Tough choices

Owners and operators discuss the ups and downs of their relationships

Owners are faced with several options when it comes to choosing an operator and they must think carefully about which path to go down.
Owners are faced with several options when it comes to choosing an operator and they must think carefully about which path to go down.
Mike Scully
Mike Scully
Ahmed Ramdan
Ahmed Ramdan
Sami Al Ansari
Sami Al Ansari
Darroch Crawford
Darroch Crawford
Premier Inn owns and operates three properties in Dubai.
Premier Inn owns and operates three properties in Dubai.
Guido De Wilde
Guido De Wilde
Aloft Abu Dhabi opened at the end of October.
Aloft Abu Dhabi opened at the end of October.
Aloft Abu Dhabi remix lounge, located in the lobby.
Aloft Abu Dhabi remix lounge, located in the lobby.

There are many pros and cons that must be considered when choosing an operator says Seven Tides Hospitality managing director Mike Scully, sparking feedback from other owners, consultants and operators alike

In today’s ever-changing market it is imperative that an owner, when choosing a management company for his property, makes the right decision for both long- and short-term reasons in order to get the maximum return on investment.

Due to the present economic climate, we will find that the enormous pipeline of future hotel projects will remain at best fragile. Projects will take a long while to get off the ground, particularly in cases where an owner needs to raise the necessary capital in order to be able to undertake these projects.

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In order to drive the pipeline forward, we will need far more comprehensive feasibility studies. These must be carried out by parties who know the market, understand the future and, most of all, are savvy in their forecasting of potential revenues and profit ratios.

Once this has been achieved, the owner will then be required to identify the correct management company for his property in a particular market, bearing in mind that decisions are based on economic conditions that will change substantially over the contract’s lifetime, which will be anything from 10 to 25 years.

It is well accepted that, particularly in the Middle East, what I’d like to call “The Big Five” dominate; these operating groups are obviously liked by banks and investors alike on the grounds that they offer an element of security in that they will certainly be around for a while.

However, there are a number of other management options available. These can either be described as local management companies or international companies that are not necessarily well-represented in the region. Many of these stem from the East, though more are now surfacing from the likes of South Africa, Spain, US or Europe.

When considering all these options it is important the owner weighs up the pros and cons of each company in relation to their own business needs – see pointers opposite.

Future predictions

I believe that due to the difficulty in raising the necessary capital, in the foreseeable future we will see a turn-around in the types of management companies and their participation in projects they are involved in.

Owners will require that management companies are more accountable for the profits generated, that benchmarks will be tougher and commitment and responsibility of meeting loan commitments will be shared to a greater extent.

I also believe that the financing of hotels will change in that third-party providers, such as IT, furniture and general fit-out companies, and a number of services such as central engineering and accounting, will be provided on a lease basis over the life of the property. This will reduce the capital the owner is required to raise.

Top tips for owners on choosing an operator

1 Big is not necessarily better. As I have mentioned in previous articles, the Middle East generates most of its business internally and contributions from hotel management systems very seldom go above 5-15% of realistic bookings for resort properties and 10—25% for city centre hotels depending on the operator and loyalty schemes offered.

2 Major hotel management companies often have a number of brands within their portfolio. Some of these are not well-known in this region and are at a disadvantage when marketing, particularly to the leisure sector whose source markets have little knowledge of the brand. Remember these companies’ fees generally come at a higher price too.

3 With today’s GDS and international booking agents, many of whom are internet-based and hold tremendous power in bookings for both leisure and business, smaller independent management companies can be as effective as major hotel companies. We cannot, however, discount the strength of brand awareness, particularly in marginal destinations.

4 Many major brands are more interested in maintaining their brand image and price integrity, which is not necessarily in the best interests of an individual property at a particular time and can result in slow reactions to difficult economic situations.

5 Smaller international management companies based in areas whose feeder markets are not necessarily those of the Middle East can be at a distinct disadvantage as they are not able to draw on regular clientele that the major brands can, however, they try to charge owners similar fees to those set by the major chains.

6 Local companies are very fortunate in this part of the world in that they generally return favourable, fairly competitive revPARs due to internal bookings — see point number one. However on the due diligence front, their systems, manuals, SOPs and ability to really hit the five-star market can be limited. They in many cases struggle to attract good quality management and skills, and consistency can be an issue.

7 Particular care must be taken when appointing management companies who are more driven by their own shareholder value and fees than they are about the return on investment of the individual owner’s property. This in recent years has become increasingly apparent and no doubt will continue to do so in the future.

Take the time to indulge in philosophy

Ròya International CEO Ahmed Ramdan advises a philosophical match

Mike has touched on many of the pertinent issues faced by an owner when selecting a hotel management company and I agree with many of his observations. What I would like to focus on is some of the key criteria that need to be considered prior to an owner making a final selection.

Begin with philosophy

In my view, it all starts with the philosophy. The relationship between an owner and a hotel management company is of utmost importance, after all this is a relationship that should last at least 20-25 years, if not longer. It is a long-term commitment and the relationship should be an enduring one that demonstrates mutual agreement, respect and trust. Of course it ultimately has to make business sense but the key to success is matching the right management company with owner.

Matching brand and product

Ensure an owner is given the appropriate advice and guidance to make sure it is the right brand to match the product while also making sure it is in line with the owner’s objectives.

Commitment from the hotel management company

Unfortunately, over the past few years, hotel management companies were spoilt for choice in this region. Yes, things have changed in the last year, but it’s more important than ever for owners to select a management company that is committed to the property, to the business and to a long-term partnership.

Bring them in early

In general, owners should bring in the hotel management company early in the process to avoid potential costly design changes or delays in the development of the hotel etc.

Commercial considerations

Despite great improvements over the past decade, the MENA region, (unlike US and Europe) is the only place where a management company has such a commanding position. They carry no risk whatsoever (with the possible exception of brand integrity). Elsewhere risk is shared.

Things will have to change in the future with more balanced terms for owners. Investors are savvier today.

They’re starting to negotiate stronger terms and more equal agreements, for example including minimum guarantee performance clauses, exit strategies and termination clauses.

Aligning owner and operator interests

Ishraq CEO Sami Al Ansari says it is time to revisit operators’ terms

While I agree with Mike Scully that choosing a management company is important, it is worth highlighting the current structure of agreements that prevail in the Middle East between operators and owners does not align the interests of both parties.

Operators or management companies continue to make money during recessions while owners lose substantial amounts, because operators fees are based on percentages of revenue and gross operating profit (above the EBITDA line) while owners are left burdened with paying for depreciation and bank interest. I will go as far as to accuse operators of deceiving owners by selling rooms well below cost to generate revenues thus increasing their fees. This cannot continue.

These terms aren’t aligned to the owner interests and are no longer sustainable in the Middle East and must evolve just as they have done in the rest of the world. The expansion of major global brands into the UAE must inevitably lead to an increase in competition among operators, and will inevitably lead to a shift in the ‘balance of power’ There is no better time for owners and investors to renegotiate terms that operators demand. The following are the major terms that must be revisited:

Fees

Management agreements usually provide that a large base management fee is payable on the basis of a percentage of gross revenues (often 2-4% of gross revenues), however, the incentive fee must no longer be paid as a percentage of GOP, but rather on the basis of net profits (often 10-20% of income after debt service).

Operator Guarantees

An operator guarantee ensures the owner will receive a certain level of profit. In the event that this level is not achieved by the operator, the operator guarantees to make up the difference to the owner through their own funds. For example, if the contract states a guarantee of US $1 million per annum, and the operator only achieves $800,000, the operator will make up the remaining $200,000.

Non-Compete Clause

An integral component of a market area’s supply-and-demand relationship that has a direct impact on performance is the supply of competitive hotel facilities. By including a non-compete clause in a management contract, an owner is assured no property with the same brand can open within a certain radius of the hotel, typically for the duration of the agreement.

An alternative to management contracts?

With great potential for conflict between owners and operators, what other options for hotel management are there? Premier Inn Hotels LLC managing director Darroch Crawford puts forward his view

The potential for conflict between owners and operators, while exacerbated by the economic slowdown, is of course not new. Since the concept began there has frequently been a strained relationship between owners and the management companies they engage, over everything from bottomline returns to the colour of the towels. It is surprising therefore that there are few examples of alternative commercial structures, between those who choose to invest in hotels and those who believe they know how to run them.

Management contracts are not necessarily the most cost-effective way to proceed with a new venture. As a result of different ownership, the management brands sometimes find the need to duplicate support functions (such as HR, finance, marketing and even procurement) and this obviously has a financial impact for stakeholders, including the customer. It is not unheard of for two properties from the same brand in the same city to enjoy different terms from the same supplier.

Premier Inn arguably has a unique stance on this issue. Premier Inn does not offer management contracts or franchise its brand. Its ideal business model is to buy a freehold piece of land, build a hotel and operate it.

No owners to consider, no disputes over management fees or performance and no compromise on brand standards or operating practices. Simple! Or it would be, if one was free to buy land in any country one chose and if regulations made it possible to build a standard product wherever one wished.

I’ll save the country by country or emirate by emirate hotel classification and minimum standards debate for another day, but what opportunities are provided to land owners and potential hotel investors by the legal restrictions on land ownership in this and other parts of the world? Do owners and investors have a choice? Or is the only route to build and hand over? What if the operator is prepared to share the risk?

Some potential alternative management structures are listed below, but try to bear in mind that these come with a health warning – operators must be prepared to invest and/or share the risk.

Simple Fixed Lease

Hotel is designed and built to the chosen brand’s specification. The brand will often wish to fit out the property and install IT systems at its own cost. Brand pays a fixed sum per annum to lease the hotel. A low risk strategy for the owner.

Variable Lease

Similar to the above, but the lease rental paid to the owner is based on a percentage of sales or gross operating profit. A shared-risk strategy for the owner.

Combined Lease

A combination of the above. A fixed-lease rental is topped up by a percentage of sales or gross operating profit. A medium risk strategy for the owner.

Joint Venture

In this scenario, the owner and operator offer a share in a joint venture company to a local partner. This is an ideal way for a local investor to benefit from the expertise and brand equity of a proven hospitality concept, while safe in the knowledge that the operator has as much to win or lose from the venture as he.

Such an arrangement would normally be based on a number of properties throughout a specific country or geography.

The smarter investor is waking up to the return on investment opportunity provided by budget or limited service hotels. Not all hotel companies are the same.

The operator’s right of reply

The history and strength of big brands is vital for owners when times are tough, says Starwood Hotels & Resorts Worldwide vice president / regional director for the Middle East Guido De Wilde

As the current economic climate continues to impact the hotel industry globally, the owner’s decision to select the right management company to operate a hotel is more critical than ever. What distinguishes Starwood Hotels & Resorts in the eyes of our owners, guests and associates is our global presence and innovative brand building – it is our turf and keeps our competitors scrambling. Our nine compelling brands, a successful and long history in the Middle East market, our local expertise and strong relationships paired with the backing of an international network allows us to own the upswing.

Global player, global network

With more than 960 hotels and resorts in almost 100 countries, Starwood Hotels is one of the leading hotel companies in the world. While major hotel companies have existed in the Middle East for quite some time, Starwood-operated hotels benefit from a global network, global resources and a global customer base.

We have negotiated preferred rates with global corporate accounts that support our hotels on a worldwide basis. Our hotel sales and marketing teams are also supported by Starwood’s global network and are able to tap into the vast account knowledge that exists both in the corporate and leisure segments.

In Europe and the Middle East we operate 10 Global Sales Offices (GSOs) staffed with more than 130 senior sales people who focus on high-profile accounts for Starwood globally and represent significant market share in their sectors — including corporate transient, incentive, meeting, conference, TMC (Travel Management Company) and leisure segments. These constitute Starwood’s biggest opportunity across our network, typically require a single point of contact and are willing to strategically drive business to our hotels.

Furthermore, the strength of a major international hotel company such as Starwood is our global footprint and ability to attract owners, partners and guests from around the world. We can create new demand by building on the customer base existing in potential new feeder markets. Starwood has paid particular attention to China and India for quite a while now and is leveraging its hotel network to develop relationships with new accounts driving business for the Middle East region.

Only strong brands will survive the downturn

With nine brands, including Sheraton, Le Méridien, Westin, Four Points by Sheraton, The Luxury Collection, St. Regis, W Hotels, Aloft and Element, Starwood’s brand momentum continues. Starwood Preferred Guest (SPG) is one of the strongest loyalty programmes in the industry that has been frequently awarded as the best of its kind.

Strong brands are never more valuable than when times are tough as guests clearly stick to brands they know and rely on. In fact, in some of our hotels, SPG drives more than 50% of the revenues.

It is indeed critical for an international hotel operator to protect brand image and integrity. We own and manage hotels and deliver on the brand promise we make as that is what the customer demands, at a price point that is competitive. This is also what our owners want.

We always believe that costs need to be creatively managed to avoid having to encroach on the guest experience. Starwood rolled out contingency programmes to decrease the risk and exposure for our hotels resulting from what we anticipated was going to be a meaningful slowdown. We have also taken a proactive approach to the cost of our existing centralised services, standards and policies. They have been carefully reviewed, resulting in a substantial cost decrease for all of our hotels and owners, which will have a direct effect on the bottom line.

Successful history in the Middle East

Starwood’s presence in the region dates back to the opening of Sheraton Kuwait in 1966 and it has built its portfolio expansion on the success of that property. Starwood is the market leader in Dubai and the UAE with more than 45 hotels and 20 more hotels in development. Looking ahead, the Middle East is a huge priority for development.

In March this year, Starwood launched with immediate success the first W Hotel in the Middle East, the W Doha Hotel & Residences, and in October we opened the Aloft Abu Dhabi, the first Aloft Hotel in the Middle East adding to the 40 Aloft properties Starwood will open around the world by the end of the year since the brand’s inception in 2008. The first Element hotel will also open in Abu Dhabi in 2011.

We believe it is critical to be able to rely on an experienced and established local team to address opportunities on the ground and act fast and decisively.

Our location in Dubai allows us to nourish existing relationships and foster new contacts, anticipate changes in the market and react to key opportunities swiftly. In 2010, we continue to stay focused on identifying and executing against the brand standards that are most important to guests while producing attractive margins for owners.

We’re also making it easier for developers to work with us through streamlined processes as well as tools and resources to ensure we are able to respond to owner needs quickly and decisively.

A win-win scenario for owners and operators

Owners and operators share the same interest: return on investment.

Management agreements are structured around a win-win scenario. Starwood owns a large portfolio of high-quality hotels around the world and as an owner we fully understand the needs of our owners that have placed their trust in our management capabilities.

We have partnerships going back more than 40 years and this cannot be achieved if we are only driving our own interest.

We have also continued to work tirelessly to establish best-in-class brands, focusing on innovation and differentiation. It is the strength of our brands that lead us not only to preserve our presence, but further expand it by working with the right partners on the right properties in the right places.

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