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Operations Management
The Future of Hotel Profitability
by: Robert Mandelbaum and Steven Nicholas CHA, June 2007
 

In the past two decades, hotel managers have made money differently than other businesses.  Lodging is an industry that has benefited from its ability to increase prices to offset sharp gains in operating expenses.  This contrasts the typical U.S. business model of increases in productivity and modest price increases.

Looking towards the future, we are starting to observe two trends that could affect the growth of hotel revenues.  The hotel construction pipeline is at an all-time high, and more projects are starting to move from the planning stages to actual construction.  In addition, we are beginning to hear some rate resistance among meeting planners and corporate travel executives.  Combined, these factors could mitigate the strong pace of revenue growth that U.S. hotels have enjoyed the past few years.

Therefore, if revenues are going to grow at a more modest pace, operators must begin to pay attention to the cost side of the equation to generate profits.  Managers no longer will have the luxury of covering rising operating costs with extraordinary increases in revenue.

To measure the impact of expense growth on hotel profits, we have analyzed select data from PKF Consulting’s Trends in the Hotel Industry database.  In the following paragraphs, we provide some analysis of select operating expenses and how management is dealing with them.
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U.S. Hotels Total Revenues And Expenses
Annual Change

Source: PKF Hospitality Research
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Labor Costs

At the beginning stages of the 2001 to 2003 industry recession, both management and hourly positions were drastically cut.  Since then, hotel managers have learned to live without these positions, indicating that there was some “fat” on the payroll.  Since 2003, as the industry has recovered, there has been immense pressure from owners to make sure that the recovery of bottom-line profits is commensurate with the tremendous increases in RevPAR.  Therefore, many of the positions that have been cut have not been reinstated.

With a cut in the number of employees, what is driving the surge in labor costs?  Based on the past four years, the answer is employee benefits.  In order to attract top talent, benefits like health insurance, 401(k), and short- and long-term disability insurance must be offered.  The result is that employee benefit growth has nearly doubled the increase in salaries and wages since 2003.

To cope with the rising benefit costs a multitude of decisions have to be considered.  These include: reducing the number of people that are offered benefits (salary vs. hourly or level of management); increase the amount of employee contribution; reduce the amount of coverage; increase deductibles; and shop for carriers.

Looking forward, managers will be challenged even more so to control labor costs during the next industry recession.  The minimum staffing requirements that exist in most properties today creates an interesting dynamic.  Without the ability to significantly cut staffing, finding a better solution to meet the benefit needs of employees at a reduced cost becomes a necessity.

U.S. HOTELS Salaries and Wages vs Employee Benefits
Annual Change

Source: PKF Hospitality Research

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Utility Costs

For the most part, management’s ability to control utility costs is very limited.  Many hotels utilize third party energy consultants that lock in pricing through the different utility companies.  In some states and municipalities, the ability to buy futures in specific utilities is available.  This practice, however, has its own risks like any other investment.

Fortunately for hotel owners and operators, the pace of hotel utility cost increases appears to be slowing down.

U.S. Hotels Utility Costs
Annual Change

Source: PKF Hospitality Research

Franchise Mandates

During the last industry downturn (2001 – 2003), the sharp drop in revenues sent hotel owners pounding on the doors of their franchise partners for relief either in reduction of fees or relaxation in some of the standards that pushed operating costs higher.  Many of the franchises gave concessions and reduced some of the operating standards.  However, the downside to these cost saving measures was a decline in the loyalty and satisfaction scores that the franchise companies believe drive the innate value of their brands.

Now, in a period of industry prosperity, franchisors are mandating additional services and amenities in an effort to attract premium customers within each market segment.  This race to attract these preferred guests has become more competitive with the addition of several new brands in the last 12 months.  The costs to implement these new competitive strategies have hit the franchisee in a number of areas.

Complimentary Services

Limited-, select-, and full-service hotels have all seen their complimentary food and beverage offerings turn into much more robust presentations than initially conceived.  The upgraded requirements for continental breakfasts, social hours, and concierge floor receptions have caused initial capital outlays for new equipment, upgraded presentation materials, and in some cases expanded facilities.  The enhanced F&B has also impacted operating expenses.  Expanded and upgraded gratis food and beverage service has escalated product costs, and in some cases, required additional staffing.

Beyond food and beverage, the brands have attempted to hold on to the most valued travelers by offering them a bevy of gifts and services “on the house.”  These include in-room bottled water, gift certificates, room upgrades, frequent point bonuses, and even pints of ice cream.  Additional perks include free use of all hotel facilitates (spa, golf, etc…), complimentary long-distance calls, and no charge for high speed internet access.  In these circumstances, hotel owners not only bear the cost of these complimentary amenities, but they also lose the opportunity to earn revenue for services that they have previously been able to charge for.

U.S. Hotels Complimentary Food and Beverage
Annual Change – Dollars Per Occupied Room

Source: PKF Hospitality Research

Beds, Beds, Beds

The recent bedding wars have forced nearly all branded hotels to replace their box springs and mattresses, along with all associated sheets, pillows, and bedding.  On a day-to-day basis, the increased quantity of linens means more laundry time, chemicals, and water, as well as an escalation in the minutes required for room attendants to change the sheets.

Hotel operators have attempted to offset these costs by incorporating green room programs which limit the amount of linen that is replaced each day.  In addition, managers are working with their vendors to supply and purchase chemicals that work in faster cleaning cycles, thus reducing water consumption and increasing labor productivity.

Investments

Euphemistically, expenditures are frequently referred to as investments.  When management decides to increase staffing, the hope is that guest service will be improved and satisfaction scores will rise.  Franchise mandated programs, while expensive, are designed to attract and retain guests.  The brands that have successfully identified the critical needs of the traveler and match these desires with their new offerings will garner the loyalty of the premium customers and be able to offset these costs.  The brands that do not will simply be left with higher costs and lacking the return on investment that has been promised.

While the lodging industry may be entering a period of stable performance, it will not be a period of relaxation for hoteliers.  During the recession, it was obvious that drastic measures needed to taken and costs were cut.  Conversely, during the past few years of great expansion, strong revenue growth has lessened the need for strict cost controls.  Controlling operational expenses during periods when revenues are growing at a modest pace requires some critical thinking on the part of management.  In the next few years, owners, operators, and brands will need to analyze the cost / value benefit of each dollar spent.

Robert Mandelbaum is the Director of Research Information Services for PKF Hospitality Research.  He is located in the firm’s Atlanta office.  Steven Nicholas CHA is Executive Vice President, Operations for the Noble Investment Group.  Steven works in the Atlanta headquarters of Noble.  The article was published in the May 2007 issue of Lodging magazine.

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Contact:

Robert Mandelbaum
Director of Research Information Services
PKF Hospitality Research
3475 Lenox Road, Suite 720
Atlanta, GA 30326
Phone: (404) 842-1150, ext 223
E-Mail: robert.mandelbaum@pkfc.com
www.pkfc.com

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Also See: Hotel Energy Costs Surge; Shock Absorbed by Revenue / Robert Mandelbaum / March 2006
U.S. Hotels: Revenues and Profits Rise, But So Do Expenses / 2006 Trends in the Hotel Industry / May 2006
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