This is the third article on “Hotel Management Agreements”, the first article lay the foundations and provide brief information on available options on the market. The second article was on the Hotel Management Agreement and in this article, we will review pros and cons of Franchise or License Agreement.
Up until 20 years ago, probably only luxury hotels and maximum of 30-40% of them were branded and the remaining hotels were independent. The world economy has changed, travelling between the countries becomes easier and cheaper. This allowed more people to travel and explore the world, there are more people travelling the world with leisure purposes than a business now. These changes have created an opportunity for hotel companies to vary their offers in different segments.
The trend towards branding is a phenomenon in the last 10 years. Big hotel companies have realised that the pie is much bigger than what they already covered and therefore, they started to develop sub-brands to provide different options to fulfil all budget segments and customer expectations. It was also obvious that owning, operating and managing hotels require more resources and would not give the profits they expected. Therefore, they decided to strengthen their central functions such as brands identities, strong commercial, marketing and distribution network to sell these services effectively who wish to use their brands.
Above is a quick summary of what has happened our hospitality marketplace. I believe 70-80% of the hotels in Europe and America are branded or brand-affiliated. There is a fine balance here, Hotels need brands, and brands need hotels for their success. Owner’s need recognised hotel brands to gain advantage vs. competition and hotel companies need more and more hotels under their flag to grow their business model. This creates a different hotel management agreement models-which is different than the older models I have mentioned in my previous articles.
In this article, we will review the most preferred and growing model called Franchise or License Agreements.
The branding is often accomplished by a franchise or license agreement from a company owning the brand. Other times it is accomplished by a branded hotel management company entering into a management agreement with the owner of the hotel, providing both the brand and management for the property.
Or in a simple term, franchising;
A business strategy allowing one party (the brand) to use the logo, trademarks and operating systems of another business entity in exchange for a fee.
A network of interdependent business relationships allowing a number of people
to share brand identification,
to develop a successful method of doing business,
to establish a strong marketing and distribution system.
As I mentioned above Franchising is relatively a new business model, different sources mention different starting points but it is commonly agreed that first significant hotel franchising arrangement began in the 1950s with Kemmons Wilson and his Holiday Inn chain. Today hotel owners increasingly affiliate their hotels with other hotels under a common brand name.
Company administering and directing the brand itself is not an owner of hotels, but rather a franchise company. Majority of franchise companies do not actually own the hotels operating under their brand names. Those companies have the right to sell brand name & determine brand standards.
For the owners, franchising helps reduce risk as proven operational methods are used. Franchisees and their financial capital expand the brand faster than franchiser could do solo.
Let’s look at Franchise agreements both brand and owner perspective while explaining the pros and cons accordingly.
Brand development requires growing the business model with the brand spreading continuously, this helps increasing fee payment to the brand due to preferential status and helping fund and grow fixed overhead of operating that brand. They cannot be seen behind their competitor brands in growth therefore, they are very aggressive to add more hotels in different locations and service levels to increase diversity and recognition of their brand.
The future success of any brand lies in the success of the following areas;
Number of hotels currently operating under the brand name
Per cent of hotels, on an annual basis, that elected to leave the brand in the past five years
Number of new properties currently being built under the brand’s name
The number of existing hotels converting to the brand (if conversions are allowed)
ADR trend for the last five years in comparison to ADR trend for the industry segment in which the brand competes
Occupancy rate trend for the last five years in comparison to the occupancy rate trend for the industry segment in which the brand competes
Per cent of total hotel room revenue contributed by the brand’s reservation system and per cent of hotels within the brand that achieves that average rate of contribution
Owners / Developers / Investment Companies
There are two key reasons to brand a hotel for owners’ perspective; it is easier to finance a hotel if it's affiliated with a brand, most of the hotel owners do not have the know-how, systems and people capital to manage a hotel by their selves.
Some of the advantages for owners are;
Acquiring a brand name with national or international recognition
Connecting brand GDS systems
Potentially increasing the hotel’s sales and therefore, increase profitability and ROI quickly
Securing financing of the hotel much easier comparing to independent hotels
Putting tested and proved systems and procedures to run their hotels
Training and developing their own teams
Reducing operational costs with proven practices
Getting support from interior design to purchasing furnishing and fixtures from the brands
These are big pluses in most of the markets, however, it comes with the fees they have to pay to be able to affiliate with a brand and get these advantages. Therefore, owners need to consider whether the brand capable of adding enough revenues to improve profitability to cover all these franchise fees and more in their respective market. If not branding a hotel does not make sense.
Franchise fees vary greatly by brand but generally fall into these categories:
1. Initial fee: The initial fee typically takes the form of a minimum amount based on a hotel’s room count. This amount covers the franchisor’s cost of processing the application, reviewing the site, assessing market potential, evaluating the plans or existing layout, inspecting the property during construction, and providing services during the pre-opening or conversion phases.
2. Royalty fee: All franchisors collect a royalty fee, which represents compensation for the use of the brand’s trade name; service marks and associated logos; goodwill; and other franchise services. Royalty fees represent a major source of revenue for a franchisor and are calculated based on a percentage of rooms revenue. Moreover, some brands charge an additional royalty fee based on a percentage of food and beverage revenue.
3. Marketing fee: Brand-wide advertising and marketing consist of national or regional advertising in various types of media, the development and distribution of a brand directory, and marketing geared toward specific groups and segments. In many instances, the advertising or marketing contribution fee goes into a fund that is administered by the franchisor on behalf of all members of the brand.
4. Reservation fee: If the franchise brand maintains a reservation system, the reservation fee supports the cost of operating the central office, telephones, computers, and reservation personnel. The reservation fee contains all distribution-related fees, including fees payable to third parties, such as travel agents and distributors. Reservation fees are based on a combination of a percentage of rooms revenue and/or a certain amount per available room per month, which depends on the source of booking per reservation. These sources include:
CRS – Centralized Reservation System
Brand Web Site
GDS – Global Distribution System
OTA - Online Travel Agencies
5. Frequent Traveller Program fee: Some brands offer incentive programs that reward guests for frequent stays; these programs are designed to encourage brand loyalty. The cost of managing such programs is financed by frequent traveller assessments. Typically, frequent traveller program assessments are based on a percentage of total or rooms-only revenue generated by a program member staying at a hotel, or a fixed amount for each room occupied by a program member. Many brands also require hotels to contribute a one-time participation fee, while others use a combination of the three methods.
6. Miscellaneous fee: This category includes fees payable to the brand or third-party suppliers for additional system and technical support. It also includes fees related to training programs as well as national and regional annual conferences. The fees for these services are usually not quantified in the disclosure document as they are normally optional.
Franchise fees change from brand to brand, segment, location and market but according to HVS research, starting from 7% up to 15% which gives an average of 11.8% of the total room revenues. In a basic way of calculation this means if a franchise fee is 10% then for every £100 in the room rate, £10 would be going to brand.
Considering the other add-on services, while some costs cannot be avoided strong brand system, presence and marketing initiatives can reduce your fees by up to 7%. To be able to make any reasonable money out of it, owners need to consider if the brand adds more than their costs? You can monitor these changes based on revenue per available room through; either in the form of rate, occupancy or cost savings. If your answer is “yes” then you should safely get into Franchise agreements.
While you are looking for a reputable Franchiser, you need to look at basic considerations I have listed below for a selecting a franchise brand:
The perceived quality/service level of the brand as Franchisers offer different brands at a range of quality and guest services
The reputation of the brand as travellers associate some brands with higher quality, service levels, and costs than other brands.
The number of fees and the total amount paid to franchiser: Fees paid to a franchiser are a negotiable part of the franchise agreement. Bear in mind, Franchise agreement tends to be written in franchiser's favour.
It is important that hotel owners should request impact studies, prepared by an independent party, be undertaken and paid for, when appropriate, by the franchiser.
The direction of the brand
Application fees, penalties associated with it
Area of protection
Brand Standards, implementation and penalties
Mandatory service programs
Key things to remember while selecting suitable Franchiser;
Even if the brand is perfect or your natural choice, the best way to get a great brand and a fair deal are to make sure there is competition, compare the results, and make sure each brand knows there is at least one other brand to "meet or beat." The process isn't an auction, but it is a controlled, selective competition that brings out the best deals from the brands and gives the owner the best choice.
Do not let the Franchisors to drive the agreement details, get some experienced third party to work for you to get the best possible deal.
All franchisers will require an initial fee and a non-binding letter of intent agreement. You might think that it is non-binding but unless you ready to go through all agreement terms otherwise you will end up losing the initial fee or paying a penalty fee.
The Franchise Agreement:
Franchise Agreement is a legal contract between owners and the brand which sets working relations, charges, responsibilities and duties of both parties as well as main rules to exit from this agreement.
I have listed the main Franchised agreement sections below;
License grant - Description of how the owner is allowed to use the brand’s logo, signage, and name in operating the hotel.
Term (length of agreement) - The most common franchise agreements are written for 20 years. - Also include windows at fifth, tenth, & fifteenth years with early outs.
Fees - Affiliation fees / royalty fees / marketing fees / reservation fees
Reports - Room revenue generated, occupancy levels, & occupancy taxes & ADR
Responsibilities of franchiser - Inspection schedules, marketing efforts, & brand standards enforcement
Responsibilities of the franchisee - Signage requirements, operational standards & payment schedules
Assignment of agreement - Ownership transfer & its affect upon the agreement
Termination or default - Events that permit a termination, or define a default, by either party
Insurance requirements: Owner should provide types & amounts of required insurance as well as proof of general indemnification policies, automobile insurance, & mandatory workers’ compensation insurance
Arbitration and Legal Fees: Responsibilities of each party related to legal disputes
The content of this article is a compilation of our first-hand experience, several well-known books, industry related articles as well as research reports. Our intention to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
This is the third part of Hotel Management Agreements series article; the fourth one will be focusing on “comparison of main Hotel Management Agreements”.
We hope you find this article useful. Please feel free to contact us to get advice, assess your property needs and help to optimise the usage of the hotel's physical and human assets to achieve superior standards of service and deliver maximum value to owners and investors within agreed profit objectives.
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