HVS Monday Musings: The Dichotomy between Management Fee and Franchising Fee in India
By Dipti Mohan, Senior Manager - Research, New Delhi and Akash Datta, Senior Vice President - Consulting & Valuation, New Delhi
Asset-light operating models have become the main stay for growth of many of the major hotel companies in India, with Management Agreements being the preferred structure. The other major asset-light model - Franchising - though is yet to gain significant traction in the country. Approximately 14% of the total brand signings in 2019 were franchised properties as compared to 10% in 2018. On the other hand, Management Agreements accounted for 76% of the total brand signings in both 2019 and 2018. In contrast, hotel franchises are the most popular model in mature markets like the US, where almost 80% are franchised.
In the past, hotel operators' reluctance to grow through the franchise route has been attributed to the following issues:
- Poor adoption of standards by hotel owners because of lack of experience in the sector,
- Low (or no) availability of good quality third party management firms,
- Management Agreements provide a larger revenue generating opportunity.
Herein lies the dichotomy: In many instances the net management fee (base and incentive Fee combined) is either less or at par with those of Franchise Fees - which, we find, are often not very well negotiated. A key reason for such a dichotomy is that managed hotels in India often suffer from lower Gross Operating Profits (GOPs), due to a combination of low Average Daily Rates (ADRs) and smaller key counts than in most other parts of the world. The relatively lower GOPs consequently impact the amount of earnings from the incentive fee. As a result, the overall management fee (including base fee and incentive fee as a percentage of revenue) are often lower or at par with Franchise Fee. The food for thought here is that the operator's responsibility and engagement is significantly higher in a Management Agreement than a Franchise Agreement and should therefore be earning a higher fee.
We believe that the sector should look at resolving this dichotomy. Hotel owners and operators should consider evaluating the franchising option more seriously.
Franchising provides an efficient growth model with lower risk for both hotel brands as well as asset owners due to distribution of responsibilities amongst both parties. It helps in bridging the gap between the brand's growth plans and the owner's concerns on cost of fee paid to brands/operators.
Franchising helps brands to expand their presence quickly, especially to smaller cities and remote locations without incurring substantial recurring capital costs, all-the-while allowing hotel owners more control over day-to-day operations of the property. Franchising truly brings with it the most indispensable attribute of a hotel company, its brand. Add to this the well-established distribution channels, loyalty program affiliation and the related sales & marketing initiatives make Franchising a compelling option.
As per a recent report by Grant Thornton, India, in general, is the second largest franchise market after the US and several sectors, such as retail and restaurants, have used franchising successfully for expansion. It is time for hotel operators to implement best practices followed by the allied sectors, including using technology and forming partnerships with third-party asset managers to promote faster growth. Brands must look to correct this conundrum and seriously evaluate the Franchising option.