GDS vs Airline show down
DECEMBER 29, 2005
News Analysis
By Timothy J. Mullaney
The Airlines' $5 Billion Showdown
A battle is looming between carriers and the companies that help them sell tickets, which may make cheap seats harder to find
Ever since the September 11 terrorist attacks nearly destroyed the U.S. airline industry, major carriers have struggled to get back to profitability. Labor costs have fallen, but fuel prices have whacked airlines anew. As AMR's (AMR ) American Airlines and Continental Airlines (CAL ) move toward the black and United, Northwest, and Delta are in bankruptcy court, carriers hope 2006 will be the year they can attack one of their most persistently high costs -- the price of the technology they use to process tickets.
The new year promises a $5 billion showdown between airlines and the companies that process reservations. Known as global distribution service (GDS) companies, they include Sabre Holdings (TSG ), Cendant's (CD ) Galileo unit, and privately held Worldspan. These outfits charge airlines $12 to $13 per round-trip to crunch fare schedules and let travel agents connect with airline reservation systems to make bookings.
GDS costs are 2.5% of some airlines' revenue -- about $160 million a year for Continental and $500 million a year for American. "It's in the top five costs," says David Cush, American vice-president for distribution. "Fuel is No. 1, then labor, then airplane ownership, and then distribution."
THREE-WAY SHOOTOUT. But major airlines' contracts with the GDS companies will run out by midyear -- and airlines want to cut their GDS costs by 50%. To get big rate cuts, they're threatening to walk away from some GDS companies completely -- or to withhold information on their best fares or schedules if others won't slash their fees.
Since GDS companies pay travel agencies like Expedia and American Express (AXP) for their business, a prolonged fight could force the agencies to hike their charges to replace revenue in order to ensure they can continue offering consumers the lowest available fares. "It's going to be a three-way shootout between the airlines, the GDS [companies], and the online travel agents," Forrester Research analyst Henry Harteveldt says.
So consumers can expect a more difficult hunt for cheap fares, whether bought directly from an airline or through an agency that uses an airline-preferred GDS. And they can also expect higher service fees from travel agents, who have to make up the revenue they expect to lose when airlines cut GDS payments. "The cost of providing our services isn't going to go down," says Jack O'Neill, chief operating officer of Carlson Wagonlit Travel.
CHEAPER ALTERNATIVES. Airlines say much has changed since the last round of deals in 2003. Back then, airlines got 10% to 15% price cuts but allowed every GDS to show every available seat. In 2004, the government deregulated the GDS business, and in so doing gave airlines more flexibility to share special fares with their favorite partners.
Meanwhile, technology has slashed the cost of alternatives. If a customer books a ticket directly on the airline's site and not that of a travel agent, the transaction can cost the carrier as little as $3. Startups ITA Software and G2 Switchworks have also invented low-cost GDS substitutes that let agents process reservations for $3 or less by using open-source software and skipping extra services GDS companies offer.
Meanwhile, the major airlines are still feeling the heat from low-cost carriers such as JetBlue Airways (JBLU ) and Southwest Airlines (LUV). JetBlue bypasses GDS companies and travel agents entirely in favor of selling more cheaply through its Web site and by phone. Southwest offers some seats through Sabre at a special discounted rate, but it sells most tickets directly, thus avoiding GDS fees.
SMALL FRY BURNED. One of the carriers' major beefs is that GDS companies charge the same rate regardless of ticket price. "I don't have any problem paying $12 to sell a $1,000 ticket -- it's the $79 ticket [that's a problem]," says Dave Slater, managing director of e-commerce for Continental.
If war breaks out, the most vulnerable businesses would be smaller GDS outfits like Worldspan, which doesn't own a big online travel agency. Sam Gilliland, CEO of Sabre, which owns Travelocity, is protecting earnings by swapping GDS rate cuts for exclusive deals on Travelocity, usually discounts included with a vacation package. Worldspan Chief Commercial Officer Ninan Chacko says the company "fully expects to work with all the [major] carriers going forward."
One possible model for a truce is Sabre's October deal with AirTran Holdings (AAI). Sabre cut GDS fees, and AirTran gave Travelocity discounted package tickets -- and stopped selling through Worldspan. Under this agreement, Sabre actually makes more from AirTran than before, both companies say, though a source near the talks says AirTran pays Sabre just $5.50 per round-trip. "It's because of increased volume and the limited participation of other GDS [companies]," AirTran VP Kevin Healy says.
ANCIENT HISTORY. Big online travel agencies could get hurt, too. American's Cush says Expedia, which didn't respond to requests for comment for this story, is relatively safe because it generates too much business for airlines to spurn. But analysts have worried that GDS cuts will hurt Expedia's earnings, as well as Sabre's, since Sabre and Worldspan share fees with Expedia. Worldspan also splits fees with client Priceline.com (PCLN ). "People aren't very optimistic about renewals," Standard & Poor's Web analyst Scott Kessler says.
It's unclear whether stirring up this turmoil will help airlines much in the long run. In 2002, carriers tried to steer business to a seller that charged them lower fees by giving Orbitz special "Web fares." Industry analysts believe the experiment ended up costing airlines more than they saved in fees, when angry customers refused to pay more than the Web fare. Expedia soon demanded and received equivalent Web fares anyway.
Airlines say most consumers already shop multiple sites to find low fares and won't get angry as cheap seats get trickier to find. But S&P airline analyst Jim Corridore says carriers are "in survival mode, maybe not thinking about the long-term implications of what they do."
UNWRAPPED PACKAGES. For sure, shoppers should change their habits. Since airlines are most willing to give a GDS very cheap tickets if they're included in packages where the consumer isn't told exactly what the ticket costs, sharp shoppers should look to large travel agencies, Travelocity President Michelle Peluso says.
But travelers who just want a ticket and aren't interested in a whole vacation package will do well to avoid the big agencies. Instead, they can use travel search engines such as SideStep, Kayak, or Yahoo! Travel that scour both agency and airline sites. The airline sites have deals travel agencies don't -- and consumers who buy direct from an airline site don't have to pay the booking fees the agencies collect, which start at $5.
The changes to come have already roiled stocks of airlines, GDS companies, and travel agencies, though Sabre has rallied since it released a bullish 2006 forecast in mid-December. But this wouldn't be the post-9/11 travel industry without a little turbulence.
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