Impact (Called Encroachment in Other Industries).
Impact is probably the most contentious issue between franchisees and franchisors, in all industries. Impact occurs when a new hotel in the chain takes business away from an existing hotel. It’s a troubling topic because every $100,000 in lost revenue to the franchisee means a loss of only $10,000 to the franchisor (royalties, reservation and marketing fees total approximately 10 percent of room revenues). Meanwhile the new hotel may represent a $100,000 to a million dollars annually in new revenues to the franchisor. The franchisor stands to earn a substantial net benefit from impacting the franchisee.
Franchisee.
The franchisee’s approach to impact is relatively simple, the System should grow, but not in my backyard. Every dollar lost to impact represents lower profits, and lower asset value. Impact, to a franchisee, is cumulative. For example, the sister hotel 15 miles west may only have taken one occupancy point, and the sister hotel 20 miles south may only have taken one occupancy point, and the sister hotel 10 miles southeast may only have taken two, but add one more and the total loss may be over 6 percent of revenues and may change a profit to a loss. If my franchisor denies this application, because of impact, this new competitor may never be built. As long as I am constantly threatened with impact, I cannot trust my franchisor to treat me fairly in business. I am concerned about retribution if I object. I am concerned about new competition from my franchisor because my marketing information is stored in the franchisor’s computer.
Franchisor.
The value of the brand is based on its distribution. If the brand doesn’t have enough representation in a city, than none of the brand’s hotels will perform. Further, if the system doesn’t have enough hotels, it will not have the funds for effective marketing. Franchisees have ulterior motives for claiming impact. They may want to protect a hotel that is vulnerable due to a lack of renovation. They may own a hotel of another brand near the new location, and want to protect that hotel from competition, etc. The brand has to be represented in these sub-markets if it is to be successful. If we don’t develop the location, and make our rooms available to our customers, someone else will get those customers. If we don’t license this hotel, someone else will and they may take even more of your business. We intend to be fair to our franchisees in the matter of impact; they just have to trust us.
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Impact is particularly threatening when the franchisor is also the owner and operator of the new hotel. In these situations, the franchisee generally is concerned that his hotel will take second place in the reservation system, and in marketing programs. Concern about conflicts of interest in terms of data use and concern about retribution also become more prevalent in these circumstances. In general, there is no protection from impact for the franchisee within the franchise agreement. To the contrary, most franchise agreements specifically reserve the right for franchisors to add units at any location. Instead, some hotel franchisors provide “Impact Policies” specifying the level of protection they offer. Unlike franchise agreements, impact policies can be changed at any time. Impact policies offer one of two forms of protection.
Area of Protection – is a protected territory around the franchisee hotel in which the franchisor agrees not to license new properties. The trouble with areas of protection is that markets change. Over the course of a 20 year franchise agreement, the bounds of a reasonable territory might grow or shrink by ten miles in any direction. Recognizing this problem, franchisors confine areas of protection to small sub-markets. The adjoining sub-market then becomes fair game for a competing hotel in the same franchise, and that new hotel may be on the border of the existing area of protection.
Impact Study – is an estimate of the revenues the existing franchisee will lose if the additional hotel is licensed. Franchisors with impact study policies generally have a hurdle such as 3 percent of occupancy or 5 percent of room sales. If the estimate is higher than the hurdle, the new franchise is denied. The measure of impact is generally defined as the amount of franchise-generated business that would be lost and could not be replaced, if a hotel of the same brand is opened, rather than a hotel of a comparable brand. Three percent seems like a hurdle that would be readily exceeded, but the definition is so narrow that the hurdle is hard to reach. Particularly since the studies do not always measure the difference in impact if no new hotel is developed, which would be likely to be much higher. Further, under these policies, the franchisee may have to defend a hotel by purchasing an impact study every six months, if the franchisor is aggressive about adding distribution in a market.
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So far, a satisfactory formula for compensating a franchisee for revenues lost due to impact has not been established. Franchisors and franchisees continue to propose new compromises.
Termination
Franchise agreements are contracts with a specified term, generally twenty years in the hotel industry. A franchisee who chooses to leave the system is, by contract, commonly liable for the present value of estimated future franchisee fees through the end of the contract term, unless otherwise specified. For a full service hotel, liquidated damages can run into the millions of dollars (for instance liquidated damages could be the present value of 8.5 percent of gross room revenues for ten or more years). They can exceed the market value of the hotel itself. A twenty year agreement with extensions is fine, when the franchisee keeps up the standards of the hotel and the franchisor continues to perform. However, not all relationships are so smooth. A few of the issues that arise concerning termination are listed below.
Franchisee.
If the buyer of my hotel wants to change the brand, but I have to sell encumbered by the franchise, the franchise reduces the value of my hotel. My franchise is reducing my revenues because it holds my rate down; I need to terminate because I need a different brand. Reinvestment required by the brand is too high for me to earn a return in this location; I need to leave the system. My franchise is no longer appropriate for my business, I need to terminate. The franchisor can replace the franchise fees from this hotel with a new hotel in less than a year; no damage is suffered if this hotel leaves the system, liquidated damages should be minimal.
Franchisor.
The heaviest cost to the franchisor, and the biggest benefit to the franchisee, is early in the term when the hotel uses the franchise to establish a customer base and set up operations, termination should not be possible once the franchisee has been availed of this benefit 20 year franchise agreements provide a stable investment platform, and are preferred by lenders. Liquidated damages for most hotels aren’t that much money. If the franchisee can get a higher rate with another franchise, they should pay the liquidated damages out of their increased revenues, and leave the system The franchisor incurs a long term loss if a planned stream of franchise fees from a hotel is taken away.
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The current movement is toward a more conciliatory approach to franchise termination among many hotel franchisors. The three common approaches are:
· to specify an amount of liquidated damages, in the franchisee agreement, that appears less onerous for the franchisee;
· to permit a franchisee to exit if the hotel’s performance is below a hurdle level;
· to offer periodic “windows” or points at which both the franchisee and the franchisor have the option to terminate the agreement.
Traditional agreements only allow the franchisor to terminate the agreement in the event of a default by the franchisee. This is to remove the temptation to kick a franchisee out as soon as a larger and potentially more lucrative hotel becomes available to the franchisor. If a franchisor wants to get rid of a franchisee and can’t persuade them to leave, they look for a default, exit window, or renewal window.
Preferred Vendors.
Franchise companies used to have purchasing departments which franchisees were required to use. The purchasing departments were largely disbanded, under pressure from franchisees. In their place, hotel companies set specifications that franchisees are required to meet when they purchase goods and services directly from vendors. Franchisors also provide a list of preferred vendors which offer special pricing to their franchisees. Most vendors in these programs provide a negotiated price, which may or may not be better than the price the franchisee can get outside the program. However, the negotiated price sets a benchmark, which is beneficial. In the case of logo’s items, the franchisee is more likely to be required to purchase from an approved vendor. In these instances, franchisees are more likely to be concerned that the prices are inflated by licensing charges.
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In some cases, those preferred vendors pay a fee for preferred status, and may contribute to the cost of producing promotional materials which the franchisor distributes to franchisees. In addition, some franchisors command a rebate from the vendor for all sales to their franchisees. In other industries, preferred vendor programs are extremely restrictive. Franchisee discontent in these industries is garnering a response in the hotel industry, particularly since Preferred Vendor programs are getting more restrictive in the hotel industry. In addition, the amount of profit reported by the public hotel companies from these programs is considerable and is getting the attention of franchisees.
Franchisee.
I can get better prices from my vendors than from the franchise preferred vendor programs and I want to be able to select my goods and vendors. If my franchisor is getting a rebate on sales to me, I should at least get a share of the rebate returned to me.
Franchisor.
Consistent quality in the system suffers when franchisees shop for the lowest price; they simply don’t get the same quality. We require franchisees to use the preferred vendor program because it is the only way to control quality in the system. The franchisee gets low prices through our program, even with the rebate, we do not owe franchisees any share of our preferred vendor fees.
Venue.
In the case of a dispute, litigation between a franchisor and franchisee is almost always in the home state of the franchisor. This has been a deterrent to franchisees considering litigation.
Franchisee.
Litigation should be in the jurisdiction where the hotel is located, otherwise the franchisee can’t afford to bring an issue forward.
Franchisor.
Litigation should be in the jurisdiction convenient for the franchisor– it’s just a matter of whose attorneys have to travel.
Transfer, Sale and Renewal.
When ownership of a hotel is transferred, when a hotel is sold, or when a license is renewed, the franchisor has the opportunity to reconsider whether to continue with the franchisee and hotel. Accordingly, at each of these junctures, many franchisors inspect the hotel and provide a “product improvement plan” that must be completed for the hotel to remain in the system. The franchisor also has the opportunity to evaluate the franchisee. The franchisor may accept the buyer of a hotel, or refuse to let that buyer into the franchise system. There is generally a fee associated with this process, and that fee can be significant.
Franchisee.
Transfer fees should be minimal, they make restructuring or changing ownership within a family unreasonably expensive. The brand is part of the value of my hotel asset. I should be able to sell that franchise agreement along with the hotel, as long as there is remaining term. I should not have to do a major renovation to renew my franchise or sell my hotel, the product has been adequate for this brand up until now.
Franchisor.
Transfer fees are a cost of doing business. The brand is our asset. We do not have to license it to anyone we haven’t accepted as a franchisee, or to allow anyone we wouldn’t want in our franchise “family”; while we reserve the right to decline a prospective franchisee, it is uncommon. Renewal is our one chance in the term of the agreement to get rid of a bad franchisee or a bad hotel, if we do not require all renewals to come up to the standard of our newest hotels, then the entire quality of the system will decline.
Sale of a Franchisor.
When a franchise company is sold, the hotel franchise agreements are part and parcel of the sale. The franchisee does not have the right to approve or disapprove the buyer of the franchise company. Nor can the franchisee set minimum standards for the new franchisor, beyond those specified in the franchise agreement. This is a significant issue because buyers of hotel franchise companies have been known to change those companies radically, often having a major impact on their franchisees.
Franchisee.
The franchisor has the right to accept or decline a buyer of my business, I should have similar rights with regard to the buyer of the franchise company. If they don’t perform after a period of time, I should be able to leave the system. After all, the buyer of the franchise company has a much larger impact on my business than the buyer of my hotel has on the franchise company.
Franchisor.
The value of the franchise company depends on the present value of the future income stream from its franchisees. If the franchisees can leave on sale, the franchise company has much less value. As current owner of the franchise company, we can make changes as radical as any buyer, and the franchisee has no recourse. They should have no recourse if a buyer makes those changes.
Information.
We are entering the era of the database and the information in databases is increasingly being sold to third party users. Hotels collect information including the names, employers, telephone numbers, drivers license numbers (in some states), payment habits, credit card numbers, auto tag numbers, frequent flyer numbers, and addresses of their customers (among other information about those customers such as smoking preferences, length of trip and other patterns of travel). More and more of that information is being stored in computers owned by franchise companies. Data about the hotel itself is also increasingly stored in the franchise company’s computer including occupancy, rate structure, group customers, contract accounts and their lead contacts, revenue, and considerable information about the franchisee.
· What happens when the data is sold?
· Should the franchisor be allowed to sell customer data?
· Should the franchisee be allowed to sell guest data?
· Should the data be available for sale to competitors of that hotel within the same brand in the local market? (i.e. should a list of loyal customers from one hotel be sold to a new hotel of the same brand opening a mile away?)
· Should a list of brand loyal guests be sold to another hotel in another market? (Say a hotel in a resort area like Myrtle Beach wants to market to chain loyal guests who have residential zip codes in Greenville and Charlotte.)
· Should the data be available for sale to hotels of other brands owned by the same company?
· Should personal information provided by guests be sold by the hotel company to other companies, like credit card companies, for instance?
· Should a franchisor be allowed to sell information about group and contract accounts at a franchisee hotel?
· Should the personal information provided by the franchisee to the franchisor as part of the application process be confidential?
·If the information is sold, who should get the money?
Personal Liability.
Franchise agreements are generally between one corporation (the franchisor) and another corporation or partnership (the franchisee). However, most franchise agreements require a personal guarantee from the franchisee.
Franchisee.
This is a corporation. Its franchisor should not have recourse to me personally if the corporation and its franchisor have a dispute about fees. The owners of the franchise company don’t provide personal guarantees, they provide corporate guarantees. The personal guarantee puts me unreasonably at risk in the event of a problem.
Franchisor.
Many franchisees are very small companies, and they have little collateral beyond a personal guarantee. They personally guarantee their real estate loans, they can personally guarantee their franchise fees.
Brand Exclusivity.
In other industries, it is common for franchise agreements to restrict franchisees from owning stores of competing brands. This is not commonly enforced in the hotel industry, but remains a feature of some franchise agreements.
Franchisee.
I own a hotel in my community and the market is ready for another hotel. My total revenues will be higher if I have two hotels with different brands and price points than if I expand my existing hotel. Good business dictates building a hotel of another brand.
Franchisor.
Our hotel operations are unique and better than other companies. We do not allow franchisees to operate hotels of other brands because they would use our procedures to benefit another company. Our brand is very strong and relatively expensive. We do not allow franchisees to operate hotels of other brands because they would fill the other hotel with our customers just to pay lower franchise fees. Our goal is to build a system of multi-unit franchisees who are totally committed to our product. If our franchisees want to build additional hotels, we want them to build only our brands.
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