Spatial Competition Between Airports for Passengers: an Empirical Analysis of the German Market

UNIVERSITY OF AMSTERDAM Spatial Competition between Airports for Passengers: An Empirical Analysis of the German Market Melissa Newham Supervisor: Prof. Dr. Jo Seldeslachts A thesis submitted in partial fulfillment for the degree of Master in Science in Economics in the Faculty of Economics and Business University of Amsterdam 30 July 2014 1 Spatial Competition between Airports for Passengers: An Empirical Analysis of the German Market Melissa Newham Abstract This paper quantifies the degree to which airports in the same region “steal” or cannibalize each other’s passengers using a unique dataset covering 21 German airports over an eight-year time period (2005-2012). Spatial competition in the airport industry is a relevant topic given the liberalisation of the air transport industry and the significant entry of secondary and regional airports in the last two decades in Europe, combined with the locational interdependence among airports. However, quantitative research concerning the extent to which airports compete for passengers is limited. Applying instrumental variable methods, my main empirical results indicate that airport entry significantly reduces passengers at nearby airports by a magnitude of 9% on average for the German market. This “passenger stealing” effect has repercussions for economic efficiency; as airports have high fixed costs and benefit from economies of scale as passenger numbers increase, it may be more efficient to have fewer airports in the market with each airport serving more passengers. Key words: airport competition, regional airports, excessive entry, Germany 2 Acknowledgements This study would not have been possible without the support of many people. I would like thank my supervisor, Prof. Dr. Jo Seldeslachts, for helping me to improve on previous versions of this study. Many thanks also to Carina Lampe and Jochem Meeuwissen at PwC Amsterdam for their support and advice as well as providing me with data. I would like to thank the Infrastructure Advisory team at PwC Frankfurt including Georg Teichmann, Benjamin Schöne, Johannes Single and Theresa Brandt for providing valuable insights into the German airport industry. Many thanks also to Donagh Cagney at ACI EUROPE for granting me access to ACI publications and data. 3 1 Introduction Traditionally, airports have been viewed as natural monopolies and objects of public infrastructure. However, liberalisation of the European air transport market starting in the 1980s and a trend towards airport privatisation introduced new dynamics into the industry and increased competition between airports (Starkie 2002). Arguably one of the most consequential events for the airport industry has been the emergence and growth of low-cost carriers (LCCs). The entry of low-cost carriers, operating point-to-point between airports, dismantled the established airport hierarchy and encouraged the development of small and medium sized secondary and regional airports in the European market (Dmitry 2012). Regional airports entering the market for commercial aviation services are often prior military or general aviation airports. They are located at some distance from major cities and are less convenient than primary airports. Regional airports have been able to attract traffic by offering low airport charges to LCCs who are eager to cut costs wherever possible in order to keep their flight prices low. This strategy is effective as the passengers of LCCs are more willing to put up with an inconvenient airport location if it means saving money on flight fares. Europe now has a network of over 440 airports, the majority (60%) of which are small regional airports serving less than 1 million passengers per year. European passengers have significant airport choice with 63% of EU citizens living within a two-hour drive from at least two airports (European Commission 2014a). The resulting density of airport infrastructure in Europe has increased competition in the market. In academic literature, competition between airports is widely discussed (notably Starkie 2002; Forsyth et al. 2010). Various lines along which airports may compete have been put forward, for example; large hub airports may compete for connecting traffic, airports may compete as cargo hubs, airports may compete for passengers with other modes of transport (high- speed rail, ferries etc.) and airports may compete for departure and/or arrival passengers (Tretheway and Kincaid 2005). An airport’s catchment area refers to the geographical zone containing potential passengers of the airport. The greatest scope for airport competition is where airports have overlapping catchment areas and hence compete spatially for passengers (Forsyth 2010). However, this spatial aspect of airport competition is also one of the most under- researched topics in scientific literature concerning airports (Dmitry 2012). 4 This study aims to quantify the extent to which market structure affects passenger figures at airports. This is achieved by conducting an empirical analysis of the determinants of passengers at an airport using a time series dataset covering 21 German airports over an eight- year time period (2005-2012).1 Germany provides an ideal case study given that the market houses numerous regional airports and there is data available on smaller airports. Specifically, the empirical model developed in this study seeks to answer the question; what is the impact of nearby airports on airport passenger traffic? And conversely; what would be the effect of airport exit on the passenger traffic of nearby airports? The answer to this question is not clear a priori. It depends on the substitutability between the airports, and whether the size of the market increases with the number of airports or if more airports simply split the “pie”. In theory, airport entry could increase the size of the market (passengers willing to travel by air) by taking passengers from other modes of transport or encouraging passengers to travel that otherwise would not have. On the other hand, airport entry could “steal” potential passengers from other airports. My key finding is that neighbouring airports do exert a negative externality on each other in terms of cannibalizing each other’s passenger markets. Applying instrumental variable methods, I find that in the German market an additional nearby airport will reduce passengers at an airport by approximately 9% on average. The results of this study have implications for economic efficiency and overall welfare as given that airports have high fixed costs and decreasing average costs with passenger numbers, passengers play a crucial role in the viability and profitability of airports. In the context of Germany, where the majority of regional airports have excess capacity and rely on State aid to remain in the market, my results suggest that overall efficiency could be increased by reducing the number of airports in the market such that each airport would serve a greater number of passengers. The remainder of the paper is structured as follows. Section 2 provides background information and a review of the relevant literature on spatial competition and airport competition in order to properly frame my contribution. Section 3 emphasizes relevant dynamics in the airport industry that a model of passenger traffic at airports will need to take into consideration, and introduces my methodology. Section 4 describes the dataset of German airports. Section 5 1 In addition, discussions were conducted with industry experts to better understand how the sector works in real life and to cross check the plausibility of the results. 5 describes the estimation strategy employed. Section 6 presents empirical results. Section 7 outlines the efficiency and policy implications of my research for the German market. Section 8 concludes. 2 Background and Related Literature Spatial competition deals with dispersed markets in which each firm faces only a few rivals in its immediate neighbourhood, further away there are more competitors however their influence is reduced by transportation costs (Gabszewicz et al. 2001). In a dispersed market “the market is commonly subdivided into regions within each of which one seller is in a quasi- monopolistic position” (Hotelling 1990, p. 41). Recently models of spatial competition have been applied to gas stations, movie theatres, hospitals and retail stores, but the airport industry is still weakly covered (Dmitry 2012). Spatial competition is relevant to the airport industry given the dispersed market structure of the sector and the immobile nature of airports. Once an airport is established in a certain location it cannot move and the airport has to rely on the flexibility of its customers. Alternative airports that are able to serve the same potential passenger market are relevant competitors. In a spatial sense, airports will compete with rivals both as a departure point for local populations and as a destination point for leisure and business travelers. In the literature, an airport’s catchment area is the term used to describe the airport’s market area, that is, the geographical region from which the airport gets the bulk of its passenger traffic. Catchment areas can be defined in a number of different ways; by geographical distance, by travel time or by travel cost. One view of competition for passengers is that airports compete most intensely for the proportion of passengers located on the outskirts of their catchment areas; in the regions where catchment areas overlap. As passengers

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