The weakening of the pound against the euro has thrown another spanner in the works for travel companies already struggling to boost sales in one of the toughest economic climates for years. The move to almost parity between the pound and euro earlier this month has highlighted just how risky a business hedging can be…
Understanding the currency hedging dilemma
The weakening of the pound against the euro has thrown another spanner in the works for travel companies already struggling to boost sales in one of the toughest economic climates for years.
The move to almost parity between the pound and euro earlier this month has highlighted just how risky a business hedging can be in the current climate.
In this scenario, hedging refers to when operators buy currency at a certain rate, for delivery in the future or immediately, to protect holiday prices from fluctuations in the exchange market.
It is a vital cog in the wheel for travel companies, usually tour operators and bed banks but increasingly travel agencies contracting their own bed stock, to run profitable businesses.
If a company commits to buy rooms at a certain currency level and the exchange rate subsequently fluctuates, the company’s overall profit from a deal can fall, or in low margin deals be wiped out altogther.
In simplistic terms this has resulted in some operators’ prices – based on exchange rates secured in forward hedging policies – being more competitive than other companies, such as bed banks, which have hedged on an “on the spot” basis in a weaker market.
Reports in Travolution sister title Travel Weekly show ski packages this January have been 30% cheaper than independently booked holidays thanks to operators’ advance buying at a more favourable exchange rate.
Despite sterling’s recovery to just under 90 pence per euro, the outlook for this year is still rocky for many operators with no clear picture on how currency markets will develop.
Association of Independent Tour Operators chairman Derek Moore fears the worst for operators in 2009, which are now faced with the double whammy of euro exchange rate fluctuations and fuel surcharges as well as a weaker holiday market.
He warned: “There will be lots of operators in trouble and eating into their accrued profits. Operators have started 2009 with fuel surcharges, the question of whether to hedge or not on the euro, and trying to find clients to buy their holidays.”
Arguably in the trade it is the bed banks that have been the biggest losers of the recent unfavourable exchange rate with the euro.
Steve Endacott, founder of the On Holiday Group which runs trade bed bank Holiday Brokers, conceded the currency situation has meant a difficult start to the year and welcomed the recent strengthening in the pound. “When currency was going against us it cost the bed banks,” he said.
Youtravel.com sales and marketing director Paul Riches admitted: “You could argue those who bought currency forward [in advance] could be better off because their brochure prices potentially look better.”
But he stressed package prices could not be compared directly with room prices offered by bed banks, adding: “It’s difficult to judge like for like because operators have the price of the flight in their packages.”
The rate worsening has also led UK travel companies to seek new lower-priced deals from hoteliers in the eurozone. Ted Wake, sales director of short breaks specialist Kirker Holidays, said: “It has given operators an opportunity to renegotiate with hotels in the eurozone. Hoteliers understand that if they wish to generate the same proportion [of business] from the UK this year as last year they will have to adjust prices. In exceptional circumstances like these, the rules don’t apply.”
Companies have different ways of hedging, with most operating a mix of methods to protect prices as much as possible from currency fluctuations.
But as Wake was quick to point out: “Generally speaking we are experts at selling holidays, not experts at currency trading. If the outlook is poor, our inclination would be to hedge. We try to minimise the risk.”
He added: “We use hedging as a useful mechanism to guarantee prices. We use a mix of mechanisms – one is the spot rate and one is the forward rate, you make a commercial judgement.”
Moore added that during earlier more stable trading periods, particularly in the 1980s, operators would simply apply a surcharge if price hikes of a certain level resulted from currency fluctuations.
He said: “In the old days it was so easy as currency was fairly stable and people were used to tour operator surcharges. Now currency isn’t stable and people are not used to surcharges.”
Having to live with a volatile currency market makes it harder for operators to plan ahead and some fare will fare better than others, according to Moore.
“The problem is some operators hedge and some don’t. Some will hedge most of what they need [for the year] and agree to buy certain amounts of euros at certain prices spread during the year,” he added.
In general terms, operators are more likely to hedge in advance while bed banks hedge on a regular on the spot basis. Exchanging currencies on the spot entails a contract for exchanging one currency for another at a fixed rate of exchange for delivery in two working days.
Companies using forward contracts can fix the exchange rate for the payment or receipt of foreign currency in the future to guard against future fluctuations in exchange rates. In these deals, companies would fix an exchange rate for the future, even if the actual exchange rate fluctuates before the payment settlement date. Companies can often have forward policies for short or long periods of time,
Cosmos mainstream products managing director Stuart Jackson said major operators would have protected prices through forward hedging. He said: “It goes without question any operator would have covered its currency position for this winter last summer and for this summer either last summer or early on in the winter so they are not sitting on any exposure on currency.
“For bed banks working on spot there is an ongoing hit on rate. There have been points in the past where it works in favour of the operators or anyone that has got a forward position on hedging.”
Major operators would have bought as much as 60% of their fuel when they put their holiday brochures together last May for summer 2009 and at the same time bought enough currency to last until Christmas 2008, explained Endacott. He said: “Tour operators hedged at around 1.50 or 1.60 [euros to the pound] and got the advantage, so when it went to 1.01 [euros to the pound] it was bad news for the bed banks.”
But he argued any price advantages enjoyed by operators would have been cancelled out by the fact they were locked into higher fuel costs. “Any advantage would have been balanced out by fuel costs,” he claimed.
The degree to which companies hedge will depend on how clear the business is on its expenditure in the year ahead, which may be linked to the size of an operator’s programmes or the amount of new product.
Other factors operators will take into consideration will include the amount of fully-inclusive tours the company sells and the amount of tailormade itineraries, often put together with current exchange rates and attracting a different price to the brochure.
According to Moore, when currency is hedged at the time brochures are priced, operators will need to provide for the possibility of a surcharge in their terms and conditions depending on currency changes. Often operators will build in currency buffers to protect them from minor exchange rate fluctuations.
Moore added: “It depends on whether you want to be safe and secure – and your prices may be higher – or if you are happy to surcharge.”
The consequences for companies if they do not secure currency rates for buying product can be dire.
Barclays Commercial head of travel Chris Lee said: “If they don’t [hedge], the success or failure of their company will be based in part not on a profit generated by their core business but on foreign exchange rate movements outside their control.”
He added: “If you issue brochures and quote fixed prices to customers, you should strongly consider protecting yourself from the time the brochure is released. If not, customers can hold you to the brochure price and if rates have moved against you, you make less, or maybe even no, profit.”
With regularly updated prices now the norm thanks to the web, online travel companies are likely to operate a more flexible hedging arrangement and some tour operators have switched to “guide” prices in brochures.
Lee added: “If you are an online travel business, you have much greater flexibility on amending your selling prices quickly and can implement a hedging strategy in parcels as bookings are made if this suits you better.”
