Oyo, an India-based network of budget-oriented hotels, said last week that it had raised $800 million in financing, led by SoftBank. Investors pledged an additional $200 million to come.

Before this, the company had disclosed $446 million in fundraising. The deal placed an approximate $5 billion valuation on a company, according to reports.

The development is leading some industry professionals to wonder how long traditional hotel groups can continue to ignore a company that now claims to host more than 125,000 stayed room nights every day, on average.

Oyo signs on hotel owners and then gets them to upgrade everything from linen, toiletries and bathroom fittings to its specifications. It also often leases properties directly. In either case, it equips hotels with staff training and standardized supplies. The company then brings them on board its hotel website, where rooms start at $25 per night. Hotel owners typically pay Oyo a 25 percent commission.

Others talk of Oyo as a phenomenon relevant only to provincial cities. Or as a company fueled by “funny money” that will collapse at the first hiccup.

To be sure, the company, led by 24-year-old founder and CEO Ritesh Agarwal, has plenty of skeptics.

Vijay Joshi, head of finance of the E&P petroleum business owned by one of India’s most powerful companies, Reliance Industries, said, “In my view, it is overvalued. There is so much hype about these companies with no real underlying assets. Something is really not right somewhere.”

In an interview last winter, Agarwal dismissed talk that his India business wasn’t making money. “We operate at double-digit positive net margins,” he said. In statements since then, he has said that he sees his company’s foray into China as an investment phase for the company in that market.

As for travelers, social media has been a platform for praise and criticism.

Some criticism of Oyo alleges that the quality check has been erratic as the company scales up. There has been pressure on the company to boost the average room rates per night but not as much urgency to invest in boosting a consistent and basic level of hospitality, some critics argue.

On the customer service question, Oyo’s net promoter score — a survey-based measure of consumer satisfaction — has recently averaged 0.58 in India, which compares well to Agoda’s, Airbnb’s, Hotels.com’s, and Trivago’s. Those brands’s net promoter scores have averaged between 0.50 and 0.63, according to a report using 2017 data by KalaGato, an India-based data analytics startup.

To be sure, some of these critics are — often not coincidentally — fans of less-well-funded competitors, such as Treebo Hotels, backed by Hong Kong-based investment firms Ward Ferry Management and Karst Peak Capital, and FabHotels, backed by Goldman Sachs. Or they are fans of traditional hotels, like Tata-owned Taj Hotels.

Agarwal has heard criticism before. In announcing the fundraising on LinkedIn, the CEO noted, “I also want to take this opportunity to thank critics who questioned us and helped us get better and made us challenge ourselves.”

Misunderstood Model?

In the past, Oyo asked independent hotel owners to invest in their properties to achieve Oyo brand standards for bedding, amenities, and internet service and it charged them a commission for bookings generated via its website and app.

This unusual dynamic of high investment and high commissions has worked because Oyo was effective at putting heads in beds at much higher rates than many independent hotel owners had managed before. Its contracts often promised 80 percent nightly occupancy in business districts and major cities, and better than 70 percent occupancy in most other areas — levels well above the 30 percent occupancy average, according to Oyo.

Oyo thus often helped boost revenue growth for partners even when average nightly rates for customers often declined. The metaphor is with low-cost carrier airlines that can make gains by offering lower prices to consumers as long as they can maintain their relative market positions and keep operating costs under the industry average.

Oyo also helped owners to steal share from local competitors who were not connected to equally efficient digital marketing channels.

Some critics claim that Oyo has a high churn rate and that many owners try it and drop.

But in an interview last winter, Agarwal said the churn rate was small relative to comparable sectors, such as the ride-hailing industry — where it’s relatively easy to turn on or turn off a partnership.

Despite investment costs and commissions higher than what Booking.com typically charges hotels, owners often end up ahead due to higher revenue, he claimed.

Over time, Oyo has moved away from its hands-off version of franchising to a more hands-on property leasing. This is a trend that Western hotel leaders have tended not to notice. About 5,000 of its properties in India are now exclusive to Oyo, as of July.

By being more hands-on with leasing properties, Oyo is in a better place to ensure consistency of service. In July, Oyo bought AblePlus, a Mumbai-based technology company, to test the installation of self-check-in technologies run by new point-of-sale registers and smart locks.

Hotel Groups at a Distance

Oyo’s funding and growth prompts a question: Should established hotel groups care about Oyo?

Until now, Oyo’s presence was distant from many major Western hotel groups’s main markets. Besides India, Oyo’s main presence lies in China, Malaysia, and Nepal.

But earlier this month, Oyo said it would enter the UK market with a plan to open up to 300 properties in 10 cities in the next 18 months via franchising.

That’s just a drop in the bucket of European hotel inventory.

But of greater potential concern is that Oyo is stealing away established legacy chain opportunities to establish brand recognition with a next-generation of digitally savvy travelers in India and China — especially as a preferred hotel brand in both economy and mid-market segments.

Oyo’s India unit alone has more than 125,000 rooms and is witnessing a tripling of growth in transactions year-on-year, according to statements Softbank released in August about its portfolio company.

Oyo has net take rates — in essence, revenue claimed by Oyo on bookings — of more than 20 percent of daily rates on average, according to Softbank. That is a level that’s competitive with the equivalent metrics used by economy- and limited-service hotels owned by U.S. and Western brands in Southeast Asia.

Some hotel executives may assume that, given its lavish funding, Oyo is burning cash. But lead investor Softbank insists that Oyo’s India hotel business has “unit-level profitability.”

Part of that claimed profitability in India is due to low customer acquisition costs. More than 67 percent of its revenue in India is generated by repeat customers, according to Softbank. Some 90 percent of its new and repeat demand comes via its direct channels, including its website and mobile app, according to the company.

In other words, many consumers book directly rather than come through online searches that require expensive digital marketing tactics. That marketing efficiency could set up Oyo for a competitive advantage against hotel chains.

Oyo China appears to be running at a loss as the company has scaled up from only a handful of properties to 87,000 rooms in 171 cities after 10 months since it entered the country. The company plans to spend about $600 million of its latest round of financing on China.

Of note, China has a hotel oversupply problem, especially among properties in the mid-tier and budget segments where Oyo is competing. China has about 12 times the number of hotels overall relative to the U.S. while having four times the population, according to Wells Fargo estimates. That oversupply leads to lower average occupancy levels.

In second- and third-tier towns where Oyo can enter and delivers substantial boosts to occupancy rates, consolidation could occur as stronger properties weed out weaker ones.

Claimed Advantages

Launched in May 2013, Oyo caught fire with many millennial, digital native consumers because of the relative lack of trust, quality, and consistency in the budget hotel segment in India, which remains mostly the province of independent hotels that are not yet under the sway of TripAdvisor-like reviews and ratings.

Instant booking of budget lodging via mobile devices was essentially unheard of outside of properties in New Dehli and Mumbai before Oyo arrived.

Oyo’s check-ins in India happen mainly through its mobile app, which connect to back-end systems to prevent errors in inventory tracking. Few Indian hotels in the relevant price category can compete with that level of technology.

Oyo’s dominance has been acknowledged by online travel players, if not hotel groups.

Earlier this year, MakeMyTrip, India’s largest online travel company, added back properties from Oyo to its flagship MakeMyTrip brand as well as its recently acquired GoIbibo brand.

The move represented an about-face for the company. In October 2015, MakeMyTrip had blocked its main competitor in the budget category, Oyo, from displaying listings on its platform. It had boycotted Oyo to nurture its own attempt at branded budget booking properties, GoStays, and because it didn’t like how Oyo was using deep discounting to woo travelers to book directly instead of via agencies. Now it’s hoping to benefit from Oyo’s rapid growth in brand recognition.

Yatra also changed its tune and began aggregating Oyo inventory, too.

Boom or Bust?

Oyo could be the first Indian budget travel brand to go global.

It may also increasingly go after the more lucrative customers that incumbent hotel groups and Western players covet. Already about 10 percent of Oyo’s India business comes from mid-market lodging and co-working spaces.

In Goa, it has experimented with vacation rentals because second homes are prevalent in that market. But it remains a niche business.

Oyo plans to remain focus on the economy segment as its base.

In an interview last winter, Agarwal estimated that Oyo had about 1 percent of the average bookings of India’s roughly 4 million rooms in the economy lodging segment, including offline and online. He aims to grow that to about 4 percent by this winter and to 15 percent within four to five years.

That will still leave plenty of room for other players to take share.

Oyo claims it is converting hotels to its brand standard in India within 30 days, on average. It achieves this partly by not insisting on a consistency in branding that Western franchises do. If a hotel’s bedsheets are up to quality standard but not branded Oyo, they’re fine with putting the hotel into service as is, for example.

Maninder Gulati, chief strategy officer at Oyo, said, “Over the years, we have developed the expertise that makes it possible for us to offer the benefits of a big hotel chain to small hotels.”

Sarah Tavel, a general partner at venture capital firm Benchmark, said — speaking in general and not about Oyo’s prospects, in particular — that capital itself can be definitive.

“There’s a lot of strength and value to having a lot of capital, but as you know, there’s a lot of damage that having a lot of capital can do to a company,” Tavel said. “It can diffuse focus, it can cover up things that aren’t working inside it, and it can stop the leadership from understanding the mechanics of its own business.”

In China, for example, Oyo is said to be offering hotels in new markets guarantees of minimum business and may sometimes have to pay hotels even if no customers arrive. A sudden recession could make that model dangerous for Oyo to sustain. Oyo’s funding may be used to seize market share and brand awareness. But price wars might break out as other competitors pile in.

In a 2015 interview with Skift, Agarwal said he saw the challenge as reinventing the concept of consistency and online distribution in marketplaces like India’s where many consumers are relatively new to online shopping.

Given the obstacles, many western and incumbent Southeast Asian players are not moving as aggressively into the Chinese market as Oyo has.

Few CEOs have had the composure and skill to handle such rapid growth and piles of money. The fundraising could trip up the company’s leadership team. But so far, betting against Oyo has been a fool’s game.

Photo Credit: Shown here is Ritesh Agarwal, Oyo founder and CEO, in Bengaluru, India, in September 2018. Oyo, which claims to be South Asia’s largest hotel chain, said it has raised $1 billion in funding. Samyukta Lakshmi / Bloomberg