Owners vs. Operators: Resolving the Misalignment of Interests for Distribution Costs

Background:

Currently, most hotel management companies/operators earn their room-related management fees as percentage of gross room revenue, irrespective of whether room revenue is generated from OTA bookings or bookings that are direct with the hotel. Generally speaking, hotel operators are not directly incentivized to do their best to generate more direct bookings, and many of them adopt the “lazy man’s approach” by relying extensively on the OTAs for room bookings. In this scenario, owners are the sole losers, since OTA commissions are destroying profitability and return on capital, and depressing the bottom line in a downward spiral.

Direct online bookings are by far the most lucrative and cost-efficient bookings at any hotel, resort or casino. As a point of reference, across the HEBS Digital hotel client portfolio, the average direct channel distribution costs (bookings via the property website or directly attributable to the digital marketing efforts) are 4.5%, compared to the hefty OTA commissions of 15%-25%.

For owners, any dollar “saved” from distribution adds to the bottom line (Net Operating Income – NOI) and the investment return. In this sense, the more inexpensive direct bookings, the better. The fewer expensive OTA bookings, the better.

For many operators, the cost of distribution via OTAs plays an insignificant role, if at all, and in many cases, as in the case of “merchant” OTA bookings, is not even accounted for in the property P&L (Profit and Loss), since the property receives the net room revenue after the commission has been deducted by the OTA.

Conveniently for operators, “agency” OTA commissions (e.g., Booking.com, Expedia’s agency model, etc.) are accounted for in the property’s financial statement as COGS (Cost of Goods Sold) in a single line item titled “Commissions” with no differentiation from brick-and-mortar travel agents’ commissions. Merchant OTA commissions are not even accounted in the property P&L.

COGS are deducted from gross room revenue. The COGS line item (“Commissions”) and its complete lack of transparency is rarely a subject of discussions between operators and owners. Quite often, it is misunderstood by owners and completely ignored. More importantly, operators are not held accountable for the cost of distribution, and frankly do not care if the hotel is over-exposed to the OTAs at the expense of direct bookings.

Direct bookings and their distribution costs—including ongoing website technology upgrades and content optimization, dynamic content personalization, reservation abandonment programs, hosting, SEO, paid search, online media and retargeting, and more—come from the “Expense Section” of the P&L and its “Sales & Marketing” line item.

Unlike COGS, the Expense Section of the P&L is frequently and heatedly discussed at any meeting between operators and owners. Expenses are scrutinized to the penny. Which line item falls as the first victim of any budgetary downsizing or adjustment? The Sales & Marketing Expenses, of course!

So it is ironic that the most cost-effective bookings—from the direct online channel—are severely restricted by the property’s sales and marketing budget, while the most expensive bookings—from the OTAs with a cost of distribution of 15%-25%—are rarely restricted, quite often not accounted for in the P&L, and can grow exponentially.

Obviously, owners and operators have opposite interests, as far as distribution costs are concerned.

How can this misalignment of interests between owners and operators be resolved?

  1. Understanding that distribution cost is the one of the VERY FEW cost drivers operators can proactively influence to reduce overall expenses

Why? Except for distribution costs, operators have difficulties controlling the other main cost drivers in hotel operations:

  • Labor Costs: creeping up due to unionized labor contract and mandated minimum wage/living wage increases in many municipalities
  • Debt Service: at best, interest rates on commercial loans are staying flat
  • Franchise Fees (Rewards, Marketing, Royalty, Reservation, etc.) are creeping up, as usual
  • Utilities: normally 5% of gross. Water, Sewage, Gas & Electric are all creeping up; Water & Sewage are growing pretty fast lately
  • Real Estate Taxes: always creeping up at the whim of local municipalities
  • Distribution Costs: reflected in the property P&L under both COGS (OTA distribution costs go under Commissions) and Sales & Marketing Expenses (direct online booking expenses such as website maintenance, SEO, SEM, direct response online media, email marketing, etc., are typically bundled here together with payroll for the sales team)

Note: The importance of these cost drivers varies property by property and largely depends on the size of the hotel, condition of the physical plant, whether property branded or independent, amount of debt, and geographic location.

Distribution Cost, as a cost driver, has been rising steadily over the last seven years due to OTAs increasing market share versus hotel direct bookings. A few years back, a study by Kalibri Labs “Demystifying the Digital Marketplace” provided concrete evidence that this dramatic shift exceeded 40%.

  1. Owners should include Direct Booking Provisions in the hotel management contracts with the operators

Owners should wake up and incentivize management companies by rewarding them for having more direct bookings. The management contracts should include special direct booking provisions to incentivize the operator to achieve more direct bookings, but also hold them accountable for failing to achieve these goals. These provisions and incentives could be:

  • Using “Total Gross Operating Profit” (after commissions) as the measure for management fees in lieu of gross revenues.
  • Establishing permissible ratio targets for direct vs. OTA bookings, and rewarding the operator if they achieve incremental shift in direct bookings at the expense of OTA bookings. For example, if at the beginning of the year the direct online versus OTA booking ratio is 30:70, and the Operator succeeds in shifting this ratio favorably to 40:60 (or even better to 50:50) at the end of the year, for every $1 in new direct room revenue, the management company gets an additional 5%-8% bonus above and beyond the management fees. These bonuses can easily be covered by a fraction of the OTA commission savings.
  1. Owners should invest in direct booking-generating technology and digital marketing

Endemic under-investing in direct online booking-generating technology and digital marketing is one of the main reasons why hospitality has allowed the OTAs to continuously gain market share over the past years.

Ask yourself the following questions:

  • Have you visited your own property website lately and liked the experience?
  • Have you tried to access your website via mobile and felt frustrated from poor usability and download speeds?
  • Does your property have a Google AMP presence?
  • Are you running multichannel digital marketing campaigns to engage potential best guests throughout the guest lifecycle including the dreaming, planning, intent to travel, and conversion point phases, and then throughout the nurturing and recognition phases?
  • Is your property website WCAG 2.0/ADA compliant?
  • Are you engaging your past and future guests via CRM, smart data marketing, personalization and one-to-one marketing, etc.?

To achieve a level of real success and lessen dependence on the OTAs, hoteliers must invest adequately in website and digital technology and marketing techniques to engage past, present and future guests and drive direct bookings throughout the entire path to purchase.

HEBS Digital has a very comprehensive whitepaper on the subject: The Smart Hotelier’s Guide to 2018 Digital Marketing & Technology Budget Planning is available for download. It provides hoteliers with a concrete mobile-first roadmap to jumpstart the property’s direct bookings and guide its digital marketing and distribution strategy throughout the year. With so many moving pieces in a hotel’s digital budget, from enhancing the property website, to revenue-generating technology, to smart data marketing, it’s important to create a strong plan of action that is realistic and aligned with your business goals.

Source: FS – All – Hotels – News
Owners vs. Operators: Resolving the Misalignment of Interests for Distribution Costs