What Makes a Hotel Profitable?
Chart: What Makes a Hotel Profitable?
by Patrick Quek, February 1999 

Given the current climate of constrained financing and reduced development plans, hotel companies are now looking at their existing operations to increase profits in the near-term.  In light of this situation, we have looked into our Trends in the Hotel Industry database of 2,800 financial statements and identified the “most profitable” full-service, limited-service, and all-suite hotels.  We then examined these top performers in an attempt to distinguish common operating characteristics.

Multiple Measurements

There are many ways to measure profitability for the purposes of analyzing property-to-property performance.  Comparisons of total profits, profits-per-available room, and of course, return-on-investment can all be employed in an effort to determine “best performers”.  Each method carries with it certain advantages and disadvantages.

For this analysis, we have decided to compare the profitability of different hotels on a contribution margin basis.  Best performers were defined as those hotels in the top 10 percent of their property category in terms of achieved profit margin.  Profits were measured after management fees, real estate taxes, and insurance, but before capital reserve, rent, interest, depreciation, amortization, and income taxes.

Like the other methods, measuring performance by comparing profit margins has its drawbacks, the first of which is the age-old argument that, “you can’t take percentages to the bank.”  However, the ability of management to drop as many dollars to the bottom-line as possible is clearly a meaningful measure of performance.

To Feed Or Not To Feed

As would be expected, the extent of food and beverage service at a property significantly affects the overall profit margin of a hotel.  Simply put, those properties that derive less of their revenue from food and beverage achieve the higher profit margins.

Obviously, this is not a blanket endorsement for the elimination of food and beverage service.  As noted in our article in the October 1998 edition of Lodging, profitability in hotel food and beverage departments is currently at an all-time high.  However, the conventional belief that food and beverage service is an absolute necessity has been challenged and frequently proven to the contrary.  Properties have either leased out their outlets or reduced their level of food and beverage service, while still maintaining high occupancies and rate premiums.  In fact, the top performing full-service hotels all had minimal food and beverage revenue, yet were still able to achieve occupancies and ADRs greater than their respective property-type averages.  The message is not to automatically eliminate food and beverage from your hotel.  Instead, developers and managers should thoroughly exhaust all the implications of varying degrees of food and beverage service on property performance and profits.

Quality, Not Quantity

Across the board, the average size of the top performers was consistently smaller than the average property profile for each category studied.  Be it the ability to manage a smaller operation, or reach economies of scale at a lower threshold, smaller properties do appear to operate more efficiently.

As might not be expected, the hotels achieving the highest profit margin in each category achieved total revenues (measured on a per available room basis) less than the average for all hotels.  While the lack of food and beverage revenue would explain this occurrence for full-service hotels, it can not be the reason for limited-service properties and several all-suite properties.

Controlled, Undistributed, And Unspent

According to the Uniform System of Accounts for the Lodging Industry, the expenses associated with the direct generation of revenue are classified as departmental expenses.  In general, these expenses tend to be more variable in nature, and therefore, more controllable.

Across the board, all the top 10 performing hotels were able to hold their departmental expenses under the average for all hotels.  This was especially noticeable in the full-service category.  The top performing full-service properties bettered the overall average profit margin by 15 percentage points.  Ten of these percentage points were gained by controlling their departmental expenses.

To be profitable, any business must also watch their overhead expenses.  Frequently, these expenses do not directly contribute to the generation of revenue for the business, and therefore, are difficult to measure in terms of payback.

In the hotel industry, administrative and general expenses cover such costs as the salary and wages for the general and manager and their staff, accounting fees, security costs, credit card commissions, and human resources.  Across the board, the top performing hotels in all categories were able to control their administrative and general expenses.  Measured as both a percentage of revenue and on a dollar-per-available room basis, the top performers achieved administrative and general expense margins well below the overall averages.

Marketing expenses are also classified as an undistributed item.  But most managers would gladly spend more, rather than less, on marketing.  Once again, the achievements of the top performers appear to be counterintuitive.  Marketing expenditures by the top performers, measured as a percent of revenue, were all less than the overall averages for all property types.  Even when measured on a dollar-per-available room basis, marketing expenditures for the top performing full-service and limited-service properties were short of the overall average expenditures.  Apparently, the top performers were more efficient in the marketing of their properties.  Remember, these hotels also achieved occupancies and ADRs greater than the overall averages.

Creativity Counts

What brings success to any individual hotel is a wide variety of controllable and uncontrollable factors.  Some are internal, while others are external.  And, as stated before, return-on-investment is the ultimate measure of success, and control on the investment side is just as critical as any operational techniques.

The lessons to be learned from this analysis is that hotel operators need to challenge conventional wisdom.  Do you really need those extra rooms?  How are you spending your marketing dollars?  What level of food and beverage service do I really need to offer my guests?

Creativity is often the catalyst of success in business.  In the hotel industry, we often rely on tried and true methods of operation.  How many hotel rooms look alike?  Do your organizational charts carry the same titles as all other hotels?  Maybe it is time to be different.  To put down the cookie-cutter.  Maybe it is time to be more profitable.

What Makes a Hotel Profitable?
Top Ten Percent Profit Margin by Property Type
Number of Rooms Total REVPAR Profit* PAR Profit* Margin Rooms Revenue as a % of Total Revenue Occupancy A.D.R.
Top 10% 131 $32,036 $17,011 53.1% 93.9% 77.2% $106.70
All 185 34,415 15,831 46.0% 87.0% 75.3% 109.98
Top 10% 80 19,012 10,818 56.9% 95.1% 74.1% 67.79
All 109 27,785 10,836 39.0% 94.0% 68.0% 58.48
Top 10% 226 38,526 16,258 42.2% 75.4% 75.7% 106.03
All 250 40,648 10,975 27.0% 63.0% 70.7% 100.09
Note: * Income before capital reserve, rent, debt service, income taxes, depreciation, and amortization.
Source: PKF Consulting
Patrick Quek is president and CEO of PKF Consulting, an international hospitality consulting firm headquartered in San Francisco.
* * *
For additional information contact 
Robert Mandelbaum at the firm:
email rmandel@pkfc.com
PKF Consulting
3391 Peachtree Road
Suite 420
Atlanta, GA  30326
phone  (404) 842-1150
fax  (404) 842-1165

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