Manage uncertainty – the third-party model

A dverse economic conditions often produce unexpected positive consequences, at least for some. This is true even in the hospitality industry, which, due to its direct reliance on the financial health and sunny outlooks of its customers, is more vulnerable to downturn than others.

One of the big winners in Europe over recent years has been third-party hotel management companies. Such firms have long done good business in North America, where the franchise model of hotel ownership is well established and specialist managers are often brought in to handle the day-to-day running of properties. Though this way of doing business was growing in popularity in Europe prior to 2008, the economic downturn has sped things up considerably.

First, the recession caused many hotel owners to default on loans, putting their properties into the hands of banks, who brought in hotel management companies to turn them around for quick resale. Then more hotel owners began to realise the significant cost benefits of bringing in a third-party operator, particularly at a time when profit margins are slim.

Instead of getting tied to a long-term management contract with a hotel brand, owners can bring in a third party under a flexible contract that can be terminated if performance targets are not met or if the owner wants to make a quick sale. The risk of termination incentivises the management company to perform and the operator, which otherwise would have to deal with management responsibilities too, can double down on its strengths of branding and franchising.

"These companies are loyal to the owner, where branded operators are loyal first and foremost to the brand," explains Stephen Collins, consulting and valuation analyst at hospitality consultancy HVS, in a 2015 report entitled 'Decisions, Decisions... Which hotel operating model is right for you?'.

"That is not to say that branded operators ignore the owner's interests nor that TPOs do not care for the brand standards dictated by the franchise agreement, but they do have different priorities. Brand managers will aim to present the brand in the best possible light and can therefore be less concerned with achieving economies in operation than an independent TPO would be."

Run with an idea

Robert Crook, managing director of the UK for Interstate, the world's largest independent hotel management company, takes this idea a step further. He believes that a third-party manager's independence actually allows it to drive the performance of the brand by holding it to account in a way that a brand-employed general manager might be reluctant to do.

"It's highly unlikely that the general manager of the Holiday Inn Express in Birmingham city centre will pick up the phone to the global vice-president of marketing for a big brand on a Monday morning after a very poor weekend's business and say, 'you need to do a better job for me'," Cook says. "If he (or she) was brand manager, he might do it once but he'd never do it twice. At Interstate, we can make that call to the vice-president of marketing and typically the response is positive and invariably proactive because we are a big customer and we manage a lot of hotels."

The relatively rapid increase in demand has caused the European third-party operations business to mature quickly, with a series of mergers and acquisitions creating a handful of large, well-resourced companies. The UK has been at the centre of much of this activity. In early 2013, Redefine and BDL joined forces to become Redefine|BDL, an entity with 60 UK-based hotels in its portfolio, a figure that has since grown to 66, making it the fourth-largest third-party operator in Europe. At around the same time Interstate bought Chardon Management, a UK-based operator with 32 hotels under management including Holiday Inn, Hotel Indigo and Best Western properties. Interstate manages around 90 properties across ten countries in Europe, a portfolio that encompasses independent hotels and almost 20 brands. Combined, these companies can offer services ranging from revenue management, to talent acquisition and F&B - the gamut of what it takes to run a hotel.

"In any territory the brands go into, they tend to hold on to operations until they feel there are operators at a skilled enough level to run their brands as they want them to be run," says Andrew Robb, director of business development at Redefine|BDL. "I think that's what's happened in the US and is now happening in the UK, in particular. I think the brands are comfortable now that third-party operators are skilled and sophisticated enough to run the hotels properly."

The customer is always right

Hotel management is not an exact science, with every brand and owner possessing different goals and expectations. Strength in depth across all the management disciplines is vital, particularly in areas that directly drive revenue, and those that we spoke to tend to agree that being able to offer consistent quality food and beverage services for events of any size is something that separates the great from the good.

The only golden rule, as it were, is to listen carefully to what the owner wants and try to align your goals with theirs. Creating a single point of contact for any queries and continually keeping owners updated on the performance of the hotel shows that, even if you represent a faceless multinational company, you are still able to take into account individual needs and geographical quirks. It also gives reassurance that the management team is acting with transparency and not trying to bury bad news. "I don't like cover-up artists," Crook says. "If something's gone wrong, put your hand up and tell them you've got it wrong. You have to have confidence to be able to do that."

It's also worth bearing in mind that many hotel owners have no real in-depth knowledge of the hospitality industry and no real commitment to remaining in it. They view their property only as a type of financial asset that historically has offered steady returns in line with favourable demographic trends. Success to them is ultimately about how you can make a demonstrable difference to the value of this asset.

"Our customers are the hotel owners and if we don't continue to deliver returns for these customers then they have plenty of other opportunities - they can invest in offices, retail, in gold, the stock market or other companies," says Robb. "So we need to deliver the returns that keep owners interested in hotels. A lot of statistics show that hotels, over a long period of time, are a strong investment but we need to remember that."

There is a school of thought that believes it is much more difficult to achieve the desired returns if a third-party manager has a hand in the ownership game, that unless it is 100% committed to management, it won't be able to convert top-line into bottom-line with the requisite conviction. Crook from Interstate is firmly in this camp.

"Some companies masquerade under the guise of a third-party management company," he says. "If your portfolio is made up of management contracts and properties that you own, you have a serious conflict of interest. If we end up having a beauty parade with another management company, I say to them 'really understand what drives their profit'. If 75% of their profit is being driven by owned property then you're not going to get any attention."

Model example

The economic downturn not only led to the maturation and increased adoption of the third-party model but also gave it a stage on which to demonstrate its worth to funders. Increasingly, particularly when inexperienced owners are involved, banks are making the involvement of a third-party operator a condition of funding, based largely on their success in turning around distressed assets during the lowest points of the recession. This follows on to a relatively new trend, the application of the third-party franchise model to some of Europe's more expensive, higher-profile hotels. Many had assumed that such properties were too valuable for owners to be willing to separate management control from brand identity.

"We are seeing franchise creep into the luxury end," said Philip Lassman, development manager, UK and Ireland of InterContinental Hotels Group, at the Henry Stewart Hotel Operating Agreements conference in London in April. "Guests don't walk into a hotel and ask whether it's a management or franchise contract."

For all these developments, the industry in Europe is still at least five to ten years behind the US, and the UK is some way ahead of the rest of the continent. Yet, with difficult economic condition showing no sign of abating, the flexibility afforded by bringing in third-party managers and the track record they have built over the past eight years suggests that it won't take long to catch up.