By Demian Hodari, Michael J. Turner, Michael C. Sturman
Hotel owners increasingly rely on hotel management companies to operate their hotels through formalized hotel management agreements (HMA). Separating ownership and operations supposedly benefits both parties: owners are able to invest in hotel real estate and access the professional operating expertise of hotel management companies, while operators can generate important income streams, expand any brands they may have, and earn profits, all without having to invest in the underlying real estate.
Although both parties have a vested interest in the hotel’s success, their different sources of income, risk profiles, and investment strategies mean they often have different interests, which may lead to misaligned and possibly even conflicting goals.
For example, because the vast majority of an operator’s fees are derived as a percentage of the hotel’s sales, owners are concerned that operators may focus on increasing sales rather than profits. Operators are also strategically focused on the reputation of their brands and their hotel-level decisions may support this at the owner’s expense. In addition, operators tend to emphasize customer relationships and long-term success of their business, while owners are more likely to have a short-term focus that emphasizes payback and returns. Furthermore, because operators rarely (if ever) share in the owner’s profit from an eventual sale of the real estate asset, their decisions may not be aligned with increasing the asset’s value, even though this is of paramount importance to owners.
The risk for owners, therefore, is that an operator, although acting as the owner’s “agent,” may in fact be tempted to act in ways that are not in the owner’s best interests. This is why owners spend considerable resources to monitor, control and/or influence the management company’s decisions and actions, including hiring asset managers.
While management companies often point out that an HMA’s incentive fee clause helps align the two sides’ interests, as they only earn profits when they generate these for owners, past research has shown that hotels rarely generate such incentive fees. This implies that such hotels are not, for the most part, generating the profits necessary for owners to pay incentives to the operators. While there could, of course, be extenuating circumstances impacting a hotel’s performance, the general lack of incentive fees suggests that owners may seek other ways to align management companies’ interests with their own.
Given the growth in hotel management agreements, and their importance to both owners and operators, we were surprised not to find any research examining the actual goal alignment of owners and operators once the agreement had been signed.
We thus set out to study the degree of owner-operator goal alignment. Furthermore, while greater alignment might suggest a more unified vision for the hotel, it does not necessarily mean the property would perform any better. In fact, less alignment could possibly mean that the management company, which has professional management expertise, might be operating the hotel optimally, even if not in line with the owner’s goals. We also looked at the relationship between goal alignment and hotel performance.
We investigated these questions though a unique survey where we matched the answers of owners and management company representatives in 64 different hotels.
Specifically, we examined their level of agreement about the priority of 21 different objectives over the coming two years and across five functional areas (Human Resources, Finance, Sales and Marketing, Property, and Operations). Hotel performance, meanwhile, was measured by the owners who rated 16 different aspects of performance related to the five functional areas. Our statistical analyses involved two parts. We first used correlation analyses to look at overall effects. We then used a series of regression analyses to look at the effects of alignment on hotel performance after putting in place controls for alternative explanations that could have arisen from property, individual and/or situational characteristics.
Overall, the goal alignment we discovered was, on average, 3.31 out of 5 (where 5 indicated higher alignment). While it can be difficult to interpret the substantive meaning attached to averages, an average only somewhat higher than the mid-point (as is the case here) suggests a moderate degree of goal alignment amongst the sampled hotels. The average level of hotel performance was 4.29 on a scale of 1 (low) to 6 (high). Although there was a relatively wide range of performance scores (from 1.44 to 5.81), the results suggest that our sampled hotels were, overall, performing reasonably well.
More importantly perhaps, we found that goal alignment was significantly correlated with hotel performance. In other words, the greater the goal alignment, the better the hotel’s performance. In order to eliminate some possible explanations for this relationship, we controlled for the effects that some other variables, such as the GM’s experience, the presence of an asset manager, and the hotel size could have on its performance. We found statistical evidence confirming that alignment does in fact have a positive effect on hotel performance.
Our results therefore suggest the need for owners and management companies to agree upon a core set of common goals for their hotels, as such alignment is linked to superior operating performance. While each party will clearly have its own objectives, an ability to align these will end up better serving each party as superior operating performance should ultimately result in higher fees for most operators and higher asset valuations, as well as returns for owners.
Researchers and practitioners often recommend that, in order to create a ‘win-win’ situation, owners and operators need to consider and agree upon a wide variety of issues in the negotiation of management contracts. While we unequivocally agree with this sentiment, it may be even more beneficial for hotel owners to, first, spend as much time and resources on selecting the ‘right’ hotel operating company and maintaining the relationship after the contract has been signed.
This may mean selecting a company whose vision and goals for the property are well aligned with their own – or one whose goals and vision are different but enticing. This is important because goal misalignment has often resulted in costly legal battles involving, among other things, accusations of management companies not fulfilling their responsibilities as owners’ agents. Owners are thus advised to have detailed discussions with different management companies, not only to ascertain their analyses and plans for the hotel, but to compare these with their own.An owner may, as well, realize from these discussions that it should in fact defer to the management company’s plans, which could in turn also help align their objectives. We thus also suggest that management companies fully commit to ensuring that their hotels’ owners not only know management’s plans for the property, but also the underlying reasons for these decisions, as this may help achieve owner support. A healthy discussion should hopefully lead to better and more aligned objectives, which should benefit both parties and help ensure a better long-term relationship.
This is the second article in a three-part series about the evolving relationships and roles of hotel owners, management companies and their general managers. In the first article of this series, we examine how involved are hotel owners in property-level decisions.
Acknowledgements: This study relied on the support of the hotel owners and members of the Hospitality Asset Managers Association (HAMA) of Asia Pacific, Europe and the Middle East & Africa, the European Hotel Managers Association (EHMA), and The Master Innholders who graciously provided the data used in this study.