Airports Commission Discussion Paper 04: Airport Operational Models Heathrow Airport Limited response Date: 11 July 2013 This document is Heathrow’s response to the Airports Commission’s fourth discussion paper on airport operational models. Our response follows a structure similar to the Commission’s own paper. Contents 1. Overview ............................................................................................................................................... 1 2. Airports, airlines and route networks: possible futures ........................................................................... 3 3. Key characteristics of different airport operating models ........................................................................ 7 4. The structure and operation of the UK aviation sector ......................................................................... 13 5. References .......................................................................................................................................... 16 1. Overview The UK is in a global race for trade, jobs and economic growth. The international economy is changing with the rise of emerging markets like Brazil, Russia, India and China. There are only six hub airports worldwide that have regular, direct connections to more than 50 long-haul destinations. To truly compete in global terms, hubs need scale to combine the local and transfer demand that makes long-haul networks viable. Large hub airports with a home-based, major network airline will increasingly shape the nature of intercontinental connectivity. A global race for this direct connectivity, and the substantial economic benefits that go with it, is well underway. No country has more than one major long-haul hub. London has one of these Premier League hubs and also has the natural advantages of geographic location and local demand, which should mean that the UK is a winner, but unlike its competitors, the UK is hampered by a lack of hub capacity. Airports, airlines and route networks: possible futures Of the futures outlined by the Airports Commission, ‘Future 1’, where the major role of hub airports is enhanced, is best supported by the evidence. Continuing liberalisation is leading to fewer, larger network carriers, who are, in turn, concentrating their operations at fewer, larger intercontinental hubs. These scale hub operations provide competitive advantage to both the hub airlines and the host country. For airlines, they are the most efficient and competitive way of connecting many different destinations - enabling more destinations to be served directly more frequently, at lower cost and for better revenue. In essence, hub scale and connectivity are self-reinforcing. For the host country, international connectivity through a hub airport supports economic growth. Direct flights are critical to trade with emerging markets. UK businesses trade 20 times more with emerging markets with daily flights than those with less frequent or no direct service. In addition, the rate of growth in UK trade is substantially lower where daily flight connections with Heathrow are not available. Competitor countries have realised the importance and value of this future. As a result, they are much better prepared for it than the UK. Competitor hubs including Frankfurt, Paris, Amsterdam, Madrid, Dubai, Istanbul and Doha either already have, or are committed to developing, capacity at a single hub that is 50% greater than Heathrow. Consequently, without additional hub capacity, the UK risks losing out - potentially losing its hub - particularly if, as expected, there is significant further consolidation amongst Europe’s network airlines. Whilst the UK’s hub capacity constraint currently points towards a ‘Future 2’, where UK connectivity declines in the face of growth from Middle Eastern and Far Eastern carriers and hubs, this future of weaker direct connectivity can be avoided if hub capacity is added in the UK. London is one of the world’s leading cities, and has all the attributes needed to win the global race for direct connectivity. These include an excellent geographic location for global aviation flows, a strong base of local long-haul demand focused on a large productive metropolitan area and home base to one of the world’s major network airlines and alliances. London is very well placed to compete and win if it has the capacity at a single hub to do so. A ‘Future 3’ with any material integration of hub and point-to-point models is extremely unlikely. A diversification of the Low Cost Carrier (LCC) point-to-point model into long-haul flying is not commercially competitive. This is because: • Point-to point and network models are structurally different - for example only 4% of LCC passengers are transfers versus 35-55% for network airlines at their hubs. A typical long-haul route, Heathrow-Nairobi, draws on 177,000 transfer passengers from 42 different inbound routes. Without transfer passengers, LCCs would be uncompetitive • LCCs are effective on short-haul as they run simple aircraft fleets, fit more seats into an aircraft and keep them in the air longer. These tactics are not competitive differentiators for long-haul • Demand for long-haul travel is relatively much lower, thinner, more variable and less price elastic than short-haul, rendering the point-to-point model ineffective • Airlines need to tailor their long-haul offer to business class passengers • There is much less scope in long-haul for LCCs to differentiate on cost e.g. fuel represents 50% of long-haul costs • Leaders of the major LCCs say it is a distraction from their core model • Ryanair and easyJet have recently placed orders for 300+ aircraft, costing over £15 billion, with not a single long- haul aircraft among them. These orders will shape the competitive landscape for the next two to three decades. Key characteristics of airport models and the structure and operation of the UK aviation sector London and the UK have benefited from a highly effective and complementary combination of airport types: a leading global hub providing global connectivity and numerous point-to-point airports providing local catchments with excellent connections to Europe, seasonal holiday destinations and a handful of long-haul connections to overseas hubs. However, with our hub operating at over 98% capacity, the UK is unable to serve growing international demand. If the other airports were capable of meeting hub demand they would be doing so now as they all have spare capacity. A recent OECD report has found that the UK’s hub “is underperforming in long-haul connectivity relative to its local market”. Their analysis indicates that Heathrow ought to be operating to at least 20 more long-haul destinations. Our hub is slipping out of the Premier League of the world’s international hub airports. Paris and Frankfurt will push Heathrow into third place in Europe within the next ten years. They already boast around 2,200 more flights to mainland China than Heathrow each year. There are 26 emerging market destinations with daily flights from other European hubs that are not served daily from Heathrow: including destinations such as Manila, Lima, and Chongqing. We estimate that with additional hub capacity, Heathrow could be providing regular direct connections to 40 more long-haul destinations by 2030, making the UK a winner. 1 Consequently, the UK is cutting itself off from growth and risks businesses and their supply chains choosing to locate overseas around other increasingly better connected hubs. We could already be missing out on up to £14 billion per year in lost trade due to poor connections. This figure could rise to £26 billion a year by 2030. Our lack of runway capacity is already hurting UK regional connections, by pushing 9,000 UK regional flights per year out of the hub. Consequently there are now 18 UK regional airports connected to European hubs – but not to Heathrow. If choice and competition are the tests, a globally competitive single hub offers the only successful future. Heathrow’s long-haul network is already the most heavily competed of the world’s biggest cities. Across the 90 routes, 48 airlines compete with 246 daily services. Relieving the capacity constraint will also have the benefit of reducing the upwards pressure on airfares that increasing levels of un-served demand apply at Heathrow . Two smaller, second division, London hubs on the other hand would inevitably result in fewer directly accessibly long-haul destinations, a less attractive choice of long-haul flight timings, less competition and higher average long-haul ticket prices. The ‘dispersed’ hub model discussed by the Commission, with reference to Germany, does not really exist. Germany’s single, scale intercontinental hub is Frankfurt. It generates the long-haul connectivity, carrying 67% of Germany’s long- haul passengers. Munich, Dusseldorf and Berlin, on the other hand, offer regional, short-haul connections. A secondary UK hub outside the South East is not viable. Airlines could today choose to establish hub operations at Birmingham or Manchester, but they choose not to, as there is insufficient demand. Despite being the second largest city in the UK by GMP (Gross Metropolitan Product), Birmingham only represents 4% of UK passenger traffic. Since 2005, even with Heathrow constrained, the UK regions have only seen regular direct services added to one new long- haul destination outside of the Middle Eastern hubs: Manchester - Los Angeles. In stark contrast, the hub