Fixed or variable costs: let’s clear things up!

Let’s take the total fixed costs of any accommodation, hospitality, or lodging facility, divide it by the number of rooms and then by the number of working days (e.g.: 500,000 € / 38 rooms / 365 days = 36 €).

The small 2-digit number that will be obtained represents the fixed unit cost, which is not a theoretical and abstract value, but rather the amount that each single room costs you every day, whether it is occupied or not.

Now take a few cards, write the number “36” on them, and attach them to every single room represented in the key rack, or to every single room entrance door and, at the end of the day, collect all the cards assigned to unsold rooms: add them up and you will know the total amount of euros you have lost or, better yet, the share of fixed costs that you will have to pay for that day (e.g.: in the case of 15 empty rooms 36 x 15 = 540 €).

Put this money in a drawer… You will need it at the end of the month!

The mental and conceptual transition from “unsold room” to “permanent loss of revenue” is a necessary shift to successfully eradicate the culturally rooted idea that an unsold room represents solely a missed chance to increase earnings. It is, in fact, a sure loss!

But, in the development of a minimum rate (bottom rate) should the starting point be COSTPAR (fixed unit costs + variable costs) or only variable costs?

Many argue that room rates are made up by adding a series of items, and I will try to list some of them, because I have heard so many mentioned, some quite original:

– Variable cost per room

– Fixed cost per unit

– Commissions of OTAs acting as intermediaries

– Room maintenance cost

– Percentage of earnings deemed reasonable

– And… many more… but I’ll stop here.

Does it not seem strange to imagine a market being compelled to absorb a price determined by internal and subjective analyses? What if the fixed costs of the facility were exaggerated and out of control? It would be like showing up at one’s employer, submitting one’s financial requirements (mortgage, private children school fees, organic groceries, weekly dinner, cinema, vacation, etc.) and then requesting one’s wages to be adjusted accordingly? Is this how the market works?

Now, I don’t want to get into the psychological meanderings of what could possibly be going through the minds of those who manage prices using their own costs as a starting point but, conceptually, anyone who knows anything about marketing also knows that it is a wrong and detrimental approach.

So, should we not take COSTPAR into consideration as the basis to determine a price?

Certainly not!  The only value to be considered is the variable room cost, not COSTPAR!

The COSTPAR of our accommodation facility is an important information for the purposes of acquiring a proper awareness concerning room costs, but we must not be conditioned by it in the determination of the hotel price rate which, by contrast, has a life of its own which is absolutely independent from costs.

Costs and revenues

Costs and revenues are two children of the same mother but, like all siblings, they are quite different from each other and – it bears saying – whereas costs are compressible up to a level, below which one must not fall to avoid eroding one’s profits, revenues are potentially unlimited.

Variable room cost tends to remain fairly constant after the rationalization of the cost items it comprises: utilities, smartkeys, tokens, laundry, stationery, food cost of breakfast service etc… Additionally, although variable cost remains substantially fixed with the  increase of occupancy, it can actually be rationalized even further by increasing the Average Length of Stay Index and also by customer type, as we are well aware that business customers are likely to consume less in general compared to leisure customers.

But what to do if one decides to outsource certain services, thus turning costs that would normally be fixed into variable costs?

The practice of turning fixed costs into variable costs is becoming increasingly popular, in order to limit administrative – and management-related – encumbrances of daily operations that occur in each individual structure: for example, staff payroll, sickness and holiday. The decision to outsource should be guided by the analysis of certain variables, some of which are detailed below:

– Impact of the value of brand reputation on revenues: by this I mean that small and exclusive facilities, for example, base their survival on a very high Average Rate which is driven by their brand reputation, and in this case outsourcing could prove to be extremely dangerous and penalizing

– Occupational excursion: facilities with vastly different occupancy rates between high and low season (and therefore we assume limited revenue management implementations) might derive greater advantages from outsourcing services

– Capacity: hotels with high number of rooms can expect more advantages from outsourcing

Can all services be outsourced?

The advice we give our clients is to consider the possibility of outsourcing Housekeeping and Catering, but carefully avoid outsourcing the front office and the breakfast service.

Still, if we have decided to outsource services, how do we calculate the variable cost?

The variable cost must obviously take into account the impact of outsourcing, however, precisely because it replaces the fixed cost, this analysis must be conducted with a grain of salt: so, an outsourced service (for example, Housekeeping) should be added to the variable cost and serve as basis for the bottom rate. If a second service were to be outsourced, for example the breakfast service, the total variable costs could prove to be excessive, which is why we recommend not to exceed the quota of one outsourced service in the calculation of the variable cost used as a basis to determine the bottom rate.

In the era of Revenue Management, income-related expenses must be the accelerator of commercial operations, not the brake; therefore, a better understanding of this type of costs can, perhaps, help the hotelier to handle them with greater serenity.

OTA commissions

OTA commissions – for instance – which are so ill-received, are expenses that should be faced with great composure, with the awareness that, in addition to driving room revenue, they also boost visibility on off-line channels. When the increase in volume of OTA bookings (measurable in terms of turnover but also in terms of increased reviews) is accompanied by an increase in brand reputation, this leads to disintermediation.

Moreover, as the word itself indicates, in order to “disintermediate” one must necessarily presuppose “intermediation” as a previous stage. Therefore, the use of an intermediary in the initial stage is a necessary evil; so, let us resign ourselves and do it to the best of our ability, fearlessly and without worrying about constantly closing sales …. it is much better to RAISE THE RATES instead.

Hidden Costs

There are also hidden costs; for instance, delayed payments, to name just one. How much does it cost a hotel to generate cash flow 30/60 days after the date of the customer’s overnight stay?

Cash flow is important, and this is guaranteed by OTAs and online reservations (which are often driven by OTAs) . Pending incoming payments represent a hidden cost that should be minimized as much as possible.

My invitation is to view each cost in the right perspective, try to rationalize and harmonize them in a unique way for each facility, according to its structural and commercial traits, but… once this is done, focus on revenues because that’s where the true success of a business lies, and in this aspect we can surely be your best partner!

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