Growth in Labor Costs Causes Mixed Profit Picture for U.S. Hotels in 1999

The results are based on the firm's recently completed Trends in the Hotel Industry survey, an annual review of U.S. hotel operations conducted by PKF Consulting since 1935. The survey measures the performance of over 1,400 hotels nationwide that were in operation for a full-year in both 1998 and 1999.

While 60.6 percent of the survey sample were able to increase their revenues in 1999 over 1998, almost half of the properties (47.3 percent) achieved less profit in 1999 than they had in 1998. "For most of the 1990s, hotel managers have been able to overcome the ever increasing costs of doing business with strong improvements in revenue," says R. Mark Woodworth, Executive Managing Director of Atlanta-based HRG. "However, in 1999, we saw competitive market conditions limit revenue growth to 3.9 percent, slightly less than the 4.0 percent average increase in operating expenses for the year."

With expenses growing greater than revenue, the average profit margin for U.S. hotels dropped from 31.2 percent in 1998 to 31.1 percent in 1999, the first such decline since 1991. "While the decline in profit margin from 1998 reflects the struggle hotel managers are currently facing, it should be noted that the 31.1 percent profit margin achieved in 1999 is still nine percentage points greater than the long-term average achieved since 1960. In addition, the 3.6 percent growth in profits did exceed the 2.7 percent rate of inflation, thus resulting in some measure of 'real' growth in profits," adds Woodworth.

Annual Change In Operating Profits* - Year Percent Change From Prior Year

1990 - 2.0%
1991 - -5.5%
1992 - 9.1%
1993 - 8.0%
1994 - 13.7%
1995 - 16.0%
1996 - 16.3%
1997 - 11.6%
1998 - 8.7%
1999 - 3.6%

Note: * Before capital reserve, rent, interest, income taxes, depreciation, and amortization.

Source: The Hospitality Research Group of PKF Consulting

Not only is the lodging industry extremely labor-intensive, but personnel and their performance are an important component of the product and guest experience. For hotels, the costs associated with salaries, wages, and employee benefits equal 31.2 percent of revenue, or 45.3 percent of all expenses. Therefore, cost controls for hotel managers start with labor costs. "Be it recruitment, retention, or compensation, our clients frequently cite anything involving labor as their number one concern," says Robert Mandelbaum, Director of Research Information Services for HRG.

Payroll and related costs at the average U.S. hotel increased 4.2 percent from 1998 to 1999. This compares to an overall increase in hotel operating expenses of 3.6 percent, and a 3.4 percent growth rate in labor costs for all U.S. private industries.

"Unlike other industries, hotel labor costs have been rising at nearly twice the pace of inflation during most of the 1990s," says Mandelbaum. "Fortunately, the growth in revenue has covered up much of this pain. However, in 1999, the 4.2 percent growth rate in labor costs exceeded the 3.9 percent growth in revenues, the first time this imbalance occurred since 1993."

Those property types that achieved the lowest gains in revenue (limited- service and all-suite) found ways to minimize their increases in labor costs. On the other hand, resorts and convention hotels (both with relatively strong 4.4 percent increases in revenue) saw their payroll cost rise 5.5 percent and 6.5 percent, respectively. "It should be noted that resorts and convention hotels also are the most fully-staffed and labor-dependent types of hotels," adds Mandelbaum.

Given the diversity of local market conditions and product types, national averages do not necessarily reflect the performance of individual industry segments. Such is the case in 1999 when analyzing industry-wide profitability.

"We find some extreme polarization in the performance of hotels, especially when analyzed along product lines," says Mandelbaum. Of the five product types tracked by HRG, limited-service and all-suite hotels earned fewer dollars in 1999 than they did in 1998, while full-service, resort, and convention properties all showed modest gains.

"Also, a direct correlation exists between average daily rates (ADR) and the ability to grow profits," says Mandelbaum. "With the cost of conducting business on the rise, the ability of hotels to raise their prices and achieve a high ADR is critical to achieving growth on the bottom-line." The Trends survey found that hotels with an ADR less than $75.00 averaged a decline in profits during 1999, while those with average rates in excess of $100 posted increases of approximately five percent.

With moderate revenue growth projected for the near-term, hotel managers will need to concentrate more on cost controls to increase profits. "The HRG has already seen managers take advantage of the Internet in an effort to cut costs and control expenses, especially in the areas of procurement and reservations," says Dr. Jack Corgel, Managing Director of Applied Research for HRG.

"Procurement is one area where the Internet is sure to benefit the hotel industry," says Corgel. "With products, suppliers, and chain-wide standards changing constantly, the Internet is an efficient tool for keeping up with the changes and one-stop shopping." A recent study by HRG measured the potential hotel procurement market at $16 billion.

The Internet also allows for direct contact between hotels and the consumer. "This not only gives the consumer a positive feeling of empowerment, but allows hotels to avoid the reservation commissions and fees paid to agencies in the middle of historical distribution channels," says Corgel.

When forced to control costs, general managers usually give those expenses that are least associated with guest service the closest scrutiny.

The direct expenses associated with operating the revenue-generating departments of hotels increased 4.6 percent in 1999. Examples of expenses in this category include the salaries and wages of front desk clerks and housekeepers, the cost of food and beverages sold, and items such as towels, glassware, and linen.

Conversely, the amount of money spent to operate the overhead departments of a hotel grew only 4.2 percent. These costs cover the administrative office, maintenance of the facility, and utility expenses. An exception in this area was the rather strong 7.8 percent increase in the dollars spent to market hotels. "Given the importance of driving top-line revenues, it is apparent that sales and marketing was an area that hotel managers could not afford to cut back on," says Mandelbaum.

The average expenses for management fees, property taxes, and insurance increased a mere 0.1 percent in 1999. "Hotel owners have become aggressive in negotiating their management contracts and insurance policies, as well as fighting tax assessments," Mandelbaum observes. "Anything to cut costs without affecting guest service."

The Hospitality Research Group (HRG), headquartered in Atlanta, is the research affiliate of PKF Consulting, the international consulting and real estate firm specializing in the hospitality industry. (1) Operating profits are after deductions for management fees, property taxes, and insurance, but before capital reserve, rent, interest, income taxes depreciation, and amortization. Gary Carr, Director of Communications of PKF Consulting, 425 California Street, Suite 1650, San Francisco, CA 94104 (415) 421-5378