Graham & Dodd Annual Breakfast 2022. I love reading on how Ted and Todd make investment decisions. “Businesses are run by people, and Buffett says he likes taking the cash flow and removing it from managers and investing it himself. There’s a known adage, when looking to buy a business: look to buy a business a dummy can run, because eventually a dummy will run it. Every time Combs meets with a company, there are two questions he always asks management: (1) How long do you spend talking to investors, and (2) what would you be doing if you were not publicly traded? The median response is 25% of the time is spent talking to investors. In response to the second question management usually lists a number of things that make a lot of sense, and Combs then proceeds to ask why they don’t do that, and they say because they feel handcuffed. When management is focused on the quarterly performance, and they don’t have the proper time horizon, they are not empowered to do the right thing. As a fiduciary you are setting yourself up for failure if you don’t have the right time horizon.“
($) Apple’s iPhones Winning Over Gen Z—and the World’s Premium Market. “From Europe to Asia, Apple’s market lead in the premium bracket is growing, and polls show that people in their teens and early 20s, known as Gen Z, increasingly see the iPhone as a must-have. Converts say they are drawn by its design, cameras and AirDrop features for sharing photos. Around 52% of people age 18 to 29 in South Korea were using an Apple smartphone as of 2022, up from 44% two years earlier, according to polls by Gallup Korea. Samsung’s share of this age group slipped to 44% from 45% in that time, the polls showed. For all older age groups, Samsung phones remain most prevalent.” I had some personal experience with how Samsung marketed its products in Vietnam. To me, this didn’t come as a surprise. Samsung can be innovative and technologically advanced. However, its products and ecosystem leave a lot to be desired. It’s not about being the first to introduce some features or being sassy while mocking its biggest rival. It’s about making things that are useful and valuable to consumers. I hope leaders at Samsung will read this piece and change their approach from bottom to top. No amount of marketing money can fix the fundamental shortcomings of its products.
($) Indonesia Shows It’s Possible to Tame Rainforest Destruction. Now, forest destruction in Indonesia is at its lowest pace in two decades. The rate of forest loss fell by more than half in Indonesia from 2015 through 2021, while it worsened in Brazil and the Democratic Republic of the Congo, homes to two other vast rainforests. It is a turnaround with lessons for policy makers, businesses and environmentalists around the world who are concerned about the effects of rainforest loss. Indonesia’s success owes to a three-pronged and overlapping approach. Strict directives prohibiting wholesale forest clearance flowed from the top rungs of government starting about five years ago. Multinational consumer-product companies pledged to avoid palm oil that involved forest destruction, blacklisted forest-slashing plantations and tracked their activities with satellites. And environmental nonprofits exposed murky supply chains that long made it hard to know whether palm oil came from a company that was knocking down forests.
More CCTV, more crime: India’s most-surveilled cities are the least safe. It’s unfathomable to read about high levels of crimes against women in India. This report is the strongest evidence that the preventative method of installing surveillance cameras just doesn’t work. Lawmakers need to think of a better solution to crimes against women that increased by 15% nationally and 40% in the capital, compared to the previous year
What Booking.com does is very easy to understand: to facilitate online travel reservations between travel service providers and travelers. The company was founded in the Netherlands in 1996 under the original name Bookings.nl. In 2000, Bookings.nl merged with Bookings Online to form Booking.com; which was subsequently acquired by Priceline Group five years later. The acquisition was so successful that the parent company Priceline Group changed its name to Booking Holdings in 2018.
Booking Holdings includes many well-known brands to travelers such as Booking.com, Priceline, Agoda, Rentalcars.com, Kayak and OpenTable. These different platforms enable online reservations for accommodation, flight tickets, rental cars, activities and restaurants. As of the end of 2022, Booking Holdings’ services are available in multiple languages to millions of travelers around the world, making the parent company one of the most powerful players in the travel industry.
Revenue streams and expenses
Let’s talk one thing that everybody understands: money. Booking Holdings (Booking) has three revenue streams: Agency, Merchant and Other revenues.
Agency revenues come from travel bookings in which the company connects travel service providers with travelers. Think of it as matchmaking. Travel service providers are responsible for processing payments as well as all the related costs. For the services provided, Booking earns a commission per every transaction for which it invoices the service provider after travel is completed.
Merchant revenues, on the other hand, are derived from transactions in which Booking does the matchmaking AND facilitates payments from travelers. In this model, because Booking offers more value than in the Agency model, it earns not only reservation commissions, but also other related fees.
Last but not least, Other revenues consist of 1/ revenue earned by OpenTable; 2/ advertising on all of its platforms and 3/ compensation for sending referrals to other online travel agencies.
On the other side of the equation, Booking has the following main, including but not limited to, expenses:
Marketing: In 2022, Booking spent almost $6 billion on its brands, search engine keyword purchases, affiliate programs and other performance advertising. This expense line item usually makes up around 1/3 of Booking’s revenue. Investors pay attention to Booking’s marketing expense because the more efficiently the company can generate traffic and business, the better the earnings will be.
Sales: Booking incurs different expenses for processing payments and making sure these payments go through smoothly. There are also costs related to call center, content translation among others. Sales makes up about 8% to 10% of Booking’s revenue.
Personel: salaries, payroll taxes, bonuses, other benefits and compensations make up around 15-20% of the total revenue
Administrative: recruiting, training, office expenses and other administrative costs amount to 5-6% of Booking’s revenue
Technology: back office software and keeping sites running reliably cost Booking about 3-4% of its annual turnover
Agency vs Merchant Model
Let’s talk about the two primary business models in the travel industry.
In the Agency model, as mentioned before, Booking acts as a matchmaking middleman between travelers and service providers without being involved in the payment. Revenue comes in the form of commission on a transaction basis. Booking only gets paid after generating actual business for its partners, ie. after guests booked, used and paid for services. To travel service partners, there are several advantages. First, they get to decide on their prices and inventory, maximizing revenue and profits. Second, there is no longer a risk of the agency (Booking) going bankrupt. Third, service providers have positive cash flow since they are paid by travelers first before having to pay Booking.
Nonetheless, there are a few downsides of this model to service providers. Being free to control inventory means that they are at risk of having unsold perishable inventory. Additionally, these providers have to absorb the costs of processing payments, including interchange, fraud protection, chargebacks and compliance. Travel merchants, especially those in the US, have higher interchange rates (2%+) than merchants from other high-frequency categories such as groceries or gas. In other words, US-based travel merchants lost at least 2% of its revenue per transaction when they process payments. It’s a real cost that any business owner will take into consideration.
In the Merchant model, the likes of Expedia and Booking Holdings buy inventory in bulk from supply partners, at a significant discount obviously, and sell it either a la carte or in a bundle with add-on services. To supply providers, the Merchant model solves the volume question and takes care of all the expenses related to payments. However, they don’t have control over inventory or prices and they have to suffer on the margin as Online Travel Agencies (OTAs) demand a meaningful discount for the value offered.
The model in which a travel service provider should engage with Booking, in my view, depends on the size of the provider and where it operates. If a provider is a small boutique hotel with 20 rooms, because the provider doesn’t have leverage over Booking, they would have to absorb a high commission rate in the Merchant model. Hence, the Agency model looks more attractive from the margin perspective. However, the provider will have to manage and sell inventory, as well as deal with all the payment-related issues.
If a provider is a well-known hotel chain with multiple properties and hundreds of rooms, the dynamic is different. In this case, the provider is more likely to engage the Merchant model: use its significant bargaining power to negotiate a lower commission while ensuring that every month, some inventory is already sold.
I want to touch on payments a little bit before we move forward. This issue may not be top-of-mind, but can have meaningful consequences to a business. First, if a merchant processes payments by itself, it has to invest in infrastructure so that popular payment methods are available and it is compliant with all regulations. This task is not always easy or cheap. Here is Booking on the topic:
We are processing more of our transactions on a merchant basis where we facilitate payments from travelers through the use of payment cards and other payment methods (such as PayPal, Alipay, Paytm, and WeChat Pay). While processing transactions on a merchant basis allows us to process transactions for properties that do not otherwise accept payment cards and to increase our ability to offer a variety of payment methods and flexible transaction terms to consumers, we incur additional payment processing costs (which are typically higher for foreign currency transactions) and other costs related to these transactions, such as costs related to fraudulent payments and transactions and fraud detection. As we expand our payments services to consumers and business partners, in addition to the revenues from these transactions, we may experience a significant increase in these costs, and our results of operations and profit margins could be materially adversely affected, in particular if we experience a significant increase in non-variable costs related to fraudulent payments and transactions.
…In addition, as our payment processing activities continue to develop, we expect to be subject to additional regulations, including financial services regulations, which we expect to result in increased compliance costs and complexities, including those associated with the implementation of new or advanced internal controls, including, by way of example, those arising from the E.U.’s Payment Services Directive 2 and similar legislation. The implementation of these processes may result in increased compliance costs and administrative burdens.
A property owner is unlikely to be as good at Booking in setting up a great payment system. Hence, it may help to reduce operational workload to just outsource this particular task to Booking. Second, interchange rates for US-based merchants are often north of 2% and have serious impact on the bottom line. A single boutique property owner can’t negotiate a more favorable term with the networks. In this case, the likes of Booking Holdings can offer value. Booking pays partners in the Merchant model in two ways: either through a virtual credit card or by bank transfer. With its market power, I think Booking Holdings can negotiate a better deal with the networks and help merchant partners lower the interchange costs. If merchants want to take payments through a bank transfer, Booking charges 1.1 – 1.9%, which is often lower than credit card interchange rates in the US. In Europe, where interchange rates are regulated and much lower than those in the US, this factor is not as relevant.
The difference in interchange rates, depending on where a property is located, is the perfect transition to the second factor determining which model a travel service provider should adopt. Here is what Booking wrote in one SEC filing:
For example, in the European Union and the United Kingdom, the Package Travel Directive and other local laws governing the sale of travel services (the “Package Directive”) sets out broad requirements such as local registration, certain mandatory financial guarantees, disclosure requirements, and other rules regulating the provision of single travel sales, travel packages, and linked travel arrangements. The Package Directive also creates additional liability for a provider of travel packages, which could be the OTC, for performance of the travel services within a packaged trip under certain circumstances. Some parts of our business are already subject to the broad scope of the Package Directive, and as our offerings continue to diversify and expand, we may become subject to additional requirements of the Package Directive. Compliance with this directive could be costly and complex or, as a result of these requirements, we could choose to limit offerings that would otherwise be beneficial for the business, any of which could adversely affect our business, results of operations, or ability to grow and compete. Any changes to the Package Directive, including any changes to the scope of the travel services covered, increased levels of consumer protections, or changes to the requirements of financial guarantees could be costly or complex to comply with and may also adversely affect our business, results of operations, or ability to grow and compete in the future.
Because of the regulatory overheads, Booking Holdings and its peers are not motivated to engage in the Merchant model as they may be elsewhere. Hence, merchants in the UK or Europe may not have this option available even if they want it.
How They Are Staying Competitive
Booking Holdings thrives when their flywheel works properly: having more travelers attracts more service providers while having more service providers is a real value-add to travelers. As long as Booking proves that it can help partners grow sustainably (ie. bring more business and value at a competitive commission), partners will come. The question becomes: how can Booking keep travelers making reservations on their platforms when there are so many alternatives out there?
The first step is mind share. Booking has to be the first name in travelers’ mind when they start the process of booking a trip. Showing up at the top of search result pages helps. Ads such as Super Bowl commercials also helps drive awareness. Both of these things require technical skills and investments. Because I think Booking Holdings is very good at SEO, judging from my experience searching for lodging, and can spend millions of dollars every year on marketing, it’s a real competitive advantage.
But the work doesn’t stop when travelers go to Booking’s sites. Travelers tend to look at other sources and see if they can get more value elsewhere. First-party providers are motivated to lower the price for the same booking on their website a bit just to avoid commission to OTAs. Therefore, Booking must first ensure parity in everything: photos, features, map location, pricing, booking protection and cancellation policies. In this area, I think Booking is brilliant in creating the Genius program. Genius is a marketing program in which participating partners get more visibility and business in exchange for, at least, an automatic 10% discount on their “least expensive and most popular room type or unit”. The more a traveler books with Booking, the more Genius benefits they have. It incentivizes travelers to do business with Booking while offering to providers access to these coveted frequent travelers. Consumers save money, partners generate more business and Booking is a happy middleman. Win-win-win.
Furthermore, it’s important that Booking becomes a one-stop shop for all things travel. A trip includes other components than just accommodation, including, you know, flights, car rentals and activities on a trip. Looking up several providers for each of the components takes time. Hence, it’s really valuable to travelers when Booking can let them reserve everything on one platform. To the best of my knowledge, AirBnb does not offer flight reservations. First-party websites like Marriott.com do offer vacation packages, but they only have the inventory that they own and reviews on those properties. With Booking, consumers have access to a wider selection and more extensive reviews.
On the connected trip, on our long-term vision is to make booking and experiencing travel easier, more personal and more enjoyable, while delivering better value to our traveler customers and supplier partners. We have expanded our offering into travel verticals other than accommodations with a focus on flights.
And in the future, we will work to link relevant travel components together to provide a more seamless and flexible booking and travel experience. We believe that as a result of this initiative and the improved consumer experience we will drive increases in customer engagement and loyalty to our platform over time. We have continued to make progress on further developing our flight offering on Booking.com, which is now available in over 50 countries.
This flight offering gives us the ability to help our consumers book another important component of their travel in one place on our platform and allows us to engage with potential customers who choose their flight options early in their travel discovery process. We continue to see that over 20% of all of our flight bookers globally are new to Booking.com. We will continue this important work to provide our customers the best possible trip experience we can offer.
Source: Booking CEO on Q4 FY2022 Earnings Call
Booking used to rely on the Agency model. They started to transition more to the Merchant model in 2017 and gained great strides. As of 2022, it made up 44% and 42% of Booking’s total gross volume and revenue respectively, up fro the mid-teens five years ago. Then they followed up with initiatives such as additional offerings (flights for instance) and payments. I think the management team has done the right things to grow their business and be competitive. The numbers don’t lie. Booking Holdings long trailed its rival Expedia in gross bookings (GB) before the pandemic, but since then, has recovered faster and better than Expedia. That translated into a bigger gap in revenue. While Expedia’s revenue hasn’t come back to pre-pandemic level, Booking’s already surpassed it in 2022. The current status, by no means, is a guarantee of future outcome. Booking must not be complacent, especially when a challenger like AirBnb is growing fast and furious, albeit at from a smaller base.