UK: Exploring Hidden Depths

Last Updated: 11 September 2009
Article by Deloitte Travel, Hospitality & Leisure Group

Most Read Contributor in UK, August 2017

Welcome

The future is – business unusual! Are you ready?

Natural disasters, terrorist attacks, geopolitical risks, a ban on smoking, epidemics, global recession and now a pandemic ... the travel and tourism industry finds itself at the forefront of unprecedented challenges. The new buzzword is "business resilience management". Planning for a doomsday scenario is an emerging art form reminiscent of the planning for Y2K. Customer relationship management takes on a new meaning when plummeting demand forces the industry to drop prices and the brand promise becomes too costly to deliver. Managing the fine balance between cost reduction and losing the human capital talent in which the industry has long invested and may regret when the upturn comes is hugely challenging. And yet, somehow, these risks must be proactively analysed, the opportunities for enhancing revenues and reducing costs must be actioned, and the brand promise must be maintained.

In this edition of our executive report, we look at some of the changing trends in our industry as a result of the above, as well as assess the impact of pandemics. One thing is crystal clear, the future is ... business unusual!

As ever, we value your feedback.

NAVIGATING THE NEW NORMAL

After months of economic uncertainty, airlines and tour operators have seen significant changes in demand for their products.

When airlines even talk about reducing the size of cutlery on in-flight meals to make planes lighter and save on fuel costs, it speaks volumes about the severity of the current crisis in the travel industry.

After months of economic uncertainty, airlines and tour operators have seen significant changes in demand for their products. Recent statistics from the Civil Aviation Authority (CAA) demonstrate the extent of these changes. For the first four months of 2009 overall passenger numbers for UK airports declined by -10.4% compared with the same period in 2008. Domestic travel fell by -11.7%, EU travel by -12.1% and non-EU travel by -6.8%.

Changed landscape

This has resulted in a number of heavy losses for operators, including a pre-tax loss of £148 million for British Airways Plc for the quarter ended June 2009, the first time that they have recorded a loss for this quarter since privatisation. The International Air Transport Association (IATA) now estimates that the global airline industry will lose $9 billion in 2009.

Airlines and tour operators need to respond quickly to these changing conditions. This is a major challenge for an industry that has to bear the huge fixed capital costs of operating aircraft, ships or hotels.

The new normal?

This article analyses the impact of changing economic circumstances on aviation and travel, looks at how operators are responding and asks whether the travel landscape has changed permanently.

Hedging your bets

The industry has been badly hit by the volatility of fuel prices and exchange rates. Although 2008 saw oil reach $147 a barrel, travel companies were able to survive initially by hedging, buying months ahead at lower prices.

With the onset of recession, oil prices plummeted, dropping as low as $34 a barrel. Many airlines have been unable to take advantage of this, having hedged at a higher price than current market rates. Ryanair, for example, hedged 80% of its fuel at $124 a barrel, losing €102 million for the last quarter of 2008.

The danger now is that oil prices, having started to rise once again in recent months, may be heading for further dizzy heights. This time round, with balance sheets weakened by the credit crunch, carriers may struggle to 'buy forward' at today's prices.

Currency headache

Exchange rates, particularly the Euro and US Dollar, have also fluctuated wildly against Sterling. This has been a major headache for operators based in the UK or those in Euroland who derive a large portion of their revenues from Sterling.

In the case of airlines, all fuel and aircraft related costs such as parts, rental and capital expenditure are denominated in dollars and a high proportion of the remaining direct operating costs are in Euros.

Most companies with so much exposure to currency markets will have a hedging strategy in place. However it is extremely difficult to beat the market in stable conditions, let alone in the current environment where balance sheets are in such a weak state.

Cabin pressure

For the flag carriers the largest impact has been felt at the front of the cabin. The collapse in the M&A market and corporate belt tightening has led to a decrease in the premium business travel from which the bulk of a typical flag carrier's profits are derived.

Operators such as British Airways, BMI and Air France have announced significant losses this year and even those that remain profitable, such as Lufthansa, Virgin Atlantic and Iberia have seen their profits eroded.

As Figure 1 shows, although economy travel has fallen, the decline in premium travel has been far more profound.

Uphill task

The credit crunch and the subsequent demise of investment banks had a huge impact on transatlantic airlines. In the space of a few months these carriers lost a significant portion of their core customer base.

The corporate world has cut travel spending, and other methods of domestic transport such as rail are being adopted. Whilst this change is largely driven by the short-term need to cut overheads, growing environmental concerns and public resentment over the expense accounts of executives suggest that, in the long-term, the flag carriers face an uphill task in regaining their former customers.

Those businesses that are still travelling are increasingly turning to economy flights, and low cost carriers such as Ryanair and easyJet are taking market share from the flag carriers. Ryanair posted a pre-tax profit of €134.6 million for the quarter ended June 2009. Budget hotels are also reaping the benefits of this trend with chains such as Travelodge expecting to gain market share as business customers 'trade down' from 4* and 5* hotels.

Spending power

Within leisure travel, job market uncertainties and the falling value of Sterling have impacted consumer confidence. Holidaymakers who had become accustomed to a strong pound have seen their spending power slashed in their favourite destinations.

Airlines have been quick to spot this opportunity with additional routes being set up to resorts outside the Eurozone in Turkey and Egypt, and tour operators have also shifted capacity to these regions.

Despite this, CAA statistics for the budget airlines continue to show good results for Euroland package resorts, with Monarch reporting huge demand for the Canary Islands as a destination for summer 2009. Flights purchased in Sterling are not being affected by the exchange rates, although it remains to be seen whether levels of spending on holiday will remain high if the exchange rates stay at such low levels.

All-inclusive trend

Fragile consumer confidence has prompted a renewed interest in package holidays offering protection to the holiday maker under the CAA's Air Travel Organisers Licensing scheme (ATOL). All-inclusive destinations are enjoying particularly strong demand, enabling customers to budget more accurately for the full cost of their holiday in advance.

In May 2009 Thomas Cook reported that 41% of its summer bookings were all-inclusive, compared to 30% in summer 2008. Along with TUI's UK brands Thomson and First Choice, Thomas Cook is introducing an allinclusive only brochure for 2010 in an attempt to capitalise on this trend.

Leaving it late

Late booking is another key trend affecting the leisure sector, caused partly by fears over company failure in the wake of the XL Group collapse that led to many passengers being stranded or having their holidays cancelled. With unemployment reaching 2.43 million in the UK, and further rises expected, consumers are also reluctant to commit to large expenditure before they need to.

Travellers are delaying booking as much as possible in order to minimise risk. This puts increased pressure on the traditional business model of holiday companies, making it harder than ever to predict departure patterns. Airlines and tour operators who have already cut their headcount are less able to respond to changes in demand at a moment's notice.

Travel companies are being forced to put contingencies in place just in case bookings are even lower than originally expected. Many players in the industry are pinning their hopes on a surge of late bookings for summer 2009.

Domestic opportunity

Other external factors, such as the swine flu pandemic, recent aircraft accidents and political unrest in countries such as Sri Lanka, Pakistan and Thailand have also resulted in consumers giving much more thought as to whether to holiday abroad, and if so where to?

So far though, it appears that UK consumers are unwilling to sacrifice their 'main' annual holiday in the sun. City breaks, on the other hand, are considered more of a discretionary spend and are suffering more, as the fall in economy passengers within Europe and declining European hotel rates demonstrate.

One consequence of the current climate may be an increase in domestic tourism. Despite the perennial uncertainties of British weather, initial predictions of a heat wave summer and the attraction of Sterling may have persuaded more travellers to stay closer to home. We are also seeing a change in the method of transport used for domestic holidays, with flights becoming less popular in favour of cheaper road and rail options.

Consolidation rumours

According to IATA, airline load factors stood at 75.3% in June 2009 compared to 77.6% in June 2008. With passenger numbers down by more than -7% when compared to the same month in the previous year, this points to a reduction not just in demand but in supply. The collapse of several airlines in the past year including XL and Zoom, coupled with cuts by the remaining carriers and tour operators, have reduced overall capacity in the market.

The logic of current market conditions would suggest that consolidation is the way for airlines to gain a competitive advantage of scale. Whilst actual M&A activity remains slow, some developments are taking place, such as British Airways recent announcement of plans for a joint business arrangement with American Airlines and a more formal merger with Iberia.

The recent financial troubles faced by Arcandor, the majority shareholder in Thomas Cook, have led to rumours of a potential bid for the listed tour operator. Again in Germany, the cash-rich carrier Lufthansa has been linked with an ever growing list of airlines, the troubled SAS Scandinavian Airlines being the latest addition.

It remains to be seen whether countries are prepared to let their national airlines merge, following an abandonment of the various bi-lateral agreements. Even the ambitious plans for Open Skies 2 between the US and Europe seem currently doomed, as the new US administration appears to be adopting a more protectionist stance with its current aviation policies.

Perfect storm

As the landscape of travel has changed, operators have found themselves cast adrift in a 'perfect storm' of rising costs and shrinking revenues. Some airlines have responded by focussing even more closely on squeezing spend from their customers. Charges for checking bags have risen, becoming increasingly disproportionate to the fare, and the cost of breaching your allowance can be punitive.

The other strategy is to reduce costs even further, a major challenge in an industry that claims to have cut costs down to the bone already. BA recently announced that it had cut spending by 20% to £580 million from £725 million, and had lengthened its schedule of orders for 12 Airbus A380 aircraft.

Staffing difficulties

Besides fuel, the biggest cost for an airline is its staff. The CAA's recent statistics on airline staff costs demonstrated that BA is paying, on average, nearly £10k more for its cabin crew per annum than its nearest competitor easyJet, and more than double that of Virgin Atlantic. As BA looks to drastically cut costs and struggles with a pension deficit of around £3 billion, it has been discussing with the unions the options of staff working for free, taking unpaid leave, and agreeing to a pay freeze for the next two years. These proposals are yet to be accepted.

In a heavily unionised industry growing talk of staff cuts has inevitably led to threats of strike action. Virgin has announced cuts and many other airlines, particularly in the US, are also facing the prospect of difficulties with staff. In the short-term airline management is set to become more challenging. Strike action would add to the industry's woes, with the threat of disruption likely to further dissuade travellers from booking business flights and holidays. Potentially this is more bad news for the bottom line and the cash balance of already beleaguered airlines.

Survival strategy

The airline and travel industries are in the midst of deeply uncertain times. A flexible response in the face of unpredictable booking patterns, cost reductions and innovative revenue streams are all needed.

Operators need to focus on those areas where consumers are spending money, such as economy business travel, all-inclusive holiday destinations, non- Eurozone/domestic holidays or cheaper, greener transport. They may need to shift away from previous 'cash cows' such as premium business travel, if they are to return to profitable results.

Whether this can be achieved quickly enough to avoid any further large scale failures is a key question. Whilst some commentators are seeing green shoots appear in the UK economy, for aviation and travel the recovery appears to remain some way off.

A survival strategy, rather than one of growth, will be the focus of discussion around most airline and tour operator boardroom tables over the next couple of years. It is clear that the landscape of travel has changed and, in some cases, these changes may be permanent. Welcome to the new normal.

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