“Optimization Treasures” Flow to Savvy Hotel Buyers
By Richard B. Evans, President of Revenue Report Card LLC & Author of “the Definitive Study of Vacation Rentals”
The ability to find measurable hidden value in a hotel, before acquisition, provides hotel buyers with foresight to confidently negotiate and recognize undetected long term benefits. The Optimization Scoring Metric, calculated in the due diligence phase of acquisition, uncovers treasures that could never be seen before.
What is the Optimization Metric?
The Optimization Metric provides hotels with an evaluation of the effects that (1) complete channel cost, (2) channel mix and (3) the merchant model, have on profit and cash deposits (I refer to these as the "critical factors").
The calculations involved in determining the Optimization Score place all reservation-vendors on an equal platform in measuring production and removes the flawed inaccuracies created by the Merchant Model. Needless to say, in a data driven society flawed metrics present big problems. These flaws, are present in the traditional calculation of hotel metrics. Follow the link, in the paragraph below, for more on "the optimization metric and flawed industry metrics".
The "Optimization Metric" was the highlight of an article recently published in HospitalityNet.org that, showed two hotels sitting side by side, both with $10 million dollars of gross reservation revenues and both with exactly the same industry metrics. Despite this, your neighbors' property deposited and reported $700,000 (7%) more to the bank and on their financial statement then you did. Only the Optimization Score metric is able to identify and quantify this material variance and the road to take to overcome it.
I described the Optimization Metric/Score as a "game changer" in industry analytics and it truly is. To reiterate, unless the "critical factors" mentioned above are taken into consideration, industry analytics are scientifically flawed and inaccurate.
At the core of the optimization metric, is reservation related cost (actual sales & marketing labor and promotional costs). These costs are allocated into revenue channels. Each revenue manager selects a channel mix. We then address the effects created by the channel mix, place the merchant model vendors on a level playing field with "direct-pay" guests, and allocate all promotional costs. The aggregate total is then applied to an adjustment factor (algorithm) we use to recognize "annual hotel benefit". On the whole, the Optimization Metric/Score provides us with a new and accurate reality of hotel performance.
The Optimization Metric Formula is as follows:
Exhibit "A", above
The inclusion of the aforementioned "critical factors" also means that for the first time, true revenue optimization can be achieved. I do not say this with any disrespect intended to revenue tacticians. Revenue tacticians are limited when considering revenue strategies, to making decisions that are based on the relevant data they have on hand. Accurate, complete and real-time channel cost has been hard to come by (and is an accounting task). The Revenue Report Card System provides fully-diluted reservation related labor, benefit & promotional channel cost at the touch of a button.
Our algorithm (or accountant provided data) applies the aforementioned "critical factors", by selecting specific items from the hotel financial statement and the same from the property management system. The result is that the revenue tactician now has complete and accurate channel-by-channel cost / profitability information that is at his/her fingertips in real time. The road map to flawless strategies begins here.
It is imperative to understand, at this stage of the discussion that ESTIMATES OF ANY OF THE COSTS WILL NOT ENABLE HOTELS TO ARRIVE AT TRUE OPTIMIZATION. Exact fully-diluted, Sales, Marketing, Front Desk and Sales Assistant wages are a must! The allocation of actual promotional costs are also imperative.
Optimization Scoring is a versatile metric that has far reaching applications. Today I'd like to discuss how this metric, calculated during the due diligence period, can disclose hidden value in properties.
For many years the "times earnings" equation has been used as a "loose barometer" in arriving at the sales value of a hotel. Needless to say, there are times when the value of land, a busy location or some other attribute might supersede a "times earnings" calculation, however, even in those circumstance the method is still used as a determining factor of selling value.
The "times earning" multiplier is created based on (1) the current state of the economy, (2) the geographic area and/or (3) how hotels are generally performing in an area. At any given point in time the multiplier can change.
Where 7 times earnings may once have been the factor used, 9 times earnings may be appropriate at another time. In every sense of the phrase, it depends on "what the market will bear" and the expected return on property investment at a given time.
Exhibit "B.1" below shows a diagram in which a hotel with Gross Reservation Revenues of $10 million dollars and a Net Income of $1,920,000 is applied to 3 different "times earnings" factors; Scenario 1 -7x earnings, Scenario 2 - 8x earnings, and Scenario 3 -9x time's earnings.
Exhibit "B.1" - using "Times Earnings" as a barometer in determining the selling price of your hotel. For simplicities sake, I have limited the complexity in the calculation presented.
Exhibit "B.2" below provides supporting narratives to the 3 scenarios presented above (in Exhibit "B.1)...
Exhibit "B.2", above
In Scenario 1 above, the hotels Gross Reservation Revenues are $10 million dollars and shows a bottom line on their financial statement of $1,920,000 of net income. Using a 7x time's earnings factor, the value of that hotel is considered to be $13,440.000. This would be the asking (or selling price).
As a side note: Hotel revenues overseen by a professional revenue manger will typically produce an optimization score range of 75.0 to 83.0; the higher the score the more efficiently (profitably) the hotel is performing.
The hotel achieved an optimization score of 69.0; this would be considered to be an unremarkable optimization result. In essence, it means the hotel is using too many expensive channels to bring in business. It also would be indicative of a hotel management team that perhaps has NOT taken "the long view" that would provide for sustaining long term growth.
The good news here is that an optimization score of 69.0, indicates that there is great potential and hidden value in this offering. By employing a qualified revenue manager after acquisition, the hotel should, for all intents and purposes, be able to raise that 69.0 to a 75.0 to 83.0 optimization range. See Exhibit "C" below for general optimization scoring ranges. As you can see above (Exhibit "B.1"), the optimization rating can be used in calculating actual dollars.
Exhibit "C" below, provides a good guideline on typical hotel optimization performance.
Exhibit "C" - above
The Result -
(Exhibit "B.1" & "B.2", above)
In Scenario #1, Gross Reservation Revenues are increased (using a typical Optimization Score level as the guideline) to $11,600,000. We than use the same 19.2% profit factor, which increases "new earnings" to $2,300,000. This is the hidden value the Optimization Score uncovers.
The new-earnings are then applied to the 7 times earnings factor that brings the sales price of the hotel to $16,100,000. This increase in potential value, of the hotel of $2,660,000, is not nor ever need to be known by the seller. It provides the buyer, however, with piece of mind and confidence in the purchase price and the potential this acquired asset could bring.
The bottom line: The above referenced buyer can now purchase the hotel at, or close to, the $13,440,000 asking price, with the knowledge that the ultimate Return on Investment would exceed desired expectations.
My next article will discuss the impact of using true and complete costs in performing displacement analysis. Hoteliers can now compare bottom line impact in comparing two pieces of business; an exact science!
Richard B Evans
President of Revenue Report Card LLC
Phone: (954) 290 - 3567