The explosion of the "merchant model" after 9/11 caught the hospitality industry by surprise. Over the last 4 years many hoteliers have been struggling to decrease their dependence on the online merchants and to develop direct online distribution strategies of their own.

Hoteliers are also trying to find answers to several critical questions: does the cost of doing business with online merchants outweigh the cost of not doing business with them? What will be those crucial developments in the online hospitality marketplace over the next five years and what can hoteliers do to prepare for and take advantage of them now? This paper provokes thoughts that may help shape executive decisions under the current circumstances.

Background
The "merchant model" is a simple wholesale arrangement that involves net rates and room allotments with cut-off dates. The concept is nothing new and existed long before Hotels.com and Expedia, in the form of the FIT wholesale model fashioned with tour operators. Companies like Gulliver's have operated in this space for decades. The only difference is that in the past hoteliers did not allow wholesalers and tour operators to publish discounted/wholesale hotel rates (net + markup) if not bundled with other travel services.

Due to a lack of understanding of how online distribution worked, exacerbated by the industry-wide desperation after 9/11, hoteliers did not impose the same restriction on the online merchants. As a result hoteliers saw their discounted rates posted all over the Internet –on merchant sites and thousands of affiliates--and suffered severe consequence to rate and brand integrity.

While hoteliers gave up rooms at steep discount, online merchants became darlings on Wall Street. Hotels.com had a market capitalization of over $3 billion at one point. This unhealthy industry practice was best illustrated by one industry executive who described the state of confusion as "Selling Waldorf-Astoria on Hotels.com is like buying Armani in Wal-Mart." Since those days, hoteliers have sobered up, but the hangover still lingers and too many hoteliers are still having difficulty weaning themselves away and adopting better online distribution strategies.

The Internet is All About Efficiency
The Internet is all about transparency, efficient distribution of information, and inexpensive e-commerce transactions. It is the most efficient marketing and distribution medium ever invented. It is simply the best direct-to-consumer distribution channel ever created and it definitely favors supplier-buyer relationships. Nowhere is this better illustrated than between hotel and customer. Hoteliers that embraced their own direct online distribution efforts first and merchants second now enjoy as much as 40% to 60% of total revenues from their own websites.

In this sense the abnormally high margins of the merchant model (18%-30%) constitute a temporary anomaly, not the rule. That is because the merchant model contradicts the very nature of the Internet as an efficient and direct-to-consumer channel. The marketplace cannot tolerate deficiencies and abnormally high profit margins except on a temporary basis in periods of major industry transitions or during the emergence of entirely new distribution and marketing media (i.e. the Internet).

Travel is all about selling a dream, an anticipated experience. Selling a hotel stay over the Web does not require warehouses, complicated wholesale and retail arrangements, fulfillment centers, etc. Hoteliers know their product, destination, and customers better than anybody else. Just think about what a smart hotelier can do by employing rich media on the Web (virtual tours, photo galleries, floor plans, interactive applications, etc).In this sense to market well online hoteliers do no need third party intermediaries, and can do the job themselves.

The proverbial "pendulum" has shifted back in favor of hoteliers. Major brands and savvy hoteliers are re-gaining control of the online distribution channel and have already proven that they can "dictate the terms of the online game" via tight control over properties, rate parity, best rate guarantees and successful loyalty programs (e.g. 75% of all Internet sales for Marriott come from the brand website)

The Merchant Model is already Evolving
The merchant model, used as the main business model by leading online intermediaries, is becoming more flexible due to the changing market conditions and increased pressure by travel suppliers: corporate contracts, lower mark-ups (e.g. 18%-22%), direct interfaces to the major brand CRSs, and last room availability on the hotel site. All of these concessions would have been unthinkable just two years ago.

This trend will inevitably accelerate over the next years as travel suppliers and major hotel brands continue to apply pressure on the online intermediaries in an environment of improved economic conditions and positive changes in consumer purchasing behavior.

The online merchants are embracing the dynamic packaging model as the next high profit margin generator. Dynamic packaging is a reincarnation, on a higher technology level, of the traditional FIT packaging that has existed since the advent of the GDS.

This business model enjoys an increasing popularity among the online intermediaries. Why? It allows intermediaries to charge much higher mark-ups (e.g. 25%-35%)
compared to the merchant model (e.g. 18%-25%). At the same time travel suppliers prefer dynamic packaging to the merchant model because it makes their distressed inventory and pricing opaque.

Forrester predicts that dynamic packaging sales will quadruple between 2004 and 2009. 68% of online travelers would consider purchasing a dynamic package (PhoCusWright Survey). All major online intermediaries have embraced the dynamic packaging model. Expedia, Travelocity and Orbitz report their dynamic packaging modules are the fastest growing segment of their overall bookings.

Comeback of the Agency Model?
The agency model (i.e. the old travel agency model that relies on supplier commissions, usually 10%) is beginning to regain at least some of its past luster as a result of the rate parity introduced by all major brands, and the lower merchant mark-ups negotiated by some of the major hotel brands (e.g. 18%). One of the typical merchants, Lodging.com, has negotiated straight commission override deals with some of the major brands.

Developments in Hospitality over the Next Five Years
Hospitality eBusiness Strategies firmly believes that the following crucial developments in the hospitality industry over the next five years will benefit hoteliers and other travel suppliers and help lessen their dependence on the online intermediaries and transform the merchant model as we know it:

• Online distribution has become the #1 channel in hospitality:
  
  In 2005 over 25% of all hotel room revenue will be booked online. Another 25% of hotel bookings will be directly influenced by the Internet but done offline. In 2006 this percentage will exceed 27%-29%. Overall travel booked online will exceed 31%-35% of total bookings over the next 2 years. (PhoCusWright, HeBS). We expect that by 2009 over 50% of all hotel bookings will be performed online.