One of the most significant shifts in hospitality (and wider travel) distribution occurred at the inception of online travel agencies (OTAs). Emerging in the ‘90s and gaining traction into the 2000s, OTAs created a new world of travel buyers, providing a new way to connect would-be travelers to companies such as airlines, hotels, and car rental providers.

Two primary business models emerged for OTAs and other travel buyers: the agency and merchant. Let’s examine each of these and consider a third option that is taking shape.

Agency model

The agency model is the more traditional of the two. As one of the trailblazers in the OTA space, Expedia deployed the agency model upon its inception in 1996. Under this model, Expedia acted as an intermediary between travelers and travel suppliers and earned revenue by receiving a commission for each booking made through its platform.

In this model, travel buyers are intermediaries and do not own the inventory they sell. This means they don’t directly handle payment processing; each supplier (e.g., a hotel) owns its inventory and must process the payment.

Suppliers process the payment and are responsible for customer service and handling cancellations, changes, and other booking-related issues.

As you can see, the agency approach is enticing. For travel buyers, it provides a low-risk and operationally lightweight entry into the market (no payment processing or customer service inquiries) and a straightforward commission-based (either a percentage or a flat fee) business model.

However, it doesn’t come without disadvantages, such as:

• Integrations and other technical hurdles

• Supplier-controlled pricing

• Limited growth potential

For example, travel buyers can create packages that bundle accommodation, flights, and car hire, but they are held to prices set by individual suppliers. This model often comes with significant distribution fees that cut margins for suppliers.

It’s also worth considering the agency model's payments, cash flow, and reconciliation aspects. The commission that is to be paid to the travel buyer is part of the total booking price paid by the traveler.

In this case, the travel buyer must wait for the supplier to pay this commission. This not only ties up the travel buyer's cash flow, but the travel buyer must also trust that the supplier issues the payment promptly and cost-effectively. This can also become a huge, time-consuming process that requires financial expertise to execute correctly.

This is why the business model quickly expanded and evolved.

Merchant model

In 1999, Expedia introduced the merchant business model, taking inventory ownership by purchasing it at wholesale or discounted prices. This allowed them to resell it at whatever marked-up prices they desired and offer more lucrative travel packages to consumers, significantly driving revenue growth.

Not only did this give them control over pricing, but it also allowed them to create additional revenue streams as it continued to deploy the agency model.

Therefore, it’s important to note that adopting business models as a travel buyer is not an either/or option. Travel buyers can and often do leverage both the agency and merchant models for their businesses.

Another prime example of this practice is the world’s largest OTA, Booking.com, which applies both models. According to its latest annual report, Booking Holdings captured $81,721 (in millions) in merchant gross bookings (a 51.7% increase year over year) and $68,906 (in millions) in agency gross bookings (a 2.3% increase year over year).

The merchant model offers other benefits for travel buyers, including pricing control and higher profit margins. Therefore, it’s unsurprising that companies like Booking.com are investing more in it.

Although the merchant model opens up the possibility, it should be noted that a merchant model arrangement doesn’t always mean the travel buyer is in control of pricing, depending on the commercial relationship with the supplier. For instance, a hotel and a travel management company (TMC) could have clearly defined pricing agreements so the TMC can not adjust pricing without consent.

By directly selling to end consumers, travel buyers can own the relationship and offer loyalty programs that reward customers with discounts, special offers, upgrades, or other incentives.

End consumers also benefit from (generally speaking) lower prices since travel buyers can sell and bundle inventory at reduced rates and provide a better shopping experience since they can seamlessly purchase their travel all on the travel buyer’s platform.

Travel suppliers who sell directly to the travel buyer benefit from fraud protection and reduce other payment complications. However, this does create new challenges.

For example, a hotel’s direct channels can be undercut by OTAs selling inventory at a lower rate, while the hotel loses the direct relationship with its customers. This can create distrust between buyers and suppliers, making it difficult to do and grow business together in the future.

The merchant model also has drawbacks for travel buyers. Since travel buyers become the merchant of record (MoR), there is much more operational overhead for processing payments and providing customer service. Since the travel buyer owns the inventory (in most cases, we’ll discuss this in more detail later), there is also the risk of spoilage if that inventory goes unsold, which can quickly lead to significant losses.

Blended models

It’s worth noting that the distinction between these models is not always so clear. For instance, a merchant model can be deployed without the travel buyer purchasing inventory before selling it.

Consider the following example: a corporate traveler purchases a room via a travel management company (TMC) platform. The TMC then buys the room from the hotel at a gross price with a virtual credit card (VCC) to complete the booking.

Finally, the hotel pays the TMC’s commission fee. In this case, the TMC is the merchant of record because it processes the payment but doesn’t hold the inventory until the moment of purchase. It’s the merchant model in agency model clothing.

Sometimes, this chain can get even more complicated with more players involved. Going back to our previous example, our TMC can purchase a room from the same hotel through an OTA that purchased the room via a bed bank that originally bought the room from the hotel.

Because of the number of players involved and links in the chain, several problems occur: a lack of transparency (and, in turn, a lack of trust between partners), a lack of control, system vulnerability, and unnecessary complications and costs.

Merchant responsibilities

The next phase of travel distribution is converging the agency and merchant models into the virtual merchant of record (VMoR).

Before we explore the VMoR model, let’s examine the responsibilities of a standard merchant of record (in the agency model, the travel supplier, and in the merchant model, the travel buyer).

The MoR typically handles the following responsibilities:

• Payment Acceptance: The MoR has the authority to accept payments from customers on behalf of the business.

• Legal Liability: The MoR is legally liable for chargebacks, fraud, and compliance with relevant financial regulations, such as the PCI DSS (Payment Card Industry Data Security Standard).

• Contracts with Payment Providers: The MoR processes transactions through contracts with payment gateways, banks, and card networks (e.g., Visa, Mastercard, and American Express).

• Risk Management: The MoR manages payment risks, such as fraud detection and chargeback resolution.

• Tax and Regulatory Compliance: The MoR ensures that taxes are correctly applied and remitted and that they comply with relevant financial regulations, including reporting to authorities.

This creates many responsibilities and liabilities and amounts to a significant operational load, distracting travel organizations from their core business of offering customers exceptional travel experiences. That’s why the VMoR model is an attractive option.

Virtual merchant of record

A VMoR operates similarly to a traditional MoR but typically in a more indirect or virtual capacity. It is often used when a third-party platform or intermediary (like a marketplace or SaaS provider) facilitates transactions without directly handling the payment processing.

Numerous examples of this exist in the business-to-consumer market. For instance, platforms like eBay or Etsy function as VMoRs, facilitating direct and trustworthy transactions between buyers and sellers.

Key characteristics of a VMoR include:

• Indirect Payment Processing: While a VMoR facilitates payments, it may not directly process payments through its own payment gateway. Instead, a third-party service or platform handles the transaction processing. Companies like Katanox strictly handle B2B payments between suppliers and buyers.

• Shared Legal Liability: The legal and financial responsibility might be shared between the VMoR and other entities involved in the transaction. For example, the marketplace may act as the VMoR for transactions between buyers and sellers.

• Risk and Compliance Delegation: While the VMoR is still liable for certain aspects of transaction risk and compliance, some responsibilities may be delegated to payment providers, the platform facilitating the transactions, or the individual sellers within the marketplace.

• Role in Business Operations: The VMoR might be more of a facilitator or intermediary, supporting the transaction flow but not necessarily being the entity that holds the merchant account, contracts with banks, or directly processes the payments.

Guided model

Since we’re already seeing model convergence, what if we apply the VMoR model to previously blended models to create an optimal ecosystem for both travel buyers and suppliers?

Within travel, companies like Katanox function as VMoRs, combining the best attributes of the agency and merchant models. This puts accommodation suppliers and travel buyers in an optimal position to focus on and grow their businesses while outsourcing the challenges associated with payments. Let’s call this the guided model.

With this model, both parties (the buyer and the supplier) control the transaction by agreeing to mutually beneficial terms (such as net price and commission fees). Since the VMoR controls the cash flow, it ensures the terms are followed, which creates transparency and establishes trust between the buyer and the supplier. For example, Katanox’s API sets the agreed-to net price of a booking so that terms cannot be circumvented.

Payment and business models are about reducing costs, maximizing revenue, and creating an ecosystem that fosters growth through beneficial partnerships. This will lead to the lowest costs and highest profit margins.