High on Travel

Between Orbitz, Expedia and Travelocity, there’s not a lot of opportunity for startups to make a dent in online travel, right?

That’s what Mark Jacobsen thought. “My perception was that online travel was a saturated market,” says the managing director at O’Reilly AlphaTech Ventures. But then he was introduced to a new company called TripIt.

“Here was a startup that was using Web 2.0 technologies like the semantic web and social media to innovate in ways that the entrenched leaders weren’t,” says Jacobsen.

It suddenly dawned on Jacobsen that online travel could be a really big category all over again. Not wasting any time, O’Reilly AlphaTech seeded San Francisco-based TripIt early last year, and participated in a $5.1 million dollar B round with travel company Sabre Holdings and European Founders Fund in April.

Venture capitalists have been pouring money into online travel for the past couple of years, and they’re showing no signs of slowing up their investment pace. They put $174 million into 26 travel companies last year, compared to $196 million invested in 22 such companies in 2006, according to Thomson Reuters (publisher of VCJ). And as of early August this year, venture investors had bet another $153 million on 13 online travel companies.

The online travel industry makes a lot of sense for VCs. For starters, it is a huge market, generating about $80 billion to $90 billion a year, and growing to an estimated $104 billion by 2010, according to JupiterResearch. Secondly, it’s a well-established space, so VCs are willing to quickly jump on opportunities and take a level of risk that they wouldn’t in less-developed sectors.

Big business

“Travel is the largest revenue generator on the web, so it’s a very easy target to think about,” says Mike Kwatinetz, a general partner at Azure Capital and an investor in TravelMuse, which raised a $3.6 million Series A from Azure and California Technology Ventures last December. He argues that the established leaders cannot be expected to keep their stranglehold on the market. “Rapidly changing technology creates opportunities for new entities to attack the space and carve out their own niche,” he says.

One such niche is travel planning. As a frequent traveler, Kwatinetz says the existing online travel options make it easy to book a trip, but the planning part is still a very painful experience. “The big travel companies are not satisfying the needs of myself and everyone I talk to,” he says. “There is a real gap when it comes to taking the travel experience to new level of sophistication.”

Online travel is a big category, but innovation does not happen with the big companies. They buy the innovators.”

Tom Ball

That’s why Kwatinetz incubated and ultimately funded TravelMuse (also known as TripOvation). The Los Altos, Calif.-based company provides a vacation recommendation engine that asks people a series of simple questions and, based on their input, gives them suggestions on where they should travel. It can also create pre-configured travel packages according to a traveler’s budget. Moreover, the site features high-quality photos and editorial content from scores of freelance writers, giving it the feel of a glossy travel magazine.

“We really believe the company addresses many of the missing pieces in online travel,” says Kwatinetz.

TripIt fills a similar gap by organizing a person’s travel plans into one central area. For instance, travelers can forward their airline, hotel and rental car confirmation emails to TripIt. The service automatically creates a master itinerary and even throws in other critical information like weather, maps and driving directions. Users can share their TripIt itineraries and travel calendars with friends in their network.

Here’s the hard part for TripIt, TravelMuse, and all the other new travel startups: making money.

Most new travel companies have a two-pronged revenue strategy. The first prong is a referral engine that allows these companies to earn a fee by referring customers to the likes of Travelocity or Orbitz. When customers book a flight on, say, TravelMuse, the transaction is actually conducted by one of the established booking engines, but TravelMuse still gets a piece of the action. The same goes for hotel and rental car reservations.

Travel FUD

But the challenge is convincing travelers to book a trip from an unknown site, even though it’s using a name-brand booking engine in the background. “There is a certain amount of fear and reluctance here,” admits Kwatinetz.

The second prong of the revenue strategy is advertising. But again, making money from ads is easier said than done. Before a new travel company can sell ads, it has to attract enough users to its site. And buying that kind of traffic costs money. Actually, it costs a lot of money because travel-related keywords are some of the priciest on the internet.

“No doubt, there’s a lot of noise in the online travel space,” says Kwatinetz. “Getting above that noise level is a critical challenge for any travel destination site.”

This category may never be completely over. The risks are high in the travel space, but so are the rewards.

Chris Fralic

Chris Fralic, a partner at First Round Capital, believes he’s overcome this hurdle by investing in Yapta, a travel company whose appeal is so unique that travelers can’t afford to ignore it, he says. Seattle-based Yapta raised $2.3 million from First Round, Bay Partners and Voyager Capital in July 2007 and another $1.3 million in debt from First Round and Voyager in May.

What’s so appealing? Basically, Yapta allows travelers to track fares from dozens of different airlines. Once you find the flight you want to take, Yapta will track it for you and alert you when the price drops. If the price declines even further after you purchased your ticket, Yapta will help you get a refund or credit from airlines that have lowest-guaranteed-fare policies, which most do.

“Even many experienced travelers don’t know about these lowest-guaranteed-fare policies,” says Fralic. “I personally saved 700 bucks using Yapta when a ticket I purchased on Delta for $900 dropped to $150 a week later.”

Isn’t that a $750 savings? “I had to pay $50 change fee, but so what?” explains Fralic.

Yapta makes money through its referral engine. It also offers a premium service: For an extra charge, it will call the airlines directly on behalf of travelers to get the refund.

Perhaps the biggest challenge for a startup like Yapta is copycats. What’s to prevent one of the established giants from adding a similar refund feature to its offering? Indeed, Orbitz recently launched its own refund tool called Orbitz Price Assurance. Once a customer books a flight on Orbitz, the service starts tracking to see if another customer books the same itinerary at a lower price. If that happens, Orbitz will issue a refund for the difference.

“I don’t know if the Orbitz tool was in response to Yapta,” says Fralic. “But I do know that you’re far more likely to receive a credit using Yapta because our service covers all tickets sold, not just those sold over Orbitz.”

M&A heats up

One thing that every travel startup has going for it is the very active mergers and acquisition climate. Microsoft in April acquired travel website Farecast for $75 million, according to Thomson Reuters. Farecast had previously raised $20.6 million over three rounds between 2004 and 2007 from Greylock Partners, Madrona Venture Group, Pinnacle Ventures, Sutter Hill Ventures and WRF Capital.

The big travel companies are not satisfying the needs of myself and everyone I talk to. There is a real gap when it comes to taking the travel experience to new level of sophistication.”

Mike Kwatinetz

In December, travel search engine Kayak.com pocketed $196 million in funding and then purchased rival site SideStep. The amount of the sale wasn’t disclosed, but VentureBeat reported that it was $175 million and TechCrunch pegged it at $180 million. SideStep had previously raised $32 million between 2000 and 2007 from Norwest Venture Partners, Saints Ventures and Trident Capital.

Meanwhile, Expedia-owned TripAdvisor snatched up user-generated travel content site VirtualTourist for an undisclosed amount. VirtualTourist did not have venture backing.

VCs expect there will be many more acquisitions in the coming months and years. “Given the IPO market, I think all venture-backed companies could be acquisition targets,” says Tod Francis, a general partner at Shasta Ventures.

Shasta’s travel bet is UpTake, a travel information search engine that helps consumers decide where to go, where to stay and what to do. Shasta is the sole venture investor in Palo Alto, Calif.-based UpTake, which has raised a total of $4 million to date, including a $500,000 Series B in June.

“Online travel is a big category, but innovation does not happen with the big companies,” adds Tom Ball of Austin Ventures. “They buy the innovators.”

Ball, for his part, recently led a Series A in The Nile Guide, a site that offers personalized travel recommendations and planning services. The San Francisco-based company raised $8 million from Austin Ventures, Draper Richards, KPG Ventures and Lehman Brothers.

Some of the major travel players are even using venture capital as a possible precursor to an outright acquisition. That’s probably why Sabre Holdings, the operator of Travelocity, led the most recent round in TripIt. “This is a good way for both companies to learn a lot more about each other,” says Jacobsen of O’Reilly AlphaTech.

Most VCs believe the travel space will continue to evolve, presenting even more untapped opportunities.

“This category may never be completely over,” says Chris Fralic of First Round. “The risks are high in the travel space, but so are the rewards.”