Seizing Advantage in Hospitality's New Frontier
The hospitality industry is on the cusp of a major market shift to Asia and Latin America where billions of new middle-class travelers—business and leisure—are looking for, well ... hospitality.
Change is coming to the hospitality industry. Although Western countries still drive the global hospitality business, it won't be long before emerging Asian and Latin American countries take the lead. Over the past three years, the number of available hotel rooms in the BRIC countries has jumped by almost 20 percent, compared to a 0.6 percent jump in the United States.1 This is the result of a major demand shift to emerging markets, which in turn is the result of a surge in the number of middle-class consumers—a scenario we believe will reshape the industry. We project that by 2025 there will be about 2 billion new middle-class consumers, most of them in Asia, who travel both for business and leisure (see figure 1). This will be a large new customer base, particularly for budget and mid-range hotel chains.
The major hotel chains are well aware of this trend, and virtually all have announced ambitious development plans targeting emerging markets. With the exception of InterContinental Hotels Group (IHG), however, those plans call for building upscale properties—basically ignoring the great potential that budget and mid-range customer segments offer. Though less glamorous than upscale developments, these properties are profitable (when operated in strong local networks) and are far less cyclical over time.
Thus the major chains face a significant risk: namely, that strong local players will snatch the lion's share of the high-profit mid-range customer segment. This is already happening in China, where local chains such as 7 Days Inn and Jin Jiang have seized solid positions ahead of the international chains. In other emerging countries, such as India and Indonesia, budget and mid-scale development opportunities still await the major chains.
Three-Pronged Strategy for Growth
The major chains can seize those opportunities by applying a three-pronged strategy for growth: choose the right countries and timing for development, manage scale effects locally, and adapt global brands and concepts to the local clientele.
Let's take a detailed look at each:
1. Choose the right countries and timing for development. Historically, hotel chains have based their development decisions on opportunity, searching for the best locations for building and the best financial partners to back their projects. Though this approach has worked well in the past, it is not ideal for today's industry. Rather, a new strategy is necessary to ensure that each decision is focused on opportunities that make the best business sense and are the most likely to deliver maximum return on investment.
With this in mind, we developed our Hospitality Index to rank the best countries for hotel development (see sidebar: About A.T. Kearney's Hospitality Index). The higher a country scores in each criterion—market attractiveness, risk, saturation, and time pressure—the more attractive it is for development. Figure 2 ranks the top 20 countries in this year's Index.
Not surprisingly, China, India, Brazil, and Russia all land in the top 10. There is no question about their potential for hotel development, particularly in the budget and mid-range segments. Success depends on choosing the right locations within these large countries, and understanding the politics and regulations well enough to avoid bureaucratic red tape that can delay projects and eat into profitability. In India, for example, debates over proprietary rights and land ownership are a constant hurdle for new construction projects. In China, choosing the right regions and cities in which to develop can mean the difference between success and failure (see figure 3).
Some emerging markets are less visible on the radar screen than the BRIC countries but offer similar opportunities. Singapore, for example, is small but has so much potential that it lands third on our list. In ninth-ranked Indonesia—with its population of 250 million, average political risk, and inadequate room supply—the issue for hotel chains may be the pace of development. We consider Indonesia a country where forward-looking chains will establish a significant presence now to fully capitalize on its potential down the road.
Some of the traditional mature markets—Europe and the United States, for example—still have room for development and remain attractive markets. Europe in particular shows strong potential for budget hotels, with eight European countries ranking among our top 20, with hotel chains that represent just 25 percent of Europe's room inventory. Fourth-ranked Germany, for example, has many economic centers with excellent infrastructures, perfect for building strong networks of budget and mid-range hotels. Although some hospitality leaders have a strong presence in Germany, there is still room for well-thought-out development projects.
As an aside, of the 34 countries in our Index, South Africa, at number 30, is the highest-ranked African country, followed closely by the only other African country, Egypt, at number 31. At first glance, it appears too early to consider Africa a market with any kind of development potential. Yes, the long-term demographics are promising, with one in every three people on earth expected to be African by 2100. But at the same time, 33 of the 49 least-developed countries in the world are in Africa. For now, the potential for chains is to set up a network of hotels in the key cities that attract business travelers—upscale as well as mid-range and budget. In a hotel development assessment of 28 African cities, we find that half (14 cities) are wholly attractive for hotel development, seven of them even showing significant capacity gaps, projected to continue to 2018 (see figure 4).
2. Manage scale effects locally. It goes without saying that smart hotel development is focused on select locales, capturing all the top-line benefits of a strategic brand network while avoiding the additional costs of supporting isolated properties. This is particularly true for budget and mid-range hotels for which a strong local network offers a distinct market-visibility advantage and triggers a premium both in occupancy and rate when a brand becomes well-known. We call this the virtuous development circle—when a powerful value proposition is built on no frills construction and lean staffing to reach critical mass at a national level and results in more visibility and customer loyalty.
The vastness of countries such as China, India, and Brazil requires capturing scale effects locally or regionally. To help define and prioritize a geographic focus, we recommend a detailed analysis to determine the attractiveness of a target region and the potential to reach critical mass, and ultimately build a leadership position.
3. Adapt global brands and concepts to the local clientele. The most powerful global brands and concepts reflect a product's true essence. In the case of budget and mid-scale hotels, however, native tastes and cultures cannot be ignored and in fact are crucial to achieving success locally.
On one hand, this means developing global concepts that guarantee good standards of design, quality, and customer experience, but that also emphasize cost-effectiveness through economies of scale. On the other hand, it means being flexible enough to make global concepts fully relevant in the local context, which can necessitate some specific adaptations. Hotel rooms in the Middle East, for example, are usually larger than in Europe. In China, insulation is not as stringent a requirement as it is in Western countries. And in Morocco, even a budget hotel is expected to have a swimming pool.
While the subject of adapting brand standards to local needs often spurs heated debates, it is crucial to successful development. And, importantly, localization requires close monitoring to guarantee that brand standards are adapted at the most economically favorable conditions for the company.
Location, Focus, and Network
Hotel chains seeking to establish a foothold in promising new markets focus on attractive opportunities for timely development. But attractive opportunities are only one part of the equation. The other is finding the right fit given a particular market's current situation and future potential, as in the ability to build critical mass and obtain market leadership.
Legendary American hotelier Conrad Hilton famously said there are three factors necessary to succeed in the hotel business: "location, location, location." We would add focus and network as two more factors that will help deliver a lasting competitive advantage in the hospitality industry's new frontier.
1 The BRIC countries are Brazil, Russia, India, and China.