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Frenemies: Is Vertical Integration the Answer to OTAs?

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Ershad Chagani

Ershad is a graduate student at Cornell University concurrently pursuing a Master of Real Estate (MPS-RE) and an MBA. This holistic education is building upon his three years of management consulting experience, where he focused on real estate and innovation as a Senior Consultant in Deloitte's Strategy & Operations practice. He has experience across a variety of industries including Real Estate, Financial Services, Energy, and Public Sector.

The relationship between hospitality companies and online travel agencies (OTAs) has widely fluctuated over the past two decades. The industry’s responses to the threat of OTAs have thus far had limited impact. This article explores a more drastic solution: vertical integration.

When OTAs emerged in the late 90’s, many hospitality companies held a positive outlook towards these tech-savvy startups. During a time when online distribution was not a priority, hotel chains saw an opportunity to utilize OTAs – the largest of which are Priceline Group and Expedia Inc. – to improve occupancy with a new price-discriminating channel, in a way that would not harm brand equity or established pricing. As the industry has shifted away from the previous multi-layered model (of wholesalers and travel agents), and towards a lean direct-to-consumer approach, OTAs have surfaced as the preferred medium through which to book travel for many consumers. This is largely because they typically offer the lowest rates while enabling consumers to compare offerings across hotel chains.

A decade ago, OTAs represented about 4% of hotel bookings. Today, that share has grown to between 10% and 20%, depending on the chain[i]. While OTAs have afforded many independent and boutique hotels exposure to a wider audience, they have been detrimental to large hotel chains. Hotels are left to pay up to 20% commissions on bookings made through OTAs, in addition to losing the opportunity to own and analyze guest data to improve the customer experience. Hotels also face the risk of commoditization and of entering potential price wars that further shift consumer habits towards price-sensitivity and away from an experiential focus. Even more threatening may be the lodging industry’s erosion of a direct link to consumers, leaving the industry in a position of vulnerability. As the market share of OTAs grows, so has the response from major hospitality companies – for good reason: Morgan Stanley estimates that $125bn of value (in terms of market capitalization) could shift between the two groups depending on how hotel chains respond. This response has thus far included advertising campaigns (such as Marriott’s “It pays to book direct” or Hilton’s “Stop clicking around”), price guarantees, additional loyalty rewards, discounts, gift cards, and even charitable donations for bookings that are made directly. Based on the growth that OTAs have continued to see, the effectiveness of this response has been limited.

 

Lobby of Marriott’s Ko Olina Beach Club in Hawaii

One strategic alternative that we have yet to see is vertical integration. Though an acquisition of either of the two market leaders – Priceline Group or Expedia Inc. – seems unfeasible due to the relative market capitalization of each ($84.4bn, and $18.6bn, respectively at time of writing) compared to even the largest hospitality company, Marriott ($46.1bn), there may be an opportunity for hotels to engage in coopetition. OTAs are platforms that connect travellers to services, and a platform’s success is hinged on its community of producers and consumers. It’s important to recognize that hotels ultimately have complete control over the product. As the five largest hotel chains account for nearly half of all US hotel rooms[ii], there exists an opportunity for these chains to come together to develop their own platform to replicate and replace the value that OTAs provide. The technology itself would not be difficult to recreate, and the community of users would follow if this new platform were able to offer the ease of booking and price competitiveness that Priceline and Expedia offer today. Collaboration between rivals can be difficult to manage, but it’s been done before. Though ultimately unsuccessful, the mobile payment platform MCX CurrentC was backed by Walmart, Target, Best Buy, CVS, Shell, Sears, Lowe’s and many others, in a similar effort to avoid POS transaction fees.

There are a number challenges that may be keeping hospitality companies from vertically integrating in this way. First, the level of cooperation necessary would be difficult to achieve. Hotels would be required to share information, data, and pricing through a related party that would ultimately report back to the chains (it can be argued that it was this reason that drove MCD CurrentC to an untimely demise). In addition, it would be difficult to balance the needs of the largest of the competitors, such as Marriott and Hilton, with some of the mid-sized chains. The positional power that the largest chains would be afforded may go as far as to deter other chains from joining such an effort. A third challenge is that the hospitality companies would be moving away from their core competency. They would be competing in an arena that they have no experience or expertise in, and would be required to at least match an experience that the largest OTAs have spent decades cultivating. Hotels vertically integrating into the bookings arena would no-doubt be challenging, but it may just be feasible. There is a strong incentive for hospitality companies to work in their collective best interest to recapture the margins that OTAs have been profiting from.  After all, $125bn of market value would certainly be worth the effort.

[i] Pillow Fight: Hotels vs. Online Travel Agencies. (2016, June 23). Retrieved December 01, 2017, from https://www.morganstanley.com/ideas/hotels-vs-online-travel-agencies

[ii] Pillow Fight: Hotels vs. Online Travel Agencies. (2016, June 23). Retrieved December 01, 2017, from https://www.morganstanley.com/ideas/hotels-vs-online-travel-agencies

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