Airline Overrides: What Travel and Procurement Managers Need To Know

By Scott Gillespie Principal and CEO Travel Analytics, Inc. April 8, 2002 Choosing the right airline strategy for your firm is one of the most important decisions youll make. Selecting an airline strategy means rigorously evaluating which airlines should be your preferred partners, negotiating the best discounts and ensuring you can meet the collective goals in your new contracts. Airline overrides and their thinly disguised cousins must be neutralized before you can make a solid decision. Heres what all travel and procurement managers should know: Airlines have long paid incentives to their preferred travel agencies to shift air sales their way. These incentives, known as overrides, have been used by airlines to reward an agency for delivering volume or market share in excess of the airlines goal for the agency. Airlines have recently eliminated commissions in North America, but at the same time have increased their incentive (override) payments to their agency partners. This pay-for-performance relationship between airlines and travel agencies, now even stronger, has serious consequences for corporate travel buyers. As a result, travel and procurement managers should insist on using independent consultants to conduct airline strategy studies. Heres why: Airlines are in a dogfight for market share, especially for business travel. Airlines have apparently concluded that commissions dont move market share, but overrides clearly do. Given that the mega-travel agencies sit squarely between the airlines and the business traveler, the airlines have to find ways to get their preferred travel agencies to work even harder to shift business travelers to their flights. So increasing the agencys potential for overrides is a logical, even necessary move. But this sets up a strong potential conflict of interest for a travel agency. Who is the agency really serving the airline or its corporate customers? But wait a lot of companies are using net-net contracts with their airlines, and paying their agencies a transaction fee. Shouldnt this neutralize the agencys economic bias toward their preferred airlines? Unfortunately, it does not, for these five reasons: Overrides are not small Overrides can be easily disguised In for counting, out for payment Subsidization of transaction fees Size matters

Overrides are not small. By design, they cant be, or the agency wont respond to the incentive. We estimate that the average mega-travel agency today earns 1-2% of its annual air volume in overrides. So a $4 billion-dollar mega agency is probably earning $40 to $80 million each year in overrides, the majority of which probably comes from a single airline. Given that in the best of times an agency makes about a 1% profit on its air sales, you can see how critical the override revenue stream is to the agency. Without overrides the agency would likely go out of business.

Overrides can be easily disguised. No one at Travel Analytics has ever managed an override contract. Still, it seems obvious that airlines have a variety of ways in which they can compensate an agency other than by sending over a check marked override payment. An airline can provide soft dollars in the form of free travel for the agency employees. This helps keep agent labor costs low pretty important for a business whose biggest expense is agent labor. An airline can provide an agency with free or deeply discounted inventory that the agency can mark up and resell at a significant profit. An airline can pay the agency a distribution fee for access to the agencys network of travel counselors. Or perhaps the airline simply pays the agency, or the agencys consulting division, a consulting fee. In for counting, out for payment. Assume your company has a net-net agreement with the airline, and so the airline presumably does not pay a penny of overrides to the agency for your volume. Your volume on this airline will likely still count toward the agencys overall market share or sales goal with the airline (in for counting), but the agency wont be paid an override on your volume (out for payment). However, if your volume or market share pushed the agency past its overall goal, the agency will be paid overrides on its other accounts. It seems clear that the travel agency still has a vested interest in steering your travelers to its preferred airlines, especially if your company can give significant volume to these airlines Subsidization of transaction fees. Is the solution for a travel agency faced with these conflicts of interest simply to refuse all forms of compensation from the airlines? Unfortunately, this action, if taken by a single bold agency, would likely cripple it in the marketplace. Why? Because the bold agency would have to raise its transaction fees significantly to replace its override income. Not many travel managers want to see their agency transaction fees go up at all, and certainly not by $5-10. Even if you are paying your agency a transaction fee, it almost certainly depends on override income to keep its overall fees competitive - and we know what the agency has to do to keep the override income coming in. Size matters. Assume your company spends $30 million on air travel a year. This means youll generate about $300,000 in annual profit for whichever travel agency serves you (the 1% rule of thumb). Lets assume your travel agency is one of the mega-travel firms, and that it claims $4 billion in annual air sales. As noted above, this means the travel agency is likely earning $40-80 million a year in overrides from its preferred airlines. Compare $300k to $40 million. This suggests that 1) the agency is not going to nominate a strategy to you that might jeopardize its override income, and 2) it will not negotiate very aggressively on your behalf if it means negotiating against its preferred airlines. Whose strategy is it, anyway? With so much override money at stake, its quite clear why travel agencies want to provide their corporate customers with airline strategies. Many travel managers have been receptive to this. A good airline strategy saves a company significant money, but it typically requires complex analysis of airline discounts and flight schedules. So why not let the travel agency do the hard analytical work, especially since the agency is often willing to do the work for free? American Express, Rosenbluth and WorldTravel BTI all promote proprietary software-based solutions designed to help develop airline strategies for their clients. Each can offer their airline strategy services for free, and often do. A corporate travel manager can certainly get an airline strategy from any of these agencies. But then whose strategy is it - or said better, for whom is the strategy really designed?

The Solution Given the travel agencies potential for conflict of interest on this important issue, it seems that agencies have only one good solution engage neutral third parties to conduct airline strategy analyses for their current or prospective clients. The solution is similar to the one chosen by the big accounting firms they recognize the potential for conflict and are declining to provide consulting services to their audit clients. A travel agency could easily outsource the airline strategy analysis to an independent third party, while advising the client on the implementation risks peculiar to the clients culture and policies. In fact, TQ3 Travel Solutions has already contracted with Travel Analytics to conduct 100 independent TANGO-based assessments for its largest clients worldwide, and to develop unbiased airline strategies for these firms. There are many other neutral third parties capable of developing unbiased airline strategies, including large consulting firms such as A.T. Kearney, IBM Consulting Services and PricewaterhouseCoopers, and small consultancies such as Corporate Solutions Group, Consulting Strategies, Management Alternatives and Travel Analytics. At the end of the day, you are accountable for selecting the best airline strategy for your firm. The best strategy means significant savings. If you need help developing a strong and unbiased airline strategy, insist on using an independent consultant. ***************** About Travel Analytics, Inc. Travel Analytics is the worlds leading consultancy in the field of strategic sourcing of travel suppliers. Clients include Coca-Cola, Compaq, Dell, Ernst & Young, ExxonMobil, HewlettPackard, Invensys, Microsoft and PricewaterhouseCoopers. Scott Gillespie founded Travel Analytics in 1999 after spending eight years with A.T. Kearney, where he was the firms global expert on strategic travel sourcing. Travel Analytics developed TANGO, the industrys most powerful and unarguably unbiased airline sourcing software. TANGO has been applied to more than eight billion dollars of corporate air spend, and is used by travel buyers, travel agencies, consultants and airlines all for the purpose of objectively evaluating airline supplier strategies. Scott has been named by Business Travel News as one of the industrys most influential executives, and has been honored by the Association of Corporate Travel Executives for his contributions to the travel management profession. He holds an MBA from the University of Chicago and a BS from Arizona State. For more information, call (440) 248-4111 or see http://www.travelanalytics.com/.