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Beginnings of the franchise model

Franchising has been around since the mid-19th century in the USA. However it was in the 1930s when Howard Johnson restaurants paved the way for restauranteurs and other businesses - ranging from car dealerships to drug stores - to start their franchising journey in the USA.

McDonalds is perhaps the most famous franchise in the world today, with over 36,000 restaurants in over 100 countries, and 90% of these restaurants are owned and operated by independent franchisees.1 Franchising enabled McDonalds to expand rapidly since their origins in the 1940s and the model is increasingly being used today by major brands across a diverse range of industries to expand their businesses globally.

Being able to expand your business through the use of another’s capital and resource makes franchising a popular model as it also allows the franchisor more time to focus on other aspects of the business, such as expansion and mitigating risk. For the franchisee the risk of failure is reduced, as you are entering into a business with a proven, reputable brand that typically will command significant market share. Franchisees also benefit from economies of scale, brand standard guides, shared systems and information and technology that would be much harder to develop and implement as an independent business seeking to compete with larger, more mature businesses.

Evolution of the franchise model for hotels

Primarily through global economic growth and other social factors, such as the arrival of low cost airlines, the growth of middle classes in emerging markets, and the impact of aspirational lifestyle advertising, the hospitality industry has continued to see upward demand over the last few decades – despite the occasional economic crisis. This demand has in turn fuelled the rapid growth of hotel chains around the world. Marriott, which is now the world’s largest hotel chain,2 operates and franchises more than 6,500 hotels and over 1.25 million rooms.3

Franchising has allowed the hotel industry to expand this rapidly and achieve high growth. Within this model the hotel is normally owned and operated by a third party franchisee and the contract entitles the franchisee to access the knowledge, processes and trademarks of the hotel company, in return for a brand licencing fee.

Challenges of the franchise model

Running hotels through a franchise model does bring about a variety of challenges due to the differing levels of control that the franchisors have over their franchisees, compared with a managed or owned location. The cost and responsibilities of property ownership are avoided, but it can be difficult to control the activities of the franchisee and ensure that their activities are up to the standard that the franchisor demands, in order to protect the brand. For example, franchisors must have confidence that franchisees are following best practice operations, particularly in respect of risk management, in order to ensure that the hotel brand – its most valuable asset – remains protected.

Insurance & risk management solutions for hotel chains & their franchisees

1 - http://corporate.mcdonalds.com 2 - https://www.forbes.com/sites/halahtouryalai/2017/05/24/worlds-biggest-hotels-2017-marriott-leads-the-pack-hilton-falls/#5f1114b47f29 3 - http://news.marriott.com/2018/01/marriott-international-marks-2017-year-historic-international-expansion/

In this article, Ben Perfitt, Alesco’s Hotels & Hospitality leader, discusses the significant opportunities presented by the franchise model for the hotel industry - and solutions to some of the risk challenges that can arise as a result of the strategic utilisation of this model for growth.

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Mature markets the US in particular - are where the franchised model has had its most success and this is indeed where the vast majority of franchised hotels for major chains, such as IHG, Marriott and Hilton are located. This is partially because over time these chains have committed to developing a rigorous process for managing the risks posed by the franchise model and because broadly the risk profiles of developed economics such as the US, UK, Canada, Australia are similar and ‘fit’ the risk appetite of the chains. A case in point is IHG, which franchises 90% of its hotels in the Americas and Europe but in Asia, the Middle East, and Africa, only 20% are franchised,4 - albeit this landscape is changing. As a result, the risk profile of the major hotel chains is changing as the franchise model now is deployed on a strategic, global basis.

The changing risk landscape

Over half of Marriott’s global pipeline is located outside of North America,5 and this growth outside of the US is not unique to Marriott. The Asia-Pacific region accounts for nearly 30% of Hilton’s total pipeline and for 2018 they estimate that roughly 40% of their net growth will be located in international markets.6 RevPAR, (revenue per available room) is a performance metric used in the hotel industry and over the past four years the growth rate achieved by IHG is two times as high as in established markets, giving them confidence in the long term potential of developing markets.7

In order to continue to secure growth, hotel chains are increasingly looking further afield and are actively considering broader investments into territories which previously would have been discounted on account of high levels of risk. For example, a decision to invest in an emerging market can be swayed by a number of factors ranging from the stability of the economic environment, the range of commercial partners, the maturity of the tourism sector, and the availability and quality of supporting infrastructure ranging from telecommunications to water. Yet utilisation of the franchise model helps influence the decision on whether to invest; if it is the franchisee that is responsible for the success of the investment and the only risk to the chain is the protection of the brand, then the threshold for ‘investment’ is lowered from a risk perspective and the opportunity then becomes commercially viable.

Once the decision has been made to open a new franchise or transition from a managed or owned location to a franchise, then the hotel company has to ensure that the third party owners comply with the requirements as outlined in their franchise agreements.

Part of these franchise requirements contain contractually binding insurance requirements which are ultimately designed to protect the hotel chain’s brand in the event of a loss. Among others these include worldwide jurisdiction for claims brought against the insured and having the ‘franchisor’ named as an additional insured on the policy. Unfortunately, the franchisee may be unable to fully comply with these requirements and even if they have found the required coverage it can be cost prohibitive to purchase.

Without the required coverage, it leaves both the franchisee and franchisor exposed if there is a claim. With the brand name above the door, a claimant on a serious case is also likely to seek damages from the well-known hotel chain, rather than the relatively less known hotel owner (franchisee) in that territory.

If the claim was made against the franchisor and they were not named on the policy, they could be held liable for millions of dollars without having the appropriate insurance in place, and this could then directly impact the balance sheet. In addition, without worldwide jurisdiction on the insurance policy, the franchisee or franchisor would not be covered if a claimant, such as a guest, made a claim upon returning to their home, as the claim would then fall outside of the holiday destination jurisdiction. Again this could directly impact the franchisor’s balance sheet in addition to the cost of time and resource to resolve the matter.

Solutions to manage the risks

Alesco Risk Management Solutions, a leading London market insurance broker, has over 20 years’ experience of working with major hotel chains and helping them in providing unique risk management and insurance solutions.

4 - https://www.ihgplc.com/en/investors/annual-report5 - http://news.marriott.com/2018/01/marriott-international-marks-2017-year-historic-international-expansion/6 - http://ir.hilton.com/~/media/Files/H/Hilton-Worldwide-IR-V3/quarterly-results/2017/q4-2017-earnings-transcript.pdf7 - https://www.ihgplc.com/en/investors/results-and-presentations

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Having worked alongside some of the biggest hotel chains through their franchising journey, we are in a great place to provide innovative, efficient and competitive insurance/risk management solutions for hotel chains and their franchisees.

In 2014 we negotiated a specific insurance facility covering Comprehensive General Liability, which not only meets the franchise agreement requirements, but is also highly competitive on premiums. Not only have we negotiated both coverage and pricing but we have also launched the product on a bespoke online platform. In 2017, we began to look at broadening the product options available on the platform and will shortly be able to offer additional coverages such as Reputational Harm, Property and Cyber to franchisees.

Our team also offers a range of risk management solutions for our clients to support them in managing the workload of tracking franchisee compliance with contractual requirements. Our Compliance Tracking platform helps hotel risk management departments in understanding which franchisees are non-compliant and helps reduce the administrative compliance workload.

Ultimately, the knowledge and expertise we’ve developed in this space helps franchisor and franchisee alike to protect their brands and their balance sheet.

The team at Alesco have developed a simple web-based product that solves an important risk and compliance requirement for Marriott, whilst providing a much needed quality insurance product, competitively priced for our owner/franchisee partners

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Kathryn Wallin, RISK MANAGEMENT, MARRIOTT

ALESCORMS.COMAlesco is a trading name of Alesco Risk Management Services Limited. Alesco Risk Management Services Limited is an appointed representative of Arthur J. Gallagher (UK) Limited which is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 1193013. www.alescorms.com

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FOR MORE INFORMATION, PLEASE CONTACT:

Direct: +44 (0)20 7877 6011 Email: Ben_Perfitt@alescorms.com

BEN PERFITT, ASSOCIATE PARTNER

OR VISIT OUR ONLINE PORTAL:www.hoopinsurance.com

CONDITIONS AND LIMITATIONSThis information is not intended to constitute specific guidance and recipients should not infer specific guidance from its content. Recipients should not rely exclusively on the information contained in the bulletin and should make decisions based on a full consideration of all available information. We make no warranties, express or implied, as to the accuracy, reliability or correctness of the information provided. We and our officers, employees or agents shall not be responsible for any loss whatsoever arising from the recipient’s reliance upon any information we provide and exclude liability for the statistical content to fullest extent permitted by law.

Hotels & Hospitality expertise in the heart of LondonDrawing together specialist hotels and hospitality expertise from across the group in the UK, US and through our GGA and wider international offering, our virtual team is able to service clients across the globe.

Our London and UK based team works for clients ranging from independent small and mid-market hotels, through to large international hotel chains with global portfolios of diverse hotel properties and brands. Spanning 5 continents and over 40 countries, our clients are hotel owners, hotel operators and franchisees, investment managers, property developers and pension funds.

We provide a cross-class offering, including Property, Liability, Construction, D&O, Cyber, Terrorism, Political risks, Surety and Mergers & Acquisitions insurance. In addition, we have developed a platform specifically for hotel operators to support them in managing franchisee insurance requirements and risks.

Clients lean on our team of brokers as an outsourced risk manager to give them the confidence that their assets, cash flow, people and brands are protected.

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