Hotel Management Contract versus hotel franchise

Hotel Management Agreement vs Hotel Franchise Operators

Introduction

For people not familiar with the hospitality sector, the hotel business structure can appear very complex at first sight. While walking by the front door of a hotel it is complicated to imagine the diversity of players involved in this business. Indeed, while some hotels are called independents, others highly rely on the cooperativeness between a brand, an owner and/or an operator. This article will focus on identifying the different business models through which a hotel can be managed.

What Are The Different Hotel Management Models?

Hotel investment is very complex as it requires a good understanding of what are the stakeholder’s interests based on its operating model. Over time, the parties’ profile getting involved in hotel investment diversified. As a result, the increasing expertise and financial support allowed creating better guests value. The globalization of tourism increased international travels, and therefore the demand for international branded hotels. As of 2018, 54% of rooms were affiliated with a global or regional chain, and 46% were independent (IHG, 2018). Looking at the largest hotel market, the US, the demand for branded hotels is expected to steadily rise in response to the change in development and financing in the upcoming years. In the US, 72% of hotels are currently affiliated with a brand, as do 91% of the pipeline rooms in construction (CoStar, 2021).

Based on their geographic localization but as well on their market segment, hotels can be operated through different business models:

  • Hotel Franchise contract
  • Hotel Management contract
  • Lease

There are three main types of players involved in the hotel business:

  • The operator, responsible for managing the hotel performance.
  • The owner, who owns the property or building.
  • The brand, who owns the brand name and expertise.

According to the type of agreement binding the parties, the operator and the brand can be one unique entity or separated players.

 

hotel management vs hotel franchise

Hotel Franchise Operators

A hotel franchise is a fee-based agreement between a business owner, the franchisee, and a brand owner, the franchisor. The business owner – the property owner or tenant – can use the franchisor’s brand name, intellectual property, reservation system and operational support tools in exchange for paying a franchise fee. The owner retains the control of the property as well as carries out the business-related liabilities unless the owner decides to hire a third-party operator to run the property on his behalf. Similarly, as the owner operates the hotel under the brand name, he is responsible for complying with brand standards and does not have any right approval over the brand changes.

The cost of a franchise includes two types of fees: the initial fee and the continuing fees.

  • The initial fee is paid upon submission of the franchisee application and covers all pre-contract charges such as market assessment, property inspections, and other services. The franchisor can give back the initial fee if the franchise is not agreed upon or decide to keep a percentage of it.
  • The continuing fees aim to align the interests of both parties and are paid monthly to the franchisor. Continuing fees are composed of a royalty fee, as well as marketing and reservation-related fees. The royalty fee represents the biggest source of revenue for the franchisor as it is most often calculated as a percentage of total room revenue. That is why, while settling an agreement, the royalty fee is one of the most important negotiating points upon which both parties aim to agree, along with other commercial terms such as Area of Protection, Key Money or Term length. The typical term for a franchise contract ranges between 10 and 15 years. Many contracts can agree on a ramp-up of those fees subject to other commercial terms application.

According to the market segment in which the hotel operates the franchise cost can vary when calculated as a percentage of the total room revenue. According to HVS, the median hotel franchise cost for an economic hotel is 8.6% and increases in relation to its market. Upscale hotel franchise cost ranges around 11.4% whereas upper-midscale and first-class categories register around 12.1% and 12.4% respectively (HVS, 2020). The franchise business model is very popular in North America and becomes more adopted by hotel groups due to its asset-light focus.

Hotel Management Agreements

A hotel management contract is an agreement between the same parties as for a franchise but does not point out the same responsibilities. Since 1963, when the first hotel under a management contract opened, this business model did not stop to improve and get more attention. In a hotel management contract, the operator/ brand is the manager (for example IHG) and the hotel owner is the managing owner (a financing group for example). The operator will run a specific brand hotel on behalf of the managing owner in exchange for a fee, most often heavily negotiated according to the responsibilities of each party. The owner is responsible for all risks such as employment contracts, property maintenance or FF&E. On the other hand, the operator is responsible for all management issues.

The hotel management agreement’s fee structure is established in order to align the interests of both parties. The business owner pays different fees to the operator for running his business:

  • Base Management fee: to motivate the operator to focus on the top line, the business owner pays most often a percentage of the hotel’s gross operating revenue, ranging from 2% to 4% (HVS, 2017). This fee can differ according to the hotel market positioning and can be whether fixed or gradually ramped up along the lifetime of the contract.
  • Incentive fee: to ensure that the operator focuses on profitability and therefore cost control, the business owner pays a percentage of the hotel’s operating profit. The incentive fee can be calculated based on:
  1. GOP (Gross Operating Profit): Profit left after deducting all department expenses from the revenue
  2. AGOP (Adjusted Gross Operating Profit): GOP less Base Management Fee.
  3. NCA (Net Cash): Amount of cash remaining after deduction of the total liabilities.

The calculation of incentive fees can become even more complex whether its calculation is based on a numerical or margin hurdle.

  • Other fees including marketing, reimbursements, loyalty programs, training etc.

Pros and Cons

Pro and Cons Hotel Franchise vs Hotel Management Contract

 

Pro and Cons Hotel Franchise vs Hotel Management Contract

 

Franchise or Management Agreement?

Knowing the pros and cons of both a franchise and a management contract, it is easier to understand the hotel group’s strategic position. There is not a one-size-fits-all model as operating internationally allows hotel groups diversifying their business model according to geographic and market positioning.  However, the difference in market trade regulations between countries can be a limitation to their diversification. Although the franchise model is less prevalent in Europe than in the USA, it seems to gain popularity from owners looking to keep a hand on their business, and from hotel groups looking to expand their portfolio with a minimum of investments. Franchise accounts for three-quarters of the total European pipeline and management contracts for the remaining (HVS, 2015). Similarly, according to STR and JLL Research, Marriott International, Hilton Worldwide, Intercontinental Hotels Group and Choice Hotels International collectively represent 82% of total franchised branded rooms (JLL, 2020). On the other side, hotel chains are still very reluctant to relinquish control over their luxury brands and favours management contracts to operate their luxury properties.  While looking at the market leader in Europe, Latin America, Middle East & Africa and the Asia Pacific, Accor operates 51% of its hotels under management contract and 49% under franchise (Accor, 2021), a good example of how hotel group manage their brand name across the world. 

Each operating model comes with its own set of advantages and disadvantages, making it more or less attractive for owners and brand companies.  While both parties have an interest in the hotel’s success, their different risk profiles, source of income and investment strategies may lead to conflicting goals if those are not carefully considered when setting the commercial terms of the agreement. 

References

  • Accor. (2021). file:///C:/Users/umd58t/downloads/EN_Digital_Accor_Global_Development_Summary_Brochure_Q1_2021.pdf. Accor.
  • CoStar. (2021, 03 18). For Hotels the Future Is Branded. Or Is It? Retrieved from CoStar: https://www.costar.com/article/1364111080/for-hotels-the-future-is-branded-or-is-it
  • HVS. (2015). Decision, Decision…Which hotel operating model is right for you? HVS.
  • HVS. (2017, 04 14). An Overview of Hotel Management Contracts in Europe. Retrieved from HVS: https://hvs.com/article/7993-hotel-management-contracts-in-europe
  • HVS. (2020). 2020 UNITED STATES: HOTEL FRANCHISE FEE GUIDE. Retrieved from file:///C:/Users/umd58t/downloads/HVS%20-%20HVS-US-Hotel-Franchise-Fee-Guide-2020.pdf
  • IHG. (2018). Industry Overview: Annual Report and Form 20-F 2018. Retrieved from https://www.ihgplc.com/-/media/FF2DB7BB29C54FF2824393006F15A08F.ashx
  • JLL. (2020, 2 4). Why More Hotels Are Owned by Franchisees. Retrieved from Hotel Online: https://www.hotel-online.com/press_releases/release/why-more-hotels-are-owned-by-franchisees/

Next Steps

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