Déjà Vu: The Billion Dollar 'Leakage' Continues to Drain the Hospitality Industry.
By Max Starkov
Tuesday, 31st August 2010
Background: Back in December 2003, STR published a much discussed article titled, 'The Billion Dollar Leak - The Impact of The Merchant Model on US Hotel Profits', in this article the authors attempted to quantify the financial impact of third party sites on US hotel industry room revenues and profits.

To describe this loss, they coined the term "leakage": i.e. revenue "leaked" from the hotel industry to third party sites in the form of abnormally high merchant commissions of 25% and higher.

Smith Travel Research estimated that the leakage would hit $1 billion back in 2003, and grow to reach $1.3 billion in 2004.
Estimated Total Merchant Model Leakage:

As we will prove below, this billion dollar leak turned into a multi-billion dollar drain reaching a staggering $5.4 billion in 2010!

Why did the hospitality industry, in these turbulent post 9/11 times, allow the third party sites (today known as Online Travel Agencies-OTAs) to earn billions of dollars in the form of merchant commissions? There are many reasons for that; here are just a few of them:
  • At the time (2001-2003) hoteliers still treated OTAs as wholesalers and typically gave OTAs wholesale/group rates, similar to the rates given to traditional tour operators. These discounted rates instantly became public across the Web, thus undermining the hotel's other distribution channels and leading to serious price and brand erosion.
    Case in point: back in early 2003 we conducted a Top 10 Market Comp Analysis Study for a major hotel brand. The results? In all markets, this hotel brand properties' rates were consistently $150-$200 per night lower (no kidding!) on OTA sites like hotels.com than on the brand own website.
  • As pure-bred Internet players, the OTAs were much smarter eMarketers, compared to most hoteliers at the time.
  • The Best Rate Guarantee was not adopted by the major hotel brands until May of 2002 (IHG), followed by the rest of the brands in 2003. In contrast, OTAs have had best rate guarantees since 1995 (e.g. HotelDiscounts.com, today known as Hotels.com).
  • Rate Parity across all distribution channels was a very novel term back in 2002 and 2003.
  • The OTAs had a "field day" dealing directly with the franchised hotels without the scrutiny of the major brands.
  • The Independent hotels were literally at the mercy of the OTAs.
2004 – 2007: The "Golden Years", or When the Industry Came Back to Its Senses

With the establishment of the Internet as a serious online marketing and distribution channel, hoteliers began to understand that overdependence on the indirect online channel (OTAs) hurts the bottom line and leads to brand erosion and loss of customer loyalty. All major hotel brands and many smart independent hotel companies undertook a series of measures to limit the impact of the OTAs and steer customers to book via the direct online channel i.e. via the hotel's own website.

Some of the best practices implemented during this period led to a complete reversal of the distribution landscape at the expense of the OTAs:
  • Best Rate Guarantees became common practice in the industry.
  • Rate Parity across all distribution channels became the industry norm.
  • All major hotel brands, boutique, and luxury hotel and resort brands negotiated corporate agreements with the OTAs, thus exploiting "collective bargaining" to negotiate better terms with the OTAs and disallow the OTAs from dealing directly with their franchisees or branded hotels.
    Case in point: InterContinental Hotel Group exemplified the industry's determination to take back control from the OTAs by severing its relationship with Expedia and Hotels.com in August of 2004 and pulling all of its hotels from these OTA websites. The main reasons cited were merchant commission levels, circumventing the brand and working directly with IHG franchisees, lack of clear marketing practices, not honoring IHG trademarks, etc. It took more than three years – until November 2007 – for IHG and Expedia to sign a distribution agreement.
  • Most hotel companies established internal E-Commerce Departments to deal with their websites, the direct online channel and various Internet marketing campaigns and initiatives.
  • Many hotel companies developed Internet marketing proficiencies and expertise at par with the OTAs.
  • Many hotel companies shifted the bulk of their advertising budgets from the offline to the online space.
  • Many best practices were created and perfected during these "Golden Years" and the direct online channel in hospitality was firmly established and embraced by the industry.
As a result of the above strategic steps, the hospitality industry dramatically increased direct channel bookings (i.e. via hotel branded websites), and decreased the reliance on merchant and opaque OTA sites such as Expedia.com and Priceline.com.

Case Study: Internet Hotel Bookings by Channel for the Top 30 Hotel Brands

In 2006 and 2007, the top 30 hotel brands and the industry as a whole increased the hotel brand website booking contribution to as high as 76.1% and decreased reliance on merchant and opaque OTA sites to as low as 18.4% from all online bookings.

Here is a summary of Internet bookings by channel for 2006 and 2007:

2008-2010: The Years of Industry-Wide Amnesia

When the recession hit the industry back in 2008, I truly believed the hospitality industry would not allow a repetition of the shameful post- 9/11 years. Why did the industry allow the OTAs (again) to have a field day at the expense of the industry, and another "billion dollar leakage" to go to the OTAs in the form of abnormally high markups and commissions?

I was convinced that during the "Golden Years," hoteliers had become seasoned eMarketers, had fully embraced the direct online channel and instituted measures and processes in place to disallow OTAs from taking advantage of the industry in an economic downturn.

Was I dead wrong or what?

The hospitality industry suffered from some kind of industry-wide amnesia and had completely forgotten the tremendous damage done to the industry by the OTAs in the months and years after 9/11.

Many hotel companies (including a number of major hotel brands) exhibited a typical "knee-jerk" reaction to the deteriorating economic environment, forgot everything they learned in the post- 9/11 period, and "succumbed to the devil" by embracing the indirect online channel (OTAs) to compensate for decreasing business. These hotel companies have been accommodating the OTAs with bigger discounts, unique promotions, etc., thus jeopardizing their direct online channel and destroying years-worth of achievements such as rate parity, best rate guarantees and more.

In other words, some hotel companies literally betrayed the industry by surrendering to the  temptations of the indirect channel and demands of Expedia.com, and some of them did this in a particularly unintelligent way.

The following clearly illustrates how within a very short period of time, hoteliers became susceptible to discounting and working with the OTAs, resulting in a significant shift from the direct online channel to the indirect online channel:

In a few short years the industry leaders – the top 30 hotel brands – lost 5% market share to the OTAs, which represents millions of dollars in bottom line revenue. The rest of the industry: smaller hotel brands, independents, resorts, etc. did not fare much better. Though concrete data is simply not available, it is logical to expect these smaller industry players lost a much bigger market share to the OTAs compared to the major brands.

There is no doubt that Expedia.com and the other OTAs have gained new market clout in this economic downturn. How did the OTAs achieve that?
  • Major hotel brands and the industry as a whole have been slow to develop a counter-strategy of their own and as a result have lost "momentum" and market share.
  • Emboldened by the industry's desperation and slow travel demand, Expedia demanded new terms and conditions that were against everything the hospitality industry stood for: last room availability, guarantees that the best rates are only found on Expedia/Hotels.com sites, penalties to properties that do not use these OTAs 100% of the time, etc. Some major brands succumbed to Expedia's demand for access to last room availability and made other major concessions contrary to business logic and accepted best practices.
    o Back in October 2009 Choice Hotels was the only major brand who stood firm against the damaging, unreasonable demands by Expedia, and told Expedia they wouldn't sign an agreement that would allow Expedia to become the de facto "Rate Police" of the whole industry and dictate its inventory distribution and revenue management decisions to the industry.
  • Expedia's 24 and 48-hour sales, as well as city-wide sales offered by hotels on Expedia and other OTAs (in breach of established rate parity principles and best rate guarantees on the hotel's own site), have convinced the traveling public that Expedia offers the best hotel deals today.
  • Expedia has taken on the role of the industry's "rate police", punishing hotels that dare not to offer this OTA all of the hotel's available rates, special promotions and even packages.
  • Expedia has been playing hotels against each other by extracting concessions which would be unthinkable in any other situation. We have seen this happen over the past two years all over the industry:
    o On the Independent hotel level, where one hotel is being played against another. Typically competing hotels in the same destination are invited to participate in a "24-hour sale" or "48-hour sale" on Expedia sites and "suggested" what the discount should be. Hotels that ignore these "sales opportunities" risk losing their "preferred status" with Expedia.
    o Expedia's approach is similar to smaller and midsize hotel chains and boutique and luxury hotel brands.
    o Especially interesting is the approach towards whole destinations, where the "threat of exclusion" motivates hotels to participate in destination-wide or city-wide promotions that demand 25%-30% discounts on top of the existing margin discounts of 25%-30%.
Back in October of 2009, in my article "The Prisoner's Dilemma, the Stockholm Syndrome, or a Case of Both?" I argued that Expedia had become the "market bully" and was taking advantage of the hospitality industry, which was struggling to survive as a result of the worst recession in modern times.

I argued further that since the removal of airline booking fees in 2008, which was the only substantial revenue source outside of hospitality, Expedia and the OTAs could survive only at the expense of the hospitality industry.

Exploiting the desperation among hoteliers, Expedia and some of the OTAs adopted increasingly aggressive market behavior toward the hospitality sector. The results were more than damaging for the hospitality industry and resulted in years of multi-billion dollar "leakages".

The Billion Dollar Leak: Experiencing an Unbearable Industry Drain All Over Again

The OTAs heavily rely on the hotel industry for the bulk of their revenues. For example, hotel bookings contribute to a little over 30% of the OTA global gross booking volume. At the same time, hotel bookings contribute to more than 60% of OTAs commissions/booking fees!

In its SEC filings, Expedia acknowledges that over 60% of its revenue comes from transactions involving the booking of hotel reservations, with less than 15% of its worldwide revenue derived from the sale of airline tickets. To clarify, over 54% of the OTAs' U.S. domestic reservation volume (44% of the OTA global gross booking volume) comes from selling airline tickets, and yet airline ticket sales produce a paltry 15% of Expedia's revenues.

In other words, hotel reservations are financing the OTAs' operations and allowing the OTAs to "make a killing" by reaping billions of dollars of abnormally high merchant (wholesale) commissions, and to survive after they stopped charging airline ticket booking fees.

In its 2007-2010 SEC filings, Expedia provides a crystal-clear confirmation that the billion dollar "leakage", first discussed by STR back in 2003, continues in full force and at much higher levels.

Over the last several years, revenue "leaked" from the hotel industry to Expedia in the form of abnormally high merchant commissions has been increasing every single year. This "leakage" exceeded $2 billion in 2007 and reached $2.3 billion dollars in 2009!

This leakage is estimated to reach $2.7 billion in 2010, based on the results from Expedia's first six months of this year and the rate of increase of 14.65% over the same period of last year.

To summarize, the $2.7 billion dollar "leakage" in 2010 is only the damage caused by Expedia. Expedia has an approximate 50% market share of the OTA market. If we calculate for the rest of the OTAs (Travelocity, Orbitz, Priceline), the total leakage in 2010 will reach a staggering $5.4 billion dollars!

What Can Hoteliers Do to Overcome this Massive "Leakage"?

Hoteliers must realize that a) the OTAs will not surrender their dominant position voluntarily, without putting up a fight (we repeatedly witnessed this after the end of past economic downturn), and b) increased travel demand, the beginning of which we are starting to notice, does not automatically translate into higher occupancy, ADRs and RevPARs: hoteliers must be more proactive and creative than the OTAs and the competition to get a "bigger piece of the pie" (increase market share and benefit more from the growing demand).

There are a few other important industry developments to be taken under consideration:
  • GDS Channel Is in Steady Decline:  GDS hotel bookings via the CRS of the top 30 hotel brands declined by 3.7% in 2009 vs. 2008, and constituted only 23.6% of the total brand CRS bookings last year (eTRAK). In Q1 2010 GDS share from total CRS booking dropped to the all-time low of 22.7%.
  • The Voice Channel Contribution Is Decreasing: Voice channel hotel bookings via the CRS of the top 30 hotel brands declined by 2.9% in 2009 compared to 2008, and amounted to 22.2% of total brand CRS bookings last year (eTRAK).
In other words, hoteliers do not have many options when considering other non-OTA distribution channels. In our view, the only viable option to drastically reduce reliance on the OTA channel is for the industry to embrace the Direct Online Channel.

Many hoteliers claim they cannot afford to market themselves via the Internet and that is why they resort to the OTAs since their services are "free." The following case study shows why the OTA channel not only is not "free", but is far more expensive than the Direct Online Channel and why focusing on the Direct Online Channel provides meaningful savings that go straight to the bottom line:

Case Study: How to Add Half a Million Dollars to the Bottom Line

A hypothetical New York City Hotel with 200 rooms, 77.2% average occupancy rate, an ADR of $215.14 in 2009 (STR), and 45% of bookings being made via the Internet will incur the following distribution costs (using the industry average 60:40 direct vs. indirect online ratio):
  • Cost of Direct Online Channel Distribution: 7,608 bookings x $12.92 = $98,295
    (Cost per booking via the hotel's own website, including website hosting and maintenance fees, advertising spend, campaign management fees, and Omniture analytics. Based on 530,000+ bookings in 2009 via hotel websites from HeBS' full-service hotel client portfolio)
  • Cost of Indirect Online Channel Distribution: 5,072 bookings x $107.57 = $545,595
    (Calculation based on a hypothetical NYC hotel of 200 rooms @ 77.2% average occupancy rate = 56,356 roomnights/2 nts average stay = 28,178 bookings total, of which 12,680 are Internet bookings (45% of total bookings).  Direct online bookings = 7,608 (60%) and Indirect Online Bookings = 5,072 (40%))
If the hypothetical 5,072 OTA bookings are instead made via the direct online channel  at $12.92 each, the bulk of the OTA distribution cost, namely $480,065, would go directly to the hotel's bottom line ($545,595 – $65,530, i.e. 5072 bookings x$12.92=$480,065). This is nearly half a million dollars added to the bottom line. Name one hotelier who would not have liked that in 2009!

Across the industry, in 2010, Direct Online Channel sales will exceed 60% of total online hotel bookings. In Q1 2010, 71.7% of online bookings for the top 30 hotel brands were direct via the brand websites, while 28.3 % were via the indirect online channel i.e. the Online Travel Agencies (OTAs).

The ultimate goal for the industry should be as follows:
  • Major hotel brands: OTA contribution (including agency, merchant and opaque model) should be kept below 15%.
  • Average for the hospitality industry: OTA contribution (including agency, merchant and opaque model) should be kept below 25% (the level the indirect channel has traditionally had for many years, even before the Internet).  
There is no doubt the Direct Online Channel provides hoteliers with immediate results in the current economic environment as well as long-term competitive advantages.  The Direct Online Channel must always be at the centerpiece of any hotelier's Internet marketing and distribution strategy. Travel consumers booking via the hotel website (direct customers), are more loyal, bring in more revenue and tend to travel more often.
What should hoteliers do to improve their direct vs. indirect online channel exposure?

Business Objectives:
  • Maintain strict rate parity across all marketing channels and maintain a best rate guarantee.
  • Create unique product offerings and provide unique value proposition via the hotel website.
  • Engage your customers directly via social media and mobile initiatives, and Web 2.0 features and functionalities on the hotel website. 
Marketing Objectives:
  • Focus on direct online channel marketing initiatives with proven ROI to increase market share and generate incremental revenue via the hotel website:
    o Website re-design and web 2.0 optimizations
    o Search engine marketing (SEM)
    o Search engine optimization (SEO)
    o Email marketing to the hotel opt-in list
    o Multi-channel marketing initiatives, promotions and contests
    o Social marketing: Facebook, Twitter, Flickr, YouTube
    o Mobile marketing via mobile website, mobile SEO and mobile marketing initiatives
    o Strategic linking and online sponsorships
Launch online marketing initiatives, addressing your top business segments and feeder markets.


Revenue "leaked" from the hotel industry to the OTAs in the form of abnormally high merchant commissions of 25% and higher will reach $5.4 billion in 2010. This leakage must be stopped and reversed as it drains the hospitality industry's bottom line and threatens the mere survival of the industry.

With GDS and voice channels in perpetual decline, hoteliers do not have many options when considering non-OTA distribution channels. The only viable option to drastically reduce reliance on the OTA channel is for the industry to embrace the Direct Online Channel.

Hoteliers need a robust Direct Online Channel Strategy, accompanied by adequate marketing funds, to be able to take advantage of the steady growth in the Internet channel and shift from offline to online bookings in hospitality due to declining GDS and voice channels.

Hoteliers must carefully employ ROI-centric initiatives, including website redesign, website optimization and SEO, paid search, email marketing, online display advertising, and proven social media and mobile marketing initiatives.

About the Author and HeBS:

Max Starkov is Chief eBusiness Strategist at Hospitality eBusiness Strategies (HeBS). HeBS is an award-winning, full-service hotel Internet marketing and Direct Online Channel Strategy firm, strictly dedicated to the hospitality and travel verticals.

Having pioneered many of the "best practices" in hotel Internet marketing and direct online distribution, HeBS specializes in helping hoteliers profit from the direct online channel and transform their websites into the hotel's chief and most-effective distribution channel, establish interactive relationships with their customers, and significantly increase direct online bookings and ROIs. Visit us online at www.hospitalityebusiness.com

A diverse client portfolio of over 500 top tier major hotel brands, luxury and boutique hotel brands, resorts and casinos, hotel management companies, franchisees, independents, and CVBs has sought and successfully taken advantage of HeBS' hospitality Internet marketing expertise. Contact HeBS consultants at (212)752-8186 or info@hospitalityebusiness.com.
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