By: Thomas Pastore - Written for HotelExecutive.com
A combination of tangible and intangible assets is used to create and develop a brand. Apropos to the hotel industry, brand development involves the integration of a trademark with focused promotional strategies, effective advertising campaigns, and appealing product design. A hotel brand has the potential to become a proven landmark that promises a specific environment to its target market from the reservation stage to the checkout stage of a visit. It is an entire package, created and developed by human ingenuity and then elevated by the favorable emotional response to it. A hotel brand, therefore, is an intellectual property asset the importance of which is significantly increasing from a business valuation standpoint.
The importance of brand creation and development in today's highly competitive hotel industry cannot be overstated. Just take a look at the 2004 Annual Reports or 10-K's of two of the top industry performers, Hilton Hotel Corporation and Marriott International. Under the Management Discussion and Analysis section for each you will find that brand identification is front and center. The Hilton Hotel Corporation's Company Overview, for example, opens with a list of the corporation's brands that are distinguished by ownership type, the number of properties and the number of rooms. The Company Overview concludes with a summary of the corporation's "core strategy" for growth, the successful implementation of which is a function of "diverse market presence, strong brands and strategically located properties".1 Similarly, Marriott International defines itself in terms of the number of brands it owns, produces, franchises, and sells in the case of its timeshare properties. The Company Overview concludes with Marriott International's commitment to maintaining the service level image that is associated with its brands by "selling the way the customer wants to buy".2 The hotel brand is ultimately what the customer buys and its proper valuation is of paramount importance in the hotel industry.
The most popular brands that customers are buying today span the full spectrum of demand with top performers in both the budget and full-service luxury segments. It follows that one of the reasons branding is such a powerful marketing tool is that it allows a single trademark to penetrate multiple markets through the development of a portfolio of brands. The degree of market diversification that effective brand development achieves is especially relevant to the hotel industry due to its sensitivity to economic conditions. Strong brand development also facilitates greater operational diversification within an organization. Hotel ownership, franchising and managing, acquisitions, and property sales are separate business segments within a hotel system each with a unique response to economic cycles, hotel cycles, and widespread industry shocks. For example, in periods of high economic uncertainty hotel systems with popular brands can continue to grow their business through franchising which is not capital intensive. Hilton Hotel Corporation's 2004 Development and Capital Spending Overview states that the hotel system intends to grow "primarily through franchising and management contracts, which require little or no capital investment".3 Similarly, in the current period of high construction and energy costs, hotel systems can grow their business through strategic conversions. For example, 39 percent of Marriott International's total room additions for 2004 were conversions from other brands.4 Brand development, therefore, is a key operating element of most hotel systems. Due to its central role in revenue enhancement through operational diversification and minimizing exposure to competitive market conditions through product diversification, it is a key driver of an organization's value.
The fundamental valuation principle applicable to any financial asset is that its value is equal to the present value of its future economic income. Therefore, of all the approaches for appraising hotel brands, the income approach is preferred because it quantifies the present value of the future income stream attributable to the brand. The steps that are necessary to isolate a hotel brand's future economic benefits are as follows:
· Disaggregate the different business segments such as Hotel Ownership, Managing and Franchising, and Timeshare;
· Segregate the sales revenues of each brand within a business segment;
· Allocate all operating expenses and capital charges associated with these sales revenues such as the continued advertising and promotional expenditures as well as the legal, contractual and other fees related to the franchising and management contract segments;
· Project the remaining economic life;
· Estimate the economic income that will be generated by the brand over its projected remaining life; and
· Capitalize the isolated economic income stream. A projection of the remaining useful life of a hotel brand requires both qualitative and quantitative analyses of a composite of life cycle determinants.
These determinants include factors such as: the historical life cycles of similar brands, the life cycles set by existing franchise and management contract agreements, and economic analyses of the conditions that affect the brand's ability to produce the required rate of return. The income stream is capitalized by applying a risk-adjusted rate of return (discount rate) to determine present value.
Two other general methods for valuing brands are the cost approach and the market approach. The cost approach values a brand by quantifying the total replacement cost of the subject brand. Because the cost approach does not take the earnings growth potential into account, it often yields an inaccurate valuation conclusion. The market approach values a brand by reference to comparable transactions. The inherent constraint in using the market approach is the availability of data on guideline brands.
There is a wide range of business advisory and valuation services that can provide hotel owners and investors with important information about the brands under their ownership whether the asset is a single brand or a portfolio of different brands. This information would include:
For many hotel operators, brands may be the single most important determinant of value. Therefore, whether you are buying, selling, investing in, or operating a hotel system, a proper identification and valuation of the subject brand(s) facilitates decisions affecting shareholder value enhancement, management performance, capital planning, and accurate business appraisal conclusions.
The author would like to thank Daria Burnes for her excellent research and contributions.
Mr. Tom Pastore is Chief Executive Officer and co-founder of Sanli Pastore & Hill, Inc. He has been involved in financial consulting for more than 20 years, specializing in investment and financial analysis, litigation consulting and public accounting. Extensive experience encompasses valuing numerous businesses in a wide range of industries including retail, services, manufacturing and holding companies. He has served as an expert witness in federal and state courts for business litigation cases in California, Arizona and Nebraska. Thomas E. Pastore can be contacted at (310) 571-3400 or tpastore@sphvalue.com.