Part III Being There
4.3 Financial and Economic Aspects
4.3.3 Economic Sensitivities
Total aggregate demand for hotel industry services is sensitive to changes in general economic conditions and follows growth patterns similar to and closely integrated with changes in other travel segments—for example, as shown in Fig.4.7, to air travel.
The rate of growth in demand for rooms, as found by Miller (1995, p. 56), is approximately 75 % of the rate of change in GNP and similar correlations between average room rates and the consumer price index have been observed. Slowing of economic growth will normally result in a downturn in occupancy rates, if not also room rates, within 6–9 months at the latest. Prevailing and prospective monetary and fiscal policies, consumer confidence levels, and many other factors—all of
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87 90 93 96 99 02 05 08 11 14
% change
RPM (U.S.) RevPar
Fig. 4.7 RevPar versus US passenger-miles flown, annual percent changes, 1985–2014
39Pooling-of-interests accounting, no longer allowed after 2001, had been approved only if certain strict criteria had been met. In a pooling, two companies combined their assets and liabilities as if they had always operated as a single entity. The advantage was that there is no charge to earnings for what in purchase merger accounting is known as goodwill amortization. Such goodwill represents the value of intangible assets such as brand names and reservation systems and operating know-how that a purchaser buys for a price that exceeds the target company’s stated book value.
In a purchase-accounting type of merger this goodwill used to be charged, according to U.S. GAAP, as an expense and written off evenly over no more than 40 years. After calendar 2000, goodwill is no longer amortized over any particular period and may remain on the books indefinitely, until it has been determined that the value of the acquired assets has been impaired.
Prior to this change, amortization of goodwill had depressed stated earnings results, with such charges in large mergers often amounting to several hundred million dollars a year. See, also, Financial Accounting Standards Board (FASB) Statement No. 142 and theNew York Timesand Wall Street Journal, December 7, 2000.
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which are outside the control of hoteliers—influence if and when an economic slowdown will occur.40All of these macroeconomic factors acting together affect RevPar averages and lodging stock prices.
Figure 4.1has shown that hotel industry profits have been quite volatile and sensitive to overall economic conditions and Fig. 4.8 illustrates that the annual percent changes in hotel occupancy rates and percent changes in U.S. GDP closely track each other. And an even higher correlation, according to Smith Travel Research, is to gross private domestic investment (GPDI). Studies by PriceWater- houseCoopers suggest that the correlation between demand and real GDP is nor- mally around 0.9 and that demand elasticity relative to real GDP averaged 1.2 from 1967 to 1991 and 0.8 from 1991 to 2000 (0.5 in 2003).41Directional changes in RevPar are also typically anticipated by and reflected in hotel share prices with lead times of at least 6 months, but this is not always a reliable indicator.
Demand for rooms is also rather sensitive to changes in the price per gallon of gasoline, with a rise in fuel prices reflected relatively quickly in fewer room-nights sold. However, although a similar inverse relationship is seen when airline ticket prices are raised, the effect is normally not as immediate or as large, probably because rising business-related air travel costs can usually be at least partially passed along through higher product prices. In all, about one-third of all lodging
-9 -5 0 5 9
75 85 95 05 15
Real U.S.GDP
Occupancy rate
% change
Fig. 4.8 Percent change in occupancy rate versus percent change in GDP, 1975–2015
40The industry has developed a forecasting tool known as the US hotel industry leading indicator (HIL), which is a monthly composite of nine different components that, on the average, are able to estimate industry demand data by 4–5 months in advance of a change in direction in the business cycle. Among the HIL components are the Treasury bond yield curve, oil prices, job market conditions, hotel worker-hours, housing activity, foreign demand, new orders, and a vacation barometer.
41PriceWaterhouseCoopers economists have also estimated the elasticity of room demand with respect to real GDP between 1987 and 2000 by hotel segment: Upper upscale was 1.02; upscale 1.46; midscale with F&B, not significant; midscale w/o F&B, 1.24; economy, 1.03; Independent,
<1.00.
guests arrive by air. Room supply and demand trends and changes in demand for lodging relative to changes in airline travel cost indices with a 1-year lag, and to changes in oil prices with a 2-year lag, appear in Fig.4.9.42
a
b
c
0 1 2 3 4 5
70 80 90 00 10
millions
supply
demand
-7 0 7 14 21
-12 0 12 24 36
75 85 95 05 15
% change cost
rooms demand airfare index
% change
% change rooms
-15.0 -7.5 0.0 7.5 15.0
-80 -40 0 40 80
75 85 95 05 15
% change oil
rooms demand oil prices
% change rooms
Fig. 4.9 (a) Overall room supply and demand, (b) room demand changes versus airline travel-cost (airfare) index changes, lagged 1 year, and (c) room demand changes versus oil price changes, lagged 2 years, 1970–2015
42PriceWaterhouseCoopers, in privately commissioned research, estimated a correlation coeffi- cient of –0.4 between changes in the airline cost index and changes in lodging demand for 1979–1997. The firm also estimated that a 1 % increase in the price of crude oil causes a 0.06–0.09 % decline in lodging demand.
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The rate of new construction is another important business cycle-sensitive variable that can affect local occupancy and room pricing over the long term.43 Up to the mid-1980s, for example, tax laws had encouraged the building of many new rooms, with the result that it was nearly a decade before demand began to catch up with supply. Once that happened, however, the industry experienced sharply rising room and occupancy rates and profits that extended into the mid-2000s. This was reflected in industry pretax profits per room—an important variable in terms of stock market valuation perceptions—rising from zero in 1992 to approximately
$6,400 in 2015 (Fig.4.1).
The incremental net supply of new rooms (often tracked through construction data offered by F.W. Dodge) relative to the existing base—i.e., the new-to-existing, n/e ratio—is therefore important in assessment of local room-addition prospects.
Such n/e (adjusted for income strata) ratios would, however, be much less useful in assessing the potential room demand in rapidly developing and densely-populated countries such as Brazil, China, and India, where rooms per capita are known to be extremely low as compared to in the US or Europe. The ratio of rooms per thousand people in the US is around 15.6 versus 1.0 or less in many emerging countries.44
The middle of Table1.6shows the industry composite operating performance for the recent years leading up to 2014 and Fig.4.10tracks lodging share prices, which tend to lead changes in RevPars.
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80 84 88 92 96 00 04 08 12
RevPar
S&P Lodging Stocks
Fig. 4.10 Annual average %
percent changes of monthly S&P lodging share price index changes versus annual percent changes of lodging industry RevPars, 1980–
2014
43Levere (2010) discusses major hotel expansion projects coming on stream even as occupancy rates and prices are still relatively weak. That’s because most of these projects had been planned and financed at the business cycle peak and prior to the long recession that began in late 2007.
44For purposes of assessing local competitive conditions, the key factors are the distance between new hotels and older ones, along with brand segmentations (e.g., upscale customers usually don’t substitute with economy hotels and vice versa), and the relative size of existing nearby hotels. The n/e ratio, of course, does not directly take demand growth into consideration, so that hotels competing even in a high n/e ratio region may not experience near-term profit impairment if growth of demand in the region is strong and able to absorb any new construction.
Another short-run economic factor that might adversely affect margins, especially during upturns, would be shortages in the local supply of labor. Although hotels use a mix of union and nonunion workers depending on location and position, overall labor costs would still be at least somewhat correlated to the national minimum wage and be affected by immigration trends. In boom times, minimum wage workers may also easily find higher paying jobs in other service industries. And although the role of unions in hotels and restaurants is not as central to operations as in airlines, union agreements (e.g., with the Hotel and Restaurant Employees or Culinary Workers Union) will normally influence growth trends in productivity and wages.
The scope of industry sectors in terms of number of establishments, receipts, and payrolls is shown in the North American Industry Classification System (NAICS) data of Table4.5. From this it can be seen that the casino segment has since 2002 improved labor-efficiency the most in terms of payroll as a percent of receipts (from 28.2 down to 25.7 %). However, the non-casino hotel/motel segment has apparently been able to expand receipts per employee somewhat faster (probably by being able to raise prices more and/or provide more service amenities) than in the other groups.
Technological advances have also helped the hotel industry to operate much more efficiently than in the past. The Internet has become especially important in allowing travelers to bypass travel agents and to see in the comfort of their offices and homes instantly available descriptive brochures and room rate and reservation Table 4.5 Hotel, casino, food service, and amusement/theme park industry number of establish- ments, total receipts, payrolls, and employees, 2012, 2007, 2002
No. of estabs
Receipts ($1000)
Payroll (annual) ($1000)
Employees (paid)
Receipts per employee ($)
Payroll as % of receipts Hotels (except casino hotels) and motels (NAICS 721110)
2012 38,763 136,887,332 35,808,135 1,453,812 94.158 26.2 2007 48,108 122,033,327 31,592,733 1,462,464 83,444 25.9 2002 46,295 89,357,109 24,204,364 1,366,850 65,374 27.1 Casino hotels (NAICS 721120)
2012 392 51,004,734 13,113,296 409,568 124.533 25.7
2007 363 44,868,577 12,037928 379,382 118,268 26.8
2002 283 33,417,673 9,428,235 373,299 91,673 28.2
Food services and drinking places (NAICS 722)
2012 598,512 516,551,775 152,774,615 10,048,664 51,405 29.6 2007 571,621 433,404,527 124,433,560 9,630,090 45,005 28.7 2002 504,641 321,400,508 92,599,349 8,307,625 38,687 28.8 Amusement and theme parks (NAICS 71311)
2012 483 12,368,602 2,951,269 125,697 98,400 21.0
2007 634 12,206,545 2,391,331 101,247 120,562 19.6
2002 772 8,101,592 1,858,356 94,107 86,089 22.9
Source: U.S. Economics Census, 2012, Accommodation and Food Services, U.S. Census Bureau, Available at:http://www.census.gov/econ/susb/index.htmlon US all industries selection. Data for years prior to 2012 may not be fully comparable because of classification changes and revisions
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options. Yet technology can cut in the other direction too if, through advanced teleconferencing and e-mail and Internet presentations, people find that they can reduce their expenditures on travel.45
Hotels, like airlines, probably have fairly limited opportunities to find cost efficiencies of scale outside of the obvious administrative and corporate areas of advertising, reservation systems, frequent traveler programs, property clustering, and computerized billing. For instance, no matter how large a chain or a property grows, it will still take the housekeeping department a fairly constant amount of time to make up a room.46Nevertheless, it is likely that there remains enough cost saving available on the administrative side to keep the global merger wheel yet spinning for a long time to come.
45As in the airline industry, technology has enabled middlemen room wholesalers such as Expedia.com to exert significant influence over the availability and pricing of large blocks of rooms (and airline seats). National hotel chain brand managers, and to an extent airline manage- ments, have thereby surrendered some of their former prerogatives. Local franchisees, who actually own the properties, now have much greater say in pricing and availability of rooms than in the past, when national brand managers had more power to dictate on these items. Online wholesalers will generally earn more on higher sales margins from their merchant than their agent activities. Expedia, which sells airline tickets, hotel rooms, and cruise packages under Web Sites that include its name as well as Hotels.com, hotwire.com, and tripadvisor.com, participates in an online travel market estimated to be around $95 billion as of 2014. SeeBusinessWeek, August 1, 2005.
Angwin and Rich (2003) note that Expedia, a full service travel agency (air, hotels, cars) created by Microsoft in 1996, and Hotels.com accounted for about 60 % of online bookings in 2002. By 2012, hotels still accounted for the majority of online travel agency revenues. As the airlines have done with Orbitz, hotels have banded together to form their own online systems. Marriott, Hilton, Hyatt, Six Continents, and Starwood formed Travelweb LLC in 2002 to sell rooms on Travelweb.
com. Six Continents, Hilton Group PLC (operator of Hiltons outside the United States), and Accor also formed WorldRes Europe to serve the Euro market. And Travelocity, owned by Sabre Holdings, also launched a wholesale hotel service around this time.
For 2014, the hotel industry estimated that online travel agencies (OTAs) cost the industry at least $2.5 billion and accounted for approximately 99 million of the 1 billion room-nights sold in the US during 2010. In 2011, OTAs accounted for around 7.4 % of US industry revenues as compared to 1.3 % 10 years earlier. The hotel industry sees the OTAs as typically the most costly of any distribution channel because OTAs are an intermediary between a hotel and the traveler.
Most OTAs, in turn, see the economics of serving the hotel industry as being much more favorable for them as compared to servicing airlines. See also Morgenson (2003), Nicas (2011), HotelNewsNow.com, 04 August 2011, and Karmin (2015).
46However, the combination of better technology and faster-than-average unit expansion of the limited service formats that require relatively lower labor content has enabled the number of hotel industry employees per 100 rooms to decline from approximately 78 in the late 1980s to 74 by the late 1990s.