Annual report and summary financial statements 2006 

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Operating and financial review

This Operating and financial review (OFR) provides a commentary on the performance of InterContinental Hotels Group PLC (the Group or IHG) for the financial year ended 31 December 2006.

Business overview

Market and competitive environment

IHG operates in the global hotel market which has an estimated total room capacity of 18.8 million rooms. Room capacity has been growing at approximately 3% per annum over the last five years. The hotel market is geographically concentrated with 12 countries accounting for two-thirds of worldwide hotel room supply. The Group has a leadership position (top three by room numbers) in more of these markets than any other major hotel company.

The hotel market is, however, a fragmented market with the four largest companies controlling only 11% of the global hotel room supply and the 10 largest controlling less than 21%. The Group is the largest of these companies by room numbers with a 3% market share. The major competitors in this market include other large global hotel companies, smaller hotel companies and independent hotels.

Within the global market, a relatively low proportion of hotel rooms are branded (see figure 1), but there has been an increasing trend towards branded rooms. For example, Mintel, a market research company, estimates that the proportion of branded rooms in Europe has grown from 15% in 2000 to 25% in 2004. Larger branded companies are therefore gaining market share at the expense of smaller companies and independent hotels. IHG is well positioned to benefit from this trend. Hotel owners are increasingly recognising the benefits of working with a group such as IHG which can offer a portfolio of brands to suit the different real estate opportunities an owner may have. Furthermore, hotel ownership is increasingly being separated from hotel operations, encouraging hotel owners to use third parties such as IHG to manage or franchise their hotels.

Figure 1

Percentage of branded hotel rooms by region 2004
Source: Mintel (latest data available).
North America 65%
South America 20%
Europe 25%
Middle East 25%
East Asia 25%

US market data indicates a steady increase in hotel industry revenues, broadly in line with Gross Domestic Product, with growth of approximately 1-1.5% per annum in real terms since 1967, driven by a number of underlying trends:

  • change in demographics – as the population ages and becomes wealthier, increased leisure time and income encourages more travel and hotel visits;
  • increase in travel volumes as low cost airlines grow rapidly;
  • globalisation of trade and tourism;
  • increase in affluence and freedom to travel within the Chinese middle class; and
  • increase in the preference for branded hotels amongst consumers.

Potential negative trends include increased terrorism, environmental considerations and economic factors such as rising oil prices. Currently, however, there are no indications that demand is being significantly affected by these factors.

Supply growth in the industry is cyclical, averaging between zero and 5% per annum historically. The Group’s profit is partly protected from supply pressure due to its model of third party ownership of hotels under IHG management and franchise contracts.

Strategy

IHG owns, operates and franchises hotels, with its brands being represented in nearly 100 countries and territories around the world. The strategy is to become the preferred hotel company for guests and owners by building the strongest operating system in the industry, focused on the largest markets and segments where scale really counts. During 2006, IHG initiated a number of research projects, the results of which will strengthen the Group’s strategy with respect to brand development, franchising operations and growth opportunities.

The Group has four stated strategic priorities:

  • brand performance – to operate a portfolio of brands attractive to both owners and guests that have clear market positions in relation to competitors;
  • excellent hotel returns – to generate higher owner returns through revenue delivery and improved operating efficiency;
  • market scale and knowledge – to accelerate profitable growth in the largest markets where the Group currently has scale; and
  • aligned organisation – to create a more efficient organisation with strong core capabilities.

Executing the four strategic priorities is designed to achieve:

  • organic growth of at least 50,000 to 60,000 net rooms by the end of 2008 (starting from 537,000 in June 2005), with specific growth targets for the InterContinental brand and the key Chinese market; and
  • out-performance of total shareholder return against a competitor set.

Growth is planned to be attained predominantly from managing and franchising rather than owning hotels. Nearly 550,000 rooms operating under Group brands are managed or franchised (see figure 2). The managed and franchised model is attractive because it enables the Group to achieve its goals with limited capital investment. With a relatively fixed cost base, such growth yields high incremental margins for IHG, and is primarily how the Group has grown recently. For this reason, the Group has executed a disposal programme for most of its owned hotels, releasing capital and enabling returns of funds to shareholders.

A key characteristic of the managed and franchised business model on which the Group has focused is that it generates more cash than is required for investment in the business, with a high return on capital employed. Currently, 92% of continuing earnings before interest, tax and regional and central overheads is derived from managed and franchised operations.

The Group aims to deliver its growth targets through the strongest operating system in the industry which includes:

  • a strong brand portfolio across the major markets, including two leading brands: InterContinental and Holiday Inn;
  • market coverage – a presence in nearly 100 countries and territories;
  • scale – 3,741 hotels, 556,246 rooms and 130 million guest stays per annum;
  • IHG global reservation channels delivering $5.7bn of global system room revenue in 2006, $2.0bn from the internet;
  • a loyalty programme, Priority Club Rewards, contributing $4.4bn of global system room revenue; and
  • a strong web presence – holidayinn.com is the industry’s most visited site, with around 75 million total site visits per annum.

With a clear target for rooms growth and a number of brands with market premiums offering excellent returns for owners, the Group is well placed to execute its strategy and achieve its goals.

Figure 2

Global room count by ownership type at 31 December 2006

Pie chart showing global room count by ownership type at 31 December 2006 – 25 owned & leased hotels,  512 managed hotels and 3,204 franchised hotels

Business relationships

IHG maintains effective business relationships across all aspects of its operations. However, the Group’s operations are not dependent upon any single customer, supplier or hotel owner due to the extent of its brands, market segments and geographical coverage. For example, the largest hotel owner controls less than 4% of the Group’s total room count.

To promote effective owner relationships, the Group’s management meets with owners of IHG branded hotels on a regular basis. In addition, IHG has an important relationship with the International Association of Holiday Inns (IAHI). The IAHI is an independent worldwide association for owners of the Crowne Plaza, Holiday Inn, Holiday Inn Express, Hotel Indigo, Staybridge Suites and Candlewood Suites brands. IHG and the IAHI work together to support and facilitate the continued development of IHG’s brands and systems.

Many jurisdictions and countries regulate the offering of franchise agreements and recent trends indicate an increase in the number of countries adopting franchise legislation. As a significant percentage of the Group’s revenues is derived from franchise fees, the Group’s continued compliance with franchise legislation is important to the successful deployment of the Group’s strategy.

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