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Mr. Narasimhan

Revenue Management

Rooms and Food & Beverage: Optimizing Revenues and Profits

By S. Lakshmi Narasimhan, Founder, Ignite Insight LLC

The Bread and Butter of Hotel Business

If you pick up the Income Statement (or Profit and Loss Statement, as it is more popularly called) of any hotel operation, one of the first things you will perhaps notice is that, between 80% and 90% of Total Revenues are contributed by Rooms and Food and Beverage departments. These two are the major revenue (and later in this article you will see) as well as profit contributors of a hotel operation.

However, between the two departments there are very little similarities other than that they tend to complement each other in a hotel operation.

The Rooms department is really the dominant revenue center in a hotel. By itself it can account for anything between 60% and 80% of hotel revenues. In comparison, the Food and Beverage department contributes between 10% and 20% of Total Revenues. Of course, this is a generic observation, actual percentages will depend on the size and type of hotel, room types and rates, number of restaurant outlets, whether a city hotel or a resort and so forth.

Two Major Operations

The best way to understand features of the Rooms and Food & Beverage department operations from a financial perspective would be to compare them.

To begin with, Rooms is a much more structured operation than food and beverage. Rooms operation has a limited number of products (read room types) compared to Food & Beverage, which boasts a varied number of offerings. This as you will see later in this article has implications both for revenues and profits.

Rooms, as a product is less flexible than Food & Beverage. By this we mean that once a hotel is up and running, any changes to the room product has limitations short of demolition and reconstruction. Of course, you can carry out soft refurbishments but that may turn out to be superficial. Food & Beverage on the other hand is more nimble and a new restaurant concept can be created with less structural damage. This has implications for the investment and the return thereon.

Revenue Contributors

The two major ingredients contributing to revenues both in Rooms as well as Food & Beverage departments are quantity and price. Quantity represents business volume, which in the case of Rooms is occupancy and in the case of Food & Beverage is covers served. Price represents the rate, which is the Average Daily Rate in Rooms and Average Check in Food & Beverage.

Why are quantity and price important to understand? Quantity and price while driving revenues also contribute to profits but in a significantly different way. Read section on Profit Contributors for a closer look at this phenomenon.

As we saw earlier, Room revenues contribute between 60% and 80% of Total Revenues compared to 10% and 20% for Food & Beverage. We also saw that the number of products (room types) is limited in Rooms. These two factors are responsible for the Average Daily Rate in Rooms being 3 to 5 times more than the Average Check in the Food & Beverage department.

For example an Average Food & Beverage Check of $25 would not be comparable with an Average Daily Rate of $125 in the same hotel. Moreover, the sales mix (room type in rooms and menu items in food & beverage) is completely different with food and beverage outnumbering rooms 50:1 or even up to 100:1. In effect, food and beverage has to serve a higher volume of covers in order to generate revenues comparable with rooms department. In a manner of speaking you could say that the average price level in dollar terms in food and beverage is much lower than in the rooms department.

Investment Angle

As much as Room Revenues are the major contributors to Total Revenues, they also require investment in fixed assets in a big way. City hotels are housed in a building, which is mostly vertically oriented (going upward rather than sideways) and often with a small footprint at ground level. These buildings often are more than twenty storeys high and become the principal fixed asset for the hotel. Within the hotel building you would also have plant and machinery consisting of the chiller, boiler, sewage disposal, water treatment systems and so forth. Thus Buildings and Plant and Machinery form a majority of the investment in fixed asset in a city hotel.

In a resort hotel, the investment may be similar in categories like building and plant and machinery but the layout is entirely different. Resorts are normally spread over a larger expanse of land than city hotels and the height of buildings may not exceed seven or eight storeys. Resorts are products catering to the leisure segment that consists of families, kids on vacation and thus require large open spaces and extensive landscaping. If the resort has a spa facility and most do, then the environment in which the spa operates has to be built with a view to provide rest and relaxation. So, it will boast gardens, fountains, quiet, secluded areas and so forth.

Investment in fixed assets is a key part of the hotel business whether city or resort hotel and owners look to find adequate returns for these investments through hotel revenues and profits.

Cost Elements

Rooms and food and beverage functions differ significantly in cost elements. Although both have common categories of costs, there are costs that are unique to the food and beverage operation only. They are:

  • Cost of food
  • Cost of beverage
  • Operating equipment
  • Live Entertainment

The most significant pair of costs that a food and beverage operation will have (and which is not applicable to rooms) is Cost of food and Cost of Beverage. This has major implications for the profitability of the operation, which is dealt with in a later section. If you sell any food and/or a beverage item, along with that sale will come direct variable costs too. These costs may range from 30% to 40% of the sale value.

The next major item of cost that is pre-dominantly in the food and beverage operation (rooms has nominal costs in this category) is cost of Operating Equipment. Operating Equipment refers to glassware, chinaware, flatware, hollowware and kitchen utensils. These are the equipment in which food is prepared and served. Without them a food and beverage operation cannot exist. These costs can often become very high owing to breakages, losses due to change of restaurant concept and so forth.

Live entertainment is unique to the food and beverage operation and most times is applicable to the lounges and bars. Of late, bars and lounges are turning into full service meal (or at least snack joints). The purpose is to draw guests to the lounge or bar. A typical promotion in such a bar or lounge is known as the Happy Hour when one drink consumed gets you another free.

Broadly, Rooms department costs tend to range between 15% and 25% of revenues. This is much higher in the Food & Beverage department between 50% and 60%. These have significant profitability implications.

Break Even Point

By virtue of the nature of their respective operations, Rooms and Food and Beverage departments vary greatly in their break-even points.

We all know that a break-even point is a point where revenues equal fixed costs. This is the point at which revenues will cover your fixed costs. Even if you did not earn any revenues, you would incur these fixed costs. Any revenues beyond this point will only bring in variable costs. This is a powerful principle for revenue, cost and profit management.

Break Even points mainly compare revenues with fixed costs but they are closely related to the business volume - occupancy for Rooms and covers served for Food and Beverage. The business volume helps to identify the level at which the department is breaking even. In other words, you would like to know at what occupancy level your Rooms department is breaking even and similarly at what covers served level your Food and Beverage is breaking even. This level aspect has implications for profit potential. The lower the business volume level at which a department breaks even, the more the profit potential. Break even thus has a close correlation with capacity.

Profit Contributors

The combination of less number of items but contributing between 60% and 80% of Total Revenues is what makes the Average Daily Rate a major factor in profit generation in the Rooms department.

As mentioned earlier, revenues are contributed both by quantity (occupancy) and price (average daily rate) but when average daily rate drives revenues more, the resulting profit is higher than if occupancy is driving it. This is principally because an increase in average daily rate does not bring with it increase in direct variable costs (which are more occupancy based). An occupancy driven revenue will bring with it direct variable costs and thus the resulting profits will be lower than compared to average rate driven revenues. This is one of the most fundamental principles of profit behavior.

The other major reason for Rooms department profits to be 3 to 5 times more than Food & Beverage is the fact that Average Daily Rates tend to be at least 3 to 5 times more than Average Checks. In short, selling one room is equal to selling five to eight covers in the food and beverage operation. Total revenue capacity for Rooms is far above that of Food & Beverage.

In all this, it is not to be forgotten that the Rooms and Food & Beverage operations serve different but complimentary roles in a hotel environment. At the end of the day, synergy between the two will optimize revenues and profits for the entire hotel.

Profit Flow Through

At the end of the day the proof of the pudding is in the profit flow through that Rooms and Food & Beverage departments deliver. Flow through measures the incremental profit dollars that are generated from the incremental revenue dollars. It is what every owner, stakeholder as well as hotel management are interested in. Stakeholders pour money into their hotel investments with expectation of a good return. Management is keen on delivering this or a better return to owners. By virtue of the factors described earlier in this article, Rooms department bring in a much greater flow through than Food & Beverage.

S. Lakshmi Narasimhan is the Founder of Ignite Insight LLC a New York City based consultancy, which specializes in Group Executive Training, Coaching and Consulting. Prior to founding his company, Mr. Narasimhan was the Vice President Finance of an award winning Hong Kong headquartered luxury hotel chain - Shangri-La Hotels & Resorts. He has more than 25 years of experience in the hospitality industry (14 of them in a senior corporate level) and has held diverse portfolios from a hotel Financial Controller to a group level Human Resources position, head of Corporate Internal Audit and head of Corporate Financial Systems. His career is epitomized by new and challenging roles. Mr. Narasimhan can be contacted at 201-253-5000 or narasimhan@ignite-insight.biz Extended Bio...

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