Is COVID19 the Cure for Hotels' Long-Term Illness?

The travel industry has been devastated by the COVID19 pandemic. Empty hotels, airplanes, highways, restaurants, and cruise ships marked the crushing end of what had been a 10-year growth cycle. While hotels have begun to recover (USA occupancy flirted with 50% over the July 4th holiday weekend), most hotels are still operating below breakeven, and more than 10% remain closed. CBRE, the leading real estate industry analysis and brokerage group, predicts that hotel RevPAR will take more than two years to return to pre-COVID performance levels.

Even while the worst part of the economic slump continues to cause problems for owners and operators, the survivors of this period are positioned to enjoy what should be the most profitable operating environment in 20 years. The reason? Cost structure reform. The traditionally high-margin lodging sector saw a steady erosion of operating profits since the late 1990s - the result of costly amenity wars between brands, rising distribution costs, and a tight labor market. Cash-on-cash returns for hotel investors dropped by as much as ten percentage points from the late 1990s through 2020 - a function of both operating margin declines and capitalization changes. The gift of COVID19 should be profound in the form of a vastly improved operating model combined with a resetting of inflated hotel asset values. Here are three areas where operating margins will improve because of the deadly virus:

Distribution costs will stabilize

Since the first hotel booking took place on Holiday Inn's website in 1996, the Internet revolution has driven up the cost of filling a hotel. Online intermediaries blew up the ancient travel industry commission model and created an environment of significant dependency, especially in major markets, which gave pricing power to a few major players. In recent years, the combination of coordinated negotiation efforts by hotel chains, the introduction of pseudo-direct booking offerings from Google and TripAdvisor, and the creation of loyalty member rates on direct websites has helped.

Coronavirus has created an additional opportunity to restructure distribution deals. OTAs like Expedia and Priceline have been devastated by the pandemic. As much as travel suppliers need bookings, these companies need them even more since, unlike brand franchisors, there are no "base fees" to fall back upon. Smart independents and the big brands should jump on this situation to renegotiate terms with the big OTAs and consider anew their direct booking efforts. Reducing the cost of 3rd party distribution by even one percentage point will have profound impact on GOP (gross operating profits) and needs to be a priority.

Elimination of costly Food & Beverage programs

In the select service category, hotels have seen significant increases in the delivery costs of free breakfast programs. These costs have accelerated the development of upper-midscale and upscale select service brands and independent alternatives. In the post-COVID19 world, the open buffet and breakfast bar is likely going to be gone forever along with many of its major cost elements. "Hot proteins" have become a staple of the Hampton Inn/Holiday Inn Express/Fairfield category over the past 10 years. These items, which include egg and meat options, generally require human preparation and have a short shelf life. The combination of added labor and waste associated with a non-revenue offering is a perfect profit drain. For the most part, we expect that these items will disappear from breakfast offerings, to be replaced with shelf-stable prepared foods, fruits, and packaged goods. Signature items, like pancake machines and "fresh" cinnamon rolls, are likely to be replaced by other, less labor-intensive offerings that eliminate the health risks of the hands-on treats.

During COVID19, hotels have begun experimenting with substitutes for their old free breakfast programs, including "grab & go" solutions. Dining rooms, currently closed, will re-open but may benefit from more seating space as serving area requirements are reduced. Although certain travel segments such as youth sports guests will lament the loss of a more "complete" breakfast offering, both safety and economic proponents will celebrate the changes that will take place in the years after this virus.

If the brands are paying attention, they will find new, more sustainable ways to differentiate their F&B programs. Everyone suffered during the "breakfast bar wars" of the early 2000s (other than the guests), so COVID19 has created an ideal opportunity for a reset/redesign that, if handled properly, can ensure a much more profitable hotel operating model for the next decade.

Labor costs will become labor investments

The biggest operating line item in any hotel is labor. For decades, hotels have tolerated a lot of inefficiency in their labor models. Relatively low wages combined with a plentiful workforce and high RevPAR made, for some operators, labor cost optimization a "nice to have" initiative. In the Coronavirus world, successful operators will have a zero-tolerance program for wasteful labor spending.

Old-school operators, used to re-using staffing models and schedules each week, will be forced by volatile occupancy to adopt variable labor plans based upon operational drivers. Connecting critical PMS (property management system) data with Payroll systems to produce efficient shift schedules is becoming a basic requirement of hotel management. While high unemployment rates may reduce the pressure on wage rates, any wage savings will be lost in a single day if a static scheduling method results in overstaffing compared to the needs of the hotel. Hotel owners should celebrate the death of "schedule like last week" models, and managers will embrace the nimble, mobile-based software tools that have emerged in the past decade which make data-driven labor management both inexpensive and easy to use. PerfectLabor, the award-winning solution offered by Hotel Effectiveness, is already used by more than 4,500 hotels. In most cases, hotels using PerfectLabor have reported sustained savings between 5% and 15% of total labor costs annually as a result of the software.

Labor has always been viewed as an "expense" by hotel owners and operators. In many cases, this expense "just happens" - at least for more traditional managers. In the post-COVID world, enlightened operators will see each day's labor costs as an investment. Like any investment, the expectation will be that there is a defined return on investment in the form of productivity and labor output. A data-driven operational approach to labor planning, scheduling, and management will ensure the maximum productivity for the lowest possible investment - a win-win for owners and operators.

2022 will be a record year

As a result of these three much-needed areas of reform and many other insights and initiatives that arise from the current crisis, the hotel industry is poised for a record-setting boom time. We expect to see profitability metrics for the industry which have not been seen for decades, and the end result will be a renaissance for investors, operators, and guests.