Value Investing – Hospitality Industry Characterized by High Fixed Costs
There is one unique financial characteristic that is synonymous with the hospitality industry; that is high fixed costs. Or another way of stating the same financial attribute is to simply state that the hospitality industry has low variable costs. There are several different cost drivers that force this industry to incur high fixed costs. These include location, initial cost of construction, costs of capital and an economy of scale. Each of these business attributes contribute to the high fixed costs of operations.
In general the hospitality industry takes care of guests for an extended period of time (at least several hours). Some writers indicate that your fancier sit down restaurants are in this industry and they are not. All restaurants are in the food service industry. Hospitality involves longer periods of contact or utility time with the guest than simply the time it takes to consume a meal.
The hospitality industry is comprised of the following lines of business:
- Hotel/Motel Operations
- Resorts
- Event Planning and Coordination
- Theme Parks
- Golf Courses
- Tourism including Cruise Lines
As the following sections explain the cost drivers for high fixed costs, think of the different lines of business as identified above when evaluating theses costs. The first contributing cost driver that forces a high fixed cost is location.
Hospitality Industry – Location, Location, Location
If you haven’t quite figured it out yet, most of the hospitality based operations have to operate in more expensive geographical zones. Some may not operate at a particular geographical zone but may operate at a competitive site such as an exit off the highway for a motel or hotel. No matter, fair market value drives the cost of purchasing a piece of land.
The cost per acre for land on the ocean or with access to the ocean is much more expensive than a comparable piece of property 20 to 30 miles inland. Often the price per acre is six to ten times more expensive. Think of a theme park or a golf course. These lines of business need many acres and this land needs to be located near a community that attracts outside visitors. In Orlando, FL; how much is one acre of land? Answer: nonresidential land near the heart of activity is selling for nearly $500,000 per acre.
Even a piece of land with access to a main thoroughfare is much more expensive than acreage two to three miles further away from the exit. The location of the property is one of the primary cost drivers for the hospitality industry. Once you own the land, now it has to be developed.