FRANCHISE, MANAGEMENT, LEASING (definition of MANAGEMENT CONTRACTS)
MANAGEMENT CONTRACTS
A management contract is an agreement between a hotel owner and hotel management company under which, for a fee, the management company operates the hotel.
In a management agreement, the chain basically provides the same services as a franchise agreement, such as brand, reservation system etc., but on top of this, there is an agency agreement, meaning the brand operates the hotel, making all the day-to-day decisions on behalf of the owner. The group names a general manager, who will generally come from its own system, or will hire and train one for the specific hotel; he or she will hire the staff, and will control costs and revenue, food costs, apply brand standards, and generally supervise the management of the hotel. The General Manager reports to the Regional Director, who in turn reports to the Regional Vice President, and there are daily and monthly reports. However, the bank account and local management company still belong to the owner. While input from the owner is welcome, interference in the day to day running of the operation is not allowed, otherwise it is no longer a management agreement. In other words, there is only one captain on the boat. Sometimes what may seem to an owner in the short term to be a wrong decision is often a good one in the longer term. So he has to put his trust in the management. At the beginning of each financial year, a budget is prepared and presented to the owner. It presents the projected revenue and operating costs, and once the cost structure is established, the manager must stick to the budget.
The different between a franchise and a management agreement is also in terms of fees. In a franchise agreement fees are collected on a room revenue basis, and in the management agreement, fees are collected on a total revenue basis and on the bottom-line.
Of course a franchise agreement will cost less for an owner less than a management agreement. But at the same time they will receive fewer services, because a franchise agreement will focus on the top line and provide sales services, as well as purchasing and advice on operation, but mainly it provides sales tools, a brand, a reservation system, a network, international advertising and exposure for the hotel operator. Let’s take the example of a less mature European market, let’s say Romania… A private individual has a piece of land in Bucharest, and wants to build a hotel on it, but he doesn’t know how to run a hotel. So he will ask for a management agreement, because it would not make sense for him to set up his own management company for just one hotel, as it would be costly, and difficult to find the right people locally. So the needs and objectives are not the same. Depending on the needs in different markets, different services are adapted to those needs. It’s not a choice of saying ‘we will only manage’, or ‘we will only lease’ or ‘we will only franchise’… it’s also what the market wants.
LEASE AGREEMENT
This is almost like ownership. The hotel group basically rents a building and runs the entire operation. It is run with the group’s staff and bank account, and they simply pay rent every year. In the management contract, the gross operating profit and net profit of the hotel belong to the owner, less a fee for the operator; and a franchise is, as mentioned above, similar in many ways. A lease agreement is therefore very close to an ownership. The only difference in an ownership is that the hotel company pays interest to the bank, and in a lease agreement, they pay rent to an owner ( and they cannot sell it).
Lease agreements are not particularly popular among big operators, because they are quite risky and costly. Ownership and leasing are an “asset heavy” way to develop. It is the profitable, but at the same time the riskiest model. The reason it is not so popular is that hotel companies cannot develop a large number of properties with lease agreements, otherwise the balance sheet becomes too heavy and/or risky. In the last financial crisis, companies that were heavily leveraged with leases and ownership were almost on the edge of bankruptcy, because they had huge losses, and had to keep paying the rent. As an operating company, most groups attempt to have a balanced portfolio with the right amount of lease agreements, the right amount of ownership, the right amount of management and the right amount of franchise agreements. If they play it right, business will be sustainable in case of bad times, and profitable in good times.
A Franchised or Managed Model?
How to decide what’s best for you… and how to take the next steps
While a certain amount of information on the topic is freely available, we have noted over the past years that there is still a great deal of confusion surrounding the pros and cons of hotel franchising or management agreements. In this section we aim to demystify the basic principles of the different business models, and help you decide what might be best for you.
For definition please also read :
FRANCHISE, MANAGEMENT, LEASING (FRANCHISING DEFINITION AND BACKGROUND)
FRANCHISE, MANAGEMENT, LEASING (definition of MANAGEMENT CONTRACTS)
When we talk about chains, or hotel brands, there are five main business models, with a number of permutations within these models:
Property fully owned and operated by the hotel brand;
Property leased by a hotel brand, which pays rent for the “walls”;
Property owned by a third party and managed by a hotel chain;
Property owned by a third party and managed by a “non-branded” specialist management company;
Property owned by a third party, with a franchise agreement with a hotel chain.
In this article, we are going to concentrate on the choice between a branded management contract and a franchising agreement.
Terminology: According to the JMBM Global Hospitality Group, the professional companies that operate hotels are interchangeably referred to as hotel managers, hotel management companies, hotel operators, or hotel operating companies. The terms have the same meaning and may be used interchangeably. A hotel brand, however, may or may not be associated with a hotel management company. The big brands like Accor, Marriott, Hilton, Starwood, etc., generally own a number of “brand” names, which they can independently licence under a franchise or management agreement. They may be known as branded operators or branded hotel managers.
WHY NOT GO IT ALONE?
In today’s world of hotel distribution and marketing that is increasingly dependent on online sales via third parties, or directly through a branded website, it is becoming more and more difficult for independent hoteliers to obtain adequate rooms sales. In the USA, where well over 50% of hotels are franchised, clients are much more likely to place their trust in a known brand; a phenomenon reinforced by the use of loyalty cards, enabling guests to amass points just like airline miles, and use them for free stays or other advantages.
In Europe, the situation changes drastically from one country to another. On the one hand, France has been the forerunner in introducing the “chain” hotel concept in Europe, with the Accor group established at the end of the 1960’s, while its close neighbour, Italy, remains the stalwart of independent small hotels. Other countries have different levels of sophistication when it comes to the penetration of chain hotels.
HOTEL GROUPS – WHO DOES WHAT?
Today, the world’s biggest franchisor is Best Western, which franchises almost all of its properties. Different major hotel groups have totally diverse policies when it comes to franchising and management. The Accor group is increasingly going towards a franchised model, although today, almost ten percent of its properties are still owned and 34% leased, meaning quite a heavy capital investment and risk. 25% of its hotels are franchised, while 31% are managed. Starwood has an equal balance between managed and franchised hotels with only a small percentage of owned hotels. For the InterContinental Hotel group, around 85% are franchised, 14% managed and 1% owned. At Hilton, it all depends on brand. Some are almost all managed, while some, like Hampton Inns, are 100% franchised. Rezidor has more managed hotels than franchises. 19% franchised, 19% leased, 62% managed. Hyatt meanwhile has a high number of owned properties – around 25%. Each hotel company has its own philosophy and reasons for leaning more towards owned, leased, managed or franchised models.
How do I select a Management Company ( operator)?
If you have decided to simply own a hotel, but not run it, you have two first choices: branded or non-branded? We are assuming here the choice of a brand, due to advantages for distribution. Here are some of the key considerations to take into account:
How many hotels does the company operate?
Does the management company operate competing hotels in the same zone?
Length of agreement?
Procedures for extending or terminating contract?
Contract terms in event of the hotel’s sale?
Base fee to be applied?
Incentive fees earned or penalties assessed relating to operating performance?
Reporting relationships and requirements?
Furthermore, is it a first tier or second tier company? First tier refers to management companies that operate hotels for owners using the management company’s trade name as the hotel brand. Hyatt, Hilton, Sheraton are examples. Second tier is management companies that operate hotels for owners who have entered into an agreement to use one of a franchiser's flags as the hotel brand. Tiering does NOT refer to the quality of the management operating the property. It can be worthwhile to talk to other owners, and look at some of the key issues they have had to deal with. When it comes to management agreements, brands have a lot of power to unilaterally impose changes in standards that all system hotels must meet. These include such things as computer systems and software, new signage and logos, loyalty programmes, design requirements, promotions and centralise services. For some owners, the cost of these brand-imposed standards may simply not be worth it. The question then has to be asked as to whether the standard benefit the brand or the hotel… Is the brand growing too fast? In recent times, some issues have arisen due to the fact that some brands and operators expanded so fast that they lacked the adequate expertise, procedures, systems and personnel to manage properly.
How do I select a hotel company to be my franchisor?
Assuming you have decided that franchising is the way to go rather than management, there are a number of basic considerations to be taken into account when making your choice. Remember, once you have chosen, and signed the agreement, there is no going back, so this process must be very thorough. Aside from the right marriage of partners, the terms of the management or franchise agreement tying them together is crucial, because it should govern the relationship for decades, and is hard to change once cast. Even if you have decided that band X is “perfect” for your project, you should compare several offers and be sure each operator knows there is at least one other brand in talks.
EXISTING PROPERTIES: If you already have a precise location in mind, or are renovating an existing establishment, one easy way to reduce your shortlist is to see what other hotel brands are in the immediate vicinity. You will therefore be able to narrow your choice to the other brands.
BRAND TRENDS: The number of hotels currently operating under the brand name, the number of new properties currently being built under the brand’s name or converting to the brand, and the percentage of hotels, on an annual basis, that elected to leave the brand in the past years;
FINANCIAL: While most franchise agreements have similar royalty conditions, in current economic conditions, other factors, such as key money and construction costs can be important points. If you are refurbishing a current establishment to fit brand standards, or considering a new build, this consideration will of course have different repercussions. Key money varies enormously depending on the brand, but is generally around 300 Euros/ room. Expect the minimum “up front” for the contract to be anywhere between 25,000 and 50,000 Euros, or more, depending how many rooms you will have. This is a negotiable part of the contract.
NO VACANCY: Occupancy rate trend for the past years in comparison to the occupancy rate trend for the industry segment in which the brand competes;
EFFICIENCY OF ONLINE BOOKING SYSTEMS: One of the main reasons for joining a group is to benefit from its direct online booking system. Analyse the average percentage of total hotel room revenues contributed by the brand’s reservation system compared to bookings through online travel agents, GDS and other channels.
CUSTOMER BASE: Some franchises have a very large brand loyal customer base that generate a large percentage of their franchisees room sales, and their franchisees thus are able to out-perform the market. Other brands are recognisable, but have lower market penetration on average.
FINANCING: The selection of a prestigious or renowned brand may strongly impact the possibility of finding financing for a project. Many lenders will not consider lending for hotel development unless the hotel is branded, and banks may even have preferences for certain brands or operators. On the other hand, hotel management agreements often limit the amount of outside financing, or leverage, being used by the owner.
ACCEPTANCE OF PROJECT: Not all projects will of course be accepted by hotel brands. For example, Marriott brands and Hilton Garden Inn franchises are generally only available for new construction hotels; they are unlikely to accept aconversion fromanother brand. Four Points by Sheraton license new construction hotels, but also accept conversions from other brands. If you are in a location where the most desirable franchises are already represented, or if you have a product that is not so mouth-watering for the franchisors, selecting a franchise may mean choosing between less desirable options.
ISSUES FOR GENERAL MANAGERS
When working for a management company, certain issues may come into play for general managers. Firstly, while the management company will offer career advancement through its various managed establishments, this may conflict with the wish of the hotel owner to have a more stable relationship with his manager. The G.M.’s loyalty can be tested due to conflicting interests of staff, guests, the brand, the management company, and the hotel’s owners.