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Friday, May 27, 2011

Distribution Fundamentals: Looking through a single lens can be hazardous

Any first year MBA student already knows that in order to see the profit picture clearly, you need to look at both revenue and cost.

The sunglass graphic at the right is one that I created to make this very basic point.

Most of you have played the game of covering up one eye and seeing how distorted your perspective can be as a result.  In fact, if you have ever had to wear an eye patch for any reason, you will know that it is extremely dangerous to drive under that circumstance.

If revenue and cost were the two lenses of glasses and you cover up either one, you will not be able to clearly see your profitability picture, which is equally dangerous, particularly when you are trying to navigate which channels to use to sell your products or services.

If you have been following the dialogue (some would say diatribe) between the airlines and the Global Distribution System companies (GDS), you will know that quite often, in their own defense, the airlines will cover up the revenue lens and talk about how the costs of the GDS channel are exorbitant.   This reduces the value of the GDS to that of a pipe, which is a gross oversimplification of the role of players like Amadeus, Travelport's Apollo, Galileo and Worldspan and Sabre.

And now with the Department of Justice in the fray and my tax dollars being used to resolve the argument,  I feel compelled to speak up.

For those that have followed my musings on distribution, you will know that I have been equally critical of decisions made on both sides of this equation.   I will do my best to present a dispassionate view of this business fundamental.

REVENUE FOCUS
If you cover the cost lens and look solely at REVENUE, when you open both eyes you may find that the cost to produce that revenue through "Channel A" is exorbitant, resulting in a loss per transaction versus profit.

An example of this might be selling lots of tickets (albeit at a low average cost per ticket of $312.69) through your own web site and having high load factors as a result.    If you do not count the cost of the website, the call center to support the website, the brand spending to drive traffic to the website, the keyword buys with Search company X, the click through fees from metasearch Y and the conversion rate for that channel, it may seem like your lowest cost channel, but if you go with a fully burdened model -- not so much.....

COST FOCUS
Likewise, if you cover the revenue lens and only look at the COST side of the equation, you will not see the clear profitability picture necessary to make the decision about what channel to use to sell your profits and services.

As an example, if the travel agency channel is a completely variable cost channel (i.e. you only pay if you sell something) AND the average domestic ticket value is $407.73, then even with a 10% commission (which is more than most agencies receive) and a $13.20 booking fee (assuming 2.2 segments @ $6 per segment, which would also be high, but is based on Travelport's recent annual report), then the net to an airline is $353.76, which is nearly $50 higher than the direct revenues of $312.69. 

CHANNEL PROFITABILITY MATTERS
At the end of the day, this analysis must be done by every airline and every GDS, and even the agencies that are affected by this battle.

When you sit down at the negotiating table (whether it is the GDS/Airline discussion, the Airline/Agency discussion, the Airline/Corporate Travel Manager discussion or the GDS/Agency table), know what you bring as value to the other player.  Know your costs (direct and indirect), but also know your average revenue contribution (domestic and international ticket average value).

I contend that this is not a technology issue, but one of business model and reinvention.  It is time to recraft the models in our industry.  Next week I will begin a series called Distribution Myths.  The first issue that we'll tack is whether disintermediation is all about technology.

Enjoy your long weekend.  Rest up.  It will be an interesting summer.
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