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Business Commentary/Dilip Thakore

It's check-out time for five-star hotels

It was inevitable. According to a report on the Indian (five-star) hotel industry by the London-based Hospitality Valuation Services, hotel tariffs and occupancy levels in India, which are already under pressure, are likely to decline further during the current fiscal year.

Though the report forsees "a marginal decline in all segments" of the hotel industry, the tenor of the report makes it clear that the worst hit will be the nation's grossly over-priced five-star hospitality companies.

The report says that room occupancy levels have shrunk by 6-23 per cent in almost all cities since 1995 and that upscale properties in Delhi and Bombay have experienced a decline in room occupancy by over 20 per cent during the past four years.

Suddenly, the bottom seems to have droopped out of the much-hyped five-star hotel industry and a round of mergers and acquisitions is very much on the cards, says the agency report.

Though saying 'I-told-you-so' is bad form, I can't help doing so. Some 20 years ago, when the great hotels race had begun to hot up after ITC's entry into the upscale hospitality business, I -- I was editor of Business India then -- had warned that a business which was so overwhelmingly dependent upon foreign customers was way out on a limb.

The high costs of construction recklessly and imprudently budgeted by managers in five-star hotel companies made high room tariffs inevitable which priced out domestic customers. But at that time no one took notice of this warning. And indeed the continuously growing volume of business travellers into India, high hotel occupancy rates and the high stockmarket valuation of the equity shares of the Taj, Oberoi and Welcomgroup companies made such warnings sound foolishly alarmist.

Yet while the managements of the hotel chains in India were busy emulating the great hotel chain companies in the US, they overlooked one critical characteristic of their business strategy: their customer base was overwhelmingly domestic. Indeed, the more successful among the American hotel chains such as Howard Johnson, Mariott and Holiday Inn offer room rates which are affordable to travelling salesmen whose largely mythical adventures are the staple of American humour.

Unlike their Indian counterparts, the pioneers of the American hotel chains understood that business travellers who are the bread and butter of the hotel industry don't want more than a clean airconditioned room with comfortable sleeping accomodation, a bar and a restaurant. These are what most American and European hotels -- especially those located in metro cities -- provide. Consequently, their construction costs and overhead expenses (as also their break-even occupancy ratios) tend to be low.

On the other hand, the promoters of India's newly-emergent hotel chains failed to make a distinction between business and resort hotels. Consequently, the properties of the major hotel companies in Indian metros are in fact resort hotels offering a plethora of restaurants, gym facilities, live music, entertainment, etc.

But offering such facilities in the metros where land prices and cosntruction costs are very high necessitates high room and restaurant tariffs which are totally out of sync with the purchasing power of the domestic middle class. Thus, despite contemporary India boasting perhaps the largest middle class in the world in terms of absolute numbers, the major hotel companies are heavily dependent upon the inflow of foreign, hard-currency customers.

Indeed, so high are the construction and overhead costs -- and therefore the room rates -- of most five-star hotel properties in India's metros that even foreign businessmen are beginning to think twice about checking into them. Experienced business travellers (and travel writers) who constitute the majority of the clientele of the listed hotel companies have for some time been complaining that room rates in upscale hotels in India are much higher than in neighbouring south-east Asian countries such as China, Thailand, Indonesia and the Philippines.

The folly of confusing business hotels with resort properties which enjoy the benefit of cheaper land costs, has been compounded by foolish food and beverage pricing in the nation's floundering five-star hotel companies.

In the developed nations of the western world, from where the managements of India's upscale hotels have drawn their inspiration, bar and restaurant prices in upscale hotels tend to be 25-30 per cent higher than in the high street. In India, they tend to be 100-200 per cent higher. The consequence is that the middle class which could provide a steady flow of income to their bars and restaurants is effectively discouraged from patronising them.

The familiar problem of a managerial inability to strike a balance between volumes and margins (aka greed control) is preventing the cross-subsidisation of poor room occupancy ratios by the food and beverage establishments of the upscale hotel companies.

Of course, there is merit in the argument which hotel property managers advance that government taxes are to a great extent responsible for pricing the rooms and bars and restaurants of five-star hotels out of the reach of potential foreign and domestic middle class customers.

The central and state governments are perhaps greedier than the promoter-managers of these establishments. They have foolishly imposed unjustifiably punitive luxury and sales taxes upon the services provided by the soft-target upscale hostelries.

But then, post-Independence India's governments have always shown a penchant for killing the golden goose. Prudent hospitality service managers would have factored this into their property development and pricing strategies. Instead, by loose property construction budgeting, imposition of unconscionably high margins on F&B services, they have aggravated the impact of government taxes which are levied on an advalorem basis.

So how can the market leader hotel companies which have painted themselves into a corner, get out of their self-created mess? Far be it from me a non-industry layman to provide detailed solutions. However, simple logic would suggest that the managements of the upscale hotel chains diversify their property mix by building or preferably acquiring lower cost, no-frills two- and three-star hotels which enjoy domestic custom and therefore higher occupancy ratios.

The ground-level reality that it is lower-end, two-, three-star hotels which are doing well should persuade five-star hotel managements to shed their outdated notions of 'grandiosity' and acquire no-frills businessmen's properties to subsidise their floundering five-star mausoleums.

Simultaneously, they would do well to popularise their F & B establishments and build a solid base of domestic patronage. This requires generating profits on volumes rather than high margins which requires inventory management and overhead cost control management skills.

In this respect, the managements of the upscale hotel majors can learn a lot from McDonalds and Kentucky Fried Chicken which have planted their flags on Indian soil.

As India's information technology companies, which are riding high on the bourses, have demonstrated, Indian industry has the ability to emerge as a force to reckon with in the fast-expanding global market for services. Ditto for the Indian hotel industry which has the capabilty to provide quality service at competitive prices. But for this to happen, their managements need to get their basics right.

Dilip Thakore

Business