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Working Paper 2007-6

Comparative Political Economy of Airport Infrastructure in the European Union: Evolution of Privatization, Regulation and Slot Reform *

David Gillen Centre for Transportation Studies Sauder School of Business University of British Columbia Vancouver, BC Email: Hans-Martin Niemeier University of Applied Sciences Bremen Bremen, Germany

* We are indebted to Christiane Mller-Rostin, Vanessa Kamp and Haibin Huang for excellent research assistance as well as to students in Transport Economics, Bremen University of Applied Science who assisted with data collection. We also thank David Starkie and Peter Forsyth for useful comments on earlier drafts as well as participants at the workshop on Comparative Political Economy and Infrastructure Performance: The Case of Airports, Madrid September 2006 for comments. In addition we are grateful for constructive and helpful comments from two anonymous referees. The research was partially funded by the research project GAP (German Airport Performance) supported by the Federal Ministry of Education and Research, Germany and by the Centre for Transportation Studies, Sauder School of Business, University of British Columbia.

Copyright 2007 by Centre for Transportation Studies




Changes to the aviation sector in the EU over the last two decades have been far reaching and have included, among other things, deregulation of the airline service sector, the formation of the EU common market, a [recent] signing of an EU-US Open Skies agreement, a gradual move to airport privatization and a continuing evolution of airport regulation and slot allocation reform. The goal of this paper is to examine the EU experience with the changes to economic regulatory policy and capacity allocation through slots and their impact on airport operations and economic efficiency. It is difficult to assess changes to airport regulation without also examining privatization initiatives and how they have varied across European states. We therefore include a brief description and assessment of privatization plans across member states. 1 The shift to more market oriented policies in the ownership and management of airport infrastructure has reflected a position that airports can improve their cost efficiency and level of service to passengers and airlines under privatization. With the Green Paper on fair and efficient pricing (EC, 1995) the European Commission views airports as part of the general infrastructure that should be priced according to social marginal costs principles (Frerich, 2004 a, b and 2006). Member states such as for e.g. the UK or Germany have also adopted these principles in their policy papers (Nash, 2000 2 ). Therefore a key objective for airport policy is that it should promote efficient provision of airport services. Secondly, there has been a shift to considering regulation or semi-regulatory processes as an alternative means of governance for the airport system. There has, for example, been substantial debate in academic circles of the merits of types of regulation price cap versus cost based regulation with single versus dual till systems and whether there needs to be regulation at all. 3 This view has been taken up by airports that depict themselves as an industry facing significant competitive pressures. Airlines, on the other hand, having substantially cut their costs and fares in the last five years criticize airports for not having achieved similar cuts. They see airports as natural monopolies which are not regulated effectively by an independent regulator. The paper is organized in the following way. We begin with an overview of the EU airport industry and the changes in traffic over time. We also provide a discussion of legislation which affects airports. We take note of the number of airports in member states and their features. Following this is a brief discussion of airport privatization as this leads naturally into the topic of airport regulation. Our purpose is to simply point out what has been happening in the EU and discuss those factors which have hindered greater privatization in the EU. This leads to an examination of the evolution of airport regulation and the distribution of differing types of regulation across member states. In this section the differences in single versus dual till price regulation are assessed. The second major topic of the paper is examined next; the evolution of slot allocation is examined and the methods of allocation assessed. In the summary section we take up the question of social marginal cost pricing and how and to what

There have been numerous other reforms that have occurred, such as deregulating ground handling and substantive changes in airline market structure. These have been driven by a number of factors including importantly a policy direction by the EU on introducing policies which focus on improving economic efficiency and competition. While these issues are interesting and important they are not discussed in this paper. The EU has 28 member states each with their own aviation sector. Despite EU dominance in aviation policy, member states still have significant influence over infrastructure policy. 2 We interpret the EU policy as an effort ot increase economic welfare by first and second best marginal cost pricing. For a more critical view see Rothengatter.(2003) 3 The most recent experiences have been to consider the role of ancillary revenue in complement with aviation revenue in providing an incentive structure to not exercise any monopoly power with respect to on aviation revenue.

extent the current governance structures of the airport industry should be reformed to increase economic welfare. 2. The EU Airport Industry

The EU airport industry has two distinguishing features. First, there are a large number of airports in many member states; in France there are 68 airports, Germany has 48, Greece with 38 and Norway with 51 and Sweden with 44, for example. The full list is presented in Table 1 and not only are the numbers of airports evident but also the proportion of airports that have very little traffic, for example, in France 54% of airports have less than 100,000 passengers annually, in Ireland it is 69% and in Denmark it is 58%. The second feature of EU airports is they are connected with and compete with a well-developed rail system. The rail system has increased the substitutability among airports and serves as a connector for others. 4 Regulatory and governance (privatization) changes have taken place at a small subset of these airports while slot allocation governs a larger number than this subset. The large number of airports has created opportunities for entry by low cost carriers and therefore has increased the opportunity for greater amounts of airport competition than experienced in other countries or regions; perhaps only the UK and U.S. have similar situations of broad geographic coverage and density of airports.
Table 1

Total Number of Airports in each EU Country and Number by Traffic Level Country Austria Denmark Finland France Germany Greece Iceland Ireland Italy Norway Spain Sweden UK < 0.1 million 0 7 10 37 18 16 10 9 11 25 4 21 25 % < 0.1 Million 0.00 0.58 0.48 0.54 0.38 0.42 0.77 0.69 0.31 0.49 0.11 0.48 0.43 0.1 to 1 million 4 3 10 20 10 15 3 2 14 13 16 20 17 % 0.1 to 1 million 0.67 0.25 0.48 0.29 0.21 0.39 0.23 0.15 0.39 0.25 0.44 0.45 0.29 1 to 5 million 1 1 0 8 14 6 0 1 9 5 10 2 11 >5 million 1 1 1 3 6 1 0 1 2 1 6 1 5 Total 6 12 21 68 48 38 13 13 36 51 36 44 58

Source: Williams (2005, data 1995)

Traffic growth within the continental EU has been strong, buoyed by an EU economic recovery, the addition of 5 new member states, a rapidly expanding and developing low cost carrier sector with strong network links to the UK and the eastern EU and the growth of the traditional legacy carrier with their shift in business model to long haul connecting passengers. The EU aviation market is the second

Hubs like Schiphol and Frankfurt have increased their catchment areas and gained market power with their connectivity to the high speed rail system.

largest, after the US, common market in the world and growth within and between the EU and other parts of the world have been well beyond forecasts. In 2004, the total number of passengers transported by air in the EU rose by 8.8%, to 650 million; 24% were carried on national (domestic) flights, 42% on intra-EU flights and 34% on extra-EU flights. 5. This considerable traffic growth has resulted in strains on some airports, most notably the mega-hubs which are reaching capacity limits. In turn this has led to delays, grey markets for slots and pressure to expand capacity, e.g. in Frankfurt. 6 While there are essentially five large hubs in the EU (LHR, FRA, CDG, AMS, MAD, MUN) there are a number of regional airports varying in size from 27 million passengers at Barcelona to 10 million at Hamburg, 10 million at Prague and 7 million at Budapest (all 2004 data). Like the US there are multiple airport groups but unlike the US a group can sometimes include an entire countrys airports, e.g. AENA, a division of the Spanish government, owns and operates all airports in Spain, Finnish Airports group (CAA) owns and operates 25 airports in Finland, LFV (Swedish state enterprise) owns and runs 19 airports in Sweden. Airport groups include Aeroports de Paris, Airports de Roma, and the ANA group, which manages all major airports in Portugal. In Table 2 passenger and freight transport numbers, are listed for 20 of Europes top airports including the growth in traffic from 2003 to 2004. 7 It is clear from this table that the growth in passenger traffic has been remarkable and has been spread across Europe and not concentrated at a few airports. Freight traffic growth has been less evenly distributed reflecting the relative growth in freight carried by integrators; the significant growth at Cologne-Bonn reflects the developments of UPS at that airport, for example. Each country in the EU has jurisdiction over airports and can set rules and regulations. However, if an airport wishes to participate in the European Common Aviation area (ECAA) it must adhere to EU law in the field of aviation. The Guide to Community Legislation in the Field of Aviation provides a detailed list of all legislation, which applies to aviation (European Commission (2006). Such legislation covers eight areas: economic policy, air traffic management, safety, security, environmental matters, social matters, passenger protection, and external relations. The Guide makes the point that such legislation is mandatory for member countries, that there is no possibility of filing differences and perhaps most interestingly, that economic aspects were of particular importance in developing the policy. The EU air transport policy is a policy for the whole of the transport sector meaning all air carriers, airports and air traffic control services. Article 87 of the Treaty has particular application to airports, as well as carriers. Article 14 and Annex III of the ECAA agreement set out the conditions of state aid, specifically such aid was not allowed to distort or threaten to distort competition by favouring agents, undertakings or products. The form of aid may be grants, interest relief, tax relief, state guarantees and preferential access to state provision of goods and services or purchasing. It could also include restructuring aid and exclusive rights concessions. Aid is allowed to be provided under some conditions, such as a regional development program, but such aid must be available to all parties. 8

5. Source: Eurostat (2005) 6. The treatment of secondary slot trading in the UK and the EU are quite different and discussed later in this chapter. 7 UK airports are included for a more complete comparison. 8 The EU has made a distinction between capital and operating subsidies but they have not balanced this distinction across modes or between service and infrastructure. In aviation subsidies can take a number of forms; in Spain (Aena Spanish Airports) loss-making airports are assisted by profitable airports. State governments

Table 2

Passenger and Freight Traffic Top 20 Airports in Europe - 2004

Passenger air transport
Country Airport 1000 Passengers 20032004 Country Airport

Freight Transport
1000 tonnes Growth 2003-2004

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20


London, Heathrow Paris-Charles de Gaulle Frankfurt am Main Amsterdam-Schiphol Madris-Barajas London-Gatwick Rome-Fiumicino Munich Barcelona Paris-Orly Manchester London-Stanstead Palma de Majorca Copenhagen-Kastrup Milan-Malpensa Dublin Stockholm-Arlanda Brussels-National Dusseldorf Vienna-Schwechat

67,110 50,951 50,700 42,425 38,155 31,392 27,160 26,601 24,354 24,049 20,970 20,909 20,363 18,889 18,419 17,032 16,467 15,445 15,092 14,711

6.2 6.1 5.6 6.6 7.9 5.0 6.6 11.1 8.3 7.1 7.4 11.7 6.5 7.6 5.4 7.9 7.7 2.3 6.6 15.7


Frankfurt am Main Amsterdam-Schiphol London, Heathrow Paris-Charles de Gaulle Brussels-National Cologne-Bonn Luxembourg Milan-Malpensa Madris-Barajas East midlands London-Stanstead London-Gatwick Munich Vienna-Schwechat Manchester Rome-Fiumicino Bergamo-Orio al Serio Helsinki-Vantaa Genoa-Sestri Athens

1,827.3 1,467.0 1,412.0 1,275.8 660.4 621.9 616.6 36.6 352.8 277.2 239.0 226.9 192.4 158.1 153.3 139.6 129.6 118.0 111.4 104.1

11.2 8.4 8.6 6.9 8.9 17.3 2.3 13.3 19.1 16.8 17.9 -2.8 17.8 24.5 21.9 -14.6 1.3 33.9 -20.8

Source: Eurostat (2005)


Airport Ownership and Privatization

Airports, as has transportation infrastructure in general, have been seen as 'public assets' suitable for promoting economic development. They have also been seen as a means of protecting a countrys national carrier in the face of increased liberalization. It is therefore not surprising that many airports in Europe are or have been owned by a level of government; national, state or local. For example, Spain, Portugal, Sweden, Ireland and Greece each own all airports in their countries while Germanys airports (larger ones) are owned by state or local rather than national governments. French regional airports are owned by the central government but are managed by local governments. However, this picture is changing as the EU has been one of the leaders in reforming ownership policy and regulations affecting airport infrastructure and the shift in airport policy were seen as a progressive move to improving economic efficiency and liberalizing access in the EU. 9 While not following the UK model of complete privatization, there has been minority selling of airports in Hamburg, Frankfurt, Dsseldorf, Rome, Copenhagen, Zurich and most recently Paris. The sale of a majority share of Budapest airport was completed in early 2006. 10

have provided assistance to airports; Schiphol, Charleroi and Strasbourg are examples ( see Cranfield University (2002) and Morrell, P. (2006). 9 Only Australia and New Zealand have been more aggressive in moving to privatization and the reliance on market forces to deliver airport services. 10 Infratil has recently purchased Lubeck Airport in northern Germany and other regional airports will move to full or partial privatization as the EU expands. In the new states of the EU, Malta International is 40 percent state owned and Slovenias Ljubljana is 49 percent state owned. Similar trends are taking place in many developed

Governments have had several motives for privatization, including a desire to stimulate more efficient performance from their airports. Airports which remain publicly owned are often corporatized, meaning that they are expected to behave more like private corporations. Privatization can be expected to alter the incentives faced by the airports owners. Thus privatization combined with strong incentive regulation, can be expected to give the owners an incentive to keep costs low and achieve productive efficiency. However, privatization is an opportunity for governments to convert fixed assets into cash. While most economists see no particular merit in this, some governments see the additional cash as desirable. This motive might explain why governments shelter private airports in many cases from competition 11 and effective regulation, an issue discussed below. Privatization does not necessarily involve higher airport charges since if the airport remains in government ownership, the government can choose to increase charges when and if it so desires. If fact, privatization limits the governments ability to raise more revenue from its airports, since it involves giving up control over their pricing. Governments will often increase rates and charges just before privatizing their airports- this is their last opportunity to do so. While privatization does not necessarily mean higher airport prices, the co-incidence of the two can lead many to associate privatization with higher prices. Airport privatization gained momentum in the 90s with the first wave of privatization of Vienna (share of 27 %) in 1992, Copenhagen (25%) in 1994, Athens (45%) in 1996, Dusseldorf (50%), Rome (45.5%) and Naples (65%) in 1997, Skavsta Stockholm (90 %), Florence (39%), Turin (41 %), Hamburg (36%) and Zurich (50%) in 2000 and finally Fraport (29%) in 2001. The crisis of aviation from 2001 onwards more or less broke this wave and only recently has the process seems to start off again with the partial privatization of Brussels, Budapest, Bratislava, Lbeck, Malta and Paris in 2006. Very often full privatization is restricted as the former public owners want to secure certain political interests to be guarantied by a golden share or a wide ownership clause. Currently at most airports the private owner has only a minority stake either in form of a stake of up to 49 % signalling private public partnership in roughly equal terms or in form of a minority of less that 25 %. Only the airports of Bratislava, Brussels, Copenhagen, Malta, Vienna (50 % plus 10% employee foundation) are privately owned by a majority share. No major airport in Continental Europe has been fully privatized without any ownership restrictions. Only for Ireland, Netherlands and Malta are there strong expectations that airports will be partially or completely privatized. Parallel to the privatization process public European airports have changed their governance structure as well. The federal government of Austria for instance has not only sold its 50% stake in Vienna airport but also the 50% stake in regional international airports such as Graz, Innsbruck, Linz to regional and local administrations (Schneider, 2004, 150). Other countries like the Slovak Republic have done the same. In the public sphere, where airports have yet to be privatized, we observe different owners at the various levels of the state from the level of the municipality, to the region and up to the central

and developing countries around the world, 11 Privatisation has not lead to more airport competition as the examples of BAA and ADP sold under common ownership and the takeovers of Frankfurt with Hahn and the failed takeover of Vienna with Bratislava show. The privatization of Bratislava was stopped due to a change in government by the anti monopoly office of the Slovak Republic in September 2006. Before the takeover was permitted under some conditions by the Austrian catell office. In early 2006 Erste Bank commented that profits from Bratislava/Kosice will be low but it is still better to pay a high price and receive low contributions thant let a strong competitor grow next door (2006, p. 1). Erste Bank estimated that the purchasing price of 525.7mn includes a premium of 359mn.

government. At the lowest level, the city government is typically the owner of the airport. In federal states such as Austria and Germany the regional state also has a share in the airport. In other countries airports are owned by the central government either fully, or partially. While there seems to be less change within the ownership of public airports the owners have adopted new organizational structures over the past three decades. To this point privatization has not changed the nature of the industry as in the UK, but it has made the airports more profit orientated. This has contributed to some cost cutting efforts especially in ground handling and to the development of non aviation business. ADP is a typical example of partial privatization to develop retail and retail business which have been neglected by the public utility type of airports management. Privatization has not lead to a strong tendency to increase aviation revenues by differentiated price structures and peak pricing. Figure 1 illustrates the distribution of privatized airports in the EU,

including the UK.

Figure 1

Fully privatized airports Partially privatized airports with a majority share Partially privatized airports with a minority share

Malta International Airport has been

partially privatized as well (Minority share privatization)


Airport Regulation in the EU

A number of larger privately owned airports, and some publicly owned airports in the EU are subject to explicit price regulation. Many smaller airports are not directly regulated but for some there is a threat of regulation, and for others, particularly regional airports, competition limits the market power they might have. Regulation of airports in Europe takes several forms. Some airports are subjected to old style rate of return regulation, or essentially cost based regulation. More recently there has been a trend towards implementing price-cap regulation when airports are privatized or semi-privatized. Price cap regulation sets an overall limit in the allowed average price increase. This differs from rate of return regulation 6

which seeks to regulate individual prices. 12 Price caps can be regarded as a form of incentive regulation, though the strength of the incentives varies. The price cap can be under a single or dual till regime; under a single till all revenues are considered when setting the price cap while in a dual till only revenues derivative from aviation operations (landing, passenger and parking charges) are considered. Some price capped airports are subject to regular cost based resets, and this form of regulation can be seen as a combination of cost based and incentive regulation (or hybrid regulation). The single till principle was recommended by ICAO and has been widely used in Europe, but this long tradition is slowly breaking down. The price cap for Hamburg Airport was the first to be set on a dual till in 2000 on the argument that regulation should be confined to the monopolistic bottleneck and incentives for developing the non-aviation business should not be stifled (Niemeier, 2002). In 2001 Malta airport followed with dual till price cap and most recently Budapest airport has adopted a dual till price cap for the period 2006 - 2011. Brussels Airport being regulated on a rate of return basis with some yardstick elements has defined a stepwise move from the single to the dual till over the next 20 years. The regulatory framework for ADP sets some mixed incentives to develop non aviation business. One might think that the French government may have an interest to develop this business as this increases the value of the airport. However, the chosen regulatory framework is a single till with a vaguely defined option to take part of real estate and retail income out of the till in the next regulation period from 2011 to 2015. 13 The differences are mainly due to different degrees of non-aviation business left out of the till. In Europe airport charges have traditionally been regulated on a rate of return or cost plus basis. We differentiate between cost based regulation, pure price caps, hybrid price caps and revenue sharing agreements; a detailed table is contained in Appendix A. To begin a number of airport authorities regulate airport charges according to principles of cost relatedness. The charges should create just enough revenues to cover total costs including the depreciation of capital and a normal rate of return on capital. The structure of charges should also be cost related, namely each charge should reflect its costs. In Europe many of the public airport systems like Greece, Poland and Finland set their charges in this way. Charges are supposed to be set according to ICAO principles of cost relatedness. CAAs and Departments of Transport which operate and manage airports directly follow this principle. In the case of formally privatized airports such as most German airports the regulator approves charges only if they are cost related. The problems with cost based regulation are twofold. Firstly, the lack of incentives to minimize overall costs generally leads to an inefficient choice of inputs and secondly, cost based regulation leads to an inefficient price structure (Sherman, 1989). Under cost based regulation the airport has no incentive to minimize costs because if costs go up the airport suffers to loss since industry prices can be increased. Secondly, an airport with peak traffic has no incentive to price efficiently and adopt peak pricing, but rather to lower the price of capital intensive peak demand in order to justify more capital assets, and charge a monopoly price at off-peak times to realize a profit that greater capital will justify (Sherman, 1989). The incentives at cost based regulated airports lead to average cost pricing with no consideration for peak and congestion pricing. Weight related charges are kept even if demand outstrips capacity at peak times or over the entire day; among the six busiest European airports Dsseldorf, Frankfurt, Madrid and Paris Orly have weight related charges (Forsyth and Niemeier, 2003).


Price cap regulation is defined more thoroughly in a subsequent section. 13 Morgan Stanley (2006) values the ADP in different scenarios between 38.1 and 127.1 per share.-

Price cap regulation involves setting an allowed average price increase plus or minus a value X where X is generally some measure of expected productivity growth. The allowed average price increase is commonly set according to a widely available price index such as the consumer price index (CPI). This is referred to the RPI-X formula where RPI is the of price increase and X is the limiting offset. The value of X is determined by the regulator based on a range of criteria including, for example, whether the industry is high or low productivity, the performance of the firm in the previous regulated period and whether the regulator wishes to incentivize the firm to reduce costs. Unlike cost based regulation price caps do not regulate profits, but set incentives for cost reduction. The gains from cost reduction can be kept by the regulated airport within the regulation period and might then be passed on to the users via lower charges in the next period. Quality might be monitored or regulated since the airport might try to achieve cost reductions by lowering quality. A criticism of price cap regulation is its short run focus and lack of incentive to invest. Pure and hybrid price caps differ in the way in which the X in the price cap formula is set; a pure price cap sets X without reference to the costs of the airport regulated but may set it with reference to a broad airport benchmarked cost while hybrid price caps set the X with reference to a regulated cost base. 14 Hybrid price caps provide fewer incentives for cost reductions. For European airports none of the regulators have developed a pure price capping system. The price caps at ADP, Copenhagen and Dublin are based on costs. Most important price cap regulation does not regulate the charging structure according to arbitrary cost allocations based on historic costs. Revenue sharing agreements in the European airport industry often relate the level of charges to the passenger growth over a certain period. These so called sliding scales can be combined with price cap regulation as in the case of Hamburg (Immelmann, 2004) and Vienna. At two German airports Frankfurt and Dsseldorf the revenue sharing agreements are the result of Memorandum of Understanding between the airports and its users legalized as a public contract between the airport and regulator (Klenk, 2004). In case of disagreement the charges would be fixed according to cost based regulations. The core of these contracts is a revenue sharing agreement. The average charge per passenger will be determined by the future passenger growth rate. At Frankfurt airport, for example, both parties agreed that with a projected growth rate of 4% average charges could be raised by 2%cent. 15 In the case of a higher growth rate airlines participate with a 33% share in additional revenues. With lower growth rates the airport cannot fully compensate revenue losses through higher charges. Only 33% of the loss can be compensated. The agreement results in a sliding scale of airport charges that is related to passenger growth. Such agreements have the important advantage that they break with the tradition of low powered cost plus regulation. Within the contract period, the airport may behave as though it is subject to a price cap, though not of the CPI-X form. Furthermore, at first sight they offer some stability if demand fluctuates. A demand shock leads to higher charges so that the airport can cover average costs as to avoid bankruptcy, which would undermine the political stability of regulation as well. However, there are disadvantages. Firstly, in the cases of Frankfurt and Dsseldorf the incentives for cost reduction and for traffic increase are rather mild as the level of charges is stabilized at a high level. It could be that for example Fraport prefers the contract to the cost plus regulation because the rate of return on the aeronautical assets is higher than the normal rate of return accepted by the cost related regulation.

14 Hybrid price cap regulation is superior to cost based regulation because it is forward looking while cost plus regulation relies on historic costs. 15 Note that these are nominal prices as the agreement is not related to the price level.

Secondly, a flat linear sliding scale guarantees the airport nearly the same revenues irrespective of output. This reduces the incentives to differentiate charges and increase output. Thirdly, it usually creates an inefficient price structure; fast rising demand leads to lower charges and lower demand to higher charges. One key issue surrounding price setting at airports is the independency and transparency as to the institution and basis of how rates and charges are set; there is an independent regulator established in only the Netherlands. Interestingly very often countries are privatizing their airports without avoiding conflicts of interest. In Austria Vienna airport was privatized in three steps in 1992, 1995 and 2001. Up to the last step the central government held a major share and regulated the airport charges. German airports are regulated by the federal states that have a minority or majority share in the partial privatized airports of Frankfurt, Hahn, Hamburg and Hannover (for further discussions see Niemeier, 2002). A fair, accessible and open process requires as a minimum a consultation process. In the past 15 years more and more European states have implemented a consultation on airport charges and it has become standard practice today. Still there is room for improvement as in most consultation processes the airports do not provide the necessary information to make a decision on airport charges transparent or plausible to the airlines. The standards of UK regulation which are open even to the general public are hardly met in continental Europe with the exception of Brussels airport in which the regulator demands a consensus among the airport and its main users. This lack of transparency is clearly indicated by the recent decision of Lufthansa to acquire a 9.1 % share in their main hub Frankfurt, so that Lufthansa can obtain a seat on the board of directors in order to be better informed and, by the recent price cap regulation of Aeroports de Paris in which the value of the regulated asset base and the percentage return on capital are not disclosed by ADP or the French government (Morgan Stanley, 2006, p. 4). 16 5. Capacity Constraints and Slot Allocation

Excess demand for airport facilities is evident in the EU as elsewhere. Increasing the capacity of airports is difficult, partly because it is expensive, and partly because such expansion often encounters environmental challenges. As a consequence, there are many airports which face excess demand, some for part of the day, and several, like Frankfurt, for all of the day. In the EU capacity at airports is rationed by means of a slot system. A slot is most commonly known as a landing or take-off right at designated airports during a specified period of time; the definition of and regulations governing slots is discussed below. The IATA (International Aviation Transport Association) scheduling process is a well recognized means of allocating slots and managing demand at slot coordinated airports around the world including the EU; approximately 213 and all international airlines take part in the scheduling meetings which are held twice per year before the winter and summer schedule is announced. Each slot coordinated airport, defined below, has a slot coordinator (termed ASC airport slot coordinator) whose appointment varies from jurisdiction to jurisdiction (see Table 3 for differences between US, Canada and EU).


While it might be very complicated to completely avoid the risk of capture many of the European regulatory systems which do not separate the functions of ownership and regulation and lack transparency and fairness seem to be perfect for regulatory capture. It gives the management of the airport the rare opportunity to influence through the owner the regulator in various ways which in turn lessens incentives for efficiency and might create rents for management and employees.

The allocation and trading of slots follows the following process:

z z z z z z z z

Each airline submits its desired schedule to the ASCs about six months before the start of the season, and the ASCs then allocate slots according procedures The ASCs decisions are formally announced at the start of the relevant international conference and this is also when airlines first see the planned schedules of their competitors. Trading starts, with airlines who did not receive their desired slots seeking to improve their allocations and also ensuring that they have consistent sets of departure and arrival times. ASCs provide information showing slot mismatches and who owns various slots (brokerage role) Airlines may trade slots at the same or different airports alter the type of aircraft flown and the destination (origin) of the flight, subject to the approval of the ASCs. All trades must be authorized by the relevant ASC to ensure that there is sufficient terminal capacity and parking space to accommodate any changes. Trading can be complex, involving many parties in simultaneous swaps of slots. Any slots not used are placed in a slot pool and the ASC allocates these slots under set rules, many governing new entrant airlines.

Slots can be obtained from the ASC from the slot pool and through grandfather rights. Slots can be also be swapped between two or more carriers. This is fairly commonplace among many carriers for scheduling and logistic reasons. Slots can be leased which is more attractive than selling as the holder retains control. They are also useful for short-term agreements with early termination clauses. Slots can be sold but there are relatively few outright sales. There are a number of reasons for this; first, airlines do not hold the property rights to slots only the right to use them and therefore slots are treated as quasi-permanent assets with a sizable amount of risk of loss attached. Second, incumbent slot holders engage in strategic behaviour based on the potential network opportunity costs and knowledge of whom current and potential competitors are. This creates an incentive for hoarding and babysitting. Third, the value of slots is higher as a package than individuallyincumbents if selling will want the full package value of each slot, but potential buyers may not be willing to pay full package value for a single slot. Slots can also be reallocated due to bankruptcy proceedings, as part of a route transfer between carriers, to redeploy slots within an alliance group and to baby-sit surplus slots for current owner. 17 Slot allocation using grandfather rights to capacity, mean incumbent airlines which have serviced a market are given first rights to access airport capacity and generally these rights are provided at no cost. 18 Also, generally, slot allocation is reserved for airports at which demand for capacity exceeds that


Air carriers operating in the EU depend on two provisions in their choice to service new routes at congested airports, namely acquisitions of slots from transfers and/or slot pools. After the primary allocation of slots, airlines are allowed to transfer slots between themselves but only under the supervision of a slot coordinator and under the provisions outlined in Article 8a of the 793/04. Airlines also have access to the slots retrieved by slot coordinators and placed in the slot pool. The rules governing access to the landing and take-off rights placed in the slot pool are outlined in Article 8 of the 793/2004. However, some scholars who? have argued these slots do not possess a high commercial value. As a result, in the UK a compensatory grey market has developed whereby monetary slot transactions are disguised as slot swaps. This situation lead to the EC to conduct an investigation into commercial slot allocation mechanisms at EU airports. Other studies that critically assess the current administrative slot allocation policy and potential benefits of market mechanisms include DotEcon 2001, Nera 2004, Task Force 2005, Madas & Zografos 2005. 18 Available slot capacity is established twice a year before the allocation of slots at the IATA scheduling conferences. This capacity is declared on the basis of a collaborative decision mechanism, where all parties concerned examine all factors, technical, operational and environmental, that affect the throughput performance of airport infrastructure. Once the process of establishing and allocating slots is completed the coordinator is responsible for monitoring and enforcement.


which is available. However, a distinguishing feature in Europe is that the vast majority of airports, even those not capacity constrained are designated as level III airports, meaning that they are slot coordinated. 19
Table 3

A Comparison of Slot Allocation, Rules and Definitions

US Yes, bought/sold EU Not allowed but de facto slots are bought and sold yes Yes but differences in UK and rest of EU Yes, most primary and secondary airports in EU Member states can designate airport as Level 2 or 3 Government body appointment high Effective reduction

Trading allowed

Swaps allowed Secondary trading Part of IATA

Yes, for operational purposes yes


No, anti-trust issues. Level 3 airports are: LAX, JFK, ORD, SFO, EWR FAA sets rule

Co-ordinator Impact on congestion Impact on capacity

airport low Effectively none

In Europe the grandfather rights provision was introduced in the EC legislature as late as 1993, when the Council Regulation (EEC) No. 95/93 on common rules for the allocation of slots at Community Airports became effective. The EU has relied on administrative measures for the most part and refrained from introducing market mechanisms in the slot allocation procedures; the exception being the UK. 20 The 1993 EU Council Regulation underwent only two significant amendments, the last one taking place on April 30, 2004. These changes however, were limited to definitions of certain terms and did not produce significant changes to the slot allocation process. The slot allocation process under the EU legislation is defined succinctly in the EC No. 793/2004 Regulation. Some of the more important clauses are found within Articles 4, 8, and 10. The member states are required to designate a neutral airport coordinator qualified to supervise slot allocation process, transactions, as well as administer penalties to negligent or ill intentioned parties participating in slot allocation in accordance with the EC Regulation (Article 4). In addition the coordinator must take into consideration other rules and guidelines, both international and domestic, conditional on their compatibility with the community law. Any slot exchanges or transfers are considered illegal if

19 A level I airport is one at which there are no slots and no need for co-ordination, infrastructure can be allocated on a first come first serve basis, a level II airport is considered slot facilitated meaning an airline can request the use of the airport facilities (runway and gates, etc.) at a particular time and the airport cannot deny access unless facilities are not available, while a level III airport is slot coordinated, an airline can request a slot but this can be denied by the airport. Clearly the property rights for airport capacity rests with the airline at level II airports and with the airport or slot coordinator at level III airports. 20 Secondary markets in slots were growing strong roots in the United States until revisions with the partial abandonment of the High Density Rule.


completed prior to the approval of the slot coordinator (Article 8). Further, in order to ensure competition is maintained, the service provided by new entrants is protected under Articles 8 and 10. For example, section 3c of Article 8a dictates slots allocated to a new entrant as defined in Article 2(b) may not be exchanged as provided for in paragraph 1(c) of this Article for a period of two equivalent scheduling periods, except in order to improve the slot timings for these services in relation to the timings initially requested. 21 Likewise, Article 10 of the EC document ensures new entrants are able to gain access to an airport by allowing the first half of the slot pool slots to service these requests and only subsequently are the remaining slots distributed to incumbent airlines. Two of the major discrepancies in the EC Regulations between 1993 and 2004 pertain to the interpretation of the words slot and new entrant. In Europe, the word slot means the entitlement established under this Regulation, of an air carrier to use the full range of airport infrastructure necessary to operate an air service at a coordinated airport on a specific data and time for the purpose of landing and take-off as allocated by a coordinator in accordance with this Regulation. 22 23Another radical change in content relates to the word new entrant. The 793/2004 regulation expanded the definition to include the number of slots held by the air carrier as a percentage of the total number of slots available on the day in question as a determining factor of whether the party should be labeled as a new entrant. Fundamental differences in the slot allocation process between the EU and US are contained in Table 3. The acquisition of slots through monetary exchanges is restricted in Europe where the movement towards market-based mechanisms for the allocation of scarce airport resources has demonstrated a greater dependency on administrative instruments. This reliance on administrative rules in mainland EU could be partly attributed to the economic integration of the European Union (EU) having a simple common allocation mechanism - and also to the fear of airline competition being compromised should entry at an airport be left unregulated. As a result the European Commission (EC) exercises the grandfather rule 24 for the initial allocation of slots or otherwise known as the primary market. In the EU slot trading is allowed in secondary markets but not slot sales; the UK has had an active slot trading market since 2001. 25 However, in Europe, the secondary slot market is restricted to slot swaps only. Nevertheless, a recent staff working document developed by the European Commission in 2004 exemplifies serious deliberations of market forces outcomes by the regulatory authorities. 26 There are two recurrent themes amongst scholars and regulators with respect to the grandfather rule criterion (See DotEcon 2001, Nera 2004, Task Force 2005, Madas & Zografos 2005. The first attests that the grandfather rights ordinance stifles competition and nurtures inefficiency in the airline industry. Although incumbent airlines, upon failure to fulfill the requirements of the 80/20 rule, are subsequently obligated to relinquish the relevant landing and take-off rights to the slot coordinator in order to be placed in the slot pool, some argue air carriers have an incentive to strategically utilize these slots even if it would be unprofitable to do so; this practice, is known as slot hoarding.. Naturally, this translates

21 Ibid. 22 Regulation (EC) No. 793/2004 of the European Parliament 23 Note that in contrast to the FAA definition which refers only to runway use, the EU definition does not limit a slot to mean a period of time set aside for the use of the runway space but it also considers the infrastructure needed to complete an arrival or a take-off at an airport and the exchange of passengers. 24 If a slot is used 80% of the time in the previous season by an air carrier the party is entitled to the same slot in the following season. 25 Slot swaps occur in a number of countries where airports are slot constrained and are 26 Commission of the European Communities, Commission Staff Working Document, Brussels, 17.9.2004


into a crippling effect on the ability of new entrants to countervail the market power of incumbent airlines. 27 The alternative view maintains the regularly observed slot abuses, against which better safeguards are recommended, are not the result of anti-competitive behaviour but rather examples of the business environment in which airlines are required to operate (Bauer 2005). Some of these inefficiencies which are generally cited as airline misconduct include late hand-backs and no-shows. Firstly, owing to the uncertainty associated with receiving the corresponding slots, it could be argued airlines are compelled to hold on to these assets, sometimes past the return deadline, while they wait for confirmation for landing rights at other airports. Secondly, no-shows could occur due to negligence and intentional wrong-doing, but both are punishable by the slot legislation. However, these events amount to an insignificant 0.5% of total capacity and a solution to eliminate this behaviour would not greatly improve capacity utilization (Bauer 2005). Presently there are several unfavourable characteristics of the EU grey market that could be corrected through legalization. The slots are traded mostly among the members of each alliance and as alliances expand so does the effortlessness to maintain this cycle. The lack of a public notice for each intended sale or purchase means many potential buyers and sellers are excluded from the trading table. Furthermore, the uncertainty that accompanies the events in the grey market, especially amongst foreign air carriers, has lead to acquisitions of the entire business of airlines. In response to the fear expressed by policy-makers over legalization of the grey market, the EU Competition Authority argues the extant competition law is sufficient to correct or prevent anti-competitive behaviour, such as intraalliance transactions and slot hoarding, which would have a far greater chance of being correctly applied if the monetary slot transactions were not shrouded in secrecy. The consequence of relying on slot allocations based principally on grandfather rights is there are no signals to either allocate scarce airport capacity or to indicate how much and what type of investment in new capacity should be undertaken. 28 6. Summary and Conclusions

This paper has examined three key areas in airport management and policy in the EU; privatization, regulation, and slot allocation and management. It analyzes the major trends of economic and institutional change over the last two decades. These changes raise two fundamental policy questions. Firstly, will the goal of fair and efficient pricing be achieved given the current trends of aviation liberalization, privatization and competition? If so, the major policy reforms of European aviation would be deemed to be successful. However, if the current trends do not move in the direction of achieving the goals major policy reforms are necessary in order to increase efficiency of the system. This leads to a second question; what are the options for policies regarding slot allocation and economic regulation of airport charges? These questions are summarized in Table 4. It summarizes the trends and tendencies of the changing governance on cost efficiency, efficient use of airport capacity, and optimal investment The EU has been one of the leaders in moving to greater privatization coupled with regulatory changes. The underlying forces for this shift in governance lie in several areas and include an integration of aviation policy into general transport policy and the movement of transport policy to rely on competition laws to discipline the behaviour of firms rather than rely on government ownership. There is in addition

27 28 The secondary markets at airports in the UK has improved efficiency of slot use but discouraging the development of such markets in mainland Europe has led to inefficient airport resource use and less effective grey markets.


the growing congestion and the recognition that financing and pricing new infrastructure may well require more private sector ownership and management. The numerous airports in the EU spread across member states also provide a sense of comfort, rightly or wrongly, that major airports will not be able to exploit their market power. This will of course depend on whether large markets are getting larger or if there are more markets. Evidence suggests it is the latter.
Table 4

Options for Policies Regarding Slot Allocation and Economic Regulation of Airport Charges
Cost efficiency Commercialization of public airports Some incentives to reduce X-inefficiency Efficient rationing Some efforts for efficient pricing, but also for use market power Mild efforts for efficient pricing but also for use of market power Use of market power limited by non aviation complementarity Inefficient and low utilization of capacity. Optimal investment Over-investment

Partial Privatization

Mild cost cutting

Tendency to over invest

Full privatization

Tendency to cut costs

Sweetening of assets, careful investments

No slot reform

No incentives. High switching costs. Slot rent captured by incumbent Increases airport competition Gold plating and high transaction costs Incentive to reduce Xinefficiency and to develop non aviation

Price does not signal investment.

Slot reform

Efficient rationing of existing capacities No peak pricing, inefficient price structure Incentives for price differentiation and peak pricing

Price does signal investment. Over-investment

Dependent regulator with cost based regulation Independent regulator with incentive regulation for monopolistic bottleneck (dual till)

Less over-investment if regulator is committed

In continental EU we have observed a strong shift to the commercialization of public airports and a slow tendency towards privatization. Overall this has set incentives for airport management to achieve the goals of efficient pricing, but these incentives are rather weak and could be strengthened with full privatization. Commercialization sets some incentives to reduce X-inefficiencies but the management of partial privatized airports face stronger pressure from owners to reduce costs especially if the public owner is in the minority. Efficient rationing could be achieved by efficient airport charges, but thus far


commercialization and privatization has not resulted in peak and congestion pricing. 29 Privatization also sets strong incentives to raise charges as management objectives shift from ensuring service and access to maximizing shareholder returns, albeit with regulatory constraints in most cases. In our view the key elements of policy reform in the EU are the question of economic regulation of airports and slot reform. 30 EU policy could leave regulation as it is or demand substantial changes. We examined dependent and independent regulators. A dependent regulator with cost based regulation we found has led to x-inefficiency and gold-platting, inefficient price structures with no peak pricing and overinvestment. It appears the prevailing system of European airport regulation is not only setting the incentives too low, but in the wrong direction. Airport pricing does not reflect the relative scarcity of airport and airway resources and this might distort airline competition and lessen the welfare gains of liberalization. On the other hand, with an independent regulator with incentive based regulation and dual till, we find there is an incentive to reduce x-inefficiency and to develop the complementary non-aviation business revenue. There are incentives for price differentiation to increase traffic and to manage demand through peak pricing. Underinvestment might occur but can be prevented by a committed regulator. The current debate on reform of charges and slots is a sign of intensified conflict between airlines and airports (IATA 2005, ACI, 2006). Slot allocation will not go away even with airport expansion; there will always be a need to have some basis of allocation. Issues of equity, efficiency and competition are all intertwined in such methods of allocation. The [continental] EU clearly favours administrative rules and despite a growing grey market in the EU argues slot trading is not appropriate for improving the system. This approach would seem to protect incumbent, particularly current or former, national carriers. The EU slot coordinators have stated they feel the current system is working and the issue is more one of fine tuning and adding capacity than a wholesale change in the IATA approach; the IATA process protects status quo, entrenches incumbents, is anti-competitive, and is generally blocking effective entry. However, the DG of the EU Competition Authority has indicated they, the Competition Authority, favours a shift toward market mechanisms. As a replacement of the grandfather rule, some measures might completely redefine the initial allocation of slots through the creation of an ongoing and anonymous primary market, such as slot auctions. The move to policy and regulatory reform for airport infrastructure in the EU was driven by many forces. The move to privatization was important for airports but underlying this was a move to more shareholder value focused owners. Regulatory indecision was stimulated by the lack of agreement on regulatory principles or even recognizing the problem associated with regulation. Governments also saw airports as cash cows and permitting higher charges. There was a growing awareness by airlines and IATA that airlines were paying a good deal more than they should for airport services. There were glacial moves to reform slot trading and generally a lack of interest in making efficient use of the existing capacity. There have been very few moves to improve decision-making over investment.

29 30

As in other jurisdictions, efficient pricing is opposed and challenged by airlines as monopolistic behavior. Of course, this is not sufficient for social marginal cost pricing as the internalization of externalities should be tackled by the appropriate environmental instruments, but this is a different topic


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Appendix A Country Airport Independent Regulator Yes, since 2001 No Type of Regulation Single or Dual Till

Austria Belgium

Vienna Brussels

Price cap with sliding scale Rate of return with yardstick elements Charges set by airport

Single till Single till, gradually introducing dual till n/a

Czech Republic Estonia Denmark Finland



Tallin Ulemiste Copenhagen Helsinki

n/a No No

Cost regulated Price cap No regulation, charges based on cost recovery Hybrid average revenue based price cap Price cap with sliding scale (HAM), revenue sharing (FRA,DUS) All other airports are cost plus regulated

n/a Dual till No




Single till




Dual till in HAM and FRA, All other Single till


Greece Hungary Ireland Ireland Italy Latvia Lithuania

Athens Budapest, Ferihegy Dublin Dublin Rome Riga Vilnius

No No Yes Yes No n/a n/a

Airport sets own charges Price cap Price cap revenue based Price cap revenue based Airports set own charges n/a n/a

Dual till Dual till Single till Single till Dual till n/a n/a


Malta Netherlands

Malta International Amsterdam

n/a Yes

Price cap Rate of return with weighted average cost of capital as asset base Cost based n/a Cost based n/a

Dual till Dual till

Norway Poland Portugal Slovak Republic Slovenia Spain Sweden Switzerland United Kingdom

Oslo International Airports ANA Bratislava

No n/a Yes No

Single till n/a Single till n/a

Ljubljana AENA Stockholm Zrich, Geneva BAA

n/a No n/a n/a Yes

Not Regulated Cost based Cost based Not regulated Price cap

n/a Single till Single till n/a Single till

Sources: Davy, European Commission (2006a), Graham, Cranfield, IATA, Airport websites, TRL