Beach towels at dawn as tour groups vie for scale

"Sorry Britain, we've won the beach towel war." So ran the banner headline in yesterday's Bild, Germany's mass-circulation newspaper. The reference, of course, was to the £1.3bn cash bid for Britain's Thomson Travel from German giant C&N Touristica.

Most UK analysts believe that the German group will not succeed with its 130p-per-share offer, which has already been rejected by Thomson, even though Thomson shares closed 0.5p down at 129p yesterday. But many feel that a small improvement in the terms could win the day. "In England they're already worrying about Germans flying them on their holidays and giving them the bad seats," Bild crowed.

If it succeeds, the deal will be the latest in a series of takeovers in the European travel sector, which has been consolidating rapidly. The bid frenzy culminated in last year's £1.5bn merger attempt between Kuoni and First Choice, and Airtours' failed First Choice bid.

Jeremy Skidmore, editor of Travel Weekly, said: "We've seen a growing consolidation in both the UK and Europe. British companies moved early to integrate vertically with travel agencies, tour operating and airlines, and then started moving into Europe. Now the Europeans are doing it, too."

Analysts say that within a few years there could be just three major travel companies - C&N/Thomson, Preussag (which controls 50.1 per cent of Thomas Cook) and Airtours.

What is driving the quest for scale? Analysts such as Bruce Jones at Merrill Lynch point to the economies of scale and buying power that can be leveraged on everything from aviation fuel to hotel accommodation. Mr Skidmore underlines the importance of reducing costs in a cut-throat market such as package holidays. "Margins in this sector are only about 3 to 4 per cent," he said. "So if you are selling 10 million holidays a year and you can cut the costs by just a fiver on each one, that is £50m extra profit."

The dash for scale has become even more important as the market becomes more competitive. In the UK, the Teletext TV-based service already accounts for between 8 and 10 per cent of the holiday market. Internet companies such as lastminute.com, deckchair.com and the hotel site Laterooms.com have been growing fast.

Added to this has been pressure on prices from low-cost airlines such as easyJet, Go and Ryanair, which mean that it can now be cheaper to book the parts of your holiday separately rather than choose a package. Ryanair, for example, has been offering a return from London Stansted to Dublin for £27. Astonishingly, £23 of this is taxes, with just £4 going to Ryanair.

The consolidation has been rapid. In the UK four companies account for 80 per cent of the market, with few medium-sized companies left.

The shake-out was given a huge spur by the Monopolies and Mergers Commission report two years ago, which was more lenient than expected and did not force tour operators to sell their travel agencies. This green light to vertical integration encouraged the major players such as Thomson, Airtours and First Choice to go on huge buying sprees, which have seen them gobble up smaller travel firms in specialist areas.

With the UK market effectively sown up, the trend extended to Europe. Airtours began expanding in Scandinavia, followed by Thomson. Airtours has also been expanding aggressively in Germany.

Vertical integration has been extending lower and lower down the chain. Airtours, for example, already owns tour operating businesses, the Going Places travel agency and its own airline. But it has been increasingly buying Mediterranean hotel groups so it has more control. Earlier this month it paid £44m for Hotel Don Pedro, a Spanish group with hotels in Majorca, Minorca, Ibiza and the Canaries.

Bruce Jones at Merrill Lynch said: "If you own your hotels right on the beach, then you can command premium prices and have a better chance of filling the rooms all year round."

In the same vein, companies such as Airtours have been buying cruise ships. Thomas Cook now has 187 hotels, and speculates that car rental would be a natural areas of expansion.

Where will all this end? Travel experts say a C&N/Thomson deal would put pressure on Airtours, which has been trying to establish itself as Europe's dominant player. It can't bid for C&N as it is a privately owned 50:50 joint venture between Lufthansa and Karstadt Quelle. A bid for the publicly quoted Preussag would struggle on competition grounds because Preussag's controlling stake in Thomas Cook.

But First Choice may also be vulnerable. As number three in the UK market it lacks the financial muscle to compete with the biggest players. It wants to play a part in consolidation and some sort of merger is likely.

There could be other problems. The growth of the internet and the advent of interactive television are likely to become serious issues for travel companies. On the plus side they own the "content" such as airlines, tour operating skills, travel agencies and hotels.

But if a substantial part of their travel agency business migrates online, the value of their high-street networks could be eroded. Thomson has already indicated that it may reduce its Lunn Poly shops. It has also pledged to invest in an e-commerce strategy and starve intermediaries such as lastminute.com of their product.

For consumers the concern is two-fold. If the UK market consolidates into, say, three major players, it could lead to reduced choice and higher prices. As Mr Skidmore said: "Even with the internet, the barriers to entry to mass market package holidays are extremely high. The major players have bought up all the beds in the major resorts."

This is something the regulators in Brussels will no doubt keep an eye on.