The internet is upending many consumer-facing business models and brands. The hotel industry is no exception. With COVID-19 also having a profound impact on the travel industry, we question, are hotel brands at risk?
Hotel branding is quite different today than in the 1950s, when Kemmons Wilson began franchising the Holiday Inn brand across the US to ensure quality and consistency for a family’s summer road trip. Since then the penetration of branded hotels in the US has increased to 72% and there are now around 300 hotel brand trademarks worldwide.
However, there is a growing consumer preference towards unique experiences and products where authenticity trumps "standardisation", and where millennials seek something different. The financial structure of the hotel industry has also exacerbated brand proliferation, with the largest hotel companies transitioning from real estate-based business models to asset light fee-based business models.
Hotel operators have responded by launching 'soft-brands' and in the last hotel cycle we saw the emergence of independent hotel collections affiliated with a larger parent company. These franchises generally appeal to independent hotel owners who want more autonomy with respect to design and programming standards but the benefits of a major hotel corporate’s reservation system.
The decision by large hotel brands to change their DNA has led some hotel owners to question the value of hotel brands and loyalty programs, and return on investment of adding a major flag. The internet offers hotel owners the possibility to attract guests without paying brand fees. Plus the slow recovery forecasted in business travel due to COVID-19 could lead owners to make permanent savings, possibly including brand fees.
However, while the changing consumer preferences for unique experiences may be devaluing traditional hotel brands, adding a flag to a hotel often leads to easier access to financing from lenders given the reduced risk of generating demand, and brands tend to perform better in downturns, both important factors post COVID-19. It can also drive consistency and loyalty.
Morgan Stanley Research investigates both sides of the argument – a case for and against hotel brands.
- Higher occupancy for branded hotels – For the US industry overall, occupancy levels were 4% higher for branded hotels than independent hotels in 2019. While this gap has narrowed over recent years, Morgan Stanley Research expects brands to outperform in the aftermath of COVID-19, as brands tend to outperform in downturns as they have superior distribution, selling, and awareness than independent hotels. The heightened focus on cleaning following COVID-19 could also play into the hands of branded hotels if they can structure, enforce and advertise superior and more trustworthy hygiene processes than independent hotels and alternative accommodation.
- Affiliated hotels can save on operating costs – Most brands leverage their scale to negotiate cheaper commission levels with online travel agencies (OTAs), so the "double commission" effect (where owners pay OTA fees as well as franchise fees) is in some way cancelled out. An independent hotel with no OTA agreement faces high distribution costs as it has to build its own site, promote it, and have online marketing techniques such as search engine marketing and social media marketing just to let the customer know they exist. Offering a strong technology platform is, if anything, becoming more important than strong brands, and if aligning with a big brand comes with a strong technology platform, then hotel brands should continue to enjoy an advantage.
- Large base of loyalty members helps drive more direct bookings and higher average spend – The number of loyalty members across the large hoteliers has continued to grow, and on average 46% of room nights were generated by loyalty members in 2019, up almost 10% since 2015. Loyalty program members are valuable given they are stickier and more likely to book through low-cost direct channels rather than OTAs.
- Financing easier to access if hotel is flagged – Developers and lenders say hotels attached to brands are easier to get financed because it takes much of the risk out of generating demand, brands tend to perform better in downturns, and investors place higher multiples on brands that are perceived to be "better".
- Hotel fees have been on an upward trajectory – Intuitively, if owners were walking away from brands, it is unlikely that fees would be increasing. More broadly across the major hotel brands, average franchise fee rates have risen 2.6% for major hotel brands since 2007.
- Opportunity for increased brand penetration in Europe and Asia – Europe and Asia offer plenty of untapped potential given most hotels are still unbranded, with brand penetration at 38% in Europe, 26% in China and 11% in India, much lower than the US at 72%.
- Technology offers other ways for hotel owners to access customers– The internet has given independent hotels the opportunity to access customers they would not have been able to previously without being a chain brand. OTAs in particular have made significant inroads into the value chain, and the OTA distribution share for the large hoteliers continues to rise. OTAs are the most expensive booking channel for hotels, but provide a one-stop shopping channel for consumers, allow hotels to show off their product (OTAs' purchasing scale allows them to be first on search websites), and hotels can improve awareness, especially for last minute and non-loyalty customers. As a result, OTAs contribute volume that perhaps wouldn't have otherwise booked. OTAs' bargaining position tends to strengthen in downturns as hotels chase occupancy and consumers tend to be more price sensitive. Morgan Stanley Research suspects the proportion of rooms sold via OTAs will increase post COVID-19.
- Branded penetration in the US has only increased 2% in the last 10 years – The penetration of branded hotels in the US is up from 69.7% in 2009 to 71.6% in 2019. It actually dipped a little after the GFC, before growing again. In addition, given most of the new supply added over the last 10 years has been branded, this implies that some existing hotels have deflagged, meaning hotel owners become independent of their big brand franchisers.
- Franchise fees have been rising despite the underperformance of branded hotels – These increases include new fees to support online marketing efforts, and increases on existing royalty, loyalty program, marketing, and reservation fees. Morgan Stanley Research thinks there is a risk that franchise fees cannot continue to be pushed up in an environment of growing OTA dominance, alternative technologies, and soft brand alternatives. These "soft-brands" or independent hotel collections offer customers an "authentic" or “boutique hotel” experience as the hotel retains its independent flag, and owners benefit from the reservation and marketing platforms of a large hotel company while maintaining control of business strategy, yield management, amenity offering, and creative design elements.
- Outdated technology and cumbersome upgrades– Many hotel brands are running on old technology developed in the 1990s or earlier, and while some brands are addressing this, progress has been slow at the former. There is also the advantage that an independent hotel company has total discretion over technology upgrades whereas branded hotels are often required to be in sync with the parent company which may not be optimal for the hotel owner.
- COVID-19 implications – A recently published Morgan Stanley AlphaWise survey on corporate travel suggested that travel managers expect to shift, on average, 31% of travel volumes to virtual meetings in 2021 and 19% in 2022. This compares to a recent survey of Fortune 500 CEOs which found around 90% expect business travel to be less frequent in the future, with 52% expecting never to return to pre-COVID levels. If business travel never fully recovers, hotels may need to make permanent cost savings. Loyalty schemes would also become less important in that scenario as infrequent leisure travellers become a more important component, thus reducing the value brands add.
COVID-19 has changed the hotel industry dynamics, leading to greater focus on cost. The impressive growth in the room pipelines of the large, branded hoteliers suggests there has not been a significant shift in demand away from hotel brands yet. However, this is an industry with long-term contracts so change would be slow, and we have not yet seen the effects of COVID-19 on contract retention, just on revenue per available room.
Morgan Stanley believes it is worth monitoring the situation, and if we start to see evidence that hotel owners are deflagging in pursuit of a lower cost alternative, the downside risk for asset light operators is significant, given they tend to trade on high multiples. If there is a problem looming, we would expect to find signs of stress in the weaker franchise brands, or those in more penetrated markets like the US.
For more on the hotel industry trends, or a copy of the full report, “Brand Saturation? The Case For And Against Hotel Brands” (3 August 2020), speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.