Will your asset benefit from brand affiliation? Helen Hangari, senior legal consultant, DLA Piper Middle East LLP shares a must-read guide to hotel franchising
The Middle East and North Africa have long been regions where most international hotel operators do business by way of entering into management agreements with hotel owners whereby they operate hotels in exchange for a fee constituted by various elements typically a base fee, incentive fee, license fee, marketing and reservations fees and possibly a centralised services fee.
Whilst this is typical for most emerging markets, the market in the MENA region is steadily maturing, a trend that is partly reflected in the growing number of international hotel operators becoming more willing to grant franchise agreements under the right circumstances, to the ‘right’ owners.
Franchise agreements are very popular in Europe and the US but, for many international hotel operators the use of such agreements is relatively new to the region. A well-defined brand, plus the meeting of guest expectations, are the cornerstone of the franchise system and critical to growth and expansion in each region where franchise agreements are used. Therefore, both must be possible in each case where a franchise agreement is to be used.
For hotel operators the franchise model is very appealing, provided that the ‘right’ type of owners exist in the market. It offers a method of quickly expanding a brand and often lends itself more to three and four star brands, of which there is a particular need and desire to further develop in the Middle East market.
The key question for hotel owners developing a hotel is whether their asset will benefit from affiliation to a brand. There are significant benefits from brand affiliation which generally result in a higher likelihood of success. For example, increased brand awareness, easier access to financing and access to centralised systems. Taking a franchise is one of the quickest and easiest ways to achieve these benefits whilst allowing the owner to still retain control over its asset.
For owners, the main differences to note between a management agreement and a franchise agreement are:
Control – under a franchise agreement, the owner retains day-to-day control and management of the hotel whereas under a management agreement, such management and control is passed to the hotel operator. Therefore, this model appeals to owners who have experience of managing a hotel and want to retain more control over their asset. However, under a franchise agreement, an owner must still adhere to the brand standards, participate in group marketing and advertising, participate in the group’s reservation system and ensure the hotel development/renovation is approved by the hotel brand. Therefore, whilst control and management is retained by an owner under a franchise agreement, this is subject to compliance with a framework established by the hotel brand. Of course, the benefits of this framework is the brand affiliation and access to customers who are loyal to that brand.
Rights granted – under a franchise agreement, the owner is granted a license of a package of intellectual property rights relating to the brand which must be used in the operation of the hotel. Access to centralised services and reservation systems are also granted. Under a management agreement, the hotel operator still grants a license of its brand and access to centralised services and reservation systems, but manages the use of these itself.
Fee structure – in general terms, the fees payable to the hotel brand are lower under a franchise agreement compared to a management agreement. Under a franchise agreement, there is typically an initial fee payable which may be linked to the size of the hotel and may be non-refundable. Thereafter, there is a royalty fee of between 3% and 5% of room revenue, a marketing contribution also based on room revenue of between 2% and 4% and possibly a separate reservation fee which differs depending on the way the hotel brand operates its reservation system. Under a management agreement, there is usually a base fee of between 2% and 4% of gross revenue, an incentive fee of around 10% of gross operating profit, a marketing contribution and reservation fees which are of a similar level to under the franchise model and then centralised services fees.
Whether a franchise agreement or management agreement is used, the key to successfully benefitting from a hotel brand is compliance with its brand standards. Under both models, the owner will be responsible at its own cost for developing a hotel in compliance with the brand standards and carrying out any capital expenditure to ensure on-going compliance with the brand standards. Therefore, whilst the increased control over an asset under a franchise agreement can appeal to an owner, such an owner must bear in mind that the success of the hotel depends on the faithful compliance with brand standards and that this serves the mutual interests of the owner and the hotel brand.
Helen Hangari is a Senior Legal Consultant in the firm’s Middle East Real Estate Practice. Helen has particular experience of the hotel sector, including advising on hotel management arrangements, mixed use development projects, branded residences and sales and acquisitions having advised many of the region’s operators and owners.