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Business> Finance
UPDATED: February 11, 2007 NO.7 FEB.15, 2007
The Era of Budget Hotels
What began as an idea from an Internet posting is now set to sweep through China

A single posting on the Internet gave birth to a large budget hotel brand. In 2001, the founder of ctrip.com, Ji Qi, noticed an online friend complaining that ctrip.com's hotel reservation prices were slightly expensive. The poster may have had no ill intention, but the reader took it to heart. Ji realized that his friend's words had hit directly upon a fault line in the current hotel industry. Luxury hotels were not economical and inexpensive hotels were neither sanitary nor practical.

Therefore, Ji collaborated with Capital Tourism Co., which invested in four Jian Guo Inns as budget hotel templates. In June 2002, Ji established the first replicable standard template, designing specific rules for every hotel under his brand.

Soon after, Home Inn entered its expansion stage, reaching 70 units at the end of 2005 and continuing on to its current total of over 130 units. In terms of expansion style, the Home Inn chain adopted an emphasis arrangement, whereby they fully establish the operation before unifying it with the expansion strategy. Consequently, as well as maintaining a frightening speed of expansion, the occupancy rate of Home Inn hotels remains above 90 percent.

Further, certain statistics suggest the Chinese budget hotel market still has plenty of room to grow.

Need for economical quality

Budget hotels occupy about 70 percent of the U.S. hotel market, but in China this proportion has yet to reach even 10 percent.

The tremendous commercial potential of the Chinese budget hotel market offers an unparalleled sense of temptation.

As the sales manager of a small business, Mr. Zhang has taken many domestic business trips over the years. Due to limits on his travel expenses, Zhang often worries about being able to find a hotel that is economical, as well as being clean and comfortable.

But a turn for the better came four to five years ago, not only in the prosperous cities of east China, but also in a few second-tier cities in central and west China, with the appearance of budget hotels such as Home Inn, Jinjiang Hotel and Super 8 Hotel.

Spending as little as 200 yuan a night, Zhang can now stay in a clean and comfortable business suite with king-size bed, broadband Internet access and service from a 24-hour restaurant offering appetizing Chinese-style fast food.

An ever-increasing number of business clients and independent tourists provide strong demand for the rapidly developing domestic budget hotel market.

This market opening, calculated to be worth tens of billions, has driven both foreign and Chinese operators to step up their efforts in the China market. Investors with various backgrounds, including old domestic hotel patriarchs, famous foreign chain brands and venture investment funds, are all rushing into a market in which the average profit margin is as high as 20 percent, and the period of return is only three to four years.

The mob swells

"Development of the domestic budget hotel market began in 1996," said Dai Bin, professor of tourism management at the Beijing International Studies University. "It entered its peak phase in 2004, and commenced its rapid expansion phase in 2005 and 2006."

He said that the current market presents four main traits: It is geared towards scattered business clients and prices are a bit high; it mainly covers the eastern coastal regions including Beijing, Shanghai and Guangzhou, as well as relatively prosperous cities in central China; domestic brands such as Home Inn, Jinjiang and Motel occupy the leading positions; the capital market's interest in domestic budget hotels is growing.

Domestic budget hotels are developing in a chain fashion and have begun brand-oriented operations. With almost 20 well-known domestic and international brands vying for market share, the current market appears to resemble a rowdy mob.

"Capital operations have become the most significant means of brand competition within the hotel industry," said Hong Kong Polytechnic University postdoctoral scholar Shen Han, who specializes in the development of budget hotels. He believes that in order to maximize the growing market share, every large domestic budget hotel brand is focused on the rapid development of their chain network, a focus which requires a huge stream of capital.

Over the past two years, the two leading hotel chains-Jinjiang Hotel and Home Inn-have remained in the phase of rapid expansion and acquisition of market share. The latter went public on the Nasdaq in October, raising over $102 million in funds and completing its IPO with a 31-fold over-subscription. The big boss of the domestic hotel business, Jinjiang's holding company, Jinjiang International, is also seemingly unwilling to fall behind. Going public in Hong Kong two months after its rival, Jinjiang International channeled the majority of raised capital directly into its budget hotel operations.

Not long ago, U.S. investment bank Morgan Stanley spent $20 million on approximately 25 percent ownership in Shanghai Motel, with plans of taking it to the United States within two years.

In the current market climate, budget hotels are engaging in external financing through various channels. However, these methods will soon be eliminated due to market saturation. When the time comes, the budget hotel industry will be faced with internal capital operations such as brand consolidation and business mergers.

Growth looking good

According to statistical data collected by the American Hotel & Lodging Association, budget hotels occupy approximately 70 percent of the U.S. hotel market. In 2000, China only had 23 budget hotels, with a total of 3,236 guest rooms; by 2006, a 33-fold increase had left the total number at 768, with a total of 83,152 guest rooms. That's a 25-fold increase in rooms.

However, the proportion of Chinese budget hotels compared to the overall hotel industry has yet to reach 10 percent. The tremendous commercial potential of the Chinese budget hotel market offers an unparalleled sense of temptation.

Using Shanghai as an example, the future growth rate of domestic tourism is unlikely to fall below 6 percent per year. This means that every year, tourist numbers will increase by 6 million person-visits, and the lodging needs of these visitors will fall mainly on the shoulders of budget hotels.

Among domestic tourists traveling to Shanghai, average personal expenses have also consistently increased, with personal expenses in 2004 reaching 1,400 yuan. If lodging accounted for one third of these expenses, then each person would spend, on average, 350 yuan on lodging. As such, the annual earnings of Shanghai's budget hotels should reach a maximum of 30 billion yuan, with subsequent annual increases bringing in additional earnings of 2.1 billion yuan.

Shen believes that if budget hotel brands can maintain their prices and levels of service, there may be many opportunities for investment. These mainly include the following four methods: collaboration with a famous brand, creation of one's own brand, forming a collaborative strategy with a brand to engage in regional representation, and leasing property to budget hotels.

For example, in the past, state-owned businesses, institutional reception houses and unused properties have been reconstructed into decent budget hotels. Old one- to three-star hotels also have in some cases been renovated into budget hotels. Through stable returns on investment and healthy cash flow, these small but popular budget hotel projects have drawn in large numbers of small to medium-sized investors.

Mergers ahoy!

According to the 2005 Global Budget Hotel rankings, Holiday Inn holds the No.1 position with its 1,484 hotels, offering a total of 278,787 guest rooms. And as No.1 among the budget brands in China, Home Inn has a total of 110 hotels, which, up to October 2006, offered 13,161 guest rooms.

But the rest are not necessarily poised for greatness in China.

"At present, many hotel chains are only focused on rapid expansion," said Xu Zurong, President of Jinjiang Hotels. "Given the lack of management and supervision capabilities, many of them will be faced with the threat of shrinkage and even bankruptcy.

The reason that we are not currently advocating blind expansion is because we want to build the brand and its core competitiveness. When the time comes for the inevitable wave of mergers, that is when we will have an opportunity. I predict that this wave of mergers will begin in three years, and we await the day with great anticipation."

Professor Dai believes that during the next two to three years, the domestic budget hotel market will still be in a phase of free competition.

Amid the heated day-to-day competition, some hotels that fail to reach the brand standards of their chain in terms of facilities and management will be eliminated. This will be particularly true for projects in which apartments have been turned into hotels.

In the foreseeable future, many small-scale operations will not be able to escape mergers with larger brands. However, it will be another five years before we see mergers between major brands and the development of a stable market.

In the future, the leading budget hotel chains will maintain their competitive edge by expanding their market scale and increasing their pace of expansion. Moreover, new competitive hot spots will appear in regional markets, such as south China and the central China region.

The key factors determining the fate of budget hotels are not just their capital strength and brand network. It is their market foundation and brand characteristics that in the end become the budget hotel chain's strategic strengths.

(Xinhua Finance)

DISCLAIMER: The information contained herein is based on sources we believe to be reliable, but is provided for informational purposes only, and no representation is made that it is accurate or complete. This briefing should not be construed as legal, tax, investment, financial or other advice, and is not a recommendation, offer or solicitation to buy or sell any securities whatsoever.

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