A new view of the airport business: two-sided platforms*

06.04.2009
By David Gillen

Airneth Fellow Column
April 2009
By David Gillen

Airports have traditionally been viewed as public utilities serving the needs of airlines. More recently they are seen as modern businesses, pursuing their own objectives and serving the demands of carriers and passengers. Regardless of which view one takes it is a perspective of one sided markets. The airport was seen as a factor of production in a downstream airline’s production function. The sources of revenue were from one side, from the airlines. Airports did not consider that passengers represented a source of revenue independently from the airlines.

However, as we have seen over the last decade airports have identified that non-aviation revenues are important and can be large. The important point to appreciate is that revenues for airports are from two sides; from airlines and from passengers. This thinking requires we consider airports as platforms lying between passengers and airlines; it brings the two together. Multi-sided markets (or platforms) serve two or more distinct customer groups who value each others participation; eBay provides markets for buyers and sellers, dating clubs bring together men and women and singles bars perform the same task. 

Airports add value to both sides by internalizing network effects which exist between the two demand groups; carriers are better off if there are more passengers and passengers are better off if there are more carriers, which access more destinations and more flights.

Adopting ‘two-sided’ thinking leads to revelations about one-sided logic in two-sided markets1. These are particularly instructive for airports, airlines and passengers.

Fallacy 1: efficient price structures should reflect relative costs. ICAO, IATA and the airlines take the position that airport rates and charges should be cost based. However such pricing principles ignore the externality that exists between the customer groups on either side of the platform (airport), therefore rather than have cost based prices there should be externality based prices; relative costs are significant but not deterministic.

Fallacy 2: Marginal cost pricing is efficient. The problem is two-fold here; first, the allocation of non-assignable costs must consider the combination of elasticities. Second, subsidizing one side of the markets may significantly impact the utility on the other side of the market, therefore the overall value of and to both sides’.

Fallacy 3: High price-cost margins indicate market power. Two-sided market thinking suggests that competition between platforms (airports) may lead to prices above costs since the competitive structure of fees will generally not reflect costs but rather the value placed on each side of the platform by participating in the market; the structure of prices matters.

Fallacy 4: A price below marginal cost indicates predation and possibly cross-subsidy. Setting prices below marginal cost may be used to generate greater surpluses by attracting those users that provide the greatest benefits to the network. For example, setting lower fees for certain types of carriers may make all carriers better off because the lower priced carriers attract more passengers to the airport.

A good example is the provision of check-in kiosks at airports by airports. The airport does not charge the passenger a fee for using the kiosk because the value to the airline is higher the more passengers use the kiosks since it results in lower costs to the airlines.

There are other fallacies one could list and discuss, but the main point is two-sided markets require two-sided thinking. The traditional view is the airline owns the passenger and the airport serves the airlines’ needs; one sided market thinking. Considering the airport as a two-sided platform places it in the centre between the airline and the passenger, the airlines serve as the airport’s distribution system.

Another consideration is that in the past there was great concern by carriers of excess costs, gold plating etc. But with two-sided market thinking these expenses are used to attract passengers, which makes airlines better off directly and with the revenue from passengers, the airlines are made better off indirectly due to lower airside prices. These conclusions are drawn on the basis that in two-sided platforms the profit maximizing prices depend on the elasticities of demand by customers on both sides of the platform, the nature and magnitude of the indirect network effects between the two groups of customers and the marginal costs for both sides. This fact is potentially very important for the analysis of market definition and market power as well as decisions regarding airport regulation. Starkie’s insight (2001) that airports even with market power would have less incentive to use it because of the complementarity between airside and non-airside revenues is a good example of two-sided platform thinking and well ahead of the first articles on two –sided markets2.

---------------------------------------------------------------

* See, David Gillen (2009) The Evolution of the Airport Business: Governance, Regulation and Two-Sided Platforms (Martin Kuntz Memorial Lecture, Hamburg Aviation Conference, February 2009)

1. I borrow this term from Wright, Julian (2004), One-Sided Logic in Two-sided Markets, Review of Network Economics, Vol. 3, No. 1 (March) pp.44-64

2. See Starkie, 2001 D. Starkie, Reforming UK airport regulation, Journal of Transport Economics and Policy 35 (2001), pp. 119–135



 news