OUR AVIATIONWORK

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FRONTIERECONOMICS

FRONTIER ECONOMICS 1

We apply economics to markets, organisationsand policies.

We use economics to help clients improve performance, make better decisions and keep ahead of the competition. Our expertise is broad, covering not just micro-economics but finance, statistical modelling, game theory, market research and even the psychological side of economics. We work with a wide range of clients from the private sector, government, regulators, and other public authorities. Our projects span the globe. And we have worked in almost every sector imaginable, from fertilisers and oil rigs to handbags and iPads.

We distil complex issues to focus on what matters to our clients. We help them make credible arguments and good decisions, backed up by robust evidence and analysis. While our analysis may be complex, the advice we provide is clear, honest and delivered using plain language. We try to build strong relationships with our clients, and many have worked with us since Frontier was created in 1999. We know that big decisions with substantial financial implications can rest on our analysis and that for clients to be comfortable making those decisions they need to trust their advisors.

Frontier Economics is one of the largest economic consultancies in Europe with offices in Berlin, Brussels, Dublin, Köln, London, Madrid and Paris.

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The aviation sector makes an essential contribution to the modern world. It forges international connections, drives trade and investment and helps establish global supply chains. The growth in low cost carriers has transformed travel. People can reach places that two generations ago would have been physically difficult or financially unattainable.

Our aviation practice.

The sector is changing rapidly.Liberalisation has led to much greater choice and lower fares. Low cost carriers’ use of small regional airports has fostered greater competition between airports, and passengers have more choice of where to fly from and to.

While the sector has grown dramatically, there is still potential for growth, particularly outside North America and Western Europe. The pattern of aviation demand is set to shift significantly east and south globally, as we see with the growth of major hubs such as Dubai, Abu Dhabi and Istanbul.

All these developments bring challenges. Airports need to finance the expansion of runway and terminal capacity, while airlines have to risk investing in new aircrafts in the expectation of growing demand. And this needs to be done in ways sensitive to the environment.

Frontier’s aviation team helps clients navigate through complex and changing times. We provide practical, impartial advice that helps them understand the markets they work in and the things that matter most to customers and those most affected by their business. Our work ranges from strategic advice to sophisticated modelling and gives clients new insights that have a practical impact.

FRONTIER ECONOMICS 3

Dan Elliott, Director Transport practice, Frontier Economics

We build long-term relationships with our clients and regularly advise on a wide range of regulatory and commercial issues. Our experience

allows us to engage with clients effectively, providing them with important insights as well as high quality outputs.

CONNECTIVITY ECONOMIC IMPACTCOMPETITIONSTRATEGYREGULATIONINVESTMENT

Connectivity.

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Over the past 20 years, two complementary models of air transport have developed. Low cost carriers provide point-to-point services between many short-haul destinations, often with an emphasis on developing connections between regional airports. Meanwhile, international hubs and network carriers continue to harness the power of the ‘hub-and-spoke’ model: attracting flows of transfer passengers who will help create new profitable connections to an increasing number of long haul destinations.

Growth in connectivity is a key element in bringing wider opportunities for tourism, business and growth.

Airports and airlines regularly advertise the number of connections they offer, and the frequency of those connections. Direct connections, of course, are better than flying indirect. But easy connections to international hubs can mean that hundreds of destinations around the world are just one stopover away.

This effect increases when hubs are inter-connected. Many indirect connections are already bursting with enough demand to justify creating new direct connections. And growth in the emerging markets is rapidly creating new opportunities.

At Frontier, we work with network and low cost carriers, hubs and regional airports. We understand that “connectivity” means different things to our clients.

We combine macro- and micro-economicinformation with detailed data on route networks and passenger flows. These detailed models help clients to identify new markets and spot opportunities for future growth.

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Case Study: EmiratesWhat was the aim of Frontier’s analysis? We analysed the economic impact of Emirates’ operations in Europe. One of the components of this analysis was to estimate the benefits of the air connectivity Emirates brings to Europe.

How did you do that?To analyse the connectivity benefits we built a connectivity model that identified those routes where Emirates provides either a unique direct connection or a unique one-stop connection. The model takes into account alliances, flight times and frequencies and covers connections between Europe and the rest of the world.

What did you find?Our analysis identified that Emirates offers 220 routes that are unique to Emirates as they are either unique direct connections to Dubai (21 routes) or unique one-stop connections (199 routes), implying that no other airline or alliance offers these connections. All of these connections are from “secondary cities” that do not have a major hub airport. Our results therefore show that Emirates makes a substantial contribution to international air connectivity in Europe’s secondary cities.

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Economic impact.As major providers of key transport infrastructure, airports are often asked to assess the “economic impact” they have on their region and country. These assessments can help explain to interested parties the role the airport has in the wider economy. And they can sometimes be used as part of investment appraisal or to help apply for public funding.

It is possible to think about the economic impact of an airport in different ways. There is the activity of the airport, and the passenger and cargo services operating there. A full analysis needs to cover every level of the aviation value chain, from security and the control tower to catering and retail. It must also consider both those directly employed at the airport and the services bought by the airport and its customers, which create indirect benefits in the wider economy. All this activity also has a multiplier effect through the economy, creating further induced activity and employment.

Then there is the value created through the use of aviation rather than aviation itself. Airports and airlines also provide connectivity which makes travel more efficient, and this can play a pivotal role in facilitating trade, investment and tourist spending: the “catalytic” benefits of aviation. In particular, there is research that identifies the importance of face-to-face meetings in overcoming the barriers to doing business across countries, especially when there are great cultural differences.

Frontier advises its clients how to measure all these economic benefits in a robust and credible way. We focus on identifying benefits that are truly “additional”, which is particularly important for investment appraisal. We specialise in assessing catalytic effects, identifying the wider economic impact of the connectivity provided by our clients.

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Case Study: Toronto What was the aim of Frontier’s analysis? Toronto Pearson Airport asked us to quantify the economic benefits from air travel today and in the future to the economy of Ontario. We analysed the benefits from international air connectivity in facilitating trade, foreign direct investment and tourism.

How did you do that?We estimated the value of Toronto Pearson as a hub airport by comparing the airport against a “what-if” scenario. Our “what-if” scenario assumes that Toronto Pearson does not provide direct flights, so all

passengers have to take indirect flights via another hub airport to get to their final destinations. We concluded that this provides a realistic approach to valuing the Toronto Pearson’s connectivity as a hub airport.

What did you find?We estimated that Toronto Pearson currently facilitates 153,000 jobs of which more than half can be attributed to connections within Canada and to the US. By 2030, we estimate that Toronto Pearson will facilitate 247,000 jobs in Ontario with an increased proportion of the employment attributable to international connections.

The virtuous circle: the key role connectivity plays in helping a well-functioning and open economy to achieve its full potential.

Lorrie McKee, Greater Toronto Airport Authority

You guys are smart. The quality of your written work is outstanding and we believe your analytical work is cutting edge.

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Competition policy.Airline mergers and alliances often raise competition issues. But liberalisation of aviation markets, the growth of low cost carriers and increasing private-sector involvement in airports have all intensified competitive pressures. Increasing competition between hub and regional airports may also be an important factor.

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Airline mergers or alliances may reduce passenger choice in some markets. But identifying the relevant markets can be complex. Route overlaps are not simple to assess. There may often be alternative routes that act as an effective substitutes. And destinations that may be effective substitutes for each other regardless of location: for instance, “sun and sand” destinations.

When looking at the competition between airports, we need to understand the catchment that each airport serves. This will differ between market segments and is more complicated than defining arbitrary drive time zones around the airport.

It is necessary to understand the extent to which passengers are prepared to switch between different origin or destination airports. And whether the airlines operating at those airports have the operational and commercial freedom to relocate services in response to changes in airport charges.

Frontier provides insights on airline mergers and alliances through our ability to analyse route networks, and where the key passenger flows happen. And by using econometric techniques that measure the price impact of changes in market structure.

We have been influential in helping regulators understand how to assess airport market power, including the use of sophisticated ‘discrete-choice’ models. Our approach helps identify where airports do and do not have market power, and helps make sure that regulation is applied only where it is strictly necessary to protect consumers.

FRONTIER ECONOMICS 9

Chris Gadsden, Head of Regulation, Easyjet

Frontier consistently delivers innovative, coherent and

theoretically robust outputs, combined with their reputation

for independence this makes them hard to beat.

Case Study: Discrete choice modelsIt is not possible to fully assess the extent to which airports compete with each other for passengers by simply looking at the overlap between arbitrary drive-time zones.

But by using real-time passenger booking data we can measure the role that ticket price and distance to the airport have in determining which airport a passenger uses, when they are presented with a choice of routes.

Discrete choice models, harnessing the information contained in millions of individual passenger decisions, can demonstrate clearly how the trade-offs passengers make vary depending on their location relative to airports in their region.

Likelihood of flying from Stansted given passenger’s home location: passengers show a very strong preference to fly from their nearest airport

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Strategy and commercial.No two airports are alike: their position, opportunities and challenges are unique. Airports are often constrained by the environment in which they operate. Runway capacity is limited, or delivering or pricing some aeronautical services presents difficulties. But successful strategies can deliver commercial growth and secure lasting competitive advantage even in the face of the changing nature of the airline industry.

Whether you are a regional airport wanting to expand traffic, or a major hub facing constraints on passenger and traffic growth but which needs to increase revenue, we can help by applying sophisticated and exacting economic tools.

Clients have asked for our expertise in many areas. “What’s the best way to grow when I’m already at full capacity?” “How do we trade off dwell-time and throughput?” “How is customer retention affected by pricing?” “How do we make best use of our retail space?”

Our approach to commercial strategy is always anchored in a thorough under-standing of our client’s unique situation. That includes its current capabilities, resources and recent performance, and its operating environment. As well as its customers’ choices and expectations, and the competitive and regulatory environment it operates within.

Frontier advises major airports and some of their most important customers and suppliers. This includes airlines, where we work on pricing strategy and the economics of customer propositions.

This also includes retailers, where our work spans areas from sources of strategic advantage, property and location strategies to category and basket optimisation. We have therefore developed a deep expertise in all areas affecting airports.

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Case Study: Airline pricing strategyWe helped a major airline review its long-term commercial strategy. We helped them understand:• the impact that both the price and non-price aspects of their service have on passenger choice.• the potential to attract new passengers and what motivates passengers not currently flying with them, and • the role of ancilliary services and products in driving profits.

Customer research and survey design – using insights from BEHAVIOURAL ECONOMICS. One of the lessons from behavioural economics is that survey responses can vary significantly depending on how the question is framed. This highlights the importance of undertaking robust market research to develop successful commercial strategies that are well-founded.

For example, Phil Greaves1 (Associate of Frontier) illustrates the importance of framing. Consider the following calculations:

1 x 2 x 3 x 4 x 5 x 6 x 7 x 8 = ?8 x 7 x 6 x 5 x 4 x 3 x 2 x 1 = ?The average guess for the second calculation is more than four times higher than for the first.This illustrates that people attach a far greater significance to the first few numbers and estimate an answer accordingly.1Philip Graves, Consumer.ology, 2010

Regulation.

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Economic regulation, particularly relating to aeronautical charges at airports, is growing in importance. It is also becoming more contentious. There is increasing involvement by private companies in airport infrastructure and more regional airports are being used. These developments may intensify competition and potentially reduce the need for regulation.

An increasing number of airports, in particular some major ones in private ownership, are now subject to formal regulation that limits the maximum aeronautical charges they can levy on their airline customers. These regulations aim to promote the efficient operation of the airports. And also encourage airport operators to invest appropriately in the capacity and service quality that airlines and passengers need.

Effective regulation makes sure airports have the right incentives to act efficiently and in the interests of their customers. It is also important that regulation does not unnecessarily hamper commercial freedom and flexibility when this is what airport users need and want. The form and intrusiveness of regulation needs to be proportionate to the risks of market power being exercised and the scale of the airport operation. Both differ significantly from airport to airport, and so, therefore, should good regulation.

Frontier covers all aspects of regulation from market power assessments to detailed regulatory design. We use our expertise in benchmarking, regulatory finance and detailed financial and cost modelling to deliver bespoke solutions. Regulatory systems necessarily involve negotiation between the regulated organisation (the airport say) and the central regulatory authority. We therefore emphasise clear communication, based on effective and evidence-based analysis.

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Case Study: Changi Airport, SingaporeWhat was the aim of the project? Changi Airport asked us to help them develop a new Opex efficiency sharing mechanism that balances incentives for efficiency with sharing of outperformance with customers.

How did you do that?We identified 6 levers that could be changed as shown in the picture below. We also reviewed regulatory precedent from various countries and sectors. Based on the levers and the precedent, we developed a small number of options that we assessed using a number of success criteria. The final option provides a good balance between incentives to the company and sharing of outperformance with passengers.

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Investment and transactions.

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There will be a continued need for large investments in airport infrastructure as demand for flights continues to grow world-wide. Investors or lenders seek the best advice on risks before making decisions on acquiring or disposing of airport assets. We always give our clients that advice.

We regularly advise regulators, airlines, airports, finance companies and governments on investments in airport assets. Our approach is defined by an economics that uses innovative techniques, quantitative analysis and financial modelling, as well as Frontier’s sector expertise. Our team has experts in corporate finance and in public policy and transport economics. Major transactions require top level regulatory and commercial expertise. Our advice is unique as we bring both of these to the table.

We have first-hand knowledge of the likely direction of future policy. We can therefore provide insights into both the operation of existing regulatory regimes and future market characteristics. Our transaction services enable our clients to put a value on their required returns from investing in airport infrastructure. We give advice that is creative, practical and informed, and which makes a difference to whether a commercial bid succeeds.

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Case Study: Impact of new runwayThe commercial case for a new runway is critically affected by the rate at which the new capacity will be taken up. But a case like Heathrow, where the existing runways are heavily congested, presents special challenges.

We helped Heathrow understand the size of the capacity gap it was suffering, on a route-by-route basis, and how this was likely to worsen by 2025. This was to better understand the likely impact on services of a new runway.

In addition, alleviating the constraint at Heathrow would have a significant impact on the way the London aviation market works, reducing the congestion premiums that currently drive passengers out to other hubs and regional airports. We estimated the value of the premium on ticket prices today and how that was likely to grow, to assess the competitive effect of a new runway on aviation markets in the London area.

40the number of new direct

connections that Heathrow could provide with a third runway.

Chris Andreou, Head of Strategy, Heathrow airport

Frontier made a critical contribution to delivering a forceful set of materials. Their contribution has been immense.

Where you can find us.

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