The Distribution Cost Conundrum: Another Major Misalignment of Interest between Owners and Operators

By Max Starkov

Background:

Recently, Mr. Richard Warnick, Managing Director and Co-Chairman of CHMWarnick (“CHMW”) wrote an excellent piece in HNN: “Optimizing for Dual Success of Operators, Asset Managers.”

In this article Mr. Warnick argues that:

“…one of the greatest sources of conflict between operators and asset managers (as representatives of the owners) occurs because of operators’ lack of appreciation for, or indifference to, hotels as an investment.” “The misalignment of interest between owner and operator is so endemic and has existed for such a long time that it has resulted in an institutionalized lack of empathy for (and understanding of) the investment/risk side of the equation by hotel operators. That is to say, what is missing in the owner/manager relationship is respect for the money.”

In my view, the misalignment of interest between asset managers/owners and operators is even more obvious in how these two, distinct industry stakeholders perceive and account for distribution channel costs.

Opposite Interests as Far as Distributions Costs Are Concerned

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 (property website) are 4.5%, compared to the hefty OTA commissions of 18%-25%.

Yet, operators and asset managers/owners have completely opposite interests, as far as distribution costs are concerned.

For asset managers/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, as we see below, the cost of distribution via OTAs plays a far less important role, and in many cases is not even accounted for in the property P&L (Profit and Loss).

Conveniently for operators, OTA commissions (Ex. 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 “travel agent commissions,” with no differentiation from brick-and-mortar travel agents’ commissions. Merchant OTA commissions do not even hit the property P&L.

COGS are deducted from gross room revenue. There is no budgetary limitation to COGS. This “unlimited commission potential” allows OTA bookings to grow exponentially without being restrained by the property budget which, as we will see below, isn’t the case with direct online bookings.

The COGS line item (travel agent commissions) and its complete lack of transparency is rarely a subject of discussions between operators and asset managers/owners. Quite often, it is misunderstood by asset managers/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 (ongoing website technology upgrades and content optimization, dynamic content personalization, reservation abandonment programs, hosting, SEO, paid search, online media and retargeting, first-party and real-time data marketing, email marketing, social media engagements, consulting, etc.) come from the Sales & Marketing Budget, which is a line item in the property budget.

Unlike COGS, the “Expense Side” of the budget is frequently and heatedly discussed at any meeting between operators and asset managers/owners. Expenses are scrutinized to the penny, and 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 18%-25% – are not restricted in any way by the budget, are quite often not accounted for in the P&L, and can grow exponentially.

Accounting for distribution cost via the OTAs as COGS and not even accounting for merchant OTA bookings, while at the same time accounting for direct distribution cost via a much scrutinized and constantly diminished single line item in the property budget is like, in your household budget, not accounting for and restricting booze and entertainment expenses, while restricting expenses for food and education.

What is the solution?

1. In their assessment of the property performance, asset managers should include analysis of distribution cost on a channel by channel basis (Direct, OTAs, GDS, voice, etc.) and evaluation of “abnormal” distribution channel exposure.
2. It is time for asset managers/owners to start scrutinizing operators based on ProPAR (Profit per Available Room). ProPAR introduces an unparalleled distribution channel transparency about the cost to acquire each booking, and allows owners and managers to focus on and prioritize the most efficient and cost-effective distribution channel.
3. Cost of direct distribution via the property website should be treated in the property P&L in exactly the same way as OTA commissions, i.e. as COGS and deducted from the gross room revenue, thus unleashing the property’s ability to adequately fund the direct online channel efforts, boost bookings via the property website and drastically decrease OTA dependency.
4. Asset managers/owners should have regular discussions with operators about how to decrease distribution costs.
5. Asset managers/owners should incentivize operators to lower distribution costs and maximize direct bookings.

About the Author and HeBS Digital:

Max Starkov is President & CEO of HeBS Digital, the hospitality industry’s leading digital technology, full-service hotel digital marketing, website design and direct online channel consulting firm based in New York City (www.HeBSDigital.com).

HeBS Digital has pioneered many of the “best practices” in hotel digital marketing and website revenue optimization, as well as a range of industry-first digital technology applications. The firm has won more than 350 prestigious industry awards for its digital marketing and website design services, including numerous Adrian Awards, Davey Awards, W3 Awards, WebAwards, Magellan Awards, Summit International Awards, Interactive Media Awards, and IAC Awards.

A diverse client portfolio of top-tier major hotel brands, luxury and boutique hotel brands, resorts and casinos, hotel management companies, franchisees and independents, and CVBs are benefiting from HeBS Digital’s direct online channel strategy and digital marketing expertise. Contact HeBS Digital’s consultants at (212) 752-8186 or success@hebsdigital.com.