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China’s budget hotel industry, which has less than 10 years’ history, has again come under the limelight. On one hand, it is the domestic giant Home Inn on an acquisition spree; on the other hand it is the rapid expansion of international predators. In less then 4 years, the number of budget hotels in China had grown from 166 in 2004 to 1476 in October 2007, almost a 1000% growth. As the industry becomes more mature, many problems previously swept under the carpet are now surfacing.

Cost challenge

Compared to ordinary hotels, cheap rent is the major feature of budget hotels, as well as the main reason for the industry’s fast expansion. But as the number of budget hotel surges in China, budget has become the biggest issue faced by budget hotels currently.

“Cost increase is a dire problem for budget hotels. Apart from general cost inflation, costs associated with expansion activities have been the chief reason for cost increases in most budget hotel chains Rajeel.” said Mr Hu Shengyang, CEO of Shanghai Inntie Hotel Management Consulting. Hu suggested that the concentration of location selection by budget hotels and their exponential growth in numbers have resulted in a reduction of potential sites. This intensifies the competition for high grade properties between hotel brands, directly pushing up site acquisition costs. Meanwhile, other costs such as personnel, building and management are also going up.

“The situation of cost increase can help the budget hotel industry become more rational.” said Mr Cheng Jun, vice-CEO of Hanting Hotel Management Group. Compared to a payback period of 1-2 years in the past, Cheng thought that the current payback period of 3-5 years for budget hotels is more reasonable in a normal market.

Mr Hu also agreed that cost increase should make the whole industry more concentrated. While some small chains may have to exit due to cost pressure, large budget hotel brands could accelerate their strategic progress, in order to secure a first-mover position in the future.

The withdrawal of Top Star Hotel, now acquired by Home Inn, has proved the point. Industry insiders commented that in order to quickly list the company on stock exchange, Top Star were furiously expanding its hotel numbers, at an unsustainable cost of 15% higher than the industry average. The failure of Top Star should give the Chinese budget hotel industry a warning signal.

Homogeneous competition

Not only costs are increasing, budget hotels in China are also facing the problem of “decreasing income”. According to a survey report in 2007, the average price per room had decreased from 328 yuan/day in 2005 to 208 yuan/day in 2006, and occupancy rate also down from 89% to 82.4%.

“On one hand it is the increase in hotel numbers, on the other hand these hotels share the same market positioning, hence the inevitable price war between budget hotels.” said Mr Hu. He explained that the early type of budget hotels in China was simply a copy of the budget hotel models from Western countries. Once a pilot hotel was proved successful, the same model would be duplicated in other cities by the company. Other new comes would also the proven model, therefore resulting in the problem of homogeneous competition across the budget hotel industry. When the industry was at an early stage, this homogeneity problem could be covered by the strong market demand. But as the industry saturates, consumers can now have more choice. Hotel operators thus have to reduce their prices to attract customers.

But Mr Cheng disagreed, saying that the key reason for homogeneity is rather due to unsophistication of the industry. He pointed out that budget hotels are also called “limited service hotels”. In developed countries, based on differentiated demand from different target groups, the meaning of “limited services” can be very different. Many multinational hotel chains have thousands of hotels, which would be classified into 8-12 grades according to different customer demands, such as tourism and business travel.

“As the market matures, hotel chains will inevitably become homogeneous.” said Mr Cui Tao, an integrated marketing expert. “The competition between budget hotels in the future will no longer be on a shop-to-shop basis, but on a collective basis. In this rivalry process, all aspects of a business, such as branding, culture, business model and cost control, would need to be combined together to achieve a core competitiveness that cannot be replicated easily.”

Management difficulty

“There will be only two types of hotels that can survive in China: individualized hotels and systemic hotel chains.” Mr Cheng forecast. He reckoned that individualized hotels can survive on their uncopyable, unique features, while the advantage of hotel chains will be their scale and uniform quality.

However, Mr Cui thought that the there is a contradictory relationship between quality control and scale, “Larger scale may mean increasing brand risk, but the formation of a brand requires scale.” In this sense, the standardisation of budget hotels is not only an issue of individual breakthrough, but a process of structural superiority. “From managing a few hotels to managing scores of hotels, the methods for standardised management would be quite different.” said Mr Cui, who has a profound background in franchise business management.

Hanting Hotel Group, a relatively new comer to the industry, is showing more caution. It is understood that apart from improving the management of standardised systems, Hanting is also strictly controlling the number of franchisees. At present, only 10% of Hanting’s hotel chain are franchised hotels. Mr Cheng admitted that “franchised hotels are more difficult to communicate when it comes to standardised management. Therefore before our management capability can be substantially improved, it would be safer to control the number of franchisees.”

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