6. An article in The Wall Street Journal reported that large hotel chains, such as Marriott, are tending to reduce the number of hotels that they franchise to outside owners and increase the number the chain owns and manages itself. Some chains are requiring private owners or franchisees to make upgrades in their hotels, but they are having a difficult time enforcing the policy. Marriott says this upgrading is important because “we’ve built our name on quality.”
a. What type of agency problem is involved here?
b. Why would Marriott worry about the quality of hotels it doesn't own but franchises?
c. Why would a chain such as Marriott tend to own its hotels in resort areas, such as national parks, where there is little repeat business, and franchise in downtown areas, where there is a lot of repeat business? Think of the reputation effect and the incentive of franchises to maintain quality.
a. The type of agency problem involved here is the principal-agent problem. Marriott, as the principal, is facing difficulties in ensuring that franchisees, the agents, maintain the desired quality standards in their hotels.
b. Marriott would worry about the quality of hotels it doesn't own but franchises because its brand reputation is at stake. As a well-established and renowned hotel chain, Marriott's success depends on the consistent delivery of quality experiences to its customers. If the franchised hotels fail to maintain quality, it could tarnish the brand's image and affect customer perception of all Marriott properties.
c. Marriott tends to own hotels in resort areas where there is little repeat business because it allows them to have direct control over the quality and experience provided to guests. In resort areas, the reputation effect is crucial since customers may not have prior experience with the hotel and rely on the brand name for trust. By directly owning and managing these properties, Marriott can ensure consistent quality and protect its reputation.
On the other hand, in downtown areas where there is a lot of repeat business, Marriott may choose to franchise. Franchising allows leveraging the incentive of franchisees to maintain quality. With a continuous stream of repeat customers, there is a stronger motivation for franchised hotels to provide a quality experience to ensure customer loyalty. Additionally, the reputation effect is less significant in these areas as customers are often more familiar with the specific hotel and its services.
a. The type of agency problem involved here is known as an "adverse selection" problem. Adverse selection occurs when one party in a transaction has more information than the other party and uses this information asymmetry to their advantage.
b. Marriott would worry about the quality of hotels it doesn't own but franchises because its brand and reputation are closely tied to the quality of the hotels bearing its name. If poorly maintained or low-quality hotels operate under the Marriott brand, it could damage its reputation and potentially lead to a decline in customer trust and loyalty. Maintaining consistent quality across all hotels franchised under their name is crucial for protecting their brand equity.
c. There are a couple of reasons why a chain such as Marriott may tend to own its hotels in resort areas and franchise in downtown areas.
Firstly, in resort areas like national parks, there is often less repeat business compared to downtown areas. This means that the incentive for franchisees to maintain quality might be lower as they may not rely as heavily on repeat customers. By owning and directly managing hotels in resort areas, Marriott has more control over the quality of the guest experience, ensuring consistency and maintaining the reputation of their brand.
Secondly, in downtown areas, there is typically a higher concentration of business travelers and repeat customers. Franchising in these areas allows Marriott to leverage the reputation effect, where customers may choose a hotel based on the chain's brand reputation rather than the specific hotel location. Franchisees in downtown areas have a strong incentive to maintain quality because they benefit from the reputation and goodwill associated with the Marriott brand, leading to higher occupancy rates and potential repeat business.
a. The type of agency problem involved in this scenario is the "incentive alignment problem". This refers to the conflict of interest that arises between the principal (Marriott) and the agent (private owners/franchisees) when their objectives and motivations are not fully aligned.
b. Marriott would worry about the quality of hotels it doesn't own but franchises because the overall brand reputation is at stake. Even though the hotels are independently owned and operated, they still carry the Marriott brand name. If the quality of these franchised hotels is subpar, it can negatively impact the perception of Marriott as a whole, potentially leading to a loss of customer trust and loyalty. Additionally, a decline in quality can undermine the value proposition that Marriott offers to its customers, as they've built their name on quality.
c. Marriott tends to own its hotels in resort areas, such as national parks, and franchise in downtown areas because of the reputation effect and the incentive of franchises to maintain quality. In resort areas, where there is little repeat business, owning the hotels allows Marriott to directly control and maintain the quality of their properties. They can ensure consistent standards and deliver a high-quality experience to guests, which in turn helps build and maintain a positive reputation for the brand.
On the other hand, franchising in downtown areas with a lot of repeat business can be advantageous for Marriott. Franchising allows them to tap into the market without having to bear the full costs and risks associated with owning and managing the properties. In these areas, franchisees have a stronger incentive to maintain quality because they depend heavily on repeat business. The franchisees benefit from the reputation and customer loyalty associated with the Marriott brand, thus providing an incentive for them to uphold the brand's quality standards.