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. Last Updated: 07/27/2016

3 Stars Could Be Heaven for Hotel Industry

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People have long been talking about the need in Russia for affordable international-standard lodging, cheaper than the four- and five-star hotels that dominate in Moscow and St. Petersburg. This year the talk has given way to plans to establish chains of just such hotels across the country.

On Feb. 20, Delta Capital Management announced plans to build up to 50 Country Inn hotels across Russia in the next decade, in partnership with Rezidor SAS, the operator of Radisson hotels.

A few days later, spokesmen from Menatep, a holding affiliated with oil giant Yukos, said the company had teamed up with Marriott and British hotel developer Sabre Projects to invest $300 million in the creation of a chain of at least 40 mid-market hotels.

Soon after, German-based hotelier Kempinski said it would establish its own chain of three- or four-star hotels in the regions. The operators of Novotel and Katerina hotels also announced plans to develop three-star hotels.

The hotel and tourism industry welcomed the reports. "Finally there will be accommodation to suit tourists' purses," said Helene Lloyd, marketing director of Tourism, Marketing & Intelligence in Moscow.

However, the projects will face many hurdles, and experts remain cautiously optimistic.

"It should be a winner if the sites can be found and put together with investment capital and operational, marketing and brand skills," said Simon Hudspeth, director of hotel consultancy HVS International. "We see lots of interest, but not much genuine development. We have several proposals out relating to potential developments and networks of developments. But I haven't seen any being built yet."

Paul Price, vice president of Delta Capital Management, explained the potential economic ramifications. He pointed out that international hotel chains derive two-thirds of room supply in the mid-scale and economy segments, with roughly one-third coming from the luxury segment.

"This phenomenon is most evident in the U.S. hotel market, as the majority of budget hotels are chain-affiliated," Price said. "Europe, which has a large base of small, privately owned hotels, is in the process of catching up. The Russian hotel market, with only a handful of internationally branded three-star hotels, offers enormous growth opportunities."

If the hotel chains do in fact come to fruition, they could provide a welcome boost. "Russia needs the identity and infrastructure of a chain of hotels," said Darren Blanchard, managing partner of Consolidated Hotel Consulting. "The business opportunity is there."

Huub Golsteijn / MT

The hotel Katerina is one of the city's few international standard three-star hotels.

Demand



But is the need there?

Stephane Meyrat, senior consultant at Hotel Consultant & Development Group, said that when non-branded, local hotels are taken into account, most hotels in Moscow are already in the two- and three-star category, since that is what most people can afford.

One- and two-star Moscow hotels achieved room occupancy levels of around 80 percent last year, Meyrat said, charging an average room rate of $18. Meanwhile, three-star hotels set rates at around $60, while maintaining occupancy levels near 70 percent.

But these numbers may be changing. Scott Antel, a partner with Ernst & Young's hospitality consulting group, said that many Russians are no longer comfortable staying in Soviet-era hotels with low standards of service.

"With increasing incomes and foreign travel experience, many more Russians expect and are willing to pay $70 to $100 per night," he said. "Overall, the three-star market worldwide should be a growth product, given the increasing numbers of people with greater incomes in Asia, Russia, the former East European countries."

The Russian hotel market is already undergoing a decentralization process, with attention focusing on the Golden Ring, Sochi, Anapa and the Krasnodar region, Yekaterinburg, Nizhny Novgorod and Yaroslavl.

Existing Players



Markku Wahlberg, general manager of Holiday Inn Moscow-Vinogradovo, said there is a definite need for midrange hotels, especially given the amount of time it will take to put them all in place. "Forty or 50 hotels in Russia looks a very high number to me," he said. "But if you look at the progress all the major chains here have been making, it is a very long process."

Wahlberg said that Six Continents, owner of the Holiday Inn brand, holds a management contract to operate a Holiday Inn hotel due to open in Samara next year, and that it is negotiating with other potential partners in Moscow, St. Petersburg and the regions.

Heimo Kayhty, chief executive of Best Western Finland, which has responsibility for the brand in Russia and the Baltic States, said Best Western wants to expand in Russia, but not as an operator, purely as a marketer of its brand. For now, the midrange brand is represented at the Best Western Art Hotel in Moscow and the Best Western Hotel Neptun in St. Petersburg.

"Best Western is a worldwide brand name and our clients are coming from everywhere in the world," he said. "Our customers want to stay with our brand in Russia and are asking if we have Best Western hotels in Russian cities."

Kayhty said the chain is negotiating with potential partners in Moscow and St. Petersburg.


Vladimir Filonov / MT

Markku Wahlberg, manager of the Moscow Holiday Inn, said there is a real need for midrange hotels, although 40 to 50 may be too many.

Local vs. International



Uncertainties arise about how international brands will be introduced at hotels across Russia.

Care needs to be taken when transplanting Western ideas of management in Russia, Wahlberg warned. "Customers don't know the brands really well here so they think international brands are all five-star. You have to take this into consideration. You have to have a little pampering."

Russian customers prefer comfort to the minimalism that is fashionable in European hotels, he added. For instance, while most Europeans are content with a shower, Russians often want a bathtub in their rooms as well.

Asked whether the Country Inn brand was likely to catch on in Russia, Price said Russian companies using the Roman alphabet such as J-7 and Wimm-Bill-Dann had no trouble becoming market leaders.

But Antel questioned whether foreign brands would be as important as owner-operators of three-star hotels in Russia as they are of four- and five-star hotels.

"Creation of a Russian three-star brand either by a foreign or Russian operator would not surprise me," he said. "This is how many of the bigger names initially got started in developing markets," with the Sol Melia and NH brands in Spain being examples of this strategy. "Entry barriers at this level are lower than for the higher-standard brands," Antel said.

Antel also said there is room in the midrange market for small, non-branded hotels, such as the 31-room Tiflis hotel that opened on Ulitsa Ostozhenka in March.

CHC's Blanchard saw the issue of midrange hotels as merely a matter of time, with the only question being who will cash in on it. "The race is on between international hotel companies and Russian entrepreneurs to meet the shortfall of a Russian group of hotels."

It's a different story outside Moscow and St. Petersburg. Cities with populations of more than 1 million may be able to sustain only 200 to 300 international-standard hotel rooms, Blanchard said. "It is practically impossible to forecast when demand could sustain 500-1,000 rooms, so each of the developers will need to watch its competitors carefully to ensure that early saturation leading to price competition does not result."

Location



Local administrations have rolled out the red carpet for the new arrivals. In its General Plan, the Moscow city government called for the creation of 19,500 hotel rooms by 2010, of which 40 percent are to be in the two- and three-star categories.

Hudspeth said that nevertheless, there are serious impediments to development. "It is always hard to find sites with good title, and to blend the investor, normally Russian, with the operator or brand provider, normally foreign."

The cost of land in Moscow, Meyrat pointed out, is another major issue. With property prices driven up by scarcity and high development costs, no midrange hotels are likely to be located inside the Garden Ring. Three-star hotels may have to charge more than $150 to break-even.

"Compared to mid-tier hotels in Europe," Meyrat said, "and in consideration of the corresponding quality of accommodation, such rates are not very advantageous to budget-conscious visitors."

"The hotels will be far from the center," Lloyd said. "I am not sure what impression tourists will have of Moscow, especially considering Moscow's traffic jams and wildly expensive taxis, if you order one through your hotel. Location is important, especially in such a large city where foreigners feel afraid or uneasy about their own security."

Vladimir Filonov / MT

Best Western has two hotel franchises in Russia operating under its midrange brand.

Cost



The Country Inn hotels are expected to cost $5 million to $12 million each in development. They will have 80 to 120 rooms, priced at $90 per night in Moscow and $70 in the regions. Price predicted a 20 percent return on investment during Country Inn's first several years of operation in Russia.

Meyrat said construction of a midrange hotel in St. Petersburg would cost $5 million to $15 million, and that it would take roughly six years of operation to earn the money back.

Robert Shetler-Jones, a director of British-run developer Sabre Projects, said the Marriott hotels his company plans to open are likely to have 150 to 250 rooms, at $70 to $80 per night. These prices are not much different from those charged by many older hotels in the regions.

Shetler-Jones said he expected construction costs to be $1,000 to $1,500 per square meter in Moscow and from $700 to $900 per square meter elsewhere.

These estimates are in line with Hudspeth's judgement that the projects will be prosperous only if they are accessible to the domestic commercial market--probably at $70 to $125 per night.

"The key to success in this market will be if you can manage to build these properties for a cost low enough to secure your return," Antel said. "Typically, three-star properties need to be built for $80,000 per room or less if they are to make money."

Blanchard said midrange hotels should not target tourists, but the budget-conscious business traveler. "If the price-sensitive, local tourist decides to trade up, or the occasional international tourist happens to stop by, then this will be a bonus for the hotelier," he said. "It certainly won't be their lifeblood."

The Regions



A lack of competition has allowed regional hotels to continue providing substandard service, Blanchard said. "We know of hotels that operate at 30 percent occupancy but still turn away clients, preferring to say they are fully booked rather than individual reservation clerks going to the trouble of doing the paperwork."

Prices in these hotels are often in excess of $100 per night in some cities in the far reaches of Russia, Blanchard said. "Price is not indicative of quality, but rather of the amount of competition in a specific market. Under a well-managed group this will soon change."

However, he warned of a backlash, as the reality of development hits home. Protective measures by existing hotel owners in some cities, including the city authorities themselves, may prove problematic.


Vladimir Filonov / MT

German-based Kempinski would like to build a chain of three- and four-star hotels.

Another critical issue is staffing. Considerable resources will have to be invested into training.

"Applying a coherent concept across a vast country requires a strong set of standards and management application," Blanchard said. "In the early 1990s, international hotels had little choice but to utilize large expatriate management teams in the early years of opening. In the budget-sensitive midrange sector, this simply is not viable for a sustained period."

Mass Market



In the face of many recent tourism-dampening events--Sept. 11, the war in Iraq, the spread of SARS and declining prosperity in the West--Russia has recorded healthy growth. The number of foreign tourists visiting Moscow increased by 32 percent last year, to 2.3 million people, according to the Moscow city tourism committee.

But the capital, through which the great majority of foreign tourists pass, is far from a mass tourism market, and the international-standard hotels in the city cater largely to business people.

Foreigners are generally guarded and unsure how to approach locally operated establishments, where ownership is often murky, managers are not commercially oriented and staff can be surly. But it is not just the hotels themselves that keep the crowds away.

"Visas, visas visas," Lloyd replied when asked about the barriers to Moscow becoming a mass tourism market. "Also the lack of a decent, user-friendly taxi service for non-Russian speakers, and unfriendly police scaring foreigners or extorting bribes from them."

Meyrat said that visas are a priority for the tourism industry, saying that while State Duma deputies are happy to take tourists' money, recently implemented strict controls on foreigners' stays might discourage people from visiting the country. "The lifting of visa restrictions in the Baltic countries has greatly contributed to the rise in general tourism, particularly in the summer months," he said.

There are still more obstacles. Blanchard said Sheremetyevo Airport is "an appalling advertisement for Russia. The structure of passport control, customs, luggage handling, porterage and access stack against the potential tourist and ensure the first visit is the last, with few recommendations to friends at home."

Nevertheless, Blanchard said, arriving at Domodedovo is a superior experience. As more airlines quit Sheremetyevo (British Airways is shifting locations in July), prospects may improve.

Meyrat said it is not just the hotels in Moscow that must change in order to attract foreign tourists and their money, but also shops and restaurants. Even though significant progress has been made since the early 1990s, there is a long way to go in order to measure up to other major tourist destinations, such as Paris, London and New York.

Also, people coming to Moscow may well want to visit other Russian locations. "The choice of mid-class hotels in St. Petersburg and in the Golden Ring cities of Vladimir, Yaroslavl and Suzdal is incommensurate with the tourism demand," Meyrat said. "This leads to unhappy surprises, though this is slowly improving."