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China: Orient express

31 August 2006
China: Orient express

Last month, InterContinental Hotels Group (IHG) announced that it had opened some 1,100 new rooms in China in the space of a month. The rooms belonged to two Crowne Plazas and two Holiday Inns, four hotels which bring the group's nationwide portfolio up to 57 hotels.

Nor is it stopping there; by 2008, IHG aims to operate no fewer than 125 hotels in China.

Even taking into account the size of the country, this is fairly rampant behaviour. However, IHG is not alone. Shangri-La already manages 20 properties in China but plans to double that by 2008. In the same period, Accor plans to leap from 34 hotels to 64 at all levels, ranging from Sofitel, its prestige brand, through to Novotel and its economy offering, Ibis.

As with IHG, both Accor and Shangri-La (in part) are planning their expansions through management contracts. As a result, there has been a feeding frenzy in the Chinese property market, with the only thing matching the hotel groups' hunger for joint ventures being Chinese companies' determination to buy up land. Players as diverse as Shanghai Airlines and former state-owned oil companies, and even Communist Party newspapers, are all racing to set up properties and cash in on the extraordinary boom taking place.

Huge potential The race is indeed on, and it is quite understandable. Among the so-called BRICs countries (Brazil, Russia, India and China), China's economy is moving the fastest. As an emerging market for hospitality and tourism, its potential is absolutely huge.

According to analyst Deloitte, China's spending on travel and tourism is expected to grow by 8.3% a year in real terms between now and 2016, compared with an equivalent annualised increase of just 2.6% in the USA (which, admittedly, has to grow from a higher point). Marvin Rust, Deloitte's tourism, hospitality and leisure partner, says: "US$35b, for example, is being spent on the Beijing Olympics alone."

Furthermore, the World Trade Organisation (WTO) predicts that, by 2020, China will be the number-one global tourist destination. "China is becoming a magnet for travellers," Rust says. "International travel to China has quadrupled to 109 million visits today, compared with 1990. In the same time, revenue from international tourists has increased by a factor of 12 and now stands at US$25b."

Added to that is a burgeoning domestic market. "By 2010," says Rust, "the domestic travel industry will be worth US$100b, with 1.75 billion people visiting other parts of the country. There is massive potential."

Moreover, these newly mobile travellers belong to an emerging middle class with money to spend. According to predictions from China's National Bureau of Statistics, the proportion of the populace who are middle class will grow to 45% in 2020, from 5% in 2005. "These people will certainly be demanding something better than staying with auntie," says Chris Rouse, senior director at analyst CBRE Hotels.

Competition Particularly important to this market will be the budget and mid-market offering. But IHG, with its Holiday Inn brands, and Accor, with Ibis, will face stiff competition from local operators such as Jin Jiang.

Chinese-owned Jin Jiang already has more than 200 hotels operating or under development in 59 cities across 25 provinces in China, with the majority at budget and mid-market level. Another local company cashing on the growth in this sector is Home Inn, a budget joint venture between the Beijing Tourism Group and online Chinese travel agency Ctrip, which plans about 100 hotels by the end of 2006.

"As the largest segment, the mid-scale hotel is considered the one that can generate the fastest return on investment and the best opportunities for growth," says Liz Hall, head of research at PricewaterhouseCoopers (PWC) for leisure and hospitality. (Hall is also the author of a report on the hospitality industry and emerging markets, to be published in next month's Hotel Directions Europe - available at www.pwc.com/hospitalitydirections.)

In particular, hotel companies are targeting secondary and tertiary cities (there are more than 100 cities in China with at least one million inhabitants each). For the hotel chains, the need to market themselves effectively and create brand loyalty means being accessible in as many destinations as possible. For these cities, there is also status to be gained by having respected hotel brands open in their vicinities.

However, there is even room for development in seemingly near-saturated markets such as Beijing and Shanghai. As well as attracting an even greater number of business travellers, Beijing has the Olympics to look forward to, while Shanghai is anticipating the World Expo 2010 - both events are driving infrastructure development in everything from hotels to subways.

De Luxe hotels
Shanghai is already the proud home of about 30 five-star and de luxe hotels. (London, by comparison, has 37 five-star properties.) And alongside the development of luxury hotels, the rise of art galleries, fashion stores and other cultural highlights is
giving cities such as Shanghai an increasingly cosmopolitan feel, which will attract a different profile of traveller again and will allow for even greater diversity in the market.

"Shanghai certainly has room for all types of niche hotels, including boutique hotels," says Kent Zhu, vice-president, sales and marketing, for Shangri-La hotels and resorts. "This segment of the hotel business here is almost blank, so there is good potential."

Compare this outlook with the wavering market in the West and it is obvious why there is so much excitement in the sector regarding China. "Emerging markets will be the growth engines of the 21st century," Hall says. "The need to avoid stagnation in domestic markets has become quite pressing for some hotel operators. Growth slowdown at home has led investors to pursue aggressive expansion abroad in order to capture new customers and grow winning global brands."

She adds that the changing way hotel groups conduct their business has made expansion even more important. "The widespread trend towards the disposal of hotel assets has meant that hotel operating companies need to manage or franchise many more hotels to make the same kind of money they made when they were both owners and operators," she says. "For example, a franchisor will typically receive less than 5% of room revenue. Scale has become critical."

There is very little precedent for this level of hotel growth - at any time, in any place around the world. Dubai springs to mind. In terms of the number of rooms appearing per square mile, one might even recall London in the 1970s. But across so many cities at once? There has been nothing on this scale.

Yet, with this expansion, is there a situation brewing on the horizon when the bubble will burst - not least, after the Beijing Olympics and the Shanghai World Expo in 2010 draw to a close - and supply will far exceed demand?

"The Beijing Olympics and World Expo will boost China's profile on the world travel map," Rust says. "However, we don't anticipate a tourism demand bubble - both domestic and international tourism are expected to continue to grow in the longer term." He adds that the opening of tourist attractions in the next decade, such as Shanghai Disneyland, will add to China's appeal.

Middle classes
Certainly, with a Chinese middle class estimated to become 45% of the population, and with so many incoming visitors, the market has almost unlimited potential. "With that number, the 100,000 or so extra rooms planned are neither here nor there," Rouse concludes. "It's just not much of a gamble."

Not only has the market arrived, but the country's infrastructure is also much further advanced. "In the 1980s, it was frontier stuff," says Robert Murray, Accor's vice-president for operations in China. "But you look now and all the brands are represented, the infrastructure has arrived, the air system is in place and the secondary cities are connected. The country can cope with the growth."

In fact, if you look at Deloitte's own figures, from its HotelBenchmark Survey for China, you can see that occupancy levels have dipped in the major cities over the past two years. In Beijing, occupancy fell in the first half of 2006 to 71.4%, from 75.2% in the same period of 2005.

Beijing's hoteliers are not likely to be unduly worried, however. Cities that start to develop their tourism industries will typically see occupancy levels stabilising after a period of rapid growth. And Deloitte's figure also show that revpar has increased in the same period by 8.5% - with the average room rate going up by 14.2% to US$110 as Chinese cities become more sought-after destinations.

Underpinning all this optimism is a feeling that Chinese hotels equal good business. Property and construction costs are low, so capital outlays are less risky. And with many hotel operators opting for management contracts, the investment risk is reduced even further. Add low wage costs and the package looks even more attractive.

"Hotels in China are low-cost compared to those in other, more established markets, so our hotels are very profitable," Murray says.

There are, however, words of warning for hotel groups.

While no one ultimately questions the potential of the market, it is advancing and transforming at such a pace that brands and operational reputations will be exposed to unfamiliar risks (see right). Hall asks these questions: "Do the companies really understand the new market? Do they have an exit strategy? Can they monitor overseas operations and local agents' performance?"

Beyond HR issues, managing joint ventures and supply-and-demand questions, Hall adds that investors need to remain aware of bigger factors facing China across all industries: an overheated economy; over-investment without proper capital allocation (as with Japan in the 1980s and 1990s); protectionism in key export markets; energy, water and transport constraints; environmental crises; and political instability.

Loyalty
There is another interesting footnote to the hotel boom in China. Another reason international chains are rushing to establish themselves in China is to secure the loyalty of Chinese travellers, not only when staying within China but also once they start heading for more mature markets in the rest of the world.

But they will not be alone. Just as they have gone to exploit the huge market in China, expect emerging Chinese hotel brands to look beyond their own shores to compete for a share in global profits.

Indeed, Robert Chess, head of hotels at commercial property agent Fleurets, says that he is aware of at least one firm enquiry during the past 12 months from a Chinese hotel company searching for a 200-bedroom property in London.

The logic is irresistible. Chinese hotel groups will be known to the increasing number of outgoing Chinese tourists and will be able to accommodate their needs.

Chess adds that while Japanese, Russian and Middle Eastern investors tend to look for flagship hotels, the Chinese requirement is more mid-market. "This isn't the mega-rich investor looking for a feather in his cap," Chess says. "It's going to be the hard-nosed business approach."

And while, for the time being, Western hotel brands know that they are light-years ahead in terms of offering luxury, even that is set to change, as Chinese companies hire Western staff and consultants. "Chinese hotel groups are in their infancy," Rust says, "and, while they may struggle today to compete with the luxury Western brands, the smart money would be on at least one global hotel brand being led from China by 2020."

So while the international hotel groups expect the hotel boom in China to bring profits, in the long term, they should expect it also to bring further competition. For the time being, all they can do is get their noses out in front and try to keep them there.

If you are interested in working in China - or anywhere else outside the UK - see this week's supplement, Working the World

China on a plate

  • Population: more than 1.3 billion
  • Number of cities with more than 1 million inhabitants: 100
  • Proportion of population ranked as middle class today: 5%
  • And by 2020: 45%
  • Expected Chinese visitors to other parts of the country by 2010: 1.75 billion
  • Expected annual value of the domestic travel market by 2010: US$100b
  • Expected number of Chinese vists overseas in 2006: 10 million
  • And by 2020: 100 million
  • Expected visits by international travellers in 2006: 109 million
  • Expected year China becomes world's number-one destination: 2020

    Sources: China's National Bureau of Statistics; WTO; CBRE Hotels; PWC; Deloitte

Operational difficulties and solutions According to Accor's Robert Murray, hotel groups must be wary when entering into joint ventures. "Having a joint venture and having influence are not the same thing," he says. "But, because we have been here a long time, we have trust from the owner and the developer."

Murray warns that special effort must be made to keep communication lines open, and says that deputy general managers are often put in place by the owners. "Meetings can take twice as long, because of translation," he says. "But if you are courteous and show a bit of flexibility, it goes a long way."

He also warns that energy costs are relatively high and that, looking ahead, a test of whether the market is sustainable will be what happens to wages, which are currently still quite low

Accor itself has a three-tier training programme, starting with junior members of staff being cross-exposed - from reception to F&B, say - right up to senior management level; last year, the company employed its first Chinese general manager.

Shangri-La, meanwhile, has the Shangri-La Academy, opened in December 2004 near Beijing. The training programmes here are open to both existing Shangri-La employees and students with a secondary education or better.

"This facility is a demonstration of the group's long-term commitment to the Chinese hospitality workforce," says vice-president Kent Zhu.

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