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BTC Warns Industry of Pitfalls of AA’s Direct Connect Policy

January 11, 2011 By: Staff
 


Underscoring the critical importance of the ongoing clash between airlines and GDS systems, the Business Travel Coalition (BTC) has issued a detailed analysis entitled “AA’s Direct-Connect Gambit Is Risky Business. Is there a path to success?

In its analysis, BTC examines five fundamental risks that it believes AA is assuming in “pursuing what seems to most observers to be a high-risk gambit,” and offers ten wide-ranging barriers it sees to AA’s success.

“Although BTC suggests a scenario in which AA could succeed, at least to a limited extent, there is scant logical rationale that would support AA’s ultimate and complete success,” the BTC argued.

The BTC's conclusion: "It is BTC’s fundamental belief that the interests of airlines and customers should be in near total alignment over time if airlines, as an industry, ever hope to achieve sustainable profitability. Perhaps it’s time for AA to return to the boardroom and put the customer, and those who service the customer, back into the center of the airline’s Direct Connect analysis and bridge what’s rational at the firm level with what’s rational at the industry level.”

The group's analysis in full:

I. Introduction & Top-Level Analysis
On January 6, 2011 a Business Travel Coalition (BTC) member, a travel management company (TMC) executive, wrote and asked, “What do you really think the end of the story is with AA?” The analysis that follows is a result of that inquiry.
One of the immutable truths about the airline industry that is played out over and again is that in airline boardrooms, policies and strategies that look rational at the firm level are often totally irrational at the industry level. If implemented, these strategies can result in collateral damage to other industry participants, including customers. American Airlines (AA) is a savvy, well-respected and innovative worldwide aviation leader. From AA’s perspective, its Direct Connect strategy most likely seems 100 percent rational.
It appears AA seeks to lower its distribution costs; lure substantially more consumers to aa.com where it can secure higher yields due to several factors; and breathe life into a now infamous 2009 “I Have A Dream” speech. AA’s CEO romanced analysts about consumers some day paying for access to AA’s fare and ancillary fee information. “I can see a day, and maybe I’m dreaming here, where those folks who are the intermediary between us and our customer have to pay for access to our product rather than us paying them to distribute our product,” said Gerard Arpey, CEO of American Airlines in April 2009.
While gazing over the travel distribution horizon, AA no doubt perceived the game-changing benefits for itself from a Direct Connect strategy while boardroom blinders apparently prevented it from seeing the panoramic fatal flaw in its plans. In reality, what made 100 percent sense to AA would indeed serve to impair critical aspects of the current distribution system (such as efficiency) of immense value and importance to TMCs, corporate travel departments, and importantly, AA’s codeshare partners and other airlines.
In the following analysis, BTC examines five fundamental risks that AA is assuming in pursuing what seems to most observers to be a high-risk gambit. We also look at ten wide-ranging barriers to AA’s success in this endeavor. Although BTC suggests a scenario in which AA could succeed, at least to a limited extent, there is scant logical rationale that would support AA’s ultimate and complete success.

II. Five Fundamental Risks AA Is Taking
1. Immediate / intermediate revenue loss in the billions of dollars. In particular, AA risks a huge loss of premium revenues that are derived from TMCs and corporate customers at the very time that AA struggles under a significant labor-cost penalty vis-à-vis other major network carriers, and thus, needs that premium revenue dearly.
2. Diminished value as a codeshare partner. AA risks devaluation of its long-term prospect as a codeshare partner for foreign carriers as it alienates TMCs and corporate customers who account for so much international traffic, and especially premium traffic.
3. Long-term market share / revenue loss of high-end TMCs and corporate customers. Once disaffected TMCs and corporate travel managers decide to change supplier partners, those decisions are typically strategic in nature and are not easily reversed.
4. Negotiating leverage loss ahead of late 2011 GDS negotiations. If a baseline objective for AA in its Direct Connect strategy is to increase leverage ahead of 2011 GDS negotiations, the opposite result could be the outcome should the marketplace ultimately reject AA’s proposition causing the airline to capitulate.
5. Regulators’ concerns about concentration of market power. Regulators in various Capitals are keenly watching this power play as they consider decisions that would lead to further consolidation of the airline industry, and responses that seek to safeguard consumers’ interests. These regulators are no doubt sensitive to any signs of abuse of market power. Such concerns can foster an environment where government intervention can be the predictable response by legislators and regulators.

III. Ten Barriers To AA’s Success
1. In a December 2010 BTC industry survey of 452 travel industry professionals, 99% of corporate travel managers and 100% of TMC executives indicated that they do not want AA’s Direct Connect product.
2. Orbitz and Expedia, according to published reports, are no longer providing AA with combined annualized sales revenue of between $1.8B and $2.4B.
3. The U.S.-based travel industry research firm PhoCusWright in a May 2010 report for the year 2009 indicated that some 87% of travelers began their shopping on the Internet. After finding the offer that best met their needs, 28% of those travelers then jumped from websites such as Orbitz and Expedia to an actual supplier’s website to make a purchase. These travelers are now blinded to AA’s offerings on these online travel agency (OTA) sites. Consequently, AA’s sales risk is dramatically increased beyond the $1.8B to $2.4B in annual sales from Orbitz and Expedia.
4. AA has had to implement aggressive short-term discount initiatives having to buy back at a premium the market shares they would have lost due to its withdrawal and expulsion from Orbitz and Expedia respectively.
5. U.S. TMCs as well as those headquartered abroad appear to be sending business to airlines that respect their and their clients’ needs as both a matter of principle - tied to a currently efficient distribution system worth preserving - and because AA surcharges to TMCs booking via Travelport now make AA fares more expensive in the travel agency and corporate booking tool displays. This likely represents millions of dollars in adverse impact to AA’s bottom line.
6. Sabre’s response to AA’s insistence on forcing Direct Connect on the marketplace was to begin charging AA full “retail” segment booking fees raising AA’s costs by double digits for tickets sold through Sabre-powered agencies. (If in response, AA surcharges TMCs booking through Sabre, then AA’s fare offerings could suddenly be more expensive than competitors’ offerings in travel agency and corporate booking tool displays.)
7. Travel industry organizations, individual distribution system participants and corporate travel managers are providing industry colleagues with leadership and analysis that expresses an opinion that Direct Connect is not a disruptive technological force designed to usher in better, cheaper, faster travel solutions, but rather a destructive anticompetitive force designed to revert the industry and consumers to the inefficiencies and opaqueness of the 1970s air ticket purchasing environment.
8. AA competitors no doubt are already aggressively capitalizing on AA’s overreaching, as they did in 2006 when AA persisted in endeavoring to transfer its cost of merchandizing and distribution to TMCs and then onto the backs of customers. The year 2006 represented the first marketplace-based airline/GDS negotiation after 20 years of U.S. government regulation. All the airline/GDS contracts were essentially up at the same time, which should have minimized AA’s risk in its efforts to force a cost-transfer. However, because of AA’s long drawn-out overreach, it was widely reported at the time that United and Delta were able to successfully poach AA’s TMC partners and corporate-customer accounts, especially in lucrative AA markets such as NYC.
The year 2011 only makes it worse from an AA perspective. Most of AA’s major competitors’ GDS contracts are not expiring until 2012 and 2013. As such, it would appear that there is enormous opportunity for AA competitors to win lucrative market shares from AA’s book of top TMC and corporate accounts. AA competitors can effectively hedge their bets, i.e. they can go about luring AA customers while preparing a defensive strategy of direct connect functionality between now and their 2012 / 2013 GDS contract expirations, should AA succeed in its gambit.
9. Major AA competitors are contractually bound to fulfill their obligations to GDSs through 2013. What’s more, the new United Airlines in particular has aggressively positioned itself in the marketplace as wanting to be the airline-of-choice for business travelers, corporate travel managers and the TMCs that support them. So, how is it remotely conceivable that a necessary condition for AA success, i.e. major network carriers following AA, could come to be?
10. For AA to secure any economic benefit whatsoever from its Direct Connect scheme, the travel industry must wholly embrace its vision of the future of travel distribution as well as AA’s plan to actuate such a vision. In addition to TMC and corporate travel manager support, this effectively means that major U.S. network airlines must disregard near and mid-term market share opportunities vis-à-vis disaffected TMCs and corporate travel managers and agree with the self-professed wisdom of AA’s plan. To follow AA, competitors would need substantial time – a luxury AA does not have – as well as money and management resources to invest in the development of an equivalent direct-connect technology and a go-to-market strategy. This would be against a backdrop of massive cultural and systems integrations at recently merged Delta/Northwest and United/Continental that place a premium on management time and attention.

IV. Is There A Success Path For AA?
BTC could find no published industry analysis or airline or travel industry expert who could articulate a coherent scenario regarding how AA could truly succeed in its high-risk scheme. One BTC source stated, “Before the Orbitz development, AA posturing was free. Now with responses from Orbitz, Expedia and Sabre this initiative is likely costing American real money. Given an exceedingly unclear and complex exit strategy from this debacle, I would like to be a fly on the wall at American Airlines’ executive meetings when its CEO asks the threshold questions about how the plan is coming along.”
BTC has long admired the strategic and storied commercial prowess of AA management and believes the carrier has to have either an Ace in its pocket that no one else can figure out, or else it could be that it is willing to settle for a limited victory in non-competitive markets like Dallas or Miami, and live to fight another day. It is conceivable that in these AA-dominated markets there are TMCs and corporate accounts that could be sufficiently encouraged to accept AA’s Direct Connect proposal.

V. Conclusion
In a January 6, 2011 Tulsa World article Henry Harteveldt, vice president of Forrester Research, and a travel and airline industry analyst, was quoted as saying: "'If American is not being displayed on Orbitz, customers may not know or care. American doesn't have free checked baggage (like Southwest Airlines); it doesn't have Wi-Fi on all its domestic flights like Delta. American doesn't have the best on-time performance, the best baggage reliability nor is it the largest airline.'"
Robert L. Crandall, former Chairman and CEO of American Airlines, in a speech entitled The Customer Is The Focus Of Everything, delivered on December 7, 2010 in Istanbul, Turkey, stated, “I think airlines should be bending their best efforts to thinking about what can be done to benefit customers -- and in the process, help themselves. To do so, every carrier must answer the questions…what do customers want, and would you be willing to do business with yourselves."
 


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