It’s nothing new to hear about hotels or owners who have said “good bye” to brands and have gone on their own as an independent hotel. This is the story of one such hotel and a look at their results. I am also going to highlight the typical costs associated with being affiliated with a brand and what some say is the biggest reason to get out while you can.
The story begins with the new owners. They bought the hotel with the express purpose of taking down the flag and making the hotel an independent. The market was strong and the hotel with its brand was doing quite well—a positive RevPar (Revenue per available room) index with a historical set of competitors and a gross operating profit (GOP) to hold one’s head relatively high. For the new owners this was not good enough, and like most new owners they were interested in only two things: repositioning the hotel and flipping it for a big profit.
Usually when a hotel owner repositions the hotel they do it through a PIP, a Profit Improvement Plan. Typically this involves a room renovation and a freshen up of the lobby and meeting space. One owner’s representative referred to this process as “putting lipstick on the pig.” It’s an effective way to increase the revenues through higher occupancy and rates because your product is for a season or two the new kid on the block, well kind of. The increased occupancy and rate translate into more revenues and usually more profits. That translates directly into a higher sales price for the asset—most of the time.
Here is a simple example of how a typical PIP works. A 500-room hotel gets a 20-million-dollar face lift including soft goods replacement (bedroom carpet, drapes, wall coverings, bedspread, lamp shades) and a select case goods replacement (hard furniture). In this case the low boy was introduced, the armoire was removed, new TV’s and communications hub were added, new coffee makers, a new vanity for the bathroom, new sink fixtures and the removal of the tub/shower in favor of the now very common extra large shower. (Who a takes a bath in a hotel room?). A pretty basic job for the rooms but they look fresh and new and sales love this because they can sell the dream again. In addition to the work in the rooms the hotel updated a few ADA issues: upgrades to the elevator cabs, replacement of furniture and carpet in the lobby, and the final touch of magic is new carpets and drapes in the 25,000 sq. feet of meeting space. Lipstick on the pig.
So, we do the math and the owner has spent $40K per room to reinvigorate the hotel within its market and the following two years we see the occupancy go up 3 points to 78% and the rate goes up $20. With the refreshed banquet space, the hotel’s group business and social catering also get a boost and the banquet revenues increase by $700K.
Considering both scenarios, the hotel has increased its revenues by 5 million dollars and in this case, 3.5 million flows to the “bottom line” to the owner’s cash flow number – EBITDA (Earnings before interest, tax, depreciation and amortisation). The hotel is now worth decidedly more. Using a cap rate of 6.5 the hotel can easily fetch an additional 50 million dollars in its selling price and the owners turn a nifty 30-million-dollar profit plus what they can pull out in operating profit. That’s how it’s done, if you catch the right wind and the market is strong you can really make those numbers sing much louder.
That’s how most owners reposition an asset. In this story they did the same renovation and on top of it they lowered the flag. Let’s see what the results were on the profit picture.
I am going to call this hotel The Overachiever! The flag means the hotel has brand equity. That equity means the banks and the lending institutions recognize a premium for the flag in two main ways. One, they see that the hotel can command a higher RevPar because of the brand affiliation and number two, they give credence to the brand having more effective management abilities in a down market. Both give the owner a slight upper hand when negotiating a mortgage for the business. They can effectively leverage the hotel at a higher rate and end up with a lower mortgage rate. These are both very attractive options for the owner.
The owners however, see a different story. They see the Hotel Overachiever as a prime asset and one that can operate more profitably without a flag. They sell their story along with their other like-assets and track record to convince the bank to go along with the purchase price, the 20-million-dollar PIP, a favorable debt load, and an attractive interest rate.
Here are the main highlights of the analysis and where OTA’s come into the picture. In a branded hotel you have five main costs that—in the view of this owner—bleed the operation. They want Hotel Overachiever performing without any of the following dragging her down:
- The biggest one is the straight up management fee which is usually 3% of total revenues. In this case the management fees are 3% of 35 million which is a cool $1,050,000. What does the hotel get for its million dollars? The brand name and that’s it, absolutely nothing else, not even the sign on the roof or the actual flag. They have to pay for those; all they get is the name.
- The next big fee is the sales and marketing fee usually 1.5% of revenue and this goes to the brands corporate advertising and marketing engine that usually promotes the brand and not individual properties – an additional $550,000.
- The third big cost is for the reservations system and the delivery of individual reservations through the brand’s call center or distribution center. Depending on the volume, it can easily be 20% of the reservations made and the typical cost is north of 10% of the average rate. In this case that equated to an additional $600,000.
- The fourth component that the brand charges the owner is by far the murkiest. It’s the chargeback for all the corporate programs. Everything under the sun from training programs to insurance to legal fees to service scores to employee newsletters, crisis hot-lines, HR surveys, financial audits, third party processing fees, fam trips, web site fees, employee service gifts. Folks – I could fill the page with all the programs brands have that they, in many cases, “mandate” to owners. Other programs are optional, but many are not and when you add up all of these it’s a big dinner check.
- The fifth component many brands charge is either an administration charge for certain centralized functions like IT or accounting oversight and it’s usually .5% of revenue in this case an additional $180K .
And depending on the deal there may also be licensing fees and incentive management fees.
Let’s look at the brand price tag in this case. In total the analysis showed Hotel Overachiever’s fees total just north of 10% of revenues and for many hotels that’s a light number. I have heard of fees being 13-15% all in.
So back again to our main character. They bought the hotel and took down the flag, paid a relatively small penalty given the expiration of the management agreement was close. The big risk for the new owner in dropping the flag was the brand recognition and the reservation system. How did they overcome these challenges? In both cases they used their partnership with the OTA’s to keep the hotel’s name front and center with consumers and they used the OTA’s distribution systems to drive the lost occupancy at very competitive rates with commissions that were not a great deal larger than they were paying the brand for their reservations.
In year one the hotel drove over 50,000 reservations through the OTA’s, nearly double the volume that previously went through the brand’s reservation system. Oddly enough, the new OTA volume came very close to the combined volume of reservations previous through the OTA’s plus the brands reservation system. The cost for all these OTA reservations was substantially higher than previously spent due entirely to the volume.
Before the new ownership took over the old owners and managers had the strategy of:
- Build a base of group through the efforts of in-house group sellers coupled with leads from national sales offices.
- Use the company’s website and reservation systems to capture transient demand.
- In the month for the month use the OTA’s to drive occupancy at reduced room rates.
The new owners with Hotel Overachiever took a different tactic:
- Build a base of group through the efforts of in-house group sellers coupled with three additional sales managers.
- Use the hotel company web site and in-house hotel web site to capture organic reservations with a focus on returning guests and database marketing.
- They also took a much longer view to using OTA’s as well as ensuring all offerings were at parity with their own web site.
- Using demand parameters offering specials and value adds to both their OTA and organic customer base.
The moral of the story is there is more than one way to fill a hotel and the profit results can be very different once we have a full understanding of the “total costs” and we also examine the other sources of business.
The results after two years were impressive. GOP was up an additional 5 points. Rooms profit was down 2% largely due to the increased commissions for both group and transient even with the $20 increase in rate and a 5% increase in occupancy. The real icing on the cake was EBITDA was up almost 10 points and over 4 million dollars more. This was due almost entirely to much lower fees and the removal of unnecessary brand costs that in this case didn’t help make the hotel more profitable. The numbers become a little muddled when you combine the PIP with the flag coming down, but there is no skirting the dramatic increased profits from this strategy. Differentiating between generating revenue and making a profit was the driver for the decision to buy and lower the flag.
One last thing of note, the hotel’s index suffered and dropped below 100%. Yet the profits went through the roof. I think far too many people look at index and increased revenues as the be all and end all. The moral of this story is there is more than one way to fill a hotel and the profit results can be very different once we have a full understanding of the “total costs” and we also examine the other sources of business. In this case the OTA’s cost the owners zero dollars in investment, only operating costs.
P.S. Back to what I promised in the opening paragraph, the biggest reason to get out while you can? I read a thought-provoking article a while back about hotel owners that have long term management contracts and they compared them to taxi drivers with million-dollar taxi licenses. A big time commitment to certain costs regardless of what happens to the customers’ habits and choices. Scary stuff, perhaps, if you’re that hotel owner tied to a brand and a long-term management agreement.