Summary: As the industry prepares for the IHIF conference in Berlin, Stephen Greyling gives his views Hotel Management Agreements and why they are no longer fit for purpose.
It is that time of year again when the great and good of the hotel investment industry gather at IHIF in Berlin to discuss the latest trends and disruptors affecting the sector. You can be certain that at IHIF there will be many presentations by operators demonstrating their awareness of industry change: announcements of new brands to attract millennials to their hotels, new apps to combat the latest sharing economy start-up and plenty of “pipeline” bragging.
However, there is one product in need of change that will not be unveiled: an updated form of hotel management contract (“HMA”). This is unfortunate for owners because, whilst the hotel industry has gone through drastic and rapid change in recent years, the typical form of HMA in circulation today is a tired old nag: firmly rooted to its original form introduced over 40 years ago.
From an owner’s perspective, the typical HMA is deficient in many respects, including:
1. The allocation of risk and control between the operator and the owner is wrong. To put it bluntly, operators have too much control, and too little risk. This goes against a basic principle of risk management: the more risk you have, the more control you should have in order to manage that risk. A good example of this is hotel staff. Operators typically expect owners to employ all of the hotel staff, and to indemnify the operator for all liability arising from their actions. However, the owner does not hire, train, direct or supervise the hotel staff day to day; the operator does. Indeed, the owner is usually strictly prohibited under the HMA from interacting with the hotel staff at all. So surely the operator should bear some responsibility for them?
2. The term for which an operator is appointed is too long. Market trends come and go in the blink of an eye. Brands and technology are here one minute, and gone the next. At IHIF, you will continually hear of an industry in change. And of operators changing their business model. Yet, operators still expect to be appointed to run your hotel under the same brand for 20+ years, often justifying the need for a long term in order “to support their stock price”! How can an owner know that the brand they choose for their hotel will still be relevant, and able to attract guests to their hotel, for the next 20 years?
3. Linked to the issue of long operating terms is operators’ reluctance to allow for early termination rights for owners. Where they will agree, it is usually conditional on them being paid an early termination fee equal to a multiple of prior years’ management fees (in some cases, operator’s starting position is a termination fee equivalent to fees payable for the remainder of the term!). This means that owners have no flexibility to adjust their strategy to meet market trends/changes or, if they do, it comes at a high price.
4. Current performance tests are not fit for purpose, as they rely upon performance metrics that are almost impossible to fail, and usually come with an operator’s right to cure a failure as well as numerous carve out exceptions for poor performance beyond the operator’s control. Modern performance tests raise enough issues to justify an entire separate article, but save as to say that owners (and operators, for that matter) should be devising new ways to test performance which better reflects today’s industry, and which have some real accountability for operators.
5. Current HMAs are dinosaur relics when it comes to dealing with modern distribution and customer review platforms. For example, nowadays OTAs generate large numbers of bookings for hotels, but the proportion of hotel bookings generated by OTAs rather than the operator’s own distribution platform has no impact upon the fees that the operator receives (indeed, operators still expect to receive reservation and central marketing fees for bookings they didn’t generate!). And today’s younger generation are less inclined to believe traditional advertising produced by the operators, but instead look to user generated content (social media or online reviews) when making decisions where to stay. Isn’t it time that operators’ obligations in HMAs were updated to include obligations to maintain high ratings on online review websites, and to actively and quickly respond to negative online reviews?
Many of these issues can be attributed to the move by many operators to “asset light” business models and the listing of operators on public stock exchanges. These factors have changed operator’s focus, from maximising value for individual owners to maximising value for their brand and shareholders. It has made them much akin to institutional landlords; in the same way that institutional landlords seek low risk income streams from “full repairing and insuring leases” where all of the costs and risks of the property are transferred onto the tenant, operators seek similar guaranteed and almost risk-free income streams from HMAs, whilst placing all of the costs and risks associated with the hotel onto the owner.
Operators will no doubt contest this view, but it was given some credence in a response from a senior executive of a major operator (which shall remain nameless, but which has recently been involved in a significant merger) at a recent conference. When asked why they considered the merger to be a success, their response was: “Just look at our share price”. Whilst that is great news for the operator and its shareholders, how do owners benefit from this?