Europe's leisure travel giants are having to adapt to a rapidly changing marketplace
The problems that beset the European package holiday industry are all familiar enough: global recession, the threat of terrorism; SARS and the rise of low-cost rivals. All have taken their toll. However, the industry's problems extend far beyond the recent economic downturn and few predict a quick recovery to the heady days before the crisis.
According to figures from IACA, the charter airline industry association, 90 million Europeans last year took a package holiday of four nights or more, still 10% below the 100 million in 2000.
Management consultants Mercer estimates that back in the late 1990s Europe's tour operators were growing at a rate of 6% a year. Since then the market has shrunk and from now on Mercer expects only modest annual growth of 3% through to the end of the decade, in line with economic growth and inflation. Figures from the latest ranking of airline charter carriers demonstrates just how little new traffic or capacity came online last year from the major operators.
So, while the all-inclusive package industry may not be dead, it is not exactly in rude health either. The issues facing tour operators will again have a familiar ring to airline managers. The emergence of the low-cost carriers and the growth of the internet have changed the way Europeans take their holidays.
Instead of the traditional two weeks in the sun on an all-inclusive deal, they are taking shorter breaks and opting for the flexibility of cheap, scheduled flights offered by low-cost carriers. And, crucially, they book package deals far later than used to be the case.
Against this background, the big tour operating groups - First Choice, Kuoni, MyTravel, Thomas Cook and TUI - have all struggled. MyTravel has been teetering on the edge of bankruptcy for the last couple of years and survival is far from certain, despite a recent debt-for-equity deal agreed with a number of banks. However, MyTravel's problems stem as much from over-expansion, particularly in the crowded German market, as from underlying structural issues within the industry.
Weak results
Although not in such dire shape, others too are struggling. TUI, the world's largest travel group, saw operating margins at its giant tourism division end last year at only 1.6%. While the group as a whole expects to show an improved operating profit of €420 million ($510 million) this year up from €240 million last, this is driven by cost cuts and profits from the group's legacy steel division, which it is trying to divest.
Ian Rennardson, leisure analyst at Merrill Lynch, warns there has been little sign of any material improvement in trading or improvement for 2005. German economic weakness has been a persistent problem and TUI recorded growth of 2% in Germany in terms of revenues and volume.
It is a similar story at Thomas Cook, the other German giant. At the end of May, bookings were up by 4.7% on a relatively weak 2003 figure. Given the apparent stability in bookings, the group says it is confident that it will increase customer numbers "at a rate above the market average" but "above all" it will show a significant increase in earnings "due to cuts in structural costs". Last year, Thomas Cook reduced costs on aircraft leases and accommodation but saw this offset by rising fuel prices, leaving it still showing a hefty loss.
Against this background, there is general agreement that the business model of the tour-operating groups needs to adapt to a changed marketplace. In a report on the sector, Mercer warns: "Some of the standard business practices are no longer working - such as booking capacity more than six months in advance and securing most bookings before the holiday season."
Mercer believes that tour groups need to respond to the changing consumer behaviour patterns by developing "a much more flexible approach to capacity management" and adds that "new risk-sharing models between tour operators and independent capacity providers are needed". This applies to hotels and resorts as well as airlines.
MyTravel, Thomas Cook and TUI entered the 2001 recession after a frenzy of consolidation in which each sought to ensure its place in the big league by buying up airlines, operators and agents across Europe. This has left all three with significant debt at a time when growth has stagnated. This has virtually toppled MyTravel and even TUI's debt reduction strategy is "increasingly at risk" says Rennardson at Merrill Lynch.
Many of the acquisitions were made at relatively high prices in buoyant equity markets. The downturn in the package sector came at a time when those investments were still being bedded in, a situation worsened by other problems faced by the industry.
Tim Jeans, the recently departed head of MyTravel Airways, made no secret of the fact that the group's six different aircraft types - including Airbus, Boeing and McDonnell Douglas - was a less than ideal starting point when he took over in mid-2003. He got rid of ageing McDonnell Douglas DC10-30s quickly and, shortly before he left the group in early August, had put in place a programme that meant a cut in capacity by one third and a focus on Airbus aircraft. Other groups have faced similar problems. Thomas Cook, for instance, had to integrate charter airlines Flying Colours and Caledonian.
All this merely exacerbated a difficult period. "External factors may have triggered the European tourism crisis but industry-specific factors have reinforced the effect," says Mercer.
As a result, MyTravel, Thomas Cook and TUI are left with high levels of fixed assets, especially hotels and aircraft. The lack of flexibility, in terms of capacity, at a time of weak demand, means these groups suffered far more than some more-nimble specialist groups such as German low-cost provider Alltours and cruise specialist Seetours, both of which increased revenue despite the downturn.
Niche markets
Perhaps the best example is provided by one of the vertically integrated groups, however. First Choice in the UKtook the decision, early in the downturn, to specialise in niche markets and has fared better than most of its peers. David Pope, leisure analyst at Brewin Dolphin, puts the success down to chief executive Pert Long. "He understands the holiday business. Every part of the business essentially revolves around the airline."
Pope adds that while leisure groups can flex their muscle on accommodation, they are relatively small players when it comes to transport. As such, their bargaining power on landing fees and aircraft leases is relatively weak. As a result, says Pope, it pays to be conservative when judging aircraft capacity needs for the coming season.
According to Pope, Long's background as a tour operator is advantageous when compared with the travel agent background of David Crossland, former chairman and founder of MyTravel (formerly Airtours). "The dynamics are different. Tour operators are far more risk averse." Pope also believes that while it makes sense for tour groups to own aircraft, they need to ensure flexibility and match aircraft capacity to their "quiet" season requirements. "There is a point at which it's better to have the flexibility rather than the fixed costs," he says.
First Choice is in the fortunate position of having a number of leases on Boeing 757s coming up for renewal at the end of the year, giving the group an opportunity to cut costs. In contrast, MyTravel had few opportunities for terminating leases without hefty penalties when it ran into trouble. But it is far from just luck that has seen First Choice emerge in reasonable financial shape. Its focus on specialist holidays, which the group expects to account for 50% of its profits, has proved a success. These tend to be holidays that offer something more than the traditional week or two in the sun. For instance, First Choice recently brought "soft adventure" provider Exodus, which offers mountain bike holidays in the Alps, where customers are more likely to get added value from a package deal that takes out much of the complexity.
Switzerland's Kuoni has also had some success specialising in a similar niche for upmarket packages. Although the Swiss group suffered in 2003 from its emphasis on long-haul destinations in the wake of the SARS outbreak, the Kuoni joined First Choice in outperforming its larger rivals with operating margins of better than 3% last year.
Package benefits
While groups such as First Choice and Kuoni show that a vertically integrated model can work in niche markets, most are quick to point out that the traditional mass-market package offering still holds important opportunities for the big travel groups.
Mercer believes that completely vertically integrated groups with a strong presence in all of the major European markets should be able to exploit their international scale - using their muscle to purchase air transport, accommodation and multi-channel distribution at a discount. However, the consultancy argues that such groups must offer the broadest possible coverage of all travel destinations, different kinds of leisure trips and customer segmentation. The only travel group to have achieved a leading position in all the key European markets so far has been TUI.
Mercer goes on to pick out the "virtual tour operator" as another strategy for success, where internet-based low-cost distribution channels allow customers to choose individual components of their holidays, often from different providers, to build a "dynamic" package.
Online agencies such as Opodo, Lastminute.com and Expedia have all sprung up over the last five years to serve this new but fast-growing market.
Vertical integrators, recognising the potential threat of posed by online agencies and low-cost carrier websites, have also ensured they are not left behind in this area. TUI, for instance, has around 50 internet portals within its portfolio, generating revenues of €726 million in 2003. The group's online sales have gone up by a factor of 10 over the past three years. TUI believes that most growth in online sales will be in the independent travel market and forecasts that only between 5% and 10% of package holidays will be booked online, depending on the source market.
However, it has decided to implement a hybrid distribution strategy to make sure it does not lose out in the fast-growing independent travel market. In a recent speech, TUI chairman Michael Frentzel responded to the charge that this is effectively internal cannibalisation: "It is not us who decides where our customers book their package holidays, flights, hotels, or car hire. It is the customers themselves who decide."
Of course, the integrated tour operators have also responded to the growth in integrated travel by launching their own low-cost carriers or increasing seat-only business. Thomas Cook's relaunched Condor has started offering low-cost seats on both long-haul and short-haul flights, with prices starting at €29 for short-haul and medium-haul destinations and €99 for long haul.
Ralf Teckentrup, board member for airlines, says: "The tour operator market we have focused on up until now has been in decline over the past two years. Condor must therefore work hard to achieve a significantly improved market share in the seats-only sales segment."
Low-cost strategy
TUI has been following a similar strategy but has also launched low-cost airlines in Germany and the UK - Hapag-Lloyd Express and Thomsonfly.
While they strive to cater for the main growth markets, the big tour groups are adamant that the package holiday is not dead. Speaking at the IACA annual general meeting earlier this year, Charles Gurassa, former head of TUI's airline division, says that "90 million people can't be wrong". He points out that the convenience of the package is still attractive for many Europeans and that such traditional holiday offerings can and will survive provided that the travel industry adapts to new market conditions.
As Brewin Dolphin's Pope stresses, this is not going to happen overnight. But at least the industry recognises the challenges ahead and, having arguably been a bit slow out of the starting blocks, is now starting to respond to a radically changed landscape.
REPORT BY COLIN BAKER IN LONDON
Source: Airline Business
