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Updated: 2007-06-12 11:18

China's booming budget hotel industry may face investment bubbles in the near future and when that happens, brand differentiation may hold the key for operators to survive in this increasingly competitive sector, experts say.

China's economy hotel industry started in 1996 when Jinjiang Inn, owned by China's largest hotel operator Shanghai Jinjiang International (Group) Co, opened the first budget hotel in the country.

The sector took off in recent years, especially in the past two years, spurred by the soaring demand for budget hotels and tour travels in one of the world's fastest-growing economies.

There were 100 franchised budget hotel brands in China by the end of 2006, double the figure in the previous year, according to 2007 Economy Hotel Report jointly released by the Ministry of Commerce and China Hotel Association.

It costs an average 7.3 million yuan to set up a budget hotel, with average per-room investment standing at 55,000 yuan, the report says.

Such modest investment and the relatively stable returns, the report says, may seem attractive for investors with a capital of 5 to 10 million yuan.

Both domestic and overseas hotel operators are rushing to expand their presence in the sector, which is still dominated by domestic players.

Jinjiang Inn, now China's biggest economy hotel chain with about 20 percent market share, plans to more than triple its budget hotels from less than 200 at present to 600 by 2010.

Leading global budget hotel brands such as Ibis, Super8 and Days Inn have all entered China and harbor ambitious plans to expend their presence.

Europe's biggest hotel company Accor SA, for example, is planning to expand the number of its Ibis budget hotels in China to 40 from the current six by 2008.

Although experts agree there is still enough room for budget hotels to grow in China, they worry about the industry's current growth rate.

"The market for economy hotels still has abundant room to grow," the report says, comparing China's market penetration rate of 10 percent among all hotel categories with America's 70 percent.

"The sector has witnessed a staggering 100 percent annual growth rate in the past two years both in terms of brands and rooms," said Zhang Minghou, assistant president of China Hotel Association and one of the main authors of the report.

"Concerns that investments in the budget hotel sector may overheat is valid as such hotels mushroom and investment returns dwindles," said Wang Dawu, director of the Center for Tourism Studies under the Shanghai Academy of Social Sciences.

Budget hotels' average occupancy rate declined from 89 percent in 2005 to 82.4 percent last year, while the average room rate slid from 328 yuan in 2005 to 209 yuan in 2006, according to the 2007 report.

Blind investment, disorderly competition and rising commercial property prices may pose problems for the industry, Zhu Yi, an analyst with Changjiang Securities, wrote in a report.

Although there's still room for latecomers, blind investment in the sector entails risks, David Sun, CEO of Home Inns, a home-grown and NASDAQ-listed budget hotel operator, said at a recent conference.

"The sector may expand too rapidly and this may lead to problems later," said Wang at the Shanghai Academy of Social Sciences.

As investment continues to pour into the economy hotel industry, experts say budget hotel operators should focus more on brand differentiation if they are to survive.

"The competition is expected to intensify and the market will be more segmented, with hotel operators' scale and brands beginning to play an important role," the economy hotel report says.

"Market positioning and choosing the most suitable segment in the market to focus on are critical," said Zhang Minghou.

Some experts also suggest that budget hotel operators should move quickly to establish their presence in second- or even third-tier cities, while avoiding concentrating on top-tier cities like Beijing, Shanghai and Guangzhou.