Capped Hotel Rates Pay Off For Buyer

A uniquely flexible program that Johnson & Johnson implemented to stabilize hotel rates a year ago is paying unexpected dividends this year.

After completing rate negotiations for its 2002 hotel program, Johnson & Johnson's travel department approached its hundreds of preferred hotels in dozens of cities in the United States and Canada with a compelling offer: The company would keep them in the hotel program through 2004 if they agreed to rate increases of no more than a combined 5 percent in the second and third years.

Much to J&J's surprise, a majority of the hotels last month did not take the increases they were entitled to for 2003. Instead, they actually decreased the company's negotiated rates out of concern they might outprice themselves in the marketplace.

The Johnson & Johnson initiative is an example of the creativity travel buyers are employing to get a handle on their hotel expenditures. Most efforts in traditional multiyear agreements in recent years have failed, primarily because of an unpredictable economy. In other words, buyers did not want to lock in a rate just in case market conditions deteriorated by the following year and left them with higher than prevailing rates.

"In developing the new program, our intention was to create some predictability over the longer term that would help our forecasting and still be a win-win for suppliers as well as ourselves," said Wendy Nathan, manager of travel services at the global health care company based in New Brunswick, N.J.

Once 2002 rates were in place, Nathan and her team held a conference call with the accepted hotels. "We were seeking to achieve some rate integrity through 2004. The hotels had the option of accepting the stabilization offer or not. Those participating could take the whole 5 percent increase in one year or incrementally in 2003 and 2004," she said.

J&J's program includes properties from four major chains. In return for their participation, the travel team agreed to hold the line on the number of preferred hotels in each market. "If we had five hotels in Chicago, for example, and three chose to participate, we would only go out to bid in 2003 to fill the two remaining spaces," Nathan said. Hotels that declined to participate were free to bid for the open slots along with others the company invited to bid.

Unlike other corporate accounts, J&J's travel volumes have remained constant during the past two years, or, in certain markets, actually increased. "Participating hotels were automatically in the program. For them, it was like a bird in the hand," Nathan said.

Hotels were given 30 days to decide. Approximately 95 percent of the hotels accepted the offer. What Nathan did not expect, however, is that 75 percent of those hotels last month chose to defer any price increase for 2003—an increase they legitimately were entitled to—and came back to the table with lower rates.

"Hotels that understood the marketplace gave us a fair market rate for their location. Had they taken an increase and competing hotels cut their rates, they knew they risked losing their competitive advantage," Nathan said. "Hotels in our program are smart. They think defensively and knew better than to do anything this year that would mean they were shooting themselves in the foot."

Terms of the agreement gave hotels leeway. "The program stipulated that you had an option to raise your prices, but you didn't have to exercise that option," said David Ogilvie, vice president of global corporate travel for Starwood Hotels & Resorts Worldwide, who participated in J&J's rate initiative. "Given the market, you might make the decision not to take your prices up because you don't want travelers staying somewhere else, especially if it's for $5 or $10."

Rate aside, there were subsidiary benefits. "In a down market, hotels got the continuity of remaining in the Johnson & Johnson program. The company's travelers also benefited by not having to move to hotels they were unfamiliar with," Ogilvie said. "Frequent travelers grow accustomed to staying in a certain hotel in a destination, and that behavior can be hard to change."

What will happen with Johnson & Johnson's rates in 2004, the last year of the stabilization program, is an open question. Should the economy strengthen and fair market rates rise in various locations, the hotels in those destinations may request rate hikes, "or their owners may grow impatient and press for rate increases, regardless of market conditions," Nathan said.

Johnson & Johnson's exposure still will be limited, however, due to the 5 percent cap. "We're protected from any unexpected upswings," she said, citing the 1996-1997 period, when hotels started pushing for double-digit increases.

Keeping the rate flat—or taking a decrease—also can be a hedge against new hotels that have entered the market. "Because they want to build trial usage, new properties typically come in with special introductory rates that established hotels can find hard to match," said Jon Elliott, Eclipse Advisors general manager of hotel consultants.

With all the rate compression that occurred in 2002, hotels also find themselves competing against properties previously positioned at a higher price point. "As a result, they find their competitive set has changed," Elliott said.

In recent years, companies have shied away from traditional multiyear agreements and even have walked away from some. "Midway through the two-year or three-year agreement, the company will send bids out to hotels again, with the buyer blaming the situation on changes in the economy," said Joe Carino, president of The Carino Collection, a New York-based hotel representation firm. "It's discouraging because there are no guarantees built into these agreements. Experiences like this put a bad taste in the hotels' mouth."

From the hotels' perspective, agreements that allow a degree of flexibility on rate are more attractive. "I can see a hotel wanting to be competitive, but who can say in three years what a competitive rate is going to be?" Carino said.

In the past year and a half, some companies even have viewed single-year agreements as suspect. "A whole year may seem like a long time in this environment," Elliott said. "There are travel managers who have their leadership coming back to them six months into an agreement and saying, 'The situation has changed radically. Let's re-bid.' The travel managers are under tremendous pressure, which gets transferred to the hotels. It's crazy."

As the travel team begins to strategize for the 2005 bid season, Nathan said, "The state of the economy at the time will be our starting point. Do we want to go with reverse online auctions as a way of getting ourselves back in line with the prevailing market rates? What will fair market rates even be at the end of 2004? Time will tell."