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You hear it and read it everywhere.
The industry has turned the corner.
Occupancy is up. Values are climbing.
Deals are getting done. The pipeline for
new properties is growing. Yet that nagging
question about performance still remains.
How much net income is the right number?
And of course, increases in net income
equates to increased value. It’s the reason
owners invest and pay management fees.
I read an article a few weeks ago which
stated that the industry is doing a good job
controlling labor costs. And the reason given
was that labor has remained a relatively
constant percent of revenue. Considering
that labor cost is the largest operating
expense, the implication of this data is
that the industry is generating the values
that it should. Well, simply put, that is a
myth. Growth in revenue and RevPar has
outpaced labor cost increases. Therefore, if
costs were being controlled, we would see
a reduction in this percent relationship.
Let’s look at a quick example. Assume that
labor costs are 40% fixed and 60% variable
and that at a base line level, labor is 45% of
total revenue. Using a base line of $10,000
of revenue, labor would cost $4,500. Now
we increase revenue to $15,000. At a
constant percent, labor would equal $6,750.
But, using the 40-60 relationship at the
$10,000 revenue level, fixed cost equals
$1,800 and variable equals $2,700 or 27%
of revenue. Therefore, the labor at $15,000
should actually equal $1,800 plus $4,050
(.27*$15,000=$4,050) for a total of $5850
or 39%. This is an attainable improvement
of $900 compared to a constant percent
relationship. And this is the case for most
of the industry’s labor costs.
I raise this issue because the only way
you can effectively optimize value is to
know what your costs should be and
measure performance in relation to
those parameters. And while I have used
labor as an example, this applies to all
operating costs. Now the key question,
how can this be accomplished?
The first step is to have accurate
standards that relate costs to volume.
These standards in some cases can
be a percent relationship, but in most
instances utilizing occupancy statistics,
cover counts and other unit based
activity will create a more accurate
relationship. The next step is to
implement a measurement system
that quickly highlights successes and
opportunities for improvement, while
ensuring that management focuses on
the right issues.
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From an ownership perspective
and generally in most management
situations, performance evaluation is
driven by the periodic Profit and Loss
Statement, a comparison of actual to
budget projections. It is here where
we find a fundamental problem in
how the industry evaluates results.
Simply put, in the largest percent of
organizations the wrong budgetary
analysis process is used. For as long
as I have been in the industry, although
there are some changes that have
recently taken place, we have used a
fixed budget model to figure out how
well a property has performed.
In an environment, where rates change
dynamically, volumes fluctuate due to
a variety of factors and business mix
changes, we need to employ the basic
accounting tool of a variable budget
model to assess performance. Using
this approach, we can determine, clearly
and quickly, where to focus attention to
drive value. We can do away with the
rules of thumb regarding incremental
flow through of new dollars, and help the operating team and owners
understand how well the asset is really
performing from a cost and a revenue
generation perspective.
It’s long past the time to implement
systems that apply variable cost
concepts to performance measurement.
Measuring P&L performance to the
initial budget is no longer sufficient.
The industry needs to understand
issues like:
- Actual costs in relation to established
standards that are structured
to reflect volume variances.
- Breakfast cover penetration
of available market at differing
volume levels.
- Beverage sales in relation to
projected penetration ratios.
These are just a few of the measurable
criteria. There are many more. But
most importantly, we need to be fully
accountable for operating results in
relation to the standards of operation
the teams are challenged to attain and
ownership expects us to accomplish.
The advent of faster computers coupled
with more sophisticated systems has
made this type of analysis much easier
to do. The outcome will be improved
accountability, better use of management
time to address real improvement
opportunities, a road map to take advantage
of these opportunities and, most
importantly, increases in flow through
that result in higher values. At the end
of the day, owner relationships will also
improve as management demonstrates
the use of tools that owners know
are further ensuring optimized results,
based on local market conditions.
Mark Heymann, ISHC, is Chairman & CEO of UniFocus.
Reprinted from FocusEd, Spring 2005 edition.
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