The traditional hotel industry

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PART

CHAPTER 1 The Traditional Hotel Industry CHAPTER 2 The Modern Hotel Industry CHAPTER 3 The Structures of the Hotel Industry

1 The Hotel Industry

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Check-in Check-Out: Managing Hotel Operations, Second Edition, by Gary K. Vallen and Jerome J. Vallen. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc.

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Over eons of time, wanderers and single travelers found security and accommodations in trees and caves, castles and churches, homes and estates. Greater political and economic freedom eventually increased their numbers. Soon, the courtesy of friendly hosts gave way to commercial enterprise. The hotel industry was born carrying this culture of hospitality. So hospitality and hotels are related concepts, deriving from the same Latin root. However, the word “hotel,” which comes from the French hôtel, meaning large house, didn’t appear until the 18th century.

The Traditional Hotel Industry

1Chapter

UNDERSTANDING THE HOTEL BUSINESS

The Service Culture

The hotel industry has flourished through the centuries by adapting to the changing environment that marks human progress. These stages have been labeled: The 18th century was the agricultural age; the 19th, the industrial age; and the 20th century the age of service, including medicine, education, and hotelkeeping. The 21st century opened with that same service culture, but will likely close as the age of technology. Innkeeping has started to adapt its hospitality heritage to the new age. The shift translates into newer kinds of, but less personal, services.

A Cyclical Industry

Hotelkeeping is a cyclical industry that closely follows economic phases. Wide swings carry the innkeep- ing industry between peaks of exceptional profits and troughs of outright distress. This rollercoaster has been most evident over the past half century. The entire travel industry was brought to its knees by the oil embargo of 1973. Innkeeping then cycled from bankruptcy to recovery. A decade later, in the early 1980s, the industry witnessed a second such distress when the federal government changed the income tax laws on real estate. (Remember, as hotels are pieces of real estate, any change in real estate will directly affect the hotel industry.) Dominant companies bought distressed properties at that time and recovery followed once again. By the late 1990s, hotel profits had reappeared. Just as the recovery was being consolidated came the tragedy of 9/11, the attacks on the World Trade Center (2001). Travel and tourism bottomed out again. Although recovery was faster this time, it was short-lived. First, a stumbling prosperity and then a dramatic downturn in the U.S. economy in 2008 halted travel once again. Business began an upward crawl anew in late 2010.

Hoteliers stop building during downturns. Three years is the typical span between planning and open- ing a hotel. It’s even longer if there are special financing, zoning, or environmental issues. Over half of the announced projects are never built. For instance, Taj Hotels took 18 months just to renovate The Pierre in New York. When occupancy and profits boom, the competition begins to rev up new properties. So new rooms often come on line—three years later—just as the cycle peaks. That increased supply exaggerates the next downward dip. Supply and demand play their traditional roles in hotel economics as they do for general busi- ness. Overbuilding (excess supply) exaggerates the downturns far more often than does insufficient demand (fewer customers).

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Check-in Check-Out: Managing Hotel Operations, Second Edition, by Gary K. Vallen and Jerome J. Vallen. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc.

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How Hotels Count and Measure

Within the cycles, new hotels and hotel rooms are built and old rooms are removed. One can never say for certain how many hotels or hotel rooms are available at a given time. Governmental agencies (Bureau of the Census) and trade associations (American Hotel & Lodging Association (AH&LA)) track and report the numbers. Other interested parties include the World Tourism Organization (WTO), the International Hotel and Restaurant Association (IH&RA), and pri- vate firms such as Smith Travel Research and PricewaterhouseCoopers. None of the figures ever agree; some not even close.

The Bureau of the Census counts once every decade and takes several years to report. By then, the numbers become inaccurate. The 2010 count, for example, was made during a horrific downturn cycle when many hotels had closed.1 Still, estimates are possible. The previous count approximated 65,000 hotels in the United States with some 5,500,000 hotel rooms. The typical hotel, about half of which are small, nonchain affiliated, has about 85 rooms. Figures get skewed, however, because convention hotels (large hotels) number less than 2% of all U.S. properties, but contain about 12% of all hotel rooms.

Hotels are valued on a per-room cost, either the cost per room to build or the resale price per room—called the per-key cost. Valuing each room at, say, $250,000—unchanged in the past several years because costs rose substantially and then fell even more so—U.S. hotels are worth nearly $1.5 trillion.

Together, Europe and the United States once accounted for two-thirds of the world’s total rooms. However, their leadership has been challenged by the robust growth of tourism and business travel in other areas, such as Asia and South America. For example, international com- panies built 50 five-star hotels in Beijing for the 2008 Olympics. Marriott Hotels opened seven of them, with its Great Wall property alone having 1,300 rooms. Growth like this changes the world’s balance.

OCCUPANCY Occupancy, a measure of supply and demand, gauges the industry’s economic health. While robust demand encourages construction of new rooms, falling demand seals the fate of old hotels. Worn-out rooms are kept in place only during boom periods, when there is a room shortage. They fall to the wrecker’s ball or are converted when they are competitive no longer. Many were renovated into dormitory rooms when American universities were in their boom years. In the 1990s, condo conversion was the hot move as luxury residential units were more valuable than luxury hotel units. One of the most publicized of these conversions was that of the New York City’s famous Plaza. The hotel’s 800 rooms were converted into 152 residential condo units and 282 guest rooms. However, the downturn that began in 2008 put an end to condo conversions.

At any given time, the number of rooms available for sale reflects the mathematics of the old and the new. During the upward cycle, more guests are buying, but fewer rooms are available. Room rates rise. Just the opposite happens in a downward cycle: There are fewer buyers and more rooms, so rates fall. Customer demand is measured by the number of rooms occupied, also called the number of rooms sold. Hoteliers count this figure every night.

Hoteliers also count the number of rooms in their hotels. Although the number of rooms is just an estimate worldwide, hotel managers know their own numbers. Whether for the world, the region, or the individual hotel, that number is called the number of rooms available for sale.

The relationship (or ratio) between the number of rooms sold (demand) and the number of rooms available (supply) measures the property’s health. It is a closely watched value that asks, “How well did we sell rooms relative to the number of rooms that could have been sold?” That big mouthful has a shortcut called the percentage of occupancy, or occupancy percentage, or just occupancy.

1Facts about the lodging industry are reported in the SC Series, but results of the 2010 Census were not yet available for this publication.

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Check-in Check-Out: Managing Hotel Operations, Second Edition, by Gary K. Vallen and Jerome J. Vallen. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc.

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The occupancy calculation is a simple division. The number of rooms available for sale is divided into the number of rooms sold (see Exhibit 1-1):

number of rooms sold number of rooms available for sale

= a percentage of occupancy

Occupancy can be computed by one hotel for one night, one month, or one year. Citywide, regional (the Northeast, for example), and national occupancies are tracked by many agencies. Among them are hotel chains, convention bureaus, and state tourism offices.

Values become less accurate as the count moves from the individual property to a worldwide number. Nevertheless, everyone is engrossed in occupancy figures. More so when estimates suggest that a mere 1% rise in chain occupancy represents millions of dollars of improved profits.

SALES PER OCCUPIED ROOM Occupancy measures quantity, that is, the hotel’s share of the market. Sales per occupied room—also called average daily rate (ADR)—measures quality. Its formula (see Exhibit 1-1) is:

total dollar room sales number of rooms sold

= ADR (a dollar value per room sold)

Given Number of rooms in the hotel available for sale 800 Number of rooms in the hotel 820 Number of rooms sold to guests 600 Number of dollars received from guests for rooms $72,000 Number of employees on staff 500 Number of guests 700

Computations Percentage of occupancy is 75%.

number of rooms sold 1 to guests2

number of rooms 1 in the hotel2 available for sale =

600 800

= 3 4

= 75%

Sales per occupied room (average daily rate, ADR) is $120.00.

room sales 1as measured in dollars2

number of rooms sold 1 to guests2 =

$72,000 600

= $120.00

Sales per available room (RevPar) is $90.00.

room sales (as measured in dollars) number of rooms (in the hotel) available for sale

= $72,000

800 = $90.00

Mathematical check:

ADR * occupancy = RevPar $120 * 0.75 = $90.00

Number of employees per guest room is 0.625.

number of employees (on staff) number of rooms ( in the hotel) available for sale

= 500 800

= 0.625

Percentage of double occupancy is 16.6%.

number of guests - number of rooms sold number of rooms sold

= 700 - 600

600 = 16.6%

EXHIBIT 1-1 Hoteliers track the health of the industry through the measures and ratios shown. Outside of the United States, bed occupancy percentage (number of beds sold,number of beds available) is often substituted for the percentage of room occupancy. Bed (or guest or sleeper) occupancy of 50% approximates room occupancy of 70%.

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Check-in Check-Out: Managing Hotel Operations, Second Edition, by Gary K. Vallen and Jerome J. Vallen. Published by Prentice Hall. Copyright © 2013 by Pearson Education, Inc.

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The health of the industry is reflected in both occupancy and price. Price, ADR, ($) increases as occupancy (%) increases. The more rooms sold—that is, the greater the demand— the higher the room rate. That’s because lower-priced rooms sell first. Conversely, as occupancy falls, so does the ADR. Supply and demand are at work.

REVPAR (REVENUE PER AVAILABLE ROOM) RevPar is an old industry standby that once was called average rate per available room. RevPar (or REVPAR) measures management’s ability to keep rates high even as occupancy declines. Hoteliers are fond of saying, “hotels fill from the bottom up,” meaning that guests elect lower rates when an empty house allows it. Superior managers strive to keep rates high even as occupancy dips within the cycle. Management does this using yield management, discussed in Chapter 5. RevPar reflects the revenue (sales) relative to the total rooms available for sale. In contrast, ADR measures the revenue per room relative to the number of rooms actually sold. (Remember, “rooms sales” and “room revenue” are interchangeable terms.) Exhibit 1-1 illustrates the computation.

total dollar room sales number of rooms available for sale

= RevPar (measured in dollars)

Both of the values, room sales and number of rooms available, are easily misstated. Total room sales must not include taxes or the value of free breakfasts or parking. Similarly, the number of rooms available must include vacant rooms, but not those permanently assigned to other uses such as offices.

Before 2008, RevPar was rising steadily, increasing at the top of the cycle aided by inflation. That value took a nose dive in 2008–2011 when the average price of a hotel room fell about 16%.

RevPar does not reflect management’s ability to control costs or produce sales in other departments. RevPar is an ideal measure for rooms-only hotels (those with no bars, no laundries, and no restaurants).

DOUBLE OCCUPANCY Exhibit 1-1 continues with the occupancy calculations. Spoken as “dou- ble occupancy,” the value is really a “percentage of double occupancy.”

number of guests - number of rooms occupied number of rooms occupied

= percentage of double occupancy

“Multiple occupancy” is a better term than “double occupancy” because more than two guests may be housed in one room. If the number of guests is greater than two, the formula falters. Assume, for example, two rooms occupied by three persons in one room and one per- son in the other. The calculation would be 4 (guests) - 21rooms2 , 21rooms2 = 1 or 100% double occupancy. In fact, it is only 50%, one room in two.

Double occupancy’s impact on room revenue is much clearer. Additional charges (a double rate) is usually levied when families, skiers, and tour groups double up. Casino/hotels want bodies on the casino floor, so they rarely charge double occupancy rates. High double occupancy is associated with resort properties, giving them a higher ADR.

Another statistical fudge occurs when comps (complimentary—free rooms) are counted as occupied. The occupancy percentage increases but ADR decreases because there are no dollars earned. Similarly, averages for the entire industry are slanted when large hotels are counted along with hotels of 50 rooms or less.

BREAK-EVEN POINT To break even is to have neither profit nor loss. Inflows from revenues match exactly outflows from costs. Hotels have large fixed costs including interest on debt payments, licenses, taxes, and fixed salaries and wages. Reducing fixed costs drops the level of occupancy needed to break even. Similarly, increasing sales from food, beverage, spa, and so on reduces the pressure on room sales. Increasing RevPar also contributes, provided the percentage of occupancy is maintained.

Break-even points are important, because there is no profit until that point is reached. Once the point is reached, profits accumulate quickly. Each sales dollar before the break-even point is used to pay off debt, pay utilities, and pay the staff. Thereafter, each dollar contributes to profits.