We are currently running a 10-part series discussing particular provisions and concepts within hotel management agreements.
The purpose of this series is to discuss common hotel management agreement provisions and concepts from the perspective of both hotel managers and hotel owners. Hopefully we will touch upon one or more topics which spark an "I've always wondered why that is the way it is but nobody has taken the time to explain it" reaction with you. We trust the discussion goes some way to demystify the topic.
Our 10-part series will cover the following topics:
- Why is the manager's fee based on hotel's revenue and profit and not some other basis?
- Why do some agreements provide that the manager is the owner's agent and some do not?
- Why does the owner employ most or all of the hotel employees (and not the manager)?
- What is the risk/reward relationship between an owner and manager?
- Why does the owner indemnify the manager?
- Why do we need a non-disturbance deed between the owner, manager and financier?
- Why the need for an area of protection?
- Why is the owner usually prevented from selling the hotel to one of the manager's competitors?
- Why does the manager impose restrictions on the owner's ability to finance the hotel?
- What is the importance of brand standards?
- Today, we will continue this series with the fourth topic.
What is the risk/reward relationship between an owner and a manager?
The starting point for this discussion is the hotel owner. The operation of a hotel is usually the hotel owner's business. The hotel owner is entitled to all the profits of the business and is liable to pay all the losses. Profit is what is left after all the hotel's expenses have been deducted from hotel revenue (and losses arise if the expenses exceed the revenues).
Hotel operation is not for the faint hearted.
Like a number of other industries such as airlines, cinema chains and public car parks, the hotel industry is selling a totally perishable product. If a hotel room is not sold for use tonight, say, then it can never be sold again. If tonight has come and gone and the hotel room has remained idle then it has generated zero income for the hotel owner.
Equally in times of high demand, it is very difficult to quickly increase supply. It takes years to plan and build new hotels. During these periods, hotel owners are entitled to significantly increase room rates. If all hotels in a given locality or city are running at 90% plus occupancy on an ongoing basis then it makes commercial sense for the hotel owner to increase room prices - and in instances of ultra high demand - substantially.
The traditional basis by which a hotel manager is paid is a combination of what are termed "Base fees" and "Incentive Fees".
Base Fees are determined by reference to the hotel's revenue.
Incentive Fees are determined by reference to the hotel's profit.
Whilst it is usual for the manager to receive both Base Fees and Incentive Fees, we have seen instances where the manager has agreed to be paid a higher Incentive Fee but no Base fee. Such business terms are not frequently seen in the high-end / luxury hotels sector.
Managers may also be prepared to enter into arrangements where payments or financial concessions are made to the hotel owner as an inducement to select one operator in preference to another. This has been seen in transactions involving highly sought after "trophy" hotels or locations. These financial inducements may take a variety of forms and are generally tailored to the personal circumstances of the specific hotel owner.