On the contracting provision side, the OTAs have managed to wield their increasing market leverage over the past decade to morph their travel agency business arrangement into what is now known as the merchant model. This provided the OTAs with the ability to convert the eyeballs visiting their sites into customers they owned rather than simply customers they provided to hotels in order to earn commission income. Once they owned the customers, the OTAs could direct them to properties that provided them with the greatest value and to withhold them from any property or chain that refused to “go along with the merchant model program.” Personally, as a free market advocate, I do not question this strategy. As a matter of fact, I applaud the fact that Expedia, for one, took a major risk to expend over $100 million investor funds to run unprecedented network TV campaigns to build this market presence and attract all these eyeballs in the first place. Then, whenever the economy suffered, they would take advantage to control their destiny by utilizing their merchant status. This was important because the agency model was resulting in ever-decreasing influence in other areas of the travel industry (air and car). In many cases Expedia did not allow its local people to negotiate deviations in the model or the main terms. It was simply very difficult for hotels to participate in the channel without being in the merchant model that the OTAs preferred.
In addition to using their market position to develop and implement their merchant model, OTAs also introduced several other terms and conditions in contracts that were very beneficial to their bottom lines. Firstly, they introduced the concept of rate parity. This was a wolf in sheep’s clothing if I ever saw one; and it was the hoteliers who invited the wolf into the room. Rate parity clauses ensured that OTAs did not have to worry about rate competition from their supplier hotels and from each other. Ironically, the hotels had suggested a rate parity clause to keep the OTAs from undercutting the hotel’s website price. Expedia sometimes even added what I call product parity clauses to ensure that hotels who wanted to offer rooms in any channel had to provide them to Expedia. The net effect here was that the intermediaries had achieved a position of superiority in the distribution chain, and had instituted a provision that eliminated competition that might challenge that.
If that weren’t bad enough for hotels, this market power provided an opportunity for OTAs to not only enforce this new business model, but to change the financial balance at the same time. They were able to take what had been very generous commission level of 10 percent and turn it into merchant model markups of 15 percent, 30 percent or even 40 percent in limited situations. I say the 10 percent was generous because the marginal costs for the intermediary were well below 10 percent. So, when the intermediaries were able to grow from 10 percent to 20 percent, their profit margins were growing more like 60 percent or even higher. The OTAs then used this extra commission to build their brand with the consumers. As hotels used the OTAs to steal short-term share from each other, the OTAs were getting stronger and building their customer bases. I have not seen any evidence that the OTAs were growing the market at all, but one could argue that by expanding reach to their brands around the world they might have contributed by increased traffic to the United States by providing more international ease of purchase. At a recent Expedia conference, Expedia made this exact point, but the jury is still out over whether that is factual and in material volumes.
Needless to say, with higher margins locked in by contractual terms that prevent price competition in the channel and an increased market power, the OTAs have been sanguine most of the last decade.
Again, the net effect here was that the intermediaries had achieved a position of superiority in the distribution chain, and had instituted a provision that eliminated competition that might challenge that. To illustrate that point, a recent STR and AH&LA report based on hotel data from 2009 to 2011 revealed that hotel room discounts to online travel agencies amounted to about $2.7 billion in 2011, compared with about $2.4 billion in 2009.
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But, looking ahead, there are some storm clouds on the horizon for OTAs, and depending on how the next decade evolves, things could get very interesting for them and their hotel suppliers. To be honest, I think it will take a perfect storm for the hotel suppliers to reverse their distribution fortunes; but the three necessary ingredients for change are in the area:
1|The hotel business economy will need to pick up so that the hotels will be willing to push back at the OTAs, at least enough to take some risks when faced with the OTA take it or leave it contract terms. Currently, business has been so poor, that the OTAs know the heavily mortgaged hoteliers cannot afford to try to fill without them. But, if there is enough business, especially group business that the OTAs do not control, then some hotels may either refuse to sign deals or will withhold inventory when they are full. We are already seeing signs that group business may be on the way back and that would be the first step.
Each of these three circumstances on their own will not shift the balance of negotiation power back to the hoteliers. And there is no certainty that the ultimate outcome will be lower distribution costs or better terms. On the other hand, the conditions are right for hoteliers to quit complaining about the OTAs and start thinking what they want their distribution channels of the future to look like. Then they will be prepared when the market conditions open the door.
