Buying a hotel franchise, whether it’s a new hotel or an existing hotel, is expensive – there’s no doubt about that. However, the operating costs of running a hotel franchise are also quite expensive and should be considered carefully when deciding whether or not a hotel franchise is a good investment.
Indeed, oftentimes, when individuals consider starting a franchise, they place a lot of emphasis on startup costs and the initial investment to either buy an existing business or start a new business (i.e. the initial franchise fee, loan interest rates, etc.). One thing they often don’t pay as much attention to is the ongoing costs of operating the business, which is arguably more important than the purchase price (indeed, they should play an important role in determining the purchase price).
In this article, we will discuss the costs associated with running a hotel franchise and what small business owners can expect if they decide to enter the hospitality industry. Of course, it’s also important to remember that the number of franchises available is incredibly broad and each has different requirements and needs depending on the category of hotel (i.e. luxury vs. value) and franchisor. Indeed, options include but are not limited to Marriott, Super 8, Sheraton, Days Inn, IHG (Intercontinental Hotels Group), Hyatt, Crowne Plaza, Holiday Inn Express, Hampton Inn, or Motel 6.
Breaking Down the Operating Expenses of Running a Hotel Franchise
Obviously, the costs of running a hotel franchise are highly variable depending on a multitude of factors. These factors include the cost of labor in your area, the hotel franchise you are operating (i.e. higher-end hotels are more expensive to operate than value hotels), the cost of utilities in your area, the size of your hotel, and more. As such, there is really no way to give an average operating cost that a hotel owner can expect. However, what we can do is break down the various operating expenses you can expect. It is then up to you, as a diligent small business owner, to carefully consider the specific circumstances surrounding your potential franchise opportunities.
Labor, Staffing, Hiring, and Training Hotel Employees
Labor, staffing, hiring, and training are some of the biggest challenges and expenses faced by hotel owners in general, regardless of whether you are in the franchise industry or just operating your own hotel. The turnover in the industry is unsurprisingly high – similar to the restaurant industry – even in hotel management (meaning it’s not just the cleaning crew that you will have to frequently hire people for).
Training employees is time-consuming and expensive, both in a direct and indirect way. Training is expensive in a direct way because you will have to pay for training programs or develop your own, and you will have to pay them while they are trained, meaning they won’t be working right from the start. Training is expensive in an indirect way because you and your current employees will have to take time out of their own work to train new hires, which can reduce their efficiency and slow their own work. In fact, the turnover associated with the hotel industry is one of the things that makes hotel ownership so difficult.
Of course, the costs associated with hotel employees vary based on where you are located. Obviously, if you are operating a hotel in New York City, you are going to have to pay your employees considerably more than if you are operating a hotel in rural Indiana. Of course, the nightly room rates you will be able to charge in rural Indiana will be a lot less than the room rates you will be able to charge in New York City – so these sorts of things tend to balance out in the long run.
Labor costs also fluctuate based on the hotel and the level of service you offer. Full-service hotels with restaurants and a bar are going to have much more demanding staffing needs than, for example, a Motel 6, which is mainly going to need people to turnover the guest rooms each time a guest checks out.
Utilities are where hotels can really rack up expenses quickly. With thousands of guests trekking through each year, you can expect a lot of water and a lot of energy to be used. This means you will be paying some impressive water and electric bills. In fact, the average hotel spends around 3% or more of their revenues on utilities – not a trivial amount by any means.
Whenever you are examining a hotel’s profitability over the long run, utility fees are something you should estimate carefully and with as much precision as possible, since a poor estimate could lead to a drastically different outcome.
Of course, your occupancy levels will also impact your utility fees greatly. A hotel that operates at 60% occupancy on average is going to incur much cheaper utility fees than a hotel that operates at 80% occupancy on average. As such, you will need to estimate your occupancy levels carefully and accurately before you can make a good estimate of the utility fees you will have to cover.
Hotel Franchise Royalty Fees
It should come as no shock that hotel franchises come with franchise and royalty fees charged by the franchisor that have to be paid by the franchisee. However, many individuals don’t realize the extent of these fees, which can be expensive and numerous. Indeed, franchise costs can take a sizable chunk out of your revenues and bottom line.
Initial Franchise Fee
There is, of course, an initial franchise fee that must be paid. This fee usually comes as a flat fee charged to the franchisee plus a variable fee based on the number of hotel rooms that the new hotel has.
For example, imagine you are opening a new hotel with 450 rooms. A franchise might charge you a flat fee of $65,000 plus $500 per room for every room over 200. Thus, your initial franchise fee outlay would be $65,000 + $500/room * 250 rooms = $190,000.
Ongoing Franchise Fees
Ongoing franchise fees are where the expenses can really start to pile up. These fees are usually broken into the following categories, which are cover different fees associated with maintaining a franchise business:
Royalty Fees: Most franchisors, including those outside of hotel chains, such as restaurant franchisors, charge royalty fees. These royalties fees are paid to the franchisor for the right to use their franchise brand, logos, reputation, and other benefits associated with using a franchise’s name.
Of course, the benefits of using an established hotel brand are that you incur a lot of goodwill and brand recognition from the outset, and you will have a built-in customer base that is loyal.
Advertising and Marketing Fees: While some franchisees pay for their own marketing, particularly locally, they also have to contribute to the national and regional advertising that is run by the franchisor. Advertising and marketing fees cover the costs incurred by franchisors as they pay to promote the various properties and hotels associated with their chain.
This is fairly easy to understand, especially when you consider the costs of marketing and the high-quality marketing campaigns most large franchises run. After all, an individual Holiday Inn Express would never be able to run the expansive, next-generation advertising campaigns run by the IHG (the owner of the Holiday Inn Express franchise). As such, this fee makes a lot of sense, since most hotel franchises rely on the advertising done by their franchisor, giving the franchise owner one fewer thing to worry about.
Reservation and Loyalty Program Fees: Naturally, as a hotel, you will need to be able to take reservations, and most franchises operate centralized reservation systems where reservations can be made for any and all of their associated properties. These reservation systems not only have a website that must be maintained but they also have other operational expenses as well. For example, they typically have a call center, central offices, telephones, computers, staff members, and more. Reservation fees charged in your franchise fee go to cover these services.
As part of this, most franchises operate a franchise-wide loyalty program. These loyalty programs have expenses similar to the reservation system (in fact, usually they are integrally intertwined with the reservation system). Your fees typically go to supporting the maintenance, upkeep, and expansion of these loyalty programs. And it is typically a great value for franchise owners since they don’t have to deal with the difficulties that come with operating a large-scale loyalty program and integrating it with a top-notch, sophisticated marketing strategy.
There are other fees that are assessed to franchises, all of which depend on the franchisor and their needs and requirements. Any other franchise fees should be found in the franchise disclosure documents and related franchise documentation. As a bit of advice, when getting ready to complete your franchise application, you should have a qualified lawyer examine any and all franchise paperwork before you sign the dotted line. That way, you can ensure that you understand all of the terms and requirements you will be legally responsible for fulfilling and meeting once you open your franchise.
Hotel Maintenance Fees
While we have already discussed a number of costs associated with running a hotel, there are even more! The hotel business is not cheap.
Maintenance fees are another huge category of ongoing expenses for hotels. After all, hotels are large buildings that require constant upkeep in order to keep them in good shape. Here are a few different ongoing maintenance fees you can expect.
Keeping the building in great shape is critical to make sure your business remains sustainable. It is never a good idea to put off important maintenance not only because it discourages repeat business but because it also can lead to more costly and intensive fixes down the road. This means, over time, you can expect expenses related to your hotel’s appliances and water system, the hotel pool, the gym, and more.
In order to maintain the building, you will also have to pay landscaping expenses. While you may not need to pay for beautiful flowerbeds, you will definitely need to keep the grass cut and pull the weeds. Thus, while expenses like landscaping are variable, they still must be considered.
Guest Room Maintenance
In addition to maintaining the building and its grounds, you will have to maintain the guest rooms and other guest areas. Is there a hole in the couch in the lobby? You’ll have to fix that. Did the tv break in room 1205? You will have to replace that. Plus, hotel rooms require remodels from time to time, and replacing linens and other durable goods becomes a requirement. These sorts of expenses should be considered and planned for accordingly.
Developing a Business Plan
If you are considering opening a new franchise hotel, the first thing you should do is develop a strong business plan and strategy that is detailed and broad in its approach. Making sure you nail down your business model and strategy before deciding to move forward with a hotel franchise is critical since it will allow you to decide whether or not opening a hotel is a good investment.
When developing this business plan, you should carefully consider the location of your hotel, make accurate estimates of occupancy and ongoing costs, estimate revenues, and drill down the financials, taking into account any loans you will need to take out. Hotels, unlike some other businesses, require a massive upfront investment, so you need to be sure that you are entering into a viable market with a viable product long before you break ground on the construction of a new hotel.
As part of this, you will need to conduct thorough and comprehensive market research. This will help you identify what travelers and individuals in the area are looking for. Certain types of hotels are better for certain types of areas. For example, you probably wouldn’t want to open an expensive, full-service, luxury hotel in a town in rural America with minimal traffic. While this is an extreme example, many market distinctions are far more nuanced, so you have to be diligent in examining your prospective investment and its long-term viability.
Even if you are not planning on opening a brand new hotel franchise and are instead looking to purchase an existing hotel franchise you will still need to be thorough in your analysis. Make sure you get to see the financials of the current hotel and drill down deep in analyzing them. In fact, we highly recommend you hire a professional business accountant to look over any financial documents. They will be able to analyze the books and see if anything looks out of place or fishy, plus they’ll be able to give you a good idea of the profitability and long-term viability of the business using a multitude of metrics and ratios.
Financing A Hotel Franchise
Financing a hotel franchise is critical to get things off the ground and running. However, this financing should not be for paying the ongoing expenses of the hotel. You’ll need to start turning a profit eventually, so financing should typically be reserved for startup expenses.
That said, opening a line of credit can be a good idea for almost any small business, since it can help smooth cash flows, especially in industries like the hotel industry, which tends to be seasonal.
Running a hotel franchise is expensive and the costs are high. Yet, small businesses owners can get caught up in the upfront costs of starting their business, sometimes forgetting to think in terms of the long run. As a result, it is critical that you remember to consider the work and expenses that go into operating a hotel franchise efficiently and profitably before you decide to get into the industry. Incorporating these into your business plan can work wonders in terms of allowing you to plan and they will help you make a decision about a potential franchise investment with confidence and intelligence.
As always, Biz2Credit continues to work tirelessly to bring our readers the latest information and news surrounding small businesses. Be sure to continue checking back here at our Biz2Credit Blog to continue to get the latest information. We are constantly posting articles on the latest financing opportunities and methods as well as guides for prospective small business owners looking to make a splash in new and upcoming industries!