Revenue is the foundation for any performance measurement, businesses thrive on a continuous source of revenue streams and if you don't have a top line, there is no bottom line to talk of either.
If revenue is the foundation, then the assets that produce them are even more critical to the success of the business.
However, revenue streams come under strain over the years when the underlying asset gets tired and worn out.
Renovation programs are designed to upgrade these assets so that revenue can be sustained.
It is a trade-off of a big chunk of investment now to earn revenue for later years.
With competition fierce, it is no more a "nice to have" but mandatory for survival.
Thus, renovations are part and parcel of a business' sustenance strategy.
How Do You Define a Renovation?
Before we proceed, it is fair to consider what exactly "Renovation" means.
Renovation is a broad term.
It can mean all kinds of things right from:
- a minor upgrade of an asset
- all the way to a full-blown addition to the capacity itself.
So, it is a word that needs to be used carefully.
Broadly, there are Major and Minor Renovations.
Most often a dollar value is used as the criterion.
This is a decision for company management and the finance division to determine.
There is however an accounting framework where capital expenditure is defined.
Renovations would generally conform to that.
The criterion for "capital item" is something that increases the life of an asset.
This compares differently to "revenue" expenditure.
In general, capital expenditure belongs to the Profit and Loss Statement.
This expenditure only serves to maintain (as opposed to increase the life of) an asset.
Renovation expenditure is a mix of the two types (capital and revenue).
However, it is pre-dominantly capital in nature.
This is logical considering the core purpose of renovation.
And that is to improve revenue streams.
This improvement can happen effectively only when the life of an asset is increased.
Real Purpose of a Renovation Cycle
How often should you renovate?
There is no one size fits all here.
The dominant purpose will depend upon individual circumstances and factors like:
- type & nature of asset
- how depreciated it is
and so forth.
This is where the term: "tired product," comes in.
For example, if:
- guest rooms look jaded with
- wallpaper fading,
- carpet worn out
- furniture aging
to name just a few factors, then a renovation is on the cards.
Renovation of a soft nature are called refurbishments.
These do not do any structural change to the asset.
Guest rooms in the industry are generally renovated once in 6-7 years.
This is more an industry practice than any rule of thumb.
A major renovation involves:
- demolition where necessary,
- re-build,
- stripping out the carpet and wallpaper,
- major re-painting,
- change of furniture
and so forth.
Renovation of the food and beverage outlets is a totally different animal.
In recent times, restaurants have experienced changing food tastes and preferences.
In this case, a renovation once in 2 years is practical.
No outlet concept can be hard coded into hotel facilities for all time to come.
Being flexible to changing guest preferences is the name of the game.
Renovation planning and execution must form part of two elements:
- capital budgeting strategies and
- revenue streams planning.
3 Things You Need to Live with in a Renovation
There are 3 things that happen with every kind of renovation.
- Disruption depending upon the type of renovation
- Loss of Revenue based on the duration of the renovation.
- Loss of Profitability due to fixed expenses
Where Are You in the Asset – Turnover Ratio Measure?
So, there is a connection between profitability and renovation to hotel assets.
A key ratio is used that measures the relationship between revenue/profit and assets.
It is the Asset Turnover ratio.
This ratio measures:
- how much dollar revenue/profit is earned
- for every dollar invested in assets.
An Asset Turnover ratio measures the capacity utilization factor for a business.
In hotel business terminology, the measure that is used is RevPAR.
It must be said though that the RevPAR is rooms department centric.
Meaning, it measures only rooms revenue.
You could calculate Asset Turnover Ratio using Gross Revenue for the entire hotel.
Asset Turnover ratio is ideally comparable over periods of time for a business.
This allows the business to check whether:
- for every dollar of asset invested
- the Turnover (revenue or sales) is falling.
This is critical for continuous revenue streams that are the life blood of the business.
Falling Asset Turnover ratio may signal need for a close look at the underlying asset.
This is where renovation cycles come in.
The expression "tired product" is often used for an asset which is wearing out.
Return on Investment
Any renovation proposal will not cut it if it does not bring in expected rate of return.
Owners and stakeholders will demand bang for their buck.
So renovations need to be worth the while, cost and effort.
There are different methods for measuring return on investment for renovations.
The most effective ones harness the powerful principle of the Time Value of Money.
This is by discounting cash flows expected in the renovation project.
In essence, you are being realistic about the intrinsic value of not only:
- the outflows but also more critically
- the inflows expected over the future years.
Financing a Renovation
One critical factor that need to be addressed is the funding of renovation projects.
Major renovation projects with capacity increase demand huge outlay of funds.
Most owners frown upon providing specific funding for renovation projects.
They require the operator to meet the fund requirements from operational cash flows.
This involves some tightrope walking by the unit financial controller.
This gets emphasized when the hotel has major accounts receivable issues on hand.
During a renovation, a Controller will find himself lacking adequate cash flows.
This is arising from revenue streams, which get suspended.
That is a double whammy.
Not only are cash flow requirements huge for renovation projects.
But they in most instances are needed in the present time.
Deposits and advances need to be paid before material supply is procured.
This is where a well thought out budget is a huge advantage.
The months during which renovations will take place should be clearly charted out, .
How to Manage a Renovation
Renovations need to be managed carefully.
Consider that it is a process that interferes and halts revenue streams.
That requires meticulous, detail-oriented thinking.
Critical path needs to be adhered to strictly, for a day lost in the process will mean:
- delayed opening of facilities and
- consequently, delayed revenue streams.
From experience, often renovation projects are put hastily in place.
These result in ill managed exercises.
Often, it is ignorance about how expenses move.
Sometimes the exercise is forced at the behest of owners or stakeholders.
A renovation exercise, not carefully, planned will:
- in terms of opportunity costs
- penalize the business many times over the actual reported renovation costs.
Renovation management consists of two main and different approaches.
First, lack of or fall in revenue over periods needs to be tackled.
Second, expenses need to be marshaled.
This relates to the variable ones which can be controlled for the most part.
Additionally, managing the labor force during renovation is a challenge all by itself.
Post Renovation Pricing Strategy
Renovation projects are often tied in with a price review if not an outright increase.
A rate hike generally accompanies room renovations involving major upgrade of room interiors for those room types.
Renovations are all about upgrading the product.
So, there is no better way to achieve return on investment than hiking up the rates.
Of course, the product needs to be upgraded accordingly as well.
The perception in the mind of customer should be of value greater than rate increase.
And it does not hurt that the price increase does wonders to the profitability.
A win-win situation eventually.
Renovation Project Subsidies
Some states in the US are considering providing incentives to those hoteliers who renovate their properties.
This is a shot in the arm for hoteliers who are looking to improve returns on investment.
It is great news for the stakeholders as well.
This initiative may well convert the fence sitters.
You are talking about those who eschew renovation projects.
Instead, they opt to do small property improvements spread over a longer time period.
An incentive program would recognize the sacrifices made by the hoteliers.
That is about pausing to review status of assets, which are producing the revenue streams.
It is indeed a laudable initiative.
Renovation and the Stakeholder
Stakeholders take a positive-no tolerance point of view to renovation proposals.
They know that their product must compete in a crowded market to distinguish itself.
However, the thought of interfering with stable revenue streams haunts them.
Many adopt a "if it ain't broke, don't fix it" approach.
At the end of the day, renovations are here to stay if the business needs sustenance.
In fact, renovations could turn out to be the litmus test to determine whether a business can re-invent itself.
And reinvention is commonplace in these days of availability glut.
The customer has an embarrassment of riches in choices and that drives prices down.
If you need to position yourself distinctly, a regularly upgraded product (asset lives are finite and need nurturing) is the least you can ensure.
Remember the customer is king.
And if the king decides that your product is tired, your survival is at stake.
So, put that money back in your asset and win the king's preference.
You can then laugh all the way to the bank.
Lakshmi Narasimhan Soundararajan is the founder of Financial Skills Academy PLUS a New York city based enterprise focused on complete financial learning ecosystem involving training, coaching and consultancy. Lakshmi taught undergraduate and graduate courses for more than a decade at New York University, Jonathan M Tisch Center of Hospitality as an Adjunct Assistant Professor during Spring and Fall semesters. Topics included hospitality finance, business development among other courses.
Right from the time he was in school, Lakshmi had a head for numbers. In fact, he says, numbers talk to him and tell him stories. At the same time, as he fashioned his career in the hospitality industry, he worked closely with colleagues (middle managers) who did not have a financial background. He saw them struggle with numbers and fear them.
Lakshmi made up his mind to commit his career to hotel financial literacy training by simplifying numbers for the benefit of his non-financial background colleagues.
He is currently working on Financial Skills Academy PLUS a membership concept portal exclusively for assisting hotel middle managers to build Financial Literacy in themselves.
His vision is for Financial Skills Academy PLUS to be the Complete Financial Learning Ecosystem for Hotel Middle Managers.
Lakshmi 's all-time favorite historical figure is Leonard Da Vinci and in particular Da Vinci's love for simplicity. While developing his membership site, Lakshmi based the value proposition for his hotel finance training courses on three foundational principles: SIMPLE. NON-TECHNICAL. USABLE.
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