Definition
Franchising is a method of doing business by which a franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor and which is substantially associated with the franchisor's trademark, name, logo and advertising.
Low risk strategy?
Franchising is one of several options available to hotel and brand owners to maximise the commercial value of their respective businesses. Faced with current challenging market conditions, the ability to access the customer base and reservations infrastructure of a multinational brand may have considerable appeal to independent operators and, for chains with established brands, franchising offers generating revenue from the brand, without the need for significant upfront capital outlay or the level of long term commitment associated with other operating/ownership structures.
International expansion
Technological advances have made international franchising easier to control and expand with less fear of brand dilution. A well-organised franchising strategy can provide speedy and effective access to markets as they become apparent. In Europe, only 19 per cent of the total room stock is franchised. When compared with a figure of 70 per cent in the USA, it is clear that there is considerable scope for the expansion of franchising as a business model in the European hotel market.
Increased regulation
With the expansion of franchising as a business concept has come the expansion of rules governing franchising relationships. National and supra-national regulation of the franchising industry has mushroomed, with many states introducing specific legislation in the past five years to protect franchisees and promote competition. International franchising exposes the parties involved to more levels of regulation.
How does the relationship work?
- The franchisor provides access to an established brand, marketing and loyalty programmes, information sharing and support systems (including purchasing), and usually to a brand-wide reservations system, all aimed at supporting the development of the franchise business.
- The franchisee in return pays for these services and plays a role in the overall expansion of the brand by maintaining and promoting the standards linked to that brand in its operating market and, if the relationships works, generating referrals for other branded hotels. The franchisor generates revenue and gains access to markets and customers, with limited direct financial exposure.
- Beyond these key rights and obligations, the structure and content of a franchise agreement will vary widely depending on the relative bargaining positions of the parties. International brand owners will invariably seek to impose standard terms on franchisees. However, no documents are set in stone, the owner of a trophy hotel in a prime location will be in a strong negotiating position to negotiate more favourable and demanding terms of its franchisor, even when negotiating with an international hotel chain.
In view of these factors, it is vital that due attention is paid to the following key areas when considering a franchising agreement:
Territorial protections
The franchisee wants protection to maximize the commercial potential of the franchise. This protection can relate to both the geographical and product markets in which the franchise is located.
The franchisor will be concerned about the future expansion strategy of the brand overall and will want to ensure that unexplored markets are not locked in to one single franchise. In addition, the franchisor will want to retain maximum flexibility to franchise sister brands in the same market. However these obligations are incorporated, due attention must be given to compliance with relevant legislation, especially where non-compete clauses, and geographical restrictions are concerned.
Protecting the brand
This is the key issue for both parties to the relationship. The agreement has very little value the franchisor or its other franchisees if it fails to specify clearly the operational and brand standards to apply. The ripple effect of problems at one hotel can have serious commercial implications for the wider organisation. Strict performance and presentation standards, operational and training programs, comprehensive review systems (both by the franchisor, and third parties, e.g. mystery guest) and controls on purchasing are all desirable to ensure that the franchisee has access to the tools necessary to maintain and promote the brand, and the franchisor has sufficient control over the operation of the franchise to ensure that this happens.
Fees and payments
Tax treatment of the fees payable under franchising agreements will vary between jurisdictions and is often the driving force in structuring payments under the agreement. Linking royalties to performance (e.g. by RevPAR) benefits both parties by incentivising the franchisee and franchisor to invest money and energy in marketing efforts and the maintenance of brand standards. Other payments can be split on an income and capital basis to maximise tax advantages. Payments for marketing (both global and local), access to reservations systems, development and training costs, and other support services, can be adapted to best fit the tax and commercial strategy of the parties.
Defining and apportioning risk
It is vital that the franchise agreement clearly apportions the risk between the parties. A key element of the franchise relationship is that the franchisee operates the hotel at its own risk and for its own benefit.
Accordingly the franchisor should ensure that:
- The franchisee sets out its own name and details on all invoices, purchase orders and official documentation used by it in connection with the operation and makes it clear that the franchisee is solely responsible for the operation of the hotel, notwithstanding the branding;
- The obligations to insure are clearly defined and that it is named as coinsured where appropriate;
- Robust indemnification provisions are inserted as a backstop if claims are made despite the other measures set out above.
Information technology
The sharing of information and provision of services through dedicated IT systems and virtual private networks is an essential between of today's franchise relationship.
In a franchising paradigm, the franchisee would have unrestricted access to the central reservation system, customer, marketing and pricing information of both the brand owner and other third party franchisees while the franchisor would have a real time access to the franchisee's PMS system and its performance data produced by the franchisee, enabling it to monitor performance and make offer advice on improving yield and or occupancy.
In reality, this level of access and mutual dependence is unusual given the likelihood that a there will be hotels competing for the same customers and, particularly in the conference and function market, hotels in different locations will be competing for the same business. Therefore each party needs to carefully consider its requirements for access to the others and third party systems (be it reservations, loyalty, purchasing airline and travel agent links), minimum equipment specifications and system availability, allocating the costs of inevitable and increasingly frequent system upgrades, data security and other related IT issues.
Conclusions
Both parties to a franchising agreement can gain significant commercial advantages from the relationship. The agreement should reflect the key objectives of both parties and provide the machinery to ensure that these objectives are not eroded.
The agreement can achieve this by:
- A thorough system of performance and quality standards and review processes
- Careful apportionment of risk
- Strategic drafting to minimise regulatory interference and maximise tax advantages.
If you would like to find out more about how franchise issues impact upon the hotel industry please contact Richard Price at richard.price@cms-cmck.com or on +44 (0)20 7367 2066 or Simon Vere Nicoll at simon.verenicoll@cms-cmck.com or on +44 (0) 20 7367 2510.
