Journal of Air Transport Management 17 (2011) 347e353

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Journal of Air Transport Management

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Airporteairline vertical relationships, their effects and regulatory

policy implications
Xiaowen Fu a, *, Winai Homsombat a, Tae H. Oum b, c
a
Faculty of Business, Hong Kong Polytechnic University, Hong Kong, PR China
b
Sauder School of Business, The University of British Columbia, Canada
c
College of Business, Embry Riddle Aeronautical University, FL, USA

a b s t r a c t
Keywords: This paper examines the forms and effects of vertical relationships between airports and airlines with
Airporteairline relationship a focus on the North American and European aviation markets. We find that such vertical relationships
Vertical cooperation
enables those participating to achieve various benefits and may be formed as a competitive response
Airport economics
to other competing airporteairline alliances. In some cases, vertical airporteairline relationships
strengthen the hub status of major airports, leading to increased employment and service quality in local
markets. On the other hand, preferential treatment of a particular airline by an airport may enhance that
airline’s market power, allowing it to dominate the airport and charge hub premiums. The competition
and welfare implications of airporteairline vertical alliances can be complicated and two-sided, subject
to the influences of other factors such as the market structures of the airline and airport markets.
Ó 2011 Elsevier Ltd. All rights reserved.

1. Introduction While potential “synergies” can indeed be achieved via air-

porteairline alliances, such vertical relationships can also have
With the growing trend of commercialization and privatization, negative impacts. Given that airports represent one of the essential
airports have been under growing pressure to be more financially inputs for airlines, cooperation between an airport and a particular
self-sufficient and less reliant on government support. In markets airline may raise anti-competitive concerns. Although the effects of
where multiple airports serve significantly overlapping catchment vertical relationships between firms have been studied extensively
areas, competition among airports is now seen as possible. The in the general economics literature, most of the conclusions reached
public utility status of airports has been fading at a time when cannot be directly applied to the air transport industry. Public
airports are increasingly being operated like a business. These airports do not necessarily regard profit maximization as their only
changes have not only introduced strong incentives for airports to or most important objective. Even in markets where airports have
increase revenue and reduce costs, but have also encouraged been commercialized and/or privatized, various regulations or
airport managers to explore new business strategies as their busi- threats of regulation exist, thus preventing airport managers from
ness environment goes through a process of dynamic change. One adopting certain business strategies (e.g., price increases).
such business strategy is to form various vertical relationships with Here we review the alternative forms of vertical relations
downstream airlines by awarding signatory airline status, signing between airports and airlines with a focus on the North American
long-term contracts, allowing them to control key airport facilities, and European markets. We further investigate the effects and
issuing airport revenue bonds, and sharing revenue with airlines. regulatory policy implications of such vertical relationships, which
Many airlines prefer to establish long-term relationships with can be complex and two-sided.
airports to allow them to concentrate their flight operations in
a few facilities by forming a hub-and-spoke network and to achieve
2. Forms of airporteairline vertical relationships
other strategic objectives. Without securing support from airports,
it is difficult for airlines to implement such strategies successfully.
Many airports have developed close relationships with airlines
That is, both airlines and airports may have incentives to enter into
despite of the fact that their interests may be conflicting to each
cooperative relationships to create a winewin situation.
others’, especially with regard to aeronautical service charges.
Some of these relationships are exclusively between an airport and
* Corresponding author. its dominant carriers that control significant market shares at the
E-mail address: [email protected] (X. Fu). airport. In practice, the following relationships are found.

0969-6997/$ e see front matter Ó 2011 Elsevier Ltd. All rights reserved.
doi:10.1016/j.jairtraman.2011.02.004
348 X. Fu et al. / Journal of Air Transport Management 17 (2011) 347e353

2.1. Signatory airlines of airports Airport, Ryanair invested $10 million in construction of a low-cost
terminal.1
Many governments now require airports to be financially
independent. Because these airports are free from government 2.3. Long-term use contracts
subsidy, many have chosen to work with airlines. Carriers that sign
a master use-and-lease agreement are awarded so-called signatory In many cases, airlines and airports cooperate via long-term
airline status. These airlines become the ultimate guarantors of the contracts. Such agreements award incumbent carriers the right to
airport’s finances. In the case of a ‘residual’ agreement, the signa- airport facilities regardless of usage, and allow these airlines to
tory airlines pledge to cover the full cost of airport operations sublease airport facilities to other carriers. The US Federal Aviation
required for the airport to break even. Aeronautical service charges Administration (1999) concludes that many full service airlines
are determined according to the ‘residual cost’ remaining after (FSAs) have long-term control over airport gates at their hubs: US
revenue from non-signatory airlines and non-aviation sources has Airways has leased 37 gates at the Charlotte Airport until 2016. At
been deducted from the airport’s costs (debt service costs, interest, Cincinnati, 50 gates are leased to Delta, with eight of these leases
and operating expenses). Signatory airlines may end up paying due to expire in 2015 and 42 due to expire in 2023. At Minneapolis,
lower charges than non-signatory airlines. Table 1 shows some of 54 gates are leased to Northwest, with 22 of these leases due to
the airport handling charges levied at the SeattleeTacoma Inter- expire in 2015 and 32 having been converted into preferential use
national Airport in 2010, where signatory airlines pay lower rates leases in 1999. In recent years, some low-cost carriers (LCCs) have
than non-signatories. also entered into long-term contracts with airports. Many
The main contribution made by signatory airlines is a service secondary airports offer LCCs favorable usage terms to attract their
guarantee and use commitment that reduces the uncertainty traffic. However, once an airline incurs sunk costs in establishing
surrounding future airport revenue and thereby allows the airport services out of the airport, it may lose bargaining power because of
to reduce its financing costs when securing long-term loans. In possible high cost of switching to a new base. Therefore, many LCCs
return, signatory airlines are given varying degrees of influence choose to sign long-term contracts with airports to lock in favorable
over airport planning and operations including slot allocation, the terms. Long-term contracts can also be beneficial to airports. They
use of terminals, capacity expansion projects, and exclusive or encourage airlines to make long-term investments and to develop
preferential use of facilities. While agreements between airports more extensive networks, thus securing airport traffic in the long
and signatory airlines are most common in the US, similar agree- run. Most airports are therefore willing to sign such long-term
ments have been also been adopted in Australian airports such as contracts. For example, Melbourne Airport and Virgin Blue,
Sydney and Melbourne (Barbot, 2009a). a leading Australian LCC, reached a 10-year agreement in 2002 for
the airline to operate from the former Ansett/Southern domestic
2.2. Airline ownership or control of airport facilities terminal.

Some airlines hold shares in airports or directly control airport 2.4. Airport issuance of revenue bonds to airlines
facilities. Such direct control allows carriers to optimize terminal
operations and to share the revenue generated from concession Many airports now choose to issue special facility revenue
services. For example, Terminal 2 of the Munich Airport was jointly bonds (SFRBs)2 to finance specific capital improvement programs
funded by the airport operating company FMG (60%) and Lufthansa such as fuel farms, maintenance facilities, and terminals. In such
(40%), the dominant airline at the airport. This form of financial project financing arrangements, airports retain ownership of their
participation entitled Lufthansa to exert significant influence over assets, but transfer the right to their exclusive use to the project
and determine matters related to planning and completion of the sponsor under a long-term lease agreement. Tax-exempt SFRBs are
terminal. These matters were dealt with in light of the airline’s exclusively secured by the revenue stream from the project in
requirements and by engaging its personnel and integrating the question, which is guaranteed by the project sponsor. The airport
airline’s alliance partners (Albers et al., 2005). In addition, profits has no obligation to SFRB bondholders in the event of default. For
generated from the terminal, including those from leasing areas example, Terminal E at Houston Airport was built for Continental
used for catering and retailing (the terminal has about 110 stores Airlines, which uses the airport as an international connection hub
and restaurants), are shared by FMG and Lufthansa (Kuchinke and and a Latin American gateway. The airport issued a $323.5 million
Sickmann, 2005). JetBlue invested $80 million in Terminal 5 of the SFRB in 2001. Rent paid by Continental secures the bonds and
New York JFK Airport to be used by the airline under a 30-year lease bondholders have no access to liquidity to avoid default if Conti-
agreement. When establishing its operating base at the Bremen nental fails to make timely debt service payments. In another
example of SFRBs, the Dallas Love Field Airport is implementing
a major modernization project with a budget of $519 million.
Table 1 Southwest Airlines, the dominant airline at the airport, guarantees
Air Cargo Handling Charges at SeattleeTacoma International Airport.

Signatory rate Non-signatory rate

1
Air cargo operational feesa Many airlines control or own airport facilities, especially in their domestic hubs.
Landing Fee $3.00 per $3.30 per Qantas owns terminals in airports in Sydney and Melbourne. In 1994, a consortium
1000 lbs MGLW 1,000 lbs MGLW of Air France, Japan Airlines, Korean Air, and Lufthansa invested in Terminal 1 of JFK
Fuel/Gallonage Fee Not applicable $0.07 per gallon International Airport in New York. Some logistics carriers have also made major
investments in their operating hubs: UPS invested $125 million at the Shanghai
Pudong International Airport and is investing another $180 million at Shenzhen
Schedule of common gate per-turn chargesb
Baoan International Airport; FedEx invested $190 million in its new Asian Transit
Wide body, 200 þ passengers $1066.00 $1172.60
Center at the Guangzhou Baiyun Airport, entitling the carrier to establish its own
Narrow body, 100e199 passengers $592.00 $651.20
control tower. DHL has long maintained its distribution hub at the Hong Kong
Regional, 50e99 passengers $414.00 $455.40
International Airport. In 2009, TNT opened its S$20 million regional hub at the
Commuter, 0e49 passengers $237.00 $260.70
Singapore Changi Airport.
a 2
Port of Seattle, effective May 1, 2010. In general, there are general airport revenue bonds (GARBS), special facility
b
SEA-TAC International Airport Tariff No.1, effective Jan 1, 2010. revenue bonds (SFRBs), and PFC-backed bonds.
 X. Fu et al. / Journal of Air Transport Management 17 (2011) 347e353 349

the SFRB issued for this project. With SFRB arrangements, the during the 1998 to 2000 in which average aeronautical revenue at
airport transfers much of the risk associated with the airport major airports in Europe was over $8 per passenger (Barrett, 2004). In
project to airlines. In return, these airlines are given preferential or 2001, Belgium’s Charleroi Airport signed an agreement with Ryanair
exclusive rights to key airport facilities. De Neufville and Odoni offering favorable conditions to enable the airline to quickly expand
(2003) in reviewing the status of airport revenue bonds find that its operations there. In comparison with published rates, Ryanair, for
national laws in many countries do not permit airports to issue example, enjoyed a 50% discount on landing fees and paid 10% of the
revenue bonds, although some European countries are exploring published handling charges. The airport also provided financial
this new approach, which is common practice in the US. support for the opening of Ryanair’s base and for advertising and
other forms of promotion of the airline’s flights (Barbot 2006).
2.5. Revenue sharing between airports and airlines

In recent years, airports have relied increasingly on concession 3. Competition concerns: airport dominance
services3 to bring in more revenue. Because these operations and the hub premium
depend greatly on the passenger throughput of an airport, there are
complementarities between the demand for aviation services and The effects of vertical relationships between firms have been
the demand for concession services. However, if airlines were studied extensively in the economics literature. For example,
unable to benefit from concession sale activities at airports, they vertical cooperation/integration may have positive efficiency
would ignore such a demand externality in making their decisions. effects such as the removal of double-marginalization (Tirole, 1988)
An increasing number of airports have started to internalize this and the coordination of optimal production and inventory levels in
externality by sharing their revenue with airlines and thereby supply chains (Cachon and Lariviere, 2005). Similar “synergy”
inducing them to bring in more passengers. For example, the effects have been identified in the airporteairline vertical rela-
Tampa International Airport has been sharing revenue with airlines tionships. On the other hand, vertical integration among firms may
since 2000. In 2006, it shared 20% of its net revenue with its have negative effects on competition, such as market foreclosure
signatory airlines. The Greater Orlando Aviation Authority (2010) is and price squeezes.
also implementing similar revenue sharing arrangements covering The competitive effects of vertical relations between airlines and
the 2009 to 2013 fiscal years. The revenue remaining after satis- airports have received little attention in the literature thus far. This
fying all requirements is divided between the parties, with 30% is probably due to the fact that the IATA prohibits price discrimi-
allocated to signatory airlines and 70% allocated to the airport nation in airport aeronautical services. This restriction, together
authority in the 2009 and 2010 fiscal years, and respective shares of with the historical public utility status of most airports, has meant
25% and 75% applying in 2011e2013. The signatory airline share is that airports have seldom been the subject of antitrust investiga-
distributed among the airlines based on each airline’s share of tions until the recent privatization wave. Nevertheless, because
enplaned passengers. In 2002, the Frankfurt Airport signed a five- airports represent one of the essential inputs for airlines, airline-
year agreement with Lufthansa and other airlines. Graham (2008) airport agreements, especially those offering exclusive deals to
describes the agreement as a risk-sharing model, which can also specific airlines, have raised anti-competitive concerns. In partic-
be classified as a type of revenue sharing contract. The agreement ular, such vertical cooperation is likely to strengthen a carrier’s
linked airport charges to traffic growth. The 2001 ratio of airport dominance at an airport, thus allowing it to gain a competitive
charges to the number of departing passengers was used as advantage over other airlines and to charge price premiums.
a reference in setting the terms of the contract. If the forecasted Network carriers have greatly expanded their hub-and-spoke
passenger figures were reached, then the reference ratio would be networks since the US domestic market was deregulated. With the
increased by about 2% annually. If passenger traffic grew faster than massive mergers and acquisitions that followed, major carriers
expected, then the airlines and the airport would share the addi- further strengthened their dominance at hub airports. Dominance at
tional revenue, with two-thirds going to the airport. Conversely, the an airport allows a carrier to achieve a substantially higher mark-up
airlines and the airport were to share the risk if traffic fell below the above cost, a de facto, “hub premium”. Borenstein (1989) in studying
planned level. On the airline side, Ryanair is an example of a carrier airline pricing for local traffic to/from major US hubs in 1987 finds
that has identified airport car parking as one of its business that domination of major airports by one or two carriers results in
opportunities and cooperated with an airport parking company higher fares for those who use them. This phenomenon has been
BCP (Davy Securities, 2006). In its negotiations with some airports, confirmed by subsequent studies, although the hub premiums
it has asked for a share of parking revenue as a condition of initi- calculated have varied from well below 10% (e.g. Lee and Luengo-
ating services. Prado, 2005) to around 20% (e.g. Lijesen et al., 2001). Some studies
have attempted to argue that a dominant carrier usually provides
more frequent and better connecting services at its hub that may
2.6. Other agreements
justify the premiums charged. In addition, much of the difference in
average airfares between dominant hub markets and other markets
The International Air Transport Association (IATA, 1997) prohibits
may be attributable to the differential effects of frequent flier
price discrimination with respect to aeronautical charges including
programs (FFPs), passenger mix, and product differentiation
landing fees. That is, airports are required to charge all airlines the
(Lederman, 2008). However, the US Department of Transportation
same price for identical services. Nevertheless, some airports have
(2001) believes that these rationales that are commonly used to
chosen to enter into exclusive or non-exclusive agreements with
explain away high fares in hub markets apply only if price competi-
airlines in recent years. Such practices are often observed for LCCs
tion is not present. It is the lack of price competition e not these other
that boost airport traffic quickly with low airfares. Ryanair paid an
rationales e that explains high prices in hub markets. The US
average of $1 or less per passenger to eight provincial UK airports
Department of Transportation (2001) 4concludes that “from
a consumer perspective, the primary disadvantage of network hubs is
3
Concession services refer to non-aircraft related operations in terminals and on
airport land, including activities such as running or leasing out shopping conces-
4
sions of various kinds, car parking and rental, banking, catering, etc. http://ostpxweb.dot.gov/aviation/domestic-competition/hubpaper.pdf
350 X. Fu et al. / Journal of Air Transport Management 17 (2011) 347e353

Table 2
Share of Enplanements of the Dominant Carrier at Concentrated Hub Airports, 2006, 2009.

Airport 2006 2009

First carrier Second carrier First carrier Second carrier

Chicago-O’Hare (ORD) United (35.06) American (28.17) United (32.73) American (26.21)
Cleveland (CLE) Continental (31.18) Express jet (30.00) Continental (31.55) Express jet (17.97)
Newark (EWR) Continental (51.96) Express jet (16.14) Continental (50.79) Express jet (12.84)
Atlanta (ATL) Delta (56.85) Air Tran (18.80) Delta (52.73) Air Tran (19.67)
San Francisco (SFO) United (44.37) American (13.52) United (34.66) American (11.17)
Dallas-Ft. worth (DFW) American (71.91) American Eagle (13.07) American (72.83) American Eagle (11.92)
Philadelphia (PHL) US Airways (37.29) Southwest (12.14) US Airways (35.09) Southwest (14.76)
Phoenix (PHX) America West (34.17) Southwest (31.54) US Airways (37.68) Southwest (31.05)
Detroit (DTW) Northwest (60.98) Pinnacle (10.30) Northwest (49.94) Pinnacle (14.37)
St. Louis (STL) American (30.88) Southwest (26.62) Southwest (34.52) American (25.93)
Houston (IAH) Continental (61.30) Express jet (25.72) Continental (62.04) Express jet (21.60)
Washington-Dulles (IAD) United (38.91) Mesa (17.84) United (38.36) Mesa (9.31)
Minneapolis-St. Paul (MSP) Northwest (66.17) Pinnacle (7.17) Northwest (52.92) Mesaba (10.74)
Miami (MIA) American (68.50) Delta (6.55) American (70.30) Delta (8.10)

Note: The numbers in parentheses are the carrier shares of enplanements, based on enplaned passenger both arriving and departing. The data are taken from the US Bureau of
Transportation Statistics (Department of Transportation) web site: <www.transtats.bts.gov/airport.asp>.

the level of market power that the hub carrier is capable of amassing 270 miles from Paris, too close to be successful as a dual hub. In
and the higher prices consumers pay as a result. This stems from the addition, the Paris-CDG Airport had a much larger population base
fact that no airline with a similar cost structure can compete effec- to support a super hub for the combined carrier. The Dutch
tively at another airline’s hub. DOT and others have reported on the government therefore imposed a condition that the combined
prevalence of high fares paid for by passengers at hub airports AF-KLM maintains services to a minimum of 42 major international
dominated by a network carrier; indeed, no credible study concludes key destinations from Amsterdam for at least the next 5 years.
otherwise”. This conclusion concerning the hub premium is consis- Consequently, the combined AF-KLM was unable to initiate any
tent with the fact that most airports have substantial market power major network restructuring involving international destinations
over local traffic due to the extremely low price elasticity of the or connecting services until 2010. In general, actual airline network
demand for landing and take-off slots with respect to airport configurations may be influenced by other factors including
charges.5 government regulation, the requirements of bilateral service
Regardless of the source of the hub premium, this benefit gives agreements, and capacity availability in major hub airports.
airlines a strong incentive to dominate an airport. As shown in Table Many studies have found that the entry of an LCC substantially
2, with the exception of airlines operating at the Chicago O’Hare reduces prices in the market (e.g. Windle and Dresner, 1999) and
Airport, virtually no major US airline shares its hubs with other thereby mitigating the hub premium problem. However, Yan et al.
airlines.6 (2008) find that Southwest increased its presence in some of its
While most full service network airlines set up multiple-hub focus city airports over time (Table 3). In 1990, it served at most 16
networks, it is not economical for an airline to have more than one routes (airport pairs) out of Phoenix but by 2006, this had increased
hub in a particular region. AirNeth (2005) observes that the closest to 50 routes out of Las Vegas. Over the years, Southwest increased
distance between two major hubs in a successful dual-hub system the number of routes it served from 81 in 1990 to 375 in 2006,
is 900 km, as in the case of Northwest’s Minneapolis-St. Paul and while increasing the number of airports from which it offered
Detroit.7 British Airways attempted to share the hub functions of services by only 100%. As a result, the average number of destina-
the London Heathrow Airport with Gatwick Airport, mainly to tions out of an airport increased from five in 1990 to 12 in 2006. Yan
relieve the congestion at the Heathrow Airport. However, it soon et al., (2008) concluded that airport concentration has allowed the
realized that it was not helpful to do so and decided to “de-hub” airline to increase its airport presence and enhance its market
Gatwick as a result (O’Connell, 2008). BA found that long-haul power in origin-destination regions served by multiple adjacent
routes could be made much more profitable by moving them to airports. That is, even for LCCs running point-to-point networks,
Heathrow and that duplicating the short-haul feeder network from consolidating operations into a few airports allows airlines to
Gatwick was costly. This is a classic example of the failure of internalize network externality effects (Brueckner and Spiller,
duplicate hubs in the same city. When Air France and KLM applied 1991).
for permission to proceed with a merger, the Dutch government In summary, airport dominance allows a carrier to charge a hub
became concerned that it might be in the merged airline’s interest premium and enjoy other related advantages.8 Airlines prefer to
to reduce hub functions in Amsterdam (AMS). AMS is about have their own exclusive hubs rather than sharing a hub airport
with other carriers. Even for LCCs running point-to-point networks,
there is evidence that they can achieve strategic network effects by
consolidating operations in their focus airports. On the other hand,
5
Gillen et al. (1988) report elasticity of between 0.01 and 0.1, depending on while a carrier may establish a multiple-hub network to achieve
aircraft size. Fu et al. (2006) conclude that this gives airports substantial market
continental coverage, it cannot afford to have more than one hub
power to increase their service charges.
6
Air Tran maintains a hub at Atlanta, but its market power is not comparable to
within any one region. These effects provide strong incentives for
that of Delta, which has established its super hub at the same airport. In St. Louis
(STL), however, it appears that both Southwest and American have considerable
market power. Whether an FSA and an LCC can locate their hubs at the same airport
8
is still an open question in the literature. Other researchers have studied the effects of hub-and-spoke networks in
7
A referee has pointed out that because Lufthansa has hubs in Frankfurt and general and concluded that such networks allow hub carriers to offer prices and
Munich, cities that are close to each other, there may not be strict criteria governing compete more strategically (e.g. Brueckner and Spiller, 1991; Zhang, 1996;
dual-hub distance. Hendricks et al., 1997).
 X. Fu et al. / Journal of Air Transport Management 17 (2011) 347e353 351

Table 3
Network Summary Statistics and Five Most Concentrated Airports for Southwest in Selected Years.

Year 1990 1995 2000 2006

Number of routes served 81 152 295 375

Number of airports served 31 46 56 62

Airport rank Airport Route # Airport Route # Airport Route # Airport Route #
1 PHX 16 PHX 23 LAS 35 LAS 50
2 HOU 14 LAS 16 PHX 34 MDW 43
3 DAL 13 STL 15 BNA 27 PHX 41
4 ELP 12 HOU 15 MDW 25 BWI 35
5 ABQ 10 DAL 13 BWI 23 MCO 28

Notes: The airports included in the above table include Las Vegas (LAS), Chicago Midway (MDW), Phoenix (PHX), Baltimore-Washington International (BWI), Orlando (MCO),
Nashville (BNA), Houston Hobby (HOU), Dallas Love Field (DAL), St. Louis (STL), El Paso International (ELP), and Albuquerque International (ABQ).Source: Yan et al. (2008).

airports and their dominant airlines to cooperate with each other be auctioned off to alleviate congestion and encourage new
and compete with other airport-hub airline combinations in the entrants into the New York City area. The department believed that
region. “granting slots without market-based mechanisms creates a system
where incumbent airlines fight to maintain large shares of the
4. Regulatory and policy implications airport traffic and to limit the ability of low-cost carriers to
compete” (Gribbin, 2008). This proposal was met with strong
Despite the positive effects described above, cooperation opposition from the airports, airlines, and other industry associa-
between airports and airlines raises concerns about its anti- tions such as the Air Transport Association and the IATA. On 8
competitive consequences and has therefore attracted regulatory December 2008, the US Court of Appeals forced the FAA to post-
attention in some countries. However, there is no consensus on the pone its auction plans for the New York airports indefinitely
optimal policy toward such airporteairline vertical relationships. pending a further judicial review. In 2004, the European Commis-
Due to the harm it may do to competition in downstream airline sion ruled against the agreement between Belgium’s Charleroi
markets, the US Federal Aviation Administration (FAA) (1999) is Airport and Ryanair, claiming that the favorable terms offered by
concerned about the practice of airports offering exclusive deals to the airport constituted illegal state aid. In December 2008,
particular airlines. In principle, the FAA is against airports giving however, the European Court of First Instance overturned the EU
particular airlines exclusive or preferential rights to use facilities, decision, claiming the agreement represented normal economic
and suggests that airports return such exclusive facilities to public activity on the part of the Wallonian regional authorities.
use. Airports are allowed to levy a passenger facility charge (PFC) to Conflicting views on airporteairline vertical alliances are likely
finance non-exclusive facilities. To receive PFC revenue in full, each to exist among regulators and policy makers not only because of
of the large airports that have a “dominant” carrier must submit to differences in legal systems across countries,9 but also because of
the DOT a plan on how they intend to promote airport access, entry, some important economic factors. First, the formation of air-
and competition. The requirement to submit a competition plan was porteairline vertical alliances may be viewed as a natural market
incorporated into the “Wendell H. Ford Aviation Investment and outcome of competition. Zhang et al. (2010) find that when there is
Reform Act for the 21st Century” legislated in 2000. According to this competition among multiple airports in a region, a dominant
Act, large and medium-sized airports that exceed a certain threshold strategy is for airports to cooperate with their dominant carriers
of concentration are required to submit competition plans. and thus enable themselves to compete more effectively with other
Such competition concerns come with good justification. airporteairline pairs. Barbot (2009b) also finds that similar incen-
Airports that provide support and preferential treatment to domi- tives exist for collusion between airports and airlines, including the
nant carriers allow such airlines to secure the key resources they case in which a secondary airport and a low-cost carrier compete
need for their operations and to gain a competitive advantage over with the main airport and full service airlines. In short, when an
other carriers. Morrison and Winston (2000) and Dresner et al. airport faces competition from another airport e either an adjacent
(2002), among others, find empirical evidence showing that airport sharing a similar market or another hub airport competing
a dominant airline’s control over key airport facilities, such as slots for connecting traffic e it is in each airport’s interest to form an
and gates, is likely to result in significant entry barriers to other alliance with one airline, normally the dominant carrier.
potential competitors. In the US, the Charlotte/Douglas Airport Second, airporteairline vertical relationships may bring
Authority believed that it had benefited from having a US Airways economic benefits to local industries and local consumers. A hub
as a single dominant carrier that was regarded as a “partner” of the airport offers local travelers better services in terms of higher flight
airport. The FAA, however, expressed concern that US Airways frequency and direct flights to more destinations. Hub airports also
exercised too much control over airport facilities and operations create more employment opportunities in the local tourism and
such as slot allocations and passenger terminal use. The mayor of
Charlotte appointed a task force to address the issues of airline
competition and the Charlotte Aviation Department, pursuant to 9
There may be different interpretations with respect to airport-related issues
a directive from the city’s Advisory Committee, hired a consultant
even within the same country. For example, on 30 September 2008, the US
to evaluate the competitive situation and to develop strategies for Government Accountability Office (GAO) issued a legal opinion stating that the FAA
improvement (US Federal Aviation Administration, 1999). does not have the authority to auction slots at New York airports. Moreover, the
There appears to be some agreement that airports should not be GAO warned that if the FAA auctioned the slots and retained and used the auction
controlled by their dominant carriers. Although the notion of proceeds, it would violate the Antideficiency Act. However, the US Department of
Justice (DOJ) Office of Legal Counsel issued an oral legal opinion on 3 October 2008
promoting competition is generally well-received, there is no which stated that finalizing and implementing the slot auction rules would not
consensus on how this should be done. In 2008, the DOT proposed violate the Antideficiency Act (US DOT, Office of Inspector General letter of 15
that 10% of the airport slots at LaGuardia, JFK, and Newark airports January 2009 to Patty Murray and James L. Oberstar).
352 X. Fu et al. / Journal of Air Transport Management 17 (2011) 347e353

logistics sectors. Button et al. (1999) examine the link between high- 5. Conclusions
tech employment in a region and whether the region is served by
a hub airport. Using data from 321 US metropolitan areas in 1994, the Significant changes have taken place in the air transport
analysis finds that the presence of a hub airport increases high-tech industry over the last two decades. Airports are under growing
employment in the region by an average of 12,000 jobs. This prob- pressure to increase revenue and reduce costs. This introduces
ably explains why policy makers such as the Dutch government have incentives for airport managers to explore new business strategies.
tried to maintain the hub status of their airports (e.g., Amsterdam). Over the years, various forms of vertical relationships have been
The Guangzhou airport authorities in mainland China have worked formed between airports and airlines, allowing them to achieve
closely with FedEx, providing favorable terms including cheap land, a range of objectives. They enable airports to obtain financial
exclusive aircraft parking space, and taxi runways to the express support and secure business volume, both of which are important
carrier. In return, FedEx invested $190 million to relocate its Asian for their daily operations and the long-term expansion of airport
hub from Subic Bay in the Philippines to the new Guangzhou capacity. Relationships of this type also allow airlines to secure
Baiyuan Airport in 2008. It is estimated that this move will access to key airport facilities on favorable terms, an essential
contribute nearly $1 billion in GDP to the city of Guangzhou.10 condition for them to make a long-term commitment/investment
As discussed so far, the economic effects of airports-airline at an airport. Such vertical relationships can serve as a competitive
alliances serving a city or region can be two-sided and complex. In response to other airporteairline alliances and may bring benefits
general, inter-firm relationships can be complex when one jointly to the local economy and consumers. Alternatively, vertical rela-
considers an upstream (airport) market and a downstream (airline) tionships may strengthen the market power of participating
market. Several studies model passenger travel choice in a region airlines, allowing them to charge a hub premium and to foreclose
served by multiple airports. In such a case, passengers choose an the entry of potential competitors. As a result, competition in the
airporteairline combination rather than an airline only (Caves et al., airline market may be harmed.
1991; Pels et al., 2003). Pels et al. (2001) point out that airlines face Most airports have substantial market power over local traffic
two types of competitors: airlines operating from the same airport due to the low price elasticity of their aeronautical services. The
and those operating from other airports. Airlines operating from presence of concession revenue alleviates an airport’s incentive to
the same airport may have conflicting interests as each tries to increase aeronautical charges, but this alone is insufficient to keep
expand its own market. Unlike carriers operating from other airport charges at the socially optimal level. Airport competition
airports, however, they may also have a common interest in making can be introduced in cities served by multiple airports, yet in many
the airport attractive to encourage more passengers to travel via it cases common ownership limits the degree of competition. The
and to divide up the resulting traffic. Such complex relationships competition and welfare implications of airporteairline vertical
among airports and airlines make it difficult to draw clear conclu- relationships can be complicated and two-sided, subject to the
sions on the effects of airporteairline alliances. influences of many factors including the market structures in the
Fu and Zhang (2010) analyze various forms of revenue sharing airline/airport markets. It is usually difficult to draw a clear
arrangements between airports and airlines. They find that the conclusion on their overall economic effects. As a result, policy
competition and welfare effects of such vertical relationships makers hold conflicting views on how such vertical relationships
depend on the structure of the airline market. One of their findings should be regulated. A possible way to deter anti-competitive
is that when an airline has significant competitive advantages over behavior at this stage is to require that exclusive contracts between
other carriers, a price-regulated airport has an incentive to collude airports and airlines be disclosed. Transparency and public scrutiny
with this dominant airline at the expense of other carriers. The can be cost-effective alternatives to regulatory measures with
intuition is that concession revenue sharing provides a competitive uncertain consequences.
advantage to a sharing airline, which can internalize the demand
externality between aviation services and concession services, and Acknowledgments
benefits from its competitors’ output expansion by obtaining more
concession revenue. Given that dominant carriers are in a better We would like to thank two anonymous referees for their
position to exploit such a competitive advantage, airports are more constructive comments and suggestions. We also thank partici-
likely to work with them. Overall, Fu and Zhang find that revenue pants at the 2008 Paris OECD International Transport Forum Round
sharing and other forms of cooperation between airlines and Table and the 2009 ATRS Abu Dhabi Conference for helpful
airports may be a source of welfare gains. However, this can have comments. Financial support via a Research Grant of The Social
a negative effect on airline competition. Science and Humanities Research Council (SSHRC) of Canada, and
In summary, airlines and airports may form various types of Hong Kong Competitive Earmarked Research Grant (RGC-
vertical relationships as a competitive response to other air- PolyU5412/07H) are gratefully acknowledged.
porteairline alliances. Such arrangements strengthen the market
power of participating airports and airlines, and bring certain
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