Manchester Airport Plc: A report on the economic regulation of Manchester Airport Plc

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Under the reference made by the Civil Aviation Authority (CAA) on 10 December 1996 (see Appendix 1.1), we are required to recommend the maximum level of airport charges that may be levied by Manchester Airport PLC (MA) for the period of five years beginning on 1 April 1998. We are also required to consider whether MA has, at any time during the five years ending with the date of the reference, pursued a course of conduct (in relation to matters specified in the reference) which has operated, or might be expected to operate, against the public interest. Airport charges currently account for about one-half of the income of MA, but in considering the maximum level of airport charges we have taken into account MA's projec-tions of income from its other commercial activities at the airport.

During each year of the current five-year period, maximum revenue per passenger from airport charges was set to increase by no more than the change in the RPI less 3 per cent (RPI-3). Even though MA has not fully recovered the maximum amounts allowed, it is likely to earn a significantly better rate of return on assets over this period than was predicted, primarily due to a higher than expected growth in the number of passengers in the earlier years of the period. MA proposed that airport charges for the next five-year period be allowed to increase by 1 per cent less than the increase in the retail price index (RPI-1), which would include the increase in airport charges it considered necessary to offset the loss of net income from sales of intra-EU duty-free and tax-free goods, when such sales are disallowed (currently expected to be from 1 July 1999).

In our consideration of the maximum level of airport charges, we have concluded that 7.75 per cent is an appropriate cost of capital for MA. We also believe that there should be some `headroom' above the cost of capital equivalent to a phased reduction in rate of return to that level. That cost of capital should be applied to a regulatory value of assets based on a recent revaluation of fixed assets, but revalued thereafter by the RPI to reduce the effect of unpredictable fluctuations in construction prices. We believe there is more scope than assumed by MA to reduce its operating costs. MA argued that a significant increase in sales develop-ment expenditure (comprising rebates and other incentives to airlines to use or increase their use of Manchester Airport) was necessary to achieve its traffic forecasts, which are broadly in line with the traffic growth forecast for regional airports as a whole in the UK. We believe it reason-able to allow for only a more limited increase in such expenditure. Finally, we believe MA should be able to generate somewhat greater commercial revenue than it has assumed to offset the loss of income from sales of intra-EU duty-free and tax-free goods.

On the above assumptions, we have recommended that the maximum revenue per passenger from airport charges should be £6.74 in 1998/99, at 1996/97 prices (this is equivalent to a reduction relative to the RPI of about 6.5 per cent in that year), and in the subsequent four years be reduced by 5 per cent a year relative to the RPI (RPI-5). This level of charges would be sufficient to compensate for the loss of income from sales of intra-EU duty-free and tax-free goods. We do not believe these proposals would lead to any financing problem or postponement of investment, despite effective restrictions on MA's ability to borrow.

We received widespread complaints from airlines that MA's procedures for consultation have been unsatisfactory. MA itself proposed some improvement to its procedures during the course of the inquiry. We have, however, concluded that inadequate procedures for consultation have operated, and might be expected to operate, against the public interest. The adverse effects are the excessive costs directly and indirectly imposed upon airlines involved in ineffective consulta-tion, and the inability of users to determine whether charges are inappropriate or not, leading to excessive charges or a structure of charges not related to the structure of costs. We have recommended that MA be required to implement consultation procedures to be approved by the CAA. We have also concluded that provision of inadequate information to users on the costs and revenues associated with the supply of utilities might be expected to operate against the public interest, MA being in a position to impose charges for utilities and increases in them that are not related to cost, and being expected to benefit unduly from this position. We have recom-mended that MA be required to make such information available to users.

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