Chapter 12 Franchise Agreements and Management Contracts Hotel

Chapter 12 Franchise Agreements and Management Contracts Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Hotel Franchise Relationship What is franchising? 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 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. Franchise benefits For the franchisee, franchising helps reduce risk -Proven operational methods are used Franchisees and their financial capital expand the brand faster than franchiser could do solo Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Hotel Franchising: Origin & Structure History of hotel franchising is relatively short - First significant hotel franchising arrangement began in 1950 s with Kemmons Wilson and his Holiday Inn chain Today hotel owners increasingly affiliate their hotels with other hotels under a common brand name. 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Hotel Franchising: Origin & Structure (continued…. ) Figure 12. 1: Ten Largest Brands 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, 619 399 133, 200 2, 092 127, 533 971 118, 114 9. Hampton Inn / Hampton Inn and Suites 1, 175 120, 589 10. Holiday Inn Express 1, 351 109, 186 6. Sheraton Hotels & Resorts 7. Super 8 Motels 8. Ramada Franchise Systems Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Hotel Franchising: Governmental Regulations Related to Franchises Federal Trade Commission (1979): Franchise Rule requires that franchisers: 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 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Hotel Franchising: Governmental Regulations Related to Franchises Franchise Offering Circular (FOC) include Name of franchiser and type of franchise it offers for sale Business experience of franchise company’s officers Fees & royalties that must be paid Initial investment requirements Rights & obligations of franchiser & franchisee Territorial protection offered by franchiser Required operating policies Renewal, transfer, and termination procedures Earnings claims A sample franchise agreement Specific info required by each state in which FOC is to be filed Name and address of legal representative of franchiser Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement A hotel franchise relationship exists with a franchise agreement. Franchise agreement: legal contract between hotel owners (franchisee) and brand managers (franchiser), which describes duties & responsibilities of each in the franchise relationship Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement: Major Elements Franchise agreement includes: Names of parties signing agreement -Name of legal entity representing the brand as well as corporation, partnership, or sole proprietor owning hotel 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. Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement: Major Elements Franchise agreement includes: (continued…. ) Fees - Affiliation fees / royalty fees / marketing fees / reservation fees Reports - Room revenue generated, occupancy levels, & occupancy taxes & ADR Responsibilities 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement: Major Elements Franchise agreement includes: (continued…. ) Termination or default - Events that permit a termination, or define a default, by either party 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement: Advantages to the Franchisee / Franchiser Advantages to franchisee Allowing hotel owners to acquire a brand name with regional or national recognition Connecting the hotel to the GDS Increasing hotel’s sales, thus its profitability Affecting ability of hotel’s owner to secure financing Assistance with on-site training, advice on purchasing furnishings & fixtures, reduced operating costs, & free interior design assistance Advantages to franchiser Increasing fee payments to the brand Growing the business (brand spread) Helping pay for fixed overhead of operating that brand Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement: Selecting a franchiser Basic considerations for a selecting a franchise brand: Quality and experience of the brand managers - Hotel owners, not brand managers, bear financial risk of poor brand management 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

The Franchise Agreement: Selecting a franchiser (continued…. ) Clues to future success of the brand Number of hotels currently operating under the brand name Percent of hotels, on an annual basis, that elected to leave the brand in the past five years Number of new properties currently being built under the brand’s name The 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 competes Occupancy rate trend for the last five years in comparison to the occupancy rate trend for the industry segment in which the brand competes Percent 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Selecting a Franchiser: Franchiser Questionnaire Figure 12. 2: Franchiser Survey Contents in franchiser questionnaire 1. Application fees 2. Area of protection 3. Recurring fees 4. Standards 5. Mandatory service programs 6. Operating performance 7. FOC 8. Fair franchising 9. Financing assistance 10. Termination Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Selecting a Franchiser: The Product Improvement Plan (PIP) A brand conversion = reflagging Process of changing a hotel’s flag from one franchiser to another 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. PIP: document detailing property upgrades and replacements required if a hotel is to be accepted as one of a specific brand’s franchised properties. Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Selecting a Franchiser: Negotiating the Franchise Agreement 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. Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Hotel Management Company Relationship: Management Companies Management contract: agreement between hotel owners and hotel management company under which, for a fee, the management company operates the hotel. Management companies will: Secure, and if it has closed, reopen the hotel Implement sales and marketing plans to maximize hotel’s short- & long-term profitability Generate reliable financial statements Establish suitable staffing to maximize customer and employee satisfaction Show hotel to prospective buyers Report regularly to owners about hotel’s condition Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Hotel Management Company Relationship: Management Companies (continued…. ) Figure 12. 3: Ten largest management companies Properties Get annual revenues (in millions of $) 1. Interstate Hotels and Resorts (with 2002 Meri. Star 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 Brand Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Management Companies: Origin & Purpose Management companies will : 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Management Companies: Hotel Management Company Structures How to examine the management company Are they first tier or second tier By number of hotels they operate 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Management Operating Agreement Major elements of management agreement include: Length of the agreement Procedures for early termination by either party Procedures for extending contract Contract terms in the event of hotel’s sale Base fee to be charged Incentives fees earned or penalties assessed related to operating performance Management company investment required or ownership attained Exclusivity (Is the management contract company allowed to operate competing hotels? ) Reporting relationships and requirements Insurance requirements of the management company Status of employees Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Management Operating Agreement: Advantages / Disadvantages to Hotel Owners Advantages Disadvantages Management quality can be improved Targeted expertise can be obtained Documented managerial effectiveness is available Payment for services can be tied to performance Partnership opportunities are enhanced The owner cannot control selection of the on-site G. M. & other high-level managers Talented managers leave frequently The 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 Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Issues Affecting G. M. s: Managing the Franchise Relationship Franchise agreement will affect G. M. ’s relationship with: Hotel owner 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458

Issues Affecting G. M. s: Managing for a Management Company G. M. s’ challenges Career management challenges - Long-term career advancement with management company conflicts with desires of the hotel owners 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 Hotel Operations Management, 1/e Hayes/Ninemeier © 2004 Pearson Education Pearson Prentice Hall Upper Saddle River, NJ 07458