Hannah Turnbull manages Elegant Suites, a hotel in a small town 10 miles inland from Florida's beautiful gulf coast. Elegant Suites has a capacity of 320 suites and offers a small, but well managed, conference center. Since opening, Elegant Suites has established a good reputation among small and mediumsized business clients as a nice place to hold annual meetings and retreats.
Hannah currently is in a quandary regarding hotel bookings for the last weekend in February. One of Elegant's long-standing clients, Piedmont Publishing, recently called Hannah about the possibility of holding its annual three-day sales conference at the end of February. Piedmont wants to reserve 75 rooms each day (= 225 total room days). Per its usual arrangement, Piedmont would pay $120 per day per room and $5,000 per day for use of the convention center. Because this is a bulk booking, the room rate is lower than the normal rate of $150 per day. Like all clients, however, the Piedmont attendees would spend additional money at the hotel. Hannah expects this miscellaneous expenditure to be $25 per person per day.
Shortly after receiving the call from Piedmont, Hannah received a call from Capelli Fashion Designers. Capelli, a prospective first-time client, wants to hold its annual threeday fashion event at Elegant Suites at the end of February. Capelli would book 225 suites per day (for a total of 675 room days) and is willing to pay $120 per suite per day. Also, Capelli would be willing to pay the normal daily rate of $5,000 for use of the convention center, although it wants Hannah to construct a runway at a cost of $3,000. Hannah was ecstatic to receive the Capelli call until she realized that the dates Capelli wants coincide with Piedmont's annual sales meeting.
Trying to figure a way out, Hannah calls both Capelli and Piedmont to see if either party would be willing to move its event to different dates. However, both Capelli and Piedmont are committed to holding their respective events at the end of February.
Next, Hannah looks at her reservations chart to see if she can hold both events. She realizes that 60 suites already are committed to other individual clients during that time.
Hannah believes strongly that she must honor these reservations.
Hannah provides you with the following summary financial data for a typical month of operations.
.:.
Hannah also informs you that if she stays with Piedmont, she is likely to sell another 57 suites to individual parties for each of the three days at the standard rate of $150 per suite. If she accepts Capelli, she will be able to sell the remaining 35 suites to individual parties for each of the three days at the standard rate of $150 per suite. However, as booking Capelli would cause an abnormally high occupancy rate (100%), Hannah anticipates the need to pay her hourly staff an overtime premium of 50% for the threeday period (i.e., the average hourly wage will be the base wage 1.50).
Required:
a. Identify Hannah's decision options.
b. Identify Hanna's best option.
c. Suppose 75 and 225 suites per day is the number of suites that Piedmont and Capelli wish to block for their conventions. However, the actual demand might be less than this estimate. While Piedmont is sure to occupy at least 60 suites, Capelli estimates that total demand might range from 150 to 225 suites. Because actual demand would not be known till late, Hannah would not be able to fill unused suites with paying guests. How might this information affect Hannah's decision?
d. Considering long-term implications, what should Hannah do?
SOLUTION:
For all practical purposes, Hannah really has only two decision options:
Option 1: Accept Piedmont’s business and reject Capelli’s offer. Thus, in total, 192 suites (= 320 × 0.60; 75 to Piedmont and 117 to individuals) will be booked for each of the three days at the end of February, with a daily occupancy rate of 60%, which is close to the usual level.
Option 2: Accept Capelli’s business and reject Piedmont’s offer. Thus, all available suites or 320 suites (225 to Capelli and 95 to individuals) will be booked for each of the three days.
Technically, Hannah has a third decision option. She could reject both Piedmont and Capelli – this is the status quo. However, Hannah does not view this option to be part of her opportunity set. As discussed in Chapter 2, Hannah has pruned her opportunity set to focus on her two most viable choices.
The table below presents the total costs and total revenues associated with each of Hannah’s decision options. In employing the gross approach, we only included revenues and costs related to the three days in question. Thus, we did not include Elegant Suite’s normal revenues or variable costs for the other days in the month. We also did not include Elegant Suites’ overall fixed costs. We could include any or all of these amounts under the gross approach as they are the same across Hannah’s two options. Moreover, it is the difference in profit that we ultimately are interested in.
The total revenues for each option comprise monies received from both corporate and individual suite rentals. Corporate suite revenues equal the number of corporate suites for the 3-day period $120; individual suite revenues equal number of individual suites for the 3-day period $150; convention center revenues are $5,000 per day, and food, telephone, and movie revenues equal the total number of suites occupied $25.
Variable costs comprise food, laundry, supplies, telephones, and movies (cost = total number of suites $30; $30 = $180,000/6,000), and labor related to cleaning and cooking (for Piedmont, this is the total number of suites $35; $35 = $210,000/6,000; for Capelli, this cost is the total number of suites $52.50 $35 × 1.50), since Hannah will have to pay an overtime premium if she accepts the Capelli offer). Finally, Elegant Suites will spend $3,000 to build the runway for Capelli. (Note: as discussed earlier, the other remaining labor fixed costs for hotel management and building and grounds are not controllable for this decision and, thus, we did not include them as part of the total cost of each option).
| Accept Piedmont | Accept Capelli |
|---|
| Data: | | |
| Total suites – corporate | 225 | 675 |
| Total suites – individual | 3511 | 2852 |
| Price per suite – corporate | $120.00 | $120.00 |
| Price per suite – individual | $150.00 | $150.00 |
| Revenues: | | |
| Suites – corporate | $27,000 | $81,000 |
| Suites – individual | 52,650 | 42,750 |
| Convention center | 15,000 | 15,000 |
| Food, telephone, & movies | 14,4003 | 24,000 |
| Total revenues | $109,050 | $162,750 |
| Variable Costs: | | |
| Food, laundry, supplies, etc. | $17,280 | $28,800 |
| Labor (kitchen help, maids) | 20,1604 | 50,400 |
| Contribution margin | $71,610 | $83,550 |
| Additional Fixed Costs: | | |
| Build runway | | $3,000 |
| “Profit” | $71,610 | $80,550 |
1351 = [(320 × 3 days) × 0.60] – 225.
2285 = [(320 × 3 days) - 675].
314,400 = ($25 × 960) × 0.60.
420,160 = ($30 × 960) × 0.60.
From a profit-maximizing perspective, we find the Cappelli Option to be the most attractive. We also could verify this using the incremental approach, using either controllable cost analysis or relevant cost analysis.
The new information would have a substantive effect on Hannah’s decision. Let us begin by re-calculating the value of each decision option assuming minimum possible demand.
| Accept Piedmont | Accept Capelli |
|---|
| Data: | | |
| Total suites – corporate | 180 | 450 |
| Total suites – individual | 351 | 285 |
| Price per suite – corporate | $120.00 | $120.00 |
| Price per suite – individual | $150.00 | $150.00 |
| Revenues: | | |
| Suites – corporate | $21,600 | $54,000 |
| Suites – individual | 52,650 | 42,750 |
| Convention center | 15,000 | 15,000 |
| Food, telephone, & movies | 13,275 | 18,375 |
| Total revenues | $102,525 | $130,125 |
| Variable Costs: | | |
| Food, laundry, supplies, etc. | $15,930 | $22,050 |
| Labor (kitchen help, maids) | 18,585 | 38,588 |
| Contribution margin | $68,010 | $69,488 |
| Additional Fixed Costs: | | |
| Build runway | | $3,000 |
| “Profit” | $68,010 | $66,488 |
From a profit-maximizing perspective, we find the Cappelli option is no longer as attractive. If Hannah were sure that demand would be at the low end, it is prudent to go with the Piedmont option. However, as we learned earlier, the Capelli option maximizes profit if demand were at the high end.
From a purely financial perspective, Hannah’s beliefs about possible demand influence her decision. Many firms construct a “best case, most likely, worst case” scenario to include uncertainty in their estimates. Sophisticated analyses could include a demand distribution and simulations.
Hotels routinely buffer themselves against demand fluctuations such as these by requiring a minimum number of occupied suite-days. Moreover, they might release the “blocked” rooms 2-3 weeks prior to the conference to increase the chance of filling any unused rooms.
If Hannah accepts the Capelli deal, she will not be able to host Piedmont’s meeting this year. By turning down Piedmont, a long-time client, Hannah may indeed lose all future business with the company. Moreover, including the possibility of uncertain demand reduces the financial attractiveness of Capelli, although it is likely the better financial option. Thus, even though the profitable short-term decision is to accept Capelli’s business, Hannah probably will feel uncomfortable making this decision because it could mean losing the Piedmont contract forever. Is the immediate incremental benefit of $8,940 (= $80,550 – $71,610; see part b. above) worth losing a valued client? It may be advisable for Hannah to go with decision option 1 and forgo this short-term benefit.