Understanding the makeup of franchise fees
 
Understanding the makeup of franchise fees
03 OCTOBER 2017 7:43 AM

An analysis of franchise fees provides insights about when and why brands increase fees and can give owners a better understanding of the costs during their decision-making process.

REPORT FROM THE U.S.—In the current market environment of modest revenue growth, hotel owners and operators are paying extra attention to their operating expenses.

According to the June 2017 edition of “Hotel Horizons,” revenue-per-available-room growth in the U.S. is forecast to remain under 3% from 2018 through 2021. Therefore, it will be management’s ability to control expenses that will enable profits to grow.

One expense that management has less control over are franchise fees. Most of the fees charged by the brand franchising companies are assessed as a percent of a source of revenue. Therefore, owners and operators have mixed emotions when franchise-related costs rise. After all, if you are paying more franchise fees, then it is likely that your property’s revenue is also on the rise.

To assist hotel management and ownership in their assessment of the franchise-related costs they are paying, we have analyzed data from 1,587 U.S. hotels that reported franchise fee payments each year from 2010 through 2016. The data comes from our firm’s annual “Trends in the Hotel Industry” survey of operating statements from thousands of hotels across the nation. Some of these properties are owned and/or operated by a brand. Others license the brand but are operated independently or by a third-party management company.

In our “Trends” database, we captured four different franchise-related fees on a discrete basis. They are:

  • royalty payments;
  • marketing assessments;
  • reservation fees; and
  • guest loyalty program fees.

For this analysis, the sum of these four components comprise “total franchise fees.” These are the data that we analyze in this article.

The cost of franchising
Franchise-related fees are typically assessed as a percent of revenue, most frequently rooms revenue. Therefore, it is not surprising that total franchise fees measured as a percent of rooms revenue has remained fairly constant from 2010 through 2016. In 2010, franchise fees averaged 6.8% of rooms revenue, or $2,326 dollars per available room. This metric increased to 7.2% in 2016, or $3,381 per available room.

Due to the ascending average daily room rates, franchise fee payments on a dollar-per-available-room basis increase as you go up in chain scale. In 2016, properties in the midscale segment averaged total franchise fees of $1,897 per available room, while luxury hotels paid $3,970 per available room. Conversely, franchise fees measured as a percent of revenue ranged from a high of 9.6% for upper-midscale hotels to a low of 5.2% at luxury properties.

The components
The increase in franchise fees as a percent of revenue indicates that they have grown at a greater pace than rooms revenue. From 2010 to 2016, total franchise fees increased at a compound annual growth rate of 6.5%. Concurrently, rooms revenue for the hotels in the sample experienced a compound annual growth rate of just 5.5%. By analyzing the four individual components of franchise-related expenses, we can identify those elements that have led the rise in fees, and those that have lagged.

In 2016, royalty payments constituted the greatest portion (29.5%) of franchise fees, followed by guest loyalty program fees (27.9%), marketing assessments (25.6%), and reservation fees (17%). This differs somewhat from the profile of payments made in 2010 when the largest share went towards guest loyalty program fees (27.3%), and royalty payments were only 26.8%.

The increase in franchise fees has clearly been driven by the royalty payment component. From 2010 through 2016, franchise royalty payments have grown at a compound annual growth rate of 8.1%. This is 260 basis points greater than the growth in rooms revenue during the same period. Guest loyalty program payments (6.8%) also increased at a greater pace than rooms revenue the past seven years. The growth of marketing assessments (5.9%) and reservation fees (4.2%) have been lagging.

Management structure matters
A total of 60% of the properties in the study sample were owned and/or operated by the brand affiliated with the hotel. The remaining 40% were either managed by the owner (non-brand), or operated by a third-party management company. Between the two management structures, we see differences in both the composition of the franchise fees and how each component has grown since 2010.

In 2016, the components of franchise fee payments were more evenly distributed at the hotels operated by the brand. Since the brand is also earning management fees at these hotels, it can be assumed that they will alter components of the franchise fees as needed to win the management contract.

At the brand-operated properties, the greatest share of franchise fees went toward the guest loyalty program (30.7%). However, the greatest growth in franchise fees at these properties since 2010 has occurred in the royalty payment (11% compound annual growth rate) component. Overall, total franchise fees at brand-operated hotels increased by a compound annual growth rate of 6.6% from 2010 to 2016, while rooms revenue grew by 5.5% compound annual growth rate.

At the hotels that are self-operated or managed by a third-party company, royalty payments (45.4%) dominate the total dollars paid to the franchisor. Since the brand is not receiving any management fees at these properties, they are less likely to negotiate any reductions in franchise royalty payments.

From 2010 to 2016, the component of franchise fees the increased the greatest was the guest loyalty payments (9.2% compound annual growth rate). This is significantly greater than the increase in rooms revenue (5.6%) for these properties over the same period. Since the amount paid for guest loyalty program fees is influenced by the benefit received from these programs, it can be assumed that these hotels have received an increasing volume of business from loyalty program guests over the years.

Assessing value
With the prospects for revenue growth limited for the next few years, hotel owners are paying particular attention to the costs associated with acquiring revenue. They want a better understanding if the investments they are making in distribution channels, management and their brand are providing sufficient returns.

When assessing the return they are getting for the franchise fees paid to their brands, owners also have the ability to dissect the value of the individual components. This enables them to make more specific comparisons to alternative brands, reservation systems, referral sources, management options or even soft-brand alternatives offered by the franchisor.

Robert Mandelbaum is the director of research information Services for CBRE Hotels’ Americas Research. To benchmark the four franchise cost components of your property(s), please visit https://pip.cbrehotels.com/benchmarker, or call (855) 223-1200. This article was published in the August 2017 edition of Lodging.

The assertions expressed in this article do not necessarily reflect the opinions of Hotel News Now or its parent company, STR and its affiliated companies. Please feel free to comment or contact an editor with any questions or concerns.

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