Charter LCC subsidiaries: a useful development? November 2002

The current troubles at MyTravel Group, the UK–based air–inclusive tour operator, appear largely to be due to weak management and poor accounting practices. But these issues mask a more fundamental problem for MyTravel (see Briefing, July/August 2002) and for the inclusive tour (IT) sector in general — demand for the traditional package holidays appears to be ebbing away.

For the European charter industry, 2002 has been a terrible year. September 11 resulted in traditional package holiday customers refraining from making a booking during the winter months for the 2002 summer holiday season, as they would normally do.

This trend was compounded by the tendency of 18–35 year old British males and females — a large part of the charter market in the UK — to stay at home to watch the World Cup on television during the early summer months. This pattern was repeated in the German market, and to a lesser extent in the Scandinavian market (the UK, Germany and Scandinavia provides the majority of north Europe–Mediterranean charter customers each year). When the football was over, MyTravel and others expected a huge surge in late bookings, but this just did not occur at the levels expected. Many in the charter industry see these as one–off events, and expect that summer bookings for 2003 will be back to the level of 2001 — but some fear that a far more long–term change is taking place.

MyTravel and others are having to face the fact that important segments of the IT market — customers, both young and retired, with relatively high disposable incomes and unencumbered with children — are switching to self–assembled holidays. From these customers' point–of view, it’s to do with flexibility — encouraged by the internet, they no longer fear bypassing travel agents and putting together their own packages if they can get the destinations, accommodation and departure/ arrival times that they prefer, rather than take the rigid one–size–fits–all packages of the tour operators.

This trend away from packages has coincided with the rise of the low cost carriers (LCCs). The LCCs initially targeted cities as their destinations, but are now increasingly offering regular scheduled flights to popular holiday destinations.

The LCCs have undoubtedly taken business away from the charter airlines over the last five years as they have intruded onto the key package holiday routes. The key battleground at the moment appears to be Spain — Alicante, Malaga and Mallorca all have LCC flights now. According to travel industry sources on the key package destination of Ibiza, Go flights to the island this summer are believed to have been primarily at the expense of the traditional charter flights there from the UK.Europe’s inclusive tour operators have been offering seat–only services for a number of years, but while giving some flexibility to holidaymakers, these seats are not sold on dedicated scheduled flights but as fill–ins on charter services. In addition, the charter airlines tend to have a non–existent or even negative brand association with holidaymakers.

Enter the charter LCCs

In response to the LCC threat, the flavour–of–the–month strategy at the tour operators is to start their own LCCs:

MyTravelLite, which started flying from Birmingham to five continental European destinations in October, uses two A320s transferred from the MyTravel Group.

German travel group TUI has launched Hapag–Lloyd Express in cooperation with Germania, which is supplying eight 737- 700s. Meanwhile Lufthansa, which owns 50% of tour operator Thomas Cook, is experimenting indirectly with a low–cost start–up of its own called Germanwings, with five A320s being operated by Eurowings (in which Lufthansa has a 25% stake) out of Cologne/Bonn.

Interestingly, the tour operator groups concerned argue they are launching low cost airlines not because they are losing business to the LCCs, but because there are "new growth opportunities".

Few analysts believe this rationale, but what is more important for the future of the traditional charter airlines is whether these tour operator LCCs succeed or not.

Tim Jeans, the ex–Ryanair sales and marketing director who now heads up MyTravelLite, claims that he can merge the culture and expertise of the LCCs with the traditional strengths of the charter carriers, which he claims include higher aircraft utilisation rates. The MyTravel Group will also be able to offer MyTravelLite passengers lots of accommodation options for the destinations they fly to.

Do the LCCs really have anything to learn from the charter operations? Utilisation rates may be higher for the charters, but this apparent advantage will disappear in a scheduled operation. And as for lots of accommodation options for MyTravelLite passengers, that’s great — but the whole point of flexibility is that passengers can and will chose whatever accommodation they want.

There is also a fundamental difference in the revenue management techniques of the charters and the LCCs. Charter carriers end up with their near 100% load factors, almost always because of last minute heavy discounting of package holidays. The successful LCCs generally manipulate fares so that they increase as the departure time approaches. So the charters have a steep learning curve in this area.

Similarly, the charter LCCs do not have the smooth user–friendly websites that are such an integral part of the Ryanair and easyJet operations.

From the point–of–view of the tour operator, the establishment of an LCC appears to be low risk; if it fails, the subsidiary can quickly be abandoned without too much of a hit to the group bottom line. The deeper problem is, however, that the charters may be getting into the LCC business without solving the fundamental problems in their core businesses.

TO/LCC alliances?

If the tour operators' own low–cost start–ups are not successful, they will look at other options. One obvious solution would be for the tour operators to cut back on their own in–house capacity, and partner or ally with a LCC, offering customers seats on preferred flights operated by the likes of easyJet or Ryanair? With a "block booking" from the tour operators on specific routes, LCCs would increase capacity to holiday destinations, and customers could be given a series of flight options for each destination, depending on the LCC timetable.

However, this is a strategic question for the tour operators, who have traditionally seen themselves as being vertical players, offering everything from travel agency services to accommodation to flights etc. under their own brand. They may be forced to be more flexible in today’s market.