13 Sep 19
Hospitality management - The Profit Fallacy
If you want to be in the hospitality business, you likely want to be involved in a profitable hospitality business. That would be a logical choice because, in the long run, only profitable organizations will stay in business. It is important to recognize, however, that if an organization’s primary focus is the generation of profits, it will inevitably go out of business because it will lose out to organizations that know enough not to focus on profitability.
To many hospitality owners and managers, profit is defined as a firm’s total revenue minus its total cost or expense. However this definition suffers from long term view as profit can be maximized in short run by managing expenses and try to boost revenues, however in long term this may not remain sustainable. Another way to look at profit is “profit is net value realized by each party in a business transaction.” Here you can see we are not using the cost as a consideration for calculating profit.
To actually generate significant profits in a hospitality business, and to be a successful manager of a business’s revenues, one must comprehend profits both completely and differently. One must acquire a revenue manager’s understanding of the meaning of profits. To begin, you should recognize that successful business persons understand that in any rational business transaction, both the buyer and the seller seek a profit. A careful reading of this definition reveals that, in a successful business transaction, both buyer and seller gain. It is the crucial foundation of effective revenue management and yet it is most often neglected when organizations, in the quest for profits, establish their prices. By this definition if hospitality customers are not making any gain in a transaction with hotel, hotel is not making a profitable successful business transaction. Its not win and lose transaction it need to be a win-win transaction.
Lets explore this more by looking at the advice given in the early 1900s by retail business legend Herbert Marcus (co-founder of Neiman Marcus) to his son Stanley when he said: “There is never a good sale for Neiman Marcus unless it’s a good buy for the customer.” Think about it and you will recognize it is true. Buyers seek a profit as much as sellers.
To illustrate; if you have ten dollars and purchase an item priced for that amount, you (the buyer) seek to acquire something that you want more than you want to keep the ten dollars you already have. If you willingly part with your ten dollars, it is only because you see a value in exchanging the ten dollars for something worth more than ten dollars to you.
It must be understood that value is different from price and money itself has no inherent value in itself, as you can not eat money or consume in other ways. This can be explained more via understanding time-tested system of BARTER. All business transactions have evolved from the barter system. Bartering is an economic activity that consists simply of two individuals trading one item for another. In such a system, the terms buyer and seller are essentially irrelevant because both individuals participating in the trade take on the dual roles of buyer and seller.
To illustrate a barter economy that does not use money as a medium of exchange, assume a baker trades two loaves of bread for a poultry farmer’s single chicken. As you can readily see in this example, the baker as well as the farmer takes on the role of buyer and seller. Just as a barter system erases the lines between buyer and seller, it erases the lines between sellers’ costs and their profits. If both participants in this transaction were voluntary participants in the trade, it could be said that they agree the cost of a chicken is two loaves of bread. The cost of a loaf of bread is half a chicken.
A profit in such a trade is not a major consideration of the baker or the farmer. This is so because both parties involved in this trade achieved a profit which you will recall is the net value achieved by a seller and buyer in a business transaction. The profit of the farmer is ownership of desired bread; the baker’s profit is ownership of a desired chicken.
It should now be clear to you, however, that money is not a measure of value, nor does it represent stored-up value. Money is simply an easy way to quantify the amount of one item its owner will give up in order to get another item. Applying this truth to the hospitality industry, it would be foolish to think that simply because a chicken dinner is offered for sale by a restaurateur for ten dollars, its value is ten dollars. If, in fact, a guest willingly purchased the ten-dollar chicken dinner from the restaurateur, it would simply mean that both parties in this trade valued the new item each received (chicken for the diner and money for the restaurateur) more than they valued keeping what they originally had.
If the trade of the chicken dinner for the money were actually made, it would be a historical fact that, at a certain time and place, this trade between two trading partners occurred. This historical fact would not necessarily establish the intrinsic “worth” or “value” of a chicken dinner to you or to me. In fact,
- if you are a vegetarian, you would not likely place any personal value on the chicken dinner.
- If you were extremely hungry, you might value the chicken dinner at much more than ten dollars.
The point to remember is that one consumer’s view of a chicken dinner’s value may, or may not at all, be influenced by what other buyers would exchange for it.
To further make the important point about the variable worth of items, let’s return to our barter economy example. Assume that the baker awoke one day to discover he had become extremely allergic to chicken. In such a case, would the worth of one chicken still be equivalent to that of two loaves of bread? Not to that baker. Not surprisingly, an incredibly large number of factors work to influence the willingness of two individuals to take part in a specific trade. The critical point for those in hospitality businesses to remember is that in each case of a willing exchange, an independent decision will made by both parties regarding what will be given up and what will be received in exchange.
In today’s Internet-influenced economy, never have so many potential trading partners had more trade-related information available to them. As a result, never have consumers been able to more carefully consider their alternative trade options (read alternative hospitality accommodations).
Now that you understand that profit (value) is a factor of interest to those who buy, as well as those who sell, products and services it should be easier to understand the limitations of the accountant’s rather one-sided formula for profits. It should also be easier for you to revisit and understand the wisdom of the statement of Herbert Marcus: “There is never a good sale for Neiman Marcus unless it’s a good buy for the customer.”
This limitation of one sided formula of profit is also called as profit fallacy, if hotel try to achieve only this one side of transaction without understanding customer side, can in long term be detrimental to business.