[The Practical Nomad Newsletter] The Amazing Race 14, Episode 9

[Edward Hasbrouck]

This column with links:
http://hasbrouck.org/blog/archives/001669.html

The Amazing Race 14, Episode 9
Bangkok (Thailand) - Guangzhou (China) - Guilin (China)
(online hotel discounts)

=====

The most conspicuous feature of the last few broadcasts of "The Amazing 
Race 14" has been the seemingly endless repetition of the same 
Travelocity.com advertisement for "Hundreds of hotels under $100".

Is this for real? Is it really such a great deal? And why are online 
travel agencies focusing so much of their advertising lately on hotels 
(and on hotels at this particular price point)?

Yes, hotel discounts through online travel agencies, in general are 
currently for real, and a good deal -- although they are nothing unique to 
Travelocity.com, and although Travelocity.com isn't usually the place to 
find the lowest price for any given hotel.

To understand why, and why the big advertising push, requires some 
background in the workings of the online travel industry and the history 
of online hotel bookings:

Sales volume doesn't necessarily make for profits, if the margin for the 
retailer (the difference between retail and wholesale prices) isn't enough 
to cover the retailer's costs. That was the problem for online travel 
agencies like Travelocity.com, Expedia.com, and Orbitz.com, which grew to 
billions of dollars a year in sales, mainly of airline tickets, at the 
same time that airlines were eliminating or drastically reducing 
commission payments to travel agencies.

Travel agencies' fees of US$5-10 for each ticket purchased online weren't 
(and still aren't) enough to cover their huge marketing and technology 
costs, not to mention the growing cost of providing even minimal post-
sales customer service. Only a continuous flood of dot-com investment 
money could -- and for a time did -- cover their losses. That ended, 
though, with the "dot-bomb" collapse of the stock market bubble in 2000-
2001. By 11 September 2001, travel (which had gotten a large but temporary 
boost from dot-com business travel) was already in decline. Despite their 
growing market share, online travel agencies were rapidly burning through 
the remaining reserves of cash they had left from their stock sales.

Surprisingly, rather than being put out of business, online travel 
agencies first became profitable as a direct result of the (further) 
decline in travel after September 11th, and the desperate situation in 
which that placed hotel owners in particular.

Before September 11th, online travel agencies sold (and advertised) 
primarily airline tickets. As a profit center, though, sales of airline 
tickets at published fares (prices set by airlines) are at best neutral to 
a travel agency's bottom line. More often they are a loss leader, whose 
cost is accepted only as a marketing expense for other products and 
services. When all of their expenses for customer service, etc. are 
factored in, mainstream online travel agencies like Travelocity.com and 
their competitors sell published-fare airline tickets below cost in order 
to get you to book your accommodations through them.

If they thought they could get away with it without alienating too many 
potential hotel bookers, most travel agencies -- online or offline -- who 
sell airline tickets at published fares would probably prefer to sell you 
an airline ticket only as part of a package, or in conjunction with a 
hotel booking. That's why they put such emphasis on trying to get you to 
book bundled travel services, rather than pricing different services (like 
airfare and hotels) separately.

That doesn't mean you can't sometimes save money by buying a travel 
package. Airlines, hotels, and other suppliers of travel services often 
give travel agencies and tour operators (both online and offline ones, 
it's important to note) lower prices for services on condition that that 
those prices be used only for constructing packages or bundles of services 
sold for an inclusive price, and not sold for separate one-off sale.

Why would suppliers offer lower wholesale prices "for construction 
purposes" like this? As long as the prices of components aren't itemized, 
packaging keeps both consumers and competitors from knowing just how 
deeply any given travel service provider is discounting. Bundling of 
services from multiple suppliers serves the suppliers' goal of price 
opacity. Equally important, it serves the agency's goal of opacity: 
packaging makes it impossible for either consumers or suppliers to know 
how much the agency has marked up the total price of the package. Instead 
of selling products or services at prices set by suppliers, and having 
their margin limited to either a publicly-disclosed transaction fee 
(typically limited by competition to an unprofitable minimum) or a 
commission fixed by the supplier, packaging and its inherent price opacity 
permits a travel agency or tour operator to set its own selling price and 
thus, more importantly, to set its own markup.

This system of pricing and sales based on an opaque markup set by the 
agency, rather than commission set by the supplier, or a transparent fee, 
is called the "merchant model", because in this type of sale the agency is 
the "merchant of record' who processes the sale, and thus whose name 
appears on the credit card charge. As the merchant, the agent collects the 
full payment from the customer, pays a contracted wholesale net price to 
the supplier(s) of travel and other services, and keeps the balance of the 
markups its profit, rather than having the supplier collect the full 
payment and remit a commission or fee to the agency, as had traditionally 
been the system.

Among the important but little-noticed implications of the "merchant 
model" are that (1) it subjects the agency to many state consumer 
protection regulations governing tour operators (most of which don't apply 
to entities that function solely as suppliers' agents), and (2) it makes 
the agency liable, as merchant, for the actions of travel suppliers, 
instead of the agency being merely an agent for the supplier. In the 
merchant model, hotels, airlines, and other providers of travel services 
are subcontractors of the merchant, for whose fulfilment of the contract 
the merchant (i.e. the agency) is responsible. Online travel agencies may 
try to evade or disclaim their responsibility, but the bottom line is 
this: The company against whom to request a credit card chargeback, or to 
make a claim against in small claims court if your chargeback is denied, 
is the company whose name appears on your credit card statement as the 
merchant. 

But I'm getting ahead of myself. Online travel agencies invested in 
developing the technical ability to sell dynamically generated packages 
(airline ticket + hotel+ car rental, for example, for an inclusive, non-
itemized price generated on the fly for your specific trip) only after the 
merchant model had proven itself, through merchant-model hotel bookings, 
as online agencies' path to profitability after 11 September 2001.

Why hotels and not airline tickets? After all, airlines and travel 
agencies already had a well-developed (offline) system of merchant model 
airline ticket sales, in the form of so-called consolidators . But 
consolidator airfares were, until recently, limited to international 
routes, and the first wave of mass-market online travel agencies in the 
USA dismissed international travel as too small a niche to bother with, at 
least initially. For this and other reasons, mainstream online travel 
agencies in the USA largely failed to recognize the potential market for 
consolidator (merchant model) airline ticket pricing and sales. 

(There are online agencies in the USA that specialize in international and 
consolidator tickets, but they remain smaller niche companies. Some of the 
largest online travel agencies in other markets, however, such as 
eBoookers.com in the UK, have made consolidator airfares their core 
business.)

A dip in demand is, in any event, more of a problem for a hotel than for 
an airline.

An airline can choose not to renew expiring leases for planes in its 
current fleet, and not to exercise options to purchase new planes. It may 
be able to postpone deliveries of new planes, or sell its planes or its 
slots in aircraft manufacturers' delivery schedules to other airlines 
(perhaps in other regions of the world, where demand is growing). As a 
last resort, it can minimize its operating costs by grounding unneeded 
planes, or even mothballing them.

Hotel owners don't have the same options as airlines. Some motels can be 
(and have been) converted to rental housing, and some hotels can be (and 
are being) converted to condos. But you can't relocate a hotel, and it's 
more difficult and costly to mothball a hotel than to park an unused plane 
in the desert. Fixed costs (mainly real estate) are a much larger fraction 
of total expenses for a hotel than for an airline, while marginal 
operating costs (such as fuel, skilled labor, airport fees, etc.) are 
proportionately greater for airlines.

When demand for travel goes down, airlines can do more, more quickly, to 
adjust capacity to demand and thus to maintain prices. And below a certain 
price point, it makes no sense for them to sell tickets at all, even if 
seats are empty. (Last week JetBlue Airways was offering transcontinental 
tickets for US$69 one way, including taxes and fees. I'm surprised that 
would even cover the marginal cost of the extra fuel required to carry an 
additional passenger.) Hotels are more likely to be stuck with a glut of 
empty rooms, but relatively low marginal costs to service each additional 
guest. So the least costly choice for a hotelier in hard times may be to 
take in guests, even at rates barely above marginal cost, to cover the 
cost of remaining open and to at least slightly offset the carrying cost 
of the real estate until times improve.

This is the situation that hotel owners found themselves in after 
September 11th. They were willing to accept much less than their regular 
rates if the only alternative was for rooms to remain empty, but anxious 
not to reduce the prices (or the expectations for future prices) paid by 
those still willing to pay as much as ever, or at least something close to 
their previous rates.

Online travel agencies seemed to offer hotels a way to market their 
"distressed inventory" of empty rooms to new customers, at fire-sale 
prices, in a way that would generate incremental revenue for the hotels 
without diverting their traditional higher-paying customers (as the hotels 
would have if they had openly cut their rates across the board). Hotels 
offered online agencies their lowest net wholesale prices ever, and let 
the agencies charge whatever they could get, as an incentive for these 
agencies to fill as many rooms as possible.

Hotels authorized these rates, and at least covered their marginal costs, 
but the real winners were the online travel agencies. The wholesale rates 
that hotels set were so low that the "merchants" in the merchant model 
were able to mark them up by 25%-40% (compared with traditional agency 
commissions of 10% to at most 15%) and still undercut the rates being 
offered by hotels themselves or though other marketing channels. 

The high markup on merchant model hotel bookings, a direct result of the 
desperate financial situation of many hotel owners after September 11th, 
was the financial windfall that made online travel agencies profitable -- 
and hugely so -- for the first time. Once the first agencies showed what a 
gold mine merchant model hotel bookings could be, others began to mimic 
their focus on them, and to expand the merchant model to travel packages 
and other services. 

Agency margins on merchant model hotel bookings declined as people began 
travelling again and the economy recovered. But they remain much higher 
than agency hotel commissions, online travel agencies haven't forgotten 
the lessen.

When demand for travel crashed again with the current economic crisis, 
online travel agencies were quick to see in other travel companies' 
distress the opportunity for a potentially even larger windfall from hotel 
bookings than they got after September 11th. They've been quick to 
negotiate lower wholesale rates with hotels, and equally quick to 
advertise them (at suitably profitable markups) -- as they've been doing 
so heavily during broadcasts of "The Amazing Race 14". Since this is the 
type of sale on which they earn the highest profit margin, they have every 
reason to make it the priority in their ads, even if regular viewers are 
probably sick of those ads by now.

The race will be in China for a couple more episodes. So I'll have more in 
my next installment about current China travel issues (including hotel and 
visa advice), as well as more on what sorts of hotels are being discounted 
most heavily and where (not just, and not primarily, Travelocity.com) to 
find the current hotel deals in China and in other parts of the world.

Stay tuned!




----------------
Edward Hasbrouck
<edward at hasbrouck.org>
<http://hasbrouck.org>
+1-415-824-0214

"The Practical Nomad: How to Travel Around the World"
(4th edition 2007)
"The Practical Nomad Guide to the Online Travel Marketplace"
<http://www.practicalnomad.com>

Around-the-World and multi-stop international air tickets:
<http://hasbrouck.org/tickets/>