Lifestyles of the Rich and Almost Famous: The Boutique Hotel Phenomenon in the United States High Tech Entrepreneurship and Strategy Group Project

Professor Ron Adner

Alec Albazzaz Beth Birnbaum

Daniel Brachfeld Max Danilov

Oriane Kets de Vries James Moed

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Table of Contents Executive summary.................................................................................................................... 4 Background on the hotel industry.............................................................................................. 6

Hotel industry economic factors ............................................................................................ 6 Hotel industry trends .............................................................................................................. 7 Segmentation of the market.................................................................................................... 8 Growth of branded hotel chains ........................................................................................... 10 Major players ........................................................................................................................ 10 Chain hotels and independents............................................................................................. 10 Boutique Hotels: a definition ............................................................................................... 11 The evolution of the boutique hotel..................................................................................... 12

Strategy Analysis of Boutique Hotels ...................................................................................... 13 Ian Schrager Hotels (ISH) ........................................................................................................ 16

Hotel as Theater ................................................................................................................... 16 Location............................................................................................................................ 16 Design............................................................................................................................... 16 Experience........................................................................................................................ 17 Restaurants ....................................................................................................................... 18 Marketing ......................................................................................................................... 18 Targeting / Pricing............................................................................................................ 18 Growth Strategy ............................................................................................................... 19

Reaction to Competition....................................................................................................... 19 Starwood/W Hotels .................................................................................................................. 21

Starwoods Timing and Approach of Entry......................................................................... 21 Timing .............................................................................................................................. 21 Value Proposition............................................................................................................. 21

Starwood/Ws Financial Structure, Support and Ownership ............................................... 22 Economics of construction and operations ....................................................................... 22 Does Size Matter? ............................................................................................................ 23 W Hotels Financial Review .............................................................................................. 23

The W Experience................................................................................................................ 24 Amenities ......................................................................................................................... 24 Restaurants and bars......................................................................................................... 24 Meeting rooms .................................................................................................................. 25 Catalogue and the W Store ............................................................................................... 25

Starwoods Competitive Advantages ................................................................................... 25 Corporate Structure .......................................................................................................... 25 Cost Savings Through Economies of Scale and Scope.................................................... 26 Quality of Service............................................................................................................. 27 Locations .......................................................................................................................... 27 Willingness To Pay .......................................................................................................... 27 E-strategy ......................................................................................................................... 28 Marketing and Public Relations ....................................................................................... 28 Growth Strategy and opportunities .................................................................................. 28 Long term strategy ........................................................................................................... 29

Boutique Growing Pains .......................................................................................................... 29 Conclusion: Is Ian Schragers approach to hotels sustainable? Will W outperform ISH? ..... 30 Pictures..................................................................................................................................... 32

W Hotels............................................................................................................................... 32 Ian Schrager Hotels .............................................................................................................. 35

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Exhibits..................................................................................................................................... 37 References: ............................................................................................................................... 48

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Executive summary

The US hotel industry has traditionally been extremely fragmented. Many small players initially

entered the market by acquiring and renovating a local property, and maintaining it as a small business

or building it into a small regional chain over time. As US consumers became more mobile and a

growing cohort of frequent business travelers emerged, many travelers developed a higher willingness

to pay for a branded hotels comfort, cleanliness, quiet, reputable service, and provision of a good

nights sleep.

Hotel brands are traditionally segmented by quality, generally falling into one of the following

category types: economy, midscale, upscale, upper -upscale, and luxury. Specific hotels can segment

further based on location, desired customer type (business vs. leisure), and hotel size. Luxury and

upper upscale hotels traditionally feature a wide range of fine services and amenities (multiple

restaurants and bars, spa services, concierge services, toiletries), large rooms, and premier urban and

resort locations. Upscale properties tend to cater more specifically to business travelers and groups,

while retaining an emphasis on quality and comfort. Midscale and economy hotels are generally

geared for short-term transient business and offer stripped-down features at a lower price point. The

major US players in hotel ownership and management, namely Marriott, Hilton, 6 Continents, and

Starwood, all maintain a wide portfolio of hotel brands (please note that we have considered the purely

franchised hotel business as outside the scope of this paper).

In the 1980s and 1990s, extensive consolidation took place in the US hotel industry, producing several

large chains that now control a large portion of US lodging capacity, especially in the midscale and

higher segments. These large, relatively stable companies can obtain financing to develop many

properties simultaneously and can develop more cost-effectively than smaller players. Chains also

benefit from economies of scale in operations, a centralized reservation system that allows them to

yield-manage more effectively than independent hotels, and a well-developed sales and marketing

organization that can attract group business. The major players have also diversified their activity from

pure hotel operations. In addition to owning, manag ing, and franchising properties under the flags of

their brands, their businesses now include real estate, time-shares/vacation ownership, car leases, and

food distribution.

In the past 20 years, a small but growing contingent of travelers, grown tired of staying in large,

personality-free hotels geared towards a mass audience, has begun to migrate towards a new, more

intimate breed of hotel. These travelers purposefully seek out properties that are noticeably different

in look and feel from branded hotels, choosing an element of surprise over the more straightforward

values of consistency, comfort and convenience. A formal definition of the boutique or lifestyle hotel

concept remains elusive, though pundits agree on the following criteria: a thematic , architecturally

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notable design offering warmth and intimacy, a relatively small number of rooms, and a target of up-

market 20-55 year olds.

The innovation of the boutique hotel is most often credited to Ian Schrager. Famous for co-founding

the legendary nightclub Studio 54, Schrager saw an opportunity to sell an alternative to the mass-

market hotel experience. The 1984 launch of Morgans in New York was Schragers attempt to market

a hip, unusual hotel experience by telling image-conscious customers you are where you sleep.

Schrager had purchased a rundown hotel previously frequented by derelicts, and with the help of a

well-known French interior designer, created a dramatic nightclub-like environment populated by a

staff of part-time models and actors. Over the next two decades, the Schrager formuladistressed

property, powerful thematic design, and limited amenitieswas recreated in ten more locations from

London to Miami. Each propertys centerpiece is a hip restaurant or bar leased to a famous chef or

restaurateur. These hotspots attract celebrities and a sophisticated local clientelegenerating buzz

and profits.

Other entrepreneurs quickly followed Schragers lead, and independent hotels across the US rushed to

re-brand themselves as boutiques. Major players in the industry also took notice and quickly tried to

exploit this growing market: Starwood Hotels and Resorts opened the first W Hotel in Midtown New

York in December 1998. Closely following the Schrager model, each property offers signat ure

restaurant and bar areas that attract not only the hotel guests, but in-the-know local residents as well,

according to the W Hotels website. However, W rejects the boutique label, preferring to call itself a

lifestyle brand, and now (in the wake of the effects of September 11), emphasizes its customer

service aspects. Although the W brand had to overcome initial industry doubts that no chain hotel

could successfully emulate the boutique experience, Starwood claims that W is the most successful

hotel launch in history and has opened 17 locations since 1998. Being a Starwood brand provides

each W hotel economies of scale in purchasing and maintenance, synergies through Starwoods guest

reward program, the Starlink central reservations system, and access to Starwoods group and

meetings sales force.

Our analysis aims to uncover the extent to which the boutique hotel concept is truly an innovation over

the traditional luxury hotel. By introducing a powerful new aesthetic and eliminating amenities

previously considered de rigueur, boutiques, led by Schrager, appear to have distinctly altered the

industrys value proposition. We hope to determine if these advantages are value creating, and more

importantly, sustainable in the face of increased competition and an uncertain economy. Boutique

hotels are highly leveraged, meaning that they attract the highest-revenue customers during times of

peak business travel. By keeping costs low and maintaining high demand with an aura of style and

exclusivity, Ian Schrager Hotels have been able to achieve operating margins as high as 45%.

However, their leverage makes them especially vulnerable in times of decline; because boutique hotels

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offer limited or nonexistent meeting space, they cannot fall back on group sales to fill rooms when

individual business travel declines, and thus must let them go empty or sell them at distressed rates

through potentially brand-diluting wholesalers. Boutique hotels experienced tremendous growth

during the economic boom of the late 1990s, but can they survive now that the bubble has popped?

Background on the hotel industry

Hotel industry economic factors

The development of the hotel industry has been linked with the international and domestic tourism and

travel sector in general. The economic growth of the 90s and the accelerated globalization of the

world economy significantly increased business and leisure travel. The development of travel

infrastructure and the decreasing cost of air and other forms of transportation have also driven growth.

Today, tourism is the third largest retail industry in the United States. Total US hotel industry revenue

rose from $62.8 billion in 1990 to $103.5 billion in 2001, while the average daily room rate (ADR)

grew from $58.08 in 1990 to $88.27 in 2001 (See Exhibit 1). i Much of this rapid growth has been

spurred by the middle and low end, while increased consolidation within the industry has put pressure

on the independent hotels to innovate at the risk being bought out.

Historically, demand for lodging has been highly correlated with GDP growth. According to

PriceWaterhouseCoopers, demand elasticity to GDP is normally 1.0. Exogenous shocks such as the

Gulf war of 1990-1991, the Asian financial debacle in 1998, and the terrorist attacks of September 11,

2001, have distorted this relationship. Additional factors that affect lodging demand include consumer

confidence, interest rates, cost of transportation (fuel prices, indirect taxation), and foreign exchange

rates. (See Exhibit 2)

Supply for lodging tends to lag well behind demand, since it takes several years to bring new capacity

onto the market. In addition, market segments influence supply, as upscale and better hotels take

longer to complete than lower -range properties. Furthermore, deve lopers have limited flexibility to

defer or accelerate projects. In 3Q 2002, total lodging supply stood at 4.2 million rooms, while 2002

total turnover in the hotel industry worldwide was estimated at around $280 billion. (See Exhibit 3)

At a microeconomic level, the main factors of industry profitability are:

Occupancy rate (OCC) and ADR are both driven by the demand-supply relationship. There

are stark differences in the performance of hotels according to location and type of customers.

Hotels relying on international travelers have been most affected by current slump in demand.

Market segmentation is also a key factor; economy hotels are more resilient during demand

downturns than upscale properties. A hotels ADR and OCC determine its main revenue

indicator: its Revenue per Available Room, or RevPAR.

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Operational leverage. The ownership structure of its hotels has a significant effect on a hotel

chains profitability. Hotel ownership is a more leveraged structure than franchising; it is

difficult for properties to adjust operating costs when occupancy rates drop during market

downturns, but franchise and other fees are a more consistent source of revenues. Similarly,

in good market conditions, owned hotels perform better than franchises for the parent

company. ii

Hotel industry trends

Several trends characterize the state of the international hotel industry over the past decade (See

Exhibit 4 for a more detailed history).

Consolidation: A number of large deals serve as examples of this important trend, such as the

Starwood acquisitions of Westin and Sheraton, the Doubletree and Promus merger deal, the Marriott

acquisition of the Renaissance Hotel Group, and the merger of Hilton and Hilton International. This

consolidation has created hotel companies with greater brand portfolios and greater global reach.

Increased globalization: Industry consolidation has encouraged overseas investment, increasing the

reach of many hotel companies. One example is the Marriott International, who recently purchased the

Hong-Kong based Renaissance Hotels. In addition to global growth through acquisition, many US-

based hotel companies are expanding their brands worldwide. In 1996, there was a rapid international

spread of US-based economy and mid-priced franchised hotel chains.

Increasing importance of finance: Financiers are increasingly driving the hotel industry. Hoteliers

have traditionally focused on internal operations, while financiers concentrate on earnings and

company growth. Although some say that this shift forecasts a more difficult negotiating environment

for travel buyers, others herald the transition as a positive step towards a stronger and more successful

industry. Wall Street has only recently developed an interest in the lodging industry, which it long

considered too risky and unstable.

The role of information technology: In 1996, it was estimated that hotel companies in the US and

Europe spent an average of 2.5% of their revenue on information technology. Slightly less than $2

billion was spent in the US and $2.5 billion in Europe. In the 1980s and early 1990s, the hotel

industry spent several billion dollars on technology, but most of that spending was kept in-house.

Many hotel companies now feel their proprietary technology is a key point of differentiation. Industry

consolidation has driven an increased appetite for spending with outside systems integrators,

outsourcers, and software developers. Many technology innovations have been driven by the

industry's need to enhance the customer experience. Smart cards, check-in kiosks, and the

proliferation of loyalty programs are all examples of hotel companies trying to get closer to their

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customers. Because many hotel companies internally developed and purchased disparate systems, they

now face a need for systems integration as the industry consolidates. Distribution costs also continue

to be high. The changing role of the Internet, managed travel, and the evolution of the global

distribution systems (GDS) used by travel agents to access air, hotel, and rental car inventory, will

likely cause changes in the way hotel rooms will be distributed in the next several years. iii

Segmentation of the market

There are many ways in which to segment the hotel industry, the most relevant ones are highlighted

below:

Segmentation by scale (level of luxury) splits the hotel industry into several segments. Industry

practice divides hotels by scale into the following broad segments: Economy, Midscale (with and

without food and beverage), Upscale, and Upper Upper Scale (including luxury hotels).iv (See

Exhibit 5) Thus Marriott markets its flagship Marriott brand to the full-service upscale segment,

where it competes with Starwoods Westin and Sheraton, as well as Hiltons Hilton and

Doubletree brands, among others. Upscale hotels primarily target business travelers and are

generally located in prime locations in urban destinations. [To a lesser extent, upscale hotels can

also be found in resort destinations, where they cater primarily to leisure travelers and groups.

Generally speaking, business destination hotels yield-manage with higher price points during the

week, and sometimes struggle to reach desired occupancy rates on weekends, especially during

off-peak periods in seasonal destinations. The reverse is true for leisure destinations.] Upscale

hotels will frequently advertise promotions and package deals to sell off their unsold inventory,

and frequently sell distressed inventory through Priceline.com and other similar channels.

Luxury brands such as Ritz-Carlton (owned by Marriott) and Four Seasons target the small but

extremely lucrative Upper Upscale segment. These hotels will offer the greatest range of luxury

services and charge a premium price; large and comfortable rooms with elegant appointments and

fixtures, extensive restaurant and bar facilities, high-end shops, spa facilities, and premier

locations are all de rigueur. Upper upscale hotels will generally let rooms go unsold rather than

be shown to offer any sort of discount, although they will market packages bundling meals or

services with hotel rooms.

Midscale hotels target traveling businesspeople and families unwilling to pay for the full range of

services in an upscale hotel. These properties offer fewer and less sophisticated restaurant and bar

facilities than upscale hotels (or eliminate them altogether and instead offer a free continental

breakfast of pastries and cereal). These hotels are generally located in urban areas, but unlike the

upscale hotels located in prime downtown locations, midscale hotels will generally be found in

suburban and highway locations. Holiday Inn Express, Ramada, Fairfield Inn by Marriott, Four

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Points by Sheraton, and Hampton Inn (a division of Hilton) are all examples of branded midscale

hotels.

Economy hotels constitute a large segment of the market. Hotels carrying the flags for brands

such as Days Inn, Travelodge, and Super 8 (all franchised by Cendant), Motel 6 (Accor) and

Prime Hospitalitys AmeriSuites and Wellesley Inn and Suites are frequent sights along major US

Interstates. These hotels (often referred to as motels in the United States) offer a limited range

of amenities and services. Furnishings are basic, swimming pools are less common than in other

segments, and few toiletries are offered. Many do not have an attached restaurant, for example,

although it is common to see a restaurant located within walking distance of an economy hotel.

Many economy hotels are franchises owned and managed by small businesspeople; franchisees

are generally not considered to be able to offer the same consistency of quality of service as hotels

owned or managed by the parent company.

Segmentation by location: Location can be used to attract a targeted customer segment. Airport

hotels are for example focused on the transit travelers in the same way as resort hotels are

targeting the leisure segment. (See Exhibit 6)

Segmentation by size: Hotels of more than 300 rooms account for only 21% of existing capacity.

Larger hotels are an urban and resort phenomenon, whereas small hotels dominate in smaller cities

and along highways. (See Exhibit 6)

Segmentation by type of customer: The key split is between leisure and business travel.

According to the WTO, business travel is expected to grow faster than leisure (95% accumulated

growth rate for the 2002- 2012 period vs. 90%), but business travel traffic tends to be more

volatile than leisure, which makes it more highly leveraged to the business economy.

Other criteria for segmenting by customer type could include booking source (such as Internet site,

managed travel, telephone or travel agent), demographics and lifestyle, customer responsiveness

to brand or price, etc. Boutique hotels target their customers by a combination of lifestyle and

demographics, an innovative targeting mix in the hotel industry.

Segmentation by style : Designer hotels present a different customer proposition than mass-market

hotels. Large hotels (especially those part of a chain) have found it difficult to avoid a

depersonalization of the service and a resulting trend towards commoditization.

Over time, the largest players (including Hilton, Marriott and Sheraton) began to segment the market

further by offering a range of hotel types and services. Through branding, companies can pinpoint

locations, price points, and level of service to attract the desired mix of business and leisure travelers.

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To broadcast a consistent image of the level of quality and service customers could expect, the largest

hotel companies now market brands specifically to each segment of traveler.

Growth of branded hotel chains

Traditionally, the US hotel industry was extremely fragmented. Many small players entered the

market by acquiring and renovating a local property, and maintaining it as a small business or building

up a small regional chain over time. Consolidation began in 1943, when Hilton became the first coast

to coast hotel chain in the United States.v In the late 1950s, JW Marriott, then a successful operator

of Hot Shoppe cafeterias in the Washington, DC area, expanded into the hotel industry with a Motor

Hotel in Arlington, VA and subsequently began a rapid geographic expansion. vi An increasingly

mobile population appreciated the consistency and quality of service and co0mfort they found at

branded hotels, and as they grew, these larger companies also began to benefit from significant

economies of scale and scope.

The consolidation that took place in the hotel industry in the past twenty years produced several large

chains that control a large proportion of US lodging capacity, especially in the middle and upper

segments. As of 2002, the four largest hotel companies in the US controlled 35% of the total room

supply. All the big players have also diversified their activity away from pure hotel operations, but

Cendant may have taken this diversification strategy to an extreme. In addition to hotels, Cendants

many business lines include real estate, rental cars, travel technology, and financial services.

Major players

In the United States, a few major players have traditionally dominated the hotel industry. Marriott is

the worlds largest hotel chain, with over 2,200 units worldwide; its brands include Marriott,

Renaissance, Courtyard by Marriott, Residence Inn by Marriott, Fairfield Inn by Marriott, TownePlace

Suites by Marriott, SpringHill Suites by Marriott, Ritz Carlton Hotels and Resorts, and Ramada

International. Hilton owns, manages and franchises 499 hotels worldwide under the brands Conrad,

Doubletree, Embassy Suites, Hampton Inn, Hilton, Hilton Garden, and Homewood Suites by Hilton.

Starwood owns, manages, and franchises nearly 750 hotels under the brands St. Regis, Luxury

Collection, W, Westin, Sheraton, Four Points by Sheraton, and Starwood Vacation Ownership. Other

major players include 6 Continents, which controls the Holiday Inn, Crowne Plaza, and Inter -

Continental brands, and Cendant, a major franchiser of economy hotels. (See Exhibit 7)

Chain hotels and independents

Chain hotels dominate the US hotel market for a number of reasons. Chains are able to lower costs

significantly by benefiting from economies of scale. As large, relatively stable companies, they can

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make real estate investments at a lower cost and develop properties more cost-effectively. They also

benefit from economies of scale in purchasing and maintenance for existing properties, and can invest

in a centralized reservation system that allows them to yield-manage more effectively than

independent hotels. At the same time, many consumers have a higher willingness to pa y for a known

quantitya branded hotels comfort, cleanliness, quiet, reputable service, and provision of a good

nights sleep, often backed up by a guaranteethan for an unknown quantity.

Boutique Hotels: a definition

In the past 20 years, a growing contingent of travelers grown tired of staying in large, personality-free

hotels geared towards a mass audience, has begun to migrate towards a new, more intimate breed of

hotel. These travelers purposefully seek out properties that are noticeably different in look and feel

from branded hotels, choosing an element of surprise over the more straightforward values of

consistency, comfort and convenience. vii These boutique hotels, often located in renovated urban

structures such as run-down single-room-occupancy hotels, small office buildings, or older hotels,

attempt to replace the cookie-cutter uniformity of a branded hotels dcor, food, and service with

more individualistic offerings.

A formal definition of the boutique or lifestyle hotel concept remains elusive. However, pundits agree

on the following criteria: a thematic, architecturally notable design offering warmth and intimacy, a

smaller size than the typical business hotel (many in the industry believe hotels larger than 150 rooms

cannot be called true boutiques) and a target market of up market 20-55 year olds.viii Most boutique

hotels can be found in trendy neighborhoods of sophisticated urban destinations, and many offer

customers high-tech amenities such as high-speed Internet access, cordless phones and CD players

with a library of music (available for purchase, of course). However, a subset of boutique hotels

located in resort destinations try to achieve the opposite effect: often located in secluded areas, these

hotels focus on a higher level of service than their urban counterparts and offer low -tech amenities

such as spa facilities, privacy, and even the absence of communications facilities as proof guests

staying at the hotel will truly be able to get away from it all. ix

Eliminating some features and services, such as spacious rooms and expansive lobbies, and replacing

luxurious fittings with cheaper, but architecturally more interesting, replacements (such as Vermont

slate for $1 a foot instead of imported marble at $8), allows these hotels to charge customers a similar

or slightly lower price point than upscale branded hotels, while lowering costs significantly from the

typical upscale independent hotel. x Architectural design compensates for smaller rooms whenever

possible (often permitting the hotel to pack more guests into a smaller space and/or renovate an

existing SRO or other nontraditional hotel building less extensively and thus save money). For

example, in the W New York-Times Square, where rooms average only 280 square feet, the

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architecture firm Yabu Pushelberg designed a translucent floor-to-ceiling panel of white

polycarbonate plastic to replace the solid wall between the bedroom and bathroom.xi Another

significant cost savings for independent boutique hotels is the fact that they do not have to pay a

franchise fee to attract customers.xii Centering the hotel around a brand-name chefs restaurant (and

often a trendy bar) in space leased from the restaurant also allows these hotels a significant revenue

stream in comparison to the typical branded hotel, for whom these services are generally not revenue

drivers. As a result, some analysts calculate that boutique hotels earn margins 30% higher than those

of standard luxury hotels.xiii

By building a thematic image powerfully conveyed throughout the property and relying heavily on

celebrity guests and public relations rather than mass advertising and a sales force to convey a hip

image, boutique hotels can successfully enter markets with high barriers by converting buildings not

normally suitable for hotel use. xiv Customers who want the experience of staying in a boutique hotel

are willing to trade off less-traditional locations and room designs that do not meet standard

definitions of comfortsuch as the rooms in Ian Schragers Royalton Hotel in New York, which run

parallel to the hotels hallways rather than perpendicular.xv Generally, rooms are smaller than normal

and often relatively dark. The hotel compensates for these flaws by providing a comfortable lobby

space that provides a Home Away From Home outside the bedroom itself and is a social huband

new kind of gathering space for guests and locals alike.xvi Ideally, the guest spends so much time in

the lobby, restaurant, and later the bar, that he or she barely notices the relatively small size of the

room. Despite all the distractions, the typical lifestyle hotel guest is traveling on business rather than

pleasure: according to PwC, 68% of guests are corporate travelers. xvii

The evolution of the boutique hotel

A number of market dynamics accelerated the acceptance and the demand for boutique hotels. These

include: Eroding brand loyalty among franchises; customer access to the GDS via travel websites (and

their subsequently reduced dependence on travel agents); the emerging trend of experience or

adventure travel; an increase in disposable income in conjunction with the largest sustained period of

economic growth in U.S. history; and the desire for more personalized service (particularly on the part

of discriminating business travelers).

The innovation of the boutique hotel is generally credited to Ian Schrager. Famous for founding the

legendary nightclub Studio 54, Schrager saw an opportunity to sell an alternative to the mass-market

hotel experience. The 1984 launch of Morgans in New York was Schragers attempt to market a hip,

alternative hotel experience by telling image-conscious customers you are where you sleep. While

Andre Putnam, the French stylist, designed that hotel, Schrager has maintained a design partnership

with noted designer Philippe Starck since 1987, and has only recently begun working with other noted

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architects and designers, including the Canadian Bruce Mau. xviii Schrager has created a new breed of

urban hotels that offer guests high style at prices lower than those of traditional luxury hotels. By

building the hotel around an A-level restaurant and bar designed to attract a sophisticated local

clientele in addition to the hotels guests, Schrager successfully gives each of his hotels a unique

ident ity that also reflects the spirit of the hotels local urban environment.

As many of the traditional franchised product developers recognized this powerful and profitable

market segment, they too began to consider the compelling factors: the restrictive nature of most

franchise agreements, the considerable franchiser costs (royalty, reservation, marketing, application

fee, etc.), which range up to 12 percent of gross income, the inconsistency between franchised

products, the premium revenue per available room of boutique hotels vs. luxury hotels and, finally, the

barriers to entry in the traditional boutique hotel marketplace.

As a result, other entrepreneurs quickly followed Schragers lead, and independent hotels across the

US tried to re-brand themselves as boutiques. Major players in the industry also took notice and

quickly tried to exploit this growing market: Starwood Hotels and Resorts opened the first W Hotel in

Midtown New York in December 1988. Closely following the Schrager model, each property offers

signature restaurant and bar areas that attract not only the hotel guests, but in-the-know local residents

as well, according to the W Hotels website. xix In fact, Starwood even hired Rande Gerber, designer

and operator of Schragers bars (and a celebrity himself, married to supermodel Cindy Crawford, able

to tap into a network of VIPs as his clientele) away from Schrager to design and manage the W hotel

bars, prompting a series of escalating lawsuits that are still unresolved.

Strategy Analysis of Boutique Hotels

The phenomenon of boutique hotels can be examined using various strategy frameworks, which can

explain the fast and furious rise of these hotels in the United States.

To begin, we have conducted a hotel industry analysis (See Exhibits 8 & 9). Although the exhibits

concentrate on Porters five forces on each of the Ian Schrager and W brands, they are mostly similar

and can be used to look at boutique hotels versus previously existing hotel types. The main message

to glean from the industry analysis is to notice how buyers and suppliers do not have bargaining

power. This means that the hotel industry itself can capture most of the economic benefits of the

hospitality category. Yet, within the hotel industry, it is worth noting that the internal rivalry is

intense. In addition, new entry is relatively easy and the many different types of hotels guarantee that

there is a large substitution effect.

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It is in this environment that boutique hotels appeared, yet another in a long list of ways that hotels

have tried to differentiate themselves. The innovation of boutique hotels was not a radical change

from current offerings. It was clear that the concept of boutique hotels enhanced the competence of

hotel operators. Many of the current practices in the industry were kept and sometimes enhanced or

lessened, but the new hotels did not represent a disruptive technology to the core concept of hotels.

By combining their existing market knowledge with new ideas of what a new and different segment of

customers desired, Ian Schrager and later Starwood were able to create (in Schragers case) or enhance

(in Starwoods case) current offerings (see Exhibit 10: What Type of Innovation is the Boutique

Hotel?). Although the concept of boutique hotels did not destroy the existing market knowledge, it did

disrupt what hoteliers believed was the correct combination of product offerings to target the lucrative

segment of young and upscale consumers (it is important to note that boutique hotels themselves are

not a disruptive technology, rather a more targeted offering to a particular segment that was either

ignored or underserved). The ultimate list of attributes combined in a boutique hotel is narrowly

aimed at this segment, and therefore the innovation of boutique hotels can be described as niche

creation (see Exhibit 11: How Disruptive Are Boutique Hotels?).

One of Ian Schragers highest-impact innovations within the boutique hotel category was the creation

of ber-hip restaurants and bars, which became city destinations (rather than the traditional model of

pushing hotel guests into its restaurants and bars). Hoteliers shrewdly realized that their expertise lay

in the hospitality industry, and not the entertainment industry (where these restaurants and bars reside).

By using alliances with well-known chefs and bar and restaurant owners rather than trying to create

these on their own, boutique hotels were able to create products that their target segment actually

desired and valued very highly (see Exhibit 12: Building of Alliances Between Hotels and

Bars/Restaurants). Ws and Ian Schrager hotels profit sharing and revenue deals with their alliance

partners will be discussed in the next sections.

Apart from restaurants and bars, Ian Schrager created other valuable new factors in his hotels, while

reducing or eliminating other factors that did not add value to the target segment. The framework of

value innovation as it relates to boutique hotels is shown in detail in Exhibit 13 (Actions for Value

Innovation). One of boutique hotels greatest advantages is the ability to offer a customized offering

in a small amount of space. This was done by reducing the size of rooms and area used by non-value

added items such as in-hotel shops and lobby space. The value curve for boutique hotels as compared

to Luxury hotels (Four Seasons) and Upscale hotels (Sheraton) is highlighted in Exhibit 14 (Value

Curve for boutique hotels).

Where did boutique hotels customers come from? These consumers were previous ly staying in the

various offerings that targeted upscale travelers. Luxury hotels offer exquisite service and a top-end

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product, but they were increasingly viewed by some as stuffy, and were mostly frequented by an

upscale, older clientele. Although upscale hotel brands such as Westin and Marriott offer a lower

price and an adequate service and product, these hotels have increasingly been viewed as cookie-

cutter, offering a uniform and unexciting product. These hotels target the average businessman. In

contrast, the boutique hotel provides a more targeted luxury, drawing in a younger, but still upscale,

crowd (see Exhibit 15: Preference Structure).

There is a paradox present in the model of the successful boutique hotel. Naturally, given the high

fixed costs and the low variable costs in the hotel industry, selling as much as possible is preferred.

But one of boutique hotels value-added offerings is the feeling of exclusivity and being part of a

vibrant scene. This cannot be accomplished by allowing too many people to be part of the boutique

product. In terms of the innovation diffusion curve, this means that there is a forced and desired break

between early adopters and the majority of adopters (see Exhibit 16: Innovation Diffusion for

Boutique Hotels). One interesting way to understand boutique hotels is to see it as Ian Schragers

attempt to turn a hotel into a fashion item. Therefore, the highest willingness to pay will lie in a new

and attractive product. There is a way to reconcile the issue of hotel size with hotel feel: expand into

new boutique hotels. The phenomenal growth of boutique hotels is currently possible because of how

few of these hotels currently exist. Instead of expanding the hotel itself, the way to expand in this

business and still keep the main value proposition of a boutique hotel is by increasing the number of

hotels in currently underserved areas. As cities become saturated with boutique hotels (as New York

might soon be), there will be a decreasing return on guests (and therefore revenues and profits), not

only because of overcapacity, but also because of the limit of upscale and young consumers in the

market.

Using various strategy frameworks, we have shown that the offerings of boutique hotels have both

increased the target segments willingness to pay while at the same time reducing the hotels costs.

This gives them a competitive advantage over luxury and upscale hotel products (see Exhibit 17:

Competitive Advantage (WTP vs. Cost)). The advantage may not be sustainable though. Issues of

further segmentation (more targeted hotels) and the loss of the new feel as time progresses may

force boutique hotels to rethink their offerings and either further value innovate to raise willingness to

pay or reduce their costs through scale.

The next sections will highlight each of Ian Schrager and Starwood timings and approaches to

boutique hotels.

16

Ian Schrager Hotels (ISH)

Hotel as Theater

When asked to define the term boutique hotel, Ian Schrager provides a simple reply: Its a hotel

with a point of view. Schrager approached hotel development with the belief that customers will pay

as high a premium for attitude, glamour, and exclusivity as they will for more traditional amenities of

a luxury hotel. In 1984, fresh from a 13-month jail term for tax evasion, Schrager and Studio 54 co-

founder Steve Rubell turned a rundown former single-room occupancy hotel (SRO) on Madison

Avenue in New York into Morgans. Draped entirely in blacks and grays, Morgans boasted provocative

Robert Mappelthorpe photos on the walls, impenetrably dark hallways, small guest rooms, part-time

models for staffand a devoted clientele.xx Today, Ian Schrager Hotels (ISH) has expanded the

concept of hotel as theater to 10 locations in New York, London, Miami, Los Angeles and San

Francisco. By starting with low cost properties such as SROs, adding powerhouse restaurants and

bars, offering limited extra services, and keeping demand high by staying at the edge of cool, Ian

Schrager claims to have achieved profit margins of 35% to 45%.xxi And the point of view? Schrager

directs the scene and the customers willingly play their parts.

Location

Schrager hotels typically begin as urban properties that have some architectural distinction, but ha ve

fallen into disrepair and can be acquired cheaply. The Mondrian, which opened in West Hollywood in

1997, (bought out of bankruptcy for $17 million), was previously a fifties apartment block built to

evoke the work of the artist of the same name. xxii Schragers 1995 renovation of the Delano in

Miamis South Beach marked the revival of a neighborhood known for its Art Deco design. ISHs

acquisition and turnaround strategy is likely what attracted the attention of NorthStar Capital, which in

March 1998 paid $255 million for a controlling stake in ISH (reportedly around 70%).xxiii NorthStars

portfolio focuses on undervalued assets [that] possess significant revenue-generating potential [and]

are either overlooked or out of favor in the eyes of mainstream investors.xxiv With the backing of

NorthStar, ISH has been able to take on more ambitious investments including a May 1998 purchase

for $177 million of the Barbizon and the Empire, New York properties with over 300 rooms each.xxv

Design

Ultimately, the Schrager developments that have succeeded prove that the value of a theatrical

production is its ability to cheaply transform an empty space into an emotionally compelling

environment. Beginning with French interior designer Andre Putnam at Morgans, Schrager recruit ed

visionary interior designers who imbued each property with a powerful theme and an element of

fantasy. The Royaltons ocean liner dcor features portholes in the bathrooms, while the

Paramounts European touches extend to Vermeer reproductions over each headboard.xxvi

17

Schragers main collaborator and ISH partner over the past decade has been French designer Philippe

Starck, whose designs combine minimalism and extravagance. For me, a hotel is a stage where I try

to inspire people to open up the door in their brains...to wake them up to realize they can reinvent their

own lives.xxvii However, ego-driven design often takes precedence over practicality (one Starck-

designed shower door is infamous for its dangerously tricky handles). Like a stage set, Schrager

achieves his look at a low cost and is known for skimping on details that do not add to the overall

effect (such as the Royaltons $1 Vermont instead of $8 marble). xxviii ISH rooms are also noticeably

smaller that those in hotels of equivalent star rating. Without abandoning his penny-pinching

philosophy, Schrager has dramatically increased his renovation budgets, allowing him to build more

spectacular settings for guestsfrom $4 million at Morgans in 1984, to the $125 million refit of the

1000-room Hudson in 2000. xxix As Schrager has taken on higher -profile projects, his distinct vision

has occasionally clashed with local sensibilities. After ISH purchased the landmark Clift Hotel in San

Francisco from the Four Seasons Group in 1999, local activists organized protests to prevent him from

destroying the famous Redwood Room of the historic property.

Experience

ISH emphasis on social engineering represents a significant departure from the path of established

hoteliers. While traditional hotel service focuses on serving the needs of the individual guest,

Schrager views a hotel as he would a nightclubguests are there not simply to rest and eat, but to be

part of a group experience, which reinforces their membership in the stylish urban elite.

I'm more of a social scientist than a businessman or a hotelier. When I sit down with

Philippe, we talk about the sociology: What are people doing, what are they avoiding, where

are people going, where are they movingtogether, en masse, or apart? We're not talking

about fabrics or walls or design, but the whole idea of the way people behave.xxx

From the outset, Schragers motto for his hotels has been you are where you sleep. Driving this

message home even further, ISH populates its hotels with a staff vetted for style and physical beauty

and often comprised of part-time actors and models. In 1996, Schragers redesign of the Mondrian

included the dismissal of a team of Latino and Asian bellhops, who were described in a famous

Schrager memo as too ethnic. (The ensuing complaint to the EEOC resulted in a million dollar

settlement.) Similarly, the utilitarian aspects of a hotel (room size, professional service) are often

downplayed in favor of spectacular lobbies, gardens and public spaces full of beautiful people that

serve to remind guests of the cachet that comes with staying at a Schrager hotel.

18

Restaurants

This phenomenon is in greatest evidence at the hip restaurants and bars that are attached to each

Schrager property and defended by various layers of doormen, maitre ds, and VIP lists. While hotel

restaurants have typically been loss leaders designed for the guest convenience, Schragers serve as

the main draw of each propertyAsia de Cuba and 44, among others, have become local hotspots and

celebrity hangouts. Created, owned and managed by celebrity restaurateurs like Alain Ducasse, they

not only create buzz, but also constitute profit centers in their own right. As landlord, Schrager claims

to take 7-10% of gross revenues and 50% of profits.xxxi For ISH guests, the relationship between a

hotel like the Mondrian and its ber -trendy Sky Bar is pricelessa room key is the only guaranteed

way to get past the bouncers. With the bars individuality comprising a major source of ISHs

competitive advantage, Schrager actively defends them from imitators. In May 2000, Schrager filed

suit against Rande Gerber, who had run three of ISHs most successful bars before leaving the

organization to join Starwoods W hotel chain. Claiming that Gerber had recreated ISH bars at W

properties and shared secrets with the competition, Schrager waged a public battle with the bar

operator, eventually buying him out of Morgans and Skybar for $1million.xxxii

Marketing

Beyond their contemporary design and central locations, ISH hotels are dependent on a steady stream

of celebrities to sustain the feeling of access that Schrager provides to guests. The aura of exclusivity

surrounding each property has, until recently, been backed up purely by shrewd public relations, never

advertising. According to Schrager, You can get a million dollars of free publicity by underwriting a

party for $10,000.xxxiii Schrager hotels have played host to events for Miramax Films and MTV, and

a team of publicists makes sure that the properties get mentioned in trendy periodicals and celebrity

magazines alike. In addition, Schragers website offers, in exchange for an email address, a few dozen

photos of celebrities mugging for the cameras at his hotels as well as a feature called The List, which

offers visitors an inside view on whats hot in each Schrager city.

Targeting / Pricing

Schragers investment in cool translated into real value in the eyes of his target market. ISH

clientele has consisted heavily of professionals from the media and entertainment industry and their

hangers-on. (Originally Schrager used this fact to justify the small sizes of his guest rooms, assuming

that his guests would most likely be too busy partying to notice. xxxiv) More generally, the segment

attracted to a Schrager hotel is looking, if not for innovation, than for a non-generic experience. In

providing an environment distinctly different from that of the predictable luxury hotel chains, Schrager

hotels also excluded the features that are more or less irrelevant to its target customers, most notably

meeting and conference facilities. This acted as a deterrent to group bookings and a draw for those

19

who seek out uniqueness. However, the ISH deliberately avoids comparisons to traditional luxury

hotels. By cutting away extraneous and costly services and focusing on image, Schrager is able to

offer his customers a completely new value proposition he describes as cheap chic. ISH room rates

run as high as $5000/night, but are generally priced slightly lower than luxury establishments.

Schrager has also made a point of publicizing the democratic rates of the Paramount on Times

Square, as well as the $95/night rooms at the Hudson (though these tiny rooms are in very limited

supply and standard rooms are listed at $175).xxxv According to cheap chic, Schrager hotels

discriminate on style but not on spending powerthus manage to be both hip and proletarian.

Growth Strategy

During the flush economy of the late 1990s ISH and NorthStar actively sought to replicate the

Schrager formula in different formats and on a larger scale. Schrager opened his largest hotel to date,

the 1000-room Hudson in 2000 and strayed from cheap chic with the Clift in San Francisco (rates

start at $260). In addition to the 1998 purchase of the Empire and Barbizon in New York for $177

million, ISH (with a loan from CSFB ) acquired the lease for the iconic St. Moritz, promising to

undertake a $100 million refurbishment.xxxvi Most remarkably, in 2000-2001, ISH acquired at its first

build-from-scratch property on New Yorks Astor Place, employing Dutch architect Rem Koolhaas,

saying There isn't as much financial upside...but this is a chance to have an impact on the skyline of

New York.xxxvii Three of the four New York projects have since been abandoned and creative

differences with Koolhaas led to a replacement with architect Frank Gehry. Nonetheless, Schrager

continues to look for growth opportunities. In the US, ISH is exploring sites in Las Vegas and is due

to open a beachfront summer camp for adults in Santa Barbara, CA. In addition, as the only

independent US boutique brand with a presence in Europe, ISH is looking to expand further into

London as well as Paris. According to Schrager, his strategy is to go into international, 24-hour,

gateway cities and do multiple hotels at various price points.xxxviii

Reaction to Competition

Schragers new focus on market-driven differentiation ultimately reflects deep changes in philosophy

that have gradually taken hold at ISH, particularly in the face of increasing competition from other

boutiques, most notably Starwoods W chain. (In New York, boutiques are so popular that no large

hotels are due to open before 2004xxxix) As more hotels adopt a design driven approach over mass-

market architecture, Schrager has found that as a competitive advanta ge, coolness, particularly in

trend-obsessed cities is both substitutable and difficult to sustain. Additionally, the recession had a

particularly negative effect on clients in former ISH strongholds like the media and tech sectors.

Changes over the pas t 2 years include:

20

Professionalization of management/staff: With the opening of the Clift, ISH installed its first

human resources department and training programs. Similar moves have been taken at other

properties where waits for room service were known to run into the hours. More recently, ISH

hired a new VP for the Paramount in New Yorkthe former general manager of Starwoods

Phoenix resort in Arizona. xl

Redesign/Renewal: ISH is believed to be pursuing a $400 million refinancing of existing hotels.

The Paramount is undergoing renovation, including the renaming of its once-trendy Whiskey

Bar.xli

Comfort over coolness: In a 2002 Wall Street Journal article, Schrager said his hotels would

become more comfortable, not quite so provocative in the rooms, [with] more lighting. I'm not

going to rely on having the coolest lobby or bar. Schrager was also said to be distancing himself

from longtime collaborator Philippe Starck.xlii

Business services: Despite previously being labeled as the media place to stay, ISH is pursuing

relationships with traditional purchasers of business travel accommodation, including Morgan

Stanley. All locations currently feature meeting spaces a. Schrager: Im giving access to my

hotels to some segments that I havent given access to before.xliii

Price Reductions: In 2002, rooms at the Paramount were offered for $145, about half previous

rates.

Advertising/Incentives: ISH launched a billboard campaign and sent 500,000 fliers to previous

guests, offering a free night for two paid nights. Additionally, in March 2002, Schrager developed

limited-time incentives for travel agents including 15% commissions and cash rewards.xliv

ISH has reacted to increased competition by re-focusing on service and individual customer needs,

ironically taking a page from the playbook of the industry it once disrupted. However, as ISH

increases the range of services and guest amenities, it runs the risk of cutting into the cost advantage it

has traditionally held over its rivals. More importantly, efforts to attract a wider clientele threaten the

delicate formula that gives Schrager hotels their aura of hipness and exclusivity, undermining the main

pillar of Schragers value proposition.

21

Starwood/W Hotels

Starwoods Timing and Approach of Entry

Timing

Starwood entered the lifestyle hotel segment because Barry Sternlicht [CEO of Starwood] wanted to

create a different, cutting edge hotel lineusing physically tired assets and converting them to cater to

a different type of market and outsourcing the restaurants and bars to professionals.xlv Starwood

launched the W line in late 1998 with the opening of the W New York in midtown Manhattan.

Designed to appeal to business travelers in the 25-49 age bracket, with incomes at or exceeding

$100,000, the launch of W happily coincided with a major economic boom, helping the brand find its

niche immediately.xlvi

By late 1998, the market for lifestyle or boutique hotels had already been well established by

entrepreneurial hoteliers. The Kimpton Group launched its first boutique hotel, the Bedford in San

Franciscos Union Square, in 1981. Ian Schragers Morgans Hotel, was opened in 1984, Chip Conley

started Joie de Vivre Hospitality with the launch of the rock nroll-themed Phoenix Hotel in San

Francisco in 1987, and the Kimpton Hotels and Restaurants Group began the successful renovation

and repositioning of old buildings into charming hotels paired with popular restaurants on the West

Coast as early as 1982. xlvii The popularity of the concept, the potential for significant cost savings, and

the relatively high willingness to pay, despite a more limited range of offerings and services, had all

been well established. The major questions for Starwood were whether an obviously corporate hotel

could draw the same stylish clientele that floc ked to offbeat boutique hotels and their popular

restaurants, and how far the concept could be extended before the market for lifestyle hotels reached

saturation.

Value Proposition

Unsurprisingly, the W hews to the classic boutique formula of small rooms and high style, charging a

price premium to Starwoods upscale Westin line. Starwood played up the hotel and room amenities

while being relatively honest about the hotels drawbacks. At the W New York, the first hotel

launched in the W line, so-called Wish Rooms are advertised at $209 per night, only a small

premium to the New York nightly average of $203,xlviii but customers are told upfront Our wish

rooms are small and cozy and so is the rateget a cozy room with the ultimate queen bed,

complimentary movie, and all the extrascustom formulated Aveda botanical bath products, lush spa-

style cotton pique W bathrobes, W Goodie Box, and much more.xlix The lobby of each W is

decorated with orchids and green apples because, according to Sternlicht, orchids are not expensive

22

and will last at least six months. When I first started this business, I put orchids and green apples at

the front desk of a property. Suddenly, the hotel looked expensive. It only cost $800 to implement,

but it changed the entire price category of the hotel.l

The website also promises savvy travelers refuge in a hectic world. Calling the hotel an oasis and

noting that the amenities are unparalleled, the hotels web page highlights some of the name-brand

talent that gives the hotel its stylish edge. Architectural designer David Rockwell has created a

tranquil sanctuary inspired by nature's elements - earth, wind, fire and water. Lose yourself in public

spaces that feel privateSavor a delicious meal at Heartbeat, the hot restaurant from Drew

Nieporentcreator of Nobu, Tribeca Grill and Montrachetfeaturing noted chef, Michel

NischanImmerse yourself in the intimate scene at WHISKEY BLUERande Gerber's creation that

redefines nightlife.li

Perhaps most importantly, Starwood feels that service is what differentiates the W from a typical

boutique hotel, and hence rejects the boutique label applied to Schragers hotels among others.

Schrager admits I was alone in this market for 13 years. When you are the only game in town, you

can get away with certain things. But, you learn that if the air conditioning does not work, it is not

good for anyoneI never had a training program or a human resources department.lii Starwoods bet

is that it can woo the same type of customers attracted to boutiques, but retain them through superior

service. To that end, it is the first company in the hospitality industry to embark on a Six Sigma

initiative, investing $17 million in training costs in 2001 alone. liii Says Sternlicht, Travelers dont

want to jump from hotel to hotel. They want to rely on certain amenities like an exciting meeting

place in the lobby of each W hotel and on a certain level of service liv

Starwood/Ws Financial Structure, Support and Ownership

Economics of construction and operations

Starwood founded the W line to fight the growing trend towards commoditization in the hotel

industry, but it still hews to a low -cost strategy whenever possible. By renovating physically tired

assets rather than engaging in new construction (a notion pioneered by Schrager and other early

entrepreneurs in the space), Starwood reaps significant cost savings.lv The W New York was financed

for $225,000 a room, in comparison to the industry average of $400,000 for a new hotel. lvi In

comparison to independents, however, Starwood can benefit from economies of scale in construction.

Further economies of scale can be reaped from Starwoods large purchasing and maintenance

contracts. lvii

23

Does Size Matter?

A W Hotel is generally far larger than the typical boutique hotel, which has approximately 150

rooms.lviii At 713 rooms, the W New York is the largest of all the W hotels controlled by Starwood;

the W Chicago Lakeshore (a converted Days Inn motel) runs second with 556 rooms. lix The average

W has about 311 rooms.lx While this is far larger than the average boutique hotel size of 150 rooms, it

is still smaller than a typical Westin, which has over 400 rooms.lxi Starwood and Schrager have both

bet, apparently with success, that customers do not highly value intimacy in a lifestyle hotel as much

as design and thematic elements, warmth, and energy. (see exhibit 18 for a list of W properties)

W Hotels Financial Reviewlxii

Despite being a new brand, W Hotels generate higher ADR and RevPAR than the average upper -

upscale properties. W Hotels mainly focus on transient business customers, which constitute 70% of

their overall business. Boutique hotels are highly leveraged: when the market is up, they do

especially well because they attract transient business customers, which generate the highest

revenues (groups negotiate discounted rates in exchange for volume). However, in economic

downturns, transient travel declines, so boutique hotels suffer more than mass-market hotels

geared towards group business. Thus W hotels high operational leverage serves them well during

good market conditions, but is a burden during bad market conditions, since W hotels have a limited

capacity to increase group sales when the transient market is underperforming.

For example, during 2001, RevPAR at Starwoods W hotels declined 16.4% and EBITDA declined

41.1%, whereas Starwoods overall North American owned portfolio recorded an 11.9% RevPAR

decline and a 23.1 EBITDA decline. (See table below). By contrast, in 2000, W hotels were more

profitable than the rest of the North American portfolio, with an EBITDA margin of 34.7% vs. 33.3%

for the portfolio. While the brand is still very new and has not yet gone through a full lodging cycle,

early indications are that Starwood was able to exploit the brands leverage during the economic

boom: the W New York, W San Francisco, and W Los Angeles together gave a 20% ROI in 2000.

Profitability comparison of W hotels vs. Starwoods North America, 2001

RevPAR (%) EBITDA (%) Margin Flow -through

W Hotel -16.4 -41.4 -930bp 2.5x

NA Owned -11.9 -23.1 -430bp 1.9x Source: Deutsche Bank, Company Information

24

The W Experience

Amenities

Lifestyle hotels compete vigorously on providing first-class amenities to their guests. A stylish cotton

bathrobe, toiletries from Kiehls, Aveda or another small, salon-quality firm, and plush bedding are

par for the course in boutique hotels, capitalizing on one of the more popular features of luxury hotels

(W rooms promise guests 250 thread count sheets, goose down comforters, and Aveda bath products).

In contrast to a Ritz Carlton or Four Seasons, which downplay their extensive business services

beneath a veneer of old-world elegance, W offers a more visible, wired approach to service and

intends to extend them further through a deal with Cisco Systems to provide extensive broadband

services.lxiii Rooms have high-speed Internet access through the 27-inch TVs entertainment system, a

CD player (and library of CDs available on request), coffeemaker with Ws own designer coffee

blend, a high-speed port for guests who have brought their own laptops, and two phones in every

room. Guests who want privacy are offered 24-hour room service from the fashionable restaurants

located in the hotels, or are given priority access to tables. Because its guests are primarily business

travelers, W offers a full-service business center in most lobbies and will arrange meetings and

functions. lxiv

Restaurants and bars

One of the keystones of the W concept is to provide trendy restaurants and bars that draw in a local

audience as well as hotel guests. This is a complete transformation of both the traditional upscale

hotel concept of a restaurant that provides sustenance to tired guests but does not attempt to serve the

type of food that would attract a clientele not staying in the hotel, and of the traditional luxury hotel

concept of a formal fine dining venue where a meal will feature extremely refined service and often

last three hours. To attract a stylish crowd interested in eating fashionable food, Starwood has

recruited celebrity chefs to helm the restaurants in its hotels, leasing the space to boldface names like

Drew Nieporent (Heartbeat in the W New York, Earth & Ocean in the W Seattle, and Icon at the W

New YorkThe Court), Todd English (Olives at the W New YorkUnion Square), and Gail

Deffarari (XYZ in the W San Francisco).

A popular nightlife venue is also a key element of the image W is trying to portray and helps keep the

hotel occupied with leisure customers on weekends. To build a collection of hip bars, W established a

partnership with former model and nightlife impresario Rande Gerber in 1996, as the company

planned its launch of the W New York, purchasing a 49% interest in Gerbers company Midnight

Oil. lxv Gerber was leasing commercial real estate at Ian Schragers Paramount Hotel in New York

when he opened a bar there called The Whiskey. His formula of tightly controlling the guest list by

effectively limiting it to guests of the hotel, local VIPs, and celebrities proved extremely popular, and

25

Gerber began to operate bars in other Schrager properties, including the Whiskey in the Sunset

Marquis Hotel in Los Angeles. When Gerber moved to the Starwood camp, his relationship with

Schrager soured and the two have engaged in a near-constant legal battle since, with Schrager buying

Gerber out of some properties and an agreement that leaves Schrager the rights to name his bars Sky

Bar, and Gerber Whiskey.lxvi

Meeting rooms

While many boutique hotels have eliminated meeting spaces as a cost-cutting measure, W uses its

function space as a competitive advantage. This enables it to derive up to 20% of its business from

groups. lxvii Although it cannot host the large functions many mass-market hotels regularly run, most

W hotels offer several smaller meeting areas and market them to executives concerned with form as

well as function. W has innovated the concept of Sensory Meetings, which promise a new way to

motivate minds and get ideas flowing, using the five senses as inspiration. Mood music, aromather apy

scents, retro candies, and many other special touches help set the tone. lxviii Of course, the hotels also

offer their meeting spaces on weekends for weddings and parties.

Catalogue and the W Store

Because building a returning clientele is a key profit driver for W, it looks to invade its customers

lives to the greatest extent possible. To that end, it has established an online and print catalog that it

places in each guest room, allowing customers to take the W experience home with them. In addition

to the W signature waffle weave cotton robe, bed linens and mattresses, and branded clothes and

accessories, customers can find in the W store catalogue a juicer designed by Philippe Starck, stylish

modern office accessories, and for the truly young at hear t, a skateboard. The chain also maintains a

physical store in the W New York Times Square.

Starwoods Competitive Advantages

Corporate Structure

W hotels benefit from significant competitive advantages by being part of the Starwood organization.

The brand can exploit Starwoods resources, from website design and upkeep to access to Starwoods

sales and marketing network. W also benefits from synergies with Starwoods loyalty programs: in a

model reliant on repeat business, 80% of the W customer base is a member of the Starwood Preferred

Guest (SPG) loyalty program.lxix This helps W retain customers, but it also brings in new customers

who experience the W brand for the first time when they trade in points accrued at other Starwood

brands or through purchases made with firms that allow customers to earn SPG points; the company

does not view cannibalization as a significant risk. Loyalty programs are also considered a value

26

driver for business travelers in the upscale segment, although not as important as price, hotel type, or

location.lxx

Because W can leverage the existing Starwood corporate structure, it can be run as a relatively lean

operation. Under a VP of operations, W has one director of sales and marketing, a training director,

and a team of 10 workin g in design and development. This team works with various architects to keep

the brand image consistent across W hotels, while each hotel remains stylistically unique, choosing

upholstery and room design elements for each hotel.

Cost Savings Through Economies of Scale and Scope

The size of the Starwood organization and number of hotels in the chain also lower costs through

significant economies of scale. All Starwood hotels share a common property management system

(PMS) connected to a proprietary central reservations system (CRS), Starlink, capable of yield

managing room rates across one hotel or an entire market (see Exhibit 19 The hotel business

transactional process reserving a room). A seamless connection between a hotels PMS and the

chains CRS offers hotels the ability to coordinate and yield manage individual and group sales

reservations. These reservations can come through travel agents accessing any one of the four

centralized Global Distribution Systems (GDS), websites (both Starwoods proprietary website and

unaffiliated travel websites, which hit Starlink via the GDS) and telephone. By contrast, independent

hotels cannot afford a customized CRS, while Ian Schrager only implemented a standardized PMS

across his hotels in early 2003. lxxi Independent hotels and small chains must find a way to link their

PMS (or CRS if they have one) to a switch providing access to the four GDS systems; this is often

accomplished by joining a marketing group or signing up with a GDS representative such as Utell,

Unirez, or Lexington Reservation Systems, all of which charge significant fees on top of the GDS

feesfor each reservation or sometimes for each night of stay. Finally, Starwood benefits from

pricing and sales information from its other hotels in each Ws market, information not available to

independent hotels and small chains.

W also benefits from Starwoods economies of scope, gaining advantaged pricing on maintenance

contracts and supplies as part of a large family of brands. In contrast, independent hotels and small

chains must purchase in smaller quantities and pay higher prices. Starwood is also able to devote

more resources to improving its supply chain management than a small chain or independent hotel,

seeking out and achieving cost savings in its purchases of items including linens, cleaning supplies,

telecommunications, and IT infrastructure.

27

Quality of Service

All W Hotels are tightly controlled by Starwood (e.g., owned, leased, part of a consolidated joint

venture, or managed by Starwood), lxxii which gives the company a far greater ability to control the

level and consistency of service than it has for franchised hotels managed by third parties. While

Starwood franchises its Westin, Sheraton and Four Points by Sheraton brands, it is not pursuing a

franchise strategy for W.lxxiii Starwood defines the service philosophy for the W brand as follows: W is

a fresh alternative combining the personality and style of independent hotels with whatever you want,

whenever you want it service.lxxiv Based on industry reviews, it has apparently succeeded in this

strategy: Business Travel News ranked W Hotels first in the upper-upscale category for 2001, rising

from fifth place the previous year, and beating long-established competition from Loews, Le Meridien,

and Inter-Continental. lxxv Cond Nast Traveler Magazine named three W hotels to its 2002 Gold List,

consisting of the magazine readerships favorite hotels, resorts and cruise lines worldwide. lxxvi

In comparison to independent hotels, W benefits from the ability to train its staff using techniques that

have been established and rolled out across the entire Starwood organization, such as its $17-plus

million Six Sigma initiative. This is especially critical in a segment of the industry that suffers higher

turnover than industry average; because lifestyle hotels tend to recruit young, trendy, good-looking

staff, there is a high risk of losing that staff to more rewarding opportunities in the fields of modeling

or acting. lxxvii

Locations

The W model is to build hotels in major urban destinations. These destinations cement the brands

status as a business hotel; to boost its leisure bookings, the line uses a heavy promotional push to

entice out-of-town and even local guests for weekend stays. Efforts include advertising (including a

major campaign in national magazines and the Wall Street Journal for late winter/spring 2003) and

targeted promotions often bundling added-value services such as spa treatments, meals, parking, spa

discounts, flowers, and champagne with rooms at special prices.

Urban locations were hardest-hit by the aftermath of the September 11th attacks on the travel industry.

However, Starwood considers that the worst is over on this front and that the companys urban focus

leaves it levered to the business travel recovery.lxxviii

Willingness To Pay

The W brand appears to be a good example of value innovation: Starwood has eliminated features and

services that are not important to customers and accentuated or implemented services and features that

add value to its base. A specific example might be its popular Wired promotion, offering guests

unlimited high speed Internet access, unlimited local, toll free, and domestic long distance telephone

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calls, and a keepsake mouse pad, in addition to the room, which was based on customer requests. Key

features such as fitness centers and the Ws signature Away Spa are accentuated, while expensive

elements not highly valued by customers, such as room space, exterior balconies, and new

construction, are eliminated. Branded hotels also offer an enhanced image of security in comparison

to independent hotels, for which both business and leisure travelers are willing to pay a premium:

10.75% for leisure travelers, and 7.73% for business travelers.lxxix

E-strategy

Internet bookings are a significant opportunity for hotels, because they eliminate all fees normally paid

to GDS companies and outsourced customer service telephone operators, as well as travel agent

commissions. Thus Starwood has made a significant investment in its hotel websites, as have many of

its competitors. This effort appears to have begun to pay dividends: the company has experienced a

60% increase in web bookings over the past year.lxxx While independent hoteliers are also investing in

allowing online bookings, many do not have the capability of eliminating third parties from the

transaction, and still have to pay GDS fees on any sales booked over the Internet. For example, Ian

Schragers site is powered by www.tabletbookings.com, and uses Pegasus to link to the GDS.

Marketing and Public Relations

W is able to leverage Starwoods significant investments in marketing in ways not available to

independent hotels and small chains. Starwood has dedicated significant resources to its hotel

websites. W plans to roll out a new web design in mid-March, and envisions a constantly evolving

web presence. lxxxi However, because W seeks a significantly different image than the other Starwood

brands, and relies heavily on PR to maintain its trendy image, it does not rely on Starwoods internal

PR department and instead pays a fee to an outside company. lxxxii

Growth Strategy and opportunities

A new location for a W hotel must meet several criteria. First, the location itself must serve the

brands image: for example, the W Atlanta (in Buckhead) and the W Suites in Newark, CA (Silicon

Valley) are Ws only suburban locations. If a location is suitably urban and hip, the market must still

be able to support a hotel at a $50 price point premium to a Westin and an even greater premium to a

Sheraton. Starwood will not open a W in a market that it believes cannot sustain greater than a $30

premium to a Westin. lxxxiii

The W brand accounted for 6% of Starwoods EBITDA in 2001, when it declined more heavily than

other Starwood brands because its distribution is weighted towards markets profoundly affected by the

business downturn in 2001. Starwood intends to grow the brand aggressively over the next five years,

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increasing the total number of W hotels to 50 by 2007. lxxxiv Starwood owns 22 properties that do not

fly the flag of one of the Starwood brands and thus appear to be ripe for conversion into W branded

hotels. lxxxv

Long term strategy

Starwood views W as a growth vehicle, feeling the brand strategy has been successful and that the line

has earned its place in the Starwood portfolio. Developers are excited to partner with Starwood in a

time of decreasing capital investment in the hotel industry. One question mark still to be resolved is

how the capital replacement cycle economics will play out for the brand. While larger Starwood

assets, such as Sheraton hotels, tend to be renovated on a 20-30 year cycle, W's upper upscale

segment, fashion-conscious target market, and reliance on design elements will require more frequent

renovations. At this point, the existing W hotels are too new to estimate the economic impact on the

life of the capital invested in the brand. Of course, this capital replenishment issue would also affect

independent boutique hotels as well as W hotels.

Boutique Growing Pains

Sensing a market opportunity, others soon jumped onto the bandwagon. In 2001, Marriott announced

it was repositioning its Renaissance brand as a chic boutique chain, stating We figure 30% of the

market out there is attracted to the boutique, sort of eclectic, sort of different, give-me-a-surprise kind

of hotels.lxxxvi Marriott has also made a combined $140 million investment with Italian jeweler

Bulgari to launch a line of boutique hotels in Europe. lxxxvii This gold-rush m entality may have created

a surplus of boutique hotels in the market. After the events of September 11th, 2001, which left the

travel industry reeling, many boutique hotels were struggling to survive. Still relatively new, they

were not yet as competitiv e as seasoned players, and without significant meeting space (a costly use of

space eliminated in many boutique hotels), they had fewer tools to drive demand during a

downturn. lxxxviii Service also became a differentiator: because staff at a boutique hotel is often chosen

for looks, style, and energy, training can be spotty and staff may neglect to maintain a deferential

service attitude under high-pressured situations. Given the ego-driven nature of the typical

boutique hotel client, keeping staff more excited by a dreamed-of career in modeling or acting than

their current job interested in what the hotel is, is a challenge boutique hotels cannot ignore if they

want to survive. lxxxix

Perhaps because of this backlash effect, W Hotels has attempted to categorize their product as

lifestyle hotels rather than boutiques, with a stronger emphasis on service as a differentiating factor

as well as the now-expected design, chic restaurants and bars, and individual style.xc Says Lisa Zandee

of W, We have never used the term boutiquethough others have used it of us. People in the US are

questioning the longevity of boutique hotels because what happens, after they come into fashion, if a

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lot more open? We are trying to make our brand last by not making it too trendy. We dont want

design that will be out of date tomorrow.xci

The events of September 11 hit urban, upscale hotels extremely hard, as business travel declined and a

shaken customer base began seeking out comfort and solace over a hip, trendy lobby scene. Given

the state of the economy, [boutique hotels] became not only less appropriate (but excessive), notes

Bjorn Hanson of PwC.xcii Says Chip Conley of Joie de Vivre, a 22-hotel chain based in San Francisco,

Were in the era of the post-hip boutique hotel. Travelers have had enough of hotels that are all about

the scene and are moving toward those that are stylish, comfortable and offer something they can

relate to.xciii We have to move away from positioning as a status symbol and move to positioning as

a comfortable sanctuary, agrees Jim Berra, Starwoods vice president of customer loyalty. xciv Despite

the volatility of the segment, Starwood