“The most important thing in our business is the quality of the real estate, the location of the real estate, and the hospitality factor ... Everything around it is noise, and owners can adjust.” – Shai Zelering, MD, Real Estate, Hospitality, Brookfield Property Partners
Report OverviewBrands are consolidating, consumer preferences are changing, disruptors are impacting the distribution landscape, and technology is evolving. Hotel owners face an increasingly complex environment in which they must choose the single, best operating model and brand strategy for a given property. Easier said than done. In this report, we examine implications for hotel owners of the major brands increasingly shifting to asset light; the growth potential for non-branded operators and soft brands; how independents can succeed when catering to experiential-minded consumers with a focus on technology and data; and key items to think about when choosing a brand. What we found through our analyses and interviews with owners, operators, managers, franchisors and other industry experts is that there may not be one best way to own a hotel. There is no “one size fits all” operating model, and decisions must be made on a property-by-property basis. Nevertheless, hotel owners can’t be idle, and should continue to be innovative, adaptable, thoughtful. They should also be willing to push back on their managers and franchisors to produce the best results. At the end of the day, the objectives remain the same: Acquire or develop strong real estate, ensure the property is run as effectively and efficiently as possible, choose the right partners, and never lose sight of that hospitality factor. This is a people business after all.
What You'll Learn From This Report
- The advantages and disadvantages of different ownership operating models (independent, brand management, non-branded management, franchise)
- Key considerations when entering into management and franchise agreements
- How income statements differ among owners, managers, and franchisors
- An overview of the hotel industry in terms of market shares of branded versus non-branded and managed versus franchised versus owned properties
- Why the large brands have increasingly shifted to asset light and consolidated
- The benefits of brand affiliation, including how loyalty programs and lower online travel agency (OTA) commissions can drive incremental revenue
- How consolidation has negatively impacted hotel owners
- The potential market opportunity for soft brands and non-branded operators
- Keys to operating a successful independent property
- How changes in the distribution landscape, from OTAs to Airbnb to Google, are influencing hotel owner decisions
- Cost considerations for hotel owners in today’s environment
- Skift Research’s proprietary ranking of seven major hotel brand chains based on 13 quantitative metrics to inform hotel owners’ decisions about brand affiliation
- Skift Research’s expectations for distribution costs, growth of independent hotels, how contracts will evolve, and how the major brands are going to respond to industry trends
- William Fortier, SVP, Development, Americas, Hilton Hotels & Resorts
- Kristian Gathright, COO, Apple Hospitality REIT
- Amar Lalvani, CEO, Standard International, Bunkhouse Group, One Night
- Raymond Martz, EVP & CFO, Pebblebrook Hotel Trust
- Sara Masterson, VP, Hotel Management, The Olympia Companies
- Chip Ohlsson, EVP & CDO, Wyndham Hotel Group
- Victoria Richman, CFO & COO, HVS Hotel Management & HVS Asset Management - Newport
- Ian Schrager, Founder & CEO, The Ian Schrager Company
- Atish Shah, EVP & CFO, Xenia Hotels & Resorts
- Julienne Smith, SVP, Real Estate and Development, Hyatt Hotels
- Ted Teng, President & CEO, The Leading Hotels of the World
- Shai Zelering, MD, Real Estate, Hospitality, Brookfield Property Partners
When it comes to owning a hotel, many public investors think of the less-than-stellar aspects of hotel ownership: lower profit margins relative to franchise and management organizational structures; more volatility in economic downturns against an essentially fixed cost structure; potentially lower company valuations; challenges with online travel agency (OTA) commissions and other distribution costs; costly investments in renovations, furniture, fixtures, and equipment, labor, insurance, sales and marketing, reservation and property management systems, and other expenses. The list goes on and on.
From inside the industry, however, hotel owners and developers see the opportunity to make a return on a real estate investment, “wow” guests with a unique experience, and provide a place of shelter, a space for people to meet and gather, a community. When a hotel owner appropriately positions a property by making smart, efficient, innovative decisions, the outcome can be a financially rewarding, and also personally fulfilling, experience.
Plus, given that the cost structures of hotels are primarily fixed in nature, cash flows generated can be quite significant, particularly in expansionary time periods. Take 2007, for instance. Asset-light Choice Hotels showed earnings before interest, taxes, depreciation and amortization (EBITDA) growth of 12% that year. Wyndham’s Hotel Group, which also focuses primarily on franchising hotels, showed growth of 7%. On the other hand, four full-service real estate investment trusts (REITs) showed EBITDA growth of 25% on average, a full 15% above Wyndham and Choice (We included Host Hotels & Resorts, LaSalle Hotel Properties, Sunstone Hotel Investors, and DiamondRock Hospitality in the average.).
We see Loews Hotels recognizing this with its “asset-heavy” approach. While other brand chains have been shedding their real estate, Loews CEO James Tisch stated during the company’s third quarter 2017 earnings call, “Why have we focused more on building versus buying? It’s simple. First, when you build something, you get exactly what you want. Second, we think the returns are great. We typically look to greenlight projects with mid-teen cash-on-cash returns on equity.”
Tisch added that because “Loews Hotels is both an owner and an operator, a business model that is increasingly rare for hotel companies,” it makes the company “an attractive partner for developers, immersive destination owners, and municipalities alike. We think like owners because we are owners, which creates mutually beneficial partnership dynamics for all constituents, something Loews Hotels has prided itself on for almost 60 years that we’ve been in the business.”
Conversely, most of the major hotel brand chains have been consolidating and combining resources, finding it is easier to grow their profit margins by increasing management and franchise contracts rather than owning properties outright. Hotel owners, then, bearing more of the real estate risk, but high potential profits, must choose wisely: join the massive brand systems with global, all-encompassing reaches, or “take the path less traveled” and remain independent in hopes of developing a one-of-a-kind, and financially prosperous, property.
However, this is just one decision a hotel owner must make in the increasingly complex, and ever-changing, environment. Should the owner go with a non-branded operator, a branded operator, or operate the property themself? If independent or using a non-branded operator, should the owner use a franchise agreement with a major brand or soft brand to get access to brand resources? If going branded, which brand is right for her or his property? As consumer preferences change, disruptors impact the distribution landscape, and technology evolves, which operating models and branding strategies best position the property for whatever the future brings?
In this report, we go over, in great detail, various changes currently happening in the hotel industry and implications for hotel owners. This includes issues such as the major brands going asset light and potentially moving further away from the day-to-day operations and how that may give non-branded operators and smaller brand franchises the opportunity to flourish. We discuss how independents are likely to succeed when catering to experiential-minded consumers with a key focus on technology and using data intelligently to enhance the guest experience. We highlight key items to think about when choosing a brand. We provide our expectations for soft brands, changes in management and franchise contracts, distribution costs, and how these changes will impact hotel owners.
What we found through our analyses and numerous interviews with key owners, operators, managers, franchisors and other industry experts is that there may not be one best way to own a hotel. There is no “one size fits all” operating model, and decisions must be made on a property by property basis. While a brand affiliation might make sense for one property, the cost of being affiliated with a brand may not bring in enough incremental demand to justify the cost for another. Some owners don’t want a brand or manager telling them what to do, while others want assistance to help them achieve results they couldn’t on their own. Even after deciding on an operating model and how to brand the property, the owner may never know if she or he made the right choice.
Regardless, hotel owners can’t be idle. The industry is evolving so rapidly, and new technological advancements are changing how consumers interact with hotels and book travel, that sitting still isn’t an option anymore. When asked how the industry can continue to be innovative, Ian Schrager, founder of The Ian Schrager Company and founder of the recent PUBLIC Hotels, stated that “You have to go outside the industry,” referencing strategies that the technology and retail industries are employing. “It’s the only way you’re going to get fresh ideas by definition.”
Owners should continue to be creative, adaptable, thoughtful, and push back on their managers and franchisors to produce the best results. At the end of the day, the objectives remain the same: Acquire or develop strong real estate, ensure the property is run effectively and efficiently, choose the right partners, and never lose sight of that hospitality factor. This is a people business after all.
- Even just a decade ago, hotel owners had only a few primary choices when it came to deciding with which brand and/or operator they should affiliate. Now, there is a significant number of brands, numerous types of structures, and new ways to think about how to position a property.
- The major brands have been shifting to asset light and consolidating for quite some time as the business model is more profitable and less volatile relative to owning real estate and because public investors tend to reward the companies with higher valuations.
- The major brands now have considerable market shares that can benefit owners in the form of access to strong systems and distribution, higher occupancies and average daily rate premiums from loyalty programs, procurement savings, and lower online travel agency (OTA) commissions.
- However, some industry participants would argue that the major brands’ massive sizes make them less creative, less nimble, more removed from the day-to-day, and perhaps more focused on decisions that benefit their stock prices potentially at the expense of healthy owner relations.
- In response, the development of soft brands has provided independent properties with the ability to enjoy the benefits of a large branded system without sacrificing the property’s uniqueness or individuality.
- On the management side, the proliferation of non-branded, third-party operators has allowed hotel owners to have more flexible management contracts with better aligned incentives.
- Having a successful independent property is dependent on the owner having the necessary expertise, passion, and capital to create a well-marketed property with its own unique sense of place and individuality.
- While the distribution landscape is ever evolving, owners can adjust to any changes by focusing on providing an elevated experience while keeping costs as low as possible.
- Skift Research’s proprietary Brand Matrix, which ranks the seven major brand chains according to 13 key quantitative metrics suggests that Marriott is the strongest brand for hotel owners in terms of loyalty, customer satisfaction, website usage, growth in revenue per available room (RevPAR), relative to the costs borne by the owner. Hilton is close behind.
- We expect growth of institutional owners in the hotel industry should drive stronger profitability and better aligned interests.
- Skift Research expects distribution fees will continue to decline, as the brands continue to educate the public about the benefits of direct booking, Airbnb, Google, and other companies employ strategies making the overall landscape more competitive, and the threat of independents joining soft brands for lower fees pushes commissions down for everyone.
- Management contracts will likely become more flexible and employ a stronger incentive structure to better align interests. As we wait for branded management contracts to renew, this likely creates room for strong growth out of non-branded, third-party operators.
- There is huge market potential for soft brands. Skift Research forecasts soft brands for five major chains could reach 136,000 rooms by 2019, representing a 19.5% three-year CAGR. We estimate the total market potential for soft brands could be 12% of total U.S. hotel supply.
- Branding strategies, contract terms, and distribution landscapes will all continue to evolve over time, but hospitality as a people business, first and foremost, will always remain at the center of successful properties.
Evaluating different types of hotel ownership
There are numerous ways to participate in hotel ownership, but here we discuss some basic structures of ownership. Hotel owners should consider all ownership strategies with the key focus of aligning the interests of the various parties to the best of their abilities and bringing in assistance where their own expertise is limited so as to yield the strongest profitability and best operating results. With this goal in mind, there are five basic structures with multiple permutations to contemplate:
- Own and operate the hotel with a franchise agreement (“Branded, Owner Operated”)
- Own the hotel, but use a non-branded, third-party operator to run the property as an independent hotel (“True Marketer”)
- Own the hotel, but use a brand – either via a branded operator or a non-branded operator with a franchise agreement (“True Investor”)
- Own and operate the hotel as an independent property (“True Independent”)
Own and operate the hotel with a franchise agreement (“Branded, Owner Operated”)
With franchise agreements, the owner has the right to use the brand name, trademarks, and logos of a brand, and also has access to the brand’s loyalty program, distribution channels, and central reservations system. The owner also benefits from system-wide marketing and publicity and proprietary knowledge from the brand regarding employee training and best practices. While the owner is able to maintain control over property decisions and operations, the owner must maintain brand standards according to the franchise agreement, which can sometimes be costly, and bears all risks of the business.
Own the hotel, but use a non-branded, third-party operator to run the property as an independent hotel (“True Marketer”)
If the owner does not have the expertise necessary to operate and run the hotel, it may make sense to use a non-branded operator (We will use the phrase ‘non-branded’ operator throughout this report to signify any third-party operator of a hotel that is considered to be an independent manager or is not affiliated with a major brand chain.) who has considerable knowledge and experience running hotels and can manage the property on behalf of the owner in exchange for a management fee. The manager generally supervises and controls the day-to-day hotel operations, including establishing room rates, handling reservations, dealing with procurement of inventory and supplies, managing employees, developing sales and marketing plans, preparing budgets and projections, and more.
The owner generally retains control over budget and capital expenditure approvals and can act in an advisory capacity by providing guidance, analysis on market performance, and share best practices from other properties. Owners may also be able to negotiate more favorable pricing on behalf of operators in areas such as insurance expenses, service contracts, and furniture, fixtures, and other equipment.
Own the hotel, but use a brand – either via a branded operator or a non-branded operator with a franchise agreement (“True Investor”)
A hotel owner can have both a management and a franchise contract.
Own the hotel, use a branded operator
If the hotel operator also owns a brand or portfolio of brands, the fees of the management agreement may also include the ability to use the brand name. Working with a branded operator may have advantages such as easier access to financing and lending, scale and distribution, as well as experience and expertise. Branded operators such as Marriott and Hilton are very large, and, as such, have very strong economies of scale and advantages when it comes to procurement, distribution, loyalty, and bookings.
However, branded operators’ incentives may not always be aligned with those of the hotel owners. For instance, large branded operators may be focused on growing market share and their geographic footprints, given they are compensated on the top-line via a percentage of revenues, or their stock price if they are a publicly traded company. They may establish brand standards that could be very costly to the owner and potentially unimportant to the consumer. All of these issues may be at the expense of generating stronger operating profits for the owner. Regardless, an obvious determination needs to be that revenues associated with the hotel are enough to cover the cost of fees from being associated with the brand.
Own the hotel, use a non-branded operator with a franchise agreement
The owner may choose a non-branded operator given that the management agreements can sometimes be more flexible or negotiable in terms of contract length, fee structure, and termination costs. However, these agreements may potentially be more limited in terms of services provided.
Non-branded operators may be a bit better aligned with the financial objectives of the owner. They want to have strong relationships with their owners and may, as a result, be a bit more resourceful when it comes to keeping costs such as labor as low as is feasible. The non-branded operators may also have more localized or regional expertise or market-specific knowledge, making them better suited for operating a hotel in a given market. Despite having to pay franchise fees to the brand, it is possible to have stronger operating margins, given the non-branded operator is more likely to focus on keeping costs low on behalf of the owner relative to working with a branded operator.
If the owner would also like to have access to a brand name, be it for distribution, loyalty, or systems, a separate franchise agreement with a hotel chain may be established.
Own and operate the hotel as an independent property (“True Independent”)
Should the hotel owner have the necessary expertise, she or he may choose to operate the property herself or himself under their own brand. The owner must have considerable knowledge regarding technology and distribution, a solid marketing or social reach, and a strong, creative, resonating brand story. This structure allows the owner to retain complete autonomy and control over the property in making decisions regarding investments, staffing, branding, marketing, pricing, and strategy. In turn, the owner reaps all profits without having to pay any sort of franchise or management fees.
Nevertheless, the cost of paying high commissions to the OTAs so as to have better placement in search results, as well as advertising expenses and other necessary costs, may offset the benefit of not paying franchise or management fees. This may not be the case if the property is located in a high-demand market, such as a gateway city like New York City or San Francisco, where demand and traffic are generally high regardless of being associated with a large brand’s distribution network, or if the property has access to a consistent level of demand.
Exhibit 1: Hotel Owner’s Advantages and Disadvantages of Different Ownership Structures
Source: Skift Research
Typical Franchise Agreements
Franchise agreements typically include an application and initial fee, which might be calculated as a base minimum of $50,000 to $75,000 or a certain amount per hotel room, such as $300 to $500 per room. After approval, the franchisee must pay ongoing monthly royalty fees, generally calculated as a percentage of room revenues. Full-service brands may also include fees as a percentage of food and beverage revenues in addition to room revenue fees. Generally, royalty fees are around 5% to 6% of room revenues. However, what is often overlooked is that franchisees must also pay monthly program fees to cover advertising and marketing expenses, fees to cover technology and reservation systems, distribution fees, loyalty fees, quality assurance programs, training costs and more. What started as 5% of gross room revenue can quickly turn into 10% to 12% off of the top line. In HVS Global Hospitality Services’ 2016/17 United States Franchise Fee Guide, a study of Franchise Disclosure Documents (FDDs) for 74 brands, showed that the average franchise cost was 10.7% of room revenue over an initial 10 years of operations (See exhibit below).
Agreement term lengths are generally long, many being 20 years, and are very costly to terminate for the hotel owner or developer. When choosing a brand, it is important to evaluate all of the associated fees included in the agreement, because once an owner decides, they are essentially locked into the contract for quite some time.
While franchise fees have historically increased over time, in the short term, there has not been any significant or dramatic changes in franchise fees. However, the composition of the fees for the owner has changed. The assessments for marketing and reservation services have generally declined while the amount that is contributed to loyalty programs and royalty payments has increased. We can see this by analyzing Choice Hotels’ 10-K filings from 2001 to 2016, which feature the rates for each of the company’s brands each year. Choice’s royalty rates increased 75 basis points (bps) over the past fifteen years (for the brands that were in existence 15 years ago), while marketing and reservation fees came down 16 basis points. (As a note, a basis point is 1/100th of 1%; 75 basis points = 0.75%)
Exhibit 2: Franchise costs are on average close to 11% of rooms revenue over an initial 10 years
Source: HVS 2016/17 United States Hotel Franchise Fee Guide
Exhibit 3: For Choice Hotels, royalty fees have been increasing over time, while marketing and reservation system fees have been decreasing.
Source: Company filings
Typical Management Agreements
Management agreements are different from franchise agreements, because the manager operates the property on behalf of the owner. Typical management contracts include a base fee, which is typically a percentage of the property’s gross revenue, generally ranging from 2% to 4%, and an incentive fee, which is based on a percentage of gross operating profits or cash flow. The incentive fee typically ranges from 10% to 30% of the relevant profit metric, but can vary.
The profit incentive is often included so as to better align the incentives of the manager with the owner. If the manager operates the property more efficiently and generates more profits at the property for the owner, the manager will get paid more. Sometimes a certain threshold is included in the incentive fee structure of the management agreement, often called “owner’s priority”and is generally calculated as some percentage of the hotel project or property cost (i.e. 10%-20% of invested capital or acquisition cost). This owner’s priority may be included so that the owner can ensure he or she will be able to generate a minimum return on investment before being required to pay the manager an incentive fee.
Interestingly, the incentive structure part of the management agreement is usually greater in management agreements made outside the U.S. The contract may be accompanied by a lower base fee, or it may be entirely structured as some percentage of a profitability measure rather than top-line. This allows for an even greater alignment of interests and lowers the perceived risk to the manager in new markets and territories.
There is generally a lot more room for negotiation when it comes to management agreements versus franchise agreements, and fees and terms can vary widely. Contract lengths may range from a couple years long for non-branded operators to up to 30 years for branded operators. Fee structures can take all different forms. Non-branded operators tend to be even more flexible than branded operators (discussed in more detail later in this report) and are often more aligned with the owners’ interests, given a branded operator must first and foremost report to the brand to which it is affiliated.
In addition to all of this, the owner, particularly when working with branded operators, will also continue to pay fees to have access to technology and reservation systems, participate in brand marketing and advertising, and pay for the costs of quality assurance and training programs. The owner is also still responsible for all costs associated with the property. Labor, inventory, capital expenditures, etc. are all borne by the owner/developer, not the manager.
Exhibit 4: Franchise and Management Agreements Comparison
Source: Company filings, Skift Research
Hypothetical Statement of Operations for a Franchise, Managed, and Owned Hotel
For the purpose of understanding the implications of different ownership structures, we lay out a hypothetical income statement for a hotel owner, a hotel manager, and a hotel franchisor. These numbers are completely hypothetical, but demonstrate the power of being asset-light, meaning managers and franchisors are able to generate significantly higher operating profit margins, returns, and free cash flow. For this analysis we used company filings for Host Hotels, Pebblebrook, LaSalle, Sunstone, DiamondRock, Apple Hospitality, and Xenia to better understand hotel owner income statements and Marriott, Hilton, Hyatt, and Choice to better understand hotel manager and franchisor income statements.
Exhibit 5: Hypothetical income statements demonstrate high margins for hotel managers/franchisors.
Source: Company filings, Skift Research
The Lay of the Hotel Landscape
In this section, we detail a few current features of the hotel industry to provide context for the rest of the report. For one, the U.S. hotel market is very much a branded market, and there is more opportunity for hotels to become increasingly branded internationally. Second, while franchises are particularly common in the U.S., management contracts and owned hotels remain more common internationally. Last, we detail the ongoing trend of hotel companies going asset-light, and, more importantly, we highlight why the brands are pursuing this strategy.
The Hotel Industry Is Increasingly a Branded One
Hip, boutique independent hotels may be getting a lot of airtime, but the hotel industry, at least in the United States, is increasingly a branded one. In the U.S. and Canada, approximately 70% of hotels are branded. Despite the U.S. being largely saturated by brands, the major brand chains are also continuing to gain ground. According to Bernstein equity research analysts Richard Clarke, ACA, and David Beckel, CPA, while independents make up 30% of existing U.S. hotel rooms, they are only 15% of the supply pipeline, suggesting that the branded percentage will likely push even higher.
In contrast, the rest of the world is only about 45% branded. For example, Marriott estimates that it has 14% share of the U.S. hotel market (based on number of rooms), but less than 4% share of the hotel market outside of the U.S. Although the rest of the world remains relatively unbranded, branding has been increasing, as demonstrated by the exhibit below. For both Marriott and Hilton, over half of the hotel rooms in their pipelines are located outside of the U.S. We expect that, as international markets continue to develop, and global travel increases, brands will continue to expand their footprint via management and franchise contracts, and international hotel owners will look for economies of scale via access to large, global central reservation systems, training programs, and marketing that large brands provide.
Exhibit 6: North American hotels are mostly branded.
Source: Wyndham company filings, STR
Exhibit 7: Hotels outside North America are increasingly branded.
Source: Wyndham company filings, STR
Franchising Popular In The U.S., While Managed And Owned Hotels Remain More Common Abroad
In the U.S., the overwhelming response has been to use franchise agreements. Based on the company filings of Marriott, Hilton, Choice, Hyatt, Accor, IHG, and China Lodging Group, Skift Research estimates that the U.S. is approximately 80% franchised, 19% managed, and 1% owned/leased for the major brands. However, internationally, given that the industry remains very fragmented, we estimate 14% of rooms are owned/leased, 55% are managed, and 31% are franchised. It is possible that the major brands have continued to manage more hotels internationally given management agreements allow the operator to maintain more control over day-to-day operations at the property as well as to gain more experience in a different geographic region. Regardless of the market, direct ownership of hotels is becoming less of a focus for major brand chains.
Exhibit 8: The U.S. is primarily franchised for the major brands…
Source: Company filings
Note: Data from Marriott represents North America, Accor represents North & Central America & Caribbean, and IHG represents Americas
Exhibit 9: …but remains primarily managed internationally.
Source: Company filings
Exhibit 10: Breakdown of managed, franchised, and owned hotel rooms for major brand chains
Source: Company filings
Through consolidation and moving toward an asset-light model, the major brands have built massive, global portfolios. The analyses above include over 5 million global hotel rooms for the major brands, representing what we estimate to be a third of global hotel supply. In the U.S., we estimate Marriott, Hilton, Wyndham, Hyatt, IHG, Choice, and Accor make up 50% of guestrooms. Because of their enormous size, along with significant fragmentation among hotel owners and contract lengths up to 30 years, the brands can maintain control over their portfolios and the industry as a whole. This allows them to implement brand standards and capital requirements for hotel owners to maintain consistent portfolios. With the hotel ownership side of the industry remaining so fragmented, working with a brand that provides revenue management and access to loyalty programs and distribution may mean the difference between life and death in terms of operational success.
The Large Brands Have Shifted Increasingly Toward Asset-Light
Large public hospitality and major brand chains have increasingly shifted asset-light, some getting out of hotel ownership entirely, in recent years. In conjunction with acquiring Starwood, Marriott — which had been asset-light for quite some time — announced a plan to sell the Starwood hotels it had come to own through the merger. Since completing the merger, Marriott has generated $1.1 billion in cash (approximately $750 million of asset sale dispositions and the remainder coming from note collections) with a target goal of $1.5 billion by the end of 2018. We expect to see another $400 million or more in 2018 coming from Marriott’s goal of not wanting to own hotels.
Marriott is not the only brand looking to get out of hotel ownership. Hilton kicked off 2017 by spinning off its real estate and timeshare businesses into separate companies. Wyndham Worldwide, La Quinta, and AccorHotels all have plans in place to separate from their real estate, while Extended Stay America is getting into franchising. Both Red Lion Hotels (RLH) Corporation and Hyatt announced asset sale programs in 2017 as well.
Exhibit 11: Recent timeline of hotel companies shifting to asset-light
Source: Company Press Releases, Skift Research
Why are the major brands recoiling from hotel ownership in favor of management and franchise agreements? We’ve identified three key reasons for the move:
1. The business models are more profitable. Management and franchise models are typically able to generate higher operating profit margins, returns, and free cash flow, relative to hotel owners. Franchise models are particularly stable given the royalty and other fees are substantially a recurring revenue stream. Both models have relatively low cost structures as well. In Exhibit 5 above, we provide hypothetical income statements for owners, managers, and franchisors which demonstrate the high cash flow power of franchise and management models.
2. The business models are more stable. Because franchise and contracts are generally constructed as a percentage of revenues, the business models for franchise and management operations tend to be more stable during times of volatility such as economic recessions. Regardless of the hotel’s performance, the owner still has to pay the franchisor and manager fees. For example, we looked at franchisors Choice and Wyndham (excluding the timeshare segment for Wyndham) in 2007 and 2009 relative to asset-heavy hotel companies such as Hyatt and several public hotel REITs. Our analysis showed that while revenue growth and adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) growth significantly outperformed the asset-light hotels in 2007, the declines seen in 2009 during the financial crisis were severe, with revenues declining 8% more and adjusted EBITDA declining 16% more than Choice and Wyndham.
Exhibit 12: Asset-heavy hotel companies’ adjusted EBITDA declined 16% more than asset-light hotels in 2009.
Source: Company Filings, Skift Research
Note: Asset-light hotels include Choice and Wyndham’s Lodging business. Asset-heavy hotels include Hyatt starting in 2009, and Host Hotels, DiamondRock Hospitality, LaSalle Hotel Properties, and Sunstone Hotel Investors.
3. Asset-light model warrants a higher valuation. A lot of the major hotel brand chains are public companies, and therefore, are focused on their stock price and valuation. Equity investors typically reward companies for being asset-light for several of the reasons already discussed, including higher margins, less volatility, less capital intensity, higher return on assets, and greater flexibility. Outside of expansionary periods, where revenue and EBITDA growth for asset-heavy hotel companies can far exceed asset-light, this translates into higher valuations for asset-light companies such as Choice, as demonstrated by enterprise value to next 12 months EBITDA (EV / NTM EBITDA) multiples. Over the time period included in the chart below, asset-light Choice had an average EV / NTM EBITDA multiple close to 14X, while an average of Hotel REITs (including DiamondRock, Host, LaSalle, Sunstone, RLJ, Apple Hospitality, Pebblebrook, and Xenia) and Hyatt, which are considered asset-heavy for their ownership of hotels, were 12.5X and 11.2X, respectively.
Exhibit 13: Choice Hotels has generally garnered a higher valuation by stock investors for its asset-light strategy.
Source: Capital IQ
Benefits of Brand Affiliation
In this section, we detail the numerous advantages for a hotel owner to be affiliated with a brand, be it via a brand franchise agreement or by using a branded manager to operate the hotel. As the industry has undergone major consolidation, the major brands have gained considerable market share and negotiating power.
Kristian (‘Krissy’) Gathright, COO of Apple Hospitality REIT, said that the major brand chains “…are institutional brands with significant global distribution, strong consumer awareness, premier system standards, strong loyalty programs and industry leading direct bookings from their brand channels.”
As a result, having access to a brand may, in certain instances, be critical in today’s environment, particularly if the hotel owner believes that “demand will be fundamentally improved with a major brand affiliation,” as noted by Sara Masterson, VP, Hotel Management of The Olympia Companies. With growing amounts of data via loyalty programs, the benefits of brand affiliation will likely grow.
Strength In Numbers: How Brand Scale Benefits Hotel Owners
Becoming asset light has made it easier for hotel companies to consolidate via tuck-in acquisitions of smaller portfolios of brand franchises or management contracts, or even large acquisitions such as the Marriott and Starwood merger. Through consolidation, the major brands have been able to gain considerable market share, with Marriott, Hilton, Wyndham, IHG, Hyatt, Accor, and Choice, making up what Skift Research estimates to be close to 30% of global hotel room supply. What this means for hotel owners is that being a part of a brand portfolio can have powerful results on financial performance.
Let’s start with loyalty. Without access to a loyalty program, a large number of hotel properties would lose a meaningful amount of occupancy and, therefore, sales. Marriott now has close to 110 million loyalty members, according to Noah Silverman, Marriott Chief Development Officer for North American full-service hotels, who spoke at the Bisnow NYC Hospitality Investment and Development Summit on January 10, 2018. Hilton has 71 million loyalty members, and Choice has 33 million as of 2016.
For some context on how these large loyalty programs influence operating results, Marriott noted in 2016 that 50% of room nights came from loyalty members, Hilton’s represented 56% of the company’s occupancy, Choice’s represented more than one-third of gross room revenues, and Hyatt’s represented 32% of total room nights.
Exhibit 14: Hotel loyalty programs are massive and contribute a lot in terms of occupancy and sales.
Source: Company filings and data, Skift Research
Note: Loyalty Contribution: % of room nights for Marriott and Hyatt, % of room sales for Accor and Choice, occupancy contribution for Hilton, % of chain-wide revenue for Wyndham identified as “loyalty contribution” for IHG; Hyatt only reports “active” loyalty members.
We looked at Franchise Disclosure Documents (FDDs) filed with the Wisconsin Department of FInancial Institutions for Marriott brands and Starwood-legacy brands and found that the Marriott Rewards and Starwood Preferred Guest programs contributed, on average, 43% to 68% in room nights in 2016, which blends to an overall rate of 53%. Wyndham Rewards contributed between 10% to 43% of chain-wide revenue, with an average of 32%. Losing access to loyalty can have a crippling effect on operations. We note that three states, Wisconsin, Minnesota, and California, have FDDs publicly available online. We used Wisconsin, because its filings were user-friendly, easily accessible, and included the relevant information.
Krissy Gathright of Apple Hospitality REIT also said that “loyalty programs are extremely important… [W]e would lose a material amount of business if we lost access to those programs.” She noted that for their branded properties, “the loyalty percentage is in the mid-50% range.”
Exhibit 15: SPG and Marriott Rewards loyalty programs contributed significant occupancy to their respective brands…
Source: Wisconsin Department of Financial Institutions, Marriott Franchise Disclosure Documents
Exhibit 16: …as did Wyndham Rewards.
Source: Wisconsin Department of Financial Institutions, Wyndham Franchise Disclosure Documents
Procurement and Distribution Cost Savings
In addition, brands can negotiate cost savings in terms of procurement and distribution commissions on behalf of hotel owners. These cost savings can be significant, given the volume and size provided by the major chains offers significant negotiating and buying power against various suppliers and vendors in terms of procuring inventory such as food, towels, linens, etc.
Major brand chains also negotiate with the OTAs on behalf of their hotel owners to reduce commission rates, something an individual hotel owner would potentially struggle to do on his or her own. Based on Skift Research estimates, hotels associated with major brand chains pay commissions to OTAs in the 10% to 15% range, while an independent hotel may pay up to 25% per booking.
Exhibit 17: Brands are able to negotiate lower commissions relative to independents.
Source: Skift Research
To demonstrate the potential cost savings, we show a hypothetical scenario where a hotel with 200 rooms books its rooms 365 nights in one year solely on an OTA (with no other distribution channels considered). If a brand pays a 10% commission, while an independent hotel pays a 20% commission, this translates into savings of $10 a room. While this may seem small, this translates into $730,000 in annual savings. Having the brand battle the OTAs and negotiate a lower commission rate on behalf of the owner can, in some ways, drive higher profits for the owner.
Exhibit 18: Lower OTA commissions via brand affiliation can result in generous cost savings.
Source: Skift Research
Marketing and Technology Investments
The scale of the major brands also allows them to invest in larger projects, such as new technological implementations and marketing programs, that individual hotel owners might not be able to on their own. Although the owners contribute the funds that go into marketing, the combination of all owners’ market funds can stretch farther.
Victoria (‘Vicki’) Richman, CFO & COO at HVS Hotel Management & HVS Asset Management – Newport, has worked with owners to help them find the appropriate brand for their property. She noted that owners have been increasingly curious about the brands’ investments in technology —what they have now, what is currently in development, or what is planned for the future, “because [the owner] want[s] to make sure … the brand is at least looking that far out.” Offsetting that is the associated cost of the new technology as well as incremental revenue, because while owners “do want hotels to stay … current … [and] interesting to people,” and to not fall behind the competition, they also want to ensure that the investments being made will improve financial results.
Access to Big Distribution Channels
In terms of driving demand to a property, particularly business travel demand, brand affiliation may help “pull business that might require access to consortia and other large travel buyers,” according to Sara Masterson of The Olympia Companies, and it can “at least get [you] in the door.” The importance of access to major Global Distribution Systems (GDS) like Sabre or Amadeus cannot be understated. The GDS connects hotels to large networks of business travel agents who can drive strong corporate demand to the properties. Although the GDSs still charge commissions, they are generally lower than those charged by the OTAs. In some cities, particularly urban markets, business travel can make up more than 50% of demand, and a property’s ability to capture that demand may be crucial.
Julienne Smith, SVP, Real Estate and Development, of Hyatt Hotels, explained how independent hotels really need some sort of “captive audience” to survive. “If a hotel is owned and operated by a single demand generator and they’re putting all of the business into that hotel,” then the property can stay unbranded. She went on to say, “But if you’re looking to fill your hotel with any corporate business, maybe with leisure business on the weekends that’s not directly tied to that one demand generator, you’re going to need a brand to help the awareness around its existence.”
It is general consensus that the major brands possess a wealth of expertise and talent. These brands have been in operation for decades and know a lot in terms of how best to operate a hotel. The major brands are often considered to have a deep bench in terms of talent, as they’re focused on developing people’s careers and providing them the best training and resources to operate the hotels most effectively. Amar Lalvani, CEO of Standard International, Bunkhouse Group, & One Night, also admitted to their benefits, saying “They have a lot of experience. They’ve got a wealth of talent…They’ve got resources from around the world. They’ve got good training programs. They’ve got the nuts and bolts down…I think they do offer a lot.”
Specific Types of Hotels Work Well With Brands
Beyond the benefits that have been discussed, it might make sense for specific types of hotels to work with a brand. Several of the people we interviewed for the report pointed out that it often makes sense to be affiliated with a brand from a manager or operator perspective when it comes to large, “big box” hotels with a significant number of rooms and a large amount of convention space. The major brands have a long history of running these types of hotels as well as considerable expertise for operating large conventions with a lot of food and beverage and catering. Their large group teams support not only the sales, but also the services side in these situations.
Additionally, a lot of the types of assets that we have referenced are large, luxury “trophy assets” in major markets that the large brands care a lot about – meaning that they’ve been operating the property for a long time, the real estate is really high value, or the market is very important in terms of demand dynamics. The brands are likely to continue to want to have a say in the operations of these trophy assets and will continue to operate them rather than hand them over to a private operator. This is not to say private or third-party, non-branded operators could not run these types of hotels, they may just not have as much experience as some of the major brands.
For certain hotels in secondary or tertiary markets where demand may be low during specific time periods, or in suburban markets where there isn’t a lot of corporate or group demand, an independent hotel may not have the ability or capital necessary to really market itself to drive business to the property. From a consumer perspective, some guests in these markets prefer a branded property simply because of the brand recognition and accompanying promise that they will get a consistent experience whether they’re in Wichita or Indianapolis or Minneapolis. Amar Lalvani, CEO of Standard International, attributes part of Standard Hotels’ success to the fact that the company focuses on urban markets with good growth dynamics. “The smaller you get, the more distant you get from high demand markets and the more commodity product you are building,” he told Skift Research, “the more logical it is to be a part of a chain that can fill your rooms with road warriors seeking points.”
A Boost to Financial Results
Earlier, we discussed the potential benefits of brand affiliation by way of cost savings when it comes to procurement and distribution. On top of that, a brand might be able to drive incremental demand to the property and, as a result, a revenue per available room (RevPAR) premium relative to an independent property. If these items boost the financial results of a property, the cost of franchise and/or management fees might be very well justified.
The benefits of being branded may become even more important during times of economic recession. A 2011 study in the International Journal of Hospitality Management by John W. O’Neill and Mats Carlbäck found that although independent hotels operated with a higher average daily rate (ADR) and RevPAR, branded hotels had consistently higher occupancies (thereby helping to limit volatility in the business) and significantly higher net operating incomes (NOI) during recession. “It appears that branded hotels, perhaps based on more sophisticated managerial tools, can sacrifice higher room rates during recessions to achieve higher occupancy and profitability,” the authors noted in their conclusion, “… brands may reduce the volatility of the business and present a less risky investment.” The authors also highlighted the intangible asset value of the brand name in terms of driving business. In the exhibits below, we highlight occupancy, ADR, RevPAR, and NOI in 2006 and 2008, so you can see the results in a good versus bad year.
Exhibit 19: Although Independents had higher ADR and RevPAR, brands had higher occupancy…
Source: International Journal of Hospitality Management
Exhibit 20: …as well as net operating income, driving lower volatility and higher profits.
Source: International Journal of Hospitality Management
Analysis by equity research analysts, Richard Clarke, ACA, and David Beckel, CPA, at Bernstein demonstrated that independent properties had lower returns on investment and gross operating margins relative to all branded hotel formats. They assume this is a direct result of the difference in OTA payments between branded versus independent hotels.
Exhibit 21: Independents have the lowest return on investment relative to brands…
Source: Bernstein Research
Exhibit 22: …as well as gross operating margins.
Source: Bernstein Research
The Reality: Encumbered or in Need of Financing
There are two realities of brand affiliation we must highlight. More often than not, when a hotel owner is considering an acquisition of a property, the hotel may already be brand encumbered (or have a contract in place), and it may be too costly to terminate the contract associated with the property. In these decisions, the cost of brand affiliation and who the operator and/or franchisor is must be weighed along with all other decisions (location, demand drivers, durability of cash flows, etc.) in making a decision to purchase a property. Breakage fees are generally very high and hard to justify.
The other reality is that, in today’s environment, lenders and financiers still prefer brand affiliation versus an independent property. In 2016, for instance, independent hotel supply grew 0.2% compared to the overall U.S. hotel supply growth of 1.6%, thus indicating that brands are more attractive to developers.
Therefore, if a property is looking to obtain access to capital, brand affiliation may simply be the best way to go. Loan officers often view independents, particularly in secondary and tertiary markets, to be too risky to justify giving capital to the owner, particularly when they know that the support of a major brand would help drive business to that property in lower demand periods via the brands’ loyalty programs.
Sara Masterson of The Olympia Companies called out this challenge by saying, “Not long ago, I probably would have told you that the value of major brands would be showing signs of fading, especially because independents can be more competitive more than ever … The reality though is if we look at the development pipeline and we look at financing, banks are still more comfortable with major franchise affiliations and that is continuing to be a driver in keeping the brands strong. Because it’s very difficult to finance a purely independent project today.”
The ability to see dramatic growth in independents may, therefore, be somewhat limited until financing institutions become more comfortable with the potential growth and competitiveness of independent properties.
Potential Downsides of Brand Affiliation
The consolidation theme in the brand space discussed earlier in this report is really a double-edged sword. While large market sizes and scale lend well to strong brand recognition, high negotiating power, and large reservation and property management systems, there are several shifting dynamics in the industry related to brands that may influence hotels owners’ considerations. Skift Research expects some of these issues may be exacerbated over time, as we expect consolidation and brand proliferation to continue.
How Consolidation Has Negatively Impacted Hotel Owners
One downside of consolidation is that what is left afterward are large corporations that have difficulty being nimble and adapting swiftly to new industry trends and innovations.
Amar Lalvani of Standard International continues to believe that, in the hotel industry, “creativity is incredibly important, and the big chains…are just not that creative. They’re great at what they do. They are strong and good operators …they gain a lot through their distribution, but creativity is lacking.”
Put another way, Ian Schrager of The Ian Schrager Company noted that “the pressure to grow made everybody try to regiment their process,” and that, with their large sizes, it makes it difficult to “turn on a dime, [and] it becomes harder and harder and harder to be innovative because you spend more and more of your time protecting your business franchise rather than looking around the corner for what’s coming down the road.”
Another aspect is that incentives have become increasingly misaligned. Because the brands are primarily compensated on top line, this encourages them to focus primarily on growing their volumes via new contracts rather than the day-to-day operations of the property. The bigger they get, the potentially more removed they get. When it comes to operating the hotel, a branded manager typically deploys the brand’s “solution” which may be based on systems and technologies that the chain has developed over time. This can cause problems when the revenue management system does not know how to take into account and adjust accordingly to idiosyncratic events like a large snowstorm that blows through the market, a parade or march, or a large convention.
“Brands run the risk of becoming too dependent on the technology being the final decision maker,” says Sara Masterson of The Olympia Companies. “We really do need to make sure we have a human element that is very much engaged with the process.”
Some would argue that the brands’ primary focus is on stock price, market shares, and brand recognition, and as a result, owner relations have been increasingly marginalized. As a franchisor or manager, the ultimate alignment is with the brand, not the individual hotel owner.
Despite Consolidation, There Are Just Too Many Brands
It is no secret that a lot of individuals in the industry feel like there are just too many hotel brands in today’s environment. While consolidation has resulted in only a few big, major parent companies, their portfolios are home to a lot of different types of brands. Marriott now has 30 brands, and Accor has 21, not including onefinestay.
Exhibit 23: The major hotel chains have large portfolios of brands.
Source: Company data
Note: Wyndham would have 21 with the inclusion of La Quinta post the acquisition close.
Having a large number of brands can be helpful in targeting different types of customers: a guest doing contract-type work for long periods of time might prefer an extended stay hotel, a more affluent guest might prefer a Luxury brand, a more economical business traveler might prefer a select service, Midscale brand.
Krissy Gathright of Apple Hospitality highlights that while it “…makes it less likely that a loyal customer would need to venture outside the brand family for his/her travel needs, I do believe it is becoming more difficult for the average consumer to truly understand the differentiation amongst the brands.”
It can also create brand dilution. For example, imagine a revenue manager operating an Upper Upscale property right next to an Upscale property as well as a Midscale property. Historically, one would presume, that the Upper Upscale should have a slightly higher price than the Upscale, and the Upscale should have a slightly higher price that the Midscale. There’s a separate customer type that should be targeted for each chain scale. However, competitive market dynamics might encourage the revenue manager to price that Upper Upscale against the Upscale and Midscale properties, and as each property attempts to undermine the other to gain additional demand, they all drive the prices to be in line with each other and potentially lower than justified.
This commoditization of brands has resulted in an environment where “most of the brands don’t stand for anything in particular” according to Ian Schrager of The Ian Schrager Company. Some have even called into question if there really are more than 30 different segments of hotel customers. Not only is it confusing to consumers, it’s also confusing to owners and developers.
While we would argue for the major hotel companies to stop creating new brands, given that, in our view, it is impossible for that many brands to have the necessary depth, integrity, and connection with customers to truly be successful, we do not expect the major chains to stop developing new brands any time soon. As stated by Skift’s Hospitality Editor Deanna Ting in an article about potential disruption from the OTAs in the brand space, developing new brands “…lets companies open up new hotels in their brand family just down the street from another one of their branded properties without violating radius restrictions or area of protection rules that would prevent two Hiltons being built too close to one another, for example. That’s why you can have a Hilton and a Hilton Garden Inn, for example, on the same block.”
Ting goes on to say that “having a lot of brands is exactly what asset-light companies strive for as well. It’s how they demonstrate growth to their investors, and generate revenue with very few incremental costs, leading to greater profits.” The economics of new brands are so good such that investors reward the public companies in the form of higher stock prices and valuations, and, as a result, we expect to see more brand development ahead. Even at the 2017 Skift Global Forum, Hilton CEO Chris Nassetta said that the company is working on a number of new brands, including a luxury soft brand, a “Hilton Plus” Upscale brand, and an urban micro hotel brand.
What will be key, then, is how the major chains are able to make sure each of their portfolio of brands occupies its own “swim lane,” as Noah Silverman of Marriott described it at the Bisnow Hospitality Investment and Development Summit. He noted that Marriott’s “goal and objective continues to be that we ensure we have distinctive brands in terms of what they offer and where they sit.”
Krissy Gathright of Apple Hospitality REIT encouraged the brands to “take the long term view as they contemplate adding new brands and expanding the development pipeline to seriously consider impact and…ensure that the pipeline of loyalty members keeps up with the pace of development to prevent value erosion.”
Focus on the Numbers
At the end of the day, the benefits of being branded have to outweigh the costs. Franchise and brand-management fees may be high, and if a property is already running high occupancies and strong ADRs, the incremental demand brought on by being affiliated with a brand in the form of a few occupancy point percentages, may not be justified. While it may get owners a bit more occupancy, it adds a brand fees on all revenue. “If an owner is holding the asset for three to five years, there is not enough time to build a brand. The owner is better off renting a brand. If an owner is thinking about three to five generations, then why pay rent for 100 years?” asked Ted Teng, President & CEO of The Leading Hotels of The World.
Potential Happy Mediums? Soft Brands and Non-Branded Operators
So far, we have highlighted numerous advantages and disadvantages of being branded. Ideally, it would be nice to get the best of both worlds, where a hotel owner has access to the large-scale distribution offered by brands, but can continue to provide an elevated, unique experience like that of an independent hotel. Soft brands offer a way for owners to have access to brand benefits but maintain individuality, and working with third-party, non-branded operators can help to better align incentives with owners and drive more to the bottom-line.
Although soft brands have been around for some time, they have proliferated quite dramatically over the past few years. Choice launched its Ascend Collection in 2008, and Marriott followed suit in 2010 with its Autograph Collection. Many others have been launched in the past couple years, such as Hilton’s Curio (2014) and Tapestry (2017), Hyatt’s Unbound (2016), and Wyndham’s Trademark (2017), as well as several other brands.
Soft brands provide independent properties the ability to be a part of a large branded system without sacrificing the property’s uniqueness or individuality. Perhaps the independent property already has strong demand dynamics and a special narrative or story to tell at the property, but the owner would just like to have access to some of the larger business travel buyers via a GDS to bring people to the property during low demand time periods to reduce volatility of the business. William (“Bill”) Fortier, SVP, Development, Americas, of Hilton Hotels & Resorts said, “That’s why we formed Curio and Tapestry, so it gives those independent owners the opportunity to connect with our engines.”
Shai Zelering, MD, Real Estate, Hospitality, Brookfield Property Partners, thinks “… there’s tremendous appeal for the soft brands. Now, it doesn’t take away the operating cost that the brands put on you, but it does take away all the extensive capital spending and renovation. And thereby allows you to be perceived as more independent in nature, with the benefit of large distribution.”
The soft brands also typically have lower royalty fees as well. Looking at Franchise Disclosure Documents (FDDs) filed with the Wisconsin Department of Financial Institutions, Skift Research found that, on average, royalty fees for soft brands were 45 basis points lower than the portfolio average for each major chain. Excluding Wyndham, the delta is 30 basis points. We note that only royalty fees from the most recent and available FDDs found in the Wisconsin Department of Financial Institutions system were considered for this analysis.
Exhibit 24: Royalty rates for soft brands were 45 basis points lower than the portfolio average for major brands.
Source: Wisconsin Department of Financial Institutions, Franchise Disclosure Documents
Some of the recently reported performance numbers for soft brands have been strong as well. The Highland Groups’ 2017 Boutique Hotel Report found that soft brands had overall occupancy of 71% in 2016, above that of the U.S. at 66%. The report also found that ADR and RevPAR have grown 3.4% and 4.9%, respectively, on an average annual basis from 2011 to 2016. One specific property, Hotel Skyler Syracuse, went from an approximate 65% of competitive set RevPAR index to 132% in November 2017 after joining Tapestry Collection, according to Tom Fernandez, director of business development at Woodbine Hospitality Group.
Chip Ohlsson, EVP & CDO at Wyndham Hotel Group, highlighted why soft brands make sense for hotel owners. “When people believe they don’t need a brand, what they’re really saying is, ‘I don’t fit into any brand nor do I ever want to fit into a brand,’” he explained. However, “they still want the benefits of a brand, so Trademark [Wyndham’s soft brand collection]… [provides] them the benefits but [allows them to] still maintain the unique independent spirit that they wanted to build their hotel on.”
There are also other soft brands in the market that may be preferable to the major brand chains, such as Preferred Hotels and The Leading Hotels of the World. These independent hotel collections offer an alternative to the major brand chains by providing independent hotels access to consortia and large business travel buyers at generally lower fees and shorter contract lengths than the major chains, potentially only a couple years long.
Sara Masterson of The Olympia Companies, which has hotels in the Preferred Hotels collection, said the shorter-length contracts help hold Preferred Hotels and other true soft brands accountable. With “a shorter contract duration,” she explained, the soft brand “needs to produce results both quickly and consistently, because owners have an opportunity to evaluate performance and make renewal decisions much more frequently.”
Flexibility in these contracts does not necessarily mean the lack or void of standards. While these “even softer” soft brand collections do have brand standards that the properties need to maintain, they are typically less rigid and less costly relative to major brands and more focused on a high level of quality or service. According to Masterson, “… they’re not evaluating the specifics…[like] ‘Do you have three flavors of ice cream on your dessert menu?’ But they’re evaluating your execution and attention to detail to make sure it’s consistent with the same type of messaging that the brand is trying to convey to its travelers.”
Moreover, soft brands like Preferred Hotels and The Leading Hotels of the World allow the property to maintain its true identity. Ted Teng, President & CEO of The Leading Hotels of the World (LHW), stated, “Chain brands define a hotel. Our hotels define the LHW brand.”
Exhibit 25: Major chains’ soft brand collection fees are higher than that of Preferred Hotels & Resorts.
Source: HVS 2016/17 United States Hotel Franchise Fee Guide
While some believe soft brands make a lot of sense in the industry, others feel the jury is still out on whether they are more hype than anything else. As you can see in the exhibit above, the cost for the major chains’ soft brands is still high, even relative to traditional brands. When asked if it was more cost effective to go with a soft brand, Raymond Martz, EVP & CFO of Pebblebrook Hotel Trust, said, “When you go through everything, our view is it depends … You may not have all the brand requirements with a Marriott or Westin, so they may be more lax there … [But] here’s the thing … when you go with a soft brand, you’re still paying fees on all the business that comes through the door. If you go through OTAs … you’re paying your 20% commission on that business which is certainly more expensive than brand or soft brand route, but you’re only paying that on the [OTA] business that comes through the door, not all your business.” There’s something to be said for a hotel owner who can turn their OTA business off and on, rather than having to pay fees on all revenue, regardless of whether it comes via the brand affiliation loyalty program or not.
There is also the problem of brand recognition – consumers aren’t particularly familiar with soft brand collections yet or what they mean. However, we would argue that if the independent property is doing a good job creating a narrative and a strong overall experience, then the consumer would know the property for its own individuality and brand affiliation would allow the property to reduce volatility and increase occupancy during low demand periods. At the same time, the costs have to be weighed against the benefits.
Non-branded operators are another happy medium for the hotel owner, should the owner decide to use a non-branded manager and go with a franchise agreement for access to loyalty programs and distribution. When we discuss non-branded operators, we are referring to managers who operate the hotel on behalf of the owner, but who are not affiliated with a major brand chain. Examples of these non-branded operators include managers like Sage Hospitality, Interstate Hotels & Resorts, Davidson Hotels & Resorts, Aimbridge Hospitality, HEI Hotels & Resorts, and Highgate.
Julienne Smith of Hyatt attributed the proliferation of non-branded, third-party operators, “in part due to the non-traditional hotelier being the developer … your retail developer is now building a hotel, your residential developer is now building a hotel. They’ve got no interest in operating hotels, so they’re hiring third-party management. When you put us in that competitive set, the brands tend to be a little bit more restrictive than the third-party operators.”
From a contract perspective, non-branded operators tend to be more flexible with terms compared to branded operators. As shown in Exhibit 4 earlier in this report, non-branded management base fees may be a smaller percentage of gross revenue (1% to 3%) relative to brand managers (3% to 4%). Contracts may also require a lower incentive fee compared to branded operators.
From an operational perspective, non-branded operators are, at times, considered to be more flexible and nimble given their size, compared to large, bureaucratic brand chains. For example, a branded manager may prefer to operate a hotel with 30 full time employees (FTEs), but a third-party operator might be a little bit more entrepreneurial or more resourceful and be able to run the property at only 20 FTEs, thereby saving the owner money. This may become particularly appealing when adding brand franchise fees on top of the fees associated with non-branded management contracts. The hotel owner is still able to see greater operating profits, even on higher fees, because the non-branded operator is able to operate the hotel that much more efficiently than a brand manager.
While some may argue non-branded operators may not have as deep of a bench compared to the talent of the large chains, they may offer regional expertise. Krissy Gathright of Apple Hospitality REIT indicated they “often have regional or specific market expertise which allows them to more effectively operate a particular hotel.” Hilton’s Bill Fortier indicated they are becoming more of a competitor, saying “the independent operators have gotten so good that we have to compete in that arena.”
All in all, many owners seem to think that incentives may be more aligned with non-branded operators in certain cases. The biggest advantage may be that they have strong positive incentives, because they want to do more business with hotel owners, so they want to see the hotel be successful.
Keys To Remaining Independent
For specific properties with strong market dynamics, remaining completely independent, rather than affiliating with a brand, can be a more fiscally responsible and attractive decision. For instance, if the property is in a market with strong growth prospects and adding a brand would not add any incremental demand, then it is possible that remaining independent would lead to financial outperformance relative to brands. Shifts in consumer usage of technology have also enhanced independents’ ability to financially perform more so than ever before.
In addition, it can no longer be ignored that consumers are increasingly preferring experiences over products. They’re looking for something that is not cookie-cutter, that is memorable and makes them feel special. Independent hotels have the special opportunity and ability—so long as they have the marketing and technological prowess, a good idea or narrative, time and energy, and a lot of capital—to create authentic experiences that make consumers want to come back time and time again.
A Unique Sense of Place
There are certain properties and markets where it simply does not make sense to be affiliated with a brand. Sara Masterson of The Olympia Companies provided two great examples where “having a brand doesn’t necessarily drive performance, but it would certainly drive costs.” For instance, a hotel on a college campus that has unique demand drivers and continual business as a result of events, conferences, and meetings at or associated with the university; and a property in a destination that has “a unique sense of place,” such as a location in a mountain resort area. In fact, brand affiliation can, in some cases, hinder performance, she indicated, because a “truly independent has a lot of latitude and flexibility to create not only design elements and architecture, but really to execute service, in such a way that makes sense in that particular space given that particular traveler.”
Being in high-demand, urban markets with large convention business, a significant amount of tourism, and a lot of activity may also lend well to an independent property being successful. Amar Lalvani of Standard International has focused on “cities that are in demand that have good growth dynamics … [and] have high barriers to entry.”
Ted Teng of The Leading Hotels of the World asked a thoughtful question regarding properties in urban markets: “If the asset is in a city center location near all demand generators, great product, well known reputation and established customer base, is the asset helping the brand or is the brand helping the asset?”
A recent study by Expedia, for example, indicated that independent properties in Las Vegas saw ADR growth of more than 10% year-over-year in Q1 2017, due in part to international guests who had 25% higher ADRs relative to domestic guests on average. In Manhattan, a market facing considerable supply issues weighing on pricing, independents showed ADRs up low single digit percentages, while branded properties were down low single digits.
Nevertheless, independents have also been performing well in smaller markets. In Q1 2017, independents in Central Valley North, California and Rochester, Minnesota, saw demand increases of 110% and 80%, respectively.
Exhibit 26: Demand growth for independents in smaller markets has also been strong.
Source: Expedia, “Independents Day” study
Note: Top growing independent destinations for Q1 2017 with a minimum of 5,000 room night stays
Part of this strong performance is directly related to the prolonged period of economic expansion we have been experiencing since the financial crisis. Independents tend to be strong in expansionary times when consumer sentiment is high and customers are willing to spend more on travel.
Nevertheless, Ian Schrager of The Ian Schrager Company called into question the need for independents to focus on key markets, indicating that providing an amazing experience is universal regardless of the market. “I don’t think that suburban or urban areas have any distinction with Apple products and other retail products. I don’t think the same product that works in New York City might work in a suburban area, but an innovative product, a distinct product with an elevated experience, would work anywhere, but it just has to be for whatever the population is.”
Our view is the same: any independent that has “a unique sense of place,” as Sara Masterson of The Olympia Companies so aptly stated, can thrive.
Technology Has Made It Easier Than Ever to Be Independent
Technological shifts in the industry have made it easier than ever for independents to be competitively positioned. The growth of social media and usage of mobile have made it easier for independents to market themselves and demonstrate the quality of their properties and the experiences they offer. In addition, an increasing number of technology platforms in the form of distribution and revenue management have made the entire marketplace more competitive such that independents have the power and ability to find the right balance of systems at the right price.
Sara Masterson of The Olympia Companies explained what it was like prior to social media: “…prior to the influx of real, available information coming from travelers,…there was a level of comfort that was provided to the traveling public, because they [consumers] were really dependent on the brand ensuring that consistency … [N]ow, with the influence of social media, and they can get social feedback so quickly, travelers are a lot more comfortable in the independent space … People are comfortable saying … ‘I don’t want a cookie-cutter experience, … I don’t necessarily want it to look like every other hotel that I stay at. I want it to be really reflective of the place that I’m in. And I’m going to know, because I look in tons of different channels now, that this is a quality hotel that’s well-maintained…”
Consumers are also increasingly more mobile. For instance, more than 80% of Americans now own a smartphone, and, according to a Google interview, 71% of travelers have conducted travel research on a smartphone. Some categories such as hotels, luxury, and family travel see higher search interest on mobile than on desktop. Using mobile makes it easier to compare prices and read reviews on apps like TripAdvisor and Yelp, rather than necessarily needing to stop off the highway to go to a particular brand just because you know there will be a certain level of consistency that is maintained. Julienne Smith of Hyatt commented that “peer reviewed and guest reviewed feedback has become more important than [even] what the brand is saying.” We expect that, overtime, communication via mobile apps may become the most common form of communication with guests.
As a result of this growth in mobile, independent properties should be able to take market share from brands as consumers shop around for the best property. In a recent study of Q1 2017 data, Expedia found that mobile share of room nights for independents grew approximately 15% year over year. In fact, mobile demand growth for independents outpaced branded in 4 out of 5 high volume markets: Las Vegas, Orlando, Manhattan, and Miami.
Exhibit 27: Mobile demand growth for independents exceeded branded in four out of five top volume markets.
Source: Expedia, “Independents Day” study
In addition, a hotel’s performance may actually be dependent on its online reputation. A study conducted by the Cornell School of Hotel Administration found that online guest satisfaction has a direct impact on financial performance for hotels. The research found that a 1-point increase in the 100-point ReviewPro Global Review Index (or GRI, an online reputation score based on review data collected from OTAs and review sites), led to an 0.89% increase in ADR, a 0.54% increase in occupancy, and a 1.42% increase in RevPAR. Because of the ease of access to social media and mobile, independents are just as favorably positioned to create their own online presence to appeal to consumers.
Another change that has benefitted independents is the rise of numerous distribution platforms. Without any brand requirements, the independent hotel owner is able to choose the channel mix that suits their property best and target the right customers at the right price at the best possible cost to the owner.
These platforms may even help independents target guests in unique ways that they might not otherwise get, such as corporate travelers who are beginning to shop around more rather than going with corporate-recommended blocks. Furthermore, without having to comply with brand-required packages such as free breakfast, Wi-Fi, parking, etc., the property has the flexibility to develop packages that cater to the specific guests they want to keep coming back to their property.
The proliferation of systems has also brought the cost down for all owners. Certain cloud-based systems are not necessarily capital intensive, providing the opportunity for small, local properties to have access to powerful revenue and distribution management capabilities.
Lalvani of Standard Hotels explains how independents can be just as strong as branded hotels. “We do everything that a major chain does. The only thing we don’t do is a formal loyalty program. Our technology is just as good … We’re in that zone where we’re small enough to be creative, but we’re big enough to at least have the means for marketing and the means for understanding distribution and technology.”
The Experiential Trend Lends Well To Independents
With consumer sentiment and travel data at high levels, and increasingly more being spent on services rather than goods according to personal consumption expenditures (not to mention growth in social media), it is hard to deny the shift in consumers craving more experiential opportunities. Based on Skift Research’s survey work, we found that consumers are more focused on experiences than products in our Experiential Traveler Trends 2018 report.
Exhibit 28: Avid travelers care more about experiences than ever before.
Source: Skift Research
Note: Avid travelers are respondents who took at least one leisure trip, one round-trip flight, and stayed at a hotel for at least one night in the last 12 months.
Independents have the flexibility and opportunity to cater to this trend and create a unique experience that hotel guests cannot obtain anywhere else in the world. Ian Schrager of The Ian Schrager Company has, in some ways, dedicated his career to doing this, having founded one of the earliest examples of the modern-day boutique hotel in 1984, when he and his business partner Steve Rubell opened the Morgans Hotel in New York City.
“By the way, people always want something different. Always. That’s just our nature. It’s part of the human condition,” Schrager said. “It’s just a question of if you’re able to execute it.” He went on to say, “unique, elevated, lifestyle hotels” cater to consumers who are looking for something different. “It’s the future of the industry as far as I’m concerned,” he stated.
The industry may argue that this trend caters more to leisure travelers, and not as much to business travelers. They may think a traveling business person just wants a clean, consistent room close to where the meeting location is at the end of the day. We beg to differ, as does Amar Lalvani of Standard International.
“Many [of Standard Hotels’ guests] are business customers,” Lalvani indicated. “The line is blurring a lot … Their lifestyles are wrapped between their business and pleasure and social at the same time, and that’s how this next generation sort of lives.”
We, of course, agree that the future of business travel is likely not staying in trendy Airbnbs an hour outside of the city where their meetings are located to have an authentic, local experience. However, independent hotels that are close to convention centers and major businesses should be able to capture market share from brands by providing things beyond a standard-size hotel room. Any brands that are not aware of the potential threat from independents have their heads buried in the sand.
Loyalty Needs To Come From Within
There is an ongoing debate in the industry about whether loyalty really matters. On one hand, strengthening loyalty programs encourages direct bookings which are, in general, considered to be cheaper than acquiring guests via other channels. We also discussed earlier how loyalty programs can contribute a significant amount of occupancy to a property.
However, Skift Research’s 2017 Outlook on Hotel Direct Booking survey found that, while branded hotels had more loyalty members stay at their properties, the overall percentages were not that high (27% for branded and 21% for independents). In addition, at a 6-point delta, independents demonstrate that they do, in fact, have somewhat of a loyal following.
Exhibit 29: 27% of guests were loyalty members for branded hotels, and 21% for independents.
Source: Skift Research
In Skift Research’s U.S. Experiential Traveler Trends 2018 report, we found that avid travelers care more about the surrounding area of their accommodation and its price when booking hotels than their loyalty or affiliation with a particular brand.
Exhibit 30: When booking, location and price are more important to travelers than loyalty.
Source: Skift Research
Note: Avid travelers are respondents who took at least one leisure trip, one round-trip flight, and stayed at a hotel for at least one night in the last 12 months.
As Shai Zelering of Brookfield Property Partners stated, “Loyalty needs to come from within.” A hotel or brand shouldn’t buy customer loyalty, but rather provide a level of service, a quality of product, and a distinct experience that the guest will always remember and will want to be loyal to the brand as a result. When it comes to retail, sometimes we can’t explain why we like a certain product –- such as a mobile phone, a computer, a clothing line. Something about the product keeps us purchasing it again and again, because we know we will always enjoy our experience with it. That is loyalty, and independent hotels can do that just as well as branded hotels.
Independents Can Outperform Brands In Certain Cases
If an independent property is uniquely positioned, uses technology wisely, and creates an elevated experience that guests keep coming back to, it is possible that the independent may outperform the branded equivalent.
With regards to some key metrics, this is already happening. We illustrated earlier in Exhibit 19 that, based on the study in the International Journal of Hospitality Management by John W. O’Neill and Mats Carlbäck, independent properties generally have higher ADRs and RevPAR relative to brands. While it is worth noting that a lot of independent hotels skew Upper Upscale, Luxury, and Resort, which certainly has an impact on their ability to capture higher nightly rates and associated RevPAR, it is possible that they can capture higher margins as well so long as the properties are run as efficiently as possible.
The fact that independents are able to capture higher ADRs and RevPAR is interesting, because chains often offer brand premiums, meaning many hotel owners see an almost immediate lift in ADR, occupancy, and RevPAR after affiliating with a brand. However, as noted by equity research analysts at Bernstein, brand premiums relative to independent hotels have been declining for both ADR premiums and occupancy premiums.
Exhibit 31: Brand ADR and occupancy premiums relative to independents have been declining.
Source: Bernstein Research
Looking ahead to 2018, STR and Tourism Economics forecast independents to outperform with RevPAR growth of 2.9% versus the overall U.S. at 2.7%. Independents are also expected to show the strongest occupancy growth (0.4% forecasted).
In Skift Research’s recent report, Room for Optimism: 2018 Global Travel Market Outlook, we detailed our expectation for another solid year of economic growth, and therefore travel, in 2018. We expect independent hotels to continue to thrive in this favorable environment and to outperform brands on a RevPAR growth basis.
At the end of the day, because of the long-term nature of contracts with brands, it may make sense to keep a property independent. Once owners go branded, they lose optionality because of the costs associated with breaking a contract.
Other Considerations for Hotel Owners
Online travel agencies may not be influencing branding or franchising strategies, but they are very much influencing how hotel owners are thinking about distribution and the cost of obtaining demand. That is not to say using OTAs is a bad thing.
Krissy Gathright of Apple Hospitality REIT reminded us that OTAs “… can be a good source of incremental revenue in periods of lower demand and as long as we pay a reasonable commission relative to that value, it can be a mutually beneficial relationship.”
In addition, the OTAs offer a very helpful way for independent hotels to ramp up their business. Sara Masterson of The Olympia Companies explained, “They play probably a bigger role in an independent hotel ramping up … because these independent hotels tend to be smaller in terms of their number of keys … As we become established, our reliance on them actually tends to drop off quite a bit.” The important thing would be to make sure the hotel provides a strong level of customer service so that guests want to return to the property and are encouraged to book directly next time.
At the end of the day, the focus should be on getting the customer at the highest rate at the lowest possible cost. Different properties require different OTA mixes. There is also likely to be a segment of consumers that prefer to book via OTAs. Gathright noted, “We understand that a portion of our guests are infrequent travelers. We are encouraging our brands to seek out an increased number of distribution partners to source those guests, while at the same time minimizing risk of overreliance on any one source and keeping costs competitive.”
In fact, customer acquisition costs are becoming more competitive. Direct booking campaigns and the major brand chains playing hardball with the OTAs have brought commissions down somewhat for hotel owners.
“Expedia’s entire inventory only exists because the industry gives them it, and that could be shut off tomorrow if owners agreed to stop,” reminded Raymond Martz of Pebblebrook Hotel Trust. The major brands also help lower commissions for the entire industry, as OTAs have to negotiate with independent hotel owners who could go branded if they were unwilling to pay the higher OTA fees associated with being independent. Ian Schrager of The Ian Schrager Company also commented that “if you’re a distinctive hotel … you can make a better deal with the OTAs,” meaning if the property is highly demanded, the OTAs will want it on their sites and offer a lower commission rate.
The existence of OTAs has also impacted hotel owner behavior in other ways outside of distribution costs. Martz also highlighted, in a 2016 article in Lodging Magazine, some ongoing issues with brand redemption programs and cancellation fees. The article sheds light on issues with brand redemption programs whereby hotel owners are incentivized to dump the last handful of open rooms onto the OTAs at really low prices in order to receive a higher payment from the brands for rooms redeemed for loyalty points. This causes pricing issues within a market as a revenue manager may have to discount rooms last minute in order to compete and also may push more inventory to the OTAs than necessary.
Cancellation fees have also been an ongoing issue in the industry, as hotels have historically been more lenient relative to other industries (i.e. airlines) with regards to their cancellation policies. Online travel agencies and metasearch engines have exacerbated the issue, as they make pricing comparisons so much easier, such that a guest is able to cancel and re-book quite easily when he or she finds a cheaper rate at the last minute. All of the brands have been implementing policies to reduce consumers’ willingness to cancel at the last minute when they find a more cheaply priced hotel as a result of increased price transparency. We expect the trend of brands cracking down on cancellation policies to continue.
The way to combat the OTAs (as well as many other headwinds in the industry) ultimately, is to continue to build brand awareness, whether it is a major brand chain or an independent property. Amar Lalvani of Standard International discussed how the whole experience of working with an OTA really can diminish the work being put in. “We do all this work to create a beautiful hotel and to train everybody and have the right experience … and then your hotel is reduced to a thumbnail picture and a massive price [and] ranked by price [on the OTA website] … [T]hey’re really commoditizing all the work that we do … the way the OTAs market our hotels or anybody’s hotels does not do justice to the effort that goes in to create a hotel.”
This also means investing time and money into elevating the overall experience for guests, whether that is through technology, service, or aesthetics, so that they want to return to the property directly, rather than shop around for the best price on their next trip. Julienne Smith of Hyatt highlighted how hotel owners and operators can customize unique experiences at the property “by doing artwork, local events, art exhibits, Thursday night mic nights, things like that, that really bring the community into your hotel. That’s when it’s about more than the fit and finishes … [but] really pulling in the community and making it [the property] a part of the neighborhood that you’re in.”
What will be interesting to see is how the OTAs respond to declining commissions, potential threats from Google and Airbnb (discussed in the next sections), the brands focusing more on data and distribution, and owners focusing on elevated experiences at the cheapest distribution cost. The OTAs are known for having an immense amount of data to understand their core customer as well as cash on hand to invest in marketing and new technological capabilities. Their size and scale also helps them retain talent in the form of the best engineers.
One strategy we expect them to take is to focus increasingly on independent hotels. The majority of operating profits for OTAs come from hotels, not airlines or rental cars, so it is important to retain these customers to preserve their margins. In addition, independent hotels likely need the help of distribution but don’t necessarily want to be a part of a brand, making them the OTAs’ true bread and butter customer.
In a recent article, Skift Hospitality Editor Deanna Ting discussed several possible opportunities for OTAs to take a more active relationship with owners, such as a “soft brand” arrangement to support brand marketing,reservation management, and offering the benefits of a loyalty program.
Krissy Gathright of Apple Hospitality REIT indicated that owners shouldn’t necessarily be opposed to working more with the OTAs. “If there are additional technology platforms that they could offer which would help drive incremental revenue, be more cost-effective and still allow the brands to preference direct bookings and own the customer experience, then that would be worth consideration.”
Expedia Partner Central is one example of how Expedia is better working with its hotels to get more value from partnering with the OTA. This online resource offers tools for revenue and property management, updating property-specific descriptions and information, marketing, and improving guest satisfaction. Expedia’s revenue management system, Rev+, has also been gaining a lot of traction. When the second version of Rev+ went live in September 2017, the company “saw adoption rates jump from thousands of users to 20,000.”
The OTAs appear to have access to an immense amount of data that gives them a strong sense of consumer behavior and desires that they may be underutilizing, Ian Schrager of The Ian Schrager Company remarked, the OTAs “could leverage that data into many other businesses … They started out as booking hotels, but they could get into anything. I mean, they could be competitive with Amazon.”
Airbnb and Alternative Accommodations
Many continue to debate the impact that Airbnb and other alternative accommodations providers and platforms are having on the industry. Some believe that alternative accommodations are having an impact on compression, or high occupancy, nights in urban markets. However, STR came out with a study in early 2017 using Airbnb-provided data which indicated Airbnb has had limited impact on the overall number of compression nights, as well as the ADR premiums associated with high occupancy nights.
Exhibit 32: ADR premiums on compression nights remain very high, indicating little impact from Airbnb.
Krissy Gathright of Apple Hospitality REIT noted that, regardless of whether Airbnb is having an impact on operations or not, “While the rise of alternative accommodations has not impacted our relationship with managers, it has some impact on our conversations with franchisors,” she said. “For example, we include alternative accommodations in our impact conversations even though it is harder to quantify impact versus traditional hotel supply.”
Certain aspects of Airbnb may not be appealing to all consumers. Raymond Martz of Pebblebrook Hotel Trust spoke somewhat facetiously, “You don’t necessarily want to have a 45-minute commute even though that’s ‘living like a local.’ but that might not be fun.”
However, aspects of the Airbnb concept are likely here to stay, as consumers crave more and more memorable experiences. Amar Lalvani of Standard International cautioned, “What people don’t understand is that the next generation, their default is Airbnb and not a hotel. So when that demographic is the one with the spending power, [it] doesn’t matter if it’s corporate or leisure … it’s going to be a real problem for the industry.”
In addition to the potential impact of Airbnb on supply and demand dynamics in the industry, it may become more about Airbnb’s ability to serve as another distribution platform. Airbnb’s current commission rate for hosts is 3%, which is substantially lower than what the OTAs are charging hotel owners (10% to 25%), though they do charge consumers 5% to 15%. This could certainly be a more economical platform that hotel owners may someday be interested in switching over to completely. We caveat that by saying, should Airbnb become a significant distribution platform for hotels, commission rates for everyone (OTAs and Airbnb alike) will probably converge, though likely at a lower rate than what the OTAs are charging today.
Airbnb appears to be testing the water with new and different strategies. The company recently announced a new hotel-like apartment concept in Florida called Niido in collaboration with Newgard Development Group. Brookfield Property Partners has entered into a $200 million equity investment program, and Silverpeak Real Estate has committed $20 million to the project.
Shai Zelering of Brookfield Property Partners believes that Airbnb is realizing, “Hey, you know what? We’ve got technology, we’ve got a good customer base, we’ve got a good appeal, but we can’t sell sleeping bags forever.” Perhaps this explains why they are getting into real estate, tours and activities (via its Trips platform), experimenting with distribution, and even a potential foray into airlines.
In our view, Airbnb certainly has the technology, capital, and wherewithal to adapt its strategy and pivot its business as necessary. With the February 2018 announcement of its CFO, Laurence Tosi, leaving the company amid tensions between him and CEO Brian Chesky, we expect that that is exactly what the company is doing. Their latest announcement, on February 7, 2018, was a partnership with SiteMinder, a cloud-based hotel distribution platform used by more than 28,000 hotels around the world. The partnership allows hotels that use SiteMinder the ability to easily list their inventory on Airbnb, further demonstration Airbnb’s intention to get more involved in the hotel distribution space.
How should hotel owners respond? Ian Schrager of The Ian Schrager Company summed it up best when he said, “They are a competitor … They’re not just for millennials, and they’re not just for bargain hunters. They’re for everybody, and I think the way you deal with that … is [by] providing a distinctive and unique experience,” perhaps by utilizing the community aspects of hotels, “ … because Airbnb can’t do that.”
Amar Lalvani of Standard International also echoed this sentiment by saying, “The idea of bringing people together in social spaces, that’s something Airbnb can never do.” By providing a community, a place to engage, a way for consumers to meet and interact, hotels can provide an elevated experience for guests that they may not be able to get elsewhere.
Noah Silverman of Marriott, speaking at the Bisnow Hospitality Investment and Development Summit, also discussed how Marriott is starting to think about how it can take “experiences outside of the hotel as well.” Marriott’s recent partnership with PlacePass speaks to that focus on providing hotel guests with travel experiences and other activities other than what they can get within the four walls of the building. In addition, brands have gotten a lot better about offering more opportunities for hotel guests to get more involved in the local environment and culture and providing a more community feel at their properties via art programs, wine tastings, and other events.
Our general sense from interviews is that hotel owners expect Google to play a larger role in distribution for travel in the future, but in what capacity remains uncertain. Shai Zelering of Brookfield Property Partners indicated “Google is much better served just collecting money for advertising,” Lalvani of Standard speculated, “clearly there’s a role for Google to play,” and Raymond Martz of Pebblebrook Hotel Trust stated “Google is the one to watch.”
Skift Research’s report A Deep Dive into the Google Travel Ecosystem 2018 examines how Google has built a platform that spans the full life-cycle of a trip, from discovery through planning and on to the destination. However, when we looked into what Google could potentially gain from becoming a full-fledged OTA, we found that, while Google could potentially earn $1.7 billion in new revenues (based on a 10% market share and no change in effective commissions of 13%) in a blue-sky scenario, the company would also likely loose $1.3bn in performance ad revenue from the OTAs, which results in a net $400mn revenue gain. We provide a sensitivity analysis within the Google report, but this analysis demonstrated that Google has limited upside in becoming an OTA while the risk is heavily skewed toward the downside, as any missteps could upset an established ad revenue business with little gain to show for it.
Whether Google becomes a big player in the distribution space outside of search is one thing, but its growth in the hotel ad/metasearch space is likely to continue at a rapid clip. We would also expect Google to have a major influence on innovations related to in-room technology such as voice capabilities.
There certainly are a number of items that could influence the distribution landscape and costs for hotel owners. All considered, our view is that independent hotels may be best positioned for any potential changes, because they have more of an ability to be nimble and respond quickly to change relative to the big chains. This is one case where being small is a major advantage.
However, the solutions to most issues we raise center on providing an elevated experience, catering to the consumer, and using data, technology, and service innovatively. In the battle of distribution versus properties, hotels win when they focus on doing what they do best. The brands that provide the best opportunity for their owners, or the independents that take the risk on their own, will be the most successful.
Other Cost Considerations for Hotel Owners
We would be remiss not to mention some top of mind items for hotel owners on the cost side including labor, construction costs, issues with brand redemption programs and cancellation fees, as well as the need for more infrastructure. Because of their relatively fixed cost structure, shifts in the wage market can have damaging consequences on profit margins. Based on filings for eight hotel REITS, Skift Research estimates that labor makes up to 35% of sales on average, further exacerbating the problem. Wages have been increasing considerably in the U.S. (see exhibit below), and unemployment has continued to be very low at around 4.1%, resulting in a very tight labor market, making it “increasingly challenging … to attract and retain associates,” Krissy Gathright of Apple Hospitality REIT said. She went on to note that “any major changes in local or national governmental policies could put additional pressure on an already tight labor market.”
Exhibit 33: Hospitality employee costs are outpacing the broader labor force.
Source: Bureau of Labor Statistics
Construction costs also continue to be an area of focus for hotel owners, as costs have been increasing at the fastest pace since the recession. This issue is compounded due to the speed that trends are changing, and that brands are continuously implementing new modifications and tech innovations that owners have to pay to comply with brand standards. Shai Zelering of Brookfield Property Partners said that, at times, these brand standards may be “beneficial to the brand, maybe marginally impactful for the consumer, but…cost prohibitive to the owner.”
Exhibit 34: Construction costs are rising as the fastest pace since the recession.
Source: Census Bureau
In the U.S., the need for more infrastructure is increasingly at the forefront of hotel owners’ minds, particularly with the ever-increasing middle class in markets such as China. Shai Zelering of Brookfield Property Partners noted that “time is better spent working…[with] the government to improve tourist visa processes and the infrastructure, so we can accommodate all the demand coming from abroad to discover the U.S. We need better airports. We need better trains. We need better transportation, which is far more important than fumbling around how much commission we are paying to Expedia. If we don’t do that, then we’re going to leave a lot of opportunity on the table.”
The final area of consideration that seems to be top of mind for owners is where we are in the business cycle. Occupancies are at all time highs, and RevPAR has been growing, though muted. With the economy growing in the 3% range, interest rates still low, and newly enacted corporate tax reform, there could be considerably more room to grow from here.
Bill Fortier of Hilton conveyed a positive energy going into the Americas Lodging Investment Summit in January 2018: “The worry right now because we’re at the top of the cycle is impact … We’ve been putting a lot of hotels into the pipeline … and some of the growth in rooms in cities is faster than demand growth in cities … That’s their [hotel owners’] biggest concern,” he said. “But I think with the economy now growing a lot faster than anybody thought it would be and with the tax breaks, that must be some of the push from these owners now to say, ‘I got to have a meeting with you, we need to get some deals going.’”
So, How to Make a Decision Regarding Ownership Structure?
We highlight a few things for hotel owners to consider when making branding-related decisions with regards to choosing a franchisor, a manager, a brand with which to align, and some analyses to consider. We do not claim to be real estate experts or hotel developers, but hope this section provides owners some key qualitative and quantitative items to think about.
Choosing a Franchisor and/or Manager
Obviously, costs should be top of mind for the hotel owner when it comes to choosing a franchisor and/or manager.
When it comes to the franchisor, this means carefully evaluating franchise disclosure documents (FDDs) to assess the multitude of fees that are included for each type of brand. The initial investment required can vary widely. We analyzed as many FDDs as we could on the Wisconsin Department of Financial Institutions website (which totaled 82 in number) and found that the minimum initial investment required by the franchisee for a newly developed hotel ranged from $2 to $4 million (G6 Hospitality’s Motel 6, Wyndham’s Super 8, etc.), but the maximum initial investment required ranged $143 to $706 million (Hilton’s Waldorf Astoria). The median was $12 to $22 million, and the average was $24 to $54 million. This includes an average investment paid to the franchisor of $181,000 to $338,000 in the form of the application and other initial fees, and the rest of the investment being composed of facility improvements, training expenses, furniture, fixtures, equipment, inventory and supplies, insurance, advertising, design and engineering fees, permits, licenses, deposits, real estate and construction costs, legal and lending fees, market and environmental studies, and the cost of labor. We note that three states, Wisconsin, Minnesota, and California, have FDDs publicly available online. We used Wisconsin, because its filings were user-friendly, easily accessible, and included relevant information, though we recognize this data may not be broadly representative of nationwide trends.
Exhibit 35: The initial investment required for a franchisee is very high as estimated by FDDs.
Source: Wisconsin Department of Financial Institutions, Franchise Disclosure Documents
Other items to consider are recurring fees, including royalty fees, reservation fees, loyalty program fees, and booking fees. In addition, costs of maintaining brand standards, potential product improvement plans (PIPs) which can include extensive work from plumbing to parking garages, and potential termination fees are all important. These costs must be weighed against the general operating performance of the brand relative to its competitive set, and what the brand is providing from a systems standpoint, training, or in terms of lending assistance.
In terms of the manager, contract terms can be highly flexible, so setting up an arrangement that best aligns the hotel owners’ interests is critical. The fees, length of agreement, incentive structure, management company investment required, and process for running the property as effectively as possible can all vary. The manager should be focused on maximizing profits while keeping costs at the hotel at an appropriate level so as to maintain customer satisfaction.
We note that, when working through franchisor and manager decisions, the distribution expenses and customer acquisition costs should be taken into consideration. Amar Lalvani of Standard International shed light on this when discussing how people are focused way too much on RevPAR index, or how a hotel is performing relative to its competitive set (i.e.., a RevPAR index of 102 means the property’s RevPAR is 2% higher than the hotels in its competitive set). Instead, owners should be thinking about “net RevPAR, meaning net of commissions, [as] the industry has always focused on RevPAR which does not take into consideration channel mix / commissions,” he explained, even if the commission structure in place to help boost RevPAR was giving away more than necessary in terms of costs.
Kalibri Labs laid this out in a net revenue metric exhibit. Guest-paid revenue represents what the guest paid in total, which includes markups from OTAs and other merchant rates. Hotel-collected revenue represents revenue the hotel receives, which does not include transaction or commission costs. COPE revenue (Contribution to Operating Profit and Expense) represents revenue after all acquisition costs, and, finally, net revenue takes out sales and marketing expenses associated with targeting the guest. The exhibit demonstrates how owners should really be evaluating revenues and the success of a particular manager or franchisor. A given franchisor or manager may drive incremental revenue, but at what associated cost?
Exhibit 36: Net revenue should take out all costs associated with acquiring the customer.
Source: Kalibri Labs
Another item that is becoming increasingly important to ask of potential managers, franchisors, and other partners is how they are thinking new technology and investments in mobile. Finally, given we are almost a decade into this slow, steady economic expansion, owners should also be assessing how brands and other partners are preparing and positioning themselves for the next downturn.
Choosing a Brand
We recognize that, when it comes to deciding on a brand, the analysis really should be which brand will bring the most incremental revenue, relative to the fees paid. This analysis should be thought of not just in terms of additional occupancy or higher ADR, but a breakeven analysis adding in the cost of the fees relative to the incremental revenue (i.e. the brand would need to result in an ADR that is $50 higher, for instance, to simply cover the cost of the fees the owner would be paying).
However, as a framework for the hotel owner choosing to affiliate with a brand, Skift Research has developed a proprietary ranking of the major brand chains we call our Brand Matrix. In our analysis, we ranked the largest major brands, Marriott, Hilton, Hyatt, Choice, Wyndham, IHG, and Accor based on 13 key quantitative metrics. This analysis does not take into consideration any sort of market analysis, as a certain brand might be more successful in an underpenetrated market, or certain markets might be oversupplied with a certain type of brand. However, we hope the analysis sheds light on some ways that owners should think about deciding with which hotel brand to affiliate.
The Lucky 13 Metrics on Which We Ranked the Major Brands for Our Brand Matrix
- Loyalty Members: Brand chains with the largest loyal following theoretically have the greatest population to target versus having to rely on OTA customers.
- Loyalty Contribution: Either disclosed in the company’s 10-K filings or estimated using FDDs, this is the percentage of room nights or occupancy (depending on how the brand defined it) that comes from loyalty members.
- Chain Scales: The primary chain scales are Luxury, Upper Upscale, Upscale, Upper Midscale, Midscale, and Economy (Independents are separated out). In our view, the brands with the greatest breadth of chain scales offer the most value to a hotel owner. In addition, a plethora of chain scales offers opportunities to reach different types of customers in different regions.
- Rooms Per Country/Territory: This is defined as the total number of rooms divided by the number of countries and territories that the major brand chain operates in. This metric attempts to demonstrate a saturation level for the brand. The higher the rooms per country/territory, the more saturated the brand is, and the hotel owner should consider other brands that are underpenetrated or where there is opportunity to take market share.
- Year-to-date RevPAR (in $): This is an overall representation of how much the brand generated in revenue per available room year-to-date. This takes into account both ADR and occupancy, so a brand that has higher prices or higher occupancies will have a higher RevPAR.
- Year-to-date RevPAR Growth (YoY): Growth in RevPAR year-over-year year-to-date shows which brands are doing the best at growing their own RevPAR, either by increasing rates, increasing occupancies or both.
- Estimated Franchise Fees: Lower total franchise fees (which include the averages for royalty fee percent of rooms revenue, marketing fee percent of rooms revenue, and loyalty fee percent of total revenue), as estimated in the “HVS 2016/2017 United States Hotel Franchise Fee Guide,” suggest lower expenses for owners.
- Fees Per Booked Room Night: This is 2016 management and franchise fees divided by the total number of occupied room nights based on the companies’ filings. We evaluate this metric to have a better understanding of how much hotel owners are paying relative to how many bookings they’re getting (i.e. is it worth it?). The lower the fees per booked room night, the higher the rank.
- Estimated TV Ad Spend ($): This is the estimated spend on national TV hotel ads as provided by ispot.tv. As many brands for each portfolio company were included as possible. We assume the more spent on advertising, the better recognition the hotel owner will receive for his or her property.
- 2017 ACSI Score: The American Customer Satisfaction Index (“ACSI”) is an indicator that measures customer evaluations of the quality of products and services via interviews. The higher the ASCI score, the higher the overall likeability of the brand.
- Estimated Direct Unique Site Visits: SimilarWeb provides unique visits to brand.com websites and estimates the percent of desktop traffic that came via direct. We calculate the percentage of direct traffic multiplied by the unique visits to estimate the amount of consumers that went directly to that particular brand.com website.
- Average Site Visit Duration: SimilarWeb provided data as to how long visitors remained on each brand.com’s website. We assume the more time spent on the site, the more the guest is engaging with the site and potentially booking.
- Social Following Rank: We took the average rank of Facebook likes, Twitter followers, and Instagram followers for the company’s main corporate account, the loyalty account, and a couple concierge-type accounts. A stronger social following not only suggests that the brand has a loyal customer base, but that the company recognizes the importance of having a social media presence with guests.
Based on the average of each individual rank, we found the brand that ranks the highest across all of these metrics is Marriott, followed closely by Hilton. IHG, Hyatt, Choice, Accor, and then Wyndham follow.
Exhibit 37: We ranked seven major brands across 13 quantitative metrics.
Source: Company filings, SimilarWeb, iSpot.tv, The American Customer Satisfaction Index, Skift Research
Exhibit 38: Marriott and Hilton rank the highest in Skift Research’s Brand Matrix.
Source: Company filings, SimilarWeb, iSpot.tv, The American Customer Satisfaction Index, Skift Research
For reference, we also monitored Google Trends to assess search interest in different hotel brands. Looking at 2017 versus 2016 data, Wyndham and IHG gained the most interest, while Accor lost the most interest. Hilton and Hyatt both declined as well, but remain above the overall average search interest. Perhaps an increase in search interest could suggest a brand improving its overall rank relative to other brands over time.
Exhibit 39: On average, hotel brands search interest increased slightly in 2017 versus 2016.
Source: Google Trends
Multiple Brands Helps Mitigate Risk
Nevertheless, we believe any hotel owner developing a portfolio of several properties should consider multiple brands within multiple segments to mitigate risk.
Consolidation has solidified a few major brand portfolios and resulted in a lot “less choice [for]… owners [that] are looking for a solution that’s not already really well represented in the market,” according to Sara Masterson of The Olympia Companies. For instance, an owner who operated a bunch of Marriott and Starwood properties suddenly found his or herself with solely Marriott properties following Marriott’s acquisition of Starwood in 2016.
Having multiple brands can help diversify a hotel owner’s risk, should a particular company face brand degradation or some other event occurs that could impact the hotel’s ability to perform. Another example would be having a portfolio of full-service, high-end hotels along with select-service and mid- to lower-end hotels to offset times in the economic cycle where one might underperform the other (i.e., full-service, luxury properties tend to underperform in recessionary times.).
In addition, multiple brands can help provide access to different customer segments as well as allow the sharing of best practices and economies of scale. Because of Areas of Protection (AOPs) that limit the number of the same type of brand that can be in a given area, a particular hotel owner who wants to build another property can look to other brands to help target a different segment in the same geographic market.
Raymond Martz of Pebblebrook Hotel Trust notes that having multiple brands within a portfolio is important, because “you’re exposed to different ideas and best practices. Some brands may do certain things well and…[can] bring it to your other operators or brands, so you have a wider swatch of best practices to pool from.” Park Hotels & Resorts, the REIT that spun out of Hilton in January 2017, recognizes the benefits, publicly highlighting its intention to diversify its portfolio in terms of brands and operators over time.
Do Your Due Diligence
We realize these types of decisions, from branding to not branding, branded operator to non-branded operator, are completely location-specific, property-specific, and market-specific. Something that makes sense for a hotel in parts of rural Minnesota might not work for South Beach, Miami, or urban Manhattan.
We also recognize that the decision analysis is complicated, subject-to-error, and at times, without an absolute, concrete answer. Vicki Richman of HVS commented, “you’ll really never know if you made the right decision, because whatever the [property’s revenue or revpar index] … is, it could have been that number for a hundred other reasons” besides what brand or operator you selected.
However, there are a few things that owners should try to focus on to make a educated, and financially sound, decision. When it comes to an acquisition, the owner should focus on the quality of the real estate, the durability of cash flows, and cash flow growth. That should be the case whether we’re talking about a REIT, another institutional owner, or a family ownership business. In many cases, a hotel owner will be able to get comfortable with a particular brand affiliated with a hotel, so long as the real estate comes at an attractive price and with opportunity for growth.
An overall view of market supply and demand dynamics is also critical. If there are already 10 properties of one brand in a market, the owner is going to be competing with its own brand to get business. In that case, it would make sense to go with a less penetrated brand, or perhaps remain independent so as to stand out. All of these factors need to be considered.
In our opinion, nevertheless, the focus should always be on sending the most dollars to the bottom line while still maintaining a high-quality product. Properties are typically valued on some measure of cash flow (i.e., enterprise value to EBITDA, etc.), so it makes sense for the owner to be focused on the bottom line and profit opportunity, and not just top-line sales.
All of this is to say – do your own due diligence. Perform various analyses to better understand the property’s cash flow growth potential and its margin trajectory. Benchmark the property’s performance against its competitive set at all times, so as to find ongoing ways to improve operations and the overall guest experience. Continuously evaluate distribution channels and search for ways to keep costs as low as possible. Some brands will make sense, while others fall by the wayside. Remaining independent may make sense, or it may not.
Skift Research Outlook
- Institutional Ownership Growth Will Improve Financial Results
- Distribution Fees Will Continue to Decline
- Management Contract Incentives to Become More Aligned; Opportunities for Non-Branded Operators to Open Up
- Brands Will Look Increasingly Like Distribution Platforms
- There is Huge Market Potential for Soft Brands
- There Will Always Be a Place for Independents
Institutional Ownership Growth Will Improve Financial Results
Skift Research expects the sophistication of hotel ownership will increase. “The history of real estate [is that] it’s evolved from individuals and families to institutions, and that’s happening in the hotel industry,” said Raymond Martz of Pebblebrook Hotel Trust. “The institutional community is very informed and organized to think about things in a thoughtful manner.” JLL highlighted in its “Q3 2017 Hotel Investment Quick Look” that nearly three-fourths of hotel-transaction volume during the third quarter of 2017 came from REITs (non-traded and public) and private equity funds. We expect this increase in institutional owners is a result of depressed asset values during the financial crisis, and, more recently, institutional investors moving into alternative asset classes like real estate to earn better returns in a low rate environment. There’s also something to be said for investors increasingly looking outside of retail for investments that are less prone to disruption by online sales. You can’t necessarily “buy an experience” on Amazon (yet).
In some ways, the growth of institutional ownership is an immense positive. Institutional owners such as public and private REITs and private equity are highly focused on the bottom line and their potential return on investment. A more analytical, and less emotional, approach to the business should help drive strategies to increase the top line but while keeping costs in check. This may also encourage growth in third party operators and independents, as these institutional investors see other ways to be nimble and find more efficient ways to run properties. Brands may be compelled to better align interests to maintain business.
At the same time, Amar Lalvani of Standard International raised a valid point by saying that these investors may sometimes be too focused on their holding period and return on investment, buying assets that they view to be at depressed valuations, putting in some capital to enhance the properties, and selling at a higher price. “When hotels are viewed as commodities to be bought and sold, I don’t think that’s what’s best for the guest,” Lalvani said. “When we think about who we want to do business with, it’s people who want to view it as something for the long-term.” Regardless of the hotel owners’ true goals, we expect that, with increased institutional ownership, we will see improved profitability and interests becoming better aligned.
Distribution Fees Will Continue to Decline
Skift Research expects distribution costs from the OTAs will continue to decrease. For one, the brands are getting better at negotiating better commission rates with the OTAs and encouraging direct booking. At the same time, the OTAs need to do what they can to maintain independent inventory on their website rather than see more independents turn to soft brands in search of lower distribution costs. This should, in theory, lower distribution costs for the entire industry. In addition, as OTAs pivot their strategies into other potential channels such as reservation management to combat competition, they may offer lower commissions simply to attract more hotels to join.
“We like being in the middle,” Raymond Martz of Pebblebrook Hotel Trust said, regarding the company’s ownership strategy. “We’re going to pick and choose what is best for us. So when brands and OTAs fight it out, we gain. At branded properties, we gain directly, and indirectly at independent hotels.”
Management Contract Incentives to Become More Aligned; Opportunities for Non-Branded Operators to Open Up
As institutional owners are increasingly more focused on margins, and as various distribution costs come down to better compete to entice hotel owners, Skift Research expects management contract incentives will become increasingly more aligned. While, historically, contracts between brands and owners have been somewhat adversarial, given the brand was more focused on top-line performance and the growth of the brand more so than the individual hotel owner, there are now greater forces at play, such as Airbnb getting into distribution, the OTAs becoming smarter and better at data, and potential disruption from the likes of Google. Brands and other operators need to work more closely with hotel owners to continue to be successful and retain their value, and, as a result, will have to become more flexible on contract terms.
That likely means base fees will come down (though they will never be 0%, as managers have to ensure they get paid somehow), and incentive structures will increase so that both manager and owner have the same goal: run the property as efficiently as possible to generate the most profits. There are also other levers to consider that could be adjusted – length of contract, services provided, procurement strategies, tech solutions offered. All of these factors could be up for negotiation. However, keep in mind that the goal should not just be to get a contract that is the most economical to the hotel owner. As Krissy Gathright of Apple Hospitality REIT said, “It is not our goal to achieve the lowest possible management fee tied solely to revenues as sometimes ‘you get what you pay for.’”
What is more important is to change the “day-to-day behavior” of the operator, Raymond Martz of Pebblebrook Hotel Trust said. He went on to provide a great example: Owners bear the costs. If the property has a massive security breach under the manager’s watch, the owner has to pay for it. Contract structures that ensure the manager is watching out for those types of issues and running the property as best as possible are crucial.
Apple Hospitality REIT is already experimenting with different structures to better align interests. Under the modified agreement with a large portion of the company’s property managers that Apple has been developing over the past couple years, operators can earn 2.5% to 3.5% of revenue based on the property’s performance relative to other hotels in the Apple portfolio. The percentage received depends on the property’s achievement of targets or goals such as a target profitability, a certain market share, or specific guest satisfaction levels. This structure limits the ability of an operator to earn high incentive fees in good economic times when the property might be underperforming the overall market or its competitive set.
Krissy Gathright of Apple Hospitality REIT stated, “we created our own unique management compensation structure which better aligns owner and operator interests…[W]e have found that over time the traditional incentive fee structure can lose its value as a performance incentive. For example, if a market outperforms initial expectations, an operator could ride along with that market outperformance and still earn incentives with subpar performance relative to the market.” This demonstrates a way that owners are able to negotiate a contract that better aligns their interests with operators so that managers achieve the best performance possible.
Management contracts tend to be long-dated, however, and we expect it may take some time for these negotiations to begin. In the meantime, this makes non-branded, third-party operators look even more attractive to hotel owners seeking that flexibility, thus providing an argument to bring to the table when contract terms do come up for renewal. Given approximately 20% of U.S. branded hotels are managed (See Exhibit 8), this implies there are approximately 725,000 rooms for non-branded operators to target (or 14% of total U.S. hotel rooms). For reference, we currently estimate there to be 690,000 non-branded, third-party operated hotels in U.S., based on data available in the Hotel Management 2017 Hotel Management Survey, so targeting the branded management segment could more than double their size.
Exhibit 40: Non-branded managers could more than double their market share by targeting branded management agreements when they come up for renewal.
Source: Skift Research, Hotel Management 2017 Hotel Management Survey
Brands Will Look Increasingly Like Distribution Platforms
Skift Research expects the major brands to increasingly focus on franchised hotels, rather than managing hotels. Perhaps as management agreements become increasingly incentive-based, and in recognition of the time required to be a hotel manager versus a franchisor, brands will instead focus on enhancing their loyalty programs and distribution. What this means for owners is that they possibly move farther away from the day-to-day operations of the hotel and more toward franchising. This also opens up additional opportunities for nimble, non-branded operators to grow.
As a reminder, franchising is a simpler, higher margin business for the brands and is considered to be more stable because being paid as a percentage of sales (rather than profits) tends to be less volatile during economic downturns. Franchising also helps the brands grow internationally with little capital investment required.
“I think a lot more people are beginning to warm up to franchise rather than management agreements, … because it’s cheaper for the hotel owner and it’s more profitable to the hotel company,” Ian Schrager of The Ian Schrager Company stated. Shai Zelering of Brookfield Property Partners felt the same. “… if you want to look at the next 10 years or 15 years, and this is my opinion … The landscape will change dramatically to the effect that you’re going to see brands moving further and further away from managing hotels.”
This likely means that franchise fees will continue to increase over time, but we expect the composition of franchise fees will also continue to change. There will likely be a greater emphasis on fees for loyalty programs and royalties and less focus on fees for marketing and reservation services in order to be competitive with other platforms. Vicki Richman of HVS indicated it used to be that “you couldn’t negotiate one word in the franchise, and now … we negotiate a lot … There are certain things they [brands] won’t do… [but] they will negotiate a lot more than people think on language.”
Skift Research expects an increased focus on franchise agreements versus management agreements will likely manifest in three different strategies.
For one, brands will likely grow select-service hotels rather than full-service in order to have less volatility during economic cycles, higher operating margins, and to remove themselves from the complicated food and beverage and group businesses. Bill Fortier of Hilton noted that “this cycle has been [more] on focused [select] service and urban locations … You don’t need as much full service, because your phone does all that for you, you can order your cab, … you can order your food, … you don’t need the concierge as much.”
Second, there will likely be more consolidation as the major brands look increasingly asset-light and see acquisitions as a way to acquire new brands, grow loyalty programs, and enhance their overall value proposition. Chip Ohlsson of Wyndham Hotel Group, which recently announced plans to acquire the franchise business of La Quinta once it separates from its real estate, indicated that the company will “always look at acquisitions; it’s in our DNA. I don’t see us ever steering away from that.” With the spin off of the company’s timeshare into a separate business, it provides them even “more flexibility to look at things.”
And third, soft brands will be the brands’ way to target hotels in higher chain scales and independents, and we expect there is huge market potential in this regard.
There is Huge Market Potential for Soft Brands
Skift Research estimates the U.S. market potential for soft brands could be 12% of total hotel supply.
Soft brands have shown tremendous growth over the past few years for the various reasons discussed throughout this report. Chip Ohlsson of Wyndham Hotel Group stated, “The runway is much greater than we ever expected.” According to The Highland Group’s 2017 Boutique Hotel Report, created in collaboration with STR—parent company of Hotel News Now—U.S. soft brand collections, most of which are in the upper half of chain scales, grew supply at a compound average rate of 23% from 2000 to 2016. For the major brands specifically, soft brand rooms for Marriott, Hilton, Hyatt, Choice, and IHG grew 16.3% year-over-year in Q3 2017. Given their overall portfolios grew 5% year-over-year in the quarter, soft brand growth is definitely punching above its weight.
Exhibit 41: Soft brand growth is outperforming total portfolio growth.
Source: Company filings for Marriott, Hilton, Hyatt, Choice, and IHG
In June 2017, Marriott announced its intention to grow its three soft brands – The Luxury Collection, Tribute Portfolio, and Autograph – by 20% in 2017 and almost 50% by 2019. Using these estimates, along with a conservative average growth rate for the rest of brands (We recognize, for instance, that Hilton has plans to grow its Tapestry brand, and Wyndham’s new Trademark brand is not included in this analysis), we forecast soft brands for these five major chains could reach 136,000 rooms by 2019, representing 18% growth, on average, over the past four years, or a 19.5% three-year CAGR.
Exhibit 42: We estimate soft brands could reach 136,000 by 2019 for Marriott, Hilton, Hyatt, Choice, and IHG.
Source: Company filings, Business Travel News, Skift Research
Seventy percent of hotels in the U.S. are branded, which implies 30% are independent. This 30% represents approximately 1.6 million based on total hotel supply of approximately 5.2 million. According to Business Travel News, approximately 41% of independent inventory can be classified in the Upper Midscale chain scale or above. Arne Sorenson, CEO of Marriott, told Skift in June 2017 “…if you move down too far [in chain scale] … You’re not getting a character or personality that comes through in that hotel, that causes a customer to say ‘You know, this is cool, I want to be part of it.’ I think the three-pack that we’ve got with Luxury Collection, Autograph, and Tribute does skew much higher in this space … And that’s deliberate.”
Should soft brands continue to skew toward the upper half of chain scales, which we expect they will so as to continue to offer an elevated, unique experience for guests, about 40% of independent hotel rooms implies there are 625,000 rooms that soft brands could scoop up into their portfolios, representing 12% of total U.S. hotel supply. We note that OTAs as well as Airbnb are currently employing different strategies to target these independent hotels, but this just lays out what is currently up for grabs. This provides another, perhaps easier, avenue for brands to grow.
“For the independent hotel owners who don’t have the marketing prowess or the distribution, I think soft brands can make sense,” Amar Lalvani of Standard International called out. “Owners have to look at what they’re getting versus what they’re paying. I don’t think it works for everybody.”
There Will Always Be a Place for Independents
Skift Research expects there will always be independent hotels. There is something deeply personal and emotional in developing and owning a hotel. Owners and developers will likely always be interested in providing a unique, innovative experience for guests, and a high level of hospitality that consumers have never seen before. Owners want to be able to express themselves and not have strict rules by which to abide.
Independents will continue to grow, in part due to the experiential economy, and consumers looking increasingly more for unique experiences rather than something cookie-cutter. However, this is not without hotel owners taking on some risk.
“Things are always different … There’s new fashion, there’s new cars…Everything changes all the time. You can’t stay within something for an extended period of time because everything around you is changing” Ian Schrager of The Ian Schrager Company said. And “you can’t do an innovative product by going into a book.” It takes careful thought and a lot of work to make an independent hotel truly successful.
In addition to consumer preferences changing all the time, the path of being independent is an expensive route. Vicki Richman of HVS noted, when you are an independent hotel, “you’re a brand of one, but it’s expensive and you just have to be prepared to spend it.” You may save on fees you’d be paying to a brand, but you’ll have to a pay a lot simply to be seen on the internet, for instance, due to distribution channel challenges, because otherwise “you are going to be invisible.”
Some will decide the effort required is just not worth it when there are strong brands, large distribution platforms, and skilled operators to help you do a good job, but, for those who are willing to take the risk, who have the passion (and the capital), the outcome is a truly unique, special experience that consumers will never forget.
Hospitality Will Always Remain A People Business
This leads us to our last point – which is that hospitality will always remain a people business, regardless of all the changes that come. Relationships will continue to be important, whether it is with managers, franchisors, employees, or guests. Customer service will always be highly valued by guests, whether it comes in the form of technological innovations or someone personally guiding you to a great, local restaurant. The quality of product will always be noticed by the guest, whether it is a consistent room in a foreign location while on a business trip, or a luxurious, unique room in new leisure destination, or somewhere that feels like home.
Companies like Airbnb have redefined hospitality by showing it could look and feel a different way than ever before. “That’s why Airbnb is so successful,” Shai Zelering of Brookfield Property Partners stated. “Airbnb says, ‘Be you.’ … [And] what the brands are trying to do is buy the consumer with a free breakfast, free Wi-Fi, [etc.] … I’ll tell you what … Nobody owns the customer … We have to think much bigger than arguing about who owns the customer, because the customer is free to choose and decide how to spend their travel time.”
“The most important thing in our business is the quality of the real estate, the location of the real estate, and the hospitality factor … Everything around it is noise, and owners can adjust.” He went on to say, “Good real estate, good hospitality will always prevail, in my opinion.”
We couldn’t agree more. Branding strategies, contract terms, and distribution landscapes will all continue to evolve over time, but hospitality as a people business, first and foremost, will always remain at the center of successful properties.
Endnotes and Further Reading
- Skift, “Loews Hotels Is Taking a Contrarian Approach…”, October 30, 2017.
- HVS, “2016/17 United States Hotel Franchise Fee Guide,” September 11, 2017.
- Blue Maumau, “Trends in Hotel Franchise Fees, The Numbers,” September 16, 2014.
- Bernstein Research, “The Long View: Hotels vs OTAs Part 1:…”, September 14, 2017.
- Wisconsin Department of Financial Institutions, Franchise Disclosure Documents
- Skift Research, “2017 Outlook On Hotel Direct Booking,” May 2017.
- SiteMinder, “Ask The Hotel Experts: Can a GDS boost…”, December 1, 2017.
- International Journal of Hospitality Management, “Do brands matter? A comparison…”, 2011.
- Bernstein Research, “The Long View: Hotels vs OTAs Part 1:…”, September 14, 2017.
- Lodging Magazine, “Why Independent Hotels Are Thriving,” March 17, 2017.
- Hotel News Now, “Soft Brand Growth Hinges…”, January 9, 2018.
- Expedia Partner Central, “Rise of Independent Hotels Sets off Industry Fireworks,” June 30, 2017.
- comScore, “U.S. Smartphone Penetration Surpassed 80 Percent in 2016”, February 3, 2017.
- Expedia Partner Central, “Rise of Independent Hotels Sets off Industry Fireworks,” June 30, 2017.
- ReviewPro, “Cornell Hospitality Research: Online Reputation…”, November 16, 2012.
- Duetto, “Independents Need To Leverage Their Revenue…”, December 21, 2017.
- Skift Research, “Experiential Traveler Trends 2018,” October 2017.
- Skift, “Complete Oral History of Boutique Hotels,” March 20, 2017.
- Skift Research, “Data Sheet: Outlook On Hotel Direct Booking 2017,” November 2017.
- Skift Research, “Experiential Traveler Trends 2018,” October 2017.
- Bernstein Research, “The Long View: Hotels vs OTAs Part 1:…”, September 14, 2017.
- Hotel News Now, “STR, TE forecast two more record years for US hotels,” January 23, 2018.
- Skift Research, “Room for Optimism: 2018 Global Travel Market Outlook,” December 2017.
- Lodging Magazine, “The Urban Hotel Market Challenge,” February 26, 2016.
- Skift, “Why Expedia or Priceline Might Just Be the Next Great Hotel Brand,” January 23, 2018.
- Revenue Hub, “Expedia vows to disrupt…”, December 8, 2017.
- STR, “Airbnb & Hotel Performance,” January 2017.
- Skift, “Airbnb is Getting a 200 Million…”, December 18, 2017.
- SKift, “Airbnb CFO Out in Management Shakeup…”, February 1, 2017.
- Skift, “Airbnb Strikes Deal to Make a Bigger Hotel Push,” February 7, 2018.
- Skift, “Marriott Expands Reach Into Tours and Activities,” March 21, 2017.
- Skift Research, “A Deep Dive Into The Google Travel Ecosystem,” December 2017.
- Bureau of Labor Statistics.
- Census Bureau.
- Kalibri Labs, “The Importance of Net Revenue Metrics.”
- The American Customer Satisfaction Index.
- Google Trends.
- JLL, “U.S. Investment Quick Look Q3 2017.”
- Hotel Management, “2017 Hotel Management Survey,” Vol. 232, NO. 4, March 2017.
- The Highland Group, “The Boutique Hotel Report 2017,” 2017.
- Business Travel News, “The Rise of Hotel ‘Collection’ Brands,” July 7, 2017.
- Skift, “Don’t Expect Hotel Companies to Stop Launching New Soft Brands Anytime Soon,” June 27, 2017.