25 April 2011
Is It All Really JUST About The Money? Airlines & GDSs To Duke It Out In Court
Sabre and Travelport - both private companies - have become the target of 2 lawsuits alleging Anti Trust behavior by AMR's American Airlines unit and US Airways. American Airlines is suing Travelport and its affiliate public company Orbitz (OWW). US Airways is suing Sabre. Both suits are similar in nature. At stake is the very nature of airline distribution in not just the USA but around the world. This analysis will hopefully provide the context of the battle. Sabre is controlled by 2 players - TPG and Silverlake Partners. Travelport is largely controlled by Blackstone.
It seems to have been a really busy time in airline distribution lately. We have had many things going on – so perhaps we should consider what is driving some of the changes going on. For many who are in the business – this battle has been a long time coming. However for the rest of the world and many others – this has caused a strong degree of head scratching. Consider this a primer on the core issue of control.
Let's just look at some of the major issues that have surfaces since October. This was the month when AA's battle with Orbitz burst into the open. Soon to be joined by Travelport, Expedia, and Sabre. Just looking at the last few weeks - I don't think we have seen such activity in a long time. Here is a list of some of the news stories over the past few weeks that have seemed to be disconnected. Here is a partial list:
• Expedia settled its battle with AA and committed to a Direct Connect – in doing so Expedia abandoned the GDS only model and agreed to go the direct connect route as well as signing its first LCC for Direct Connect – Air Asia in a far reaching Joint Venture.
• Delta Airlines signs with Farelogix to create alternative distribution services for the nation’s second largest carrier making a clean sweep of all the major North American carriers are now signed up to participate with the Farelogix platform. AC, UA, CO, AA, DL, US. Delta also makes the 13th Airline to have publicly committed to the system.
• The FAA Re-authorization bill passed without the GDS provisions that were defeated 3 times during the passage of the bill.
• The DoT issued new passenger regulations but in issuing this new "Passenger Bill of Rights" it declined to force (for the short term at least) provisions which would have made the airlines display ancillary services via the GDS.
• AA filed suit against Travelport and its affiliate company Orbitz Worldwide (owned 48% by Travelport) alleging anti trust behavior.
• US Airways filed suit against Sabre also alleging anti trust behavior.
• The DoJ after a lengthy evaluation approved the Google/ITA deal – the deal has now closed.
Are these unrelated? I don’t think so. But let me just focus on the 2 lawsuits.
For a minute let's just consider what is driving their thought processes. I am taking this from the perspective of the parties who filed the suits. We have not yet seen the defense other than both parties (Sabre and Travelport) has said they will vigorously defend their position. I have opined before that in my view Travelport’s statements lack some substance and so far have contained some factual inaccuracies but since they have not filed a formal brief – this can be construed as PR spin. . Don’t forget GDSs and Airlines can hire some pretty serious legal firepower. This battle is not new. Don’t think for a minute that the Airlines have not just woken up yesterday and said - "we're bored, let's go after the GDSs". This battle was clearly a very long time coming.
Both lawsuits (AA vs Travelport/OWW and US vs Sabre) are very explicit in what they want and the respective positions. While they appear to be similar - each airline comes from a very different space. The AA lawsuit is somewhat of a pre-position. The US suit is backward facing for the contract it already signed.
The AA lawsuit actually names Sabre several times in its suit against Travelport. AA has made its sentiments known that it feels the GDS model needs to change. Possibly after 9/11 and perhaps we can trace the lineage of the battle to the very moment that Sabre was spun out and AMR (AA's parent) put the resulting cash in its pocket. US Airways however is not quite in the same position. They are the smallest of the big airlines (Now comprising just 5 in the USA). They never owned a GDS. This makes them the least able to apply leverage in the ongoing battles. They also have effectively put themselves up for sale by delivering a message that consolidation is not yet over and that US Airways is ready to be merged into another airline - AA according to analysts - perhaps being the favorite. One could even opine that US is trying to ingratiate itself with AA. I make this point because I believe US Airways thus is not arguing from any position of strength. Ultimately in terms of scale we have to remember that the market share of each of the major American GDSs exceeds that of any airline in the USA market.
The driving forces for the lawsuits are that the airlines believe they asked nicely (well as nicely as an airline can) that the GDS behave differently. IE that the GDSs change their model. The GDSs refused both publicly and privately to budge. Indeed they went on to consider any change should be viewed as a nasty attack on their core business model, for which a vigorous defense needed to be mounted. Were the airlines napping on the job? Perhaps yes they were for a while. They thought they had a deal with the GDSs.
in 2006 the airlines and the GDSs entered into a form of social contract. The background at that time was that the GDSs were scared that the Airlines would provide content on their own websites that could not be seen on the GDSs. Thus moving both the trade as well as the consumer to more favourable content on the airlines own sites. The genesis of the Full Content Agreements was that the Airlines would give the GDSs full content in exchange for reduced fees. (I want to avoid using the term discounts which is how the GDSs saw this). This social contract worked pretty well because essentially all the major legacy carriers signed up for it.
In airline distribution - the traditional basis of the distribution landscape is one for all and all for one. Or as I prefer to characterize it as "one size fits everything." However the GDSs lawyers might have been smarter than the airlines' lawyers. Why? Because the GDSs managed to put in a number of provisions that created a far stricter contractual environment. So the issue of full content tied with a number of other provisions gave the GDSs a distinct edge. At the same time the GDSs started down a path of increased tighter contract provisions with their user community; the travel agents - the subscribers. In doing so they created a Gordian Knot. The airlines were trapped. The subscribers were trapped. The analogy - admittedly somewhat extreme - but humour me here I think you will find the comparison is not that odorous - it could be likened to a drug cartel (aka the GDSs) were able to control distribution.
But let’s not shed too many tears for the airlines. In the early part of the millennium the airlines ceased to provide compensation in the form of standardized sales commissions to the agencies. Thus the agency players and the airlines ceased to have a compensated relationship. They still however retained a contracted relationship either directly or via ARC. The corporate customers of the agencies allowed the water to flow downhill by paying the increased freight of an access fee for use of the agencies' services. Thus these agencies - TMCs - were able to transfer from a supplier paid fee model to a consumer paid fee model - a transition that went remarkably well. Even the leisure agents tried this for a while but this fell apart when Priceline refused to join the fee based model. In recent years the other OTAs - largest players such as Expedia and its fellows abandoned the fee model for leisure bookings. Sadly the independent small agents were not so lucky and this effort drove many of them out of business. From a peak in the mid 1990s to today the number of agency locations has collapsed from 55,000 to now below 20,00 outlets.
Thus there is dissonance in that the travel agents are in many cases not directly compensated for selling airlines product. This somewhat advantaged position works for the airlines because they regard their product as being valuable and that the consumer and their channels should pay to access the product. This conveniently forgets that the agents actually do add value in aggregating content for the creation of neutral offers to their consumers a core value proposition for the consumer.
The GDSs too started playing a number of games. Firstly they had created an artificial MSRP pricing structure and backed it up with the charade of saying they were providing large discounts to the airlines. How much of a charade? Even after allowing for the cut rate prices -Amadeus's margin in 2010 as provided by their annual reports show a margin of 48% on its GDS business alone. The other publicly available information for Travelport shows that its margins declined from a peak of 33% in mid 2009 to the current level of 28%. (Does Amadeus know something that Travelport doesn’t?) We can safely assume that Sabre is in the same ballpark. The average segment fee (net revenue) for each company was as follows:
Travelport – rose from $3.47 in Q1 2007 to $5.83 in Q4 2010.
For Amadeus we only have data from 2009 which shows the revenue per segment rose from (Q1 2009) $3.28 to just under $5. ($4.97 in Q4 2010) when converted from Euros to Dollars.
So despite the social contract between the GDSs and the airlines the actual cost to the airlines rose significantly during this time. NOTE I am using publicly available information and you can find this out for yourself on the websites of Travelport and Amadeus.
Indeed one could argue that the social contract was flawed to begin with but the GDSs (now fully controlled by the money guys in the form of Private Equity/Venture Capitalists) had obligations to increase their margins. How did they do that? They cut costs by slashing payrolls, cutting pure R&D and by changing their agreements.
In the case of Travelport there were significant synergies gained by the merging of the Worldspan and the Galileo businesses. However Travelport was upfront and said it would not bite the big one and merge its (now 3) GDSs into a single code base. In my analysis all the GDSs gained incremental net revenue through two techniques. Through unbundling their core segment fees, long before the airlines became effective at unbundling – the GDSs were doing this and made good money from it. But they also changed the contracts to further tie the airlines. At the other end they were able to generally reduce the cost of the subscriber delivery through cutting back on services. But the one area that they could not cut was in the segment incentive fees (aka as US Airways describes them “Kickbacks”). The competition for smaller pie – i.e. the reduced agent community – meant that the GDSs had to pay ever increasing incentives to the agencies to ensure a reliable user base. What happens is simply the GDSs take a portion of the fee that the airlines pay and kick back this portion to the travel agents.
To examine this - have a look at Travelport's 2007 and 2010 end of year financials.
Cost of revenue.....................................$1,167
Selling, general and administrative......$1,286
Separation and restructuring charges.......$90
Cost of revenue.....................................$1,164
Selling, general and administrative...........$547
I think you get my point. During this time Travelport's segment count fell from 416.2 Million to 349.4 Million segments (all 2007 vs all 2010).
Rumours abound of the amounts paid not just to get agents to switch but also just to stay in place. These payments are so large in more than one market the asking price for a GDS segment incentive is $4.00. To cover this cost the GDSs must be indeed cross subsidizing the bigger agents (i.e. those with market power) from two places firstly the weaker and smaller agents who tend to be brick and mortar; secondly from those markets where they don’t have to provide incentives due to their market power – which today are very few.
In addition to the core issues above – the airlines feel that the GDSs have not kept up the investment in two key areas. Functionality to support the sale of ancillary and unbundled products (seats, bags credit card charges etc). The other charge is that the GDSs have actually inhibited the ability of the airlines to sell personalized services via the intermediary channels. For whatever reason - the GDSs do not provide these services today except in very few cases.
The core of the arguments that the airlines feel harmed is not just based on cost. But ultimately it is based on the argument of who controls distribution. So these lawsuits are about breaking the Gordian Knot.
Want to read some more?… actually you could have largely done a cut and paste of the law suits by going to a not quite so obscure website and downloading the Airlines comments on the US DoT NPRM concerning the Passengers Protection. Last week the US DoT turned this into law. Curiously only after two events. Event 1 - the Dept of Justice had approved the Google Acquisition of ITA Software. Event 2 – the FAA bill was approved by the US Congress. Coincidence?
The final rule making is here: DOT-OST-2010-0140
For AA’s comments on this rule making go here:
For US’s comments go here:
So now you know – where you sit in the debate should at the very least be powered by the information to hand.
I recommend that you go through the other submissions on the dockets. There is a lot of material in there. Then sit back and think – are these events connected? Yes. Is my answer. However the airlines feel emboldened by the changes coming. What we are seeing is nothing short of a fundamental shift in Airline distribution.
Catch the wave. Open Distribution is with us.