Many Developers/Owners will leverage their property by engaging in a franchise agreement which will help them benefit from the recognition, distribution and reach of a brand. Determining which franchise affiliation works for the specific model requires a deep analysis of the costs and benefits of each Franchise. By using quantitative and qualitative methods, we can evaluate the franchise development decision.
Let’s begin the analysis by reviewing Moral Hazard. A general hotel manager will operate a hotel as they choose. They will allocate revenues to areas of the operation as they see fit. As business managers, they will manage risk and loss as they choose. Tying a manager to a franchise creates an environment where they must act within the brand standard. They are forced to operate within the confines of a pre-determined set of rules, regulations and expectations. This scenario generally gives the owner more comfort and confidence that their operation is being managed according to their expectations.
The second advantage to a franchise agreement are the Search Costs. To begin a project, owners/developers will spend significant resources to locate the best place for their project. Franchises, that have a healthy operating history, have the analysis to determine best locations for new hotels. Leveraging the franchise will benefit the franchisee to utilize the information and streamline the process of determining best location. It will also help the franchisee get set-up and running faster as the franchisor has the assets necessary to establish themselves in the location at a much faster pace.
A third area to evaluate is Distribution. Hotel Owners must determine the best way to present their product to the market. This is in the form of channel managers, tour operators and/or brand managers (Airbnb, Orbitz, Expedia, etc). When working through a franchisee, these channels are already set-up and running. This excels the distribution and gets the product on the market quickly. Franchisors will generally require a lower cost of booking than a channel or tour operator. This is because the franchise is already earning revenue from the franchise fee. There is an important analysis here that the owner must consider: pay less money up-front and per-month for a non-franchise manger, but pay higher costs for distribution vs higher up-front costs for a franchise, while saving money by utilizing the franchise’s distribution network.
When reviewing the final element, Financing, the Hotel company can use the borrowing capacity and equity of the franchising company to borrow money and expand quickly. This does not apply to all scenarios and some hotel companies are not interested in rapid growth. The companies that have the ability to leverage quickly are those that tie-into a well-known global franchise brand. These large conglomerates are billion-dollar empires that provide small amounts of leverage to hotel companies, which in turn are large sums of money when received by the hotel companies themselves. Both operations are incentivized to grow and expand their footprint, thus ensuring long-standing relationships.
North America continues to be the biggest proponent of utilizing franchises, while Africa is the least. As of 2019, North America consists of more than 60% franchises while the rest of the world is closer to 40% to 50%. Brands play a large role in how to determine hotel operations. Although there is a cost to enrolling a franchise, one must determine if this scenario is worth it for their business model.
