Due to the constantly changing economic environment, my ownership announcement for the first quarter of 2022 includes a full analysis of the latest market trends and our strategies to address these trends. Because of the length of this message it was separated into two correspondences. Part 1, which included my Revenue Analysis, was previously sent out and is still accessible here.
Today, I will deliver Part 2 of my update by discussing our expense results and tactics for this area. Unfortunately, we cannot have a conversation on expenses without having a conversation on inflation. Inflation is real, especially as it relates to wages and the impact that slow supply lines have had on our ability to restock our shelves and the associated cost. As such, let’s begin Part 2 by exploring in more detail HEI’s new infrastructure platform.
Part 2: Expense Analysis
Back in June of 2020, we knew we would have to reinvent our reporting model to lower our cost of operations through a flatter organizational structure. Our goal was to improve our expertise in the supervision of complex responsibilities at a lower cost. But, to no surprise, almost two years ago few of us foresaw the inflationary environment we face today. When the pandemic stretched to every corner of the world, inflation just did not rank high on our industry’s list of most pressing concerns. While we have accounted for some labor cost increases, we well underestimated the unexpected burden that inflation has created.
Accelerated inflation at this rate is something we have never before encountered so early in a recovery cycle. Furthermore, the hospitality world has traditionally had the luxury of raising rates first and having expenses follow, which is a dangerous combination. This means many people have probably (and unknowingly) developed a blind spot for recognizing red flags in expense management if they are not preceded by a red flag for revenue management. As such, a significant portion of our industry will be blindsided by the effects of inflation in the coming months. Luckily, HEI has always been innovative in expense management and we have already sounded the alarm with corrective actions. As your fiduciary partners, we are employing early preventative measures now to mitigate the potential inflation impact.
Even in this inflationary environment, we are committed to improving margins through strategic cost reductions in compliance, supervision, and variable costs that regulate cost increases. Our new infrastructure platform rightfully and necessarily abandoned the cost prohibitive and rigid traditional organizational structure of the hospitality industry. We reworked our entire reporting system for on-property associates in sales, revenue, and finance to provide more targeted supervision at a lower cost by above-property leadership (i.e. the individuals who can provide the best guidance on a discipline-by-discipline basis for these areas). This unique structure has allowed us to become a nimbler organization that reacts quicker to changing trends while maintaining a dedicated, loyal workforce. Moreover, the platform is customized for each property on a department-by-department basis and, in some cases, even addresses human resources. The different types of customizations that these departments can receive falls into either the “Enterprise” and “Centralized” HEI classifications.
In an Enterprise Department, the highest-ranking on-property leader is directly overseen by an Enterprise Director (who is an above-property leader with extensive knowledge of the discipline). In some cases, the degree of offsite assistance can even be extended to include additional remote aid that works alongside the on-property team. In contrast, a Centralized Department is a broader collection of both on-property associates and remote/offsite individuals who fulfill property-specific functions, make up the majority of the department, and are directly supervised by a Centralized Director.
The HEI Infrastructure Platform’s shift to more profitable above-property supervision in sales, revenue, and finance has led to foundational changes that are incredibly valuable for our hotels, especially as they weather the inflationary environment our country is in. For example, the traditional need for Directors of Operations and Assistant General Managers has already been successfully flattened, as the restructuring of supervisory responsibilities has given General Managers more time to invest in the supervision of their operations departments. By leveraging technical offsite experts, the burden on General Managers needing to be “experts” in everything is reduced and results have improved.
Although our General Managers have always been the leaders of our hotels, historically our industry has stacked more and more responsibilities on top of each other for them. This led to GMs being stretched thinner and thinner, until suddenly more leadership roles needed to be added to hotels to counter the limited time GMs now had. This resulted in bloated departments that turned out to be disastrous when the pandemic came knocking in 2020. Conversely, the HEI Infrastructure Platform is designed to scale our GMs’ responsibilities to be more realistic. This includes shifting their primary supervision responsibilities to focus more on the operating departments of front office, housekeeping, engineering, food & beverage, banquets, and human resources – departments that need a strong on-property leader to be successful. Without dedicated on-the-ground leadership in these disciplines, hotels suffer lower guest satisfaction, food and beverage quality, operating efficiency, cleanliness, associate satisfaction, and more. Then, when such critical metrics start to experience decreases in performance the first instinct of many in the industry is to just “throw bodies” at the problem, a decision that could actually exacerbate the issues a property is experiencing, especially after you add inflation into the equation. Adding on-property leaders requires additional wages, yet with no guarantee of the expertise that is most needed to improve guest and associate satisfaction. So, by shifting supervision responsibilities for sales, revenue, and finance away from the General Manager and onto limited above-property leadership, we are actually giving our General Managers the ability to better oversee the many layers of operations between themselves, their most trusted operational leaders, and the hourly teams.
In summary, the HEI Infrastructure Platform provides three elements that are invaluable in today’s inflationary environment:
Improved performance through the reallocation of leadership and supervision, while reducing the unneeded intermediary staffing,
Enhanced and more discipline-savvy supervision for on-property teams in the sales, finance, and revenue disciplines which can be scaled at an overall lower cost to the hotels, and
Reduced variable costs and improved margin performance to that of the industry.
If you are interested in learning even more about the HEI Infrastructure Platform, you can access a short instructional video here. (For the best viewing experience, please watch this video in Google Chrome.)
Now that being said, while the new infrastructure platform is significantly reducing costs, it is not the magical cure for inflation or other market behaviors that can negatively influence operating costs and overall profitability.
Assuming one accepts the realities of inflation and understands our obligation to demonstrate the value of our new infrastructure platform, our responsibility now is to ensure that any cost increases our hotels experience over 2019 is below that of the actualized inflationary cost. While I cannot commit that our new infrastructure platform will allow us to absorb all costs of inflation from our 2019 base year, we are prepared to commit that we will be successful at absorbing at least 40% of inflation from our 2019 base as long as our hotels hit at least 60% occupancy. Once this occupancy requirement is hit, the HEI Infrastructure Platform is capable of acting as an effective cost reducer and buffer against inflation. This is perfectly illustrated in our March and April results, which truly demonstrated the positive potential of this platform.
Even with all the benefits of our new HEI Infrastructure Platform, there is one constraint that has become clear. Our new platform cannot provide the same level of efficiencies at low occupancy levels. The fact is, fixed costs can only be adjusted so much and without a minimum occupancy base the benefits of the platform are simply not achievable. However, we will still always adjust our strategies if and where occupancy is less than 60%.
As an illustration of the power of our new HEI Infrastructure Platform, let’s look at our combined performance for March and April, where we operated at 69% occupancy. During this period, we only experienced a 1.3% increase in our rooms cost of operation versus the same two months of 2019, despite actual inflation of 8% over the same period. However, realize that we increased comparable wages by over 4% to 2019, via scheduled and well-deserved wage increases for our associates. Therefore, despite the intense economic pressures we actually achieved a reduction in our expenses of approximately 3.5%. This is a direct result of the flatter organization and revised supervisory structure I describe above.
In our overheads, with the same assumptions of 8% inflation and 4% wage increases, we achieved a total undistributed operating expense savings of 6.4% to 2019. This is the improvement we were hoping for with the introduction of our Enterprise and Centralized service deliveries, and we are thrilled to see our theorized benefits materializing into actual results. Overall, we reduced our undistributed operating expenses for the portfolio compared to 2019 on a comp hotel basis by 5.2 million. In our F&B departments, we yet again demonstrated phenomenal results. We experienced an overall margin improvement of 520 basis points over 2019, despite $15 million less in revenues. We recovered a majority of that shortfall in revenue through expense savings associated with our strategies and reduced the overall shortfall to the GOP line to just under $500,000.
These results indicate we are in a strong position to fulfill our June 2020 commitment that restructuring our organization would allow us to improve GOP margins at a lower revenue level and permit us to recapture 2019 income levels far sooner in our recovery than our competition. Now looking beyond the recovery period, and knowing where there is still opportunity to enhance our new platform, we are even more confident that we can continue delivering industry-leading margin results with incremental revenues beyond that of 2019.
In simple terms, our new infrastructure platform is one of the most significant ways we can ensure that our properties are more profitable than they were in the past. And, just as exciting is that not only are we creating value for our owners, but we’re creating value for our associates and their families at the same time. We grow more confident every day that we can combine the cost saving benefits of the HEI Infrastructure Platform with the cultural improvement policies designed under the umbrella of HEI Loves. This means we are able to provide improved profitability without negatively impacting either the quality of the associate experience or the overall status of guest satisfaction.
Building Better Supervisors
HEI recognizes that leadership is a quality that must be actively built and fostered within individuals so that they can supervise their teams in both a productive and caring manner, which is why the Building Better Supervisors initiative is so important! Building Better Supervisors blends the values that our associates receive under HEI Loves with the benefits that our owners receive with our HEI Infrastructure Platform. Without this initiative, the key principles of HEI Loves are almost impossible to implement.
While all leaders typically want to support the performance, growth, and career development of every associate on their team, overloaded workdays and ever-growing lists of responsibilities can easily sideline this intent. Surprisingly, the pandemic is what provided the opportunity to implement many of the visionary areas that we had already identified prior to 2019. Once it became clear that there was no more room for improvement in our staffing structure without adding additional stress and strain onto our associates, or disappointing our customers, we realized that we had to consider other ways to increase our organization’s productivity and profitability while maintaining our commitment to care for our associates. As such, we created a new organizational structure that allowed associates to work under the leaders that would be most influential to their progression (i.e. the HEI Infrastructure Platform), while cultivating a culture that put emphasis on the long-term career development and personal enrichment of every member of the HEI family (i.e. HEI Loves). Building Better Supervisors cements these achievements and helps grant our organization the most devoted and skilled workforce in the hospitality industry.
Additionally, by introducing our above property leaders to HEI Loves, we are inspiring them to take a more vested interest in the training and development of the on-property members of their teams. In other words, Building Better Supervisors gives individuals that join HEI an Ivy League education in their chosen discipline, allowing them to grow into the technical experts they were training under and creating a workforce that sees HEI as the destination for long-term career growth. The result is an environment where associates are treated with the respect they earned and deserve, as well as grow more knowledgeable and loyal to the organization, and thus less likely to leave it.
HEI Loves has already had an enormous positive influence on our culture and results. It has already had a significant impact on turnover, as illustrated by my colleague Anthony Rutledge in his latest owner correspondence:
“Our voluntary turnover rate is already down 6.9% this year. Through the lower turnover rate, as well as the success of our efforts to reduce the time and costs associated with training and onboarding, we also reduced total employee turnover cost by 17.6%. Meanwhile, the average number of days needed to fill an open position has also decreased, by 10.1% as compared to pre-pandemic levels. This means that we are not only retaining our people longer, but we’re also attracting new associates more quickly.” – Anthony Rutledge
I believe Building Better Supervisors will continue to produce more positive results like those outlined above.
I want to conclude by emphasizing why we believe the philosophies behind our new infrastructure platform are the basis of the future and what you should expect from a best-in-class operator. First, there is simply no more room in our hotels to reduce expenses by pushing back on hourly labor; nor is it the right thing to do. Second, the greatest opportunity for rightsizing our operating infrastructure is by flattening our on-property management structure while enhancing the supervision of our more complex disciplines with offsite leaders. Thus, my aim is that everyone reading this correspondence walks away fully understanding that the HEI Infrastructure Platform is designed to positively influence the operation of hotels by establishing the following improvements:
By flattening our organizational structure through the elimination of cost of compliance positions, fixed costs are reduced within our operating departments. Correspondingly, this fixed cost reduction improves cost per unit sold. Success in this restructuring also results in improved food and beverage margins.
With the implementation of Enterprise and Centralized services (and leadership positions), hotels’ P&Ls show an overall reduction in overhead expenses. A&G, A&S, and other areas also all operate at a lower overall cost compared to that of 2019.
Combining these cost strategies with our constant focus on the top-line tactics that I shared in Part 1 of my update, we are all but assured to achieve our original commitment of increasing margin performance at a lower revenue base.
Let me end this latest update with my personal thanks to each and every member of the HEI family. While Anthony and I keep our owners up-to-date on the latest at HEI through our correspondences, it always feels like our words are never enough to truly highlight how privileged we are to be working with one of the most dedicated property and corporate management teams in the industry. Without their leadership of our associates, and belief in the strategies and commitments we are trying to accomplish, this level of success simply could not be achieved. Anthony and I have both been with HEI for close to two decades at this point and are fully aware of how blessed we are to be working with such an outstanding associate community.
Ted Darnall, Partner & CEO of Lodging and Technical Services