Arne Sorenson is back on the banks of the Ganges River. “It was sensory overload,” he says, a faraway look in his eyes as he recalls a trip to India’s holy city of Varanasi 11 years ago with his wife and their four children. “There were holy cremations being performed on timber fires, throngs of people bathing in the river, and clusters of floating candles.” The family’s guide, Sorenson recounts, was one Dr. Shailesh, a learned sage with an aristocratic air and a wicked laugh who reminded Sorenson and his wife of “a Brahman version of Vincent Price.” The overall experience, says Sorenson, was “super intense.”
As the CEO of hotel colossus Marriott International (mar), Sorenson has made travel his business. But spend a few minutes with him, and it quickly becomes clear that it’s also a personal passion. His sixth-floor corner office at Marriott’s headquarters in Bethesda, Md., is decorated with spears and bows and arrows that his parents, Lutheran missionaries who raised him in Japan, brought back from New Guinea. And the walls feature ample photographic evidence of his own adventures, such as a group shot taken at the summit of Mount Kilimanjaro. Says Sorenson: “Exploring new places is the source of my family’s most unforgettable times together.”
And it’s not just him, insists Sorenson. A growing number of people worldwide share his passion. Indeed, Sorenson believes we are entering a new golden age in travel and hospitality. He points to China’s fast-growing new middle class, a vast cohort of potential travelers who are eager to see the world beyond Beijing. Closer to home, he cites the preference of the millennial generation for making memories (and snapping Instagram pics) over shopping. “They want fresh, exciting experiences far more than they want to buy stuff,” he says.
This deeply held conviction is a major reason why Sorenson engineered a transformative deal for his company: the $13.6 billion acquisition last September of Starwood Hotels & Resorts, which added such iconic brands as St. Regis, Westin, and W to Marriott’s roster, as well as profitable budget properties such as Four Points. Prior to the purchase, Marriott stood in a virtual tie with Hilton as the world’s largest hotel company. Now it towers over the field. The merger added 381,440 hotel rooms, swelling Marriott’s total portfolio to 1.203 million—50% larger than Hilton’s, and 62% greater than the room count at third-place InterContinental Hotels of the U.K. Today one in seven hotels in North America, and more than one in 14 worldwide, are controlled by Marriott.
The Starwood deal is just the beginning of an epic drive for growth at Marriott, which ranks No. 163 on this year’s Fortune 500 with $17 billion in 2016 revenues. Sorenson, 58, pledges to add, on average, around 100,000 rooms annually over the next three years, or 50% more than Marriott and Starwood combined opened in 2016. Here’s probably the most astounding (and maybe the scariest) statistic: 36% of all hotel rooms under construction in North America, and 23% worldwide, are slated to be managed or franchised by Marriott. So far, Wall Street seems to approve of the plan. As of late May, Marriott’s stock price had risen 60%, vs. a 15% gain for the S&P 500 over the past year.
Sorenson is going all in on hotels as no industry leader has ever done before. But the success of Marriott’s historic expansion campaign is far from a sure thing. The company faces a few major—and growing—challenges.
The most obvious threat to the traditional hotel industry, of course, is the rise of Airbnb and other home-sharing businesses that allow travelers to bask in a local scene by booking, say, a family’s flat on the Seine or a condo in Miami Beach. Since its founding in 2008, Airbnb has recorded more than 160 million “guest arrivals” and now has over 3 million listings worldwide in some 65,000 cities. In March the San Francisco startup was given a valuation of $31 billion by its investors. Among hotel companies, only Marriott’s $40 billion market value is bigger.
But the digital disruption doesn’t stop there. Marriott is feeling more pressure than ever today from online travel agencies, or OTAs. Led by the Priceline Group (No. 268 on this year’s 500 list) and Expedia (No. 317), travel sites are selling an increasing share of the world’s hotel rooms. They’re especially attractive to leisure travelers, who, for example, can tap Expedia to compare rates and locations for 385,000 properties, including inventory from Marriott and other major chains. The expanding scale of the OTAs gives them clout and undermines Marriott’s leverage.
“Airbnb and the OTAs are coming for our children,” says Ian Schrager, the hotelier who virtually invented the boutique lifestyle category with Morgans hotels in the 1980s and who’s now collaborating with Marriott on a new hotel brand called Edition. “They are a direct mortal threat.” (For more on Schrager, read “The Original Hospitality Disrupter.”)
If that weren’t enough, Marriott is tripling down on new construction at the tail end of a recent hotel building boom—one that industry analysts warn could soon lead to a glut in supply.
None of this appears to daunt Sorenson, who loves citing big macro forecasts that support his optimism. “The story is the hundreds of millions of new people a year with the resources to travel,” he says. “Last year, travelers around the world made 1.2 billion international trips. By 2030, the number’s expected to reach 1.8 billion. So hotels will be one of the world’s best growth markets.”
As bullish as he is, Sorenson knows he can’t merely build hotels and wait for the travelers to come. To capitalize on the Starwood deal and his expansion plan, Marriott must battle harder than ever to lure a growing share of fickle travelers. So the hotel giant is investing heavily in lifestyle brands, boosting its rewards programs, and playing hardball with its online booking rivals. Will it be enough for Sorenson’s daring bet to pay off?
When Starwood first put itself up for sale in early 2015, Sorenson wasn’t interested. He thought the size and complexity of a potential merger would outweigh the advantages. But just a few months later, the very bigness of the move suddenly looked like a virtue. “I was negotiating an extremely difficult deal with Expedia that almost didn’t get done,” he says. “I recognized that in the future we’d need far larger scale to prevent the OTAs from taking a lot more of our share of bookings.”
And the more Sorenson examined Starwood, the more he became convinced that it was an ideal takeover target for Marriott. Starwood would bring with it the most loyal clientele in the business: the members of its super-generous Starwood Preferred Guest rewards program. “I decided that to keep people booking directly through us and not the OTAs, we needed a more powerful rewards program,” says Sorenson. “It’s our moat.”
Along with the loyalty program came Starwood’s portfolio of chic, distinctive properties. Prior to the merger, Marriott’s 19 brands were highly tilted toward mid-market, “select service” properties catering to price-conscious road warriors—notably Courtyard, Fairfield Inn & Suites, Residence Inn, and SpringHill Suites. No less than 53% of its rooms clustered in those limited-service categories. By contrast, well over three-quarters of Starwood’s 11-brand portfolio was either in luxury, with properties such as St. Regis, or so-called upper-upscale, the category between true luxury and limited service, consisting of brands like Westin, Le Meridien, and Sheraton.
Lifestyle hotels are designed to make guests feel that they’re staying in places catering to their fun-seeking, healthy, or aesthetically elevated lifestyles. Sorenson believes this curated approach will be a magnet for millennials. Today’s young travelers, he says, want more than a clean bed and a room-service burger. A hotel should not only feature designer decor but also connect with the community—and even be a partner in adventure. Revelers at Marriott’s Edition in Miami Beach skate around an ice rink next to a subterranean nightclub, cocktails in hand.
The Starwood deal has handed Sorenson two promising new lifestyle brands: Element and Aloft. Element is the only extended-stay hotel chain in the lifestyle space. And many of the new ones will have a completely novel offering: four rooms clustered around a communal lounge to attract groups traveling for sports events or reunions—customers who might otherwise rent an Airbnb together. Aloft, on the other hand, is tailored for midsize cities with fewer activities for business travelers. The central attraction is a bar that lures plenty of locals by offering karaoke nights and performances by the town’s musicians. Folks chat and drink in the lounge while shooting pool or playing checkers seated on facing leather sofas. Today the two brands have a total of 150 hotels. Over the next three years that number is expected to double, raising the room count from 25,000 to more than 50,000.
The growing shift toward these highly individualized venues is beginning to capture a growing number of older, traditional travelers as well as millennials. According to Schrager, all hotels will need to go this way to keep the clients they have now, let alone attract new ones. Airbnb can provide a house and a bedroom, he says, but not the beehive of activity in the lobby. “Even the Courtyards have to evolve,” he says. “Every brand needs to do something that Airbnb can’t do. That’s Arne’s mission.”
Sorenson is just the third CEO in Marriott’s 90-year history, and the first without the last name Marriott. He joined the company in 1996 and worked his way up through the executive ranks before taking over as CEO in 2012. Tall and affable, he looks equally as comfortable in jeans and black cowboy boots, addressing a group of Marriott execs in Dallas, as he does in a suit back in his office.
Prior to Marriott, Sorenson (whose first name is pronounced “Ar-nee”) was a partner at the law firm Latham & Watkins in D.C., where he specialized in merger and acquisition litigation. And as the onetime M&A lawyer weighed the Starwood deal, he recognized another bit of potential synergy: Like Marriott, Starwood employed the same asset-light model that has long ruled the industry. But Marriott, Sorenson felt, was a lot better at financial blocking and tackling than Starwood—creating an opportunity for him to boost the profitability of Starwood’s portfolio.
Although it’s often characterized as a plodding manager of cookie-cutter properties, Marriott—which started as a root beer stand in 1927—is actually one of the great financial pioneers in U.S. industry. The architects of the Marriott template were two legendary CFOs: Gary Wilson starting in the mid-1970s, followed in the early 1990s by Stephen Bollenbach, who later went on to run Hilton. Their core principle was that Marriott should own as little real estate as possible. The company should instead focus on two lines of business: managing and franchising hotels owned by others. Marriott today is still run on the same model.
For its managed hotels, Marriott furnishes all personnel in the U.S., from the housekeepers to the general managers. Those “on-property” folks account for about 200,000 of its total workforce of 226,500. The owners of the properties reimburse Marriott for 100% of those personnel expenses. Marriott also provides other major services at cost: The first is sales and marketing, including selling blocks of rooms for conventions. The second is managing the two yet-to-be-merged loyalty programs—Marriott Rewards and Starwood Preferred Guest. The third consists of operating the gigantic phone and Marriott.com reservation system, the source of 70% or more of all managed and franchised bookings.
Marriott’s profit from these managed properties flows from two sources: It collects management fees of around 3% of total hotel revenues. And it also gets an incentive fee from U.S. properties of up to 25% of operating cash flow, over and above a minimum that owners pocket first.
For franchised properties, the system is simpler—chiefly because the owners either operate the hotels themselves, or outsource management to contractors. So Marriott doesn’t provide the workforce, but it does supply, at cost, management of the loyalty program and the reservation system. The franchisees can either do their own sales and marketing to attract group business, or outsource to Marriott. The profit comes from a franchise royalty fee that’s 5% to 6% of room revenue only. Marriott also provides support services. “It’s simple,” says Tyler Morse, CEO of MCR Development, a major Marriott franchisee. “I pay Marriott to fill my rooms because it’s cheaper than doing my own marketing and paying the OTAs.”
Here’s the brilliance of the asset-light model: It enables Marriott to rapidly grow fees using tiny dollops of capital rather than the huge investments that developers make to expand their business by building more and more hotels. Sorenson has proved to be a master at the game. From 2012, the year he became CEO, to 2015, Marriott’s fees from management and franchising, as well as such additional income including credit card fees, expanded by 31%, to $2 billion.
By any measure, Marriott’s profitability is stellar. Its operating margin, for example, hovers around 50%. The reason is twofold. First, its expenses have expanded a lot less than its fees, providing strong “operating leverage.” Second, unlike real estate developers, Marriott benefits from minimal interest expense and depreciation (a function of capital costs). And its huge free cash flow has enabled it to repurchase lots of shares. Over Sorenson’s tenure, Marriott’s stock has delivered total annualized returns of 23.1%.
But after a half-dozen boom years, the market going forward looks a lot less favorable. The problem: a glut of new hotel supply. “In the financial crisis, loads of hotels that were started earlier opened, but very few got started,” says Jan Freitag, SVP of hospitality research firm STR. “It wasn’t until 2011 or 2012 that construction heated up again.” Because of the lag, the supply of rooms opening each year was depressed from 2011 to 2015. Customers were booking rooms faster than hotel owners were adding them. As a result, both occupancy and rates surged. Now that scenario is reversing as hotels in the pipeline begin to open. “For the first time in years, supply will outgrow demand in 2017,” says Freitag.
Further clouding Sorenson’s ambitious growth plan is that the looming oversupply problem is particularly acute in Marriott’s staple product: select service. During the past 15 years, Marriott’s prime growth engine has been select-service hotels in North America—led by Courtyard, Fairfield, and extended-stay entry Residence Inn. Those are the no-frills venues. In a Fairfield, for example, guests fill their plastic coffee cups from canisters, and breakfast is a bagel popped into a toaster.
After the financial crisis, banks became extremely reluctant to lend for expensive, full-service hotels. “The banks went from demanding 20% equity for a full-service hotel to 40%,” says Tony Capuano, Marriott’s global chief development officer. But select service was far less risky—both for lenders and owners. A full-service Renaissance could cost about $50 million, compared with $15 million for a similar-size Fairfield; that’s a cost difference per room of $250,000 vs. $120,000. Select service was, and still is, a lot more profitable. “You can run them with about 20 employees, and you don’t need ballrooms or big kitchens that cost a lot and take the place of rooms,” says Mit Shah, CEO of Noble Investment Group of Atlanta, which owns around 30 Courtyards and other Marriott select-service hotels. “The profits are a lot more consistent, because fixed costs are so low.”
The biggest growth in select service came in secondary markets, many of which had lots of older, full-service properties. “We figured out that the small markets were underserved,” says Capuano. “So we sent out people with a credit card and a map to find the best locations.” The developers targeted such cities as Minot, N.D., and Hattiesburg, Miss. The strategy spearheaded Marriott’s expansion. From January 2011 to year-end 2016, the pre-Starwood Marriott added nearly 90,000 select-service rooms in North America.
Marriott is counting on the same workhorse to continue driving unit growth. Of its current pipeline of 430,000 rooms, around 40% are Fairfields, Courtyards, and other select-service brands in North America. The hotels are already popping up on more and more corners opposite industrial parks and data centers, often with a Hampton by Hilton or Holiday Inn Express across the street.
“We’re close to being in an overbuilding situation,” says Dewey Weaver, the owner of InterMountain Management, a firm that owns or manages 53 Marriott select-service hotels. Weaver says that in places like Jackson, Miss., and Phoenix, the market is already saturated. “I haven’t bought land in two years,” he says.
Marriott, however, could compensate for a U.S. slowdown with gigantic growth in what will, over the next decade, be the world’s fastest-growing major hotel market: China. Prior to the merger, Marriott was relatively weak both in China and across Asia. Starwood, by contrast, was the leader in the region among global chains, thanks to Sheraton’s long-standing position as a top full-service brand. Although the deal lifted Marriott’s hotel count by 170% to 264 in greater China, its portfolio is mainly big, full-service hotels concentrated in the biggest gateway cities such as Hong Kong, Beijing, and Tianjin.
The thriving segment in China today, however, is domestic business travel. And the boom markets are the 15 or so cities with populations between 4 million and 10 million—notably coastal metropolises such as Wenzhou and Quanzhou. Traditionally dominating those secondary cities are locally owned, super-budget venues. But the increasingly affluent, brand-conscious Chinese road warriors crave a step up in quality. And that’s a huge opportunity for the purveyor of Courtyard, and Fairfield and Residence inns.
Today, Marriott’s select-service offering in China is limited to 54 hotels. But its runway the next several years could rival the huge growth in the U.S. over the past half-decade. In 2018, Marriott plans to open 56 hotels in China, including 21 in select service. Its goal: to open 100 hotels annually in China by 2020.
Spreading the Marriott brands in China also boosts business abroad. The Chinese already lead the world in outbound travel. More than 100 million Chinese a year vacation or do business overseas. And as the middle class expands from 100 million to an estimated 400 million by 2020, the global market in Chinese tourism will explode. “A big goal of expanding in China is making domestic travelers familiar with Courtyard, Marriott and our brands,” says Craig Smith, Marriott’s president for the Asia Pacific region. “They tend to seek out the same brands when they travel abroad.”
While many inside and out of the hotel industry view Airbnb as a formidable disruptive force, Sorenson is surprisingly dismissive of the threat posed by the nine-year-old startup. “We see Airbnb as mainly lower-priced leisure travel, where people make trips they otherwise wouldn’t make because it’s suddenly become so affordable,” he says.
It’s hard not to view such a statement as a bit of gamesmanship—a polite dig at an upstart. But for now at least, Sorenson is still speaking from a position of strength. With hotel occupancy and room rates at record levels, evidence is scant that Airbnb is taking lots of Sorenson’s business, especially from the higher-priced brands in the Marriott portfolio.
What really worries Sorenson are the OTAs, because they could potentially undermine Marriott’s value proposition to its hotel owners. Sites like Expedia.com and Priceline.com have become increasingly valuable to owners as a way to fill in gaps between the bookings that come from Marriott’s system. But for every room booked, the owners pay a fee to the OTA—on top of what they’re already paying to Marriott. The danger is that down the road owners might start deciding to drop Marriott (and its fees) and go exclusively with OTA bookings.
That’s why Sorenson led the charge for hotels in the negotiations with Expedia in late 2015. He saw that the travel sites were gaining leverage. “The OTAs were only booking about 8% of our rooms,” he says, “but that was up from 4% three or four years earlier, and I thought it would keep growing.”
Led by Sorenson, the owners of Marriott brands formed a united front. Their position: If Expedia declined to make the concessions Sorenson was demanding, the owners would pull their offerings from Expedia en masse. The negotiations were in a standoff until 24 hours before the deadline. Expedia finally broke the deadlock by giving ground and, for instance, reducing the booking fee for owners from around 16% to 12%. And Sorenson scored a coup that bound owners more tightly than ever to Marriott.
So far, Sorenson’s strategy of building scale is working. The OTAs’ share of bookings remains flat at around 8%, and more new hotels are signing with Marriott and other branded hoteliers than ever before. The combined rewards programs are growing faster than ever, says Marriott, at around 1 million new members a month. As long as those higher-margin direct bookings remain strong, Marriott’s owners will be happy and its business healthy.
As hard as he negotiates, Sorenson prides himself on putting just as much energy into seeking out fun—through travel, of course.
Back in his office, he’s telling the story of the group photo on Kilimanjaro. Arne, his wife, and their children made the climb in 2010. They spent a challenging night in a crater at 19,000 feet, some 500 feet below the peak. “We were all suffering from altitude sickness,” recalls Sorenson. As they made the final ascent, “the guide kept saying ‘Poli, poli!’ ”—meaning “Slowly, slowly” in Swahili. When they finally got to the summit, Sorenson and his family stood together and soaked in the triumph.
Now he’s taken Marriott to the top of the hotel world. The challenge will be keeping it there.
A version of this article appears in the June 15, 2017 issue of Fortune with the headline “Marriott Goes All In.”