It is, and it frequently happens.
Hotel management companies charge a base fee of two to five percent of revenue. And many charge an incentive fee of fifteen percent of any increase in revenue over that of the prior year. The base fee is assured. The incentive fee may or may not amount to much, if there's an improvement in revenue over last year at all. (There are also upgrade fees, and those offer their own opportunities for abuse, but we're not dealing with those as part of this question.)
So, if I want to ramp up my fees, the fast-and-easy way to do it (if not the best way for the client-owner) is to get as much money coming in the door, as soon as possible, without a lot of thought to how much your costs are eating up almost all of it as fast as it comes in. Offering low rates to certain people just to fill the rooms? Do it. Renting to rowdy local people? Do it. Bringing business into the hotel that costs us as much as they pay us? Do it.
But if our agreement is tied to profitability, such an agreement would have hazards of its own. It would incentivize a lot of bickering between us and the client-owner about what should count as profit and what shouldn't, and how we could have made more profit if we'd done this, or hadn't done that. It would disincentivize reinvestment, or even good maintenance. It would incentivize shortcuts that would have consequences that would come up later. It would incentivize the taking of risks that might have bigger consequences that would sooner or later show up. It would incentivize doing things on the cheap. Your property would lose value over time and sooner or later have bigger problems.
You don't know me, you might not feel you have reason to take my word for it, but we don't do it that way. If I'm managing a hotel for you, I want us to work well together; and if we do, I want you to be an investor in another hotel that I will also be managing and collecting base fees for managing, so I want you to be happy and feel that you're getting as good a return as possible on the one in which you're already invested, that we're already managing.
What you noted here is something that shows up in lots of fields (insurance and banking, especially) called moral hazard -- what might appear to be in my best interest in accordance with our agreement or contract might not be altogether in your best interest; or what works within the agreement for you might be to my harm. Am I going to think only of myself, or am I going to be committed to the business relationship between us and take what's best for both of us into account before making any decision or taking any action? And what are you going to do before you have some decision to make -- are you going to do the right thing by me, or are you going to do what you can?
It's a common human failing: we each want to be outlaws and not be bothered or inconvenienced by rules or contracts in any way, but we want the other guy to play by rules and abide by contracts. To the extent we have any use for rules and contracts at all, we want them only to keep the other guy in line; and we want them interpreted, if not altogether rigged, and applied in our favor and to our benefit. That doesn't work.
A sense of partnership and mutual trust, on both sides, is necessary to make any hotel management agreement (or any other contract) work.
One thing that, back in the day, drove people nuts about the Japanese and doing business with them is that it took so long to get an agreement negotiated and signed. But they went about it differently than the way we do over here. The reason it took so much time, and so many meetings, and so many visits, and so many conferences, with any Western company, was that they spent the time getting to know that company and the people in it. They wanted at least a basic relationship in place, they wanted to know that that sense of partnership was present on both sides.
Understand it that way, and you might understand why they'd think the way we do it is messed up.
With a relationship to which we're both committed, with that sense of partnership on the part of both of us, with my confidence that no matter what comes up, you're going to do right and be fair to me and your confidence that no matter what comes up, I'm going to do right and be fair to you; we can carry on some pretty complex business on an ongoing basis, with very little by way of written, legally enforceable agreement, and we will always work out any problems that come up in a way that we are both happy -- often, even in ways that the written agreements don't tell us how to work it out. Or maybe they do, but the solution written in the contracts obviously won't work for the one or the other of us in a given situation, and we might be better off to work out something instead that will work for the both of us in that situation.
Without that relationship in place, we're sooner or later going to have problems.
No written agreement, drafted by even the best lawyers, in the most detail, can anticipate every little problem that conceivably come up and state in advance how it will be dealt with. Even those contracts that try will eventually come to be applied to a situation where much of the problem is in the agreement itself: someone wants the advantage for himself, the other side wants to use a clause in the agreement to secure for himself an advantage that the parties didn't intend. That's why Westerners spend so much time in court.
Laws and written contracts can even on a good day give you so much leverage. They can stop someone from doing something -- sometimes. They can force things that can be forced at all -- sometimes. You can sue someone, but it's what you do when you think it's your only chance: doing that, or the threat of doing it, isn't going to work for you on a day to day basis. Relying too much on external control psychology as opposed to trust, relying upon law and courts to keep your day to day business dealings under control, is like running a rowdy bar without bouncers: sooner or later the cops are going to get tired of getting calls to your establishment because you can't handle security and are always needing help with your unruly drunks.
To the extent that our agreement works at all, it will be because each of us is committed to the agreement, and the intent of the agreement, and the best interests of the other as contemplated in the agreement. Or even better, to the relationship that we have.
Originally appeared on Quora
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