Definitely Doug 9/27/24: Small Vendor Management and the Tradeoff between Risk and Innovation

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Startups and early-stage companies are the innovation engine of our industry. There are thousands of them, many with fantastic ideas; I have covered many of them in this column over the years. They often hit the radar of hotel IT executives, sometimes through diligent sales efforts or publicity, but more often through internal referrals from hotels, owners, or management companies.

But early-stage companies are risky. It is hard to get disruptive innovation without them, but many of them fail, or at least fail to deliver what they promise. You know there is never a guarantee, but you do want to manage your risk.

I have spent the last 35 years in the hospitality tech space, first as a consultant to both senior hotel executives and vendor CEOs; then as founder and, for well over a decade, CEO of the trade association HTNG, where I interacted daily with top hotel CIOs and vendor executives; and in more recent years serving on numerous vendor boards. During that time, I have witnessed many hundreds, maybe more than a thousand, attempts by hotel companies to deploy new technologies from startups and early-stage companies.

Failure is far more common for startups than success. Fortunately for customers, most failures happen while products are still in limited deployment, minimizing any long-term impact on the business. But a few are disasters: at least three that I can recall cost hundreds of millions of dollars. One that was so crippling that the only viable solution was for the hotel company to sell out to another hotel group.

Today I will address techniques for working with smaller, innovative vendors while minimizing business risk. I am talking about companies that range in size from one or two up to maybe 100 employees, with revenue of no more than $20 or $30 million. Beyond that size, the issues typically change. However, there is one notable hybrid situation, where an established, larger company enters the hospitality market for the first time. They still face many of the issues of a startup with respect to their hospitality business, just not generic startup risks. It is also easier for them to walk away from the hotel industry if it proves harder to penetrate than they expect, leaving their customers no better off than with failure of a pure startup.

There are many lessons that go in the other direction as well, for early-stage tech vendors trying to understand how to crack into the hospitality market. But that will be a topic for another week.

For hotels to manage risks when dealing with early-stage tech vendors, there are two critical tasks.

• First, while you hope for success, you must plan for failure.
• Second, you need to understand why and when your vendors might fail, so that you can both structure the deal to get as much protection as is reasonably feasible, and to protect yourself in the worst-case scenario.

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Planning for Failure

Perhaps the most spectacular (and expensive) project blow-ups I have seen were major system replacements that lacked a fallback plan. This seems fundamental, yet I have seen a surprising number of projects (even at large hotel companies) where the no one ever asked, “what happens if we turn the switch and it doesn’t work; how will we get back to where we were?” Even the best vendors can fail for a variety of reasons both within and outside their control.

Sometimes the plan for failure is simply to turn off the new system. That may suffice if the system is not mission critical itself and has not required significant changes to other systems that are. I will not name names, but on multiple occasions I have witnessed major hotel groups try to replace central reservations or property management systems with one from a small vendor. Often such projects opt for a “big bang” approach (converting all properties at once), which can make it very challenging to fall back to the old system if something fails after go-live and is not quickly fixable. This is not conducive to the CIO’s job longevity.

The more critical the system, the more important it is to have a fallback plan, and the more difficult and expensive it is to build one. But if you do not, you risk the success of your company. The big bang approach is almost never necessary; it is usually chosen for cost reasons. Running two critical systems in parallel as properties are gradually shifted from one to the other can be complex and expensive, especially when the properties share a key centralized database such as reservations or loyalty accounts. In one case, gradual deployment added about $10 million in cost to a project that ended at $33 million. But that added cost greatly reduced the risk. There were many issues in the early deployments that would have been disastrous if the entire group had converted simultaneously. Instead, these problems were identified and fixed early on, when only a few pilot hotels had been converted, and the project succeeded.

Evaluating Early-Stage Vendors

How do you evaluate whether a ten- or 50-employee vendor can deliver technology successfully, and identify and plan for foreseeable risks? I list below some things you can look at to make an informed assessment. No single one will determine success, but any one can lead to failure, so it is important to consider them all. Where a vendor scores poorly, you should have a plan that is not based on the vendor’s promise to deal with it, but rather what you will do if they cannot. Contractual provisions are one thing, but they provide little value if the vendor has gone out of business or has no money.

I will assume that you have identified a small company with a product that you like and wish to deploy. You have done your due diligence on the functionality, at least as much as it is possible to do without actually deploying it. But what are the other things you should evaluate?

Company history: Startups often have the best ideas, but product ideas are just one element needed for a successful company. Nearly half of startups fail within the first five years, and by the time you do a deal with one of them, they are likely two or three years into their journey.

Look at the company’s growth over time on whatever relevant metrics you can get: customers, sales, staff, partners. With startups, it is less about how long they have been around or how big they are, but how quickly they are building success. Be wary of sales and marketing claims that cannot be verified; many startups imply a level of success far beyond what they have achieved. Press for the details behind key marketing claims, if only to assess how honest the company is being. Having hotel logos on the website means nothing unless there are real hotels behind it. They often imply brand approval when the truth is a that they may have only signed a single rogue property that dropped the product a year ago. Marketing spin is one thing, flat-out lying is something else.

Company size: Startups and early-stage companies evolve their capabilities over time, not all at once. Very small companies cannot do some things as effectively as larger ones. You want a company that is small enough to be truly innovative, but also appropriately sized for the project.

You may end up being the vendor’s largest client, and you will want them to listen to your needs. But you also need them to succeed, which means they need lots of other clients. You also want a best-in-class product, but those come from satisfying the needs of a diverse set of clients, not just one. One rule of thumb I use is to estimate the annual revenue a vendor will earn from your project at maturity, multiply that by three or four, and compare it to the vendor’s current total revenue. If it’s larger than that, you will likely be too dependent on a vendor that does not have enough other similar customers.

Startups are often less than transparent about their size. Early on, I find the company on LinkedIn and click on the Insights tab to get an approximate employee count. For smaller companies, I look more closely on the People tab. I have seen companies that show ten employees, but then on closer look I find that all but one or two are advisors, investors, or part-time contractors with full-time jobs elsewhere. Armed with this information, I have a conversation with the company about their current staff and explore any significant discrepancies. Some companies that use offshore contract developers often have a hidden full-time work force of some size that does not show up on LinkedIn, and this can increase their credibility.

A final comment applies mostly to large hotel groups, especially ones that have rigid internal processes. I have seen several cases where a group did a big contract with a startup or early-stage vendor and really wanted them to succeed, but ended up killing them instead. One chief technology officer I knew at a major hotel group realized, after killing startups multiple times, that it was better to walk away then to kill the goose that laid the golden egg.

Large companies impose a lot of demands on their suppliers, which can take enormous amounts of both the supplier’s management time and monetary costs. Larger suppliers are structured to deal with these demands, but startups often discover how big they are only after the deal is done. The hotel company’s finance, compliance, procurement, legal, security, contracting, and insurance groups may each have checklists, and often do not care whether a particular demand is reasonable in the context of your vendor.

Management team experience and tenure. Most startups that eventually succeed have a core team of two or three founders who have worked together for at least two or three years (sometimes including at a prior company). A single founder is less likely to achieve success because they have only their own skills and leadership style. It is the mixture of skills and styles from different people that compensate for individual weaknesses or blind spots and build a successful organization. For any significant deal, I want to get to know the entire team and see how they interact with each other in different situations face-to-face, not just on a Zoom call. Do they build on each other’s strengths, or does one dominate discussions and decisions?

Another important consideration is the leadership style relative to the size of the company. Small companies, up to maybe 50 staff, tend to be most successful when led by founder/entrepreneurial managers. However, the styles and skills that tend to make those individuals successful in startups (being hands-on, attention to detail, focus on product design and sales) can drag them down when they try to grow the company much further. By the time a company reaches 100 or so staff, it needs executives skilled at organizing, motivating, and delegating. It also needs strong leadership for all key functions: finance and administration, human resources, technology, operations, marketing, and sales.

A few founders successfully transition from startup mode to managing a midsized or larger company, but this is uncommon. Many founders are self-taught and fail to recognize how they need to adapt, and even those who do are often unable to do so. This is why you see many companies that have a strong initial growth spurt suddenly stall out when they reach 50 or 100 staff. One person cannot manage that large a staff in the same way they could manage five or ten people in a startup. The company may limp along for many years with marginal profitability and little or no growth, or third-party investors may ultimately force a management change.

When evaluating an early-stage vendor, the important thing is to assess how well the current leadership team works together, and when and how they will navigate the transition to later stages. You want leadership stability during the planning and implementation of any major project you engage them for, so look for warning signs that it might be lacking.

Reputation. It goes without saying that you need to check references, but startups and even some early-stage companies may not have relevant ones, particularly if you are looking at them for a project significantly larger than their prior ones. I do not put much faith in references provided by the company in any case; those are always the happy ones. Instead, I carefully note any customers referenced in sales presentations, on websites, or in press releases, and ask them for specifics. If I see a hotel company logo on a website, I ask who they work with there and what product or service they are using; I will usually be able to get the name of either a person or at least a specific property (if they won’t tell me at least that, it’s a red flag). Sometimes they give me contact details as well (that’s a good sign) but more often I track down the person I need to talk to via LinkedIn.

If the company has partners (such as interfaced products), it is also useful to reach out to ones that are particularly critical, or any you already know. Do the partners agree with the claims they make about the partnership? Have projects been well managed? Are mutual customers happy? Is the management team trustworthy?

With startups, I like to hear that the company is responsive, customer focused, delivers what they promise, and that the product works as expected. If I reach out independently to several identified customers and partners focusing on those issues, I have a good chance of uncovering both the good and the bad.

Financial history.  While ideally you would like to see historical financial statements for any company you are considering doing a big deal with, early-stage companies often will not share them, and even if they do, they may not be meaningful especially if there have been no funding rounds with professional investor participation. The books of many startups are sloppy and inaccurate, and only get cleaned up when outside money forces the issue.

In the absence of reliable income statements and balance sheets, I ask for the narrative of the history. While the absolute numbers may not be very precise, the trends are usually meaningful. How consistent has growth been over the company’s lifetime? Are there good explanations for discontinuities? Did growth resume when the causes dissipated?

For Software-as-a-Service (SaaS) businesses (which now account for most of the startups I see in our industry), I try to get as good an approximation as I can of their revenue growth rate and gross margin. When expressed as percentages, the sum of these two numbers in a healthy SaaS business should be 40% or greater (the so-called “rule of 40”).

Of course, some vendors you might be considering may still be pre-revenue, in which case the traditional tests are often meaningless. For those, I probe much more deeply on their spending. It should be consistent with their progress to date, and balanced across all critical activities. A lone entrepreneur can build a great product and make a few sales with almost no financial investment by working nights and weekends while employed full time, but if there is no budget or staff for other core business activities (marketing, legal, accounting and tax compliance, etc.), and only a very general plan to fill those roles with future funding, then the risk of failure is very high.

Funding history. Many startups and early-stage companies are funded only by friends and family money, which usually does not tell you too much about the investment quality of the business. Those who have gone through at least a seed funding round, however, should have the more solid financial reporting (see prior section) that is typically demanded by professional investors. If your proposed deal is significant to the company, you should be able to speak with any significant investors as part of your due diligence.

I like to ask investors first about the history: when did they get in, what was the timeline of the fund when they did, and did they participate in later rounds? Were they the sole investor, or did they lead a group? If there was a major business opportunity for the company and it needed cash quickly to capitalize on it, would the investor group be willing and able to support it? Investors rarely give bad references on companies they have money in, but if they put in additional money only under duress, and do not bring in co-investors in those later rounds, it can be a sign that not all is well. The same is likely true if an investor says “the fund we invested from is winding down, we can’t put anything more in,” and doesn’t follow that with a “but” and suggest another approach (indicating that they are open to investing again, just constrained on the “how”).

A final warning is that early-stage companies sometimes get more funding than their executive team can manage. While less common, I have seen companies with entrepreneurial, evangelistic leaders who have a great public presence and who raise tens, sometimes even hundreds of millions of dollars. Unfortunately, even big investors sometimes bet on managers that turn out to lack the ability to effectively spend all the money (see comments above on the management team and tenure). If the company has just gotten a large funding round, I would pay particular attention to what the investors expect, how the executive team plans to manage spending the funds wisely, and how the investors will likely exert influence.

Hospitality experience. A McKinsey consultant who worked in hospitality for a couple of years once told me that every industry she had worked in believed they were totally different from other industries, but that in her (and McKinsey’s) experience, this simply wasn’t true; there were far more commonalities than differences. But after a year or so as senior executive for a major hospitality tech vendor, she amended her point of view, saying that “okay, hospitality is the one exception.”

No two hotels are identical, the sales process is often long and complex, products often need many integrations, installation cannot disrupt operations, and everything has to run 24 hours a day, 365 days a year … just to name a few of the issues that trip up industry entrants.

Hospitality experience matters a lot to startup success. But this is an area that also trips up tech companies who enter hospitality from another industry.

To be sure, such companies can bring in some great, proven technologies that solve business needs that hotels share with other industries. Many of them have entered multiple industries and have templates that they use and reuse successfully. They often recruit leaders and sales managers with deep hospitality experience and networks. But many are not prepared to adapt their templates, business models, and practices significantly, and fail as a result. A common issue is that company leadership refuses to accept the long sales cycle faced by most hospitality tech products, and they model their budgets based on closing significant sales after six months or less. A year later, the sales team claims to have a lot in the pipeline but has closed only one or two small accounts. Before long, the division is shut down for “poor performance,” even if the true culprit was unrealistic planning.

Some of these companies have great products, and if you can live with that without hospitality customizations, they can be excellent solutions. But I would be very cautious when those customizations are important. If the company shuts down their hospitality division, these will likely be orphaned, and you will be left hanging in the wind.

With startups, on the other hand, hospitality experience is key. There are simply too many things that work differently in hotels compared with other businesses (usually for good reason) and it takes years of experience to learn them. Look for an executive team with (depending on the specific product) a deep understanding of hotel operations, marketing, distribution, finance, or other relevant areas.

Security profile: If your product touches guest, employee, or payment data; accesses the hotel network; touches staff, guest, or guest-room devices; or needs remote support, then consider the security risks. Most smaller vendors do not understand how to build secure products, and underestimate the ability of malicious actors to cause mayhem or worse.

Security evaluations are complex, and far beyond the scope of this article. Look for vendors who have relevant security certifications such as ISO 27001 or PCI-DSS, but more importantly, assess your risks and how to mitigate them. The major hotel brands all have fairly strong risk assessment processes for technology products. A vendor who has passed any of these will have the scars to prove it (and their security will likely be much better than those who have not).

For a startup that presents any of the above-mentioned risks but that has no security bona fides to share, I would hire a good security consultant to spend one day on a high-level assessment. This is not enough time for a full security audit, but it should be enough to assess whether the product is well designed from a security standpoint, or if there are or might be significant gaps. You can then decide whether a deeper look is needed, whether the risks are acceptable, or whether the design is so sloppy that you cannot continue with the vendor.

Support and Service Levels: Vendors who get past the initial startup phase generally offer a set service plan or a few options, but these are designed based on their operational needs and capabilities, not yours. For the specific product, what kind of support do you need? For any mission-critical system, you want the ability to get first and second level support immediately. For secondary back-office systems, 24-hour email support might suffice. Even some very small companies provide follow-the-sun 24-hour support, but the quality can vary wildly. Conduct multiple tests for sufficient language fluency, understandability, and agent competence; also evaluate escalation processes and timelines.

You should also have an executive contact or account manager who can be reached at least during business hours when required.  For a larger contract with an early-stage startup with just a few employees, it is not unreasonable to expect to be able to call one of the founders via mobile at any reasonable hour. How they respond to a request to provide an off-hours executive contact will tell you a lot about their commitment to customer satisfaction.

Another key issue for some products is on-the-ground support for hardware, networks, installation, and training. Larger, established companies may have good geographic coverage using their own staff, but smaller companies often use third-party contractors. Be sure to ask if this is the case and check the reputation of their contractor. Many use the same ones, so you may already have experiences, whether good or bad.

Localization Experience: This one applies if you will be deploying the product in countries where the vendor has little or no prior deployment experience. I cannot tell you how many vendors I have spoken to who, when I ask about localization, answer “oh, that’s no problem, we can do any currency and any language, and change the tax rates.”

That is a red flag that the company has no experience in localization; there is so much more. Different countries have different hardware certifications, voltages, currency rounding rules, regulations (such as the European General Data Protection Regulation), payment networks, police and immigration reporting requirements, accounting standards, required invoice formats, employment rules, and much more. Tax structures get ridiculously complex in some countries. I have seen vendors who have implemented taxes successfully in the U.S. and many other countries throw up their hands when they discover the complexities of European Union value-added tax. In some countries, whether a tax applies, the rate, and whether it must be collected or simply reported to tax authorities  can vary depending on whether the customer is a business or an individual, and their legal country of domicile – all things that are foreign to U.S. and other simple tax structures. And in some cases each transaction must be reported to the tax authority in real time!

Of course, beyond the minimal requirements, hotel operational practices, work rules, and terminology are also often distinctly different from region to region or country to country and may require application changes.

To be sure, some products are simple enough that they can be easily localized, but for others, beware. Early-stage software companies routinely underestimate what is required to localize their products, often by orders of magnitude. Make sure they have very detailed requirements before you agree on cost; I have seen vendors walk away from signed deals because they simply could not afford to deliver something that turned out to be much more complex than they realized.

Contracting. The entire topic of contracting is complex and out of scope for this article, but when you receive a proposed contract, I recommend going back through everything above that you asked them, where their answer was important to your final decision, and make sure it is covered appropriately. The point is not to make the contract unfair or one-sided (that is rarely helpful with an early-stage company), but rather to have every important expectation clearly understood and documented.

Conclusion

Some of the most innovative technology products I see each year come from startups and early-stage companies. It is difficult to maintain competitive advantage without innovation, but that often means dealing with immature, underfinanced, risky companies. Today’s article has provided some ideas for how to do that more effectively.

As always, feedback to my articles is welcome. Since the host site does not support discussions, I will post a link to this article on my own LinkedIn page once it has been published, and I invite you to comment, like, or share from there!

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