Just by the size of their numbers, millennials will have a significant effect on the hospitality industry. In the United States, there are over 90 million in this demographic, making them the largest generational segment with a spending power of over $200 billion. In terms of travel consumption, millennials will account for over half of all travel spending by 2020.

Although definitions of the millennial generation vary, the general consensus is they were born between 1980 and 2000. Generational segments are just one way we can divide the market, though. From a marketing standpoint, we are interested in the consumer behavior of this demographic. And just like other forms of market segmentation, not all constituent members behave the same. Some millennials have a consumer behavior similar to baby boomers while, conversely, some baby boomers act millennials. As a fun aside, google ‘How Millennial Are You’ and fill out the questionnaire developed by the Pew Research Center.

Millennials are often misunderstood by their boomer bosses and have become maligned. If one does a search beginning with ‘millennials are’, the auto-suggestions will likely yield the next four top keywords as ‘lazy’, ‘entitled’, ‘stupid’ and ‘screwed’. Hopefully, after reading this you will come away feeling that they are not lazy, entitled, stupid or screwed.

Events Shaping Their Lives
To understand millennials, one needs to understand the events that shaped their lives. Some of the older millennials remember the Challenger explosion in 1986, the deaths of 80 people in the Branch Davidian compound fire in Texas in 1993, the 9/11 terrorist attacks in 2001, the 2004 Indian Ocean tsunami and Hurricane Katrina in 2005. They also remember the Columbine High School shooting in 1999, the first of a string of mass murders of both innocent and random people at schools, universities, theaters and other public venues. They have witnessed random acts of violence almost instantaneously as the internet has connected this generation with these events in real time.

Millennials have witnessed economic uncertainty and the collapse of the internet bubble, followed by the worst global recession since the Great Depression.  Finally, they have witnessed their parents working long hours, sometimes resulting in dysfunctional families or divorce. Some watched as companies that employed their parents did not always appreciate the sacrifices they made for their careers.  Many parents lost their jobs due to downsizing or when the company they worked for was part of an acquisition. These formative events help explain why, as a cohort, millennials want to work to live and not live to work.

Millennials will work long hours to finish a project, but they do not want to work long hours. They are not lazy; they want time to live life to its fullest. Millennials have an almost insatiable desire to learn. When they feel they are no longer learning, they will look for another job. This makes them ideal candidates for special projects that keep them engaged while they complete the tasks the organization needs them to perform on a daily basis. When they travel, they want to go local and enjoy the culture of the community they are visiting. Airbnb locations are often located in said community, and this, along with the affordable price, is key reason why millennials often prefer Airbnb.

Another profound influence on millennials is technology. They were the first generational cohort to grow up with the internet and are sometimes referred to as digital natives. They grew up with cell phones and social media sites including MySpace and Facebook. They are now moving from expensive subscription cable TV to using WiFi to gain access to last week’s cable shows through Netflix, Hulu or other online providers of stored content. If they are interested in a news item, they look it up online. Comparatively, most spend little time reading print media.

In their cars, they are often listening to their own music — that is, when they happen to be in a car. Those living in urban areas prefer not to own a car, using public transportation, Uber and Zipcar when they need to get somewhere. This is why print and broadcast media are not as effective as social media for reaching millennials. Their desire to use public transportation was crystallized in a study by Chase Card Services, which found that almost one-fifth of millennials said they will not stay at a hotel that does not have easy access to public transportation.

Brand Loyalty
One of the areas I specialize in is creating loyalty through branding. I became interested in how to create loyalty amongst millennials.

First, although they are brand loyal, they expect immediate recognition from brands. They do not want to stay in a basic room 35 times before they start to get upgrades as a gold member of a loyalty program. They want to be recognized as being important the first time they walk through the door. A challenge for brands is how to maintain their legacy loyalty programs that have been effective with baby boomers while also providing instant benefits for millennials.

New brands catering to this youthful generation can indeed design appropriate loyalty programs. For example, citizenM’s loyalty program has a one-level ‘citizen’ designation. When you join, you instantly get 15% off room rates, a free drink, plus a more liberal cancellation policy. Hilton and Marriott now have programs where loyalty members get discounts on hotels as well as free WiFi. These immediate benefits will attract Millennials.

Millennials are also influencing hotel designs, resulting in spaces that enhance social interaction. The new concepts – such as Moxy, citizenM and Radisson RED – all have public areas that invite social interaction. Because millennials use these public areas, their rooms can be smaller. The new social aspect of the public areas not only attracts millennials but is also a feature that seems to create value with boomers and Gen Xers.

Some brands have gone even further, eliminating the front desk and moving to a computerized check-in. Millennials prefer these self-service technologies (SSTs) because they eliminate human error and not because they do not like human interaction. In fact, they are very social. The use of SSTs creates an opportunity for companies to reduce their labor by having millennials perform the tasks of ordering, checking in, making reservations and anything else that can be digitalized.

Radisson RED has several recruitment videos showing opportunities for employees with tattoos and unique hairstyles, while other hospitality brands have policies against visible tattoos, facial hair, body piercings or unique hairstyles. With the growing trend of millennials exhibiting individual expression through physical body alterations, considerations about hiring policies have thus come to the forefront. Radisson RED realizes that these features are common traits among millennials and seeks employees who represent this generation. Some current hotel policies will not survive if hospitality firms want to focus on millennials.

These are exciting times for the hospitality industry. Although millennials are changing the design of hospitality spaces, the format of loyalty programs and employment models, many of these shifts are refreshing and necessary. They can and will enhance the travel experience for not only millennials but also for all the other generations.
References:

• Walsh, E. (2014). Looking Ahead: Millennial Travel Trends-Part1, retrieved April 2016 from https://www.turnerpr.com/blog/millennial-travel-trends-part-1/.
• Bolton, R., Parasuraman, A., Hoefnagels, A., Migchels, N., Kabadayi, S., Gruber, T., Loureiro, Y., and Solnet, D. (2013). Understanding Generation Y And Their Use Of Social Media: A Review And Research Agenda, Journal of Service Management, Vol. 24 (3), pp. 245-267
• Ng, E., Schweitzer, L. & Lyons, S. (2010). New Generation, Great Expectations: A Field Study Of The Millennial Generation, Journal of Business Psychology, Vol. 25, pp. 281-292.
• Strutner, S. (2014). Generation Y Travels Fancier Than The Rest Of Us, Survey Finds. Retrieved, April 2016 from http://www.huffingtonpost.com/2014/06/17/millennial-travel_n_5492127.html.

About the Author

John Bowen is a former member of Cayuga Hospitality Consultants.

‘Book direct’ is the war cry of hotel owners, management company executives, chain CEOs and many marketing consulting groups. Like real war, the costs and benefits must be evaluated, particularly by those who will be paying for it – hotel owners. This is even more critical for a war that is unwinnable.

“Wars are won and lost on the basis of superior strategy and overwhelming resources.”
-Clausewitz, On War, Book 2, Chapter 2, 1873

An Unwinnable War

In this war to win the hearts and minds of modern travelers, intermediaries like Google, Expedia and Priceline have the resources and major strategic advantages. Individually and collectively, they have massive financial resources to invest in technology (website and mobile), systems, databases, marketing, talent and so forth – more than any single chain, much less an independent property.

They have strategic advantages in their market power, reach and capitalization. Their strategic proposition for the consumer is also more compelling – an efficient means to assemble, determine value for and obtain the lowest prices for a comprehensive travel experience. They also have the traveler and supplier information to execute a seamless user experience. Moreover, their mobile apps are efficient, proactive and executed in real-time.

On first glance, a war against these opponents is unwinnable.

Hotels can offer only a part of this. Their websites limit consumers’ evaluations to the confines of their own brand.com, though most provide external and independent access to TripAdvisor reviews and social networks. Further, their consumer traveler assistance is limited to the property and local area via mobile-concierge-type apps.

Chains are winning some battles. They are leveraging loyalty programs as part of the now widespread ‘book direct’ advertisement campaigns that communicate better deals for their loyal consumers as well as mechanisms to evade intermediaries’ rate parity agreements. They are also using apps, targeted at loyal guests to improve the hotel experiences and produce additional non-room revenue before, during and after the stay.

The strategic weakness of this approach is that consumers are often members of multiple chains’ loyalty programs and multiple mobile apps. All of these typically provide points and assistance only for the hotel stay. On the flip side, OTA intermediaries provide both points and assistance for the entire travel experience. They are a ‘one stop shop’.

As well, the hotel’s loyal customer is not a new or incremental customer. In effect, the owner is paying (to the chain or others) more to keep an existing customer and, hopefully, produce a better room rate margin. The question for the owner is whether the investment is worth the result.

Strategically, intermediaries have resources and advantages to counter the bottom line effects of chain loyalty program actions. They can offer better deals for the intermediary loyalty program customers – for example, prices that are below parity or chain discounts. Intermediaries can also offer their loyal consumers last minute prices below that of a chain’s at competitor properties right up until check-in. With this capability, they can make trip arrangements to accommodate a change and cost-efficiently manage the entire travel experience. They can even force major hotel brands to lower their loyal customers’ rates as the chains try to preserve guest bookings with value ads or the promise of lower rates (that is, the best rate guarantee). In either case, owners’ margins are reduced and intermediaries are well-positioned to manipulate chain rates and reduce loyalty program benefits.

Alas, there’s always hope. The most significant weapon that owners have to drive direct business is revenue management. Hotels can and should execute revenue management where the highest margin rates are offered on available inventory and the lowest rates – that is, those offered to the OTA merchants – are rejected.

Increasing revenue management efficiency is a battle than can be won, but only when market or property inventory demand exceeds supply. The risks here come during economic downturns or off-peak periods when intermediaries have the clear strategic advantage. They can choose to benefit their well-behaved partners – for example, through better results page position – or punish them accordingly.

With the hotel industry as fragmented as it is, there is little that an individual owner can do. Hence, owners must carefully evaluate the importance of a viable relationship with intermediaries versus waging an unwinnable war.

Measuring the Effects of War Accurately is Essential

Consulting groups frequently estimate the margin effects of intermediaries solely on the basis of their merchant rates and commissions. On several occasions, I have been critical of this methodology. My major criticism is their failure to explicitly include media effects of presence and prominence on their sites, otherwise known as the Billboard Effect. Despite disagreements over the exact size of this effect, the actions of properties that have left and returned to OTA sites confirm the existence of a statistically significant impact.

Intermediaries’ market power emanates from profitably driving consumer eyeballs to their visual display real estate. The majority of their hotel-based profits comes from the economic rents levied for properties to appear on their websites. Like the real estate industry, intermediaries compete with one another on creating valuable digital displays and the rent they charge suppliers to occupy this space.

Both activities could eventually benefit owners. The missing element for intermediaries and owners in all of this is an accurate metric of the net revenues generated for owners by appearing on their digital real estate. It is the same element missing in aggregate measurements of intermediary margin impacts. An additional collective downside for owners is that one owner’s net gain is, for the most part, another’s loss. In effect, intermediaries mostly shift share rather than create new market business.

Wrapping your head around all this takes time, so don’t panic. A reasonable approach for owners is to first recognize that a war with intermediaries and OTAs is unwinnable. Next, participate in battles that are winnable, only after evaluating the costs and benefits. Thirdly, find ways to work effectively with your intermediary opponents based on joint efforts to measure the net revenue generating impacts of the business relationship.

About the Author

Zachary Schwartz is a former member of Cayuga Hospitality Consultants.

A Silver Lining in the Dark Clouds of the Great Recession?

While it takes an accomplished clairvoyant to predict where RevPar ¹, ADRs² and Occupancy³ will be in the coming months, or for that matter the coming years, for those hospitality owners and operators trying to weather the economic storm there has been some positive news recently out of a place that few wish to spend “too many a night” – the United States Bankruptcy Court⁴. In the spring of 2011 an oceanfront hotel owner was successful in arguing that it is permitted to use the revenues generated from its guests’ stay and use of amenities to assist in the reorganization of the company. This court ruling of first impression⁵ was made despite vociferous opposition from its secured lender. The secured lender claimed that by virtue of judicial precedent and its Absolute Assignment of Leases and Rents that it “owned” all hotel revenues⁶ and therefore the hotel owner had no funds from which to fund its proposed reorganization and accordingly the Chapter 11 bankruptcy case should be dismissed and the lender immediately permitted to foreclose on its collateral.

THE ASSET

Ocean Place Resort and Spa occupies a prominent beachfront location on the New Jersey Coast, roughly a one hour drive south of Manhattan and five miles from the Garden State Parkway. With 254 rooms, 40,000 square feet of meeting space, three restaurants, a bar/lounge, tennis courts, a parking garage and a full service spa, Ocean Place sits alongside 1000 feet of sandy beach. Its 17 acres included the “economic amenity” of a redevelopment agreement with the City of Long Branch granting it rights for a full “mixed-use” build-out approaching 1.4 million square feet.

FINANCING

Ocean Place Development, LLC, for all intents and purposes, was a single asset special purpose entity⁷. The original lender, Barclays Capital Real Estate Inc. (“Barclays”) advanced, on a non-recourse basis, approximately $53,000,000 to Ocean Place (the “Loan”) secured by a plethora of legal documents including a Mortgage, Absolute Assignment of Rents and Leases, a Security Agreement and UCC and fixture filings. Also included in the “collateral” was a “bad boy” a/k/a “springing” guaranty where in the case of fraud or a bankruptcy filing the loan becomes fully recourse to the borrower and its principals. The omnipotent loan structure was and is the “financing du jour” to prevent, and in the case of a risk tolerant borrower, protect the secured lender in the event of a bankruptcy filing.

LOAN DEFAULT, LOAN SALE AND ATTEMPTED FORECLOSURE

The Barclays Loan matured in January of 2008. Up until the maturity date Ocean Place was current on its loan. Post maturity it paid interest to Barclays at the default rate of 9.8% but then in January of 2010 ceased making payments. After several months of marketing of the loan for sale, in October of 2010 AFP 104 Corp. (“AFP”)⁸ purchased the Loan from Barclays for a purported $40.5 million. Following the purchase AFP obtained a Judgment of Foreclosure and, subsequent to several statutory adjournments obtained by Ocean Place, scheduled a foreclosure sale for February 22, 2011. On February 15, 2011 Ocean Place filed Chapter 11 in New Jersey which stayed the foreclosure sale. At the time of the bankruptcy filing the secured lender, now AFP, was purportedly owed $57,245,372.00 (AFP “stepped into the shoes” of Barclays notwithstanding the discounted price it paid to purchase the loan).

THE FIRST BANKRUPTCY BATTLE: THE ABSOLUTE ASSIGNMENT OF LEASES AND RENTS AND “OWNERSHIP” OF THE HOTEL REVENUES

There is no argument that in order to successfully reorganize in Chapter 11, or for that matter, to pay one’s own daily living expenses, that “income” is the life blood. In the case of the battle between AFP and Ocean Place that “life blood” took the form of Hotel Revenues. In bankruptcy parlance such revenue is referred to as “cash collateral.” ⁹

Two days after the bankruptcy filing Ocean Place sought the court’s permission to use its cash collateral, the Hotel Revenues, in order to pay its ordinary and necessary operating expenses and to reorganize. In the legal battle that ensued the secured lender, AFP argued that it “owned” the Hotel Revenues and therefore they were not available as income to assist Ocean Place in its Chapter 11 reorganization. AFP relied on the precedential authority of In re Jason Realty, 59 F.3d 423, (3d. Cir. 1995) as well as the Absolute Assignment of Leases and Rents given by Ocean Place to AFP as successor-in-interest to Barclays. The language of the Absolute Assignment of Leases and Rents defined “rents” to include: . . . all revenues and credit card receipts collected from guest rooms, restaurants, bars, meeting rooms, banquets rooms and recreation facilities, all receivables, customer obligations, installment payment obligations and other obligations now existing or hereafter arising or created out of the sale, lease, sublease, license, or rendering of services by Borrower [Ocean Place] or any operator or manager of the hotel or the commercial space located in the Improvements [the premises] or acquired by others . . ., license, lease, sublease and concession fees and rentals, health club membership fees, food and beverage wholesale and retail sales, service charges, vending machines sales and process, if any . . .whether paid or accruing before or after the filing by or against Borrower of any petition for relief under the Bankruptcy Code.

Jason Realty, a decision of the United States Court of Appeals for the Third Circuit (Delaware, Pennsylvania and New Jersey) is followed by many other federal appellate and bankruptcy courts.¹⁰Jason Realty was a single asset limited partnership which owned and operated a two story retail and office building. Like Ocean Place it filed Chapter 11, also in New Jersey, to stave off a foreclosure sale. Like Ocean Place it also granted to its secured lender an Absolute Assignment of Leases and Rents. In Jason Realty, the Third Circuit Court of Appeals found for the secured lender, First Fidelity Bank, NA, in holding that the Absolute Assignment of Rents “evidences an absolute assignment of title to the rents, with the assignor [Jason Realty] receiving a license to collect the rents.” As a result, court found that the rent proceeds from the leases were not property of the Jason Realty but rather property of the lender, First Fidelity Bank, pursuant to the Assignment of Leases and Rents. Thus, the “life blood” of Jason Realty’s ability to reorganize, the rents, were not “available” to the debtor to fund its proposed plan of reorganization. In the case of Jason Realty, no rental income meant no “life blood” and the reorganization failed.

HOTEL REVENUES ARE NOT RENT

The court in Ocean Place, however, in a case of first impression¹¹, held that hotel revenues were not “Rent” within the meaning of the Uniform Commercial Code explicitly adopting an analysis of hotel revenues found in a New York case¹² and finding that the hotel room revenues were “accounts” or “payments intangible” and are not interests in the realty.¹³ Specifically, the court held that hotel revenues [defined as revenues generated from room occupancy, food and beverage sales, catering, gift shop purchases, and spa and related hotel services] generated by the Debtor [Ocean Place] did not constitute “rents” and therefore the hotel revenues could be used to pay its ordinary and necessary operating expenses and to reorganize. ¹⁴

While the court did find that the secured lender had a perfected security interest in the hotel revenues as “personal property” and not rent, and was “adequately protected,”¹⁵ Ocean Place was granted permission by the bankruptcy court to use the hotel revenues, as its “life blood” to attempt to reorganize. Needless to say, AFP was not happy with the outcome. However, the case is on-going and the battles rage-on as of the date of this article.

CONCLUSION

The court in Ocean Place found that Hotel Revenues were not “rent” within the meaning of the Third Circuit Court of Appeals decision of In re Jason Realty, LLC. While the court arguably had the judicial prerogative to extend the Jason Realty decision to assignment of Hotel Revenues, its decision not to do so can be seen as a victory to hospitality owners and operators weathering the economic storm by allowing the use of the revenues to attempt to reorganize. No doubt, however, legal counsel to hospitality lenders will be scrutinizing the decision and their loan documents for a “work around.” In the meantime, the question has been posed whether owners of other distressed property, such as parking garages, storage facilities and other real property that generate revenues which are not necessarily “rent”¹⁶ will seek a further legal extension of the Ocean Place decision¹⁷ .

• 1 1RevPar: revenue per available room; a metric used in the hotel industry which is calculated by multiplying a hotel’s average daily room rat
• 2 ADR (Average Daily Rate): a measure of the average rate paid for rooms sold, calculated by dividing room revenue by rooms sold. See id.
• 3 Occupancy (Occ): is the percentage of available rooms that were sold during a specified period of time. Occupancy is calculated by dividing
• 4 In re Ocean Place Development, LLC., 447 B.R. 726 (Bankr. D.N.J. 2011).
• 5 cf In re Kingsport Ventures, L.P. d/b/a Kingsport Comfort Inn, 251 B.R. 841, 846-50 (Bankr. E.D. Tenn. 2000). The Ocean Place court expressl
• 6 Hotel Revenues: The court in Ocean Place defined hotel revenues as including revenues generated from room occupancy, food and beverage sales
• 7 Hotels generally are not considered a single asset real estate entity (“SARE”) under existing bankruptcy case law. See In re CBJ Development
• 8 AFP 104 Corp. is the indirect subsidiary of United Capital Corporation (OTC Pink: UCAP, formerly NYSE Amex: AFP). United Capital Corporation
• 9 “Cash collateral” means cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents, whenever
• 10 See Wachovia Bank N. A. v. Encap Golf Holdings, LLC, 690 F. Supp. 2d 311 (S.D.N.Y. 2010); First Fidelity Bank, N. A. v. Eleven Hundred Metro
• 11 See Note 5.
• 12 See In re Kearney Hotel Partners, et.al. 92 B.R. 95 (Bankr. S.D.N.Y. 1988) (in the context of a bankruptcy avoidance action the court found
• 13 In re Ocean Place Development, LLC at 732-33.
• 14 Id at 733.
• 15 The term “adequate protection” is generally read as intending to protect a secured creditor from “diminution in the value of its collateral
• 16 The Ocean Place court made note that pursuant to the Uniform Assignment of Rents Act (“UARA”), adopted by the Uniform Law Commission in 2005
• 17 See Room Revenues are Not “Rents”: Hotel Creditors Cannot Check in to Jason Realty, 30-6 ABI Journal 24, 77 (July 2011).

About the Author

Francis L. Gorman is a former member of Cayuga Hospitality Consultants.

Last year I posted a blog to remind hotel owners that they needed to have an exit strategy that embraces the circumstances and timetable under which they plan to exit their hotel investment. Since then, major and dramatic – some say seismic – changes have occurred in the domestic and international economy and in the hotel capital markets. It is advisable to revisit the exit strategy and revise it to reflect the current environment and foreseeable circumstances.

First the good news:

• The hotel industry is and remains cyclical and demand is closely correlated with GDP. So when the national economy becomes strong again — some are already calling an end to the recession — the demand for hotel rooms will improve.
• Supply growth has been sharply constrained by changes in the financial markets so little new product has entered most markets and not much is foreseeable for a while. So when demand strengthens, an existing hotel that has been well-maintained and well-operated through the down cycle will be likely to benefit.
• A property whose financial capital was put in place before the high-leverage, low cap rate era should, with aggressive asset management in place to tighten costs, be able to survive until the upturn.

Now the bad news:

• Average daily rates are going to take a while to come back. We saw this after the September 11th event and this time around it may take even longer for hotels to regain enough pricing power to achieve the rates that were in effect in mid-2008.
• Between tightened underwriting standards and increased interest rates, most five-year term loans that come due this year, or in 2010 or 2011, will not be able to be fully rolled over. The hotel’s value is going to have to be reset and, in most cases, additional equity injected. The “experts” are forecasting “haircuts” ranging from 25-60% of 2005 – 2007 value. And a number of vulture capital funds are waiting patiently for weak owners who fall by the wayside.

Let us review and update some of the circumstances that indicate that it is time to leave a hotel investment:

• You are out of money [“the well is dry!”] Either the hotel isn’t doing well or financing to replace outstanding debt that is maturing isn’t available. The hotel needs an infusion of equity and you don’t have it, cannot get a return sufficient to warrant investing it or cannot raise it. This is what the bankers call a troubled asset and brokers refer to as “a distress sale.” The selling price is going to be favorable only for the new owner.

• The picture isn’t pretty [“it soon will be raining on my parade!”] A new competitor is coming in – the brand is out of favor – the location is no longer prime – demand is declining — the property is older and needs much upgrading and refurbishment – a union agreement (or the threat of one) or a legislative mandate such as a “living wage” or retroactively applied building code change has changed the economics – and so on. For whatever reason or reasons, a large outflow and/or a small inflow of cash are foreseeable. Clearly, this hotel will not produce the desired return on investment in the near or medium-term future.
• My ship has come in [“here’s my pot of gold!”] There are at least two versions of this: One is the “Greater Fool Theory” where a prospective buyer wants the hotel so badly, for whatever reason, that he is willing to overpay for it, giving you a handsome profit.The second is where the land the hotel occupies has become so valuable that it makes economic sense to buy the property, tear the building down, and replace it with a different, more profitable use –shopping center, mixed-use development, offices, condos and the like.Believe it or not, these “ships” will be sailing again in the future. But presently they are far out at sea, or perhaps even in dry-dock. The challenge is to forecast how long it will take, and how much additional cash outlay will be required before they arrive at the pier.
• The time is right (again) [“timing is everything!”] The bulk of the tax benefit has been realized – Opportunities considered more attractive (or safer) are available – cash is needed for other purposes — estate planning (or estate settlement) needs dictate a sale – the partners are arguing about objectives or future strategies. These are just a few examples.If a potential or planned exit strategy is thought out, it can be modeled in a pro forma and the effects of various strategies considered and refined. The forecast and an asset management approach can then be utilized by the owner to increase his total return on the investment by:
  • Managing the outflow of capital expenses (and maintenance costs) appropriately.
  • Structuring financing and lease versus buy decisions for greatest benefit.
  • Making short-term decisions on a host of other items, including service contracts, booking agreements, sales & marketing activities.
  • Creating an audit trail of exceptional expenses to make a case to a prospective buyer as to why the net operating income (NOI) should have been higher.

Several hotel owning companies periodically perform an exercise called a “re-buy analysis” on the hotels they already own. Considering present property and market conditions, availability of financing, new opportunities or potential threats that have arisen, capital needs, return on investment objectives and alternate opportunities available, would they buy that hotel asset today? Would they now revise their strategies from what was originally put in effect? This is a great asset management discipline that should be applied by any hotel owner on an individual asset basis.

If you model the likely income and realistically project the amount of debt that can be supported for at least the next five years, you will quickly pinpoint opportunities and roadblocks. If the hotel was highly-leveraged and its debt is maturing in the next few years, this would be a very good time to reset your exit strategy. Will it be on your terms or someone else’s? If you plan to stay in the hotel, you will need to restructure your capital stack. If you can come up with strategies to add value, perhaps you can convince the lender to write down the loan by less than he would be facing if he put the property into foreclosure and sold it to a new owner at market rates. Even though the loan decision is likely to be made on the basis of trailing twelve-month’s earnings, and not the proforma, if the future scenario is presented carefully and thoughtfully, it can enhance the prospects for a favorable outcome.A sound exit strategy, put in place and then reset to current conditions, will greatly increase the likelihood that when you exit your hotel investment it will be on the most favorable terms available, and that your return during the holding period will be optimum for the circumstances.

About the Author

Jim Burr is a former member of Cayuga Hospitality Consultants.

Why OPTIMBUY?

When confronted with the challenges of food / hospitality products purchasing, small and mid-size organizations (“S&MS”), like resorts, hotels, restaurants and hospitality groups are handling the situation with mixed results which cost them dearly on their bottom line.

OPTIMBUY provides supply chain consulting services to these organizations to implement new practices, negotiate better deals and generate savings and costs reduction, building long term relations with their suppliers – partners, while operating under a unique pay-for-performance model.

The day-to-day of small and mid-size operators:
Relying either on a one man show or a tiny team at Corporate or on each single location / property‘s chefs or managers, S&MS do their best to deal with the giants of the hospitality manufacturing and distribution worlds as well as their local purveyors. The show must go on: amazing foods on the tables, impeccable service and delighted customers who will come back to experience once again the magic delivered by our boutique S&MS.

Focused on problem solving, production and customer satisfaction, S&MS operators have, in the best case scenario, surrounded themselves with a network of trusted suppliers, but have spent little time on negotiating terms and conditions. They did not analyze their spend by category / sub-category, did not survey the potential providers, did not do a market basket comparison through a bid process, and didn’t have access to benchmark data.

Some are still cherry-picking suppliers. They feel they get the best deal by switching from Joe to Jack and Paul and back, except that vendors are smart. Some will be competitive on some key items but get their money on the rest. Some will be competitive for a few weeks / months and when the relationship is built and cherry-picking ends, they’ll get their money back. Some will split the business or alternate amongst themselves. S&MS using this practice are missing the big picture, lowering supplier’s service and commitment, and adding indirect costs like administrative costs, products receiving, quality control…

Some have joined a “GPO”, a Group Purchasing Organization, like Avendra, Premier, FoodBuy, BuyEfficient or anyone of the 800+ GPOs in business in the country. GPOs will provide access to their deals / preferred pricing / terms and conditions, some with manufacturers, some with distributors, some with both. This does come with constraints when you have to buy from the distributors or manufacturers selected by the GPO which may not be the perfect fit for your business or your liking. It also may not be the most competitive way to reduce costs as, rightfully, GPOs need to make a living and will get a share of the savings they generate. The questions become what share should a GPO get? 25% or 75% of the savings, and over which period? For a few years or forever?

When the general economy is not at its best and every penny counts, S&MS have to challenge the way they do business and look for every opportunity. They cannot only expect to stabilize and increase their top lines, they have to address the middle of the page and go after the dollars moving through their facilities, storerooms and freezers.

The mysteries of the food supply chain:
Let’s pick, coffee – a highly volatile commodity. Currently the raw material, the “Arabica Green”, trades at close to $2.50 per pound (a 65% increase from two years ago) and gets into our locations at $7 to $12 per pound. Don’t misunderstand: Lots of transformation / operations / transportation needs to happen between the hills of Columbia and the loading dock of your hotels or restaurants. But only large and X-large organizations have the resources to practice strategic sourcing and analyze the cost components of what they purchase in order to buy on futures or negotiate best in class deals with formula pricing.

The manufacturing world has built models initially developed to impact their costs and profitability and to reward distributors and operators with programs such as volume incentives or growth incentives. These have transformed into complex mechanisms such as pricing, deviated pricing, bill backs, rebates and allowances resembling a maze hard to navigate without insight knowledge and benchmarks.

The value-added products strategies (pre-washed, pre-cut …) which removed costs from the kitchen have also created opportunities for manufacturers to increase margins, but also for negotiation. When the question becomes “make” or “buy”, pricing and terms are critical in the decision making process.

Any craze is an additional opportunity for them: sustainability, green, organic, fair trade, low this / low that, Omega 3 enriched, free of trans-fats, hydrogenated oils, monosodium glutamate (MSG), high fructose corn syrup or artificial flavors. Should you pay more? And if so, how much more to get the products you need?

The consolidation of the food distribution industry, via mergers and acquisitions, is reducing the competitive landscape. The need for higher margins and ROIs has resulted in practices making it more complex and less transparent for S&MS operators to understand costs and value creation. Strategies such as Distributor brands, Packers programs, Regional distribution centers, Cross docking, Vertical Integration (production and/or transportation), Earned income need to be accounted for. Understanding the levers of distribution costs such as drop size, case cost or payment terms will help you drive win-win agreements with your distributors. Deciding which product categories to buy from which distributor, or whether to place orders online or over the phone, or to buy a distributor’s brand versus a national brand, will reduce or add to your costs.

The solution:
When hiring an in-house purchasing / negotiating team is not an option, S&MS should reach out to external consultants who can assist them in building the right programs with the right distributors and manufacturers, provide benchmarks, expertise or resources and, at the end of the day, reduce costs. They will also help with proper contracting to minimize risks, ensuring that suppliers do carry liability insurance, do trace the origin of their products, do have an HACCP plan, do have a recall process and more.

OPTIMBUY helps S&MS craft responses meeting their needs, one client at a time.

Based on an assessment of current practices and review of a client’s agreements / deals, OPTIMBUY expert consultants work with clients’ individual / purchasing team / management to build customized programs generating savings. OPTIMBUY negotiates / renegotiates current deals on a standalone basis or assists clients in selecting a GPO for partial or total participation in its programs, whatever makes more sense for the client. OPTIMBUY operates on a “Pay for Performance” model and earns a share of the savings generated for its client.

Editor’s note:
OPTIMBUY defines small / mid-size hospitality organizations as organizations with a foodservice spend ranging from $5M to $50M. Foodservice purchases primarily include food, beverages, paper and disposables, smallware, as well as cleaning products purchased from distributors or directly from manufacturers.

OPTIMBUY is a supply chain management consulting firm specializing in food and hospitality related products. In just three years, OPTIMBUY has advised clients on more than $1 Billion in foodservice spend. The new contracts they have negotiated have averaged for their clients savings ranging from 3 to 10%.

OPTIMBUY is a Cayuga Hospitality Advisors preferred partner.

About the Author

Chris Rochette is a former member of Cayuga Hospitality Consultants.

Four Seasons Uses an Arbitration Clause to Defeat an Owner’s Request for an Injunction to Terminate its Management Agreement

This Stroock Hospitality Industry Practice Group Special Bulletin discusses BRCP HEF Hotel Tenant LLC v. Four Seasons Hotels Ltd. (the “Four Seasons Aviara Resort Case”), which illustrates how an arbitration clause in a hotel management agreement (“HMA”) can defeat an owner’s attempt to seek emergency relief from a court in order to terminate a manager.
The Termination Dispute

The dispute in the Four Seasons Aviara Resort Case arose when the hotel’s owner (“BRCP”) and Four Seasons could not agree on a 2009 operating budget, a scenario that is likely to play out in many hotels in this economy. Four Seasons proceeded to operate the hotel under the 2008 budget and demanded capital from the owner. In March 2009, the owner terminated the HMA and started an arbitration seeking a declaration that termination was proper. The owner also sought the same relief from a federal court in California.

On May 8, 2009, the owner demanded that Four Seasons vacate the property by May 11 to make way for a new management company. That day, Four Seasons wrote to the arbitrators requesting a conference to seek injunctive relief halting the termination. On May 11, each party sought an injunction against the other in federal court, in a procedural battle over whether termination should be decided in court or by an arbitration panel.

The Owner’s Failed Attempt to Litigate the Termination Dispute in Court

The owner’s filing asserted an absolute power to terminate the HMA, relying on the 1996 Third Circuit Court of Appeals’ decision in Government Guarantee Fund of the Republic of Finland v. Hyatt Corp.,¹which firmly established this power of termination under the law governing agency relationships. The owner demanded preliminary injunctive relief prohibiting Four Seasons from: (1) holding itself out as the manager of the hotel; (2) incurring any further obligations on the owner’s behalf; (3) continuing to occupy the hotel property; (4) obstructing access to the hotel by the new manager; (5) interfering with the owner’s personal property, including the hotel’s books and records; and (6) retaining or expending any of the hotel’s revenues or the owner’s funds.

Four Seasons’ Response: The Dispute Must Be Arbitrated Under the HMA

Four Seasons’ injunction application cited the fact that the owner had allegedly attempted to seize the hotel “by force” and requested a court order “that Owner desist from further unilateral action until the parties can go before the arbitration panel and meaningfully resolve their disputes, in terms of interim relief and long-term issues, as they are obligated under the HMA to do.”
The Arbitration Provision in the Four Seasons Management Agreement

Four Seasons’ strategy to move the termination dispute into arbitration was based upon a broad arbitration clause that provided as follows:

Except as to matters to be determined under this Agreement by auditors and as otherwise provided in this Agreement, any controversy or claim arising out of or relating to this Agreement shall be settled by arbitration . . . .

Neither BRCP nor Four Seasons claimed that the dispute fell outside the arbitration clause. However, the owner argued that, under California’s arbitration statute, the Court had authority to render injunctive relief “in connection with an arbitrable controversy.” The owner also argued that federal courts routinely grant injunctions in aid of pending arbitrations.
The Court’s Resolution: Rejection of Owner’s Request for Injunctive Relief Seeking Termination

On May 27, 2009, in a terse, one-paragraph order, the court rejected the owner’s arguments and ordered the parties to arbitrate their dispute as Four Seasons had urged. The court’s decision followed decades of precedent in which courts defer to the federal policy favoring arbitration where the parties entered into a contract with a broad arbitration clause. The court reasoned that:

Commensurate with the court’s limited role in disputes subject to binding arbitration, the court defers ruling on the pending motions to allow the parties the opportunity to address their claims in the chosen forum [i.e., the arbitration]. Under the Federal Arbitration Act, “it is for the arbitrator to determine the relative merits of the parties’ substantive interpretations of the agreement,” . . . and not this court.

The Four Seasons Aviara Resort Case’s Lessons For Hotel Owners About Arbitration

Negotiate Your Arbitration Clause Carefully

Arbitration “should be compelled ‘unless it may be said with positive assurance that [the] arbitration clause is not susceptible of an interpretation that covers the asserted dispute.”² Because federal law empowers an arbitration panel to issue injunctive relief,³ a demand for an injunction is not sufficient to avoid arbitration, unless the arbitration clause expressly removes injunctive relief from the arbitrator’s power, which the arbitration clause in the Four Seasons HMA did not do.

The owner in the Four Seasons Aviara Resort Case apparently believed that a court would be a better forum in which to litigate a management agreement termination. This strategy raises a host of issues about the deficiencies of alternative dispute resolution as a means of resolving hotel disputes – a topic that is beyond the scope of this Special Bulletin. Suffice it to say that whether arbitration, as opposed to a court proceeding, is a preferred method of dispute resolu-tion is a complex legal question. No owner should consider an arbitration clause to be simply a boilerplate provision that is a secondary consideration to the economic terms during the negotiation of an HMA. The arbitration provision is critical. If the owner wants to reserve its right to litigate certain aspects of the relationship with the manager in court, then it should customize the provision appropriately: for example, by excluding disputes regarding securities law violations, fiduciary duties and/or books and records. If an owner is apprehensive about relinquishing its right to have a court of law handle potential disputes, then it should avoid entering into any type of arbitration agreement.

Read Your Arbitration Clause Carefully Before You Try to Go to Court

When an owner agrees to an arbitration clause like that in the Four Seasons HMA, an attempt to go to court to seek termination is typically a losing strategy that only results in significant and ultimately pointless legal expenses for the owner. Worse yet, the owner is then consigned to adjudicating its claims before an arbitration panel that it just tried to avoid by going to court. Such a strategy risks diminishing the owner’s credibility with the panel members, perhaps adversely impacting its claims on the merits of the dispute. While Government Guarantee Fund establishes an owner’s power to terminate an HMA at will, the test in the Four Seasons Aviara Resort Case will be whether and how the arbitration panel applies that legal precedent to the owner’s attempt to terminate Four Seasons HMA. Arbitration awards are not typically appealable and, if the panel’s ruling is mistaken on the law, it will be difficult and expensive to attempt to have the award set aside.

• 1 95 F.3d 291 (3d Cir. 1996). Cecelia L. Fanelli, one of the authors of this Bulletin, represented the successful owners in Government Guarant
• 2 David L. Threlkeld & Co. v. Metallgesellschaft Ltd. (London), 923 F.2d 245, 251 (2d Cir. 1991).
• 3 See, e.g., American Express Fin. Advisors Inc. v. Thorley, 147 F.3d 229, 230-31 (2d Cir. 1998).

About the Author

Cecelia L. Fanelli is a former member of Cayuga Hospitality Consultants.