Competition tends to be good for consumers since it drives down prices, but bad for businesses for the same reason. However, when looking at which investments to pick, we need to look at the situation from a business-financial perspective. In the area of reduced competition as a boost for businesses, two parts of the travel industry look particularly appealing.
The airline industry is known for ruthless competition, market share-grabbing price wars, and headline-making bankruptcies. But instead of continuing to pursue this self-destructive path, airlines have realized that competition can be reduced and stability increased through a series of consolidations.
In 2005, America West Airlines and US Airways merged to form today's US Airways Group (UNKNOWN:LCC.DL). Three years later, Delta Air Lines (NYSE:DAL) merged with Northwest Airlines, an airline passed in total size only two years later upon the merger of United Airlines and Continental Airlines to form United Continental Holdings (NYSE:UAL). Even today, the proposed merger between US Airways and American Airlines parent company AMR is awaiting a trial to determine whether these two carriers can merge to create a new world's largest airline.
Although consumers are against seeing airlines cut capacity and downsize out of less traveled airports, the airlines have to worry about their own bottom lines. These mergers have not only allowed carriers to more effectively manage capacity, but they also reduce the number of carriers needing to raise fares for an industrywide fare increase to take hold.
For these reasons, airlines have managed to revolutionize their industry in less than a decade of mergers. While they are still cyclically exposed, their greater size and better pricing power helps to strengthen financials. This helped US Airways and Delta Air Lines report significant profits for 2012 despite an unfavorable economic climate. United Continental would have also reported a profit if not for a one-time merger-related charge.
Fewer companies than meets the eye
Most consumers are probably unaware of the relatively few number of major competitors in the car rental industry. While travelers may see numerous rental-car counters at the airport, many of these brand names are owned by the same parent. Avis Budget Group (NASDAQ:CAR) owns Avis Rent A Car, Budget Rent A Car, and Zipcar, which Avis Budget acquired for $500 million earlier this year. Hertz Global Holdings (NYSE:HTZ) controls Hertz Rent-a-Car, Dollar Rent A Car, and Thrifty Car Rental. And the private company Enterprise Holdings owns and operates the National Car Rental, Alamo Rent A Car, and Enterprise Rent-A-Car brands.
Through consolidation, car-rental companies get many of the same benefits as the airline industry. Fewer competitors means more pricing power and makes the management of fleet sizes easier. In addition, larger rental-car companies benefit from greater economies of scale in both ordering cars and shifting them to where demand is most needed. This allows these large rental car companies to benefit both on the car cost side and on the demand-flexibility side.
Why these setups work
Airlines and rental-car companies are both in highly competitive industries that require massive capital costs. With a diverse field of competitors, consumers get low prices as competitors beat each other down in an effort to grab market share. However, when only three or four major players exist, pricing power is better contained among the top dogs.
These industries are also both pretty much fully consolidated, assuming the US Airways/AMR merger goes forward. With three big competitors in each, it would be difficult to see regulators allowing any further consolidations; especially with their current stance on the pending airline merger.
But having three big competitors does work for these industries. It has formed them in a way that is oligopolistic in nature but necessary for consistent profits. Investors previously hesitant to buy into the airline or rental car industries because of a fear of price wars and competition may want to give both a second look.
Alexander MacLennan owns shares of AMR and Delta Air Lines and also has options on Delta, US Airways, and Hertz. The Motley Fool owns shares of Hertz Global Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.