First pandemic, now economy force hoteliers to rethink cost lines

There's a saying: "Becoming rich is hard. Staying broke is hard. Choose your hard."

It's an aphorism that in the context of running hotels rings with clarity; especially now, as hoteliers are tasked with navigating a landscape that is cluttered with obstacles stemming from pandemic residue and macro-economic concerns—inflation and interest rates to war and energy costs. 

It puts the hostile in hostelry.

Before anyone knew the difference between coronavirus and Corona beer, the hotel industry was flush with cash—from owners and operators and down into the brands. Top-line revenue was easily convertible into gross operating profit, especially since operating costs weren't exceedingly onerous. 

Then the pandemic hit, which put hoteliers, particularly management companies and asset managers, on high alert: no longer could pure reliance on RevPAR deliver bottom-line results. In the height of the pandemic, most expenses dropped to near-zero levels, as many hotels shuttered altogether and their largest cost—labor—was denuded due to furloughs or layoffs. Business slowly came back as the pandemic abated with revenue delivery generated on the back of higher room rate integrity than past crises, though coupled with lower occupancy rates.

When demand started to strengthen, led by leisure, these rates gave cover to an increased cost trajectory, which has now been exacerbated by the current macro-economic environment and strife in Ukraine. The confluence has, for example, ballooned utility costs, specifically energy, putting a crimp on profit margins. According to HotStats, total utility costs on a per-available-room basis in Europe were up to €9.14 in August 2022, the highest they've been on record on a nominal basis. They've since backed off some to €8.74 as of October 2022. Electricity, meanwhile, has skyrocketed to €6.54 on a PAR basis in August; by comparison, it was at €3.77 in August 2019. It's currently at €5.61, more than €2 higher than at the same time in 2019. 

Still, hotel rates are giving cover to the jump in costs. "At the moment, the growth in average rate, so the growth on the top line, is offsetting much of the operational headwinds that are coming our way. While we are seeing unprecedented operational headwinds, we're also seeing unprecedented levels of rate growth," said Mike Grove, COO of HotStats, a profitability data reporting firm. 

Inflation has both a positive and negative influence on the hotel industry. On the one hand, it allows hoteliers to set rates on a nightly basis to keep up with any vacillations. Conversely, higher inflation impacts the costs of goods, meaning a hotel's purchasing power is eroded. "The inflation impact is that it's significantly helped the top line but is driving higher costs on the bottom line," Grove said.

In the instance of the UK, some operators will have fixed or hedged utility costs over three years ago; therefore, still leveraging a price that they paid three years ago. They may not be seeing any increase, yet, but those out of contract, having to renegotiate or having to move to a variable rate, they may be paying up to 200 percent more than they were three months.

As Grove pointed out, if utilities are going from around 4 percent of total revenue to as much as 12 percent, then 8 percentage points of GOP margin are getting stripped out.

Expense Management

Al Malik, managing director of Remarkable Hotels and chairman of Oxsana Hospitality, a membership organisation within the hospitality industry, fortuitously fixed his utility contracts in February 2022 through the end of 2024. He said they have increased but no where near the levels the industry is experiencing right now. Though energy costs are getting all the headlines, other utility costs are also on the rise, such as water, which Malik underscored. His company moved its water contracts in June and tapped a company that audits all its utility invoices to make sure it hasn't been overcharged or made any overpayments.

"One of my members recently got a £50,000 refund from his electricity supplier," Malik said. "We are concerned about every single cost line as the cost of doing business crisis has increased at all levels."

One way Malik has combatted the rise in expenses is to cut back. He cancelled a couple of software contracts and replaced them with free-to-use software, which saved him over £5k a year.

Oxsana Hospitality is working with its members to create a bespoke insurance package that could reduce insurance premiums by as much as 40 percent.

"It’s going to get harder for at least two years," Malik said. "We’re going to need to stay on top of these operating costs with regular reviews and constant renegotiation."

Unlike utilities, labor is even a harder expense to contain. Even before the rise in inflation that has put further pressure on wage growth, hotels were dealing with other industries poaching their employees, from Amazon to Walmart, and every other big-box retailer nipping at its ankles.

That's the case claimed by Ben Seidel, CEO of U.S.-based management company Real Hospitality. He said that the hotel industry is being flanked on all sides by a litany of costs and revenue-reducing threats. Consider cyber insurance: More prevalent cyber break-ins have forced companies to pony up for insurance. And it isn't cheap.

"You're looking at general liability rates going up in the industry," he said, citing what he called "phenomenal judgments" levied on companies, the exorbitant awards that come with that and the accompanying legal fees. 

Like Malik, Seidel has been able to contain most utility costs by avoiding long-term agreements. Real Hospitality historically will not sign more than a one-year agreement on anything vendor related. Yet these being extraordinary times, Seidel recently asked his owners to consider three-year agreements on its corporate energy contract.

"If you look at next year alone, you're looking at the ever-changing geopolitical environment, ESG scoring, the cost of natural gas and the cost to generate electricity—it so undefined and moving that the general advice that we've got is that if you're going to sign a one-year contract, you're going to get slammed," he said.

Seidel is not just looking at trends now, but 5, 10 or even 20 years ahead. Consider natural gas, which creates fewer emissions than coal when it's burned, but producing and transporting gas releases large amounts of methane, which is a greenhouse gas. As NPR reported, under President Joe Biden's administration, the U.S. is aiming  to cut all carbon pollution by 2035, a first step toward the broader goal of zeroing out greenhouse gas emissions across the entire economy to thwart climate change.

Real Hospitality manages hotels across the U.S. and in different climates, each unique in its energy needs. He calls natural gas a huge challenge to navigate as nations seek to curb it. When new hotels or being developed or renovated, Seidel is adamant about going to electric or conductors in things like kitchens. "The concern is about the pricing of natural gas since it's going to go away," he said. "Does that mean the price is going to get cheaper or more expensive as we move toward renewable energy?"

Other escalating costs he pointed to were healthcare. He said that many things like heart and cancer screenings were put on hold during COVID, but could pick up now, which could mean more positive diagnoses. "We're expecting those to rise," he said. "What does that mean for our healthcare costs?"

Being the CEO of a management company means you are always on your toes and looking for ways to save your owners money. "I get paid to worry about things like food and free breakfasts—this is what we're trying to convey to the brands," he said. "While we're able to raise our rates, our breakfast cost alone is 16% higher than what it was this time last year."

Seidel said the uptick in leisure and family travel is a revenue boon, but it also eats into the cost base. He said that his numbers have gone from an average of 1.3 people per room to 2.4. "That's the good side about traveling with your family, but the free breakfast and all these freebies that you get with these selections, that gets multiplied by the number of people that are in a room," Seidel said.