Chapter 15

How Management Companies

Manage Hotels

Hospitality Today
An Introduction

Eighth Edition
Competencies

1. Identify unique characteristics of the hotel

business.
2. Explain why hotel management companies
came into existence and summarize the history
of management companies.
3. Describe a hotel management contract.

Slide 2
Hotels Are Different!
• Unlike most other businesses, hotels operate
twenty-four hours a day and must provide a
multitude of readily available specialized
services.
• In many ways, a hotel is more like a miniature
self-sustaining society than a normal business.
• Because a hotel can be so many things,
managing it can be complex and extremely
demanding. Managers and their staffs must be
prepared to cope with a variety of activities
and emergencies.
Slide 3
Why Management Companies Exist

• Managing a hotel requires a great deal of

special expertise.
• Experienced managers and employees
understand that it is not possible to write down
everything they know in training manuals, and
that mastery of the science of running a hotel
can’t be acquired in a training course.
• For this reason, inexperienced owners began
hiring management companies to run their
hotels.
Slide 4
The Era of Hoteliers

• Until well into the twentieth century, hoteliers

were thought of as skilled professionals.
• Their special skill was the knowledge of how to
manage a hotel.
• Hotels were started and operated by hoteliers,
just as restaurants were started by chefs.

Slide 5
A New Breed of Hotel Owners
• In the last half of the twentieth century, a new
breed of hotel owners appeared.
• These new owners were entrepreneurs who regarded
the hotel buildings and the land they occupied as
attractive investments, or they were real estate
developers who felt that a hotel would be the best
use for a piece of property they owned.
• These new owners knew nothing about the hotel
business, so some hired professional hotel managers
and operated their hotels as independent properties,
while other turned management over to a hotel
company.
Slide 6
Early Lease Agreements
• From the standpoint of these new owners, the most
logical way to employ a hotel company was a lease,
an instrument that they were very familiar with.
• Under this arrangement, a hotel owner or developer
would simply rent out a structure to a hotel company
either as a fully developed and furnished turnkey
operation or, more likely, as an unfurnished building
that had to be outfitted by the hotel company.
• Under early lease arrangements, the hotel company
was responsible for hiring and managing the entire
staff of the hotel, collecting all the revenues from
sales, and paying all operating costs.
Slide 7
The Origin of Management Contracts

• In the early 1950s, the InterContinental Hotel

Corporation (IHC) pioneered the management
contract.
• IHC signed its first management contracts while
the hotels in question were still under
construction.
• Instead of paying rent and keeping the hotels’
profits, IHC did not pay rent and received from
each owner a management fee (which originally
was based on a fixed fee per room) and an
“incentive fee.”
Slide 8
Incentive Fees

• An “incentive fee” is the portion of the

management fee that is based on a percentage
of a negotiated level of profitability.
• An incentive fee is intended to motivate the
hotel company to produce maximum profit for
the owners, so the company can collect the
maximum incentive fee.
• The earliest incentive fees were a fixed fee per
room, but before long more complicated
formulas were introduced.
Slide 9
The Growth of Management Companies

• In 1970 there were fewer than ten management

companies operating twenty-two properties.
• Since contracting with a hotel owner to manage the
hotel for him or her was virtually a new field, there
was little information or experience to guide the first
U.S. management companies. To address this
situation, Robert M. James started the International
Council of Hotel and Motel Management Companies.
• It did not take long for the strategy of separating
hotel ownership from hotel management to gain
traction and over the next four decades the number
of independent management companies mushroomed.
Slide 10
What Is a Management Contract?
• A hotel management contract is a written
agreement between the owner of a hotel and a
hotel management company.
• Under a management contract, the
management company assumes the
responsibility of operating the hotel and
receives a fee for its service.
• The operator (management company) can be a
brand operator or it can be an independent
management company.

Slide 11
How Management Contracts
Have Changed

• Under the earliest management contracts, the

operator was simply regarded as a company
hired to perform a service.
• The management company got paid for
performing those services, but took no financial
risk and therefore was not entitled to any
profits.
• However, some management companies now
own a piece of the hotels they manage, thereby
assuming a minor share of the financial risk.

Slide 12
Other Changes to
Management Contracts

1. Investment approaches
2. Relationships between owners and operators
3. Environmental concerns
4. Economic climate

Slide 13
1. Investment Approaches

• At one time, most financing of lodging facilities in

the United States was done by insurance companies
and lending institutions.
• They invested for the long term, hoping to realize
both profits and appreciation on the value of the
property.
• Today, the situation has become dramatically
different. Some major hotel brands follow a
strategy of “asset light” by developing their large
hotels, only to sell them after achieving a stabilized
profit while continuing to operate them under a
management agreement with the new owner.
Slide 14
2. Relationships Between
Owners and Operators

• The relationship between owners and operators

has dramatically shifted as well.
• There has been a significant change in
management contracts due to increased
competition among operators and the more
active role of owners in managing their
investments.
• The relative bargaining strengths and
negotiating abilities of the owner and the
operator affect how the risks are shared.
Slide 15
3. Environmental Concerns

• Environmental concerns have slowed hotel

development in ecologically sensitive areas in
the United States and abroad.
• Today it is recognized that hotels and resorts
might damage ecologically sensitive areas,
making it harder to get approval to build.
• Often the cost of meeting environmental
requirements can substantially increase the
capital required to develop a new property.

Slide 16
4. Economic Climate
• With the economic downturn at the end of the
first decade of the twenty-first century, hotel
development was stalled.
• This resulted in few new management contracts
becoming available and shifted bargaining
power to hotel owners.
• Even as the economic environment changed and
worldwide hotel development resumed, hotel
owners were emboldened to negotiate more
favorable contractual provisions.

Slide 17
What Are Contract Provisions?
• Contract provisions detail the exact terms that
the parties have agreed upon.
• Although the basic provisions of all management
contracts are similar, there can be significant
differences from contract to contract.
• These differences include the amounts invested by
the owner and the management company; the
nature and amount of control exercised by each
party; fee structures, including the incentive
arrangement; and contract termination provisions.

Slide 18
Management Contract Provisions

• Operating term • Termination

• Fee structure • Operator investment
• Reporting requirements • Operating expenses
• Approvals • Other provisions
• Performance

Slide 19
The Operating Term Provision

• The operating term provision defines the length

of the initial term of the contract and its
renewal options.
• The management company usually prefers a long
initial period, while the owner usually prefers a
shorter one.
• While a long-term contract offers stability for
the operator, the owner, and the lender, it is a
disadvantage to the owner if the owner wants to
remove the operator before the contract comes
up for renewal.
Slide 20
The Fee Structure Provision

The fee structure provision addresses:

• Technical assistance fees
• Pre-opening management fees
• Post-opening management fees (typically a
basic fee plus an incentive)
• Operator-reimbursable expenses

Slide 21
The Reporting Requirements Provision

• The reporting requirements provision defines

the types of reports that will be provided by
the operator to the owner.
• It also outlines how frequently these reports
will be provided.
• These reports include budgets, financial
statements, variance reports between budget
and actual performance, market plans, audited
statements, and—in some cases—weekly and
daily activity reports.
Slide 22
The Approval Provision
• Since the management contract is an agreement
between the hotel’s owner and operator, decisions
about the hotel’s development or operation
generally require input from both parties, or at
least an approval from one party of the other’s
decision.
• The agreement should have an approval provision
that defines in what areas approvals are necessary.
• Most contracts require the owner’s approval of the
hotel’s general manager, controller, and director of
sales.

Slide 23
The Performance Provision
• Performance clauses allow an owner to terminate a
management company that has not met a
predetermined criteria standard within the
implementation period.
• The criteria standard is generally a dual benchmark
of revenue and a level of profitability, while the
implementation period is the time that the
management company has to achieve the criteria
standards.
• The contract also generally includes the “ability for
operator to cure” and “exceptions to termination,”
each of which should be very carefully defined.
Slide 24
The Termination Provision

All management contracts contain a provision

that allows either party to terminate the
management agreement under certain conditions.
Typically, these include:
• Non-performance of a contract provision by the
other party
• One of the parties filing for bankruptcy
• One of the parties causing licenses to be
suspended or revoked

Slide 25
The Operator Investment Provision
• Today, more operators are investing in the
properties they manage, usually in the form of loans
or equity.
• When an operator loans money to an owner, the
management contract specifies the amount in the
operator investment provision, along with how the
loan will be used, the term of the loan, and the
interest rate.
• An equity contribution may be in the form of cash,
free technical services, waived pre-opening
management fees, or even conversion of incentive
fees.
Slide 26
Advantages of Management Contracts

• For owners, the primary advantage is that they

buy the services of an established hotel
operator with a proven track record and a good
reputation.
• An experienced operator can offer marketing
expertise and systems of cost control that
would otherwise not be available to the owner.
• For operators, the biggest advantage is that
they can control a large number of properties
with a relatively limited investment.

Slide 27
Disadvantages of
Management Contracts

• For owners, one of the primary disadvantages is

that while a management contract relieves
them of day-to-day operating responsibilities,
they still have to carry all or most of the
financial burden.
• For operators, a major disadvantage is that
their reputation is on the line at every hotel
they manage. Moreover, the owner may make
decisions regarding the property’s development
or sale without the operator’s input.

Slide 28
Slide 29