Getting away with the minimum guarantee

This reveals an interesting facet about OYO’s business model.

A minimum guarantee is a double-edged sword.

OYO might have abandoned its Ponzi-like scheme of partial inventory, wherein hotel owners had perverse incentives to boost imagined usage. But the new model of picking up total inventory has its own share of risks as is apparent by this hotel owner’s experience.

So should OYO do away with minimum guarantees?

Not at all.

The presence of the minimum guarantee is the primary reason why hotel owners sign up with OYO in the first place.

But wouldn’t OYO’s much-vaunted technology chops allow it to price the minimum guarantee at a sustainable level? Surely, it doesn’t require very advanced technology to view a hotel’s legacy records and peg the minimum guarantee at a level that is sustainable for OYO.

The problem is not with technology.

It is with human behavior and incentives.

No hotel owner would sign up with OYO if the minimum guarantee sum was not pegged at a level that is higher than what he would have reckoned he would have made by himself in the first place. It would make no financial sense for the hotel owner to agree to “fair” market value as he would probably make that much in any case and not even have to pay any partner a 20% cut.

The only exception would be an adverse selection of sorts—hotels that are grossly sub-standard whose owners couldn’t care less about occupancy rates and would be happy to offload these headaches to OYO. But would these hotels then have the mindset to meet OYO’s operational standards and stay within the prescribed limits? Probably not. If these hotel owners had that level of customer service in mind, they wouldn’t have been subpar in the first place.

So what does OYO do?

For one thing, it can’t do away with high minimum guarantees. Instead, it uses its enormous funding chest to follow a scorched earth-like policy to capture the market. Given that OYO’s competitors such as Treebo and Fab Hotels don’t even have 10% off OYO’s funding even when combined, OYO can crowd out these players simply by pricing itself out.

But as the hotel owner, we spoke to confirmed, a deal that seems too good to be true inevitably ends up being just that. A hotel owner might tie-up with OYO lured by the minimum guarantee, but given that this figure is set at an unsustainably high peg, sooner or later the jig is up.

A few months after the hotel owner tied up with OYO, the company sent a letter conveying its decision to reduce the minimum guarantee from Rs 14.5 lakh per month to Rs 9.2 lakh ($13,000) per month. The agreement between the hotel and OYO had no provision for any such change (The Ken has reviewed this agreement). Not only did OYO unilaterally impose this change, but it also pressured the hotel owner by delaying payments and not clearing monthly dues completely (The Ken has a copy of the emails exchanged between the hotel owner and OYO).

One would think that the hotel owner could simply cancel his agreement with OYO and move out, but that is not as easy as it sounds.

Source of customers

During the course of the partnership, OYO has completely taken over the hotel’s source of customers. The hotel’s own bank of regular customers has diminished as the OYO umbrella brand has obfuscated the hotel’s own brand and customer personas have changed. Having committed oneself to a higher cost structure makes it tough for the hotel owner to shift to an OYO competitor who wouldn’t pay such a high minimum guarantee in the first place.

Most hotel partners of OYO would probably therefore acquiesce and comply with OYO’s arm-twisting as they have few alternatives.

The hotel owner we spoke to didn’t. He has since taken his hotel off OYO after giving the mandatory 60-day notice period as required by the agreement (it is another thing that OYO continues to list the hotel on its website). He has also initiated legal action against OYO for breach of contract and non-payment of dues.

This is not an isolated case.