Travel Business Outlook for 2008

Will four worrisome "Cs" upset the travel industry's apple cart in 2008? Although recent industry forecasts for next year are almost uniformly upbeat, economists and analysts are fretting that potential speed bumps in four crucial areas -- credit, consumer confidence, crude oil prices and, to a lesser degree, currency exchange rates -- could threaten travel's fortunes.

Even as forecasters call for continued strong growth for the industry in 2008, at least one key outlook, from the International Air Transport Association, has been adjusted downward in deference to the still-unfolding credit crisis, declining consumer confidence and persistently high crude oil prices.

The anemic U.S. dollar, meanwhile, is being viewed as something of a wild card, with both positive and negative ramifications.

Yet, even as economic storms threaten the economy's health, the U.S. and global travel industries appear poised for resilience in the year ahead. At least, that's the current thinking among several of the industry's leading economists and analysts, who foresee solid growth for '08, though not quite as robust as the uptick in '07.

The growth theme is consistent across major sectors of travel, from airlines to hotels to cruise lines. As yet, it doesn't appear that leisure travel will become a victim of declining consumer confidence. Nor do businesses appear ready to cut back in a meaningful way, despite qualms about credit and other indicators of a shaky economy.

The fifth 'C'

A big driver behind the optimism for next year is a fifth "C" -- capacity. Most elements of the industry, perhaps chastened by past excesses and by fears lingering after 9/11, have avoided overaggressive expansion despite the temptations posed by years of healthy growth. The payoff is twofold. First, the industry is less reliant on growth in supply, which can wither in a soft economy. Second, limited supply keeps the door open for continued price hikes.

On the interest rate front, price sensitivity has begun creeping into analyses of next year's market conditions, but most observers believe that corporate planners and consumers are more likely to trim around the edges than to walk away over higher prices -- barring a full-blown recession.

A top-line forecast for next year from the Travel Industry Association illustrates current thinking about growth in '08. The TIA forecasts that total travel expenditures in the U.S. will grow by 5.2% next year, just slightly less than the estimated 5.7% growth this year. Clearly, the TIA's forecast indicates continued confidence that the industry will hold up well even as other economic pillars falter. Notably, the TIA issued its forecast in late October, and thus far has resisted any downward revisions.

Suzanne Cook, the TIA's senior vice president of research, recently acknowledged that "things have continued to deteriorate a bit" since the '08 forecast was released. "There certainly is concern about oil prices and other economic factors," she said. Cook also noted "a fairly steep decline" in consumer confidence in November.

But even in the face of disquieting developments on Wall Street and Main Street, she said, "It doesn't seem to be affecting people that much so far in terms of what they're planning to do."

Her observation of strong current activity tempered by shakier macro indicators going forward is common among industry watchers as they peer into next year's travel fortunes.

In addition to well-balanced capacity, perhaps the key positive encouraging optimism is consumers' apparent unwillingness to cut out vacations and family visits -- at least, that is, as long as they have jobs and aren't too seriously hammered by rising fuel prices and the "negative wealth effect" of declining home equity.

Volatile consumer confidence

Adam Weissenberg, vice chairman for tourism, hospitality and leisure at Deloitte, admitted to being "a little more cautious than I would have been two months ago." But he declared himself "surprised" at how well consumer travel sentiment has held up, even in plans for next year.

Deloitte's latest survey of 2,027 consumers, conducted in October, found that "75% of Americans plan to spend at least as much on leisure travel in the coming year as they did in the past year."

Another finding spotlights just how strong consumers' desire to travel has become. "The vast majority of respondents (93%), said they have taken a leisure/vacation trip in the past year," whereas in 2005, only 85% said they had done so, Deloitte's survey noted.

Moreover, Weissenberg said, "At this point, we just haven't seen that drop-off yet."

Cook remained optimistic that such a drop-off would not materialize anytime soon. She noted that even though consumer confidence overall "has been very volatile recently, it's still stronger than it's been in prior periods where there have been concerns." Indeed, long-term tracking of consumer sentiment reveals that declines through last month have been relatively modest in comparison with past dips.

Businesses seem to be reading from much the same script as consumers.

Companies "are planning to travel," said Jorge Caamano, business travel analyst with the National Business Travel Association. An NBTA survey released in October found that 73% of 215 members polled "expect travel spend to increase 5% to 10%" next year, while only 10% expect '08 spending to be flat.

Whereas leisure travel has grown considerably in recent years, corporate travel has not expanded at the same pace, which could indicate that businesses would be hard-pressed to reduce travel significantly from already depressed levels. "I think travel's going to continue," Caamano predicted. "It's hard to avoid it."

But Caamano also sounded a theme that could yet emerge as a major trend in '08, potentially cutting across multiple segments of the industry: "The forecast clearly shows what companies are planning to do," Caamano said. "They are planning to reduce costs."

Findings from the NBTA's survey, along with other indicators, could presage a coming pricing battle. The NBTA, for example, found that "16% of travel buyers will restrict business class bookings in 2008, a jump from 7% in 2007."

If aggressive price increases begin to crumble under pressure from financially squeezed consumers and aggressive corporate travel planners, suppliers including airlines, cruise lines and hotels would stand to lose a key driver of continued revenue and profit growth.

The argument against a price battle is that the travel industry's capacity discipline not only will prevent price capitulation, but in fact will keep the way open for continued rate increases in '08, just as forecasters are expecting.

Airlines, especially U.S. carriers, have played the capacity card to great effect, as demonstrated in the rapid-fire announcements earlier this month of expansion curtailments by Southwest, Continental and Delta.

John Heimlich, chief economist at the Air Transport Association, said he expected U.S. carriers to continue managing a finely tuned balance between broader economic and industry factors in the year ahead.

"The slowing economy and higher fuel prices have resulted in cutbacks to schedules," Heimlich said, "which have helped maintain the supply/demand balance for carriers, which has helped them maintain some degree of pricing power," albeit not quite enough to offset higher fuel costs.

Heimlich forecasts "meaningful revenue growth" for U.S. carriers in 2008 and a third consecutive year of profitability, though profits are predicted to decline somewhat to between $3.5 billion and $4.5 billion, from 2007's projected $5 billion. Load factors "are starting to plateau," he said, which could affect rate strategies.

Even as capacity still appears favorable enough to give carriers some degree of continued pricing power next year, other factors are supportive, as well.

In a research note distributed last month, Jamie Baker, managing director and senior equity research analyst at JPMorgan, observed, "With domestic fares still some 12% below levels of the last pricing peak [before adjusting for rising incomes and inflation], making the argument that domestic fares have gotten out of hand appears difficult."

Brian Pearce, chief economist at IATA, agreed that capacity constraints (and accompanying high load factors) have been a major contributor to U.S. carriers' recent strong performance. In fact, IATA expects North America to be the most profitable region among airlines this year for the first time since the late 1990s. "Load factors have grown much higher there than in other regions," he said.

But Pearce cautioned that a softer market would make it harder to maintain high load factors and "more difficult to have fares reflect surcharges and price increases."

IATA has trimmed its global profit forecast for next year significantly, to $5 billion; the forecast was $7.8 billion in its September outlook. Part of that reduction can be attributed to a slightly lowered revenue forecast reflecting concerns about credit and confidence, but crude oil likely is the bigger gremlin, given its sharp ascent from $67 a barrel since the September forecast.

"We're expecting the fuel bill to rise to almost $150 billion next year, which is about 30% of operating cost," Pearce said. In contrast, fuel accounted for just 13% of operating cost in 2002, when oil was $25 a barrel. (IATA, like some other observers, expects a modest pullback in oil prices next year and currently is projecting $78 a barrel.)

Although IATA envisions a "reduction in growth" next year rather than a recession, Pearce predicted the softness would be felt more severely in North America than in other markets.

Pearce also believes that the looming economic challenges in the U.S. could ultimately undermine carriers' pricing power, despite aggressive capacity-control moves. As the economy continues transitioning from secure jobs, rising stock prices and bulging home equity to far more sobering times, "I think it's going to be far harder for airlines to pass along increased fuel prices," he said.