CHAPTER 1

The Hotel Industry: Past and Present

Objectives and Student Goals:

Student Objectives for this chapter are to:
• develop a framework of historical reference that will document the direction of hotel
development in Canada and demonstrate the industry's vibrancy across the centuries.
• create an appreciation for the magnitude of the hotel industry and the variety of its
products.
• develop a desire to build a technical vocabulary as an entree to the profession and a
prerequisite to understanding the lectures and reading materials that follow. Create an
acceptance of change, whether it is market driven, financially required, or
operationally necessitated, as a paradigm of the hotel industry and as an element of the
student’s professional profile.
• create knowledge of the several structural patterns (franchise, referral, management
contract, joint venture, and management lease) that have emerged as the industry
adapts to changing environments and innovates to meet the competition.
• develop sensitivity to the dynamics of the guest as the major force in the dynamics of
the lodging industry.

At the conclusion of the chapter, the student should be able to...

• recount a brief summary of the history of the industry in Canada.
• identify types of hotels, using proper terminology, and distinguish between service
plans and classes of hotels.
• understand that rating systems have validity only in the location of their use and
maybe not even
there.
• distinguish among franchise, company-owned, management contracts, and
management-lease arrangements. Sense the change in operational approach and in
host-guest relations when the hotel and the guest deal through third parties.
• differentiate between the hotel as an operating business and the hotel as a real estate
investment.

Chapter Summary:
Chapter 1, indeed, all of Part I, explains the milieu of the hotel business. Students
understand better the single department—the front office—if they appreciate the
magnitude of the industry and the setting or culture in which that industry operates.
Chapter 1 does this using several techniques. A brief history of the industry emphasizes
inn keeping's changing profile. Definitions and specialized vocabulary introduce the
terminology that is prerequisite both to professional membership and to the learning
material to come.
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The origin of the hotel/hospitality industry is obscure. However, the Christian bible cites
Christ's birth in the manger of an early inn. Historians know that tabernas (inns) serviced
the travellers on the iters (the roads) of the Roman Empire. Providing service to the
relatively large number of Crusaders between the 11th and 13th centuries was the
responsibility of the Catholic Church, which relied on one of its orders, The Knights
Hospitalers, to deliver those accommodations. Commercial travel in Europe was an
outgrowth of British commerce, which carried over to the English and French colonies in
the 1700s.

Mass travel is a modern phenomenon that emerged after World War II. Mass tourism
continues to grow as political freedom, economic wherewithal, and social equality spread
across the globe. With the large powers at peace and the economic engine of
development running at full steam, international travel and, consequently, the hotel
industry are poised for decades of growth.

Estimates abound as to the importance and size of hotel keeping. Certainly, its economic
contribution is critical to the global economy whether as a service to the business
community or as a destination for tourism development. The industry's ups and downs
reflect, in part, the limiting characteristics inherent in hotel keeping. (1) The product is
perishable—a room not sold tonight is lost forever. (2) The location and product
inventory (rooms) are fixed—they cannot be moved as demand patterns change. (3) Entry
into the business takes large amounts of capital—creating huge fixed costs that
necessitate high occupancies to achieve a break-even level of volume. (4) Activity is
seasonal—with all the adjunct problems of operating an ebb-and-flow business.

The hotel industry isn’t monolithic: There are numerous variations and permutations.
Hotels differ in size (as measured in number of rooms); in class (of services rendered); in
purpose of use (type of hotel); and in plan offered (meals provided or not). Worldwide,
most governments—with Canada the major exception—have classified and formalized
these differences into rating systems as a service to travellers. Room rate is one measure
that consumers use to rate hotels, but it serves managers, owners and lenders equally
well. Percentage of Occupancy (a ratio of the number of rooms sold to the number of
rooms available) is another standardized measurement. Outside Canada, most countries,
along with the international organizations that monitor the business, use a Percentage of
Bed Occupancy (a ratio of the number of beds sold to the number of beds available).
Historically, transportation dictated the composition of the inn. The character of the
industry is still shaped by travel and transportation, but other components also impact on
the industry's structure. Among these are new methods of marketing and distribution;
new approaches to ownership and finance; and new concepts of management structure
and product delivery. Each component impacts operations, especially that of the front
office.

No longer is the norm that of a single guest making a single reservation directly with the
hotel. A host of intermediaries has been interposed between the guest and the hotel. This
theme of intermediaries—third parties—is repeated throughout the book. Whether for
reservations, folio settlements with credit cards, telephone systems, incentive packaging,

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or whatever, intermediaries have taken on the hotel's business. They wedge themselves
between the guest and the hotelkeeper, weakening the host/guest relationship and
complicating the function of the front office.

Conventions and trade shows, which mix group and individual business reservations, are
contrasted to incentive groups and single entity bookings, purer forms of the group
business market. Tour and wholesale packages, the leisure side of group business,
emphasize the elasticity of price and demand.

The chapter discusses segmentation: the shattering of one industry definition into many
pieces. Changes in the hotel product reflect the changing demands of the buyer/guest.
Buyers of products expect choice: choice in auto models; choice in financial instruments;
choice in beers. So, too, in lodging, that has been segmented into categories and
subcategories. Segmentation gives rise to examples of budget, limited-service, and hard-
budget subdivisions within the economy sector, itself one division within an ever-
segmenting industry.

One trend seems contradictory to lodging's segmentation. As a whole, commercial hotels

grow more like resorts even as resort hotels mirror their commercial counterparts. The
former add recreational facilities like spas and running tracks. The latter extend their
operating year by filling the house with business meetings and convention groups.
Simply put: There is no single definition of a hotel; indeed, nor for the industry itself.

Key Concepts of the Chapter:

Historical Perspective. Dynamic change is one of the major themes of chapter one. The
student must understand the lodging industry as one that continually remakes itself. The
observer sees rapid changes in the products being offered to the public because, in part,
the buying public and the financial structure of the industry are changing, as we shall see
throughout this first unit. The industry has a long heritage that has served the needs of a
shifting environment by shifting, changing and redefining itself. From Inns along stage
coach lines to railway hotels to mom and pop motels along our burgeoning highway
system to the current plethora of product, we work in an industry that is constantly
changing and adapting.

Special Industry Characteristics. The lodging industry has some special issues with
which management must contend. Hotels sell a highly perishable commodity, guest
rooms, with an unchanging supply of product in a permanent location. High fixed costs,
both large up-front capital investments and labour-intensive operations contribute to
boom-and-bust cycles as business volume lags or exceeds the high break- point that these
special characteristics impart.

Traditional Classifications. Classifying hotels makes it easier to understand the

numerous segments into which the industry has splintered. Among the traditional
classifications are size (measured in number of rooms available); class (services offered

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determine the rate charged, ADR); plan (number and kinds of meals included in the rate);
and type (resort, commercial residential, and convention.). New groups such as limited-
service hotels, theme hotels, and extended-stay hotels are broadening the meaning of
“hotel.” Another entry is boutique hotels, which are small, upscale, and very fashionable,
with a limited product and clientele, much like a boutique shop.

Condominiums and Timesharing. Condo and timeshares (now interval ownership or

fractionals) have given hotel financing an interesting twist. Essentially, the
builder/promoter borrows from the occupant/owner rather than from more traditional
banking sources. With the condominium, the buyer/lender buys the real estate. With the
original timeshares, the buyer/lender bought nothing but the right to use the property for a
fixed number of years. Interval ownership, which long suffered a questionable
reputation, has gained respectability with the entry of Four Seasons Hotels and Intrawest
into the field. Equally important, “deeded” timeshares now allow the buyer/lender to
actually take title to the unit. Although the chance of resale is still very marginal, resale
opportunities are now possible.

Packages and Breakage. Packaging products adds to their market appeal. That’s why
both the hotel industry and its third-party “partners” offer leisure guests room, meals,
entertainment and transportation for one fixed price. (However, hotels have stayed away
from the high-risk transportation ingredient.) The guest pays for all the services with one
fixed figure. Breakage is created if some guests do not use certain features that have
been included in the package. The sum has been collected but the service is not
delivered. If the hotel has sold the package, the breakage accrues to it. If wholesalers
create and sell the package, the breakage accrues to them. Wholesalers pay the hotel for
each guest service used, evidenced usually by a coloured charge slip or voucher. If the
guest doesn’t buy the service, no voucher changes hands and the hotel has no evidence
with which to charge the wholesaler.

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Professional Vocabulary:
Average Daily Rate (ADR). ADR, which is expressed in dollars and cents, represents
the hotel's (or the chains, or the industry's, or the nation's) ability to earn a given level of
dollars per room sold. ADR is a measure of room rates actually paid by guests rather
than room rates quoted to them. Average Daily Rate is obtained by dividing the total
revenue from all room sales for the period (day, week, month, year) by the total rooms
sold for that period: Room Sales (Dollars). As an "average," it does not represent the sale
of any given room, but does lend itself to other terminology: Sales Per Occupied Room;
Average Room Rate.

Boutique Hotels. Boutique hotels have gained fashion during the past decade or so. Like
a boutique shop, boutique hotels are small, upscale, and very fashionable, with a limited
product and clientele. Initially, few boutique hotels were profitable, so they were often
tagged Trophy Hotels. Trophy Hotels are owned for the pleasure of ownership, merely as
trophies, rather than as financial investments. Careful financing, marketing and operating
skills have changed some boutique hotels to profitable ventures. Such boutiques often
originate in renovated buildings so rooms are smaller than the industry norm and lack
many of the amenities. It’s this absence of amenities and the Spartan decor that attracts
the chic crowd for some reason. The high return earned by Ian Schrager (co-founder of
the infamous Studio 54 in New York City), who originated the boutique concept, has
attracted the chains. Starwood has launched a new brand called “W.” Starwood says that
it stands for warm witty welcome. If the W chain reproduces the product across the
nation, its very predictability will undermine the basic concepts of boutique hotels,
uniqueness, and individuality.

Percentage of Occupancy. The percentage of occupancy, which is a ratio expressing the

number of rooms sold to the number of rooms available for sale, is the lodging industry’s
most widely used statistic. Occupancy percentages are computed over time (daily,
weekly, and annually) and over distance (nationally, locally and individually). Whatever
the computation, the dividend (the number of rooms sold) and the divisor (the number of
rooms available for sale) must agree in both time and geography.
Plan. Plan gets more attention than it merits. Almost every hotel in Canada and the vast
majority elsewhere operate on the European plan (EP), and only the European plan.
Under the EP, meals—if taken in the hotel at all—are charged separately and in addition
to the room charge. The American plan (AP) hotel includes three meals (breakfast,
luncheon and dinner) within the room charge. Hotels operating on the modified
American plan (MAP) change or modify the number of meals included with the room
rate. Luncheon, the noontime service, is the meal most commonly omitted, giving the
guest flexibility during the midday. Cruise lines and conference centres include the full
American plan but call it by some other name. “All-inclusive” is a popular replacement
for the less marketable AP.

Revenue Per Available Room (RevPar). RevPar is a new name for an old measure that
has been reintroduced as realtors, financiers and other nonhoteliers have entered into and
invested in the lodging industry. RevPar serves them well since it is a measure of

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management’s capability. To understand RevPar, one must understand occupancy and
average daily rate, which typically move in opposite directions. Increases in occupancy
often come at the cost of ADR. RevPar is the product of their multiplication and says, in
fact, considering both occupancy and rate, here is what this hotel is able to achieve.

Elasticity. Elasticity is a term employed by both physical scientists and economists. The
former use it to describe the relationship between an external force and a substance. If
the substance readily responds to the external force by changing shape and character, or
resumes its original shape after the force is removed, it is said to be elastic. It’s the same
to the economist: Elasticity is the degree by which guest demand (the substance)
responds to price change (the external force). It makes no difference whether the price
change is up (hence demand falls) or down (hence demand rises). Elasticity describes a
condition in which price changes produce corresponding changes in demand. There are
degrees of elasticity within each category and price level. For example, the leisure
market is elastic. Because leisure guests have discretion, they will stay away—or
come—as prices rise and fall. The business market is relatively inelastic.
Businesspersons need to come and they will do so with much less regard to price. Hotel
room rates have followed airline rates in applying the principles behind elasticity.

Franchising and Management Contracts. The franchise company (the franchisor) and
the management company have much in common. Both sell intangibles and both earn
fees from those sales. The management company is paid for its managerial skills; the
franchisor for the right to use its name, its reservation system and its operational systems.
Neither company requires much capital since neither has real estate investments. (That is
changing as both face increased competition and improved industry earnings, which
encourage owners to bargain more stringently). Fees are paid by the hotel owner, who is
also the franchisee, (the franchise buyer). As a result, large, well-known hotel companies
may simultaneously be owner/operators, franchisors, franchisees, management
companies, and/or lessors/lessees. When business was poor, franchise and management
companies took fees up front and the hotel owner stood the losses or profits. As business
improves, we can expect the hotel owner to lease (rent) the hotel for a fixed sum and the
hotel company will stand the profits or losses.
For the franchise fee, the franchisor provides the franchisee with a logo, a recognizable
(to the public) identity. Reservation systems, operational guidance and national
advertising tie the franchisee to the franchisor, but always for an additional fee. The
franchisee gets clout from affiliating with a big company, but retains the rights of an
independent businessperson.

Third Parties. Third parties (intermediaries) are a term coined by the authors. No
dictionary offers the definitions used in the book. The hotel industry faced enormous
hurdles as it shifted from a local industry serving a limited area to a global industry
serving the world. It lacked the resources to fund the necessary technical capacity and it
lacked the reach to find and attract a global guest. Other parties moved in to fill the
breach. These businesses interpose themselves between the guest and the hotel, but they
provide services that neither the hotel nor the guest could function without. Third parties
are evident in a long list of services beginning with computer-reservation systems, with

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credit-card transactions, with travel-agency bookings, with check-cashing verification
and with wholesaler packaging.

Answers to End-of-Chapter Questions:

1. At the point at which the text is being printed, Winter 2007, the industry is
experiencing an up period in its economic cycle. It has recovered after Sept 11, SARS,
Mad Cow, threats of terrorism and threatened recessions after what was likely the highest
rate of growth ever in the industry through the 90’s. Occupancies are increasing, average
daily rate is increasing, and there is some indication that hotel companies realize that they
must not overbuild. Whether that realization will restrict growth is unlikely given the
history of the overbuilding boom and bust cycles. The biggest issue facing the Canadian
Hotel industry is the shrinking U.S. market which has always been our largest. The
student should answer in the specific period in which the text is being used by quoting
occupancy and ADR in terms of today versus historical experience (see Exhibit 1-2).

2. A recent graduate might select the large company because its operations are far-flung.
This means greater geographic opportunities and more varied professional experiences.
The chain has a formal training program, which the local, individual hotel may lack.
Employment with the chain offers a better base of experience and a wider range of
professional contacts to be used when its time to move on. The local franchise is smaller
with greater chance for identification and recognition; might have a more family-oriented
environment; and offer a better chance at generalization, with less specialization.

3. As the hotel industry has segmented, it has focused on the marketplace, which, itself,
has segmented. To attract guests to the hotel, each property must offer what its particular
guests want. Having done that, the hotel can reach out for secondary markets provided
they do not destroy the primary market.

4. The student should refer to Exhibit 1-17 on page 36 as well as consulting the internet
for worldwide figures to obtain the number of rooms and the number of hotels in each
chain. Dividing one by the other produces a rough estimate of the typical size of hotel
controlled by the chain. All figures are estimates; may not even be consistent within the
book; and are best-case guesses in the fall of 2005. The results are close to what one
would expect from each chain with its own identity and markets. Chapter 1 itemizes the
small hotel at 100 rooms or less, the medium-sized hotel from 100 to 300 rooms, and the
large hotel at anything over 300 rooms.

Answers to Case Study Questions:

1. Other options would be a management contract, or hiring a GM on a contract basis.
Shyam could also hire one of the franchise chains to manage his hotel and possibly reflag
it with one of their flags.

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2. A disadvantage of flagging a property is that the property and the owner may loose
some of their ability to customize the customer guest experience. Most chains have fairly
rigid standards that must be followed. The hotel may also be forced to buy from
approved suppliers of the franchise as well as give up a portion of revenues in franchise
fees, royalties etc.

3. The hotel could join a referral group like Best Western. In this case they would be able
to retain more of their independent status while enjoying the advantages of a chain
franchise operation.

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