Great industries are built on great partnerships, and the hospitality sector is no different.
The US hospitality industry, for example, has been built on the partnership of hotel brands and franchisees. In addition, successful partnerships enable growth for all stakeholders, which has been the case for hotel brands and owners over the last quarter-century.
NB: This is an analysis by Vikas Bhakta, founder and CEO of Ve-Go Technologies.
Since the Great Recession of 2009-2010, online travel agencies have held an increased role in the hospitality industry for room distribution.
But, unlike the successful partnership forged between hotel brands and owners, despite what others have said here on Tnooz, I believe OTAs have engaged in business practices that negatively affect not only the hotel industry, but also the communities & travelers we serve.
Tax obligation
When consumers purchase a hotel room, there is a hotel occupancy tax associated – yes, the same hotel occupancy tax AirBnb is currently reviewing with regulators.
In the US, hotel occupancy tax is split between state and local and is a major source of revenue for government budgets.
The table below reflects the difference in tax obligation between OTA bookings, such as Expedia, Hotels.com, or Priceline vsersus traditional and direct hotel bookings:
NB: * refers to room rate (estimated for ease of calculation)... ** refers to occupancy tax and "fees": mid-range; set by governments, parity by OTAs
Magically, the OTA loophole of deducting commission before calculating tax obligation yields a difference of $3 – which would normally serve as revenue for state and local governments, is now padding OTA bank accounts and profit margins.
With our 15% occupancy tax assumption, every $100 travelers’ spend with Expedia, Hotels.com or Priceline, equals a loss of $3 for state & local communities – and a direct profit for OTAs.
In 2013, OTAs are estimated to have accounted for $40B in US hotel sales, if we assume all bookings were paid through OTAs, it would equal $1.2B in annual state & local tax revenue shortfall due to the bad business practices of OTAs.
Over the past few years, plenty of US state and local governments have taken the OTA tax remittance loophole to trial, yet few have prevailed.
Even more alarming is the vigorous fight and enormous bankroll OTAs employ to fight against state & local governments in courtrooms across America. If you collect full taxes, but fail to remit…
It’s not a loophole, it’s bad business.
Guest experience
According to a 2012 JD Powers report, travelers who book on OTAs rated their experience 45 points lower than guests who booked or called the hotel directly.
In many instances, the lack of flexibility offered with OTA rates creates friction between hotels and their guests.
As a front desk agent, I have personally experienced guests who would like to modify/cancel their stay, but due to the lack of flexibility in OTA rate rules – we were forced to have unhappy travelers stay with us.
OTAs should ensure the entire travel experience is memorable – not simply prey on booking commissions & then deliver inferior customer service along the way.
Consumers who argue OTAs ability to aggregate hotel listings has provided a huge benefit for search & booking – I would agree with them 100%.
But, JD Powers North American Hotel Guest Satisfaction Index Study states travelers who book on OTAs are more likely to report problems – I’ve known more than my fair share of hoteliers who say LRA (Last Room Available) has a different meaning for OTA guests.
Unfortunately, no hotelier aspires to provide inferior service to OTA guests, they would much rather provide great service and be compensated fully for their effort. When guest experience suffers due to the distribution model…
It’s not a better distribution solution, it’s bad business.
AdWords marketing
OTAs, in their simplest form, are websites with outsized marketing budgets, which are paid for by outsized booking commissions.
For example, Priceline and Expedia - two of the biggest overall spenders with Google – combine to account for $2.5 billion in annual spend on Google AdWords.
OTAs bid on hotel names to compete with hotels and drive up marketing costs for hotels, while simultaneously increasing distribution costs as each booking displaced to OTAs entails a significantly higher customer acquisition cost for the hotel.
Today, OTAs operate globally at scale and possess marketing budgets that surpass the largest of global hospitality brands.
In addition, OTAs operate with the ability to undercut savvy marketers with fewer resources. If OTAs out-bid you on AdWords, on your own hotel name…
It’s not superior marketing, it’s bad business.
The Billboard Effect
In 2010, hoteliers were led to believe OTA presence would lead to an increase in overall bookings, as well as direct bookings. At face value, more bookings and more revenue seem great, but as plenty have found, an increase in bookings and top line revenue does not always translate to profits.
In fact, HAMA & HotelAVE published their findings on profit reduction due to OTA payment structure.
In particular, the Expedia Partner Preference program has been found to decrease profitability for hotel owners. This begs the question: what are the risks associated with OTA bookings eroding profit?
Incremental revenue at the expense of profit undermines a hotels’ ability to deliver quality product & service on a daily basis, as well as invest in refurbishments & capital expenditures on an on-going basis. If incremental revenue erodes profit…
It’s not incremental, it’s bad business.
Risk versus Reward
For hotel owners, the worst business practice employed by OTAs is the commission structure: 15-30%. For decades, the industry-standard for distribution commission has been 10% – at that commission fee, all partners can succeed without endangering the other’s ability to grow and expand.
Since 2010, OTAs have experienced a meteoric rise in share of bookings; in turn, hotel owners have experienced a reduction in profit margin, relative to top line revenue increase.
In other words, OTAs are eroding the profitability experienced by hotel owners during previous economic expansion cycles – and in some cases, OTAs have eclipsed profits margins of hotel owners.
Coming off the worst recession in the history of the US hotel industry, owners expect the greatest reward, for bearing the greatest risk – owning the real estate.
But, OTAs, and their irrational commission fees, have changed the risk/reward relationship for hotel owners.
As good investors do, when risk outweighs reward, they find somewhere else to invest.
For example, as the US hotel industry exceeds 2008 Occupancy, ADR, and REVPAR levels and nears the peak of the cycle, construction activity fails to match previous cycles – with a 50% reduction in new rooms opened 2014 YTD.
Even with the robust US pipeline, the 383,000 rooms reported in June 2014 pales in comparison to the 463,000 rooms in June 2006 – and falls well below the 569,000 rooms in 2007 and 654,000 rooms in 2008.
Furthermore, secondary & tertiary markets – with the exception of Oil & Gas markets – have almost non-existent supply growth when compared to previous cycles.
Muted supply is considered healthy for the economics of current hotels – but comes at a loss for travelers seeking more options at competitive prices. If the risk of building a hotel is greater than the reward, hotel owners stop building hotels…
It’s not rocket science, it’s bad business.
Conclusions
For most industries, distribution costs are marginal, at best. Amazon has built an empire by lowering distribution costs for a number of verticals.
As Jeff Bezos famously vows:
"Their margin is our opportunity."
Amazon prides itself on lowering prices for consumers, by lowering distribution costs. Conversely, OTAs are increasing prices for travelers, by increasing distribution costs.
Today’s OTAs may be a necessary evil, but with the explosion of smartphones, mobile apps, and open APIs – the possibilities are endless for tomorrow’s mobile travel agencies...
NB: This is an analysis by Vikas Bhakta, founder and CEO of Ve-Go Technologies. Follow him on Twitter @VeGoCEO.
NB2: Rain laptop image via Shutterstock.