Orbitz takes off

As Internet companies close by the dozens each week, consumers continue to swarm to Internet travel sites and airlines' Web sites in record numbers, searching for bargain airfares, rental cars, hotel rooms and vacation packages.

Three of the top five e-commerce sites sell tra- vel: Travelocity.com, Expedia and Hotel Reservations Network, which operates the Hotel Discounts.com Web site. And a number of competing start-ups boast revenue and traffic that most Internet companies have only dreamed of.

But the landscape that has made the online travel industry a true New Economy gold rush is changing this week, with the entrance of a consortium of industry giants hoping to cash in on travel sites' proven business models.

Whether that change will be good or bad for competition and consumers depends on who you are and whom you ask. But the controversy highlights the legal, business and technological issues that arise when dominant businesses in the brick-and-mortar world form partnerships to create massive Internet marketplaces to compete with independent Internet start-ups.

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The challenger consortium is Orbitz, an independent, Internet travel start-up that launches this week in Chicago with more than $100 million in backing from five of the largest U.S. airline carriers — American Airlines, Continental Airlines, Delta Air Lines, Northwest Airlines and United Airlines.

Announced in 1999, the widely publicized and much-hyped new service immediately drew regulatory scrutiny for potential antitrust issues — the opportunity for big carriers to collude on prices and drive competitors out of business. It's a concern that regulators increasingly face as industries worldwide collaborate to offer improved consumer and business-to-business marketplaces.

After a 10-month investigation, the U.S. Department of Transportation in April cleared Orbitz for takeoff, saying its discounted fares and cutting-edge technology would allow customers to easily search massive amounts of flight information, which could enhance consumer choice.

"New competition in the online travel agency business is inherently desirable," the DOT said.

And that's a message that bears repeating across the economy, said Jonathan Zuck, president of the Association for Competitive Technology. "To compete, you must continue to improve your technology and services, instead of trying to delay or block new competitors from the markets," he said.

The consortium clearly seeks to collude on prices and squeeze out independent agencies, the American Society of Travel Agents said.

Those concerns are backed by a study earlier this year by Jerry Hausman, a professor at the Massachusetts Institute of Technology who estimates that the service will ultimately cost consumers $3.2 billion in higher airfares.

Hausman's study, which was sponsored by Orbitz critics such as the ASTA, the Interactive Travel Services Association and Southwest Airlines, predicts that Orbitz "will allow its airline owners to jointly agree on anticompetitive initiatives that they could not enforce individually."

Executives at Expedia and Travelocity echo those concerns, pointing to agreements that Orbitz has with 35 charter members as evidence of unfair competition. Those airlines are required to offer Orbitz any specials that they give to other travel services. At the same time, they are allowed to pay part of their $2 million annual Orbitz membership fee through fare offerings that are exclusive to Orbitz.

"We're concerned this group of airlines has come together to control prices," said Terrell B. Jones, CEO of Travelocity.

Orbitz, however, insists that its technology prevents airlines from fixing prices. In fact, Orbitz will scan all available fares and display them according to consumers' preferences — even showing the fares of airlines that have no contractual agreements with Orbitz, company spokeswoman Carol Jouzaitis said.

The MIT study "is not even slightly credible," Jouzaitis said. "Bought and paid for by Travelocity and Expedia, who fund ITSA. The author never once spoke to anyone at Orbitz in his research, and made seriously erroneous assumptions and factual errors."

Another study backs Orbitz. According to a January report from The Progressive Policy Institute, a Washington, D.C., think tank affiliated with the Democratic Leadership Council, the new company will enable travel suppliers to lower the hidden distribution fees paid to huge computer reservation systems.

"This new service has the potential to benefit consumers and airlines by providing a wider range of fare options, bias-free displays and reduced booking fees," the PPI report said in reference to Orbitz. "The development of a new online system that has the potential to cut the cost of airline ticket distribution should be embraced, not resisted."

Still, regulators will be watching. Twenty-three state attorneys general have said that they will be scrutinizing the company for price collusion, and the DOT has promised another review in six months.

In the meantime, online travel bookings are expected to continue growing to record levels.

Online bookings will represent 7 percent of the travel market this year, and that will grow to 20 percent within five years, she said. And total U.S. leisure and business online travel purchases will more than triple in the next five years, from $18 billion in 2000 to $63 billion in 2006, Kim predicted. "The Internet will continue to grow as an important channel for information, products and services, precisely because of its ability to help travelers find the best possible fares and rates," Kim said.

Overall, the online travel industry reached $1.2 billion in sales in January, representing nearly one-third of all e-commerce transactions, according to a survey by Nielsen//NetRatings and Harris Interactive.

Online travel sites spurred another $681 million in offline revenue generated by shoppers who logged on to compare prices, but then made purchases by telephone, fax or in person.

"For every one person we sell something to, there are 20 people who use us and don't buy from us," said Richard Barton, CEO of Expedia. "We're focusing on converting those shoppers into buyers."

Orbitz's supporters and some industry analysts see that as proof that there is plenty of room for more players in the Internet travel industry.

"Orbitz is coming into a market that is growing like wildfire," said Henry Harteveldt, a senior analyst at Forrester Research. "Online travel, when it comes to the economy, is Teflon-coated. We have every indication that Web travel is growing and that it will continue to grow."

Still, the Internet's early travel players are nervous.

Combined, the two had bookings totaling $4.3 billion last year, according to PhoCusWright, a Connecticut research firm that tracks the online travel industry.

Traffic to individual airlines' sites is also gaining ground. Last year, for the first time, the airlines sold more tickets through their sites than the through online travel agents. And according to a recent survey by Jupiter, traffic to the airline sites is growing faster than traffic to online agents' sites. In February, visits to airline sites rose 26 percent, to 10.4 million, compared with a 7 percent increase, to 15.4 million, for online agents.

Within just a few years, Orbitz expects to capture 20 percent to 30 percent of that combined online travel market. The consortium offers a broader selection than other online travel agencies, said Jouzaitis, who pointed to the company's agreements with 35 charter member airlines.

Even though its official launch is still a few days away, Orbitz is already off to a good start. In February, the site began a trial run that it said has so far attracted more than 100,000 registered users and has sold more than $1 million worth of tickets. In April, Orbitz attracted 429,000 visitors, according to Jupiter. It ranked 12th among travel sites; the April leaders were Travelocity, with 7.4 million visitors, and Expedia, with 6.8 million.

For a standard booking fee of about $3.50 per ticket, Orbitz will sell seats on any airline, with the exception of Southwest, which does not allow other Web sites to sell its tickets. Airlines that sign the charter agreement get a 33 percent discount off that fee, but they must agree to include Orbitz in any special fares they make available on other sites.

That means if an Orbitz charter member airline strikes a deal with Travelocity or Expedia for special rates on a certain route, or has special Web fares on its own site, that airline must offer that rate to Orbitz.

Orbitz's charter members also commit to spending up to $2 million per year each to market the site — a sum that can be repaid, in part, by offering online fares exclusively to Orbitz.

Those agreements worry incumbent online travel sites.

"Whenever a group of powerful suppliers get together to do anything, it should interest the government and consumers," Expedia's Barton said.

Others have expressed similar general concerns. But where the regulatory agencies have invested the time and resources to thoroughly understand Orbitz's infrastructure and the market, they have found that Orbitz will have a pro-competitive impact, Jouzaitis said.

Early signs are that competition is indeed improving services. In recent months, Travelocity and Expedia have both launched improvements to compete with Orbitz. Orbitz promises to deliver the broadest range of discounted fares, culled from 450 airlines and tailored to customers' price and flight time preferences, at a rapid-fire pace.

Expedia's new Expert Searching and Pricing (ESP) averages 400 price and schedule combinations for every round-trip U.S. flight search, up from six to 15 possible combinations. The technology took four years to develop, and cost $30 million.

Like the technology behind Orbitz, Expedia's search engine lets consumers sort options by airline, lowest price, shortest flights, and departure and arrival times. And once travelers have selected a flight, Expedia's improved system gives them the option to book an air and hotel package that the company said will, in most cases, save money compared with buying the components separately.

Travelocity has also beefed up its site in the past few months by enhancing its "best-fare finder." It's the first application of Travelocity's own new pricing technology, which, like Orbitz and Expedia's ESP, bypasses the mainframe computers that travel agents and airline reservationists have used for decades.

Travelocity's best-fare finder lets travelers search for the lowest published fare between two destinations, regardless of day and time, and check a calendar for applicable dates.

Until now, however, the fares on those dates were often sold out; Travelocity's new version displays dates, within a three-month window, on which the published fares are actually available for booking. Threat or Hype?
Despite his company's complaints about collusion by Orbitz members, Expedia's Barton said the perceived threat of Orbitz is much more interesting than the real threat will turn out to be in the end. "We see them as a potential new competitor, and one that has a pretty high mountain to scale to establish a business," he said.

When Wal-Mart Stores entered the travel marketplace with an online offering, everyone thought it would put Expedia and other travel sites out of business, Barton said. Yet, 10 months ago, Wal-Mart bailed out of the online travel business, he said.

Meanwhile, Expedia and Travelocity are beating Wall Street's expectations.

Expedia said that for its fiscal third quarter, ended March 31, pro-forma earnings before noncash items came in at $4.4 million, or 9 cents per share, compared with a loss of $21.4 million, or 50 cents per share, a year ago. Revenue rose 88 percent, to $110.2 million, from $58.8 million a year earlier. Including items such as the amortization of good will and the effects of stock-based compensation, Expedia posted a net loss of $17.6 million, or 37 cents per share, compared with a loss of $66.5 million, or $1.56 per share, a year earlier.

Expedia's main areas of revenue are its merchant business, in which it sells customized travel packages, and its agency business, which collects a fee for selling an airline ticket.

The merchant segment grew 42 percent, while the agency business grew 39 percent, Barton said. The remaining revenue came from licensing and advertising, which are shrinking as the ad market declines.

"We are working pretty hard to make people make and take better trips," Barton said.

Like Expedia, Travelocity also reached profitability ahead of schedule, reporting its first quarterly net profit — $618,000 before special items. Travelocity, which also reported positive cash flow in the first quarter, had previously projected profitability for the second quarter. But when special items of some $24.6 million are included, Travelocity's net loss in the first quarter was greater than in the first quarter of 2000 — $22.1 million, compared with $9 million.

"It's really great to have reached that milestone, and reached it early. We really focused on reducing costs," Travelocity's Jones said. "The online travel market is really a dynamic space. Now people have realized this is a business model that works online. It's a complicated product that sells well online."

Travelocity also focuses on customer ser viceo grow its business. It has more than 1,000 customer ser vice personnel in three call centers around the country, Jones said. "We make sure our customers' first experience is a good one," he said.

Consumers have come to trust Travelocity, Jones said. "Orbitz doesn't have a brand," he said.

Its fare search technology, from Massachusetts software company ITA Software, pulls fares and routing data directly from airline databases — bypassing Computer Reservation Systems (CRSes) — then filters it with powerful, PC-based computers, said Jeremy Wertheimer, president and CEO of ITA.

"This software does a better job of finding good fares," Wertheimer said. "Orbitz has good technology. Orbitz is going to be the sum of the technology they have and all of the other things that they do."

Another Orbitz advantage is its promise to cut the fees its member airlines pay to intermediaries for accessing CRSes through companies such as Amadeus Global Travel Distribution, Galileo International, Sabre and Worldspan.

Those CRS companies charge a commission for every transaction. Airlines already avoid CRS fees when customers book flights directly on the airlines' Web sites. But with Orbitz, airlines can avoid paying CRS charges incurred while selling tickets through other online travel sites, which typically rely on a CRS for booking, Jouzaitis said.

Orbitz's system is essentially its own CRS, with a database of domestic flights. Orbitz plans to combine the advantages of both the airlines' Web sites and the independent travel agencies, including exclusive e-fares, but will also display flight options offered by many carriers.

Not everyone is happy about that. Just a few weeks ago, Dallas-based Southwest filed a lawsuit in federal court in California, accusing Orbitz of giving consumers incorrect information about Southwest's fares and flights.

Orbitz posts Southwest's published schedules and fares, but Southwest blocks it from selling the airline's tickets or displaying Southwest's online specials. Southwest sells about 30 percent of its tickets at its Web site, generating about $1.7 billion annually, but it blocks other Internet travel sites such as Expedia from selling its tickets.

Like Southwest, other airlines have become more aggressive in selling tickets online to bypass CRS fees, and have made significant investments in technology and improvements to their Web operations in the last few years. In a bid to draw travelers away from the third-party sites, they have tacked on features such as cut-rate Web-only fares, online check-in, wireless and e-mail travel alerts, and reservations for hotel rooms, cars and vacations.

American, for example, paid about $1.3 billion in commissions to travel agents and online travel sites such as Travelocity and Expedia last year. The airline is looking for ways to sell more tickets for less, said John Samuel, American's vice president of e-business.

Orbitz could be the vehicle, but it's too early to tell, Samuel said.

"Jeff [Katz, CEO of Orbitz] is going to have to prove his product has better features and provides better customer service," Samuel said. "Time will tell."

Hotwire a Hot Ticket

Orbitz may be the biggest Internet move by a consortium of airline heavyweights, but it's not the first.

Last September, at a time when dot-com businesses were falling like quail during hunting season, a group of six major airlines joined forces to try to beat the discount travel sites at their own game.

It's too soon to predict whether that attempt, Hotwire, will beat out com panies such as Priceline.com, which launched the original name-your-own-price concept. But Hotwire certainly has an advantage — a financial stake by a reputable group of carriers that control which sites are offered their extra seats for sale at heavy discounts.

That advantage — combined with the booming demand for online travel choices — has moved Hotwire into the top 10 ranking of online travel sites less than six months after it launched.

Building on Priceline's popular bidding model, Hotwire lets Web surfers search for discounts on the routes they want to travel. Like Priceline, the actual flight times, number of stops and carrier remain a mystery until the ticket is purchased. But unlike Priceline, Hotwire lets consumers search the prices, then take time to think about whether they want to buy the ticket. With Priceline, you can't search without making a bid that you are willing to stick to if a ticket for that price is found.

Additionally, with Hotwire, consumers are guaranteed the seats will be on one of its partner carriers. On Priceline and other travel sites offering similar secret discounts, the seats may also be on super-economy carriers such as AirTran Airways, JetBlue Airways or Spirit Airlines.

At the beginning of this year, Hotwire expanded into hotel reservations, rental car services and international air tickets, in addition to its existing domestic airline ticket sales service. Hotwire offers ticketing for 19 international and eight domestic airlines, and reservations for 2,000 hotels in 25 major markets. It claims its rates provide a savings of 40 percent or more from regular airline and hotel prices.

Hotwire says it beats the ticket prices of other popular online services such as Expedia, Priceline and Travelocity.com by tapping into a vast reservoir of unsold seats. An estimated 3.5 million airline seats are unoccupied each week.

"With Hotwire, suppliers get money for seats that otherwise would go empty," said Karl Peterson, co-founder and CEO of Hotwire. "Consumers can save up to 80 percent on an airline ticket."

With more than 2 million registered users and 300,000 airline tickets sold so far, Hotwire has caught on like wildfire with Web-savvy travelers. The site relies on key partnerships. Peterson, who was a venture capitalist at Texas Pacific Group before launching Hotwire, developed close relationships with airlines and other travel businesses. He saw a need for these companies to dispose of excess inventory on the Internet in a way that wouldn't jeopardize their full-fare business.

Hotwire has become so hot with consumers, primarily through word-of-mouth advertising, that it has made the big Internet travel sites such as Expedia and Travelocity take notice. Both have launched their own bidding services this year.

Privately held Hotwire is backed by $75 million in venture capital, including investments by American Airlines, America West Airlines, Continental Airlines, Northwest Airlines, United Airlines and US Airways.

The airline investors have no say in the company's day-to-day operations, Peterson said. The service has also adopted a firewall to prevent the airlines from seeing how many seats each carrier is contributing to Hotwire's inventory, he said.

Hotwire does not provide revenue or profit figures, since it is privately held, Peterson said. But he said the company makes money on every transaction it does, and it sees a bright and profitable future ahead.

"The good news is this is a huge market," Peterson said. "We have high ambitions for the future. We will reach profitability on a much faster basis than anyone who started before us."

Online Travel Grows Despite Economic Slowdown

Dollars spent on leisure and unmanaged business travel booked through the Net:
1998 $2.2 billion
1999 $6.5 billion
2000 $18 billion

Projected to grow to $63 billion by 2006
29% of U.S. online consumers research and purchase travel on the Internet.
29% of U.S. online consumers research leisure travel online, but ultimately purchase offline.
42% of U.S. online consumers are not yet using the Internet for travel shopping.
42%The portion of the total U.S. travel market that online travel will represent in 2006