Hotel Franchising in Europe is an update of our previous report published in 2010: The report aims to assist owners in increasing their understanding and awareness of the franchise business model and current market trends.

The fees outlined in this article apply solely to hotels operating in Europe.

Introduction

Franchising is still much less developed internationally than it is in the USA, but is rapidly gaining momentum in Europe with many international hotel operators continuing their push for franchise agreements � a less �hands-on' approach than management contracts.

Many operators have established a substantial franchise portfolio in key markets and, as a result, franchising is perceived as a more viable option by both owners and developers. Franchising is also important for brands entering new markets, as it allows them to increase footprint rapidly.

Hotel brands are arguably more important than ever, as they have a reach that independent hoteliers cannot match. For example, large operators have the resources to keep up with rapidly moving technology, whereas this might be more challenging for smaller independent hotels.

Operators also have the depth of knowledge and the ability to send their �specialists' (be it in marketing, IT, operations, finance or other areas) across the regions to assist their properties as needed. When considering franchising, brand affiliation is important.

The importance of selecting the appropriate brand for a hotel resides in the impact it will have on the positioning of the hotel within the market, its capacity to maximise occupancy and achieve room rate premiums, and the potential benefits of the chain's distribution channels and know-how.

All of these factors will ultimately be reflected in the bottom line, and therefore both owners and lenders will be interested in properly understanding and considering the overall benefits that a brand will bring to the hotel when assessing if the additional franchise cost is worth it.

Franchising in Europe

Franchising in Europe is not as transparent as it is in the USA. In the USA, because the Federal Trade Commission regulates the sale of franchises, information regarding each franchise fee structure is readily available. This eliminates, in theory, any potential for negotiating contracts. We note that this article is focused on Europe and is therefore limited to the information franchisors and franchisees we interviewed were willing to share.

Because Europe is a collection of independent countries, as opposed to the USA, this has resulted in a slower uptake of franchise agreements in the region. However, it is fair to say that there is an increasing recognition of the strength of a hotel brand and brand affiliation, and this is expanding.

Despite this, challenges remain. For example, brands instantly recognisable and successful in one European market (say Louvre Hotels, in France) may have a more difficult time gaining recognition in other European markets.

Furthermore, hotels in Europe are still widely unbranded, and it is estimated that about a third of room stock carries a brand; where franchising is concerned, this issue currently presents more opportunities than threats. In the USA, an estimated 70% of hotels are branded (with approximately 50% held under franchise agreements).

This clearly means that the opportunities for brand growth in Europe, including franchises, are significant. Anecdotal evidence suggests that, whilst hotel operators were keener on management contracts just a few years ago, franchise contracts are now at least equally likely to be proposed to owners by the brands.

Opportunities � Independent Management Companies

Franchising leaves the day-to-day management of the hotel �up for grabs'. Many owners will not have the expertise and resources to manage all their hotels themselves, and this is where independent management companies can step in to manage the daily operation of the hotel. Over the past few years the presence of independent management companies has expanded greatly in Europe.

Rewind twelve months and there were several companies separately providing independent management in Europe and the UK. 2013 saw the consolidation of two main players (although we note there are also a handful of� independent, smaller companies).

Interstate Hotels & Resorts rapidly expanded its European footprint in 2013 with the acquisition of UK-based independent management companies Sanguine Hospitality Management and Chardon Management, while Redefine Hotels and BDL Management also merged in 2013 to create Redefine BDL Hotels.

Independent management companies are becoming increasingly sought-after in Europe. The emergence and increasing presence of these companies have led to brands making strategic decisions to expand via franchises as they know independent management companies can manage the properties efficiently and to a high standard.

TABLE 1: HOTEL CHAINS AND BRANDS SURVEYED

Note: This is not a comprehensive list of franchise brands and not all brands are available as franchises

The franchise and independent management contract complement each other: the franchisor provides the brand name and marketing platform (amongst other things, as discussed later in this article) and the independent management company provides the expertise and know-how to manage the day-to-day operation of the hotel.

The franchisor, independent management company and owner work as a �trio' to manage the property effectively.

The partnership is mutually beneficial. Particularly in Europe, owing to the diverse market, as franchisors and management companies cannot typically be the masters of all things in all markets across the region.

Although various brands are well established in many markets, this combined method is increasingly useful when operators are in the process of establishing presence in new markets and require the combination of an internationally recognisable brand and local knowledge and know-how.

Clearly, implementing a franchise agreement and a management agreement with an independent management company moves the hotel into the double fee scenario; however, we note that independent management fees are typically more competitive than those of the brands. There are several other benefits including the following:

• Owing to their close relationships with franchisors, independent management companies are often able to help owners negotiate more competitive franchise fees;
• Cash flows are typically run at a tighter level with marketing costs (which are covered by the franchise agreement) usually lower;�
• The term of the management agreement is characteristically much shorter (starting at a minimum lock in of five to ten years) and exit options are typically more flexible.

In conclusion, independent management companies open the door for expansion for both the franchisor and the owner.

Franchisors in Europe

Our research consisted of surveying a sample of hotel companies in Europe (see Table 1). The sample spans the full spectrum from large international players to smaller European operators. Brands included in the sample range from limited-service to luxury fullservice hotels.

All companies sampled currently franchise some or all of their brands in Europe or are planning to do so in the near future. We note that we also spoke with Hyatt and Hard Rock Hotels; however, they are not currently franchising in Europe.

A one-size-fits-all approach to franchising does not work in Europe, owing to reasons discussed previously. Our findings are based on an average of �typical' fee structures.

TABLE 2: BASIC CONDITIONS

Source: HVS Research

Basic Conditions

Table 2 sets out the general conditions required for building purposes and the terms for franchise agreements in Europe, by segment. We note that there is no set formula which defines what franchisors look for in a project.

Typically,whether a property is an existing or new-build hotel is not an issue as long as the brand is a good fit for the type of product and the positioning of the hotel. Conversions are just as capable of achieving a profitable return as new builds.

Franchise Fees

Perhaps the most important part of evaluating the potential of a hotel franchise is the structure and amount of the franchise fees.

Initial Fees
The initial fee typically takes the form of an amount based on the hotel's room count. Research shows a wide range in initial fees, with average minimum fees of about �400 a room (the lowest fee just over �200) and the average maximum of about �900 a room (with some of over �1,000).

Therefore, for a hypothetical 150-room hotel, this initial amount could range fromabout �70,000 up to �140,000, whereas for a smaller 75-room hotel this amount would range between �40,000 and �70,000.

In addition, we note that some agreements call for an initial amount to be paid as a lump sum upon submission of the franchise application; this is often the case for hotels with a lower room count. We highlight that the initial fee range has changed quite significantly since our previous research on this topic was carried out in 2010.

The initial fee is typically paid (either partly or in full) upon submission of the franchise application and covers the franchisor's cost of processing the application, reviewing the site, assessing market potential, evaluating the plans or existing layout, inspecting the property during construction, and providing services during the pre-opening or conversion phases.

In the case of reflagging an existing property the fee is often reduced and occasionally waived. Depending on the agreement, some franchisors will return the initial fee if the application is not approved, whereas others will keep a share in order to cover their administrative costs. If the fee was only partly paid on application it is typically retained by the franchisor.

Continuing Fees
Payment of continuing franchise fees starts when the hotel assumes the franchise affiliation, and fees are usually paid monthly over the term of the agreement.

This report will consider the following continuing fees:

• Royalty Fee;
• Advertising or Marketing Contribution Fee;
• Reservation Fee;
• Frequent Traveller Programme Fee/Loyalty Fee;
• Miscellaneous Fees;
• Other � �All In Fee'.

Royalty Fee
Almost all franchisors collect a royalty fee which represents compensation for the use of the brand's trade name, services marks and associated logos, goodwill, and other franchise services.

Royalty fees represent a major source of revenue for the franchisor. These fees are characteristically subject to negotiations between both parties, and can vary by brand, but typically range from 2.5% to 5.0% of rooms revenues.

In some instances, franchisors require an additional percentage of other revenue streams, most commonly food and beverage revenue. The average amount is 2.0% of total food and beverage revenue, and this is payable on top of the rooms revenue in certain agreements.

Advertising or Marketing Contribution Fee
Brandwide advertising and marketing consists of national or regional advertising in various types of media, including the internet, the development and distribution of a brand directory, and marketing geared toward specific groups and segments.

In many instances, the advertising or marketing contribution fee goes into a fund that is administered by the franchisor on behalf of all members of the brand. We note that franchisees ideally want their contribution to impact their region, which may not always be the case.

From our discussions with the various operators, these fees normally range from 2.0-4.0% of rooms revenue or 1.0-2.0% of total revenue. These fees typically vary by market and in some instances are paired with the reservation fee.

Reservation Fee
If the franchise brand has a reservation system, the reservation fee supports the cost of operating the central office, telephones, computers, and reservations personnel. The reservation fee contains all distribution-related fees, including fees payable to third parties, such as travel agents and distributors.

The calculation of this fee is the one that varies the most across our survey from one operator to another. The reservation fee can be based on a percentage of room revenue � a wide range of 1.0-5.0%, and even higher if based solely on the reservations generated by the brand's distribution channels.

It can also be calculated as an amount per available room per month (ranging from �4.00-�10.00) or a combination of both approaches. In addition, we note that, as previously mentioned, some franchisors include the reservations fee in the advertising or marketing contribution fee.

Frequent Traveller Programme Fee/Loyalty Fee
Franchisors often offer incentive programmes that reward guests for frequent stays; these programmes are designed to encourage loyalty toward a brand. Many franchisors now require franchisees to bear their fair share of the costs associated with operating a frequent traveller programme.

The cost of managing such programmes is financed by frequent traveller assessments. Frequent traveller programme assessments are typically based on a percentage (ranging between 2.0% and 5.0%) of either rooms or total revenue generated by a programme member staying at a hotel. We note that in some instances a euro amount fee (say �7.00) is payable to the franchisor based on an amount of loyalty programme points awarded.

Miscellaneous Fees
Miscellaneous fees include fees payable to the franchisor or third party suppliers for additional system and technical support and fees relating to training programmes and annual conferences.

Sometimes franchisors offer additional services to franchisees including but not limited to consulting, purchasing assistance, computer equipment, equipment hire, on-site pre-opening assistance and marketing campaigns.

The fees for these services are�not generally quantified in the disclosure document. Our survey considers only mandatory and quantified costs.

Other � �All In Fee'
Generally, these various fees are applied individually, but in some cases franchisors combine a number of formulas which amount to an overall fee. These come in the form of an annual fee of a total euro amount which covers everything, or an overall percentage of total revenue.

Conclusion

As discussed, a one-size-fits-all approach to franchise agreements is not possible in Europe due to the independent nature of countries in the region. Franchise agreements have become more established in certain markets across Europe and are therefore increasing in popularity and acceptance.

In addition, they give owners the flexibility to enter markets they do not currently have a foothold in, sometimes with the assistance of independent management companies: the franchisor provides the brand name and marketing platform (amongst other things, as discussed previously) and the independent management company provides the expertise and know-how to manage the hotel.

If the past year is anything to go by, the continuing expansion and consolidation of independent management companies across Europe in the next few years is likely to speed expansion of franchised properties in Europe.

We do not expect it to grow to the extent franchises are popular in the USA in the immediate future; however, we do expect a significant uplift. Independent management companies have a good track record and are an efficient way to grow brands.

Their nimbleness certainly remains a key advantage compared to the heavier corporate structures of established brand operators. Taking on a franchise is a complicated investment. Selecting the appropriate franchise for the property entails exhaustive research and investigation.

The information presented in this article provides some general insight into franchise fee structures but should not be relied upon other than as a preliminary resource.

About the Authors

Lucy Payne is a Consultant & Valuation Analyst with HVS's London office.

Lucy holds a BSc (Hons) in International Hospitality and Tourism Management from the University of Surrey and a certificate in Hotel Real Estate Investment and Asset Management from Cornell. She joined HVS in 2010 and since then has worked on a number of valuation and feasibility assignments across Europe and Africa.

Tel: +44 (0) 20 7878 7757 / lpayne@hvs.com

Sophie Perret is a Director at the HVS London office.

She joined HVS in 2003 following ten years' operational experience in the� hospitality industry in South America and Europe. Originally from Buenos Aires, Argentina, Sophie holds a degree in Hotel Management from Ateneo de Estudios Terciarios, and an MBA from IMHI (Essec Business School, France and Cornell University, USA). Since joining HVS, she has advised on hotel investment projects and related assignments throughout the EMEA region. Sophie has recently completed an MSc in Real Estate Investment and Finance at Reading University. She is responsible for the development of HVS's business in France and the French-speaking countries and also focuses on Africa.

Tel: +44 (0) 20 7878 7722 / sperret@hvs.com

� HVS June 2014 - Reprinted with permission.
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