Tuesday, November 3, 2009

Texas Cities vs. PCLN, EXPE, OWW et al: A Draw at Best

Late last week, a jury in San Antonio delivered a verdict on a class-action suit against the major OTAs that was brought by around 170 cities in Texas. The verdict against Expedia, Orbitz, Travelocity and Priceline is for $20M plus court imposed penalties and interest.

While this sounds dire, (and if you read the lawyers press release you would think this was a slam-dunk) a detailed analysis beyond the headlines should give the edge to the OTAs. Why?

First of all, the jury rejected the municipalities' claims that the OTAs willfully pocketed tax dollars that were collected (as taxes) from consumers. This precedent setting verdict finally makes it clear, once and for all, that the OTAs are not collecting taxes and pocketing it - a position that many of the other lawsuits have taken and one that was sure to ring true with juries, particularly in this day and age. The "tax and pocket" position was a highly emotional stance that anyone who truly understand the true economics of the merchant model would obviously reject. Yes, taxes and fees have long been bundled together but the spirit and goal was clearly not to defraud consumers or rob cities and towns of tax dollars - the intent was to protect the underlying contractual agreements around margins.

Secondly, the jury rejected punitive damages against the OTAs because they agreed that the OTAs were not, in fact, pocketing tax revenues. Obviously, this is a no-brainer.

Interestingly, the jury did find that the OTAs "control hotels" and therefore are required to remit the occupancy taxes required by hotel operators. Knowing more than a few hotel General Managers, I can't imagine a statement that would boil their blood faster (except, maybe to say that "corporate" controlled their house!) than to say an OTA controlled the hotel. By now, everyone knows that hotels set pricing, inventory, discounts and room allocations either on the fly or during negotiations with the OTAs. The OTAs then re-market those rooms that have been offered to them to sell. This is hardly control. Furthermore, the hotel is clearly in control of the guest experience - after all, it is the hotel that decides which rooms to allocate to specific guests and who to "walk" when things go wrong.

Lastly, we believe the jury's definition of "control" may expand well beyond the OTAs. Put in the context of the ruling, traditional tour operators control rooms as well. Traditional tour operators (which pump a lot of rooms into Texas resort cities) have always paid the occupancy taxes based on the net rate of the room, not the gross selling rate. This has been going on long before the Internet and the OTAs came along.

Bottom line: if Expedia and the like are hiring, firing, allocating capital, negotiating with unions, customers, franchisers and managing to get the beds made and the bacon crisp, we'd agree that they control the hotel. Last I checked, these functions were not part of the OTA business model.


  1. Tom: I wrote about this too for Tnooz http://bit.ly?4EwcKw and can't believe that you've swallowed the ITSA Kool-Aid that the San Antonio verdict was a draw. $20.6 million, plus penalties and interest, which could be very substantial.

    Yes, we know that the OTCs are not hotels and do not operate hotels. But "control" is not defined under these local Texas ordinances and the judge instructed the jurors to use common sense to make their determinations.

    Obviously, 12 federal jurors agreed that the OTCs control hotels in the sense most likely of negotiating contracts and marking up wholesale prices etc. (A can of worms, I know.)

    Also, it is interesting that the jurors declined to find the OTCs guilty of "conversion" ie collecting taxes on the retail rate without remitting the taxes and this indeed is a victory for the defendants.

    However,under the radar, the jurors did assess all of the defendants, with the exception of Travelnow and Travelocity.com, monies for "breakage"... which I understand is allegedly collecting some portions of the tax recovery charges on the net rate and failing to remit to the hotel. Expedia-related entities were hit up some $3.5 million for such "breakage."

    This stuff always can get reversed on appeal. But, I seriously doubt, in their heart of hearts, that the OTCs are viewing the San Antonio ruling as just another day at the office or "A Draw at Best."

  2. Dennis,
    No Kool-Aid here, just facts. I agree no one at Expedia probably woke up and was happy with a $20M+ hit to the collective industry. Not the makings of a good day at all.

    But to purport that OTAs control hotels in any way shape or form is just silly. If a hotel really believes that an OTA is controlling their business, they can simply refuse to do business with the OTA. It may be a revenue hit to the property (a la Choice) but the OTAs don't make the distribution choices for a hotel - the hotel does. Regarding mark-ups, if the hotel is a chain (and most of these hotels are) the chain actually sets the mark-up, not the OTA. How is that control?

    Judging from the juries I have served on, 12 federal or other jurors are hardly in a position to understand how the business works at the end of the day. Heck, a lot of GMs are in the dark when it comes to distribution.

    The big take-a-way (that makes it a draw in my opinion) is that the jury absolved the OTAs of collecting tax and simply keeping it. This takes the "evil AIG-esq factor" out of the argument.

    But good debate is always good!