Market struggles to adapt to changing traveller needs and competitive pressureThe well publicised challenges faced by one of travel's oldest and best loved brands, Thomas Cook, show only too clearly the extent of the problems facing tour operators in the current environment. One-off events in far flung destinations (Egypt and Thailand in this case) can trigger much wider difficulties because they come on top of the ongoing pressure on core mainstream businesses as they struggle to change to meet the demands of today's travellers. The traditional high-volume tour operating model based on pre-booking flight and accommodation capacity is increasingly under threat. As more travellers opt for online and niche solutions to their travel, the traditional model is at best viewed as one in terminal decline. Agile operators and travellers can now compile travel packages with shorter booking lead times and lower costs of doing business. Within this overall scenario, the less innovative, traditional businesses continue to experience balance sheet stresses and these are particularly acute for smaller, generalist operators and those with above average gearing. IntroductionThe UK tour operator market for overseas travel is shrinking. Despite some recovery in the UK economy the travel industry continues to recede overall. Since 1999, the number of overseas holidays taken by UK travellers has continued to fall year on year and now stands at c36 million per annum. The recent and now likely to be protracted, economic downturn has amplified this trend both for package and independent holidays with a 20% decline in holidays taken between 2008 and 2010. In the same period, the number of package trips declined to 14.1 million – comparable levels last seen in the mid-1990s. Set against this macro-economic backdrop is the changing behaviour of travellers both in the type of holidays sought and the approach to booking. Summer travellers are less likely to book a traditional flight and accommodation package and, if they do, are more likely to do so later in the booking season and to use online approaches to shop around and build a package from its constituent parts. To a large extent we're all tour operators now. This change to booking behaviour, and the increase of innovative, niche market travel companies, is particularly troubling for the traditional industry players. These operators estimate market demand and commit capacity in terms of flights and bed stock even before the brochures are printed and selling starts. These commitments can be made a year or more before the relevant holiday season even starts. Come winter, the operators see how the season starts to assess how the key booking period is going. Over the last couple of years a trend in poor sales has led to discounting to sell stock and trying to flex and cut capacity on their estimated need. With customer trends and market forces having such quick impact on the market, this long lead time to market is putting severe pressure on the traditional and less flexible operators. The changing marketThe total market for UK traveller expenditure is worth around £30bn, including tour operator packages and independent travel usually organised online. The operator market includes a few vertically integrated providers – such as Thomas Cook and TUI – who sell both through traditional retail and online channels and have flight operating capability, own-brand hotel capacity, or both. There are also specialist providers of travel solutions appealing to distinct niche, travel communities. Some of these are significantly sized – such as Kuoni – but most providers are smaller and target their business at recognisable groups either by product (eg degree of luxury, specific destination or type of 'adventure') or by the traveller demographic (eg age profile). Tour operators will tend to take on the risk of building travel packages as a principle and then seek to sell that 'product' on to prospective travellers. Operators are in direct competition with agencies such as Expedia, Lastminute, Priceline, Opodo and Travelocity, who provide a service for prospective travellers to build their own package. As might be expected, the online agencies have lower fixed operating costs, sleeker business models and less exposure to the cash traps of the advanced-booking model traditionally used by operators. As a result, the traditional operator business model, for those who have not responded to the changing environment, is in decline and those businesses still shackled to that way of working are also generally in decline. The industry tends to run on low margins at the best of times and these are being further eroded by consumer spending cuts, fuel and Air Passenger Duty increases and commodity price rises in general. Original business models were built on a fuel price of $30 per barrel and not the current circa $100 and did not have to take into account the EU Emissions Trading System, which all airlines join next year; therefore those with a newer and more efficient fleets will be better placed to cope. With the occasional shock to the travel system provided by natural disasters such as tsunamis and floods; political instability, particularly in the Middle East and North Africa; and the costs associated with business failures affecting one element within a chain of operations, already thin margins can be decimated. Failing fastSince January 2011, twenty ABTA/ATOL registered tour operators have gone into administration and analysts are predicting a flurry of failures ahead. Under current legislation, tour operators must demonstrate their solvency, cash flow and adherence to Civil Aviation Authority requirements annually. The impact on margins from factors already noted, together with rising aviation fuel costs and air passenger duty have left many businesses teetering on the edge of failure. The number of tour operator businesses facing 'critical distress' is estimated to have risen by 49% in the past year. Given that the economic cycle in the industry typically leads to cash reserves being at their lowest during Q4, signs of real distress during Q3 are particularly worrying. The combination of an overstretched balance sheet and uncertainty over future revenue is generally the recipe for distress. We believe further consolidation and restructuring is inevitable. Where once the core competences for this sector were contracting skill and the management of lead times, the game has shifted to understanding rapidly changing customer requirements and lowering financial risk. The position for lendersIf you have credits in this sector, the five things you should be focusing on as a priority are:
An existing business deviating from this ideal is likely to have problems in the short to medium term. It is unlikely that businesses with significant costs tied up in high street retail operations or those focused exclusively in the commoditised end of the market will be able to endure the economic and market uncertainty of the coming years. Those businesses still wedded to buying capacity during the year before the sale season present particular concerns for lenders and many will breach covenants in this coming quarter if bookings do not flood in. Although revenue can be generated in the traditional tour operator business, the customer base is ageing and is unlikely to be replaced like-for-like by the next generation of buyers looking for unique and bespoke travel experiences. The younger replacement holiday buyers are increasingly used to alternative models of dynamic packaging via on-line distributors and using low cost carriers. However, some tour operators are already responding to the changing environment by looking closely at their business plans and financing and taking steps such as those below:
Lenders need to pay attention not only to the overall exposure within their tour operator customer businesses but also look closely at the underlying economic cycle, customer demographic, current business plan and seasonality of cash flow to get the full picture of risk. As always lenders need to be scrutinising customer cash flow forecasts across all phases of the working capital cycle. Investment and consolidation activity requires careful due diligence, given the increased polarisation within the market favouring larger businesses with significant online capability and small specialist niche providers. Key pointsWe believe the sector will see higher levels of business failure, restructuring and consolidation in the near future as a result of longer term structural changes in the market and shorter term economic pressures. While some traditional tour operators have introduced change and flexibility many will face financial discomfort and those with weak balance sheets and poor forward sales will be hit hardest. As we approach the traditional low point in cash cycle at a time when recession in the UK economy is a real threat and global political uncertainties undermine consumer confidence, the likelihood of prospects improving in 2012 is low. Feedback & commentsTo provide feedback on this Sector Foresight, or to suggest other sectors you would like us to cover, please email hayley.willans@kpmg.co.uk Unsubscribe | Privacy | Legal © 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved. KPMG LLP, 15 Canada Square, London, E14 5GL Designed and produced by RR Donnelley. |
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