Airlines complain about the high cost of distribution through travel intermediaries but what are the real issues. Former airline executive, revenue optimisation consultant and EyeforTravel guest columnist Tom Bacon goes in search of the truth.

Before getting started let me say this: reducing the cost of intermediaries, although real, is not the only objective of the airlines when they work to achieve more direct distribution.  Improved customer engagement (return business, customer relationship management, special offers) and additional ancillary revenue - which is increasingly important for airlines - are arguably as important as cost reduction.  However, the cost of intermediaries certainly adds to the legacy carrier cost disadvantage.

Counting the costs

The cost of distribution through intermediaries is high and many of the customers acquired are lower fare, price sensitive customers.

Southwest, Spirit, and allegiant all have an advantage in distribution costs relative to United, Delta, American, and USAirways.

For the year-ending second quarter 2012, as reported in industry filings, majors’ reservation or distribution costs as a percentage of passenger revenue ranged from 6.5% to 8%.  By comparison, Southwest reported 4.5% - a huge advantage in an industry that is challenged to make any money at all. 

For domestic business, the cost of distribution through online travel agencies (OTA’s) is double-digit – probably 12% or more for many carriers.  The cost includes global distribution system (GDS) fees and OTA commissions.  Distribution through one’s own airline website, by comparison, is probably closer to 5%, or less than half that of OTA’s.

The distribution cost of a ticket through traditional ‘bricks and mortar’ travel agencies is comparable to OTA’s, except that the average fare for traditional agencies reflects a high proportion of business travellers.  So, distribution through agencies typically costs less than 10% of the ticket value.

Metasearch (companies like Kayak and Hipmunk) offer search capabilities like OTA’s but refer customers to airline websites for booking, thus avoiding the higher GDS cost or OTA commission.  The distribution cost of metasearch is, however, still somewhat higher than direct bookings.

Despite the various distribution-related initiatives of the legacy carriers over the past few years, they still rely heavily on intermediaries for distribution. Around 50% or more of their passengers book through OTA’s or traditional agencies.  Moving from 50% direct to 90% direct bookings (more like Southwest) could reduce distribution costs from over 8% of passenger revenue to 5%; this is consistent with the cost comparison to Southwest cited above.   Again, this cost saving would come with greater customer engagement and the potential for increased ancillary revenue – highly compelling for airlines.

An important role

Having said all that, OTA’s play an important role in reaching customers who are not inclined to go directly to the airline websites for their travel needs.

Although airlines complain about how difficult it is for them to differentiate themselves on OTA’s that focus on price and schedule only, some travellers clearly love the service they provide.

For customers to go to the airline website instead of using OTA’s requires new advertising or promotion – somewhat of an offset to any distribution cost savings.  For the year-ended second quarter 2012, Southwest, for example, spent over twice what some of the legacy carriers spent in advertising as a percentage of passenger revenue.  In fact, the legacies typically spend less than 1% of passenger revenue on advertising – dramatically lower than many other B2C businesses.

Moreover, OTA’s offer a competitive distribution channel for underserved markets or new markets.  Advertising is simply not an economical alternative for airlines in many markets.

Corporate affairs

Airlines have not replaced the agencies role in booking corporate travel. Many airlines rely disproportionately on business travel for revenue and corporations still rely heavily on traditional travel agents to manage their global travel requirements.

American Airlines famously has pushed for traditional travel agents to implement new technology that would allow American to avoid some of the GDS fees.  This initiative triggered legal action between American Airlines and SABRE, which ended in a compromise agreement last month.

The ‘billboard effect’

Some customers research their options on online travel agencies but book their travel on the airline website.  In this case, the airline receives the benefit of participating in the OTA but avoids much of the cost.  If the billboard effect is 1:2 (half of the OTA users end up booking direct) then the cost premium for OTA’s is halved.  In fact, rather than eliminate OTA’s, airlines’ objectives may be met by increasing the billboard effect.  With many ancillary services only available on the airline websites, customers may increasingly do basic fare and schedule research on OTA’s but go to the airline website for booking.

Looking forward

Most large airlines that covet Southwest’s lower distribution costs don’t want to give up the benefits of OTA’s or traditional travel agents nor do they want to dramatically increase advertising spend.  Spirit Airlines advises that ‘tweaking’ channels will not fundamentally change airline distribution costs but that is the most likely course of action for the major carriers.  It will take a multi-faceted plan with clear objectives to change customer behavior. 

Airlines will sensibly continue to push for change and will continue to experiment with distribution alternatives. But a dramatic shift is unlikely in the medium term given the caution with which they are addressing this challenge.  If some majors can increase direct penetration by 5-10 % points (from 50% to 55-60%) that would constitute impressive results over the next two to three years.

Tom Bacon is a former airline executive and industry consultant in revenue optimisation.  He produces a regular monthly column for EyeforTravel.com. He can be contacted at tom.bacon@yahoo.com