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Thursday
Dec062012

We The People: Does BTC (Business Travel Coalition) Really Stand For Bamboozling The Consumer?

[Note:  much of this blog is directly lifted from the trial transcripts AMERICAN AIRLINES, INC. v. SABRE, INC. ET AL)

To bamboozle is to trick or deceive someone through misleading statements or falsehoods. That is precisely what Kevin Mitchell and the Business Travel Coalition (BTC) are up to these days – yet again. From my perspective, this means protecting monopolists by conspiring with anybody and everybody to inflict harm on anyone or anything that might bring competition to the Global Distribution System (GDS). It is time someone calls them out on it.  For too long, the industry has looked the other way in allowing the fox (BTC) into the chicken coop (air travel consumers) under the guise that the BTC advocates on behalf consumers against the big bad airlines.

In its latest façade, the BTC has started a “We The People” campaign urging the administration to enact measures against the industry that will ensure that the “all-in” cost of air transportation is made available to all distribution channels, including the GDSs.  The petition reads:  

“Proceed immediately with a U.S. Department of Transportation rulemaking to restore air travel comparison shopping for consumers.

Airlines have been charging for services such as for checking bags and have been hiding fees by withholding information from travel agencies such that consumers cannot efficiently compare the prices of alternatives and must visit numerous airline websites. This unfair and deceptive marketing practice is harming consumers.

Airlines have been able to withhold fee information for 5 years - evidence of a failing market. Importantly, when Congress deregulated this market, consumer protections were consolidated at DOT leaving travelers with no legal recourse under state consumer-protection laws.  

DOT must require airlines, via a rulemaking, to provide fee information to sales channels where they offer base fares so consumers can see, compare and buy the complete air travel product.”

What BTC thoroughly ignores in its petition is that innovation is already solving challenges of distributing ancillary products which the airlines reasonably want to sell in as many channels as possible. But the larger question is why BTC is taking on this fight when there are far greater issues in play that impact flyers? The answer is, of course, that the consumer is not BTC’s interest here.

You see, it is impossible for the BTC to represent air travel consumers because it represents, and advocates for, a sector of the industry that monopolizes airlines.  The distribution sector of the industry conspires against airlines that challenge that monopoly even if it means harming the very same consumers BTC now claims it wants to protect.  I’ve reviewed transcripts from the American Airlines v. SABRE, Inc. trial - the best public record to demonstrate this activity by the GDS and the large travel interests, but it could be any airline in the way this plays out.  The AA-Sabre trial was settled before a jury had the opportunity to decide the case in which SABRE was accused of conspiring to harm American in numerous actions not limited to setting up boycotts and ensuring that the airline suffered economic harm.

BACKGROUND/SIMPLE PRIMER

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems. Every time a consumer works with a travel agency, the agent offers information most likely provided by a GDS. It is the airlines that supply that data to the GDS.

First, a brief history.  In the early years following deregulation, GDS were mostly owned by airlines and used to provide information to intermediaries like travel agents to sell tickets. The systems were biased toward the airline(s) that provided the technology and built using pre-internet technology. GDS were compensated for providing and maintaining these vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias. As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; instead they became a tool of the travel industry to sell a service. Today, the airlines pay an intermediary to distribute their own product – and are paying a price much higher than the GDS transaction costs. The airlines’ costs reflect an outdated model burdened by expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper to an airline’s own customers.

Two companies control 90 percent of US GDS services to travel agents despite the fact that there are other channels that can provide the very same information for a fraction of what airlines now pay.  But don’t be fooled:  It is the consumer who ultimately pays these costs, despite what the BTC and its members will tell you.

THE TRIAL – A STORY

Six years ago, in a boardroom of a very powerful company, a decision was made to bring American [replace with any “problem” airline] to its knees with a series of attacks to get what the powerful company wanted. These attacks hurt not only American Airlines, but also American consumers, because this is a story about how a very powerful company in a very secret way spent years planning to crush new competition to preserve their monopoly.

That plan had many parts and only began by hiding or dropping a problem airline’s flights from their display. Remember, the main product of the GDS is the display – that’s what travel agents use to book flights for their clients. So you drop one airline from the mix, and that airline doesn’t get the booking.

Next, they decided to double the problem airline’s fees overnight. And organize industry boycotts. And threaten exclusion of a problem airline from the GDS.  And use false excuses to blame American.  And hide behind secrecy and deception.  And more.

Airlines know there are two ways to sell tickets to corporate travelers. The old way is the GDS way.  The new, better, more innovative way, is through technology called Direct Connect. It can cut their costs. It can personalize the interaction with their consumers. It offers greater flexibility and a better way to sell tickets and other services and products. These are advantages already used by other airlines, including Southwest and Air Canada, to their great benefit. And in this case they are advantages American wanted, too.

Every company operates for profits, but this case details evidence that Sabre had a plan. Because Sabre is owned by private equity groups hoping to sell within five years, that plan provided a five-year exit.  It was called Project Sovereign.  The essence of the project was to do anything to protect the rich cash flows enjoyed by Sabre in order to maximize the sale price in five years. 

The  airline Direct  Connects are  attempting to have  systems where  they  can  have  the  complete view  of their  customer and  offer  these  specialized deals  for their  clients using  modern  technology. They'll be personalized. They'll be up to date. And  hopefully they'll give  the  traveler exactly what  they  want  at the best  price  for  that  customer.  The threat to the legacy GDS model is to go directly to the consumer – bypassing the middleman (GDS).

Sabre had one primary goal: To neutralize American and it’s attempt to disrupt the model. The GDS was their fortress.  In a word, Sabre would seek to delay and destroy American’s Direct Connect. 

Then in 2006, a mere two months after the new contract between Sabre and American was signed, a Sabre executive sends an e-mail to just a small group of top executives and he says, let's do an initiative -- that's corporate speak for "plan" -- let's do an initiative that targets getting as many things as possible in place. To do what? Neutralize American. Neutralize American's market move to disrupt the model.  American found out about the plan through a mis-directed email.  The plan was first called Five Plus Five so as to disguise it in case American found out about it.  Ultimately the plan was renamed Project 99. 

The plan, in the complex language favored by the GDS, involved "deployment of tools for marketplace awareness and promotions and other non-GDS airline activity."  Or, in simple terms, Project 99 would monitor American and track what the airline is doing that doesn't involve a GDS.  It also sought to "put contractual hooks into the travel agents" – referring, of course, to the corporate agents so critical to an airline’s business travel.  The goal?  To handcuff them to Sabre, and determine how to stop or limit American's marketplace actions.  Finally, it sought to "get clarity on algorithm changes" -- GDS- speak for exactly the kind of biasing the government was trying to restrict.

It began on Christmas Eve, 2010, after Sabre already had been conducting six weeks of secret biassing. According to the e-mails, on December 24 the companies doubled the intensity of the bias, from 60 percent share to 30 percent share, meaning that American’s fares were that much less likely to show up on agents’ screens.

And when did this happen? 4 a.m.  Because when you do something at 4 a.m. on Christmas Eve you do it hoping that no one will notice.  This isn’t to say everyone that ended up being a part of this plan was a willing conspirator.  The evidence showed that some big travel agencies did not want to participate. One of them was BCD Travel, which Sabre executives described as “livid” at Sabre's actions.   In the end an under pressure, however, even BCD agreed to bias in over 6,000 markets. Project 99 was operational.

At the same time all this was happening, Travelport began to put a new tax on American’s flights and then add that tax to the fare price so American’s flights fall all the way to the bottom of the list. Then Expedia started biassing and American’s flights pretty much dropped out altogether. Soon, all the big travel agencies joined the boycott and the biassing.

Enter the Department of Transportation. It takes a hard look at what’s going on and deems it deceptive and wrong.  The DoT inspector even calculated damages at hundreds of millions of dollars. That includes $188 million for Sabre’s six-year sabotage of Direct Connect and $544 million in lost cost savings and product sales.  Add another $261 million from what investigators believe were illegal contract terms and lost web sales for a total of nearly a billion dollars. Exactly what Sabre intended.

But that is only how an airline was hurt.  What about corporations?  Air travel consumers? Travel agents?  We just don’t know.  And we certainly don’t know at what frequency some of these activities take place.  Why do major travel advocacy groups ignore these actions?

THE ONLY CONSUMER ADVOCATE NOW SHOULD BE DOJ, CERTAINLY NOT BTC

On August 25, 2012, The Economist wrote:  The GDSs, meanwhile, are lobbying America’s Department of Transportation to force airlines to include “core” extras (such as bag fees and check-in charges) in the fares they quote to the GDSs, to make for fairer comparisons with carriers that offer all-inclusive fares.  My fear in this action and why BTC is pressing for signatures on a petition is only to ensure that the GDS receive information that only guarantees that their monopoly is emboldened going forward and that new technology like Direct Connect is forever blocked from mounting a competitive product.  Stifling innovation is after all what the GDS want – particularly their owners who want to sell monopoly revenue streams back to the market.

Bottom line: we desperately need an industry correction that allows a natural evolution in business practices so the free market can work. A federal lawsuit may achieve that. Free competition will spur the innovation that anti-trust laws are designed to promote. A federal lawsuit may do that. When competition wins, the consumer wins. When innovation is allowed, the consumer wins. Don’t be fooled by the GDS industry and its supporters hiding behind the false boogeymonster of “hidden fees”. Consumers have no idea how much it already pays to an industry that stifles competition each and every day. And the largest cost is the opportunity cost imposed by the GDS industry that would rather direct consumers’ attention elsewhere.  We do not need an advocacy group with these interests pretending to be the best in protecting air travel consumer interests. 

Before the DoT makes another rule, let’s hope that DOJ completes its investigation of the distribution sector so monopolists can no longer conspire to stifle innovation.

Tuesday
Aug092011

Global Distribution Systems and the Pretense of Consumer Protection?

This past weekend, I found myself immersed in the messy divorce between airlines and the Global Distribution Systems (GDS) that used to be their “partners”.

In this case, I was looking at complaints filed by American Airlines and US Airways against Sabre and related companies, and then Sabre’s and Travelport’s complaints against American Airlines.  Readers know that I believe this is one of the more transformational events in the industry and I finally found the time to read in detail each party’s take on an increasingly tense situation.

In coming weeks, this fight is likely to again come to the fore.  The story is about monopolies and not market power. 

There is no elevator speech on this topic.  Within the industry, it’s all inside baseball. To the outsider, it’s incredibly obscure. But here’s the crux of the matter:  American, US Airways and other airlines are trying to retake their inventory from the GDSs that have for years listed their flights and taken a piece of the ticket price. 

What the airline’s want, in other words, is broader competition through an alternative mechanism to sell airplane seats and other travel related products – not to eliminate the GDSs.  

After all, airlines understand competition. Airlines understand fragmented markets.  Airlines understand pricing dictated by competition and macro economics, and monopolies and duopolies of vendor industries.  There is no global airline company with more than a 7 percent market share.  Even the top 10 airlines in the world together have less than a 40 percent share of global capacity. 

But when it comes to the GDSs, it is a different story.  Sixty percent of airline tickets are sold through travel agents and it is this sector of the industry that is ripe for competition.  According to MIDT data today, three players dominate the field in the U.S.: Sabre with 58% of the market; Travelport with 33%; and Amadeus with 10%. 

Travel agents make money by using the GDSs. The contracts between the vendor and the agent impose such significant switching costs that the financial penalty is too steep for most agents to consider an alternative booking channel.

As US Airways wrote in its complaint, the American Society of Travel Agents confirms the industry’s dependence on the legacy GDSs.  As of the end of 2009, 85.7 percent of travel agencies use only one GDS.  94.9 percent of travel agents using a GDS have not changed their GDS provider in the last two years and a remarkable 86.7 percent of agents are using the same primary GDS that they were seven years ago when the GDS industry was deregulated.    

As a business model, the GDSs are more about suppressing competition than spurring innovation.  Seven years after deregulation, barriers to entry in the GDS space have blocked all new competition. Contrast that with the domestic aviation market where low cost carriers now fly more than 31 percent of ASMs flown.

Market power is a seller's ability to exercise some control over the price it charges. In our economy, few firms see perfectly elastic demand. All products have a differentiation, whether due to consumer tastes, seller reputation, or location, as with airlines that convey upon a seller some degree of pricing power. Thus, a small degree of market power is common and understood not to warrant antitrust intervention.

Market power and monopoly power are related but not the same. The Supreme Court has defined market power as "the ability to raise prices above those that would be charged in a competitive market," and monopoly power as "the power to control prices or exclude competition."  In many markets, but not all, airlines do have market power in that they are able to set revenue in excess of marginal cost.  The last thing they are is monopolists as they have no ability to control prices or exclude competition.

In its complaint against American, Sabre makes a feeble and even laughable attempt to point to American’s monopoly power over certain routes at Dallas/Ft. Worth, Chicago O’Hare and Miami.  Sabre goes so far as to name non-hub cities like Abilene,TX; Augusta, GA; Brownsville, TX; Champaign, IL; and Dubuque, IA as city pair markets where American has monopoly power.  But it is simply wrong to suggest these cities are examples of monopolies, when each is blessed (given their population and underlying demographics) to have entry into the nation’s air transportation grid and each faces some direct or indirect competition. It is just as wrong to suggest that American has no competition on its Augusta GA to Dallas/Ft. Worth route when Delta flies those skies multiple times a day. 

This is a network business and American Airlines holds a 15.2 percent share and US Airways 9.6 percent of capacity in the domestic network market. In fact, the top five airline competitors hold an 80 percent market share in the U.S. domestic market, with the largest carrier, Delta, garnering a 20.1 percent share of ASMs.  This is a far cry from Sabre’s 58 percent share of the U.S. GDS market and that three firms have 100 percent of the U.S. domestic market.

To read the GDS’ complaints, you would think that we’re back in 1978 when schedule and price were the only consumer consideration. Thirty-three years later the GDSs still force the airlines to compete only on two factors; schedule and price. By limiting how airlines compete, the product is the definition of a pure commodity.  

After all, Southwest does not turn its inventory over to the GDSs. How can you have a discussion on price and service without Southwest – which now competes in markets that account for 95% of domestic demand – as part of the dialogue?

GDS advocate Kevin Mitchell, Chairman of the Business Travel Coalition (BTC) has a questionable take on the issue.  In Sabre’s complaint, Mitchell says: “The stakes in this conflict are clear: either an improved airline industry and distribution marketplace centered around the consumer, or one that subordinates consumer interests to the self-serving motivations of individual airlines endeavoring to shift costs and impose their wills on consumers and the other participants in the travel industry.”

He’s right on one point: the stakes are clear.  This is a battle about an improved airline industry – one that is sustainable over the long term; and a distribution marketplace centered on the consumer. But that’s only going to happen when the airlines have control over their own inventory.  Only when airlines have the ability to package their product based on their knowledge of consumer behavior will it become all about the consumer.  To protect and advocate for the GDSs in fact subordinates consumer interests because this legacy distribution vehicle does nothing but thwart competition and stifle innovation. 

Perhaps it is OK with the GDSs and the BTC that shifting (cutting) labor costs in bankruptcy was an appropriate strategy as long as the annuity from the airlines to the GDSs to the travel agents was not affected.  But that assumes an annuity in perpetuity, and fewer and fewer of those exist in today’s airline business. The business of the GDSs can be done cheaper and better by those with technology younger than 1960.  What the GDSs and the BTC claim is an entitlement is anti-competitive at its core.

Mitchell also proclaims to be a consumer advocate.  Remember it was he and Kate Hanni who teamed to advocate for the three hour tarmac delay rule which, with the help of the gullible Secretary of Transportation Ray LaHood, purported to “protect the rights” of some fraction of one percent of all passengers.  Today he supports a monopoly making its money off of 60 percent of air travel consumers.  Now it is Mitchell who rails against what he calls “Hidden Fees” like seat upgrades, baggage fees, and charges for pillows and blankets to name a few of the 16 specific revenue items the Department of Transportation wants the airlines to report.

This, keep in mind, is an industry that earned a scant two cents on every dollar in 2010 and yet the government wants to dig further into the file cabinets of every airline in the country in a misguided attempt to account for the money those fees are bringing in. In case you have been living under a rock, the genesis of ancillary fees has been among the most covered and scrutinized stories since 2008.  In 2010, US airlines generated $3.4 billion in baggage fees and another $2.3 billion in reservation change fees for a total of $5.7 billion.  What about the fact that the industry’s fuel bill in 2010 was $6.5 billion higher than in 2009?  The Air Transport Association forecasts that the industry’s fuel bill in 2011 will be $14 billion more in 2011 than it was in 2010.  Remember, it was the rising cost of fuel in 2008 that served as the catalyst to unbundle the airline product in the first place.

The airline industry already pays more than its share of taxes and fees.  But if it is transparency of “hidden fees” that the regulators (and Mitchell) want, then I as a passenger also want to know how much of my ticket price goes to the GDSs just as I want to know how taxes on my airline ticket are disseminated to various government agencies. 

To me GDS fees and taxes are similar as they both support legacy interests/ideals – some might argue outmoded models -- without any meaningful return to the airlines. That said, there remains an ongoing need for GDSs, particularly with respect to the support they provide to the thousands of travel agencies worldwide and to their international reach.

Today, the GDS industry earns $7 billion in revenue with no product other than the airlines own schedules and prices.  Is that innovation?  Some estimate that the work of the legacy GDSs could be done for 20 cents on the dollar.  That’s a lot of money spent on something that belies innovation.

The GDS role was relevant until about 2002 when market share was the name of the game.  Now the industry is focused on profits.  In fact, this is an industry that would have lost money in 2010 if not for the fees that Mitchell decries.  The GDSs need time to develop the software necessary for it to “up sell” better seats on US Airways.  Imagine how long it will take for the legacy GDS systems to account for 16 fee buckets as defined by the Department of Transportation (a potential new regulatory requirement).

But Mitchell bangs the consumer drum while advocating for an industry serving the airline industry that has monopoly powers over the very companies it calls customers.  

Concluding Thoughts

According to the U.S. Department of Justice (DOJ), “U.S. antitrust laws reflect a national commitment to the use of free markets to allocate resources efficiently and to spur the innovation that is the principal source of economic growth.”  Today’s GDS industry, circa 1960, represents anything but free markets or innovation.  Rather is about protecting a monopoly revenue stream at the expense of allowing the consumer to customize the travel experience depending on their wants and needs.

According to the US Airways complaint, the DOT made four assumptions when the GDS industry was deregulated: 

1) Airline divestiture of their interests in the GDSs made it less likely that a GDS would favor one airline over another;

2) Forthcoming technological changes – including online, direct-to-consumer ticket sales – would operate as a check on the market power of the GDSs;

3) Airlines’ ability to control access to their own content, including webfares and other discounts offered through an airline’s own website or select distribution channels – would reduce the GDSs market power; and

4) Vigorous anti-trust enforcement would help ensure competitive markets.

No matter how well-meaning those assumptions, they haven’t held water largely because of the power of the legacy GDS industry. So perhaps it is high time that the DOJ file suit against the GDS industry.  Why is it OK that Amazon.com is able to offer recommended products to consumers based on past purchase behavior and the airlines cannot?  Why can the consumer pick from a variety of offerings when picking a cable television or cellular phone plan but is so limited in options for air travel purchases?   

Today, all the consumer can do when buying from a travel agent is to make the purchase decision based on service and price.  Limiting indeed.

We desperately need an industry correction that allows a natural evolution in business practices so the free market can work.  A DOJ suit may achieve that.  Free competition will spur the innovation that anti-trust laws are designed to promote.  A DOJ suit may do that.  When competition wins, the consumer wins.  When innovation is allowed, the consumer wins.  Don’t be fooled by the GDS industry and its supporters hiding behind hidden fees; the consumer has no idea how much it already pays to an industry that stifles competition each and every day.   The biggest thing hidden there is the opportunity cost imposed by the GDS industry that would rather direct consumer’s attention elsewhere.

Tuesday
Mar292011

To The GDS's: Either Evolve Or Dissolve -- It's That Simple

In the March 12 Economics column of The New York Times, University of Chicago economist Richard Thaler correctly titles his piece as it pertains to the airline industry:  “This Data Isn’t Dull. It Improves Lives.” The column then goes on to distort the intentions of the airline industry. 

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems (GDS).  Every time an air travel consumer works with a travel agency, the information being supplied by the agent is likely provided by a GDS.  The data necessary to enable the agent is supplied by the airlines to the GDS.   

In the early years following deregulation of the airline industry, GDS were largely owned by airlines and used to provide information to intermediaries to sell tickets on particular carriers.  The systems were biased toward the airline(s) providing the technology to the travel industry community.  These massive networks were built using the technology prevalent at the time – prior to the advent of the internet – and GDS were compensated for providing and maintaining vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias.  As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; rather they became a tool of the travel industry to sell a service.  Today, the airlines pay an intermediary to distribute their product – and they are paying a price much higher than the prevalent transaction costs. The airlines’ costs reflect an outdated model replete with older and more expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper.

But the intermediaries don’t pay the airlines for the airline-created content they use to lure customers to their respective websites so they can sell hotel stays and rental cars.  It makes no sense.

Name a financially successful industry that turns over control of its inventory to an intermediary. I can’t think of one either.

Airline travel is now available for purchase on multiple channels via the internet, including through the airlines’ own websites. Those sites typically provide carriers with the most control over the shopping experience while also being the lowest cost channel for the transaction. It is simply much cheaper and more efficient to use newer, internet –based technology to distribute tickets without the need for a “gatekeeper” between airlines and agents.   

Now the airlines also want to be able to go directly to their customers via their own channel.  Not that the airlines do not value the higher yield business that comes from agencies.  The motive is not, as some detractors have said, because airlines want you only to shop at their sites or not reveal what the cost of a trip is if you check two bags.  Rather, airlines are looking for ways to differentiate themselves by offering additional products and services to their customers that enhance the travel experience. This information is something the GDS cannot provide today without a significant investment in their systems.

Duopolists are typically reluctant to invest new capital unless it is absolutely essential to protect its cash cow

The airlines don’t necessarily want - or need – to drive all transactions to their sites and there is still a role GDS can play in this process. GDS could be content aggregators, allowing customers to easily compare fares. Right now, though, that’s a role GDS seems unwilling to take on perhaps worried about risking their fees.  

There are other factors at play here as well. First, airlines know their particular customers better than the government or the GDS. Plus; the GDS haven’t evolved as the industry has dramatically changed.  

Today’s GDS force the airlines to compete only on two factors; service and price. By limiting areas how airlines compete, the product offered is the definition of pure commodity. This was true in 1983 just as it is today. 

Despite the airline industry’s efforts to remove more than $20 billion in expenses over the past decade, the price of another commodity essential to its business increased more than fourfold – oil.  The airline industry is left with little choice, if it is to ever be a sustainable business, but to begin the process of de-commoditizing its product and finding new revenue sources.  To do so, means fundamentally altering its legacy relationship with the GDS and recapturing control over its inventory.

The airline industry has found new ways to generate revenue by offering customers products they value and are willing to pay for, including seat upgrades, passing through security faster or day passes to airport clubs. Bag fees, now charged by the majority of U.S. carriers, reflect a more accurate way to pay for what you use. In other words, customers that don’t check bags no longer subsidize the cost of those who do.  

Yet the GDS and supporters claim airlines aren’t being “transparent” in their pricing that they do not want to reveal the total cost of trip to a passenger.  Few industries have price transparency like the airline industry – compare it to cell phone contracts – and the majority of customers know exactly what they’re paying for when they travel.

Thaler is right; the data supplied to the GDS is anything but dull and service and price competition have benefited many by making air travel affordable to the masses. This will certainly continue as the competition is as hungry today as ever.

This is not a fight about defending the purity of data or somehow withholding it from those whose only aim is to presumably help customers. No one, including the GDS, can really dispute that this information comes from the airlines.

Despite the rhetoric, it’s also not about protecting customers from an industry desperate to reach more. This is about protecting an outdated mode of operation and stifling innovation.  The GDS duopoly cannot move fast enough for an industry that sells “time saved”.  The GDS doesn’t want its revenue tap turned off. It’s time the GDS recognizes it can’t support interests other than their ultimate customer – the airlines.  The airlines are simply looking to adapt to new economic realities and help their ultimate customer – the person who actually buys a ticket.

Duopolist.  Monopolist.  Neither is accepted in the airline business.  Now the airline business says it is time that vendors servicing the airline industry cannot be duopolists or monopolists either.  It is all part of the evolution of the business that began in 2002. 

Monday
Jan102011

Unbundling, Rebundling and Now De-Commoditization

As the new year begins, I’m encouraged that airline industry is truly making changes necessary for long-term survival.  Over the past decade, airlines have engaged in a restructuring period like no other since deregulation – in fact making the kind of meaningful structural changes some thought deregulation itself would bring .

American Airlines’ aggressive posture in restructuring the way airline tickets are distributed is an obvious next step in this process.  In most businesses, low-hanging fruit is found where a middleman is involved, as is the case with the aggregators like Orbitz and Expedia.  For the airlines, this effort has some risks and involves more than just cutting costs.  It is about addressing some of the core issues that plague airline pricing and can be termed the de-commoditization of the very product airlines sell – a seat from A to B.

On November 25, 2009, Swelblog wrote about a presentation that former Air Canada President and CEO Montie Brewer gave at MIT titled:  Five Reasons Why the Airline Industry Will Never Be Profitable.  According to Brewer, one significant reason the industry will fail to earn a profit over a sustainable period is the presence of the Global Distribution Systems (GDS).   Now before our very eyes, American Airlines has taken the leadership to challenge the roles played by the Online Travel Agencies (OTA) and the GDS.

Reason #1 cited by Brewer as to why the industry will never be profitable is that the capacity-lead business model causes “constant overcapacity”.

Since deregulation the airline product has been commoditized.  In the commodity framework, the only way the industry, or an airline, can grow revenue is to grow capacity.   But that model didn’t work for airlines, where Computer Reservations Systems and the GDS’s institutionalized the notion that in order for an airline to grow revenue, it needed to offer more and more capacity even before demand warranted.

The addition of capacity led to low and lower operating costs.  On the margin, revenue exceeded cost.  Uneconomic capacity was being deployed each and every day.  Ultimately, it created an industry too big to be sustainable.  If not for the price of oil, the airline industry would never have shed the level of capacity it did between 2008 - 2010.   

The GDS were a major contributor to the commoditization of the airline product.  Therefore, airlines that distribute directly to the consumer have the best likelihood of differentiating, and more importantly, not commoditizing, their product.  This fact contributed to the trend in which certain airlines did well even as much of the industry suffers. Note the one airline in the US that does distribute directly to the consumer:  Southwest.  And Southwest has differentiated, not commoditized, its product. 

What is a commodity?  According to Miriam Webster, a commodity is a good or service whose wide availability typically leads to smaller profit margins and diminishes the importance of factors (as brand name) other than price.  Commoditization can be defined as the process of prices moving substantially lower because of strong competition. Commoditization happens because too many competitors enter a market when they see the large returns that can be earned on certain products. However, those returns soon disappear as competition drives prices lower.

Each defines the airline industry.  Each defines patterns that today’s industry executives are trying to break.  Just because it was done one way or another yesterday does not mean it is the best way of doing business tomorrow.  Enter the Business Travel Coalition (BTC).  Under the veil of protecting consumers, the BTC is doing nothing more than protecting the interests of the money that keeps the organization in business.  Every time the airline industry makes a strategic or commercial move to improve its profitability, the BTC pushes back because change does not serve its clientele well. 

Which leads us to Brewer’s Reason #5: “Nobody Really Wants It to Be Fixed.”  Brewer makes a powerful case that things are fine the way they are . . . and, for the most part, the airline industry value chain, consumers and the government know it.

When it comes to low fares,  consumers can shop the internet and find some market on sale (and the same will be true tomorrow if American and others are successful). They may even find the price of a ticket today equal to or less in nominal dollars than a fare charged two decades ago.  When adjusted for inflation, it is hard to find any consumer product that is a better bargain than air travel.

Taxes and fees account for nearly $60 - or 20 percent - of the average price of a ticket today.  This compares to $22, or 7 percent, in 1972.  In other words, the government is getting a bigger share of a shrinking pie.  GDS fees go up as the real price of a ticket is in decline.  Anything that the industry can do to address margin degradation in the business should be considered and be done.  And that is precisely what American is doing.

There are few areas that remain on the income statement where costs can be cut.  Distribution happens to be one just as the industry is asking the government to examine whether the tax burden imposed on the airline industry is disproportionate.   As the old saying goes: Two percent here and two percent there on top of taxes and fees that consume 20 percent of the ticket price adds up to real money . . . money the industry cannot afford over the long term.

Perhaps most compelling is that all the players in industry's value chain -- GDSs, OTAs, airline caterers, aircraft lessors, ground handlers, manufacturers, airports, fuelers, travel agents, maintenance repair organizations and freight operations -- don’t want it changed.  That’s because each earn a higher return on invested capital than the airline companies that keep them in business.

BTC members do not want the airlines to take control of their inventory because it is sure to weaken the powerful grip the GDS and OTA have over the industry today.  Ask yourself, would you really want to be in business if you did not have near complete control over your inventory?  I think not.   Do GDS and OTA know your customers better than you do?  I think not.  In short, a commodity is a product that has a low degree of differentiation.  Over the past decade, the product offered by the network carriers and the low cost carriers have converged to where there is little to no differentiation because schedule and price are the only differentiators.  This must change if the industry is truly committed to achieving a structure where it earns at least it cost of capital.

Loyalty has increasing value to air travel consumers today, in part because elite members of frequent flyer programs typically aren’t charged the ancillary fees other passengers pay.  Base fares will be disciplined by competition whether American is successful in its attempt to rewrite distribution rules or not.  This industry always adapts.  Travel agents continue to exist today even after the industry stopped paying domestic commissions in 2002 – assuming they evolved and adapted to find replacement revenue streams. 

One can make a case that the GDS have been every bit as destructive a tool as constructive.  Any system that promotes adding inefficient capacity should be changed.  They served their purpose when market share was king.  They serve significantly less purpose in an industry increasingly focused on its bottom line.  Short term this may be about saving some portion of a booking fee.  More important is the long term notion that an airline that takes control of its inventory creates value for its customers based on the knowledge the airline has of its customer.  To say the customer loses out is a tired refrain coming from the same "Chicken Littles" that "Cry Wolf" every time the industry tries to institute systemic change. 

Let the restructuring continue.