The economy hotel sector in China is now undergoing a stage of consolidation. Two years ago, the ready availability of money in the sector – from initial public offerings, venture capital and bank loans – caused asset prices to soar. Land and property prices surged and costs rose sharply, reducing the profit margins of economy hotels. It was a classic bubble scenario, but the worst is over, according to speakers at the China Hotel Investment Summit, held in Shanghai in late April. The strongest hotel chains are still expanding fast, although more cautiously than before, while some unbranded local hotels are beginning to fail.


The biggest economy hotel chains in China – Green Tree Inns, Home Inns, Jinjiang Inn, Han Ting Inn, Super 8 and 168 – are accepting lower rates of return and concentrating on enhancing revenue, controlling costs and raising service standards to distinguish themselves from their non-branded competitors. “With the increases in the cost of land and labor, we have to do everything we can to increase revenue,” said Mitchell A. Presnick, CEO of Tian Rui, the master franchisor of Super 8 hotels in China, Hong Kong and Macau.


Meanwhile, the industry is still expanding fast in China. “We have to expand into the countryside, where costs are lower and there are still good opportunities. Our return on investment in small cities is no lower than it is in big cities,” said Presnick.


Liquidity is hardly in short supply in the economy hotel sector. Jinjiang, Han Ting and Super 8 have all received recent cash infusions, and all the major budget hotel chains in China are adding new hotels. In doing so, the chains have some key advantages over their local, unbranded competitors: They have more money for expansion and brands that, they hope, can deliver loyalty programs, consistent service and reliable room quality. And the sector still has a lot of room to grow. “In the U.S., 60% of all hotels are economy hotels, but in China, only 5% are economy hotels,” said Zhang Tuo, COO of Han Ting Inn.


Some companies, including Green Tree Inn Hotels and Jinjiang, take equity in some of their properties, but for the most part, especially on the budget end of the spectrum, the chains prefer to expand by franchising: Someone else owns the property, outfits it and manages it according to the specifications and guidelines of the parent hotel chain. This is the fastest way to expand, although it does bring its own set of risks because the parent company has less control over service and property standards than if it manages the hotel itself.


Lured by the obvious potential of the economy hotel market – China has 1.3 billion people who are traveling in ever-greater numbers – many foreign hospitality companies are joining the great expansion race. China Knowledge at Wharton recently interviewed Steven A. Rudnitsky, president and CEO of Wyndham Hotel Group, and Stephen Young, senior vice president of international development of Wyndham Hotel Group for China, East Asia and Indochina, about why the Parsippany, N.J.-based company decided to enter China and what their strategy is going forward.


Wyndham Hotel Group, a business unit of Wyndham Worldwide Corp. — which reported revenues of US$4.36 billion in 2007 — is one of the largest integrated hotel franchise and management companies in the world, representing more than 6,500 hotels and 550,000 rooms in 59 countries under 10 brands. The group sold approximately 86 million room-nights in 2007.


Wyndham oversees the Howard Johnson, Ramada, Days Inn and Super 8 brands in China, and will soon open an upscale Wyndham Hotel in Xiamen. It has appointed Tian Rui as master franchisee to oversee Super 8, its economy brand’s expansion in China. Tian Rui, which received a US$50 million cash infusion from Aetos Capital last August, franchises some Super 8 hotels while it directly manages other Super 8s. This year, said Presnick, CEO of Tian Rui, the company plans to open 48 new hotels, which it will manage, while at the same time opening new franchise hotels. “Franchising is the fastest mode of expansion,” said Presnick.


Rudnitsky helped build the Pepsi Brand in China in the mid-1990s and was also responsible for the launch and growth of the TripRewards loyalty program, now the largest of its type in the lodging industry, with seven million members.


Below is an edited version of the interview.


China Knowledge at Wharton: How many hotels do you have in China now, and what are your expansion plans?


Rudnitsky: When you look at the Asia Pacific region, you can’t help but start with China, just because of the tremendous growth that has occurred over the last 20 years. If you look at the lodging industry in China, which is roughly $17 billion, and you benchmark that relative to the U.S., which is roughly $130 billion, with 300 million people as opposed to 1.3 billion people, and you’ve got GDP growth here of 10% versus 2% in the U.S., you can say to yourself, ‘There’s a lot of room to run.’


And then being a brand guy – I helped launch Pepsi in China in the mid-1990s – you have to really be focused on the value of the brands, and finding partners in this country that really understand the culture and the dynamics of doing business in China.


We happen to have a selection of brands that are incredibly adaptable long-term for growth within China. We play across a lot of different segments, whether that is our first Wyndham opening up in Xiamen towards the latter part of this year, or our Howard Johnson brand and Ramada in the upscale-midscale arena, then Days Inn and Super 8 in the economy sectors. So we’ve got a complement of brands with great applicability in China.


Young: At the end of last year, we had 128 hotels in China. We have a total of 10 brands in the U.S., but in China at the present moment we are focusing on five: the Wyndham brand, the Ramada brand (which includes both Ramada and Ramada Plaza), Howard Johnson, Days Inn and Super 8. With Wyndham, we attract the upscale segment, and we have Ramada, Howard and Days Inn at the midscale segment. We have Super 8 in the economy segment in China.


China Knowledge at Wharton: What particular brands or market segments are you emphasizing in China?


Rudnitsky: You have to look at domestic versus international travel. Global brands in the higher end have a bit more of a skew toward international guests, as opposed to brands in the economy arena or mid market arena, which have more of a skew toward domestic travel.


Speaking of the mid market and economy brands, a lot of the companies really zeroed in on the luxury end, on upscale, first-class sectors, and there is real opportunity there, but as the overall economy continues to grow, there will be a real need for the economy and mid market products like Super 8 and Days Inn to deliver for that domestic traveler. That’s what really appeals to us.


For example, in the U.S., we have 2,100 Super 8s in a country with about the same number of square miles as China, with less than a third of the population. When you think about what we’ve accomplished with our partner Mitch Presnick [CEO of Tian Rui], and you do the math, you have to believe that with the right discipline, the right marketing and the right partners, [you can achieve] long-term growth.


China Knowledge at Wharton: How do you price your economy hotels?


Young: The economy segment would be in the region of RMB 200 to RMB 300 per night (US$ 28 to $43).


China Knowledge at Wharton: How does Wyndham manage all those brands? Do you manage them directly or are they franchised?


Young: The five brands all use different business models. For Wyndham and Ramada Plaza, we run a full management contract business model. We manage the hotels. For the Ramada brand, we do direct franchising, which is also controlled from the head office. But for Howard Johnson, Days Inn and Super 8, we have a master franchisee in China (each of the brands has a separate master franchisee). The master franchisees develop Howard Johnson, Days Inn and Super 8 in China.


China Knowledge at Wharton: So the more upscale the brand, the more control Wyndham Group has of the property?


Young: Yes, you are absolutely correct. Direct franchising gives us more control than master franchising. For more upscale hotel brands like Ramada Plaza, a full management contract is our preferred business model.


China Knowledge at Wharton: What’s the process of finding potential Super 8 properties and fitting them out?


Rudnitsky: As the master franchisor, our role is more limited. Mitch’s role is seeking out the venues and the franchising partners that have the ability, the commitment and the venue that makes strategic sense for that market. We provide the brand standards and other metrics that our master licensee has to adhere to, and we provide other ancillary resources that make him even stronger than he is.


China Knowledge at Wharton:  As a franchisor, how do you keep the standards high?


Rudnitsky: The standards are very explicit, and before anyone can even put the flag on the building, all the standards have to be met. It’s not just the type of furniture, it’s the safety requirements, the size of the rooms…. We provide them with a list of areas that they need to adjust in order for that property to meet the standards. And when they are all met, it can open up. Then we put in our central reservation system and put the flag in front of the building. Then they are a franchisee, whether they are part of a master franchise system or a direct franchise system. After that, we have a series of processes where we audit and do quality inspections to ensure that they have maintained their product standards.


Young: Also, in order to convince the franchisee to cooperate, we do a lot of training programs. It is not good enough to have quality inspection; we also need training programs so they understand the concept. That is the key.


China Knowledge at Wharton: How difficult is it to get property owners to adhere to the quality standards?


Young: When we directly manage the hotel, we send our GM, we send our people on the ground and we control the way we operate, but in a franchise model, you really have to convince the franchisee. In other words, he has to buy your concept. So we have to spend a lot of effort convincing the owner.


China Knowledge at Wharton: What’s your sales pitch when you approach a property owner and try to convince them to convert the property into, say, a Ramada?


Young: It is an international brand, it has a long history and it is recognizable. Because Ramada now has 27 hotels in China – including hotels in Urumqi [in Xin Jiang Province in northwest China] and hotels on Nanjing Road [in downtown Shanghai] — the distribution of the brand creates power in the domestic sector. We stress the brand power.


China Knowledge at Wharton:  Who is your competitor in China?


Young: Han Ting, Homes Inn, Jinjiang and 168.


Rudnitsky: As you head up the ladder, our Ramada brand competes with the Inter-Continental product. They are a strong brand. They have several brands, including Holiday inn and Crown Plaza, and they are aggressively going after business here in China as well.


China Knowledge at Wharton:  What lessons from the U.S. market are applicable in China?


Rudnitsky: Well I would first quote Sun Tzu [a famous ancient Chinese militarist and strategist], from the Art of War, and suggest that to win without fighting is best. That thought is applicable as it relates to competing. To secure a brand and put a flag on a particular asset, you don’t want to get into a fight that nobody wins and where nobody makes money.