Value proposition

Online travel is a real success for the airlines but care is needed to ensure it continues to deliver

It is hardly an understatement to say that online travel distribution has changed the face of the industry. In part, this is due to the sheer value of online sales, but more important, is the way that the technology has forced every player in the value chain to re-evaluate its strategies and business processes. Airlines, global distribution systems (GDSs), travel agencies, corporate buyers and consumers have all changed their behaviour as a result of new technology.

This year online travel agencies will account for around revenues of $40 billion. Despite the hype, this still only represents a small portion of the world's $750 billion spend on travel. And in the US market, at least, the volume of direct airline website bookings has actually slowed, although that is in large part due to the rise of online agencies like Expedia, Travelocity and, latterly, Orbitz.

Yet online travel has nevertheless helped airlines re-engineer a significant part of their cost base. For the first time in three decades there is now a serious alternative to the GDS and travel agent as a path to market. This is the real success of the online channel, supporting a reduction in agency commissions and driving significant changes in the business model and focus for the GDS providers.

Internet attraction

Low-cost carriers were the first to seriously exploit the online channel. Booking via the internet is easy and there are financial incentives to make it more attractive than the telephone or a travel agent. AirTran, easyJet, jetBlue, Ryanair, Southwest and others benefit from this cheap distribution. So much so that Ryanair now takes well over 90% of its bookings directly from the web into its OpenSkies reservations system, supplied by Accenture-owned Navitaire.

The fact that Ryanair educated Irish travellers to find the best fares on the internet, arguably helped the turnaround at Aer Lingus. This behavioural shift allowed the Irish flag carrier to pull its lowest fares from traditional distribution channels and exploit technology from IT travel specialist Datalex, as well as its own capabilities, to drive down distribution costs.

Major network carriers have also benefited from web sales. However, to do to do so they first had to build or buy additional technology that allowed their mainframe reservations systems to connect with customers via the web. So costs rose as they found themselves supporting new online channels alongside traditional sales processes.

Airlines also experienced a significant rise in transaction costs in the legacy systems as customers spent time looking before booking. In addition, many airlines saw a substantial hike in transaction fees from customers booking with credit or charge cards. But overall, the avoidance of travel agency commissions and GDS fees has easily outweighed the higher technology costs.

The growth of special internet fares and the creation of the internet-ready Orbitz booking site by American, Continental, Delta, Northwest and United generated attention from the US regulators. This was uncomfortable at the time but ultimately no specific legislation was deemed necessary.

The value proposition from Orbitz was very simple: airlines were invited to join as charter members and offer fares no higher than those on their own websites. They made a contribution to marketing and benefited from a shrinking distribution cost per ticket over time. Reduced distribution costs were funded using the GDS segment rebate traditionally paid to travel agents.

Orbitz was linked to the Worldspan GDS, which paid an incentive of $1.75 per booking to travel agents. This was used to fund a rebate on booking fees to Orbitz airline participants, creating immediate value. Orbitz also made a contractual commitment to deliver technology that would eventually reduce distribution costs to less than $1 per ticket by bypassing the GDS altogether.

Orbitz funding

The airlines had to dig into their pockets to fund the $205 million Orbitz needed to get going, but an initial public offering raised $300 million. That more than returned the start-up capital and generated new funds for technology and market development. Orbitz recently launched a business travel service aimed at corporate travel departments and managed to sign McDonalds as its first major customer. The success of Orbitz has led to similar ventures by airlines in Europe (Opodo) and Asia Pacific (Zuji).

Some airlines have been successful in leveraging online success to sell their shares in a GDS. In 2003 American, Delta and Northwest Airlines raised around $1 billion from the sale of Worldspan.

Not long afterwards, Orbitz announced that it was having problems with Worldspan and gave formal notice of contract termination. The flurry of activity led to speculation that the airlines had succeeded in their attempts to secure direct connections to Orbitz for inventory distribution and could now renegotiate GDS contract terms. These included compensation to Worldspan for reduced bookings once Orbitz began implementing direct airline connections. Worldspan and Orbitz recently announced they had resolved their differences, but no details of the new contract terms have been announced.

The GDS will remain a critical component for online travel, but fees have shifted downward. Some enthusiastic cheerleaders for all that is "dotcom" have predicted the demise of the "dinosaur" GDS companies. However, the hard fact is that all major online players use a GDS as a cornerstone of their service. In META Group's view the GDSs are, and will remain, a critical component of the online travel world.

Online travel could not have had such a successful start if the GDSs had not been supportive. Expedia was launched by Microsoft in 1995, but even the world's most successful software company could not escape the need for GDS content to launch its service. Worldspan has provided core booking services to Expedia from the beginning.

Since its subsequent acquisition by US Interactive, Expedia has put on spectacular growth, handling over $8 billion in travel sales in 2003. In recent years Expedia has adopted a merchant model, selling accommodation and travel packaged offerings to its 60 million registered customers.

Travelocity too has close ties with a GDS, having been created by Sabre. It was floated as the dotcom boom got going and bought back after the bubble burst. This was a shrewd move, although Sabre also paid $757 million near the zenith of dotcom hype for technology and clients from Getthere, an online operator for corporate travel.

Online travel distribution has shifted market power away from intermediaries. With a viable alternative in place, airlines have been able to reward travel agents on the basis of the value they bring, as opposed to flat commission rates. GDS fees have been reduced and the business model is shifting back to its roots.

Agencies will soon be required to pay a share of the costs rather than receive incentives for using the systems. As a result they must charge fees to clients who will only be willing to pay if the agent's expertise is adding real value.

Faced with a reduction in fee levels as well as a downward trend in the overall number of bookings, the GDS companies have had to seek ways to generate new revenue streams. These include the adoption of a transaction charge model by Travelocity; the growth of airline IT services at Amadeus; and Galileo's exploitation of synergies with other parts of its corporate parent, Cendant.

The real success of the online world has been the leverage it has placed on key components of the distribution value chain. Market power has swung towards the airlines and away from the intermediaries. As a result it is seen that:

incentives will go only to those in the chain that add value; airlines pay lower GDS fees; travel agents will pay for GDS services; airlines have a real opportunity to take a larger share in the total travel spend through ventures like Orbitz, Opodo and Zuji.

Despite the considerable success of online travel, for the airlines there are risks. Competition between distribution channels may lead to yield erosion if not managed effectively, and as airline IT suppliers also become merchants for airline services there is scope for damaging conflicts of interest.

Overall, however, the picture is positive. Airlines investing in online distribution have benefited handsomely, while those that have not should be planning to do so. It only represents 5% of the market today but the online space will be the critical battleground for airline marketing over the next 10 years.

Online travel sales by segment $ million
Type	1999	2000	2001e	2002e	2003e	2004e	2005e
Air	4,680	9,018	13,965	17,506	21,641	26,080	31,296
Lodging	1,094	2,620	4,081	6,025	7,854	10,035	12,827
Car rental	475	1,320	2,353	3,338	4,303	5,487	6.998
Cruise/Vacation	155	420	880	1,346	2,158	3,112	4,492
Total	6,404	13,378	21,279	28,215	35,956	44,714	55,613
Source: META Group research e=estimate

Online majors travel bookings revenue $ million
Provider	2001	2002	2003	02-03
Expedia	3,600	5,300	8,200	55%
Travelocity	3,100	3,500	3,890	15%
Orbitz	818	2,566	3,440	34%

 

RICHARD CLARKE OF META GROUP IN LONDON

Source: Airline Business