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The billion dollar leak – The impact of the merchant model on US hotel profits

The impact of third party Internet sites on hotel reservations is the focus of intense debate in the hotel industry today. This article will attempt to quantify the financial impact of third party sites on U.S. hotel industry room revenues and profits. While many hotel operators believe these sites have a beneficial effect on their occupancy we feel it is important for hotel operators to identify the potential impact that third party Internet retailers can have on their revenues and more importantly, on profits. This article, we believe, can shed some light on this topic.

In the merchant model transaction, the hotel receives the net rate previously negotiated with the retailer. Guests booking rooms via third party sites pay the amount posted by the Internet retailer and do not know or care what percentage or dollar amount the hotel ultimately receives for the services. The Internet retailer keeps the difference between the consumer`s final price and the hotel`s net rate. The Internet retailer assumes no risk and incurs no cost if the allocated inventory goes unsold.

Based on the financial disclosures of publicly traded companies and STR`s estimates of total industry revenues we have estimated the merchant model room revenue share of total online hotel sales. From there we then extrapolate an industry-wide merchant revenue figure commonly referred to as leakage (i.e. revenue leaked from the hotel industry to third party sites).

Total Merchant Model Leakage Figure: – PhoCusWright estimates that 49% of the $6.3 billion in online hotel sales in 2002 are generated by online travel agencies. 75% of this revenue is generated through the merchant model. Based on this data, total merchant model sales were estimated to be over $2.3 billion in 2002.

The $2.3 billion is gross merchant model revenue and requires adjustment for certain costs to reflect net proceeds from the merchant model. Based on publicly available information and industry research reports we derive a total industry merchant model leakage figure

Estimated Total Merchant Model Leakage

We estimate that third party merchant sales leakage from the U.S. hotel industry was about $676 million in 2002 and that number is expected to increase to over $1 billion in 2003.

Hotel Industry Impact: – Despite recent difficulties in the U.S. hotel operating environment, the industry has been profitable for the last 10 years. The table below details industry revenues and profits for the last two years and our forecast for 2003:

Estimated US Hotel Industry Performance

To appreciate the full financial impact of merchant model leakage, we have also estimated the impact on industry profits. In an article recently published by the investment bank Bear Stearns, the argument was made that an incremental dollar generated through an occupancy gain increases profits by $0.60 because of the increased variable costs associated with filling the room (e.g. labor, utilities, laundry, etc,). However, a dollar gained purely through an ADR increase flows to the profit line with only a 5% expense. Adding to this logic, it can be assumed that revenues leaked to third party sites if realized by hotel companies, would have almost completely impacted the bottom line. Revenue given up to third party sites can be considered incremental revenue to the hotel operator, i.e. dollars the guest actually paid that go to the third party site instead of the hotel. Based on these assumptions we estimate the potential profit impact of merchant model leakage as shown below:

Estimated US Hotel Industry Results and Leakage Percentage

Given the industry room revenue figure in 2002 was $78.9 billion, the roughly $676 million in estimated leakage revenue equates to less than 1% of total room revenues, which may not seem much. However, applying the leakage figure to industry profits shows a different picture. The industry gave up an estimated 4.5% of profits by shifting pricing power to the Internet retailers. We assume that this number will likely increase, to around 6% in 2003.

Assuming the industry is poised for further recovery in 2004, the impact of the merchant model on industry profitability should not be underestimated. The primary argument of the third party merchants is that they help generate incremental bookings the hotel would have not captured without the help of this distribution channel. But hotel management should carefully evaluate the cost/value equation that third party retailers propose. By subscribing to the merchant model, hotel managers are shifting at least some of their pricing leverage to the third party sites. If lodging demand increases in 2004, there is potential for increased room rates. Hotel managers locked into wholesale arrangements may not fully benefit from rate increases which, in turn, can impact profitability. In most cases the amount of room inventory allocated to Internet merchants is probably relatively small. But, as we have tried to show on a macro level, leaked revenues can impact profits which then can impact owners` returns and company stock prices. Third party distribution sites have their place, hotel operators just have to make sure they understand the full implications of the collaboration.

Conclusion: – The figures presented here are based on a number of assumptions. However, the underlying fact is that the third party players are a force to be reckoned with and that their actions can impact hotel industry profitability. Every hotel operator should understand the costs and opportunities that third party merchant sites present. The third party sites are here to stay. Using them to form a mutually rewarding relationship is in the hotel operators` hands.

The impact of third party Internet sites on hotel reservations is the focus of intense debate in the hotel industry today. This article will attempt to quantify the financial impact of third party sites on U.S. hotel industry room revenues and profits. While many hotel operators believe these sites have a beneficial effect on their occupancy we feel it is important for hotel operators to identify the potential impact that third party Internet retailers can have on their revenues and more importantly, on profits. This article, we believe, can shed some light on this topic.



In the merchant model transaction, the hotel receives the net rate previously negotiated with the retailer. Guests booking rooms via third party sites pay the amount posted by the Internet retailer and do not know or care what percentage or dollar amount the hotel ultimately receives for the services. The Internet retailer keeps the difference between the consumer`s final price and the hotel`s net rate. The Internet retailer assumes no risk and incurs no cost if the allocated inventory goes unsold.



Based on the financial disclosures of publicly traded companies and STR`s estimates of total industry revenues we have estimated the merchant model room revenue share of total online hotel sales. From there we then extrapolate an industry-wide merchant revenue figure commonly referred to as leakage (i.e. revenue leaked from the hotel industry to third party sites).



Total Merchant Model Leakage Figure: – PhoCusWright estimates that 49% of the $6.3 billion in online hotel sales in 2002 are generated by online travel agencies. 75% of this revenue is generated through the merchant model. Based on this data, total merchant model sales were estimated to be over $2.3 billion in 2002.







The $2.3 billion is gross merchant model revenue and requires adjustment for certain costs to reflect net proceeds from the merchant model. Based on publicly available information and industry research reports we derive a total industry merchant model leakage figure



Estimated Total Merchant Model Leakage







We estimate that third party merchant sales leakage from the U.S. hotel industry was about $676 million in 2002 and that number is expected to increase to over $1 billion in 2003.



Hotel Industry Impact: – Despite recent difficulties in the U.S. hotel operating environment, the industry has been profitable for the last 10 years. The table below details industry revenues and profits for the last two years and our forecast for 2003:



Estimated US Hotel Industry Performance







To appreciate the full financial impact of merchant model leakage, we have also estimated the impact on industry profits. In an article recently published by the investment bank Bear Stearns, the argument was made that an incremental dollar generated through an occupancy gain increases profits by $0.60 because of the increased variable costs associated with filling the room (e.g. labor, utilities, laundry, etc,). However, a dollar gained purely through an ADR increase flows to the profit line with only a 5% expense. Adding to this logic, it can be assumed that revenues leaked to third party sites if realized by hotel companies, would have almost completely impacted the bottom line. Revenue given up to third party sites can be considered incremental revenue to the hotel operator, i.e. dollars the guest actually paid that go to the third party site instead of the hotel. Based on these assumptions we estimate the potential profit impact of merchant model leakage as shown below:



Estimated US Hotel Industry Results and Leakage Percentage







Given the industry room revenue figure in 2002 was $78.9 billion, the roughly $676 million in estimated leakage revenue equates to less than 1% of total room revenues, which may not seem much. However, applying the leakage figure to industry profits shows a different picture. The industry gave up an estimated 4.5% of profits by shifting pricing power to the Internet retailers. We assume that this number will likely increase, to around 6% in 2003.



Assuming the industry is poised for further recovery in 2004, the impact of the merchant model on industry profitability should not be underestimated. The primary argument of the third party merchants is that they help generate incremental bookings the hotel would have not captured without the help of this distribution channel. But hotel management should carefully evaluate the cost/value equation that third party retailers propose. By subscribing to the merchant model, hotel managers are shifting at least some of their pricing leverage to the third party sites. If lodging demand increases in 2004, there is potential for increased room rates. Hotel managers locked into wholesale arrangements may not fully benefit from rate increases which, in turn, can impact profitability. In most cases the amount of room inventory allocated to Internet merchants is probably relatively small. But, as we have tried to show on a macro level, leaked revenues can impact profits which then can impact owners` returns and company stock prices. Third party distribution sites have their place, hotel operators just have to make sure they understand the full implications of the collaboration.



Conclusion: – The figures presented here are based on a number of assumptions. However, the underlying fact is that the third party players are a force to be reckoned with and that their actions can impact hotel industry profitability. Every hotel operator should understand the costs and opportunities that third party merchant sites present. The third party sites are here to stay. Using them to form a mutually rewarding relationship is in the hotel operators` hands.

Theodore Koumelis
Co-Founder & Managing Director - Travel Media Applications | Website

Theodore is the Co-Founder and Managing Editor of TravelDailyNews Media Network; his responsibilities include business development and planning for TravelDailyNews long-term opportunities.

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