Laying it on the Priceline
The Web site lets you name your price, but is that good business sense?
NEW YORK (CNNfn) - It seems like a consumer's utopia. The ability to get the product you want at the price you want to pay sounds too good to be true. One firm, however, says it's the new reality in the age of Internet commerce.
Let's say you need a round-trip plane ticket from New York to Chicago and you want to pay $150. You've checked out all the major airlines, maybe even a few minor ones, but none of them meet your price requirements.
Enter Priceline.com, a rapidly growing Internet firm that will scour each airline until it finds one that will meet your price.
More than 1 million people have used the 11-month-old service, and the company's ads featuring former "Star Trek" and "T.J. Hooker" star William Shatner have given Priceline an even higher profile.
Because the Stamford, Conn.-based company has filed for an initial public offering, Priceline is in the midst of a Securities and Exchange Commission-mandated "quiet period," so company officials were not available for comment.
But the company has stated its business model is based on exploiting what it calls "brand-neutral" demand. Under that theory, consumers don't care what airline they take or what hotel they stay in, as long as the service meets their needs -- and their price.
But under this strategy, will Priceline.com -- as Shatner says in the ads -- be big, really big?
Dependent on air
Priceline employs an unusual e-commerce business model, one in which the company is wholly dependent upon the participation of other firms - particularly the 18 participating airlines -- for its success.
So how does the company make money? After completion of a successful transaction for airline tickets, Priceline earns the spread between the customer's offered price and the fare charged by the carrier.
Or, as Sara Zeilstra, an analyst at Warburg Dillon Read, explained it, Priceline capitalizes on the fact that neither consumers nor the airlines are aware of how Priceline conducts transactions.
According to airline analysts, it costs carriers an average of $50 to $75 to seat a passenger on a round-trip flight in the continental United States. If a customer offers to pay $300 for a ticket from New York to Los Angeles, Priceline will tell the airline someone wants the ticket for $275.
The airline doesn't mind because while $275 may be well below its standard fare, making a $200 profit for filling a seat at the last minute is a safer bet than waiting for someone to come along to pay full fare.
Priceline then informs the customer that the $300 bid has been accepted, and -- guess what? -- Priceline gets to keep the $25 difference.
"It's interesting because when Priceline is making money on the spread, they have complete control over their margins," Zeilstra said. "If someone bids $500 and they know the airline charges only $300 for a flight, that's more money in their pocket. They have the ability to determine their margins as long as the supply is there."
From its inception in April 1998 through December, Priceline generated $30.4 million in revenue through sales of nearly 135,000 airline tickets.
For automobile and mortgage services, the company collects fees from the customer, the seller or both.
Nonetheless, like most Internet startups, Priceline's model has yet to turn into profits. According to an SEC filing regarding its IPO, Priceline had a 1998 net loss of $114.4 million ($67.9 million from non-cash charges), or $1.41 a share, and the company said it expects losses for "the foreseeable future."
"The issue is getting the supply to meet the demand," Zeilstra said.
Consumers in charge
If Priceline's model isn't yet profitable, it's certainly pro-consumer. The ability to pay exactly the price you want isn't something that most people come across every day.
Not that users should offer $100 for a new car and expect to hit the road in a new, candy-apple Volkswagen Beetle. Priceline does provide guidelines regarding how customers should make their offers.
The site specifically states that users should limit their airline ticket requests to no lower than 20 to 30 percent below the lowest available fare on a particular route. Priceline says about a third of the customers who make reasonable offers obtain an airline ticket through the site.
For hotels, the company gives customers a price range for different hotel chains. For auto purchases, Priceline provides factory invoices.
But not all customers are thrilled with the way the service works. Some users have lamented in Internet newsgroup threads that if Priceline finds an airline that will match your price, you're locked into the purchase. No chance of turning down the ticket if you don't want to take a flight at midnight.
Priceline clearly states this policy on its site. Company executives point out that the only way to get airlines to participate with Priceline is to convince them that the site is catering to leisure travelers.
Therefore, users must be flexible regarding when they are willing to travel and on what airline. Selling tickets at rock-bottom prices to business travelers isn't in a carrier's best interest.
Other Priceline users have complained that once you make an offer, you can't change the price if it's been refused. But Priceline notes that users can change any part of their offer - such as the travel dates - other than the price. Upping the price after you've bid too low would defeat the purpose of the service, after all.
With those issues in mind, the company isn't about to consider any changes to its service.
Preparing for the public
In the next few weeks, Priceline will begin trading publicly on the Nasdaq stock market under the symbol "PCLN." The company, which hopes to raise between $70 million and $90 million in the offering, is obviously hoping to ride the wave of successful Internet IPOs.
If history is any indication of investor logic, Priceline's $90.1 million net loss should translate into a smash hit of an IPO.
But one good day on Wall Street doesn't guarantee success in the long term. Realizing that depending on airlines for revenue is a dangerous proposition, Priceline has expanded its offerings to include home mortgages, hotel reservations and cars.
And while some of Priceline's current strategies will win the hearts of consumers, they won't help put the upstart firm's books in the black.
Priceline will, for example, sometimes supplement a user's bid with its own cash if a supplier won't meet a customer's price. But can the company continue this practice as long as it keeps bleeding losses?
Priceline says yes, noting that all companies are willing to spend money to acquire customers. The company bases its supplement on the projected long-term value of its customers. A frequent Priceline customer who is looking to buy four tickets to Paris is more likely to get a boost than a first-time customer looking for a ticket to Cleveland.
Zeilstra said the company also is willing to suffer near-term losses in order to gain confidence from suppliers.
"They're making negative gross margins in order to make people understand what they're doing," she said. "Sometimes airlines aren't quite open to this idea, so Priceline will sometimes underbid to get them to come on board. Once the airlines realize there is interest and they're filling up their seats, more will be willing to participate."
If Priceline is to succeed in the way Amazon.com Inc. (AMZN) has succeeded in becoming an e-commerce leader, the company will have to diversify its offerings.
The company has indicated that, down the road, its service can do as well in the business-to-business market as it can in the business-to-consumer market.
"In general, the business-to-business market has the potential for better margins," Zeilstra said. "When dealing in that market, you don't have all the marketing expenditures you deal with when you're trying to attract consumers."
Priceline is also likely to move into other consumer markets. Amazon, for example, has expanded well beyond books to offer music, videos, toys and gifts. Zeilstra said it would be wise for Priceline to move horizontally into other markets, as well.
"There are several different business models where they can leverage their business," she said. "It wouldn't surprise me if they got into consumer electronics and PCs. The great thing about Priceline is that they can test the waters (in different markets) and expand later without having to tear down a shop."
Diversity could be Priceline's path to greatness -- and profitability.
Then again, Amazon has made it to the top of the mountain without ever earning a dime.
-- by staff writer John Frederick Moore
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