How Priceline's Business Works

Priceline Stock Price

Yes, you’ve seen the commercials. No, you can’t get that annoying jingle out of your head (can’t you hear it now: Price-line Ne-gog-i-ator!). Beyond catchy ditties, Priceline has quietly been building a monster business over the past decade. Were you aware, for example, that Priceline’s market value in currently in excess of $23 billion and its stock has risen more than 500% from the depths of the recession in late 2008 (see chart above)?

Captain Kirk, Travel Agent

Priceline Stock Price

Priceline is best known for its Name Your Own Price travel system. Using the service, customers select a price, service level, and general location (if appropriate) for hotel rooms, car rentals, airline tickets, and vacation packages. But there must be a catch, right? Yes, sort of: information about the provider (including the exact location of the hotel and travel itinerary) are withheld until the purchase has gone through with no cancellation rights for the customer (see screenshot to the right).  A risky proposition undoubtedly, but given the steep savings many are willing to take the chance.

Priceline’s Name Your Own Price system is, in some sense, a progenitor to the flash sale phenomenon of the past few years, a win-win for consumer and supplier alike. The travel industry is an opaque market full of excess supply; a hotel essentially only needs to cover the marginal cost of maintenance on a vacant room to make money.  Priceline solves this problem by quietly selling off supply overhang while simultaneously giving the consumer an illusion of a hard fought exclusive deal.  Meanwhile they take the difference between what the consumer is willing to pay and the supplier is willing to sell to turn a tidy profit.

Name Your Own Price

At the height of the dot-com boom, Priceline attempted to extend this model to gasoline, groceries, long-distance telephone service, cars, and mortgages.  Thankfully, they refocused on their core travel business and have been growing like gangbusters ever since.        

While it offers a range of travel-related products, hotel reservations are Priceline’s core business.  For the quarter ending September 30, they processed 40.6 million hotel nights, 7 million rental car days, and 1.6 million airline tickets.  To give you an idea of Priceline’s meteoric growth, in the whole of 2010 they handled 92.8 million hotel nights, 16.3 rental care days, and 5.9 million airline tickets.

The Numbers
While Americans strongly associate Priceline with Name Your Own Price, the service is increasingly secondary in their growth strategy.  Why? It turns out the company has built a sprawling international organisation through acquisitions. Under their, Booking,com, TravelJigsaw, and Active Hotels brands, Priceline is now the largest hotel reservation site in the world. According to their 10-K, international operations accounted for 69% of gross bookings and 82% of consolidated operating income in 2010

Priceline Revenues By Geography

International revenues grew at a compound annual growth rate (CAGR) of 68% from 2006 to 2010 versus 15% for domestic revenues (see chart above for revenue breakdown by geography). The recent surge in Priceline’s international business reveals several important trends critical to understanding why they have become a stock market darling. The bulk of Priceline’s international revenues are from, a hotel reservation site. Unlike the Name Your Own Price system, does not act as the merchant of record on the transactions it processes. In English: that means they do not charge your credit card for the travel services provided. Instead, they make money from travel commissions, customer processing fees, and Global Distribution System reservation booking fees. In other words, operates a massive global marketplace for hotels and essentially charges consumers and suppliers a toll for using the system.

Revenues By Segment

These tolls are classified as ‘agency revenues’ by Priceline (see chart above for revenue breakdown by segment). Transactions where Priceline acts as the merchant of record are appropriately dubbed ‘merchant revenues.’ They also make a small amount of money from advertisements hosted on their sites, labelled as ‘other’. Agency revenues more or less tracked the growth rate of international revenues from 2006 to 2010, growing at a CAGR of 59% versus 17% for merchant revenues. 

Profit Margin

Why is this important? Priceline’s agency revenues have no associated cost of revenues. In other words, Priceline is more or less collecting tolls without having to a lift a finger (to the tune of $1.4 billion in 2010).  They are basically minting money out of their international operations.  It is important to note that not all of Priceline’s international revenues are agency revenues, both Agoda and TravelJigsaw are booked under merchant.  Unsurprisingly, Priceline’s profit margins have spiked, jumping from 7% in 2006 to 17% in 2010 (see chart below outlining profit margins to the right).

Priceline’s ability to sustain its meteoric growth, however, will depend on whether it can maintain its hold on the online travel market.

The Pervasive Google Threat
Google is like the kid with their hand perpetually in the cookie jar. It seems like you can’t write about an internet business without discussing the existential threat that Google posesIn the case of Priceline, we believe the threat from Google is overrated and will have minimal impact on their business.

As you may have heard, Google recently moved into the travel space with the release of Google Flights and Google Hotel Finder. Already the effort is being criticised for prioritizing its Google’s results on relevant searches and it may soon be the target of an antitrust investigation. Priceline is well positioned, in our opinion, to defend itself from these attacks.

First off, Priceline has already begun to de-emphasise its airline booking business. Beginning in 2007, they eliminated all booking fees associated with airline travel. Why, you may be wondering, would a company refocus away from a service that booked 5.9 million airline tickets last year? Well, as airline prices began to significantly rise, Priceline was one of the first to notice that air travel had been commoditized. As they discuss in their 10-K, once airline fares rose they noticed that consumers engaged in “increased shopping behaviour,” reducing the efficiency of their advertising. In other words, consumers do more research and shop around for the best deal, disconnected from any loyalty to the provider. It’s also worth mentioning that several of the largest carriers, including Southwest, use proprietary booking systems and don’t even appear on travel sites. Google Flights, therefore, represents more of a threat to Kayak than Priceline.

But what about hotels? It would be a mistake to treat flights and hotels as similar products. Flights are largely a function of getting from point A to point B.  Hotels, on the other hand, incorporate a slew of other variables besides price including location, amenities, and overall experience. Unlike air travel, hotels have also not experienced a precipitous price increase in the past few years, nor are they expected to in the near future.  Since consumers are thus unlikely to engage in “increased shopping behaviour” when booking a hotel, brands and advertising matter. Priceline has been in the market for over a decade, is an established web destination in its own right, and spent almost $600 million on advertising in 2010.

One final observation: Priceline spent more than $550 million for online advertising in 2010.  Presumably a significant portion of this went to Google.  Now that Google has turned around and decided to directly compete with a major client, one cannot help but wonder: is this the way to foster healthy long-term business relationships?

The Bottom Line
Priceline has a booming business abetted by a brilliant international acquisition strategy. They are arguably the leader in online travel industry and we expect that their margins will only continue to improve in the near future as they capitalise on the shift towards international and agency revenues. Like many other companies, Priceline faces a strategic threat from Google, but we believe is it mitigated by their clout in the marketplace and the nature of the online travel business.

NOW WATCH: Briefing videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.