Ted Darnall, Partner & CEO of Lodging and Technical Services, discusses how our new world platforms drive top-line revenues and bottom-line profitability in a post-pandemic world.
A few weeks ago, an article appeared in The Washington Post entitled ‘Hotel industry emerges from pandemic with new business model, possibly fewer workers.’ The theme of this article was the recovery of the hotel industry in the post-pandemic era, and the sources of the article were individuals with significant brand or portfolio management responsibility within our industry. The message was simple: many top professionals believe the changes that have occurred through the pandemic, if properly adapted into our future strategies, will result in an industry that can be more profitable than it had before.
As most of you know, we have been believers in this philosophy since the early days of the pandemic, and we’ve invested significant time and energy in rebuilding our organization to ensure we can accomplish just that. It is our quest to demonstrate that we can produce higher GOP margins on like revenues to 2019 in the post-pandemic world. However, with the timely appearance of this article I thought I would take a moment to support the messages within it and remind everyone of the mechanisms HEI has put in place to achieve this goal.
It is clear by what we have accomplished in just over a year that we are a leader in not only the design of a new world platform, but in building the infrastructure necessary to support it. It is one thing to talk about it, but it is yet another to understand what it will take to accomplish it, and yet another still to commit to the change necessary to get there. Surely not a single owner will gain from the possible benefits of a new world without an operator who is committed to the change required to achieve them. And I can assure you, HEI is fully committed to this.
“If you always do what you’ve always done, you’ll always get what you’ve always got.” – Henry Ford
It’s important to note that moving from the old to the new is a transition, and different organizations and cultures will want to transition at different speeds. Some will want to move as quickly as possible to yield the full benefit of the new world structure on their current real estate, and others will want to take more of a wait and see approach. However, the fact is that the new world structure will produce the type of results that will simply not allow owners to be competitive without their commitment to it.
The new world processes that are currently being implemented within our organization can be broken down into three basic categories: revenue, cost of operations, and most importantly profit contribution.
As we transition to new world strategies there must not be any loss of revenue performance. Improved margin with decreased revenue is simply not a complete solution. To the contrary, we remain confident that the strategies we’ve identified will not only maintain our market share performance at a lower cost, but in fact produce even greater top-line results than in the pre-pandemic period.
Cost of Operations
We have invested significantly into how we can reduce the cost of every unit we sell. Over the last ten years there has been a significant shift from variable to fixed costs in our industry, caused by numerous added programs, the growth of workers’ compensation and health insurance costs, and an overall increase in fixed labor. Regardless, this shift took an industry that was well regarded for its highly variable basis to one that took on more fixed staffing and costs every year. Therefore, our initial focus has been to reduce our base costs and shift back to a more variable environment. As a result, we’ve prepared ourselves for phase two, where we can reduce variable costs while maintaining discipline on the fixed, ensuring that overall unit profitability can continue to grow for years to come.
In 2018 we instituted the concept of profit contribution. This is the philosophy that each transaction in the hotel is an opportunity to earn additional profit, either by increasing the revenues or decreasing the cost of the unit sold, from a draft beer to a room service transaction to something as often overlooked as parking. Even before the pandemic, this focus allowed us to show significant and consistent GOP growth during a time in our industry where transparency had capped upper-upscale RevPAR growth at just about 2%. Through the pandemic we have continued to leverage this philosophy to apply strategies to maximize earnings, and it has become clear that profit contribution must be the most important and foundational element to our overall new world platform.
Saying Goodbye to an (Unhealthy) Industry Obsession with Market Share
If we look back on history, even as recently as the Great Recession, we see that industries like automobile manufacturing and airline travel were significantly impacted in their overall profitability and cash flow due to their decades-long obsession to meet investor market share expectations. They produced brands that were unnecessary or added routes that were unprofitable all to represent that they were growing their share of the market.
However, if you look at the airline industry, there was one outlier. Since the beginning, Southwest Airlines has focused on per-seat profitability. They have one simple philosophy in growing their routes and running their system; that is, ensuring they can improve the profitability of each seat they sell. Anyone who has studied Southwest will know that decades ago they discovered that the largest impact on their overall fixed cost per seat was the amount of time their planes spent at the gate. Therefore, they redesigned their entire culture around simply shortening the time at the gate and significantly reducing their fixed cost allocated to every seat sold, and in so doing they demonstrated some of the highest profitability growth the industry has seen. They have stayed committed to this philosophy of unit profitability, never chasing market share for the sake of market share, and have looked only at segments of the business they are confident will meet their unit profitability objectives.
As we studied the challenges of the pandemic, we realized that with many hotels in our comp set closed (either temporarily or permanently) we could no longer look to winning the comp set as a measure of success, nor as an important strategic focus. It forced us to expand to what we now call submarket management. For this, we look beyond the hotels in our own comp set to compare ourselves to the broader landscape. And we’ve observed a few things. First, many of those hotels were arbitrarily gathered into our comp sets just because of their brand affiliation or, worse yet, just to meet the guidelines of setting a comp set. Second, the basic principle of statistics is true: when you expand the size of your sample, the accuracy of your comparability increases. And most importantly, by looking beyond the limits of your narrow comp set you have much better visibility into the true revenue opportunity that exists within your market. Our customers don’t shop in comp sets.
So since early in the pandemic we have shifted our revenue teams away from the unhealthy industry obsession of the STAR report to ensure we are accurately measuring our accomplishments and targeting our revenue strategies against the entire submarket. We believe this is a shift that will be embraced throughout our industry in the coming years; as brand “swim lanes” have become narrow, the submarket better represents the true revenue opportunity and should be the focus of your overall revenue management.
Thanks to our data management capabilities, we have built an accurate picture of the submarket for every day of the week, which allows us to develop individualized strategies for the observed market behaviors. These market behaviors vary, and there is more volatility from market to market than we originally anticipated, but it has been a valuable team learning, side-by-side with our asset managers, to advance our understanding of these newly observed market behaviors and together agree upon which strategies will allow us to thrive. You may remember from my last note that we are thrilled to see our industry avoid becoming a commodity. In fact, the pandemic has reinforced that ours is one element of the travel sector that continues to perform based upon the amenities, location, and quality of the various product offerings. The buying decision is still driven by the experience as much as the price, especially in the upper-upscale and luxury segments, and this has prevented us from being pulled into the commodity abyss where so many other segments in the travel industry now reside.
How Our New World Platforms Drive Top-line Revenues and Bottom-line Profitability
Even amidst the depths of the pandemic last year we could already see many of the benefits of our new world programs, and we’ve heard from so many of you that we were successful in preserving cash flow at a level far superior to our competitors. However, our programs were never designed to be solely cost saving measures. Rather, as I’ve indicated repeatedly here and in previous notes, they are designed to disrupt the industry with an innovative approach to drive profitability on both the top and bottom lines.
As markets recover, it is becoming evident that we have been successful in driving the results we hoped we would in a sustainable way. In an upcoming communication from Dan Walworth, he will provide more detailed information about the results we’ve achieved through the first half of 2021 thanks to our new world platforms. The speed, efficiency, and cost of execution of our sales, revenue management, and finance platforms have all been improved and remain supported with improved analytics, technology, and information accessibility.
Perhaps the one area we’ve pushed the hardest to challenge the status quo has been within our sales organization. And while we took significant action during the pandemic, this table was actually set a while back. We identified over three years ago that ours was an industry that desperately needed to rethink the traditional sales approach: how teams were deployed, how goals were assigned, and how the true cost of acquiring a sale wasn’t rigorously watched. We also had little visibility on how leads, typically assigned by region or market but not necessarily by value or capacity, were prioritized. Furthermore, sales talent was oftentimes difficult to attract, with limitations in place as to who got the leads and a risk that a heavily worked lead might never make it through daily business review. It was apparent to us then that success in sales required us to completely reinvent the sales process.
As it happened, the reemergence from the pandemic’s devastating effects on our sales organization turned out to be an opportune moment to do so. With economic conditions forcing our sales teams to shrink, we knew we had to move quickly to ensure we still had the coverage necessary to respond to and close every precious sales lead. And we also knew that our vision from three years prior could be centrally deployed as a perfect solution to the problem, as it would not only significantly reduce costs immediately, but also improve both the volume and quality of the business that was booked. It has not been easy, but we have since redesigned the entire sales organization, including how revenue management communicates with sales, how leads are captured and assigned, how our most valuable leads are immediately “green lit,” and how we prioritize closing business within the first 14 days.
The results have been undeniable. In the immediate wake of the pandemic, where cash flow preservation was most essential, we succeeded in keeping sales expenses close to zero. But even more compelling are our recent results, which will be included in more detail in Dan’s upcoming correspondence. In summary, our group share has increased, thanks to a more thoughtful and well-mapped sales process supported by the right technology and supervision, and the cost of every group transaction has decreased, thanks to a smarter organizational design and the increased number of transactions that can be successfully handled by each seller. This is a prime example of our profit contribution objective as we have reduced fixed costs per unit while increasing the yield of each unit.
The True Cost of Sales
Obviously, a key element to improving profit contribution in sales is understanding the cost of acquisition for each room night sold. We have built new reporting that reveals the cost of each sales transaction, and the results have been eye-opening. This cost ranges from as low as $15 at our most efficient hotels to as high as $75-100 at others, with surprisingly little correlation to group share across the range. Clearly we must be as focused on cost of acquisition as we are on group share. But progress can be made; by reviewing our transactions and staffing levels at one hotel, we reduced a $72 cost per transaction to just $26 within 45 days without negatively impacting closure ratios or booking pace. In short, overspending for group share is simply not consistent with the philosophy of profit contribution, and we expect this new focus will greatly inform staffing, spending levels, and our marketing mix for the 2022 budget.
I believe that group sales is the single most inefficient process we have in our hotels today. And while certainly we understand that group business is essential and there are even circumstances where any group business will contribute positively to overall profitability, our cost of acquisition (which can account for as much as 80% of the income we receive) is extremely high. Without approaching sales in a new world manner, we will never be able to maximize margin performance.
Group business continues to shift to an increasingly electronic booking environment. In 2007 (the year the iPhone came out), 70% of all transient transactions in branded hotels came from the call center. Obviously that’s no longer true, yet if we ignored that transition and still behaved the same way we would still be fully staffing our call centers. Yet strangely we are still looking at sales in the same way.
Today, almost 70% of our group leads arrive electronically. The fact is that we must move away from call centers for group the same way we moved away from them for transient. And HEI is committed to taking a leadership position in that evolution while positively impacting our overall results. We still believe solicitation is important, provided they are based on the submarket as opposed to the direct comp set. But like with telemarketing, we’ve reached a point where people are far more dependent upon E-RFP tools to identify where they want to do business, and we need to be most responsive to that customer in order to close more business more cost-effectively and maximize share while maximizing its contribution to profit.
Are you ready for some truly radical thinking? It is our belief that in the near future we will be able to provide services like group sales to our owners on a transactional cost basis. In other words, each hotel will only pay for the transacted lead if and when it has been booked. We are already prepared to offer that structure for hotels on our centralized sales platform, and we are reaching out to select owners on that presently. But there may come a time when we can shift a good percentage of the on-property group and catering staffing into a variable cost, paying our sellers even more handsomely for booking business while dramatically reducing the overall cost of acquiring each piece of business.
Drawing a Parallel with the World’s Most Successful Operators
While we will (humbly?) claim that we were one of the first in hospitality to focus so intently on profit contribution, we are clearly not alone in our quest for it now. I mentioned earlier The Washington Post article that pointed to leaders like Hilton’s Chris Nassetta and Host’s Jim Risoleo who are striving to emerge from the pandemic as higher-margin businesses, yielding more profitability from each customer.
Meanwhile, some of you may have read news from Disney’s last shareholders’ meeting about their intent to transition their parks division from its traditional total admission profitability model to one that maximizes profit per admission. For years, Disney believed that the key to profitability was getting as many people into their parks as possible, knowing they would gain incremental sales off guests via the many F&B and merchandising outlets once they were inside. What they discovered so profoundly during the pandemic was that there was a much deeper and emotional demand for their product than they had realized, a demand that would motivate significant additional spend from each guest. And they further observed that they could actually reduce the number of admissions every day, reducing their costs of park operations accordingly, and so by increasing their focus on what each admitted guest spent and reducing their fixed cost in turn they could actually increase their overall profits by focusing on profit per admission. They ultimately believe this will result in higher profits with fewer people in the park than could be achieved under the previous strategy.
In my opinion, there was no better example of the pandemic motivating changes in corporate behavior than this. Here’s a company whose theme park division has been around since the 1950s, frequently considered to be the best at what they do, only to learn in 2020 that their business model wasn’t the right business model. Reading this has only strengthened our resolve that refocusing our industry onto the profit of each room sold as opposed to the number of rooms sold or the market share earned is the right decision.
The Results of Our New World Platform
As I’ve said, our new platform is being built in a two-stage approach. The first stage has been focused on reducing our fixed costs in a number of ways: by flattening our operating organization; by moving many non-exempt management positions to overtime-eligible managers or supervisory positions, enabling our GMs to adjust their time appropriately with business volumes while ensuring our associates are compensated fairly; and by boosting the property-specific contributions of our above-property resources in areas such as sales, accounting, human resources, and revenue management. The second stage of our platform redesign is to now attack the variable costs associated with all units sold, reducing that variable expense over time. So, over the next 24 months our goal is simple: continue to reduce the base cost allocation to every unit sold, shift more costs into the variable category, and then address our variable expenses through comparative hotel analysis. Ultimately this is a roadmap to our overall goal of producing higher GOP (in both margin and total dollars) on 2019-like revenues.
To measure our progress against this, we can look directly to our change in profitability as revenues return. Currently, from one month to the next, revenue performance is just a little bit better. Key to emerging from the pandemic with higher margins that generate higher returns on your capital than ever before is to ensure proper flow of those incremental revenues. Four months ago, we explicitly committed to a goal of at least 50% flow on incremental revenue increases each month.
Once again, our results are incredibly strong. In the first month following that commitment we achieved 57% flow on incremental revenues, the second month was 64%, and the third month was 52%. Now that the June results are in, I can report that we achieved a 73% flow on incremental revenues from May to June. Furthermore, HEI’s consolidated profit margin in June was less than 60 basis points away from that of June 2019 on 44% less revenue. This is primarily the result of the revisions we’ve made in our platform to drive higher revenues at a lower base cost of operation. And we continue to believe that this remains the best indicator of whether we remain on the path to increased profitability with our new world platform.
HEI as a Preferred Employer
Clearly, HEI has a leading business model that drives superior investment returns. However, this business model is nothing without the strength of the people who drive it. As an organization, we know that we must be a preferred employer not only within our industry but within each marketplace as well, and we must accomplish this goal without material impact on overall profitability. I am proud to say that my partner, Anthony Rutledge, has taken on this task for two important reasons. One, he is a strong believer in the quality of the associate environment and he trusts that the manner in which we treat our associates positively affects our profitability. Two, he is motivated by a desire to ensure that our company reputation is that of a preferred employer throughout our industry. He has assembled a team of executives and key property personnel to lead this process, ensuring we do business smarter, with compassion and respect, demonstrating the true meaning of empathy. Ultimately, we will prove to ourselves and the industry that it’s not all about what our associates get paid or what their benefits look like, but it’s also a factor of how they’re treated and how much they believe in the organization they work for.
HEI as Your Preferred Operator
Now I’ve gone on much longer than I originally anticipated, but I understand how important it is that we continue to communicate our strategies and results. And when I saw this article a few weeks ago and how it lined up so consistently with our objectives it compelled me to share how what we mapped out back in May and June of last year has at its core not changed, but has evolved, become reality, and is now producing compelling results.
Because ultimately, our ability to deliver superior returns for our owners is who we are. We know that when you put an exit cap on the results our platform produces for each of your hotels you see very clearly the benefits we deliver, and the benefits you’ve captured by betting on HEI as your operator of choice.
So in the end, my point is this: it is critical that we all band together on the importance of transitioning to the future way of doing business, for an inability to make that transition will result in missed opportunity and reduced competitiveness. I truly believe this, and I am confident that we have the leaders we need to support, learn, and take a little risk in this transition. Nothing happens without risk, and nothing happens perfectly from the beginning; it is the vision and the commitment to the vision that makes execution possible. Hope is not a business plan, but as Dan starts to educate us all on the powerful results of our new world platform, I am hoping for your continued support in allowing us to help you lead the industry.
Ted Darnall, Partner & CEO of Lodging and Technical Services