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Budget hotel industry remains a tough nut to crack

These new-age hotel aggregators are trying to untangle the budget hotel market one step at a time

Aug 9, 2019 by Moulishree Srivastava
Budget hotel industry remains a tough nut to crack

In 2004, when everyone in the Indian hospitality industry was betting big on the premium segment, Taj Group took a chance with budget hotels by launching Ginger brand with rooms priced under Rs 1,000 a night. But things didn't work out as it had expected. Unviable real estate prices forced it to revise the tariff plan to Rs 1,399 a night in 2007. By 2015, the prices further escalated between Rs 1,800 and Rs 4,000.

“Two decades ago, India was all about luxury tourism. Either we had five stars or we had unbranded hotels. There was nothing like mid-tier or budget segment,” says Jaideep Dang, managing director of JLL India’s hotels and hospitality business.

In the early 2000s, major international hotel companies led by Marriott set up shops in India. They brought multiple brands and identified the mid-market opportunity when Indian hospitality chains like Oberoi, Taj and ITC were largely catering to foreign tourists.

“Then a decade ago we saw an increasing number of Indians travelling not only overseas but also within India,” says Dang. “Local traders, mid-tier businessmen and mid-executive guys began travelling, but not everyone had a budget of over Rs 10,000. That is where these mid-market hotels started mushrooming.”

Marriott came up with Fairfield, Accor brought Ibis and HotelF1, and IHG rolled out Holiday Inn Express. These became purely room-driven, mid-market hotel brands (ranging from Rs 3,000-Rs 6,000), competing with Indian brands such as Lemon Tree and Sarovar Hotels.

Among the premium luxury brands, only Taj Group has tried to make inroads into the budget segment but in vain.

“Companies that tried to get into the budget hotel segment have been premium hotel operators. Their systems, processes and people who are running the show have been thinking of luxury for many decades. They have to first unlearn everything to offer a budget product. Only then it will work as a model,” explains Dang.

“So if you start spending more on budget hotel rooms, you do not get your return on investment because of the low rates. This causes the development mismatch.”

And that's when online hotel aggregators seized the day.

Checking in

In 2015, three individuals, all in their 30s — Sidharth Gupta, Rahul Chaudhary and Kadam Jeet Jain — were going through a turmoil. What to do next?

While Gupta and Chaudhary were vice-president, strategy at Myntra, Jain was associate director at MakeMyTrip. Two months, 34 ideas and seven in-depth discussions later, they bet their future on the budget hotel industry.

After speaking to almost a hundred hoteliers across Delhi, Jaipur and Bengaluru, the trio decided to run independent properties under the brand Treebo, a budget hotel aggregator.

“We were looking for a large and deep enough problem to solve. Managing budget hotels fit that criteria because India being an emerging market with low disposable incomes, 70% of the travel happens in the economy segment well under 50$ a night and therefore presents a large opportunity,” says Chaudhary, co-founder, Treebo.

“We wanted to pick something where our destinies are in control, profitability is clear and where we do not need to be a billion dollars in top line to break even,” he says.

Chaudhary’s reasoning to get into the budget hotel segment was simple: “If you are collectively managing budget hotels of 25 rooms each efficiently, you should be creating value, not taking it away.”

Treebo joined its competitors Oyo and FabHotels - which had been around for a year or two- to offer consumers affordable yet quality hotel experience.

These new-age online hotel aggregators, as traditional hospitality players like to call them, tried to untangle the budget hotel market one knot at a time. Three years down the line, Oyo has over 9,000 branded properties in India, while Treebo and FabHotels have about 500 properties each. And they are just scratching the surface.

The hospitality landscape and the budget space vacuum

According to research firm Hotelivate, approximately 2.72 million accommodation rooms were operating in India in December 2018 across the spectrum — branded/traditional hotel chains, new-age hotel chains, independent or unbranded hotels and alternate accommodation such as guesthouses and homestays. By 2023, this figure is anticipated to rise to 3.33 million units.

Almost 72% of the rooms function under independent, unbranded segment and 15% are alternate accommodations. Branded or traditional hotel chains that dominated the organised sector previously form only 5% of total units, while new-age hotel chains, expanding rapidly with their highly scalable models, constitute 8% of the rooms.

That means, there are still 1.59 million unbranded accommodation rooms in India open for Oyo, Treebo and FabHotels to grab onto. A budget hotel usually is a 25-room property, with the prices below Rs 3,000 per night. Going by this, India has roughly over 75,000 independent, unbranded budget hotels.

To be sure, there is a huge headroom for growth for everyone, yet the battle for hotel properties has turned murky. Since 2015, many budget hotel startups including ZoRoom and WudStay came, bled and went away. Only three companies—Oyo, Treebo and FabHotels were left standing.

Evolution of the business model

Before raising its first round of funding from Accel Partner in July 2015, FabHotels bootstrapped for about nine months. About five days later, Oyo announced its USD 100 million round from Softbank. Around the same time, Treebo set its foundation in Bengaluru.

Oyo was then primarily working with a partial inventory model — branding and selling a few rooms per hotel — which was easier to scale as it required less money and persuasion to bring hotels on board. FabHotels adopted a mix-model approach — partial as well as full inventory model, which allowed them control over every aspect by promising hoteliers minimum revenue guarantee.

Minimum revenue guarantee is the money an operator pays to its hotel partners irrespective of their actual business per month. Hotel operators either take a cut or charge commission on the revenue generated over and above the guaranteed revenue.

“During our early stages of brand building, full inventory control at times required underwriting certain occupancy (hence guaranteed revenue) to give confidence to the asset owner,” says Vaibhav Agarwal, co-founder of FabHotels.

“While we were bootstrapped, we were not willing to underwrite any occupancy. Within few months of raising our first institutional round of capital in Jul'15, we moved completely to a full control model.”

Treebo, on its part, since its inception, went for the full inventory, manchise model — a buzz word comprising of ‘management’ and ‘franchise’ — where operators closely work with franchise properties.

“Owners were anxious about us being new in the industry. So our first four hotels were signed on minimum guarantees. We would carry our personal cheque books when we went to meet hoteliers,” says Chaudhary. “It was very difficult to make money on the first few hotels. But then we were able to grow to 40 hotels across seven cities by the end of 2015.”

By the end of December 2017, Oyo adapted to the full inventory model from partial-inventory aggregator model.

Unlike Oyo, Treebo and FabHotel had limited funds, so they used the minimum guarantee to create success stories when they entered a new market. Once they had on-boarded a few good properties and created word-of-mouth publicity among local hoteliers, they signed manchise contracts based on revenue sharing. Both the hotel chains phased out the minimum guarantee model a year after starting operations.

However, with Softbank to support its back, Oyo continued its frenzy of on-boarding independent budget hotels by paying them a huge sum as monthly revenue assurance. Meanwhile, it sold rooms at deeply discounted rates to shore up occupancies across its properties. As a result, it scaled to over 9,000 hotels in five years. In June, it replicated the same model in China.

“Oyo has been following the loss leader strategy. To maintain a monopoly, 60% of Oyo’s inventory gets sold under Rs 999 per night in any city, which doesn’t create any value for the hotel owners, because the cost of operations itself is much higher,” says an industry insider declining to be named. “The right model would be uplifting the service levels at the right price points because customers are willing to pay for quality.”

Oyo raising a whopping USD 1.7 billion over the years from SoftBank Group, Sequoia Capital, Lightspeed Venture Partners and Airbnb, among others, have led investors to look at the sector in a new light. Oyo’s prime rivals too have ended up being benefited from its growth story. Treebo has raised a total of USD 57 million so far and counts SAIF Partners, Matrix Partners, Ward Ferry Management and Bertelsmann India Investments as its investors. FabHotels is bankrolled by Goldman Sachs and Accel, among others, with a total investment of USD 40 million.

“The millions of dollars pouring in this industry has created higher brand awareness among consumers and it has also encouraged new supply creation,” said the industry insider quoted above. “There is a deeper understanding among hoteliers regarding the standards that need to be followed to become part of a brand.”

A tough nut to crack

India has been a tough budget market with only a few players in the segment, despite the untapped potential, sustained interest among investors’ and increasing awareness among customers and hotel owners. However, in China and Southeast Asia, several budget hotel companies such as China Lodgings, Homeinns, GreenTree Inns, 7 Days Inn, RedDoorz and Zen Rooms have been operating and thriving.

“Internationally, budget brands have operated with a larger hotel footprint than their mid/up-market counterparts. This gap is more stark in emerging geographies such as China,” says Fab’s Agarwal.

The Chinese budget hotel industry started growing in 2001-02 when Homeinn was founded. This was followed by the inception of GreenTree Inns in 2004 and China Lodgings and 7 Days Inn in 2005. Experts believe India will follow the same path because its macro parameters like per capita income and the number of travellers are similar to that of China’s ten years ago.

There are differences too. “The Chinese hotel industry wasn’t capitalised like the Indian hotel industry. Chinese budget hotels grew organically beginning with the leased and operated model. Over time, they added franchise and managed model, which today has become their growth engine,” explains the industry veteran quoted above.

“In contrast, Indian budget hotel startups have raised vast sums of money, especially, Oyo. And they have started with the franchise and managed model itself, so the best is yet to come.”

“We will see this market grow bigger and probably double every four years. Just as China Lodging has 18 brands, India will have multiple brands and players, because it is not to do with industry structure but the capital structure,” he adds. “Several startups are growing organically, and whoever provides good customer experience wins.”

However, there aren’t many budget hotels that have survived the market. There aren’t any prominent new players either.

“Oyo does seem to follow the scorched-earth policy — nobody else should exist. We have seen it with Zo Rooms, which Oyo first agreed to acquire but backed out later. They have a very aggressive stance towards competition,” says the industry veteran. “In India, the industry is still very nascent, and we have a player, which has raised a lot of capital and used that money not so much to improve customer experience but on marketing and to destroy competition.”

Those who do not have the moolah find it extremely difficult to survive because the hospitality industry, like real estate, has a high gestation period and demands sustained investments.

"It depends on how much fuel you have in your tank. If you do not have enough coal, the chances are you will be eaten up. That’s exactly what has happened,” says JLL’s Dang.

Moulishree Srivastava

Moulishree Srivastava is a Bangalore-based tech journalist. She focuses on emerging Indian startups and unicorns. She can be reached at moulishree@thepassage.cc.

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