A study of hotel profitability during recessions in 2009 and 2001 shows hoteliers cut variable costs, including labor, as demand dropped.
BROOMFIELD, Colorado—In December, we discussed the revenue-per-available-room impact of the prior two recessions across several industry segments and markets. This time, we will examine profitability and labor costs during these two periods.
Many economists are predicting the next recession will likely come in 2020 or even late this year. The largest threat to the overall economy is escalating trade wars, but many other economic risks and negative indicators are on the rise.
In the hotel industry, we’ve already begun discussing a possible ongoing “profit recession” or declining profitability. Our industry feels the pain of recessions more than most, and the impact is immediate. From a 6.5% decline in demand, the 2009 Great Recession produced a devastating 18.2% decline in rooms revenue, which translated into a GOP decline of 27.6%.
In 2001, RevPAR had already declined for five months before the 9/11 terror attacks. That month, however, RevPAR plummeted 23.2% across the nation. By the end of 2001, rooms revenue had fallen 9.6%, while profits declined 16.8% from 2000 levels.
These two recessions were very different, yet the effects to our industry were very similar. For instance, GOP declined at similar levels relative to rooms revenues, 1.5 times and 1.75 times the decline in rooms revenues. This is very typical of this relationship, as we usually see GOP increase or decrease at some multiple of rooms revenues, and that multiple tends to be between 1.5 and 2. Similarly, labor costs decreased both years, but at roughly half the declines in rooms revenues each year. This is not a coincidence as roughly half the revenue declines came from occupancy and half from rates. The occupancy declines allow hoteliers to reduce hours and labor costs, while ADR declines rarely lead to any reduction in costs.
Digging deeper into 2009
Ancillary departmental revenue declines in 2009 were fairly consistent with rooms revenues, as shown in the chart below. Miscellaneous Income was the outlier here, actually increasing primarily due to increased cancellation fees. Food and other F&B revenues actually declined more than rooms revenues, as group demand dried up in 2009. Overall, total revenues declined 17.4%, roughly a percentage point less than rooms revenues.
On the other hand, most departmental and undistributed expenses realized declines of approximately 10%, far less than the revenue declines. Management fees are the one expense that did decline as much as revenues (-24.3%) in 2009. Base management fees are calculated on a percentage of total revenues, so we expect them to decline as much as revenues, but the greater decline indicates incentive management fees (which are based on profits) were even more affected. Franchise fees and reserves are the only other two expenses that also declined at near revenue-levels, as they are similarly tied to revenue performance.
Property taxes actually increased in 2009. Of course, property taxes and assessments are typically two to three years late to react to changing hotel performance and valuations. This happens with largely fixed expenses such as property taxes, though highly variable expenses that are dependent on occupancy levels decreased far less than the declines in revenues. For instance, departments we consider to be more variable, such as utilities and property operations and maintenance, actually realized the lowest levels of decline because these expenses are closely tied to demand levels and not revenues. As such, the declines are in line with the demand decline, but declines in ADR don’t impact utility costs or POM expense.
In 2009, labor costs declined 9% overall. POM labor decreased the least (-6.7%), while F&B labor declined the most (-12%). Labor costs are generally perceived as a variable expense, but there’s also some fixed component to labor costs. Hotels can reduce hours in slow periods, but only to a certain point, and also cannot simply hire/fire full-time staff on a daily basis to keep pace with demand. In addition, some staff such as A&G and marketing are generally salary-based employees, rather than hourly, which makes those labor costs effectively fixed. This difficulty in staffing has given rise to increased contract labor, which can be more easily managed to accommodate varying demand levels, albeit at higher hourly rates.
These two recessions give us a great indication of what we can expect for the next downturn. Demand declines of 6% to 7% and revenue declines of 10% to 18% gives us a reasonable range of performance. The next downturn will most likely be less extreme than 2009, but even a 14% revenue decline would likely translate into a 21% to 28% decline in profits.
The revenue decline could be balanced somewhat by a 7% reduction in labor costs, but only enough to keep up with demand declines. Declines in ADR would fall largely to the bottom line, if not for the fee-based expenses such as management fees. Variable expenses will also help lessen profit declines, but fixed expenses will amplify them and are less controllable. The real opportunity for hoteliers in the next downturn lies in managing variable expenses that are tied to demand (i.e. labor costs), as well as revenue management aimed at maintaining profitability, rather than being solely focused on revenue levels.
Joseph Rael is the Senior Director of Financial Performance of STR’s Consulting & Analytics division.
This article represents an interpretation of data collected by STR, parent company of HNN. Please feel free to comment or contact an editor with any questions or concerns.