Tour operators are taking a close look at the way in which they carry out business after a tumultuous couple of years
After decades of largely profitable growth, the last few years have been something of a reality check for European tour operators. Profit margins have dwindled into the same range as the scheduled airline sector, and one major UK tour operator, MyTravel, has only narrowly avoided bankruptcy.
While many have noted that the demise has coincided with the rise of the low-cost airlines and the increased popularity of independent travel, tour operators are quick to point out that there is still a market for the traditional one- or two-week package holiday in the Mediterranean. They concede, however, that it is a mature market, with few signs of growth. And, as financial analysts point out, the Internet is clearly changing people's travel habits.
"A value chain is being eroded from all directions," says Jamie Rollo, leisure analyst at Morgan Stanley. In addition to the price "visibility" provided by online booking engines and the emergence of the budget carriers, he warns that the shift to late booking is damaging tour operators. "It makes capacity and yield management much harder, and reduces the valuable income from early deposits," he adds.
This all comes at a time when the major tour operators have moved towards vertically integrated business models, buying up hotels, cruise ships and airlines to offer a complete package to holiday makers. There have also been a series of cross-border mergers as tour operators went for geographical scale. This has left only five major tour groups in Europe: TUI, Thomas Cook, First Choice, MyTravel and Kuoni.
The turmoil of the last few years has certainly put this business model to the test. UK-based First Choice, which has a greater emphasis on high-margin niche holidays than its main competitors, has been the best performer. Switzerland-based Kuoni, which has a similar profile, has been hard hit by the SARS crisis due to its reliance on Asia trade.
Vertical to virtual
The big three, Thomas Cook, TUI and MyTravel, have all struggled, and some observers are questioning the vertically integrated business model. "They should really be virtual holiday companies," says David Pope, leisure analyst at stockbroker Brewin Dolphin. "They shouldn't actually own anything, but should package together the various segments and negotiate on volumes."
While defending the value of the vertically integrated model, tour operators are well aware of the need to add more flexibility into their business model in order to cope with fluctuations in the travel market.
Excess capacity has become as much an issue in the package holiday sector as it is for scheduled airlines. "Despite four consecutive years of margin declines and a financial crisis at MyTravel, I do not see the tour operating industry as a whole acting rationally with regards to capacity management," says Rollo. "Volume does not drive profit, and consumers will continue to be educated into booking late if the industry's chronic overcapacity is not remedied."
One of those grappling with this issue is Glen Chipp, managing director of Thomas Cook Airlines UK, formerly JMC. He explains that part of the problem is that as tour groups bought up other operators over the past four to five years, they acquired the associated charter carriers. Thomas Cook, for instance has added three airlines during this period, including JMC. "They have brought with them a significant amount of summer capacity," he says. "Balancing capacity has become a critical issue."
There are those who believe tour operators have got it all wrong in gearing up for the summer peak. "They should have enough capacity for the winter season, and should use third-party carriers to fill the gap for the summer season," says Pope. David Crossland, the founder of Airtours (now MyTravel) and something of an industry legend, espoused this philosophy. However, the tendency has been for operators to try and match airline capacity to summer demand and farm the excess winter capacity out to other parts of the world - the favourites being North America and the Hadj traffic in the Islamic world. For instance, MyTravel is wet-leasing six aircraft to Indonesian flag carrier Garuda for this year's Hadj, while Thomas Cook UK has five aircraft working for sister airline Thomas Cook Belgium. Analysts argue, however, that with so many charter carriers trying to find takers for their aircraft in winter, rates tend to be on the low side. Charter carriers also tend to reserve all their heavy maintenance programmes for the winter.
With TUI fending off the threat of a hostile takeover bid and having recently undergone a boardroom shake-out that saw the departure of airline head Charles Gurassa, MyTravel has been taking the lead when it comes to reviewing the airline business model.
The group has been forced to take a longer and harder look at its business than its immediate peers after its brush with disaster, and with former Ryanair sales and marketing head Tim Jeans at the helm of the group's airline operations, old ways of doing things are being challenged.
The way the airline sits within the group is changing. "We are now a cost centre rather than a profit centre," says Jeans. "We are working much closer together with tour operators on costs." He says that traditionally MyTravel has offered a flat seat rate to operators. "We were left to pick up the pieces. We are now liaising with tour operators. We are sitting down and planning and looking where we can work smarter. We are looking at it from an operating cost rather than market seat rate point of view." If it does not make economic sense for MyTravel Airways to do the flying, then third-party carriers will be used. "We will outsource it," says Jeans.
The drive towards cost control will see other changes too. When he was put in charge of the group's airline activities in June this year, Jeans had a remit to overhaul that part of the business. "The airline cost base had been allowed to grow," he says, pointing to the fact that, partly through a series of acquisitions, the group had managed to acquire six completely different aircraft types, not to mention various different sub types. In addition to the extra support, pilot and engineering costs, cabin crew could not necessarily cross qualify across different aircraft types. "It was clear that significant surgery was needed."
This process has already started with the ditching of the group's ageing fleet of three McDonnell Douglas DC-10s. Although a buyer is being sought for these aircraft, the company admits that it is likely they will be broken up for scrap. The ditching of the DC-10s is bound up with the group's urgent need to write off aircraft as it attempts to restructure its finances.
Jeans says that the days of tour operators flying 350-seat aircraft are over. "It is no longer possible to make money on the tail of the aircraft," he says, adding that while around two-thirds of passengers on an aircraft of this size would have bought on brochure, the rest will be late bookings with various degrees of distress selling. "If you are selling the last 100 seats at a loss, then cut out the last 100 seats," he says, arguing that the short-haul aircraft of choice for charter carriers today should be the Airbus A320 and new generation of Boeing 737s, as is the case with low-cost carriers.
Jeans is at pains to point out that it is not a question of the efficiency of these types of aircraft. "It is just that the market has moved on. You have to offer flexibility." He points out that a Boeing 767 flying the London Gatwick to Palma Mallorca route has a capacity of 2,400 seats per week, compared with 1,000 for a 737-700. "We are not immune to the capacity-yield equation," he says.
In the mix
However, Chipp at Thomas Cook believes there is a place for a wider aircraft mix. "The key is to be able to match route capacity to demand," he says. As an example, if a charter carrier has one or two A320s on a route, there is a choice of 180 or 360 seats. An A320 plus a Boeing 757, however, gives possible combinations of 180, 235, 360 or 470 seats, with increments of 55, 125 or 90 seats. "The more aircraft types you have in your fleet, the more flexibility you have," he says. "But of, course, if you have too many, your engineering costs are too high." Thomas Cook UK has three types, A320s, Boeing 757-200s and 757-300s, with capacities of 180, 235 and 280, respectively.
The use of smaller aircraft has implications for the traditional cost advantages of the charter sector. Charter carriers have tended to beat others, including low-cost carriers, in terms of unit cost, mainly due to the higher capacity levels and aircraft utilisation levels. Smaller aircraft will obviously erode this.
However, the high utilisation levels were partly achieved through night flying, and charter carriers have found that customers are far less willing to accept these types of flights as they have become used to the regular frequencies offered by low-cost carriers. Travellers have also grown used to flying out of regional airports rather than having to travel to major hubs. As Jeans points out: "This all comes at a cost."
Regional view
He says that a rationalisation of the number of regional bases at MyTravel is a distinct possibility. The major in-house charter operators have tended to base their regional operations away from their main competitors where possible, but have built up a system of buying seats off each other where needed. The airline is also looking at the long-haul side of its business. Destinations that can only be served once a week, such as London Gatwick-Las Vegas, may well be hived off to third-party carriers.
As they work out how to get the best out of their in-house airlines, tour operators cannot afford to take their eye off what the low-cost carriers are up to. The decision by a number of tour operators to set up their own low-cost subsidiaries has been well documented - two notable examples being TUI's Hapag-Lloyd Express and MyTraveLite. Independent charter carriers such as Air Berlin have also introduced a low-cost product.
The jury is still out on this strategy given its sudden and recent emergence. Financial analysts have yet to be convinced. Rollo of Morgan Stanley, asks: "Is the €40 million [$45 million] start-up loss at Hapag-Lloyd Express not proof that running a dual strategy leads to duplicate costs and risks competing with itself?"
Those that have gone down this road are adamant that the two products can exist side-by-side. Jeans, now chief operating officer at MyTravel Airways, but who had headed the launch of MyTravelLite, says that the Birmingham to Malaga route has grown 125% since its low-cost offering entered the market in October 2003 alongside the established charter product. "This demonstrates an enormous pent-up demand for low-cost travel," he says. "It is not cannabalising core charter traffic."
Budget decisions
While TUI and MyTravel have both decided to go down the low-cost route, Thomas Cook has decided to stick to its guns. Chipp says that while "you can't afford to be complacent", the group has not been tempted into this game.
Thomas Cook experimented with a scheduled offering, setting aside a daily 08.00h slot from London Gatwick to Malaga, operated by either an A320 or a 757. "We made a reasonable margin on the seat-only business," says Chipp. "But when we analysed it, we found that we would have made more money if we had used the aircraft for our all-inclusive business."
Most observers agree that there is little room in the UK for another low-cost entrant, although there is room for developing the seat-only business. In Germany, this accounts for up to 30% of capacity in the charter sector but is a more recent phenomenon in the UK. TUI launched Britanniadirect.com last year as a vehicle for selling seat-only business primarily over the Internet. This was restricted to distressed stock on a limited number of destinations, but is now being expanded to include a block of seats on all flights throughout the network, providing more choice on destinations and also, crucially, travel times.
While charter operators insist that the low-cost sector does not mean the death of the charter industry at the moment, there is no doubt that it is helping to change the way they do business, just as it is in the scheduled airline sector. The debate about the extent of change needed is still far from over, and with aircraft leases in place, changes in fleet composition may take time. But in a fast-moving business at the heart of the dotcom revolution, tour operators cannot afford to assume that the old way of doing things will see them through into better times.
REPORT BY COLIN BAKER IN LONDON
Source: Airline Business
