By virtue of the choice of a developer to build a hotel or accommodations and the competitive array of brands/managers on the market on one hand, and an operators toolbox of contract types, brands and options for alternate geographic market focus there is unlikely to be a significant inequality of balance of power going in management or franchise contract negotiations. Nevertheless, the product and it’s status, the market/operators circumstances and developers knowledge or chosen approach to the agreement can shift the bargaining power to or from the owner.
In principle, the general interests of the operator and the owner in an effective Hotel Management Agreement (HMA) or Hotel Franchise/License Agreement (HFA) are aligned, and in economic ‘good times’, where both parties have the goal of maximum profitability a standard HMA/HFA should fulfil a satisfactory balance. By their nature fee structures, will cause a divergence of interests but should be resolved by market norms and reasonable negotiation. Less evident are the effects of future potential economic downturns that will inevitably put a strain on the agreement and the alignment of interests of the parties.
The standard HMA/HFA is drafted and presented by the operator and while a regionally experienced operator should anticipate specific market issues and potential market challenges, the operator’s development team is unlikely to offer an initial draft which elevates its exposure to risk. Rather than share risk, terms are likely to protect the operator’s position and the draft agreement may omit resolutions that might add operator responsibility or consequence under challenging circumstances.
The long term nature of hotel agreements and specifically the agency structure of an HMA means that there cannot be a satisfactory win-lose outcome for either party. The operator is looking to maximise fee incomes from the agreement, but they also have many other needs that on balance will offset the demand for maximum fees, such as quality, flexibility, longevity, publicity etc. The operators representative may have a sizeable influence on the process but is probably not the final decision maker and will almost certainly need to substantiate the project and negotiated package is appropriate for the brand. While future fees probably have some impact on their performance rewards, there will also be many other individual motivations to conclude the negotiations successfully.
It is therefore vital to understand the strength that the project and status have before reaching deep into the Head of Terms and HMA/HFA negotiation process. It can boost your standing, help focus your strategy, improve your approach, focus on the crucial element and even support the operators representative in finding and obtaining approval for the best long term deal.
The following factors will influence the balance of power of the parties in the negotiation of the HMA or HFA:
Project & Owner Influences
Location: The negotiating strength of a central or strategic micro-location in a highly desired city or region, cannot be underestimated and is the most likely factor to get a hotel operator motivated for negotiation particularly if in a market which has proven a challenge to access. An operators development team is usually well attuned to a cities ‘best spots’ and if your project is in one of them expect a rapid response to your initial development enquiries. Apart from the promise of high incomes and longevity a strong location can also provide for a brand flag showcase especially if operators are looking for further growth in the region all of which gives leverage to the owner.
Brand/Property Synergy: Where the property is a close fit for the brand especially if in the early concept stages or during development where full flexibility remains on the fit-out and the owner can promise little or no deviation from brand standards then the owner is in a stronger position. Hotel developers have to fight internally with their brand teams and project approval boards to get project authorisation, and an ‘on brand’ product without departure from brand standards makes it far achievable to squeeze through a heavily negotiated deal that maybe oversteps some of the operator’s commercial contract thresholds. Projects with the clear prerequisites to be developed to a successful hotel, but a yet undefined concept can have an HMA/HFA agreed early. While this provides flexibility in such case, it also includes uncertainty for the operator, and they may hold back in negotiations, wary that once detailed design, build permits and finance has been resolved the property may start to deviate from the brand or be scaled back in size or facilities.
Property Size: Economies of scale are likely to equate directly to higher total revenue and higher profitability, both of which are the foundation of the operator’s fee structure. While an operator might be internally calculating a per key fee income, they should have their eye firmly on the bigger picture and the overall total fee potential, thus on a larger hotel of more than 250-rooms the operator probably has a freer hand to discount on these top-line fees. Conversely, a small hotel, for example, less than 100-rooms has much more limited potential, doubtless higher operating costs and lesser income, though the small size of the property may also reflect the scarcity of real estate and subsequent market conditions such as extraordinarily high levels of ADR which compensate for the small size. Operators and their development teams are often measured/rewarded by their pipeline and delivery growth achievement based on the number of hotels or number of rooms during a year. Thus, for example, an operator faced with a 400+ room signing in December is more likely to give owners more attention and flexibility, to execute the deal.
Income from Operations: As the operator’s fee income for an HMA is based on total revenue turnover and GOP, whatever builds on those incomes may add to the negotiation position of the owner. In an HFA fee income is usually from room revenue, but occasionally can be agreed to include other income streams. A hotel with extensive conference facilities, quality food and beverage facilities, exclusive location, a luxury property with attainably high rates should be factored in. It should be noted however that few areas are as operationally profitable as guestroom sales and where the incentive fee or other contractual terms is based upon a profitability percentage of with relatively top-line areas such as restaurants the operator will be less flexible in these terms.
Proficient Development Team: A developer with a strong and/or proven development team (consultants, advisors, architects, legal counsel etc…) that can illustrate delivery of real estate projects is highly appealing to hotel operators, especially in emerging markets where this is not usually the norm. It immediately flags to the operator the commitment of the developer to the delivery of a quality product, an understanding of the complex needs of a hotel development, provides for a significantly higher probability of final project delivery and relieves the operator of the role to educate and support the developer through every minute step of the process. While these consultants in themselves give the owner a stronger negotiating position, they also provide time and cost savings for the operator. In the early stages of development, with the absence of a project team, being open to an operator’s professional suggestions for partners should also facilitate a more open negotiation process.
Time to Market: A project with a long development window is far less attractive to an operator than a hotel with immediate or short term conversion. Often long term projects especially when they are part of a masterplan with large scale residential, office or leisure infrastructure are far more prone to failure to materialise, there are high risks that market fundamentals will change, finance fails to come together, and project focus gets distorted. While it would not necessarily be overlooked, a project with a delivery timeline over 5-years is potentially beyond the strategy of the operator and cause them concerns about long term technical support, potential area restriction issues, and with their internal calculations for discounted cash flows, carry insufficient current value. Conversely though a project with a short time to market might provide a strong negotiation platform for an owner, as operators seek short term targets; missing out on the resources of an operators support, deviations from brand requirements, potential retrofits or missing market opportunities potentially erase any such benefits of a late decision to brand a new property.
Owner Profile: With the introduction of such laws as anti-bribery and anti-money laundering which put the onus on corporations, operators are increasingly concerned with the profile of their partners especially in emerging markets. A strong non-politically exposed owner with whom the operator can enjoy longevity and potentially further projects has become a vital element of the project approval process, and this comfort can add to the negotiation stance.
Owner Financial Standing: An owner with a strong financial standing, that does not need additional funding for the development and is not likely to seek project financing support from the operator is highly attractive to operators, especially when they have the finances to maintain the property at a high standard throughout its lifecycle and would have the financial ability to expand the hotel if the market opportunity arises.
HMA Negotiating Experience: A hotel management agreement is a multifaceted contract with many seemingly straightforward obligations but also significant implications that simply cannot be understood by a novice to the operation of hotels or hotel agreements. Nevertheless, many hotel agreements are concluded by in house lawyers with no hotel experience on either the basis that the lawyer will learn/interpret the agreement terms during the process, which can be very long and drawn out process or trust the operator to provide fair and equal clauses throughout the agreement. A hotel experienced international lawyer with regional experience, or at the very least a consultant with knowledge of HMA/HFA’s strengthens the owner’s hand and should speed up the negotiation process.
Operator Influences
Operator Presence: If a hotel operator is established in your market and has not reached any point of market saturation the expertise, brand strength, efficiencies etc are possibly the main reasons for engaging that operator. However, this may come at a cost, that operator may not be as motivated as other operators to negotiate, and a brand competitor may be ready to offer the earth to gain market entry. The question may be whether you trade brand strength for seemingly better commercial terms, they would be a multitude of other factors to consider, many of which would be subjective.
Operator Strategy: As with most corporations operators have detailed one year and multi-year business development growth plans which in some cases are broadly published in the press (often with a strong positive PR spin) or with public companies in the development or investment sections of their respective websites. With their asset light models, while most hotel operators are relatively opportunistic as to new opportunities, some will follow a much stricter growth focus, which might restrict growth in certain geographic markets with specific brands or alternatively promote growth by use of more flexible fee structures or even financial incentive or income guarantee tools. Operators developers may be incentivised themselves by personal rewards or ease of internal approvals to find specific hotel opportunities. If your development matches a proactive strategy of an operator then you will have considerably more strength in negotiation.
Brand Lifecycle: Brands are constantly evolving and particularly now with challenges from disruptors, alternate accommodations and the changing profile of clients new brands are being conceived weekly. The initial growth period of a brand is a critical period full of risk and product modification. Launching a brand past a critical mass both globally and regionally requires that an operator take on the brand development costs including departing from the asset-light strategy, investing directly into a prototype and the preliminary properties or taking on leases and development investment in geographical locations that would not typically be in their strategy. Depending on the growth cycle of the brand operators may wish to mitigate these risk and accelerate growth by working with multi and single unit development partners by offering incentives can be favourable contract terms or provide direct investment or other commitments. Even with older more established
Competitor Strategies: Even if other hotel operators are not a good fit for your development their influence on the market can drive more competitive commercial terms. Several new operators or brands pushing for market entry might not succeed in establishing themselves immediately but their presence and discounting of terms will cause some reaction in commercial and contractual terms. Once some principles are accepted, they are very difficult for operators to reverse as due to confidentiality the market is routinely opaque, with speculation about competitor tactics fuelled by intermediaries. At the same time operators with leading positions do not want to lose them or allow a competitor a foothold in the market and might accept a compromised position rather than risk losing a potential client.
Market Tendencies: Hotel markets are both cyclical and reliant on macro-economic factors. As markets shrink after a short lag there is often also a reduction of pipeline opportunities, however, if that follows a sustained period of growth, then competition from established hotel operators is likely to be fierce. The owner should then be in an advantages negotiation position though is possibly carrying more risk with the falling market. Operators will reassign their strategic markets focus, but assuming they built up stronger presence, resources and commitments in the market will likely take time to retract.
Process Influences
Head of Terms: A Head of Terms can be an excellent tool for laying out the basis for an agreement, ensuring the owner and operator are on the same page and providing focus. However, the owner may not yet have the project team such as legal or hotel expertise representing them while still in these early stages and most likely does not have full access to the HMA/HFA. While in most emerging markets the head of terms is unlikely to be enforceable and the owner should be able to walk away from the HMA/HFA negotiation, before finalising the head of terms it is important to avoid committing to incomplete or unknown terms. Avoiding such obligation is especially critical if the operator insists that ‘the head of terms constitute a binding commitment’ and ‘the agreement shall substantially reflect the terms’.
Pick Your Fight: Not every clause of the HMA or HFA carries equal weight by the owner and the operator, and contractual obligations which may have little real meaning or use for an owner may have value for the operator or cause the operators representative/approval board to look closer at the commercial value. Fighting every clause of the agreement may be a tactic but may get a lesser result. Is a termination clause that has a negligible chance of ever being triggered really worth 0.25% off the royalty fee?
See: HMA Contract Terms or HFA Contract Terms