Third-Party Management Agreements

Most people in the travel business, and many outside it, are familiar with four models of hotel operations:

1. Owned – Independently owned and managed

2. Managed – Fully serviced and managed by a brand

3. Franchised – Managed by owner together with a brand and their eco-system

4. Leased – Head-leased property from landlord

In South Africa, the first two models have ruled the roost for several decades. The UK has a strong combination of all four models with the lease model being the least favoured due to the mitigating risks involved. Most established brands in these parts of the world either own the hotels that they operate or have a management contract with the owner.

The third model – Franchised – is fast gaining in popularity over recent years, for many mutually beneficial reasons. In the US and Europe, most branded hotels operate under soe sort of a franchise model, leaving the brands to focus on marketing, distribution, and development. This model gives the owners direct control over the operations of the hotel while enjoying the support and recall factor of a known global brand. However, it is contingent on the ownership possessing the requisite skillsets to operate the hotel themselves and the hotel complying to the selected brand standards.

Another model that has been prevalent in more developed markets and is rearing its head in developing markets in recent years is that of third-party management. To put it simply, this is a hybrid version of both a management contract and a franchising model. An owner might want to be more involved in his asset but lack the operational skills, team, or inclination to operate the hotel themselves. At the same time, they recognise the benefits of having an established brand name on their hotel.

Enter the third-party soft brand or independent hotel operator, who will sign a management contract and may also help negotiate a more favourable franchise arrangement with a brand of the owners choice. This forms a three-way partnership between the owner, operator, and brand which has had major successes globally.

With a third-party operator, there is also room for a more direct dialogue between the owner and operator, and by default also through to the brand, about what is really important and necessary for that particular asset. The owner and operator can, in many cases, choose which of the franchised brand programmes and initiatives they want to participate in and select certain levels of brand service.

In the US and UK, most franchised hotels in the midscale segment and upwards are, in fact, third-party managed. Companies like Aimbridge Hospitality, for instance, manages over 1,500 hotels in the US. Highgate alone operates nearly 10% of the total market share in Manhattan. HHM has a portfolio of over 240 hotels across the US and Canada, all third-party managed independent and branded hotels. The above three companies indicate the sheer scale and potential of this model in developing markets like South Africa and also amplify the call for the continued growth of this model across the UK.

“This business model is no stranger to the US and UK but is ‘relatively new’ to the South African market and still needs a lot of explanation across many big hotel owner boardroom tables. Having said that the opportunity to evolve and learn from the developed markets have shown that the performance outputs increase exponentially due to multiple professionals holding each other accountable for the greater good of one hotel business while driving stronger top-line revenues and cost efficiencies,” says Neil Hughes, Managing Director of Providence Hotels in South Africa.

While popular in the developed hospitality markets, the third-party management model has only recently started gaining ground in developing markets like South Africa. Below is some food for thought for a hotel owner or investor on the benefits to be had under a third-party management agreement.

Third-Party Management Agreements can offer Shorter and more Flexible contract terms:

Hotel companies see a management contract as a long-term strategy and, therefore, ask for longer durations with stricter termination clauses to protect their longer terms interests. While this might work for some owners, others might be averse to committing upfront for too many years. A third-party operator is more likely to be amenable to a shorter contract period and with more flexible terms. For instance, it might be possible to sign a third-party management contract for, say, ten years while brands would ask for at least twice that duration or more if it were only managed under their brand.

It is also easier to sell a hotel asset unencumbered from a brand and inflexible contract, thereby potentially increasing its market appeal and eliciting more responses. At the end of the day, it all depends on the long-term goals of the owner and whether this fits into their ownership and investment strategy.

Efficiency of a management structure with lower costs:

Big brand hotel companies can have costs towards corporate-level initiatives, improvements in brand standards, and so on, from time to time. These are implemented by the brand uniformly across its portfolio and, in most cases, the owner does not have a choice in the matter. With a third-party operator, there is room for a more direct dialogue between the owner and operator about what is really important and necessary for that particular asset within its specific market and under its own unique circumstances.

The owner and operator can, in many cases, choose which of the franchised brand programmes and initiatives they want to participate in, brand dependent, and this can have a direct and significant impact on a hotel’s bottom line.

More flexibility on brand specifications:

While considering an asset to sign up, hotel brands have very specific standards for each brand within their portfolio. For pre-existing or “brownfield” assets, this might lead to additional project costs to become compliant with these required standards.

In some cases, compliance might simply not be possible due to structural limitations. On the other hand, a third-party operator is usually more flexible on this required property improvement front, assessing each hotel rather as an individual asset than through the lens of a common brand standard.

Similarly, hotel brands tend to be more open to a franchise arrangement than a management contract with a less-than-fully-brand-compliant asset; assuming, of course, that the bare minimum standards and FLS (fire and life safety) norms are met.

More localised attention and a hands-on approach:

Since, in most cases, the third-party operator is based within the same country or region, there is a direct line of oversight between the operator head office and hotel asset. A smaller team structure and fewer levels of hierarchy mean that performance analyses and strategic decisions are taken by the most experienced professionals in the team and not solely dependent on the unit head. The collective experience of the team is available for the benefit of the hotel and its owner. Also, being of local origin, a third-party operator has a better understanding of the market in which it operates.

“This aspect of developing your business and evolving within a market cannot be over emphasised. It is absolutely paramount to have an operator that understands, speaks lives and breathes the local culture. Without this you are dealing with corporate hierarchies that have no idea of the local complexities and ways of doing things,” adds Hughes.

Alignment with owner’s interests:

A hotel brand typically has priorities aligned with its own corporate strategies, brand development and brand shareholder interests. The priorities of an owner might sometimes end up getting pushed down the list. A third-party operator, being a smaller entity than a big global brand and in more direct contact with an owner, is more likely to be aligned with their interests and be more agile in their approach.

This is a critical factor in the selection of an independent operator by the hotel owner looking to hand over the reins to someone else to operate their hotel asset.

Third-Party Operators have multi-brand knowledge and experience:

Third-party operators are likely to be working or have worked with multiple brands and so, tend to be more aware of varying market dynamics. They have exposure to best practices from different companies and thus, can be more effective in a competitive environment.

Independent Hotel Companies understand all of the distribution and technical systems used and become the drivers together with the owners and brand of the local, regional and international hotel strategy and can keep an eye on things that owners may miss or not fully understand. Also, understanding the local business and social cultures is essential to success in established and developing markets and many times it is only the local operators that can breach these gaps in communication and understanding most especially in developing markets.

This also assists in the various franchise contract negotiations during the time of determining which brand is the best possible fit for a property so perhaps a good idea to have your independent operator on board before you select and negotiate your franchised brand.

Big Hotel Brands are more receptive to the Third-Party Management model

International hotel brands are today far more open to franchising their brands than ever before. They recognise that this is an effective way to quickly increase their footprint in a new or developing region. Marriott, Hilton, Accor, Hyatt and Minor are now more willing to consider franchise agreements, especially for their budget, midscale and upscale brands across developing markets.

Wyndham Hotels and Resorts, the largest franchised portfolio of hotels in the world, is very bullish about its growth in Africa and across the UK. If there is an experienced third-party operator to run these assets, it would no doubt give big brand franchisor’s an additional sense of comfort.

Fee Structures under a Third-Party Management Agreement:

On the flip side, though, a hotel owner will have to pay the third-party operator as well as franchising fees to the brand. If the contracts are negotiated properly and in the best interests of the hotel business this might decrease the additional load but there is invariably an increase in their total pay-out vis-à-vis a conventional management contract.

However, an experienced operator should be able to mitigate this through diligent expense management so that there is no impact on the bottom line and should also be able to increase top line revenues by using the brand and its systems to the hotels advantage.

Asset Management by an Independent Hotel Operator:

Another route to consider for an owner could be to hire a strong Asset Manager to oversee hotel performance. An Asset Manager can make the difference between a hotel that is a success or not, by closely monitoring key performance metrics and contributing to its long-term strategies.

In a branded hotel on a management contract, an Asset Manager can work as a bridge between the operator and owner to communicate expectations, control under-performance, and align goals. Providence Hotels offers Asset Management services and has done so for almost a decade now to many hotels across South Africa and the UK. We see this, and third-party management, as growing needs of the industry in the future of both markets but especially in South Africa.

De-flagging in Today’s Economic Climate:

De-flagging is a streamlined restructuring in which a company decides to operate as a distinct, independent unit while removing its brand identification.

Heavily contributed to recent economic times, many large hotels are choosing to go independent to bring a unique customer experience and to stand out in a competitive market. De-flagging allows hotels to let go of the limits of a brand and make a name for themselves.

With the access to information and understanding of hospitality technical systems and global distribution it is much more of a reality to owners that, with the right independent operator and assistance, they can take their hotel asset to the market independently. For many hotels this has been a very lucrative conversion but only those hotels and owners that have implemented the right support structures around them.

In conclusion:

While the points listed above might help an owner make an informed decision, the most crucial step is the assessment and selection of a qualified hospitality partner. There are several companies in the market to pick from among hotel brands, but very few credible and established third-party operators and asset managers.

An owner must be thorough and objective while screening its options. This selection will lead to the start of a long partnership so due diligence is critical to ensure its success.

“Hotel owners across the UK and South Africa, and other more developing markets, are looking for alternative models to consider and the rise of the Third-Party Management models are becoming more and more prevalent. These offer owners and investors flexibility and agility within their markets and allow them to have a voice in the future of their asset. With the right independent management company at your side you should have a stronger performing hotel business and asset,” comments Hughes.

About Providence Hotels:

Providence Hotels is a dynamic and innovative full-service hotel management company currently operating more than 20 hotel properties across the UK and South Africa over the full spectrum of hotels, resorts, serviced-apartments, lodges, and boutique guest house establishments. Their experienced management teams work in collaboration with individual hotels to develop a bespoke hotel management solution for each of their individual properties. They focus on specifically defined operational approaches, bespoke sales & marketing strategies, and superior hospitality finance advice to ensure sustainable growth of revenues and across all guest and stakeholder touchpoints.

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