The luxury hotel industry is undergoing a major transformation as more chains adopt the franchise model instead of owning and operating their own properties. This article will explore the reasons behind this trend and its implications for the future of the hotel industry.
The hotel industry is a highly profitable business, despite being seasonal in nature. The price, quality of service, and amenities provided by the hotel depend on the type of hotel you go to. The hotel industry can be broadly classified into 4 main types – luxury, upscale, midscale, and economy.
Today, We are going only going to focus on Luxury hotel chains like Hilton, Marriot, IHG, etc, and will understand why they are shifting their business model to franchisees.
In this article:
What is Franchise?
Franchising is a business model where a company allows independent business owners to operate under its name and brand while adhering to specific rules and guidelines. Think of McDonld's or Domino's.
The hotel industry is no exception to this trend, with many hotel chains leveraging the benefits of franchising to expand their business, increase their market share, and offer greater convenience to their customers. This article explores how franchising has transformed the hotel industry, using case studies of successful hotel chains.
How did Franchises transform Hotel Industry?
In 2010, roughly 70% of branded hotels were franchised operations. By 2019, that figure rose to roughly 80%. Hotel companies are increasingly shifting towards franchising. While moving away from ownership of the real estate, they also earn a consistent stream of revenue from franchise agreements, while possessing more capital to invest (capital freed up by moving away from ownership) and expand their brand.
Hence, this expansion implies that franchise hotels are more likely to outperform owner-operated hotels, as they are closer to economies of scale. Additionally, these corporations will possess fewer liabilities (as they don’t need to take on debt to buy real estate) and hence have stronger balance sheets. This will be rewarded with higher stock prices.
The franchise model is a type of business model in which a business owner (the franchisor) shares their brand products, services, and business plan with a third party (the franchisee) so the franchisee can open their own branch under the franchise.
For example, the franchisor would be a hotel brand, such as JW Marriot. The franchisee is the third party that owns the property – this could be an independent owner, a real estate company, etc. The franchisee pays a franchise fee to the franchisor to use their brand and receive support in operating their business.
This fee will include initial investment and other smaller fees that cover aspects such as marketing, brand compliance, and quality control. Owners are often real estate investment groups or real estate investment trusts (REITs) that pool investor money to buy hotel real estate assets, namely the land, and buildings. These owners then usually franchise a hotel brand, sometimes known as Flags, to operate the hotel under.
Pros & Cons of Franchising Hotels
The hotel industry has been transformed by franchising in several ways:
Rapid Expansion: Franchising allows hotel chains to expand rapidly without having to bear the financial and operational risks associated with direct ownership. Through franchising, hotel chains can expand into new markets and territories quickly and efficiently, leveraging the local knowledge and expertise of the franchisees.
Increased Brand Recognition: Franchising enables hotel chains to increase their brand recognition and awareness, as each new franchisee adds to the brand's footprint and reputation. This is particularly important for smaller hotel chains that may not have the financial resources to invest in extensive marketing and advertising campaigns.
Standardization of Quality and Service: Franchising allows hotel chains to maintain consistent quality and service standards across all their properties, regardless of location. Franchisees are required to adhere to strict operational and service guidelines set by the franchisor, which helps to ensure a consistent guest experience.
Cost Savings: Franchising allows hotel chains to benefit from economies of scale, as franchisees are able to purchase supplies, equipment, and services at lower costs through group purchasing arrangements negotiated by the franchisor.
Impact of Pandemic
During the pandemic, restrictions placed on travel and stay-at-home orders issued by the authorities led to a sharp decline in hotel occupancies and revenues. Many hotels were forced to shut down, especially luxury hotels, resulting in many employees losing jobs. Economy class fared better. This explains why JW Marriot is leading in the industry – due to their well-recognized midscale brands.
Since luxury hotels have higher operating costs, economy, and midscale hotels could still afford to stay open at lower occupancy rates, whereas luxury and upscale brands could not. It was observed that firms with a larger size, more leverage, and more cash flows were more resilient to stock declines.
REITs were even worse hit, with share prices falling up to 70%, with smaller REITS faring even worse. Shareholder confidence fell as REITS were not able to pay dividends. There was a need for hotel businesses to change management and operations style to ensure employees’ and customers’ health and safety. Many individuals are still concerned about the coronavirus and actions being taken to prevent contagion and are unwilling to travel, dine, or stay at hotels.
Future of Hotel Chains
While the hospitality industry has experienced a severe downturn, it is expected to set back on its previous growth trend in the next couple of years.
The number of travelers is on the rise, and incomes are also increasing in many developed countries. Almost half of international travel is for leisure, and hence the rise in the standard of living implies a growth in the luxury market.
With location being an important factor for luxury hotels, most such hotels are situated in tourist destinations that will see a rise in tourists.
Here is a quick comparison between Hilton Group, JW Marriot, and IHG.
The Hilton group’s portfolio includes luxury, upscale, and midscale hotels. Luxury brands include the Waldorf Astoria, LXR, and Conrad Hotels, which are in landmark destinations like Dubai, Turkey, Rome, and NYC. These hotels account for less than 5% of the total hotel rooms in Hilton’s portfolio. Hilton’s upscale and midscale brands are the biggest contributors to the portfolio. In the upscale category, their flagship hotel The Hilton provides spaces for events and is known for the restaurants and bars in their lobbies. Doubletree is targeted towards business travellers, and is famous for warm chocolate chip cookies served to guests upon check-in. Garden Inn and Embassy Suites are other well-known upscale brands. The Hampton Inn attracts leisure travellers in the midscale category with its complimentary hot breakfast and waffles. The pandemic impacted revenue, as pre-pandemic Hilton was earning 8-9 billion dollars every year. In 2021 Hilton grossed nearly 6 billion dollars with over 1 million rooms worldwide.
JW Marriot earns the most revenue. It has the highest number of rooms compared to its competitors. It’s luxury brand includes well-known names like the Ritz Carlton, Saint Regis, JW Marriott, and The W. Its upscale category includes recognizable names such as the Sheraton, Westin, Marriott. Marriot has the mature midscale market share that Hilton lacks and provides many rooms in trusted names such as Courtyard, Fairfield, Aloft and Residence Inn. The JW Marriot has the highest market capitalization and grosses nearly 3 times as much as Hilton. It grossed 14 billion dollars in 2021 across 1.5 million rooms. Before covid, the corporation was grossing 20 billion dollars a year.
IHG (Intercontinental Hotel Group)
The Intercontinental Hotel Group is based in Europe, but its portfolio contains recognizable American brands as well. Its luxury brands include The Regent and Six Senses, located in areas like Maldives, Fiji, and Portugal. Its upscale brands include Crown Plaza and Holiday Inn. Pre-pandemic, IHG was grossing 4-5 billion every year in revenue. In 2021, it grossed 2.9 billion dollars across its 900,000 hotel rooms. Four Seasons Hotels and Resorts portfolio contains only upscale and luxury brands. It grossed around 4 billion dollars in revenue pre-pandemic. In 2021, it grossed 1 billion dollars. Many Seasons hotels bear their flagship name. Others bear the name of the city the hotel is situated in.