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In September 2015, when Lufthansa Group began adding an $18 (16 euro) surcharge on tickets booked through middlemen, one of the leading such global distribution systems, Sabre, said it wasn’t worried.
The Texas-based Sabre said that fewer than 2 percent of the bookings it sells via travel agents were from Lufthansa. So, even if lost a lot of ticketing business, it wouldn’t be hurt too much.
Fast forward to Tuesday, when a top Sabre executive was saying pretty much the same thing. Only this time the comments were in response to the May 2017 announcement by International Airlines Group (IAG) that in November it would start adding a surcharge to British Airways and Iberia bookings made through third-party technology companies.
Sabre says that London-based IAG represents less than 2 percent of its bookings. The tech giant is again not expecting to take a substantial hit because of the surcharge.
Rick Simonson, Sabre’s chief financial officer, spoke at an investor conference run by Bank of America Merrill Lynch.
A primarily European problem?
One of Sabre’s points is that its Madrid-based competitor Amadeus is more vulnerable to the distribution strategy shifts of European-based airlines because it processes more of those airlines’ tickets.
But Simonson’s broader point is that the U.S. and European markets are different.
Simonson says that in the U.S. market — where Sabre has greater market share than rivals Amadeus and UK-based Travelport — the three distribution systems charge “quite a bit lower” fees on average for airlines to use their services than is common in Europe.
Given relatively lower fees, the airlines feel less urgency to get the tech middlemen out of the distribution chain, according to Simonson.
But in January, United said it wanted a better deal with he global distribution systems.
“In an ideal world, we’d get to a balanced relationship, where the GDSs were fairly compensated for what they add, but that it was fairly compensated and the customers actually had the choice of whether to go direct or whether to use the GDS,” said United president Scott Kirby at the time.
“I’m not 100 percent sure how the situation will evolve,” Kirby said. “There’s the potential for GDSs to be partners. But that has to be a balanced relationship if they’re going to be partners.”
Simonson’s fee analysis was based at least in part on a 2016 study by Bank of America Merrill Lynch, which happened to co-lead Sabre’s IPO in 2014.
That report found that distribution system pricing has fallen approximately 20 percent over the last decade in the U.S. due to the deregulation of the industry and fee structures that incentivized carriers to provide full content offerings via third-parties.
In speaking with investors, Simonson obliquely referenced another supposed structural reason why surcharges aren’t coming to the U.S. — opposition from Expedia, Inc., the largest buyer of air tickets in the U.S. and Sabre’s largest online travel agency customer.
Expedia’s prices for tickets would go up overnight, if a surcharge were added, putting it at a competitive disadvantage with airlines’ own websites and, to a lesser extent, metasearch sites such as Google Flights and Kayak to the extent airlines grant them booking capabilities.
Another of Sabre’s points is that most of the tickets that Lufthansa Group has moved over to direct distribution so far among corporate customers have been so called “local” tickets, meaning short-haul flights within Europe that don’t have a high transaction value.
So the amount of actual revenue moving out of the distribution system channel is relatively small due to the nature of the bookings.
Sabre also argues that the surcharge is most-effective for the airlines in home markets where Lufthansa Group and IAG have dominant market share — and where corporations don’t have many alternatives for flying other airlines to avoid the third-party booking fee.
Exhibit A: Simonson notes that in the fourth quarter, Lufthansa Group reported that its airlines had growth of about 5 percent in the direct channel and of about 5 percent in the third-party distribution channel.
So the growth in direct bookings did not necessarily ruin the middlemen’s business.
Sabre argues that the European airline groups will not have the market power to be able to make such changes work overseas.
Meanwhile, in North America, the company is betting that the surcharge would only have enough weight to hurt Sabre if a majority of the four dominant airlines, namely United, American, Delta and Southwest, applied it. Yet it would be unlikely for the airlines to pile on in that way because the government might accuse the airlines of breaking competition laws if they appeared to be acting in concert to affect pricing.
American Airlines was a leader in pushing for direct bookings with travel agencies and trying to diminish the role of the global distribution systems, but abandoned the effort even before its 2013 merger with US Airways.
Without several airlines making the same move at once, no one airline would likely risk losing market share by unilaterally making its tickets more expensive than its peers by tacking on a surcharge.
To that point, Simonson cited a Delta executive’s recent comments that that airline would not adopt a surcharge similar to Lufthansa Group’s.
Confidence or over-confidence?
Sabre’s confidence is in striking contrast with the tone of Lufthansa Group and IAG, which have been willing enough to take the risk of having their airfares be more expensive than their peers, despite together representing only about 10 percent of overall ticket sales in Europe.
Sabre and its peers are also betting that technological challenge of trying to do direct bookings for complicated itineraries, which also tend to have higher transaction values, will prove to be too much for airlines and travel agencies to handle.
But technology providers to airlines like Lufthansa and IHG, such as Farelogix and Vayant, along with the airline lobbying group IATA (International Air Transport Association) say that technology has changed significantly in recent years to make direct digital distribution by airlines less costly than in the past.
Predictions by Sabre executives haven’t always been on target.
When Lufthansa Group announced its surcharge, the CEO of Sabre at the time, Tom Klein, predicted that the move would prove to be a temporary negotiating tactic that the airline group would abandon under pricing pressure from other airlines.
But this year Lufthansa has said it has found the impact of its surcharge to be neutral on its finances. It called the surcharge a success and began to expand its effort to sign up corporate customers outside of its home markets. Lufthansa said its bookings volume hadn’t been hurt by the fee.
Seeking an edge in broader negotiations
IAG is simultaneously negotiating a renewal of its multi-year contracts with Sabre and distribution tech rival Amadeus. In recent years, Sabre and Amadeus have required that, in simple terms, IAG provide any fare it offers in on its branded sites like lufthansa.com or in other online places, such as Google Flights, also to the distribution systems for distribution systems for tens of thousands of agents worldwide.
Lufthansa and IAG have been eager to negotiate their way out of these so-called “full-content agreements.”
When asked about this issue, Simonson said: “If they come off a full-content agreement, a carrier falls back onto what’s called a base-level participating carrier agreement. They pay us more money.”
Airlines must pay those higher fees in that scenario under their existing contracts.
“Investors often ask us, is this business going to decline, is it going to stay flat, is it going to be disintermediated [by airlines],” Simonson said.
“Instead, the business grows. It was $2.4 billion last year. Its revenue is growing at 5 to 7 percent this year, one-and-a-half times the growth in gross domestic product.”
Simonson acknowledged that Sabre has had to adapt its business to handle shifts of how airlines want to sell their tickets.
As airlines do more direct bookings, companies like Sabre continue to risk seeing a decline in their airline ticket distribution business.
There are two sides to the distribution systems’ airline businesses: the distribution side and the airline IT-provider element. The distribution systems believe that losses on the distribution side might be recouped in their sales of reservation software systems, which airlines typically need to help handle their direct bookings and the upselling of products like checked baggage fees.
Simonson’s remarks echoed ones made by Sabre chief executive Sean Menke in an interview with Skift in May, when he said that, “by ignoring indirect channels, carriers now realize they have been leaving money on the table, which is why there has been significant growth in carriers making ancillary and branded fare content available through the global distribution systems.”