Summary

F&B (food and beverage) offerings which provide a fine dining experience are increasingly proving an attraction in themselves for hotel residents and non-residents alike, improving hotel occupancy rates and profitability.  So what does an owner, who may not already have the expertise to deliver that in-house, need to consider in any F&B outsourcing arrangement?

Hotel food and beverage (“F&B”) offerings have historically been viewed by owners and hotel operators as a “necessary evil” to service the hotel’s guests, with high costs and low margins.  However, this mind-set is changing. Owners and hotel operators are now increasingly focusing on developing a quality dining experience with the aim of not only enhancing the hotel’s occupancy and ADR by creating a “dining destination”, but also boosting the F&B's profitability by drawing in diners from outside of the hotel.

One of the ways to achieve this is to outsource the hotel’s F&B offering to a third party F&B operator who, like hotel operators, can leverage their branding and expertise to improve the F&B’s performance.  This is a particularly relevant option where the owner or hotel operator does not have the necessary F&B expertise in-house.

What are the practical implications of F&B outsourcing?

There are a number of practical matters that will need to be addressed, typically in the hotel management agreement (“HMA”) and/or a separate service level agreement between the hotel operator and the F&B operator:

• Extent of the outsourced F&B area: This will need to be clearly defined, and carved out of the hotel operator’s remit under the HMA. Where F&B outsourcing is contemplated at the outset of the relationship between the owner and the hotel operator, this can be addressed in the HMA from day one.  However, where there is an existing HMA, the parties would need to amend it to allow the owner to effectively “take back” the F&B area from the hotel operator before outsourcing it to the F&B operator.
• Shared facilities and employees and apportionment of costs: The parties must identify whether there will be any shared facilities or employees, and agree how the associated costs will be apportioned between the hotel and the F&B area. This may not be a straightforward formula, and is likely to involve detailed analysis of expected usage of the shared facilities and employees by the hotel and the F&B area.  However, it is very much in the parties’ interest to have a clearly defined mechanism for cost apportionment from the outset to avoid disputes later.
• Exclusion of F&B revenues and operating expenses: F&B revenues and operating expenses should be excluded from the hotel’s financials, to ensure that the hotel operator does not earn fees on revenues generated by the F&B operator. Equally, the hotel operator will not want F&B operating expenses to be taken into account when calculating the hotel’s profits, as this will affect the hotel operator’s incentive fees.  Unless, of course, that is the commercial deal agreed between the parties.  For instance, we have seen examples where the hotel operator operated the hotel restaurant under an existing HMA and agreed with the owner to outsource restaurant operations to an F&B operator, but the quid pro quo for them doing so was that the hotel revenue was “topped up” by a notional restaurant revenue based on the restaurant’s historic performance prior to the outsourcing.  This effectively made the hotel operator whole for the loss of fees that they would otherwise have earned on the revenues generated by the restaurant had restaurant operations not been outsourced.
• Services to be provided to the hotel by the F&B operator: The parties will also need to agree on any services to be provided by the F&B operator to the hotel. For example, will the F&B operator provide in-room dining or breakfast service for hotel guests?   Coupled with this, the hotel operator will almost certainly look to impose service level requirements and KPIs (key performance indicators) on the F&B operator, such as maximum times for delivery of in-room dining orders, and collection of trays and breakfast door hangers. 
• Reimbursement rates: Where the F&B operator provides services to the hotel, the outsourcing agreements will need to address reimbursement rates for meals consumed by hotel guests, which may include pre-agreed rates negotiated by the hotel operator with third parties. For example, we have seen instances where the hotel operator enters into contracts with airlines for air crew to stay at the hotel with inclusive meals at set prices, which the F&B operator may have little say over but is nevertheless expected to honour.
• Restrictions on competition from hotel operator: The parties should also agree any restrictions on competing F&B operations by the hotel operator in the hotel, as well as any exceptions to these (for instance, the hotel operator may want to continue operating a “grab and go” counter in the hotel lobby).
• Brand standards compliance: The F&B area will obviously be guest facing, so the hotel operator will be very concerned that the F&B area’s standards are commensurate with the hotel. The hotel operator will therefore no doubt look to impose a certain level of brand standards compliance on the F&B operator.    
• Performance test: The outsourcing agreements should also address performance testing of the F&B operator’s performance by the hotel operator. This can be based on, for example, meeting service level KPIs, quality control audits, and the results of guest satisfaction surveys.

Outsourcing models

The owner can consider the following outsourcing models depending on their preferred risk position for F&B operations:

• Lease: Under this model, the owner leases the F&B area to the F&B operator and, in effect, transfers the risk and return of the F&B business to the F&B operator in exchange for a “guaranteed” rental income. This rental income is often split between a minimum fixed base rent and a variable turnover based rent, depending on the level of risk and share of profit that the owner wishes to achieve.  As the F&B operator is taking on a higher level of risk under this model, they will almost certainly expect a higher (if not total) level of control over the F&B area and operations.   
• Operating Agreement: This is essentially the same operating model as the HMA with the hotel operator, in that the owner appoints the F&B operator to operate the F&B areas on its behalf (in return for management and incentive fees) but retains the majority (if not all) of the risk and return of the F&B business. Consequently, the owner may expect to retain a higher level of control over the F&B area and operations than under a lease.

Regardless of which model the owner chooses, there will need to be a contractual nexus between the hotel operator and the F&B operator so that the hotel operator can impose and enforce, for instance, compliance with hotel brand standards, service level requirements, performance testing, and termination rights.  This can be achieved by joining the hotel operator as a party to the lease or the operating agreement, or by having a separate service level agreement between the hotel operator and the F&B operator. 

One of the key areas to be addressed in outsourcing agreements is the right to terminate the F&B operator’s appointment.  The termination provisions will need to be carefully negotiated to ensure that both the owner and the hotel operator are entitled to participate in any decision to terminate, and grounds for termination are clearly defined, so as to avoid disputes later where one party is satisfied with the F&B operator’s performance but the other party is not.

Conclusion

Outsourcing a hotel’s F&B operations can be beneficial to all parties if the result is increased F&B revenues and profitability as well as higher occupancy and ADR (average daily rate) for the hotel.  However, there are many practical considerations and potentially conflicting interests that need to be addressed and carefully documented between the parties to increase the chances of a successful F&B outsourcing.