Chapter 12
Franchise Agreements and
Management Contracts
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
Hotel Franchising: Origin & Structure
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.
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
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
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
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 companys 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
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
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 brands 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
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
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
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 hotels sales, thus its profitability
Affecting ability of hotels 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
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
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 brands
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 brands
reservation system and percent of hotels within the brand that achieve
that average rate of contribution
Hotel Operations Management, 1/e
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
Selecting a Franchiser:
The Product Improvement Plan (PIP)
A brand conversion = reflagging
Process of changing a hotels 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
brands franchised properties.
Hotel Operations Management, 1/e
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
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 hotels
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 hotels condition
Hotel Operations Management, 1/e
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 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
Brand
Hotel Operations Management, 1/e
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
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
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 hotels 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
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
Issues Affecting G.M.s:
Managing the Franchise Relationship
Franchise agreement will affect G.M.s relationship with:
Hotel owner
Hotels franchise service director (FSD)
- Responsible for day-to-day relationship between franchiser & franchisee
- Assisting hotels sales effort
- Monitoring and advising about hotels 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
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 owners 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
