The Rise of Third-Party Hotel Management Companies in Russia

Only a few decades ago hotels were not considered as investment-attractive assets. There were more attractive opportunities available within the real estate sector, with a shorter return on investment period requiring smaller investment. While the real estate market became more saturated, and the economic cycles shortened and shifted, hotel investment started to become more attractive, in its own right and as part of mixed-use properties and entertainment zones.

At the same time, the hotel sector has been influenced by global trends as Tatiana Veller, National Director, Head of Hotels & Hospitality Group at JLL described. “Global hotel Brands are moving away from traditional format, where the hotel is something standardized and the traveller knows exactly what to expect. Hotels have been perceived as a “safe heaven”, particularly in extreme locations. Today, the world is more transparent. There are fewer borders, travelling is part of the everyday routine, and hotels are undergoing a transformation from “home away from home” into “experience”.

The business model of the industry itself is also changing. “To the hotel management companies, - adds Veller, - this means they need to be more flexible and focus not only on management contracts but franchise agreements, as well as alternative arrangements for growing their chains, which historically were not as popular in Russia and CIS, but are now gaining traction.”

With the expansion of the hotel sector in Russia and more knowledge available on the market, franchising has become a more popular concept, allowing investors to run their own properties. Financially, franchising means less fees to the operator. Management contracts are typically very long term with high fees involved. If hiring a third-party management company, the contract period may be much shorter. From the operator’s perspective, to grow globally and expand rapidly, the managing companies need to go asset light rather than own the assets, manage or franchise them. Being a capital-intensive business, outsourcing the flag to an existing property is much easier and minimises the risk.

Pavel Elnikov, Senior Associate, Head of Hospitality and Leisure, Russia and CIS, DLA Piper has explained why the franchise model was not widely used by investors in Russia: “Looking at the average investor's profile in Russia and the CIS, a hotel project would be either the first hotel project in the investor's portfolio, or a result of the diversification of business. Therefore, with very little or no experience in hotel operations, such owners would generally be looking at the management model and only consider franchising as a remote possibility. However, now with less attractive debt financing opportunities the relative number of investors has decreased, while "the quality" of the remaining investors has increased. The modern investor is more profound both in terms of market knowledge and expectations of the financial result. Therefore, all models are being studied more thoroughly. We have seen several recent cases when investors were discussing management agreements with an option of conversion to a franchise after several initial years of operation. They do not exclude the possibility of being more engaged in the management of the hotel and, ultimately, running it themselves, or engaging a local partner who will manage it for them.”

All the operators agreed that while determining Management Agreement Vs. Franchise, most of the owners would choose franchise to save costs. As Aron Libinson, Vice President of Operations and Development, Russia, CIS and Georgia at IHG said: “Very often the owners judge the cost of branding as the only driver for the chosen model and they ignore other elements, such as operational efficiencies, different use of tools and better top line performance that a brand or professionally managed hotel could offer.”  Alexey Korobkin, Senior Director of Development at Marriott International agrees, “The franchise agreement allows the hotel to maximize its revenue in the most cost-efficient way. Whilst management of the hotel and its operations will determine how successful the hotel is at retaining its revenue.”

At the same time, the Russian market is reasonably young and the owners lack of experience to manage hotels efficiently from day-one leads to the need of a third-party management company, according to David Jenkins, Vice President Business Development Russia, CIS, Baltics and Israel, Carlson Rezidor Hotel Group. David Jenkins said: “Often it is the element of control and of course the business type of the investor. Family businesses often want to franchise as it is a way to have children involved in the business etc. Corporations usually want distance hence management rather than franchise.”

Alexis Delaroff, COO, AccorHotels Russia, Georgia & CIS confirms: “Hotel business is becoming more and more sophisticated and complex, and in my view only experienced Operators and General Managers can cope efficiently with such a task.”

When choosing a business model, the investor needs to fully understand the pros and cons. Franchising gives more opportunities if the investor is ready to learn the business or engage a third-party operator, but at the same time it presumes responsibility for running the business and an investor cannot expect the same level of support from the brand as it would receive under a management model. Management agreements are not as flexible, and in such rapidly changing world, it is essential to be able to quickly adapt to the new business.

With the millennial generation growing, there is no such thing as customer loyalty. Customers’ behaviour is changing, technology is progressing and competition from alternative accommodation is increasing. Hotels need to be able to adapt and adjust quickly to provide a safe long-term investment.

Therefore:

• What would be the mix of management and franchise agreements in Russia and CIS?
• Who are the loyal customers of the brands in the future?
• Do hotels need to adapt and be seen as an easily adjustable and advanced product and hence, a safe investment for long-term perspective?

Pavel Elnikov will lead a session, next week, at the Russia Hotel & Tourism Investment Conference to discuss these issues. He’ll be joined by Tatiana Avdoshina, Business Development Director and Deputy General Director, IFK Hotel Management; Maxim Khoroshenkov, President, Cosmos Group, LLC; Alexey Korobkin, Senior Director of Development, Marriott International and Vadim Prasov, Vice-President, Federation of Restaurateurs and Hoteliers of Russia; Managing Partner, Alliance Hotel Management.

For more information, please join us at Russia Hotel & Tourism Investment Conference, taking place 24 October, 2017 at the Radisson Blu Belorusskaya.