In-Depth: Russia in Chains
Even in Moscow and St. Petersburg construction of new accommodation facilities proceeds slowly. For example, the volume of hotel space commissioned in Moscow in 2005 to 2006 stands at less than 120,000sqm. One can say with certainty that in terms of investment appeal hotels as commercial properties are still losing out to their key rivals – retail, office and residential projects. The reasons are obvious. Hotel projects require huge investments. Hotel operations are fraught with higher costs than incurred in rival sectors. Therefore, the payback on investment is longer.
Developers must realize that they are not likely to secure any returns on their investment until after 8 to 10 years since the moment construction begins. In conditions of political and economic instability of the past 15 years few could afford to withdraw cash from operations for such a long period of time. Lagging behind in quantity terms entails consequences, characterizing qualitative differences between the lodging sector and other commercial property sectors, hence, it is hardly surprising that many elements that have long become common for more advanced segments, are only taking shape here.
On the whole, the hotel sector seeks to adhere to the traditional scheme practiced in all other segments of the property market: developing a concept, raising funds, construction, sale and maintenance. That scheme shows the stages of the project, and key players involved in implementing each of them. As regards the hotel property sector, here that scheme is still only taking shape, which confuses some investors who seek more certainty; on the other hand, with vacant niches available, the sector has high development potential.
Also, there are factors that make hotel development an increasingly high priority both in Moscow and in the province. With the total stock of Russia’s hotel space estimated at 16 million square meters only 20 to 25 percent meet modern requirements while all the other facilities require overhaul or replacement. To restore the Soviet-era hotel stock alone it is necessary to refurbish or build anew at least 200,000 rooms.
It has to be noted that so far the Soviet epoch remains, to a certain extent, a target for the hotel industry development. In 1990, over 50 million people were employed in the hospitality sector. The business travel volume in those days many times exceeded today’s levels. It is possible to assume that if the Russian economy recovers from the negative consequences of the transition period the hotel sector is likely to grow 3 to 4-fold and the country will witness its boom.
Stable economic and raw materials sector growth provides spare cash that could be poured in the hotel real estate market that has enormous potential in this country. The main risk that impedes active growth in the hotel sector is the magnitude of the task. Russia needs at least 1,000 new hotels across the country.
Investors who have sufficient funds to finance large hotel projects seek to optimize returns, in particular, by saving on the scale of development. Optimization of costs is possible where the developer offers a typical product, has established ties with suppliers and hires a professional management company to run the property. The main hindrance that prevents Russia’s hotel sector from booming is the lack of management mechanisms, rather than shortage of cash. At the same time, international experience shows that it is possible to eliminate that obstacle by unification of the end-product and creating hotel chains.
What are the advantages of building hotel chains? Such an approach towards hotel management ensures effective maintenance of a large number of properties by means of unification of lodging facilities and management system. Promotion and sale of the product ensures higher occupancy rates and better financial results. The hotel chain is a group of properties of analogous class, consolidated within a single system with unified management and common features that boost its internal and external effectiveness. Internal effectiveness is based on the optimal use of organizational resources and optimization of material, financial and information processes for the purpose of achieving the best possible market performance.
The largest hotel chains in the world unite thousands of hotels and hundreds of thousands of hotel rooms, which speaks for the effectiveness of that form of management. Suffice it to cite the following example: Intercontinental Hotels Group runs nearly 537,000 rooms worldwide – twice as high as Russia’s total hotel stock. Moreover, even the chains uniting only two or three properties run under unified management standards, obtain a marketing advantage. For example, in the late 1990s much was written and said in Moscow of the commercial success achieved by three Marriott hotels, which secured leading positions on the market. Today, other projects by Mospromstroi – Holiday Inn on Lesnaya Street and Sushchyovsky Val stick to that path.
Despite the obvious advantage of unification, Russian-made hotel chains are still few and even hotels run by international hotel operators are rare. In Moscow, hotels that belong to international chains under franchising or property management deals, account for only 10 percent of the market; in others cities that share is even smaller.
Russia’s class of hotel proprietors, owning a large number of lodging facilities, has yet to be formed. Professional property management services are not developed, as hoteliers do not trust hired managers.
The situation is changing fast as the Russian hotel market today is not what it was fifteen years ago. There are two possible scenarios of development of Russia’s hotel chains. The first scenario deals with Russian management companies. Russia’s first hotel chains were established on the basis of ‘community’. At that stage unification proceeded in line with the principle “you run what you own”. Hotel chains based on such a model are run by management companies, whose powers are quite wide. But rapid development of that model is impeded through a number of obstacles. To begin with, in order to secure ownership in a chain of hotels, start-up capital of tens of millions dollars is required. Secondly, to build a chain of hotels, a number of properties ready for operation are necessary.
For example, the Amaks Grand Hotels company has acquired 14 hotels across Russia, and in doing so has formed a hotel chain. An alternative to acquisition is construction, which, however, is far more time-consuming, which tells on costs and returns. Thirdly, it is assumed that the owner of the chain will run his properties, but at the modern stage of Russia’s hotel market, hoteliers lack professional management skills. Building a chain of hotels is a task that only major corporation can tackle, being able to mobilize considerable resources for a lengthy period of time. Development of 10 small hotels providing 1,500 rooms is estimated at $130 to $150 million. The workforce required is at least 1,200 employees, plus at least 100 employees of the management company and the staff of building companies.
Before the years 2004 to 2005, neither business majors nor financial institutions showed any special interest in the hotel industry. A number of plans were announced but none of those has ever been finalized. For example, the Basic Element company planned to build 10 to 15 hotels across the country, but so far those plans are still far from completion. Thus, construction of hotels with a view to run the chain afterwards proves to be a complicated, costly and time-consuming method of building a national hotel chain. To all appearances, such chains will be the last to arrive on the local market.
At the same time, there exists an easier and quite effective method of creating hotel chains, based on the principle of trust management. The history of such chains is quite easy. The most successful projects have caught attention of market operators who for reasons of their own failed to manage their properties as effectively. In recent years international experience in trust management of hotels is seen by the most advanced Russian firms as the means of boosting effectiveness of their business enhancing their share on the domestic market. A management company uniting properties of various owners is a key element of the hotel chain. One of the recent examples is the Orange Ring Hotel Management company (ORHM), which, positioning itself as a hotel management company, runs nine business and premium class hotels.
What makes Russian hotel chains different from international networks is the lack of uniformity. Hotel customers abroad have a clear idea of the quality of services offered by a certain hotel chain and are able to form their opinion of a certain hotel proceeding from the brand it belongs to. In Russia, on the contrary, a stay at a hotel that is a part of a chain does not necessarily provide a guest with a clear notion of other hotels of the same chain. Today, management companies undertake manifold properties. For example, Heliopark Hotel Management runs hotels in the cities, as well as countryside resorts, OHRM operates business hotels and premium class resorts. Besides, Russian management companies have not developed any single standards, which could boost effectiveness of hotel services.
So far, none of the Russian chains unites more than 20 hotels. Domestic operators are quick learners but lack of experience results in failure to meet deadlines, dragged out negotiations, failure to offer a wide range of services and other complications undermining relations between operators and owners. At the early stages of building a hotel chain, special importance has to be attached to incentives for employees and efforts to retain skilled staff and top executives. In less than twelve months after it was founded Amaks Grand Hotels lost heads of departments who quit the chain to launch a company of their own, Akkord Management Group, in February 2006. One of the top managers at ORHM had earlier headed Heliopark, active in the Moscow Region, while the head and founder of Hospitality Management Group, Tatiana Gostenina, worked at Katerina Hotel before launching HMG.
Russian operators occupy a niche of their own, without competing openly with international brands. They offer services in the segments where foreigners have not secured foothold yet. Those are small low-income properties, ignored by international operators, - resort hotels operating on high seasonality markets, hotels in remote parts of Russia. That approach enables domestic chains to accrue experience and funds for further expansion. Perhaps, in the future they will be able to compete more successfully with foreign brands who are less flexible and not as well adjusted to the Russian market.
The foundation for further expansion of domestic hotel chains run by Russian managers will be laid namely by their foreign rivals, who will breed a new generation of managers in this country.
A characteristic feature of Russia’s hotel market today is participation of foreign capital in its development. The mechanism of raising funds is based on an alliance of the head of the project (general contractor), a management company (operator) and a financial institution. An example of such an alliance is the joint project by SRV International, Rezidor SAS, Delta Capital Management, and Scandinavian funds Swedfund and Finnfund, to build a chain of hotels under the brands Radisson SAS, Park Inn and Country Inn. The first Park Inn hotel has already been launched in Yekaterinburg.
Another tendency is consolidation of Russian government bodies, Western management and capital, which makes it possible to carry out large-scale projects within a comparatively short period of time. For example, Conseillon Belegging B.V. has set up a group, which, in addition to Accor (Ibis) includes the TempStroiSistema corporation, while financing of the project is provided by the European Bank for Reconstruction and Development. The company is building hotels in Kaliningrad and Nizhny Novgorod.
Those are but a few of companies who are ready to spread their hotel chains across the country. The first projects in the province will set a certain tempo for other market operators, who will try to keep up.
This piece was contributed to Vedomosti by Marina Smirnova, head of valuation and consulting at Colliers International. The point of view of the author does not necessarily reflect the position of the editors.