29 March 2013
Hotel Lawyer on branding your hotel or running it as an independent. When should you brand your hotel and when should you leave it unbranded? How do you know when the benefits justify the costs? And if you decide to brand, should you go with brand management or an independent operator? What are the considerations?
Few decisions are more important. Here is hotel lawyer, Robert Braun to share some insights garnered by our Global Hospitality Group®’s experience in helping clients with more than 1,000 hotel management agreements and franchise agreements.
To Brand or Not To Brand
Robert E. Braun | Hotel Lawyer
Why the hotel branding and management decisions are so important
One of the first decisions in the hotel development or acquisition process can have a lasting impact on the success of the project: whether the property should be branded, and whether that brand should manage the property. The hotel’s brand will be a defining part of the profitability, image and value of the hotel, and there may be no other decision which has a greater effect on the future of the property. Similarly, the management of a hotel can enhance the value of the brand, protect the owner, or detract from the value of the hotel — by as much as a 50% swing.
The 3 fundamental questions
While a hotel owner will live with these choices for years – if not decades – owners and developers often fail to ask three key, threshold questions:
- Should the hotel be branded?
- If it is branded, which brand?
- And if it will be branded, should the brand manage the property?
We recognize that there are many voices in the decision. Lenders or other investors may be more comfortable when a hotel is branded, and may feel that a brand manager will better operate the hotel. Some investors may be predisposed to one brand or another (often based on personal experiences as a guest, rather than an owner), and may have preconceptions of the ability of hotel ownership to operate the property. However, even where these strong voices have input, the owner or developer should consider the pros and cons of brands and brand management.
4 options available to hotel owners for branding and management
At the outset, there are four basic choices available to an owner:
- Management by the brand, where a single firm will agree to operate the hotel under a specific brand, and the owner essentially hands the property over to the manager with oversight rights, and obligations, defined in a management agreement.
- A franchise with a third party manager. Here, the owner enters into two agreements, one of which is a license agreement with the brand, giving the owner the right to operate a hotel under a specific brand, and a second with a third party manager who will actually operate the property.
- A self-managed franchise. In this case, the owner obtains a license or franchise to operate under the brand, but manages the property itself.
- Finally, an unbranded hotel, operated either by a third party manager or by the owner.
Why a Brand?
Brand standards and support. Brands provide many benefits. The major brands establish standards, which are intended to be consistent across all operations so that guests are better assured that they will receive the level of service and amenities they desire and expect, wherever the property is located. Along with standards, brands provide operating manuals, which are intended to provide a “turnkey” approach to the operation of the property. This is intended to reduce the number of mistakes and help ensure that the property is, in fact, operated pursuant to the brand standard.
Importantly, brands provide services that drive occupancy, such as reservations systems, websites, brand marketing, loyalty programs, and quality control. While they are often cited as important reasons to affiliate with a brand, they can be costly to establish and maintain, and the direct benefit to the property is not always apparent.
But are the benefits worth the cost? There are, however, a number of reasons not to use a brand. The most obvious reason is cost. Brands charge a variety of fees – management, royalty or license fees, loyalty program fees, marketing fees, reservations fees, training fees – the list can seem endless. Moreover, many of the fees are unrelated to the brand’s actual performance. Base management or license fees and marketing fees are paid on gross revenues, regardless of the source of the revenues. Thus, the brand is compensated for occupancy even if the brand was not responsible for it.
Similarly, brand standards, while benefiting the property in some ways, come at a cost. These standards are designed to benefit the brand, not a specific property. Even if a standard does not add value to a property, the owner is obligated to adopt it because it is a brand standard. Brand standards are generally inflexible, and impose added costs on owners.
Ill conceived programs? More than that, some hotel programs are ill-conceived. Over the past 25 years, we have seen brands adopt programs to centralize sales, accounting, quality control and other functions only to revert back to the prior regime of decentralized services when they do not provide the benefit promised. The cost of these programs are borne by hotel owners, and the cost is multiplied over the development of the plan, its implementation, the struggles to overcome flaws, and finally dismantling the plan. Brands have the luxury of experimenting because they do not have to foot the bill.
Are expensive loyalty programs worth the cost? There is also a big controversy as to whether loyalty programs actually benefit hotels. A recent study by Deloitte calls their effectiveness into question (“A Restoration in Hotel Loyalty: Developing a Blueprint for Reinventing Loyalty Programs“). Again, the owner must consider whether their benefit is worth the extra cost, both in terms of contributions to the loyalty program and redemptions by guests. These programs are not optional.
Issues with long-term commitments. Owners need to recognize that both brand management agreements and brand license agreements require a long-term commitment, measured in decades. Brand affiliation agreements make it difficult, if not impossible, for an owner to terminate for bad performance of the operator. This lack of control can significantly depress the value of the hotel at sale, or even lead to financial failure and foreclosure.
In addition, owners must take into account that the terms of these long-term agreements do not protect owners from the possibility of brand dilution or decline. There are a number of brands that, over the years, rode a roller coaster of changing target markets and ability to deliver on owner expectations. Many left owners without expected support for years or declined in value. Nonetheless, the owners were obligated to support expensive brand standards and programs that did not deliver expected benefits. (Amfac, RockResorts, Red Lion, Wyndham Resorts, Doubletree, JW Marriott, Westin and Sheraton to name a few). Some brands recovered to varying degrees over years. Others did not.
Why not be independent?
Given that branding a hotel carries with it costs and burdens, some owners consider whether it would be advantageous to go it alone. Those who do cite a number of advantages:
- No license or system fees – at the outset, the owner will save in the neighborhood of 10-15% of gross revenues that it would otherwise pay to the brand for the right to operate under the brand name.
- Greater flexibility to meet the market. While unbranded properties don’t have the support of system standards, they also do not have to take the good with the bad, and can structure a hotel standard that perfectly meets their market. Moreover, they can experiment and change, which can be difficult, if not impossible, in a brand’s regime.
- Don’t pay for what you don’t need. There are some instances in which a brand simply isn’t needed. For example, a hotel adjacent to a university hospital might not need a brand affiliation to drive occupancy. The location of the property itself will put heads in beds and drive a high occupancy.
Owners need to be aware, however, that taking the independent route has its drawbacks as well.
- Unbranded hotels lose the benefit of a support system, including detailed operating manuals and procedures, training, access to best practices, and perhaps most importantly, the bench strength and human capital that can make the difference between a successful and unsuccessful hotel.
- Not having a brand also makes the owner rely on its own resources and that of its manager. Placing the success of the hotel in the hands of the wrong third party manager can be a risky venture.
- An unbranded hotel will not have a dedicated reservation or marketing system. While there are a number of generic options available, they are not necessarily designed to the specific needs of the hotel or, conversely, require increased investment by the owner to create an effective reservation and marketing program.
- An unbranded property is vulnerable to marketing programs by larger, branded operators. With larger marketing budgets, a branded property may be able to compete more effectively with an unbranded hotel.
Who Should Manage the Property?
Once the decision is made about whether the hotel should be branded or unbranded, the owner must address whether to have the brand itself manage the property, or whether to seek a third party manager (or self-manage).
Brand Managers provide a number of benefits. They are closest to the standard and how it is implemented; the brand cannot argue that its own manager is failing to meet the operating standard (unless the owner interferes with the process or fails to provide capital). Some owners also see brand managers as being the most efficient alternative, since typically only a single management fee is paid, instead of a franchise or license fee and a separate management fee. And in many cases, the brand manager will have the deepest bench – the brand is likely to have more experienced personnel who can “parachute in” to the property to fill a vacancy temporarily, or to provide specific expertise on a problem.
Brand management also comes at a cost. While the nominal fees might seem to be less, brand operators are more likely to emphasize the highest interpretation of brand standards and be less concerned with achieving economies in operation or even maximizing revenues. The primary concern of a brand operator is the presentation of the brand, regardless of its economic impact on the owner. To put it directly, the loyalty of the brand manager is to the brand, not to the property. And to exacerbate the issue, brand managers are difficult and expensive to oversee. Since they have full access to and control of the hotel, even understanding where their operations might be improved can be difficult.
When is it appropriate to engage the brand to manage the property? First, brands reserve the exclusive right to operate certain of their flags. For example, Ritz-Carlton, Four Seasons, W and other flags are exclusively operated by their corresponding brands, since they are flagship properties and the brands protect those standards jealously. It is the right choice because there is no other choice.
In addition, certain types of properties, such as large, convention hotels, require skills and expertise — and national group sales offices — that have been developed by only a small circle of operators. While there are a number of independent operators that can operate larger hotels, the staffing, systems, and resources of a branded operator will normally benefit hotels with more than 600 rooms, significant meeting space, multiple food and beverage outlets.
The decision to brand a hotel, the selection of the brand (if any), and the selection of the manager are all interrelated and essential decisions for the hotel owner. The outcome of the decision will have a lasting impact not only on the current income and success of the hotel, but on the ultimate value of the property.
We use the practical experience gained from helping clients with more than $87 billion of hotel transactions and more than 1,000 hotel management and franchise agreements to provide guidance in assessing the relative cost and benefit involved in each such decision. Our clients find it helpful in confidently making their business decisions to be able to tap this virtual database of market terms and solutions from more than 25 years of hotel transactional deal making.
More information about hotel branding and management
The right hotel brand and management agreement can be the difference between success and failure of a hotel. The Global Hospitality Group® at Jeffer Mangels Butler & Mitchell LLP has negotiated, renegotiated, litigated and advised on more than 1,000 hotel management and franchise agreements all over the world. To see how we help clients in this arena, please click here to see our brochure.
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