The online travel industry is a huge and growing market worth $100 billion in the U.S. alone. From China to South America, consumers are increasingly using websites and mobile apps to book flight tickets, hotel rooms, and even cars and bicycles. Furthermore, the current bullish business cycle supports an increase in travel spending. These reasons make the online travel industry a very attractive sector for investing.
However, no attractive industry is free from intense competition. In the U.S., increasing competition between Expedia (NASDAQ:EXPE), Priceline.com (NASDAQ:BKNG) and Orbitz Worldwide (UNKNOWN:OWW.DL) has become so intense that on October 14, Deutsche Bank analyst, Ross Sandler, downgraded Expedia from "Buy" to "Hold" after indicating intense competition could lead management to cut its guidance for the year. This pulled Expedia shares down almost 8%. How can Expedia survive intense competition?
The key to survive is constant innovation
Expedia shareholders shouldn't be too surprised about the downgrade. So far this year, shares have produced losses of roughly 21%. Although revenue is increasing, driven in part by the recent acquisition of hotel price comparison site Trivago, profitability remains weak. Between the second quarter of 2012 and 2013, Expedia experienced a 49% decrease in free cash flow, a 39% decrease in operating income, and a 28% decrease in adjusted earnings per share.
Increasing competition affects Expedia in two ways: first, by capturing more market share, and second, by forcing Expedia to rely on heavy discounts to avoid losing sales. At the same time, as the cost of online advertising rises, so do user acquisition costs. The combination of these factors produces strong pressure on the company's earnings.
The good news is that Expedia's traffic metrics remain healthy. Gross bookings were up 19% in the last quarter. The company may also have a real mobile opportunity. Mobile app downloads were up 250%. Now, Expedia needs to engage new mobile users as much as possible because applications usually have a binary outcome -- an app is used either every day or not at all. This is where innovation plays a key role.
Priceline, up almost 70% this year, understood the importance of mobile at a very early stage. The company has changed its development orientation from web-based to mobile-based, acquired meta-search travel engine Kayak -- which had a very loyal mobile user base and a top-downloaded application as early as in the third quarter of 2012 -- and invested in television campaigns that demonstrated how customers can use their mobile devices to book hotels.
Priceline's geographical revenue diversification strategy is also worth noticing. International markets occupy 43% of Expedia's revenue. In the case of Priceline, as much as 80% of 2012 bookings came from overseas, including emerging economies in Asia Pacific and Latin America, where the online travel market is not saturated and smartphone penetration is still low.
On the other hand, Orbitz, up an astonishing 233% this year, is not only innovating its mobile experience, but also its business model. Last month, the company signed an agreement with Australian-based travel company JTG. Orbitz will help JTG build its online presence. The partnership was set up to build a new booking platform, called Helloworld, an attempt to aggregate various travel agents in a single digital place.
Orbitz can benefit enormously from this partnership. First, the company already has the infrastructure and team needed for creating high-traffic websites and applications. Building a new platform will not bring additional major expenses, and Orbitz will benefit from a new stream of revenue, exposure to the Australian market, and JTG's network.
Final Foolish thoughts
In an increasingly competitive online travel industry, the key to survive and consistently deliver positive cash flow lies in constant innovation and geographical revenue diversification. Investing should be focused on companies that provide a unique and real mobile experience, target emerging economies where online travel is still a relatively new concept, and aren't afraid of changing their business models to benefit from new synergies, clever partnerships, and non-traditional revenue sources.
Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends Priceline.com. The Motley Fool owns shares of Priceline.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.