Performance control on the horizon

Everything is changing except for the agreements? Experts will shed light on this subject in a panel discussion at this year’s hotel conference at Expo Real. Martin Schaffer, Managing Partner at the consultancy mrp hotels in Vienna (and host in this talk), explains the topic of distribution costs, franchise fees and performance control in this guest contribution.

„All chains have to expand in order to generate more revenue. Behind this growth, a large distribution engine is normally hidden away and with it, an enormous cost pool. Today, during negotiations between investors/owners and operators, questions concerning distribution usually arise after ten minutes, except in negotiations for fixed lease agreements. Distribution costs are increasing significantly; in some cases, commissions to OTAs amount to eight to ten percent of the revenue alone (without including discounts to tour operators); the summarised fees of the chains often amount to more than ten percent of the revenue in addition.

Consequently, the obvious question of an investor for a potential operator is: What does your brand offer me for ten percent? How much are the total distribution costs, as there are also savings on OTA commissions through global deals? So far, the average daily rate (ADR) has been the right parameter for the comparison of hotels but it has to be some kind of ’net ADR‘ in future – ADR minus distribution costs.

Fee structures are outdated

Through internet fees, distribution costs have changed considerably in the last few years resulting in far-reaching consequences for the hotel’s profitability. This highly complex, difficult and very dynamic subject thus arouses increased alertness on both sides of the bargaining table. In order to keep up in the fast global growth competition, operators need simple agreements and distribution models (especially in franchise), which do not overtax anybody. The fast global growth of the chains is one of the reasons for the spreading of franchise.

In reality, amongst others, this correlation becomes visible through the fact that even mega players have allocated their ‚core brands‘ (e.g. Hilton, Marriott, InterContinental, Sheraton) for franchising in individual cases. Most recent examples include Esplanade Hotel Berlin as Sheraton franchise or Le Méridien Hamburg as a franchise with the lessee Munich Hotel Partners.

The currently high demand on properties raises the buying prices and therefore increases the expectations of the lessee and franchise partner. Due to this, franchise will only be possible at locations with a high GOP in future. The fee structures of the mega chains are often unsuitable for B and C locations, which are in high demand among most of them at the moment. Nonetheless, the run on these locations continues!

Today, franchise agreement costs make up ten to 15 percent of the total revenue, depending on the strength of the brand. In reference to the described development, investors/owners also demand a performance orientation for franchise agreements, as has been the case with management or lease agreements for a long time now. They only want to pay what the chain delivers. However, they often forget that strong brands are able to achieve higher ADR and generate a higher loyalty among the guests. German Treugast Consulting concluded this July: Brands are driving rates. On
average, brand hotels are able to obtain room rates that are 15 percent higher than those of individual hotels in Germany.

Performance tests increasingly discussed

So far, there are only very few standardised ‚control lists‘ on the market for the brand performance concerning franchising. According to MRP Hotels, such systems should be developed. If no fixed lease agreements are concluded, owners will have to observe the performance vigilantly in future. Owners who conclude lease agreements based on revenue, NOI or GOP will have to deal with running business operations in detail to be able to estimate the performance, just like in a management agreement. If they are unable to do it themselves, they have to employ asset managers.

For some time now, the chains have been retracting from lease agreements in the German-speaking countries as well. Existing lease agreements expire, and then operations are transferred to lease companies with a franchise brand. The dilemma for the investor: with these new and in most cases still very small lease companies, no recoverable corporate guarantees can be achieved and they are dependable on the funding of the lease company or the individual ’special project vehicles‘.

Performance tests have to be initiated by the owner or investor during negotiations. There is a big discussion on this subject in the market. Which criteria or factors have to be taken into consideration during such tests? Definitely a comparison among competitors with so-called ‚competitive sets‘ based on ADR, occupancy or room revenue (RevPAR). However, distribution costs cannot be compared this way (especially as there are no published investigations à la STR) – the brand could have bought its business for a considerable amount (via high commissions). Conceivable could also be that owner and operator negotiate a fixed degree of performance in percent or orientate themselves towards pre-defined revenue, results or budget achievement threshold values, which they are not allowed to fall short of.

The conclusion from this distribution and performance issue can only be that increased sales performance has to be incentivised. Or chains have to substantially improve their own advantages from their deals with OTAs, especially with respect to globally better conditions. Then, the management would be able to re-earn its fees for the brand very fast. – The calculation begins.“

Articel by Martin Schaffer, MRICS issued in Hospitality Inside


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