Agent Issues Competitive Settlement Plans: A Key to Empowering Agencies By Mark Pestronk / January 14, 1999 Share 1 -- Mark Pestronk is an attorney at the Law Offices of Mark PestronkIt is a major honor for me and a highlight of my career to be asked not only to present a paper today, but also to have helped organize and judge this conference. Of course, the real organizational credit goes to John Hawks, whose idea this conference was, and who almost single-handedly has brought it from concept to reality. Thank you, John, for the opportunity to help advance the state of the industry by bringing together all these legal experts, and placing us together end to end to see if we can reach a single conclusion.I am now entering my twenty-fifth year of law practice, representing travel agencies in trade matters. Most of those trade matters involve the airline-agency relationship. I would like to tell you what I have learned in those 25 years. I am like both the hedgehog and the fox. Like the fox, I know many things; my head is just filled with facts and trivia. But, like the hedgehog, I do know one big thing: the seven or so major U.S. airlines have all the power in the airline-agent relationship, and the agencies have none of the power.I see this reality every day in my law practice, in ways large and small. This is the essential problem for agencies, and I would submit that the task of this symposium is to figure out how to use the law to reverse the situation not merely to redress the balance of power, but rather to reverse the status quo completely to give agencies the preponderance of the power in the airline-agency relationship.Is this possible, you ask? Can 18,000 mostly "Mom and Pop" agencies get power over seven giant airlines? I believe that the answer is yes, and that one means for changing the balance of power is for agency groups to establish settlement plans that compete with ARC.History LessonWhy is it that, although there are four CRS's competing vigorously for agency allegiance, there is only one ARC? The answer is history. It isn't that ARC is the best of all possible worlds, as Kathi Argiropoulos would have you believe. Of course, ARC has tried reasonably hard to help agencies: from the Advisory Council, to the JAB-ARA, to the Arbiter's Rules of Practice and Procedure, to David Collins' motto that he wants a "level playing field", ARC has made tremendous strides to be fair, reasonable, and to provide due process far agencies. But all this is besides the point. It's just that ARC is like AT&T before telephone deregulation: it has no economic incentive to negotiate with agencies.Conversely, why is it that there are four competing CRS's instead of just one? Again, the answer is history. Our job as lawyers should be to take the best of history and use it to reform the worst of history. So, let's proceed.My insight is that ARC and CRS have much in common. First, they are airline-controlled. Second, they are regulation-laden; although ARC's regulations arise by contract and CRS's by government rule, this is really a distinction without a difference. Third, they are indispensable to agencies. Fourth, they have reporting mechanisms; although ARC is used to report sales and CRS used to report reservations, this is also really a distinction without a difference. If we stretch our imaginations just a little, we can see that, in many ways, ARC and CRS have more in common than anyone has ever noticed.At the same time, the experience of agencies in the United States shows a gigantic difference between ARC and CRS: ARC inhibits price competition, while the CRS is inherently pro-competitive and fosters price competition. ARC prevents travel agencies from making more money; CRS is a money-maker. Let us see what lessons we can draw from this difference and what can be done to make ARC more like CRS.How Does ARC Dis-Empower Agencies?In most industries, the acquisition of volume and market share enables the acquirer to negotiate more effectively with suppliers. However, in the travel agency industry, a large travel agency has no special negotiating power with airlines. I believe that agencies' powerlessness is largely due to the fact that there is only one settlement plan. The effect of ARC is to allow airlines to refrain from engaging in price competition for agency services. This effect occurs in at least three ways, as follows:The Uniform Reporting CycleUnder the uniform weekly reporting cycle, agencies must report all airline ticket sales on a weekly basis. The reported sales are automatically deducted from the ARC account through a draft also required by ARC rules. This practice fixes the price of credit extended to agencies by the airlines.I recognize that I cannot offer any economic proof that, if there were competitive settlement plans, agencies would be able to negotiate better credit terms. I cannot prove that some agencies could obtain permission to pay some carriers monthly or even that some agencies could actually receive a bonus for prompt payment or for plating everything on one carrier. However, I am convinced that these favorable possibilities would be present, just as they are in the case of CRS.Reporting at Full Tariff RateARC rules require agencies to report all tickets sold at the tariff rate. The tariff reporting requirement suppresses agencies' ability to price competitively. If agencies wish to charge clients a service fee, they cannot include the fee in the price of the ticket. ARC's reporting system stifles the imposition of such fees by requiring that they be charged separately from the tickets with which they are connected.Once again, I cannot offer any economic proof that agencies would be able to charge higher or more comprehensive service fees if the fee were on the ticket, but, again, I am convinced that it would be so.Dissemination of Sales Information to AirlinesARC's requirement of reporting sales by individual branch location enables the airlines to obtain detailed information about agencies' business patterns. The airlines have, in turn, used this information to compete directly with agencies and to suppress agencies' ability to earn override commissions.Many branch locations are intended to serve a single corporate account. Discrete reports for these branches reflect volumes for individual clients. ARC will provide any airline with this information for a fee. Carriers use the information to sell directly to agencies' large clients, reducing agencies' volume and commission income.The provision of sales information to the airlines has had an even more onerous and insidious effect. Before ARC's information was available, override commissions were paid on the basis of fixed sales volume targets or sales growth targets. Since it became available, airlines have abandoned volume and growth-based overrides for market-share overrides.In order to earn override commissions under a market share formula, the share of an agency's sales on a particular airline must exceed the share that other agencies in the peer group sell on that airline. The definition of peer groups and the identity of the locations or city pairs clustered together for purposes of determining market share are determined by the airlines.Market-share overrides suppress price competition among the airlines for agency services in at least two ways. First, they suppress the overall amount of commission that agencies can earn by creating a zero-sum game. Agencies cannot increase market-share on one airline without decreasing it on another. Second, they prevent agencies from fully benefitting from increases in overall travel volume. If travel volume rises generally, the airlines retain the lion's share of the increased revenues. Agencies earn no override unless their share of the paying airline's traffic increases faster than the share of other agencies in the peer group. The overall effect is that market-share overrides reduce the amount of commission income available to agencies.While it is true that most of the major airlines now also use CRS data to determine market-share, they still depend on ARC sales data in their formulas to at least some extent.With agency-owned settlement plans operating in competition with ARC, market-share formulas would be either impossible to administer or at least so difficult to administer that these stingy, zero-sum-game formulas would be abandoned. Then, major U.S. airlines would likely compensate agencies using the same volume-based formulas used by cruiselines, tour operators, hotels, and car-rentals. Again, I cannot prove that this would be so, but I am persuaded by the analogy to CRS, where agency compensation keeps getting better and better.How Do CRS's Empower Agencies?In the United States, the four CRS vendors compete fiercely for travel agency services. As a result of this competition, there are major opportunities for profit in CRS deals. In my practice, for example, I have identified no less than 25 business issues to be covered in every CRS negotiation 25 ways in which agencies can make money from CRS contracts.It is not the inherent economics of the CRS industry that makes CRS profitable for agencies. It is not that CRSs are so inherently lucrative that they are driven to share their revenue with travel agencies. After all, if there were just one CRS one reservations settlement plan, if you will I am sure that no agency would make money from the CRS. Rather, CRS empower agencies because of competition.Making ARC Like CRSI would like to propose that agency groups set up one or more plans to compete with the airline-run settlement plans. With competition, the settlement plan owners will need to offer inducements for a travel agency to choose one plan over another. Smart travel agencies will see opportunities for negotiation of better payment terms and higher commissions.In addition to receiving better compensation, agencies could use competition to empower themselves further regarding the non-compensation matters that ARC directly regulates, such as use of ticket stock, staffing locations, opening and closing locations, repayment terms in case of default, and a dozen other matters that affect the daily business of the agency today. Agencies could choose the plan that offered the best rules and could even negotiate their own rules just as they do with CRSs.Let me close by noting that I do not represent any agency groups that want to set up competing settlement plans. It is simply that I see such competition as the best hope for finally doing something about the "one big thing" that I know.