Perspective - Strategy & economics

What Thomas Cook's collapse tells us about the power of disruption

Thomas Cook's collapse after 178 years shows that even the most venerable of businesses are not immune to the power of disruptive change. We look at some of the causes of its demise.

28/10/2019

Alex Tedder

Alex Tedder

Head and CIO of Global and US Equities

Schroders

Whilst the failure of UK holiday firm Thomas Cook was sudden and a considerable shock to many, the writing has been on the wall for some time now. Driven by technology and specifically by the advent of online booking and reservation systems, the travel industry has long been undergoing a radical transformation across each of the three key areas: booking agents, airlines and accommodation providers.

Newer, more nimble companies such as Booking.com or Expedia have transformed the booking process. Low-cost Southwest Airlines, EasyJet and Ryanair have decimated the profitability of many legacy airlines. And dynamic new business models, such as Airbnb, have drastically changed consumer perceptions around accommodation. Against that backdrop, Thomas Cook had to respond pro-actively to re-shape in order to survive. Unfortunately it chose to do the opposite. 

What went wrong?

A glance at Thomas Cook’s financials is insightful. Operating margins in the 2005/06 fiscal year (to October) were a paltry 2.7%. In 2007, the company merged with MyTravel in an attempt to create scale, but synergies were sparse and even after the financial crisis margins never exceeded the low hurdle set in 2007. 

At the same time, in part due to an ill-timed decision in 2011 to take on the retail operations of the Co-op Group and Midland Co-op, Thomas Cook Group drastically expanded its leverage profile. Long-term debt, which was 20% of equity in 2009, rose to 260% in 2012 and carried on rising until the bitter end.

Management refused to acknowledge that the business model it was pursuing – essentially sticking to the package tour formula and relying on the brand to carry it – was utterly flawed.

Most importantly perhaps, the company failed to appreciate that, when it comes to travel, consumers behave no differently than when they buy food or clothes. They look for value, and they like to be in control.

“Don’t just book it, Thomas Cook it” was a catchy slogan for sure, but when it came to the crunch, consumers increasingly did just book it.

With hindsight, it’s clear where the company went wrong, but the decision-making process during these crucial years is hard to fathom. Despite the obvious rise of companies such as Booking.com, with its simple and transparent price comparison format, the online strategy at Thomas Cook remained weak.

Believing that customers valued the High Street experience, the company continued to run a network of more than 500 stores and under-invested in its online platform. That meant the company had no chance of getting anywhere near the price competitiveness of Booking.com (which achieved operating margins of 35% in 2012). It also meant it was saddled with a significant lump of fixed lease obligations acting as a deadweight on the way down.

Everyone’s a travel agent now

According to the Association of British Travel Agents (ABTA), more than 80% of UK holidaymakers booked their holidays online in 2018 (compared to just 15% who booked in a shop or over the phone). Again, in what now seems an extraordinary error, the company’s management failed to recognise that going online not only gave holiday makers the flexibility to tailor their trip to their own needs, it also allowed them to separate the different parts of a holiday and search for the best deals piece by piece.   

The rise of low-cost airlines, with their simple online reservation systems and transparency (“no-frills” doesn’t have much downside in terms of expectations) was driven by the realisation by most consumers that if they booked their flights separately they could save money. The likes of Ryanair and EasyJet were happy to oblige, rapidly expanding their fleets as well as the number of destinations served. Despite the obvious disruption, Thomas Cook persisted with a strategy of running its own airline.

At the time of the collapse, it still had 34 airliners on its books: a staggering lease-adjusted capital commitment of perhaps $2 billion. Thomas Cook wasn’t the only travel group to cling to the notion that owning a fleet of aeroplanes is a core business: UK charter travel group Monarch collapsed in 2017, with 35 aeroplanes in the fleet at that time.

Airbnb changed the accommodation game

An obscure San Francisco start-up founded in 2007 revolutionised the accommodation industry. Airbnb quickly established itself as an alternative to hotels and hostels around the world. Holiday makers have the freedom and flexibility to book for as few or as many days as they like, with a wide range of different types of accommodation available.

The company, which is expected to hold an initial public offering in the next year, firmly fits the mould of a disrupter, using new technology to quickly take market share away from established players, including all the traditional package tour operators. By October 2019, two million people per night were staying in accommodation arranged through Airbnb. Despite the efforts of regulators in places such as New York, London, and Singapore to restrict the company’s growth, the trend looks likely to continue.

In 2018, the company achieved an annualised revenue run-rate of around $4 billion: a powerful example of how disruptive companies, one they gain traction in a particular industry, can eclipse incumbents in size and profitability.

The final straw: new low-cost package tour competitors

Thomas Cook failed to address competition from both the lower and higher ends of the market.  Specialist travel companies, offering high-end customers the chance to create tailor-made trips, retain a presence on some high streets and have a carved out a niche that can survive the disruption in the mass market.

At the same time, at the low-end new budget package holiday providers such as Jet2Holidays have emerged. Jet2Holidays sells low-cost package holidays to those unwilling or unable to put trips together themselves, either from its website or through independent travel agents. It doesn’t have an expensive network of high street stores and is able to offer its holidays at rock bottom prices. Budget airlines offer tickets often at heavily discounted prices, all booked through their websites.

The rise of the "staycation"

Uncertainty relating to the UK’s departure from the EU (originally scheduled for March 2019) resulted in many UK holiday makers delaying their 2019 summer holiday plans or choosing to take their holidays at home. This trend for so-called “staycations” was exacerbated by a slowing global economy and geopolitical tensions in many parts of the world.

The weaker UK pound since the Brexit vote and summer heatwaves in 2018 and 2019 also weakened demand. Terrorist attacks in countries such as Tunisia and Egypt, both key markets for Thomas Cook, also led to fall in demand for the company’s package holidays.

The end was inevitable

Numerous re-structuring and re-financing attempts, including a bid by Chinese conglomerate Fosun Group in 2015, merely served to postpone the inevitable. From July 2016 to May 2018, the share price soared from 59 pence to 136 pence as some investors began to buy the idea that Thomas Cook’s model could be re-invigorated. However, a series of profit warnings saw the share price collapse to 5 pence by early 2019. By May 2019, analysts at Citigroup described the company’s shares as “worthless”.

There were many reasons why Thomas Cook collapsed, but foremost among them was the management’s pursuit of what can only be described as an analogue strategy in a digital age.

Disruption more than ever is a feature of everyday lives. It is transforming consumer habits and the way companies interact with their customers. Arguably that transformation is just beginning as ultra-fast connectivity and artificial intelligence radically change the way that services such as travel planning are delivered.

The successful companies of the future will be those that embrace and adapt to change caused by this disruption. Conversely, those companies that fail to adapt or seek to deny that changes are happening (like Thomas Cook) will fall by the wayside. For investors prepared to think ahead, there will be many new opportunities in the future.

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