Hotel Business Models Have Evolved, why not Hotel Management Agreements?
Photo by Chris Liverani on Unsplash. Right, Vanden Auweele: Time to review HMAs
By Stephan Vanden Auweele
5 July 2022
The hotel management agreement (HMA) was fashioned from the 60s and 70s when the business was different and the first brands, such Hilton and Sheraton, appeared internationally.
In those days, HMAs were simple (I have one from 1973). Everything was covered in 10-15 pages, compared with the 200-plus pages today dotting the i’s and crossing the t’s on investment, liability, distribution, legal — you name it.
Initially operators were also investors. Then they invented the asset-light model, which changed the accountability for each party and clouded their KPIs (Key Performance Indicators) in the eyes of the investor.
This is why the question — “What added value do operators bring to the table today?” — has become perennial among investors. Before, the logo of operators, which was a symbol of their know-how in running hotels (primarily rested on the GM), was enough added value.
But fast forward to today, one can’t blame the owners if they are doubtful about the value of operators. Take this example: Before, a chain’s regional operations team covered 15 to 20 hotel; today it’s 50 to 70 properties.
Most importantly, the business model of the larger operators has changed. It is now less focused on hotel management and more on distribution. This makes owners wonder, at what price are they paying the operator to bring in customers, as this is a huge cost and it affects their bottomline?
While HMA and franchise fees are well discussed and negotiated, we hardly hear anything about distribution fees, which are more complex, and less transparent. They include a mountain of costs including IT, reservation, online and loyalty program costs.
In many cases those fees exceed the management fees. While their existence is justified, how efficient are they? How do they compare with the costs/risks of third-party distributors? What is the percentage of total revenue that is from the operator’s own systems?
There are huge variances in costs/performances of systems between operators. These variances can reach easily 50 percent of GOP margin.
Quick Refresher
Let’s quickly recap the basic principles of an HMA. Investors own the hotel; operators manage it for investors. Yet investors have no right to interfere even though they shoulder virtually all the business risks, unless there’s gross negligence by the operator.
In all the years that I have explained this to investors and senior leaders of other industries, most if not all were astounded. They couldn’t fathom a model where the investor owns the assets (land, walls, furniture, systems, etc), and shoulders the liabilities, while the operator has all the rights to make all the decisions, except investment ones. And this, for 15, 20, 25 years or more.
Yes, there are performance clauses, but how many of those have been applied successfully?
The idea that a GM, along with all the staff, is on your payroll yet reports to someone else in another organization is mind-boggling and, indeed, in many cases has led to confusion and conflict, especially when the GM is being asked, whose P&L or balance sheet are you managing/representing?
Having worked 25-plus years on both sides of the fence (investors and operators), it is clear that the HMA is due for a review.
Today’s business complexity and ‘risk models’ call for a clearly defined scope of responsibility. Large investors may have a better understanding and/or leverage but for small or mid-sized investors , this is surely much more complicated.
The Price of Distribution
Originally, sales & reservation was a main part of hotel operations. Today, attracting customers/bookings is mainly done by an operator’s teams and systems based all over the world, at least for the large operators.
How efficient this is done is unclear, as the investment in these systems is substantial in order to compete with OTAs, tour operators and other online channels. A large operator just announced $1 billion investment in a new system which will take two to three years to develop.
Whereas 10-20 years ago the operators’ call centers would bring five to 10 percent occupancy, these systems can provide up to 70 percent or even more of online bookings.
So, besides the emotional “brand image” of a hotel, distribution is today the main asset that operators bring to the table. Smaller operators struggle, as it is expensive and complex but a necessary evil. Hence many of them end up joining a larger operator’s distribution platform or rely on expensive third-party players.
Other Components
Let’s look at other components of a hotel. Interior design is the responsibility of the design architect. Operators may give some inputs to ensure the hotel is functional and follows the brand standards, with the lower category products being more standardized.
Then there is location, which is key, but this parameter is already known ahead of signing any HMA.
The next part is the physical operation of the hotel, which is mainly overseen by the GM and his team. This team report results to the operator but also to the investor. Normally a face-to-face meeting is held monthly between the GM and the owner representative. Whereas historically the GM was the sole accountable person for the hotel, today the GM is often restricted on many levels on what he/she can do, especially to optimize the commercial approach of the hotel.
Both the operator and the GM surely want to optimize the hotel’s performance. But when a hotel isn’t producing, whose door should the investor knock on?
There is of course the franchise option, where owner runs the hotel. But not all want to do that. Or the lease model, where operator leases the building from the investor. But this is against their asset-light principle.
Different Lenses
From operators’ perspective, their objective is clear: Expand the network, be it HMA, franchise or lease, to grow the customer base, reservations and loyalty. Their asset-light model is all about controlling the customer, not so much about owning or running the property. Location is not their main concern as long as they have quality properties in each. They can switch physical properties within the same city/area without concern.
From owners’ viewpoint, they want to maximize returns on investment, be it short or longterm.
So how do these strategies conflict?
A simple example is when an operator has several hotels in a city. In reality the hotels, owned by different investors, compete with one another. In truth, the scale of the operator, while benefiting all investors, also becomes a conflict of interest when operators try to optimize the performance of each property.
There is a ‘related parties’ clause which stipulates how companies should legally respect each other, but what happens to their investment if their operator has related parties? How well is this conflict of interest controlled and what measures are in place to make each party accountable?
The time has come for an HMA that is more equitable in deliverables and risk sharing.
One way perhaps is to separate the management fee and the distribution fee. Some of the larger operators haven’t changed their distribution fees in 15 years, despite having increased their portfolio by 40-50 percent and enjoying 500 percent increase in production.
One thing is clear, investors, distributors and operators need to look at the challenges ahead and the needs of each other. Some operators have evolved and become distributors also; others still stick to the old operators model despite the business having changed drastically. Covid-19 has only accelerated trends that were already seen in the industry. Investors must question what they are paying for when entering into a longterm partnership with an operator.
On the other side, operators should assess what business they are in, and to what extent their business model aligns/conflicts with the interests of their partners.
Can we get a better win-win equation for all parties?
Stephan Vanden Auweele was chief hospitality group officer of Asset World Corp, a position he left in July 2022 after four years with the company. He was responsible for the overall operation of all the hotels and future developments in the group, which are considerable (see the articles here and here)