Pricing & Profit
How tour operators set prices and factors which can affect holiday prices and the profits made thereon
The average profit made on package holidays is extremely slender. Many non-travel companies supplying consumer products achieve a net margin on sales turnover of 10 - 12 per cent. The Civil Aviation Authority (CAA) records that the average tour operator's return on turnover in recent years remains around just two to three per cent and amounts to just some £8 profit on a £400 holiday.
Not only are the margins low, tour operators also have to manage considerable risks not faced by other higher margin industries. For example, holiday prices are set over one year before a holiday takes place and a significant proportion of costs can be subject to considerable fluctuation - especially exchange rates and aviation fuel. Although tour operators are able to protect themselves from some of these fluctuations by "buying forward", this is expensive. Accurate forecasts are vital: unnecessary costs are incurred if too much is "hedged".
Accurate forecasting is also necessary for another reason. Late surcharges to clients are not allowed under the Package Travel Regulations - and surcharges under two per cent of the package price cannot be levied at any time. Remembering the average two per cent profit margin, adverse fluctuations outside the tour operators' control can be enough to push the programme into break-even or loss.
Yet another risk can arise from the unexpected loss of popularity of a country where the tour operator has contracted heavily. Perhaps because of political or security concerns, or natural disasters such as typhoons or volcanoes, or as a result of economic factors such as adverse currency movements or new aviation or tourist taxes. There is a high level of price elasticity between holiday markets.
Questions arise in respect of the variety of prices in tour operators' brochures. The underlying reason for the different prices are the differences in demand that occur at different times and places. Tour operators set prices to ensure that as many aircraft seats and hotel beds are used as possible.
The main components are:
- Season Pricing
Package holidays are normally organised into two seasons: Summer (May to October) and Winter (November to April). In the summer more people wish to go to their holidays in August than in May. However, tour operators need to keep their planes as full as possible throughout the year. This is achieved by varying the prices to reflect the varying demand for holidays.
The Summer period is the main time to travel both due to holidays and due to the weather – so there is a double pressure on demand. August is also the main month for holidays throughout Europe, so pressure on beds comes from all outbound markets. More people wish to travel in school holidays. There are only a finite number of beds & aircraft seats, therefore prices must rise for those periods.
Tour operators are generally committed to beds & seats for a full 6 month season, so the only tool available to even out demand is price. Some Local Education Authorities are beginning to move to a 6 term year, with holidays being slightly more spread, although current plans appear to be to reduce the main summer holiday. However, in return, the government is threatening to penalise parents for taking children out of school in term time. If this occurs, there may be even more pressure on demand in the peak holiday periods, which may result in even higher prices. It should be remembered that in order to fill aircraft in the quieter months, like May, tour operators frequently sell holidays at or below cost price, in order to ensure that the flight is filled.
- Flight Times
Better overall prices can be achieved if aircraft are used throughout the day and night. Most customers would prefer to travel during the day, but some are prepared to travel at unsociable times if the price is right. This policy helps keep all the holiday prices down, not just those using midweek night flights. Some airports operate a similar policy and their charges vary according to the time of day or at weekends.
- Regional Departures
The prices for flights from regional airports are set to keep aircraft as full as possible. Tour operators are keen to provide regional departures for people like to travel from their local airport. However, in this case tour operators, airlines and sometimes airports incur additional expenditure:
The demand for a specific destination is usually lower for smaller airports, but all the services need to be provided and have to be paid for by fewer passengers
Airlines may have to fly an empty plane and staff to a less frequently used airport
Flights can be longer from regional airports than Gatwick, so all the flight costs - fuel, staff etc are greater.
- Single Room and Other Accomodation Supplements
Most tour operatorsí contracts with hoteliers and apartment owners are based on a price per room, whilst their brochure holidays are sold per person. As a result, the per person price for a single traveller includes the whole room cost. This applies to both single rooms in hotels and self catering units, where, for example, three people may want to occupy accommodation for four.
Rooms are generally allocated according to the size pf the party travelling. Operators usually pay a fixed rate for individual types of accommodation, regardless of the differences in room sizes. This sometimes means that customers pay an accommodation supplement for a self catering unit, although it is not equipped with facilities for more than the number of people occupying the accommodation.
In relation to single rooms, whilst there is some small cost saving for a hotelier in having single customers, this is minimal, and the cost per room is therefore broadly comparable with the cost for 2 people – the only real saving is the food cost – cleaning, heating, lighting & maintenance costs for the room will be the same as a double room.
Tour Operators and Exchange rates
A high proportion of the costs incurred by tour operators is in foreign currencies, for hotels, transfers, airport charges etc. in the destination country. Also aviation fuel is priced in US dollars.
As holiday prices are advertised a long time before the tour operator has to pay hotels, airlines, etc, variations in exchange rates could have a major impact on their profit. Take a £500 holiday as an example. £300 may be payable in foreign currencies. The tour operator would expect to earn 2-3% (say £15) profit. So if there is a change of only 5% in the rates of exchange the tour operator's profit is either doubled or reduced to zero (5% of £300 = £15). This is not a risk which a prudent business person would wish to take.
Some years ago banks and other financial institutions provided schemes whereby a tour operator can agree to buy amounts of foreign exchange at a pre-agreed rate (this is known as hedging). There is a charge for this service but it does provide certainty for the tour operator and this is particularly important given the very slim profit margins.
Not all currencies can be hedged however, and the cost of doing so when only small amounts are involved is high, so this service cannot be used for all holidays. In these cases tour operators sometimes decide against giving a "no surcharge guarantee" - although they remain legally prevented from passing on the first 2% increase in costs. So the consumer still enjoys some protection from price increases.
The cost of aviation fuel (which is priced in US $) also varies and similar opportunities for hedging are available to help airlines guarantee their prices.
In these ways tour operators now have a similar level of control over their costs as companies in other sectors operating solely in the UK. This assists in keeping holiday prices very low.
Package holiday prices are lower in the UK than in the rest of Europe. The reasons are that:
With a restricted but not total ban on night flights, UK airlines can operate, on average, three rotations (return flights) per day as opposed to two rotations in Germany. This obviously reduces the cost of each flight for British consumers.
From Scandinavia, they have to fly further.
UK tour operators will also fill the beds they contract for the entire season (1 May to 31 October) whereas the European tour operators tend to operate with a shorter season. As a result, hoteliers charge more to those countries providing shorter seasons giving less utilisation of the hotel. In addition the empty return flight at the beginning of the season and the empty outbound flight to collect the last remaining passengers (so called empty legs) will be spread among fewer holidaymakers.
In Italy and Spain, holidaymakers book their holidays very late which increases the risk for the operator, making prices higher.
Another significant difference is the split between hotel and self-catering holidays. In the UK, a similar number of each type of holiday is sold. In Germany, self-catering represents 15-20% of all sales whereas in Scandinavia and Holland the percentage is 70-80%.
Finally, it is a common myth that UK tour operators work with lower profit margins than those in the rest of Europe. With the exception of Italy and Spain, where the economics are totally different because of late bookings, the profit margins across Europe are around 2% of turnover.