Traditionally, three primary models of hotel operation contracts have dominated the industry: ownership, franchise and management. However, over the past decade, hybrid agreements, such as the manchise, have also become increasingly popular, alongside the use of third-party operators.
The key characteristics of these contracts are explained below:
Ownership: direct ownership means that both the asset and the hotel operations are owned. This option provides owners with the most control, but also comes with the highest level of risk. It requires the owner to make significant capital investment and also contribute management expertise to the project.
Franchise: this model allows owners to maintain operational control, while benefiting from a brand’s recognition, marketing, loyalty programs and reservation systems. The franchisee pays an initial fee and ongoing royalties, based on revenue, and is bound to global, brand-imposed initiatives. The model is contingent on owners having the required skillset to operate the hotel themselves.
Management: these contracts involve a hotel owner ceding operations to a hotel brand or hotel management company to run the property for a fee, which is often a percentage of revenue and incentive on profit. The brand/management company is responsible for day-to-day operations, staffing, marketing and overall management, while the owner retains ownership of the property.
Manchise: this hybrid model combines elements of management and franchise contracts to customize the balance of control and support. With shared responsibilities and benefits, it allows owners to initially operate the hotel under a management contract with a hotel brand, which can later transition to a franchise agreement, once certain conditions are met.
Third party operators in demand
The use of franchising models is on the rise, buoyed by many brands shifting their focus from hotel operations to brand development and distribution. This, in turn, is fueling the need for third-party operators (TPOs), also known as independent operators or white-label operators. During the last 10 years in Europe, the number of hotels operated by TPOs has increased by 40 percent, according to a study by HVS. While the rise in the Middle East has been slower, we have still noted a steady increase in demand for this model over the past two years from both hotel owners and hotel brands – a trend which is likely to continue.
The massive growth across the hospitality sector in the Middle East, especially in Saudi Arabia and the UAE, is attracting many investors/owners who want to be involved in the asset management and decision-making process of their projects. However, some may lack the experience, team members or time to operate the hotel alone. Working for and with the owner, third-party operators have the required skillset and regional knowledge to manage the hotel, while also remaining hyper-focused on profitability.
Benefits for all parties
The rise of third-party operators is also rooted in the alignment of interests between the owner and the operator. TPOs allow hotel owners to have better control over the management of their assets, clearer operational visibility and more contractual flexibility, all designed to drive high returns on their investments.
Contracts with a third-party operator take the form of a management contract. As part of their scope, TPOs can help select the most suitable brand and handle franchising negotiations on behalf of the owner. This three-way partnership between the owner, brand and operator is usually beneficial to all parties, with the TPO mediating between the brand’s focus on its individual success and the interests of the owner.
Third-party management unpacked
A third-party management agreement provides a structured framework that allows owners to leverage the expertise of a management company, ensuring the efficient and profitable operation of the hotel, while maintaining ownership and benefiting from the property’s long-term value appreciation.
In these types of agreements, management companies provide operational agility and reactiveness, with established and transferable processes and procedures in place, while often bringing the benefits of multi-brand experience.
Third-party operators can manage all aspects of hotel operations at any stage of development – from site selection to day-to-day operations, including:
• Business development and advisory
• Design and construction
• Pre-opening
• Takeover and turnaround
• HR and training
• Sales and marketing
• Revenue management
• Accounting
• Technology
Workable solutions
Management contracts are ideal for real estate investors who own hotel properties but lack the expertise or desire to manage daily operations. They are also suitable for developers who focus on construction only and outsource all management of operations. Additionally, management contracts are often preferred by multi-property owners with diverse international brands or local brands, as well as institutional owners.
Third-party management contracts have several benefits for hotel owners, which include:
• Owner-centric decision-making and engagement based on transparency
• Shorter and flexible contracts
• Tailored-to-fit and highly focused management services
• Expertise of a management company in operating hotels efficiently and profitably
• In-depth market knowledge of a management company’s local team
• Performance accountability with benchmarks for the management company, such as occupancy rates, RevPAR and overall profitability
• Rigorous cost control with regular financial reporting and auditing rights by the owner
• Access to professionals through clustering capabilities
• Access to global distribution solution partners driving incremental revenues at a lower cost (also applicable for branded [franchised] properties
However, there are also challenge associated with these contracts, including:
• Owners must cede a degree of operational control (lower when compared to the brand-managed property model, however)
• Management fees and other associated costs may be perceived as substantial
• A financial risk if the management company fails to meet performance benchmarks or brand requirements
Manchising: a balanced approach
The manchise model is often ideal for hotel owners looking to benefit from professional brand management expertise initially while planning for greater control and autonomy in the future. During the initial management phase, the brand management company has operational oversight. They are responsible for the day-to-day operations, staff training, marketing and adherence to brand standards. The owner benefits from the
expertise, support and training in setting up and stabilizing the operations.
After a predetermined period or achievement of performance benchmarks, the management contract can transition into a franchise agreement. The hotel continues to operate under the same brand, but the owner takes over the operational control or decides to appoint a third-party operator to oversee the management of the asset under the franchised brand.
Manchise agreements are well suited to new hotel developments, where the owner seeks to stabilize operations before taking full control. They are also popular in cases where an owner plans to eventually manage the property, but initially needs the expertise of an established brand.
Again, there are several benefits of a manchise agreement for owners, namely:
• Risk mitigation during the critical initial period of operation
• Smooth transition from management to franchise with operational standards in place
• Flexibility for owners not yet ready for operational responsibility but planning to assume this in the future
• Continued association with a reputable brand, which enhances marketability and trust.
The challenges tend to be:
• The dual-phase nature of the agreement, which can lead to complex contract terms
• Transition risks from management to franchise
• Initial higher costs
• Risk of quality drop after takeover by the owner’s team.
The hotel management approach, which is dominated by the franchise model managed by a third-party operator, is proving to be a winning formula for all parties involved.
