Technological innovation is permanently disrupting different industries and business areas, and the travel industry is no exception. Online travel agencies – OTAs – are changing the way we make travel reservations, and Priceline.com Inc (NASDAQ:PCLN) is an industry leader benefiting from abundant growth opportunities in the long term. The flight may get bumpy, so fasten your seat belt, but this stock will be reaching higher altitude over the next years.
A great business model
Pricing has become a critical aspect in the travel business, especially for younger travelers who are also more prone to go online when making bookings and reservations. Online travel agencies like Priceline, Expedia Inc (NASDAQ:EXPE) and Orbitz Worldwide, Inc. (NYSE:OWW) are making the price discovery process more efficient via technological innovations, and this makes it much easier for travelers to find the most convenient deals in hotels, plane tickets or car rentals.
OTAs make it possible for hotel operators, airlines and rental car companies to clear their inventory without damaging the brand value. When running a hotel or an airline, occupation is a key factor for profitability: the additional cost of one more guest in a hotel room that would be otherwise empty is almost irrelevant, so it makes a lot of sense from a financial point of view to offer steep last-minute discounts if the room is going to be empty anyway. The same goes for an unoccupied seat in a plane, or a car wasting time in the parking lot of a rental car company.
The problem with offering aggressive discounts is that the brand could get tarnished, and it then becomes more difficult to convince clients to pay the regular price if they have got accustomed to expecting big discounts. Doing it via OTAs as last-minute deals and under special conditions, companies get to clear their inventory by selling to bargain hunters while at the same time protecting the brand image. Needless to say, clients are more than happy with these kinds of deals, which can be spectacularly cheap.
Competitive strength
While Expedia Inc (NASDAQ:EXPE) is bigger in the U.S., Priceline.com Inc (NASDAQ:PCLN) has built a leadership position in the lucrative European hotel business, and this has allowed the company to outgrow its competitors in terms of sales and earnings per share over the last years.
Hotel bookings provide higher fees than plane tickets or car rentals, and Europe – in spite of economic weakness – is a major destination for travelers all over the world. This has provided a big advantage for Priceline.com Inc (NASDAQ:PCLN) when it comes to sales and profit margins. While Priceline has operating margins barely below 35%, Expedia is much less profitable with operating results at 6.5% of sales, and Orbitz Worldwide, Inc. (NYSE:OWW) is still struggling to make money.
Priceline.com Inc (NASDAQ:PCLN) has the first-mover advantage in Europe, and the company’s focus on international expansion bodes well in terms of future growth opportunities, especially in emerging markets. Priceline purchased Bangkok-based Agoda in 2007, and this gave the company an early entrance into the promising Southeast Asian markets.
Priceline.com Inc (NASDAQ:PCLN) has also formed a partnership with the biggest Chinese OTA, Ctrip.com International, Ltd. (ADR) (NASDAQ:CTRP), and this could be a huge opportunity for the company over the next years. Competition will be tough in China: Expedia Inc (NASDAQ:EXPE) owns a majority stake in the second largest OTA, eLong, Inc. (ADR) (NASDAQ:LONG), and other players like local search engine Baidu.com, Inc. (ADR) (NASDAQ:BIDU) are also fighting for a piece of the pie. But the size of the market should provide enough room for several players to benefit from China in the long term.
At the end of the day, Priceline.com Inc (NASDAQ:PCLN) benefits from the network effect: travelers want to go were they can find more and better deals, and companies like hotel operators, airlines and car rental businesses choose to partner with the OTAs that can bring in more customers. More users make the service more valuable, and this attracts more users on both sides of the transaction. Even if competition is getting tougher, Priceline is in a position of strength to face the challenges that may arise over the next years.
Turbulence ahead
Expedia Inc (NASDAQ:EXPE) has been increasing its presence in Europe lately, while Priceline is counterattacking by trying to gain market share in the U.S. This has led to growing advertising spending by the two biggest players in the industry, and it could put some pressure on profit margins in the middle term.
Both Priceline and Expedia Inc (NASDAQ:EXPE) have strengthened their competitive position by acquiring metasearch companies Kayak Software Corp (NASDAQ:KYAK) and Trivago, respectively. Metasearch companies integrate results from different search engines to provide better and more information, and Kayak is quite popular in the U.S., so Priceline is gaining access to a valuable competitive asset with this deal. But Kayak Software Corp (NASDAQ:KYAK) has thinner margins than Priceline, so this acquisition is another factor that could hurt the company´s margins.
Although Google Inc (NASDAQ:GOOG) is not likely to get involved at the transaction level, the search engine is dominant enough to demand growing advertising fees from Priceline and other companies in the industry, especially in the context of increasing competitive tension among them.
Priceline has a very profitable business model, and margins tend to rise with growing sales due to a relatively fixed cost structure. Over the next quarters, however, increased competition, acquisitions and growing advertising spending could be a negative for margins, and investors should be ready to withstand some uncertainty in the middle term.
Bottom line
Priceline is an industry leader in an attractive business with promising growth prospects from a long-term point of view. Even if margins come under pressure over the next quarters, the company is far more profitable than its competitors, so it has more gas in the tank to increase spending in the fight for growth and market share. This flight may be getting turbulent, but this plane is going in the right direction.
The article This Innovative Leader Will Continue Flying Higher originally appeared on Fool.com is written by Andrés Cardenal.
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