FINLAND S HOTEL INDUSTRY: ONE-SIDED AND CENTRALIZED

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1 FINLAND S HOTEL INDUSTRY: ONE-SIDED AND CENTRALIZED Martti Palonperä Vespertie 8 A 8, Helsinki mobile [email protected] -

2 2 FINLAND S HOTEL INDUSTRY - ONE-SIDED AND CENTRALIZED First and Second Tier Hotel Operators, and Hotel Consortia Hotel business companies - the operating companies - are divided into two major categories: branded first tier operators and independent second tier operators. The first tier operators have one or several brands of their own. Without brands of their own all others are second tier hotel operating companies. Examples of international first tier operating companies are Marriott International 1, Starwood Hotels and Resorts 2 and Accor 3. The Finnish first tier operators are: Restel (Rantasipi and Cumulus), S-Group (Sokos Hotels), Scandic, Omena, Kämp Group (Glo), and Holiday Club Resorts. An independent operator may only have one hotel (such as Hotel Arthur, Helsinki) or several units (Lapland Hotels, 11 hotels different from each other). An example of an international second tier operator is the Interstate Hotels & Resorts IHR. IHR operates some 400 hotels, mainly in North America but increasingly in Europe also. The company has two new owners, with one of them being of special interest: the Chinese Jin Jiang Hotels with more than 700 hotels in China. A second tier hotel operator may chain in two ways: it can purchase a membership in a hotel consortia, or a franchise license and services from a first tier operating company 4. A consortia membership does not give the hotel a brand. This is because the concepts and physical standards of the consortia member hotels vary. The hotels also use their own independent names. Prerequisites of a franchise license, however, are that the participating hotel must continuously fulfill the brand s physical and service standards, and identify itself with the brand name. Please, see figure 1, the nine alternatives for the hotel operators and real estate owners to operate and own hotel real estate. 1 Ritz Carlton, Marriott Hotels & Resorts, Renaissance Hotels, Edition Hotels, Courtyard by Marriott, AC Hotels by Marriott, Residence Inn by Marriott, Fairfield Inn & Suites, TownePlace Suites by Marriott, and SpringHill Suites by Marriott 2 Le Meridien, Westin, The Luxury Collection (in Finland Kämp), Aloft, Four Points by Sheraton, Sheraton, Element by Westin, St. Regis, and W Hotels 3 Ibis Budget, Ibis and Ibis Styles, Novotel and Novotel Suite, Mercure, Adagio, Pullman Hotels & Resorts, MGallery, Grand Mercure, and Sofitel Luxury Hotels 4 Restel, Scandic and the S-Group also have adopted the role of a second tier operator. They have started franchise cooperation with the InterContinental Hotels Group, Hilton Worldwide and The Rezidor Hotel Group. Along with that the trio has got new operating knowhow.

3 HOTEL OPERATORS AND REAL ESTATE OWNERS WAYS TO ORGANIZE COOPERATION AND BRANDING 3 1. INDEPENDENT HOTELS No brand identity, individual hotel names, operator may have more than one hotel unit A. Second Tier mgmnt company owns and operates B. Second Tier mgmnt company leases and operates C. Second Tier mgmnt company and mgmnt contract An independent hotel may be 100% independent or belong to one or perhaps several voluntary hotel consortia, such as: Finlandia Hotels, Best Western, Leading Hotels of the World, Utell, Supranational, Relais & Châteaux or Small Luxury Hotels of the World A. First Tier mgmnt company owns and operates 2. BRANDED HOTELS Multiplied brand identity B. First Tier mgmnt company leases and operates C. First Tier mgmnt company and mgmnt contract D. Second Tier mgmnt company owns and operates FRANCHISE LICENSE E. Second Tier mgmnt company leases and operates F. Second Tier mgmnt company and mgmnt contract Figure 1 Hotel Industry is about Investing in Hotel Real Estate Finnish real estate investors and owners have had a stronger impact in the structure and development of the industry than they themselves or even the hotel operators understand - or have understood with the most recent years excluded. As a matter of fact, together with the operators, hotel real estate owners are the hotel industry and form its two different but tightly interlinked sectors. Managing a hotel is basic business whereas owning hotel real estate represents investing in long-term. From the return demand and risk perspectives they are two different issues. An international, also in Finland for decades prevalent trend is that hotel operations and hotel real estate ownership separate from each other. There are two approaches to do that: lease contracts and management contracts 5. With differently positioned brands included, hotel operators concentrate on developing their business expertise and expanding through chaining. Investors concentrate on financing and administering their hotel real estate portfolios. The mental distance between the operators and the owners vary. If there is a management contract between the two the interaction usually is more active. Unless the operator is a so-called operator-owner, i.e., also owns the hotel real estate, in Finland lease contract is the only option for an operator to get a hotel. Several years back some Finnish hotel real estate investors did poorly their management agreement homework. For them - enhanced with bias - this has meant that the term management agreement has become a curse word. 5 By nature, management contract is an agent agreement. The operator gives its industry expertise and chain services to the owner of the real estate and the furniture, fixture and equipment. The operator may have one or several own brands. One of them is used for flagging the hotel. Or the brand may be acquired through a franchise license. Or the hotel may be operated as an independent one without a brand. Operator pays from cash flow for all operating expenses with salaries and wages of the hotel personnel included and, as agreed in the agreement, basic and incentive fees to itself. The remaining cash flow belongs to the real estate owner. Owner s risk is bigger compared with a lease agreement but so can and should be the return on invested capital also. There are effective ways to narrow down the difference in risk between the lease and management contracts.

4 Among the income producing real estate hotels represent investment in special real estate. As the only lessee the operator literally pays for the real estate owners mortgage interest and installments as well as for the return on owner s equity. In spite of the special, onepurpose nature of hotel real estate the Finnish real estate investors want to fade out the investment risk by treating hotels equal to any other income producing real estate with multiple tenants. For minimizing the risk owners accept lease contracts only. In practice they eliminate the risk by shifting it on the operators. This is achieved by signing leases with bankable lessees only. With a slight exaggeration there are three operators in Finland that reach such status: Restel, Scandic, and the S-Group. With them there is a low lease risk and, therefore, low investment risk also. The rest, i.e., the Finnish second tier hotel operators do not even get a chance to negotiate over lease contracts. For them the necessity to invest in and own their hotel real estate has created a strong wall against entry to the hotel industry. The same applies to the expansion of existing second tier operating companies. There are a couple exemptions that have managed to cross the lease contract barrier. All of them, however, have started and prospered in some other business first (Royal Restaurants, Kotipizza/Omena, and the Kämp Group) and only then become eligible for hotel leases. The Finnish independent second tier operators have suffered a crushing loss when competing for real estate investors first and then hotel guests, and not without reason of their own. During the past decades the previously described practices have caused the industry to become one-sided. The practices also have successfully kept the international hotel operating companies out of the country. This is because they favor management contracts over lease contracts. As a result we have got a hotel operator oligopoly - triopoly - formed by Restel, Scandic and the S-Group. Nationally they have a 53,5% share of the room supply, and 70% in the 23 largest cities of the country. In Helsinki the share is 74,5%, in Turku 69,3%, in Tampere 81,2%, and in Oulu 74,8%. Their room revenue based market shares are even higher. Hotel Positioning On the basis of technical standard, supply and quality of services hotels position themselves inside a figure of pyramid shape. Please, see figure 2. 4

5 Need for corporate and brand support, and product homogeneity increases Hotels First-Class Lower (economy) F u l l S e r v i c e H o t e l s Luxury Lifestyle & Boutique, Upper Upscale, Upscale Upper Limited Service Upscale & without F&B First-Class Hotels Food & Beverage, meeting and other services Possibility for hotel specific individuality and non-branding increases Lower (economy) 5 Budget Hotels Figure 2 The down and upward pointing arrows on the sides of the pyramid symbolize the possibility of a hotel to stay independent or to brand and chain. In addition to centralization, positioning of the Finnish hotel industry is one-sided. An overwhelming majority of hotels - let them be independent second tier ones or those with a brand of the oligopoly - are packed in the middle of the pyramid. By concept they represent the so-called full service hotels 6. In Finland there are two, or actually three obvious supply gaps: budget and limited service hotels. The budget hotel chain Omena of eleven units (2014) does not yet fill the gap. There is no branded limited service supply. Restel operates four hotels without a restaurant, i.e., limited service hotels - under the full service brand Cumulus. Inside the limited service segment there is a slot of its own: extended stay hotels. With three units the Hellsten Hotel Apartments (former StayAt, former Accome) does not fill this sub gap. Companies subleasing individual apartments try to do that, as well as Forenom Apartments, part of the Barona Concern. Irrespective of how a hotel positions in the pyramid, cost effective utilization of space and building techniques are of vital importance. Importance of cost effective construction gets emphasized toward the base of the pyramid. Cost effective construction does not, however, represent the best expertise of Finnish hotel operators, designers and developers. Sometimes I even have felt that the issue is not of real interest. Design inefficiency not only 6 In addition to room department, one or more restaurants, a bar, meeting facilities and, possibly, other services. The rule of thumb is that, with extended-stay, limited service and budget hotels excluded, other hotels are full-service hotels.

6 means higher investment in space but also higher capital and maintenance expenses. Ultimately, they are reflected on the operators and owners cash flows. Advance Security Non-branded mid-class hotels have great difficulty in standing out from the mid-class supply with bulk features. With standing out I mean advance security from the customers point of view, knowing in advance from year to year what kind of a hotel the guest is going to, what she or he has bought. The importance of advance security must not be underestimated. Hotel guest literally lives his or her hotel experience. For more than 40 years the Finnish hotel industry has energetically opposed official hotel star classification, even a voluntary one. The lack of the classification, or rather its background effect has already done the damage. The classification would have had some role in physically structuring the industry, and in differentiating room pricing also. Nevertheless, official star classification would still communicate some advance security to the guests. To the hotel real investors classification is not of major importance. It tells something about the hotel s technical standard but only little if anything about the hotel concept or the skills of the operator. To the hotel guest the brand is the best guarantee on advance security. In guest s mind a brand evokes the image of the hotel hotel concept with standard and quality of services included. Toward the bottom of the hotel pyramid the importance of advance security gets strongly emphasized. Along with that increases the necessity of a brand. This does not mean that hotels should be alike. Besides, one can already claim that in Finland hotels already are similar, all in the full service mid-class segment. Positioning leaves room for variation. Budget hotels can be taken for an example: They have three alternatives to positioning: luxury budget, budget, and raw budget. Brands inside those sub-segments are different. At the narrow tip of the hotel pyramid a hotel s individuality may even be emphasized. There individuality is not a threat to advance security. The prerequisite of course is that, in guests mind, the standard and quality of the hotel justify a position at the pyramid s tip. Instead of a brand a membership in a consortia crucially selecting its hotels, such as Small Luxury Hotels of the World (Hotel Haven, Helsinki) or Design Hotels (Klaus K, Helsinki), may be sufficient. But, there is no harm in branding at the pyramid s tip either. Hotel Fortress Finland Centralization, the limited number of hotel operators restricts Finland s hotel industry from developing and diversifying. If a hotel project was of direct competition to a triopoly operator s existing hotel, say in the City of Oulu, or the project hotel positioned differently from a loose midscale full-service concept, it will not be of the operator s interest. The situation might be the same for the second member of the triopoly. In such a case the third member would have a strong position in negotiating the lease. Or the project dies because all other operators will neither get the lease nor financing for the real estate investment. The Finnish real estate developers have already learned this. Thus, they search for sites suitable for midscale full-service hotel projects and offer them to the triopoly to be constructed in the traditional manner. The developers also are aware that, in the minds of the real estate investors, management contract is the invention of the devil himself. This is so in spite of the fact that increasingly in Europe and especially in other parts of the world management agreements have become common, even prevalent. Without exaggeration one can say that in Finland there is no fourth or fifth alternative for an operator. Therefore, the safety seeking real estate investors do not have alternatives for 6

7 lessees either. The lack of alternatives has advanced so far that, for the sake of self-interest some of the present hotel owners, i.e., lessors no longer want to open the gate of Finland s hotel fortress. New, differently positioned, branded and cost effective room supply presents a threat. If materialized, such capacity would start taking away demand from the older fullservice midscale hotels positioned in the mid-section of the pyramid. Often those hotels also are in need of renovation. A further consequence is that the operators would start loosing lease payment capability and willingness to renew leases of some properties. That again would have a direct impact on values of such hotel real estate. The reserved nature of Finland s hotel industry has also had another consequence, delayed us from adopting new. Compared with the international hotel operators, it is easy to name half-a-dozen issues that we have adopted with a delay from 20 to 40 years. The way out - is there one? In North America some 70% to 75% of the hotel capacity is branded. Branding is clearly a smaller issue in Europe, perhaps about 25%, but the share of franchised hotels is constantly increasing. Based on room supply of Finland s triopoly one can say that in a way we have a similar situation with North America. There is a notable difference, though. In North America there are eight gigantic international first tier operators, and smaller and larger second tier operators by the hundreds. Why? What has kept the second tier operators and also the terrifying management agreements alive for decades in North America? The answer is franchise cooperation. Real estate investors consider franchise brands a kind of an insurance against default. The owner of the franchise license often is the real estate owner, not the second tier hotel operator. With franchising the question is not only of creating advance security for the hotel guest but of more: operative expertise, training support, marketing strength, and effective utilization of global distribution channels. The Finnish second tier operators have neither understood this nor its connection with the real estate investment. The same can be said about the Finnish hotel real estate investors. One way or the other the peripheral Finland must get a strong enough international first or second tier operator, or we must give birth by ourselves to a fourth and fifth domestic alternative for an operator. Secondly, we need one or several providers of international franchise services who also are aware of the country s special challenges and serious enough of entering. Thirdly, our independent hotel operators must understand the possibilities of franchise cooperation, and not only the costs. Just like real estate investments, franchise cooperation is for the long term. Fourthly, Finnish real estate investors need to change their attitude. Management contracts are a valid option along with leases. How else is it possible that the management contracts are so prevalent elsewhere in the world? Finland is not a special case in this issue either. Fifthly, operators and real estate investors must better understand the conformities to law of their respective businesses and strive for better mutual interaction. The same applies to lending institutions. The sixth prerequisite is the knowhow of designing and constructing more cost efficient hotels. 7

8 These are the demanding elements for our hotel industry to open up and Finland to become a developed hotel country. 8