Calculating Breaking Point in hotel pricing - part 3
First of all, managers must first be able to calculate the total fixed costs in the hotel. Fixed costs include staff (permanent) salaries and payroll related expenses and benefits, insurance, taxes, utilities. Total fixed costs are the sum of all the expenses that a hotel must pay for during a time period (e.g. month) that will not fluctuate regardless of how many or how few paid for guestrooms were occupied.
Next would be to establish the variable room costs. These costs arise only when a room is used or occupied and hence the term variable. When a room stays vacant for the night, no variable cost is incurred and the only costs payable are the associated fixed costs. Variable costs for guestrooms will typically include wages (e.g. contracted room attendant – if any), amenities, linen laundry costs, use of energy and water by the guest/s and when servicing the room and provision of the room’s fair share of capital budget for furniture, fixture and equipment (F,F & E) towards planned long-term refurbishment.
Setting the minimum selling price for each guestroom becomes the next step. Obviously, the selling price must cover the aggregate expenses that arise from both the fixed and variable costs. It doesn’t stop there though. Knowing the total fixed costs for the entire hotel and the variable costs associated with each sold guestroom is one part of the equation. Calculating the number of guestrooms that must be sold, at the minimum selling price, to be able pay for all costs (fixed and variable)… is the other part of the equation. And, that’s when the hotel’s break-even point is established.
Let’s say the Imperial hotel in NY has 800 guestrooms. The hotel’s total fixed cost (FC) per night is $ 20,000. The variable cost (VC) per guestroom is 8.50 per night. Now let’s assume that the average daily rate (ADR) last night was $ 79. To calculate the breakeven point for a given time period, we use the following formula:-
BEP = $ 20,000 Total FC divided by ($79 ADR minus $ 8.50 VC) = 283.68 rooms
What this means now is that the Imperial hotel must sell at least 284 rooms at an average daily rate of $ 79 to pay for its fixed and variable costs obligations in full. Sell less than 284 rooms at an ADR of $79 any night and the hotel suffers a loss. Greater the loss should the hotel sells less than 284 rooms at less than $ 79 ADR. Conversely, for every room above 284 rooms that it sold, the pre-tax profit per room is $ 70.5. Obviously, the more rooms it can sell above the 284 threshold, the greater the profits.
To summarize; in a 30-day month, the hotel must sell a minimum 8520 guest room nights (35.5% occupancy), at an average room rate of $ 79, generating a total $673,080 in room revenue (excluding taxes) to stay above the red zone. The Imperial hotel could on the other hand sell a fewer number of guestrooms at a higher than $79 ADR or go the opposite direction by selling a greater than 284 rooms at a lower ADR, each night, to generate breakeven point income.
Continuing with our example, let’s now assume that the Imperial hotel is on course to finish the current year of operations on a positive note: that of achieving an annual occupancy rate of 55% at $ 81 ADR, with reasonable profit expectations. The hotel manager, whilst given a ‘pat on the shoulder’ for a job done well, is then told by the hotel owners that they expect an improved performance in the ensuring year. The goal for him is to increase profits next year by 15%. That’s when things will get tough – particularly where the demand side in the marketplace is expected to remain flat.
More on this the next time, till then watch your costs.
Ilzaf Keefahs is a freelance writer who enjoys focusing on hospitality related matters that he is passionate about, and likes to share his views with hoteliers and customers alike. He delves into the heart of hospitality to figure out both customer service and consumer trends that impact the industry.
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