By David Schollenberger, Partner, Head of Gaming, Hotels and Leisure, Healys LLP
Many international hotel management and franchising companies and well as franchisees and investors have focused their attention, development efforts and investments in Asia and the US over the past several years. The UK and Europe have seen less focus and expansion in the UK. This may be currently changing with prevailing market conditions.
According to a recent article in the Economist, last year saw hotel occupancy rates reach their highest in a decade in the UK. A building boom in hotels is underway to try to keep up with demand but there is still no sign of over capacity.
Franchising of hotel brands offers a quick and easy way into the hotel business in the UK and has advantages for both franchisees and franchisors.
Franchising hotel brands from the major hotel companies offers a prospective franchisee a tried and tested systems for hotel development, use of a worldwide recognised trade mark, brand, know-how, operating standards and processes and reservations delivery. This allows a franchisee to develop and operate its hotel business more efficiently and with less risk using the valuable assistance and know-how of a hotel company that has decades of experience in the business.
Franchisees must also consider some of the downside of franchising. Franchisees will be required to pay substantial upfront and ongoing fees to the franchisor for use of the brand, training, marketing fees, use of the reservation systems and building and equipping the hotel in accordance with fairly rigid standards. Franchisees must weigh the value of the brands recognition in their locale, the expected reservations delivery of the franchised system and the success of other similar franchises with the brand in their area.
For the franchisor, it allows the quick entry into new markets without having to make a substantial capital investment or financing and keeps the addition of property assets off the balance sheet. It can spread a brand name and goodwill associated with its hotel business much more cost effectively than purchasing land and building company owned hotel properties. Many more hotels can be added to its system in a much shorter timeframe with higher ROIs. With land prices in the UK soaring, particularly in London, franchising is a more attractive vehicle. It is no accident that multinational hotel companies such as Choice Hotels International and IHG do not feature company owned hotel properties but rather rely on franchising for expansion. A franchising relationship also tends to be legally more robust than a hotel management agreement, and is less easy to being successfully legally challenged in courts and terminated.
The key downside for hotel franchisors with franchising is that the operation and upkeep of the hotel is not directly within the control of the franchisor. If the franchisee is not financially strong enough or has sufficient experience and managerial ability, it can lead to a hotel that quickly becomes non-compliant with the brand standards and suffers from lack of investment. Non-compliant hotels in a franchise system damage the reputation of the whole brand. Unsuccessful franchisees will disadvantage the franchisor, hotel guests and all stakeholders. The franchisor may suffer continuous fee disputes with the franchisee and brand dilution caused by a sub-standard hotel. Hotel guests will not receive the benefit of the service level and facilities commensurate with the brand. Investors and financial institutions providing financing for the hotel lose value in their investment or may face financing defaults. Franchisors therefore need to rigourously screen and perform due diligence on franchise applicants. Areas to be vetted include the proposed location for the hotel and competition in the area, the applicants suitability and financial strength, the applicants hotel industry experience and management resources and track records of success in obtaining financing and constructing similar hotels.
From a regulatory standpoint, the UK is a friendly and easy market in which to franchise. Franchising is lightly regulated in the UK . There are no onerous requirements for registration or a Franchise Disclosure Document equivalent to what is required in the US. There is no specific franchise law and general contract principles apply. It is recommended as a best practice, but not mandatory to make a disclosure to prospective franchisees. The British Franchise Association is a trade association in the UK to which many of the major hotel operators offering franchising are members. The BFA’s Code of Conduct provides non-binding guidelines for its members with respect to advertising, disclosure to franchisees and fairness in the relationship between franchisors and franchisees.
Professional legal advisers play an important role in ensuring that both franchisors and franchisees have fair and compliant agreements in establishing and maintaining a franchise relationship. Specialist industry knowledge is important because these relationships are meant to last decades and understanding the rights and duties getting it right on the front end is critical to success.