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2HRS2GO: Priceline walks a narrow path

COMMENTARY -- (Nasdaq: PCLN) has no room for error.

Shares of the online seller of travel services, gas and groceries dropped more than 40 percent today after the company warned of lower-than-expected revenue in the third quarter. PCLN stock had already taken a couple of beatings this year; since the market correction that began in March, Priceline stock has lost more than 88 percent of its value.

The drubbing applied to Priceline this morning could have been worse, when you consider that shares were killed in July following a second quarter report that met or topped analyst expectations on the top and bottom lines. And there's your problem right there.

Investors simply aren't impressed by Priceline's business model anymore.

Despite the company's hype about a "Name Your Own Price" revolution, this is merely a flea market where companies dump unsold product. You name a price (read: auction bid) and it's accepted if it happens to be the best offer that meets the seller's minimum (read: auction reserve price). If all the offers are too low -- and this month, that's happened more often than in the past -- then the goods aren't sold.

No one has ever aggregated this much airline or hotel inventory before, but the model itself isn't revolutionary. It appeals mainly to bargain hunters like me. Not the most desirable shopping demographic in the world.

Today's warning raises other questions about the viability of the model itself. Priceline sells other goods besides airline tickets, but travel still generates most of the company's revenue. And that's the segment that took an unexpected drop this month.

Executives blamed disappointing airline ticket revenue on a decline in the number of offers accepted by the airlines, as well as a drop in the average offer price.

CEO Dan Schulman insisted demand remains strong, but there's no reason for anyone to be happy if the quality of that demand is declining. Schulman -- whose 10-minute conference call included nearly two minutes spent reading the Safe Harbor statement and didn't feature a question-and-answer session -- blamed the disappointing ticket offers on "general turbulence and upheaval" in air travel, new fuel surcharges that raised prices, and Priceline's own unsuccessful promotions.

Schulman also cited "special sales" by airlines that resulted in lower average ticket prices this month.

So by the CEO's own admission, many of the factors hurting prices were out of the company's hands. And that's the real problem faced by Priceline in the long-term, because the service's sole appeal is price.

And when things get more expensive, Priceline has no other way to attract customers, especially as its reputation swoons. Consider the following Instant Messenger conversation (edited for grammar and rearranged to eliminate those weird threads you always get on IM):

    Colleague: Can't tell you how happy I am about Priceline getting whacked. I hate that service.

    Me: I like Priceline. It's cheap, especially in the off-season. But at least I have a column topic for today.

    You never know how they'll route you -- Or the time. You want to go San Francisco to phoenix ... and the **** route you through New York. And it's a red eye to boot!

    I can live with the scheduling.

    Interview me. I have a thing or three to say.

    I need quotes I can print.

    But I gotta tell you, Priceline is bogus. It's totally anti customer. Why can't the f***rs first present the customer with alternatives before charging their credit cards?

    Because the whole thing is based on filling excess inventory. I can live with the exchange -- you want to fly cheap, you make sacrifices.

    I know. Still, I don't want to spend $350 for a trip that routes me out of my way and leaves at some ridiculous departure.

    I'd never pay $350 for any Priceline trip.

    Good man.

    But I've gotten roundtrips to NYC on Priceline for $190, at least in the offseason. I like that.

    Flying which carrier?

    It's usually TWA. Painful connections in St. Louis.

As I told my peer this morning, I don't mind the limitations imposed by Priceline's service. I'd like Priceline to survive and thrive, because anything that challenges the airlines to keep ticket prices low works for me.

The company claims its user loyalty is increasing, but so are questions about the quality of service. Unlike a traditional retailer, Priceline can't promise things will improve, because service is out of its hands. Its inventory is at the mercy of whatever is available from airlines, hotels and grocers.

And when the cost of that inventory rises, Priceline can't do anything to stimulate demand except offer some price promotions. As Schulman noted this morning, that didn't work either.

Priceline plans to expand into other fields, including term life insurance and business-to-business services. But Priceline started in airlines because that was supposed to be the ideal venue for this. If the company is having airline problems now, why will this model work for other markets?

That's the real concern of investors. If the problem were only competition, shareholders wouldn't lose sleep, because then it would be just a question of execution.

But when the basic business foundation starts developing cracks, people have a legitimate reason to worry. 22GO

• Hotwire ready to take on Priceline
• Citing airline woes, Priceline issues 3Q warning>