Distribution and channel management: where now? September 1999

Distribution and channel management practices at the world’s major airlines have changed radically in the last four years. Further progress is required but not necessarily guaranteed. Until about 1995, travel agencies unquestionably performed best for the passenger along this value chain, and were in turn rewarded with 80% or more of total airline passenger bookings. In accessing information, for instance, the travel agencies were for the general public the only reliable, easily used source for unbiased, multiple carrier flight listings. In making reservations, by and large they did so more painlessly for the passenger than for any other distribution channel. In accessing other services, they did so with unparalleled convenience, and so forth across the entire value chain.

Disequilibrium factors

Six factors upset the equilibrium among distribution channels, allowing the initial round of commission cuts, led by Delta Air Lines in February 1995, and all subsequent rounds to stick.

• Heavy profit pressure on the airlines — emanating from the bleak economic performance of the early 1990s;
• An emerging understanding of the factors that affect passenger choice of airlines — that passengers mostly choose the carrier, and that travel agents influence carrier choice only on a small percentage of the tickets they book;
• Recognition that the airlines’ compensation of agencies had been cross-subsidising other travel partners and corporate travel management programmes — principally hotels and rental cars;
• The increasing strength of airline brands as FFPs and alliances gained momentum;
• A better understanding of profitability by passenger segment — that for many airlines their highend business travellers contributed more than 100% of their profits; and
• Emerging technology would facilitate more robust direct relationships with passengers — initially electronic ticketing and viable software-based direct booking products, and later the Internet.

From an airline perspective, all-in travel agency distribution costs totalled between 15 and 19% of passenger revenues when commissions, overrides, agency support, credit card and CRS fees were fully accounted for. The time when these costs could be accepted at then-current levels simply had passed, especially in view of the fact that the travel agency channel cost per ticket was more than twice that of the direct channels.

All US carriers, and a high percentage of nonUS airlines, have now significantly lowered their distribution costs. But individual responses have varied greatly and carry the mark of unfinished business in most cases. Commission rates are down across the board, having been reduced in several waves of cuts in most cases. Override policies have tightened up. Direct channel usage is much higher than would have been thought possible at the beginning of the decade, as passengers use proprietary booking products such as Eaasy Sabre (American Airlines), United Connections and Priority Travelworks (US Airways) plus the Internet. An added bonus is that direct electronic channels are about twothirds as expensive as the traditional direct channels (ticket-by-mail, airline/city ticket office, etc.).

The potential impact is dramatic. Consider the case of an airline with total distribution costs of 15% in 1995 with an 80/20 indirect/direct channel mix. A reversal to 20/80, with all directs in electronic channels, would drive an astonishing 7% of revenues to the bottom line, even if indirect channel costs did not drop. Clearly, savings of this magnitude are not on the cards in the shortterm, but establish boundaries on the savings opportunity.

Separately, carriers are accumulating valuable experience on the leisure side. Auctions for low-end capacity are proliferating, run both by carriers themselves and by electronic intermediaries such as Priceline.com. Special deals such as last-minute travel for fixed low prices are now well-established on carrier Internet sites. These mechanisms, targeted at one-off, low-end market opportunities, allow the carriers the chance to accumulate experience that can be applied to the distribution of higher yield seats now and in the future. Combined with the understanding of travel patterns and preferences gained through FFP databases, these techniques can be profitably applied to an airline’s best customers.

Online travel agencies are part of the indirect channel world but with commission rates in the 45% range — about half current agency levels — are looking a lot like directs. Passengers, especially business travellers, have become more comfortable with new technology. The growth in e-commerce is conditioning the public, and specifically higher income and education segments most likely to travel frequently by air, to use the Internet to buy direct rather than subscribe to traditional distribution channels, in everything from books to pet food. However, the airlines’ ability to take full advantage of these trends is bounded not only by the pace of public adoption of new technologies, but also by the relative unfriendliness of many airline Internet sites.

Taken together, these pluses and minuses should signal a bright future for airline distribution, punctuated by lower costs and more direct relationships with customers. Despite all of this progress, however — new technology, emerging channels, lower costs — the structure of airline distribution is little changed.

Large sales forces still support the high cost indirect distribution channel. While commissions have fallen close to what might appear to be a structural floor in many markets, overrides are still negotiated. Corporate discount levels are often high enough to be justifiable only on a defensive basis, since they could never move enough incremental traffic to match the profits negotiated away. The integration of electronic distribution with corporate travel management is largely unachieved. Carriers that have broken ranks and pursued cost reductions greater than their peers — such as SAS, which published disappointing financial results in August — have suffered, at least in some measure.

What are the next steps?

We suggest at least five:

First, airlines must prepare the infrastructure supporting direct distribution for much higher traffic volumes. This means Internet sites with slick front ends and continuously improving technology guided by a steady stream of customer feedback (online surveys, analysis of complaints and service interruptions, usage analysis, etc.).

Second, agency incentives should be derived on a rigorously analytical basis, with costs and benefits explicitly understood and quantified. Too often a spirit of gradualism pervades negotiations, which inspire the airlines to settle for doing a bit better than in the last round, rather than seeking a paradigm shift based on changed realities. If an override programme costs more than the margin achievable on the incremental traffic it’s likely to drive, it may be a bad idea. If it costs more than the contribution to fixed costs that it’s likely to drive, it’s definitely a bad idea.

Third, corporate programmes that offer discounts from the first dollar are not likely to be justifiable in terms of incremental traffic; while they may be rational from a competitive standpoint, it’s important to be certain lest a carrier give away margin needlessly. Often the sales department is not the best positioned to perform an objective review of these agreements — a check by disinterested, quantitative staff is a good idea.

Fourth, those airlines with most or all of their sales force committed to support the travel agency distribution channel should consider redeployment, to at least some extent, to lower cost distribution channels targeted for expanded use in the future.

Finally, airlines should move with all speed to provide the technology support necessary to manage corporate travel programmes with reduced intermediary involvement. Many corporations will choose to continue to involve agencies, either because they value third party involvement or because the travel manager — agency — travel provider relationship and approach are firmly entrenched. This should not, however, dissuade the airline, especially those with a commanding home market seat share, from providing a viable direct alternative. So, airlines have made significant progress in the last several years in distribution strategy, following more than a decade and a half of stagnation following US deregulation in 1978. In 1999, it’s important to recognise that the last four years of progress will only be consolidated and continued if the industry resists the temptation to take another 15-year breather.