American Airlines vs. Sabre Holdings: Destruction or Creation of Airline Traveler Value?

In January 2011, American Airlines (AMR) and Sabre Holdings, parent company of Travelocity, came to loggerheads over content, fees, and the role of global distribution systems in the future of air travel.  While American Airlines seeks to gain efficiencies and customer intimacy by encouraging customers and ticket brokers to connect directly with the American Airlines information systems, Sabre Holdings decries a reduction of choice and transparency and responds with a lower placement of American Airlines offerings in their distribution system.

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The air travel industry is clearly undergoing change once again, and this change will affect the air traveler.  But is this change good or bad?  Sabre Holdings indicates that these moves are (1) bad for the traveler and (2) demonstrate an abuse of power by profit seeking airlines.  But should we take their statements at face value?  Is American Airlines squeezing the distributors and harming customers or is this representative of a needed strategic shift that will improve overall welfare?

In this article, I will examine the conflict between American Airlines and Sabre Holdings in the context of shifts within the larger technological and competitive environments, and the need to serve end-customer needs.  In doing so, I will demonstrate Sabre Holdings’ position to be specious.

Customer Advocate or Adam Smith’s Self-Interest

First of all, let us acknowledge that Sabre Holdings position is self-serving.  They make their revenue by charging American Airlines to distribute their product.   If American Airlines reduces or discontinues its business with Sabre Holdings, Sabre loses.  Moreover, these losses are substantial.

Airlines have typically paid Global Distribution Systems (GDS) operators like Sabre Holdings $3 per ticket for each leg of a domestic flight.  Annually, these fees accrue to the tune of roughly $1 billion in fees paid from airlines to GDS operators.  Clearly, a substantial amount of commerce is at stake in this negotiation.

Because Sabre Holdings stands to profit substantially from maintaining the status quo, any comment from Sabre Holdings on American Airline’s distribution strategy should be examined with a critical eye.

Who Is The Goliath And Who Is The David In This Fight?

Second of all, let’s not think of Sabre Holdings as the little guy being beaten up by the big American Airlines.  It is difficult to state which of these two titans inherently have more ammunition and reserves in this battle.

At one time, Sabre Holding’s valuation exceeded American Airlines.  Today, Sabre may face a lower valuation, but its strength within the GDS industry remains formidable. There are only a handful of major GDS operators to connect ticket brokers and end travelers to airlines like American.  Most of these GDS businesses are owned by private equity firms known for their deep reserves of financial strength.

Similarly, while American Airlines is big, it is neither the only nor the biggest airline.  American Airlines is the third largest US airline by traffic.  Along with Delta and United Airlines, American Airlines competes with Southwest Airlines who is in fact, the largest US airline by domestic seat-miles flown.  Furthermore, American Airlines has not demonstrated a trajectory of strong profits.  In fact, American Airlines has had negative earnings for the past 3 years.  With such a poor performance record in the recent past, it seems imperative that American Airlines explore strategic alternatives before their tenuous strength erodes.

This is not a fight between David and Goliath, but rather two Goliaths that hold a vested interest in the outcome.  Sabre Holdings clearly would profit from the status quo.  American Airlines clearly needs to explore its strategic options.

The only David in this fight is us, the traveling customer.  And neither side is fighting on our behalf or against our interest, but rather both are fighting for us.  That is, they are fighting to own the customer relationship with us.

The Disintermediary Meets Disintermediation

In essence, Sabre is an intermediary between travelers and travel services, where airlines are just one of several different services that a traveler requires.  GDS businesses operate a two-sided market, where the services they supply to one side of the market, the travelers, are supported by the sale of access to these travelers by the other side of the market, the airlines.

As such, the strategic choice of American Airlines to reduce its dependence on Sabre Holdings and instead seeking to increase their direct interactions with travelers is one of Sabre Holdings losing a customer.

It is not unheard of for large intermediaries to lose customers.  Newspapers used to supply us with advertisements along with our news but now marketers increasingly reach us directly via the web or online advertising. For newspapers as with GDS operators, their disintermediation between marketers and customers was brought upon by changes in technology as well as changes in customer habits.

When the Sabre took the role of a market intermediary for airlines tickets, the rest of the world was still using electronic data interchanges (EDI).  For the most part, EDI systems have been displaced by the internet with online exchanges, auctions, and XML interfaces.  American Airlines appears to be driving the airline industry towards a similar IT architecture upgrade in asking intermediaries to access information directly.

More damaging than technological developments to the relationship between airlines and GDS suppliers is the change in offerings and customer buying habits.

Unbundling the Bundle

Holman Jenkins in his Wall Street Journal editorial correctly noted the role of unbundling in airline offers as a driver to the needed realignment between airlines and GDS operators.

In the past, an airline ticket bundled the right to travel along with ones bags neatly stored in the cargo hold while being served beverages and food by a lovely flight attendant.  Because most all airlines provided the similar service levels, the main differentiator travelers used to select between competing airlines is price.  And GDS operators gladly provided prices.

As airlines unbundle the offer, ticket purchases become more complicated.  Now, rather than simply choosing an airline and fare, travelers need to choose a level of service.  Bags or no bags?  How many bags? What weight?  Food or no food?  Drinks?  Extra legroom?  Extra-wide seats?  Frequent Flyer Mile top-up? And who knows what the future options will be.

Unbundling the bundle is a known strategy for improving price alignment and profits as an industry matures.  It enables the price of the basic offer to be reduced (or increase at a rate lower than the increase in the cost to produce), and therefore expand the market for the offering.  A side effect of unbundling the bundle is the need for customers to make more choices.

Travelers have more choices today than they did five years ago regarding how they travel.  Simple websites that list price and airlines for a destination are insufficient for enabling intelligent choices by travelers.  Travelers also need to know the level of service to expect, the cost to improve the service to the desired level, and perhaps some guidance in making choices.

In other words, price isn’t the only metric of value.  Service levels need to be disclosed as well.

As such, travelers need intermediaries that go beyond the role of clerks that ring-up transactions, rather travelers need intermediaries that take on the mantel of salesman and both explain the various offers and options to guide our decisions towards greater satisfaction.

The current iteration of GDS suppliers and their websites simply don’t provide this level of interaction.  As such, it makes strategic sense for the airlines to reduce their dependence on them and seek to move customers to a superior buying channel: direct.

When the airlines directly own their customer relationship, they can better tailor the offerings to the needs of their customers, and perhaps deliver higher customer satisfaction.

Southwest Airlines (LUV) doesn’t use GDS suppliers, and never has to the best of my knowledge.  If a traveler wants to buy a ticket on Southwest, they must contact Southwest.  In the interaction with Southwest, the traveler is allowed to select from a number of flights along with selecting the level of service desired.  If you are curious as to how well this approach works, recall the market position of Southwest:  (1) highest domestic passenger miles flown, (2) high customer satisfaction, (3) profitable for nearly every quarter since inception.

A Needed Strategy Change

Sabre Holdings has attempted to frame the battle as (1) fighting for the needs of travelers, (2) fighting against a bully exerting excess buyer power, and (3) performing a valued service for travelers.  Yet none of these positions are defensible upon closer examination.  Rather, we see that (1) Sabre is fighting for its own profits, (2) has power significant power to use against its opponent, and (3) performs a service that needs drastic and dynamic improvements to keep up with the industry evolution.  It isn’t surprising American Airlines is reducing their purchases of service from Sabre Holdings.  What is surprising is that Sabre Holdings is attacking their key customer.

We shouldn’t expect American Airlines to quickly win this battle against Sabre Holdings.  Roughly two-thirds of American Airline travelers purchase tickets through GDS intermediaries, and most corporate travel managers rely on GDS as well.  But things are looking positive for American Airlines.  Priceline.com (PCLN) reached an agreement to directly interact with American Airlines information systems late in January.

While the battle between these Goliaths will provide amusing drama, this analysis clarifies the value of this strategy change for American Airlines and travelers alike and therefore the likely outcome.  As for Sabre Holdings, their claims are specious and their future uncertain.  Perhaps the Travelocity’s Roaming Gnome (owned by Sabre Holdings) will go the way of the Sock Puppet (previously owned by the now defunct Pets.com).

References

• Mike Esterl, “Dogfight Erupts in Plant Ticket Sales,” Wall Street Journal, 6 January 2011.
• Mike Esterl, “American Airlines Sets Distribution Pact with Priceline,” Wall Street Journal, 19 January 2011.
• Holman W. Jenkins, Jr., “The Airlines Discover ‘Content’,” Wall Street Journal, 21 January 2011.
• Mike Esterl, “Airlines Revamp Sites to Sell More Than Seats,” Wall Street Journal, 25 January 2011.

Note: At the time of writing, the author is not currently a direct consultant to nor investor in any of the firms listed in this article.