Penalty Clauses Prevailing

<B> Penalty Clauses Prevailing</B>
<I>Tackling Air Negotiations Amidst Fulfillment Frenzy</I>

By David Jonas

As airlines and corporate buyers become more educated about realistic goals for negotiating contracts, carriers have been implementing penalty clauses to ensure that those goals are met. Some travel managers and analysts view such a stipulation as another uncooperative airline tactic, while others recognize the mutual potential benefits.

"We're doing them because it's the evolution of the industry itself," said Pat Terrion, British Airways' senior vice president of sales of USA, during the National Business Travel Association conference last month. He cited the proliferation of net fares and multiple carrier agreements and asked, "If someone wants a deeper discount, what's the commitment?"

Terrion's counterpart at Continental, vice president of market planning and revenue programs Mark Bergsrud, said, "penalties are rare with us," but acknowledged that he has come across them. "I've seen a few, which may have been used in particular circumstances based on past inability to perform," he said. "We might like to use them, but we wouldn't get as much business." However, he said, if Continental is "wary of the deal," the contract would be structured differently. "If someone says they have five transatlantic carriers, with no other preference, and they promise us 50 percent share, we need to put in terms and conditions such as a letter of credit."

Many analysts, while wondering why a buyer might sign such a shared-risk agreement, understand the rationale behind such an approach. "Travel managers for years have gotten away with not fulfilling their deals, while the airlines have simply taken the corporations word that they would follow through," said Randall Malin, principal in Malin & Associates of Los Gatos, Calif. "As the relationship between airlines and corporations becomes more sophisticated, travel managers will be more pressed to deliver. In fact, I am surprised it has taken this long for penalty clauses to come into play."

Indeed, Carol Salcito, president of Management Alternatives Inc. of Stamford, Conn., has been seeing a growing number of penalty clauses in the past few years, a trend she said was likely initiated by foreign flag carriers and now includes U.S. airlines. "Corporations willing to work with the airlines and negotiate acceptable clauses might get a slightly better deal," she said. "It's about putting your money where your mouth is."

Frank Morogiello, AA's managing director of national accounts and sales programs, said that there should be some retribution if a corporation does not fulfill the contract. "However, over time, goals have become more reasonable from everyone's perspective," he said. "We used to ask for 80 to 100 percent market share, but now people are buying smarter and we also are more educated." Morogiello said that about 10 percent of all corporate clients fail to fulfill their contracts, though that number is lower than it has been.

As expected, some travel managers are skeptical of signing deals that include penalties. Kevin Iwamoto, air and car supplier manager for Hewlett-Packard in Palo Alto, Calif., said if BA can convince its clients to agree to such terms, then more power to them. But, he said, "if I were a long-term partner, I wouldn't want that imposed, especially since that arrangement does not make allowances for change in the volatile airline industry."

Still, other industry insiders suggested that customers need to build credibility by avoiding overcommitment and ensuring the ability to drive traffic through policy and agency. In the past, if you didn't fulfill, you wouldn't get as good a deal the next year. Now, airlines are implementing cash-back clauses (including letters of credit) for insufficient performance, as well as quarterly point- of-sale discount decreases based on inability to hit negotiated commitments.

Another method that differs slightly from penalties, and is used by Delta and many others, is cancellation of the agreement if routine measures show particularly poor performance. Delta said it does not use other penalty clauses in its contracts.

An opposite approach--and one more favored by many--is back-end cash incentives or rebates that reward corporations for meeting or exceeding set goals. "If the airline goal is to see how a client will perform," suggested Iwamoto, "offer a back-end discount for a year, evaluate the arrangement and then move the discount up-front if both parties are happy with the results.