In business, we hear the term “Hotel Competitive Advantage” being used often, but the term is widely misunderstood. In this article, we’ll define what it really means to have a competitive advantage, explore the 4 main sources that create one and provide examples in the hotel industry. We’ll also discuss how you can maintain your hotel's competitive advantage once it’s been established.
What Is A Hotel Competitive Advantage Anyways?
Simply put, a hotel (or any company really) has a competitive advantage when it is able to generate excess returns over an extended period of time. Excess returns mean returns that are in excess of the cost of capital required to build and operate the hotel. Without a competitive advantage, a hotel may still earn excess returns temporarily, but eventually, competition will catch up as others see the opportunity to invest in a hotel in the area as well.
Eventually, the market will be flattened out due to competition and there will be no benefit to an investor opening a hotel in that competitive set. You can picture this happening with any industry, in any geography. If enough coffee shops open on a single street, they can’t all possibly be busy and profitable. If even more open up, none of them will be profitable. It is the law of supply and demand and hotels are no different.
How Do You Get A Hotel Competitive Advantage?
Another way to think of a hotel competitive advantage is to build a barrier to entry that makes it harder for other hotels to enter your market. This is also often referred to as a moat. If you are able to successfully create a moat, you can keep new market entrants out, which will protect your excess returns from being eroded away by competition.
There are four main sources of a hotel competitive advantage:
1. Customer facing
2. Production advantages
3. Efficiency advantages
4. Advantages due to government policy
We will discuss each of them as examples below and also provide you with some hypothetical examples of these within the hotel industry.
1 - Customer Facing Advantages
If your hotel could easily raise prices without losing guests or experiencing a drop in RevPAR then you might have a customer-facing advantage. These occur when a customer is more willing to stick with their current hotel provider and pay a higher price rather than switching to a new cost provider.
In the hotel industry, a great example could be brand loyalty to a specific chain out of habit.
The classic consumer example of brand loyalty is Coca Cola or Starbucks, but of course within hotels some guests are Hilton loyal, Marriott loyal, etc.
Aside from habit, loyalty (also called customer captivity) can come from high search costs. In the example of a hotel brand, they might simply trust the Marriott brand name and brand standards and would be hesitant to take time to compare other properties. This can also occur with independent hotels when a guest has a positive interaction and they continue to stay at that same property every time they are in the area. High search costs are found more frequently when purchases are not frequent and involve decisions that are critically important.
Finally, switching costs can create customer captivity. Here, loyalty points programs play a vital role, both through the brands, but also with the OTAs. If you have points built up and you are used to a particular brand out of habit, the chances of you switching (and risking loss of those points) is fairly low.
Are Brands Competitive Advantages?
If you think about it, every hotel has a name and a brand. Of course Westin is a more iconic brand than “River Lodge Woodlands Inn”, but both have brand names all the same. No name soda is still a brand name. So, if a brand is something that every hotel in the world has, it can’t really be argued that a brand is the source of a competitive advantage. However, if you can charge $40 more for a room each night because you are part of the Hyatt brand, even though there is a property across that street with rooms that are nearly identical, that is a clear indicator that you have a brand that people are willing to pay more for. This loyalty is most likely generated though from a customer facing advantage and not the brand itself.
Do Customer Captivity Advantages Last Forever?
So, if guests are so loyal to their hotel brands, how do new brands like CitizenM or even players like Airbnb do so well? Unfortunately (or fortunately depending on what side you’re on), competitive advantages based on customer captivity don’t always last. This is because guest’s tastes change over time along with their needs and desires. Your grandparents probably didn’t book a yoga/remote work trip at an eco-resort in Costa Rica, but that would certainly be a desirable trip for many people in their 30s today. Guest preferences change with social norms, pop culture and new information.
This brings opportunities for innovation that destroy demand for old products and brands. As well, the internet has been able to weaken traditional customer captivity advantages because guests are now able to be better informed online before making a decision of where to stay. They can now view photos, videos, check reviews and even see if they know anyone who has stayed there by checking on Instagram. When customers have the ability to compare products more easily before choosing a hotel room, it can erode the strength of barriers like switching costs, search costs and even sometimes habit.
2 - Production Advantages
A production advantage is when you have lower manufacturing costs than your competitors. In the hotel world, Kemmons Wilson, the founder of Holiday Inn comes to mind. Kemmons had a background in the construction industry building homes and had much lower costs as a result versus his competitors. As he scaled the business, he also used his insider knowledge from the construction industry to design hotels that would feel both spacious and modern while minimizing his costs. He was then able to charge the same price (or in some cases lower) than his competitors, but he had a higher return on invested capital because of his lower costs.
Production advantages can also come from proprietary production technology which enables businesses to manufacture hotel products that are hard for competitors to copy. This could be the case with new hotel companies in China - click here to view a hotel being built in only 6 days!
Hotels can also benefit from structural advantages. The most typical example from the hotel industry that comes to mind is the property’s location. Since land is a scarce resource in high demand areas, the hotel owner who benefits from owning the property will have a structural cost advantage. This is the case for hoteliers and brands that have owned key real estate for a number of years. Prices have now gone up and cities, resorts and communities have been built around them. New hotel competitors would have to spend many millions of dollars to compete which would erode excess returns and profitability. Having said that, it is important here to keep in mind that the owner of the structural cost advantage is the one who will generate the excess returns. Therefore, if the hotel is simply leasing the land, the prime location will not be a competitive advantage to the hotel investor but to the land’s owner.
Finally, distribution can be a competitive production advantage. Oyo is now one of the world’s largest hotel brands after being founded a relatively short time ago in 2013. The founder was only 17 years old when he started the company. So how did they do it? In short, Oyo identified a large network of independent hotels that they felt they could assist with marketing. Oyo implemented a brand standardization process for cleanliness, service, decor, health and safety and in return, hotels were added to the distribution network. Oyo is able to assist their hotels with marketing at a fraction of the cost these hotels would have had to incur on their own. This level of distribution created a competitive advantage for any independent hotels trying to compete with Oyo who were not in their marketing network.
3 - Efficiency Advantages
Efficiency advantages are what is often called “economies of scale”. Going back to the Oyo example, their marketing budget is an economy of scale efficiency advantage as well because they are able to spread the cost of advertising over more individual units than their competitors. The competition will have a difficult time matching Oyo’s level of advertising and it’s operating costs per hotel would be much higher than Oyo's.
A classic example of this is Marriott, who have many economies of scale including:
- Vendor discounts
- Corporate hotel sales and marketing team and lead generation
- Loyalty program leverage
- Marketing program leverage
- National employee/hiring network
- Global hotel presence
- Hotels across each comp set in a given community
Usually many of a hotel’s costs are fixed costs (sales costs, marketing costs, etc), so the company with the largest unit volume has a cost advantage because the cost is spread out over a large volume of hotels versus just one. Anytime hotels can gain leverage by spending the same dollar, where that dollli> invested benefits all hotels across the portfolio, they have an efficiency advantage.
Network Effects
Sometimes a company can deliver more value to the customer as the number of customers increases. When this occurs, it’s called a network effect. A classic example in the hospitality industry is Airbnb. The more hosts that sign up to rent their home on Airbnb, the more options their guests have. The more guests that sign up, the more hosts are incentivized to join. As the company grows, it’s value offering to it’s customers becomes stronger. Another example of this is a hotel management group. As they build their portfolio of hotels, they gain access to more sales prospects, which they can then cross sell to other hotels. As they can offer their guests more hotel options in larger geographic areas, they become a better partner. As the business grows, it provides more values to both the customer and the hotel in a way that is self-reenforcing.
4 - Government Policy Advantages
Whether we like it or not, government policy can limit entry into specific markets. An example from the hospitality industry could be a specific number of hotels permitted to operate within an airport terminal. Another is a hotel brand that has been mandated by a government organization. This advantage is typically very strong and hard to change, but it only exists as long as the government policy or regulation is in place. Other examples of government policy in the hotel industry could be environmental, where only a certain number of hotels are able to operate within a given area. Zoning is another example. If the government (local, state or national) changes their policies, the advantage can erode with the policy change.
Sustaining Your Hotel’s Competitive Advantage
Research has shown that the best way to create a hotel competitive advantage and maintain it over time is to focus on creating a true customer-facing advantage. You can strengthen it by adding a scale-based advantage. When you focus on becoming the hotel of choice for your customer and engrain your property as a habit in their mind, it is likely that they will not search for other options. When you consistently deliver on your promises and build customer loyalty, you build customer captivity.
Be aware though that customer’s habits change with the times and the trends and keep an open mind or else you could also become disrupted. When you paid a customer advantage with a scale advantage and lower your operating costs (while maintaining high margins), you make it very hard for competitor’s to enter and successfully compete. In short, great customer service and low operating costs can help keep competitors out and help your hotel maintain it’s profitability.
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