Hotel investors have long believed that a property that is encumbered with a long-term management agreement is worth about ten percent less at sale than one that is not. But if an owner lacks substantial hotel management experience, most lenders will require a professional manager to be in place before they will commit to financing. Brands with flagship or luxury marquees insist on tight control and most will seldom put their name on a property they do not manage. Many owners prefer to focus on the development and entrepreneurial parts of the business and leave the details to someone else. For these and other reasons, if you have a sizeable property it is likely that a third-party is managing your hotel under a long-term agreement.
There are differences if you are dealing with one of the third-party managers like Crestline or Interstate, which manage properties across multiple chains and brands. In this article, I’d like to focus on the big brand managers; the companies like Hilton, Hyatt, InterContinental Hotels Group, Marriott, and Starwood, all who manage several different branded hotels within their own organizations. So, they are managing the brand, they are managing the system and they are managing your individual hotel. They wear several “hats” in the process and you need to recognize is that at times the “brand hat” or the “system hat” may not necessarily be a good fit with the needs of your property. Let’s look at a few of the areas of potential conflict:
System Standards and Bureaucracy
A management company is a bureaucracy, with hierarchical organization and formal rules put in place to assure standards of performance and service. Those characteristics are good, to a point, but they are accompanied by difficulty of making changes quickly, limitations on risk-taking, and a tendency to let inertia continue, at least for a while. Most managers appear to drink heavily of the company “Kool-Ade” and if you speak with them you will find that they honestly think their brand is the best, that the hotel owner should almost feel privileged to have them managing for him and if the company did not already “invent” it, it is either unnecessary or not very good.
Brands now get input from “owner advisory councils,” but some of the brand standards seem to be capricious, and to have little foundation in customer-based research. Things like ice buckets and bathroom amenities seem to be forever changing, resulting in shortened useful life and increased owner cost. Has anyone documented that these make any significant difference in customer choice or satisfaction, or did the change occur because a brand official was tired of the old ones, or received a great sales pitch from a supplier?
The business downturn that followed the events of September 11 brought new willingness by the brands to reconsider some of the standards of operation, at least during bad times, but many of them remain arbitrary. A hotel that has virtually no demand for its restaurant after 2:00 p.m. may still be required to keep it open until 2:30 or 3:00 p.m., and absorb the extra costs to do so, in order to comply with brand standards. The “me-too” approach followed by the airline industry is in evidence, with “improvements” made by one of the major brands quickly matched by the others, without apparent study of actual guest impact. The point of difference temporarily created is quickly lost, and higher marginal costs are institutionalized. Take a look at the varieties of new bedding, wireless high-speed Internet, flat-screen televisions and Starbuck’s coffee for a few examples.
An owner, however restrained, typically wants it “now.” He expects the manager to instantly identify problems and opportunities and to act on them with all dispatch to reduce costs and increase sales. It is easy to lose sight of the reality that the management company rules and chain of command must be followed, and frequently it is necessary for communication to move up and down the line before action is approved and can be taken.
An owner wishes to provide guests with what they want, and are willing to pay for, but not more. Change for the sake of change costs him money.
Fee-based Revenue
The manager typically gets a base fee based on a percentage of total revenue and an incentive fee based on profits. The base fee is not dependent on the revenue being profitable to the owner and sometimes it is not. The manager can drive revenue at both the hotel and the brand level, thus increasing fees, without providing a profit to the hotel or a return to the owner. A few examples:
• Unprofitable brunches and holiday parties; more food outlets open than needed, uneconomic local food and beverage promotions.
• Marketing programs that produce new business, but at disproportionately high cost.
• Changes in system standards previously discussed, from logos and signage to bedding and flat-screen televisions to new lobby schemes. The owner is required to provide capital for them in order to continue to meet brand standards. Some may increase room rates and revenue, and so fees to the brand, but they may not produce an acceptable return on the extra owner investment needed.
Cost Recovery for System Services
An owner expects to bear a share of system costs. But does the allocation method distribute them fairly, or, in the words of George Orwell, are “some pigs more equal than others?” Some points to consider:
• Revenue-based assessments place the greatest burden on the larger, high-rate city and resort hotels. The cost to deliver the service may not be any greater than the cost to deliver the same service to a smaller, suburban hotel.
• Several of the brands run with an area manager or Area V.P. organization, where a person who is responsible for several managed properties is also the General Manager of a hotel. There are also shared services agreements, under which accounting, sales and revenue management, to name three, are performed for several properties and costs distributed among them. You may assume these arrangements work out well for the brand. You need to be sure they are effective and fair for your hotel.
• Costs for new programs put in place are usually recovered through allocation to the properties then in the system. Once a program is up and running, a hotel added to the brand comes in under the umbrella. If it is lucky, a hotel that helped fund the start-up gets some benefit of the economies of scale in the form of a lower unit cost. The “goodwill” accrues only to the brand, and becomes another system advantage that can be used to attract new properties – which may be potential competitors.
• When new brands are introduced under the “family umbrella,” they share much of system marketing, the frequent traveler program, and the like. But they may not pay the same rates or any start-up fees.
• A hotel may be required to participate in and pay for programs it does not need, or which it may be able to get at least the equivalent of locally at a lower cost. The timetable for implementation of a program at a property may lead to displaced revenue or increased costs.
System Growth
Growth and vitality of the brand has far greater benefit for its owner than does any single property, however large and grand. More rooms means exposure to more customers and increased brand awareness. It also means more franchise/marketing/ management fees, greater clout for shared marketing programs, more frequent traveler card carriers and more hotels to share costs among. Therefore, one of the top priorities for brand managers is to grow the number of properties in the system. The newest property may be down the street, or around the corner from your hotel.
The brand CEO’s reasoning is disarming: “The new brand facility is not being built to compete for your hotel’s customers; we are putting it into place to attract guests your property is not now serving and to take business away from other competing brands. It will have little or no affect on your hotel.” But let’s have a dose of reality: unless the new-build is a convention hotel or a destination resort that creates (or at least relocates) demand, the new property will feed off the customers already in the market. Some will be ones who formerly stayed at your hotel. And they will have equal access to what were formerly your competitive advantages: the brand affiliation, its reservations system and the frequent traveler program. The new property will be completely new (or totally redone if it is a conversion). Some of the amenities and services you now charge for (breakfast and high-speed Internet are notable) may be free. And its room rates may be lower. So it should not surprise if you then see your occupancy falling, your room rates under pressure, or a little less contribution to occupancy from the family reservation system and the brand frequent traveler program.
There is a huge financial incentive for a brand to put a new hotel into your market, especially if it is a franchised one. Take the case of 2007 performance cited for mature hotels of one brand in a family cited in its franchise offering circular: occupancy at 71.9% and average rate of $121.15. For a 120-room facility, at average performance, this would suggest rooms revenue of more than $3.8 million. Such a property would produce total fees to the brand over $375,000, of which perhaps roundly half would be profit, suggesting incremental brand net income of at least $190,000. Assume the brand manager was earning incentive management fees from your hotel at 15% of cash flow over a given hurdle rate. It could “give up” $50,000 in incentive fees and remain $140,000 ahead. But such a loss of income would translate to lost profits of more than $333,000 to the managed hotel owner.
That brings us to the asset manager’s secret. The (say) $333,000 in lost income may be only a short-term headache. The real financial impact is the reduction in hotel asset value. If the “cap rate” for the property is 8.0, those lost profits translate into over $4.1 million in lost value, or in the potential selling price of the hotel.
If you have a territorial restriction in your Management Agreement, about the only protection it gives you is that another hotel with the same name as yours won’t be built within the named radius. But wait – the brands have many other “arrows in their quiver.” If you own a Marriott Hotel, you could find yourself in competition with a Renaissance; if you have a Hilton, you could see a DoubleTree; if you have a Westin you might have to compete with a Sheraton; if you own a Crowne Plaza you might wind up with an InterContinental nearby.
The threat of another “big box,” though these have happened in larger cities, may be the least of your concerns. What you need to watch out for are the “ankle biters” that are part of the same brand family and which share a common reservation system and the same frequent traveler card. Let’s look at the possibilities from the major brands who manage:
Those are just the main brands. Several have a suite product (Hilton Suites - Marriott Suites - Sheraton Suites) besides the separate all-suites brands listed. Most also have a Resorts designation; several have vacation ownership tag-on’s and spa sub-brands are beginning to emerge. Several of the brands above are relatively new – at least under their current owners. And more are coming.
There are other areas where the goals of the owner and the manager may be very different. Let’s look at a few of them:
Managers Job Growth, Career Path, Bonuses and Benefits
As long as there is good performance, an owner would prefer the hotel’s executive team to remain in place for a long time. That way they become involved in the community and are familiar to key customers. The owner expects to see them compensated competitively, but does not expect to pay for packages that are much greater than what prevails in the local market. The manager is trying to provide relatively consistent levels of pay throughout the company, and is compelled to be competitive in major markets. This may lead to inflated management salary levels in smaller cities. Management companies aspire to provide job security for their managers and tend to be slower in ordering layoffs or delaying the fill of a vacant position than an owner may feel is warranted by the current activity levels or economic conditions.
The manager also strives to create career paths for employees who wish to pursue them; moving department heads to management positions and key managers at smaller hotels to larger ones. The turnover tends to create temporary gaps in managed hotel service delivery and cost efficiency, and usually results in billing the property for relocation and sometimes recruitment costs.
Bonus plans are better than they once were, with several of the managers using some form of a “balanced scorecard” to work out eligibility, but there still may be disconnects between annual owner profitability and long-term viability of the property and the amount of bonuses paid. Bonus is usually calculated based on the annual budget, so there is opportunity for an “enterprising” manager to “sandbag,” (purposely understate expected profits) or “milk” a property by temporarily cutting back in areas like sales and maintenance to reach a greater bottom line and earn a higher bonus. Eventually, these “savings” need to be repaid. Usually, the catch-up cost is higher, and, with the loss of revenue that occurs while this is being done, leads to significantly reduced distributions to the owner. Finally, the brand wishes to be an employer of choice and to compare equally or favorably with other brands in benefits. This tends to create a condition known as “a rising tide that floats all boats,” with brand managers who are paying little of the benefit costs themselves, passing on the costs of what seems like a “Cadillac” benefits program to hotel owners.
Marketing Programs
Brand managers tend to focus on participation levels and economies of scale when these are developed and managed. This may result in a hotel being placed under a particular marketing “umbrella,” and paying its share of the costs for a program that is not suitable, and which does not add value. There are also questionable and probably unproductive advertising “rollups” where an in-season hotel winds up offering a “value rate” like $279 in an ad, next to an off-season property in a different locale that is advertising a rate like $99. Brand programs advertised that feature extras like free breakfast to stimulate weekend occupancy may take dollars away from a hotel whose weekends are already strong. “Participating hotels only” gives a property an opportunity to opt out, but the brands highly encourage participation and customers, who usually do not look at the fine print until it is shown to them, tend to become displeased at an exception.
Hotel web sites that are designed by the manager are typically designed with the brand in mind, not the individual hotel. An independent competitor, and/or possibly another branded hotel in the same market may have a web site that loads more quickly, is more graphically powerful and user-friendly and which has been better optimized for search engines than yours. The groups and meetings tab on your hotel web site will take you back to the brand screen in several cases. The planner who wishes to get an RFP from your property may have to enter its name all over again. Sometimes, they will be invited to consider alternatives from other hotels within the brand.
System Roll-outs
These range from things like a new property management system to maintenance tracking systems to new training programs to a new amenity package. Most seem to be developed to fit an “average” property, and there is often little provision for individualized hotel needs, goods already on hand or guest demand. New installation and training costs almost always have to be paid. Like early settlers of the west, the hotels that pioneer systems installations tend to collect “arrows,” as the system is refined on the fly. Unless there is an urgent need at the property level, or the owner is angling for other favors from the brand managers, there is little advantage to being on the front end of one of these rollouts.
Purchasing Programs
These are also designed to fit a “typical” brand hotel and participation by the management team is strongly encouraged, if not mandated. This may not produce the best possible cost savings in a property for several reasons including:
• A hotel may have specialized needs that cannot be met on a cost effective basis
• A named supplier, who is considered best across the system, may have inferior operations in the area where the hotel is located. I have seen this in the area of elevator maintenance.
• Other hotels of other brands that are in the same market create opportunities to use local suppliers to get equal or better quality at lower prices. I have personally experienced this in the Orlando, Florida market.
• Minimum order requirements, that are necessary to limit delivery costs, may not be a good fit with the use patterns and economic order quantity of a particular hotel.
• Food purchase specifications may not be optimized for intended use of the product or what customers are willing to pay for. A hotel may find itself overpaying for quality it does not use and which its customers do not expect.
Reconciling the Differences
The successful hotel owner who has one of the big brand managers directing the operations of his property needs first to understand the manager’s goals and how they differ from those of ownership. He or she then needs to become a healthy skeptic about actions the brand takes and programs it proposes. Next steps include:
• Challenge the status quo. Request managers to prepare mini-P & L’s to prove the profitability, or lack of it, of multiple food and beverage outlets, brunches, holiday dinners and other special promotions.
• Strive to cut through the bureaucratic “maze” by regular and thorough reviews of hotel performance – from revenue and cost variances to market share to sales production and booking pace. Get explanations for, and thoroughly understand the reasons for “positive” variances, as well as negative ones. Push for actions and timetables to solve problems identified and exploit new opportunities surfaced. Do not accept “business as usual” unless it truly is, and you are completely satisfied with your cash flow and investment return. Participate in brand advisory councils, or at least provide input to other “representative” owners who do.
• Study, understand and question the annual operating and capital budgets. Get information about trends from industry experts and other owners and compare to what is happening at your hotel and in the local market. Get very good explanations for differences or request changes to be made.
• Delve into brand programs. Determine what, if anything, they do for your hotel, how success and ROI (return on investment) are measured and how fees are determined and assessed. If people or services are shared, be sure that the arrangements lead to favorable results at a fair cost for your hotel.
• Unless there is an urgent need, try to keep your hotel in at least the second of three waves for system rollout timetables. That way the system put into effect at your property will be more fully tested and modified.
• Go on record with challenges to new hotels of a brand family that are proposed for your market area. Document current and future contribution from the brand’s reservation system and frequent traveler program for follow-up with senior brand executives.
• Get your own hotel web site, or at least a “splash page” if the brand will let you have one. Most brands now oppose this, but many exceptions exist. Have that web site professionally designed and search engine optimized. Recognize that this is not a static process; the site needs to be checked and updated often. If you cannot get your own hotel web site, lobby for and insist that the one developed by the brand be upgraded.
• Demand to see the benefits to your hotel from joining in buying programs. Government regulation has required this to be voluntary and if they are not paying off for you, you may get out.
• Regularly monitor conformance of the manager to the terms of the management agreement and document instances of non-compliance. This may not be more earthshaking than (for example) a brief letter saying that the monthly financial statement that was due on the tenth of the next month was not received until the 14th and that it is expected by the tenth in the future. This puts you on record as not tacitly condoning non-conformance by silence. It also provides the owner with a “gotcha,” which may, with others, become useful when a serious divergence occurs between the interests of the owners and that of the brand managers, and remedies available under the agreement are considered or possible renegotiation of the management agreement seems called for.
Unfortunately, hotel demand is currently weakening in most markets; room rates are under pressure and hotel profits are declining. Reduced leverage and higher cost of debt will reduce the prospect of new brand competition for a time, but will also lessen the value of an existing hotel asset. The disparity between the goals of the brand manager and the hotel owner is likely to widen and stress levels are apt to increase. An owner needs to understand those differences, and take aggressive action to restore or maintain balance and assure that the management company fully understands and remains focused on the owner’s goals. In that way, he will retain the maximum amount of cash flow and investment return possible and preserve more of the asset value.
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