Franchising is a proven route to the successful international expansion of hotel brands. Global brands such as Hilton, IHG and Marriott have been using franchise agreements for decades to successfully grow in both traditional economies and emerging markets. Franchising is an established way of expanding a hospitality business internationally. The global hotel franchise market is expected to grow from US$37 billion to US$77 billion in the next 10 years. Together with management agreements, it is the preferred form of international expansion for many successful hospitality brands.

Benefits for all concerned

Franchising works because it offers real benefits, not only to the hotel brand but also to the local hotel owner. It offers a number of clear advantages to hotel owners looking to improve their average daily rate (ADR) and occupancy and it is at the same time attractive to the brand owner. For the brand owner, it removes the need to invest capital and other substantial resources in opening new locations abroad. A franchise agreement has a number of advantages over a management agreement. It is a more straight-forward relationship with a clear division of responsibilities that plays to the strengths of both parties.

A franchise agreement enables hotel owners to be in charge of their own budget, subject only to an overarching obligation to comply with brand standards. The painful budget approval process does not apply. Some franchise brands do not even impose a mandatory FF&E reserve. Many hotel owners see this is as a major benefit. In view of the fact that budgets are heavily dependent on local market conditions, there is a feeling that a strong local owner knows their own market best and does not require oversight by a manager imposed by the brand. General manager selection and employment matters are also firmly in the hands of the owner, with the franchisor having little or no say in the matter. Again, many owners are of the view that they have a better understanding of the local employment market than a global brand. Yet the local owner benefits from the prestige of international brand affiliation. They have access to the same distribution system as a managed hotel. They also have access to the know-how, good name and quality assurance program of the company acting as franchisor. So franchising is arguably a win-win partnership where each party can focus on what they do best.

From the perspective of the brand, franchising enables hotel companies to access the required capital and grow the business internationally by partnering with high quality local hotel owners without the complexity of a management agreement. In today’s global market, local investors are highly sophisticated and have a strong understanding of the local hospitality market. Many no longer require a management service but they would like to affiliate with a brand. This is reflected by the statistics, which show that the majority of new supply for major brands is through franchise. Franchising gives the hotel owner access to the blueprint of a strong proven concept with a known reputation whilst keeping control of the purse strings. 

Planning to franchise

In order to take advantage of the potential that franchising offers, one needs to plan the approach carefully. It is important to be discerning as some would be franchisors will not have the structure in place to support a franchise offering. Provided there is a management model already in place, it may be possible to leverage existing structures. Some will have to be modified for franchise. Before buying a franchise from a new franchisor, owners should conduct due diligence. Why is the brand turning to franchise? Has the franchise been well planned, structured and executed or is it a response to an opportunistic approach. Owners should ensure there is a robust training program suitable for training management level executives working for the franchisee. Many brands that come from a management model, focus more on day-to-day staff training. How will they train your GM and your executives? How often will the hotel be visited by the brand and how will the hotel be supported to ensure it can correctly capture the brand’s recipe for success. What will be the charges for those visits? Does the brand offer a thorough quality assurance and audit program where you can view your scores and take quick and easy steps to address challenges? Is there a good match between franchisor and franchisee as regards business philosophy, approach to operational standards and cooperation. A successful franchisee needs to have significant operational experience. Does the brand offer a well-documented brand manual and online resources? The franchise system must be followed correctly and needs to be made easy for the franchisee. The franchisee needs to invest in training and brand upgrades but they should not be guinea-pigs. The reality is that on those relatively rare occasions where international franchises fail, this is usually due to lack of collaboration and support from the franchisor.

Financial model

There are numerous differences between a franchise agreement and a management agreement when it comes to the financial model. In a management agreement, the typical model involves payment of a base fee and an incentive fee coupled with a broad range of charges and reimbursements for various important services. Through the incentive fee, the manager participates in the profits of the hospitality business. In a franchise, there is no profit participation. A franchisee only pays the franchise fees. These are payable on the top line, regardless of profitability. A typical franchise fee is 4%, so it is higher than the base fee in a management agreement, but it is the only direct fee that you will pay. The franchisee will also pay a marketing and reservations contribution, typically on a percentage basis. There would not typically be many other recharges (except travel expenses for visits and audits). Finally, the hotel will pay a loyalty program fee in the region of 4%-5% of “qualifying revenue”. Some large franchisors offer packages (Marriott and Hilton have a package) but it can be difficult to ascertain which services are included in the package because franchisors reserve the right to increase the package charge and they also reserve the right to alter what’s included in the package. Statistics suggest the total percentage of revenue that is paid to the franchisor ranges from 8-12%. Some fees are calculated on the basis of room revenue, whilst others are based on total revenue. So where do the savings come from. Many say that the main saving in a franchise is on operating costs. I have been told that a flip from management to franchise has saved some owners 5-7% on operating cost and salaries. Large owners also benefit from complexing vanilla services with their other hotels.

Negotiate a robust LOI

Before entering into an arrangement with a franchisor you need to ensure their trade name is fully protected in your country and that any franchise fees are structured tax efficiently. That requires some expert professional advice at the term sheet stage. Any area of protection should also be secured to prevent cannibalization of your catchment area. Early planning is therefore key. It is important to get support from specialist franchise lawyers when negotiating the franchise agreement. This begins with the letter of intent (LOI). Whilst the LOI is non-binding, it can be extremely difficult to negotiate against a signed LOI.

Franchise laws

Global franchise laws are often overlooked by hotels looking to franchise. These typically require the franchisor to provide the franchisee with a formal prospectus or disclosure document. Owners should study this document carefully as it contains extremely valuable information. If you have not been given the required disclosures, this may be a useful argument at a later stage, when looking to exit the relationship. Some countries prohibit unfair terms in franchise agreements, for example, Australia, Germany and France. Some countries require that the franchise agreement is registered in order for it to be valid. For example, in Saudi Arabia, if this has not been done, you may be able to terminate the franchise agreement and claim damages. Franchising is very much a specialist area. It is an urban myth that franchise agreements cannot be negotiated. The market is competitive more and more brands are offering a franchise option.

If you are interested in expanding your hotel through franchising, Dentons is here to help. Drawing on our experience representing more than 400 franchise systems in 80+ countries, Dentons’ unique Franchise Advisory offering includes both legal advice and franchise consultancy to help you build a robust and sustainable franchise operation.