An Economic Analysis of the Tourism Industry-Implications of the Online Travel Intermediary

Informational asymmetry and fragmentation of capacity suppliers in the tourist industry provide travel intermediaries with market power. Market structure is characterized by over-capacity in off-peak seasons, high fixed costs and low variable costs, leading to product under-pricing. Forward sales of capacity at low contract prices surrender profits from consumer surplus to intermediaries enjoying oligopsony benefits. The creation of formal futures contracts in rooms and seats would permit operators to hedge demand uncertainty and retain more of the profits. Online intermediaries can serve the interests of domestic hotel operators through exploitation of databases to provide analytical solutions to capacity utilization and to develop demand balancing. π The contents of this paper in part or in whole are entirely those of the authors and do not represent the views and opinions of Sasin of Chulalongkorn University and any organization associated with the authors. Comments are welcome. All correspondence is directed to Pongsak Hoontrakul, Research Fellow, Sasin-GIBA, Chulalongkorn University, Sasa Patasala Building, 8 floor, Soi Chulalongkorn 12 (2), Phyathai Road, Bangkok 10330, Thailand. Private Tel. (662) 954 1689 ; Fax (662) 954 1690 ; Email : Pongsak@Hoontrakul.com URL : www.Pongsak.Hoontrakul.com An Economic Analysis of the Tourism Industry 2 “An Economic Analysis of the Tourism Industry Implications of the Online Travel Intermediary” by Peter Ryan and Pongsak Hoontrakul Although one of the most important industries in the world economy, tourism has not received serious attention from economists. The implications of tourism for developing economies are far more significant than for mature economies, yet virtually all nations recognize the importance of the industry. Development economics already includes tourism in addition to agricultural and industrial issues. Many of the features of the tourism industry resemble those in other long-studied areas of the economy, implying that similar analyses and solutions to problems should be applied. The direct influence of the airline industry on tourism provides a bridge between classical economic analysis and the less-studied aspects of tourism. In determining a policy for industrial development, governments must focus on the domestic retention of value from engaging in an activity. Typically, the majority of tourism revenues do not remain on-shore due to the structure of the industry and its participants. We identify the significant features of the travel and tourism industry and provide an economic analysis that will indicate opportunities for value creating strategies. This demonstrates the importance that a large, publicly recognized online travel intermediary can have for further development and increased domestic profitability of the tourism industry. The case of the Thai industry is used as a focus. This study provides direction for the strategy of such a travel intermediary by showing where the information available from online sources can be used to improve the design and pricing of services in the hospitality sector. It also gives a summary of how the information is to be used in analytical methods to optimize the sale of capacity in the sector under certain types of contracts. The presentation includes introductory material indicating the significance of the industry, and a summary of the value retention by the various players in the industry, both domestic and international. There is also a brief strategic analysis of the industry by comparison to modern trends in corporate development through the characterization of the role played by travel intermediaries in the traditional sense in contrast to that of an online intermediary, using its larger database and sophisticated planning tools. An enhanced role involves the design of tourism services, marketing, An Economic Analysis of the Tourism Industry 3 and financing initiatives. Next, there is an examination of the macroeconomic, microeconomic and financial issues involved in the industry and their implications for the creation of an effective online intermediary. Finally, a linear program is presented as an analytical tool to optimize the contracting policies of service providers. 1. Scope of the Tourism Industry Statistical aspects Current statistics on global tourism indicate that it is now the largest “export” industry, as it is for Thailand in particular. One measure of this gives $474.2 billion in annual global tourism revenues, as estimated by the World Tourism Organization, or over $600 billion when passenger transport is added. For Thailand, 323.5 billion Baht in tourism revenues constitute 6% of GDP as of 2002. Furthermore, the growth rate in revenues of 6% compared to the average GDP growth of 3.14% in the past five years implies that the potential share of GDP is even greater. (The share of GDP has risen from 4.66% in 1997 to 6% in 2002.) Of the latest sales volume of 323.5 billion Baht, however, it is estimated that only 30% is retained by Thailand, the remainder flowing to foreign hands. This figure contrasts with estimates as low as 20% for Caribbean nations (highly dependent on tourism but exposed to cruise liners) and as high as 60% in India. These retention rates result from “leakage” due to import of supplies and materials unavailable in the host country (international standards and tastes) and to export of financial flows (repatriation of profits earned by investors) plus overseas promotional expenditures. As well as leakage from the gross receipts of tourism, there are additional structural losses. Most of these are comprised of foreign carriers’ fares and foreign travel agents’ fees and profits. Increasing the share of domestic airlines and travel agents then can have a significant effect on increasing tourism revenues. Various studies have also questioned the net benefits of tourism at differing stages of development, which may be an issue of timing of investment and return cash flows. Costs of building infrastructure added to congestion may well make expansion of tourism a short-term negative proposition. Nevertheless, tourism is generally accepted as being beneficial on the whole and specifically to economic development. In An Economic Analysis of the Tourism Industry 4 summary, the size of the actual and potential tourism market more than warrants efforts to increase both its gross and net revenues. The value chain and value retention The value chain in tourism can be summarized as formed by the end user or consumer, paying the total sales (above), linked by the carriers (largely airlines) to the hotels, resorts, restaurants, physical attractions and other members of the hospitality sector, with the linkage provided by the travel intermediaries, themselves either domestic or international. With 25% as a minimal target profit margin for a large intermediary, it is clear how significant is the share of the value chain captured by the intermediaries; of this the portion taken by domestic Thai agents is estimated to be minimal. (Insert diagram about here) The transfer of payments from consumers to the providers of goods and services in the tourism industry is filtered, at a cost, by the travel intermediaries. This filtration is viewed as a friction on the efficient transfer between the two parties, implying that a “tax” is imposed on users’ ability to afford and enjoy the goods and services provided, and with the “tax” reducing the profits of the service providers; or else it is a reasonable price reasonable price for valuable and necessary services that enhance the enjoyment of the product by the end users. The justification for the intermediary services comes from the existence of informational barriers between users and providers, plus the possibility that experienced travel consultants have built up capital, to be rewarded by charges for enhancing the tourism experience of average consumers. One concludes immediately that more efficient intermediaries in a competitive market can reduce the “tax” by improving the information flow. The technology of online services offers the benefits of lower overhead and centralized databases enabling the reduction of the “tax” and identification of opportunities for enhancement of tourist satisfaction through matching of needs and solutions. A further benefit is the opportunity for the intermediary to provide databased analysis of travel patterns allowing service providers to refine their offerings and pricing strategies. The implementation of IT applications to tourism results in value creation analogously to the realization in the 90’s of the benefits of the computer/internet revolution. The expected benefits of the computer for productivity enhancement were delayed until the potential was realized through the full deployment of communications networks; so too, the conventional use of computers An Economic Analysis of the Tourism Industry 5 to achieve ticket bookings can be greatly extended by merging this technology with database exploitation, now seen through CRM (customer relationship management). 2. The Role of the Travel Intermediary Increasingly in fully developed economies, corporations are recognizing that a fully vertically integrated production process results in lower return on capital. High labor costs make domestic production non-competitive. Consequently, successful corporations in Europe and North America are turning to out-sourcing of low-margin manufacturing operations. High-margin activity consists of the creative design of product and services, distributed using advertising and branding for the enlargement of market demand as well as sophisticated delivery channels. This process is further aided by arranging financing and structuring contracts to build markets and sales. This strategy has been implemented in established industries such as auto manufacturing (with parts production and assembly largely off-shore) and modern tec