MONEY-GROWING: Hotels: A Chain Reaction

The Russian hotel market and its juiciest piece – the capital – are set to grow rapidly. This has not only been asserted by top city officials from their lofty rostrums; the forecast is seeing confirmation in the ever-increasing activities of the hoteliers themselves.

Apart from finding a construction site, investors are facing another serious problem when it comes to choosing a management company to run their newly built hotels. And for the time being it remains unclear which companies will win over the hotel owners – renowned but expensive international brands, or the up and coming Russian management companies.

Fettered by One Chain

“Most of the international management companies are already represented on the Russian market,” maintains Ilya Shershnev, development director of Swiss Realty Group (Moscow). “Of the majors, only Hilton and Ritz have stayed out. These companies are managing the top-class hotels, and the competition between them is already being felt in Moscow.”

With the four hotels it manages in the city, Marriott is the most active on the market, believes Shershnev. Radisson, which runs the largest quantity of international class hotel rooms in Russia, is also highly active.

Hotel chains Radisson SAS, Holiday Inn Sheraton, and Hyatt have already had their bite of the pie in the capital’s market. Accor Group, another international hotel operator, too, is stepping up its activities. Accor manages Novotel on Ulitsa Novoslobodskaya.

In June one more international hotel management company, Swissotel, announced its arrival in Russia. Swissotel is currently negotiating the prospects of managing the hotel tower in Enka’s Riverside Towers business center.

Accor is set to expand its chain of hotels Ibis, Novotel and Sofitel in Moscow, St. Petersburg and several other cities.

In a move that will create even greater opportunities for foreign management companies on the Russian market, Rezidor SAS, the owner of the Radisson hotel chain, together with investment funds plans to construct 50 Country Inn hotels in Russia within 8-10 years.

“For western management companies Moscow still remains one of the most important emerging markets,” holds Aleksandr Bobylev, deputy director general of the Baltschug Hotel management company.

“In the near future, in addition to the management companies that have long settled here, Hilton and Four Seasons are to announce their presence in the capital. Other players that are not yet present are also interested in taking over the management of certain hotels. The possibilities do exist, as the city plans to double the number of hotel rooms by 2012.”

However, some of the big names are putting off their entry into the Russian market, unsure as to whether yet another upscale hotel chain will find a niche here. One mistake and millions of dollars will be frozen in the form of a hotel that doesn’t interest anybody. That is why that while securing sites for construction, investors are, nevertheless, not rushing to erect new hotels.

Considering this problem, a truly sensational decision was taken by the Accor hotel operator in June, as it announced its readiness to lower the risks and to assure the development company that it will participate in the project from as early as choosing a site for the new hotel.

According to Vladimir Ilyichyov, regional development director of Russian Management Hotel Company (Accor Group), to ensure successful cooperation with investors and developers in Russia the company is ready to guarantee investors that it will purchase the hotel after construction is completed at a price, agreed on beforehand.

That will dispel investors’ worries about having to look for a professional hotel management company afterwards. Yet, hotel management companies are not always ready, like Accor, to initiate the construction of hotels, being indecisive about the prospects of securing such ‘non-profile’ assets. “Western management companies have sought and will seek to render complex management services, without burdening themselves with participation in the capital and investments,” says Bobylev.

“Some cannot afford it, others do not consider it necessary. At the same time hotel owners must understand that they bear all the risks connected with the hotel management themselves, not sharing them with the management company.”

For instance, according to Ilya Shershnev, Marriott, one of the most active hotel operators in Moscow, holds de facto ownership (under a 49-year lease agreement) in only one of the four hotels it runs – the one it took over after purchasing the Renaissance chain.

Today international management companies are expected to do well. For instance, Marriott International, one of the largest US hotel operators, reported net profits of $169 million in the last quarter of 2003, as compared to a net loss of $37 million a year earlier.

The company’s quarterly returns grew 6 percent to $2.8 billion. Having survived the crisis that hit the hotel business in the wake of the tragic events of September 11, 2001, in its report Marriott notes a certain improvement in business conditions against a background of a growing number of business trips.

To Russia with Love

Enlisting the services of international management companies gives certain advantages to the hotels, among which Bobylev names the brand name proper and the highly-efficient hotel reservation system, as well as the new systems of offering hotel services, marketing research, operations and quality control.

But all those merits are to a certain extent overshadowed by the complications in relationship between management companies and hotel owners with regard to the distribution of risks and responsibility.

“By tradition hotel management agreements are based on two pillars: the owner’s refusal to interfere in the process of management and the management company’s refusal to guarantee any results of their management,” says Bobylev.

“Besides, management services are not cheap and payments are calculated on the basis of western accounting principles. To avoid any unpleasant surprises and to preserve the partnership for as long as possible, before talks with western management companies hotel owners must also do their homework well.”

The responsibilities that the management companies are so unwilling to assume are guaranteeing a good income to the hotel owner regardless of the operator’s risks. These include such things as low inflow of guests due to the bad location of the hotel, a drop in volume of sales brought about by political tension or a negative economic situation in the country on the whole or in the city.

On the other hand, without letting the management company have full control over the hotel its owner is also interested in rigid control over the management company itself.

“The tide of discontent rising among hotel owners is likely to hit management companies any time now,” believes Bobylev. “As soon as hotel owners finalize the work on forming a single system of calculating the effectiveness of the management of their projects, they may secure arguments substantiating their claims against the management companies as regards effective hotel management.”

Today management companies, charging a hefty fee to prove their importance to hotel owners, claim that professional management leads to the growth of capitalization.

However, they use intricate methods for calculating yields, while hotel owners are more interested in the real value of their business, maintains Bobylev.

For instance, on an equal playing field with regards to the quality of services offered by international management companies, their effectiveness, determined on the basis of their different methods, differs by approximately 15 per cent.

Not all is well in the sphere of contracts, either. By western standards, the optimal term of an agreement with a management company is 8 to 10 years. The owners prefer to make the term that long so as to prevent the management company from yielding to the temptation to siphon off as much cash out of the hotel as possible in a short time and then leave.

But Russian law does not stipulate a management agreement that satisfies both the owner and the management company.

The contract covering the entrusted administration of property is not applicable here, because it imposes an obligation on the management company to bear liability for the property, while other forms of contract allow for the possibility of their termination by the owner at any moment.

The system of settlements, used as a basis for remunerating management companies for their services across the globe, is not applicable in Russia either. As a rule, the compensation is calculated as a percentage of various indicators from the hotel’s financial performance.

American Hotel Association has devised a special procedure for determining those indicators and upgrades it at regular intervals; however, those principles are not applicable in Russia for dozens of reasons both of a legal and a managerial nature.

That is why the parties usually decide themselves on the procedure of determining the value of services of the management company. On average, the management companies get 1.5 to 2 percent from the hotel’s receipts per year, and another 8-12 percent from the amount of cost minimization.

Yet, despite all the legal problems and the difficulties that arise, investors value international brand names and do not run the risk of hiring Russian management companies for major projects.

Our Own, Our Kin

Russian companies have begun to actively invest in the reconstruction and construction of hotels.

Metalloinvest intends to invest some $60 million in the renovation of the Minsk Hotel, and then of the Tsentralnaya Hotel on Tverskaya Street.

Guta is renovating the Savoy Hotel; the Metalloinvest-Market group of company is investigating properties and sites for developing a 3-star hotel chain in Moscow and St. Petersburg.

Finam Investment Company is coordinating pre-project work under the Moscow government’s program for development of low-cost hotels in the city.

However, Russian management companies alone will clearly fail to satisfy the demand for hotel management services. According to the evaluation of experts from the Hotel Consulting and Development Group, there are no full-fledged domestic management companies as such on the Russian market. In Russia each hotel struggles to survive on its own.

Hence, so far the ideas of unification among Russian hoteliers are not very popular, because hotel owners are not ready to let outsiders interfere in their marketing strategies or pricing policies.

And still, there are examples of developed management companies, albeit singular. UMACO, established in 1998, began its operation with the construction and management of Katerina-City Hotel on Shlyuzovaya Naberezhnya [embankment]. The hotel was commissioned in two stages.

In 2001-2002 UMACO managed the Katerina Iris Congress Hotel in Korovinskoye Shosse outside Moscow, and in 2002 took over the management of the Moskva and Chaika hotels in the Black Sea resort of Sochi.

Intourist is set to operate hotels in the Yaroslav Region. Their construction is financed by the Directorate for Construction Investment Programs (DIPS). “A Swedish chain, too, sought to manage the hotels, but preference was given to Intourist,” says Sergei Tkhor, deputy director of DIPS.

“Firstly, Intourist assumed an obligation to ensure that not less than 40 percent of the rooms are filled annually in each of the five hotels. Secondly, Intourist traditionally specializes in accommodating foreign tourists, who make up approximately 70 percent of all tourists, and namely on domestic tourist routes.”

Russian management companies are developing, market participants admit, but so far their outfit is insufficient, and many do not even understand why they ought to invest money in forming a brand name.

They also fall far behind their western counterparts in terms of the style of interaction with lessees and the size of property in their management.

“They are no legends so far, and that is why they are experiencing problems with securing properties and gains,” holds Oksana Krymina, director general of the BESH marketing company. “A good name increases the value of services of the management company by 30-40 percent. Where our ‘Pupkin & Co’ charges 1 ruble, a foreign operator will charge 1.40 rubles.”

Most Russian hotel operators are created by the hotel owners themselves and service only their hotels. Management companies hired on an open market on the basis of competition are divided in two groups depending on the type of business they are involved in.

The first group includes companies involved only in the operation and management at the expense of the hotel owner. In Krymina’s opinion, in this case the management company develops faster as the quantity of square meters it operates grows.

The second group of companies is involved in investments and real estate management. Those companies experience fewer problems with finding property as they build them themselves.

Lack of qualified personnel at all levels, from top executives to plumbers, too, poses a serious problem, even though Moscow has over 50 institutions of higher education and schools that offer hospitality training.

To solve the problem UMACO has even set up the special service Katerina Hospitality Personnel Training System (Katerina HPTS) to train its staff, employed in the expanding Katerina hotel chain.

Another reason for the shortage of personnel is that university graduates have nowhere to practice, as hotels are reluctant to hire inexperienced staff. In 2003 Moscow authorities opened a training hotel, the only such hotel in Russia, at Tourist Hotel.

The city earmarked $2.5 million to establish that enterprise. 40 to 60 trainees can practice here at one time. They study all the levels of hotel service, including work in the restaurant, the porter service, overseeing waste disposal, the security service, up to the duties of chief engineer and director.

Another problem Russian management companies are faced with is poorly developed marketing strategy. “For instance, a managing company often laments that the hotel owner’s choice of a manager is ‘purely political’ and is determined by the results of tenders,” says Oksana Krymina. “At the same time its own web-site is neglected and instead of a booklet there is just a few pages…”

In the framework of the project for preparing a set of guidelines entitled Managing Real Estate – How to Choose a Management Company, BESH asked the heads of companies involved in the real estate market to share their management experience, to share their professional quality standards and the special properties of the services their companies offer. Krymina hopes that these measures will help make marketing more effective.

Cultivating Different Fields…For Now

It cannot be ruled out that as domestic management companies develop the difference between the quality of services offered by them and by their foreign counterparts will diminish. However, for the time being they are cultivating different fields.

An undisputable advantage of the ‘chain scheme’ is the guaranteed level of quality offered in all hotels – the links of the chain – across the world.

However, overall standardization on the capital city’s market may not prove so appropriate, especially on the market of low-cost hotels.

Judging by the zeal with which Russian investors have begun constructing 3-star hotels, they are not counting on the assistance of international hotel operators.

According to the forecasts of Colliers International, Moscow’s hotel market is to increase by more than 1,700 rooms in 2004-2006. Most of them are 3- / 4-star hotels. For the time being, Russian and foreign companies operate in different segments of the market, as the spheres of the activities rarely coincide.

In Krymina’s opinion, so far there can be no serious competition between them, because foreign management companies are mostly interested in upscale first class hotels, while Russian operators occupy the niche of 2- / 3-star hotels.

Something resembling competition exists in the segment of managing top class real estate, especially in cases when both the investor and the developer are major foreign firms, she says.

“To effectively compete with western chains in managing hotels Russian companies will have to apply great efforts,” says Ilya Shershnev of Swiss Realty Group. “They have to learn to render services at the right level and at a much lower price.”