The air fare distribution model as we know it is threatening to fragment. Mark Frary explains how evolving business models will impact on travel management companies.
WHEN THE GUILD OF BUSINESS TRAVEL AGENTS changed its name to the Guild of Travel Management Companies (GTMC) back in 2005, it was not just a simple rebranding job; it was the result of a dramatic change in the way that the organisation's members operated their businesses. It reflected the change of its members from being the agents of suppliers (and airlines in particular) who were remunerated through airline commissions, to working on behalf of their corporate clients, who suddenly had to get used to paying fees for the first time.
Whether this change has been as clear-cut as it sounds is arguable. Travel management companies (TMCs) get fees for carrying out transactions as well as for offering various types of service - such as managing refunds, producing reports and offering consultancy - that previously came as part of the package. Many buyers still pay an all-in management fee that covers all of these transactions and extras.
But that is not the end of the TMC's income. TMCs also make money from override commissions for the volume of business they bring to a supplier (and extra overrides for delivering increasing market share to them), from shadowy sales and market agreement (SMA) fees for promoting suppliers through advertising or events, and from GDS incentives - fees paid by global distribution systems (GDSs) to the TMCs for booking through them.
Travel buyers, who believe - rightly or wrongly - that they sway the TMC's behaviour away from the client's best interests have long viewed such 'hidden' income streams with suspicion. But are we now standing at another crossroads that will see TMCs having to change again?
With the typical TMC's income bolstered by contributions from suppliers and GDSs, it is worth looking at the pressures from suppliers to reduce those payments. Fees from SMAs have been falling recently, particularly in the last couple of years as airlines and other travel suppliers have cut their own marketing budgets.
Override payments look set to continue, particularly for those TMCs that can guarantee large volumes and increase them.
However, the consolidation of suppliers - witness the tie up between British Airways and Iberia in January - is likely to mean that there are fewer sources of these overrides.
The current spat between American Airlines (AA) and the GDSs over distribution costs is being watched carefully by TMCs. They are obviously worried costs might increase, since accessing content from an airline's direct connect system might be more expensive than using the GDS.
But they are also concerned that the fragmentation of the current distribution system will mean less money coming their way from the GDSs. Could this be the reason that many of the big TMCs have remained outside the very public battles raging over the AA issue?
As well as declining income, there are increasing costs to consider. Bonding has become more expensive, and is set to become more so. There are currently proposals on the table to update the Air Travel Organisers' Licensing (ATOL) scheme to a flight-plus basis.
This could see TMCs being required to take out ATOL cover any time they make a booking on behalf of a client involving more than just a flight.
TMCs are also being required to take out bonding for their purchases of rail tickets under a new regime introduced by the Association of Train Operating Companies (ATOC), which comes into full force in April. The so-called TARIF scheme will cost TMCs a small percentage of their rail turnover.
THE LOW-COST MODEL
It is clear that currently there is scope for a new business model for the modern TMC. And what better idea to ape than another area that has seen impressive growth in the last 15 years - the low-cost airline?
It has always niggled TMCs that no matter how fat the request for proposal document and the complexity of some of the questions involved, that many business travel accounts are actually awarded on the basis of the lowest transaction fee.
The result is that there is a constant downward pressure on these transaction fees. It comes as no surprise then to hear that one of the major TMCs is currently offering zero transaction fees to at least some of its clients for any booking that is handled completely online and without recourse to a real travel consultant.
That does not sound like a model for business success until you realise that if the pressure really is inexorably downwards, then why not go straight to the bottom and pick up all the business?
A transaction fee of zero sounds like a non-starter until you think about how modern TMCs make money. The transaction fee is becoming less important compared to the ancillaries - the fee for a human consultant to pick up an online booking, any change fees, the cost of using the 24- hour service centre in the event of a problem, and so on.
In fact, the volcanic ash crisis made many TMCs realise how lucrative a business disaster could be.
A move to zero transaction fees would mean that the TMC would have to rely increasingly on these other income streams, with a business model starting to resemble the no-frills carriers, particularly Ryanair, with its low and zero headline fares and ancillary charges for virtually everything else. And if one TMC does it, you can expect others to follow.
If the airline world is anything to go by, TMCs might take to these ancillary charges rather well.
In this new model, if it comes to pass, travel buyers really will have a little more transparency than they perhaps bargained for.
This time two years ago, the prospects for some TMCs did not look very appealing. The mighty Lehman Brothers had fallen and the global economy had begun to unravel on the back of something esoteric called collateralised debt obligations - business travel had fallen off a cliff as a result.
Even the most optimistic in the business travel industry felt that the TMC sector would undergo some form of consolidation in the following years but merger and acquisitions (M&A) activity has been comparatively thin on the ground. The table shows (see below) some of the main acquisitions.
So why has the market not seen more consolidation? Chief executive of the GTMC, Anne Godfrey, says the level of M&A activity was nowhere near what the market was expecting, especially given the decline in business travel in 2009 and early 2010. "We lost and then gained two members in M&A activity last year," she says.
Despite this, Godfrey notes that "there is a lot of talk of refinancing and of acquisition although few have done it yet. I suspect there are people looking to be bought and others keen to buy and that, come the end of 2011, mergers will actually be happening rather than just being talked about it."
David Trunkfield, partner at PwC in charge of travel and leisure, agrees that things may be about to change. "When markets are in decline, as business travel was from mid-2008 for a couple of years, people tend to be wary of buying businesses where top-line profits are falling," he says. "I think that is why there hasn't been much in terms of consolidation other than small companies in distress. But now that business travel has clearly turned the corner, I think now is a reasonably good time to buy. You will be buying into companies that will have a good three or four years of reasonably good growth as business travel rebounds.
2007 and 2008 was at the end of a long period of economic expansion, business growth and M&A. I don't think we will get back to those levels quickly, but if we have a prolonged expansion that will last five years there is no reason it will not."
Norman Gage, director of business travel at Advantage, says: "Some acquirers are looking for rapid growth. To a large extent, the market is just static at the moment and there is not a lot of churning of accounts."
PwC's Trunkfield also believes that the private-equity- backed acquisitions of the noughties will now start to be put back on the market. "Private equity backers will, broadly speaking, always be looking for an exit," he says.
"It is the same in a number of different industries. If your private backer bought your business in 2007-2008, they were not going to sell in 2009 when performance was not as good as it might have been. But as businesses return to growth and their prospects look better, I think we will see more of those sort of deals start to come through in travel over the next 18 months."
Advantage's Gage says he is often contacted by private equity firms looking to break into travel. "I am not sure about their sincerity - they think they will make a tax loss," he says. "I don't think some people are serious enough about wanting to develop travel."
Ian Skuse, a partner at travel specialist law firm Piper Smith Watton LLP, says there is a lot of interest in finding small and medium sized TMCs to add to existing businesses.
"There has been a certain shrinkage in the industry as TMCs have coped with cutting workforces and they now need to look at growing organically or growing by acquisition," he says. "A benefit of the latter is that it allows them to consolidate overheads and, hopefully, pick up good contracts the target company might be handling."
WHY SELL NOW?
Advantage's Gage says there is currently a misconception in the market that business is bad and that anyone trying to sell is being forced to hold a fire sale. "That is not the case," he says. "The TMCs that I know that are in discussions on selling are being quite bullish about the price."
He argues that the owners of some TMCs are reaching an age when they want to retire.
"A number of people in the business are reaching the age where they have been doing it for 20 years and want to get out at the top of their game," he says.
However, some TMCs, particularly the small independents, are often reticent about selling to what others might call asset strippers.
Although they may be keen for an exit, they may not be willing to sell to a company that just wants to buy the business and then get rid of the very staff that have built it up in the first place.
Piper Smith Watton's Skuse says: "There are some TMCs that have been in a state of distress and are looking to refinance their business or find a merger partner. There are others where you get an owner wanting to retire and wanting to keep their staff all in place, and who are looking for a different sort of white knight who can maintain the status quo."
Norman Gage says it will be interesting to see whether any of the TMCs currently looking for a buyer - he won't reveal who they are or how many - sell to staff through a management buyout, given the problems this can cause.
"One of the problems comes with IATA [International Air Transport Association] in selling your business on - if you substantially change the ownership by more than 49 per cent in three years, you have to put up a bond which can inhibit a management buyout," he says.
The GTMC's Godfrey says the decision to sell is down to a combination of things: "It is not an easy time to be a small TMC. Everything that is happening is increasing costs for the TMC. It is a very competitive market - the tender process has become gold- plated and critical mass helps get good deals.
"For some, the decision to sell is a lifestyle choice. People get into travel because they love it, but they see an end - they want to sell the company on the up and then enjoy the rest of their life with what they have made. Travel is a very entrepreneurial industry."
Finance for doing deals is also harder to come by. "Business travel and travel in general are not seen as attractive investments by banks and insurers," Godfrey says. "The City seems to have downgraded the entire travel industry, and business travel is tarred by what is happening in leisure travel."
HOW MUCH IS IT WORTH?
In any M&A negotiation, price is the most important factor. Valuations in travel have traditionally hovered around seven to eight times earnings, although this has now fallen back to three to four times earnings.
Skuse says expectations of selling price are often too high in the current market and deals often do not go through because of a failure to agree on price. "I have clients on the prowl [for acquisitions] and I think often people are not realistic about price unless they are desperate. Real estate, for example, was valued in an optimistic way in the past but these things have a different price tag these days."
PwC's Trunkfield says that profits are likely to have fallen significantly over the last couple of years, leading to cheaper valuations.
TURNING THE CORNER
At the recession's height, there were some people who were predicting a total meltdown for business travel, or were saying that it had changed irrevocably, with fewer people travelling and those that did travelling on cheaper tickets.
Trunkfield disagrees: "I don't buy the argument that business travel will never return to previous levels, but one thing we do believe is that business travel to Europe is not going to come back in the way it used to exist.
"People recognise that shorthaul business class travel is a luxury and you don't get that much for it. I think long-haul business class travel will come back, although this will take time to percolate through."
Anne Godfrey believes that the recession has made business travellers more compliant to policy in the short-to-medium term and that travel on low-cost carriers and in premium economy is here to stay. However, premium business travel is returning. "To do business, you need to go where the customers are," she says.
As an investment, then, the business travel sector is looking more positive.
"Travel has always been seen as a more volatile and cyclical sector and in a sense there is no recurring revenue," says PwC's Trunkfield. "Every year you are reliant on finding customers, unlike a subscription-based business where there is a steady stream of predictable revenues."
TMCs have lived in a low and no-commission era for several years now. "There is pressure on fees both from customers and from airlines in terms of what marketing fees and overrides they are willing to pay," Trunkfield says. "On the other hand I think there is also a trend for big TMCs to introduce various web-based booking tools so they can reduce their own costs."
Yet Trunkfield says business travel is not a bad area to be in: "If you look at the broader travel sector, business travel margins are not that bad. Mainstream leisure tour operations' margins are between 2 and 4 per cent."
THE EFFECT ON BUYERS
There are a number of competing forces working on the TMC sector that will change its business model. As in other sectors, some TMCs will find the new business models required to survive are too challenging for them. Their buyers will be TMCs that are able to adapt, or companies from a different sector with a different mentality and expectations on profit margins.
Consolidation to fewer players could be taken to mean higher prices because of less competition. Inevitably, new players - particularly online players with lower cost-bases than more traditional TMCs - will emerge to broaden the competition again.
Costs are increasing in the TMC sector and are likely to continue to do so. At the same time incomes are coming down.
Inevitably, this pincer movement will mean that TMCs will have to look at the income streams that remain to bridge the gap. If transaction fees really are coming down to zero, at least for online transactions, then ancillary charges seem to be inevitably heading upwards.
With the costs of travel itself increasing - through rising demand, higher VAT and the escalating cost of oil - buyers have a tough time ahead.
|Nov 2008||Bath Business Travel||Baxter Hoare*|
|Aug 2009||Grosvenor Travel Management||Strand Travel Management|
(business travel operations)
|Nov 2009||Wings Corporate Travel||Travel Alliance|
|Jan 2010||Wexas Travel Management||BJB Travel|
|Nov 2010||Wexas Travel Management||Bath Business Travel|
|Feb 2011||Good Travel Management||Mercian Travel Centre|
*Baxter Hoare subsequently sold off in May 2010