chapter 12 franchise agreements and management contracts

Chapter 12Franchise Agreements and

Management Contracts

Hotel Operations Management, 1/e ©2004 Pearson Education Hayes/Ninemeier Pearson Prentice Hall

Upper Saddle River, NJ 07458

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

The Hotel Franchise Relationship

A network of interdependent business relationships allowing a number of people 1) to share brand identification, 2) to develop a successful method of doing business, and 3) to establish a strong marketing and distribution system.

For the franchisee, franchising helps reduce risk -Proven operational methods are usedFranchisees and their financial capital expand the brand faster than franchiser could do solo

Franchise benefits

What is franchising?



History of hotel franchising is relatively short- First significant hotel franchising arrangement began in 1950s with Kemmons Wilson and his Holiday Inn chain

Today hotel owners increasingly affiliate their hotels with other hotels under a common brand name.

Hotel Franchising: Origin & Structure

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 right to sell brand name & determine brand standards

Conflict can arise between hotel owners and brand managers- G.M. should balance legitimate interests of hotel and brand



Brand Properties Rooms

1. Best Western International 4,008 304,664

2. Holiday Inn 1,576 295,252

3. Days Inn Worldwide 1,947 164,023

4. Marriott Hotels, Resorts & Suites 433 160,540

5. Comfort Inns and Comfort Suites 2,065 159,619

6. Sheraton Hotels & Resorts 399 133,200

7. Super 8 Motels 2,092 127,533

8. Ramada Franchise Systems 971 118,114

9. Hampton Inn / Hampton Inn and Suites 1,175 120,589

10.Holiday Inn Express 1,351 109,186

Figure 12.1: Ten Largest Brands

Hotel Franchising:Origin & Structure (continued….)



Supply potential franchisees with disclosure document at either the first face-to-face meeting or ten business days before any money is paid by franchisee to franchiser

Federal Trade Commission (1979):Franchise Rule requires that franchisers:

Hotel Franchising:Governmental Regulations Related to Franchises

Provide evidence, in writing, of any earning claims or profit forecasts made by franchiser

Disclose number and % of franchisees achieving earnings rates advertised in any promotional ads that include earnings claims

Provide potential franchisees with copies of basic franchise agreement used by franchiser

Refund promptly any deposit monies legally due to potential franchisees who elected not to sign a franchise agreement with franchiser

Do not make claims orally or in writing that conflict with written disclosure documents provided to franchisee



Name of franchiser and type of franchise it offers for saleBusiness experience of franchise company’s officersFees & royalties that must be paidInitial investment requirementsRights & obligations of franchiser & franchiseeTerritorial protection offered by franchiserRequired operating policiesRenewal, transfer, and termination proceduresEarnings claimsA sample franchise agreementSpecific info required by each state in which FOC is to be filedName and address of legal representative of franchiser

Franchise Offering Circular (FOC) include

Hotel Franchising:Governmental Regulations Related to Franchises



Franchise agreement: legal contract between hotel owners (franchisee) and brand managers (franchiser), which describes duties & responsibilities of each in the franchise relationship

The Franchise Agreement

A hotel franchise relationship exists with a franchise agreement.



Names of parties signing agreement-Name of legal entity representing the brand as well as corporation, partnership, or sole proprietor owning hotel

Franchise agreement includes:

The Franchise Agreement: Major Elements

Detailed definitions- Any definitions subject to misinterpretation by parties to the agreement are defined.

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

Franchise agreement includes: (continued….)


Reports- Room revenue generated, occupancy levels, & occupancy taxes & ADRResponsibilities 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

Franchise agreement includes: (continued….)


Insurance requirements- Owner should provide types & amounts of required insurance- Proof of general indemnification policies, automobile insurance, & mandatory workers’ compensation insurance

Requirements for alteration- Rights of the franchiser to change the agreement

Arbitration and legal fees- Responsibilities of each party related to legal disputes

Signature pages-Authorized representative of the brand & owners of the hotel will sign the franchise agreement



Advantages to franchisee

The Franchise Agreement: Advantages to the Franchisee / Franchiser

Allowing hotel owners to acquire a brand name with regional or national recognitionConnecting the hotel to the GDSIncreasing hotel’s sales, thus its profitabilityAffecting ability of hotel’s owner to secure financingAssistance with on-site training, advice on purchasing furnishings & fixtures, reduced operating costs, & free interior design assistance

Advantages to franchiser

Increasing fee payments to the brandGrowing the business (brand spread)Helping pay for fixed overhead of operating that brand



Quality and experience of the brand managers- Hotel owners, not brand managers, bear financial risk of poor brand management

Basic considerations for a selecting a franchise brand:

The Franchise Agreement: Selecting a franchiser

Perceived quality / service level of the brand-Travelers associate some brands with higher quality, service levels, and costs, than other brands.

-Franchisers offer brands at a range of quality and guest services

The amount of fees paid to franchiser- Fees paid to a franchiser are a negotiable part of franchise agreement

Direction of the brand



Number of hotels currently operating under the brand namePercent of hotels, on an annual basis, that elected to leave the brand in the past five yearsNumber of new properties currently being built under the brand’s nameThe 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 competesOccupancy rate trend for the last five years in comparison to the occupancy rate trend for the industry segment in which the brand competesPercent of total hotel room revenue contributed by the brand’s reservation system and percent of hotels within the brand that achieve that average rate of contribution

Clues to future success of the brand

The Franchise Agreement: Selecting a franchiser (continued….)



1. Application fees2. Area of protection3. Recurring fees4. Standards5. Mandatory service programs6. Operating performance7. FOC8. Fair franchising9. Financing assistance10. Termination

Contents in franchiser questionnaire

Selecting a Franchiser: Franchiser QuestionnaireFigure 12.2: Franchiser Survey



Conversion will always require some facility modification.When a potential franchiser inspects a hotel property whose owners are interested in a conversion, a PIP (product improvement plan) will be prepared.Estimating expenses to implement PIP is the hotel owners’ job.

A brand conversion = reflagging

Process of changing a hotel’s flag from one franchiser to another

Selecting a Franchiser: The Product Improvement Plan (PIP)

PIP: document detailing property upgrades and replacements required if a hotel is to be accepted as one of a specific brand’s franchised properties.



Franchise agreement is negotiable.

Franchise agreement tends to be written in franchiser's favor.

Owners should evaluate all components of proposed franchise agreements.

Hotel owners have demanded that impact studies, prepared by an independent party, be undertaken and paid for, when appropriate, by franchiser.

G.M.s must become adept at operating hotels in best interests of their owners, as well as in compliance with their owners’ franchise agreement.

Selecting a Franchiser: Negotiating the Franchise Agreement



Management contract: agreement between hotel owners and hotel management company under which, for a fee, the management company operates the hotel.

Management companies will:

Hotel Management Company Relationship: Management Companies

Secure, and if it has closed, reopen the hotelImplement sales and marketing plans to maximize hotel’s short- & long-term profitabilityGenerate reliable financial statementsEstablish suitable staffing to maximize customer and employee satisfactionShow hotel to prospective buyersReport regularly to owners about hotel’s condition



Hotel Management Company Relationship: Management Companies (continued….)

Figure 12.3: Ten largest management companies

Brand PropertiesGet annual revenues (in

millions of $)

1. Interstate Hotels and Resorts (with 2002 MeriStar merger) 357 2,800.0

2. Destination Hotels & Resorts 29 545.0

3. Tishman Hotel Corp. 17 521.8

4. Prime Hospitality Corp. 198 485.0

5. Lodgian 106 448.0

6. John Q. Hammonds 56 436.7

7. Kimpton Hotels & Restaurant Group 34 400.0

8. Outrigger Enterprise 39 400.0

9. Ocean Hospitalities 93 339.0

10.Sunstone Hotel Investors 52 293.0



Reflag hotel from lower quality brand to higher one

Reflag hotel from higher quality brand to lower one

Manage / directing major renovation of hotel

Operate hotel in a severely depressed market

Handle bankruptcy / repossession of hotel

Manage hotel that is slated for permanent closing

Manage hotel when G.M. unexpectedly resigns

Manage hotel extendedly time for owners who elect not to become directly involved in day-to-day operations

Management companies will :

Management Companies: Origin & Purpose



Are they first tier or second tier

How to examine the management company

Participation in actual risk and ownership of the hotels they manage- The management company is neither a partner in nor owner of hotels it manages-The management company is a partner (with others) in the ownership

of hotels it manages

-The management company only manages hotels it owns

-The management company owns, by itself, some of hotels it manages, and owns a part, or none, of others it manages

Management Companies: Hotel Management Company Structures

By number of hotels they operate



Length of the agreementProcedures for early termination by either partyProcedures for extending contractContract terms in the event of hotel’s saleBase fee to be chargedIncentives fees earned or penalties assessed related to operating performanceManagement company investment required or ownership attainedExclusivity (Is the management contract company allowed to operate competing hotels?)Reporting relationships and requirementsInsurance requirements of the management companyStatus of employees

Major elements of management agreement include:Management Operating Agreement



Advantages

Management quality can be improvedTargeted expertise can be obtainedDocumented managerial effectiveness is availablePayment for services can be tied to performancePartnership opportunities are enhanced

Disadvantages

Management Operating Agreement:Advantages / Disadvantages to Hotel Owners

The owner cannot control selection of the on-site G.M. & other high-level managers

Talented managers leave frequentlyThe interests of hotel owners and the management companies they employee sometimes conflict

The costs of management company errors are borne by the owner

Transfer of ownership may be complicated- High cost of buyout limits the number of potential buyers



Hotel owner

Franchise agreement will affect G.M.’s relationship with:

Issues Affecting G.M.s:Managing the Franchise Relationship

Hotel’s franchise service director (FSD)- Responsible for day-to-day relationship between franchiser & franchisee - Assisting hotel’s sales effort- Monitoring and advising about hotel’s use of reservation system- Advising franchise on availability and use of franchiser resources

Brand (managers)

Staff- Brand standards will affect every department in hotel.

Guests



G.M.s’ challengesCareer management challenges- Long-term career advancement with management company conflicts with desires of the hotel owners

Issues Affecting G.M.s:Managing for a Management Company

Dual loyalty issues (owners vs. management company)- Hotel owner’s best course of action works against the best interests of own company.

Strained EOC relationships

Affected and concerned employees- A new management company implements its benefit, pay, seniority, and related employment policies in place of those of a previous management company

Conflicts with brand managers

chapter 12 franchise agreements and management contracts

Documents

hotel franchise relationship

hotel owners

hotel operations management

brand slide

history of hotel franchising

brand managers

franchise company

brand identification