Mixed Use Projects: The New Panacea for Stakeholders
Is there a business case for this multiple business model investment?
By S. Lakshmi Narasimhan Founder, Ignite Insight LLC | June 30, 2019
Stakeholders operate in an obsessive continuous growth nirvana state. For them, projects should be churning out incremental returns in all market conditions and at all times, never mind the seasonality of the hotel business. Having pumped in huge amounts of capital into projects, their psyche may well be justified.
However, reality is different and there is no choice but to embrace it. Customer preferences are incessantly changing, supply is on the increase and demand is under pressure. In this scenario, continuous growth cycles are a pipe dream. Is there a way out?
Vanilla Hotel Projects
In days of yore, traditional hotel projects (sometimes called vanilla projects) worked well. A combination of hotel accommodation and food and beverage business models brought home the bacon. The rooms and restaurant combination worked well. Rooms with an intrinsic ability to command upwards of 80% departmental profit were the bread and butter of hotel revenues. Restaurants with their much lesser departmental profits (from 30% to 50%), however produced traffic to the hotel. This combination worked excellently delivering good bottom line and generally keeping stakeholders happy. Over the latter part of this decade, millennial and Gen Z customer profiles have almost sounded a death knell to this vanilla project approach. How so?
The Saga of Stalling Returns
This potent mixture of young, mobile, urban customers have changed completely market segmentation techniques entrenched for about half a century. Their tastes and preferences have meant that traditional room and restaurant combinations are producing less incremental revenues and profits. This has manifested itself in falling room occupancies and plummeting average rates. In other words, the bottom line is dwindling and the returns stalling. Landmark trends like smaller hotel room numbers, shrinking room sizes and an obsession for personalized experiences has meant that the age old room restaurant model was slated to collapse.
Hotels being seasonal businesses tend to rely on peak month occupancies to boost bottom line. This means that even normally, the lean month periods are challenges to keep the sales graph from dipping too drastically. In a situation of steadily decreasing occupancies, a key chunk of peak period revenues and profits were disappearing. In this situation, a radical rethink of the rooms restaurant business model was imperative. The infusion of new areas of revenue generation and profit retention was a severe need. Enter the concept of mixed use projects.
What is Mixed Use?
In the context of traditional vanilla hotel projects consisting of rooms and restaurants, what is a mixed use project? A mixed use project brings in multiple sources of revenue from a business model which goes beyond rooms and restaurants. Art, culture, local artisan wares, entertainment, retail, recreation are some of the newer sources of revenue which form part of the mixed use project concoction.
So, you are now having the spectacle of retail displays, art and artisan wares in hotel lobbies, organic plants and vegetables grown in roof top restaurants and so on. It is a complete paradigm change and fueled by demands from the millennial and Gen Z customers. So, what is it that attracts owners and stakeholders to embrace this new phenomenon?
The Allure of Multiple Business Models (with Risks to Boot)
Owners are intrigued by having choices in their sources of revenue all built into one mixed use project. They seem to finally taking on board the "do not put all your eggs in one basket" principle. Multiple business models entail the outcome of different levels of revenue generation and profit retention. By adding, say a retail business model into the accommodation and restaurants, the mixed use project is allowing a totally different revenue source to operate. Retail business not only can generate a lot of foot traffic to the hotel project but also has excellent profit margin prospects. Of course, even in the retail business model, there are various levels.
For example, economy, midscale or upscale are generic categories that can come into play. Bringing in a reputed brand for retail or local crafts, organic produce etc. can provide that extra flavor that is a far cry from the monotonous rooms and restaurant models. Even restaurant models have taken a hit in this process. More restaurants are turning casual and bars are thriving spots to congregate which again drives traffic to the project.
Just to put things into perspective, a mixed use project with multiple business models is not entirely a rosy picture. With different business model behavior, revenue patterns and profit retention also undergo risks. So, it could both be a bouquet as well as a brickbat. When new revenue streams come in and take a different path to traditional models, they also disrupt bottom line behavior.
Mixed use projects tend to be huge undertakings considering that they consist of multiple business models. This means sustaining revenue generation and retaining precious bottom line becomes a challenge. Volumes will play a big part in this endeavor to earn year on year growth. Until the project generates what is known as critical mass, or the minimum volume for sustained profits, ROIs may be strained.
Retail as a Fresh Source of Revenue
The single most significant new addition to revenue sources in a mixed use project is the retail business. Retail business models operate vastly different from traditional accommodation and even restaurant models. Retail businesses almost always thrive on volumes. The introduction oftentimes of global brands into the cocktail that is a mixed use project creates an element that is critical to unit revenue sales. In other words, the revenue per square foot.
The entire real estate industry is founded on this revenue per square foot paradigm. So much so, that even in traditional vanilla hotel projects, this KPI has begun to make its presence felt. Of course, the exact extent of volume also depends upon the level of retail branding that is in place. For example,, are you a base level or economy retail brand, a midscale one or an upscale one.
What is retail claim to fame? Well, for one thing it generates the kind of foot traffic that very few other sources can boast of. It is also a fact that the retail model in recent times has undergone major changes and is no more only the apparel industry that it leaned on. Today retail may mean a beverage, lifestyle, local artisan work, bodegas and so on. This variety in retail offerings makes the attraction factor even more appealing. No wonder boutique hotel lobbies have started having art studios, coffee joints etc. mostly with a reputed brand behind them. The brand factor is another of the retail model's unique selling propositions.
Changing Restaurant Models
With retail providing that differentiated set of offerings, restaurants in mixed use projects and boutique hotels have been reinventing themselves. Gone are the short table turnover yielding fine dining and sit down meal periods. Instead casual dining has taken a lead and has even created casual versions of sit down cuisine. However, the area that has led this renaissance are the bars. Bars have created hot spots of foot traffic (taking a leaf out of the retail model), often times located on rooftops with live music and an electric atmosphere drawing crowds.
Bar food has morphed into innovative snacks and finger food accompanying the foundational alcohol offerings. Prices are kept tantalizingly affordable even while creating the volumes required for a solid profit margin. Millennials and Gen Z are social animals and these hotspots are the perfect venues to chill out.
Business Case for Mixed Use Projects
So, what is the business case for mixed use projects? To begin with, on a solid foundation of rooms accommodation, these projects have been innovating significantly. Right from room design, lighting, furniture all the way to room sizes have been changing. As for room sizes, these have been shrinking based on the paradigm of getting the guest out of the room and into communal spaces in the hotel. The concept of communal spaces has caught on virally and hotels generally have been attempting one-upmanship by reinventing communal space concepts.
With all of these innovations has come the concept of affordable luxury. This has redefined what luxury is as well as what affordable can be. A paradigm shift indeed. This shift has financial implications too. Customers are willing to pay premium prices for commensurate experiences. In a way, hoteliers have been thrown the gauntlet. If they can create unique personalized experiences, they can charge heftily for those too and that is acceptable.
The focus on retail has meant that once foot traffic had been generated volumes will spew out the margins after fixed costs are covered. Similarly, in bar inspired communal spaces, again, volumes will bring home the bacon.
In all, mixed use projects while being a significant capital investment had enough going for it in terms of revenue generation and profit retention ending up in good returns of investment. Something to make stakeholders smile all the way to the bank.
The Way Forward
What is the way forward? The future is indeed bright for mixed use projects. Buoyed by a young, sophisticated, urban demand base (millennials and Gen Z) which is willing to fork out big bucks if unique, personalized experiences are delivered, stake holders have been falling over themselves to jump on to this bandwagon which has long term implications for their return on investment.
On the one side constant innovation keeps the demand fertile and on the other, intelligent pricing keeps the bottom line thriving and happy. This is a heady cocktail that no self-respecting stakeholder will be willing to pass up.
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