American’s GDS Gamble

American AirlinesCollectively, the airline industry is posting record profits in 2010, but at least one major player thinks it can do better.  Its contracts with a number of key distribution partners coming due, American Airlines chose December 2010 to start a now heated battle with back-end global distribution systems (GDS) and consumer-facing online travel agencies (OTAs) that could decide the future economics of selling airfare online.  Compete used its proprietary panel to assess some of the risks American faces as it works to create a direct connection with its third-party vendors.

Cutting Out the Middleman

American Airlines global distribution systemsAmerican has pushed “Direct Connect” as a pro-consumer enhancement, but there are clear financial motives to circumventing the intermediaries.  Most airlines load fare information onto the GDS systems, which the OTAs use as a one-stop-shop for providing flight options to customers.  When an OTA sells an airline ticket, the carrier pays the OTA a fee, roughly $5, for the sale. They also pay the supporting GDS approximately $9.  The GDS then gives the OTA nearly half of their cut as a sales incentive.   All told, of the revenue earned on a flight sold via an OTA, a carrier like American could end up sharing upwards of $14 of it.

AA’s logically named alternative, “Direct Connect”, eliminates the GDS from the transaction by having vendors source American rates straight from the airline. Their reward? The $9 previously paid to the GDS stays in their pockets as pure profit. But poised to lose roughly half of their current revenue on each ticket sale, and facing increased distribution complexity (imagine a “direct-connect” model for every airline partner) and cost, it’s not hard to see why the OTAs have been less than enthusiastic about this proposed break from the status quo.

The Opposition Organizes

For American Airlines, adoption of the new distribution model was non-negotiable, and when the time came to renew distribution contracts with Orbitz, “Direct Connect” was the only option on the table. And when Orbitz, a flight-centric OTA with a great deal to lose from a disruption, failed to capitulate, AA called their bluff and pulled all inventory from the site.

Expedia must have sensed they would be next. So, rather than let AA work its way through the OTAs one at a time, it joined ranks with Orbitz, voluntarily pulling American flights from their site and forcing American to feel the effects of simultaneously losing two of its largest third-party vendors. Next, Sabre (a major GDS and parent company of Travelocity) has threatened to take the fight offline by pulling American flights from its search results, which would reduce AA’s presence in thousands of brick-and-mortar travel agencies, as well.

At this point, both sides are standing firm, both leaving money on the table. But in predicting how the current stalemate is resolved, the question begs asking: who needs who more, American or the OTAs?

Any unified action by the airlines could spell disaster for third-party vendors, which attract a majority of their shopper base via the flight path. Short of Delta’s exit from a few long-tail websites, however, that has not yet materialized, and AA’s competitors have thus far chosen to watch carefully from the sidelines (and potentially capitalize on a larger share of Expedia and Orbitz flight bookings).

In the meantime, American’s brand loyalty is clearly being put to the test. Will consumers know enough, or care enough, to find their way to AA.com as the airline’s product becomes increasingly difficult to find? Will AA bookings on Expedia and Orbitz migrate to other suppliers on the same site, or will these shoppers actively seek out American Airlines in channels where they remain available?

The Hidden Role of an OTA

Largely overlooked in the coverage of this standoff is a secondary role OTAs play in the flight shopping routine of today’s internet consumer. That is the role of a search aggregator; picture a shopper conducting a search on Expedia or Orbitz to compare prices, then booking the reservation direct at the website of the most competitive airline. If this practice is common, the repercussions of the AA/OTA breakup would be felt not in the lower margin, third party bookings, but in the lucrative direct bookings that these recent actions were intending to nurture. And, data collected from Compete’s consumer panel suggests that it might be significantly more common than American would have hoped.

American Airlines booked flights onlineConsider, prior to the fallout, just how frequently AA.com and the OTA sites in question were visited in conjunction with one another. In September 2010, one of every four shoppers on AA.com also visited the flight path on Expedia.com that month. Cross-shop with Orbitz was also impressive, and taken together, one third of American Airlines website shoppers also visited Expedia and/or Orbitz flight content that month.

What’s more, those who visit the OTAs are some of American’s most desirable shoppers.  During September, approximately 41% of flight bookers on AA.com also viewed flight content on at least one of the two now “off-limits” OTAs that month. That means that AA.com shoppers who also visited Expedia or Orbitz were significantly more likely to book on AA.com than an average site shopper.

It’s true that consumers have a rapidly increasing number of choices if they are looking to price shop flights, and American is actively directing consumers toward alternatives – most notably Kayak. But current consumer activity would need to change dramatically for meta-search engine sites to make up for all of the visibility lost through Expedia and Orbitz. In November, more than 70% of Expedia and Orbitz flight shoppers did not visit Kayak, meaning American has effectively locked themselves out from an audience of several million domestic consumers.

The Southwest Model

It’s also very true that airlines do not necessarily need the OTAs, for visibility or distribution, to survive. One need only look at the perennially profitable Southwest Airlines, which has had only sporadic and limited involvement in the GDS establishment since its inception, for proof. But Southwest’s success American Airlines Southwest shopped brand booked flightis not an accident – the airline has invested heavily in both time and money to prevent the commoditization of its product that internet transparency has otherwise facilitated. And in return, they have been rewarded with consumer loyalty that no other U.S.-based carrier can match.

Consider: of shoppers that visited Southwest.com in November and ultimately booked a flight anywhere, nearly 2/3 booked with Southwest.  Equally impressive, most Southwest customers don’t even consider alternative brands; for 56% of Southwest’s flight bookers in November, Southwest.com was the only airline website they visited that month. Contrast with American, which captured just 36% of total flight bookings made by its shoppers, and saw less than 1/3 of its bookers display single-site loyalty. Growing these loyalty metrics would likely be crucial to developing a client base committed to the American brand even when it doesn’t show up at the top of the Orbitz Matrix search results.

The Consumer Decides

American Airlines created the GDS roughly 50 years ago, and in doing so, reshaped the framework of travel distribution. It seems only fitting that they now take the lead in trying to destroy it. But it will be the consumer, voting with their clicks, who decides where the damage will be inflicted. Compete will be measuring the fallout from this zero-sum game by looking for redistribution in the following key metrics moving forward:

  • Can American compensate for lost OTA bookings with increases in visits to and bookings on AA.com?
  • Will other airlines see increases in referrals from Expedia and Orbitz by nature of a greater share of voice in those channels?
  • Will incomplete search results cause Expedia and Orbitz to lose relevancy to the consumer, causing shifts in visitation to sites outside the fray (Kayak, Priceline)?
    • And will cross-shop between www.AA.com and its remaining partners increase accordingly?
  • Will booker numbers on Expedia and Orbitz drop, or will other airlines simply grab a larger share of bookings on those sites?