Cut-throat competition for online travel

I have been contemplating investing in Expedia so I'll be covering the industry in more detail (until I get bored of it or feel that it is a bad investment.) You can get a sense of the cut-throat competition for online travel by noting how much Orbitz (OWW) collapsed when Expedia (EXPE) announced last week that it wasn't charging a book fee. Barron's reported the following last week:

As the recession-pressured market for leisure travel shrinks, the competition for online travel customers is heating up.

Expedia (EXPE) today unveiled an aggressive new promotion, which it calls “Free Nights and No Fee Flights,” offering to pick up the tab for one night in a hotel for stays of 3,4, or 5 days at a group of more than 700 participating hotels, and also waiving booking fees for flights booked before the end of May. The hotel promotion currently is for bookings made by April 9 for travel through May 15; the company said additional deals will be posted for bookings beginning April 9 for travel through the end of May.

Priceline (PCLN), which has permanently dropped airline booking fees, today is down $6.70, or 8.2%, to $74.58. Even harder hit is Orbitz (OWW), which is down 57 cents, or 28.2%, to $1.45.

Orbitz completely collapsed because more than 50% of its operating earnings supposedly come from booking fees. The travel section of The Wall Street Journal has details on how dependent the various OTAs are on the fees:

Online travel sites like Expedia, Travelocity and Orbitz typically charge $6.99 to $11.99 to book an airline ticket–you pay for their service. The fees are fairly well hidden because the sites fold them in with government taxes and fees. Those companies also make money off hotel bookings, car rentals, travel insurance, advertising and whatever else they can gin up.

But savvy shoppers know they can use the booking sites to shop across many airlines, and then typically book the trip directly from the airline and save the online agency fee. What’s more, the online booking sites face lots of competition from search-only sites like Kayak.com that compare lots of different offers and then send you to whatever Web site you want–most likely an airline’s booking site, but sometimes a vendor like Orbitz or others. The search-site gets a referral fee; the traveler gets the cheapest price.

Priceline.com and Hotwire.com, which is another site owned by Expedia, were the first to eliminate their airline booking fees. But they are mostly off-price vendors — they take seats airlines don’t think they can fill at published prices and sell them through Priceline or Hotwire at deeply discounted prices. The sites can mark up the price and take a cut, so the booking fee wasn’t so important to them. For the sites that sell at published prices, the booking fee may be the only money they make out of the transaction.

For Expedia, which has acquired numerous other travel Web sites including TripAdvisor, SeatGuru and Hotels.com, selling hotel rooms has been a more lucrative business. Expedia and others negotiate special deals with hotels, and sometimes even buy up inventory from hotels that they resell at whatever price they can get.

Rather than booking fees, the reseller is getting a chunk of the price you pay for the room. Same goes for travel packages that the booking sites aggressively push. Add a hotel room to your air ticket, and the site is going to make more money. (You may or may not end up saving money with a package — best to compare hotel prices independently, and check several sites because they can have different inventory.)

It remains to be seen if Expedia can actually build up a moat in this industry. It's still not clear to me how these companies work and what competitive advantage, if any, they have over originial service provider (I just made up that word, OSP.) On top of the declining leisure spending due to the severe recession, price wars will be painful for these companies. So far it looks very much like the airline industry, which is not a good thing since airlines have been one of the worst industries for investors.