Today’s Biggest Challenge in Hospitality: Eliminating Cost Disadvantages

By Greg Miller

In today’s market climate it’s more critical than ever to eliminate cost disadvantages and become more successful. The logical starting point is to limit fixed overhead costs that remain constant despite fluctuating business volumes. This calls for precise forecasting. Then it is necessary to ascertain the value (or lack thereof) of all cost-related activities by listening to your guest feedback.

As in sports, it’s important to understand that winning the game depends upon how well we anticipate our competition and how well we employ our resources. So it is vital to understand what our competitive target costs should be. And no competitive target costing system is complete unless it is juxtaposed next to a total quality management system.

Limiting Fixed Overhead Costs

In the current difficult economy, revenue is less reliable than in the past. In this environment, a savvy operator does his best to reduce his Fixed Cost components and have more variability.

The table above provides a quick example of how changing your Fixed Cost structure can help you when your occupancy falls below your equilibrium level. In this example, a hotel which had been operating at 68% occupancy and $165 ADR finds that it is facing a period of lower occupancy and ADR. The example uses 60% occupancy and a $150 ADR to emphasize the potential impact of just one cost center — The Rooms Department Payroll & Related line.

In this example, the hotel expects to return to its equilibrium in two years. The expected lower occupancy of 60% is to the equilibrium level as 0.88 Occupancy Variable Ratio. If everyone working in the Rooms department was on a fixed salary and worked the same hours regardless of volume, the assumed payroll using the last year of equilibrium expense at $1,365,000 rises from 13.3% to 16.6% of Room Revenue (an increase of ~$3/occ rm).

For purposes of example, let’s assume that the fixed payroll is lowered dramatically to just 50%. The impact on the Dept. Profit would be a full percentage point higher or $1.46 per occupied room night. To get to the 50% Variable Cost structure, the number of salaried positions would be reduced and considerable effort would be made to schedule hourly-wage staff according to business volume.

OK…the example is admittedly overly simplified in order to emphasize the need for better forecasting and for eliminating static schedules.

The first lesson here is to be more sophisticated in the budget modeling. Restrict payroll spending in low-volume periods. To a great extent, it is accurate expense forecasts that allow you to be aggressive in holding the line on payroll costs, thus delivering improved margins.

Too many hotel management organizations concentrate all their effort on the level of spending and the possibility that some properties are wasting money. However, controlling costs is not just about avoiding waste! Controlling costs has much more to do with effectively employing resources to realize a greater potential. Use measurable objectives (such as performance targets) that can be monitored, tracked and improved.

The primary goal is to be efficient and effective. But there can be a huge gap between doing “the right things” to be effective versus simply doing useless tasks right to be efficient (according to what someone says you must do simply because it has always been done that way). Nothing is quite as useless as doing with great efficiency what should not be done at all.

Expense-Oriented Profitability

Beyond the obvious effects of revenue variations, non-payroll expenses also need to be closely monitored to deliver optimum profit. Using the prior example where the hotel drops to 60% occupancy at a lower ADR, the savvy operator realizes that even after he reduces his fixed component of labor to 50%, he still has at least another $1.50 per occupied room of expense cutting to go to get back to the desired profit margin (and that assumes all Other Rooms expenses are 100% variable to volume, which is a stretch).

Managers at all levels should intensify their efforts to observe operations. Certainly, these observations will include efforts to isolate non-value-added activities. More importantly, though, managers must be in touch with day-to-day operations to glean insight from customer feedback regarding non-value added activities. At this point, formal re-engineering may not be taking place; managers simply spend three or four days mentally re-engineering operations. Once that is accomplished, re-engineering can be done in earnest.

Ascertaining Value of Cost-Related Activities

In reality, analysis of customer needs and wants will result in three types of activities: value-added activities, non-valueadded activities and conditional activities.

By way of example, a non-value added activity could be that a hotel is providing every guest room with a gold-leaf hotel-logo shopping bag. While the guests may take the bag with them, they didn’t expect it and don’t have a practical need for such an item. Eliminating this expense is appropriate and expected given the current economic conditions.

Meanwhile, a value-added activity would be taking care to ensure that every guest room is not only clean but that it is in proper working order. According to surveys of frequent travelers, the guest room upkeep continues to be the biggest disappointment for travelers, which includes operable lights, remote controls, alarm clocks, plumbing and so on. Focusing effort to ensure that rooms are operable before a guest lodges a complaint would certainly lead to greater implied value for the customer.