Hotels in the Age of Innovative Disruption

Nicholas Vasseghy December 2023

The contemporary hospitality industry can be traced back to the 18th century when Europeans embarked on tours across Europe. However, the roots of the travel industry extend even further back in history to the existence of Caravanserais along the Silk Road during the Achaemenid Empire, which emerged around 550 BC or possibly even earlier. The hotel franchise model experienced significant growth in the first half of the 1950s, a period characterized by a robust expansion of the US economy, marked by a remarkable 37% growth, and a substantial 30% increase in the purchasing power of the average American family. This economic prosperity was further bolstered by a sharp surge in automobile ownership, with over 50% of American households acquiring cars during the 1950s. Additionally, the cost of gasoline remained quite affordable at just 27 cents per gallon. This confluence of factors, including increased disposable income, widespread automobile ownership, and cost-effective fuel, facilitated a surge in domestic travel, prompting Americans to embark on road trips and explore various regions of the country. Consequently, the 1950s witnessed the emergence of numerous original hotel franchisors.

While the appearance and technical aspects of the industry may have evolved, the fundamental nature of accommodating both group and individual travelers remains unaltered, as does the economic foundation of the industry.

The number of hotels globally: 187,000

The number of US facilities classified as hotels: 65,000

Low-End Market Disruption

The travel industry witnessed the emergence of New Market Disruptors in the mid-1990s, primarily in the form of online travel agents (OTAs). It is important to note that these disruptors did not fundamentally disrupt franchise systems, although they did exert some influence on them. Instead, their primary impact was on the booking channels within the industry. OTAs also effectively cultivated an entirely new market by targeting untapped segments of society that had traditionally not engaged travel agents. This novel demographic found the convenience and user-friendliness of online booking to be highly appealing. Moreover, they not only paid no commissions or fees to travel agents but often secured more affordable room rates through these online platforms. Without a doubt, within a span of a decade, Online Travel Agencies (OTAs), which initially emerged as low-end disruptive innovators in the travel sector, succeeded in displacing traditional travel agents from the market. Nevertheless, their innovative strategy, characterized by shifting operational costs to hotels, coupled with imposing higher commission rates, engendered discontent among hotel proprietors and franchisors. This discontent persisted despite the fact that OTAs, particularly in their initial stages, primarily targeted non-consumer segments, thereby generating supplementary revenue for the hotel industry.

By 2010, online travel agencies (OTAs) expanded their market presence beyond newly established non-consumer segments to include existing traveler segments. This strategic expansion caused hotels to perceive OTAs as a direct threat to their revenue streams, although it's important to note that while there was a correlation between the presence of OTAs and changes in the hotel business, causality was not established. This perception prompted hotels to take action to safeguard their financial interests. The established incumbents implemented various strategies, making use of their existing resources, processes, and profit models, to counter the disruptive entry of these new market players.

After conducting an analysis of multiple case studies, the foundational principles of Disruptive Strategy elucidate why this approach may prove ineffective. Core businesses face formidable challenges when attempting to reallocate entrenched resources, modify well-established processes, and apply traditional profit formulas to counter the dynamic and swiftly evolving landscape of new market innovations.

Online Travel Agencies (OTAs) represent just one facet of disruptive innovations within the travel industry. A multitude of new market entrants have emerged, augmenting the travel sector, expanding the scope of the traveling market, and providing significantly enhanced services to consumers. These novel innovations have substantially increased the dimensions of the hotel industry, contributing billions of dollars to its overall size. Franchisors perceived Online Travel Agencies (OTAs) and other emerging market entrants as potential threats. Various franchisers adopted a spectrum of strategies to address these perceived challenges, ranging from nuanced and adaptable measures to more robust and restrictive actions. These strategies encompassed establishing competing enterprises against the entrants and implementing restrictive and punitive franchise regulations.

The “Combatants” ?hastily integrated the new modular businesses into their core operations without effectively evaluating and managing their businesses' interdependency or modular architecture. This oversight led to revision in their established profit formula, misplacing the resource allocation, skating away from where the money was. Simultaneously, certain franchisors initiated the integration of day-to-day operations of independent franchisees into their core business operations. This integration was achieved by implementing new rules, regulations, and fees. This divergent approach deviates from the conventional franchise-franchisor relationship business model and, furthermore, contradicts the principles of a free-market economy.

Nypro’s NovaPlast case study is the perfect example of this approach. The substantial shift of over one trillion dollars in business from hotels to OTAs within the span of a decade serves as compelling evidence that the integration of dynamic modular businesses into well-established core operations and mandating prohibitive rules on hotels is an unsuccessful endeavor. Essentially, franchisors are attempting self-disruption. Several hotel operators went beyond the minimum requirements stipulated by franchise regulations, demonstrating a reluctance to embrace innovative management techniques, even in light of the clear productivity gains associated with new tools and methods. As a result, this approach has led to a larger portion of the market share being redirected towards emerging market entrants. Hotels adhering to this pattern are currently observing a decline in key performance indicators (KPIs), particularly with regard to the revenue index.

The result of this approach is evident: as per Phocuswright Research, Online Travel Agencies currently account for over half of online leisure sales in the hotel industry. Furthermore, according to Amadeus, OTA bookings are projected to reach 239 billion in 2025, compared to 146 billion in 2019.

Franchisors’ Job to be Done???????

The hotel franchise business model relies heavily on brand recognition and reputation. The franchisor is responsible for enhancing, maintaining, and improving these critical elements, while the franchisee pays to secure this public recognition. With the rapid proliferation of hotel brands in recent years, the task of franchisors to foster brand reputation and recognition has become significantly more demanding than in previous times, especially when their focus is divided by Online Travel Agencies. As demonstrated through case studies such as GM's OnStar, EMC's CLARiiON, and Godrej Group's Chotukool, hotel franchisors may find it necessary to integrate or acquire new innovations into their core business, but only after the modular business has independently evolved and grown to a stage where integration is feasible, aligning with profit formulas. Otherwise, the existing core business processes can impede, if not outright obstruct, the successful assimilation of new innovations into the core operations.

Challenges, Opportunities, and Takeaways!

1.???? Disruptors are Opportunities:

Disruptors often present opportunities long before they become threats, yet franchise companies tend to overlook this window of opportunity.

2.???? Resisting Innovations:

Franchisors frequently exhibit resistance to embracing innovation. But when the core business does accept certain innovations, it often integrates the modular business hastily, lacking the right resources and processes. It is advisable to refrain from integrating or acquiring innovative businesses into the core business until they have established desirable profitable formulas.

3.???? Imposing Rules:

In response to new market entrants, franchise companies imposed rules and regulations, diverging from the traditional franchise/franchisor model.

4.???? Franchise Commoditization Formula (FCF)

The FCF, a long-standing performance benchmark, was set aside as resources were redirected toward emulating and integrating disruptive innovations.

5.???? Monitor and support new market entrants

This path can be a cost-effective and pragmatic strategy, transforming potential competitors into future allies who may eventually merge with or be acquired by the core business.

6.???? Franchisors' Primary Objective

The foremost goal for hotel franchisors should be the enhancement of brand recognition and reputation, as these attributes constitute the intrinsic strengths of franchise systems that have proven resilient against the efforts of new market entrants. It is vital to recognize that this strength can be eroded when the public recognition of brands is compromised. Under such circumstances, the potential threat posed by new market entrant franchisors or other innovators will surpass that of OTAs. It is worth noting that numerous emerging small brands have encountered challenges in their growth trajectories, mirroring the difficulties faced by several European brands seeking to establish a foothold in the US market, only because American Brands are still generally strong and the franchise companies excel at seeking and exploring new and emerging ideas.

7.???? Travelers remember the hotels, not OTAs

Despite changes in the industry, the core business, where the primary revenue lies, remains centered around brand recognition, which holds greater weight than OTA booking channels. Travelers tend to forget which website they used for booking but remember the hotel, their experience, and the brand for a considerable duration. Travelers continue to rely on established brand names regardless of their booking channels.

8.???? New Market Travelers

Data from the United Nations World Tourism Organization (UNWTO) revealed a significant increase in traveler volume during the 2010s when OTAs gained momentum. European traveler volume, for instance, increased by approximately 140 million from 2000 to 2010 and by 250 million from 2010 to 2020. The one-trillion-dollar revenue shift from hotels to OTAs was primarily driven by OTAs themselves, creating a new segment in the process.

9.???? Low-End Disruptors vs. Traditional Travel Agents

While franchise companies may perceive low-end disruptive innovations, such as OTAs, as potential threats to their sustaining business, this outcome is only likely if these disruptors are in the same business category. In reality, OTAs are not disrupting franchise systems; they have effectively replaced traditional travel agents and, along with other innovators, have contributed to the overall business volume of hotels. Hotel franchisors often allocate resources to manage OTAs and other innovative entrants that do not pose a threat to the franchise model. Consequently, fewer resources are available to enhance or maintain brand recognition.

10. None Franchise Brands scoring higher than Franchise Brands

A limited survey conducted by Daryon Hotels International asked travelers to rank hotel brands based on recognition, including a few independent hotel names as reference points. Surprisingly, some non-franchised names scored higher than established brands, a finding that should raise concerns for any hotel franchisor.

Lastly

One of the fundamental tenets of the Disruptive Strategy is “ You can’t disrupt yourself.” Nevertheless, there exists one exception: when a business is teetering on the brink of insolvency or facing a hostile takeover, it may become imperative to summon the courage to disrupt the business by enlisting innovative market entrants who possess the capacity and vision to comprehensively overhaul and reinvent the business.

Western Union and Dunkin' Donuts heeded this call to action, resulting in their ability to adapt and thrive. In contrast, companies such as Kodak, Blockbuster, Toys 'Я' Us, and numerous others failed to undertake this necessary disruption. ?Avert Kodak Moment for your business!? Disruptive Strategy might be the key.