The Purpose of Business

In increasing numbers, professionals in the hospitality industry are coming to the realization that management of their revenue (revenue management) is critical to their organizations’ success.

Essential RM Term

Revenue: The total amount of sales achieved in a specified time period. Revenue is calculated as:

Number of units sold X Unit price = Revenue

It may seem surprising that only recently has the full-time position of revenue manager (RM) been created by forward-thinking hospitality organizations. What is really surprising is that it has taken so long. What these progressive entities are discovering is that every member of their organization has a role to play in revenue management. Even the professional hospitality associations that normally provide up-to-date information to their members have only in the past few years (or still have not!) created coursework, certifi cation programs, and continuing education/professional development

classes focusing on revenue management. The materials used for instruction are few, and the majority of these materials have been developed primarily for the lodging rather than foodservice segments of the hospitality industry. Similarly, only recently have professional hospitality educators felt that revenue management was a topic of suffi cient depth and complexity to warrant its own course content. They are now discovering that virtually the entire hospitality curriculum could (and perhaps should) be designed around the basic tenants of revenue management.

Because of the importance of a business’s revenues, it would seem that implementingeffective business strategies designed to optimize revenues would be crucial andfairly straightforward. It is crucial, but for a variety of reasons, it is not easy. The mostsignifi cant of these reasons is that most traditionally trained hospitality managers do notunderstand the basic tenants of revenue management, nor do they fully appreciate thelarge number of organizational misconceptions, biases, and misunderstandings thatactually work against them when implementing effective revenue management strategies.

This course is designed to address and dispel many of those misconceptions, biases, and misunderstandings. The reasons it is important to do so are fundamental to business success because, in the final analysis, effective managers of an organization’s revenues simply must do three things:

1. Understand the importance of revenue management

2. Understand the many complex factors that infl uence revenue management strategy and tactics

3. Become better at making revenue management decisions than their competitors

Interestingly, these goals should not be new. Those in business have, since the beginning of commerce, grappled with the complexity of how to best price the products they made and the services they provided, especially in the face of competition from others offering similar products and services. These early entrepreneurs understood the importance of strategic pricing because of a simple mathematical truth; in a service business, the sum of prices paid by the business’s customers equals the total revenues received by that business.

It is important to recognize that if an organization’s primary focus is the generation of profi ts, it will inevitably go out of business because it will lose out to organizations that know enough not to focus on profi tability.

The Purpose of Business

We start our examination at the very beginning. If you are reading this book, it is mostlikely because you are now or in the future want to be, in the hospitality business. If thatis true, it would be fair to ask: What will be your purpose?

Stated differently, if you plan to go into business, what isthe purpose of your business? Even more specifi cally, whatis the purpose of a hospitality business? Ask that questionto many hospitality professionals and you are likely to getone of two reasonable answers;

1. To achieve profits

2.To generate returns on investment for the business’s owners

Both answers are fl awed and if you hope to successfully manage revenues in a hospitality

business, you need to understand why.

Essential RM Term

Hospitality business: An organization providing food, beverages, lodging, travel, or entertainment services to people away from their homes.

The Profit Fallacy

If you want to be in the hospitality business, you likely want to be involved in a profi table hospitality business. That would be a logical choice because, in the long run, only profi table organizations will stay in business. It is important to recognize, however, that if an organization’s primary focus is the generation of profi ts, it will inevitably go out of business because it will lose out to organizations that know enough not to focus on profi tability. The two previous sentences are not contradictory. The critical nature of profi ts should not lead those in business (and especially those in the hospitality business) to focus their efforts on maximizing their companies’ profi t levels. The organizational focus must be elsewhere.

To understand precisely where organizations should direct their primary attention, you must fi rst analyze the commonly accepted (but unsatisfactory) defi nition of profi ts, and then come to a deeper understanding of the concept of profi ts.

To many hospitality owners and managers, profi t is defi ned as a fi rm’s total revenue minus its total cost or expense. That seems logical. If you know basic accounting, you also know that, with a very few exceptions, hospitality accountants and managers use the words expense and cost interchangeably. Specific types of costs (expenses) may be identifi ed in a

variety of ways. Some common terms for various types of costs include fi xed costs, variablecosts, controllable costs, and noncontrollable costs, but they are all considered costs.

Similarly, the terms sales or income are often used as a substitute for revenue. The resultis that it is not unusual for accountants to defi ne profi ts utilizing one of the following twoversions of the accountant’s profi t formula:

Accountant’sProfi t Formula

Sales = Costs+Profit

Applying basic algebra, and substituting more familiar and commonly used terms, the accountant’s formula becomes:

Profit= Revenue - Expense

As you will learn in this course, the accountant’s formula (as well as the economist’s profit formula, which you will study later in this chapter) is not completely on target, although it does touch on some aspects of truth regarding profi ts. You likely are fairly familiar with this commonly accepted but inadequate meaning of the word profi t. But being familiar with a concept does not necessarily mean that the concept is fully understood or is useful. To actually generate signifi cant profi ts in a hospitality business, and to be a successful manager of a business’s revenues, you must comprehend profi ts both completely and differently. You must acquire a revenue manager’s understanding of the meaning of profi ts.

Essential RM Term

Profit: The net value achieved by a seller and a buyer in a business transaction.

In fact, the use of money as the item to be exchanged in this example illustrates clearly a fundamental truth about the twenty-fi rst-century economy; namely that our current technology-driven economy still operates in much the same way as every other barter system in the history of mankind. Revenue managers can learn important lessons from that time-tested system.

Essential RM Term

Barter system: A trading system in which goods and services are exchanged without the use of money.

It is important to recognize that money has no inherent value. You cannot eat coins or currency, nor can the owners of

money do much of anything useful with the metals, paper, or other items people generally accept as money. Money is highly useful, however, because if those who have it can agree on its value, it greatly facilitates the many trade transactions that can take place in a money-based economy. Its use is more effi cient and more convenient than a barter system.

Money: An acceptable medium of exchange used as the measure of the value of goods and services.

As part of their study of wealth, economists study businesses and business profi ts. Like those in the field of accounting,economists have a formula for profi ts that should be understood by revenue managers:

Economist’s Profi t Formula

Profit = The reward for risk

Economics is the area of knowledge that describes how humans earn and spend their resources (money). When business owners elect to spend their own money by investing in a business, they do so to achieve investment returns that, when added to their original investment amount, increase these investors’ total wealth.

A simplifi ed formula for expressing an owner’s return on investment (ROI) is stated as a percentage related to the owner’s initial investment. ROI is commonly calculated as:

ROI: The short version of “Return on investment”: ROI is the reward to investors for taking an

investment risk.