I took a break from my opinion pieces as it has been a bit busy lately ensuring our brightness of future, but great to be able to reach out to you again with this thought piece.
In order to decide on my next topic, I re-read my previous opinion pieces and the comments that they triggered and – based on the input from #WeOwnTheBeds and David Livingstone (by the way we have not heard from either of you yet regarding your concerns). This, coupled with the fact that you chose to remain anonymous and I could not contact you, I decided that perhaps there was a lack of knowledge and an understanding on what DMCs do and how their commercials work.
I will focus on leisure tourism and leave it to my colleagues in MICE to broaden the understanding in that segment.
What is the purpose of a Destination Management Company?
In essence, a DMC is one of the stakeholders of the traditional distribution mechanism between supplier and consumers that looks like this:
Supplier – Local DMC – Overseas Wholesaler – Overseas Retailer – Consumer
Each of these stakeholders obviously plays a role and in an oversimplified fashion could be described as follows:
Supplier: Owns the physical and tangible product
Local DMC: Selects and contracts product, creates international pricing, promotes destinations, finds source markets and distributors, manages reservations flow, manages cash from source to supplier, handles clients in-destination and manages experiences, deals with crises, educates travel trade in source market, communicates consistently on developments to all stakeholders.
Overseas wholesaler: Adapts product to local requirement, creates pricing, finds distribution mechanisms, promotes product and destination, enables bookings, takes some risk and manages cashflow.
Overseas retailer: Owns the consumer, recommends destination and product, triggers the booking and manages consumers cash, contracts and risk.
As there are so many stakeholders to the distribution, how costly is it?
I fear the answer to this question is, very costly. Not sure if the financial costs have ever been transparently published, if not I think it is high time. All of the costs below will obviously deviate slightly per company, but I have seen enough income statements in my time to have a researched opinion to share.
- DMCs, depending on their sales, marketing and technology spend, have a cost base of approximately 11% of turnover and have a profit ‘target’ before tax of 2% and hence need to achieve margin levels of 13% to remain sustainable.
- Overseas wholesalers have a slightly lower cost base of around 10% and a similar profit target adding 12% to the cost of distribution.
- Lastly, retailers have a lower profitability with higher infrastructure costs leading to a commission requirement of 10%-15%.
Adding all of this up gives this channel an overall profitability of no more than 5% at a total distribution cost of between 35% and 40%.
This financial logic applies to both dynamic as well as static rates and is currently reflected in the commissions requested through the DMCs… often leading to the perception that DMCs must be hyper profitable, rich, creaming it – not knowing that most of the commissions end up overseas to cover that channel cost. The question that needs answering by the supply chain is whether the value delivered by each of the above stakeholders independently is worth the total distribution cost.
Whilst on finances – many countries’ consumer protection laws do not allow for a material prepayment, so even when prepayments are due to suppliers, they often can’t be received from the overseas counterpart making DMCs inherently cash negative.
No doubt most DMCs, including ourselves, have a preference for cash arriving earlier in destination. Logic is that the DMC work process costs are incurred months if not years before receiving money for a service or product…very similar to suppliers. I have a sneaky suspicion that post-COVID-19, consumer protection acts will move even further away from achieving this, regardless of the noise levels in most media.
Are there cheaper ways of distributing?
The high cost described above has allowed disruption in our industry through OTOs (online tour operators), OTAs (online travel agents), bedbanks, consolidators, own portals and who knows what else the future will bring.
One of these booking platforms adds similar value as a DMC to the supply chain, most of them are purely transactional and highly automated commodities. All of them have a lower distribution cost, but at what value proposition to the destination and its product? Think commodity trading, think global players with no preference for destination, think no ground handling, think huge acquisition cost through internet marketing…
Why does there need to be some level of rate equilibrium in a source market?
An approximate rate equilibrium is in the interest of all stakeholders in the market as consumers inevitably then make a choice on a booking channel based on the value provided and not on the discounted price. Hence the supplier’s rate strategies should consider differentiated cost of distribution in the various channels and adjust nett rates or commissions to achieve such equilibrium in the face of the consumer.
Why would that be of any benefit to the supplier you might ask? Logic says that if one channel has a distinct pricing advantage, they develop a dominance towards a supplier… and dominance over time is never to the advantage of the dominated party.
A balance of channels through clever yielding, allocation of inventory and rate structure appears to be the better solution. Also, different channels will perform in a varied fashion depending on circumstances, for example my expectation is that OTOs and DMCs will out-perform other channels post COVID-19 as they were in a better position to assist on the ground when drama escalated and are now developing solutions to make our channels more effective going into the future.
Why can DMCs not charge for services like other professional services companies?
Great question, and for years I have answered it by explaining that the travel industry since the 1800s has worked that way and taught the consumer that the work, expertise and intellectual property of the channel members is in essence ‘free’.
Whilst this argument might still be right, I actually now think that the travel space behaves the same way that the FMCG (Fast Moving Consumer Goods) market works. FMCG product has a expiry date, there are multiple stakeholders involved from product to consumer (think warehouses, distributors, retailers), product owners have a preference to define their monetary value proposition in the face of the consumer and inevitably want to be in charge of their own destiny and, lastly, product owners want to distribute as widely as possible… the broadest net catches the most fish. Hence most FMCG products define their retail price or at least recommend same and differentiate their distribution channel through different discount structures and nett rates.
Does this sound familiar? Yup, identical to the tourism product distribution space, and after all, once the commercials of each channel are understood, the costs of using a channel can be priced in at source, and managed there. What cannot work is distributing through a DMC traditional channel at a lower cost applicable to a different mechanism.
Quo Vadis (Where are we going) with DMC commercials? As a departure point each DMC will have to make a decision if they want to compete within the commodity marketplace and develop technical solutions to achieve this. Hence the DMC world could split into two functions; low-cost commodity trading versus high-cost personal authentic experience-based services or of course either or.
In an increasingly separated multi-channel distribution network, suppliers will have to make a conscious decision if the expensive DMC channel adds enough value to validate the cost and then develop pricing models that support the overall distribution philosophy both in a static as well as in a dynamic environment.
Lastly – in a strange fashion – whilst COVID-19 is currently threatening the sheer existence of DMCs (and the industry as a whole) it has ultimately given this industry sector a new lease on life, new purpose and new areas of value proposition hence the future is bright once we get there.