Expedia, Travelocity take hit over airline commission flap

Shares of online travel agencies Expedia and Travelocity slumped Thursday after airlines Northwest Airlines and KLM Royal Dutch Airlines jointly said they would eliminate Internet travel commissions.

In a terse release Wednesday, Northwest and KLM said they will eliminate Internet commissions effective Thursday. Northwest said it was paying Internet sites a commission of 5 percent capped at $10 for every ticket sold. The airlines, however, will keep paying commissions to traditional travel agencies.

If other airlines follow the lead of Northwest and KLM, Expedia and Travelocity are expected to respond with ticket surcharges, which will maintain profit margins but could hurt revenue growth, analysts said. Airline ticket sales account for a big chunk of sales for the online travel agencies. Expedia and Travelocity, the largest online travel agencies, garner revenue through transactions and advertisements on their respective portals.

In early trading, shares of Expedia (Nasdaq: EXPE) fell $3.12 to $12.50, or 20 percent. And shares of Travelocity (Nasdaq: TVLY) were off $6.87 to $15.37, or 30 percent.

CIBC World Markets cut its stock ratings on Expedia and Travelocity in response to the Northwest and KLM news. Analysts said they were surprised that Northwest and KLM decided to target online travel agencies, but warned that profits and sales could take a hit if other airlines follow.

"Similar to the fare increase tactics utilized by major airlines, we believe Northwest and KLM are sending a zero-commission signal to competitors, in hopes that the other major airlines will follow suit," said Prudential Securities analyst Mark Rowen, in a research note. "If competitors do not follow their lead, we believe Northwest and KLM will quickly retreat from the zero-commission stance, rather than risk losing market share in the online consumer arena."

Rowen, who advised his clients to "sit tight" pending more information, maintained his "strong buy" ratings on the two online travel firms. Paul Keung, an analyst with CIBC World Markets, cut his ratings on Expedia and Travelocity to "buy" from "strong buy."

Analysts said Northwest and KLM could start a dangerous game of chicken. If other airlines also cut online commissions, Expedia and Travelocity would have to add a ticket surcharge for their services. Many traditional agencies have already added a surcharge.

Indeed, Travelocity has already imposed a $10 surcharge on Northwest and KLM tickets and said it will work with other suppliers to find alternate routes. "We are surprised that Northwest and KLM would put themselves at a competitive disadvantage by forcing us to charge a service fee that we must now pass on to consumers," said Terrell B. Jones, CEO of Travelocity in a statement. "We are pleased that other airline partners, including direct competitors of Northwest and KLM, are going to continue to pay us for the value-added service we provide them."

That's a nice volley, but analysts warn that surcharges would eliminate a cost advantage for online agencies and could curb demand. Rowen said revenue growth could disappear and profit targets could be pushed out if surcharges become standard practice.

Without airline commissions, even Orbitz, an industry-backed online travel agency scheduled to launch in June, would have a tough time growing sales, said analysts.

The Northwest and KLM move was irrational and hinted at an online bias, analysts said. Prudential estimated that traditional travel agencies accounted for roughly 60 percent of the $125 billion in U.S. air travel bookings in 1999, and the airlines pay these agencies 5 percent of the gross ticket fare, with a $50 round-trip cap. Prudential estimated online travel agencies booked only 6 percent of U.S. air bookings in 1999, and the airlines cap payments to these agencies at just $10 per ticket.

So why pick on the Internet agents?

"This is a bold and unexpected move by a major supplier and its alliance partner because they did not eliminate commissions for traditional agencies, a higher cost distribution channel," said Keung. "It also sets into motion a dynamic game that will be played out among suppliers and Internet agencies."

Keung laid out three scenarios:

•  Airlines follow Northwest and KLM. Online agencies respond with a $10 service fee on all tickets. Internet agencies would then rely on net fares, bonus overrides, and incentive fees. Analysts noted that Expedia and Travelocity have been preparing for this environment.

•  Some airlines follow Northwest and KLM and online agencies give better treatment to suppliers willing to pay commissions and overrides.

•  Northwest and KLM are the only suppliers to cut Internet commissions and the airlines lose a distribution channel.>