The UK Airport Industry Report

Introduction

The development of the UK airport industry can be termed as consistent. Despite numerous ups and downs including it has thrust itself as a leading industry in European economy and in particular UK. In the UK there exist about 40 airports scattered all over the kingdom which vary in passenger numbers. With the exception of London Heathrow, the remaining airports classification is based on their annual passenger capacity with four large airports accounting for over 20 million passengers. The UK airports do much more than passenger service. They offer shipping and airfreight services, air transit or air taxi and general aviation services. Besides they offer craft maintenance, testing and flight training services including custody services (CRI, 2006).

Main body

When analyzed from a non aviation perspective, the UK airports are a source of other non aviation services that include light industry units and storage services. In comparison, small and large airports are equally significant in the UK since they compete against each other for the limited passengers with equal might. With additional competition from newly established civil bases created from past military infrastructure, size comes last in this competitive industry that focuses on reliability. In the year 2004, the turnover from UK airports totaled GBP 2.56 bn marking an increase of 5% over 2003 turnover. In this market income is generated from two broad sources namely aviation and commercial services. Income from non core services has tended to outweigh revenues from aviation services. This stresses the airports’ thirst to maximize revenue from their commercial ventures as compared to their core business. The competitions within markets are a concern for the industry as the limited opportunities come under scrutiny (Graham, 2001).

In the UK there is a great overlap of wide-ranging catchments for passengers making the airport industry highly competitive. The market has seen differentiation of individual airports that include long haul destinations. Freighter operations have also been concentrated to a few airports with London Heathrow setting pace as a national leader. With the dominance of large airports in the UK, smaller airports have to devise ways of surviving this competition and that includes being price takers when sourcing for new contracts and attracting new customers (Starkie, 2002). However it is the larger airports that benefit from economies of scale. Competition is envisaged to lead to a fall in mean prices below average costs showing a planned approach to the development of the industry as opposed to a market-led approach. In the UK, the airports are stipulated by UK accounting standards and law to report their financial statements for their 12 months results. From east London to London Heathrow, there is a blaring disparity in turnover propped by a discontinuity in the size range. Heathrow, Gatwick, Stansted and Manchester are larger than the rest of the airports. When London Heathrow nets a total of £1bn in annual sales, Southend can only manage £ 5m at another extreme (Graham, 2008). Analysis of smaller airports indicates a consistent profitability despite the low turnovers. Higher up, profit margins does not correlate to turnover hence showing the extent of the nature of competition. The airports have developed a mature competitive strategy despite the industry being inherently a natural monopoly. These calls for price controls and the regulation of financial returns through effective competition that would what individual airlines would be charged by the airports. Specific problems hinder the full growth of the airport industry and these include failure to break up state enterprises especially the British Airports Authority despite privatization in 1980s. In other two UK regions London and Scotland, it continues in regular possession. In the greater Europe, privatization is top of the agenda for air industry regulators. The aim is to restructure ownership and provide a slightly less intense but competitive industry where competition would be the main driver of the industry. In the UK price controls are seen to depress investments by creating hold up problems. It is feared that regulators would renege on their commitment to a regulatory settlement leading to a fall in incentives for investment due to the disparity in periods of amortization and regulatory settlements. The solution therefore would be to establish long term contracts with airline customers to deliver vertical supply contracts. The term ensures security provided by the contract to sink costs in extra infrastructure and in the event avoid hold up problems (Littlechild, 2007).

Air travel is by far a large and growing industry. It spurs economic growth, world trade, international investment and tourism hence it is central to the growth of other industries. Over the past decade, air travel has grown by a considerable percentage annually in the United Kingdom. Travel for business and leisure has seen a dramatic rise in figures worldwide (Starkie, 2002).

Researchers have analyzed the UK air industry using Michael Porter’s five forces by developing concepts in industrial organization economics to determine the competitive strength and attractiveness of a market. These forces are classified into a micro and macro environment depending on how they affect an organization. Michael Porter provided a model that maps an industry as interacts with the five forces. This can be used by a business manager to create an edge over the competitors in the industry that the firm operates.

Porter states rivalry as a major force in the traditional economic model. Rivalry is competition among firms in an industry. Sometimes competition is not ultimate and with some firms being quasi price takers the general consensus is that firms adopt a competitive advantage over their rivals. The extents of rivalry among firms vary from industry to industry creating differences worth noting before taking a plunge into one.

Economists have adopted industry concentration to measure the extent of rivalry in a given industry. This employs the concentration ratio (CR). In the US, the Bureau of Census from time to time reports the CR for key standard Industrial classifications. The concentration ratio can be used to show the market share held by specific firms in the industry. A large concentration ratio indicates a large chunk of the market share is held by the largest firms showing the industry is concentrated. If the scenario is of a few firms sharing the market it draws closer to a monopoly making it less competitive. A low concentration ratio depicts an industry with many rivals with none having a considerable market share. This goes further to outline a competitive environment where each firm has an equal stab at the market share (Porter, 1998).

In the UK initially, the BAA controlled the airline industry in a monopoly style formation however it ceded control over ownership by floatation of shares. This led to an alteration in the nature and intensity of competition experienced in most UK airports. The market share is controlled to a large percentage by the big four; London Heathrow, Gatwick, Stansted and Manchester. Competition to be a focus for linking air services is at its peak with many airlines including express freight carriers opting to negotiate contracts for establishing operating bases and route networks. This has raised the bargaining power of not so large airports due to their availability and lack of congestion (Condie, 2004).

In the event that the industry experiences a rather low level of rivalry among firms, the industry is deemed disciplined. This can be attributed to previous history of competition in the industry or compliance with ethics and conventional trade practices and in some instances the role played by a market leader. In this industry, market conspiracy is a taboo and is outlawed. Sometimes rebel firms outmaneuver the market in search of a competitive advantage shifting the erstwhile disciplined market. This sets a chain of events thus increasing rivalry in the industry. This competition can be wrapped in words like cutthroat, strong or weak depending on the approach used by the firms to try and regain control of their previous positions. A firm may be forced to explore certain options in order to survive the onslaught of others. These options may include changing prices to try and regain control. It may also differentiate its products and processes setting apart from competitors. Consequently it can exploit distribution channels to boost its presence in the market. Besides, it can use the suppliers to push the products closer to the buyers (Porter, 1998).

Before liberalization of the UK airlines industry, present day legacy airlines used to concentrate on specific geographic locations from where they run their base operations. Fag carriers tended to concentrate on the capital city focus. Low cost carriers however are disinterested in particular geographic markets and instead choose locations that maximize their returns on capital. This elevates competition that exists between airports from that of spatially adjacent airports to that involving a wide geographical coverage thrusting low cost carriers to set up bases throughout Europe (Gillen & Niemeier, 2008). The viciousness of competition is increased by the following industry phenomena. Rivalry in the industry is sometimes increased by a large number of firms in their quest to compete for the same resources and customers. The competition gets worse if the firms have identical share of the market forcing them to fight for market leadership. Slow pace of market growth makes firms to struggle for a portion of the market share. Firms operating in a growing market are able to boost their revenue by virtue of the expanding market. When fixed costs rise it increases rivalry. Firms that experience total costs equivalent to their fixed costs are forced to produce at full capacity to operate at lower unit costs. Faced with this task, the firm is forced to sell a large quantity of product leading to a scramble of the market share and eventually increased rivalry (Porter, 1998).

Other factors that intensify rivalry can comprise high storage costs causing stockists and producers to sell faster. If all the other stockists attempt to sell at the same time the flood the market, they raise the competition for customers. Low switching costs raises competition among firms as the choice presented to customers gives them the option to switch freely from one product to another hence firms outdo each other in attracting customers. Lack of product differentiation also intensifies rivalry and where stakes are high firms open an all out war against other firms. Industries with barriers to exit make it expensive to abandon products hence a failing firm is left with no choice but to continue fighting in order to remain relevant. The aircraft industry in UK is one such industry where after injection of billions of pounds into the business one cannot just walk away leaving all that to waste. Instead airlines and airports have managed to divest into other non core businesses to boost their presence in the industry. If the rivals are of a diverse mix then the industry becomes unstable with each firm misjudging the other’s moves. The airline industry for example is populated by airlines that historically are flag carriers, small crafts and executive jetliners, luxury cruises and dreamliners. Their missions and profit strategies are as diverse as they come hence planning a reaction on strategies taken by other categories of airlines need cautious approach (Porter, 1998).

The second force in Porter’s model is the threat of substitutes. Substitutes are products available in other industries. It becomes a threat when the demand of one product is altered by changes in the price of a substitute product. This affects the product’s price elasticity as more and more substitutes enter the market and customers get exposed to alternatives thus it becomes difficult for firms to raise prices in the industry. This massive competition brought about by threat of substitutes originates from products in other industries. The costs of air travel are constrained by global fuel prices and their substitutes exist as other forms of transport like rail, sea and road. The airports that are already established experience competition from emerging ports and private landing ports (Porter, 1998).

Conclusion

Porter’s third force is buyer power. This is the influence that consumers have in an industry. A strong buyer power translates to a phenomenon called monopsony where one buyer is served by many suppliers. In this market the buyer reigns by setting the price in the industry. Practically very few pure monopsonies are in existence if any. Related to buyer power is supplier power as porters’ fourth force in the model. It stems from the need for factors of production. This leads to a symbiotic relationship between the buyer and supplier. If suppliers wield considerable force in the industry they can influence the price at which these factors; land, labor, capital and raw materials are pegged in a bid to benefit from the margin. In the event that incumbent rivals do not put controls for future entry into the industry, new firms can enter and increase the level of competition experienced. With guaranteed entry and exit of the industry by firms and in cases where there is free entry and exit, profits will be insignificant. In some cases industry characteristics make it difficult for firms to enter or exit the industry leading to barriers to entry or exit. The high costs of setting up and operating an airport in the United Kingdom makes the venture a very expensive one. This acts as a barrier to entry. Barriers to exit take the form of long term contract commitments that have to be seen till their expiry.

References

1. Condie, S., (2004) Powerful Customers: Working with the Airlines in Vass, P. (Ed), The Development of Airports Regulation-A Collection of Reviews, CRI, School of Management, University of Bath.
2. CRI, (2006) Statistical Series: The UK Airports Industry, Airport Statistics 2005/6, CRI, School of Management, University of Bath.
3. Gillen, D. and Niemeier, H-M. (2008) ‘The European Union: Evolution of Privatization, Regulation, and Slot Reform’ in C. Winston and G. De Rus, Aviation Infrastructure
4. Performance: A Study in Comparative Political Economy, Brookings Institute, Washington DC.
5. Graham, A., (2001) Managing Airports: an International Perspective, Butterworth Heinemann, Oxford.
6. Graham, A., (2008) ‘Airport Planning and Regulation in the United Kingdom’, Brookings, Washington DC.
7. Littlechild, S. C., (2007) Beyond Regulation in C. Robinson (ed), Utility Regulation and Competitive Markets, Edward Elgar, Cheltenham.
8. Porter, M. (1998) Competitive Strategy; Techniques for analyzing industries and competitors, US, free Press.
9. Starkie, D. (2002) ‘Airport Regulation and Competition’, Journal of Air Transport Management, 8, 63-72.
10. Starkie, D. (2008) Aviation Markets: Studies in Competition and Regulatory Reform, Ashgate, Aldershot/IEA, London.

Appendix

Diagram showing Michael Porter’s five forces