Although the U.S. lodging industry as a whole has grown substantially in the past twenty years, a nota- ble shift has occurred in the distribution of rooms. Long-standing chains have been eclipsed by newer brands, and most of the growing brands operate mid- scale limited-service hotels or upscale and above. Midscale hotels with food and beverage and econ- omy chains, as well as independents, have seen reductions in market share and absolute room sales, even though these groups all have more rooms to sell. The lesson is clear: hotel brands must constantly reinvent themselves and work to appeal to new demographic groups.

Keywords: U.S. lodging supply and demand; hotel brands; independent hotels; market trends

T wenty years can seem like a lifetime in the hotel industry. In that time, a hotel could be built, prosper, decline, and be renovated or removed

from the supply. Smith Travel Research (STR) has tracked the hotel industry performance during that time, and we have an unmatched view of the winners, losers, fads, and legacies the industry has produced. This perspective allows us to comment about inter- esting trends and look for nuggets of insights in our mountain of data.

It seems the past twenty years have particularly seen changes to the “legacy brands,” the hotel chains that have been the backbone of the U.S. lodging industry since the 1950s. This is particularly true of midscale hotels with food and beverage and the econ- omy segment. The data presented in this article will

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demonstrate why it is important for brands in these segments to continue to reinvent themselves and why it is important for brands in other segments to pay attention to what we observed or risk experiencing the same fate—namely, the headaches that come with a shrinking piece of the reve- nue pie.

For the purposes of this article, I divided the U.S. lodging industry into three groups:

• Group 1: The luxury, upper-upscale, upscale, and midscale-without-F&B (food and beverage) chain scales

• Group 2: The economy and midscale- with-F&B chain scales

• Group 3: Independent hotels

While group 1 has some legacy brands, a substantial number of new brands popu- late those four segments, as the bulk of new construction in the past twenty years has taken place in this group. Group 2 tends to have more brands that have faced challenges time and time again during the forty, fifty, or sixty years they have existed. In short, many of the advances in market share of group 1 seem to have come at the expense of the share of properties in groups 2 and 3.

Analyzing Supply Comparing the breakdown of supply and

demand for the three groups provides the first interesting point of reference. In 1989, group 1 represented 21 percent of supply, group 2 represented 35 percent of supply, and group 3 represented 44 percent of supply.

In 2009 that breakdown was substan- tially different. Group 1 had 41 percent of supply, group 2 owned 27 percent of sup- ply, and group 3 constituted 32 percent of supply. This means that during the past twenty years, more than 80 percent of the net room growth has taken place in group 1. Remembering that many rooms have closed

during that time or converted to another segment, this does not mean more than 80 percent of the new construction took place in group 1 but, rather, that the total effect of building, closing, and converting have resulted in this supply transformation.

What is even more dramatic is that, even though groups 2 and 3 have reduced sup- ply share substantially, there are about 1.6 million more rooms in the industry now than there were in 1989. Group 1 has added almost 1.3 million rooms, while group 2 has added about 180,000 rooms, and group 3 has added about 100,000 rooms.

Analyzing Demand From a demand perspective in 1989,

group 1 had 22 percent of the demand, group 2 had 35 percent, and group 3 owned 43 percent. Thus, twenty years ago, the demand share realized by each of the groups was remarkably similar to the supply break- down. It is easy to see where all the demand growth of the industry lies. There has been a transformation intuitively observed by many, but the dramatic nature of the shift is lost until you scrutinize the numbers.

Equally as dramatic is the corresponding demand number change on an annualized basis. Demand in group 1 has increased by about 750,000 rooms on a daily basis, while group 2 is selling 28,000 fewer rooms a day than twenty years ago, and group 3 is sell- ing 54,000 fewer rooms a day than it did in 1989. While these are annualized numbers pulled during a downturn, it stands to rea- son that the impact would remain extremely dramatic regardless of the health of the business cycle or when the industry begins to experience an uptick in business.

It is astonishing that two segments that represented 80 percent of the room supply twenty years ago are selling fewer rooms now, while the industry as a whole is sell- ing about 660,000 more rooms a day than it did in 1989. With such a large increase

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in the number of rooms to sell, it only makes sense the demand numbers would increase, but the dramatic nature of the increase is what stands out.

Revenue Breakdown Breaking down revenue for the groups

tells the same story. Group 2 had 28 per- cent of total spending twenty years ago; now that share is down to 16 percent. The fact that hotels in group 2 generate more revenue now in nominal dollars is purely a function of the dramatic increase in average daily rates (ADRs) experienced by all seg- ments of the industry during the past twenty years. Perhaps the following number is the most revealing figure of all: group 1 gar- nered 30 percent of the industry’s revenue twenty years ago; it now records almost 55 percent of the overall revenue. That num- ber seems certain to continue to grow.

Real Estate Cycles The industry’s current situation stems in

part from the fact that a large number of rooms do not get demolished when they become obsolete. Because many owners do not have mortgage debt on older properties, the owners can be profitable at a much lower occupancy level than those with debt service. These types of older hotels can sur- vive with an occupancy level that is 15 to 20 percent lower than the occupancy rate of a newer hotel that has debt service. Addi- tionally, the nonclosing of hotels is a func- tion of the lack of an alternative use for the real estate. In many cases, it might just be easier to keep operating the hotel and not worry about building something new, espe- cially in an environment where debt and equity for any sort of real estate deal are difficult to find. It is clear that the economic environment has little to do with hotel clos- ings but, rather, the real estate cycle. The old saying, “The industry isn’t overbuilt; it’s underdemolished,” is true.

Brand Evolution Despite the decreases in performance

metrics, the hotels in group 2 still attract guests—in large part because of the age demographics of their guests and because there are not enough rooms in the other segments to accommodate the demand.

Another reason why the brands in group 1 could be faring well is the generational attraction. A large number of baby boom- ers continue to patronize the hotel brands they have always used or that they got to know as they grew up. On the downside, those segments could get hurt in ten to fif- teen years when that generation is not trav- eling anymore.

To some degree, this is a dynamic that brands do not want to see. Investing in exist- ing brands becomes more important. At the same time that these brands must cater to their existing guests, they also must evolve to attract future generations of travelers. The reality is, there is a disproportionate amount of people in group 2 hotels who are in higher age brackets. It is a demo- graphic trend that probably works against brands in those segments, unless these brands actively target the Gen X and Gen Y traveler to generate new demand.

I am confident that as the industry con- tinues to evolve, group 1 is going to become more dominant in all metrics. This trend is true despite the fact some brands in group 2 and a number of hotels in group 3 have worked to freshen themselves to remain competitive or even take back some share.

Some of these efforts will work—these segments will not fade away. There are plenty of examples of brands doing a good job of refurbishing and refreshing. Brand managers must make sure they have established solid brand standards and that properties are adhering to these set standards. Additionally, it is contin- gent on brand leaders in group 2 to create products that attract consumers, which

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will enhance longevity for the segment. Equally as imperative, owners of hotels in group 2 must make sure they are follow- ing brand guidelines to continue building positive brand momentum.

Hotel owners and operators in group 1 need to pay attention to what is happening in group 2 because the brands in that group could face the same situation at some point. The brands that stole market share from the older brands are themselves maturing. Unless the owners of the brands in group 1 recognize what happened twenty or thirty years ago and take steps to prevent it from happening to them, ten years from now they could find themselves in the shoes of today’s group 2 owners.

The lesson is simple: make sure a prop- erty (and a brand) does not become obso- lete. Once a significant portion of a brand’s properties feel tired and outdated, the cus- tomers know a brand is struggling, and they take their business elsewhere. Recog- nizing the needs of the next generation of travelers is critical.

Services, amenities, the physical plant, and technology all play major roles in the ability of a brand to stay relevant. How a building can handle the next wave of tech- nology improvement is a big issue in today’s ever-changing IT world. Increasingly in this day and age, it is more about technol- ogy and allowing road warriors to stay connected to the home office than about having a coffee maker in the room (although that is expected as a standard amenity).

There could be a silver lining from this recession for brands that might be strug- gling to stay relevant. Private equity houses and banks have accumulated large amounts of cash and are staying on the sidelines in today’s volatile environment. But at some point, an investor is going to take advan- tage of the lack of upkeep and liquidity and invest money into a brand.

Brand Acquisition As the overall economy recovers, I expect

the formerly frozen lending markets to thaw, and brand acquisitions will resume. Because of the cyclical nature of the hotel industry, brands change owners from time to time, and this cycle will be no exception.

The increasing pace in the change of ownership also should hold true for a num- ber of independent hotels, which have been acquired by owners who have branded them. A number of iconic independent hotels have been acquired by owners who then added them to the stable of a brand in the luxury segment. As I pointed out above, in 1989, group 3 represented 44 percent of the sup- ply, but it now has about 32 percent. This is particularly a function of the many reflag- gings and hotel closings (independent hotels typically account for about 75 per- cent of hotel room closings).

We expect group 3 to maintain a fairly solid foothold in the industry for a number of reasons, the first being the attractiveness of the segments to owners who wish to forge their fortune. Also, there is a trend for functionally obsolete older hotels to become independent, as they lose the brand affilia- tion, before they close.

The internet can be the big equalizer for independent hotels. The reach of the web and the growth in the number of third-party marketing companies have helped inde- pendent hotels regain some of their footing in the ongoing battle with their branded counterparts.

A Look into the Crystal Ball As I look into the crystal ball and think

about the future development of the three groups, some trends come to mind. One is that existing brands in group 2, regardless of corporate affiliation, do what is neces- sary and keep their properties up in line with travelers’ expectations as they hold

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their owners to the existing brand stan- dards. However, it is also possible that a competing company creates a new brand that takes away demand and pushes the older brands further toward oblivion.

During the past few years (until the real estate bubble burst), investment in real estate was driven by short-term eco- nomic gains. Now the economic cycle has changed, and owners can no longer flip their hotels easily. So the question for owners throughout the United States is this: do they wait for the time to come when market fundamentals improve and they can sell their properties, or do they put the money into the asset to make it appropriate for the next twenty years of traveler demand?

Regardless of what brands do, the indus- try will evolve. With those changes, it is a near certainty that STR will change the way we look at industry segments. It is not clear what the names and compositions of all the segments will be, but there likely

will be a shift. Case in point is that the midscale-without-F&B segment, which was once the new kid on the block, is at a stage where some of its hotels are reaching maturity and maybe even obsolescence. Even if STR does not create a completely new segment to include those hotels, the performances of those aging hotels could begin to look more like the hotels in group 2, making the arguments I made about investment and upkeep even timelier.

Overall, our data show that the hotel industry has shifted dramatically during the past twenty years. Midscale hotels with F&B facilities and economy hotels, together with independent properties, have lost share in supply, demand, and customer preference. The current consumer favor- ites in the other chain scales are strong performers, but as they age, their owners face the same questions their competitors do. STR will pay close attention to supply and consumer shifts and keep reporting on this ever-evolving industry.

Mark V. Lomanno is president of Smith Travel research.

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