As Rates Fall, Will Profits Follow?
Trends in the Hotel Industry / United States Cities / 1999 1st Quarter Results 
PKF - 1st Qtr 1999 - Once again, U.S. hotels experienced strong growth in profits during 1998.  However, a slowdown in performance during the first quarter of 1999 creates concern for the continuation of this trend.  

So far, the 1990s have been the most profitable decade for U.S. hotels since PKF Consulting began its surveying back in 1929.  Through 1998, the average hotel in our survey will have increased its profits 71.2 percent since 1990.  This is 24 percentage points greater than the pace of inflation during the same period.

Preliminary results from our 1999 Trends in the Hotel Industry survey show that the average hotel in our survey increased its profits 7.1 percent during 1998.  While this rate of growth is slower than the double-digit percentage growth in profits achieved from 1994 through 1997, it is still more than four times the pace of inflation for 1998.

Old Fashioned Economics

Lots of discussion has been given to the fact that the U.S. economy is now operating under the laws of a "new economy" that runs contrary to traditional economic conventions.  Despite record low unemployment rates, labor costs have only risen slightly.  Individuals are investing heavily in start-up companies, even though they have yet to generate a profit.  This has contributed to record growth in the stock market.  Technologically driven efficiencies in operations have allowed for increased corporate profits, despite limited increases in prices.

Hotels, on the other-hand, have made their money "the old fashioned way."  For most of the decade, automated yield-management systems readily identified favorable supply/demand situations that resulted in aggressive pricing practices for U.S. hotels.  The net result was room rate growth 1.5 times the pace of inflation. 

Even more startling is the fact that room rates continued to grow, even though occupancy levels began to decline.  Each year since 1996, more than half the cities in our Trends survey experienced a decline in occupancy.  Despite experiencing a drop in demand, hotels continued to raise their room rates an average of 7.3 percent per year.

While hotels were able to enjoy strong increases in pricing and revenues not seen by other industries, the cost of operating a typical hotel has risen faster than the cost of operations for other businesses.  During the 1990s, labor costs for lodging employees have gone up anywhere from 1.5 to 2.0 times the national Employment Cost Index.  In total, operating costs for the average U.S. hotel grew 3.3 percent per year.  This is a low figure, yet greater than the 2.8 percent pace of inflation for the same period.

Thrive The Old Way, Dive The Old Way

Hotels may have thrived during the 1990s by taking advantage of a favorable economic and operating environment.  But, how susceptible are they to the downside of a poor economy or competitive conditions?

During the first quarter of 1999, the average occupancy for hotels in major U.S. cities declined 1.5 percent.  Of the 44 lodging markets in our survey, 26 had a first quarter occupancy less than that achieved during the first quarter of 1999.  As stated before, this is not uncommon.  In fact, it is the continuation of a trend first started in 1996.

However, during the first quarter of 1999 we began to see a weakness in room-rate growth, which we previously cited as the main reason for the recent tremendous upsurge in profits.  During the first quarter of 1999, the average room rate for hotels in our survey grew a mere 1.9 percent.  Even more shocking was the fact that 11 markets in our survey experienced a decline in ADR, an occurrence that is very rare.

Unable to offset the declines in occupancy with substantial increases in room rates, the growth in REVPAR for these 44 markets for was an extremely anemic 0.3 percent during the first quarter.  In fact, flat or declining occupancies, combined with flat or declining room rates, resulted in a decrease in REVPAR for 21 of the 44 markets surveyed.

Given the correlation between growth in rates and profits, it can be assumed that the first quarter of 1999 was not a profitable one for the U.S. lodging industry.  Will this continue through the rest of 1999?

Lagging Economics

In order to project future performance, it is important to understand some of the reasons behind the decline in first quarter average room rates.

Historically, changes in the economy have not had an immediate effect on the travel industry.  Since people tend to make reservations in advance, hotels usually feel the effect of a significant economic event a few months later.

As you may remember, during the third quarter of 1998, the stock market experienced significant declines.  News quickly spread of slower growth in corporate profits, and consumer confidence began to wan.  This affected the hotel industry in two ways.

First, when corporate profits are low, the travel budget stands out and becomes a primary target for cost reduction.  Throughout the latter months of 1998, several corporate travel planners and meeting planners said that they would be unable to afford significant growth in room rates.  In turn, as reported in our Fourth Quarter 1998 edition of Trends in the Hotel Industry, hotel managers became less aggressive when quoting corporate and group rates for 1999. 

Concurrent with this cutback in corporate and group travel budgets was a reduction in consumer confidence, which had a similar negative effect on leisure travel plans and personal travel budgets for early 1999.

It is apparent that the negative frame of mind for both hotel consumers and managers during the last few months of 1998 definitely had a significant impact on the performance of hotels during the first quarter of 1999.  Third and fourth quarter pessimism during 1998 certainly contributed to the declines in average room rates, and to a lesser degree, the declines in occupancy.  Once again, this proves the theory that economic and market conditions during the "booking period" need to be examined in order to correlate the effects of the economy on the hotel industry.

Carrying this theory forward, let's look at current economic and market conditions in order to foretell future movements in occupancy and ADR for 1999.

Examining Today For Tomorrow

Certainly the strength of the domestic economy and Wall Street has improved since the third quarter of 1998.  This should, in turn, lead to a greater acceptance of increased room rates by corporate, group, and leisure travelers.  Mitigating this positive effect would be the quantity of discounted room rates already confirmed by hotel managers during the last few months of 1998.

Of concern is the effect of the war in Yugoslavia.  Travel to Europe has curtailed, which should mean a boost in domestic vacations.  However, increases in gas prices and airfares could effect domestic travel patterns.  Historically, such increases in transportation costs have resulted in an increase in shorter, regional trips.  While this pattern would help secondary cities, it would potentially hurt remote resort destinations.

Ultimately, it is the mindset of the hotel manager that will dictate future pricing policies.  Our fourth quarter 1998 survey of hotel managers did show a tendency towards more moderate rate increases in the face of both new competition and a decelerating economy.  Now, with competition still high, but with an improved economy, will managers let their yield management systems loose and become more aggressive with their room rates?  Or, with they continue their practice of discounting?

Not Great, But Better

As we move into the summer months and the volume of travel picks up, look for a reversal of the negative growth in room rates that we saw during the first quarter.

The most competitive markets are the suburban, rural, and highway markets dominated by limited-service hotels.  However, since most of the guests at these properties book in the short term, these hotels should benefit from the expected increase in domestic travel.  Come summer, expect to see the hotels along the nation's highways become more aggressive with their room rates.

For the larger, full-service hotels, expect the automated yield-management systems to start identifying the stronger summer demand patterns and implement a corresponding rise in rates.

By year's end, expect moderate rate growth to overcome the negative trend of the first quarter.  In addition, while occupancy rates will trend downward, the year-end figures should not show as dramatic a decline as they did in the first quarter.  By the end of the year, we expect most markets to experience at least a minimal increase in their REVPAR.

With only moderate growth in room rates and the resulting minimal increases in revenues, hotel managers will be hard pressed to continue the tactics which have yielded strong profit growth.  Any increase in profits will now be derived through better management and cost controls in the middle of the financial statement, not a booming top line.

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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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