Copyright: melpomen

The digital transformation of our economy has produced a number of dominant players who exercise a near-monopoly in their sector, such as Amazon, Google and Facebook. Some suggest that this comes with the territory and is an effect of platform business models [1] [2]. However, positive network effects are not a guarantee for success. Barriers to entry and switching costs have just as much influence on the success of platform business modes as they have on other business models [3].

To illustrate that the digital transformation does not change competitive analysis, in this blog I present a competitive analysis of the digital airline booking ecosystem using the techniques present in our recent ecosystem design book [4].

Let’s start with the pre-internet situation.

Offline Ticket Booking

Pre-internet, ticket booking consisted of calling up an airline or visiting one of their offices or visiting a travel agent (TA). The offline value chain was dominated by Global Distribution Systems (GDSs), which aggregate information about seat inventory to travel agents (TAs).

The arrows in this diagram represent value propositions. Airlines provide information about their inventory to GDSs, who aggregate this for TAs. TAs provide a booking service to travelers. This system grew steadily from the first computerized reservation systems in the 1960s to an ecosystem dominated by GDSs in the 1990s.

A history of GDSs

In the 1960s, GDSs started as computerized reservation systems (CRSs) owned by airlines. From 1976, airlines connected their CRSs to travel agents by placing a booking terminal in the TA’s office. TAs had to pay for the installation and maintenance of each terminal and needed training to use them. This was expensive for TAs but it greatly reduced booking time.

In the 1980s, the airline industry was liberalized, and fuel prices dropped. Many new airlines sprang up and major airlines aggregated the inventory of other airlines through their booking terminals, for a fee. TAs now could use one terminal to search for flights of several airlines. The CRSs had become two-sided platforms that connected multiple TAs and multiple airlines.

However, the major airlines who owned the platforms started self-preferencing by placing their own flights higher in the search results than that of competitors. (Surprise!) Regulators were quick to prohibit this.

Eventually, the booking platforms divested from the airlines. After a process of mergers and acquisitions, there are now three major GDSs: Amadeus, Sabre and Travelport (which owns Galileo, Apollo and Worldspan).

GDSs also aggregate inventory in train travel, car rentals, hotel rooms, cruises, and even airport transfers. In this blog we only look at airplane seat booking. As airline tickets are the least profitable part of a trip for a TA this ignores the sources of profit for TAs. But it does allow us to understand the competitive position of GDSs with respect to online travel agents, discussed below.

Booking a seat

In the above offline ecosystem, travelers can book a seat with a travel agent or directly with an airline. A travel agent can compare prices and conditions across airlines and can offer the cheapest flight, possibly composed from segments provided by different airlines. Booking directly with an airline has the advantage of easier changes and cancelation of the flight, but had the disadvantage of having to visit or call an airline office, and lacking comparative price data. Less than 20% of reservations were made directly with airlines.

Revenue model

TAs receive commission from providers. The highest fee is taken from insurance companies, the lowest from airlines, with hotels and tour operators in between.

GDSs receive a fee of on average $5 per flight segment per booking from airlines, which they share with the TA where the booking was made. The size of the fee and the percentage of the split with TAs is negotiated and depends on the bargaining power of the TA. TAs also pay a subscription fee to the GDSs they use. All but the largest TAs have a subscription with only one GDS.

Competitive analysis

In this ecosystem, GDSs are platforms with positive network effects. The more airlines provide information to a GDS, the more useful the GDS is to a travel agent. And the more travel agents use a GDS, the more useful the GDS is to airlines. Major airlines typically provide their inventory to all GDSs, though GDSs do tend to concentrate on one geography (North America, Eurasia, or the global south). Travel agents usually have a subscription with one GDS only. Jonathan Knee cites a Merill Lynch report stating that GDSs consistently captured up to 10% of airline industry profits ([3], page 204).

GDSs’ positive network advantage is protected by high barriers to entry. GDSs are integrated in airline processes and software, and it is very expensive to start a new one with all the interfaces to airlines that GDSs have. This complexity effectively prevents new entrants in the market.

At the same time, TAs have high switching costs due to asset specificity of their interface with a GDS. It takes a lot of training to learn to interact with a different GDS. And since all major airlines are connected to each of the three GDSs, TAs can make sufficient revenue from subscribing to one GDS only.

Online Travel Agents (OTA)

With the opening of the internet in the 1990s, this ecosystem was disrupted by the rise of online travel agents (OTAs). Many of them were financed by airlines, perhaps in an attempt to break the power of GDSs.  The ecosystem is now more complicated.

It is easy to start an OTA. Like any other TA, they need to take out a subscription with a GDS. OTAs do not compete with GDSs. They are clients of GDSs and compete with physical TAs and with each other.

In this competition, they are at a disadvantage. First, their fixed costs are low, the number of travelers is large, so it is easy for competitors to enter the market and get to a break-even point. However, to make it known that they exist, they have to heavily spend on offline marketing. Without massive offline marketing in public spaces like airports and highways, no traveler will be aware of the existence of the OTA.

In addition, they depend on the gateway to the internet, Google Search. Much of the online marketing budget of an OTA will be spent on Google ads. The marketing budget of OTAs is an important part of their fixed cost. Both Booking.com and Expedia spent about $6 bn on marketing in 2022, which for Booking.com is 35% of revenue and for Expedia 52%.

Despite so much effort to acquire customers, OTAs lose customers easily. For example, many travelers prefer booking on the airline‘s website even after finding a flight on an OTA.

Metasearch engines

A new addition to the competitive landscape are metasearch engines. Shortly after the rise of OTAs, metasearch engines like Skyscanner, Kayak.com, and Google Flights sprang up. They catch some of the potential visitors of OTA web sites and refer them to these websites ¾ against a fee. Or they refer them to an airline site, if they pay a higher fee, so that the OTA never sees them.

Google expanded Maps into a metasearch engine for OTAs by extending its route planner with flights. This increased the money stream from OTAs to Google in the form of referral fees. In addition, they seem to have a contract with the small OTA Kiwi.com, who specializes in flights that consist of segments provided by different airlines.

Metasearch engines sift through deals not only of OTAs, but also of full-service carriers, and of low-cost carriers (LCCs) which typically don’t distribute their inventory via GDSs. As a result, the visitors will get the widest possible range of flights available in the market.

When competing with other OTAs, an OTA has no unique selling point. All OTAs compete for the same travelers, they show the same cheap flights because they use the same GDSs, and they all use the same SEO tricks to get high in the Google Search listings.

Switching costs for travelers across OTAs are very low. OTAs try to create customer loyalty by membership programs.

In contrast, when competing with physical TAs, they miss USPs that physical TAs have. Usually, flight booking is part of travel booking that also includes hotel, tour and other bookings. Physical TAs nowadays sell travel as an experience that will transform your life. They may specialize in adventure trips, luxury trips, active holidays, green holidays, corporate travel, and more. Plus, if something goes wrong, the traveler knows who to go to. Offline TAs are far from dead.

To sum up, OTAs end up with high fixed costs for marketing and have trouble capturing their customers. They are caught in between Google Search and GDSs and need to spend considerable amounts to Google to acquire customers, and to GDSs to acquire information. And metasearch engines make acquiring customers harder and more expensive. Customers tend to use OTAs as search engines and turn to airlines for actual booking.

As a result, there has been a process of consolidation that resulted in two large players, Booking and Expedia, who can spread out their marketing costs over more transactions and can generate more revenue from their GDS subscription than a smaller player can. Booking and Expedia capture 90% of the online booking market ( [3] page 208).

Today, 50% of airline sales consist of direct bookings with airlines ([3] page 208), which offer the same convenience as OTAs. About a third of travelers globally book tickets with OTAs, which leaves about 20% for TAs. This includes the profitable category of corporate travel and, as indicated above, traveling to enhance your life experience. Corporate travel accounts for 75% of airline revenue.

New Distribution Capability (NDC)

GDSs exchange data via the EDIFACT protocol, defined in the 1980s. This is a limited and rigid data format that does not allow airlines to sell optional extras, such as the ability to select a seat, to upgrade a seat, get more legroom, take more baggage, get priority boarding, get a better meal, use Wifi, buy carbon offsets, access the lounge, etc. etc. Airlines generate most of their profits from these perks. Also, they would like to track their customers to offer dynamic pricing, which is not possible with EDIFACT.

In response to these needs, the International Air Transport Association (IATA) released an XML-based communication standard called New Distribution Capability (NDC) in 2015. This allows airlines to interface with travel agents directly, using message formats that describe optional extras and identify the across transactions.

As soon as NDC was released, Lufthansa Group, which covers Austrian Airlines, Lufthansa, SWISS, Air Dolomiti and Brussels Airlines, started charging $16 extra for bookings received through a GDS and paid out $1 for bookings directly at Lufthansa.  However, by this time, GDSs had evolved into software providers for the hospitality industry, airports and airlines and were extending their services with retail platforms using the NDC standard. Also, smaller TAs did not have the capability to develop NDC interfaces and stuck with GDS’s EDIFACT communication anyway.

After a battle of 5 years, Lufthansa Group reached an agreement with Sabre to continue using connectivity using EDIFACT, but with reduced surcharge for TAs, plus NDC connectivity through the Sabre retail platform without surcharge.  The release of NDC plus powerplay by Lufthansa Group had forced GDS in upgrading their technology.

Lessons learned

This story illustrates two classical factors that go into building a moat around a business: barriers to entry and switching costs.

OTAs have low barriers to entry, which explains why many sprang into existence in the early internet days. However, they need to spend a high amount on offline marketing to become known and have a high fixed online marketing cost to continue to attract customers. These costs are too high for small OTAs.

At the same time, metasearch engines increase customer acquisition costs for OTAs and also deflect customers away to direct booking airlines. OTA switching costs for travelers are low and customer loyalty is low as well.

This explains a consolidation of OTAs in two major players, Booking and Expedia, which can spread their marketing costs over a larger set of transactions, can keep customers longer on their site, and motivate customers to return by membership programs.

GDSs have high fixed costs and the barrier to entry is high. (O)TAs and airlines have high GDS switching costs. Only large players like Lufthansa group can afford to threaten cutting ties with a GDS. But even in this case, GDSs are now travel technology providers and are able to incorporate any distribution technology that threatens to become a competitor.

Positive network effects explain the revenue generated by GDS from connecting airlines and travel agents. But they do not explain their competitive advantage. Competitive advantage of GDSs consist of high barriers for new entrants, high switching costs on both sides of the platform, and the size to incorporate new connection technology in their platform.

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