Oyo China operations are on the brink of collapse

Oyo, the SoftBank-backed budget hotel chain, is in a world of pain. Oyo has slashed over 5,000 jobs since June 2019. That’s a similar proportion (~20%) but twice the number of employees WeWork let go after it imploded in the lead up to IPO. The two firms draw ready comparison due to their SoftBank-led capital injections, aggressive expansion plans, enigmatic CEOs, and struggle to make more money than they spend.

In a two-part series, I’m going to piece together what went wrong and explain what Oyo’s demise in China means for SoftBank, Vision Fund One, and Vision Fund Two.

Let’s begin with what went wrong.

Burning cash in turf wars

Oyo was started in May 2013 by Ritesh Agarwal, a 19-year-old Thiel Fellow. It started by aggregating and standardizing budget hotels and hostels in India—improving fallow assets, giving budget hotels a makeover, and improving search and booking efficiency.

Maybe some of the trigger-happy capital injections were warranted.

The model was quick to attract SoftBank’s attention and capital. To fuel Oyo’s expansion in India, SoftBank led Oyo’s Series B ($100 million), its Series C ($90 million), and its Series D ($250 million). A year after Oyo’s November 2017 launch in China, SoftBank even kicked in a $1 billion dollar Series E to bankroll Oyo’s global ambitions. Oyo’s status as India’s largest hotel chain kept the dollars rolling in.

Maybe some of the trigger-happy capital injections were warranted. Oyo’s expansion in India and entry into China was a little like the Eastern Front before winter—swift, decisive, and dotted with victories. Less than 18 months after launching in Shenzhen, Oyo surpassed Home Inn and Hanting to become China’s second-largest hotel group, managing 10,000 hotels in 320 cities. China, it seemed, had the requisite conditions to allow firms like Luckin Coffee and Oyo to blitzscale over physical assets.

But that growth wasn’t exactly cheap.

Oyo’s China operations posted a $197 million loss between March 2018 and March 2019. That loss accounted for 60% of Oyo’s $325 million in losses in that period. While that’s not WeWork levels of capital incineration, the China operations’ EBITDA margin of -66% is enough to make even Luckin Coffee’s accountants blush.

Part of that expenditure is inherent in Oyo’s business model. Oyo aggregates and standardizes the experience and amenities at independent hotels, working with independent hotel partners for a cut of their revenues. That necessitates a sales network to win over independent hoteliers, capital outlay to get the hotel up to scratch, and ongoing spend to attract patrons to Oyo-branded hotels. 

Yet part of Oyo’s initial spend was an accidental turf war Oyo sparked between itself, Meituan and Ctrip.

I can safely bet Agarwal didn’t know what his openness and candor would lead to.

Sources told me that CEO Ritesh Agarwal privately met with Meituan’s CEO Wang Xing and Ctrip’s CEO Jie Sun soon after committing to aggressive expansion in China. In these meetings, Agarwal laid out his vision for Oyo to be China’s largest hotel chain. Agarwal wanted to expand China’s domestic travel pie, and give users the choice to book Oyo-branded hotels through either Oyo’s own app, Meituan or Ctrip.

I can safely bet Agarwal didn’t know what his openness and candor would lead to. Both Xing and Sun saw a large hotel chain with its own digital infrastructure as a potential threat, not an ally. In short order, Meituan and Ctrip each hatched up their own independent hotel aggregators and barred Oyo-branded hotels (in Chinese) from being listed on their platforms. Unable to drive traffic through China’s largest online travel agents, Oyo had no recourse but to invest further in online and offline marketing, further upping the firm’s burn-rate.

In April 2019, Oyo capitulated. It agreed to pay an annual “toll”, which guaranteed Meituan and Ctrip facilitate search and booking of Oyo-branded hotels through their respective platforms. Insiders reckon Oyo will cough up around USD 58 million per year to Meituan (in Chinese), and we can expect a similar-sized cheque with Ctrip’s name on it. All up, an expensive lesson in digital competition.

Model 2.0 mess

If you think that sounds something that goes down in an episode of Succession or Billions, then you ain’t seen nothing yet.

After WeWork’s implosion in September last year, SoftBank urged its Vision Fund portfolio companies, including Oyo, to pull their heads in and focus on profitability. Oyo’s solution was to take more of its partners’ profits.

Oyo didn’t expect that China’s independent hoteliers would connect digitally, contest the changes and even protest at Oyo’s Shanghai headquarters.

Around October 2019, it started to unilaterally and retroactively amend contracts with “Model 2.0” hotel partners. Oyo’s Model 2.0 gives hotel partners a monthly income guarantee. In exchange, Oyo has tighter control over hotel operations and takes all the revenue the hotel makes above the monthly income guarantee.

By modifying Model 2.0 contracts, Oyo set out to do two things. First, it wanted to reduce the amount of money it was already on the hook for – paying hoteliers less than they’d been promised. Second, it needed to lock hoteliers into a lower guaranteed monthly income going forward.  

Sources responsible for Model 2.0 tell me that they expected only a small number of hotel partners to kick up a fuss about the revised contracts. After all, Oyo had pulled a similar stunt in India, to minor social media blowback. Oyo didn’t expect that China’s independent hoteliers would connect digitally, contest the changes and even protest at Oyo’s Shanghai headquarters.

Critically, word of Oyo’s bad-faith contract dealings spread at a time when Oyo was renewing agreements with “Model 1.0” hotels. These hotels, which make up most of Oyo’s hotel stock in China, don’t have a monthly income guarantee. Instead, Oyo takes a cut of their booking revenue. Oyo’s brawl with Meituan and Ctrip, squabbles with existing hotel partners and an unclear value proposition led to a mass exodus of Model 1.0 hotels between November 2019 and January 2020. Company insiders tell me that even before COVID-19 broke out, Oyo lost close to two-thirds of its Model 1.0 hotel partners—a stunning reversal of fortunes.  

What remains to be seen is how many Oyo-branded independent hoteliers are left solvent after Covid-19’s roundhouse kick to China’s domestic tourism sector. Funnily enough, some hoteliers have similar doubts about Oyo’s financial wellbeing: Media reports (in Chinese) chronicle hoteliers defying epidemic fears to scramble across the country and livestream attempts to get promised revenue back from Oyo at their offices. You can’t make this stuff up.

Crippled unicorn

Cue the mass lay-offs. An emphasis on lowering cash-burn, reversals in each international market and dented travel outlooks have accelerated Oyo’s downsizing. Just yesterday, local media reported (in Chinese) that Oyo China’s head-count was at 2,734. If correct, then Oyo’s silently slashed around 3,000 jobs outside of previously-announced redundancies.

While it’s conceptually easy to pin layoffs and even Oyo’s potential exit from China on Covid-19, the firm’s maneuvers in the Middle Kingdom have sown the seeds of its own undoing. From unwittingly starting a turf war with savvy travel giants to screwing over hotel partners and hoping to get away with it, Oyo’s compromised prospects in its second-largest market globally.

In the next part of this series, I’ll outline what Oyo’s failure in China means for SoftBank’s Vision Fund.