LECTURE NOTES 10

THE AIR TRANSPORT SECTOR & ON-LINE

DISTRIBUTION
1. CHARACTERISTICS OF THE SECTOR
Air transport is now a major industry. It emerged in 1919, soon after the First World
War, but it was not until peace was restored after the 2WW that the era of major
expansion really began.

Aviation provides the only worldwide transportation network, which makes it
essential for global business and tourism. It plays a vital role in facilitating economic
growth, particularly in developing countries.
It is the key element in the worlds largest industry, travel and tourism, which
generates aprox. 4000 bil. US$ in revenue a year, takes almost 11% of consumer
spending and employs over 200 mil people, or roughly one in every nine people in the
global labor force.
More than 40% of international tourists now travel by air (47%).
The air transport industry generates a total of 29 million jobs globally (through
direct, indirect and induced impacts).
Aviations global economic impact is estimated at US$ 2,960 billion, equivalent to
8% of world Gross Domestic Product (GDP).
Over the last 50 years, the airline industry has consistently grown at a very fast
rate, well above the growth in world GDP (6.2% a year compared to about half of
that for GDP).
The high rates of growth have not been accompanied by high profitability rates.
Airline profit margin have been well below average compared with firms in other
industries and over the last few years there have been some heavy losses.
The worlds 900 airlines have a total fleet of nearly 22,000 aircraft. They serve
some 1,670 airports through a route network of several million kilometers managed
by around 160 air navigation service providers.
25% of all companies sales are dependent on air transport. 70% of businesses
report that serving a bigger market is a key benefit of using air services.
The air transport industry includes those activities that are directly dependent on
transporting people and goods by air. This includes:
the aviation sector airports, airlines, general aviation, air navigation service
providers and those activities directly serving passengers or providing airfreight
services;
the civil aerospace sector, which comprises the manufacture and maintenance
of aircraft systems, frames and engines.
1
Together, these two sectors provide a measure of the total industry, which is termed
the air transport industry.
Drivers of growth
The demand for air transport has increased steadily over the years.
Passenger numbers have grown by 45% over the last decade and have more than
doubled since the mid-1980s. Freight traffic has increased even more rapidly, by
over 80% on a tone-kilometer performed basis over the last decade and almost three-
fold since the mid-1980s.
Its rapid growth has been driven by a number of factors, including:
Rising GDP, disposable income, and living standards increasing the
demand for travel for both business and leisure purposes.
Reduced air travel costs improvements in airline efficiency and increased
competition have reduced world airfares by around 40% in real (i.e. inflation-
adjusted) terms since the mid-1970s.
Globalization and intensified international trade - the average distance
traveled tends to increase as people take long-haul holidays and do business in
countries which now have more favorable political and social environments.
Deregulation, relaxation of travel restrictions, air transport
liberalization - starting with the US domestic air market in the late 1970s,
followed in the 1980s by the European Union (effectively completed in the late
1990s), with other regions deregulating gradually.
Technical characteristics of aircrafts that result in several advantages for
air transport compared to other means of transport:
- rapidity
- flexibility adaptable and convertible capacity passengers to mail or cargo,
military into civil
- just-in-time accessibility to markets - providing a new and faster mechanism
for distributing goods and services throughout the world, contributing to
growth in existing industries, increasing overall economic efficiency.- air
transport reduces the cost of trade and opens up new market opportunities by
moving products and services quickly over long distances.
- reliability scheduled airlines frequency, timetables, relatively stable
tariffs, taxes
- efficiency economic efficiency larger access as a result of decreased prices
- convenience
- safety
2. DEMAND FOR AIR TRAVEL
Demand is highly elastic with respect to income, rather less elastic with respect to
fares and relatively inelastic with respect to service levels.
2
- high income elasticity can be seen in the relationship between
economic activity and air travel demand. Although air travel tends to
grow faster than GDP, it still follows very closely the cyclical pattern of GDP.
In North America, high average income levels are reflected in each person
making at least two air trips per year, whereas in countries like China and
India, only one in every 100 people take an air trip.
There are also other socio-economic factors that influence demand, like:
- a continued increase in paid holidays and in the number of two-income
families should bring more people into the category of those able to afford air
transport.
- the influence of increased higher education should also have a positive effect
on air travel demand
- the growing integration in North America and Europe might increase
demand within those regions
- liberalization of airline competition
Demand for air travel comprises two different segments, with different
motivations to travel and with a specific behavior with respect to various travel
offers: leisure travel demand and business travel demand.
Leisure travel has been growing more rapidly than business travel and is
something that affects the aggregate elasticity of demand. The demand for leisure
travel is price elastic, but that for business travel is price inelastic. Across the world
as a whole, the leisure/business breakdown is now approx 60/40, virtually reversing
the position as it was in the early postwar period. The business travel share varies
widely, being very much higher on domestic routes. It also varies a lot by airline
(Swissair, for ex. business passengers more than 20%).
Business travelers are very important for the airlines for it is mainly these
passengers who pay high fares that yield a lot of revenue for British airways, 30%
of passengers generate 70% of revenue.
Business travel has been the primary source for high-yield passengers, critical to
the economic viability of the hub-and-spoke model used by the major airlines.
However, over the past several years, business travel has accounted for an ever
smaller share of airline revenues. In 2001 before September 11, the share had
dropped to 23 percent, from more than 35 percent in 1999, in the United States.
While some of this drop is normal cyclicality as companies cut back on travel, other
factors indicate that the decline may be longer term. After September 11, the
inconveniences caused by time-consuming new security measures have made
business travel even less attractive, and the likelihood is that these inconveniences
will continue for the foreseeable future.
In order to reduce the cost of travel, companies have made several fundamental
changes that are likely to have long-lasting effects on business travel revenues.
3
Large corporations have used their purchasing power to negotiate volume
discounts on fares, with price reductions on some routes often as high as 20 to
30%. Furthermore, most corporations are now enforcing the travel restrictions tied
to these volume agreements.
Some alternatives to business travel on commercial airlines may now finally take
hold. Companies are turning increasingly to travel substitutes such as
videoconferencing and have been experimenting with shared corporate jets as
a replacement for first-class travel for top executives. New advances such as Web
conferencing have boosted demand for videoconferencing services, with a 30% year-
over-year increase prior to September 11. Forced behavioral changes in the
aftermath of the terrorist attacks have pushed the growth rate for these services up
to 40%. In addition, the expansion of fractional jet models for business aircraft
significantly increases the availability of business jets as a travel alternative. The
corporate jet option, which is becoming more attractive given the increased time
required to negotiate security procedures at major airports, takes away at least 10%
of first-class travelers (2005). In view of these changes in the way corporations work
and purchase travel, we believe that business travel revenues will remain under
pressure even when the world economy recovers.
4. AIR TRANSPORT OFFER
Two countries, USA (20%) and UK (10%) represent aprox 30% of the world air
transport offer. There are two ways of conducting air transport operations:
- scheduled flights
- non-scheduled flights charter flights aprox 17% of international air traffic
Charter flights are more frequent in countries that specialize in tourism,
representing aprox. 60% of RPK in European countries.
5. REGULATION VERSUS COMPETITION DEBATE
Natural monopoly theory
For many years air transport was a closely regulated industry, both domestically
and internationally.
Governments traditionally regarded air transport as, in some sense, public utility.
Strictly speaking, it is not. Economists prefer to reserve the term public utility to
enterprises that have the characteristics of a natural monopoly.
Natural monopolies exist where the advantage of size are so great that a
service can only be provided, at least cost, if it is supplied by one and only
one firm. A single firm becomes the monopoly because the average cost of providing
the service reaches a minimum only when an output rate large enough to satisfy the
entire market has been reached. In a situation like this competition will not be
sustainable.
4
There is a general agreement on the need for regulation in natural monopoly
industry. These are industries in which the ration of fixed costs (inescapable) to
variable (escapable) cost is often very high. The fixed costs are often associated with
heavy infrastructure investment, which often generates some enormous economies
of scale, with average costs falling as output expands. Telecommunications, gas and
electricity distribution, water supply are often cited as examples.
It is recognized that there are elements of natural monopoly in the supply of airport
facilities. But are there any in airline operations? Where airport authorities supply
runaways and terminals, navigation and air traffic control facilities are supplied by
governments and where the track is god-given, airlines are very much in the
position of having their infrastructure supplied for them.
It is generally accepted that airlines are characterized by a relatively low
fixed to variable cost ration. Most of the costs incurred are escapable. There are
also some sunk costs like advertising expenditures. It is also not true to say that
there are no elements of natural monopoly in airline industry. Investment in
sophisticated computer reservation systems involves a great deal of capital
expenditure and the average cost of running a system falls sharply as the number of
bookings increases.
But a priori sunk costs in the airline industry are very low by the standards of other
industries.
Also, a priori, there is no particular reason to expect the long-run average cost of
airline operation to fall with increase in output.
Even though airlines do not qualify as public utilities from an economic point of
view, governments treat them as quasi-public utilities.
Contestable markets theory
The theory of contestable markets was developed in the early 1980s. The key point
in this theory concerns the threat of competition, as distinct form actual competition.
According to this theory, firms in oligopolistic industries will still price at the same
levels as they would in more competitive industries, provided a threat of competition
exists. For the threat of competition to be credible and for a market to be classed as
contestable, a number of pre-conditions must be met:
- no barriers to the entry of new firms to the market no extra costs borne by
new entrants that are not borne by incumbent firms already in the market
- there should be no heavy sunk costs cost that once incurred, is inescapable
For its entry to be a real threat, a new firm must be able, if it wants to, to engage in
hit-and-run entry. It must be able to go into the market, make profits for a brief
period of time and, if things look as if they are not working on a long term basis, get
out of the market again without having irrevocably committed a lot of resources and
without losing a lot of money. If hit-and-run competition is profitable, any attempt
by incumbent firms to raise prices above competition levels will provoke entry.
5
- the time it takes incumbents to respond to new entry by varying their prices
is longer than the time the new firm needs to make its entry profitable
there must be some delay in the reaction of incumbent firms; otherwise the
incentive for entry, the existence of prices above competition levels, could be
withdrawn as soon as entry takes place, making entry an unattractive
proposition.
The proponents of this theory considered the airline industry as a textbook example
of a contestable market (Bailey and Baumol, 1984).
Experience of deregulation scope economies theory
Until 1978, the U.S. government, through the Civil Aeronautics Board (CAB),
regulated many areas of commercial aviation such as fares, routes, and schedules.
The Airline Deregulation Act of 1978, however, removed many of these controls,
thus changing the face of civil aviation in the United States.
The most important effect of the Act was on the passenger market. For the first time
in 40 years, airlines could enter the market or (from 1981) expand their routes as
they saw fit. Airlines (from 1982) also had full freedom to set their fares. In 1984,
the CAB was finally abolished since its primary duty, that of regulating the airline
industry, was no longer necessary.
What effect did deregulation have in the short term?
- First, many airlines abandoned less profitable routes that took passengers to
smaller cities. Decontrol of routes permitted them to plan their operations as they
see fit.
- A second effect was the increase in productivity by removing the previous detailed
restrictions on airline prices. Decontrol of prices allowed airlines to fill their planes
by offering large numbers of heavily discounted fares for seats that would otherwise
go unused. And deregulation has compelled improvements in efficiency through the
intense pressures of the price competition it unleashed
- A third and related effect was the growth of hub-and-spoke routes. The major
airlines adopted key cities as centers for their operations; these key cities served as
stops for most flights, even if they were not on a direct route between two other end
points. Delta Air Lines had a major hub at Atlanta while Eastern ran its hub
operations from Miami. Both airlines ran many daily roundtrip flights from their
hubs, thus keeping planes in the air for more hours each day and filling more seats.
For example, the number of daily nonstop flights between New York and West Palm
Beach, Florida, jumped from five to 23.
- Fourth, deregulation allowed new start-up airlines to enter the market without
having to agree to the demands of the larger established airlines.
Route strategies: the hub and spoke system
During the 1980s a system of predominantly point-to-point routes was replaced by
one where the major airlines concentrated their routes on a few major airports
linked by frequent services using large aircraft, with smaller, nearby airports
6
connected to these hubs by shorted routes using smaller aircraft. This hub-and-
spoke system offered two major benefits:
It allowed greater efficiency through concentrating traveler and
maintenance facilities in fewer locations, while permitting cost savings
through higher levels of capacity utilization and the use of larger, more
cost efficient aircraft for inter-hub travel. The efficiency benefits of the hub-
and-spike system were reinforced by scheduling flights such that incoming short-
haul arrivals were concentrated at particular times to allow passengers to be
pooled for the longer-haul flights on large aircraft.
It allowed major carriers to establish dominance in major regional markets
and on particular routes. In effect, the major airlines became more
geographically differentiated in their route offerings. The ability of a single airline to
dominate individual hubs was reinforced by mergers. For example, when TWA
acquired Ozark in 1986, it controlled over 80 percent of flights in and out of St Louis.
Northwest accounted for 65 percent of traffic in and out of Detroit Metropolitan
Airport. The hub-and-spoke system also created a barrier to the entry of new
carriers who often found it difficult to obtain gates and landing slots at the major
hubs.
The hub and spoke system also allowed the major airlines to offer a more
integrated, through-ticketing service by establishing alliances with local
(commuter) airlines. Thus, American Eagle, United Express, and Delta Shuttle
were franchise systems established by AMR, UAL and Delta respectively whereby
commuter airlines used the reservation and ticketing systems of the major airlines
and coordinated their operations and marketing policies with those of their bigger
partners.
Air lines are just a special form of network. Because aircrafts differ in range and in capacity
this network is partially hierarchical. Because customers want to go from an origin to a
destination it is also partially a peer network. A well-known method to reduce the number of
connections between nodes is to set up a concentrator. In the first case we need 10
connections whereas in the second case we only need 4. Obviously it does not come for free: to
go from A1 to A4 we need to first go in A5.
7
Most disinterested observers agree that airline deregulation has been a success. The
overwhelming majority of travelers have enjoyed the benefits that its proponents
expected. But, deregulation also has given rise to a number of problems, including
congestion and a limited reemergence of monopoly power and, with it, the
exploitation of a minority of customers. It would be a mistake, however, to regard
these developments merely as failures of deregulation: in important measure they
are, in fact, manifestations of its success.
These problems practically illustrate the lesson that the dismantling of
comprehensive regulation should not be understood as synonymous with
total government laissez-faire. The principal failures over the last fifteen years
have been failures on the part of government to vigorously and imaginatively fulfill
responsibilities that the deregulated industry never intended to abdicate from.
1. Tendencies to Increased Concentration and Price Discrimination
The wave of mergers and airline failures has made the industry more concentrated
at national levels than it was before deregulation. But concentration at the national
level is not as important as concentration on individual routes. What passengers
care about are the choices available to them between two particular points. By
wiping out restrictions and freeing carriers to enter any market, deregulation
produced an estimated 25 percent increase in the average number of airlines per
route despite the mergers.
In this as in all other unregulated industries, there is always the possibility of anti-
competitive behavior (that is why there are antitrust laws). The re-concentration of
the industry reflects, in part, the failure to disallow mergers of direct competitors.
8
Also, some of the largest airlines have, at least in the past, used their computerized
reservations systems to handicap their smaller competitors. Frequent-flyer
programs, operating agreements and mergers with regional feeder airlines, and
deeply discounted discriminatory fares have all put smaller competitors at a severe
disadvantage and contributed to the demise of many of them. Like the hub-and-
spoke system itself, these practices also have large efficiency advantages and so pose
a familiar dilemma to scholars and practitioners of antitrust. Moreover, these
potentially anti-competitive stratagems were scarcer before deregulation because
they were unnecessary. Under that regime the government forced the airlines to
operate as an effective cartel.
The instances of sharply increased price discrimination that deregulation has made
possible are both a competitive and monopolistic phenomenon. They reflect intense
competition for the travelers most likely to be attracted by price differences among
competitors. They also have promoted economic efficiency in very important ways.
The deeply discounted fares to discretionary air travelers have helped fill planes
and, by doing so, helped make possible more frequent scheduling, which is
particularly valuable to the full-fare travelers.
Still, the discrimination also reflects the exercise of monopoly power, no longer
curbed by direct price regulation. The increasing sophistication with which the
leading carriers practice what the industry euphemistically calls "yield
management" enables them to take full advantage of that monopoly power,
particularly in the unrestricted full fares paid by about 10 percent of the travelers.
The continuing reconcentration of the industry threatens to extend that exploitation
to an increasing proportion of the flying public in the future.
There are three possible ways in which government might respond to this dilemma.
First, it could do nothing. The high, unrestricted fares paid by the minority of
passengers who cannot qualify for discounts may well be compensated for by
frequent-flyer credits and by the improved convenience of schedules that the high
fares and hubbing help make possible. The airline industry is far more competitive
than it was; the benefits of that competition have been widely distributed; and
industry profits have been lower, on average, since deregulation. In these
circumstances it would be reasonable to conclude that no remedy was required.
Second, the government could actively attempt to make markets more competitive by
assuming responsibilities that it has neglected. It could vigorously enforce the
antitrust laws. It could also remove barriers to competition by expanding airport
capacity enough to allow new competitors to operate on routes, by dissolving
preferential arrangements between hub-dominating carriers and their hub airports,
and above all, by allowing foreign airlines to compete for domestic traffic, either
directly or by investing in local carriers.
9
Third, where restoration of more effective competition proves infeasible, price
ceilings could be reimposed to protect travelers subject to monopolistic exploitation.
2. Safety in the Skies
Air travel is unequivocally safer now than it was before deregulation.
Of course, the margin of safety may have narrowed. The skies have become more
crowded and airlines may, under pressure of competition, have cut corners. If so, the
proper remedy is not economic regulation, but more spending on policing safety, air
traffic control, and airports.
3. The Quality of Service
The question of what has happened to the quality of service is more complicated.
First, service for smaller towns and rural communities has improved. They have, on
average, experienced a 35 to 40 percent increase in the number of scheduled
departures and, thanks to hub-and-spoke operations, have an increased number of
destinations available to them. On the other hand, the planes serving them are, on
average, smaller and less comfortable.
Second, travelers have endured an undeniable increase in congestion, delays, and
discomfort. But these are not, in themselves, a sign of failure. After deregulation,
low-cost, aggressively competing airlines offered the public low fares, with
correspondingly lower-cost servicenarrower seating, longer lines, and fewer
amenities. The incumbents responded with very deep discounts, accompanied by
similarly poorer service. The enormous response of travelers to the availability of
these new options is a vindication of deregulation, not a condemnation, even though
the quality of the air travel experience has deteriorated as a result.
Third, much of the congestion is the result of the failure of governments to do their
job. When the demand for any service exceeds the available supply, it means two
things. First, the service is probably being produced in inadequate quantity. Second,
it is underpriced.
As for the supply side, the airline industry relies primarily on the government to
provide sufficient air traffic control and on local authorities for airports. The
governments have not fulfilled those responsibilities. As for the demand side, the
spectacle of airplanes filled with passengers, queued up on runways for an hour or
more, proves that the price of access to airports and to the air traffic control system
at those times and places is too low.
1. DEREGULATION AND LIBERALIZATION
FREEDOMS OF THE AIR
International air services (apart from services within the European Union) are
governed by the provisions of inter-governmental instruments. These instruments
are usually in the form of air services agreements (ASA) - which are formal treaties
between countries - accompanying Memoranda of Understanding (MoU) and
exchanges of formal diplomatic notes.
10
ASAs cover the basic framework under which airlines are granted economic
bilateral rights to fly between two countries. The frequency, capacity and other
operational issues are normally covered by MoUs.
The bilateral system has its basis under the Chicago Convention and
associated multilateral treaties. The Chicago Convention was signed in December
1944 and has governed international air services since then. Nearly 200 countries
are signatories to the Convention. The Convention also has a range of annexes
covering issues such as aviation security, safety oversight, air worthiness,
navigation, environmental protection and facilitation (expediting entry and
departure at airports).
Air service agreements are negotiated by governments within the framework
of the five freedoms of the air defined in the Chicago Convention 1944 (International
Air Transport Agreement):
First Freedom of the Air - the right or privilege, in respect of scheduled
international air services, granted by one State to another State or States to fly
across its territory without landing
1
st
freedom the overflying rights
Second Freedom of the Air - the right to land in its territory for non-traffic
purposes
2
nd
freedom rights to land for technical reasons
Third Freedom of The Air - the right to put down, in the territory of the first
State, traffic coming from the home State of the carrier
Fourth Freedom of The Air - the right to take on, in the territory of the first State,
traffic destined for the home State of the carrier
3
rd
/4
th
freedom rights to carry traffic from/to the home state
Fifth Freedom of The Air - the right to put down and to take on, in the territory of
the first State, traffic coming from or destined to a third State
Fifth Freedom' is the right, in conjunction with a flight to or from the airline's
home country, to take on, in a second country, passengers, mail and cargo destined
for a third country, and the right to take on, in a third country, passengers, mail and
cargo destined for the second country.
5
th
freedom rights to carry traffic to/from third countries en route.
Ex: [Lyon] Toulouse Madrid - Lisbon (Air France)
In addition, other "freedoms of the air" are often referred to. Although not formally
defined, these are commonly understood as follows:
Sixth Freedom of The Air - the right, of transporting, via the home State of the
carrier, traffic moving between two other States.
11
6
th
freedom carriage of traffic between two foreign states via the state in which the
airline is registered neither recognized nor defined in the Chicago Convention
Ex: BA carries a passenger from NY to London, where he is transferred to another
BA flight to Bombay, BA Copenhagen [London ]- Malaga
Seventh Freedom of The Air - the right of transporting traffic between the
territory of the granting State and any third State with no requirement to include on
such operation any point in the territory of the recipient State, i.e the service need
not connect to or be an extension of any service to/from the home State of the carrier.
7
th
freedom operation of stand-alone services entirely outside the territory of its
home state, to carry traffic between two foreign states
Ex: US Airline operating a shuttle service between Tokyo and Seoul
Eighth Freedom of The Air - the right of transporting cabotage traffic between
two points in the territory of the granting State on a service which originates or
terminates in the home country of the foreign carrier or (in connection with the so-
called Seventh Freedom of the Air) outside the territory of the granting State (also
known as consecutive cabotage").
8
th
freedom: right to carry traffic between two points within the territory of a foreign
state, with the origin or destination in the home country cabotage
Ex: BA [London] Hanover Leipzig
Ninth Freedom of The Air - the right of transporting cabotage traffic of the
granting State on a service performed entirely within the territory of the granting
State (also known as "stand alone" cabotage).
9
th
freedom internal cabotage right to carry traffic within the territory of another
country
Ex: Air France in Morocco
Mutual exchange of the first and second freedoms usually takes place as a matter of
fact. In exchange for the remaining 3 freedoms, governments bargain hard. 3rd and
4th freedoms are always granted together. 6th freedoms are effectively two 3rd/4th
freedom services linked together, each of which are operated under the relevant
bilateral agreement. In negotiating traffic rights all governments are concerned
about the market share secured by their own national carriers.
Depending on its location a country has or does not have good opportunities to carry
6th freedom traffic. For instance European countries have good opportunities and
Australia virtually none.
The 8th freedom is almost never granted. Europe is a special case: EU airlines were
granted the 5th and 7th freedom on international routes throughout the Union in
1973 and 8th freedom in 1997.
12
The air transport sector in the European Union was liberalized in three
successive stages.
The first "package" of measures adopted in December 1987, started to relax the
established rules. For example, it limited the right of governments to object to the
introduction of new fares. Some flexibility was allowed to enable airlines in two
countries which had signed a bilateral agreement to share seating capacity. Until
then, absolute parity had been the rule.
In June 1990 a second "package" of measures opened up the market further,
allowing greater flexibility over the setting of fares and capacity-sharing. Moreover,
the new provisions extended the right to the fifth freedom and opened up the third
and fourth freedoms to all Community carriers in general.
13
These measures, which were initially limited to passengers, were extended to freight
by means of a decision taken in December 1990.
The last stage: the "third package"
The last stage of the liberalization of air transport in the European Union was the
subject of a third "package" of measures, which were adopted in July 1992 and
applied as from January 1993. This package gradually introduced freedom to
provide services within the European Union and led in April 1997 to the freedom to
provide cabotage, i.e. the right for an airline of one Member State to operate a route
within another Member State.
The main measures are as follows:
Community license: the market is open to all airlines which hold a
Community air carrier's license (Council Regulation (EEC) No
2407/92). For a company to obtain this license, most of its capital must be
held by Member States or nationals of the European Union. The latter must
also exercise effective control over the company. The technical capabilities
and financial capacity of the companies concerned are sanctioned by means of
national certificates. The third "package" stipulates that companies must
submit a two-year development plan to the authorities and provide proof that
they will be able to cover their operating costs for a period of three months
without income. Lastly, companies which use leased aircraft are required to
take up adequate insurance.
Freedom of access to the market is laid down in Regulation (EEC) No
2408/92. This text opened up all international air routes in the European
Union to all companies which hold a Community license without any
restrictions as from 1 January 1993. Since April 1997, unconditional access to
all domestic markets has been granted to all airlines in the European Union.
The most important safeguard measure in the Regulation on access to the market
concerns public service obligations, which enable governments to maintain services
considered essential for harmonious development within their territory.
This is done in two steps. Firstly, for a given route, the Member State publishes the
public service obligations which will be imposed on the carrier in terms of
capacity, flight frequency and fares. Then, if no carrier states that it is prepared to
provide a service, the Member State may restrict access to the route concerned to a
single carrier and decide to grant that carrier financial compensation in exchange
for compliance with these obligations.
Freedom with regard to fares and rates was an essential part of freedom of
access to the Community market. Regulation (EEC) No 2409/92 stipulates
that airlines are no longer required to submit their fares to the national
14
authorities for approval. All they have to do is to inform them forty-eight
hours before applying the new fare. The Regulation does, however, provide
for control mechanisms to be reintroduced in exceptional circumstances.
Generally, a fare increase can not be objected to if there is a high level of competition
on the route concerned or if the arrival of new competitors is not hampered by legal
provisions or practical contingencies, e.g. saturation at an airport. Conversely, if it is
established that airlines are involved in a price war which has already led to two
consecutive and general drops in fares and none of them is making any profit on the
route concerned, the national authorities may object to a fare reduction.
It has not been necessary so far to apply such a measure since 85% to 90% of
passengers now travel at reduced fares within the European Union. The
Commission has, however, noted that the "fully flexible" fares, which are not subject
to any kind of restriction as regards changing the reservation, the length of stay at
the destination, etc. are still excessively high on some routes.
7. STRATEGIC ALLIANCES
Airline alliances can cover many areas:
Code sharing.
Block spacing.
Links between Frequent Flyer Programs.
Joint sales and marketing.
Joint ventures in catering, ground handling and aircraft maintenance.
Joint passenger and cargo flights.
Joint purchasing and insurance.
On one hand there are technical alliances, for instance ventures in catering, ground
handling and aircraft maintenance. This sort of tactical alliance is created to reduce
costs. For instance in one area a couple of airlines can agree to specialize their
maintenance teams. One airline maintains 747 aircrafts and another A330 and A340
aircrafts.
The most famous alliances are strategic alliances created to handle code sharing,
FFPs and some marketing programs. They do not only consist in a commercial
agreement. Participants agree to adapt their schedules to increase the number of
useful connections inside the alliance.
Code sharing is an agreement between two airlines under which an airline that
operates a flight allows another airline to offer that flight under its own flight code.
Technically, code-sharing is a arrangement between two carriers that allows them to
sell seats on each other's flights under their own designator code. In the case of
connecting flights of two or more code-sharing carriers, the passenger's entire flight
is displayed as a single carrier service on a reservation system. From the customers'
perspective it gives the impression of an on-line service and offer some features
related to this service such as single check-in, common frequent flyer program and
coordinated flight schedule. Code-shares cover a wide range of services, as does the
15
major strategic alliances, but more often it involves a single service or a small
network of services.
A stronger form of code sharing involves blocked space arrangements. In this
case, one carrier buys space on another airline's craft that it sells in its own right
and thus using its own designator code.
Block spacing consists for an airline in allocating a number of seats to another
airline on some of its flights.
These alliances aim to increase the marketing power of their members in order to
successfully meet the challenges of globalization. Alliances aim to provide a global
offer to international travelers. The trick in alliances is to have a member in each
market. Air France is in Skyteam, Iberia in Oneworld and Lufthansa in Star
Alliance. It has also to be said that even if airlines wanted to create regional
alliances in order to dominate a market governments would not allow it
The three main global alliances are:
URL Members
http://www.staralliance.com/ Air Canada, Air New Zealand, Ana, Asiana
Airlines, Austrian Airlines, British Midland,
Lot Polish Airlines, Lufthansa, SAS,
Singapore Airlines, Spanair, Tap Portugal,
Thai, United, US Airways, Varig, Adria, Blue
1, Croatia Airlines
http://www.oneworld.com/ Aer Lingus, American Airlines, British
Airways, Cathay Pacific, Finnair, Iberia,
LanChile, Qantas
http://www.skyteam.com/EN/index.jsp AeroMexico, Air France KLM, Alitalia,
Continental, CSA, Delta, Korean Air,
Northwest Airlines
A former alliance, Qualiflyer, founded by Swiss Air died on December 31, 2002.
The first alliance, Wings, founded by Northwest and KLM no longer exists though
its core companies, Northwest, Continental and KLM still cooperate.
Global alliances will continue to change both in composition (it is easy for an airline
to change of alliance) and responsibilities (for instance Star Alliance has an IT hub.)
8. DISTRIBUTION
Network actors in the distribution system:
16
- CRS, Computer Reservation Systems, are the aggregators that gather the Airlines'
and other travel producers' offerings in one place and make them available to travel
sellers equipped with a suitable computer. In essence, the CRS sell information
distribution to the Airlines and information access to the travel agents etc.
- Traditional Travel Agents refers to the brick-and-mortar travel agents that have a
broad range of products in categories such as Airlines, Hotels, and Car rental etc.
- Web Sellers mainly use Internet as their customer interface. Four sub types in the
Web Sellers group have been identified:
- Agent Web, a travel agent with Internet as the main customer interface and
sells many Airlines tickets, makes hotel reservations etc. Some Traditional Travel
Agents have a web interface in conjunction with their physical stores.
- CRS Web, an online travel agent owned by a CRS.
- Proprietary Web, a web interface owned and operated within an Airline's
organization. This Web Seller often only offers its' own tickets. Sometimes other
Airlines' offerings are also available; tickets on Airlines in the same alliance are
more common to be offered in this case.
- Collaborative Web, a joint-venture between Airlines with several Airlines'
offerings; the owning Airlines' and others.
GDS are behind multiple-carrier booking engines (collaborative webs): Expedia and
Orbitz use Wordspan, Travelocity Sabre and Opodo Amadeus.
Computer reservation systems, today known as Global Distribution Systems
(GDS), were first developed by airlines to handle internal airline operations.
When first developed in the 1960 and 1970, CRSs were simply seen as devices for
saving time and labor in handling large and growing amounts of flight reservations
data.
All that changed with deregulation. In deregulated markets, passengers have very
many options for their journeys, in terms of carrier, fares, routes and they cannot
longer rely upon any one individual airline to provide them with a list of
alternatives. For that they have to go to travel agents who are linked into one or
more of the powerful CRSs owned or hosted by major carriers.
As computer technology advanced and airlines recognized that handling
reservations by computer was much more efficient and cost-effective than taking
reservations over the telephone, the airlines opened their systems for travel agent
use.
Around 50% of all flight bookings are made through CRSs operated with the aid of
Visual Display Units located in travel agents shops. Access to the first screen page
and if possible to the top line has become an extremely important factor in airline
competition!!
Concerns related to CRS operation:
programming the computer to bias the selection of flights in favor of those who
operated it. Because CRS owners would charge high prices for services provided by
other airlines, Codes of Conduct have been introduced to regulate this aspect.
17
possibility of CRSs becoming more and more oligopolistic very high fixed costs,
marginal costs close to zero, average costs declining as number of bookings dealt
with increases.
Six systems eventually emerged by the early 1980s allowing agencies direct access to
airlines, hotels, and car rental companies. Because of the high cost of automation at
the time, only large travel agencies could afford automation. In 1980 just over 4,000
agencies were automated. US:
American Airlines Sabre
United Airlines Apollo/Covia
Delta and TWA - Worldspan
Europe:
- Galileo International & Amadeus
Far Est:
- Axess & Abaccus
Because of increased competition, four major systems that provide CRS services to
travel agencies remain today Apollo (distributed by Galileo), Amadeus (formerly
System One), SABRE, and Worldspan (formerly DATAS II and PARS systems). By
the late nineties, around 97 percent of US domestic retail agency locations were
automated with one or more of these systems.
Some of the low-fare airlines are seeking to escape high distribution costs by
withdrawing from CRS and introducing ticketless flights ValuJet small company
based in Atlanta, specialized in leisure traffic over short-haul routes.
It is estimated that the cost of producing a single ticket comes to between 15 and 30
$. Ticketless travel is now possible because of automation and the widespread use of
credit cards.
Galileo International (Apollo) 100% Cendant Corp
Amadeus 25% Air France, 25% Iberia, 25% Lufthansa, 25% SAS-> public
Sabre 100% public (AA + Abacus from Asia sold its 82.2% interest to public)
Worldspan Delta 40%, Northwest Airlines 34%, Trans World Ailines (wholly
owned subsidiary of AA) 26%
GDS companies are reinventing their business model by offering innovative products
to enhance booking capabilities for purchasers of travel.
SABRE has established itself as one of the leaders in online travel through its web
interests including GetThere Inc. and Travelocity.
Amadeus has been building its e-commerce roots with investments in Vacation.com,
1travel.com, Travelbyus and Uniglobe. Its primary push has been in creating
country specific Internet booking solutions for agencies and corporations.
Worldspan is behind a number of ecommerce companies such as Expedia and
Priceline. Galileo has been beefing up its online presence with its Travel Point
booking site and its business travel counterpart, Corporate Travel Point. Galileos
new owner, Cendant, is purchasing CheapTickets.com and corporate booking web
18
site developed, Highwire. Cendant already owns Wizcom a hotel and car rental
booking system.
In addition to leveraging existing networks to meet the demand for high-speed
Internet connections, GDS companies are introducing e-business solutions such as
back-office applications, customer relationship management software and online
marketplace products.
9. LOYALTY SCHEMES IN AIRLINE MARKETING
There are essentially three kinds of schemes that large airlines can use to exert
power, through control over distribution channels in the marketing of air services.
These are:
1. frequent flyer programs
2. corporate rebates
3. travel agency commission overrides
1. Frequent flyer programs
For the eligible ticket bought, the passenger accumulates mileage points
according to distance traveled and to the class of ticket purchased, first and business
class passengers receiving points at multiples of the basic rate.
The passenger can exchange the mileage points for rewards in the form of free or
discount tickets, upgrades from one class to another, special concessions on car hire
and hotel accommodation and other benefits in the form of free gifts, dedicated
lounges at airports etc.
The first FFP American Airlines 1981
The first European carrier to introduce FFP British Airways initially it was a co-
owner of Air Miles, which was not a program for frequent flyers only (awards could
be earned by purchasing other things, too gas), then Latitudes
Lufthansa Miles & More
Conditions applying to mileage points can be rather complex, making it difficult to
compare one FFP against another.
European FFPs are less generous than their counterparts. Where European and US
carriers are in direct competition, as on transatlantic services, European FFP have
to be more generous to remain competitive and so give special bonuses.
a. FFPs provide a valuable source of marketing information about
premium fare passengers enabling airlines to target them more
effectively; the European FFPs are much more targeted at business
travelers
b. FFPs are partially substituting for media advertising, they are
discounts for quantity purchases
19
c. FFPs create strategic advantages for airlines with high market
share and reduce the potential for competition a large network
gives passengers more opportunities both to earn mileage points and
to use them. FFP may be considered a barrier to entry for new
entrants with a small network
d. Business travelers are heavily influenced by their FFP
membership in choosing their flights of a particular airline.
Frequent flyers resident in a hub city could become captive to the
hub airline.
The only real way of offsetting the disadvantage of a small network is for the airline
to link its FFP with those of other carriers
Ex: Virgin Atlantic & British Midland & SAS - Eurobonus
Virgin Atlantic & Air New Zealand & Delta
Midland & United & South African Airways
2. Corporate rebates
Companies in Germany are trying to trace all the accumulated mileage of employees
flying Lufthansa and to ask them to be handed over.
In Sweden, Saab-Scania, Electrolux, Volvo convinced SAS to award benefits
directly to companies and not to travelers
Virgin Corporate Freeway scheme introduced in 1994 250 companies
The benefits of business travelers are used to obtain free tickets for other staff. 12-
15% reduction of company travel budget
- they are also a threat to competition advantage of large networks
3. Travel agency commission overrides
TACOs are designed to encourage agents to concentrate bookings on a single carrier.
TACOs are paid over and above the standard level of commission 7%
A target threshold is established based on agents previous sales. One the threshold
has been reached, the additional commission is paid not just on additional sales, but
on those already made within the year in question as well.
TACOs are deals with intermediaries less exclusive and have less direct influence
on travel decision.
Concerns:
- agents can earn TACOs from different airlines at the same time
- once the threshold is reached, the following year override commission will be
that much harder to achieve
- the incremental commissions earned can become very high 50% of the
airlines additional sales revenue
- agents might increasingly lead travelers to sub-optimal choices in order to
meet override targets
10. LOW-COST CARRIERS
20
Everyone is talking about the growing importance of low-fare airlines as means of
air transport. The concept originated in the USA, where Southwest Airlines first put
it into practice in the mid-1970s. In Europe, no-frills airlines began to play a role
from the mid-1990s, initially in the UK and Ireland. Since then, though, the trend
has also spread to continental Europe. Besides the long-established companies such
as Ryanair or easyJet there are now about 30 airlines that can be classed as low-cost
carriers. From 1999 to 2003 the number of seats on offer soared 400%. The growth of
these airlines will continue. Forecasts indicate that by 2010 their market share, as a
percentage of passengers on intra-European flights, may climb from just under 10%
at present to around 20-25%. Much of the growth in the no-frills sector did not
detract from the established airlines as the low fares generated additional demand.
The number of low-cost carriers is now also rising in the Asian-Pacific region (e.g.
Air Asia, Bangkok Air, Pacific Blue Airlines, Freedom Air).
Unlike the established network airlines, low-cost carriers:
- serve large to medium-sized cities on a purely point-to-point basis;
- transfer passengers play practically no role.
- they do not offer intercontinental flights.
- they target price-conscious business and private travelers.
The airlines achieve cost advantages in a variety of ways:
- no free in-flight service: no newspapers, no food etc.
- no seat reservation
- no frequent-flyer programs
- no airport lounges
- no choice of class
- no choice of seats
- no connecting flights
- no refunds
- no possibility of rebooking to other airlines
- no travel agents and
- no expensive computer reservation systems; about 90 percent of easyJet and
Ryanair tickets are booked over the Internet.
Distribution is mainly via the internet, with correspondingly low costs, meaning that
the airlines can save considerably on ground staff.
Wages are generally lower than those of the established airlines, or working hours
are longer. The fleet consists mostly of aircraft of a single type in order to obtain
synergy effects in maintenance and the training of personnel.
In addition, the aircraft are in service longer owing to the very short time spent on
the ground. Tighter seating increases the planes capacity.
Low-cost carriers adjust their fares according to the number of seats still available
on a flight, pricing the outward and return flights separately. Despite cheaper fares,
the breakeven load factor for a no-frills carrier is very low (55% at Ryanair,
according to the company itself).
21
The companies negotiations with airports on the latters charges are particularly
important. Since low-fare carriers frequently have considerable market clout in
dealing with regional airports which often have free capacities some have been
able to negotiate extremely low charges.
22
- By keeping the logistics simple, no-frills airlines cut turnaround times on the
ground and maximize revenue-generating air time. On short-haul routes, for
instance, easyJets planes are in the air an average of 12 hours a day, compared with
9 hours for the most efficient traditional scheduled carriers.
- Some European low-cost carriers fly to and from secondary airportslocated
as far as 100 kilometers from city centersthus minimizing landing and ground-
handling fees. On intra-European international routes, this adds up to an operating-
cost advantage per seat and kilometers flown (unit cost) of 40 to 65 percent as
compared with major scheduled carriers.
- Lower costs and higher seat-load factors permit no-frills carriers to offer fares 50
to 70% lower than those of the incumbents.
The average price (revenues divided by the number of passengers) of the no-frills
carriers for a one-way ticket on international intra-European routes is 50 to 85,
compared with 180 to 200 for British Airways and Lufthansa. This approach
attracts price-sensitive and flexible travelers, but the lack of convenience
and flexibility makes the low-cost model unappealing for most passengers
traveling on business.
- Regardless of the approach low-cost carriers take, they enjoy protection from
business cycles, since in hard times demand for premium service tends to decline
as more passengers seek less expensive travel alternatives.
Excluding Ryanair, the European low-cost segment accumulated losses from
1996 to 2001, and AB Airlines, ColorAir, and Debonair went bankrupt.
In the United States, the low-cost industryexcluding Southwest Airlines
lost almost $1 billion from 1996 to 2001, and bankruptcies were rife.
With easyJets acquisition of Go, Ryanair and easyJet between them account
for more than 88% of the scheduled low-cost market in Europe. Southwest
Airlines holds 50% of the US low-cost market.
This pattern suggests that a winner-takes-all dynamic favors the first
entrants, which can use low prices to stimulate demand and build brand
power
Later low-cost entrants, with the same costs and prices, have a harder time
generating the traffic needed to fill their planes.
Trends on the low-cost segment
So how do the low-cost carriers plan to grow in the medium term? - by opening
routes in markets that arent served at all by the bigger airlines, with their
emphasis on business passengers.
Stimulating demand in Continental market segments that have little overlap with
the incumbents routes may be enough to fill the new airplanes. But in the long
term, it is unlikely that low-cost carriers can equal their penetration of the United
Kingdom on the Continent.
23
Where could long-term growth come from?
Analysis suggest that it would require the low-cost airlines to take market share
from the big incumbents and charter companies. But the no-frills will find it difficult
to overcome the structural limitations and competitive challenges in these markets.
France, Germany, and Italy all have the levels of domestic traffic needed to sustain
low-cost offerings, but flights in these markets are already highly competitive and
priced lower than international flights
Given the obstacles to growth in the charter and domestic markets, the
expansion of international routes would appear to be the logical long-term growth
path for low-cost carriers. British Airways short-haul network already suffers from
fierce low-cost competition
What scheduled incumbents fear most is that some of their business traffic
could be at risk if the low-cost offering reaches a critical mass, both in daily flight
frequencies and the number of destinations. This scenario is already a reality in the
London area, where low-cost routes with at least three daily flights are
concentrated; more than half of British Airways international short-haul routes face
low-cost competition. It is doubtful, however, that any other region is big enough to
make such a broad low-cost offering possible
At the same time, the low-cost carriers will be hard-pressed to maintain or improve
their cost positions as they come of age. They might, for example, lose start-up
advantages such as the free or discounted use of secondary airports as those
facilities gained a better bargaining position when contracts came up for
renegotiation.
Europes low-cost airlines can double their market share in the next five years,
mainly by stimulating demand on the Continent. But shaping the future of intra-
European air travel would require the no-frills to make major inroads into the
incumbents customer base. Evidence suggests that this isnt likely to happen
without taking its toll on the profitability of the low-cost carriers.
Two trends seem likely to determine the future of the low-cost carriers.
- First, there is now high potential demand for discount products in air
transport, as in other sectors. But demand growth is set to decline going
forward.
- Second, the capacities of low-cost carriers are currently expanding at
exorbitant rates. EasyJet and Ryanair, for instance, have each placed a huge
order for 250 aircraft (including options) with Airbus and Boeing,
respectively. These orders are the largest ever in the history of civil aviation.
There are bound to be excess capacities in this segment soon if this is not
already the case.
The no-frills airlines have to compete not only with each other but also with the full-
service providers and with other forms of transport. Excess capacities will therefore
keep prices permanently under pressure for a long time to come. This makes it
doubtful that many companies will in fact manage to continue their success story.
Consolidation is, thus, inevitable in this market. Probably just a handful of
24
independent low-fare airlines will remain in Europe in the long run. But low-cost
carriers will certainly retain their place in the air transport sector.
11. ON-LINE DISTRIBUTION
In the field of tourism, technology represents a dynamic and powerful factor
responsible for numerous changes in the past, present, and future of the travel
industry. Technological advances especially in the last two decades have facilitated
the distribution of travel services and will have a major impact on the future
structure of travel distribution systems.
1. The Link between Technology and Tourism
Within the last two decades the tourism industry has experienced tremendous
growth. During this period, a series of rapid and radical changes has been noted.
The resulting evolution has made travel marketers realize that they are not only in
the business of moving pleasure and/or business travelers, but also in the business
of communication and information.
Changes in consumers characteristics, preferences, and decision making, and
continuous alterations in a highly competitive global environment have created an
ever closer relationship between tourism and information technology.
It is important to note that contemporary travelers have different characteristics
from travelers of three decades earlier at the beginning of mass tourism
development. The lack of travel experiences of earlier travelers and the complexity
of the distribution systems favored the creation of standardized travel packages for
groups.
By contrast, todays consumers tend to be better educated with wider exposure to
travel and strong preferences for unique travel experiences. Their desire for
customized travel has influenced their decision-making process as well.
To create memorable travel experiences, suppliers need to provide todays
prospective traveler with a full range of options. Here, the completeness and the
clarity of the information offered to the traveler by the seller are essential variables
of satisfaction.
The complexity of the issue increases as the competitive global environment of
tourism continuously generates more information.
The combination of these forces and the need for high professionalism in handling
the information provided to the consumer necessitates the use of technology to
gather, manage, distribute, and communicate information. Technology surfaces as
the enabler that allows tourism businesses to carry out all these functions in order
to create products and services that address personal travel demands. Additionally,
it helps satisfy the need for value which emerges as a determinant factor of
consumer satisfaction. Technology, then, acts as a strong driving force which is
reshaping the tourism industry and providing companies with a competitive edge.
2. Electronic tourism: a new distribution channel
25
The entire travel industry is experiencing an unprecedented period of change. The
development of information technologies and telecommunications plus the boom in
e-commerce have had a major impact on travel marketing by offering new
channels for distributing products.
Tourism is, moreover, the dominant industry in retail e-commerce, far ahead of
books, music and computers. Many experts believe that 33% of all on-line
transactions are related to travel. However, the first challenge facing on-line travel
agencies is convincing Web users that the tools for shopping on the Internet are
effective since more and more consumers are using the Internet to research travel
information. The trick now is for agencies to convince these lookers to purchase
products on line. According to Forrester Research, only 20 per cent of lookers
actually buy on line, for the reasons listed below.
Reasons why consumers do not purchase travel products on line:
- they prefer the services of a travel agent
- the information found is incomplete
- they do not trust virtual agencies
- someone else organizes their travel plans
- they do not know any good travel sites
- they do not know how
- they are neophytes on the Internet.
Source: Forrester Research
The various tourism sectors that have embraced the Internet revolution have
developed numerous alliances with IT companies such as IBM, Logibro and ITA
Software. These companies have, in turn, created customized services to meet the
needs of the tourism sector.
3. Overview of the top players in on-line distribution
The North American market
In the United States, many travel agencies have taken advantage of the
development of new technologies to modify their distribution channels while new
companies have sprung up.
The chart below illustrates the top agencies in the on-line travel industry.
26
In less than three years, Travelocity.com and Expedia have become major
companies.
Since 2003, the situation has changed, with Expedia becoming the market leader.
27
The European market
Launched in September 1999, eBookers is now the second largest European on-line
agency. Its chief British competitor, Lastminute.com, is now Europe's leading
independent online travel and leisure company.
The year 1999 was notable for the arrival of Travelprice.com. This agency quickly
established itself and has recorded increasing sales since the year 2000.
28
4. New methods of electronic distribution
4.1. Click-and-mortar agencies
As seen earlier, consumers still hesitate to purchase travel products on-line because
they prefer the services of a travel agent. For this reason, on-line travel agencies
feel obligated to add a human touch to their services.
The creation of click-and-mortar agencies (on-line players supported by a network
of traditional travel agencies) is a response to this concern.
While numerous traditional travel agencies hasten to establish themselves on the
Internet, some virtual agencies are trying to develop off-line sales and support
infrastructures. Hotel Reservations Network, Cheap Tickets and Lowestfare.com
offer customers the option of reserving plane tickets or hotel rooms through a call
centre.
Often criticized for their absence from the Web, traditional agencies are now
developing the infrastructures needed to offer customers the option of on-line
transactions.
The strategies differ. Many are setting up their own sites, like the Carlson Wagonlit
group (carlsontravel.com, August 1999) and American Express, who announced in
the summer of 1999 that it would be investing US$250 million in its Web site. In
early 2000, French travel groups Nouvelles Frontires and Club Mditerrane
launched their Internet subsidiaries, NF Online and Club Med Online.
Other agencies have decided to acquire or establish partnerships with firms already
established on the Web. For example, in August 1999 Rosenbluth International
purchased
Biztravel.com and created Rosenbluth Interactive. French group Accor purchased a
2.5 per cent interest in U.S. agency WorldRes.com for US$23 million and Cendant
acquired Cheap Tickets for US$425 million.
Consequently, partnerships are proving to be viable solutions: there is more
cooperation between the old and the new economy. Large chains and traditional
brands are increasing their Internet presence. According to the most recent figures,
11 of the 15 most popular on-line retail sites during the 2007 holiday season were
29
click-and-mortar companies, in other words, companies using both on-line and
off-line distribution.
4.2. Name-your-price systems: New business models
E-commerce today is powered by new business models that go beyond the traditional
consumer-vendor relationship. The latest technologies enable customers to play a
more active role in finding information and making decisions. Some examples of
these new ways of doing business are auctions, name-your-price systems and group
purchasing.
On April 6, 1998, Jay Walker presented consumers with a new way of purchasing
products and services on the Internet: the name your price on-line system. It is
a sort of reverse auction, in that the potential consumer tells the supplier what he is
looking for, for example, the desired destination, travel dates and price he is willing
to pay. In return, the agent, or in this case the Web site, transmits the offer to the
supplier who can either accept or reject it.
The system was an instant success with 1.5 million unique visitors in its first month
of operation. Following the lead of Priceline.com, other distribution companies
developed similar business models, negotiating contracts with suppliers to offer
consumers an attractive array of discount products and services. The mechanism
between supplier and consumer can take various forms, but in the case of
Priceline.com, inventory is purchased only when the consumer closes the deal.
Lowestfare.com, Cheap Tickets and Travelscape.com are among the companies who
have used the Priceline.com model to sell their on-line travel products.
5. Virtual consolidation
New methods of on-line communication have reduced the access barriers to the
travel market, leading to a flood of new players. Hundreds of Internet sites have
sprung up in the last few years, looking for a share of this expanding market.
According to Bear Stearns investment bank, there are approximately 1,000 virtual
travel agencies. These start-ups are founded on new ideas and supported by investor
confidence in the new economy. They have significant financial resources at their
disposal, enabling them to serve both national and international markets.
Over the years, the number of online tourism providers, both generalists and niche
players, has increased, and the market has experienced a gradual consolidation into
the hands of the larger and better-funded companies. There have been some notable
merger transactions and acquisitions in the US and European travel industry in the
past couple of years.
In 2004, Orbitz ($1.25 billion), and Ebookers ($404 million) were purchased by the
US company Cendant, and Lastminute.com was bought by the US company Sabre in
May 2005. New travel-specific search engines emerged, such as the US aggregator
www.sidestep.com (May 2005), which proposes to consumers a single site to explore
30
and book travel packages and filter their results to find precisely what they are
looking for.
From a B2C perspective, the top three US online travel agencies, Travelocity,
Expedia and Orbitz, last two owned by Cendant Corp., comprise about 77 per cent of
the market.
On the B2B side, large American travel groups such as Sabre Holdings Corp. and
Cendant Corp. dominate the online market.
Consolidation of Virtual Agencies on European Market
In August and September 1999, British agency eBookers.com acquired La
Compagnie des Voyages, the first French on-line agency, and German agency
Teletravel Flugreisen GmbH. Almost four months later, it announced the purchase
of three other players: Lloyd Tours, Finlands largest discount agency (revenues of
US$9 million), and two German players, Take-Off Reisen and Cosmos. eBookers.com
is now present in eleven European countries: Denmark, Finland, France, Germany,
Ireland, the Netherlands, Norway, Spain, Sweden, Switzerland and the United
Kingdom.
On August 15, 2000, Lastminute.com acquired the top French agency, Dgriftour,
for US$88.4 million. This deal made Lastminute.com at the time the third largest e-
commerce site in Europe. The transaction was motivated primarily by Dgriftours
expertise at marketing travel in France. The company enjoys a high recognition
factor (45%) in the country.
At present, Opodo and Travelocity represent 60 per cent of the entire online travel
market.
6. The airlines and on-line travel distribution
The airlines too have recognized the importance of e-commerce, using it to establish
direct relationships with their customers and reduce the cost of issuing tickets. It is,
in fact, much cheaper to issue a confirmation number and a receipt rather than print
up a properly completed paper ticket. According to the carriers, they save $30 for
every ticket purchased on-line.
Airlines are taking an increasingly large share of the U.S. on-line travel market. The
number of tickets sold through airline Web sites is growing steadily. Although
airlines are subject to the same rules as travel agencies, they often offer exclusive
rates and special promotions to consumers who visit their sites, thus motivating
them to purchase their tickets directly rather than from a travel agent.
Discount carrier Southwest Airlines dominates the U.S. on-line market with
estimated sales of over US$1.4 billion, or 26 per cent of their overall sales. The
seventh largest carrier in the U.S., Southwest has succeeded where other carriers
have not because the average volume of reservations on airline sites is 3 to 8 per
cent of total revenues.
In Europe, British carrier EasyJet records 86 per cent of its airline reservations on-
line. Plane ticket sales top US$1.4 million per day.
31
Not to be left behind in the on-line travel boom and to further reduce the cost of
selling and distributing tickets, the top carriers in the world have recently begun
launching their own virtual travel agencies. Their goal is very clear: compete head-
to-head with the major virtual agencies.
Orbitz stirs up controversy
Several months behind schedule, American, Continental, Delta, Northwest and
United Airlines five airlines that control 75 per cent of domestic air travel in the
United States officially launched Orbitz.com. This new portal sells tickets for 455
airline companies, including 35 partners, makes hotel reservations and arranges
car rentals. A few days after its launch, the site announced that it was selling 10,000
plane tickets per day. After one month of activity, Orbitz.com was ranked the sixth
largest travel site with just over four million visitors.
The announcement of this site sparked controversy and generated a lot of press.
Given the somewhat monopolistic nature of the alliance behind Orbitz, the entire
traditional distribution network is seriously wondering whether Orbitz will violate
anti-competition regulations. Its competitors fear that member airlines will be able
to offer discount tickets on Orbitz that will not be available to other intermediaries.
To prevent this form of collusion, the U.S. Department of Justice, at the request of
the American Society of Travel Agents (ASTA), examined the new competitive
environment created by the arrival of Orbitz. Despite an apparent competitive edge,
Orbitz has not yet won the e-commerce war, where the major online travel agencies
are waging a tough fight.
Expedia, Travelocity.com and Priceline.com already enjoy impressive market shares,
which means Orbitz will have to invest heavily in marketing to attract and retain
consumers. Orbitz will also face the problem of respecting the individual interests of
all the partners who, after all, are still competitors who want to attract customers to
their respective flights.
Hotwire: Discount portal
Following the announced creation of Orbitz, Hotwire entered the distribution
network in October 2000 as an initiative of U.S. carriers America West, American,
Continental, Northwest, United and US Airways. This business portal offers
discount flights, accommodations and car rentals. Hotwire was started with an
initial investment of some US$75 million from the partner carriers and the Texas
Pacific Group. Technology partners include Eland Technologies, Sabre and Scient.
Paradoxically, Sabre, which owns a 70 per cent interest in Travelocity.com, a
competing on-line travel agency, will be a distributor for Hotwire. Hotwires
structure differs from that of Orbitz: the partner carriers hold no voting shares in
the company.
July 18, 2001, Orbitz and Hotwire signed an agreement to share information about
airfares and hotel rates. This facilitates their customers access to all airfares and
hotel rates.
32
Opodo takes off
Two months after the launch of Orbitz, nine airline companies launched Opodo.
Aiming to become the European leader of the on-line travel market, this portal
started up in December 2001 for the German, British, French and Italian markets.
Air France, British Airways and Lufthansa each hold a 22.8 per cent interest in the
company, Alitalia, Iberia and KLM each hold a 9.14 per cent share and Aer Lingus,
Finnair and Austrian own the rest. The site uses Amadeus technology and offer a
wide variety of products: 480 airlines, 55,000 hotels and 23,500 car rental
companies.
Reduced commissions
On February 28, 2001, Northwest Airlines and KLM announced that as of March 1,
sales commissions to on-line agencies would be eliminated. This decision came at a
time when the sales of airline tickets through virtual agencies were taking off. In
fact, 42 per cent of all airline tickets sold on line (representing US$3.6 billion) are
sold through Internet travel agencies.
The decision to cut commissions had a significant impact on the industry,
particularly the small independent travel agencies. In early March, Southwest
announced that its tickets could no longer be purchased at Travelocity.com. This
move was intended as a response to customer service issues.
The question was whether other carriers will follow suit. Forrester Research had
forecasted that all airline companies would eliminated their commissions to on-line
agencies, leaving them with the choice of either passing on service costs to their
customers or seeing their profit margins shrink.
Ticketing Automation
Other technological advancements have facilitated the distribution of travel while
cutting costs and increasing responsiveness.
Satellite ticket printers (STP) now allow travel intermediaries to issue tickets
directly.
The electronic ticket delivery network (ETDN) is another form of STP. The
difference between them is that the supplier collects a commission for the usage of
ETDN, while only a printing fee is received in the case of the STP. Electronic kiosks,
which are stand-alone computer terminals found in hotel lobbies, airport terminal,
and tourist information offices, now allow travelers to perform a series of different
functions such as hotel check-in, purchase of airline tickets, or receipt of information
about what a destination has to offer.
Another development in facilitating the distribution of travel are electronic travel
documents, simply referred to as ticketless travel, where the passengers personal
information exists in an electronic file with the airline. All the passenger is required
to do is present personal identification to obtain a boarding pass (Gee, Makens, &
Choy, 1997, p. 213).
Electronic procurement: a new type of alliance
33
Business-to-business (B2B) e-commerce and virtual marketplaces are slowly
developing. For businesses, there are many advantages to using these Internet
sourcing systems: access to a large supply of products and services, competitive
prices, economies of scale and reduced order processing, just to name a few.
Forrester Research estimates the B2B market is worth over US$6.3 trillion. The
travel industry, particularly the airline and hotel sectors, will benefit from this
boom, which has already created a number of alliances and partnerships.
On Air Canadas initiative, 13 of the worlds biggest carriers announced the creation
of the largest B2B e-commerce site for the airline industry. Launched in the fall of
2000 under the name Aeroxchange, this Web site offers airlines the worlds largest
selection of airplane parts, services and general supplies. It is expected to process
purchases worth more than US$50 billion a year for various items, especially
airframes, aircraft assemblies and engine components, as well as maintenance
contracts and a wide range of aeronautical goods and services. In addition to the
founding members, airlines who do not belong to the Star Alliance, other firms with
industry ties and their suppliers will be invited to use the services of the site, which
will be administered independently of the carriers themselves.
8. The Future
The single most important issue concerning the future of the travel distribution
systems is the elimination of the intermediary or middleman (i.e. travel agent and
even the wholesaler) from the distribution chain.
Indeed, the two most powerful technological trends, ticketless travel and the
Internet, tend to challenge the survival of travel intermediaries. Individual
computer users with direct access to ample on-line travel information can make
their own travel arrangements. This, in combination with the possibility of using an
electronic, instead of a regular ticket, makes traveling possible without the use of
intermediaries.
It is possible that travel intermediaries will shift their business on-line.
This could involve collecting, managing, adding value, and redistributing
information via the World Wide Web to computer users. They can also make use of
upcoming technologies by providing on-line videos of vacation destinations and
direct e-mail messages to update their customers on the latest travel bargains.
However, one should keep in mind that competitors from fields not directly related
to tourism, such as telecommunications and computer companies, possess
technologies that can make on-line travel planning possible. These companies
constitute a serious threat for travel intermediaries that plan to go on-line.
No matter what the future developments may be, many insist that the value of the
personal element of the travel intermediary business cannot be substituted by non-
personal technological advancements. Additionally, it can be argued that those who
do travel frequently, such as corporate executives, cannot spend time on booking
their own travel.
34
What can be stated with certainty is that the structure of travel distribution systems
is changing, and adopting new technologies to do business will be the single most
important factor in the future survival of travel intermediaries.
35