How Andy Cosslett Restyled IHG

When Andrew Cosslett took the helm of InterContinental Hotels Group (IHG), the world's largest hotel group, he knew little about the industry. But what the former senior executive with British packaged goods giants Cadbury Schweppes (CSG) and Unilever (UL) did know was the power of branding.

In his two years as CEO, Cosslett has turned IHG into a fast-growing portfolio of seven well-defined brands. The Windsor (England) company's brands include the upscale InterContinental and Crown Plaza; mass-market favorites Holiday Inn and Holiday Inn Express; extended stay chains Candlewood Suites and Staybridge Suites; and the recently launched affordable boutique Hotel Indigo.

The biggest change, however, has come in IHG's business model. Instead of owning the bricks and mortar, the group is now mainly a manager and franchisor of hotels similar to its three big U.S. rivals: Hilton Hotels (HLT), Starwood (HOT), and Marriott International (MAR). In 2003 the company owned 202 of the 3,700 hotels in its portfolio. Cosslett has since sold 175 of them, returning a total of $7 billion to shareholders in the process.

The result has been lower revenues but much more stable and faster growing earnings, something investors love. The shares are up 14% for the 52 weeks ending May 16. On May 9, the company reported a 5% rise in operating profits from continuing operations, to $88 million, for the three months ending Mar. 31.

Revenues from continuing operations rose 10%, to $388 million, but would have risen 20% if the effects of currency fluctuations, largely the weaker dollar, were stripped out. BusinessWeek London correspondent Kerry Capell spoke with Cosslett at the company's headquarters about the future of IHG and the industry.

What are the growth prospects for the hotel industry?

It is a golden time for us. We have many tailwinds pushing us along as an industry. The first is the Internet: Hotels follow travel trends, and more people are booking online. Currently, 18% of our rooms are booked online. Most of those bookings are through our own Web sites, with less than 1% coming through travel agents' sites.

Another factor is the success of low-cost airlines worldwide that is making travel easier and more affordable for more people. Plus, people are wealthier, living longer than ever before, and traveling more. And finally, for the first time we have massive nations that are able to travel, such as Russia, the whole of Eastern Europe, and China.

For the industry, Asia represents the biggest single growth opportunity because the demand factors are so compelling. We can't see an end to growth in Asia for all brands, but particularly the top-end brands.

You've been expanding rapidly in China.

We are the largest international hotel group in China and have been in the country with Holiday since 1984. Because we have been in China longer than any other foreign hotel group, many Chinese think we are a domestic company.

Some 85% of the patronage of our Holiday Inns in China are Chinese domestic travelers. We are committed to double the number of hotels in China from 68 today to 125 by the end of 2008.

We are expecting that over the next decade, 100 million outbound trips a year will be made from China. These Chinese travelers will come to all these big cities around the world and look for brands they think are Chinese, such as Holiday Inn.

But we also expect China will become the world's No.1 inbound tourist destination over the next 10 years. So the luxury end of the market also offers amazing growth opportunities. We have six InterContinental hotels open there now and 11 more signed up.

The other big one is what happens to the domestic traveler within China. We see a parallel with the U.S. in the 1950s and 1960s when the government built major highways linking the country. China is doing the same. But even based on current demand, across all categories, China is today short of 1 million branded hotel beds, we believe. Fewer than 10% of hotels in China are branded, so there is huge potential.

With so many hotel groups operating a similar management and franchise model, is it getting tougher to find new hotels?

No. If you look at our current signing pace, it is four times what it was five years ago. Other major companies have also increased their pace of signings. So what is happening is the big companies are getting bigger because they have the scale, marketing prowess, and systems capability. The people who will be squeezed won't be the big guys or the niche players but the ones in the middle. There are a lot of them.

If you look at the top four operators—Marriott, Hilton, us, and Accor—we probably have 10% of world's hotel beds between us. What that tells me is there are tremendous opportunities for these companies to take a bigger chunk of the market.

The other big dynamic that separates this market is that 60% of hotel beds today are not branded. That is changing rapidly. In the past 10 years the hotel market has grown at 3% per annum and the branded hotel market 11%. So clearly the dynamics are all moving in favor of branded chains. Where do you see the biggest opportunities for IHG?

We spent the past two years collecting a huge wealth of knowledge about our brands, 45 of our competitors, the markets in which we operate, and our 2,000 owners. We did forecasts to better anticipate growth over the next decade.

The biggest market over the next 10 years is the U.S., not in percentage terms but in quantum terms. America will be the biggest market, and China will probably be fastest percentage growth for the foreseeable future. We see growth right across all our brands.

What else have you learned from all that research?

The aim was to get a predictive model so we can see at what point are some of the concepts that are already powerful in the U.S. ripe for exporting to the rest of the world. One example is extended stay hotels.

Today, they only exist in the U.S., where we have two brands, Staybridge Suites and Candlewood Suites. Our model tells us that Britain is similar to where the U.S. was a decade ago when the extended stay model began to take off. That's why we have seven signed deals for Staybridge in Britain, the first of which is expected to open in early 2008.

Have you seen any impact from rising interest rates?

So far we see little evidence of it holding back supply or capacity coming on. We have a very strong forward order book of more than 1,300 hotels that we have yet to open. We are seeing the odd delay here and there in the pipeline but nothing that gives us cause for concern.

Why did IHG change its business model?

The usual model of the hotel industry has been one of ownership. The problem with that model is that it distorts your business as you get the whole profit-and-loss impact coming through your income statement.

The hotel industry goes through demand cycles where rates tend to go up until typically after around seven years, supply catches up and rates flatten off. And if your costs continue to rise, then profits can drop substantially. That boom-and-bust cycle is why the valuations of hotels over the years haven't been that good.

The new model means IHG is primarily a managing and franchising business, not an owner of hotels themselves. The advantage is that you can use other people's money to grow. And it means that you should be able to grow faster. As long as you are opening more hotels when the bad times come, you won't be as adversely affected, because overall revenue continues to rise. So it's a model that offers predictable cash flow generation.

How does IHG rank among its competitiors?

Our board recognized that the future performance of IHG relative to peers such as Marriott, Hilton, and others is all about our ability to have a brand portfolio that is more attractive than the other guys'. We have the strongest international portfolio of any branded hotel group, with more leading positions in more of the countries that count than anyone else. Ten markets account for 80% of the world's hotel beds, and we have a top three position in six of them, including the U.S., Britain, and China.

What changes have you made to IHG's strategy?

We have a strong international position, a strong brand portfolio, and a powerful operating system, but prior to IHG going public in April, 2003, the business had been growing at just 1% per year over a five-year period. The reason was that IHG had not been growing its net room count.

One of the first things I did was to set a target, for the first time in the company's history, of opening 50,000 to 60,000 rooms on a net and organic basis by the end of 2008. It was a huge challenge and one that meant a quadrupling of our previous growth rates.

But we are on track, and growth is now running at 4% to 5% per year. To ensure we meet our target we will have to open one new hotel a day until end of 2008. Today, under this new model, what we are selling is demand and the strength of our brand.

Where in the U.S. are the biggest opportunities for IHG?

For us, the U.S. is very interesting as a market, and we are seeing good growth across all our brands there, especially with InterContinental. The brand came out of Pan American World Airlines, which began opening hotels in 1947 along the airline's routes to cater to airline crew and staff. This is why InterContinental is so strong internationally.

Perversely, though, the InterContinental brand is relatively weak in the U.S. compared with our international strength, but this gives us a fantastic opportunity. Travelers who know and like the InterContinental brand from visits overseas are likely to seek it out when they travel within the U.S.

In contrast, some of our competitors are saturated because they have been in the U.S. for many years. InterContinental is only in 18 U.S. cities, so there is plenty of room for growth, with at least 30 cities to go. What does InterContinental offer that other luxury hotel chains don't?

A lot of hotels, especially at the luxury end, try to shut their doors when you walk in and cocoon you. We are trying to do something a bit different. We want to help you get the most out of your time when you are visiting.

Most people at this level of income have everything and have been everywhere. So it is about offering them a unique experience, we call it "in the know."

Because InterContinental is 60 years old, and because it has been on more continents and in more markets than any other hotel brand, it gives us permission to be an ambassador in the markets in which it operates. People used to refer to InterContinentals as being the second embassy in any city.

The brand reputation is that the lights don't get turned out, so when we had the recent hostilities in Beirut the hotel remained open. But you don't have to be in a war zone to use an InterContinental. You will still get all the wonderful service and amenities that you get from any top luxury hotel.

We put 40,000 InterContinental staff through training last year at a cost of $10 million. We don't want to take away any of the things that make staying at a luxury hotel such a special experience. We just want to demystify and de-clutter that experience and make it less intimidating.

That means training the staff, teaching them all about the location they operate in, so they can engage with guests in a knowledgeable way. We are also trying to use technology to help engage our guests on their terms, not ours.

Typically, at even the best hotels if you want to see the concierge, you'll stand in this line and wait. We are trying to change that so the concierge is more accessible through technology. You can go on the Web site and ask the concierge questions before you even leave home. Maybe in the future you will even be able to text the concierge a request as you're waiting at the airport.

How is the InterContinental brand faring against its competitors?

It is a very fast-growing brand. We signed 26 InterContinental deals, four of which are in the U.S., last year for hotels that will open in the next few years. This is the highest number we have ever had by a long way.

Our total pipeline for new InterContinental hotels is 40 worldwide. At this end of the market, our main rivals are Westin in the U.S. and Four Seasons, JW Marriott, and the Ritz-Carlton in the rest of the world.

Could IHG survive without its less expensive brands?

The way the IHG system works, we are beautifully covering about 85% of the market. We are not really interested in the uber-luxury market, as it is too specific and too tailored, and we are not really interested in the economy area because we don't make a sufficient return. We play in the mid to upper end of the market.

Our model works on the power of the whole—each brand supports one another. Our brands are positioned precisely against different consumer groups. But whether it is InterContinental or Holiday Inn Express, the process and the systems which drive them are the same.

It is like Procter & Gamble (PG) selling diapers and toothpaste. The operating systems at P&G that drive innovation are exactly the same, but the customer buys a different output at the end.

In the first five years after it was launched, Holiday Inn Express was the fastest-growing hotel brand in the industry, going from zero to 1,000 hotels during that time. When it was launched 14 years ago, it was at quite a budget price.

But now the price points are remarkably similar to Holiday Inn; the market has simply segmented into those people who prefer the Express experience, of super-efficiency but minimal amenities, to those who prefer the more full-service approach of Holiday Inn. Often the two hotels are located side by side.

How do you see the hotel industry evolving in the years ahead?

Traditionally, the industry has segmented itself by price, which is ridiculous. If you think about beer, consumers don't segment themselves by price. They segment by preference, whether it is for lager or bitter or ale.

This tells you how far the industry still has to go in terms of understanding its customers. How we see the landscape changing over the years is that hotels will no longer have a price-led strategy. Instead, you will have people making choices not on the basis of price but on the basis of preference for a particular product. It is all about psychographics; it is not about how much you can afford but who you are and what you like.

Was this new segmentation the reason you launched Hotel Indigo two years ago?

Yes. In the hotel industry you have never had any of the big players like us going after places where the boutique hotels have played. Launched two years ago in North America, Indigo will appeal to people after more of a sensory experience.

It is a slightly funky, more affordable boutique option with limited service. It is very stylish but nonpretentious. We now have eight open and 40 signed or under negotiation in North America. The U.S. tends to be our incubator for new ideas. Now we are refining the product and the brand and will bring it to Europe in 2008 and Asia in the near future.

What you will see happening in the hotel industry is what you see in all mature industries. Take cars. Twenty years ago, there was fundamentally less choice. Now there is a massive fragmentation of the market as it caters to different needs.

Hotels in the past have been segmented by price and not much else, and I think that will change. You will find an increase in number of brands out there trying to appeal to particular types of customers. In the past, hotels have tried to not offend anyone, and as a result there has been this kind of sea of sameness; this will change. Hotel brands in the future will have to stand for something.