Can Direct-Booking Campaigns End Up With Both Sides Declaring Victory?

Shifting hotel bookings to their own websites is clearly a positive for the large hotel chains, but online travel agencies could actually come out ahead, as well.

For the online travel agencies, much of the volume that moves to hotels’ own channels will be replaced by smaller chains and independents. The commission rates from those entities are likely meaningfully higher than those paid by the mega brands in the U.S. If volume is shifted rather than lost, the online travel agencies should benefit from higher commissions and improved margins on each transaction.

The worst-case scenario for the online travel agencies would be a broad shift in consumer behavior where direct booking becomes the norm for all hotels. Given the online travel agencies’ vast inventory and huge marketing budgets, the most likely result is a gradual increase in direct booking for the large chains and some smaller ones riding the direct booking campaign coattails. The majority of volume would simply shift between the larger hotels to smaller ones and independents resulting in a neutral to positive economic outcome for the online travel agencies.

Neither Side Is Fibbing

The ongoing debate surrounding direct booking continues to play itself out during earnings season. The hotels have touted their success while Expedia once again emphasized that there was minimal impact thus far. At first glance, this seems to be inconsistent where one side must be disingenuous, but the economics behind the scenes supports the claims by both sides, although there are obviously risks involved.

Expedia was the first of the large online travel companies to report earnings in the third quarter of 2016 with Priceline and TripAdvisor reporting on November 7 and November 9,  respectively. Expedia’s room night growth, excluding the impact of acquisitions, was up 11 percent year over year. This was down from 12 percent in the prior quarter. However, Expedia states this has reversed course with 14 percent growth in September.

Most large, publicly traded companies would be ecstatic to see consistent double-digit volume growth, but compared to Priceline, and Expedia’s own historic growth trajectory, these numbers could be described as subpar.

The fear surrounding Expedia’s core online travel agency business is that volume is slowing due to the success of the large hotel chains’ direct-booking campaigns. However, this is more likely correlation versus causation where the actual driver of slower growth is the maturing of the U.S. online travel agency market (Expedia derives nearly two-thirds of its bookings domestically).

After the initial rapid growth phase where offline booking moved online, Expedia benefitted from the broad acceptance of mobile usage in the U.S., adding to Internet usage in general. Subsequently, Expedia consolidated domestically, purchasing Travelocity and Orbitz.

In the U.S., Expedia’s growth going forward will be more about broad operational effectiveness and conversion, maturing industry growth, increasing inventory, and growing Expedia’s share of bookings versus other online travel companies, suppliers and offline players. A reasonable expectation for the next few years would be a mid-teens percent volume growth outlook for Expedia’s core online travel agency business excluding the impact of acquisitions.

Priceline’s Booking.com remains the industry leader and last quarter guided to 18 to 23 percent room night growth for the third quarter after a strong 24 percent performance in the second. Management also guided to 15 to 20 percent gross bookings growth in constant currency for the third quarter after an impressive 21 percent result in the second. We will see how the results play out next week, but these numbers support our view that direct booking is not hurting the online travel agencies.

DIFFERENCES BETWEEN PRICELINE AND EXPEDIA

Looking at the headline growth numbers, one may assume that Expedia is being hurt by the direct booking campaigns while Priceline is not. This is not the case. Instead, there are a few key differences between Priceline and Expedia’s core online travel agency businesses at play.

The first is simply that Priceline’s Booking.com is far more internationally focused. Outside the U.S., the hotel market is more fragmented and there has been less industry consolidation on the online travel agency side than in the U.S.

Priceline’s Booking.com has unmatched scale as well. Both Expedia and Priceline have continued to add inventory in the 20 percent-plus range, but Booking.com dominates the space.

Expedia Vs. Priceline Hotel Room Count

Source: Company filings. 

Note: In the fourth quarter of 2015, Expedia removed nearly 20,000 indirect or third-party properties, offsetting 18,000 new properties added in its hotel count.

A subtle, but important, reason that Priceline can maintain 20 percent room night growth or more is management choosing to emphasize the agency model. Under the agency model, Priceline simply receives a commission for getting the guest to stay at the hotel. This is much less complicated than the merchant model Expedia historically emphasized in the past. Under that methodology, the online travel agency actually does the booking, handles the payment, and takes on the associated risks. The compensation is higher, but the process is more complicated and it is more difficult to add smaller chains. The agency model helped contribute to Booking.com’s scale advantage.

Overall, Booking.com continues to master digital marketing and utilizes its scale and agency model to maintain high conversion rates. We will get another update from Priceline next week on its earnings call.

On Expedia’s third quarter earnings call last week, CEO Dara Khosrowshahi once again emphasized that the direct booking campaigns are not hurting Expedia. When asked about the performance in more versus less brand-heavy markets (essentially amounts to U.S. vs. international), he responded:

“We’ve measured pretty carefully our performance in, call it, brand-heavy markets versus brand-light markets. We continue not to see any measurable difference between the two. So, it doesn’t seem to be affecting our results. What it is doing is that it is shifting more share of our supply to the independents who’re growing faster than some of these brands and also to – there are some brands who are giving us the best inventory.”

His next set of comments support our view of pricing differentials helping profitability per booking:

“So in general, the players who are giving us the best inventory are growing faster in our marketplace, both in terms of direct bookings and then you would think as far as the traffic that they’re acquiring. So, and that shift actually is giving us some decent margin, call it, relief versus what we’ve seen in the past. So, you’ll notice that revenue per room night trends are generally improving as the year has gone by and some of it is due to the shift.”

The exact amount of Expedia’s hotel room night growth being impacted by direct booking is impossible to quantify precisely, but we can back into a rough approximation. Skift estimates the largest hotel chains make up 10 to 15 percent of Expedia’s total hotel properties and several large chains have stated that nearly 60 percent of their bookings come through their rewards programs, which are a good proxy for direct booking.

The hotels are seeing gradual success in moving traffic to their own websites. For example, in the third quarter, Hilton had two percent of channel shift in its favor. This is meaningful for Hilton, but for Expedia, we estimate that this likely amounts to roughly five basis points of Expedia’s hotel inventory.

If we assume other top hotels achieve similar success, Expedia would see roughly 0.25 percent of volume lost plus whatever the smaller chains benefit from in terms of their own direct bookings. At worst, this seems to suggest the latest quarter had perhaps a 0.5 percent negative headwind for Expedia from direct booking on volume and, likely, the impact was neutral economically.

If the larger chains were able to push direct booking to 80 percent of total bookings over time, Expedia’s longer-term volume headwind from the booking campaigns could be roughly two to three percent if all this volume was lost rather than shifted to smaller chains and independent hotels. If volume is simply shifted, the headwind would fade or even become a tailwind.

Conflicting Narratives

The conflicting narratives from the online travel agencies and the hotel chains do not mean that either side is wrong. Instead, it comes down to how a booking shift impacts the groups differently. For the hotels, a two percent shift of inventory in the quarter would add around 20 basis points of growth to profits assuming a 10 percent commission is removed from the online travel agencies and ignoring extra marketing and personnel costs to achieve this. However, in the short-term, it is likely that the chains’ price concessions to loyalty members and other rewards are valued near this 10 percent number (if not higher) and the shift would be neutral and somewhat negative when adding in increased marketing spend.

Over time, if the hotel chains could reach 75 percent of bookings being done directly off a 50 to 60 percent starting point, they could realize a 1.5 to 2.5 percent benefit to earnings growth, which is quite impactful; this assumes a 10 percent commission removed without a price concession and normalized marketing spend.

For the online travel agencies, shifting booking from large to small suppliers would increase the online travel agencies’  effective take rates and could actually make them better off even if they lose some volume. For the small chains and independents, the increased volume is worth the fees where the online travel agencies are both a key demand-generator and effective marketing channel to compete with the mega chains.

If done correctly, a gradual and rationale industry booking shift could benefit the three key players in the online travel ecosystem at the expense of those outside of it. Independents and small chains not using the online travel agencies would get hurt as they lose share to those that are.

If direct booking could be positive for both parties, it begs the question, why wouldn’t the online booking sites embrace direct booking by the large hotels who pay lower commission rates than smaller competitors. The first part of the answer is simply that there is no guarantee that all lost volume gets shifted. Additionally, the online booking sites do not want direct booking to become a broad industry trend. The second part is that the only way all sides can win is if there is not a prolonged pricing battle and all sides behave rationally.

Some hotel chains have pushed discounted rates for direct booking and not offered the online booking sites equivalent best rates. In retaliation, the online travel companies appear to have engaged in dimming. This consists of moving the hotels not providing the best rates down in the search queue or lowering the visual attractiveness of the listing by removing pictures in order to push booking away from those hotels. If this directly resulted in a simple share shift, there would not be an issue. However, if a pricing battle ensues, it would also hit smaller players as they try to maintain competitive rates versus their larger peers and also engage in discounts, creating a negative feedback loop.

If volume is shifted rather than lost, but average price per room night falls, the commission for the online booking sites would decrease as well. It is not the channel shift itself that could negatively impact growth for Priceline or Expedia, but instead, it is the potential for price compression across the industry. Given recent partnerships between the online travel providers and several hotel chains, it seems likely that both sides will find new ways to work together without the issue escalating into a negative headwind for the entire ecosystem.

Expedia’s core online travel agency business should continue to be a steady driver of consistent free cash flow growth for Expedia, but Expedia’s acquisition of HomeAway is likely to prove to be transformational. The alternative lodging space could very well become the largest growth driver for the company as we look out over the next five to 10 years.

HomeAway has vast inventory that is hard to find elsewhere. Additionally, the blurring of the line between alternative and traditional lodging should continue. Expedia is already beginning to offer HomeAway inventory on Expedia.com and will expand it to sister company Hotels.com. For more on the HomeAway acquisition and Expedia more broadly, please see our 2016 Trends Report on Expedia [subscription].

Priceline should continue to put up stellar organic growth numbers driven by Booking.com while Expedia’s core online travel agency business will have solid, but slower growth, with Expedia’s longer-term growth path being determined by the success of its alternative lodging push. There is enough room for growth in the industry for both online travel agencies and the hotel chains to succeed simultaneously, albeit with different drivers.

Jared Wein is Skift’s Senior Research Analyst.