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Airlines try to make Internet work for them

Posted by iNext - 2005-11-03

U.S. airlines are getting less economic bang out of each seat than they did a decade ago, in part because of the growing legion of computer-savvy travelers using the Internet to find bargain fares.
But airlines and other travel companies are trying to reverse that trend, at least a little, by developing ways to use the Internet, the same tool that has helped cause their financial pain. Their aim is twofold: cut distribution costs even further in the next five years than they have in the last 10, and increase unit revenue by developing applications that will induce Web-surfing travelers to pay slightly higher average prices. (Video: Online tickets sales soar)

The first ticket was sold via the Internet almost 10 years ago, in December 1995, by Alaska Airlines. Mark Guerette, that carrier's unofficial "webmaster" back then, says it was "pure excitement" when a family of four from Washington's Olympic peninsula bought the first airline tickets online.

By 1998, every carrier was experimenting with online sales, mostly as a way of cutting the expensive middlemen - travel agents - out of the game. Airline executives at the time also wanted to learn how willing consumers might be to shop for and buy travel in a digital environment.

"We thought we had hit the big time when we hit 50 sales a week," a few months after AlaskaAir.com began selling tickets, says Guerette, today director of AlaskaAir.com. Back then, no one dreamed that "one day we'd be approaching 50%" of tickets being sold online.

This year, about 42% of all travel sale transactions in the USA - airline seats, hotel rooms, car rentals, cruises, tours and other services - will take place online, according to independent consulting firm PhoCusWright. That's about $94 billion worth of travel sales out of a total U.S. travel market estimated at $224 billion this year. By 2007, online's share of the total will move to 55%, or $136 billion.

But the law of unintended results also has been in play. In their rush to cash in on the promise of online commerce, airlines created a marketplace in which every consumer has easy access to low fares. And thanks to the explosive growth of discount airlines, there are lots more of those cheap seats available than there were a decade ago.

That's been great for consumers, but devastating for airlines. While U.S. airlines' revenue grew nearly 48% to $132 billion last year from $89 billion in 1994, the proliferation of cheap seats caused the industry's average revenue per available seat mile to fall to 11.7 cents in 2004 from 12.65 cents in 1994. That 7.5% drop has been a huge factor in U.S. carriers' more than $35 billion in losses since 2000.

Now though, "The tide is turning," says Peter Belobaba, an airline economics and operations research expert at the Massachusetts Institute of Technology. "We're 10 years into it, and there are massive changes" taking place in the distribution of airline tickets.

The growth of online sales, and the gradual elimination of commissions paid to travel agents that began in 1994, has trimmed $7.5 billion in airline costs since 1994, Belobaba says. Now, carriers are trying to cut costs even further. They are backing new third-party websites, and employing new software on their own websites that allows them to partially bypass the big, expensive ticketing networks used by most travel agents. Those four big computer reservations systems - Sabre, Galileo, Worldspan and Amadeus - collectively are known as global distribution systems, or GDSes.

Some of the new websites, such as kayak.com and sidestep.com, are search engines. They scan a wide number of airline-operated and third-party travel websites for the best deals. Then, for a modest finder's fee, the search engines transfer consumers directly into the selected airline's website. The airlines also are boosters of new third-party websites, like the one being developed by a Chicago start-up called G2 SwitchWorks, and beefing up their own websites with new software developed by companies such as ITA Software that effectively allow those websites to operate as low cost GDSes. That's why they sometimes are called GNEs (GDS-New Entrants, or "Genies").

Airline officials now are making it clear that the "legacy costs" built into the big GDSes make them too costly for financially distressed carriers to continue using.

Last month, American Airlines CEO Gerard Arpey told analysts and reporters that American will have dramatically lower distribution costs in place by the end of 2006. All of American's GDS contracts expire next year, and Arpey says the world's largest airline won't continue selling tickets via some or all of those old systems unless they can get their costs close to American's cost of selling tickets directly to consumers.

Analysts say other big airlines, most of which will be negotiating new GDS deals in 2006, are likely to take a similar stance.

The GNEs, which run on much less expensive and more efficient network servers, are giving airlines negotiating leverage. But GDS executives say their systems are getting more hip technologically, which narrows the cost gap vs. the GNEs. Just as important, GDS executives say their systems produce more revenue - in some cases, lots more - per ticket sold than do either the GNEs or the airlines' own websites. Big corporations, whose travelers tend to pay higher fares, still prefer, by larger numbers, to book their travel through GDSes. "We understand the difficult situation the airline industry is in right now," says Chris Kroeger, senior vice president for North America of the Sabre Travel Network.

But on top of finding ways to trim distribution costs, "We're also focused on the revenue side of the equation," he says. "On a lot of websites - airline sites and online agencies - price is king. That's helped contribute to the decline in average revenue per ticket."

GDSes can help airlines get "sometimes as much as double the yields they can get via the online channels" by helping them differentiate their services and prices, Kroeger adds. But just as the big GDSes are trying to narrow the cost gap vs. the GNEs, the GNEs are trying to narrow the revenue gap vs. the GDSes.

In various stages of development are new applications that will let GNEs and airline sites offer different fares and services to virtually every traveler who logs on to the sites, based on their known preferences, previous travel purchases, income levels and frequent-flier status. "GDSes will be around a long time," says Noreen Courtney-Wilds, director of sales at JetBlue. The 5-year-old discount carrier began selling tickets via both its own website and GDSes, but since last December has sold only through its own site.

"The GDSes will have to reinvent themselves in many ways. And they're not as needed as in the past. But they're still needed," she says.

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