Applying Performance Tests in Hotel Management Agreements

Abstract

Determining an appropriate test of a management company's performance in operating a hotel can be one of the most divisive bargaining issues in a management contract. Tests can be based on a hotel's return, operating margin, or revenue per available room. Each individual type of test has drawbacks, and it may well be best to use a combination of tests. Of the three individual tests discussed, the most easily supportable is arguably one based on a hotel's income before fixed costs (IBFC, also known as net operating income, or NOI). Use of multiple tests is generally most fair to both parties; for operators, they have the added advantage of providing enhanced protection against the consequences of uncontrollable outside events. Properly crafted multiple tests also protect the owner from an operator that is a poor match for a given hotel property or market.