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January 13, 2011

American Airlines, hoisted on their own petard (SABRE)

Last month, American Airlines removed its flight listings from Orbitz when they could not agree on commissions. Then Delta airlines stopped listing their flights with a half-dozen of the smaller websites. In general, the airlines are squeezing the middlemen, and hope to move the transaction to their own websites where low-cost competitors (JetBlue, etc) won't be presented to the potential customer. The theme has been airlines firing external websites.

This week, a truly remarkable thing happened: Sabre Holdings (a primary reservations company) fired American Airlines. It's sort of a man-bites-dog story when compared to what's happening throughout the industry.

I'm coming to learn that most of the problems I'm involved with are the direct results of brilliant solutions implemented ten or twenty years ago. The theory of unintended consquences suggests that the unintended consequences of any change will almost always exceed the desired outcomes, and that over time most solutions become problems.

There was a time when business processes exploited the capabilities of computers and automation by disintermediation, or the removal of middlemen. The intermediary (broker, agent, wholesaler, distributor) once connected the producer to the market and took a bit of money for it. Removing/replacing the intermediary left a bit more cash for either the new intermediary or the producer to keep.

Take cars. The car companies make cars but they don't have stores of their own. Dealers provide the interface with the market, motivated by their own markup. Some wunderkind develops, the website can operate much less expensively than a dealership, and the website replaces the dealership. Usually the new intermediary doesn't immediately replace the legacy broker, they just coexist awkwardly for a while, but as soon as the industry or economy gets rough, the cost dynamics favor the technology-based intermediary, and the legacy mom-and-pops are gone.

Video rentals. Remember when there were mom-and-pop video stores? They were disintermediated by bigger operations: Hollywood, Blockbuster, etc. Seen any of them lately? They're all being disintermediated by Netflix, which first found a niche through IT-based distribution, and which lately has moved into its destiny of web-based distribution. Internet killed the video store.

Once there were mom-and-pop bookstores; now there's websites and Kindles and Nooks. Once there were music stores where you could go into booths, listen to a record, and then buy it and take it home. Now there's iTunes and Pandora and no physical product at all. Once there were stockbrokers, the priests of the financial industry, the people you had to go through in order to invest. Now there's

Change isn't necessarily bad; there were jobs in the legacy shops, there are different kinds of jobs in the new shops, things move on. In many industries that relied on intermediaries, computers and networks and the internet are a disruptive innovation.

One of the functions that has been disintermediated to the point of obliteration is that of the travel agent. At one time, airlines couldn't deal with selling their tickets and interacting with the public on a sufficient scale to handle all the business; the travel agency provided travel agents who provided the expertise, and in return the travel agency drew commissions of 10% to 12% of the airplane, boat, train, hotel, and rental car fees.

Travel agencies were prone to "racking", which is putting the brochures for the trips most profitable for the agency on the most visible display racks. If there were two lines serving New York to Chicago, the travel agency was motivated to put the passenger with the tickets that were most lucrative for the travel agency.

American Airlines didn't like the influence the travel agencies had over their business. In the early 1950s aviation was booming, and the legacy people-and-paper systems weren't efficient enough. A funny thing happened; the story goes that in 1953, a senior IBM salesman found himself seated next to the American Airlines CEO on a flight. They started talking about how IBM's new military SAGE system could be adapted to meet American Airline's needs. Their conversation sparked the development of a system called Semi-Automated Business Research Environment, or SABRE, which was developed by IBM and owned by American Airlines.

American opened up their new technology to all comers. As more airlines looked at the system, they opted in to using SABRE to manage flight information with the travel agencies. But American Airlines now controlled the digital sales racks, and they accomplished "racking" in a big new way; SABRE presented flight info with a bias in favor of American's flights. American/SABRE believed that travel agents would be more likely to book flights that appeared on the top of the first screen. They were right; 92% of the time, the booking was made on flights on the first screen. American manipulated the results to be on the top of the first page.

In one example, New York Air in 1981 added a flight from La Guardia to Detroit, challenging American in an important market. Before long the new flights suddenly started appearing at the bottom of the screen. Reservations dried up, and NewYorkAir was forced to cut back from eight Detroit flights a day to none. On another occasion, Sabre deliberately withheld Continental's discount fares on 49 routes where American competed.

American Airlines developed SABRE as a key business strategy. SABRE became a profit center as big as the airline itself. In the last 1990s business consultants recommended spinning SABRE off from American Airlines, so that American could "focus on its core competencies"; after all, they're an airline, not an IT company.

Sabre Holdings left American Airlines with an IPO on March 15, 2000. It now employs approximately 9,000 people worldwide. Sabre Holdings operates the Sabre Travel Network, the Sabre Airline Solutions, Sabre Hospitality Solutions, and

Spinning off Sabre was an American solution that seemed brilliant at the time. This week, Sabre Holdings announced it would no longer carry American Airline's flights. This is Frankenstein's Monster firing Herr Doctor. Why is this happening?

The issue is American's Direct Connect service, a computer portal American asking travel agencies to use to access American's ticket inventory instead of using Sabre. Sabre, Expedia, Orbitz and some consumer advocates think that American's tactics with Direct Connect are aimed at making fare comparisons harder for online travel sites and for customers.

I'm convinced that back in 2000, people got bonuses for suggesting that American should spin off SABRE, get out of the geek stuff and focus on running an airline. Only ten years later, SABRE is throwing American out. Life is funny that way.

The current trend of jostling to see who gets to keep the business is of small interest, nothing too intriguing. But the notion of the reservations processor firing the airline is unique, and the fact that the airline was father to the enfant terrible is perhaps a lesson to those who think that outsourced functions are just as reliable as in-house shops.


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