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REPORT The Importance of Airport Competition on Air Fares Paid by Consumers PREPARED FOR Gatwick Airport Ltd. PREPARED BY InterVISTAS Consulting Inc. March 2014 Executive Summary There is a 30 year literature on the impact of market structure (i.e., competition) on air fares. Most of that literature is US based, but nevertheless reveals some important findings: The type of carrier matters more than the number of carriers. This is especially echoed by findings of recent research by in the US.1 Specifically, the presence or not of low cost carriers (LCCs) is the single most important factor in determining fares paid by consumers and the level of traffic. The presence of airport competition is a major factor in reducing air fares between origin-destination city pairs. There are two important gaps in the literature, however. First, the literature finds substantial benefits of airport competition, but the estimation models were formulated so that they do not make clear whether airport competition is really due to the LCC effect, or whether there is a pure airport competition effect, after controlling for LCC effect. Second, there is a need for results based on European data. This report addresses these two issues as follows: We use US data to separate out the pure airport competition effect from the LCC effect. In doing so we consider differing forms of competition: Primary competition on the same route (e.g., competition between carriers serving Heathrow-Paris CDG) V-competition in the same market using a different airport at one end (e.g., service at Gatwick- Paris CDG as a competitive alternative to Heathrow- Paris CDG). Parallel competition in the same market using different airports at both ends (e.g., service at Gatwick- Paris Orly as a competitive alternative to Heathrow- Paris CDG). Using US data allows us to establish that the effect is a result of an improved model specification which separates out the airport and LCC effects, rather than something due to switching data sources from US to European data. We then apply the model to European data. 1 J.K Brueckner, D Lee and E. Singer (2010), “Airline Competition and Domestic US Airfares: A comprehensive Reappraisal,” working paper. University of California, Irving. InterVISTAS: Airport Competition and Air Fares i Our key result from the new analysis on US routes is that airport competition matters. As in previous literature, the LCC effect is present and strong. This is true whether the LCC is on the primary route or on an alternative competitive route, and the magnitude of the impact was similar whether the competition was primary, V- or parallel competition. In contrast, an additional network carrier on a primary route had little or no impact on average fares (a common finding in the recent US literature), but a network carrier on an alternative route (i.e., V- or parallel competition) did lower fares. This airport competition effect of a network carrier was smaller than the LCC effect, but it was fare reducing and statistically significant. This is evidence of an airport competition effect separate from the LCC effect. With the European data, there were some differences in the results, but the presence of a pure airport competition is verified. The LCC effect is present and strong in the European data. Again, this is true whether an LCC is on a primary route or on an alternative competitive route. But the magnitudes are much higher for the presence of an LCC on an alternative route than for presence on primary routes. We also observe that the European LCC effect is larger than the US LCC effect. Turning to the effect of competition from network carriers, an additional network carrier on a primary route has a modest impact on average fares. More importantly, a network carrier on an alternative route (V- or parallel competition) results in an appreciable reduction in average fares and this airport competition effect is statistically significant. In Europe, this airport competition effect is much higher than was found in the US. Policy implications Consistent with the previous literature, the presence or not of an LCC in a city-pair market is the single most important driver of lower fares for consumers. Policies that support the growth of LCC carriers produce tangible benefits. Polices that constrain growth of these carriers result in foregoing benefits to travellers and the nation. In both the US and the European data, we find that there is a pure airport competition effect, one that is separate from the LCC effect. In other words, airport competition matters for the average fares paid by consumers (and through the price elasticity it matters for the level of traffic on a route), regardless of whether that competition is delivered by LCCs or network carriers. Specifically, our results indicate that enabling more network carrier competition on primary routes (i.e., between the major airports) produces little or no fare and traffic benefits for consumers and the nation. However, there is a fare reducing effect of competition between network carriers when the network carriers compete from different airports, either V-route competition or parallel route competition. This is smaller than the effect of LCC competition, but it is positive and statistically significant. InterVISTAS: Airport Competition and Air Fares ii Airport competition matters. Our results, based on analysis of average fares paid by consumers in the top 1000 European origin-destination markets, shows that markets with network carriers at more than one airport in an urban region produce genuine fare reductions. Markets with network carriers serving a single airport in the region have higher fares. The presence of a low cost carrier reduces fares in the market, but this effect is larger when LCCs serve an alternative airport on at least one end of the route. From these results we infer that in the current debate regarding airport capacity in the London market, consideration should be given to where that capacity will produce fare benefits for consumers. Connectivity at high fares is of much less benefit than connectivity at affordable, competitive fares. A capacity decision that only adds capacity at the primary airport used by network carriers will have two detrimental effects from a fares point of view. First, by curtailing the growth of LCCs at Gatwick and eventually Stansted, Londoners and visitors will pay higher fares in the future at all airports. Second, by inducing network carriers to serve only one airport, Londoners and visitors will forego fare competition benefits that we observe when network carrier service is available at two airports. InterVISTAS: Airport Competition and Air Fares iii Contents Executive Summary ....................................................................................................... i 1 Introduction ............................................................................................................. 1 1.1 Previous investigations into competition and fares ............................................ 1 1.2 Purpose of this study paper ............................................................................... 2 2 Econometric Investigation of the Impact of Market Structure on Average Achieved Fares ........................................................................................................ 3 2.1 Introduction ....................................................................................................... 3 2.2 What the Existing Literature Tells us About Methodology for Analysing Air Fares3 2.3 Description and Sources of Data ....................................................................... 4 2.4 Market Definition ............................................................................................... 7 2.5 Use of Average Fares ....................................................................................... 9 2.6 Econometric Model ............................................................................................ 9 2.7 The Effect of Route Distance – Differences Between the US and Europe ....... 13 3 Results Using the US data .................................................................................... 15 3.1 Introduction ..................................................................................................... 15 3.2 The U.S. Regression Results .......................................................................... 15 3.3 Key Findings from the U.S. Data ..................................................................... 18 4 Results Using European Data .............................................................................. 19 4.1 Introduction ..................................................................................................... 19 4.2 The European Regression Results Using 2006 data ....................................... 19 4.3 Statistical Tests on the 2006 European Data ................................................... 22 4.4 The European Regression Results Using Pooled 2006 – 2012 data................ 23 4.5 Key Findings from the European Data ............................................................. 25 5 Assessment ........................................................................................................... 27 5.1 Introduction ..................................................................................................... 27 5.2 Key Findings on What Matters for Fares ........................................................

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