Dushyant Singh, Associate Director, PricewaterhouseCoopers Private Limited, suggests focus on Tier-2 cities, rather than the major metros, and an asset-light mode of operation
Rajiv Ramakrishnan, our fictitious entrepreneur in this case study, owns and manages a five-star hotel, The Penthouse, which is situated in the heart of Bengaluru city. His hotel has 210 rooms, 10 suites, 4 restaurants, four banquets halls and two conference halls. The Penthouse is also present in two other cities–Chennai and Hyderabad and has been functional for the last six years. While The Penthouse and its restaurants are very popular with the local community, Rajiv has been grappling with issues such as excess inventory and low occupancy rate. Rajiv wants to increase the occupancy rate of his hotel, increase the share of business clientele which is very low currently, make the brand national and expand the overall number of rooms, over the next decade.
NOTE: Rajiv owns all 3 hotels – brand and the underlying asset, the land and building.
Dushyant Singh is an Associate Director at PricewaterhouseCoopers in India, where he leads their business and commercial due diligence competency. He has over 15 years of experience across strategy consulting, due diligence, business development and M&A. He specialises in providing strategic and market advice to corporate groups and private equity funds in the context of their investment, acquisition and growth decisions in India, and has worked extensively in the media, entertainment, travel and leisure sectors. He is an alumnus of the Indian Institute of Management, Kolkata and of Sydenham College, Mumbai.
Large chains have several advantages over independent hotels. It is not just the brand recognition and familiarity, but global relationships, corporate tie-ups and loyalty programs that drive traffic to its properties. Despite this, the Indian market does throw up an opportunity for new players to establish themselves; the industry is still small given the size and maturity of India’s economy, and is expected to see steady growth over the next decade. Since the luxury hotel industry is capital intensive, with a fairly long break-even period for individual properties, and only moderate return on capital for the asset owner, Rajiv should consider the option of an alliance with an international chain of hotels as a means to reduce his risk and potentially improve his returns on his existing properties. However, if expanding the scale of operations and number of locations is a goal, building one’s own brand could be the more attractive option.
An advantage that The Penthouse has is the fact that its food and restaurants are popular among the local communities of the respective cities. As an immediate move, Rajiv and his team can improve the hotel’s revenue by stepping up its MICE (meetings, incentives, conferencing and exhibitions) and Banquets businesses. Given the size and structure of the hotel, restaurants, banqueting and conferences should together account for over 50 per cent of the total revenue; moreover, lack of a strong branded chain need not be a barrier. While the Average Room Rate (ARR) for MICE business is low, this business increases occupancy for the hotel, and leads to trial of the hotel among the corporate clients. MICE and Banquets businesses can partially take care of excess inventory issues for the hotel. One point of consideration is to keep the banqueting facilities insulated from the rest of the hotel (e.g. with a separate entrance and kitchen), otherwise, a preponderance of banqueting events can dilute the positioning of a property wishing to promote itself as a business hotel.
The transition to an asset-light “operator” model enables more rapid scaling up of the business and improves returns to the shareholders.
In the longer term, success in the corporate segment is tied to the number of locations covered by the hotel and its network, and, not being part of a large brand or chain, The Penthouse is at a disadvantage. While it builds its portfolio, The Penthouse can look at developing its network of relationships with loyalty programs of airlines and credit card networks. In the short term, as the economy has slowed down, many companies are looking to cut travel costs, and this could be an opportunity for The Penthouse to win corporate deals against stronger, but higher-priced brands. Realisation and margins on such bulk deals are usually low, but they usually guarantee a base level of occupancy and therefore reduce excess inventory.
The Penthouse needs to concentrate on its online presence and step up its marketing activities online. Travel shopping and related research are both moving online, and the hotel’s ability to manage its brand, as well as to make targeted and relevant offers to potential customers online, are increasingly going to differentiate winners in this space. Customer data mining, dynamic pricing and search engine optimisation are capabilities that Rajiv’s marketing team will need to develop rapidly.
As Rajiv begins to build his portfolio of properties, he will need to define a positioning and a branding for The Penthouse chain of hotels. For this, he needs to assess the perception of the hotel’s brand among the customers, experience of the customers and identify where it stands vis-à-vis the competition. This will also drive the chain’s choice of cities to grow into – new industrial centers or emerging tourism destinations.
Long term strategy
While the immediate move is to build its brand and get rid of excess inventory, the long-term strategy should be to build a broader presence and increase the size of the portfolio. Growth should focus on Tier-2 cities, rather than the major metros. Presence of major brands is lower in these cities, making it easier for a new brand to establish itself. Moreover, land costs are lower in such cities, lowering the pressure on break-even and return on capital.
The high cost of debt vis-à-vis expected return on capital on a hotel project (excluding appreciation on the underlying real estate) makes leveraging a risky approach for new hotel projects. Rajiv should, therefore, rely on equity funding to the extent possible. One possible approach could be to partner with real estate developers on new projects – wherein the land and building is brought in by the partner as equity contribution to the partnership.
Over a period of time, as the flagship properties become established and Rajiv builds The Penthouse brand, his company should aim to evolve from being an owner and operator of hotel properties, to being a specialist operator and manager of hotels. This transition to an asset-light “operator” model enables more rapid scaling up of the business and improves returns to the shareholders.
This is an industry, which is people-intensive, but is struggling to retain its people. High attrition is an industry-wide challenge as some of the skills required in the hotel industry are also in high demand in other service industries. Evolution of low-touch and self-service operating models, with a lower employee headcount per room, may alleviate this challenge in the long term, but for the most part, the Indian hotel guest still expects a high degree of personal service and this may not change in the short term.
As he expands the chain, Rajiv has to build a model where he trains his people in his central flagship properties, and then moves them out to newer upcoming properties to implement the same kind of processes and practices. This will ensure that there is a uniform and consistent customer experience across all his locations.
There are three main challenges. The first is real estate. Findings plots of two acres or more, with clear titles, in central locations in cities is very difficult today. This apart, the cost at which such land comes to Rajiv needs to make financial sense for the project to be viable. The second challenge is funding. This is a capital-intensive industry with a long lead-time. The steady-state rate of return for the asset owner is not spectacular either, and so expansion costs have to be funded through equity rather than debt. Rajiv’s expansion is therefore limited by the extent of funding he has at his disposal and his ability to bring in equity partners. A transition to an asset-light business model, where The Penthouse is the hotel operator and brand owner, and ties up with owners of hotel properties (i.e. the land and buildings and ‘hard’ assets) to manage their properties, would be a long term goal, and this transition would also enable more rapid expansion. Finally, managing the people and ensuring consistency of brand and experience across multiple properties and cities is imperative.
Rajiv’s immediate focus is to build The Penthouse brand and create a strong positioning for it among the corporate community. Simultaneously, his long-term strategy should be to increase the number of locations it covers. For this it could move to an asset light type of model where it is the brand owner and manages the hotel. These strategies can help Rajiv to combat his issues and build a good presence for The Penthouse brand over the next decade.