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Lemon Tree

Patu Keswani was born in a well-to-do middle class family. His father was a railway engineer and his
mother an army doctor. Patu was a good student and, as expected by his family, studied engineering from
IIT Delhi and management from IIM Calcutta. He then joined The Taj Group of Hotels and spent 15 years
there as a corporate executive rising up to the post of Chief Operating Officer and Senior Vice President
of Special Projects. Subsequently he left the Taj Group in 2000 and accepted a lucrative assignment with A.
T. Kearney Inc., as Director in their India Office.
After two years of consulting work Patu felt tired of what he was doing and realized he needed to do
something more enjoyable. The dream of building a small hotel in an unusual space had frequently come to
his mind, and after tossing around the pros and cons, 42 years old Patu left the security of corporate life to
start own hotel venture. .I was suddenly getting tired of what I was doing a sort of mid-life
crisis. I wanted to do something where I would wake up in the morning and do something I
would really enjoy.

The Hotel Industry in India

The hotel industry is similar in nature across the globe. Demand is driven mostly by growth in economic
activity and tourism, and is cyclical in nature. Revenues for a hotel chain are a factor of occupancy rate
(number of rooms occupied) and average room rates (popularly termed as ARRs). Revenues are also
derived from food and beverages, management services and so on.
The hotel industry is a highly capital intensive industry. Huge capital is required for procuring land, then
development and maintenance of the hotel. Therefore the other driver for profitability of the industry would
be controlling the costs. Capital costs (real estate and construction costs) are major chunk of fixed costs.
Other significant costs are operating costs, F&B costs and employee costs.
The Department of Tourism (DoT) has classified hotels into seven categories: heritage hotels, 5-star
deluxe (5-D), 5-star, 4-star, 3-star, 2-star and 1-star. Traditionally, India has had a hotel industry that has the
supply of rooms in the shape of an hourglass. It has a considerable number of rooms in the deluxe
segment (including the heritage hotels, 5-star deluxe and 5-star hotels), with many well-known business
houses being players in this segment. At the lower end of supply are a large number of guest houses that
are usually built on residential properties and serve the budget segment.
As an executive and then a consultant in the industry, Patu had observed that strangely there had been no
major players and relatively little investment in the mid segment. .I felt that the Indian hotel market
was like the automobile market. So in the hotel context, for the Mercedes, there were the
Oberoi, Taj and ITC options. For the scooter, there were guest houses. For the in-between,
there was nothing really.

Lemon Tree Inception

Patu was smart enough to identify this supply demand gap and smarter to understand that profitability
could be achieved by cutting costs judiciously. This led him to think about starting a hotel that would cater to
the needs of mid range consumers. These mid range consumers used to primarily stay in guest houses in
the absence of a better choice. A few of them would alternatively choose to stay in a 5 star, although it
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meant excessive expenditure for them. This observation was the seed behind the inception of Lemon Tree
Hotel.

Patu decided to launch a hotel that would provide good quality service and ambience but at half the price of
a 5-star hotel. Such a reduction in prices could be managed profitably only if the costs of the hotel could
also be considerably reduced in comparison to a 5-star. With years of operational experience as well as
new-project knowledge, Patu went about identifying these areas systematically. .As the COO, I
asked each hotel to present their attributes in ratios, and see which hotel was performing the
best. I then created the hypothetical 20-point hotel which combined the best of these 21 hotels.
This is how in my mind I designed a hotel that could be successful in all parameters.

A typical 5 star would engage a lot of floor space for building lobby and other amenities while Lemon Tree
decided to utilize most of its floor space for rooms. He also reduced the cost of development (steel and iron
fittings, wood work etc.), while ensuring that the quality of service was maintained. Unnecessary frills, which
are a common part of 5 star services, were removed. Moreover, costs were reduced not only through
optimum utilization of space, but also by cutting on staffing and energy costs, that make the two most
important components of operating costs in hotel industry. Energy costs were reduced by proper emphasis
on conservation mechanisms and eco friendly processes. Since hotel industry is a highly capital intensive
industry, interest payments on loans also made a huge component of costs. By all these cost cutting
means, we were able to build a hotel at one third the cost of a 5 star In 2004, we launched our
first Lemon Tree in Gurgaonand branded it as a high quality budget business hotel.

Of funds and finances

From the idea to the launch of the first hotel was not an easy journey, taking 3 years to finally setting up the
hotel. Early 2000s were the times when the sentiment of market was not in favor of entrepreneurs. The
economy was under the threat of a recession forced by the IT bust, and new ventures were generally being
discouraged by investors. Fortunately he had acquired a good reputation during his working career, and his
friends from Taj and A T Kearney came to his side and supported him. Patu financed a part of the launch
from his own savings while his friends provided the rest in return for a part of equity. Many of them actually
left their lucrative jobs to join Patu in his venture. Patu had bought the land at Rs 1.35 crores, while the cost
of setting up the Hotel was around Rs 9 crores. He invested Rs 2.5 crores of his own, got friends and family
members to put in Rs 3 crores, while an NRI friend invested Rs 4.5 crores. His pet dog Sparky was made
the mascot of the hotel and also a shareholder.
Patus operational strategy was to keep tariffs at 50% of local 5-star hotels, while building rooms at 1/3 the
cost of 5 star hotels. He provided all services in a transparent form and charged phone, laundry, etc at
actual cost plus 15% surcharge. With his vast experience in hotel operations he initiated around 180
practices to control operational quality and cost.
Their time, risk and investment did not go in vain. Lemon Tree was profitable right from first year of
inception. Its profits increased more than 4 times in the next year. The profit earned per room was
considerably higher than the industry standards.
The first hotel confirmed the ratios of space planning that Patu was banking upon for economical success.

The Lemon Tree brand

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However, customer feedback mechanism that was in place reflected that customers found disconnect
between the branding of the hotel and the image that was created. Lemon Tree proclaimed to be a high
quality budget business hotel. The customers indicated a misfit between the word budget and services
like - 24 hour room service, 24 hour reception, coffee shop, gymnasium etc. which were usually not
provided by other budget hotels. Through research it was also discovered that over two thirds of the
customers visiting this first Lemon Tree used to stay in guest houses and they loved Lemon Tree. With
these inputs, Patu decided to launch next hotel that would be upscale and would cater more to consumers
who wished to stay in a 4 star hotel but stayed in a 5 star owing to lack of availability. Patu also decided to
launch 2 separate brandsLemon Tree and Red Fox hotelkeeping the pricing strategy for LemonTree at
60% of 5 star tariff and 30% at Red Fox.

Culture

The Lemon Tree chain flaunts of an altogether different ambience and a fresh look as compared to any
other premium hotels. Like a Lemon, it is fresh, cool and sparkling with zest. It differentiates itself not only
in terms of prices and services but how they look different and provide same services differently. The bright
colored interiors, lighthearted jokes and fun filled quotes painted on walls, the furniture, the stationary and
not to forget the young and lively staff with yellow ribbons on their ponytails everything kept the
atmosphere lively and spirited within the hotel. These hotels were instantly recognizable with warm
welcomes; spontaneous smiles; friendly, yet professional services. It provided a contrast to the working
environment and made it refreshingly different for business as well as leisure travelers. A first look of
website itself brings the same feeling in your mind. The entire experience brought the customers back to
the Lemon Tree Group All this stemmed from the culture inculcated within the group. The hotel staff was
young and was encouraged to be entrepreneurial in nature. There was a sense of belongingness among
the staff. The employees had fun in the working hours itself which resulted in minimum employee attrition.
Patu recognized the importance to people and ensured that he builds hotels for his shareholders and
stakeholders.
Some of the innovative practices Patu started were to formally have a K9 squad ( canine squad). The chief
of security in each hotel today is actually a specially trained dog. Patu introduced a scheme for executives
in which they were offered shares at discount, with the condition that they must stay with the firm till the
IPO. 7.5% shares were given to employees and the group now has 21 employees whose share value has
crossed Rs 4 crores. A wide range of premium training programmes were introduced for employees
including programmes at IIMs, Singapore, HongKong, USA, etc. He also introduced hiring
socially/physically handicapped persons for back-end operations, where people do not have much
customer interaction. The plan is to have of all recruitments from this category for maintenance,
housekeeping, gardening and other jobs.
.In February 2003, there were just 10 of us. We talked about what our company would stand
for. The key was to have a culture that was employee-centric but very professionally run. We
built a very simple equation my job is to take care of the employees, the employees job is to
take care of the guests and guests would then take care of the returns.

Expansion

The extraordinary success of the first two hotels led him to consider an expansion strategy. The biggest
hurdle for the expansion was the availability of land in key cities. This concept of key cities was important in
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the hotel industry as demand of hotel rooms is a follower of economic activity. Thus Patu faced two issues:
availability of land in major cities and availability of money and finances to fund the growth. Fortunately,
Patu was able to find around nine to ten plots at reasonable prices in the period between 2004 and 2006 in
these major economic hubs. Patu did not hesitate to accept it as luck but more so, it was the risk appetite
that allowed him to invest so heavily in real estate without a lot of capital to back it. His vision and plan to
expand to a massive scale backed up his intentions. The real estate was funded through borrowings and
investment from High Net-Worth Individuals (HNIs), who Patu happened to know from his past.
Five Lemon Tree Hotels entered into operation by late 2007. Such a growth and future opportunities also
attracted Warburg, the renowned PE firm to take interest in the group. Warburg offered to purchase 26% of
equity stake in the group in early 2008 and Patu accepted the offer. Warburg Pincus decided to invest Rs
300 crores for a 26% stake in Lemon Tree Hotel and Red Fox, valuing the venture at Rs 800 crores. Within
2 years the group valuation went up to over Rs 2000crores and Shinsei Bank and Kotak Reality fund
invested Rs 35 crores for a 4% stake.
The capital generated through the sale was reinvested in the business to fund growth .
.Holding a 90% share in a billion dollar company is a much better proposition than holding a million
dollar company in entirety is what Patu shared with his friends.

During the period of 10 years, 2002-2012, the group set up 18 hotels across the country. Competition soon
started intensifying efforts to enter the segment and Taj ( Ginger), ITC ( Fortune), Sarovar, Holiday-Inn,
Accor, Mariott and others started coming in.
Patu decided to scale up futher. Attracted by the future prospects of the group the Netherlands based APG
group ( assets over 400 billion $) took a 6% stake in Lemon Tree and set up a joint venture Fleur Hotel in
2012. The JV has a equity base of Rs1000 Crores with Lemon tree holding 53% and APG having the
balance 47%--they have a debt component of Rs 1250 crores. The total outlay of Rs 2250 crores is
planned to be invested in 35 new hotels.
Patu also started a venture for managing hotels called Carnation Hotels with Rattan Keshwani ( no relation)
of Oberoi. He also inducted senior professionals like Murli Rao ( Leela), Saurabh Nandi ( P&G), Aradhana
Lall & Rahul Pandit ( Taj) to manage critical functions

Questions for discussion:

1. Was Patu adequately qualified to start the venture?

2. Do you agree with the evaluation of opportunity he made? What were the important aspects of his
business model?
3. What are the risks that Patu took while starting the venture?
4. He launched the venture at the age of 42. What are the advantages of starting early versus starting
late?
5. Is India a good place to start new ventures?
6. Besides starting their own ventures, are there other options for innovative people?
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