It was 1999 and Stelios Haji-Iaonnou and the easyGroup management team were reviewing European car rental business to determine whether it represented an attractive opportunity for the group to enter. So far, Stelios and his team had an enviable record of spotting and exploiting relevant market opportunities. They were keen to identify their next one. The European car rental market, with sales of close to €6 billion, was mature and established. The market was also one that was very concentrated with the top three players in each market having shares ranging from 50 – 80% (Exhibit 1). The team started a detailed review of the market and its relevance to easyGroup. The entry decision would not be clear-cut.

Market Overview in 1999 In reviewing the European car rental market, it is useful to look at the past in terms of country, usage and location information; and the future in terms of market (demand) and fleet size forecasts (supply).

Country and Usage The European car rental market is dominated by five countries1: France, Germany, Italy, Spain, and the UK. Over the reviewed period of 1995 – 1999, these countries had a wide variety of growth rates in value terms. Volume turnover growth of 8.1% (Exhibit 4) was recorded by the French car rental market over the five-year review period, largely due to the dynamism of leisure rentals. In European terms penetration remains low, but in 1999, 7.5% of French citizens rented a vehicle. The maturity of the business sector resulted in a rapid slowdown in growth as operators focused on the dynamic leisure sector where penetration remains low. Short duration car hire proved particularly popular and personal car hire amongst the young has been a notable growth area. In Germany, real value growth of 21.4% (28.3% nominal) for the five-year review period reflected the recovery from the post-reunification recession. However, the car rental market remains adversely affected by continuing cutbacks in companies’ travel

1 Market statistics are from Euromonitor. © Business School, May 2003. This case was written by Taman Powell under the supervision of Professors Pascal Courty and Michael G. Jacobides. This case is intended for teaching purposes only and is not meant to represent either adept or inept handling of an administrative situation.

1 budgets. This has prompted car rental operators to cooperate with and in offering all-inclusive deals. In Italy, low value growth of 5.6% (Exhibit 3) equated to a fall in real growth of 3.5% over the same period. In terms of volume, growth was also relatively modest at 9.3% (Exhibit 4). At 64.2% (Exhibit 6) of total market value, business usage dominates the market, reflecting Italians’ preference for using their own cars when taking holidays. The rental market therefore largely consists of incoming business and leisure travellers. Furthermore, business usage was the larger and more dynamic sector over the review period and the market did not suffer the price competition evident in other key markets. As the Spanish market was yet to reach maturity it’s high value growth rate of 25.3% (Exhibit 3) and volume growth rate of 25.9% (Exhibit 4) is perhaps not unexpected. The Spanish market is characterised by a strong tourist influence and is heavily seasonal in nature. Some 56% of rental volume turnover is accounted for by private usage, the remaining 44% attributed to business use and insurance replacements. Many businesses have made cost savings by entering into long-term leasing agreements with car rental operators. A stronger economy in Spain has underpinned rising business travel with many businesses achieving cost reductions by entering into long-term leasing agreements with car rental operators. This dynamic sector has led Spain’s growth of 41.8% over the review period. The leisure sector still, however, accounts for the largest share of value. This reflects the strong tourist influence in this country, with incoming foreign customers renting transport at their holiday destination. In the UK, value growth was 10.7% over the 1995 – 1999 period (Exhibit 3) but this failed to translate into real value growth and resulted in an overall fall of 0.4%. The widespread availability of special discount offers, particularly in the business sector, and competitive pressure on prices generally was responsible for the marginal decline in real value of the UK car rental market over the review period. Domestic demand was adversely affected by the greater number of UK residents holidaying abroad and renting vehicles at their destination.

Location Car rental from locations other than airports accounted for the bulk of market value in France, Germany and the UK; whilst airport sales dominated the car rental market in Italy and Spain (Exhibit 8). The high level of sales through airport locations in Italy and Spain are attributable to the reliance on incoming business and leisure travellers using airports as pick-up and return points for vehicle hire. In Italy, business usage dominates both airport and non-airport locations, but leisure usage from non-airport locations is outperforming business usage from the same locations. In Spain, on the other hand, the non-airport sector is the more dynamic, despite the ongoing profitability of the airport sector as a result of proximity to tourists. In key markets where non-airport sales are more dominant a slightly different pattern is evident. In the UK and Germany, the more dynamic location has proved to be airports. France stands alone with its larger non-airport sector also achieving the more dynamic growth, largely as a consequence of rising business sales from non-airport locations. It should however be noted that while business sales from French airports declined over

2 the review period, the largest increase in growth came from leisure usage originating at the same airports.

Market & Fleet Size Forecast Euromonitor predicted both France and Spain would experience dynamic volume and real value (Exhibit 10 & 9) growth over the period 1999-2004, well in excess of the remaining key markets. Although Germany will record the highest real value growth overall at 23.6% (Exhibit 9). The potential of the Spanish market remains unfulfilled and car rental is forecast to grow strongly as price policies change. Falling prices will make car rental accessible to a wider consume base. Once the exclusive province of executives and foreign tourists, price reductions will lead to greater occasional rentals and special deals for ordinary Spaniards. To fulfil this demand, the fleet in Spain is expected to grow by 17.6% over the forecast to reach 134,954 vehicles in 2004 (Exhibit 11). Consumers will also demand cars of a higher quality. Market potential will also underpin the strong growth in the French car rental market, although this is likely to be restricted to the leisure sector where maturity is yet to set in. The size of the French car rental fleet will follow market demand (Exhibit 11), however, at present the critical size is undetermined since the market is not stabilised, and this will question the ability of the companies to manage a wider fleet, operating in an environment where cost pressures are important, but economies of scale are expected. Italy is forecast to be one of the few key markets to record low levels of real value growth and transaction volumes (Exhibit 10). A reliance on foreign business and leisure travellers will continue to underpin real value growth, whilst volumes will be sustained by the rising number of tourists arriving by plane. The Italian fleet size is predicted to grow at an average rate of 4.1% per annum over the forecast period (Exhibit 11), though a change in customer demand profiles will result in substantial fleet replacement rather than just enlargement, possibly as concern for the environment prompts the introduction of alternative energy cars. Real value growth is forecast to exceed volume growth in Germany over the period 1999-2004 (Exhibit 9 & 10), as a revaluation of the industry takes place and consolidation increases. There is likely to be increased demand for longer-term deals in both the leisure and business sectors, but more particularly in the latter. Sales will increase generally as greater cross-marketing and cooperation takes place. Internet ticket purchasing will also have a greater influence on the market over the forecast period. Following a trend towards shrinking fleet sizes during the mid-1990s reflecting a decline in the market, fleet sizes have since grown steadily, and are forecast to continue the growth trend. There was an 8.6% growth in fleet size between 1996 and 1999, which is forecast to continue, with an 8.5% increase between 1999 and 2004 (Exhibit 11). The weakest-performing market is likely to be the UK, where stagnant real value performance will be a consequence of no real price increases and only modest volume growth. One bright spot may be the increase in home ownership in London and Southeast England and possible subsequent decline in car ownership which may prompt wider car rental for occasional usage and specific events. Fleet sizes in the UK are predicted to rise rapidly in 2000 in response to increased millennium demand. 3 Thereafter growth will slow almost to an optimum equilibrium level. One of the reasons for this predicted plateauing effect is the potential drop-off in demand. The sheer volume of traffic in the UK already puts many foreigners off driving, and continuing growth in the number of cars is forecast for the immediate future.

Operations While there are large differences among operation in the way they manage their car retail business, how effectively they can buy and sell their cars, how efficient the second hand car market is etc., a ‘typical’ large car rental business’ key cost items would be depreciation ~ 31%, travel agent commissions ~ 15%, staff costs and administration ~ 13%, airport concessions ~ 9%, franchise arrangements ~ 4-5%, advertising and promotion ~ 3-4% (Exhibit 2). Car depreciation is the key cost item for a car rental company representing just over 30% of the total cost base. This cost is driven by the company’s ability to purchase cars at favourable prices from OEMs and resell them on the second hand car market. From a purchasing standpoint, scale is the key factor that facilitates the purchasing of cars at a favourable price. From a resale perspective, the challenge is to not flood the market with too many of the same car, and therefore depress the price. Additionally, much higher prices can be achieved (~+30%) via selling retail versus selling on the wholesale market. The downside of selling in the retail market is the requirement to operate second hand car dealerships, which adds additional complexity to the car rental operation, and requires different capabilities to be successful. Many car rental operations now enter into guaranteed buyback agreements with the OEMs, usually for a period of six months. This has the benefit of allowing the car rental operation to focus on their core business, while the relatively short period provides the flexibility to change the fleet composition every six months. From the OEM standpoint, the guaranteed buyback provides a stream of nearly new quality used cars that they can manage the resale of. Controlling a segment of the second hand market can help the OEM to manage the resale price, thereby influencing the level of depreciation and therefore enhancing the desirability of their new cars. Travel agent commissions and airport concessions are also key cost items in the operation of a car rental company, representing almost 25% of the cost base. Given that a significant proportion of car rental customers are business or leisure customers who will be using a travel agent and arriving at an airport, it is important to have a good relationship with the travel agent who can recommend the service and a presence at the airport for the customers convenience. Many car rental companies also formalise this via promotions with travel agents to provide fly-drive packages to their customers. Staff costs and administration comprise almost 15% to the cost base of a typical car rental operation. Staff costs cover all branch personnel; sales staff, administration, car jockeys, and car washers. This level of staffing is required to manage activities ranging from managing sales to walk-in customers (without prior reservations), parking and cleaning returned cars, and providing petrol and servicing.

4 Competitive Landscape As the market is changing, operators are facing different issues, developing activities in areas with good growth potential, finding strategic locations and globalisation of their networks. The market is under price pressure from the external environment, and differences in prices will flatten. The French market is very fragmented outside the top three companies and consolidation is under way. Medium-sized and independent companies are losing ground, not having sufficient means to fight against the leading rental chains except for niche sectors, e.g. luxury car rental. Although the number of operators decreased by 2.3% from 1998-99, the number of outlets increased at a similar rate. This illustrates the fact that integrated chains are becoming bigger and developing their distribution network, and highlights that entry barriers are quite significant in this market. With outlets at every airport and covering all regions of Italy, the four largest companies dominate the Italian car rental market. Only one of them, Maggiore, is an Italian national company; Avis, Hertz and Europcar are all owned by international groups. Together they controlled over 90% of the Italian car rental fleet with the rest run by small companies, usually located in tourist areas. In 1999, 91.5% of total market turnover was almost evenly divided amongst these four companies. The three leading car hire operators in the UK (National Car Rental, Hertz and Avis Rent-a-Car) were subject to fluctuation of market share over the whole five-year period, which is indicative of the volatile and unpredictable environment of the car rental market. The most significant move came from National, which leapt from third to first after its successful acquisition of Alamo. The market became increasingly competitive, with many car hire firms being forced to cease operations or merge with larger groups. However, the total number of operators grew overall, as the market saw the continual emergence of many new small operators, consequently buoying the total number. The car rental market as a whole in Germany is dominated by five companies, which currently control 74.8% of the market. The dominance of these companies has led smaller operators to form alliances in order to remain competitive in the marketplace. Sixt, as market leader, currently controls almost 28% of the car rental market. The company’s share of the market has grown dramatically over recent years due to an aggressive expansion strategy both domestically and internationally, effective marketing, and the innovation of luxury car hire promotion for business customers. Avis took a 22% value share of the Spanish car rental market in 1999, slightly down on 1998. Europcar accounted for 19% of the market, Hertz 11.5% while Atesa and Budget disputed fourth place. Together, all the aforementioned companies controlled more than a 60% value share of the car rental market. Budget, considered the number three car rental company in the world saw its turnover increase by 20% since its entry into Spain in 1996.

Hertz In March 1999, Hertz became a wholly owned subsidiary of the Ford Motor Company. With operations in over 150 countries, and a total worldwide fleet of approximately 450,000 vehicles, Hertz is the largest car rental company in the world.

5 Car rental is the company’s core business, but it is engaged in other activities through several wholly owned subsidiaries. Hertz Equipment Rental Corp (HERC) rents a full range of construction and industrial equipment to contractors, industrial and government markets. Hertz Claim Management Corp (HCM) is the 12th largest claims administrator in the US. Hertz Technologies Inc markets telecommunications and information management services worldwide. Hertz has led the way with ‘cooperative marketing’ between different segments of travel and tourism industries. Hertz participates in packaged tour plans with airlines, tour operators and hotels. The car hire fee is included in one price together with the airfare and the charge. This is an important means by which Hertz captures airport business, upon which it is very reliant. Hertz is the leading car rental operator in France, with over a fifth of total rentals and a passenger car rental fleet of 20,000 cars. Hertz is the second largest operator in the UK with 140 branches with rental locations at all the major airports and 20 of the main British Rail termini. Hertz Deutschland has a fleet of 12,000 vehicles and a network of over 240 rental points in Germany. Hertz is particularly strong in the business and tourist sectors, which combined account for some 87% of total turnover. In terms of basic metrics, rental turnover for 1998 was USD3.6B (representing 4.7% growth over 1997) and net profit was USD$277M (representing 37.1% growth over 1997).

Avis On a worldwide scale, Avis operates in 146 countries with a fleet of over 400,000 cars and 5,000 outlets. The International Division has joint holdings in nine countries, in addition to licensee operations in 60 countries around the world. WizCom International Ltd, founded in 1987, provides a broad range of computer services and systems, including reservation services and on-line electronic credit card authorisation systems, to hotel and travel companies. The company has the largest number of rental points (522) in France, half of which are company-owned, giving the company a 15% share of the market in 1999. With a car parc of around 67,000 vehicles, including minibuses, vans and trucks, Avis occupies second place in terms of market share in Italy, but is placed first in terms of rental revenue in 1999. Avis operates the largest distribution network in the UK, with 200 stations and a fleet of 200,000 vehicles. It is the leading brand in the UK for daily rental, with a 14% share. Some 55% of current Avis business is generated through the corporate sector. Avis is the third largest vehicle hire company in Germany and after a year of consolidation in 1998 when rental points and fleet size were reduced, 1999 saw the number of rentals increase 23% to 680,000. The company now plans to extend both its network of rental points and its fleet of vehicles.

6 In terms of basic metrics, rental turnover for 1998 was USD2928M (representing 43.1% growth over 1997) and net profit was USD$64M (representing 130.9% growth over 1997).

Europcar With a network of 4,500 rental points in 120 countries worldwide, the company is one of the world leaders in car rental. It is the joint largest car rental operator in Europe. Europcar is jointly owned by Volkswagen and the Belgian Compagnie Internationale des Wagon-Lits, which was acquired by the Group in 1996. Europcar accounts for 16% of total rentals in France, with 13% of rental points. It is market leader in the vehicle rental market in terms of the size of its rental fleet, 20.5% of passenger cars. The company has substantially increased its share of the Italian market in recent years and is now thought to account for around 15% of its value. Europcar’s fleet in Italy consists of around 5,000 cars. Europcar has a total of 425 rental points in Germany, with a fleet of more than 25,000 vehicles. In terms of basic metrics, rental turnover for 1998 was USD1539M (representing 27% growth over 1997) and net profit was USD$15.4M (representing 62.1% growth over 1997).

EasyGroup In 1995, Stelios Haji-Ionnou founded easyJet, a low-cost, ‘no frills’, point-to-point that took advantage of the deregulation of the European airline industry. EasyJet was based on the very successful US low cost carrier, Southwest Airlines. Based at the underused Luton Airport north of London, easyJet began operations with two leased Boeing 737s, flying from London to and . EasyJet avoided travel-agent commissions by taking reservations only by phone. (Internet ticketing began in 1998.) Adverts invited passengers to ‘fly to Scotland for the price of a pair of jeans’. Part of easyJet's takeoff reflected Stelios's Bransonesque knack for attracting free publicity. When British Airways launched a clone of easyJet in 1998, called Go, Stelios and nine colleagues bought tickets on Go's inaugural flight to Rome. Wearing bright- orange jumpsuits, they sat in the back of the plane, giving interviews to journalists and handing out free tickets for easyJet flights. When Greek travel agents took the airline to court for its strict policy of selling direct to customers (today 92% of easyJet's reservations are taken over the Internet), Stelios promised to give a free ticket to anyone who showed up outside the courthouse to cheer him on, thereby ensuring a camera- ready spectacle. In another notable publicity move, Stelios allowed ITV, a London- based television network, to create a reality show called Airline that focuses on the drama inherent in keeping easyJet aloft. Stelios credits a great deal of easyJet's success to two strategic imperatives. One is what he calls ‘sweating the assets’ – ensuring that his planes are as full as possible and that they are flying as much as possible. "If you have a very expensive fixed asset," he says, "you need to make it work for you." It's not unusual for an easyJet plane to make eight 7 or nine hops around Europe in a day, beginning before dawn and ending around midnight. The second imperative, which helps Stelios sweat the assets, is sophisticated yield management – a software-driven pricing system that can set an almost infinite number of fares for a given flight. "There are some very wide fluctuations, based on the demand for the seat," Stelios explains. "There are no pricing rules other than that it's cheaper if you buy early." That $45 London-Nice round-trip, when purchased at the last minute, could cost up to $450. "Who is the more valuable customer for easyJet?" Stelios asks. "You need all of them to fill a plane, from the vacationer who wants the $45 ticket to the businessman willing to pay $450. They're all equally valuable to us." Following the success of easyJet, in 1998 Stelios formed easyGroup. EasyGroup is a holding company with the aim of exploring new ventures to extend the ‘easy’ brand and capitalise upon the expanding use of the Internet. The first such venture, easyInternetCafé, the chain of the world's largest Internet cafes and the cheapest way to get online, started trading in June 1999. EasyGroup have an openly stated policy of only developing businesses that are consumer facing, are in a price elastic market with the opportunity to grow the market through lower prices, sell a perishable commodity, and that have incumbents with a high unit cost base and no low-cost competitors. In terms of positioning, all new businesses must adhere to the ‘easy’ principles of fitting and building the ‘easy’ brand, providing good value to the customer, using technology to cut costs and improve quality, selling directly to the consumer, being a simple offering, not playing by the traditional market rules, not being a white-label, not bundling products, and being easy-to-use Lastly, the business model must have unit cost-savings of the order of 50% compared with the best in the market (excluding potential marketing benefits from the easy brand), must have zero or very low marginal cost, must be possible to yield manage the price, and must have the potential to significantly increase utilisation (occupancy) compared with the industry.

8 Exhibit 1 1999 Car Rental Concentration Ratios

Car Rental Concentration Ratios Leading Leading 2 Leading 3 (1999) company companies companies France 20.2 40.1 59.5 Germany 27.9 43.8 57.5 Italy 23.4 46.3 69.0 Spain 22.0 41.0 52.5 UK 27.8 53.7 78.9 Source: Euromonitor

Exhibit 2 Typical Cost Breakdown

Item Cost (%) Depreciation 31 Other (inc. staff) 13 Airport Concessions 9 Franchise Arrangements 4-5 Travel Agent Commissions 15 Telecom Costs 4-5 Advertising & Promotion 3-4 Insurance 3-4 Rent (check-in & maintenance) 3 Other Operating (eg. car storage) 3 Maintenance 3 Reservation Fees 2 Credit Card 2 Bad Debt 1 Vehicle Preparation 0-1 Source: The Budget Report on Car Rental in Europe 1989

9 Exhibit 3 Car Rental Sales (current prices)

1995 1999 % growth

France (M FRF) 7,563 9,380 24.0 Germany (M DEM) 3,102 3,981 28.3 Italy (B ITL) 824 871 5.6 Spain (M ESP) 69,130 86,648 25.3 UK (M GBP) 517 572 10.7 Source: Euromonitor

Exhibit 4 Number of Transactions (‘000)

1995 1996 1997 1998 1999 France 5,647.0 5,770.0 5,724.0 5,888.0 6,105.0 Germany n/a n/a n/a n/a n/a Italy 2,250.0 2,290.0 2,350.0 2,400.0 2,460.0 Spain 2,475.0 2,688.0 2,873.0 2,997.0 3,117.0 UK n/a n/a n/a n/a n/a Source: Euromonitor

Exhibit 5 Car Rental Fleet Size (‘000)

1995 1996 1997 1998 1999 France 130.7 131.0 135.0 137.5 141.1 Germany 152.0 151.0 160.0 162.0 165.0 Italy 250.0 265.0 280.0 290.0 305.0 Spain 92.7 98.4 104.1 109.2 114.8 UK 145.9 154.4 171.6 172.4 173.8 Source: Euromonitor (note - Italy includes vans, trucks & minibuses)

10 Exhibit 6 1999 Car Rental Sales by Usage Type (%)

Insurance Business Leisure Replacement France 36.0 62.0 2.1 Germany 56.4 33.0 10.6 Italy 64.2 35.8 – Spain 39.6 53.6 6.8 UK 54.0 43.0 3.0 Source: Euromonitor

Exhibit 7 Car Rental Sales (1995/1999 % value growth)

Insurance Business Leisure TOTAL replacement France -8.2 22.0 -6.6 8.1 Germany 19.1 34.4 76.3 28.3 Italy 9.7 -1.0 – 5.6 Spain 41.8 17.0 12.1 25.3 UK 5.8 14.7 72.4 10.6 Source: Euromonitor

Exhibit 8 1999 Value Sales by Location

Airport Non-airport TOTAL France 22.9 77.1 100.0 Germany 33.5 66.5 100.0 Italy 65.0 35.0 100.0 Spain 60.0 40.0 100.0 UK 35.5 64.5 100.0 Source: Euromonitor

11 Exhibit 9 Forecast Sales

1999 2000 2001 2002 2003 2004

France (M FRF) 9,380 9,729 10,068 10,374 10,664 10,928 Germany (M DEM) 3,981 4,167 4,389 4,614 4,783 4,921 Italy (B ITL) 871 880 887 897 908 919 Spain (B ESP) 86 90 94 97 99 101 UK (M GBP) 572 571 570 569 568 567 Source: Euromonitor

Exhibit 10 Forecast Number of Transactions (‘000)

1999 2000 2001 2002 2003 2004 France 6,105 6,230 6,476 6,645 6,837 7,001 Germany n/a n/a n/a n/a n/a n/a Italy 2,460 2,509 2,562 2,615 2,668 2,721 Spain 3,117 3,251 3,384 3,499 3,608 3,716 UK n/a n/a n/a n/a n/a n/a Source: Euromonitor

Exhibit 11 Forecast Fleet Size (‘000)

1999 2004 % Growth France 141.1 155.1 9.9 Germany 165.0 179.0 8.5 Italy 305.0 372.0 22.0 Spain 114.8 134.9 17.6 UK 174.5 186.0 6.5 Source: Euromonitor

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