Right Direction, Wrong Amount

As U.S. hotel managers began to prepare their 2009 budgets in the summer of 2008 there was a sense that the following year was going to be challenging.

The U.S. economy was in recession, gas prices were on the rise, and news of declines in home values and employment were prevalent. Occupancy levels for U.S. hotels had begun to slide, but average daily room rates (ADR) were still on the rise.

Unfortunately, as management started to refine their projections of revenues and expenses for 2009, the economic news got worse. Lehman Brothers declared bankruptcy in September, the stock market began to collapse, and the depth of the "financial crisis" grew. By October of 2008, both hotel occupancy and ADR levels were declining.

In response to the deteriorating market conditions, hotel managers did budget for declines in performance in 2009. However, like most prognosticators, they did not foresee the magnitude of the record-breaking deterioration that would occur.

Now that hotel operators are in the middle of preparing their budgets for 2011, what lessons can be learned from past practices? To assist hotel managers, PKF Hospitality Research (PKF-HR) examined the accuracy of 580 hotel budgets for the year 2009. The data was taken from the Trends in the Hotel Industry database of PKF-HR.

Budget Inaccuracy

Looking towards 2009, the hotel managers in our survey sample budgeted for a 3.7 percent decrease in total revenue. Unfortunately, at the end of the year, total revenue declined 17.8 percent.

An underestimation of both the number of rooms expected to be occupied and average room rate paid contributed to the discrepancy in budgeted total revenue. The properties in our research sample anticipated a 2.2 percent decline in occupied rooms in 2009, but actually ended up accommodating 7.9 percent fewer rooms.

Given the anticipated competitive market conditions, hotel managers realized that some degree of discounting would be required in 2009. Accordingly, they forecast a 1.3 percent decline in ADR for the year. Unfortunately, the need to discount increased throughout the year resulting in an actual decline in ADR of 11.3 percent for the survey sample.

The net result was an actual 18.3 percent decline in RevPAR in 2009, far greater than the budgeted decrease of 3.5 percent. Since rooms revenue comprised 63.1 percent of total revenue for the hotels in our survey sample, this explains the underperformance in budgeted total revenue.

To offset the anticipated declines in revenue, the hotel managers in our survey planned to cut their costs. Total operating expenses (operated departments, undistributed departments, fixed charges) were budgeted to decline 2.3 percent from 2008 to 2009. As the year progressed and the dramatic fall off in revenue became evident, management was forced to cut their expenses to an even greater degree. By year end, the hotel operators in our survey sample responded by cutting their costs a stout 12.0 percent in 2009.

Despite cutting costs by 12.0 percent, the hotels in the survey sample were unable to match the declines in revenue and achieve their target net operating income (NOI). NOI was anticipated to decline 7.6 percent in 2009, but the sample properties actually suffered a 33.7 percent decline on the bottom-line. At the end of the year, hotels fell short of their budgeted dollar profit levels by 28.2 percent.

Looking Towards 2011

As hotel managers prepare their budgets for 2011 they do so in a hopeful environment. After suffering record-breaking declines in 2009, the U.S. lodging industry has shown signs of turning around during the 2010. Demand is up, occupancy is on the rise, and ADR declines have begun to contract.

Based on the initial signs of recovery observed in 2010, and positive economic forecasts provided by Moody's Economy.com, PKF-HR is forecasting strong growth in both revenues and profits in 2011. According to the September 2010 edition of Hotel Horizons®, unit-level total revenue is projected to increase 5.9 percent in 2011, while profits are expected to rise 10.8 percent.

In June of 2010, PKF-HR conducted an assessment of the accuracy of its Hotel Horizons forecasts. That analysis found that, "The accuracy of Hotel Horizons® forecasts is somewhat inconsistent during periods following a turning point, which are typically unstable periods for the economy." Learning from this analysis, projections of strong growth in performance for 2011 are somewhat risky.

Despite the risks, PKF-HR believes it is appropriate for hotel managers to set relatively strong revenue and profit growth as goals for performance in 2011. However, based on our analysis of historical budget accuracy, optimism should not cloud reality. Just as hotel managers have historically not forecasted sufficient declines when approaching the downside of an industry business cycle, they should temper their expectations of gains during the initial stages of a recovery.

About the author: Robert Mandelbaum is the Director of Research Information Services for PKF Hospitality Research. He is located in the firm's Atlanta office. For more information on the benchmarking and forecast reports PKF-HR offers to assist hoteliers in the budgeting process, please visit www.pkfc.com/store. This article was published in the September 2010 issue of Lodging.

photo of Robert Mandelbaum


Discounting Dilemma

Robert, it looks like the discounting became a self-fulfilling prophecy - everyone expected the other guy to cut, so they matched that cut or discount,.