With the revelations from American Airlines’ earnings call as well as lawsuits, especially that filed against Sabre by US Airways on 21-Apr-2011, it may only be a matter of time before the great distribution battle is settled once and for all in the airlines’ favour. After all, the deals that have been cut by US Airways and American favour the direct connect strategy. Even so, those deals have largely between between the airlines and online travel agencies. The big test is now between airlines and global distribution systems. US Airways' move will only accelerate the industry-wide battle, with potentially wide-ranging repercussions. Although the conflict has so far been contained in the US, its principles will be watched closely by industry and regulators alike all around the world. The key issue is whether the airline industry can evolve from a mode of transportation to a retail business.
US Airways filed suit against Sabre in New York's Southern District Court on Thursday 21-Apr-2011, charging it with being anti-competitive and engaging in anti-consumer behaviour. The carrier sought "to halt (Sabre Holdings') anticompetitive and anticonsumer practices, as well as recover monetary damages".The suit is all the more interesting given the fact that US Airways and Sabre only recently reached a new agreement in Feb-2011. But US Airways alleged that it was forced into the deal. The carrier relies on Sabre for over 35% of its income and said, although it had "sought a new contract without exclusionary restrictions that protect Sabre from competition", it "was forced to acquiesce to Sabre's 'my way or the highway' demands as a part of any new deal".
American Airlines already has a suit pending against Sabre for many of the same reasons cited by US Airways, but has suspended litigation while the two negotiate. That suspension expires on 1-Jun-2011. While US Airways has so far only chosen to tilt at the biggest GDS windmill, Sabre, American has also taken on Travelport and Orbitz for anti-consumer and anti-competitive behaviour. US Airways has not made clear why it did not also sue Travelport/Orbitz.
So far, Amadeus remains the only GDS that has not been sued by US airlines. But, explained Farelogix President Jim Davidson, Amadeus’s small market share - less than 10% - would make monopoly charges hard to prove in that jurisdiction - “although, I think some interesting eyebrows are being raised in Europe where it enjoys market conditions similar to Sabre, Travelport and Orbitz here,” he said.
See related story: American lobs new shot across Orbitz' bow
Commoditisation vs merchandising and raising revenues is the bridgehead for American
The importance of the distribution fight cannot be understated, given the comments by AMR Chair Gerard Arpey last week that revealed plans for an entirely new airline model. He said, for example that “we put a lot of focus in terms of managing costs and that is an important consideration but the real leverage comes from being more aggressive and gaining control of our ability to merchandise."
Most executives have been touting a new focus on managing the down cycle and return on invested capital goals of 10-15% over the business cycle or the focus on cost containment and capacity control. Observers had assumed that these initiatives would carry businesses through to their new goals because margins were, indeed rising.
Meanwhile, on the sidelines, American has been developing the airline of the future and waging its battle against monopoly distribution systems on its own.Even American’s toughest critics, such as JP Morgan Analyst Jamie Baker, missed the point even as he was asking American why it was not being as innovative as it has in the past.
The point is, according to Mr Arpey, this fight is not about lowering costs - it is about raising revenue.
“American has taken a beating for this but the ones who push it first get to define the rule as it evolves,” said Farelogix's Mr Davidson. “I give Arpey a lot of credit for that. Those who are critical of any airline looking at this as a revenue strategy rather than as cost savings are being short sighted. What Arpey can’t control is fuel, it is locked into labor, but by challenging GDSs they are looking at a Golden Goose. They are saying I can’t do what I do on my web site though this channel where our corporate buyers are. What I’m being told by GDSs is that they will get to these changes sometime and then it will be a catalogue, which only means a continuing race to the bottom as everyone matches. The worst thing airlines do is limit how they display their product and not to understand who is shopping. It is what consumers are nowadays.”
Ancillaries to be a key part of the retail revival
Ancillaries will make fuel hedging look like child’s play, said Mr Davidson. He told CAPA that we are looking at the beginning of a trend in which ancillary revenues will account for as much as 35-40% of revenues, even for legacy carriers. Without breaking the shackles of GDSs some airlines will not survive as US Airways so vividly pointed out in its filing against Sabre.
It has been thought that such percentages were relegated to the likes of ultra-low-cost carriers such as Spirit or Ryanair or for niche carriers such as Allegiant, but Mr Arpey’s vision is far wider than that and casts an entirely new light on the embattled chief executive and his under-performing airline.
“I got off that earnings call yesterday and said to myself, ‘oh my God! The airline just went retail’,” said Mr Davidson, who was surprised, despite the fact that his company is involved in the development of the direct connect strategy. “To me, that is exactly what is happening. Airline ancillary services will be the next hedge because I do think it is starting to look at retail and bundling and unbundling and targeting. They are looking at distribution on their own web site and finding they are not there yet. They are further along on those sites but that still leaves 50-60% of the business in the dark ages where they don’t know who is buying or how to make offers. Arpey got a look at retail and wants a way to test initiatives in the market to see if they work and, if not, pull it back. It takes months to make changes in GDSs now and I can’t imagine them testing anything. They fell asleep at the switch.”
He also said that the consumer is also expecting to be courted for their business to be offered special deals, for websites to know who is buying and to tailor the product to the individual. “You have to look at the margins on some of these products,” said Mr Davidson. “What is the margin on WiFi versus the margin on a seat. The mentality should be a distribution strategy that is retail versus looking at distribution as cost reduction. The retail strategy on airline.com continues to grow and American was a pioneer in that. Even so, the industry is falling farther behind because the most important channel is for the corporate traveler where prices have already been negotiated. These are high-yield people an airline wants to create a special relationships with and who want to be given a package that defines what they want in their travel experience. Consumers want them to know who they are and how important they are so, for this trip to happen on one preferred airline versus another, that shopping experience needs to happen up front. They are asking what the airline has put together from the airline store for them and that is very important.
"Amazon doesn’t tell suppliers how to distribute their products. They just want to sell the product. They want to make it as easy as possible for the suppliers to sell that product. Everyone says that travel is different, more complex. In fact it is not,” argues Mr Davidson.
As a "provider of distribution technology and services for the travel industry" Mr Davidson's company, Farelogix has vested interests in the market, but is also well positioned to sense the wider implications of the current confrontation.
Evolving from a transportation mode to a retail business
That means that the multi-billion dollars ancillary revenue stream enjoyed by the US industry is only the tip of the iceberg. It also means the evolution of the industry from a mode of transportation to a major retailer is now in the balance of these law suits.
“This is a big deal,” said Mr Davidson of the fact that US Airways is now joining the battle. “This is a matter of three big distribution companies -- Sabre, Travelport and Orbitz not listening to the people who are paying the bills. These law suits are now shining a light on GDS practices and, once they break the shackles, airlines are going to take off like we’ve never seen before. This is going to force more transparency and that is ironic given the DOT initiatives and the GDS-sponsored groups who have made transparency a drumbeat. With this we see the underbelly of an GDS industry that cannot say they want transparency here but not over there. Transparency will change the industry and we’er seeing that today.”
He alleges the GDS industry has earned billions of dollars from airlines but failed to invest in developing a system airlines as retailers can use. “Merchandising is going to define what an airline looks like into the future and define how to create the relationship, the loyalty and customer experience,” he continued. “Otherwise they are just a metal tube with a certain number of seats. Sure they can now do something with those seats but if they know who is asking, they might sell an upgrade one day for USD120 and on another for USD30, when the passenger is at the airport kiosk, because they are then dealing with a perishable product. That is why this is so exciting.”
Mr Davidson could not speak to how long it will take GDSs to catch technology up to the needs of the industry but, if nothing else, the industry attacks will stimulate a much greater urgency for them to respond effectively
The pressure is now on the GDS to respond to airline technology needs
“I think we’ll see you’ll see the (competing) technology swoop in,” said Mr Davidson. "That doesn’t mean that GDSs won’t adjust and make the required investment. They’ve just felt they didn’t need to and through their market power they could force people into a process that is consistent with what they have place. This will force more innovation which is good. This will force everyone to be more competitive and there won’t be so many contractual limitations so there will be more innovations and opportunities.”
When asked whether the other airlines may be smelling blood in the water to the point they’ll file their own suits, he said he hoped not. “I hope there are enough folks within the GDSs and the airlines and the consumer advocates that will avoid that,” he said. “The DOJ and the DOT have been looking at this a long time and the good news is this is bringing it to a head. They’ll develop new rules to play by that will mean a more open market, more transparency - and they’ll let the market and innovation drive it rather than an old business model that has been in place for a very long time. Obviously, there are enough people challenging the value of GDSs, saying they pay too high a price for not getting what they want in a distribution system. When those models get rattled you see new entrants quickly and you’ll see business models opening up. It will be a little bit of both in this case.”
US Airways suit, like American's, also seeks monetary damages. A win will encourage others
Filed in the Southern District of New York, the US Airways suit not only seeks a halt to Sabre’s monopolistic practices but the recovery of monetary damages as well, similar to what American is seeking from Sabre’s two GDS counterparts. The addition of US Airways into American’s lone battle to turn ticket distribution on its head, changes the landscape but the court battle is still to be won. However, US Airways pointed out that, historically, both the Department of Justice’s Antitrust Division and the Department of Transportation have recognised that Sabre exercises significant market power over airlines.
The next question is when Delta and United would join the fray, since they have as much to gain if American wins. Delta CEO Richard Anderson has quantified the costs to his carrier at USD300 million annually. Industry-wide, according to consultant Robert Mann, distribution costs amount to a “USD1 billion bogey.” But that might be an underestimate, since American Airlines alone has quantified its costs in the USD1 billion range.
It was very clear during Thursday’s United earnings call that CEO Jeff Smizek also sees more ancillaries on the horizon for the carriers. When asked if ancillaries are now mature, with few new products expected, he said absolutely not, despite the technologies issues for GDSs and OTAs.
“You will see us doing considerably more targeted offers,” he told analysts. “You’ll see customer relations management continue to dis-aggregate the product but also re-aggregations of the product based on the passengers history. We’ve developed a lot of sophistication at United that will help improve revenues. What has changed is our ability to merchandise better than what United has been historically able to do. Today it is much more sophisticated at the web site, the airport and even on board. These will be profitable products for us not withstanding the loyalty benefits which are quite profound.”
Chief Revenue Officer Jim Compton chimed in, indicating that is actually what customers are demanding. “We are hearing from customers they want to build their travel experience and that results in many more opportunities,” he said. “What we are seeing, based on the products, is that travel is an experience people want to participate in.”
That does not include the lost revenues from not being able to merchandise their products effectively, given the roadblocks erected by GDSs. Indeed, American said yesterday that merchandising will be the key to raising enough revenue to achieve ROIC goals.
US Airways says GDSs should have invested more, instead of using "monopoly power" to increase profits
In its complaint, US Airways echoed American’s oft-stated problems with the current GDSs. They have not evolved to accommodate modern airline marketing. They were developed and priced when technology was much more expensive and have not stayed current or lowered costs as technology and communications costs have dropped.
US Airways President Scott Kirby called Sabre’s costs artificially inflated. GDSs have yet to go through the industry restructuring the airlines have endured over the last decade. Indeed, it is that restructuring, or lack of it, that makes this fight so critical for both sides.
"The airline industry and other technology services providers have become more efficient,” said Mr Kirby. “Yet Sabre's conduct has enabled it to charge inflated prices with outdated technology that was developed before the Internet existed. Lower-cost, more technologically-advanced alternatives and innovative fare products are being shut out by Sabre's actions.”
The carrier went on to quantify the harm Sabre’s “monopoly power” allegedly does. It increases “pricing for airlines and travellers, stunts the growth of more cost-effective and technologically-advanced alternatives, and reduces choice by obstructing or delaying the distribution of innovative fare products,” it said in its complaint.
US Airways cited as an example its offer of more favourable web-only and other discounted promotional fares through several distribution channels, each of which was available before Sabre began enforcing full-content agreements.
"Forced to accept Sabre's monopolistic practices"
The lawsuit comes of the heels of a new Sabre/US Airways agreement in Feb-2011 and offers a glimpse into Sabre’s alleged strong-arm tactics - which US Airways said would kill the airline if it didn’t agree.
“During negotiations with Sabre, US Airways made it clear that it sought a new contract without exclusionary restrictions that protect Sabre from competition,” said US Airways. “However, Sabre threatened to shut off access to US Airways if the new agreement did not include these anti-competitive restrictions. US Airways was forced to acquiesce to Sabre's ‘my-way-or-the-highway’ demands as a part of any new deal.”
Over 35% of US Airways' revenue is booked through Sabre and its affiliated travel agents. As the largest GDS in the US market, Sabre structures the distribution model so that travel agents rely on a single GDS, allegedly imposing significant economic penalties on travel agents for non-Sabre bookings, according to the airline.
“If Sabre excluded US Airways from its offerings to its travel agents, those agents could no longer book US Airways tickets through Sabre,” said the company. “US Airways would not be able to survive the subsequent loss of revenue. Given this disproportionate market control, US Airways is forced to accept Sabre's monopolistic practices.”
Airlines argue technology would evolve faster with more competition - but no-one is there yet
US Airways’ ability to market its product through its web site are precluded under Sabre's full-content requirement, which the airline says robs the market of discounted fares. Indeed, Sabre also allegedly threatened to block the company’s Choice Seats programme from being offered through other channels, despite the fact the GDS did not have the technological capability to offer the new product.
“Sabre’s limitations have delayed the introduction of products such as Choice Seats,” said the airline.
US Airways recently agreed with Online Travel Agent Expedia to offer Choice Seats but the OTA suffers from much the same technological limitations and thus even that is taking time to roll out, as Expedia gets its technological act together. American’s recent deal with Expedia suffers from the same problem and CEO Gerard Arpey would only say “stay tuned” when asked for a timetable for when Expedia can begin marketing American’s customised products.
"US Airways wants to be able to widely distribute its products and services to consumers in a cost-effective and efficient way, but Sabre continues to erect roadblocks to this goal,” said Mr Kirby. “US Airways and travellers would see enormous benefits if Sabre had to compete on a level playing field."
Sabre, said the airline, as a dominant distributor, “has engaged in a pattern of exclusionary conduct to shut out competition, protect its monopoly pricing power, and maintain its technologically-obsolete business model.”
The carrier charges that Sabre's market power is wielded through exclusionary commitments from travel agents and other GDSs, as well as through anti-competitive requirements imposed on airlines in order to sell their tickets, resulting in higher fares, fewer choices and reduced innovation.
US Airways went on to allege that Sabre prevents travel agents from using direct-connect technology for bookings. It also cited the barrier to entry for new distribution channels because of the incentives Sabre pays to travel agents from the revenues it collects from airlines, meaning that airlines are effectively paying for Sabre to compete against their own websites.
“In order to receive the highest financial incentive, Sabre effectively forces Sabre travel agents to work with Sabre, which prevents the travel agents from working more closely and collaboratively with other distribution alternatives,” said US Airways. “Sabre has further ingrained itself in other aspects of travel agencies, such as fulfillment and billing functions, which creates further barriers for the growth of better, more cost-effective distribution alternatives.”
Government intervention is unlikely, where it might risk loss of transparency
While the lawsuits make their way through the legal processes, the government is highly unlikely to intervene in the airline/GDS battle, despite Mr Davidson’s hopes. There is an opportunity, given the Department of Transportation’s upcoming rule-making regarding transparency for all fees at the point of sale. But with the DOT’s populist leanings, it is doubtful that the complexity of the issues will lend itself to quick soundbites so favoured by Secretary Ray LaHood.
And, when it comes to consumer interests, the airlines themselves are not necessarily best positioned to judge the best course. The current system does have the great consumer value of ensuring transparency in pricing, something that the internet has entrenched.
The issue for consumers is primarily (but not uniquely) finding out the bottom line costs - with all the fees for bags or other ancillary offerings - before they get to the point where they click to purchase, according to Consumer Travel Alliance Director Charles Leocha, who is urging the DOT to act swiftly on the proposed rulemaking.
“I just don't want this lack of transparency to drag on for another year and a half,” he told CAPA, bringing up the next big issue: “Google is entering the arena with all of these ancillary fees and that will only serve to make price comparisons more difficult and drive consumers to the airlines because they are the only ones selling the extra services.”
if he’s right, that won’t help increase the competition for distribution services.
Resolving a highly complex issue against a moving background
Perhaps the biggest problem with the present confrontation is not only that its ingredients are immensely complex but it is occurring against a moving background, where technology and other potential new entrants are almost certainly going to shift the paradigm - regardless of the outcome of these airline moves.
Mr Davidson suggests much will be solved with the segmentation of the market. “ You have to look consumer, leisure, infrequent traveller, whose only sensitivity is price differences,” he said. “The airlines see that and they will have a product for that market. The corporate market is different. It is not about shopping but effective execution on the travel experience. It’s about authenticated shopping where someone who signs in wants to be known for their importance - just as the airlines want to know who is shopping. Those are two different channels, two different products. The problem today is the market is now one size fits all.”
Even this is not consensual though, The airlines argue that price sensitive consumers are also missing out on lower fares because of the way tickets are sold through distribution channels, not because they aren’t available in this era of rising fares.
For the airlines, the holy grail is for distribution channels actually to pay airlines to display their content, Achieving that has to be a long odds bet. But if the airlines could at least gain greater control over the distribution of their various products they will have achieved much of what they want.
The bottom line: confrontation remains the likely course
In the battle to restore merchandising to the airlines' armoury, consumer interests must remain paramount. If regulators are reluctant to intervene in the dispute for fear of disturbing or reducing existing transparency levels, it will all need to be fought out in the courts. In that case, where the airlines are relying on the GDS' market dominance for their credibility in the legal actions, they will be sensitive to the possibility of undermining the industry case by adopting a common position. The airlines too have substantial clout, so must be seen to be acting independently.
That said, if American and US Airways can succeed in their claim for monetary damages - or much more likely achieve out of court settlements - others will inevitably join in. The bottom line is that, with such massive revenues at stake on each side (and other competitors sitting on the sidelines) there is a stern priority to seek accommodation. It is still too early to predict if that will be possible. Indeed, as things stand, confrontation looks to be the order of the day.