Is There a Way to Save These Web Wonders?
Profit Eludes Priceline as Growth Takes a Toll
By Julia Angwin
The Wall Street Journal
01/26/2001
(Copyright (c) 2001, Dow Jones & Company, Inc.)
Priceline .com Inc. is among the Web's best-known brands. Its "name your own price" system is one of the pioneering ideas to emerge from the Internet's ferment.
Yet Priceline has lost millions of dollars, its stock has sunk to below $3 (3.25 euros) a share, and key executives have fled. Now the U.S. company faces the pressing question of whether its name-your-price system can be expanded profitably beyond its core airline-ticket business -- or whether it needs to consider another way of selling goods.
And an even bigger question looms: Will the company ever thrive?
Priceline 's airline-ticket business has the potential to be quite lucrative. In fact, it could become one of the most profitable travel agencies on or off the Internet if it scaled back its grand ambitions.
On average, Priceline earns about $35 in profit and fees on an airline ticket it sells for $215. By comparison, a travel agent earns a commission of about $10 selling the same ticket. The difference? Priceline buys tickets for unsold seats that the airlines heavily discount, then marks them up so that it earns a gross margin -- that is, profit before overhead and other expenses -- of 9% to 12%. Travel agents, in general, earn a 5% commission on tickets.
But Priceline has been unable to turn a profit mostly because its expenses are too high. The two-year-old company has poured its gross profits from airline tickets, as well as hundreds of millions of dollars it raised through stock offerings, into largely failed efforts to expand. The goal, as envisioned by founder Jay Walker, was to become a one-stop shopping center for goods ranging from trucks to toothpaste and services from car insurance to cellular-phone plans, all sold through Priceline 's name-your-own-price, or "demand collection," system.
To carry out its plans, Priceline bought expensive computer systems, hired high-priced software programmers, and spent lavish amounts on advertising campaigns starring pitchman William Shatner. An affiliated company, Priceline WebHouse Club Inc., spent $363 million in a now-aborted venture to sell gasoline and groceries online.
Although Priceline has scaled back many of its international ventures, it recently raised another $25 million for its Priceline Europe affiliate.
The company could be profitable tomorrow if it cut costs even deeper than it has and focused only on selling its most popular product, airline tickets. But Priceline Chairman Richard S. Braddock says the company is choosing the longer route to profitability by trying to boost ticket sales and then adding new products, which it won't disclose. "We won't get to profitability by further cuts, we'll get it by growing our business," he says.
Yet getting Priceline into the black won't be easy. In a troubling sign, the company's sales of tickets and other travel items have slipped over the past six months. After posting significant sales growth every quarter since it went public in March 1999, Priceline saw its revenue fall 3.1% to $341 million in the third quarter of 2000 from $352 million in the second quarter -- compared with a 36% increase between the same two quarters a year earlier.
Part of the problem was new price competition from airlines, which offered steep discounts in the third quarter after a summer of severe weather delays. Meanwhile, the airlines added fuel surcharges to Priceline 's costs, cutting its profits.
Yet Priceline expects fourth-quarter sales to fall below the third-quarter level. It attributes the slowdown to bad publicity in October from its financial woes and other problems, and decreased customer traffic due to the closing of the WebHouse sites. The company had about $131 million in cash remaining as of the third quarter last year, its latest reporting period, which should last at least a year at the current rate it is being used.
A more permanent threat looms in the emergence of a competing start-up, Hotwire.com, that sells cheap airline seats and is backed by a number of major airlines. Like Priceline , Hotwire doesn't tell users which flight they are taking or how many connections they will need to make before they purchase the ticket. However, unlike Priceline , Hotwire provides the price of the ticket upfront, rather than requiring customers to bid for tickets.
That could help attract customers who have been put off by Priceline 's complicated system, in which consumers must figure out what they think a ticket is worth, place a bid on it, and then check back later with the Priceline Web site to see whether the bid was accepted. Although Hotwire hasn't yet captured much market share, its existence threatens Priceline 's ability to continue marking up its tickets by as much as it has been.
"I will virtually guarantee you the airlines will find a way to take a piece of the profit," says James M. Higgins, an airline analyst at Credit Suisse First Boston.
Priceline contends that airlines will continue to give it first crack at cheap tickets in preference to Hotwire because the airlines prefer Priceline 's bidding system. This system keeps customers from knowing the true price of a ticket and theoretically protects the airlines from having to match the price for other customers.
Yet some experts say the name-your-own-price part of the equation is not as crucial as Priceline makes it out to be. "It's probably an important gimmick for marketing," says Erik Brynjolfsson, co-director of the Center for eBusiness at the Massachusetts Institute of Technology. But he says Priceline could consider building a system that lets some customers choose the time of their flight in exchange for paying a bit higher price. The idea would be to use Priceline 's well-known brand name to capture more customers.
The bidding does allow Priceline to decide how much money it wants to make on each sale by adjusting the markup -- although executives concede that sales decline when the company chooses higher margins. In the third quarter, Priceline 's various operations earned a combined 15.9% gross profit margin -- profit before paying salaries, advertising and other expenses -- while it accepted about 50% of customer bids.
Right now, the $35 profit on the $215 airline ticket doesn't cover the other expenses involved in the business. More than one-third, or $13.55, goes toward credit-card processing fees, credit-card chargebacks and outsourced customer-service representatives. Another $8.93 pays for Priceline 's costly TV, radio and print ads. And finally, there is the cost of Priceline 's staff, about half of whom are devoted to keeping its computers humming and programming them for new businesses. In the third quarter, employee costs absorbed $14.70 of that per-ticket gross profit. Since then, the company has slimmed down to 395 employees from 535 as it shut unprofitable businesses, closed some international operations, and otherwise tried to get into the black.
Analysts agree that Priceline has potential to become a good small travel business, but that its future beyond that is uncertain.
"My feeling is that they can turn this into a profitable business," says Michael Legg, an analyst who follows Priceline at Jefferies & Co. "The question is: Are they large enough to sustain stand-alone status or do they get bought out or merged with someone? My bet is if they don't merge, they'll go private."
While Priceline officials won't comment on such speculation, they say the company hasn't given up its plans for expansion into nontravel areas. Once it is profitable, it will grow again -- but in a careful, low-expense way, says Mr. Braddock. He says Priceline will "entertain selective expansion . . . with stringent financial controls." He adds, "We're going to make money on this and move forward." |
