{audio:0:00:00} Mark, a pleasure to have you with us today. I think a good place to start would be to take a step back and provide some context as to when you first joined Hilton, shortly before the financial crisis and the situation with Blackstone, as owners.

{audio:0:00:17} Blackstone bought Hilton, in late 2007. I wasn’t there, but I think they quickly brought on Chris Nassetta, who was an experienced hotelier, who had been running Host, which was a REIT, so a real estate background. Then Chris had started to build up a team and I think they had bought on the CFO, a week or two before I joined. What Chris had been doing, in those first six to nine months is, he had been going around, meeting with different leaders in the company, trying to understand what the opportunities were and, basically, working with Blackstone to agree some high-level directional issues for the company.

{audio:0:01:04} I came on board, right as we starting to execute a transformation. It was a very exciting time, because you had a private equity owner, who was motivated to see change. There’s no sacred cows, so we were able to go after whatever we thought was necessary, to make the change. I came in at the moment we were ready to start executing that transformation.

{audio:0:01:35} As you stepped into Hilton, what was the strategy?

{audio:0:01:43} For me, literally, on day one, I started working on the transformation of the company. What I mean is the execution of an organizational transformation. We spent, probably, four months or so and we went through individual functions, like finance, HR and we looked at each individual function and tried to figure out, what were the changes we could make, to streamline the company? What had happened, going back to Blackstone’s thesis, is that the company was divided between different business units. You had a timeshare unit, you had the international unit, the US domestic unit and these were all run separately. There were different HR departments, different finance groups, different systems. The idea was to combine all that together and drive as much scale as we could.

{audio:0:02:45} Even within international US, there was a lot of regional activity going on. To shoot for scale, our idea was, you had the same systems everywhere, the same way of working. The goal at first, was to shoot for scale which is, again, streamlining everything and making it very similar. That was one of the key tenets as we went through and made the changes we made at the company, was to streamline all the business units and the regional ways of doing things, into one business.

{audio:0:03:25} What was the biggest challenge?

{audio:0:03:29} In any transformation, I think the biggest challenge is to get everybody aligned that a change needs to happen. Separate from Hilton, I’ve also worked with other companies, in an advisory capacity and you often see that the board is not all in on making dramatic changes and/or in the leadership that exists, there are people that don’t want to make that change. Having that mandate to decide what you want to do is the most important thing.

{audio:0:04:09} The second thing is, it’s the leadership, such as the senior VPs and above, or whatever you consider to be your senior leadership group, getting them on board. I find it fascinating, because you sometimes have very, very smart people, who really know their space. But for them, change is scary and they see a plan that they want to execute on and they’re like, I don’t need a transformation right now; we need to get going. But what they don’t often realize is that they’re operating within something that’s restrictive, that’s limiting the whole potential. Even if they did execute on, sometimes, a very good plan, you still won’t reach the full potential for the whole company. Trying to get everybody on-board, where you have a leadership group that’s of the same mind, that’s one of the bigger challenges.

{audio:0:05:06} Everything is really around alignment. The last thing is just aligning the culture. Once you’re done with the transformation, trying to figure out how you align everybody around the purpose of the company, again. When you do a transformation, it’s very disruptive to people who work at the company. It can be very disruptive to the leadership, too, especially if you are bringing on some new leadership. But trying to figure out how to align the culture, where everyone is motivated and they understand the purpose of the company and they are all swimming in the same direction when they get going, is a challenge. That falls into part culture and part trying to implement some performance-driven metrics, where people are aligned, in terms of what they’re doing.

{audio:0:05:48} What will happen is, when you run a transformation, inevitably, some functions or some parts of the company will try to revert back to what they were doing before, because they would say, that’s what we were doing before. Sometimes, you need fundamental change. To press change down into the company is beyond just the nine to 18 months of the transformation process. There’s an ongoing transformation effort, in terms of making sure that whatever you wanted to, sticks.

{audio:0:06:23} You step into Hilton, there’s implementing systems for scale, changing the culture, transforming the business, spinning out timeshare. How did you then think about building a portfolio of brands, under one roof?

{audio:0:06:43} The regional idea wasn’t really a ground expansion of brands. I guess there was an idea that one or two would be launched. But just thinking about the rationale would be brand to brand. The Hampton Inn brand, for example, was performing very well, but the question would be, if you looked at Hampton Inn, its average daily rate was north of $100. Meanwhile, Marriott had Fairfield Inn, which was averaging more like $75. There was space for Hilton to say, hey, there’s another part of the market that, maybe, we are not capturing. Part of that comes from looking at the customers and part of that’s also coming from owners, where owners are happy with their Hampton Inn and they say, we’d like to build another product with you. We already have a Hampton Inn, in the market, but we see an opportunity to go to this other space. That’s just one example where Hilton launched Tru, which was a slightly more downscale product, to Hampton Inn.

{audio:0:07:58} We looked at the full spectrum. I think the other thing I will just mention, really quickly, is luxury. Hilton was, and even today, continues to have a lower supply in the Luxury segment. Luxury is important, firstly, because talking about filling up the space, it’s important that you can go after the luxury-oriented customer. But the other thing is, there’s a halo effect. When you have the Waldorf Astoria, in Beverly Hills, that shows up in a lot of magazines or on TV shows and that is good for branding. There’s a mixture of getting that customer, but then also having that halo effect of the hotels themselves.

{audio:0:08:44} Does a higher premium mix drive more loyalty to the brand, in that sense? As you said, it drives awareness and great brand equity, in a way. Does that actually lead to higher loyalty penetration and stickiness with customers?

{audio:0:09:01} I would agree with that, yes. There’s a couple of things to be said there. You have to have the hotels in the right locations, to drive frequency and loyalty. The challenge you have with sub-scale brands is, how do you drive loyalty if you only have 20 locations and you go to New York City and there is nothing in Time Square, if you are a customer, you obviously have to go with another brand. It’s making sure you have the buildings in the right locations and then, within that, more to your point, people want to trade up, at times, to go on a nice vacation with their spouse, or resorts are also important. Having those places where people can burn their points, in a location, when they want to take a week off over Spring Break. Having those, what we call burn properties, places where people want to go at their leisure and they’re aspirational properties, is important to have, in terms of helping to support loyalty.

{audio:0:10:01} How would you compare Hilton’s portfolio to Marriott’s, for example?

{audio:0:10:07} At least when I was there, Marriott had the Ritz-Carlton brand and they also had JW Marriott, which was relatively bigger than Conrad. Ritz-Carlton and JW Marriott were just significantly bigger and there was a big opportunity to grow in luxury. Then Marriott, at the time, I think it had a few more brands but, generally speaking, I think there are a lot of comparisons. Their appeal of Courtyard and other brands, in Residence Inn, much like Hilton had some counterparts to those. I think Marriott is also a very good company and they have some very good brands.

{audio:0:10:51} I think what was interesting was, Marriott launched Autograph Collection, while I was at Hilton. Autograph Collection was this idea that you don’t have to have strict brand standards but, basically, you create some kind of pillars around what the hotel needs to be. Then you go out and you convert hotels that are independent hotels that might have a more unique flavor. It’s not a programmed hotel; it’s whatever is in the local market. Again, it just has to meet some basic standards but it’s more like what we call collection brands. It’s interesting, when Autograph launched, it was a very slow launch, at first. I think there were some questions around, what am I really getting when I do this. What has happened, over time, is the importance of the loyalty system and the technology systems and the marketing and distribution systems, which have become much more important than even the individual brands themselves, within these brand families.

{audio:0:11:51} Suddenly, something like the Autograph Collection started really taking off. Therefore, you start to see Hilton also getting in the game and now you’ve seen pretty much every brand family has these collection brands. The benefit for the system, like Marriott or Hilton, is that you have what we call conversion brands. Rather than signing a deal, especially in a downtown area, where it might take three to five years to build a hotel, you can convert a hotel and it joins your system within three to six months and it’s already up and running and you start generating fees right away. From a financial perspective, they are also very attractive.

{audio:0:12:36} How do you look at the strategy to grow conversions or what drives conversions, as you just mentioned, at that end of the market?

{audio:0:12:47} In terms of conversion, I think there has been a little bit of a pivot, in terms of the value of the chain, over the last 10 to 20 years. For example, when you build a Hampton Inn, you have a playbook on how that hotel should be designed, how it should be operated and there’s a lot of value in that. By the way, those programmatic hotels continue to do very well, especially outside of major urban areas. That’s probably not the right comment to make, because if you look at places like New York City, they’ve done a bunch of those. But it’s tougher, because there are very strict rules and so it’s better to do that if you have a new construction. Whereas, if you want to convert existing buildings, some type of conversion brand is better.

{audio:0:13:37} As you’ve seen travel and tourism really boom, over the last 10 to 15 years, it’s made sense for people to figure out how they can best allocate their real estate portfolio. Some of them have said, I’ll convert. The value of Hilton now, the loyalty program has become so valuable; the same thing with Marriott. That’s what Marriott wants, is that combine Bonvoy with the core Marriott company. Marriott Bonvoy is incredibly important now and that becomes the chief master brand. I think Marriott now has 30 brands and I would challenge anyone to list them all. But it almost doesn’t matter; you choose the flavor of Marriott that you want to interact with and it’s all connected through their loyalty brand.

{audio:0:14:32} How did you think about loyalty when you were scaling Hilton? What was the playbook for building a program or, more broadly, thinking about driving loyalty, with travelers?

{audio:0:14:47} Traditionally, the loyalty has really just been like a frequency program and a way to encourage people to come back and, obviously, that helps with reducing marketing costs, in the long term and encourages people to book direct. It allows us to market to those people. But I think the loyalty system for the brands has transformed a little bit, because now, the importance is also about understanding the guest profile. Number one, you can drive better marketing and then, when they are on property, ideally you can provide better customer service. I still think we’re in the early days of that latter point. I think, in the future, there is going to be better integration of that guest profile into what happens at the property. Today, there is still room for opportunity there and I think this goes to the longer play, which is, who owns the customer profile? That’s whether it’s Amazon or Google or if it’s an OTA or if it’s Hilton.

{audio:0:15:54} I know, at some point, you’re going to ask my about the OTAs and I think it’s interesting that the OTAs have spent very little time on individual customer profiling, because their whole idea was to drive as many people into their funnel, to drive conversion. To ask someone a bunch of questions around who they are, as it’s going through, slows down the conversion. It’s been a great way for Expedia and Booking to fill their initial business, but I think the ongoing business is going to be this race to understand and deliver a more personalized experience to the customer. I think the brands have a little bit of a headway there.

{audio:0:16:37} Can you just elaborate, or maybe share, how well do the chains know the customer, today? How up to date are the systems? How much data do they have? How targeted is the marketing? How much do they have to improve, to actually get where we think they need to get, to really drive higher and higher levels of direct distribution?

{audio:0:17:09} I could say positive and negative things or areas of opportunity, for almost all the hospitality companies. The reality is, the big brands have the system funds to invest and have the best technology available, for fully integrated technology sets, which includes how you distribute your rooms, how you actually manage the inventory and then how does that connect to what happens at the property? Obviously, Hilton and Marriott are the larger scale and they have pretty integrated technology sets which, in some ways, is very good. However, the challenge is, because you have these very large systems, that are customized, a little bit, by country or whatever, the challenge is, how do you achieve those, in any type of pace, to keep up with the evolving technology? I think, as we all know, cloud-based technology is the flavor of the day, right now. The idea is, once you move things into the cloud, then you can integrate data much better. I think everyone is still in this cloud migration.

{audio:0:18:24} Although I would argue that chains have a pretty good job and they actually know the customer, there is a lot of room for opportunity, in terms of collecting that data and utilizing it. I feel as if I should go on and add some anecdotes here. Just one example that you might hear in the hotel industry is that, when someone books through an OTA, often that person books through the OTA and then goes and stays at the property and getting the information around that person and sharing it back up to someone like Hilton, at their headquarters office, is a challenge. That’s part of the push to get more people to book direct, so that we get to know them.

{audio:0:19:15} One of the games that you play on there is that when someone books through an OTA, when they stay at the property, we try to get the property level to enroll them in the loyalty system, so then they get caught back up into the system and then, from that system, they can start working on enhancing that profile and really getting to know that customer. There’s just a lot of work to do. I think the future will be, at the property level, you will get much more information about the customer and you’ll be able to aggregate that at a corporate level. Right now, I think there’s a lot of challenges there.

{audio:0:19:52} What does Booking and Expedia say, when you try and gather data from them? Do they even have the data themselves or is it only really Google that knows, exactly, who the traveler is, booking and staying at your hotel?

{audio:0:20:06} For Booking and Expedia, they’re a marketplace and they’re trying to figure out how you drive people through the funnel and, obviously, they have the best websites to drive their conversion. Their focus is on that. Their argument concerning sharing any type of customer data is that once that person stays, it’s the hotel’s job to get that information and provide a great experience and try to get them to rebook direct. However, one of the concerns, if you are an OTA, is if you share the customer data in advance, the question is, will that hotel take that data and, basically, cancel the reservation and rebook them direct or do something else that probably isn’t what Booking or Expedia wants to see. There are some questions around data sharing and I think it’s going to be an ongoing battle.

{audio:0:21:13} Just going to your point on Google, Google is very interesting because there’s a whole other stock of data that no one really has. Google doesn’t really know what that person’s doing, on property. It’s not as if they really know that person, as a traveler, but they know that person really well, in terms of what they’ve searched for, what’s their interest. For me, they have my credit card data now and all sorts of other things. I think they’ve done a pretty interesting job at becoming almost the hub of my data life. For Hilton or Marriott, or any other hotels, they have the unique understanding of what that person does, specifically on property, when they are travelling. They each own a little bit of a different piece of the customer journey and there is overlap. I think everyone is trying to figure out, how do you own as much of that, as possible.

{audio:0:22:14} How did you split driving loyalty between business and leisure customers?

{audio:0:22:20} One point is that I look at the hotel industry as three groups. There is group business, which is either you are travelling for business and you are attending a convention or you’re attending a wedding or whatever. Then you have business traveler, the weekday traveler, and then you have the leisure traveler. Just to look at group, which a lot of people don’t know, is that often groups, they get booked in room blocks and, often, you don’t know who that customer is, at the hotel level, because you sold the group and then the group is populating those rooms, essentially, with people. The ability to drive any type of loyalty, through that group booking, is very difficult. Over time, it’s an opportunity for hotels to work on driving more loyalty. Getting those people, who are staying there for group, who might not otherwise stay at the hotel, trying to get them tied into the system. Group is probably between 20% and 25% of the business.

{audio:0:23:31} Who owns that customer then? Is it the premium corporate travel agents or the companies themselves?

{audio:0:23:38} Sometimes, it’s a sales incentive group, where 1,000 people get together, they’re going to some resort in Cancun and group sales people sell those rooms. But it’s not really about the individual reservation and you’re not billing that individual person. There’s no real reason for you to know that person, other than, at some point, you want that person to be coming back as an individual or business traveler.

{audio:0:24:12} Then you have business travel. Business travel is the core of these loyalty programs and Starwood was especially good at this, which was the Monday through Thursday customer, who is often a more frequent customer and you want that customer to be back and you want that loyalty and you want that person. A lot of these people are less price sensitive, because they get really tied into that loyalty program. Even if there are two different chain hotels, in different chain families and the one hotel is $20 more, that person will stay at that hotel, regardless, because they have that loyalty. Having that loyalty around the frequent customers, which is often the business customer, that’s one of the key themes of these loyalty systems.

{audio:0:25:05} Then you have the leisure customer, as well. There are not a lot of people who are travelling a lot for leisure. I should caveat that. There’s an emerging group of people, really young people, or especially retirees, who travel a lot for leisure and they have some loyalty too. But the other thing you’re getting from leisure, is that people who are business travelers get used to a brand, they have that loyalty and then they keep that loyalty in their leisure. That’s a combination of that trust that you know the brand. Part of it is, you get upgrades, a discounted room or whatever.

{audio:0:25:45} It’s a slightly different loyalty experience for each one of those groups but, obviously, the overlap is that, at some point, you have the individual customer. So whichever purpose they’re travelling for, they’re going to stay loyal to your brand.

{audio:0:26:00} How do you drive a different experience for different customers, in terms of loyalty?

{audio:0:26:28} There are two points here. Firstly, the key is, you want to deliver an experience that meets the expectation of whatever that brand is. I think Hilton and Marriott, those are two of the bigger brands and they have a lot more power over their owners, to push consistency. That consistency then assigns value to the brand. If you have a brand that is totally inconsistent, then there’s really not that much value in the brand because, as a customer, you don’t know what you’re getting.

{audio:0:27:05} Just reverting back to the point on loyalty which is, in part, having a customer experience that you trust and you know what you’re going to get. That’s why I look at a brand like Hampton, which is not a particularly sexy brand, but it’s an incredibly consistent brand and when people stay there, they know exactly what they’re going to get. Therefore, there is a quite a bit of loyalty that drives a brand like that.

{audio:0:27:33} There’s loyalty, in terms of that consistency. But the other point you were mentioning, which is getting people into the loyalty system, you have to get to know who that person is. It’s trying to figure out how you drive sign-ups. If Hilton sent you an email to ask you to sign up to the loyalty system, you’re probably not going to do it. The other challenge that you have is, if someone travels once a year, how do you drive loyalty? These are significant challenges and is why you still have some of these chains who have 50% to 60% loyalty, you still have 40% to 50% that are not signed up with the loyalty program. A lot of that has to do with the fact that they are just not frequent travelers. Some of it comes down to, as I mentioned, they book through an OTA or they book through a group. The goal is to get as many of those frequent customers, as possible, into your loyalty system and encourage them to be loyal customers.

{audio:0:28:41} As you said, for Hilton and Marriott around 55% to 60% of the system is loyalty customers. Where do you think this caps out?

{audio:0:28:55} That’s a very good question. I think part of it is going to depend on the location of the hotel. If you look at resort hotels, where you are going to have a mix of people who are frequent travels, who travel and they stay in work hotels, all the time and they want that resort experience and they use the loyalty points or they’ll get an upgrade or whatever, then they’re going to stay with the chain.

{audio:0:29:27} But you also have a lot of people who travel once a year and they’re just not going to be loyalty customers. A hotel like that is going to have a much lower percentage of loyalty. Part of this is just going to be the mix of hotels. In particular, if you go outside the US, you have the long tail of customers which is just bigger. The vacation policies are usually better, culturally, people like to travel more. You have unique experiences, across country borders, in a continent like Europe. The loyalty just becomes less of a percentage. Part of this has to do with the mix of the hotels you’re at and then the other thing is just the mix of customers. I said before, you might have a sales incentive group and if you’re having groups, you’re just going to have a lower loyalty system number.

{audio:0:30:27} But again, all of the hotels are saying, hey, I want to get all of our hotels to, basically, work for us. Even though they’re paying the franchise fees, they’re also asking them to get that customer to sign up. The pitch is, get them to sign up, so then they’ll book direct with us and so we won’t have to pay the OTA commissions, which are going to cost you even more. Especially with chains like Hilton and Marriott, which have a lot of influence over the owners, they encourage this behavior and that’s been working for them.

{audio:0:31:02} Just to wrap this up, your question about how much more can they get, above the 50% to 60%, I would be surprised if it got higher than 65% to 70%. Part of that has to do with mix of business and part of it has to do with where the hotels are located. As the big chains expand more and more into Africa, Latin America and places in Asia, where you just may not see that loyalty of customer, or the frequent customer, they just make up less of the business. You’ll have the benefit of strengthening in the US, perhaps, as you get more people signed up to the systems, but then you also have this counterweight of expanding into markets where you don’t have as big a loyalty base.

{audio:0:31:49} Do you think the partnership strategy that Hilton and the chains are rolling out, with ride-sharing companies, Amazon, etc., is going to have any impact on driving loyalty?

{audio:0:32:04} Yes. First of all, I think about, if you travel once a quarter, the challenge you get for someone like Hilton is, how are you relevant for that person, on a regular basis? Once a quarter is not a lot. If you can earn points in your Uber, everyday, and Hilton is relevant for that experience, then you’re driving loyalty, because you’re keeping Hilton top of mind. That will help because, when they choose to book, hopefully, they have Hilton in the mind and are booking through Hilton.com. As this relates to the most extreme case, I look at the OTAs and you probably have a lot of infrequent bookers there and, again, the OTAs have a very good strength, in terms of marketing on Google and whatnot, to get the infrequent customer. But if you’re on Expedia and you only book once a year, how does Expedia get that customer to come back? It’s incredibly hard because you’re just not top of mind.

{audio:0:33:20} A lot of this just has to do with having your brand be top of mind. I think the other challenge, then, is adding more value to the points. If you’re only using it for hotel stays and you don’t travel that much, it may not be as useful as, hey, I can earn points and then earn discounts on my Uber ride. There’s some immediate value there, especially for an Uber ride, which is lower dollar value. You can get some immediate benefit from that.

{audio:0:33:51} Moving on to look at the franchisees, can you lay out a typical cost structure and the fee structure, at a franchisee level, today?

{audio:0:34:03} As a franchisee, they are hotel owners and it’s very capital intensive and they will often hire a third-party management company, who will manage the people at the property. If you’re an owner, and you’re trying to make a decision around a franchise, you have to pay a license fee of, call it 5%, and that license fee goes to the profit of a company like Hilton and then you also pay a whole bunch of system fees. Those system fees are supposed to be used, specifically, to drive the programs at the hotel, whether that be the technology, the distribution, the marketing elements of the hotel. So that could be another 5% of your spend, which is spent on that. That 5%, ideally, is reducing your costs. If you are an individual hotel and you were to spend on marketing, you would spend at least that portion of that 5%, if not more. The chains add value when they can take that 5% system fee and provide much more value than that 5% that you’re paying into it.

{audio:0:35:37} Just to give you an example, if you think about the loyalty system, if you can get people who are automatically going to say, I know what a Hampton Inn is, I can easily book through the website, I’m going to stay at that hotel and you get a ton of business that way, that’s why there’s a lot of value. A lot of the chains will talk about direct bookings and system production. They’re trying to say, hey, we’re providing a lot of value to you, through that 5%.

{audio:0:36:05} But just to go onto your other point, which is asking about the franchisee costs, you have the cost of the people in the building, that’s all done by you. You still have to pay all the commissions if a booking comes through an OTA or a travel agent. Then you have to deal with the upkeep of the building, so all the utilities and the maintenance and capital expenditures for renovations and that kind of thing. Then you have to deal with real estate taxes and whatever other costs there are in running a building. It’s a very different kind of model, in terms of what happens when you have economic downturns or what you have to be good at. The franchisor, like Hilton or Marriott, are very good at understanding the technology in the marketing and the standards that try to drive guest loyalty. This is why these companies have split off, because the ownership, for the franchisee, they have to know the capital markets, how do you actually get debt, where is a good place to build and all that stuff.

{audio:0:37:19} With that 5% franchise fee, royalty fee, plus the system fee, is that itemized or is that just one bucketed fee with marketing?

{audio:0:37:31} The license fee is usually just one fee. But it’s that system fee, everyone does it a little bit differently. For example, Extended Stay America, which recently started franchising, they tried to create the most simplified fee and just say, we’ve got one fee and then they have a list of things that are covered by that fee. But I think a company like Marriott or Hilton, even within their individual brands, they have different fee structures. The reason why is that because an Extended Stay hotel might have different characteristics or needs and, therefore, what adds value for that hotel, there might be different fee requirements from a Hampton Inn, for example. That’s just one thing to note.

{audio:0:38:23} Often, you’ll see hotels separate out the sales and marketing and distribution fee, separate from an IT fee or something like that. You might have three or four fees tied into it. Then it can get really complex. There are fees that hotels will do, for services on behalf of the hotel. For example, let’s just say that individual hotels are usually not very savvy on search engine marketing. Someone like Hilton or Marriott will say, we’ll do your search engine marketing for you. You give us whatever money you want and we’ll do it and maybe it will be a small profit margin, because Hilton and Marriott, again, will benefit from that hotel being full, through the license fee. Or call centers; so when you call a hotel and the front desk agent is busy, attending to the guests, that will get transferred now, typically, over to Hilton or Marriott and there is a fee associated with that. Those are fees for services that the brand is offering, on behalf of the hotels, to help them operate or perform better.

{audio:0:39:35} There is a mixture of things that are done, on behalf of the system and then there’s stuff that is done on behalf of the individual hotels. Essentially, you’re outsourcing that business, as a hotel owner and saying that you are just going to let the brand system take care of that for them.

{audio:0:39:50} I’ve seen some of the chains increase the royalty fee, over the last few years. How do you look at the cap of that fee and what works, in terms of the unit economics, at the franchisee level?

{audio:0:40:09} It’s a very good question; what’s the right fee? I think the leaders in this space are saying, okay, if that hotel was an independent hotel and it moves over to my brand, then first of all, I’m adding a bunch of value. The lenders are going to see that value and they’re going to give me a better deal on financing and the buyer who buys that property will also suddenly see additional value, so they will be willing to pay a higher capitalization rate of how you value that hotel. Therefore, the brands look at those factors and they say, hey, before they were charging 4% and I’m worth a lot more than that because, as soon as they join my system, that hotel is going to perform better, with lower debt service and their cap rates are going to go up. Therefore, I’m a lot more valuable and over time, they’ve come up with that number which is 5%, 5.5% or 6%. Then people in the franchise space look at the leaders and they say, well they’re at 5%; I can easily charge at least 4% and offer a discount to those guys, at my relative performance. For the leaders in this space, that’s how they’re thinking about that franchise rate. They’re trying to argue that they’re adding value.

{audio:0:41:43} There is also supply and demand. The big guys, in particular, are seeing a lot of demand, even at that 5% rate. If they feel as if they can get away with it and you continue to drive unit growth, then it makes sense for them to continue to charge that, or even consider escalating it. In a case like Hampton Inn, where you already have 2,000 Hampton Inns, in the US, and you might say, I only have space for about 300 or 400 more and so I need to make this even more exclusive. One of the ways to do that is, obviously, to get the best location, first of all but then the second thing might be considering the ability to drive up their rate, even further.

{audio:0:42:26} Do the franchisees refinance when they convert to the brand and actually get a lower financing cost, on the property? I’m just trying to think of the leverage at the franchisee level and how they think about financing the building.

{audio:0:42:45} I’m often thinking about it from the new construction standpoint. As you’re building a new hotel, it’s much easier to go out to a lender and say, hey, this property has never existed before. You have to trust me that’s it’s going to work and the ‘trust me’ is the link with Hilton. I think, in a conversion, it ends up being a little bit different because there is an operating history around that building. It’s a slightly different experience for the lender because it’s less of a ‘trust me’ and more of, these are the statistics. If you were to refinance, first of all, there are probably clauses, within the lender document that say, if you’re going to tie this building up with additional obligations or change certain things, there is going to be a discussion with the lender, around that.

{audio:0:43:37} It was a good question, though. If you had existing property that was independent and then you were to go branded and you were at 6%, could you get it down to 5%? I think you could probably make that case but I also think it would be on a very localized basis. It could be dependent on where you were at before with the building, versus where you are at with the conversion.

{audio:0:44:01} Do you have a sense of the leverage at the franchisee level, in the system, for the big chains? How leveraged are they, especially today, given the Covid issues? How can they withstand these pressures?

{audio:0:44:21} Typically, for an individual hotel, you have maybe 50% to 60% mortgage, through a traditional loan and then you may have an additional 15% to 20%, through a mezzanine financing vehicle. That’s just for an individual property. If you’re a REIT, the REIT, real estate investment trust, they may do things differently. They might do things more on a portfolio basis. Sometimes they do it on an individual basis. They also have access to different levers, in that they can float bonds and stuff. It’s not necessarily a mortgage; there could be other factors. There are more options out there.

{audio:0:45:14} There are two big differences between now and a 2009. Firstly, we’re not in a financial crisis, where the banks themselves were the ones that were having the issues. Right now, as hotels aren’t getting the business that they used to, they are able to go to lenders and work things out. Maybe they rework the loan; maybe there’s a forgiveness of the payments for three months. The banks can take that hit. Whereas before, when the banks were stressed, it’s a whole different issue because you can’t refinance something if your mortgage is expiring and you go to the bank and say, I need to refinance. Today, you can do that, but then you couldn’t.

{audio:0:45:58} The other thing is, I think people have learned from 2009. There’s a lot of scars. People said, we have this hotel; we need to be prepared. There’s some people that are either inexperienced or, for whatever reason, caught off guard, but lenders and owners, generally speaking, were in a better position this time around than they were in 2008.

{audio:0:46:25} I would just say one more thing. I sometimes hear this, but I think it’s a big factor, which is that the cycle is very long. Typically, an economic cycle, especially in lodging, is about seven years. We were 11 years into this cycle. Anyone who did anything in the hotel business, over the last four years, should have known that we were really long in the cycle and that we were due for a hiccup. Obviously, no one predicted a pandemic, but they would have said, there’s going to be some economic downturn. Therefore, they were at least better prepared than if it had happened three years into the cycle.

{audio:0:47:05} How have you seen the underlying profitability of the owners change, over the last decade or so? Are these franchisees actually earning more cash profit, in certain brands or sectors of the market?

{audio:0:47:21} First of all, I think hotels have become smarter in how to drive profits. In particular, you see a lot more limited-service hotels being developed which, by nature, they’re very low labor costs. If you build a Hilton Garden Inn or a Hampton Inn – again, I don’t mean to dote on Hilton; there are other great brands out there – the economic and labor model is very low cost and so you have a higher margin. By that nature, you might say, the numbers are getting better.

{audio:0:48:05} However, you’ll still talk to owners, especially in the last three or four years, and they would say a couple of things. Number one, the brand costs continue to creep up. What they mean by that is, what are the brands requiring you do for a loyal customer, in terms of upgrades or free breakfasts. I think there’s been a little bit of an arm’s race to drive loyalty and, therefore, their costs often get pushed onto the owner. Certain owners will complain that that’s been issue. The other issue is that you have creeping commission costs, whether that be more OTA business or, especially in the group business, there is group intermediation; there are third parties that do group bookings and you have to pay commission to them, so I think commission costs have gone up.

{audio:0:48:56} The last thing is labor costs. We see this in most cities, where people want to drive up the minimum wage. There might be valid reasons for that but then hotels just need to think through, how do we manage that increase, if the minimum wage goes from $9 to $15 and you’re dependent, heavily, on hourly workers, that impacts your costs. I think, if you talk with individual hotel owners, especially full-service owners and luxury owners, they might claim that there has been a lot of cost creep and, therefore, it’s been harder for them to manage their costs. But if you look at the industry, in general, we’ve actually seen really good profitability numbers, just because of that shift towards the lower operating cost hotels.

{audio:0:49:44} Do you see a risk of post-pandemic fees coming down or slowing down the growth or maybe the hotel franchisors helping the owners more and giving back some of the profit pull to the owners? How do you see that evolving?

{audio:0:50:09} I think you will see two things. Number one, especially for the big chains but I think all franchisors, such as Hilton and Marriott, they’re going to try to figure out, how do we help our hotels and they want to show that they’re good partners. So the first thing they need to do is cut their own costs which are, as I mentioned, those centralized services that they are doing on behalf of owners. Those owners now don’t really need those call center businesses, for example; it’s way down. So they need to reduce their call centers or even the need for detailed revenue management. They’re trying to bring down a lot of those variable costs, as well.

{audio:0:50:50} What I think you are going to see in near term is that hotels might say, hey, we could forgive your franchise fees or forgive a couple of percentage points or rebate you some amount, or they’ll just postpone payments and say, don’t worry about paying the franchise fees for six months. There’s going to be all sorts of different flavors of that but people will help, on a temporary basis. I don’t think fees are going to come down, but I do think that all of the chains have to take this opportunity to relook at their costs and say, are the costs that I have adding value? Where can I drive more efficiencies? I think, to myself, there needs to be more automation.

{audio:0:51:40} As I think about a quality assurance process, which is, is that hotel following all these standards, how do you make that more automated, where you don’t have to have a quality assurance person flying out to that hotel, twice a year? I think there is going to be a little bit of looking at the cost base. It could also be marketing. How much are we doing for brand building, versus how much are we doing in digital, trying to figure those pieces out. There’s going to be a mixture of that, just trying to really press the brands to justify the fees that they are charging.### {audio:0:52:16} I guess, the cost of it depends on the growth in demand in travel and ADRs and occupancy, across the system. Given the leverage and that that the management contract is subordinate to the interests on the debt that finances the hotel, it seems as if, unless we get a certain level of occupancy, it’s going to be hard for the franchisors to get back to that level they were earning at, in the next 18 months or so?
{audio:0:52:56} Absolutely. The percentage will stay the same but the dollar amount will be lower. They’ve been through this before, in 2009 and 2010. I think the big difference between now and then was, back then, business got hit, but a hit is a 30% drop in RevPAR and now we’re looking at a 90% drop in RevPAR. I keep getting this question around what is a fixed cost and what is a variable cost. What that looked like in the last 10 years or even in the last downturn, is very different from what it looks like now. This time round, people are looking at fixed costs as variable costs. They’re saying, we just can’t do things that are base or normal. Now, you have general managers, at hotels, acting like front desk agents. You would have thought a general manager was more of a fixed cost but now, he’s spending time checking in guests. People are doing all sorts of things, just to survive.

{audio:0:54:03} I do want to bring up one other point which is, I think, where you may be going with this. At the property level, if you think about breakfast, I think there is a standard around what the breakfasts look like and I think brands are going to have to back away from some of those requirements that they have. Firstly, it’s the safety issue and, secondly, how do you get people to come back to work? If you have a really low occupancy, that breakfast is suddenly going to cost you a lot more. If you are an 80% full hotel and you have a buffet, sure, everyone is coming in and eating from that and it makes more economic sense. But if you’re running at 40% occupancy, to have the staff and food and beverage costs, suddenly, it doesn’t make much sense. I think there’s going to be an adjustment, by the brands, in terms of what the requirements are, at the hotel, at least in the near term, until we get back to some type of occupancy that makes some type of normal economic sense.

{audio:0:55:02} I was pretty shocked that in the Q1 earnings for Marriott, the CEO mentioned that the cash break even, for select and full service hotels is actually 30% and 40%, respectively, which was much lower than I expected, where you can actually break even at relatively low occupancies. I think they are keeping some hotels open, because when you get to a certain occupancy, you have a certain amount of fixed cost, where it is almost more expense to close the hotels than keep them open, at a very low occupancy level?

{audio:0:55:40} I think that 30% to 40%, I roughly believe those numbers, but a lot of that has to do with hotels that are not in a poor, urban, downtown environment, like New York City, where the break-even costs might be a big higher, because of the real estate costs and the labor costs. If you think about opening, it’s going to be much easier to open up a hotel that’s in a suburb or along a highway, where your break-even costs are much lower. In a city, like New York City, hotels might be more hesitant to open up, because once you get the labor back in there, there’s less flexibility and so the break-even point is just a little higher. Therefore, it might be a little bit more of a challenge. The last thing you want to do is open up a hotel, have it open for a month and then have to do the whole furlough and shutting down again. That would not be the most cost optimal way to do things.

{audio:0:56:46} Is there anything that you are worried about in the system or, more broadly, with the hoteliers today and the travel landscape?

{audio:0:56:55} Obviously, the biggest concern I would have, especially if I was a hotel owner, is that the question is, will the virus flare up again and what will be the government’s response? Even as we talk, it’s June 4th right now, and you’re starting to see cases tick back up. One might argue, that was expected but the question then is, if that was expected, what’s the threshold to say, we need to start shutting things down. I think that is the number one concern.

{audio:0:57:33} The concern that I worry about is, especially for markets either in urban downtown markets or resort markets in Hawaii, is how do you get people travelling again? I think the confidence around that could take a very long time. There’s a lot of concerns, right now, around demand but I think the hotel industry has been very innovative and they’re trying to do all the right things, in terms of reducing costs. The only other thing that I worry about a little bit is, what is the damage that’s been done to the hotels, in terms of furloughing or laying off employees and they say, I just don’t want to go back to the travel industry. I’m going to work for Amazon or some other thing and I don’t feel the security, anymore. I love being in the travel industry; I’ve been in it for most of my career. I love serving people and I love the aspects of travel. I think there are a lot of people that follow my line of thinking too and that’s why they’ve been in this industry for a bit. But I do worry that we may lose quite a number of people who just see this industry as higher risk than it has been in the past.

{audio:0:58:49} How do you look at the relationship between the large chains and the OTAs, like Booking and Expedia?

{audio:0:58:59} The OTAs add value in the industry, especially for that long tail of customers who don’t know exactly where they want to book. The OTAs have replaced the search around, to figure out what you want to do, especially if it’s in a market that you haven’t been to before. You want to look around and say, hey, what’s going on? I haven’t been to London before and I need to know where do I want to stay, what are people saying? I think the OTAs provide an immense amount of value for that, not only in breadth of options, but they also add value because of the look to book. There’s a ton of people looking and they are paying these hotels. The hotels’ technology infrastructure often can’t handle the volume of look to books. It’s something that’s not often talked about, in the industry. But if everyone searched on Hilton, for example, or even a smaller hotel chain, the way they look on Expedia, then the Hilton or long tail chain websites would just crash. So they have provided this technology aspect.

{audio:1:00:10} The other thing that the OTAs are very good at is content. You often have really good photos, you have good reviews, right on the website. Unfortunately, although the websites of the chains and the individual hotels are getting much better, you still see, at times, better content on the OTA website. The OTAs play their role. They’ve, obviously, driven a lot of business which then concerns owners, because if you are an owner and you’re paying a franchise fee and then you’re also paying the OTA fee, it feels like a lot of money. Owners speak up to the chains and say, hey, this is too expensive. The owners may also speak up to the OTAs and say, hey, the 20% commission is a high commission rate. I think there’s a little bit of a love/hate relationship with the brands and the OTAs as I think, ultimately, deep down, all the CEOs understand that the OTAs add value; there is a partnership there. The question is, there is a lot of grey area, in terms of how they partner. The frustration is really over that grey area.

{audio:1:01:26} When I say grey area, number one is, the transfer of customer information, so maybe we could turn them into loyal customers. Again, Expedia and Booking have certain techniques to try to partner with hotels, in terms of data sharing. It’s not like the OTAs haven’t done anything; there is some effort there. The other thing that is a big stressing point is, who is spending money on Google? If you have an individual hotel and if the OTA is bidding on some keywords that the hotel feels that’s their hotel, they’re basically driving up marketing costs. That’s another source of frustration. There are other sources of frustration but the question is over this large grey area of dispute that, I think, will simmer for as long as there are two separate entities. I don’t think that’s going to get resolved in the near term.

{audio:1:02:26} Do you think that the independents have the digital infrastructure, the know-how, the capital, to bid directly on those keywords, on Google, for example, through these companies that pop up, like TravelClick or these solutions that aim to provide that scale, for smaller independents?

{audio:1:02:50} There are two comments on this. Firstly, the independent relationship with the OTA might be very different because, if you’re paying the commission to an OTA, and you get a lot of business through them and that saves you money, versus being part of a brand name, you might not look at that commission as that bad of a thing. I think if you are an independent hotel, one of the frustrations is the gap between an independent hotel commission and a branded hotel commission. The OTAs have to continue to work on explaining the justification for that gap.

{audio:1:03:25} I think the other problem that you have, as an independent hotel, is if the OTAs change their search algorithms or how the hotel is presented and that suddenly hurts their business, that can be very bad. The thing with a company like Hilton, is they’re not a marketplace. They provide a very consistent look and feel. The demand from the customer is not going to change, dramatically, based on something that an OTA is going to do. Whereas on the OTAs, you can see a sudden change, based on where you end up in the sort order.

{audio:1:04:04} In terms of digital infrastructure, for individual hotels, there’s a company called Cloudbeds out there now, which is very good. They go after long tail hotels and they’re very cost affordable. Basically, accommodation of a property management system and a CRS system, in one. It’s cloud-based; it’s very easy to sign up. The benefit of that starts with the fact that you have a working website, that can handle the volume, that has the right photos, that’s laid out well. That’s going to help you because, inevitably, there’s always going to be people who search on OTAs, but they might want to book direct. If you have that quality, direct booking experience, that’s going to shift some of that business away from OTAs and towards your independent hotel.

{audio:1:04:52} The second thing is, that these guys bring some distribution capability. So now you can be present on multiple websites which, again, also drives people to booking direct but also might diversify where you get your bookings from. So those are just a couple of examples but you’re exactly right. Whether it’s TravelClick, Cloudbeds, Mews, which is a smaller company, but there are emerging players that are trying to address the long tail.

{audio:1:05:22} Do you think it’s a risk to the OTAs, such as Booking and Expedia?

{audio:1:05:30} There’s a number of risks to the OTAs. This is probably a small one. The reality is, the market is very big and I think that the OTAs have ways to continue to grow. I think the market is going to continue to grow. It’s hard to say. We have this Covid situation going on, but let’s take out the Covid situation, in the long term. People love to travel. The wallet share of travel has increased, over the last 10 years. I do believe, assuming we can get Covid under control, we will continue to see growth in travel. I think there is still room for the OTAs to continue to grow. Sure, on the margin, if you could just get rid of all of those websites and direct bookings and you just had the OTAs, the OTAs would be bigger. I think, probably, the OTAs take that into account, when thinking about their forecast and their numbers. Everyone is going to try to drive some direct bookings and that makes sense and I don’t think they’re going to have any issues with that.

{audio:1:06:34} What do you think is the major risk to the OTAs then, if this is a relatively smaller one?

{audio:1:06:40} I think the big question is, down the road, what’s the value of OTAs and what’s their core value proposition? The issue that you have, in particular, with Google, being the top of funnel is that Google has decided to create more and more travel products. Those travel products allow you to search and dream, much like you would on an OTA. They also have a breadth of hotels. There’s a lot of arguments that can say that the Google experience, there are elements of that that it’s a not the same as the OTA experience. For example, I mentioned before, the ability of looking at content. The OTAs have demanded that the hotels provide them with three photos of every room or something like that. There’s that consistency and the knowledge of the OTAs that Google doesn’t have. But still, there are a number of bookings that, probably, can start with Google and then go directly to the websites. There’s a big threat of, where it’s at now. There’s also this threat of where it’s going.

{audio:1:07:50} You’re starting to see Google have this ability where they have your profile, they have your credit card information, where you can search for a hotel and it will say, you are interested in this hotel, click here and then Google will send your credit card information and your name and all that profile information, directly to the hotel and you will end up getting booked by the hotel and you never leave the Google experience. I think there’s a bunch of reasons to say that we should be concerned about Google.

{audio:1:08:20} I think there are ways that the OTAs can combat those threats. Part of that is that the OTAs have to just find ways to put the pressure on product innovation. For me, one of the things that I think is missing is, what I wish I would have, whether it was Hilton or Google or Expedia, for example, they should know who I am. They should know that I travel every year, at Thanksgiving, to a certain city and they should know which hotel I like to book. They can have that more customized experience. You see a little bit of that, on Netflix; you’ve watched these things, this is what you’d probably like to watch next. There should be some more intelligence around the OTA platforms. I think the OTAs are in a unique position to do that. I think the chains will take longer to get there and they also just don’t have the breadth of inventory and the knowledge about my flight patterns and my rental car patterns and all that other stuff. I think there is a big opportunity for the OTAs there.

Hilton Brand Strategy, Loyalty & Distribution

How Hilton built a portfolio of brands for all market segments

How hotel loyalty schemes are moving from simple frequency plans to full customer experiences

Hilton Brand Strategy, Loyalty & Distribution

Former Global Head of Corporate Strategy at Hilton Worldwide

inpractise.com/articles/hilton-turnaround-loyalty-otas

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Mark Morrison

Former Global Head of Corporate Strategy at Hilton Worldwide

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Hilton Brand Strategy, Loyalty & Distribution(June 4, 2020)

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