Expedia 2007 Annual Report Download - page 39

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the entry and subsequent emergence of several of the largest traditional carriers from the protection of
Chapter 11 bankruptcy proceedings.
The traditional carriers’ need to rationalize their high fixed cost structures to better compete in this
environment has caused them to curtail their domestic capacities, thereby increasing their load factors and
enabling them to more easily pass along fare increases. Competitive pressures have also caused them to
consider consolidation opportunities to better share fixed costs and reduce redundant flight routes. While these
attempts have historically been unsuccessful either due to antitrust concerns or reluctance among target
companies to consummate mergers, more recent discussions have apparently progressed to very advanced
stages for a number of carriers. Should one or more of these combinations prove successful, it could result in
further capacity reductions and airfare increases.
Higher load factors are positive for Expedia from a demand standpoint, but negative if they lead to reduced
availability of merchant air capacity and fare increases. Fare increases are generally negative for Expedia’s business,
as they may negatively impact traveler demand, and our remuneration is tied principally to ticket volumes, not
ticket prices. Fare increases were especially pronounced in late 2007, and have continued into early 2008.
Carriers have aggressively pursued cost reductions in every aspect of their operations, including distribution
costs. Airlines have successfully negotiated lower (and in some cases, eliminated) travel agent commissions and
overrides, and focused on increasing direct distribution through their lower cost, proprietary websites. In addition,
in 2006 carriers succeeded in reducing payments to global distribution system (“GDS”) intermediaries as those
contracts expired. The GDSs in turn have passed on these reductions to large travel agents, including Expedia,
which historically received a meaningful portion of their air remuneration from GDS providers.
As a result of these decreased costs of distribution and high load factors, Expedia’s revenue per air ticket
has decreased more than 10% in each of 2005, 2006 and 2007, and air revenue now constitutes less than 15%
of the Company’s overall revenue base. However, Expedia anticipates greater stability in the non-booking fee
portion of its air remuneration beginning in 2008 as it has signed long-term agreements with nine of the top
ten domestic carriers and has anniversaried the GDS reductions which took place in 2006.
In addition to the challenges presented by higher load factors, increased fares and lower remuneration per
air ticket, most larger carriers participating in the Expedia marketplace have reduced their share of total air
seat capacity. At the same time larger LCCs such as Southwest in the U.S. and RyanAir and EasyJet in Europe
have increased their relative capacity, but have not generally participated in the Expedia marketplace. These
trends have impacted our ability to obtain supply in our agency and merchant air businesses.
The hotel sector has until recently been characterized by robust demand and constrained supply, resulting
in increasing occupancy rates and average daily rates (“ADRs”). More recently, supply has begun to outstrip
demand, and industry experts anticipate this trend will accelerate in 2008. In addition, hotels have begun to
see their occupancy rates leveling off, and in some cases decreasing, with ADRs growing at a slower rate, or,
in some markets, decreasing. While lower occupancies have historically increased Expedia’s supply of
merchant hotel rooms, and a lower rate of ADR growth can positively impact underlying demand, lower ADRs
also decrease our revenue per room night as our remuneration varies proportionally with the room price.
Increased usage and familiarity with the internet has driven rapid growth in online penetration of travel
expenditures. According to PhoCusWright, an independent travel, tourism and hospitality research firm, in
2007 35% of worldwide leisure, unmanaged and corporate travel expenditures occurred online, with 51% in
the United States, compared with 32% of European travel and 15% in the Asia Pacific region. These
penetration rates have increased considerably over the past few years, and are expected to continue growing.
This significant growth has attracted many competitors to online travel. This competition has intensified in
recent years, and the industry is expected to remain highly competitive for the foreseeable future.
In addition to the growth of online travel agencies, airlines and lodging companies have aggressively
pursued direct online distribution of their products and services over the last several years, with supplier
growth outpacing online growth since 2002, and now accounting for more than 60% of all online travel
expenditures in the United States according to PhoCusWright.
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