Ideally, the ultimate goal for any hotel is to increase the top line (sales and revenue) and decrease the expenses (variable and sometimes fixed costs) to get the biggest increase in hotel’s bottom line without touching the guest and staff satisfactions. When a hotel’s occupancy rates and RevPAR rise, it is usually a good indication that management is executing well, and in order to achieve such a goal the focus needs to be on both revenues and costs. Hotels can boost their bottom line by increasing revenues or decreasing costs, this is why running a successful hotel is an ongoing challenge that requires the combined forces of both management and staff and I would add the hotel customers.
Hotel operations is like with any other business, understanding the bottom line of your hotel operation cost will help you to understand whether you are making a loss or profit from it and adjust your business practices and strategy accordingly. However, the catch is that not many hoteliers or owners really understand the top line. It is therefore hard to guess as to what their bottom line is.
While it may seem boring to revenue management understanding the financial part of running a hotel, it is actually quite important. It will make it easy for you to see exactly how much profit you’ll make for any number of guests visiting in a given period which translating into room nights and revenue.
In simple definition the terms Variable costs and fixed costs in hotel operation is used to distinguish between those costs that have direct relationship to Hotel occupancy and those that has no relation to occupancy and business .
For example: If your hotel daily fixed costs includes and not limited to (i.e. mortgage, taxes, insurance, utilities, labors, maintenance, phone and internet, marketing , etc.) come to a total of $5,000, then you will have to generate revenue with the same amount $5,000 from your guest rooms before you can begin to cover your variable costs.
Next, you will need to consider your hotel variable costs. If for example food costs $30 per guest, supplies $15 per guest and cleaning is $20 per guest then your total variable cost per guest would be $65.
When you add your fixed expenses to your variable expenses per guest you get a total of $5,065, Interpreted another way, this would mean that the hotel must sell at least 100 guestrooms at an average daily rate of $50.65 on daily basis before it would generate a profit. The hotel could sell a fewer number of guestrooms at a higher ADR or a greater number of guestrooms at a lower ADR in order to reach the breakeven point in sales, but bear in mind that the breakeven point in sales may not be the same because of the variable costs associated with providing guestrooms for use.
This means that if hotel generate a revenue of over $5,065 per month, you will have made a profit or will just reach to the breakeven point (Revenue = Expenses).
Total Fixed Costs
Total fixed costs for any hotel are the sum of all the expenses that a hotel must pay per month / year that will not fluctuate because of the hotel occupancy level or the sum of generated revenue, but they are said to have little direct relationship to the business volume because they do not change significantly when the number of room nights or revenue increases or decreases.
Examples of Fixed costs are: To calculate the breakeven point for a given time period, we must first be able to calculate the total fixed costs that the hotel will incur, typically fixed costs may include the following : The hotel land, the hotel building, Interest on loans, insurance expenses, lobar cost includes salaries and wages (payroll), Out sourced services contracted for fixed amount in a month e.g.:- security or maintenance services, Taxes to government, Yearly maintenance contract fees for all equipment’s, machineries and Hotel Management software’s, Reservation expenses, marketing activities, entertainment fix activities i.e. In house moves / satellite TV/ Music, ……..etc., more and more can be add to the list.
Remember one more time that some of those fixed cost will be in place either the hotel is running one room occupied or running full house capacity at 100% Occupancy, there will be the payroll and benefits expenses of the least number of employees that must work even if the hotel has no guests i.e. maintenance staff, gardeners, minimum number of kitchen staff, front office and housekeeping , and the expenses of the utilities that must be maintained even if the hotel has zero occupancy (e.g., such as maintaining a minimum amount of heat to keep water pipes from freezing in the Winter). With each of these aforementioned expenses, the amount of the expense will not deviate regardless of how many or how few guestrooms are sold.
Total Variable Costs
Variable costs are clearly related to hotel occupancy level and business volume from F&B banquets and outlets. As business volume or occupancy increases, variable costs will increase; as hotel occupancy decreases, variable costs should decrease as well. Variable expenses are deemed “variable” because they are only incurred if a room is sold or used. If the guestroom remains vacant for the night, there are no variable costs that the hotel must pay for any required costs associated with maintaining a non-used guestroom would be considered a fixed cost.
Examples of Variable costs are: There are many factors that go into the cost-per-occupied room which will typically include the expense of cleaning supplies for F&B and Housekeeping, Guest room amenities, linen for guest room, restaurants and banquets, Chemicals for laundry and water treatment plants, T/A commission, Administration & General, management fees , utility expense associated with servicing the guestroom’s linens, the expense of the utilities associated with the guest’s occupancy (e.g., electricity, water, heat, etc.), and the guestroom’s fare share contribution towards a capital budget for replacing furniture, fixture, and equipment in the guestroom every 3-7 years as part of a regularly scheduled refurbishment …….etc., more and more can be add to the list..
The Revenue Management Role
Understanding the total fixed costs for the entire hotel operation and the variable costs associated with each guestroom sold is the key factor to establish the minimum selling price for the hotel either for room or for F&B activity, thus It is no surprise that hotels set the minimum selling price for each guestroom at or above the variable expenses for each guestroom.
Failure to do so would be foolish and lead to assured deeper financial loss with every room sold. But setting the room price must also reflect its contribution towards supporting the hotel’s total fixed costs. Knowing, the average selling price, a revenue manager can easily calculate the breakeven point for the hotel, both in terms of number of guestrooms that must be sold but also in guestroom revenue that must be generated, in order for the hotel to realize a point of profitability.
There are many hotels (some of them I dealt with them myself) they refuse to include the fixed cost and some of the variable cost in the room price calculation, they even tend to calculate how much the room amenities cost and this would be the base of the price point. Hoteliers always tend to ignore those kind of cost while at the end of the month the very simple calculation of the hotel profit is total hotel revenue generated minuses all the hotel type of cost.
We all knows that the two major ingredients contributing to revenues both in Rooms as well as Food & Beverage departments are quantity and price. Quantity represents business volume, which in the case of Rooms is occupancy or number of rooms sold and in the case of Food & Beverage is number of covers served. Price represents the rate, which is the Average Daily Rate in Rooms and Average Check in Food & Beverage.
After your understanding for the different type of cost, you already calculate how to set your pricing strategy based on your cost, now knowing your break-even point is important because it tells you how much revenue (sales) your hotel has to generate to cover expenses, it is that golden number your hotel must surpass to make a profit. Anything above this amount provides you with extra cash to reinvest in your business and/or pay your own salary. But calculating the break-even point is like trying to predict weather. Shifting variables make it difficult to lock down firm figures with perfect accuracy. However, there is a simple process called a break-even analysis that helps you understand how profits change as revenues fluctuate. It is a useful tool for forecasting your break-even point in any given situation.
Here is an example to illustrate how to use the breakeven analysis formulas. Let’s assume that the XYZ Hotel has 450 guestrooms. The total fixed costs for the hotel on any given night are $11,175.00. The variable costs per guestroom are $9.54, broken down as follows:
- Labor expense to service guestroom: $4.00
- Laundry expense: $1.70
- Cleaning chemicals and supplies: $1.00
- Amenity items: $1.30
- Utilities consumed by guest and to clean room: $1.54
Total variable expense per guestroom per night: $9.54
Now let’s assume that the average daily rate for the hotel last night was $90.00. To calculate the BEP (Breakeven Point) in Units for a given time period use the following formula:
BEP in Unites = Total Fixed Costs for the Hotel $ 11,175
———————————————————— —————- = 114.62 Rooms
Selling Price per unit – Variable Costs per unit $90.00 – 9.54
This means that given the total fixed costs, variable costs per guestroom, and an average room rate of $90.00 the XYZ hotel would have to sell at least 115 guestrooms before it realized profitability last night. If it sold 115 or fewer guestrooms at an ADR of $90.00 or less, the hotel would not generate sufficient gross revenue to meet its expense obligations. Yet, for every room above 115 guestrooms that were sold last night, the hotel is generating a pre-tax profit of $80.46 per room. Obviously, the more guestrooms it sells over and above 115 rooms, the greater the profit amount.
To calculate the Breakeven Point in Sales one merely needs to multiply the Breakeven Point in room sold by the selling price. In the above example, the selling price would be the average daily rate for the previous night:
BEP sales = (Breakeven Point Units) (Selling Price) = (115.00 rooms) ($90.00) = $10,350
Hence, if the selling price is set at $88.93 (or if the ADR for a given time period was $90.00) the XYZ Hotel must generate at least $10,350 in guestroom sales before its operation is considered profitable. As an example, if the hotel generated gross guestroom revenue of $36,000 (400 guestrooms sold at an ADR of $90.00), then it would realize a profit of $22,931. This is calculated as follows:
* Profit beyond BEP = [(Units sold beyond BEP units) (Selling Price – Variable Costs per Unit)]
* Profit beyond BEP = [(400 rooms – 115 rooms) ($90.00 - $9.54)]
* Profit beyond BEP = (285 rooms) ($80.46.39) = $22,931
once you understood the Correlation Coefficient between Revenue Management, Breakeven Points and Hotel Operation Cost will lead you to fully involve revenue management in each step of your operation since it is the link between the hotel cost and the breakeven analysis to generate revenue and profit. Remember Revenue Management and Breakeven are a powerful analytical tool that hotels managers can use for any item or service that they sell, not just guestrooms. As long as the business operation’s total fixed costs, and the variable costs and selling price for each item can be determined, the breakeven point of profitability can be calculated. The above supplied formulas can also be used to determine how a change in expenses or selling price will increase or decrease the number of units that must be sold in order to achieve profitability.
In our next post we will try to examine how to reduce the major cost involves in the hotel operations, we will start by Hotel Operation Cost is in Raise part II, The Labor Costs.