terminal competition at heathrow airport...terminal competition at heathrow airport 7 development...

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.


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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


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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


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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.


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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


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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.


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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.

https://www.caa.co.uk/Data-and-analysis/UK-aviation-market/Airports/Datasets/UK-Airport-data/Airport-data-2018/





12

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.


13

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,


/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.

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/440316/airports-commission-final-report.pdf

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/440316/airports-commission-final-report.pdf

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



https://aec.heathrowconsultation.com/?gclid=EAIaIQobChMI4MPsod2g4wIVmpntCh0sTwnJEAAYASAAEgKJwfD_BwE&gclsrc=aw.ds

https://aec.heathrowconsultation.com/?gclid=EAIaIQobChMI4MPsod2g4wIVmpntCh0sTwnJEAAYASAAEgKJwfD_BwE&gclsrc=aw.ds


14

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.


15

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.

https://www.adamsmith.org/research/ready-for-takeoff

http://heathrow-westconsultation.consultationonline.co.uk/wp-content/uploads/sites/78/2019/04/Heathrow_W_MAIN_Stg1_FULL_Spreads.pdf




16

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


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,


/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.

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/653879/updated-appraisal-report-airport-capacity-in-the-south-east.pdf




https://www.oag.com/the-heathrow-forecast


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/.

https://aec.heathrowconsultation.com/wp-content/uploads/sites/5/2019/06/Future-Runway-Operations.pdf




https://aec.heathrowconsultation.com/plans/


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/.

https://aec.heathrowconsultation.com/topics/airfield/


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.





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-


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-


content/uploads/sites/78/2019/04/Heathrow_W_MAIN_Stg1_FULL_Spreads.pdf. 39 See Figure 4 above.








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.


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.

https://aec.heathrowconsultation.com/topics/airfield


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


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.


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.


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.


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/.

https://www.oxera.com/agenda/the-thames-tideway-tunnel-returns-underwater/


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.


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.

https://www.heathrow.com/file_source/Company/Static/PDF/Investorcentre/Heathrow-(SP)-Limited-Regulated-31-December-2018.pdf

https://www.heathrow.com/file_source/Company/Static/PDF/Investorcentre/Heathrow-(SP)-Limited-Regulated-31-December-2018.pdf


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.


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).

http://www.toulouse.aeroport.fr/sites/default/files/contrib/societe/lasociete/tarifs/redevances_a-2018-en_ok.pdf

http://www.toulouse.aeroport.fr/sites/default/files/contrib/societe/lasociete/tarifs/redevances_a-2018-en_ok.pdf

https://media.brusselsairport.be/bruweb/default/0001/23/5af91f3fb34251deebcfa562282ea5e94b776878.pdf

https://media.brusselsairport.be/bruweb/default/0001/23/5af91f3fb34251deebcfa562282ea5e94b776878.pdf

https://mediacentre.heathrow.com/pressrelease/details/81/Corporate-operational-24/9088


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,


/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/.

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

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

https://www.heathrowexpansion.com/other-news/easyjet-expanded-heathrow-would-lead-to-lower-fares-and-new-uk-and-european-routes/



33

Figure 12: Illustrative example scenarios for airline distribution across terminals


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.


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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 -


/cma-advice-on-impacts-of-airport-slots.pdf, visited 30/8/19).

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/767230/cma-advice-on-impacts-of-airport-slots.pdf

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/767230/cma-advice-on-impacts-of-airport-slots.pdf


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).

https://www.adamsmith.org/research/ready-for-takeoff


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.

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



http://publicapps.caa.co.uk/docs/33/CAP1825%20iH7.pdf


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).

http://publicapps.caa.co.uk/docs/33/CAP1151.pdf

https://www.caa.co.uk/uploadedFiles/CAA/Content/Accordion/Standard_Content/Commercial/Airports/Files/PwC%20-%20H7%20Initial%20WACC%20response%20document.pdf

https://www.caa.co.uk/uploadedFiles/CAA/Content/Accordion/Standard_Content/Commercial/Airports/Files/PwC%20-%20H7%20Initial%20WACC%20response%20document.pdf


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


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.


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.


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).

http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/transport-committee/airports-national-policy-statement/oral/79002.pdf

http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/transport-committee/airports-national-policy-statement/oral/79002.pdf



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.


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.

http://publicapps.caa.co.uk/docs/33/CAP1151.pdf


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


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:


(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.


https://publicapps.caa.co.uk/docs/33/CAP%201060%20Airport%20Operating%20Expenditure%20Benchmarking%20Report%202012.pdf

https://publicapps.caa.co.uk/docs/33/CAP%201060%20Airport%20Operating%20Expenditure%20Benchmarking%20Report%202012.pdf

http://publicapps.caa.co.uk/docs/33/CAP%201133.pdf


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.

https://assets.publishing.service.gov.uk/media/57399d43ed915d152d00000b/evaluation_of_baa__market_investigation_remedies.pdf

https://assets.publishing.service.gov.uk/media/57399d43ed915d152d00000b/evaluation_of_baa__market_investigation_remedies.pdf


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/.




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.

https://www.eurocontrol.int/concept/airport-collaborative-decision-making

https://your.heathrow.com/wp-content/uploads/2018/07/2015-Responsible-Heathrow-Performance-Report.pdf

https://your.heathrow.com/wp-content/uploads/2018/07/2015-Responsible-Heathrow-Performance-Report.pdf


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/

https://www.heathrow.com/file_source/CommunitiesTrust/Static/PDF/February_2019_GHSP.pdf

https://im.ft-static.com/content/images/89937494-55ed-11e0-8de9-00144feab49a.pdf

https://your.heathrow.com/at-the-heart-of-heathrow-apoc/


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.


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.


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.


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.


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,


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.


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.


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


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.


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


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.

https://www.caa.co.uk/CAP1433


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.


61

Figure 16: Comparison of regulatory accounting challengers in HAL vs. BT/Openreach


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.

https://www.heathrow.com/file_source/Company/Static/PDF/Partnersandsuppliers/Restructure_of_Airport_Charges-Consultation_Document-2010.pdf

https://www.heathrow.com/file_source/Company/Static/PDF/Partnersandsuppliers/Restructure_of_Airport_Charges-Consultation_Document-2010.pdf


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).


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.


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.

https://www.anewjfk.com/projects/the-new-terminal-one/

https://ny.curbed.com/2018/10/4/17937028/jfk-airport-renovation-expansion-nyc-cuomo-renderings

https://www.munich-airport.com/press-munich-airport-international-expands-activities-in-the-usa-6940418

https://www.munich-airport.com/press-munich-airport-international-expands-activities-in-the-usa-6940418

https://im.ft-static.com/content/images/89937494-55ed-11e0-8de9-00144feab49a.pdf


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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.

http://www.globalconstructionreview.com/news/ireland-considers-third-private-terminal-dublin-ai/

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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.

http://www.aatc.org/about-us/#whoweare

http://www.aatc.org/about-us/#whoweare

http://www.airport-world.com/news/general-news/1587-tbi-to-manage-new-international-terminal-at-hartsfield-jackson-atlanta.html

http://www.airport-world.com/news/general-news/1587-tbi-to-manage-new-international-terminal-at-hartsfield-jackson-atlanta.html

https://www.irishtimes.com/business/transport-and-tourism/daa-wins-contract-for-riyadh-airport-1.2544008

https://www.irishtimes.com/business/transport-and-tourism/daa-wins-contract-for-riyadh-airport-1.2544008

https://www.tokyo-airport-bldg.co.jp/company/en/corporate_profile/profile.html

http://www.airportsworldwide.com/Airports/Past-Airport-Projects/Toronto-Lester-B-Pearson-International-Airport/

http://www.airportsworldwide.com/Airports/Past-Airport-Projects/Toronto-Lester-B-Pearson-International-Airport/

https://www.icao.int/sustainability/CaseStudies/Belgium.pdf


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.

https://ec.europa.eu/transport/modes/air/airports/ground_handling_market_en

https://ec.europa.eu/transport/sites/transport/files/modes/air/studies/doc/airports/2009_02_ground_handling.pdf

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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


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.

https://www.ofcom.org.uk/__data/assets/pdf_file/0016/50416/dcr-statement.pdf

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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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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.

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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.

terminal competition at heathrow airport...terminal competition at heathrow airport 7 development...

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