capacity since there would be no
48 See Figure 4.
Terminal Competition at Heathrow Airport
29
gain from cannibalising traffic from its existing terminals. We discuss the implications of these
incentives for passengers and airlines further in Chapter 5.
4.5.2 Runway constrained phase
Although a three runway Heathrow Airport will be constrained by annual ATMs of somewhere
above 740,000 per annum, there is no hard constraint on the number of passengers. Terminals
would be able to adopt commercial strategies that encourage airlines to deploy larger aircrafts
and supply the stand capability and terminal capacity for them to do so. The constraint on
passenger numbers is thus softer. We anticipate that independent terminals would have additional
incentives to encourage a greater passenger throughput in this way, even once the runways are
capacity constrained.
Ultimately, however, the runway capacity will place a break on passenger numbers. This raises
the question as to whether competition between terminals would continue to be effective – a
question that turns on the availability of a margin of spare capacity at the terminals.
We find that independently competing terminals may, in aggregate, build an additional margin of
terminal capacity above that which is available through the runway, to allow them to compete to
gain a higher share of available passengers. Operators would trade-off the risk of carrying unused
capacity against the opportunity of additional passenger revenues should they be successful in
gaining market share. In the case of Heathrow West, it may make commercial sense to build a
margin of excess capacity since the incremental cost of including extra capacity during the T6
construction phase may be relatively small compared to the cost of retrofitting incremental
capacity at the later stage. The additional capacity could then be used to compete for a greater
share of Heathrow’s overall passenger demand. Clearly terminal capacity plans would in any event
be subject to airline consultation to waylay any concerns over inefficient spare capacity.
Whether the resulting excess capacity would suffice for competition to be effective once the ATM
restriction has been met is difficult to predict. We can use a stylised model to estimate the margin
of spare capacity required for competition between terminals for airlines to be effective. This has
similarities to an approach adopted by Frontier (2008).49 For the purposes of illustration only, we
assume that a new terminal operator, who invests a fixed amount of capital into a new terminal,
would expect a return on investment equal to the post-tax WACC in the mid-range derived by
PwC on behalf of the CAA for the prospective H7 price control, i.e. 3.4%.50 We further assume
that the annual operating costs of the new terminal is 5% of the capital investment.51 The new
terminal operator would expect (either under regulation or non-regulation) to receive revenues
to cover the annualised cost of this investment (including the cost of capital) and its opex.
49 Frontier (2008), paragraphs 11-21. 50 PwC quotes a vanilla WACC range of 2.5-3.4%. Adjusting to a pre-tax range gives 2.8-3.9%. PwC, ‘Estimating
the cost of capital for H7 - Response to stakeholder views: A report prepared for the Civil Aviation Authority
(CAA)’, February 2019. Changes to rules to revenues recoverable in respect to AICC may alter this assumption.
We note further that the incremental cost of financing a new project may vary from the average cost of
financing an existing asset. 51 We note that in the Heathrow (SP) Ltd 2018 Regulatory Accounts, 2018 opex is £1,130m and the 2018 mid-
year RAB (Regulatory Asset Base) £15,994m, giving an opex/investment ratio of 7%. This is likely a blending
of the relatively new T2 and T5, and the older T3 and T4. We expect that in a new efficiently designed terminal
opex would be lower.
https://www.heathrow.com/file_source/Company/Static/PDF/Investorcentre/Heathrow-(SP)-Limited-
Regulated-31-December-2018.pdf.
Terminal Competition at Heathrow Airport
30
The stylised model assesses whether the new terminal operator could profitably reduce its prices
by an assumed 5%-10% to attract airlines.52 To be profitable, the price reduction from the
competitive level (the level at which revenues cover opex and capex) would need to attract
enough airlines to grow passenger volumes as to offset the price reduction on existing business.53
This depends on the amount of spare capacity the new terminal has available and whether the
price reduction would suffice to incentivise airlines to fill this capacity.
For example, if a terminal had no spare capacity, a price reduction would be unprofitable because
the terminal would lose revenue on existing business and would be unable to attract more
airlines.54 If the terminal had 10% spare capacity, and a 5% price reduction allowed it to fill this
gap, the price reduction may be profitable. Whether this is the case depends on the terminal’s
operational margin – this can be calculated based on the assumptions above – and the cost
increase resulting from increased usage – this depends on the share of opex that is variable. If
the cost increase resulting from the increase in usage is relatively small (i.e. if a small share of
operational costs is variable), the price decrease will be profitable. If, on the other hand, the cost
increase is relatively large, or if a 5% price reduction does not suffice to fill the capacity, then the
price reduction may not be profitable.
In Figure 11 we show the results of this calculation for a range of assumptions on the proportion
of opex that is variable (0-100%) and the price reduction that is required to fill this capacity (5%
and 10%).
Figure 11: Spare capacity required to facilitate competition in stylised model
Source: AlixPartners modelling.
52 Although this assumption of a 5%-10% price reduction is ultimately arbitrary, it does correspond to the price
change (in absolute terms) typically considered in competition economics for the purpose of considering
market definition, e.g. in the SSNIP (small but significant non-transitory increase in price) test. 53 Algebraically, the trade-off between price and volume can be written as: cost*(1+spare)*(1-p) = cost +
spare*v*opex where “cost” is the annualised cost of the terminal including opex, “p” is the price reduction,
“spare” is the percentage of spare capacity available, “v” is the percentage of opex that is variable and “opex”
is opex. Rearranging gives: spare = p*cost/((1-p)*cost – v*opex). 54 We note that if a terminal wanted to attract certain types or airlines (e.g. those with those with a steady load
profile), the price reduction may still be profitable. This simple model abstracts from this possibility.
Terminal Competition at Heathrow Airport
31
Figure 11 shows that in a reasonable assumption range where 40-60% of opex is variable,55 and
where a price reduction of 5-10% is required to induce a greater number of airlines to switch to
the new terminal, a spare capacity margin of 7-16% would be required.
In the model we assume that the terminal operator must reduce its price to all airlines (i.e. that
it has no scope at all to price discriminate). If, instead, the terminal operator could charge different
prices to different airlines (e.g. a lower price to new airlines, or existing airlines that expand by
launching new routes), the terminal operator would need a smaller margin of excess capacity to
profitably attract airlines.56 HAL itself offers discounts on domestic routes.57
This analysis suggests that a capacity margin of no more than 16% (and possibly considerably
less) would suffice to enable price competition between Heathrow West and HAL. Whilst this would
not be sufficient to accommodate a move by a major alliance it would allow Heathrow West to
compete against HAL for a smaller grouping or non-aligned carriers.
Even in the absence of spare capacity, competing terminals would be attempting to position
themselves as the preferred location for the most ‘valuable’ airlines, i.e. those airlines that are
able to deliver:
● a steady load profile of passengers throughout the day or year;
● a high ratio of passengers per flight to ensure efficient use of gate and stand infrastructure;
● quick and efficient plane turn to further ensure efficient use of gate and stand infrastructure;
● a high level of retail spending per passenger.
Even in the absence of spare capacity, terminal operators would thus compete for inter-terminal
airline moves that would be to their advantage – even to the extent of providing incentives for
less valuable airlines to vacate to create space for more valuable airlines.
4.6 Competition in terminal operation: example scenarios
Although we cannot at this stage forecast the airlines or routes that would use each of Heathrow’s
terminals, it is useful to outline a range of plausible scenarios. This is because the regulatory
structure, the strength of inter-terminal competition, and the nature and magnitude of costs and
benefits of terminal competition, will likely be inter-related at least to some extent. Our analysis
55 The most variable component of opex is likely to be staff costs, since this includes security and terminal
assistance staff which is likely to be directly proportional. This is likely to be around half of total costs, and so
a range of 40-60% is appropriate. 56 The EC Airport Charges Directive (2009/12/EC) states ‘Member States shall ensure that airport charges do
not discriminate among airport users, in accordance with Community law. This does not prevent the
modulation of airport charges for issues of public and general interest, including environmental issues. The criteria used for such a modulation shall be relevant, objective and transparent.’ (Article 3). It is common
practise for airports to offer discounts to new airlines or to existing airlines launching new routes (see for
example http://www.toulouse.aeroport.fr/sites/default/files/contrib/societe/lasociete/tarifs/redevances_a-2018-en_ok.pdf, see pp.9, or
https://media.brusselsairport.be/bruweb/default/0001/23/5af91f3fb34251deebcfa562282ea5e94b776878.p
df, pp.11). These are not regarded as being discriminatory. 57 See https://mediacentre.heathrow.com/pressrelease/details/81/Corporate-operational-24/9088 (visited
30/8/19).
Terminal Competition at Heathrow Airport
32
covers what we consider to be a selection of possible scenarios of market development post
Heathrow-expansion.58
As part of the AC process, SEO Economic Research was commissioned to look at scenarios for
airline responses to expanded capacity at Heathrow (and Gatwick). In respect of Heathrow
expansion, the consultants developed two broad airline responses:59
● Hub carrier growth at Heathrow, point-to-point growth at Gatwick: The hub carrier and
partners benefit from additional capacity at London Heathrow as it enables operation of a more
efficient, fully developed wave-system for coordinating arrivals and departures at the airport,
maximising opportunities for transfer between flights. A significant share of Oneworld carrier
operations currently operated from Gatwick moves to Heathrow.
● Point-to-point growth at Heathrow and Gatwick, Heathrow remains the network hub:
Additional capacity at Heathrow is primarily taken up by point-to-point carriers. Low cost
carriers (LCC) and point-to-point carriers gain market share at the expense of Oneworld
carriers, both at Gatwick and Heathrow.
These scenarios represent extreme positions. In practice, there is likely a spectrum of scenarios,
which depend crucially on how much capacity IAG/Oneworld would take up in the expanded
western campus of the airport.
The starting point for our more detailed example scenario analysis below is that the competition
to design and build the terminal has taken place, and that Heathrow West has been selected to
operate the new terminal – T6. A common assumption we make across all example scenarios is
that Heathrow West (T6) would compete to secure an “anchor” carrier or alliance. This could be
IAG/Oneworld, Star Alliance, Virgin/Delta, or a new entrant such as easyJet (e.g. as a premium
base, complementary to its other existing London bases). We note that easyJet has already
announced its interest in setting up a Heathrow base.60 Other LCCs may also see an operation at
Heathrow as being complementary to their bases at other South East England airports.
Based on this we present four example scenarios which, while not forecasts or predictions of what
airlines will use which terminals, represent a range of possible outcomes from competition
between Heathrow West (T6) and the remaining HAL terminals. These are shown in Figure 12.
58 The CC (Competition Commission), now the CMA (Competition and Markets Authority), and the CAA have
concluded that Heathrow is a distinct market. This means that we need to look at scenarios for the whole of
Heathrow; but assuming the CC and CMA are correct in determining Heathrow to be a distinct market we do
not necessarily need to extend our scenarios to the whole of the London catchment area. In practice, of
course, other airports in London could compete against the Heathrow terminals especially if the extended
Heathrow capacity was attractive to low cost carriers (LCC), and so whilst our scenarios do not explicitly
describe the wider London catchment area, our analysis takes account of possibly larger market effects where
these are relevant. 59 SEO Economic Research, Market Response to Airport Capacity Expansion: Additional estimates airline
Responses, April 2015,
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/439171
/stategic-fit-market-response-to-airport-capacity-expansion-additional-estimates-airline-responses.pdf. 60 https://www.heathrowexpansion.com/other-news/easyjet-expanded-heathrow-would-lead-to-lower-fares-
and-new-uk-and-european-routes/.
Terminal Competition at Heathrow Airport
33
Figure 12: Illustrative example scenarios for airline distribution across terminals
Source: AlixPartners.
Example scenario 1: IAG with its Oneworld partners takes all the capacity of T6
(whilst still retaining all its capacity in T5). IAG and Oneworld secures a commercial deal
with Heathrow West in which they take all capacity. Whether this is likely depends on the
willingness and ability of IAG to secure sufficient slots to fill both T5 and T6 capacity (see
Section 4.7).
Example scenario 2: IAG with its Oneworld partners takes a proportion of capacity
in T6 (whilst still retaining all its capacity in T5), leaving a shortfall that Heathrow
West seeks to fill with other airlines. In this scenario Heathrow West (T6) would want to
ensure that as much of its capacity is filled as quickly as possible, bearing in mind that total
terminal capacity for the airport could exceed runway capacity. It is likely that it would initially
have a proportion of space capacity that could be offered to non-aligned airlines at other
terminals, or an airline not currently at Heathrow (such as easyJet). Heathrow West (T6) would
effectively be competing against all HAL’s other terminals to fill capacity, and against other
South East England airports to attract new airlines. This scenario would apply in the event that
either IAG and Oneworld demand fell below that 80 mppa capacity of T5 and T6, or IAG failed
to secure enough new slots.
Example Scenarios 1 or 2 appear to be consistent with what is currently envisaged by IAG.61
Example scenario 3: Star Alliance or Virgin/Delta moves into T6 competes, taking a
proportion of the capacity, but still leaving a shortfall that Heathrow West seeks to
fill with other airlines. As in Scenario 2, Heathrow West would seek to fill the spare capacity,
and could offer attractive terms to easyJet, Virgin and Delta, and other non-aligned carriers.
61 IAG submission on “Arora Group Consultation on Initial Plans for Heathrow West”, paragraph 1.4.5.
Terminal Competition at Heathrow Airport
34
Example scenario 4: No anchor carrier in T6. In this scenario there is likely to be extensive
spare capacity in T6, which Heathrow West would seek to fill by offering good terms to potential
new entrants at Heathrow Airport (such as easyJet) and/or to non-aligned origin-destination
(OD) carriers.
Effective terminal competition can feature in all these scenarios.
Independently of the scenario, Heathrow West would need to compete with HAL to attract airlines
during the expansion phase. In view of the sunk costs that an airline or airline network may incur
in establishing a new base in T6 it appears likely that long term contracts would feature in any
commercial agreements between the airlines and the terminal operator. In all example scenarios
1 to 4, competition would occur between terminal operators to secure long term contracts, in
which the operator may agree to modify the terminal to the needs to the airline. Depending on
airline business models and how far in advance of the opening of the terminal the contract was
agreed, these modifications could be extensive. However, it should be noted that extensive inter-
terminal airline moves have occurred in the past at Heathrow – such as the openings of T5 and
the new T2, and at other airports such as the swaps between BA, Virgin and easyJet at Gatwick.
These moves occurred without the discipline of terminal competition to ensure a smooth switching
process.
As explored in Section 4.5.2 above, competition could continue to be effective in the runway
constrained phase. The nature and extent of competition would vary by scenario depending on
the rate of passenger growth, the excess capacity, the type of airline entry that occurs, etc. Even
if short-term competition for airlines was less effective in this later phase (due to lack of
opportunities to switch), we expect that long-term contracts – which would be negotiated during
the competitive expansion phase – as well as the buyer power of large alliances such as IAG would
impose sufficient competitive constraints on the operators.
4.7 Slots
The three runway Heathrow would have an increased capacity from 480,000 to at least 740,000
ATMs annually. We understand that that current slot guidelines, implemented independently by
ACL, allocate runway slots to airlines with reference to a particular terminal.62 Since all terminals
would be accessed from all runways this would not be problematic.
The regime for slot allocation would have an impact on the likelihood of each scenario. Currently
slots are regulated by EC Regulation 95/93 amended by Regulation 793/2004. These lay down
rules on the allocation of any new slot capacity at an airport, ensuring that half of any new slots
are offered first to “new entrants”, before being made available for allocation in the slot pool to
existing airlines at the airport. However, these existing rules, particularly the definition of a “new
entrant” within the rules, do not seem designed to deal with a large number of new slots (circa.
350 daily slot pairs will be added with Heathrow expansion) should be allocated.
Whilst (at the time of writing) the UK’s exit from the EU could mean changes to the slot allocation
regime,63 it seems likely that any replacement regime would seek to preserve competition
between airlines at an airport. Since IAG already has over half of the available slots at Heathrow,
62 Frontier (2018), pp.37. 63 The DfT is currently reviewing the UK’s slot allocation regime (see CMA advise to the DfT -
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/767230
/cma-advice-on-impacts-of-airport-slots.pdf, visited 30/8/19).
Terminal Competition at Heathrow Airport
35
it may not be granted more than half of the slots available from any expansion – thus making our
Example scenario 1 less likely.
5 Costs and benefits of terminal competition
5.1 Introduction
We believe that the introduction of competition at Heathrow Airport, by changing the incentives
of terminal operators, has the potential of generating substantial benefits for airlines and
passengers, as well as the UK economy as a whole. These potential benefits must be weighed
against any potential costs, such as the risk of coordination failure and the need for a change in
the regulatory framework. This Chapter aims to do exactly this.
We note that we are not the first to consider the potential costs and benefits of terminal
competition. As mentioned in Chapter 2, Frontier, in its report prepared for easyJet in 2008 as
part of the BAA airports market investigation, expressed the view that the introduction of terminal
competition at Stansted airport would be beneficial and feasible.64 While the Competition
Commission eventually opted for other remedies, it concluded at the time that “significant benefits
could be derived from introducing terminal competition, particularly at airports that are under
weak competitive constraints from other airports, either because of their isolated geographical
position or because of some other unique characteristic which confers substantial market power
on them.”65 The possibility that the CAA could manage a tender for the building and operation of
Terminal 6 at Heathrow was explicitly considered in its final report.66
A more recent contribution by Andrew Lesh from the Adam Smith Institute calls for CAA to
consider the costs and benefits of terminal competition.67 The report emphasises the potential
benefits of competition in the design and construction phases, noting that HAL has already lowered
the expected cost of its plan since Heathrow West’s plans became public. Further, the author
stresses that competition at the operational stage leaves more room for innovation, could ensure
that facilities are provided in an efficient way and limit the need for price controls. He concludes
by noting that the benefits of competition must should weighed up against potential losses in
coordination efficiencies resulting from joint ownership. A report by Walbrook Economics68 is
similarly optimistic about the potential upside of terminal competition.
The more recent contribution by Frontier (2018) commissioned by HAL is more sceptical about
the potential benefits of competition and puts more emphasis on potential costs.
We start our own assessment of the costs and benefits of competition with a brief overview of the
current regulatory framework and discuss its implication for HAL’s incentives. We then set out
how competition between rival operators could generate costs and benefits at various stages of
the process (design, finance, build, operate). This is broadly in line with the structure of the more
recent Frontier report.69
64 Frontier (2008), paragraphs 11-21. 65 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, paragraph 10.348. 66 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, paragraph 10.351. 67 Matthew Lesh, Adam Smith Institute, ‘Ready for takeoff – building competition in the aviation industry’,
available here: https://www.adamsmith.org/research/ready-for-takeoff (accessed 9 July 2019). 68 Walbrook Economics, ‘‘You can go to any airport terminal you like so long as it is grey’ But why?’, 11th July
2019. 69 Frontier (2018).
Terminal Competition at Heathrow Airport
36
5.2 Problems with HAL’s current regulatory framework
The CC, when investigating BAA in 2009, looked at the issue of competing terminal ownership at
Stanstead (in part due to possibility of building a new terminal at the airport). Whilst not pursuing
this at the time the CC did conclude:
“However, we recognize that terminal competition has the potential to benefit airlines and
customers in the future and are of the view that it should be considered as part of the DfT’s
reform of the regulatory regime to allow scope for such an option to be pursued in future.”70
There is strong reason to believe that such benefits would also apply at Heathrow Airport. The
principal reason is that the current reliance on RAB-based regulation pricing, and regulatory-
determined service quality levels, fails to give the best value to passengers and airlines. This is
implicitly acknowledged by the CAA in proposing to add a new licence condition on HAL to promote
efficiency in the operation of the airport.71
HAL’s current regulatory framework may encourage (if not properly addressed) problematic
outcomes:
● over-investment in the quality of investment due to RAB regulation (sometimes referred to as
“gold-plating”);
● service levels that, for some metrics, may be higher than those optimally required by
consumers;
● a lack of incentive in general cost control (both opex and capex).72
Gold plating
The incentive for over-investment stems from the principal that all efficiently incurred investment
is remunerated at the weighted average cost of capital (WACC) determined by the regulator.
Although there is nothing wrong with this principle, there are two problems in its practical
application.
Information asymmetries mean that it is difficult for a regulator to make a case that capital
expenditure was not efficiently incurred especially for an airport such as Heathrow with few (or
no) true benchmark comparators.73 Indeed, to date write-downs to HAL’s RAB required by the
CAA for inefficiently incurred capex have been minimal as a percentage of total investment. For
example, in the most recent regulatory review of HAL (Q6) the CAA disallowed only £30 million
of investment due to inefficiency, and a further £35 million pending further review of over-running
70 CC, Appendix 10.11, “Introducing terminal competition at BAA’s airports”, para. 63,
https://webarchive.nationalarchives.gov.uk/20140402212103/http:/www.competition-
commission.org.uk/assets/competitioncommission/docs/pdf/non-
inquiry/rep_pub/reports/2009/fulltext/545_10_11.pdf 71 CAA, ‘Economic regulation of Heathrow Airport Limited from January 2020: notice of proposed licence
modifications’ CAP 1825, August 2019, see Chapter 2. Available at
http://publicapps.caa.co.uk/docs/33/CAP1825%20iH7.pdf (visited 31/8/19). 72 Such concerns are also highlighted in the first Frontier report (see Frontier (2008), paragraphs 48-75). 73 As pointed out by Frontier, the absence of suitable benchmarks is particularly severe in the airport sector.
This is because airports vary in design, may have been constructed for different purposes and with different
functionalities, and are often state operated. See Frontier (2008), paragraph 59.
Terminal Competition at Heathrow Airport
37
expenditure on the T3IB (T3 Integrated Baggage facility).74 In respect of this last amount the CAA
commented:
“The CC's opinion in its final report on the Phoenix Natural Gas price control review in 2012
was that such adjustments [for inefficient capital spend] should take place in exceptional
circumstances only.” 75
Even if the total write-down for inefficient expenditure (£65 million) was upheld, this was still less
than 1.5% of capex over the previous regulatory period.
Concerns about information asymmetries are supported by a report prepared by Cambridge
Economic Policy Associates (“CEPA”) for the CAA.76 For example, CEPA found that it was unable
to assess whether the process of opex capitalisation was robust and concluded that “it is not
possible […] to assess (based on the data provided) to what extent HAL’s capitalisation approach
is appropriate in regulatory terms”.77
It is also concerning that the CAA is proposing to allow Heathrow to pass through to the RAB
(subject to the efficiently incurred test) £2,838m of Category C Heathrow expansion costs at an
earlier stage than was previously envisaged (i.e. prior to the DCO) – more than a four-fold
increase from the previous figure of £672m.78 It appears that in the existing regulatory framework
the incentives on HAL to accurately forecast, budget and control costs is limited.
In respect to the WACC, although significant amounts of consultancy and regulatory effort is
expended in getting to the “correct” cost of capital for investors in the company, the persistent
downward trends in consecutive regulator periods suggest that at any one point in time there has
been a margin of benefit to investors through regulatory lag. This would incentivise them to
pursue RAB growth for its own sake.79
Figure 13 shows the pre-tax return that HAL has made on its RAB, compared to its allowed return
forecast at the time the regulatory settlement was made, and the average regulated WACC over
the current Q6 regulatory period. HAL has consistently exceeded its regulated return – both in
individual years and over the period as a whole by an average of 80 basis points.
74 CAA, ‘Economic regulation at Heathrow from April 2014: Notice granting the licence’, Appendices C and H,
February 2014, http://publicapps.caa.co.uk/docs/33/CAP1151.pdf. 75 CAA, Op. Cit., para. C69. 76 CEPA, ‘Review of Operating Expenditure of Heathrow Airport’, 22 March 2017. 77 Ibid., page 36. 78 CAA, ‘Economic regulation of capacity expansion at Heathrow airport: consultation on early costs and
regulatory timetable’, CAP 1819’, July 2019, Figure 5, and paragraph 2.44. Figures at 2017 prices. 79 Real pre-tax HAL WACCs: 7.75% (Q4), 6.2% (Q5), 5.35% (Q6), and 2.8-3.9% (proposed for “as is” H7 –
calculated from PwC, ‘Estimating the cost of capital for H7 - Response to stakeholder views’, February 2019,
https://www.caa.co.uk/uploadedFiles/CAA/Content/Accordion/Standard_Content/Commercial/Airports/Files/
PwC%20-%20H7%20Initial%20WACC%20response%20document.pdf).
Terminal Competition at Heathrow Airport
38
Figure 13: HAL’s actual vs. regulated return on RAB (pre-tax)
Source: HAL Regulatory Accounts.
Service levels
RAB based regulation requires additional intervention by regulators to maintain service levels, as
airports could otherwise cut costs by reducing outputs. This is problematic in so far as regulators
cannot determine the optimal level of service, i.e. the level at which the cost of increasing service
quality further exceeds consumers’ willingness to pay for such improvements. In practice, this
can translate into service levels that are higher than optimal.
The prescription of uniform service levels by a regulator is also inefficient as customers (airlines
and passengers) may have heterogeneous preferences. Not all airlines (or the passengers of those
airlines) may be willing to pay for provision of air bridges, free Wi-Fi, or guaranteed departure
lounge seating availability. However, as the CAA must prescribe these obligations in a uniform
way, there is limited room for customisation.
Opex and capex cost control
The current regulatory regime does provide an incentive for HAL to reduce opex costs over the
settlement period. However, as cost savings are reflected in future determinations, there are
reduced incentives to cut costs, particularly towards the end of the settlement period. This reduces
the incentives of HAL to engage in drastic costs cutting measures.
Similar concerns arise in respect to capex since HAL can add capex expenditure to its RAB –
provided that the CAA cannot show that investments were done in an inefficient way.
As we show in the following sections, a competitive tender for the right to build T6, as well as
ongoing competition between terminal operators would help to alleviate these concerns.
5.3 Cost and benefits of competition
As discussed in Section 4, some of these costs and benefits (at the design and financing stages)
could be realised through the simple implementation of a competitive selection process – even if
Terminal Competition at Heathrow Airport
39
HAL ultimately won the concession. Other benefits (at the build and operation stages) could only
be realised if an independent operator won the contract.
5.3.1 Competition in design
While there is currently no official tender process, HAL and Heathrow West already compete – to
some extent – on the design of the terminal. There could be further benefit as design competition
leads to greater transparency of proposals and costs between promoters. We note that HAL’s
most recent total capital cost estimate for opening the new runway in 2026 will be in the region
of £14 billion, with a total expansion capital cost of around £32.5 billion up to 2050 (in 2014
prices).80 However, at present no detail as to broad scope of these costs is available.
This competition could be further intensified in the future if an appropriate tender mechanism was
put in place to select the most suitable operator. The question is whether such competition is
likely to result in a design that provides greater benefits for airlines and passengers, as is the
belief of IAG:
‘By having an alternative developer, such as the Arora Group, this presents a significant
opportunity to improve the overall scheme, benefitting consumers and the competitiveness
of UK compared to other aviation hubs.’81
In principle, competition in the design of a new terminal can generate two types of benefits:
(a) Competition could result in a terminal design with functionalities that better meets the
needs of airlines and passenger;
(b) Competition could result in a terminal design that provides these functionalities in a more
efficient way.
We discuss these issues in the following sub-sections.
Competition in design functionality
Any terminal operator that wants to attract traffic needs to ensure that its design meets the
requirements of current and future customers. As emphasised by Frontier82, these requirements
may differ between airlines – it is not possible to satisfy the need of all interested airlines at the
same time. LCCs are likely to have different preferences than full-service airlines, and hub airlines
require different functionalities than point-to-point operators, etc.
Frontier argues that HAL has an incentive to design a “one size fits all” terminal that can
accommodate different requirements to maximise the option value of the facilities. This is because
the current slot allocation rules require that half of new slots would be reserved for new entrants,
who may not be network carriers. According to Frontier, any independent terminal operator would
be in a similar position as HAL – it would also need to strike the right balance between a “one size
80 CAA, ‘Economic regulation of capacity expansion at Heathrow airport: consultation on early costs and
regulatory timetable’, CAP 1819’, July 2019, paragraph 9. 81 IAG submission on “Arora Group Consultation on Initial Plans for Heathrow West”, paragraph 1.2.2. 82 Frontier (2018), page 16-18.
Terminal Competition at Heathrow Airport
40
fits all” and a more specialised design.83 Frontier argues that there are no reasons to believe that
such an independent operator would be better placed at striking this balance.
We agree that any developer would wish to retain some flexibility in relation to how new terminal
capacity may be used as the aviation industry evolves over time. However, as noted above, HAL’s
regulatory framework likely leads it to propose solutions that are excessively flexible (i.e. solutions
that can accommodate the needs of network carriers and LCCs) and thus excessively costly. For
example, HAL would have less incentive to design (part of ) a terminal that is suitable only for
LCCs. This is because of the impact this would have on the RAB, and because it may consider that
demand will exceed ATM capacity in any case, such that it would have no need to try to win LCCs
from other airports.
An independent operator whose prices are not regulated under a RAB-based regime, or who had
a prospect of not being regulated under a RAB-based regime, would face different incentives. The
operators could weigh the savings of a no-frills solution against the revenue implications and the
risk of stranded assets. Provided that the operator was sufficiently confident to attract LCCs, it
could build parts of the airport to attract such companies based on a discounted charging
structure.
It follows that an independent terminal operator would have better aligned incentives for design
functionality to allow flexibility in terms of the airlines that could occupy the terminal, without
over-specifying simply for the sake of maximising the RAB.
Further, we do not agree with Frontier’s concerns that an independent operator would result in a
design that would compromise the status of Heathrow as a hub airport. Indeed, IAG - the UK’s
major network airline – supports competition in scheme design:
‘IAG believes that having alternate plans for delivery is also likely to improve the quality of
the masterplan, as competition is likely to generate innovation, as it is in the interest of
each developer to show that their masterplan can deliver a better overall solution for
stakeholders such as passengers.’84
Appearing before the Transport Select Committee inquiring into the ANPS, Willie Walsh (CEO of
IAG) said:
‘Arora has a very credible alternative... He has more experience than probably anybody,
including Heathrow, of building facilities at Heathrow airport. He does so in a commercial
fashion and he builds very good facilities. I have absolutely no doubt that he does it at a
fraction of the cost of Heathrow. There is strong merit in looking at that. He is very credible,
but the issue should not be restricted to one person. The CAA should have the power to
force it and the NPS should allow it.
I would not specifically say that it should be Arora or Heathrow. What Arora has done is
very credible. He deserves credit, because even the idea of somebody proposing an
83 Frontier also discusses the likely implications that an airline-owned model may have on terminal design. It is
argued that the airline would likely design a terminal that focuses too much on its owns needs to the detriment
of others. We do not discuss these issues as there are currently no proposals for such a model. 84 IAG submission on “Arora Group Consultation on Initial Plans for Heathrow West”, paragraph 1.2.4.
Terminal Competition at Heathrow Airport
41
alternative has forced Heathrow to look at cheaper delivery. As soon as that is removed,
Heathrow will breathe a big sigh of relief. We have to facilitate that competition.’85
There are factors to consider here. First, hub operations of airlines are typically concentrated in a
single terminal. Following expansion in line with Heathrow West’s current plans, there would be
sufficient space for IAG/Oneworld, Star Alliance or any other network grouping to run its
operations from a single terminal. Second, an independent operator has every incentive to design
a terminal that is well integrated with the rest of the airport. A terminal that is poorly connected
with the rest of the airport and does not allow for efficient passenger transfers would be
unattractive for airlines, and thus risk undermining the operator’s ability to generate revenues.
The concerns raised by Frontier are thus unwarranted.
Competition in design efficiency
Independently of whether a “one size fits all” or a more specialised design is chosen, there remains
a question regarding the “how”. Functionality requirements can be met using an efficient or less
efficient design. The more recent Frontier report does not deal with this aspect of the design
process. We believe that this is a significant oversight.
Competition at the design stage can play an important disciplinary role. It forces companies to
adopt cost efficient solutions and alleviates the shortcomings of the current regulatory
mechanism. To understand why, one needs to understand the different incentives faced by HAL
under the current regulatory framework and those of HAL and independent operators in a
competitive setting.
HAL, under the current regulatory regime, has an incentive to maximize the value of its RAB post
investment. As explained by Frontier in its earlier report, “[where] a regulated company can
capitalise within its Regulatory Asset Base (RAB) all investment that it carries out then it may
have a strong incentive to over-invest in both quantity and quality terms, relative to the level that
best benefits its customers.”86 Such incentives are partially contained by regulatory intervention
– the CAA uses consultations and benchmarking to determine efficient levels of investment.
However, due to information asymmetries these mechanisms are imperfect. The Frontier report
goes on to state that the problems of regulation are particularly severe in the airport sector, as
“[a]irport designs, particularly terminal designs, vary so enormously that it is difficult to establish
useful benchmarks regarding how much these assets should cost.”87
This means that HAL’s incentives may not be well-aligned with those of its airline customers or
passengers. It needs to make sure that it meets the customers’ minimum requirements to ensure
demand, but it has considerable latitude to exceed (inefficiently) those minimum requirements or
to implement them in an inefficient manner. These concerns are shared by airlines such as IAG,
which already criticised the current HAL proposal as being too expensive.88
If it faced competitive pressures, HAL would likely have stronger incentives to more closely and
innovatively align the specifications of the terminal so that they meet the needs of users now and
in the future, and then ensure that the design efficiently meets those specifications, rather than
85 Transport Committee Oral evidence: Airports National Policy Statement, HC 548, Tuesday 20 February
2018, http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/transport-
committee/airports-national-policy-statement/oral/79002.pdf (visited on 30/8/19). 86 Frontier (2008), paragraph 48. 87 Frontier (2008), paragraph 59. 88 IAG website, ‘IAG Response To Department For Transport Statement On Heathrow Expansion’ available here:
https://www.iairgroup.com/en/newsroom/press-releases/newsroom-listing/2018/24-05-2018-153807086
(accessed 10 July 2019).
Terminal Competition at Heathrow Airport
42
focusing on providing the facilities that maximized its long-term RAB. A failure to do so could
result in the loss of the concession to build the new terminal. The same is true for any independent
airport operator, such as Heathrow West.
Further, provided that the independent operator is not subject to RAB-based regulation or had
the prospect of not being subject to RAB-based regulation, the incentives to build an efficient
terminal would be further strengthened. The operator would need to design a terminal of sufficient
quality to attract airlines. However, any unnecessary “gold plating” of the terminal would reduce
its profitability. The same is true for the adoption of inefficient solutions for the same specification
or level of quality. Unlike HAL under the current regulatory framework, the independent operator
has every incentive to minimise these costs.
Finally, it is important to note that competition in design would not be limited to the terminal
facilities. As noted in Section 3.4, Heathrow West’s current plans cover other aspects such as the
integration of the airport with existing transport infrastructure and the management of
environmental impacts. Competition between two alternative providers could lead to the
identification of solutions that would otherwise not be considered by HAL. To be competitive,
proposals would need to be environmentally sustainable and limit the impact on the surrounding
communities. The benefits of competition on such parameters could be substantial.
Conclusion
Overall, we find that competition in terminal design could generate substantial benefits for
passengers and airlines. Even if HAL is eventually chosen to build and operate the new terminal
capacity, the competitive process would force it to align its plans more closely with airline
requirements and to cut unnecessary costs.
The costs associated with competition at this stage appear to be relatively limited. The incremental
cost of considering two rather than one DCO application should also be limited in comparison to
the substantial cost savings that could be generated for a project of such scale. Even a cost
reduction of just 1% would translate into savings well in excess of £100m.
5.3.2 Competition in finance
Competition could in theory lead to a lower cost of financing. An independent operator could – in
theory – finance the development of the new terminal with a cost of capital that is below HAL’s
regulated WACC. Alternatively, a contractor may offer a financing package with a higher required
return, but with different risk sharing arrangements and other characteristics that render the
proposal more competitive overall.
Frontier (2018) deals at length with examples from other regulated industries, where competitive
tenders have at first sight reduced financing costs below those of the incumbent.89 The report
then goes on to dismiss these apparent success stories as misleading. Frontier concludes that
they can be explained by (a) different risk allocation and (b) the fact that interest rates – and
thus the cost of financing for new projects – had come down, while the incumbent’s historic WACC
was used for the comparison.
We broadly agree with these conclusions. Whether HAL or a third party finances the project should
not affect the underlying cost of financing. The project characteristics and risk allocation, not the
operator, should determine the cost of financing. Provided that the risk allocation is the same for
89 Frontier (2018), pages 22-31.
Terminal Competition at Heathrow Airport
43
all bidders – HAL and independent operators – then the cost of financing this new asset should
be similar.
That said, there could be risk sharing advantages of splitting the funding over two companies:
HAL for the airfield expansion and central campus terminal works, and Heathrow West for T6. It
is conceivable that this result in a lower overall cost of capital than HAL undertaking all the
financing alone (virtually doubling the size of the HAL RAB). Further, innovation in risk-sharing
mechanisms could lead to arrangements that better align the incentives of the developer with
those of airlines and passengers. The implication of alternative risk sharing arrangements for the
construction process are covered in the following Section.
5.3.3 Competition in build
There are significant differences between the incentives faced by HAL and a potential independent
operator in managing the build phase.
As pointed out by Frontier (2018), HAL does not build its own infrastructure. The work is awarded
to construction companies in competitive tenders.90 Capex triggers in the regulatory framework
are used to incentivise HAL to encourage a timely completion of works. In addition, Frontier
claims, HAL has an incentive to ensure a smooth completion because this minimises disruption
for the airport as whole. Finally, the report claims that HAL may be better placed to coordinate
the work on the shared parts of the infrastructure and thus reduce disruptions at existing
terminals.
The incentives of an independent operator are not discussed explicitly by Frontier (2018). We find
that – depending on the regulatory framework chosen – these may differ substantially from those
of HAL. An independent party may have stronger incentives to complete construction on budget
and on time and may deal with delays or required alterations in a more flexible and efficient way.
There are several reasons why this may be the case:
● An independent operator has a stronger incentive to apply pressure to the contractor to
avoid cost-overruns. In the absence of RAB based regulation, the operator would be unable to
pass additional costs onto customers. HAL, on the other hand, may worry less about cost
overruns – provided it can convince the CAA that there were unavoidable and should thus be
included in the RAB. For example, a large part of the overrun of costs for the T3IB (T3
Integrated Baggage system) was allowed into the RAB.91 Even if RAB-based regulation was
introduced, the independent contractor could be incentivised through more flexible sharing of
construction risk.
● Further, an independent operator may be willing to agree to risk sharing with regards to
total construction costs, sharing part of the construction risk, leading to higher financing costs,
but better incentives to complete construction efficiently. HAL may be less likely to agree to
such an arrangement without competitive pressure from another potential developer.
● An independent terminal builder would have stronger incentives to complete construction on
time than HAL because it can then begin to gain market share at an earlier stage. HAL on
the other hand, in the absence of competitive pressure, would want to minimise risk of excess
capacity and may thus target a longer construction period. This is reflected in the differences
90 Frontier (2018), page 18. 91 See CAA, ‘Economic regulation at Heathrow from April 2014: Notice granting the licence’, Appendices C and
H, February 2014, http://publicapps.caa.co.uk/docs/33/CAP1151.pdf.
Terminal Competition at Heathrow Airport
44
in expansion that we discussed in Section 3.5. While HAL wants to phase expansion over a
period of 24 years, Heathrow West plans to increase capacity at a much earlier stage.
● Further, in a non-RAB-based regulatory regime, an independent operator may not be
immediately remunerated for investment in assets in the course of construction of
the terminal by charging current operators, as HAL is currently. Any delay in the construction
would translate directly into lost revenues. This further strengthens the incentives to put
pressure on contractors.
● Finally, an independent operator would be more flexible in the response to complications that
may arise during a construction process. In the absence of RAB based regulation with
predetermined capex triggers, an operator could balance on-time and cost-efficient delivery.
Revenue implications from delays could be traded off against additional expenditure required
for timely completion. Similarly, the operator could react to changes in airline demand during
the construction phase with greater flexibility, and redesign aspects of the terminal.
These differences in incentives could lead to substantial benefits for airlines and passengers. If
Heathrow West was selected, passenger terminal capacity may increase much faster than
currently envisaged by HAL. This would allow for an increase in passenger numbers at a much
earlier point in time. Further, the risk of cost overruns – or the risk that these are passed on to
customers – may be substantially reduced.
As to Frontier’s other claim – that HAL may be better placed to coordinate work between the
terminal and the shared infrastructure – we note that is inconsistent with Frontier’s own emphasis
on the outsourcing of the construction phase to a third party. Any coordination between this third
party and the rest of the airport should not be affected by the identity of the ultimate owner of
the terminal. The coordination of the terminal and runway design can be addressed in a
consultative process that involves HAL, the independent terminal operator and the selected
construction companies.
5.3.4 Competition in operation
Competition in operation occurs as the new terminal opens, or more precisely as soon as
discussions start with airlines on contracts to take the new terminal capacity. Already at this stage
benefits of competition would have been realised through design, construction and possibly
finance.
Benefits
The case studies of Appendix A2 show in general terms the benefits of competition in operation
across a range of industries, including airports and other previously regulated sectors that have
transited from regulated monopoly to more competitive structures (albeit still with elements of
monopoly bottlenecks within the vertical supply chain).
The benefits arise from the removal of imperfect regulatory structures which previously distorted
the incentives of the monopolies. As noted in Section 5.2, the regulatory framework that applies
to HAL is also imperfect – HAL’s incentives are not always aligned with those of airlines and
passengers. Such concerns have been expressed by HAL’s main customers. For example, Willie
Walsh, chief executive of IAG has said:
“Heathrow is a monopoly with a history of gold-plating facilities and very high airport
charges. Benchmarking its cost proposals against similar schemes is critical and very
Terminal Competition at Heathrow Airport
45
welcome. It is imperative that Heathrow provides a full, detailed cost breakdown for
expansion before Parliament votes on it this summer.
“Introducing competition to build and operate new terminals at the airport could drive costs
down further.”92
At the operation stage, HAL has an incentive to inflate some service levels beyond what would be
optimal for consumers. This relates to the principal of allowing efficient cost recovery, where
“efficiency” is determined by technical cost efficiency rather than allocative economic efficiency.
It is entirely natural that airport management prefers a higher quality airport. The regime of
recovery of technically efficient costs allows this management objective to be pursued beyond a
level that provides incremental value to consumers.
The lack of incentive in general cost control (of both opex and capex) stems from the information
asymmetries and lack of any comparable Heathrow benchmark, that prevent the CAA from
determining an efficient cost base in an entirely satisfactory way.
At HAL’s last full regulatory review for the Q6 period, the CAA studied opex efficiency for the UK’s
major airports.93 This included literature reviews of recent studies (using latest data), including
econometric analyses adjusting for various non-controllable factors, and the CAA’s own analysis
using the most recent data. The CAA concluded:
“Overall the evidence suggests that there is significant scope for cost reductions in opex
per passenger at Heathrow relative to its current position” 94
This discussion suggests that there is a large potential benefit from HAL being exposed to
competitive pressure. Realistically, however, without this being tested by exposing HAL to greater
competitive pressure, we can never know how large this benefit would be. The break-up of BAA
(discussed in Appendix A2) released many benefits by exposing Heathrow to inter-airport
competition from Gatwick and Stansted. Nevertheless, the fact that Heathrow remains the UK’s
only global hub airport with exceptionally good transport links to central London gives it a unique
market position. This is precisely the reason why the CAA determined that Heathrow retains a
dominant market position, protected from the full impact of competition.95
A good indication that terminal competition will yield benefits is provided by the impact on Gatwick
following its exposure to competition after the break-up of BAA. The example is particularly
relevant given the expectation that an expanded Heathrow is likely to compete for some of the
routes that are or could be operated from Gatwick – for example outbound European destinations
and long-haul destinations currently operated by BA and Virgin from Gatwick.96
The CMA concluded:
92 IAG website, ‘IAG Response To Department For Transport Statement On Heathrow Expansion’ available here:
https://www.iairgroup.com/en/newsroom/press-releases/newsroom-listing/2018/24-05-2018-153807086
(accessed 10 July 2019). 93 CAA, “Airport Operating Expenditure Benchmarking Report 2012”, June 2013, CAP 1060,
https://publicapps.caa.co.uk/docs/33/CAP%201060%20Airport%20Operating%20Expenditure%20Benchma
rking%20Report%202012.pdf. 94 CAA, Op. Cit., Para 3.8. 95 CAA, ‘Market power determination in relation to Heathrow Airport – statement of reasons’, 2013,
http://publicapps.caa.co.uk/docs/33/CAP%201133.pdf. 96 A full analysis of this is provided by OAG, “The Heathrow Forecast”, October 2018, Op.cit.
Terminal Competition at Heathrow Airport
46
“Of the divested airports, improvements are most evident at the largest divested airport,
Gatwick, which was the first to be sold and has benefited from the longest period for the
development and implementation of its new commercial strategy. Under separate
ownership Gatwick has been actively competing to attract and retain airlines and routes
and to become a more attractive airport for passengers. Improvements at Gatwick are
reflected in 70 better relationships and operational arrangements with airlines, increased
efficiency, capacity generation, innovation and better service quality. Increased competition
and better performance of Gatwick have also allowed the use of more flexible regulation.”97
Interestingly, since divestment, service performance has improved markedly at both Gatwick and
Heathrow, shown by their respective scores on ACI’s ASQ survey – see Figure 14.
Figure 14: Airport Service Quality performance improvements for HAL (left) and GAL
(right), against average of European competitors
Source: HAL (‘Heathrow (SP) Limited, Results for the 6 months ended 30 June 2019’, 23 July pp.7); GAL
(‘Monthly Performance Report’, June 2019, pp. 23)
More recently, in amending HAL’s licence the CAA has concluded commercial deals, rather than
regulatory settlements, “reflect the potential wider strategic benefits for consumers”,98 including:
● Airlines and airport operators will be able to focus on the challenges of capacity expansion,
rather than issues for establishing detailed price controls;
97 CMA, “BAA airports: Evaluation of the Competition Commission’s 2009 market investigation remedies”, 16
May 2016, see para. 5.5.4,
https://assets.publishing.service.gov.uk/media/57399d43ed915d152d00000b/evaluation_of_baa__market_i
nvestigation_remedies.pdf. 98 CAA, ‘Economic regulation of Heathrow Airport Limited from January 2020: notice of proposed licence
modifications’, CAP 1825, August 2019, paragraph 1.5.
Terminal Competition at Heathrow Airport
47
● facilitating airport operators and airlines to work together to deliver better outcomes for
passengers, for example, reduced prices, improved service quality and the development of
new services;
● the potential for future commercial arrangements relating to capacity expansion to support
traffic growth and the overall affordability and financeability of the capacity development at
Heathrow; and
● better arrangements for managing passenger traffic risks through risk sharing arrangements
between airlines, airport and terminals.
To the extent that independent terminal operators will compete to attract airlines, the above
factors welcomed by the CAA in the interest of passengers would apply even more. A competitor
terminal would provide a yardstick against which airlines could compare the pricing and service
offering terms of HAL to enable better contractual negotiation in a competitive context.
A final point to note is that increased capacity at Heathrow would allow into the airport a greater
number of airlines and a greater diversity of airline model (we have previously noted the interest
expressed by easyJet in developing a base at Heathrow). This would increase competition between
airlines. easyJet itself claims:
“Typically when easyJet enters an airport in competition with legacy airlines it can offer
fares around 30% lower. This is because easyJet’s low cost operating model delivers a cost
per passenger significantly lower than those airlines – and Heathrow would be no
exception.”99
To the extent that terminal competition accentuates this process, competing terminal operators
would encourage increased airline competition, to the benefit of passengers. For example, the
competitive impact that may be associated with easyJet taking up a proportion of the capacity in
Terminal 6 (as described in Example scenarios 2 and 4 of Section 4.6), whilst outside of the scope
of this report, is something that should be borne in mind.
Costs
The more recent report by Frontier (December 2018) provided a comprehensive analysis of the
“practical obstacles” to terminal competition. Primarily these involve the loss of centralisation
benefits and the problem of delineating the parts of the airport infrastructure to enable a third
party to coordinate with the existing system at HAL.
The first point to make in response to Frontier’s concern is that the new terminal operator would
have every incentive to cooperate and coordinate its activities with HAL, since its entire revenue
stream would depend on this. It is true, however, that regulatory safeguards may be necessary
to ensure HAL has an obligation to reciprocate.
Secondly, the necessary level of coordination and delineation is evidently possible, and in many
areas already addressed. Airports already host numerous independent organisations with their
own operations and facilities – border control, ATC, airline staff, baggage handlers, retail
concessionaires, HM Revenue & Customs, the UK Border Agency, public transport operators, etc.
99 https://www.heathrowexpansion.com/other-news/easyjet-expanded-heathrow-would-lead-to-lower-fares-
and-new-uk-and-european-routes/.
Terminal Competition at Heathrow Airport
48
Initiatives such as Airport Collaborative Decision Making (“A-CDM”)100, now implemented at 27
airports across Europe – including Heathrow, make this collaboration, in a cost-efficient manner,
part of business-as-usual. Extending the A-CDM concept to include an independently operated
terminal should be feasible.
It is relevant to note that out of the 75,780 people working within the perimeter of Heathrow
Airport, only 6,421 (8.5%) work for HAL.101 Within this collective of around 400 different
companies102, many organisations already compete – notably airlines and ground handlers. Table
4 illustrates the distribution of 246 or these 400 companies that operate at Heathrow recorded in
the Heathrow Employment Survey.
Table 4: Distribution of companies with employees based at Heathrow
Type of organisation Number Examples
Airlines/airline handling
agents
69 British Airways, Virgin Atlantic, Qatar Airways,
American Airlines, Emirates, Delta, Etihad Airlines, Finnair, Flybe, Iberia, Air France,
Beijing Capital Airlines
Government services 6 Border Force, HM Customers and Excise, HMRC,
Police
Airport operator 1 HAL
Catering & retail 60 Cartier, Ted Baker, Hamleys, Boots, Jack Wills,
Hermes, Zara, Paul Smith, The Harry Potter
Shop, Mulberry, Harrods, Sunglass Hut, MAC, Valentino, Ralph Lauren, WHSmith, Costa,
Starbucks, Carluccio's, Harry Ramsden
Other public passenger
services
9 Omniserv, TfL, National Express
Cargo/freight courier services 8 DNATA, Segro, ASC Cargo
Building and maintenance
contractors
34 MACE, Balfour Beatty
Other 58 NATS (air traffic control), Vanderlande
Industries (baggage systems)
Source: Heathrow Employment Survey 2013 (Ipsos MORI), pp. 18.
In respect of ground handling, only two airlines (BA and United) have their own operation, whilst
all other airlines employ independent ground handlers.
100 A-CDM ‘… aims to improve the efficiency and resilience of airport operations by optimising the use of resources
and improving the predictability of air traffic. It achieves this by encouraging the airport partners (airport
operators, aircraft operators, ground handlers and ATC) and the Network Manager to work more transparently
and collaboratively, exchanging relevant accurate and timely information. It focuses especially on aircraft
turn-round and pre-departure processes. It also allows the exchange of more accurate departure information,
particularly target take-off times, with the European ATFCM network, leading to improved en-route and
sectoral planning.’ https://www.eurocontrol.int/concept/airport-collaborative-decision-making, accessed
22/8/19. 101 Sources: Heathrow Employment Survey 2013 (Ipsos MORI) and Heathrow Airport Holdings Limited, 2013
annual report, page 47 (average of December 2013 and December 2012 HAHL airport employees). 102 HAL, “Responsible Heathrow, 2015 Performance Summary”, page 31. Available here:
https://your.heathrow.com/wp-content/uploads/2018/07/2015-Responsible-Heathrow-Performance-
Report.pdf.
Terminal Competition at Heathrow Airport
49
Table 5: Ground Handlers at Heathrow
Ground handler Market share (by ATMs)
BA 52%
Menzies 22%
Cobalt 9%
DNATA 5%
Azzurra 3%
Swissport 3%
ASC 3%
United 2%
Source: Heathrow Ground Handlers Performance Report, February 2019,
https://www.heathrow.com/file_source/CommunitiesTrust/Static/PDF/February_2019_GHSP.pdf
The shared interests of all parties across all areas of airport operation incentivise cooperation and
coordination (where this does not hinder competition).
Coordination of multiple activities is one of the core tasks of an airfield operator. The addition of
terminal competition should not raise any new coordination costs material enough to undermine
the benefits of competition.
Even under single terminal ownership HAL has struggled at times to coordinate all activities. This
mostly recently came to light during the September 2010 snow storms that closed both runways
with ensuing operational issues across the whole airport. HAL responded to this event by
commissioning one of its independent non-executive directors, Professor David Begg, to lead a
panel of enquiry into how Heathrow could perform better in future. The enquiry concluded:
“Achieving this target [that the airport never closes as a result of circumstances under its
control, except for immediate safety or other emergency threats] will require BAA to lead
a collaborative programme of work and investment with the airlines, NATS and CAA. The
panel recommends that these parties collectively work together to implement improved
snow plans, agree investments in additional equipment and resources, improve and
collaborate more effectively on command and control processes, improve consistency of
passenger communications, and establish approaches to passenger welfare that are focused
on the needs of the passenger.” 103
This should, and in future will, happen regardless of separate terminal ownership, with the HAL
airfield operator rightly taking the lead role in this coordination activity – governed by the
appropriate non-discrimination clauses that will be required in its licence.
Heathrow’s APOC (Airport Operations Centre) was established in 2014 to in part address the issue
of increased coordination and collaboration. According to HAL:
“Multiple stakeholders sit in APOC, including airlines, NATS, Border Force, the Metropolitan
Police and the Highways Agency ensuring that APOC produces results that are best for the
airport as a whole.” 104
103 “Report of the Heathrow Winter Resilience Enquiry”, March 2011, chaired by Professor Begg, para. 9,
https://im.ft-static.com/content/images/89937494-55ed-11e0-8de9-00144feab49a.pdf. 104 https://your.heathrow.com/at-the-heart-of-heathrow-apoc/
Terminal Competition at Heathrow Airport
50
APOC can continue. It already deals with multiple independent operators on the airport (including
NATS, Border Force and the police), and so an independent terminal operator would fit neatly into
this framework. It is not clear to us why Frontier, in its most recent report claims that the
introduction of an external terminal operator would undermine the ability of APOC to play this
role.105 This is particularly surprising given Frontier’s assessment in its first report from 2008
where it stated that “[t]he only difference would be that an additional terminal operator (or
operators) would be involved in coordination arrangements.” 106
Frontier list a variety of other perceived costs or risks that could result from the introduction of a
new terminal operators. None of these appears to be material, as we set out in a summarised
way in Table 6 below.
105 Frontier (2018), page 43. 106 Frontier (2008), paragraph 252.
Terminal Competition at Heathrow Airport
51
Table 6: Frontier’ perceived costs of independent terminal operation
Perceived costs or risks Our assessment
Lack of coordinated governing system: Frontier relies on the disruptions in the UK rail
industry following the timetable changes in
2018 as an example of the dangers of a lack of coordination. The ORR had suggested that the
absence of a single body with oversight and
authority to identify and flag risks contributed
to the disruptions.
ACL would retain responsibility for slot
coordination over both terminal operators.
Inability of APOC to operate: Frontier notes that APOC was established to monitor overall
airport operations to minimise delays. It is
claimed that this would not be possible without
vertical integration of the terminals.
We do not see why APOC could not continue. Essentially it monitors and alerts all relevant
airport stakeholders as issues arise. It already
deals with multiple independent operators on the airport (including NATS, Border Force and
the police), and so an independent terminal
operator would fit neatly into this framework.
Common IT standards: Frontier claims that
the introduction of a third party would create the need for a new interface to allow for inter-
working of the common IT infrastructure.
Frontier acknowledges that this is not unsurmountable but claims that it could create
a vulnerable weak spot.
Interworking of IT infrastructure is routine
between competitive telecoms networks. Although disputes occasionally occur over
commercial issues, at a technical level
common standards are routinely agreed.
Cost duplication. A new operator would
inevitably lead to cost duplication in the head-
office and in terms of infrastructure.
Duplication of head-office costs happens in
industry with multiple firms competing in the
same sector. The duplication is insufficient to create a natural monopoly. Heathrow West’s
plans do not foresee any major duplication of
infrastructure.
Service quality: Frontier notes that HAL
would have no control over service quality at an independent terminal, which could decide to
provide a lower quality service (e.g. a no-frills
terminal).
For reasons provided in Chapter 4 above, we
do not believe that this is a concern. To the contrary, if an independent operator finds that
a lower service quality and thus lower cost
solution is in line with airline and passenger
interest, this should be encouraged.
Stakeholder engagement: HAL would be unable to uphold its commitments to support
sustainable growth, as the third party may not
uphold the same standards.
Heathrow West would need to ensure that it contributed to sustainable growth
commitments for Heathrow as a whole.
Indeed, it would most probably need to make its own individual commitments as part of its
planning approval which would be on a par
with those offered by HAL.
Business development: HAL’s ability to place
partner airlines next to each-other would be
weakened.
Ability to place partner airlines next to each
other would be one of the core non-price attributes over which Heathrow West would
compete with HAL. Competition would only
enhance the likelihood of this happening.
Source: Frontier (2018) and AlixPartners.
A more serious concern with terminal competition than any of these listed in Table 6 is that
competing terminals would give too much weight to airline priorities rather than passengers. The
CAA has tended to have a rebuttable assumption that airlines represent passenger interests.
However, there could be areas of concern, particularly around services provided directly by the
airport to the passenger (e.g. security queues). If this is a concern the CAA could mandate, as it
did at Gatwick Q6 deregulation, that all service standards be maintained.
Terminal Competition at Heathrow Airport
52
Conclusion
Overall it appears likely that the benefits of inter-terminal competition at the operational stage
could lead to substantial benefits for passengers and airlines. As discussed in Sections 4.5 and
4.6 we expect that competition would be effective, at least in the expansion phase where terminal
capacity would exceed demand. The imperfections of the regulatory systems would be replaced
with genuine competition, forcing terminal operators – both the entrant and incumbent – to
become more efficient and to respond to adjust their offerings to meet the requirements of
airlines. Further, the potential for LCC entry into the Heathrow market, which appears less likely
under a scenario where HAL does not have to compete, could lead to increase inter-airline
competition and associated passenger benefits.
There certainly are costs associated with the additional need for cooperation between competing
operators. However, as explained in detail above, these concerns appear to be overstated in the
Frontier’s most recent report. The existence of separately owned and operated terminals around
the world (see Appendix A2) certainly suggests that these potential obstacles are surmountable.
It is this point that led Frontier to pose the following question in 2008: “[Given that these] airports
continue to operate effectively […] we would […] ask CAA why the approach that is operationally
feasible in the US is not feasible in a UK airport?” 107
5.3.5 Effect on regulatory burden
Terminal competition could have both positive and negative effects on the regulatory burden to
both the operators and to the CAA.
Terminal competition would create a new need for regulatory oversight over the accounting
separation between the HAL airfield and the HAL terminals. In Appendix A1 we discuss why,
contrary to what is claimed by Frontier in its December 2018 report, this would not create a
significant workload. In comparison with other sectors such as telecoms, which have much more
complex joint and common cost structures between the bottleneck and competitive components
of the vertical supply chain, the task appears manageable and we believe that the CAA would be
well placed to enforce this.
The obligation on HAL to prepare separate regulatory accounts for the airfield and the terminal
should not raise any significant problems. The separation would result in separate charges to be
levied for runway access and terminal usage.
Furthermore, the complications regarding the definition of boundaries and separation of
responsibilities appear to be over-stated by Frontier. These are issues that are resolved at other
airports with independently operated terminals, where clear demarcations of responsibility are
possible. For example:
● We have already stated that we expect HAL to remain responsible for snow clearance from
the runway, taxiways and aprons; and the provision of emergency fire services.
● Each terminal would be responsible for its own passenger security operations, and
assistance for passengers with reduced mobility. These activities are and can be
outsourced without the loss of any inter-terminal economies of scale.
107 Frontier (2008), paragraph 253.
Terminal Competition at Heathrow Airport
53
● Use of baggage systems would most likely be facilitated by commercial agreement between
the T5 and T6.
The CAA may decide that Heathrow West needs to maintain an actual or shadow RAB and be
subject to a price control. This should not create significant incremental costs to the situation
where HAL would do the same for its own terminal expansion.
On the other hand, terminal competition may allow for a significant reduction in the regulatory
burden with respect to other aspect of the airport operation. Heathrow West as well as HAL’s
terminals could be exempted from full building block RAB regulation – as in the case of Gatwick
Airport. Economic regulation would then concentrate on the much simpler task of regulating the
airfield without terminals. Whether this is feasible would depend on the effectiveness of inter-
terminal competition, as discussed in Chapter 4.
Even if this were not the case and building block regulation was required for both terminal
operators, the CAA would have the benefit of competing Heathrow specific benchmarks for both
terminal operators – particularly for opex and service standards – to greatly improve the quality
of the regulatory decision – to the passenger benefit.
5.4 Summary
We conclude that there are substantial benefits of competition at the various stages in passenger
terminal provision. Competition in terminal design offers the possibility of bringing forward plans
that better suit the needs of passengers, airlines (including LCCs) and other stakeholders such as
the local community. Further, competition by a non-RAB regulated entrant is likely to lead to
terminal design that is more efficient, because it avoids the gold-plating incentives that are
inherent in the current regulatory framework. If an independent operator was chosen, further
benefits will be generated in the construction process. This is because the incentives of an
independent operator differ from those of a regulated HAL, with the incentive to release terminal
capacity at an earlier stage, allowing for competition between operators to take place. This
competition, effective at least during the expansion phase, will generate additional benefits.
Terminals will have to compete to attract airlines by choosing an appropriate trade-off between
costs and service quality – this is a substantial benefit compared to the current system where the
regulator needs to prescribe a one-size-fits all solution. The benefits of competition at the
operations stage will expand beyond operational cost savings and an increased use of commercial
deals between terminal operators and airlines. Entry by airlines with different business models
(i.e. LCCs) could stimulate competition between airlines and thus drive further benefits for
passengers and the UK economy as a whole.
The costs of terminal competition appear to be manageable. The separation between terminal and
airfield operations and the presence of multiple terminal operators in airports across the globe
shows that this is feasible. Concerns raised by Frontier appear to be exaggerated and not in line
with practical operations. The additional regulatory burden – a requirement to impose separate
regulation on the airfield – appears to be limited, and indeed light compared to other regulated
industries. Further, the potential scale-back of terminal regulation, which could be implemented
provided that the CAA finds that competition is effective, must be weighed against these additional
costs.
Overall, we find that the benefits of terminal competition for passengers, airline and other
stakeholders are likely to be substantial. The costs, on the other hand, appear to be manageable
and exaggerated in the Frontier (2018) report.
Terminal Competition at Heathrow Airport
54
6 Conclusion
This report has investigated the benefits of introducing competition into the provision and
operation of capacity expansion at Heathrow. Whilst development, construction and operation of
the third runway is integral to the existing airfield and best carried out by HAL, this report has
focused on the case for competition across all stages of development and operation of passenger
terminal capacity – ultimately to further the interests of passengers and all stakeholders (including
local residents) in the competitive choice of terminal design, development and operation.
Under the existing model all passenger terminal infrastructure at Heathrow is under the ownership
and operation of HAL. Airport charges and service offerings are regulated to provide HAL with an
expected return on all efficiently incurred investment in its RAB. Provided the allowed return is at
least acceptable to shareholders HAL will have a financial incentive to maximise the RAB – a
phenomena known as ‘gold plating’. In the absence of competition HAL has limited incentive to
develop and implement its investment plans in a way that provides the best value for money
either for airlines or ultimately for passengers. Whilst this is a challenge faced in many regulated
infrastructure markets, regulators seek to counteract these effects by introducing competition
where feasible in different parts of the value chain.
In the current framework, there is no opportunity for direct comparison or market testing of HAL’s
expenditure other than the tenders that HAL itself organises for suppliers and contractors to
undertake work to HAL’s own design, and the efficiently incurred expenditure test appears to have
little effect on HAL’s renumeration. Neither is there a strong incentive for HAL to develop its
service offerings in a way that best meets the needs of passengers and airlines that could take-
up the new capacity at Heathrow - be they low cost or full-service carriers, and point-to-point or
network operators.
Case studies from around the world show that:
(a) independent operation of passenger terminals is common, and consistent ensuring that all
airport operators – airfield, terminals, emergency services, border force, air traffic control,
retail franchises and many others – work together; and
(b) there are strong benefits to passengers from introducing competition in airport services –
from the break-up of the former BAA, to competition in specialised airport services such as
baggage handling.
We find the evidence leads clearly towards the benefits of unlocking choice in design and
competitive forces in the operation of passenger terminals at Heathrow. These benefits include:
(i) Design: competition in the design of terminal capacity will lead to increased
innovation and focus on passenger and airlines interests. This relates not only to the
features and costs of the new terminal capacity, but also in relation to location within
the airport, the plan in relation to how quickly capacity is to be brought onstream, as
well as options relating to associated airport infrastructure and community
engagement.
(ii) Construction: an independent operator, if not tied to HAL’s existing RAB
renumeration model, will have stronger incentives to bring capacity online on time
and on budget.
(iii) Operation: an independent owner of terminal capacity will have increased incentives
to offer commercial deals with an appropriate balance of costs and quality of service,
Terminal Competition at Heathrow Airport
55
in the interests of airlines and passengers. This will apply irrespective of whether
either HAL or the independent terminal operate under a regulated price cap. In either
situation the terminals will have to compete to gain airline share, seeking additional
efficiencies and demand growth opportunities to allow then to price below the cap.
Whilst changes will be required to the economic regulation of the airport, to allow for terminal
competition, we find that these changes will be relatively easy to design, implement and monitor
compliance when compared to more complex situations in other regulated sectors (such as
telecoms). Further, terminal competition will increase the effectiveness of regulation of HAL by
adding a competitive benchmark. It will also offer the possibility of lifting the regulatory burden
on HAL itself from a strict RAB based regulation to looser safeguarding and monitoring regime –
providing HAL with greater flexibility to respond to customer preferences and market trends.
Terminal Competition at Heathrow Airport
56
A1 How the regulatory framework could operate
A1.1 Introduction
In this Appendix we look at the appropriate regulatory structures required to enable terminal
competition. Contrary to what has been suggested by Frontier in its latest report, we consider
that they are unlikely to be onerous or disproportionate compared with the benefits.108
Specification of the regulatory framework is outside of the scope of this report, and so we do not
take a definitive view on terminal regulation. The form of terminal regulation would need to
prevent any adverse effects of market power, based on an assessment of the degree of market
power of the terminal operators.109 Nevertheless, in order to consider the costs and benefits of
terminal competition in this report, it is helpful to briefly outline how a regulatory framework
would allow for competition between terminals.
A1.2 Regulating the new terminal operator
Chapter 4 gives an indication of the range of scenarios in which two competing terminal operators
could work at Heathrow Airport. The scenarios indicate that Heathrow West (T6) would likely need
to compete strongly to fill new capacity, particularly during the expansion phase and potentially
beyond this.
That said, the regulator cannot know the competitive outcome in advance of setting the regulatory
regime or drafting any licence conditions. In addition, the market outcome may evolve according
to the speed at which new capacity is taken up, or the market structure for airlines at Heathrow
changes. This suggests that a relatively flexible regulatory structure may be required that includes
a range of options appropriate to the market outcome. In this Appendix we outline what that
range could be.
The regime should allow the new terminal operator to negotiate commercial arrangements,
possibly including new and innovative terms relating to growth incentives, and fixed and variable
components for leasing capacity over different lengths of time.
To protect the interests of all airlines, including those with less bargaining power in such
negotiations (and so protect competition between airlines at Heathrow), it may be necessary to
include licence backed commitments like those in Gatwick Airport’s licence. Commercial deals
would be monitored by the CAA, with a requirement that the average price must not go above a
regulatory determined “fair price”. In the case of Heathrow West (T6), this fair price could be
based on the regulated price for the HAL terminals, or the stand-alone cost of the Heathrow West
T6.
Finally, in parallel with the above, Heathrow West (T6) could be required to maintain a shadow
Regulatory Asset Base (“RAB”) in the same way that Gatwick is required to do so. This would
allow the CAA to revert to full RAB building block regulation should the market for terminal
capacity turn out to be non-competitive. This regulatory fall-back could be triggered even before
opening of the new terminal if it becomes apparent that Heathrow West (T6) is not constrained
by competition from either HAL or other South East England Airports in setting the price and other
terms and conditions for its terminal facility.
108 Frontier (2018), Op. Cit. Section 5. 109 Such an assessment would need to be done by the CAA and is outside the scope of this report.
Terminal Competition at Heathrow Airport
57
In the circumstance that full RAB-based building block regulation is introduced for both HAL and
the independent terminal operator, the CAA may wish to consider an option of a single regulated
price cap applied across the whole airport. Since RAB based regulation of both terminals would
only happen in a situation where competition between terminals in insufficiently strong, setting a
single regulated price may be advisable so as not to disadvantage airlines based in the higher
cost terminal. However, it would also be important that both terminal operators are able to recover
their efficiently incurred costs – in the same way as RAB regulation works today. This could be
achieved by the following mechanism:
● The separate RABs, cost and commercial revenue stacks, and passenger forecasts of both
terminal operators are aggregated into a single building block calculation, with one single cost
of capital to determine the regulated price cap paid by the airlines across the whole airport.
● True-up payments are made between terminal operators to ensure that each recovers its own
efficiently incurred RAB and costs (net of commercial revenue). The cost of capital would also
need to be adjusted to allow for the risk premium of the new build terminal, using the same
methodology as applied to HAL’s WACC for the risk of building the new runway.
● Under this scheme, assets in course of construction (“AICC”) could continue to enter the
combined RAB – this process is sometimes loosely called “pre-funding”. HAL would be required
to pass-on true-up payments to Heathrow West as soon as Heathrow West started investing
in line with the AICC recovery principle.
If a single regulated price were set across the whole of Heathrow, terminal operators would still
compete on quality of service offered to both airlines and passengers, with scope for competitive
innovation in different methods of service provision.
A range of regulatory options could be considered for access to Heathrow Airport to protect the
interests of all airlines, including those with less bargaining power in such negotiations (and so
protect competition between airlines at Heathrow). For example, this could include licence backed
commitments like those in Gatwick Airport’s licence. Commercial deals could be monitored by the
CAA, with a requirement that the average price must not go above a regulatory determined “fair
price”. In the case of Heathrow West (T6), this fair price could be based on the regulated price
for the HAL terminals, or the stand-alone cost of the Heathrow West T6.
A1.3 Regulating the HAL terminals
A1.3.1 Charge regulation
We anticipate that subject to a detailed market power analysis, the HAL terminals would likely
continue to be price regulated in essentially the same way as now. This may include the runway
access charge being separated as described in Section A1.4.
In the same way as happens now, the CAA would need to assess the appropriate regulation for
HAL terminals based on HAL’s degree of market power and the likelihood that competition will
constrain its pricing. Whilst this market power analysis would take account of Heathrow West’s
impact on HAL’s market power, regulation of HAL and Heathrow West will not necessarily be
symmetrical. Heathrow West will need to price in order to either: (i) attract new airlines to
Heathrow; (ii) attract existing airlines at Heathrow to expand using T6; or (iii) attract existing
Heathrow airlines to switch from other terminals to the new T6, and this may place a competitive
constraint on its pricing. HAL, on the other hand, will benefit from its incumbency position. Airlines
already operating from HAL terminals may require a significant discount from a new terminal
Terminal Competition at Heathrow Airport
58
operator to switch, providing HAL terminals with a degree of market power not possessed by
Heathrow West.
Frontier argues that terminal competition “requires that terminal charges (the charges levied by
the terminals to airlines to recover the cost of the terminal-based infrastructure and services) are
deregulated”. 110 This is not the case in other regulated sectors, such as telecoms and posts where
incumbent providers continue to be regulated as long as they have Significant Market Power
(“SMP”) whilst competing against unregulated competitors. We find that asymmetric regulation
may also be appropriate for terminals at Heathrow. HAL terminals can continue to operate under
a cost-based price cap regulation (to safeguard against any misuse of market power), while
recognising that this is a “cap” and not a fixed level. Should competitive pressure against the
independent terminal drive prices below this level, which may well be the case with additional
cost efficiency savings beyond those predicted in the regulatory settlement, HAL would reduce its
charges to below the cap.
At some point in the future, if it becomes apparent that the independently operated Heathrow
West (T6) is exerting a significant competitive constraint on the pricing of the HAL terminals, HAL
terminal regulation could be relaxed to mirror that of Heathrow West (T6).
We note that the possibility of deregulating terminals was envisaged by the Civil Aviation Act
(2012). The Explanatory Notes to the Act state:
Subsection (7) states that the CAA should have regard to the market(s) in which the
operator has substantial market power (test A) when choosing the airport area that is to
be the subject of a market power determination. The following simple example illustrates
what is meant here. Imagine the CAA concluded that the operator was dominant in the
provision of runways, but not in the provision of passenger terminals. In such circumstances
subsection (7) would not prohibit the CAA from making a market power determination in
relation to an area that included the passenger terminals, but it does mean that the CAA
would need good reasons for doing so.111
A1.3.2 Service quality regulation
Whilst we anticipate that HAL’s price regulation would continue until such as a time as competition
is sufficient to constrain its market power, we also anticipate that the existing service quality
regulation (“SQR”) would continue.
A1.3.3 Transfer passengers
There are scenarios (particularly those where most of IAG/Oneworld’s operation remain in HAL’s
T5112) where HAL may have an incentive to degrade passenger transfer experience between T5
and T6, to preserve as much IAG/Oneworld business as possible. This may require conditions to
be inserted into HAL’s licence (and Heathrow West’s licence if required) to ensure efficient
handling of inter-terminal transfer passengers, including passenger flight information to ease
transfer. Analogous situations arise in other regulated sectors and are generally addressed
through operator licence obligations.
In the case of HAL, compliance could be incentivised by simply extending the existing service
quality incentive scheme metrics (particularly Way Finding, Flight Information and Transfer Search
110 Frontier (2018), pp.34. 111 DfT, ‘Explanatory Notes: Civil Aviation Act (2012)’, para. 60. 112 IAG submission on “Arora Group Consultation on Initial Plans for Heathrow West”, paragraph 1.4.5.
Terminal Competition at Heathrow Airport
59
Time) to cover passengers transferring to or from the independent terminal, therefore impacting
HAL’s bonuses and rebates under the scheme.
Alternatively, the CAA may decide – in line with Test B of the Market Power Test – that competition
law provides sufficient protection against such an abuse by HAL.113
A1.3.4 Baggage systems
Heathrow West would have the option of either:
● building its own baggage handling system, interconnected to allow transfer bags with the T5
system; 114
● coming to a commercial arrangement to use the baggage handling system of HAL’s T5
(essentially dropping bags into the T5 system).
We do not envisage any need for regulatory intervention in this regard since dealings between
Heathrow West and HAL would be covered by commercial agreement, with the fall back of
Heathrow West building its own infrastructure.
A1.4 Airfield regulation
Terminal competition would require separate regulation of the airfield. This would be a bottleneck
facility essential to both terminal operators, as planes from both terminals must be able to land
or take-off from any of the three runways to ensure safe and efficient operation of the airport and
importantly to meet requirements for noise respite. Figure 15 is an overview of the relationship.
Figure 15: Relationship between HAL and Heathrow West in respect of the airfield
Source: AlixPartners.
113 CAA, ‘CAP 1433 - Market power test guidance’, August 2016, available here: https://www.caa.co.uk/CAP1433. 114 The importance of this is shown in the IAG submission on “Arora Group Consultation on Initial Plans for
Heathrow West”, paragraph 1.4.5.
Terminal Competition at Heathrow Airport
60
We anticipate that HAL’s airport charges would be disaggregated into airfield and terminal
components (the practicalities of this are discussed below). Heathrow West would pay the airfield
access charges on behalf of the airlines it hosts and pass the charges onto its airlines. HAL could
offer a bundled charge to the airlines its hosts, provided that the same airfield access component
was visible in its regulatory accounts (as described below).115
Absent regulation, a vertically-integrated HAL may have the ability and incentive to discriminate
against the downstream terminal competitor. Discrimination can be price or non-price based and
allow the vertically-integrated airport to increase its market power across more of the value chain.
This incentive (alongside ability) underpins the use of non-discriminatory access obligations in
other regulated sectors as incumbents are unlikely to be willing to voluntarily provide access on
fair and reasonable terms without a regulatory obligation.
This situation is common in many regulated industries, and the principal tool to remedy price
discrimination is to ensure that access charges to the bottleneck facility (in this case the runway)
is separately regulated with its own RAB, and that the same regulated price is charged to both
terminal operators.
This requires a regulatory accounting regime for HAL that separates the terminal and airfield.
Contrary to what has been suggested by Frontier in its December 2018 report, we find that this
would not be difficult because most assets and activities are wholly attributable to either terminal
operations or the airfield.
In fact, accounting separation of airfield and terminal activities appears to be a much simpler task
than the regulatory dual till allocations that most European airports are already required to do
where the terminals themselves are split between aeronautical and non-aeronautical activities,
including Europe’s largest hub airports.116
It is also much simpler than accounting or functional separations already done by many regulated
companies, as shown in Figure 16 for BT and Openreach. Regulatory accounting between BT and
Openreach needs to meet the challenges that much of the infrastructure of the Openreach access
network and the BT core network is in the same duct and trenches, and so much of the cost is
common to both companies. By contrast HAL’s costs are, too a large part, easily separated
between the airfield and terminals with only a relatively minor overlap of common costs.
115 Alternatively, all airlines could be required to separately purchase airfield access from HAL and then terminal
usage from their own terminal providers. In theory the two methods would have identical outcomes. In both
cases there would be an incentive on HAL to provide inferior access to airlines hosted at the non-HAL terminal,
which would need to be addressed non-discriminatory safeguards discussed in this section. In practise this
alternative may have the advantage of greater transparency but may not be preferred by airlines as it entails
separate transaction or negotiations with HAL and Heathrow West.
116 For example, Aéroports de Paris (ADP), with the cost allocation methodology described in the ‘Economic
Regulation Agreement between the Government and Aéroports de Paris, 2016-2020’, Appendix 8.
Terminal Competition at Heathrow Airport
61
Figure 16: Comparison of regulatory accounting challengers in HAL vs. BT/Openreach
Source: AlixPartners.
HAL has in the past undertaken cost allocation exercises to support its disaggregation of the
regulated airport charge cap to the departing passenger charge, aircraft movement charges,
aircraft parking charges and other regulated charges.117 It is a difficult exercise to allocate costs
between different types of passengers within a terminal (e.g. domestic, short haul and long-haul
OD passengers, and individual transfer flows) but the overall allocation of costs between airfield
operations and passenger terminals is straightforward. In its 2010 Structure of Aeronautical
Charges Consultation, HAL provided a breakdown of its RAB assets. This is reproduced in Table
7.
Table 7: Analysis of HAL’s 2009/10 RAB
Facility Passenger
assets (£m)
Landing assets
(£m)
Parking assets
(£m)
Total (£m)
Terminals 4,377 4,377
Runways &
taxiways
273 273
Stands 180 180
Control tower 72 72
Landside facilities 784 784
Land &
landscaping
122 1,049 49 1,220
Services 274 14 288
Baggage 446 446
Detailed asset
allocation 6,003 1,409 229 7,641
Other 1,048 246 40 1,334
Total 7,050 1,655 268 8,974
Source: HAL, “Structure of Aeronautical Charges Proposals: A Consultation Document”, 2nd August 2010,
Table C1.
Interestingly, Table 7 shows that detailed asset allocations can be made for over 85% of HAL’s
RAB. It is also significant that each asset facility category is predominantly allocated to only one
117 HAL, “Structure of Aeronautical Charges Proposals: A Consultation Document”, 2nd August 2010, Annex C,
https://www.heathrow.com/file_source/Company/Static/PDF/Partnersandsuppliers/Restructure_of_Airport_
Charges-Consultation_Document-2010.pdf.
Terminal Competition at Heathrow Airport
62
of “passenger assets”, “landing assets” and “parking assets”; the main exception being “other”
and “land and landscaping” which is easily allocated in any event. This suggests that cost
allocation between the airfield and terminals is unlikely to be problematic.
Non-price discrimination may also occur and affect the competitive equality of runway access,
particularly priorities in snow clearance to give access to terminal stands. We anticipate, at least
initially, this would be done by HAL. Enforcement via HAL licence conditions should not be onerous,
and indeed already exist in HAL’s license.118. It is worth noting that compared to other regulated
sectors (e.g. telecoms) HAL’s operations are self-contained on one site and, for the most part,
outcomes (e.g. such as plane movements) are visible to all stakeholders.
In the case of aircraft movements between the terminal and runway (including aircraft pushback
from the stand over the apron and into the taxiways), these are controlled by the air traffic
controller (ATC) for the airfield – currently NATS. Whilst the ATC is appointed by HAL in a
competitive tender, the fact that it is an independent organisation would provide reassurance as
to non-discrimination.
In addition to charge control the airfield operation would also be subject to its on SQR (e.g. control
post search, for which it would be responsible).
118 HAL’s licence condition D2.11 states ‘The Licensee shall so far as is reasonably practicable coordinate and
cooperate with all relevant parties at the Airport …’, see
file:///C:/Users/jsandbach/Downloads/Heathrow%20licence%20consolidated%20version%20(1).pdf
(accessed 30/8/19).
Terminal Competition at Heathrow Airport
63
A2 Case studies
A2.1 Introduction
Heathrow West would not be the first non-airport entity to operate a terminal. Structural
separation between airport and terminal operations has been tested at airports around the globe,
including JFK, Riyadh, Atlanta, Newark and Sydney. In this Appendix, we look at the lessons that
can be learned from these cases, and the wider benefit of competition in infrastructure industries.
This experience can then be used to look at the specific case of the costs and benefits of
competitive passenger terminal provision at Heathrow in Chapter 5.
In Section A2.2 we provide an overview of these cases and discuss whether the separation was
successful or caused operational issues.
While there are few examples of genuine competition between terminals, there is ample evidence
on the effect of competition between airports. Section A2.4 looks at the break-up of BAA and
summarises the benefits that competition generated for airlines and passengers. While the
situation is not directly comparable to the scenario under investigation, it allows us to identify the
parameters of competition on which airports – or terminals – may compete.
Finally, Section A2.5 looks at other deregulated sectors where competition has been introduced
at different levels of the value chain. The examples provide some valuable insight into the benefits
that competition can generate. They also shed light on the types of regulatory tools that need to
be deployed to preserve effective competition in industries with vertically integrated incumbents.
A2.2 Separate ownership of airport terminals
Structural separation between airfield and terminal operations is widespread, as we demonstrate
through various examples below. The most common case is that of airline operated terminals – a
form of separation that is particularly common in the US. However, there appear to be few
examples of genuine inter-terminal competition, where independent operators compete to attract
airlines from other terminals within the same airport.
Maybe the most prominent example is John F. Kennedy International Airport (“JFK”). The Port
Authority of New York and New Jersey controls three airports, including JFK.119 The six terminals
at JFK, on the other hand, are operated by other parties – five by airlines and one (Terminal 4)
by a subsidiary of Schiphol Airport.
As all but one terminal is managed by airlines for their own operations, there is only limited
competition between terminals. Indeed, the Port Authority told the UK Competition Commission
during the BAA airports markets investigation that potential competition was not the motivating
factor for the outsourcing of the terminal operations.120 That said, the development of an
independent terminal appears to have generated competition to some extent.
The Competition Commission concluded that the independent terminal generated what it calls
“genuine competition”. Following the completion of the terminal in 2001, 12 smaller airlines
transferred from their previous terminals within the first six years. 121
119 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, Appendix 10.11. 120 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, Appendix 10.11. 121 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, Appendix 10.11.
Terminal Competition at Heathrow Airport
64
The benefits generated by the independent operation were also recognised by other parties.
According to the Transportation Research Board of the National Academies Terminal 4 at JFK was:
“generally recognized in the industry as the preeminent example of nonairline, private
sector participation in terminal development and operation, with benefits having been
realized in increased operating efficiency, enhanced levels of service for passengers and
airlines, and reduced operating costs”122
These benefits identified in the independent development and operation of JFK’s Terminal 4 are
consistent with Heathrow West’s own ambitions. Other terminals are undergoing major
redevelopment by their independent operators, including: a new Terminal 1 due to open in 2023-
25, occupying the current sites of Terminals 1 and 2 and the former Terminal 3 and to be managed
by Munich Airport International;123 a new Terminal 7 combining the existing site with the old site
of Terminal 6; and renovation of Terminal 8.124
To be clear, the introduction of terminal competition at Heathrow airport does not require a
replication of the JFK International structure of six diverse and independently operated terminals.
Rather, these examples show the willingness of independent operators to invest.
Frontier (2018) raises the issue of JFK’s poor performance under the extreme snow conditions of
January 2018, and highlighting a lack of coordination between airlines, terminal operators and
the Port Authority.125 In many ways this is analogous to Heathrow’s experience in the December
2010 snow event that lead to the commissioning of one of BAA’s independent non-executive
directors, Professor David Begg, to lead a panel of enquiry into how Heathrow could perform
better in future. His report concluded that greater coordination was needed between the airport’s
multiple independent parties, including airlines, NATS and the CAA.126 Coordination of different
airport groups in times of extreme meteorological conditions127 is a challenge that all major
airports need to address and plan for, irrespective of whether terminals are independently
operated.
It is also worth noting that the presence of multiple independent terminals did not create any
significant operational complications. The Competition Commission concluded that such
complications appear to be “soluble”.128 HAL would ensure that all airfield related services are
coordinated with both its own terminals and the independently operated terminal, respecting any
regulatory non-discrimination requirements.
Finally, it is of note that independent terminal operation at JFK International does not compromise
cost efficiency. The relative operational efficiency of JFK is shown by figures presented in a study
122 Transportation Research Board of the National Academies, ‘Airport Cooperative Research Program Report 66
– Considering and evaluating privatization’, 2012, page 84. 123 https://www.anewjfk.com/projects/the-new-terminal-one/ and
https://ny.curbed.com/2018/10/4/17937028/jfk-airport-renovation-expansion-nyc-cuomo-renderings
(accessed on 21/8/19). 124 It is worthy of note that Newark Airport has engaged Munich Airport International to operate and maintain its
newly developed Terminal 1 (https://www.munich-airport.com/press-munich-airport-international-expands-
activities-in-the-usa-6940418. Accessed 30/8/19. 125 Frontier (2018), page 39. 126 “Report of the Heathrow Winter Resilience Enquiry”, March 2011, chaired by Professor Begg, para. 9,
https://im.ft-static.com/content/images/89937494-55ed-11e0-8de9-00144feab49a.pdf. 127 And also other disruptive events such as sudden changes in security concerns. 128 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, Appendix 10.11.
Terminal Competition at Heathrow Airport
65
on airport performance by Vasigh et al. (2014). Total expenditure per passenger at JFK in 2010
was just 61% of that at Heathrow.129
There are other examples where separate terminal ownership has been considered. Dublin Airport,
including all terminals, is currently owned and operated by the state-owned Dublin Airport
Authority (“DAA”). However, the incumbent has and is currently being challenged for its monopoly
position. The Irish Government considered introducing competition in 2002130 and is currently
going through a similar thought-process.131
As part of the 2002 consultation, 13 organisations or consortia submitted expressions of interest
for the construction and operation of a second terminal. A report by a panel that reviewed the
proposals132 identified various potential benefits for airlines and passengers resulting from the
development of an independent terminal. It concluded that competition between terminals –
provided that sufficient capacity was available – would give airlines a choice between terminal
operators, leading to various competitive benefits such as improved customer service, best-
practice facilities and increased customer choice (i.e. better matching of facilities and services
with the requirements of differentiated airlines).
The report also dealt with regulatory issues, such as the requirement for operational regulation
to ensure fair access to shared infrastructure and improved cost-transparency to prevent cross-
subsidising by the incumbent. Despite these additional hurdles, which were not deemed to be
insurmountable, the report concluded that an independent terminal would be a viable strategic
option. Concerns about the loss of unified airport control raised by international airport operators
were given little weight, as the panel thought that communication between parties could resolve
this.
While the government eventually decided against the independent terminal in 2005,133 the issue
is back on the table today. A report commissioned by the Irish Department of Transport, Tourism
and Sport (“DTTAS”) concludes that an independent competing terminal would maximise choice
to airlines.134
There are various other examples of terminals that are owned and/or operated by entities other
than the airport. While these are not examples of genuine inter-terminal competition at the
operational stage – terminals were given pre-defined roles (e.g. domestic flights) or are operated
by airlines who may not compete to fill capacity with non-aligned airlines, they allow us to assess
the feasibility of structural separation between airfield and terminal operations and the
coordination between different terminal operators. Further, the examples highlight that
competition at the planning phase can and has been introduced in various cases.
129 Vasigh, B., G. R. Erfani, B. W. Sherman (2014), ‘Airport Performance and Ownership Structure: Evidence from
the United Kingdom, United States, and Latin America’, Journal of Aviation Technology and Engineering 4:1,
page 40–49. 130 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, Appendix 10.11. 131 Global Construction Review, ‘Ireland considers third, private terminal at Dublin Airport, but airport says no’,
29 October 2018. Available here: http://www.globalconstructionreview.com/news/ireland-considers-third-
private-terminal-dublin-ai/ (accessed 8 July 2019). 132 Panel Report to Minister for Transport (Ireland), ‘Dublin Airport – Review of Expressions of Interest for an
Independent Terminal’, February 2003. 133 Citing concerns for separating the charges between terminals, the additional lead time that would be required
for independent development, and the impact on the existing operation and financial structure of the airport. 134 Oxford Economics & CEPA, ‘Review of Future Capacity Needs at Ireland’s State Airports’, August 2018.
Terminal Competition at Heathrow Airport
66
The busiest airport in the world – Hartsfield-Jackson Atlanta International Airport – is owned by
the City of Atlanta and operated by the Department of Aviation.135 The domestic terminal is
operated by the Atlanta Airlines Terminal Corporation, a corporation of airlines.136 The
international terminal, which started operation in 2012, is operated by to TBI Airport Management,
Inc., a global airport operator.137 138
The new domestic Terminal 5 at Saudi Arabia’s King Khaled International Airport in Riyadh will be
managed and operated by DAA International, a subsidiary of DAA. The five-year contract includes
the management of all third-party commercial tenants and car parking within the terminal.139
Other examples are Tokyo Haneda where the domestic terminal building is independently
operated by the Japan Airport Terminal Co., Ltd.140
While not all of the cases noted above have proven to be successful, one can identify specific
reasons (and lessons for how best to implement terminal competition) from these cases:
● Toronto Pearson Airport’s Terminal 3 was designed, built and operated by a privately funded
consortium. The 40-year concession commenced in 1988 with the terminal penning in 1991.
The terminal won international acclaim and awards for its design and innovation and was
completed in time and on budget. The market was segmented, with a compulsory allocation
of full-service international carriers to Terminal 3 (where charges were higher) and LLCs and
regional carriers to the other terminals. Consequently, there was little effective competition
between the terminals. Ownership was returned to the Greater Toronto Airport Authority in
1997, only six years into the original concession term.141
● The Brussels Airport Terminal Company (“BATC”) was created in 1987 to expand and operate
passenger terminal capacity at the airport. The federal government’s Airways Authority held
30.77% of the new company, while the remaining portion was held by institutional and private
investors. The Airways Authority remained responsible for the airfield and provision ATC
services. However, in 1998 the Government decided to create a public entity for ATC
(Belgocontrol), separating it from the airport. As part of this restructuring it also decided to
create a single entity responsible for the airport, integrating BATC.142 The Competition
Commission noted that this may have been due to a misalignment of incentives between the
airfield and terminal operators, which was created by different charging structures.143
135 Hartsfield-Jackson Atlanta International Airport website, ‘About ATL Fact Sheet’, available here:
https://www.atl.com/about-atl/atl-factsheet/ (accessed 8 July 2019). 136 Atlanta Airlines Terminal Corporation website, ‘About us’, available here: http://www.aatc.org/about-
us/#whoweare (accessed 8 July 2019). 137 Airport World, ‘TBI to manage new international terminal at Hartsfield-Jackson’, 11 May 2012, available here:
http://www.airport-world.com/news/general-news/1587-tbi-to-manage-new-international-terminal-at-
hartsfield-jackson-atlanta.html (accessed 8 July 2019). 138 Transportation Research Board of the National Academies, ‘Airport Cooperative Research Program Report 66
– Considering and evaluating privatization’, 2012, page 22. 139 The Irish Times, ‘DAA wins contract for Riyadh airport’, 22 February 2016, available here:
https://www.irishtimes.com/business/transport-and-tourism/daa-wins-contract-for-riyadh-airport-
1.2544008 (accessed 8 July 2018). 140 https://www.tokyo-airport-bldg.co.jp/company/en/corporate_profile/profile.html. 141 http://www.airportsworldwide.com/Airports/Past-Airport-Projects/Toronto-Lester-B-Pearson-International-
Airport/ (visited on 22/8/19); and Competition Commission, ‘BAA airports market investigation’, 19 March
2009, Appendix 10.11, paragraph 18; 142 ICAO, ‘Case Study on Commercialization, Privatization and Economic Oversight of Airports and Air Navigation
Services Providers, Belgium’, https://www.icao.int/sustainability/CaseStudies/Belgium.pdf 143 Competition Commission, ‘BAA airports market investigation’, 19 March 2009, Appendix 10.11, paragraph 19.
Terminal Competition at Heathrow Airport
67
These two examples demonstrate the importance of: (i) a regulatory structure that aligns
incentives for outcomes (e.g. consistent SQR metrics and incentives for on time performance in
both airfield and terminal operations); and (ii) promoting competition in operation between
terminals to fully secure the benefits of independent operation.
The examples above highlight that structural separation between airfield and terminal
development and operations is feasible and common practice in many countries around the world.
This shows that any practical issues that may arise from the structural separation or the presence
of multiple terminal operators are surmountable. This conclusion was shared by Frontier in the
2008 report.144
While we have not identified many instances of genuine inter-terminal competition in operation,
elements of competition can be found at airports around the globe. Publicly owned airports use
competitive tenders to find innovative and efficient terminal operators. Further, the example of
JFK highlights how the presence of an independent operators can lead to improved choice for
airlines with significant new planned terminal investment over the next 5 years.
A2.3 Competition in Ground Handling
The impact of competition in one aspect of airport operations can be seen in the opening of ground
handling services to competition in 1997. Large airports are now required to allow a minimum of
two ground handlers, one of which must be independent of both the airport and the airport’s
dominant airline (and also allow a minimum of two airlines to self-handle). The EC describes the
impact of this as follows:
‘Since 1997, the provision of groundhandling services in the EU is covered by Directive
96/67/EC. The Directive opened up groundhandling services to competition. Prior to this,
monopolies were the norm for groundhandling services at EU airports and many airlines
complained about high prices and poor-quality services.
Under the EU rules, there is now free competition for the majority of groundhandling
services at larger EU airports, resulting in more choice for airlines. This in turn means
improved service levels and lower fares for the passenger.’145
A study on the impact of the directive by the Airport Research Center shows that the effect on
grounds handling services were positive.146 The authors find that the number of baggage, freight
and mail, ramp, fuel and oil handling providers at the EU-15 airports generally increased following
the implementation of the directive.147 Prices for ground handling services decreased accordingly,
as providers had to compete for airlines.148 Specifically the report finds a correlation between the
change in level of competition and the change in prices:
‘With focus on the EU-15, prices decreased with a higher intensity at airports with a former
handling monopoly than at airports, which already have had open markets.
144 Frontier (2008), paragraph 138. 145 EC, https://ec.europa.eu/transport/modes/air/airports/ground_handling_market_en. 146 Airport Research Center, “Study on the Impact of Directive 96/67/EC on Ground Handling Services 1996-
2007, Final Report”, February 2009. Available here:
https://ec.europa.eu/transport/sites/transport/files/modes/air/studies/doc/airports/2009_02_ground_handli
ng.pdf. 147 Ibid., pages 62, 66, 72, 74. 148 Ibid., pages 87 ff.
Terminal Competition at Heathrow Airport
68
At EU-15 airports, the prices continued to decrease between 2002 and 2007. This proves
that competition still exists in the European ground handling market (due to the renewal of
licences for restricted markets and the continuous pressure for market openness for
others).
Considering the findings for the ground handling markets in the New Member States, in
general prices for ground handling services decreased since the introduction of the
Directive. However, at some airports where competition had not started yet, prices did not
change. Therefore prices could decrease in the future at New Member States airports. The
trend in the decrease of prices is maintained, thanks to competition pressure at airports
covered by the Directive; however the extent to which prices decreased was influenced by
other factors such as improvements in ground handling technology.’ 149
A new evaluation of the effects of the directive of competition in ground handling services is in
the making.150
Whilst recognising that ground handling is an activity of limited scope compared with terminal
operation, the success of competition in this activity is illustrative of the generic benefits of
competition within the airport setting.
A2.4 Competition between airports
A further analogy as to the potential benefits of competition in the airport context may be drawn
from the experience of the change in ownership of the London airports in recent years. The main
London airports (Heathrow, Gatwick and Stansted) were formerly owned by BAA. A report
published by the CC into the BAA-owned airports found that competition in the airports market in
London was not effective. To address these shortcomings the Competition Commission proposed
a package of remedies, which included the divestiture of both Gatwick and Stansted to different
purchasers and the deployment of a more flexible regulatory framework. 151
The effects of these remedies have since been evaluated by the CMA (successor to the
Competition Commission) in a report from 2016.152 According to the CMA the results suggest
“strong evidence of positive changes at divested airports.”153 The new commercial strategies
developed by the divested airports to attract airlines led to increased passenger growth, improved
efficiency in capital investment and operations and higher service quality. In addition, both
Gatwick and Stansted have signed long-term agreements for airline charges. The report highlights
that point-to-point operators in particular were able to negotiate lower airport charges. Further,
the introduction of innovative charging structures by the airports led to more efficient use of
existing capacity.154
149 Ibid., page 165. 150 European Commission, “Ground handling services at EU airports — evaluation (2010-18)”, available here:
https://ec.europa.eu/info/law/better-regulation/initiatives/ares-2019-414136_en. 151 Competition Commission, ‘BAA airports market investigation’, 19 March 2009. 152 CMA, ‘BAA airports: Evaluation of the Competition Commission’s 2009 market investigation remedies’, 16 May
2016. 153 CMA, ‘BAA airports: Evaluation of the Competition Commission’s 2009 market investigation remedies’, 16 May
2016, paragraph 1.5. 154 CMA, ‘BAA airports: Evaluation of the Competition Commission’s 2009 market investigation remedies’, 16 May
2016, paragraph 1.6.
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69
The CMA went on to conclude that the benefits of competition would have been further enhanced
had it not been for airport capacity constraints in South East England.155 The CMA wrote:
“From the airlines’ perspective, the main disciplining force they can use to incentivise
airports to reduce charges and increase service quality is the threat of switching some of
their routes, or their entire operations, to alternative airports.” 156
To date, according to the CMA, lack of airport capacity has inhibited this process at London’s
airports.157
While this is not an example of inter-terminal competition, it does provide some valuable insights
into the types of competitive benefits that such competition may generate.
A2.5 Other sectors
Policy makers in other infrastructure sectors have long expressed a preference for competition
over regulation. Insights as to how regulatory bodies have introduced competition can be used to
inform the policy debate in relation to airport terminal competition. For example, whilst there are
important differences in technology and industry structure between the airports and telecoms
markets, the framework under which competition has been introduced in telecoms illustrates the
benefits of large-scale infrastructure competition, whilst retaining a dependency between
infrastructure operators to ensure full working of the system as a whole. It also illustrates how
issues of vertically integrated operators competing against competitors in one part of the value
chain can be addressed by regulatory oversight.
155 CMA, op. cit. paragraph 1.25 156 CMA, op. cit. paragraph 1.25 157 CMA, op. cit. paragraph 1.25
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70
A2.5.1 Telecoms
The benefits of infrastructure competition have
long been recognised since the initial
privatisation of BT and the launching of the first
infrastructure competitor in the UK – Mercury
Communications Limited in 1981.158 Since then
infrastructure competition has reached into
progressively more of the telecoms value chain,
including areas of the local network, with clear
consumer benefits. At each stage full
interworking between competing networks has
been an absolute requirement.
Ofcom, in its 2016 Strategic Review of Communications”159 stated:
“… it has historically been competition from cable that has played a greater part in driving
network upgrades. In the early 2000s, one of the factors that drove BT to increase the
performance of its initial broadband service was the availability of cable broadband.
Similarly, BT announced its rollout of superfast broadband shortly after Virgin Media’s
upgrade to DOCSIS 3.0. BT’s recent announcement of G.Fast investment plans was in the
context of Virgin Media offering a maximum service speed of 200Mbit/s compared to a
maximum of 80Mbit/s available from Openreach for VULA.” 160
Ofcom continues:
“The best driver for investment and innovation is network based competition: and this is at
the heart of our future strategy. We believe competition between different networks
(including those built from scratch or built using duct and poles owned by others) is the
best way to drive investment in high quality, innovative services for consumers.
“Providers that offer services using their own network will be able to decide what type of
network they build. Instead of being constrained by BT’s chosen strategy of incrementally
upgrading its existing copper network, competing operators should have the opportunity to
build their own FTTP networks.
“Investing in their own network also gives providers full control over the quality of service
provided. Competing operators can strive to win customers by offering a better quality of
service than their competitors. Such competition can help address one of the main concerns
expressed to us in this review: the poor quality of service received by many consumers.”
161
158 The UK policy of telecoms infrastructure competition, of course, followed that of the US with the break-up of
the AT&T monopoly, and the launching of the first long distance infrastructure competitor to AT&T – MCI
(Microwave Communications Inc.). 159 Ofcom, ‘Making communications work for everyone: Initial conclusions from the Strategic Review of Digital
Communications’, 25 February 2016, https://www.ofcom.org.uk/__data/assets/pdf_file/0016/50416/dcr-
statement.pdf. 160 Ofcom, Op. cit. para 4.11. 161 Ofcom, Op. cit. para 4.12-4.14.
COMPETITION IN TELECOMS
Competition in retail and infrastructure –
introduced since privatisation of BT – led to
significant consumer benefits:
• Consumer focused investment in
infrastructure;
• Improved service quality and innovation.
Competition allowed Ofcom to scale back regulation to Openreach (access network),
leading to significant savings.
Terminal Competition at Heathrow Airport
71
The benefits of infrastructure competition in telecoms can, therefore, be summarised as:
● high quality investment (by which we could include investment targeted to the needs of
consumers), with competitors being able to choose the type and form of their own investment;
● competition in service innovation;
● competition in service quality;
● the existing incumbent will “up its game” to meet competition, as shown by BT’s response to
the cable industry and Virgin Media.
The analogy here to terminal competition is clear. Competition in terminal design and operation
would allow the opportunity for consumer benefits.
Furthermore, Ofcom argue that:
“Where network based competition can work, there is the real prospect of removing existing
regulation.” 162
Competition can reflect changes in technology and the market, which would be difficult to capture
in the regulation of an incumbent monopolist. Ofcom essentially now need to regulate Openreach
(the access network), and not BT’s core network. This is a significant saving of regulatory effort,
despite the extensive safeguards needed to protect BT’s competitors from discriminatory access
to the Openreach network. In the case of Heathrow, and safeguarding access to the runway, the
implementation of safeguards would be significantly simpler, as we showed in Section A1.4.
162 Ofcom, Op. cit. para 1.29.
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72
A2.5.2 Postal services
Whilst we regard the telecoms sector as being
the most relevant, it may also be instructive to
look at the UK postal services sector. Royal Mail,
the incumbent provider of postal services in the
UK, is regulated by Ofcom under the Postal
Services Act (2011).163 Competition between
Royal Mail and other postal operators has been
introduced across time. For letters it takes place
in access mail (operators sort bulk mail for
commercial customers and use Royal Mail’s
network for the final delivery) and used to take
place in direct delivery (operators deliver
directly to households). There is significantly more competition in parcels, where Royal Mail is
only one of many major players.164
Ofcom described the benefits of competition in the sector as follows:165
“As with other businesses, competition in general is central to ensuring that there are
incentives for Royal Mail to:
• Maintain focus on efficiency in the delivery of universal services
— Constrain pricing
— Innovate in service delivery
• In parcels, competition has already led to:
— Greater choice for consumers, including introduction of Sunday deliveries and
delivery to neighbour
— Major changes to Royal Mail parcel processes
• We expect direct delivery competition to offer similar benefits.”
As with telecoms, there are issues of competitor access to Royal Mail’s delivery network. These
have been addressed through regulation (and competition law)166, which obliges Royal Mail to
provide access on non-discriminatory terms, to align access prices for bulk operators to zonal
costs, and to inform customers in advance about changes in price and non-prices terms to allow
them to adjust.167 These measures are intended to enable competition between Royal Mail and
other bulk mail operators.
163 Ofcom, ‘Review of the Regulation of Royal Mail’, 1 March 2017, available here:
https://www.ofcom.org.uk/__data/assets/pdf_file/0033/97863/Review-of-the-Regulation-of-Royal-Mail.pdf. 164 Ofcom, ‘The UK postal market: sustainability, efficiency and competition’, presentation by Ed Richards, Chief
Executive, and Chris Rowsell, Competition Policy Director, 2 December 2014, slide 6, 165 Ofcom, ‘The UK postal market: sustainability, efficiency and competition’, presentation by Ed Richards, Chief
Executive, and Chris Rowsell, Competition Policy Director, 2 December 2014, slide 9,
https://www.ofcom.org.uk/__data/assets/pdf_file/0013/10444/briefing_slides_dec14.pdf. 166 See Ofcom complaint by Whistle UK Limited against Royal Mail, case reference CW/01122/01/14. 167 Ofcom, ‘Review of the Regulation of Royal Mail’, 1 March 2017, paragraphs 5.23, 5.47 and 5.51.
COMPETITION IN POSAL SERVICES
Royal Mail’s exposure to competition in bulk
mail and parcels generated various
consumer benefits:
• Cost efficiencies and pricing constraints
in letter delivery;
• Increased choice in delivery options for
parcels.
Principles of non-discrimination in access
pricing allow for competition in parts of the
value chain.
Terminal Competition at Heathrow Airport
73
Similar regulation, such as non-discriminatory access, would be required to enable terminal
competition. Non-discriminatory access to HAL’s runway and prevention of margin squeezing of
competitors could be more easily resolved, as costs of runway operation should be more
transparent that those of mail delivery.
A2.6 Conclusion from case studies
The case studies shown in this Appendix point to the benefits of competition – including
competition in infrastructure. As discussed in further detail in the Chapter 5, we expect that similar
benefits could be generated in the airport sector. We find the evidence leads clearly towards the
benefits of unlocking choice in design and competitive forces in the operation of passenger
terminals at Heathrow.
Case studies from around the world show that: (i) independent operation of passenger terminals
is common, and fully consistent with a strong overall airport coordination ensuring that all airport
operators – airfield, terminals, emergency services, border force, air traffic control, retail
franchises and many others – work together; and (ii) there are strong benefits to passengers
from introducing competition in airport services – from the break-up of the former BAA, to
competition in specialised airport services such as baggage handling.
Further, the experience shows that partial deregulation requires different regulatory tools. In
particular, the regulator would have a role in preventing any form of discrimination by the operator
of the essential facility – in the case of Heathrow the airfield and other services requiring airfield
access, particularly terminal operation. However, these regulatory tools are well known in other
sectors and can be applied easily in an airport context.