American battles for ownership of customer

In November, American notified OTA Orbitz as its contract ran out on 01-Dec-2010, it was withdrawing its content - fares and schedules. It did so on 23-Dec-2010, but said the move had little impact on its bookings. It should be noted that Orbitz is owned by Travelport which unsuccessfully tried to block American's move. In retaliation, OTA Expedia began biasing American flights downward on its search screens in advance of pulling them completely when its contract ran out on 31-Dec-2010.

See related report: Sabre, Expedia drop American Airlines

This was followed by a pre-emptive offensive strike by Global Distribution System (GDS) Sabre is a completely different game since Sabre accounts for about 32% of revenues compared to the 35% generated by American itself.

American's cool in dealing with the Orbitz/Expedia actions quickly changed, taking Sabre to court for violating its contract (still effective through September) and increasing distribution costs by USD157 million. Sabre accounted for about USD7 billion of American's USD18.9 billion in total revenues earned between Dec-2009 and Nov-2010.

Airlines pay GDSs booking fees per sale and before 05-Jan-2011, Sabre charged American USD2.73 on the average domestic point of sale. On 06-Jan-2011 that went up to USD7.31 for each domestic point of sale and on 04-Feb-2011 was set to increase to USD7.36 for each international point of sale.

GDS Dec '09 Nov '10	AA Revs affected area	% Total	AA Revs unaffected areas	% Total
Sabre	USD6.2B	32.5%	USD320M	1.7%
Expedia	USD1B	5.4%
Travelport	USD341M	1.8%	USD2.051B	10.8%
Orbitz	USD592B	3.1%
Amadeus			USD1.230B	6.5%
AA.com+*			USD6.781B	35%
Indirect sources			USD446.M	2.4%
Total USD18.9B

Affected areas = those subject to GDS/OTA action
AA.com + includes website, phone and airport locations
Source: Testimony of AA Director Distribution Strategy Cory Garner in court filing asking for relief from Sabre action

Sabre biasing American is very serious as can be seen by the impact on just two routes which drove its rankings down.

Route	AA ranking domestic displays affected areas	AA ranking European displays
ORD-DFW	3rd screen, 4th position Rank 16	1st screen, 1st position
NYC-LAX	8th screen, 4th position Rank 46	1st screen, 1st position

Source: Testimony of AA Director Distribution Strategy Cory Garner in court filing asking for relief from Sabre action

Fallout

One might think that Sabre's action, compounded by the previous Expedia and Orbitz moves would see American backing down. But American is not backing down for good reason. It is banking that, in the long term, it will benefit while, in the short term, impact will be minimal.

With the complete evolution of the airline industry in the past decade, airlines have twisted themselves inside out to reduce costs. The last frontier in that effort is distribution costs. Coupled with the inability of GDSs to evolve fast enough to accommodate the airlines' new business model, something had to give.

Analysts have been pushing airlines to tackle distribution costs and it fell to American to challenge the system, because its contracts ended sooner than those at United and Delta which run through 2012/2013. Less than a year ago, analysts asked American Chair and CEO Gerard Arpey about reducing distribution costs and Arpey's grand vision was revealed.

"I can see a day, and maybe I'm dreaming here, where those folks who are the intermediary between us and our customer have to pay for access to our product rather than us paying them to distribute our product," he said.

Before the Sabre action, Stifel Nicolaus Analyst Hunter Keay suggested that the actual fallout will not be known for at least a couple of months. He doubted the scuffle will have any meaningful impact on American given the small percentage of revenue coming from Orbitz.

Barclays Capital agrees. "The dispute between AMR and Orbitz has escalated beyond our expectations with broader retaliation against AMR than we initially envisioned," said the company. "There are few historical analogies for this situation, but examples of distribution shifts for [JetBlue] and [Southwest] suggest the impact on relative revenue generation will be manageable, especially in light of the injunction against Sabre...We see material upside potential in AMR, fundamentally and from an equity perspective, and it remains our top pick, though this dispute may have some near-term impact given more substantial and abrupt changes to its distribution platforms than AMR likely expected several weeks ago...The upside potential justifies the near-term risk."

"The airlines are simply tired of paying the whole cost of distribution while others in the distribution chain make a much higher return on capital and equity than they do," Former AMR Chair Robert Crandall told CAPA. "I hope all the airlines follow AA's example, in which case the airlines will clearly win."

And that is probably as it should be. The airline industry has clearly morphed into new cost-efficient persona and so, too, must their distribution method if it is to be compatible with the industry's combined austerity and revenue enhancement moves.

In a nutshell, American just wants to do what other retailers take for granted - market directly to the consumer with customized offerings to individual travelers - but the current GDS distribution model does not allow it nor does it share the valuable consumer data that allow retailers to tailor their pitches. In addition to cutting costs, American also wants to capture millions in ancillary revenues that now go to the OTA or GDS.

While it is unclear the impact of the GDS/OTA, Orbitz-Expedia-Sabre triple whammy will have on the airline, American reported that the Obitz/Expedia actions yielded upticks in AA.com bookings as well as bookings on Priceline, Travelocity and Kayak.com.

American's strategic moves to counter the loss of Orbitz and Expedia kept its bookings up. Indeed, it is using the savings in booking fees to fund such efforts. Critics, however, said the heavy discounting of 15-20% masked the true impact, charging American was buying traffic. Even so, American had to do something to increase the visibility of the distribution change and its discounts are really just an investment in maintaining market share.

The upside

American, which is striving for nothing less than a completely new paradigm in travel distribution, has two of the three major GDSs -- Sabre, Travelport -- against it, along with a host of other travel associations, travel management companies and travel agents. Amadeus, the third GDS, is now actively following the debate to ensure that its contracts with the airline are not abrogated. American's contracts with Travelport and Amadeus expire this year as well.

American, according to Senior Vice President Government Affairs Will Ris, is doing nothing less than challenging one of the largest [oligopolies] in the travel business. Indeed, if it could break that, American's competitors will be scrambling all over themselves to follow American's lead.

"Why should it be mandatory for us to provide content without compensation," he asked. "The airlines have done a great job at cutting costs but distribution is one area where we've had the most difficulty in controlling our costs."

This fight is only a continuation of a battle that has raged since the 1990s when airlines cut out brick-and-mortar travel agents by dropping commissions

Regardless, the outcome is likely to create a 21st Century distribution system that, American hopes, will benefit everyone, not just distribution systems and travel agents. Airlines want to move their services from being a commodity to a product that distinguishes one carrier from another.

Changes to the current distribution model are inevitable and is expected to continue as new players - Google, with its proposed acquisition of ITA Software - enter the fray and redefine how consumers search for and buy travel products. ITA Software is at the heart of how GDSs do their job, creating another threat to the three giants.

Critics would have us believe that this is all about the consumer, suggesting American's moves are putting the consumer at a disadvantage by the one-stop-shopping, cost-comparison model developed by airlines and now copied across other retailers. They also suggest that Direct Connect, adopted by several airlines, not just American, is a GDS bypass.

Not true. Yes, it is about consumers. It is about who gets to own the consumer shopping experience - GDSs or the airlines themselves through Direct Connect. As for it being a GDS bypass, airlines disagree, saying the fight is over the commercial terms - who pays who and how much. Airlines actually want to continue working with GDSs.

"All member airlines have communicated to GDS providers that they would consider selling optional products and services through indirect distribution channels under the right commercial terms," said the Open AXIS Group, which is the single alliance supporting American. Delta has dipped its toe into the raging waters by cancelling contracts with several very small OTAs.

"It is the responsibility of the GDS network to ensure that an airline, from which they derive a majority of their revenue, has the ability to market and sell its own product the way the airline wants to, without being forced into a display that ultimately commoditizes the airline's optional products and services," said the group, noting GDSs have been unwilling to invest in the changes necessary for the new airline environment. "Although this method of display is easiest on the GDS, this current GDS-centric model inhibits airline product choice, lessens the airline brand, and ultimately limits the consumer's ability to make his or her own choice. What needs to change is the distribution method, which requires a technology and commercial capability, The Open AXIS Group distribution standard is inclusive to all distribution channels, either direct to an agency or via the GDS network."

"The airlines constitute, collectively, a transportation system in which each is dependent, to some considerable extent, on the presence of the other participants," Mr Crandall told CAPA. "No one airline or group of airlines can take a traveler everywhere and the product is expensive enough that consumers will insist on having the ability to check price and service options. Cross-retailer, price-check apps are now turning up everywhere, and if the airlines abandon the GDS model, some other service and price-check alternative will appear."

And therein lies the real issue. GDSs have to adapt to the new airline environment or the market will replace them and it may be coming sooner rather than later depending on whether Google is allowed to acquire ITA Software. Already consumers can find American in a host of internet locations as meta-search engines such as Kayak.com point them in the right direction and Southwest and JetBlue have been successful without third-party distribution systems.

GDSs and OTAs are on the wrong end of this argument. Pushing for the status quo, ignores the fact the industry has already changed and there will be new competitors on the distribution scene in the not too distant future. It would also stifle the innovation that a 21st century marketplace demands. Ironically, their refusal to change is only making GDSs and OTAs less relevant.