CAA Benchmarking Proposal & Responses to the CAA Paper Presented by Sylvana Thiele & Lori Palotas

Main reason for Benchmarking 2 main problems with setting regulation: –Regulators don‘t have sufficient info –Therefore the firm has an incentive to influence the system Benchmarking suggested as an alternative to overcome these problems –CAA proposes that benchmarking could be used to set price caps

Benchmarking for Price Cap Setting A firm‘s future and present price cap would not be set by its own costs – incentive gone to ‘game‘ the system Setting price caps by this method would be challenging –Difficulty in finding the right comparators, do not have complete information and need to find a way to be able to take differences of airports into account –Benchmarking doesn‘t have to be used alone –Benchmarking must be sustainable over time

Benefits of Benchmarking Reduces asymmetries of info between regulators and firms - therefore reduces scope of game playing Increases incentives for firms to reduce costs through price caps Incentives for making appropriate investment decisions Comparison is not restricted to cost and efficiency – can be used to compare other factors In terms of other Economic Regulation: To estimate a fully specified cost function for airports and their services To benchmark costs of major investments To estimate long-run incremental costs To assess performance on service quality standards

Criticisms of Benchmarking Could provide poor incentives for firms to try to meet the needs of users and customers –Methodology might not be robust over time –Benchmarking could set the price incorrectly Depending on whether price is set below or above costs could lead to problems Price cap setting should be limited to quality of the benchmarking and the potential of its benefits should outweigh the negatives

Problems that are acknowledged in Benchmarking Airports Outputs have to be defined Airport data is often limited Data adjustments have to be made, therefore a degree of judgement is unavoidable Airports have different strategic objectives Lumpy investments / different investment cycles Unexplained differences could be wrongly concluded as an efficiency gap

CAA Assessment and Next Steps If benchmarking is not robust enough to set price caps, it could still be valuable –E.g. Projecting average or incremental costs or to improve understanding of key cost & revenue drivers CAA plans to: fully estimate airport efficiency, performance and cost functions using quantitative techniques Make an assessment of the main partial productivity indicators Make a case study comparison between each of the regulated airports and appropriate comparators

a) key factors which differentiate airports Source: BAA response – Use of benchmarking p Comments on using top-down approach to cost benchmarking?

b) factors which cannot be meaningfully address:  Capital intensity  Service standards  Operating costs link to revenue  Product innovation  Airport investment is lumpy  Indirect cost 1.Comments on using top-down approach to cost benchmarking?

Conclusion:  not enough adequate data  too many fundamental differences  large number of external variables affecting results  unreliable results  wide error range 1.Comments on using top-down approach to cost benchmarking?

Proposal :  bottom-up approach assessing investment projects specific areas e.g. service level agreement  examination of key processes Identification of Material and controllable costs Identification of inefficiencies quantifiable improvements due to a target setting approach 1.Comments on using top-down approach to cost benchmarking?

2. In what areas is benchmarking likely to be of greatest value? Benchmarking alternative to regulation for setting price caps?  instability of the results may not provide a sound basis for setting the price cap ➔ regulatory risk for the company

Proposal:  focussing on key processes  complementary tool: -measuring operational and economic efficiency -providing explanatory data  Helpful: -as a performance guideline for regulator -for judging the optimum price and service quality 2. In what areas is benchmarking likely to be of greatest value?

3. Comments on quantitative techniques and benchmarking? Conclusion:  Econometric Analysis: -need a clear understanding of how to interpret and use data -limited to sample sizes -are error prone -too complicated  Reasons: -fundamental differences between airports -cost data is not available

Proposal:  use partial statistical and qualitative measures 3. Comments on quantitative techniques and benchmarking?

Thank you for your attention!

References: Civil Aviation Authority: The Use of Benchmarking in the Airport Reviews, Consultation Paper, December BAA plc: BAA Response, The Use of Benchmarking, February others: Airtours, BARUK, BATA, BMI, British Airways, Gatwick Consultative Committee, Heathrow AOC, IATA, Manchester Airport plc, Monarch airlines, Ryanair, Virgin Atlantic Airways. Papers online at: