The distribution drain

In the ever-widening search for cost reductions, distribution is a key area. Airlines have traditionally paid high fees to GDS companies, but now they are looking to cut these while exploring cheaper alternative.

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By  Neil Denslow Published  March 27, 2005

|~||~||~|Faced by record oil prices and increasing competition, airlines around the world are looking to cut costs wherever they can. Distribution is a key area of focus, as it represents a major expense that is much more under the direct control of airlines than other big outgoings like fuel and labour costs. As such, the airlines have already put plans in place to throw out paper tickets and they are increasingly squeezing travel agents commission. One of the largest targets remains though; namely the fees paid to the global distribution systems (GDSs). While airlines may dream of a world without GDSs and more particularly the commission they have to pay, the reality is that there will always be a need for GDSs in some form or another. Carriers will always need support in marketing their tickets and getting them to the consumers, especially outside of their home market, and a GDS provides the cheapest and quickest of way to do this. “The GDS distribution channel continues to offer airlines the most cost effective way to reach the greatest possible number of customers,” comments Stuart Nassos, vice president of strategic marketing & sales, EMEA, Sabre Travel Network. For consumers and travel agents, meanwhile, GDSs are the only way to compare different fares from different airlines or to plan a journey that involves more than one carrier. “The real purpose of a GDS is to aggregate information from many different sources and then present a coherent offer to the travel agent or end user,” explains Ian Tunnacliffe, vice president, Meta Group. Yet, while there may always be a need for an intermediary between the airline and the consumer, this does not mean that the present situation is unchangeable, particularly the fees that airlines pay to GDS. At present, the GDSs charge around US $4 per segment, and this has become a key point of contention between GDSs and carriers, who are looking to cut costs wherever they can. “Distribution is a big ticket item for airlines,” comments Tariq Sultan, vice president, IT, Gulf Air. GDSs are particularly important within the Middle East because of the low usage of the internet, which means that airlines here are much more reliant on travel agents than carriers operating elsewhere in the world. For instance, Southwest Airlines, which is one of the leading carriers worldwide for online sales, derives around 60% of its revenue from its own website. JetBlue achieves even an even higher figure - 75%. By comparison, most of the carriers in this region are yet to even implement an internet booking engine (IBE), and those that do have one report low uptake. Gulf Air, for instance, says that less than 2% of its tickets are sold via its website. “We are not happy with the volumes,” admits Sultan. Gulf Air is aiming to improve its online offering in a number of ways, including updating its Sabre IBE. Other airlines in the region are also looking to begin to make use of IBEs with AACO leading a project to help carriers without a system in place implement one. “The public is ready to make use of online travel, but it needs to be made available [to them] by the airlines,” says Mouna Moussi, head of industry affairs, Arab Air Carriers Organisation (AACO). Yet, the experience of Gulf Air and internet travel portals in the region suggests that Middle East travellers may not be that enamoured with the idea of making their travel arrangements online. With the major global travel portals, such as Expedia and Travelocity, not having entered the local market so far, the main player in the region is MyTravelChannel (mTC). The portal is owned by the Emirates Group, but despite this support, mTC is yet to make a significant impact on the local travel scene. The company has signed a number of deals with local internet portals, such as maktoob.com, Albawaba and Albaha, for instance, to boost its online presence and it has also introduced a range of services to allow customers to pay for their ticket offline to overcome widespread reluctance about using credit cards online. However, while the site increased the number of airline bookings it recorded last year by over 300%, their total value was only around $300,000. “Online purchasing above $100 in this part of the world is still an emerging market,” admits Simon Lewis, general manger, mTC. This local reluctance to engage in online shopping extends beyond the travel industry into all areas of online shopping. Madar Research, for instance, estimates that the total value of B2C transactions in the GCC, excluding online brokerage, was just $797 million, with online hotel and airline bookings accounting for $270 million. Online transactions are predicted to grow at a rate of more than 20% per annum through to 2008, however.||**|||~||~||~|AACO also hopes that once more local airlines begin to offer tickets online then their combined marketing clout will help to drive up online sales. “With more airlines implementing IBEs — and there will be more in the future — then the public will become more aware of them, because the airlines will advertise them,” says Moussi. The low level of sales achieved online in the Middle East clearly raises the cost of distribution for carriers here, as they have to pay commission to both GDSs and travel agents. However, it does also protect their yields to some extent, as local travellers are much less able to shop around for the best price offline. “Online travel shopping in the region is low, which results in less comparison shopping,” notes Nassos. “The flag carriers are also typically still dominant in the region, so there is greater price control than in other parts of the world,” he adds. Attempts to ‘bypass GDSs’ and sell directly via the internet also overlooks the fact that carriers accounting for around half of the total number of passengers worldwide use a GDS as the booking engine on their web. However, even when looking at GDSs in just the traditional role of serving travel agents, trying to bypass them overlooks the additional revenue that a GDS can generate for a carrier. This is a key consideration, which has lead to some airlines, such as Virgin Express, deciding to uses GDSs when they had originally planned to just distribute via their own website. “There is a correlation that says that the channels with the lowest distribution costs also have the lowest yields,” adds Tunnacliffe. “So, if you are losing a few percentage points on your average yield, then all of the savings you have made in reducing your distribution costs can be lost.” Attempts to use the airline’s own website for distribution can also generate additional indirect costs, which also need to be factored in. “The cost of selling a ticket online is not just the cost of the CRS, the cost of hosting the website and the on-going maintenance of the website, airlines also have to attribute the cost of marketing the site as well,” notes Lewis. While attempts to utilise the internet for distribution have had little impact in the region so far, local carriers have been able to benefit from new GDS pricing arrangements that were driven by airlines elsewhere in the world. Legacy carriers in the US and Europe faced by the threat of low cost competition, and armed with the option of using the internet for distribution, have been able to wring concessions out of the GDSs. This is particularly true in the US, where deregulation means that carriers can negotiate different deals with the GDSs. (Previously, the GDSs had to offer the same terms to all carriers, both large and small.) The GDSs responded to these moves by cutting their fees. Sabre, quickly followed by Worldspan and Galileo, led the way in 2003 with three year long direct connect agreements (DCA3s). The GDS agreed to cut its fees by 10-15% in return for access to all of the airlines’ fares, including those otherwise only available via the internet. These deals are soon to run out and exactly what will replace them is unclear. However, it seems certain that the fees will continue to fall. “These [DCA3s] are just the first step,” says Tunnacliffe. “What I think we are going to see is the average GDS booking fees coming down. Over a period of time, I think they are going to come down quite substantially from where they are now,” he predicts. One possible model is that adopted by Amadeus in 2004, which did not follow the other three GDSs in offering DCA3s. Instead, it launched what it described as value-based pricing, whereby the airlines were charged different fees depending on where the ticket was sold. The main difference is that tickets bought outside of the carrier’s main markets are charged at a higher rate than those sold elsewhere. “The feedback we have received from the airlines and the travel industry in general, is that they appreciate our new way of thinking,” says Sari Vahakoski, director, markets, Central, Eastern & Southern Europe & MEA, Amadeus. “Where we add value, they are willing to pay more, and where we do not add value, they pay less.” AACO, which leads joint GDS purchasing agreements for most carriers in the region, is aiming to make the most of this new situation by re-assessing its arrangements. At present, the airline organisation has two GDS deals in place, with the carriers split between Galileo and Amadeus. However, it is now set to hire a consultant to work on potential new deals based on the new possibilities offered by the increasing deregulation. “There could be many ways and avenues for the future especially with the regulation of the CRS code of conduct, the prospects of each of the GDSs and the differences in their future IT strategies [see box],” notes Moussi. Any new arrangement would clearly aim to cut distribution costs, but Moussi adds that this is not the sole criterion. “One part of our work is that there is an added value in terms of cost reduction,” she says. “However, at the same time, we are not just talking about a two year contract, but something for the future. The strategy is therefore very important, as is how to plan to for it…. You might pay less in the short term, but more in the future, if you do not make the right decision now,” she adds. ||**||

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