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by Patrick Quek

Talk to people in the hotel industry and the number one concern for most is the fear of over-development.  The number of new hotel rooms currently coming on line nationwide is equal to the number which appeared during the years of greatest development in the 1980s.  The most immediate impact of such new development will be seen in the basic measurements of market performance for the industry:  occupancy, average daily rate, and REVPAR.

While the road to profitability in the hotel industry certainly starts at the top of the income statement, at the end of the day, it’s the bottom line dollars you take to the bank.  For this article, we have analyzed data from our 1997 Trends in the Hotel Industry database (1996 data) to examine the correlation between occupancy, ADR, and REVPAR growth and the operating profitability of U.S. hotels.

Learning To Eat Smaller Portions

Bringing back the old Betty Crocker analogy, while the entire pie of travelers seeking overnight accommodations is growing, the pie is being cut into more pieces.  The result is declining occupancies.  In 1997, hotel managers in 23 of the 42 cities surveyed in our Trends in the Hotel Industry report experienced an occupancy equal to, or less than that achieved in 1996.  For 1998, we are projecting that the hotels in 30 of the cities we survey will experience flat or declining occupancy.

The threat of declining occupancies immediately sends shivers down the spines of most hoteliers.  The thought of losing guests is contrary not only to a hotel manager’s personal competitive instincts, but to the training most sales people receive.  However, a closer look at the numbers reveals that hotels can afford to lose occupancy to some degree, and still achieve growth in profits.
 
 

On average, those properties in our Trends database that experienced a zero to five point decline in occupancy still managed to achieve a 6.4 percent gain in operating profits.  The primary factor allowing these hotels to still increase their profits was an average 6.7 percent gain in average daily rate.  It can be assumed that these hotels enacted yield management programs that emphasized pricing over volume.

As would be expected, those hotels that were able to increase their occupancy also achieved the highest the highest gains in both dollar profits and profit margins.  Only those hotels that experienced a decline in occupancy in excess of five points were unable to show any improvement in profitability.  For these latter hotels, rates could not be increased enough to offset the decline in rooms occupied.

Profits Move In Step With Pricing

As has been proven, aggressive pricing can overcome some degree of losses in occupancy.  The question then becomes, how high do you need to increase your rates until they start having an impact on the bottom line?
 
 

On average, it appears that any increase in ADR will result in an increase in profits.  Even those hotels that were only able to raise their ADR less than five percent were able to show a 3.5 percent improvement in bottom line dollars.  Unfortunately, it appears that low ADR growth does not allow improvements on profit efficiency.  The average profit margin for those hotels with low ADR growth actually declined 0.2 percentage points.  Those properties unable to raise their ADR in excess of inflation (3.0 percent) comprised the majority of properties with a decline in profit margin.

For those hotels that were forced to (or opted to) discount heavily, and in turn experienced a decline in their ADR, the impact on the bottom line was devastating.  The average profits for hotels with a decline in ADR dropped 10.1 percent.  On the other end of the spectrum, hotels that were able to increase their rates in excess of 10 percent saw a 32.3 percent average growth in profits.  It is obvious that a very direct correlation exists between movement in ADR and profitability, in either direction.

Money In, Money Out

The combined movement of occupancy and ADR dictates the level of rooms revenue (REVPAR).  Previously, we’ve examined the individual correlation of these two statistics on profitability.  When comparing REVPAR to profitability, it appears that no matter how it gets in, if revenues increase, most likely profits will too.
 
 

As expected, hotels with a decline in revenue averaged a 13.2 percent decline in profits.  I suspect, however, that if your hotel experienced a decline in revenue, this is most likely an indicator of problems more extensive than just a loss in profitability.

As new hotel development continues, more and more hotels will face competitive market conditions.  How you adjust your policies regarding pricing and sales to combat the new competition can directly affect the profitability of your hotel.  The key is to take advantage of the automated yield and revenue management programs that are available to hotel managers today.  If handled properly, new competition does not necessarily mean a loss in profitability.

Patrick Quek is president and CEO of PKF Consulting, an international hospitality consulting firm headquartered in San Francisco.

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