“Would you like to take your coffee table home with you today?” the front desk agent asks at check-out. Thanks, but I’ll pass. “The bedside lamps are 30% off?” she persists. I politely decline, pay a hefty hotel bill and go along my way.
I’m not saying that’s exactly how it will play out, but that’s basically the idea behind West Elm’s latest move into hotels with the first one opening in Detroit in 2018. West Elm’s move into the hotel industry can be viewed as a creative way to grow and keep up with expansion, by having customers experience their products and then buy the ones they like. A very interesting concept indeed, and only time will tell if they have real sticking power.
West Elm is not the first one to jump into hotels either. Shinola watches, Equinox gyms, and Restoration Hardware have all announced hotel plans. Partnering with hotel management companies to run the hotels; these companies want to leverage their brands and diversify into a lucrative, but crowded business. There is seemingly very little connection between their business models and products with hotels, so why are these companies jumping in with huge capital investments?
First, hotels, by definition, have a lot of foot traffic; it’s a transient place where you can have hundreds of thousands of people pass through in a year. It’s the perfect revolving door for customers to view your products. Second, hotel room economics are favorable in today’s environment. Overall hotel supply in the US has grown 24% in the past six years according to STR, a hotel data and analytics company, but it has been concentrated in large cities and high growth corridors like New York City. There is still a lot of unmet demand in the rest of the country; hence, the choice of secondary and tertiary cities (for the most part) to launch these hotels.
Third, these companies are relying on successful brand transferability experiments by other brands into the hotel business – Bulgari, Versace, Virgin etc. If done right, they can establish themselves as reliable hotel operators with the added value of their brand. Fourth, and in my opinion the largest consideration for West Elm, is that it will simply cost them less capital to bring the hotel to market. With Furniture, Fixtures, and Equipment (FF&E) being a big part of the capital expense in a hotel, West Elm will significantly reduce that cost by making their own. With the fixed cost lower than a comparable hotel, the bottom line is they could work out the same margins with less hotel occupancy or average rate.
On the surface, it’s a sound business model and an exciting idea. Much is made of the fact that millennials prefer different experiences and crave an alternative to the established brands and the rise of boutique hotels. So shall we rejoice this new age of brand expansion and expect this to be the new normal? And, should the incumbents be worried about an onslaught of new hotels from non-traditional companies?
Though the concept has a viable market, I do not believe that the incumbents – not even the small boutique hotel chains, let alone the large behemoths like Marriott and Hilton – have anything to worry about. First and foremost, in the beginning, these new hotels will not have the same benefits of scale in terms of consumer demand that hotel companies command today. Many major companies leverage loyalty and their network to bring about efficiencies in customer acquisition which are lost to a singular hotel. Independent single hotels’ differentiator more often than not, becomes price which erodes margins. Successful independent hotels are mostly limited to high occupancy corporate markets like New York or Hawaii where they make money by filling more rooms, rather than commanding more room rate from fewer customers.
Second, successful models of independent hotels have something unique that no other hotel has. St. Andrews or Gleneagles in Scotland come with some of the world’s best golf courses and that is why they thrive. Absent this, the brand takes over and can successfully carry a hotel like a Bulgari or Virgin – which may be argued as a somewhat logical extensions to their core businesses. Third, experience in this industry counts. Service culture is extremely hard to cultivate among your employees and requires a lot of effort and resources. It’s taken decades for some of the largest names in the business to really make a mark for themselves.
When I joined Starwood, it was a real estate company that also ran hotels. By the time I left 11 years later, it was a hotel company that also had real estate.
Such transformation is rare and these hotels will struggle to keep up with the industry including capital investments to keep up with technology and services.
All of this creates a very precarious position for these hotels in the long run. Lower margins based on volume of business and not average rate, very little differentiating factors, lack of clout in the consumer acquisition space, and the high capital intensive nature of the business will make these hotels vulnerable in a downturn.
I don’t mean to sound the alarm just yet, a hotel is still a lucrative business if you can get over a certain threshold occupancy/rate combination that covers your fixed costs, and West Elm’s hotels may very well manage to stay above the water to become decent, respectable, independent hotels in their own right.