According to FairSearch, more than half of the world's travel sales are consummated online. For online search giant Google (NASDAQ:GOOGL), travel ads by online travel agencies, or OTAs, are a good source of revenue. Google accounts for approximately 67% of all U.S. online searches.
Online travel companies such as Priceline (NASDAQ:PCLN), Expedia (NASDAQ:EXPE), and TripAdvisor (NASDAQ:TRIP) have been competing fiercely to establish themselves as the travel agencies of choice for customers. To catch the eyes of prospective customers, these companies have been spending massively on sales and marketing, particularly on online ads. Priceline spent $1.8 billion on online ads in fiscal 2013, while Expedia spent $1.2 billion. TripAdvisor spent $236.5 million on ads last year. Their top lines have also continued to grow impressively.
Online ad spending for the three companies has been growing at an even faster clip than their revenues. Priceline has more than tripled its online ad spending in the last three years. About 90% of that money ends up in Google's coffers.
Expedia spent 46% of its revenue on sales and marketing expenses (of which online advertising takes the lion's share) in fiscal 2013, up from 42.8% in the previous year. TripAdvisor spent 39% of its fiscal 2013 revenue on sales and marketing compared to 32.8% the year before.
Google has been the biggest beneficiary of the cutthroat competition in the industry. Although it's rather difficult to get the actual figures for the share of online ad spending by Expedia and TripAdvisor that Google gobbles up, they are probably in the neighborhood of Priceline's -- about 90%. Quite likely, the trend pervades the entire industry. Little wonder that Google's revenue has been expanding exponentially over the last few years.
Google still wins without having to dominate the online travel business
Google acquired ITA Software, the most dynamic online airfare system in the world, back in 2010. Many online flight searches are channeled through ITA Software. Following the acquisition, there was a lot of hue and cry by OTAs, who feared that Google would use its overwhelming dominance in online searches unfairly to its advantage. Many OTAs such as Orbitz and TripAdvisor, among other travel companies, use ITA Software's proprietary QPX system, an airfare search and pricing system.
The Department of Justice allowed Google to acquire ITA Software on several conditions, including allowing competitors to continue using the software, using a firewall that prevents it from knowing how licensed companies are using the software, and investing adequate amounts of funds in R&D to keep the software updated. Google agreed to extend the existing ITA contracts up to 2016.
Google, however, got one major leeway: It is allowed to show its own results up front when users search for travel deals. This way, it's able to compete head-to-head with other popular travel sites such as Kayak, Bing Travel, and other popular sites. But Google does not need to directly dominate the air travel business to be a winner in the industry. The huge reliance on its popular search engine by customers doing online travel and hotel reservations ensures that the company continues to win through increased ad revenue as the stiff competition in the space forces companies to jack up their ad budgets.
Hotel reservations more lucrative than air travel reservations
Online travel companies do not make nearly as much money from air travel commissions, as they do from commissions earned through hotel reservations. The gross margins for air travel also tend to be much lower than for hotel reservations. For instance, Priceline gets roughly 97% of its revenue from hotel reservations and enjoys 23% gross margin from the segment. Airlines, on the other hand, contribute only 1.7% of the company's revenue despite accounting for 15% of its gross bookings. This is due to the very low gross margin for the segment at just 3%.
It is, therefore, quite likely that most of OTAs' online ad dollars are directed toward the highly lucrative hotel reservation segment. Priceline does not offer its own meta-search product and does not use Google's ITA software. Not surprisingly, the company has revealed that it is willing to pay Google more if it can leverage its ITA software to provide it with better-qualified leads. If the other travel companies that do not own meta-search products feel the same way, then Google's revenue from ads directed at the travel industry might see significant growth in the future.
Foolish bottom line
The rapidly expanding online travel industry is playing directly into Google's hands. Although the company has a significant presence in the vertical online travel search market, its rivals' success benefits it as well.
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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Google and Priceline.com. It also recommends TripAdvisor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.