Remaking the hospitality industry.

Fifty years ago, economist Joseph Schumpter coined the phrase "creative destruction" to describe an underlying dynamic of capitalism, a process in which rapid economic expansion automatically engenders forces that bring about a period of contraction. Doubters of this famous economic axiom need look no further than the hospitality industry for verification.

Consider these statistics from the New York City-based accounting firm Coopers & Lybrand: During the boom-boom years between 1980 and 1987, hotel rooms in the United States increased a phenomenal 40 percent. Six years later, more than 20 percent of all loans to hotels are in default, restructure, or foreclosure, while 60 percent of all U.S. hotels are experiencing a net loss. Hotels as an industry haven't been profitable since 1985, analysts say.

As for the airline industry, deregulation in 1979 kindled an explosion of air travel and the creation of a dozen new airlines. Today there are three more major carriers than there were prior to deregulation, and of those nine carriers, three operate under Chapter 11 bankruptcy protection. Moreover, in the last six years, the airline industry has lost more money than it has made in its 65-year history, according to the Air Transport Association of America, Washington, D.C.

Clearly, the creative destruction unleashed in the economy has not limited its effects to the hotel and airline industries. The go-go years of the 1980s have given way to the oh-no 1990s, an era of layoffs, salary freezes, and cutbacks across the spectrum of U.S. businesses--from automotive to computer and publishing industries. But the impact on the airline and hotel sectors has been particularly severe. Both industries are weathering their worst years ever.

"I think the best characterization of the hospitality industry right now is that it is restructuring itself, almost the way a molecule would, breaking apart old bonds and creating newer, more stable ones," says Mark Lomanno, research manager for Smith Travel Research, Gallatin, Tennessee. Smith Travel is recognized as a foremost source on travel data and trends. "If the operative word in the 1980s was development, in the 1990s it is operations--how to build more efficient ones."

In the report that follows, ASSOCIATION MANAGEMENT takes a look at how the hotel and airline industries arrived at where they are today and where they are going in the next couple of years. When will they return to profitability? What are the ramifications for association meetings?

Hotels: targeting a mid-1990s recovery

During a panel discussion not too long ago, Roger Dow, vice president of sales and marketing services for Marriott Hotels and Resorts, Washington, D.C., took a moment to muse on the vagaries of change. He noted how we live in a world where even revolutionary figures like Mikhail Gorbachev and Ross Perot come and go with lightning speed. "And who would have thought," quipped Dow, "that the Resolution Trust Company would be the fastest growing hotel company today?" The remark brought laughter and also wonderment.

Yes, who would have thought that the building boom of the 1980s would put hundreds of hotels in the hands of the federal agency charged with selling off the tangible assets of the country's failed savings and loan institutions? Who would have thought that Marriott, which at one point accounted for one out of every three new hotels, would find itself on the financial ropes last year? (Marriott has undergone a major shakeout in the last 18 months as it shifts from being a real estate development company back to the more profitable business of being a hotel management company.)

The shortest answer is that in the 1980s too much financing became available for real estate investments that weren't sound, particularly hotel developments. Analysts point to the passive-loss tax laws of the early 1980s and the deregulated banking industry as the twin engines that powered the financing locomotive, which in turn resulted in the overbuilt, overfinanced hotel market found in the United States today.

New federal tax codes in the early 1980s made real estate an ideal tax shelter, almost a no-lose situation. Under these laws, taxpayers could use losses from passive investments (tax shelters, limited partnerships, research and development partnerships) to offset income earned elsewhere. This made master limited partnerships popular vehicles for financing hotel construction. An orgy of hotel construction ensued, with many hotels being built with no economic justification except write-offs.

The Tax Reform Act of 1986 eliminated many of the tax-shelter benefits of real estate development, and consequently investors who were in it strictly for the tax write-off dropped out. Even so, hotel development continued. Plenty of financing still could be found, thanks to the deregulation of the savings and loan industry.

"With the deregulation of the savings and loans, an unprecedented level of lending to high-risk real estate developments began," writes David Arnold, national director of management advisory services at the Philadelphia office of Pannell Kerr Forster, in the company's 1991 Trends in the Hotel Industry report. "Commercial banks soon followed the path of the S and Ls and competed with one another to see who could lend the most to the various new hotel developments. Scrutiny of these loans was minimal, at best. Many properties were built, particularly in the economy hotel sector, with no objective feasibility studies or other due diligence. As a result, a number of new hotels were built that shouldn't have been, compromising both themselves and those properties that did make economic sense at the time."

Arnold adds that many of these new properties were overinvested. "Take the example of the 200-room suburban, first-class hotel, which is expected to perform at a stabilized level of 70 percent occupancy and an average daily room rate of $60. Because of the developer's desire to be 'the best,' and with the ease of obtaining money, the property is built for $100,000 a room, all of which is debt. The hotel will never make money, simply because it is overbuilt, or overinvested, for its market. |Even at 100 percent occupancy, 365 days a year, the gross room rental revenues won't equal the investment for almost five years.~ Such is the case with many, many new hotels throughout the country," Arnold says.

Perhaps most crippling of all, many new hotels were financed with fairly expensive debt (interest rates of 10-14 percent). Consequently, net interest payments as a percentage of profits have leaped from 7 percent of total revenues in 1977 to nearly 15 percent in 1989, according to the accounting firm Coopers & Lybrand. This fact, combined with weak occupancies and deep discounting because of overbuilding, plus the drop-off in travel resulting from the recession and Gulf War, spelled disaster for many in the hotel industry.

The occupancy rate nationwide sank to 62 percent in 1991--well below the 68 percent that is considered a break-even point. It is expected to improve only slightly in 1992. According to Smith Travel Research, the midyear 1992 average hotel occupancy was 61.8 percent. Lenders this year reported that their nonperforming hotel loans have jumped to 23 percent in 1992, with full-service hotels suffering the brunt of closures. The average hotel sales price plummeted 40 percent, heating up a round of consolidation and property swapping that is expected to continue for the next two years at least. Not surprisingly, new hotel construction has ground to a halt.

"The industry is paying for its excesses," remarked James Treadway, president of the Seattle-based Westin Hotels & Resorts' North American division, in an April issue of AH&MA magazine. "Even without the recession and the Gulf War, our industry would not be healthy. I believe we are paying the price for the irresponsible overbuilding in the 1980s."

What's ahead. Is there light at the end of the tunnel for the hotel industry? Most analysts predict that demand will catch up with supply by 1994. "Even during 1991, in the midst of the recession, there was a .8 percent increase in demand," notes Smith Travel's Mark Lomanno. "And demographics indicate that demand will continue to grow through the 1990s. More senior citizens will be traveling as baby boomers age."

Business and convention travel, however, remains problematic for the hotel industry. According to a September 1992 report on the lodging industry prepared by Margo Vignola, an analyst with the New York City investment firm Salomon Brothers, business and convention travel represents about half of total hotel demand. Yet this sector has been the hotel industry's softest segment throughout the last two years. "In part, this reflects the soft economy," Vignola says. "Businesses curtail travel during tough times. Whether this travel market will pick up is closely linked to how the economy performs, a difficult thing to predict at any time, let alone during an election year."

It is true that overall meeting attendance numbers dropped in 1991, according to the International Association of Convention and Visitor Bureaus, Champaign, Illinois. But ASAE's 1992 Association Meeting Trends found two positive indicators. First, membership attendance at association meetings increased an average 10 percent in 1991. And second, the study showed that the number of association meetings rose from 13.9 held by the average association in 1989 to 16.7 in 1991.

Pannell Kerr Forster's Arnold agrees that demand will probably catch up with supply sometime by 1994. But room rates, which have been subject to rampant discounting in recent years, will rise only slightly, he believes. "It won't be anything dramatic. Probably meeting professionals will find better hotels harder to book, however, because in terms of overall value to the customer, they'll represent the best buy," Arnold adds.

"Most hotels spent too much on their construction. Under reorganization, many of these properties are being written down in terms of value, so a $40 million hotel may now be valued at $25 million. That means the hotel can charge a rate that the market will bear and still make a buck. For the consumer, this represents a terrific value." Arnold cautions, however, that meeting professionals should be prepared for a decline in the "fresh" hotel supply that marked the market in the past. "New construction has been severely curtailed, especially in downtown areas, so you better get used to what's out there," he says.

But even after the equilibrium between supply and demand for hotel rooms is restored, the hotel industry may never be the same again. The calamitous events of recent years have sparked profound changes in the way hotels are owned, operated, and managed. To sum it up in the fewest possible words: The industry will be performance driven as never before. As one vice president of sales for a major hotel company remarked, "We hoteliers are now in the business of asset management for owners.... The business of being hoteliers is out the window while we become professionals at techniques like yield management." Many hotel executives predict hotel owners will be taking a much more active role in management.

Kenneth F. Hine, CAE, executive vice president and chief executive officer of the American Hotel & Motel Association, Washington, D.C., adds, "We think we're going to see a lot more consolidations and mergers within the hotel industry and a great deal of syndication driven by real estate values. Some companies might go broke, but with the reorganization of debt, the future of the industry looks bright. The companies that emerge from this will be stronger and more profitable."

Indeed, Hine speculates that the restructuring now going on could lead to the emergence of mega-chains. Salomon Brothers' 1992 lodging report supports that view: "Many independents have been forced to affiliate with larger chains either through outright sale, management agreement, or (in most cases) franchise operations. As a result, chains have been able to expand their market share with minimal capital outlays."

Sean Hennessey, senior vice president of the New York City-based real estate consulting firm Landauer Associates, makes the important point that hotel market health varies by region. As for the big picture: "Our forecast for the national hotel market shows modest improvement in occupancy levels. But the effects of the 1980s are still to be reckoned with. Foreclosures and recapitalization will escalate. Properties will increasingly need to downsize operations in an effort to bring costs in line with the price expectations of both corporate and leisure travelers." He says cutbacks could include everything from eliminating doorkeepers, scaling back hours for concierge service, and using potted plants instead of fresh flowers. Even the humble pillow mint may disappear.

New concepts. Some hotel companies are embracing new corporatewide management strategies to cope with the economic realities of the 1990s. For instance, both the Ritz-Carlton Hotel Company, Atlanta, and the North American division of the Westin Hotel Company are implementing total quality management. Total quality management emphasizes quality in all aspects of a company's operations, as well as participatory decision making involving all those affected by the decision--from top management to lowest-ranking employees. Customer satisfaction defines success, so vendors and customers also are involved in some issues.

Horst Shultze, president and chief executive officer of the Ritz-Carlton Hotel Company, has called total quality management the "fire that is burning in the American business world... Those companies not using TQM won't be in business 10-15 years from now." Adds David Evans, vice president and general sales manager for Westin Hotels and Resorts, "We are challenged to become hotel sales and services executives, not just room and food and beverage managers. The practice of TQM teaches you to really know your customer and deliver the most important things: value and service."

In an attempt to simplify room rates for customers, several chains, including Marriott and Sheraton, have instituted "rationalized" pricing structures, to which consumers can gain access for each property by calling the chain's central reservations number. Negotiated volume rates are still a way of life with hotel companies, but more emphasis is being put on value-added services versus rate and price, say analysts like Pannell Kerr Forster's Arnold. Finally, hotel marketing is becoming more performance driven.

"You have to be able to track the productivity of marketing programs so that you have some sense of the delivery of room nights and revenues versus the cost," remarked Robert Cotter, senior vice president and director of marketing for ITT Sheraton Hotels Hawaii, Honolulu, at the June 1992 Annual Hospitality Industry Conference, in New York City. "That's what the science for the next couple of years is going to be--taking those costs and assessing whether or not they perform."

Airlines: fighting for profitability

If the 1990s have been tumultuous years for hotel business, they have been no less traumatic for the airline industry(*), which had a net profit of $128 million in 1989 but a net loss of $3.9 billion in 1990 and $1.9 billion in 1991, according to Air Transport 1992, the annual report of the U.S. scheduled airline industry.

According to Tim Neale, spokesperson for the Air Transport Association of America, which published the report, the Persian Gulf War drove up the price of fuel and with the recession caused a precipitous drop in air travel in 1991. He adds that government regulations have driven up the cost of air transportation, and heavy discounting--some say driven by bankruptcy-protected airlines--eroded any gains in air travel volume.

Fare restructuring. It was against this backdrop that American Airlines, Dallas, announced in April 1992 a revolutionary fare structure--one that included only four fare categories, eliminated all negotiated contract fares, and allowed tickets to be refunded or reissued but imposed a $25 fee on all such transactions. Unrestricted coach fares were slashed 38 percent. All discount fares were consolidated into two categories--7-day and 21-day advance purchase--and priced similarly or somewhat below previous levels. First-class rates were trimmed between 20 percent and 50 percent.

American's chair, Robert Crandall, has stressed repeatedly that the fare structure is not a promotion but a permanent restructuring designed to simplify a fare-selection process that had become too confusing for consumers. He says the TABULAR DATA OMITTED restructuring is designed to avoid the classic situation of the past in which passengers on the same flight could be paying radically disparate fares, even if they booked them with the same advance notice. Crandall says the new fare structure is designed to stimulate air travel and give American more control over pricing and profitability. (American hopes to raise the average fare paid by allowing fewer people to travel on a discount.)

American's initiative sparked an immediate response from other major U.S. carriers. Delta (Atlanta), USAir (Arlington, Virginia), and United (Chicago), for instance, said they would match the initiative, including the elimination of negotiated airfares, but would honor any existing convention contracts.

Says Eugene Rondeau, then American's national manager of conventions/company meetings, "We haven't taken away the negotiated airfare from the convention market--we've in effect given it to everyone. But what I would like to focus on is that we still provide a number of services and negotiable items to the convention market that other carriers don't. In these tumultuous times, American will continue to remain competitive." He says the airline can provide print support, negotiate air freight, and negotiate special discounts with ground operators in select areas, among other things. Rondeau says that--besides value--"dependability, safety, route structure, and quality service" are of paramount importance to association meeting professionals, and these are all areas in which American's record excels.

Continental, Houston, went along with the four-fare structure but is offering convention groups a discount of 2-5 percent off the new coach fares. Jane Tice, director of Continental's group and convention sales, notes, "A volume buy still warrants a volume discount. We're still very much in the meetings and conventions business. This kind of discount offers as much as 50 percent off coach, which exceeds the 40-45 percent discount off unrestricted fares that was typical of convention discounts in the past."

Still some room for negotiation. Northwest Airlines, Minneapolis, has taken a different tack with regard to meeting airfares. "We are negotiating for meeting and convention travel on a case-by-case basis," says Larry Knickerbocker, manager of corporate sales development. He says Northwest's efforts will be targeted toward those customers "who can demonstrate effective ability to manage transportation purchasing and shift transportation market share . . . . They've got to be able to know volume and point of origination, and they've got to show they can effectively market the deal so that travelers take advantage of it." Other factors to be evaluated are the customer's relationship with Northwest Airlines, meeting size, seasonality, and schedule strength.

"We value meeting and convention business, but we have to approach it prudently. Clearly some markets are more important than others . . . . Everything that was negotiable in the past we will consider negotiating if it will help the association shift market share."

It's too early to tell the outcome of the new approach to convention airfares, say many airline executives. Further, "the situation is so volatile that it may be dangerous to make any predictions," warns Bill Downes, manager of Delta Meeting Network, Atlanta. Indeed, this summer there was a furor of fare discounting, despite the new fare structures. ATA's Tim Neale says the summer's discounting will contribute significantly to a year-end profit loss for the industry, which he estimates will total $2 billion.

What it all means for associations

Association executives for the most part aren't really sure what impact revamped convention fares will have on meeting attendance. But one thing heard again and again is that without the special fare, an attendee has no incentive to book a ticket with an official carrier for a meeting.

John Crawford, president of the Screen Printing Association International, Alexandria, Virginia, observes, "If a delegate can't see even a psychological advantage to booking with the official air carrier, he's going to book an airline for price, convenience, and/or frequent flyer mileage credit." Crawford's association will not have an official carrier for next year's annual meeting, a fact that means the association will not get any productivity tickets (free tickets based on the number of seats booked by attendees), which most associations use to offset travel expenses for staff and speakers.

Linda Karson, director of meeting services for the American College of Cardiology, Bethesda, Maryland, says the elimination of negotiated fares has changed the way her association does business. For next year's annual meeting (attendance of about 17,000), the association will publish an 800 number for the meeting's official travel agency. This way, attendees will be able to book tickets on the airline most convenient for them, and at the same time the association will still earn free tickets based on volume of bookings--but they will come from the travel agency, Karson says. "Conceivably, we can earn even more complimentary tickets this way, since delegates can book any carrier."

A wait-and-see attitude pervades association executives' views of the new airfare structures. However, when it comes to working with hotels, the impact of that industry's new bottom-line imperative is much more apparent. Nowhere is it more apparent than in hotel contracts. Many hotels say they have been stung by attendance drop-offs and meeting cancellations in the last two years. (One major chain reportedly lost 900,000 room nights last year through attrition at meetings.) As a result, hotels are writing tougher contracts and getting stricter about sticking to them.

"We are seeing tremendously complicated hotel contracts . . . and much tougher stipulations with regard to attrition," says Lorraine Bergstrom, director of meetings for the American Compensation Association, Scottsdale, Arizona. She acknowledges this is a direct result of the large losses some hotels suffered as a result of the drop in group business. "But," she says, "our feet are really being held to the fire. In some cases, we are being asked to guarantee numbers that are just impossible to predict. You'd have to be a genie." Donald Glass, president of the Massachusetts League of Community Banks, Boston, and a 25-year veteran of meeting planning, was surprised to find a tough new attrition clause in a hotel contract he had signed; his association would be required to cover 80 percent of the original number of room nights blocked, a number guesstimated three years before the meeting.

Cancellation clauses have become tougher, too, say association executives. It used to be that an association was liable primarily for loss of room revenue on peak night. Now some contracts are stipulating liability for total loss of revenue, including everything from food and beverage to bar revenues. Karson, like many of her colleagues, is responding by inserting contract clauses of her own, designed to protect the association and give it more leeway in a variety of situations. For instance, Karson has inserted clauses that stipulate what conditions the association would abide by should the hotel voluntarily or accidentally become insolvent or change ownership. She also has detailed clauses regarding possible changes in the labor situation at a property.

Among veteran convention organizers there is a profound awareness that no product is as perishable as an airline seat or a hotel room. There is an awareness, too, that meeting organizers on the whole must be more careful, accurate, and responsible in tracking and predicting such things as room pickup, meeting room needs, and food and beverage expenditures. Moreover, professionals understand that to gouge a property on room rate is, ultimately, to shoot yourself in the foot.

On the other hand, better management and more automation at hotels would help not only profitability but customer satisfaction as well, say some planners. "It would be a big investment initially, but ultimately if hotels would automate their administrative systems, it would be far more cost-effective in the long run, and that would benefit everyone," Karson suggests.

She points out that she has never worked with a hotel that could upload her association's disk of room reservations. "They have to have hard copy and then key it into their system, and then we have to check their copy for mistakes. With 17,000 attendees, that's very time- and labor-intensive."

Automated checkins and checkouts, a computerized reservation-waiting system, electronic room keys, and room service that can be ordered by television are some other labor-saving measures hotels can adopt, she says. "They all help the bottom line and customer satisfaction. Maybe we wouldn't have to do away with some of the niceties, like in-room amenities, if administrative costs could be cut instead."

But not only hotels and airlines are undergoing transformation in the 1990s. Like every other type of organization, associations are grappling with budget and staff cutbacks as well as mergers. They must make sure meeting programs are genuinely meaningful and valuable to members, and they must market convention events effectively if they are to maintain attendance levels. "Everybody everywhere is being asked to do more for less," observes Bergstrom, of the American Compensation Association. "It's all part of a larger productivity issue confronting American business."

The danger is that with both convention organizers and hospitality suppliers facing tougher performance measures, a we-they mentality will emerge if indeed it hasn't already. But the upcoming years will bring many issues to the fore that will help unite buyers and suppliers in the hospitality industry. Here are a few:

* There is a growing need for legislative action to curtail escalating room taxes that are hurting hotels and associations.

* The Americans With Disabilities Act is just the beginning of a new imperative for diversity management in the American workplace--an imperative that calls for the united efforts for both meeting professionals and suppliers.

* Finally, the rapid internationalization of commerce, including meetings, is already having a profound effect on all segments of the business travel industry.

Truly the vagaries of change are sweeping through the businesses of running hotels, airlines, and associations. But out of these difficult times will undoubtedly arise stronger, more performance-driven organizations, in which partnerships will play a more important role than they ever have before.

"We've got to get back to partnership thinking," stresses Karson, who as the spouse of a convention services manager may be onto something. "We need to just sit down together and establish our mutual needs as honestly as possible .... We're all dealing with tremendous changes. But then, if you don't like change, you're probably in the wrong industry."

Experts Forecast Growth

At the recent Travel Outlook forum sponsored by the U.S. Travel Data Center, Washington, D.C., and the Travel and Tourism Research Association, Salt Lake City, experts from all sectors of the industry offered several key projections.

Businesses will remain cautious concerning travel, because of the sluggish economy, according to Elizabeth Stewart, manager of market research for the U.S. Travel Data Center.

She predicts 1992 business trips to total 158 million and travelers to reach 35.5 million. Business trips will rise 5 percent over 1991, while the number of travelers will remain stable. For 1993, Stewart forecasts a 3 percent increase in business trips; the number of business travelers is expected to remain flat.

In other findings released at the travel forum:

* The hotel sector of the business travel industry is only expected to experience modest growth in 1992.

* A 7 percent jump in international visitors to the United States and a 9 percent rise in outbound travel is predicted for 1992.

* Cost-cutting measures by airlines will return the industry to profitability within the next year.

* The airline industry will experience a 3 percent rise in international and domestic passenger miles in 1993.

* The hotel industry will experience a 3.5 percent increase in room demand in 1992, and dollar sales should improve 4.7 percent. For 1993, room demand is expected to climb 4 percent and dollar sales 6 percent.

* The automobile industry predicts an 8 percent increase in auto travel in 1993.

* Amtrak forecasts an 8 percent increase in passenger miles in 1993 and the introduction of new features such as self-ticketing and video entertainment.

* Editor's note: Even as ASSOCIATION MANAGEMENT went to press, the American Airlines decision to reduce its management staff by 576 was a grim reminder of the volatility of the airline industry.

Regina McGee is a writer living in Boston.