Tip of the Ice Berg

Article Published in Business Travel Executive, August 1998

As bulk purchasing gains momentum,
travel managers will have new choices to make...

The New York Times reported June 26 that "American Express' planned bulk purchase of airline seats on Virgin Atlantic Airways from Continental Airlines may be the credit card company's first in a series of deals." The article goes on to estimate that American Express "...obtained a estimated 25-30% discount ... [and] it will sell the tickets to its corporate customers as refundable, unrestricted tickets." An American Express spokesperson further suggested that AMEX will make other similar purchases.

In the article, Carlson Wagonlit's President Travis Tanner "... expressed skepticism at bulk airline seat purchases."

Tanner's skepticism notwithstanding, the economic drivers of the cost of capital, and related recovery risk -- relative to the ever expanding seat capacity and rapid growth of point-to-point airline services -- is FORCING airlines to shift some of their respective airplane's investment recovery risk to third party business entities.

Whether it's...

(a) companies launching or owning airlines like SAS Software/Midway Airlines or Kimberly Clark/Midwest Express

(b) or companies guaranteeing lift in market segments like the ProAir guaranteed purchase agreements with General Motors and Ford

(c) or travel entities taking risk via bulk purchase guarantees as in the AMEX and Virgin/Continental deal or the growing number of corporate direct agreements like Siemen's-Nixdorf/Lufthansa

... we're seeing only the "tip of the ice berg" of what is to come in the distribution of airline seats.

While cost containment, for both airline and corporate/agency buyers, has been a major facet in each of the examples above, it remains distribution of the seats that is the controlling factor. This economic reality is changing the structure of air travel -- and with it, the very core of the way air travel product is distributed.

In his book "Managing the Unknowable", Ralph Stacy describes how companies seek improved efficiencies through economies of scale by eliminating the inefficient or fringe functions. It is this very dynamic that is creating the evolution of direct distribution ... as airlines and corporations seek to control the inefficiencies of intermediary third party distribution channels.

But Stacy also notes in "...Unknowable" that it is the fringe processes where new solutions evolve ... the new solutions that eventually supplement or replace the traditional, formerly efficient, processes. Over the past few years, the fringe deals in air travel product have been direct purchase agreements with large corporations.

Direct purchases were largely enabled by e-tickets ... as the author suggested would happen in his essay "Ticketless Travel" in 1995. Ticketless technology, a fringe concept in 1995, has evolved to enable new, alternative distribution solutions. Beginning in the third quarter of 1998, one of the most traditional icons of the industry, ARC, will offer off-line electronic direct settlement to airlines.

Going forward, drivers for expansion of this new distribution solution, not recognized in the recent airline era of "good times", will be...

1. Cost constraints brought about by the growing point-to-point availability of lower cost new efficient small jets' seats that are entering the market, and ...

2. The ignored pending trickle-down impact of the Asian economic crisis.

Both factors will impact the airline industry first. The expanding capacity will drive greater risk distribution by airlines to cover airplane capital costs. Electronic commerce solutions will evolve concurrently to minimize the cost of control over the new distributed risk solutions.

Judgement Calls

From a corporate travel managers perspective, it is important to recognize that the 1960's driven architectures of today's CRSs are too inflexible to deal with almost any evolution of the new distribution model one can envision. These systems will remain good airline seat inventory solutions -- will be functionally unable to respond to the new distribution models. As such, the CRSs, and the roles of travel agencies, must change. CRSs, in particular, that are not now in the process of changing the core of their basic distribution architectures, the services they provide agencies and corporate clients, and/or the way they charge for those services -- are at great risk.

It is probable that the CRSs will become the "critical path" of constraint in the immediate future of airline seat distribution. With most CRSs unable to rapidly respond in their core architecture, corporate travel managers will find it necessary to identify the fringe solutions that offer the greatest efficiencies. These are likely to be specific to the business needs of each respective corporation.

What we see today in the examples above is limited "testing" of a few new risk sharing and distribution efforts. Most significant in these tests is that the airlines are departing from share of lift in a given market to more targeted performance criteria, market pair ownership. Mr. Tanner's skepticism is supportable, because the majority of human's typically resist fringe ideas and processes. While we all recognize that change is inevitable, few willingly accept it.

Still, the "reality check" is that the market pair emphasis and ownership only forces expansion of the distributed risk solutions. Travel is the second or third largest expense for most companies. If large companies are successful in controlling their costs in this manner (and some corporations are achieving 40% or more in net travel cost savings using direct purchase agreements), this becomes a cost advantage over smaller competitors. Accordingly, the smaller companies must find ways to control their costs in order to compete with the big companies.

Logically, it can not be long before a number of smaller, more nimble companies, will band together to collectively consolidate their market pair buying power. Using a new business entity --which I call the "reverse consolidator" -- the banded companies willingness to "own" seat inventory will provide, effectively, the buying power to negotiate the same sharing agreements with the airlines that are common in the AMEX, General Motors, Ford, and Seimen's agreements. The term "reverse consolidator" reflects the reality that the consolidator is representing the buyers agreed willingness to take risk and own seats -- as opposed to the common concept of consolidating on behalf of a given airline.

More to Come

In point of fact, AMEX's deal is only different from the concept of a "reverse consolidator" in that AMEX is, itself, absorbing the risk (at least, publicly). But that risk is certainly against a known corporate buying level -- one that allows AMEX to manage the risk with a high degree of security. As the market pair models become smaller, it will take guarantees to the collective buying group to insure the risk for most "reverse consolidating" entities. Few travel agencies today can afford such risk without the guarantee of corporate backers.

As a result, the next few years will be filled with experimentation. On the one had, the airlines will seek new ways to share seat-ownership risk. On the other, corporations acting independently or through "reverse consolidators", will seek to lower their costs by assuming some of that seat-ownership risk. Distribution of these seats will be "caught in the middle", unable to be served by the current distribution paradigm, both airlines and corporations will seek fringe alternatives to lower the cost of distribution. This will become very apparent when the "reverse consolidator" seeks to distribute their inventory among its corporate client base ... and, subsequently, to outside companies.

The model or process described above is increasingly apparent. It follows closely the models found in other commodity product distribution systems. While there will be continued experimentation and evolution, the AMEX/CO/Virgin, General Motors, Ford, and Seimen's-like agreements are but the beginning ... the "tip of the ice berg" to come.