Is franchising a better model for hotel owners than collaborating with brands on the basis of a hotel management agreement? A few weeks ago, I had the pleasure of moderating a panel of white label managers on the advantages of using the franchise option in the hospitality industry. 

Let’s recap quickly the main points of difference between a franchise model and a managed model:

• The franchise fee model is based on a percentage of room revenue without any incentive fees.
• In franchising, the recharges are very limited, typically the franchisee only pays for one or two annual visits.
• The hotel owner, in its capacity as franchisee, has significantly more control over the finances of the hotel.
• The owner is in charge of CAPEX investment, subject only to compliance with the brand standards, for which it can typically negotiate a cap.
• Franchise agreements tend to be shorter than hotel management agreements.

Partnering with white label managers

Some owners feel that they are not set up for the franchise model because they do not have the capacity and experience to manage the hotel. While 20 years ago, this would’ve been a significant obstacle, in the current market, owners have access to a large variety of white label hotel management companies, many of which specialize in specific regional markets. Sometimes owners are concerned that the total combined management fees and franchise fees will exceed the cost they would have had under a direct management agreement. Whilst this can be the case, the panelists were clear that special, combined fee models may be available.  However, everyone agreed that the most significant saving is on operating expenses. The three white label managers I interviewed unanimously stated that a saving of 5 to 7 percentage points can be achieved in this area through complexing together hotels, better staff management, and more cost-efficient purchasing.

Budget process

The franchisor in a franchise agreement has no role in the budget process of the hotel. Both the annual operating budget and the capital investments are decided by the franchisee. Obviously, the franchise agreement will require the franchisee to comply with brand standards, keep the hotel in good repair, and undertake periodic renovations. However, these are not hard obligations, and the scope of the renovations can be negotiated on a case-by-case basis, depending on the condition of the hotel. Similarly, any property improvement plan (PIP) can be negotiated both in the case of franchise or management agreement. The panel emphasized the beneficial role of the white label manager in relation to this process. It was made clear that hotel owners should not immediately agree to comply with the full list of required improvements, as there is always room to negotiate a renovation plan that fits the budget.

White label managers can help make the budget process more collaborative. In particular, their standards are not tied to a specific brand, and they therefore have more flexibility on implementation.

Brand relations

A single hotel owner may lack negotiating power when faced with the long-standing experience and strict concept requirements of a major global brand. Good asset managers and white label managers have an important role to play in brand relations, bridging that gap. They will know where the brand can be flexible and can secure savings and compromises for the owner.

Negotiating the franchise agreement

Unfortunately, some owners do not spend enough time negotiating the franchise agreement to secure the protections they need against what has sometimes been described as the “brand hammer”. Whilst it is correct that franchise agreements are not fully negotiable documents, there are important elements that can be negotiated, even in the hospitality industry. These include:

• Area of protection: This is a restricted territory where the brand will not position a competing hotel for an agreed period of time.
• Holiday: this is a provision that provides limitations on the obligation of the hotel owner to make repeated expensive investments in the event of a brand-standard change.
• The right to sell the hotel with minimal interference: Whilst it can be difficult to sell free from encumbrances, there’s more flexibility in a franchise for a flag change, in the same family of brands, or even a termination on sale.
• A franchise fee discount during the initial five years: Most brands differentiate between franchise fees which are negotiable and centralized service charges which are non-negotiable.
• Burn off restrictions: Equally, for the area of protection, some brands may provide unreasonable burn off restrictions. Often these are tied to a delay in the opening date or completion of renovation works. A sufficient safety margin should be built into the renovation plan, and it may also be possible to negotiate an extension.
• Termination and liquidated damages: This is another area that should be carefully negotiated both as regards the calculation formula and the multiple.

Overall, everyone on the panel agreed that the franchise option offers a good alternative structure to hotel owners that want to take back control of their asset.