Will Commission Cuts Kill the Small Travel Agent?Published: May 08, 2002 in Knowledge@Wharton
When an industry’s revenue base vanishes, it’s time to collapse – or transform.
That’s the choice travel agents have faced since March 2002 when eight of the nation’s ten largest airlines (all except Alaska and Southwest) reduced their base commissions to zero. Air Canada, that country’s dominant airline, followed on April 23.
As a result, agents will have to change from being commission-dependent retail clerks into service-focused professionals with knowledge that leisure travelers are willing to pay for, Wharton professors and experts say.
“Non-value-adding intermediaries will fail,” says Eric Clemons, professor of operations and information management. “Intermediaries that provide coaching or some additional service will succeed. But service will no longer be free.”
The Impact of the Internet
The new, no-commission world has been on its way since 1995, when airlines first started cutting down on the fees they paid travel agents to sell their tickets. “Stevie Wonder could have seen it coming,” says Bill Maloney, referring to the blind American singer/songwriter. Maloney is chief operating officer of the American Society of Travel Agents (ASTA), a trade association representing more than 24,000 online and offline agents.
Small storefront travel agents will be the most affected, according to experts. As Clemons notes, large agencies rebate commissions to their corporate customers and have been acting on a fee-for-service basis for years.
The changes that small travel agents make will go to the heart of their business, says marketing professor David Reibstein. “In an era which used to exist … travel agents were extremely useful because they had information systems which allowed them to easily track all the different airlines.” Even into the 1990s, travel agents could make money as mere portals to GDS (Global Distribution System) networks such as AMR Corp.’s Sabre (now an independent company), which were the only way to quickly compare fares on several different airlines.
But the Internet changed all that. Online travel agents provide free portals to GDS systems, and independent travelers can now compare airlines’ own deals in a few clicks. Major airlines have even set up their own clearinghouse sites, Orbitz and Hotwire, cooperating to aggregate multiple airlines’ fares in one place.
“One of the nice features of the Internet is that it’s a wonderful tool for providing information,” Reibstein says.
The share of travel sold online will have gone from zero five years ago to 15% of the travel business in 2002, according to research firm PhoCusWright. And a much greater number of travelers research trips on the web, even if they book offline, the firm adds.
Airlines also used travel agents to hold leisure travelers’ hands as the airlines pushed to expand their customer bases, Clemons says. Now that air travel is a widely-accepted way to get around, the airlines no longer feel they need to pay travel agents to bring in first-time fliers.
Prodded by the effect of the Internet, commission cuts and the decline in travel after September 11, the number of retail travel agent locations dropped 15% from January 2000 to February 2002, according to Henry Harteveldt, travel industry analyst for Forrester Research. Harteveldt expects the remaining 27,000 outlets to shrink to below 25,000 by the end of this year.
“The agents that survive the current shakeout period will be smarter and will probably do more business, because they’ll have fewer competitors,” he says.
Food and Wine Tours
David Rojahn has spent the past few years reshaping his business to fit the new reality. One of the small travel agencies that would be most affected by the commission crash, Rojahn’s Denver-based DTR Travel, Inc. has only five employees and grosses about $3 million per year, he says.
Rojahn has repositioned his business to give expert advice on family travel, small cruises and food and wine tours. “Just as you saw the demise of general practitioners in medicine, you are increasingly seeing travel agents who are specializing,” ASTA’s Maloney says.
According to Rojahn, travel agents in the future will have to provide inside information that travelers can’t easily get off web sites. “The survivors will be there because they’ve figured it out for their market and their expertise,” he says. “There will be an incremental value added that you’re willing to pay for.”
Most travelers are already paying those incremental fees. According to ASTA’s Maloney, before base commissions were zeroed out, 88% of agents charged fees averaging $15-25 per airline ticket. An August 2000 study by Consumer Reports Travel Letter found fees to be much higher for planning and researching trips – up to $225 at one small agency in Dallas.
Rojahn’s strategies highlight other opportunities for travel agents; cruises and package tours are complex travel products still mostly sold by travel agents. (“The cruise industry has ignored web technology,” says Harteveldt.) But the Internet may yet change those markets as well; Forrester projects a tripling in online cruise buying by 2006, even though their 2006 projection for online sales is still less than 10% of the total 2001 cruise market.
Override Commissions and the Consumer
This all sounds fine for the consumer so far: fewer, higher-quality travel agents providing expert advice and consumers paying for the quality of service delivered. Unfortunately, override commissions may help spoil the consumer’s party.
Override commissions are kickbacks from airlines to travel agents for steering plenty of business to one preferred supplier. There’s no requirement for travel agents to disclose preferred-supplier relationships to customers. And “their existence raises serious questions about the value of information a travel agent provides you,” according to a June 2001 analysis by Consumer Reports Travel Letter which found, separately, that only 51% of 840 travel agents surveyed provided their reporters with the lowest fares available on the first call.
Air Canada (AC), for one, paired its April 22 elimination of standard commissions with an expansion of its “Horizons 2000” incentive-commission program. Horizons 2000 pays Canadian travel agents bonuses on domestic tickets sold, if they also sell certain levels of Air Canada international tickets. Because AC dominates the Canadian domestic ticket market – even as there is increasing competition in international fares – this could skew the more desperate agents to steer international traffic towards Air Canada.
Clemons worries that override commissions will make online travel agencies less reliable. “Online agencies are going to have to make money somehow, and since most of them are not going to be able to provide highly tailored, individualized coaching, their principal revenue sources are likely going to be overrides and performance bonuses from airlines,” he says.
But Harteveldt disagrees. The major online travel agents can influence airlines’ market share, and thus have enough clout to get access to special low fares. Expedia and Travelocity, the two largest online agents, together booked more than $1.3 billion in travel during the fourth quarter of 2001, according to the companies’ financial statements. Expedia expects 45% of its 2002 transaction revenue to come from “merchant model inventory,” which is consigned at wholesale prices and then marked up for retail sale.
According to a 1999 study by Lorin Hitt, professor of operations and information management at Wharton, online travel agencies are playing pricing games anyway, independent of override commissions. “This market is not characterized by perfect competition, but … [online travel agencies] engage in both horizontal product differentiation and price discrimination,” he writes.
Rojahn doesn’t apologize for receiving overrides at his small brick-and-mortar agency, though he acknowledges that lack of disclosure is a problem. He said the market will drive fuller disclosure, a faith that Consumers Union lacks. The consumer-advocacy organization is currently asking the Department of Transportation to mandate that travel agents disclose overrides. (The DOT has not yet made a decision on the issue.)
But there’s one constituency in the travel industry that’s raking in the money from commission cuts and sees no downside. According to Clemons, the latest moves reflect how the airlines hold the power in today’s travel industry – something that Reibstein says may turn against the consumer in the end. “The only unambiguous winner here,” he notes, “is the airlines.”