Who Bears the Risk in the Hotel Business?
Albert BarraMarch 25, 2019 · 3 min read
In the hotel business, there are many stakeholders: brands, operators, executives, board members and owners. But only one of them bears, by far, the greatest risk.
Risk in this sense means holding a large number of cards when, suddenly, the game ends and you have to account for all of them.
These have been strong years in most markets where the hotel sector has remained robust and grown year after year. Some markets have recorded several years of strong RevPAR growth, in the double or single digits. Strong RevPAR growth delivers solid profits, more than enough to cover payroll and expenses while leaving a healthy return. But what happens when the music stops? Who survives and who does not?
The last economic downturn in hospitality occurred in 2007–2009. During that recession, a typical hotel could have seen its revenue decline for three consecutive years. This could have meant a decline of more than 20 per cent from its 2006 peak. GOP in this scenario would have fallen by 30% over the same years. The drop in cash flow was discouraging, given the high fixed cost of labour, union contracts and distribution costs. Revenue would have declined due to lower occupancy and fewer banquets, but the main culprit was Average Daily Rate. Cash flow before capital expenditures suddenly headed downward. How can this be? What happens when revenue stops growing?
In the hotel business, owners bear all the risk. Brands are largely paid through the fees they earn. In this scenario, their management fees declined in proportion to the fall in revenue. On the other hand, the brand was still providing its other management services.
Owners tried to get the brand to throw anything overboard from the sinking ship, but that was never enough to correct the equation. The general manager and the rest of the management team had to tighten their belts during this period, and they survived because they were essential to mitigating the ongoing financial disaster. The owner bore all the risk.
So, how can being a hotel owner be so dangerous? It seems like a good investment. A hotel could remain in business for decades and could be a popular venue and destination.
To see and understand the realities of the business, you need to look behind the curtain. But behind the curtain, the total cost of payroll, including benefits, is enormous. This is the great immovable object that destroys the desire to own a hotel.
Payroll is like a field that needs to be burned every few years. The one major problem with payroll in a hotel is that you cannot get rid of it, nor can you reduce it significantly. There is only one number you can count on in a hotel to rise every year: the average hourly wage.
For hotels to survive the next major recession, they must act now. Take measurable steps to innovate. They need to find their own path. But you can be certain of two things:
The last economic downturn in hospitality occurred in 2007–2009. During that recession, a typical hotel could have seen its revenue decline for three consecutive years. This could have meant a decline of more than 20 per cent from its 2006 peak. GOP in this scenario would have fallen by 30% over the same years. The drop in cash flow was discouraging, given the high fixed cost of labour, union contracts and distribution costs. Revenue would have declined due to lower occupancy and fewer banquets, but the main culprit was Average Daily Rate. Cash flow before capital expenditures suddenly headed downward. How can this be? What happens when revenue stops growing?
In the hotel business, owners bear all the risk. Brands are largely paid through the fees they earn. In this scenario, their management fees declined in proportion to the fall in revenue. On the other hand, the brand was still providing its other management services.
Owners tried to get the brand to throw anything overboard from the sinking ship, but that was never enough to correct the equation. The general manager and the rest of the management team had to tighten their belts during this period, and they survived because they were essential to mitigating the ongoing financial disaster. The owner bore all the risk.
So, how can being a hotel owner be so dangerous? It seems like a good investment. A hotel could remain in business for decades and could be a popular venue and destination.
To see and understand the realities of the business, you need to look behind the curtain. But behind the curtain, the total cost of payroll, including benefits, is enormous. This is the great immovable object that destroys the desire to own a hotel.
Payroll is like a field that needs to be burned every few years. The one major problem with payroll in a hotel is that you cannot get rid of it, nor can you reduce it significantly. There is only one number you can count on in a hotel to rise every year: the average hourly wage.
For hotels to survive the next major recession, they must act now. Take measurable steps to innovate. They need to find their own path. But you can be certain of two things:
- It is not a question of if, but of when we enter the next financial disaster that ends up sinking hotels.
- Ownership will always bear the burden, whatever a hotel’s management model may be.