Priceline Business Model Seen Flawed
Priceline Business Model Seen Flawed
By Hal Plotkin
Silicon Valley Correspondent
You might think that priceline.com Inc.’s {PCLN} shares are a bargain at less than 11, down from an all-time high of 165 back in April 1999. But so many questions have arisen about the fundamental viability of the “name your own price” online retailer that only one major Wall Street analyst perceived last week’s selloff — based on an earnings warning — as a buy signal. Indeed, the concerns continue to pile up, including a story in Tuesday’s The Wall Street Journal that raises questions about the vaunted business-process patents that vice chairman and founder Jay S. Walker has assembled to thwart competition.
Priceline.com stock performance since IPO
“It’s pretty clear that priceline’s reverse-auction approach appeals to only a small niche of online buyers,” says Andrew Bartels, an analyst at the Giga Information Group in New York. “My view is that demand for it will continue to be limited.”
Priceline.com’s shares lost more than 40 percent of their value last week, after the company warned that third-quarter revenue would come in somewhere between $340 million to $345 million. Analysts had been forecasting that third-quarter sales would be $20 million to $40 million higher.
While revenue will come in lower than expected, priceline.com officials still say they expect the third-quarter loss to come in at a penny a share, which would be in line with the consensus analyst earnings estimate compiled by First Call Corp. prior to the recent warning.
The revenue warning nonetheless led several securities firms, including Jefferies & Co., Merrill Lynch and Salomon Smith Barney, to either downgrade the stock or set substantially lower 12-month price targets.
The priceline.com selloff was particularly disappointing to investors who had heeded near-unanimous earlier analyst advice, from many of those very same sources, to buy the company’s stock on assurances that it would be one of the first big online retailers to achieve profitability.
Even so, not everyone jumped ship.
“I think one of the most-important things coming out of the warning was the fact it didn’t hit the earnings,” says Robertson Stephens analyst Lauren Cooks Levitan, a longtime priceline.com backer who reiterated her firm’s “strong buy” rating on the stock immediately after last week’s announcement. “It means the other businesses are working and that they really rescued the company from the problems they were having on the airline side.”
Airline-ticket sales make up about 85 percent of priceline.com’s revenue. A decline in those sales was responsible for the company’s revenue shortfall during the most-recent quarter, according to priceline.com officials, who attributed the problem to a number of issues, including cut-rate ticket deals offered directly to consumers by carriers and cancelled flights stemming from a labor dispute at Ual Corp.’s {UAL} United Air Lines.
Levitan sees those problems as mostly transitory in nature. She also notes that priceline.com has recently expanded into other areas, including selling gasoline and long-distance services, using the same “name your own price” model it pioneered in the travel sector.
“It might take a few quarters for investors to appreciate the diversification of priceline’s model,” Levitan says. “But we didn’t think it made sense to downgrade it after the warning. It doesn’t really meet all our criteria for a “strong buy” as well as it does for a “buy,” but we think it’s a good stock for investors who can buy it and wait until we get to [next year’s] Q1 when we expect it to show profitability.”
The company didn’t release an estimate of the total dollar volume of non-airline ticket sales but says revenue for the just-ended third quarter in those markets will be up about 20 percent over the previous quarter.
Other analysts, however, say there are fundamental problems with priceline.com’s basic business model, regardless of which consumer market the firm targets.
“Our research indicates that for most people the primary advantage to shopping online is convenience, not price,” says Rob Labatt, an analyst at Gartner Group’s Dataquest in San Jose, Calif. “Priceline can deliver on price, but it’s not the most convenient.”
Labatt notes that consumers who use priceline.com’s core airline ticket buying service must agree to make their purchase before they find out exactly which flight they are on or which airports they might have to use. Consumers also have to be aware of current competitive prices in order to haggle for the best possible deal, he says.
“It takes quite a lot of research to even know what price to bid,” Labatt adds. “That’s a lot of work for a savings that can often be quite small.”
Priceline.com officials have countered that argument recently by pointing out that nearly 40 percent of sales during the second quarter came from repeat customers. But the flip side of that, analysts say, is that 60 percent of the company’s customers didn’t come back — at least not last quarter.
“I’ve heard, just anecdotally, from a lot of people who tried the service and who ended up getting tickets to places they really didn’t want to go at times they really didn’t want to travel,” Labatt says. “Those people use it once, but they don’t use it again.”
Good travel agencies, by contrast, typically have a much-higher repeat-customer rate, according to analysts.
Joshua Friedman, a former travel agent who is now an analyst at International Data Corp., in Mountain View, Calif., shares some of those concerns. “I still think priceline has a pretty good model, but it’s not going to be for everyone,” he says.
Friedman says that several of the most-lucrative travel sectors, such as business travelers and those looking to book short vacation travel, don’t respond well to a service that doesn’t let them even know exactly when they might arrive at their destination prior to confirming the purchase of a ticket.
“If you’re talking about saving $20 or even $100, it still might not be worth it,” Friedman says.
What’s more, Friedman notes that several of the nation’s largest airlines are rolling out a competing Web site, Hotwire.com, which is designed to help them sell their own distressed inventory without the need of an intermediary such as priceline.com.
“Over time, the airlines could start moving inventory away from priceline and toward their own operation,” Friedman says. “That’s a real threat. They could eventually just zero the seats they make available to priceline down to nothing if they want.”
Levitan says she doesn’t think that will happen.
“The whole point of priceline is to help the airlines liquidate their distressed inventory without wiping out their price structure,” Levitan says. “If the airlines do that, why would anyone ever pay full price again? That’s what they would discover if they really do try to do this all by themselves.”
Several analysts also noted that priceline.com has a patent claim on the “name your own price” scheme that could complicate things for competitors if upheld by the courts. On the other hand, they also say competing sites probably can continue to legally offer very similar auction services that don’t require an opening bid from consumers. More movement in that direction would further jeopardize priceline.com’s core discount airline ticket business, they say.
The other big unknown hanging over priceline.com is how popular its “name your own price” model will be in the new markets it has targeted for future growth.
Some say priceline.com can take its model and run to other markets but that it probably won’t ever be able to escape from the weaknesses in its own business plan.
“I see the same issues emerging in every consumer area,” Labatt says. “If it’s convenient, consumers will do it. But if it’s not convenient, it will not appeal on a massive scale, and the real promise of the Internet is doing things on a massive scale.”
Friedman adds that priceline.com faces some other thorny issues concerning how it does business. There are cases, for example, where ill-informed consumers bid more for a ticket than they would have paid if they had simply purchased the same ticket at its listed price directly from the airline.
“I’m not sure how moral it is if the consumers think they are getting the best deal possible when it turns out they really aren’t,” Friedman says. He adds that the jury is still out in terms of how consumers might respond to such practices should they become more apparent.
In Connecticut, there is the possibility a real jury might eventually decide at least some of those issues.
Over the weekend, Connecticut Attorney General Richard Blumenthal confirmed that he is investigating complaints contending that priceline.com makes inadequate disclosures to consumers before they make a purchase.
At issue, he says, is whether priceline.com has done a good enough job of letting consumers know they have agreed to purchase an actual airline ticket when they finalize a bid on the site. He also says his office has received complaints from consumers who have purchased gasoline online through priceline.com and who then had trouble finding stations willing to fill their tanks at the agreed upon discount price. Earlier this month, Connecticut’s Better Business Bureau revoked priceline.com’s membership because of the number of consumer complaints it received.
Priceline.com officials have said they are working to resolve the issues raised by the authorities in Connecticut.
“That could be a big problem if it turns out consumers don’t like the way their purchases have played out,” Bartels says.
“In theory, the idea of matching people with perishable goods, such as airline tickets, is a very good idea,” Labatt says. “But in reality, matching people to those needs is a pretty difficult business.”
Few industry analysts doubt that priceline.com’s model will continue to appeal to at least some consumers at least some of the time. But it is getting increasingly difficult to find many who think priceline.com’s “name your own price” model, as currently configured, will ever become a dominant form of online commerce.
“The appeal is for consumers who have price as their single most important [criterion],” Bartels says. “That’s important. But it’s just one niche in what is a much-larger overall market.”
Priceline.com officials turned down CNBC.com’s request for an interview, citing recently imposed Securities and Exchange Commission regulations designed to prevent the selective disclosure of financial and operational data.
Priceline.com is scheduled to release its official results for the third quarter on Nov. 2.
