American Airlines takes on GDS charges with a new distribution model – and intermediaries fight back

All legacy airlines have been struggling to cut costs wherever possible. And, as they do so, the relative size of GDS expenses inevitably grows. But try as the airlines may, there seemed to be no relief from the segment charges that they pay.

The challenge in reducing GDS costs is complex; their pervasive role means that any cost reduction achieved may easily be outweighed by a larger revenue loss, as business dries up.

American's Direct Connect program - allowing free access to those who go directly to AA.com to search and book - is trying to accomplish what Wall Street has been after for some time, reducing those distribution costs. Direct Connect would not only reduce distribution costs but turn distribution into a revenue generator. At the very least, American is trying to force a new distribution business model on the industry and consumers, in favour of AA.com.

American has been discussing Direct Connect with the industry since last year, but has otherwise not commented. In its response to CAPA, American's Director Marketing and Communications Strategy Stephen Schlachter said the company was not ready to talk about the program yet.

What are the savings with Direct Connect?

Still, this leaves many questions, such as how much the airline is expecting to save in distribution costs with Direct Connect; how much does it expect to raise in revenue from the pay wall; and why this is happening now? Perhaps most importantly, what will its response be to critics such as Business Travel Coalition (BTC) and American Society of Travel Agents (ASTA).

Despite the lack of detail, the discussions have already prompted so much concern from TMCs, OTAs and GDSs that the BTC and ASTA were barraged by complaints late last year that what American wants to do would "flip the distribution system economic model" on its head - from one in which the airline pays GDSs and OTAs to include its content, to one in which major distribution systems pay American for access to its unbundling, merchandising and selling activities, according to BTC's "Dear Colleague" letter currently being circulated. The letter already has 100 signatories.

American's move is just the latest signal in a battle that American CEO Gerard Arpey illustrated a year ago, envisioning a day when sales intermediaries would pay American for access to that product. That is now exactly what the airline proposes.

But not everyone is convinced

"At the airline firm level, this probably seems very rational to (American)," said Business Travel Coalition (BTC) Chair Kevin Mitchell, who is leading a fight to stop Direct Connect. "It generates more revenue while lowering and shifting costs. But it also throws so much complexity and burdens the industry with so many new costs, it is irrational at the industry level. The airlines just don't get it. They want to eliminate the middle man but corporations have a very efficient and time-tested way of doing business and this will undermine that."

What makes this confrontation so interesting is that many low-cost carriers - in an effort to access the higher-yield business traveler - have meanwhile been converting to GDSs, so they can gain access to the corporate travel management market. Corporate travel managers want the ease of one-stop shopping; they also want to be able to track spending and employees worldwide. All of that would unravel with American's plan, according to BTC.

Which, of course, begs the question as to why American would put itself at such a competitive disadvantage by bucking a well-oiled system. Observers suggest rolling out Direct Connect would only serve to drive corporate travel managers away from American and into the laps of its competitors. Indeed, said Mitchell, that is exactly what happened the last time American tilted at GDSs by withholding content. Competitors used sales forces to fan out across the nation to poach American's TMC-partners and corporate customers. The upshot? American pulled back its initiative.

But the times may be changing - or not. Do GDSs still wield their old power?

In 2008, GDSs processed USD98.7 billion in travel agency and OTA bookings, according to a background paper provided by BTC to the industry. "Each GDS handled about USD65 million price and availability requests per day," the paper said. "Faced with ubiquitous access to unbiased comparative travel information, complete price transparency, unlimited channel choice and very low search costs, consumers are able to make optimal travel decisions. This in turn fosters inter-brand competition among the airlines and produces the best services at the best prices for consumers, while also enabling the airlines to reach tens of millions of consumers in a cost-effective manner."

The information coming out of the BTC and the American Society of Travel Agents (ASTA), has prompted a letter to airline CEOs - including American - to sign on to maintaining current procurement practices and processes and ensuring full transparency of all fares, taxes and ancillary fees in the booking process.

Even so, the pressure on airlines (and GDSs) to cut costs is immense. Airline analysts are using their razor-like focus on costs to suggest cost-savings initiatives across the board. During financial conference calls last year, analysts specifically targeted the costs associated with GDSs and OTAs.

A cost reduction here means an increase elsewhere

BTC's Mitchell says the move, if adopted industry wide as GDS contracts run out, would take the industry back before the days of the computer reservations systems (CRSs) when travel agents had to call individual airlines to get fares and book a ticket. What is known is that integrating information and transactional capability through a Direct Connect program will force large data system restructuring costs on intermediaries.

"If a corporate travel buyer had to deal with six or seven airlines and their individual closed system, you will have to create work-arounds and that will mean a lot of investment in new technology," Mitchell told CAPA, noting the role of the TMC is not just to book but to get all the data, do all the auditing and all the employee tracking worldwide. "And these buyers don't just deal with the six or seven domestic carriers, they are dealing with airlines around the world. They work with a third of all the world's airlines. It will layer in at the industry level a lot of complexity and costs. A TMC is not going to be able to afford to purchase the content through a GDS without passing that cost on to their customer. That will increase travel costs. There are also huge consumer implications which means they will invariably pay higher fares if the content is not available for them to search, get all the information they need and make an informed buying decision.

"At a more strategic level airlines' cost for GDS services is about 2.5% of each ticket on average," Mitchell continued. "If you look at the higher-priced business travel, that percentage falls under 1% because the ticket value is so high. What the airlines get for those percentages is unbelievable because this is the way corporations want their travel programs managed and they want access through GDSs, TMCs and OTAs."

As an example of the value of the going through GDSs and OTAs, JetBlue said in 2009 before switching reservations systems to Sabre earlier this year, that participation equaled a USD39 million quarterly premium just by having access to the higher yield corporate marketplace. In addition, although Air Canada openly wants a way around GDSs and TMCs and is well known for withholding content, last month one of its marketing executives said that in a perfect world they wouldn't want to work with distribution systems but they are what corporate buyers want - and participation wins loyalty.

In its position paper on the subject, BTC said the consumer benefits of an open system, "unequaled in any other line of commerce, are now threatened. The American plan could restrict consumer access to large segments of key travel information; reduce transparency and force higher prices; restrict channel choice; force higher search costs; decrease productivity within the distribution system and raise costs through high distribution system investment which would ultimately be borne by the airline consumer."

The principal concern for GDSs, TMCs and OTAs is laying out the substantial costs of new technology that would be required for American's proposed model change and then passing it along to its client - the traveler. But, American would say they could avoid the fee by using AA.com. However, distributors would counter by saying Direct Connect doesn't allow the cost comparison needed to serve their clients.

Loss of transparency could be another downside

The next concern is thus the potential for losing the transparency for consumers, already having trouble with the new landscape surrounding ancillary fees.

"The sale of ancillary services is earning billions in incremental revenue for the airlines, but the process by which information about them is accessed and through which they are paid has often been opaque and inefficient, or worse," according to the BTC's position paper. "Corporations that manage their travel under policies governing thousands of travelers are extremely concerned about the subornation of their management controls if employees are buying travel in one place and ancillary services elsewhere. Some airlines are not creating any mechanism for timely direct communication with travel intermediaries in a manner that can easily be consumed and displayed in the shopping and booking process, of the constantly changing fees for services such as checked bags. In addition to the lack of information, the technical means for the 'pre-sale' of ancillary services at the time of booking in many cases do not exist for intermediaries", according to the BTC paper. An example of the types of services claimed to be suited for the direct connect platform is the offer of a discount to a corporate account, bundled with negotiated ancillary benefits, such as free checked bags and/or preferred seat assignments or assured access to seats in a roomier part of the cabin. American claims this so-called 'advanced functionality' can only be obtained through a direct connection.

"Direct Connect would disadvantage consumers," the paper continued. "For example, some airlines today offer, by email, up-sell opportunities after the initial booking and again when they check-in online the day before flight. A passenger will receive an email offer to upgrade to a roomier section of the plane, without change of fare class. Other ancillary services may be offered, such as discounted checked bag fees, at the time of online check-in within 24 hours of flight time. How the airlines will parcel out these opportunities to customers and agents is unlikely to be channel neutral under a Direct Connect program. In other words, consumers using a travel agency, including an on-line agency, may not receive the same information or opportunities as those consumers using the airline's own website. Travelers who prefer to buy through an intermediary channel are therefore deprived of the opportunity to get online discounts offered for pre-registration of checked bags."

But airlines argue the GDSs lack ancillary functionality.

The real issue is the inability of GDSs to provide functionality to accomplish these tasks, argue the airlines, according to the position paper, which noted that ancillary revenues functionality have forced GDSs to evolve. And, they may be right. At a recent Computerised Airline Sales and Marketing Association (CASMA) meeting, it was suggested that GDSs won't be able to delivery functionality to support ancillary revenues for at least a year.

But BTC's position paper disputes this. "The contention that offerings can only be had through Direct Connect is wrong," it said. "GDS systems are already providing a platform for key airline merchandising initiatives (e.g., pre-paid seats) and have been using XML programming language connectivity for years. Moreover, forward thinking members of the aviation community and associated intermediaries are hard at work on the development of internationally accepted technical solutions to enable the same ubiquity for ancillary services as exists for basic fares and flight information. But one airline is not cooperating."

And ancillaries promise a new battleground.

Those fees are already drawing the attention of the most activist Department of Transportation in memory. It recently slapped US Airways with a USD40,000 fine for violating rules that require airline price advertisements to disclose the full price consumers must pay for air transportation.

In addition, legislators are watching ancillary fees closely to ensure consumers have access to the complete fare (including all ancillary and other fees and taxes) before they book. They also want to know whether the shift to ancillary fees is diluting Aviation Trust Fund revenues - which come from a percentage of the ticket price. The suggestion has already been made for the government to tax such fees and the General Accountability Office is now studying the issue with a report expected out in July. The issues raised by BTC and ASTA will only add to the interest of a department that has been very active in ensuring a level playing field when it comes to booking engines.

In addition, there is a more strategic issue, says BTC's position paper. Once airlines shift the cost of distribution onto the backs of the travel agents then there is no incentive to use the system more efficiently. "Today, airlines have a disincentive to make very frequent schedule changes because each time they do, they generate a cancel and a rebook in the GDS. Both of these result in an added charge to the airline as each transaction drives added data processing costs in the GDS - as well as added costs for the travel agency who must notify the client," said BTC.

"If GDS participation is free to the airline, why would airlines not engage in more schedule change churn to 'maximize' fleet utilization? More globally, an airline that knows a corporation pays the GDS bill will have no disincentive to demand added functionality the carrier may want from the GDS - like more ability to merchandise and sell unbundled products to corporations, like pre-reserved or special seating for a fee, often in an ad hoc non-standardised way, because for the airline, 'price is no object.'"

Disturbing the status quo is never easy - or risk free

Once again, American is pushing the envelope. It can only conceive of doing so because of its market size - and the possibility that the majors may follow suit. But even then, the course is hardly free from risk.

There are massive financial and resource issues at stake here - not to mention potential regulatory hurdles.

In this industry, the only constant is change. American has frequently been at the vanguard of that evolution. But a move of this nature would probably be seen not as evolutionary. Revolutionary is more the direction.

It remains to be seen, however, whether or not it can unilaterally change the industry distribution systems.