Twenty years ago, hotel franchises were few and far between. There was Holiday Inn and a bunch of obscure brands, the latter having since become extinct. Back then, franchise agreements gave the franchisor the upper hand. Franchisees felt overburdened by fees and lacked the necessary resources for success.

However, the franchisee/franchisor relationship has improved dramatically in recent years. Whereas franchisors once dictacted the terms, today's license agreements are negotiated more equitably between the two parties. Franchisee advisory boards, now commonplace, have helped aid the cause.

“What has evolved for us is less the agreement itself, but more the continued growth in our relationship with our franchisees,” said Autumn Murray, manager of corporate communications and community affairs for Six Continents Hotels Inc. (formerly Bass Hotels and Resorts) in Atlanta.

“We work in tandem with [franchisees] to design operating standards, technology platforms and quality requirements that are sensitive to their investment returns, while driving a consistent customer experience in all of our hotels,” he added.

The “12 Points of Fair Franchising,” a report issued three years ago by Atlanta-based Asian American Hotel Owners Association (AAHOA), has had a big influence on license-agreement negotiations. The report outlined many basic concerns of the average franchisee, motivating franchisors to re-evaluate and, in many cases, change their policies toward franchisees.

“Certain companies have adopted at least six points or eight points, and some of them are even looking to all the points,” said AAHOA chairman Dhansukh Patel, a Nashville-based hotelier.

“Typically, we feel like the contract the franchisee signs is 100% on the side of the franchisor,” he said. “We feel it needs to be fair and equitable for both parties. We're always pushing the 12 points. We recommend to all our members that they write letters to the franchisors encouraging their support. We want to make it fair, and we have seen a lot of positive response from the franchisors.”

The battle over turf

Necessity has dictated many of the changes in basic licensing agreements. Competition is fierce. While the average hotelier may prefer to have exclusive brand protection for a large market, franchisors generally look to maximize market penetration.

Consequently, one of AAHOA's 12 points addresses impact, encroachment and cross-brand protection. The intent is to give franchisees some guarantee that the franchisor will not build new properties with the same brand too close to existing properties.

Increasingly, protected territories are an integral part of the negotiation process, according to Richard Saltzman, vice president of franchise sales and development for New York-based Cendant Corp., the world's largest hotel franchisor.

The average hotelier has a multi-million dollar, 15-to-20 year investment in each property. Two same-branded hotels built too close together for market conditions can be devastating to a hotelier's bottom line.

“What we've noticed over the last few years is an increased reliance on protected territories,” Saltzman said. “Some of our brands have protected territories already built into the franchise agreement, but some of them don't.”

Most of the major hotel franchisors now offer some form of area protection in their licensing agreements. Many franchisors had already implemented area protection long before AAHOA developed its 12 points. For example, Parsippany, N.J.-based Wingate Inns International Inc. has issued area protection in all its licensing agreements since the company's inception in 1996.

There is no set boilerplate for determining fair and equitable terms for area protection. Every market is unique and carries multiple factors that must be considered when designing protection.

“Some franchisors grant a 20-mile radius depending on location,” said Stanley Turkel, a New York-based hotel consultant. “Obviously, if you're in New York, a 20-block radius will suffice. But, if you're out in the suburbs or the country, 20 miles might not be enough. But franchisors may only give area protection for three years, or two years. After that, you're on your own.”

“Each area of protection is site specific,” noted Keith Pierce, president and CEO of Wingate. According to Pierce, the franchisee and the brand management team mutually agree on a trading area. The objective is to ensure each property maximizes its revenue potential. The terms for protection in urban areas are going to be different than in rural or less populated areas.

“If we create an area of protection that is too small, it undermines the ability of the property to drive the highest revenue possible,” Pierce said. “In certain markets, you know the market size is such where it can handle two, three, four, five properties, and that's understood. The competitive environment gives you some guidance on that.”

Brands, brands and more brands

There are more franchise brands than ever. Brand marketing has become so sophisticated that niche segmentation lines have blurred. To further complicate matters, many franchisors offer sister brands with similar target markets.

Initially the two brands may appear distinct, but marketing strategies often put two brands from the same franchisor in direct competition with one another. A tightening economy only exacerbates the situation as slight amenity delineations become less of a factor. In short, a room becomes “just another room” for many guests shopping for bargain rates.

“In general terms, as you create more brand subsets, those are new brands that can be placed next to sister brands,” Pierce said. “With Wingate, we don't operate that way. A Wingate is a Wingate is a Wingate. For example, we are launching a Wingate Inn & Suites concept. The area of protection for an existing Wingate would not allow for a Wingate Inn & Suites to go into that area of protection.”

Such was not the case for Silver Springs, Md.-based Choice Hotels International. While Choice does offer area protection to its licensees, in recent years many of the franchisor's brands had become indistinguishable to the average guest. Thus, many franchisees ultimately found themselves in direct competition with sister Choice brands.

According to Michael Barnard, vice president of development and capital investment for Choice, the franchisor realized that many of its brands, including Comfort Inn and Sleep Inn, had become indistinguishable. “For many years, three of our brands had similar images,” he said. “We don't want to dilute the market by putting similar logos into a specific market.”

Choice's reaction was to make each brand's new logo distinctive, thus eliminating situations in which a customer driving down the street might see a similar Choice logo for different brands, according to Barnard.

“A bunch of our logos are, in some cases, going on 20 years old,” he said. “We're rolling out a new logo and sign package program to basically update our images. The basic rule of thumb is an image becomes antiquated in 10 to 15 years, and all our images were similar. The time was right to go ahead and reposition some of the brands and upgrade the images.”

Choice also is offering franchisee incentives and loan programs to help defer the cost of installing the new logos.

Choice has responded positively to franchisees' concerns, AAHOA's Patel said. According to Choice officials, the franchisor is considering its policy pertaining to crossover markets for its Sleep Inn and Comfort Inn brands, but has not made any formal decisions yet.

“We cannot go back and fight about things that have been done in the past,” Patel said. “But we can surely start fresh from here and make sure we have the dialogues, that we have the communication, that we are talking to [Choice] face-to-face before they go ahead and do something.”

Councils spur communication

Choice's dialog with its franchisees is just one example of how franchisors and franchisee advisory councils are opening up lines of communication to address the changing issues of the marketplace. Most major franchisors actively solicit the advice of their franchisees through advisory councils that have been instrumental in corporate policy change.

“Our advisory council meets on a quarterly basis,” said James Abrahamson, president and COO of Milwaukee-based Baymont Inns & Suites, a mid-priced, limited-service hotel chain. “We're very active in terms of meetings and interaction between the franchisee community and ourselves.”

According to Abrahamson, the chain hosts frequent conference calls and spends a lot of time in dialogue on many issues, including its amenity program, and its marketing and advertising programs.

“We really look to get [approval] from our franchise advisory council as we move forward on projects,” he said. “They're a very important part of the team.”

Franchisee advisory boards often are used as a sounding board before franchisors initiate new marketing strategies. What sounds like a good idea in the corporate boardroom might have fatal flaws when implemented at the licensee level.

“Many proposed changes to brand standards are modified after receiving feedback from our [franchisee] advisory council,” said Tom Keltner, executive vice president of brand performance and franchise development for Beverly Hills, Calif.-based Hilton Hotels Corp. “In addition to our advisory council, we also have an online franchisee feedback service. You can now actually apply for a Hilton franchise online.”

AAHOA has been working with many of the major franchisors to set up advisory boards. “We are trying to create a better dialogue between the franchisee and franchisor — open communication rather than the franchisor just implementing policies without consulting franchisees,” Patel said.

Liquidation damages

AAHOA also lobbies for fair and equitable terms for hoteliers that wish to be released from licensing agreements. Standard agreements require franchisees to pay hefty fees ranging from $100,000 to millions of dollars to terminate licensing agreements.

“If people want to take a sign down and put another sign up, there needs to be some sort of compensation to the franchisor,” Keltner said. “Absolutely, we're going to charge liquidation damages.”

In recent years, franchisors have taken a more flexible approach. In 1998, Cendant enacted a new policy that basically gave every licensee, regardless of the original terms and maturity of the contract, the right to vacate the agreement under certain conditions.

“Basically, we told licensees unhappy with the performance of their franchise properties that if a property was not performing to the level that the franchisee was hoping for, the franchisee would have the opportunity to revisit the relationship at [a certain] time,” Saltzman said. “If franchisees decided to exit our system, they could. Of course, there were certain parameters that had to be met in order to utilize that policy.”

According to Saltzman, a franchisee must be in good standing and have maintained a property to a certain quality.

Financing

While the economy may not officially be in a recession, it's no secret that loans for new projects are harder to come by in today's market. The debt/equity ratio has shifted so dramatically that in many cases developers now need twice as much equity to break ground on a new property. And, even if a developer can raise the required capital, banks are increasingly reluctant to fund new projects.

Most franchisors offer various financial incentives for new developers, such as development advances and mezzanine loans at competitive interest rates. In the past, these incentives have been used much like a second mortgage for amenity upgrades and seed money. Now, these same development advances often are falling short of filling the debt/equity gap of the first mortgage.

“The growth rate of new projects in the pipeline is slowing,” Abrahamson said. “It has mainly to do with supply and demand and the fact that underwriting those deals for both equity and debt has diminished. I think this is a timeout [in the market], but I think we're in for a soft landing.”

“I think demand growth will, within the next year to 18 months, begin to increase again,” Abrahamson added. “We'll find ourselves in a more harmonious supply and demand growth. We won't, however, see the tremendous building cycle that we've seen over the last five years replicated.”

Pierce also observes that financing hotel projects is tough in the current climate. “We're starting to see situations where individuals are having a difficult time getting the financing source tied up,” Pierce said. “Now it's a 65% debt with a 35% equity play.”

Even if a prospective developer qualifies for a $250,000 development advance on a $5 million project, that doesn't drastically alter the debt/equity equation, Pierce noted.

“You haven't closed the gap enough to make the deal become a guarantee,” he said. “The development advance is good seed money. It's also a good investment from the standpoint of the franchisor. But the lending requirements have become so stiff that, in the end, someone needs to step up to the table with $1.5 million on a $5 million project.”




Aaron DeWeese is a Loudon, Tenn.-based writer.