2. MANDARIN CO
Mandarin Co operates a chain of 30 hotels across the country of Eastland. It prides itself on the comfort of the rooms in its hotels and the quality of service it offers to guests.
The majority of Mandarin Co’s hotels are located in major cities and have previously been successful in attracting business customers. In recent years, however, the number of business customers has started to decline as a result of tough economic conditions in Eastland.
Mandarin Co’s policy is to set standard prices for the rooms in each of its hotels, with that price reflecting the hotel’s location and taking account of competitors’ prices. However, hotel managers have the authority to offer discounts to regular customers, and to reduce prices when occupancy rates in their hotel are expected to be low. The average standard price per night, across all the hotels, was $140 in 20X7, compared to $135 in 20X6. In addition to room bookings, the hotels also generate revenue from the additional services available to customers, such as restaurants and bars.
Summary from Mandarin Co’s management accounts:
| |
Year ended 30 June 20X7 |
Year ended 30 June 20X6 |
| |
$000 |
$000 |
| Revenue – Rooms at standard price per night |
111,890 |
104,976 |
| Room discounts or rate reductions given |
(16,783) |
(11,540) |
| Other revenue: food, drink |
24,270 |
23,185 |
| Total revenue |
119,377 |
116,621 |
| Operating costs |
(95,462) |
(92,379) |
| Operating profit |
23,915 |
24,242 |
Other performance information:
| |
Year ended 30 June 20X7 |
Year ended 30 June 20X6 |
| |
$000 |
$000 |
| Capital employed (Note 1) |
$39.5m |
$39.1m |
| Average occupancy rates (Note 2) |
74% |
72% |
| Average customer satisfaction score (Note 3) |
4.2 |
4.5 |
Note 1: Capital employed is calculated using the depreciated cost of non-current assets at all Mandarin Co’s hotels.
Note 2: Occupancy rates for the year ended 30 June 20X7 were budgeted to be 72%.
Note 3: Customer satisfaction scores are graded on a scale of 1–5 where ‘5’ represents ‘Excellent’. On average, in any given town in Eastland, the top 10% of hotels earn a score of 4.5 or above and the top 25% of hotels earn a score of 4.2 or above.
Two themes are becoming increasingly frequent in the comments Mandarin Co’s customers make alongside the scores:
- Repeat customers have said that the standard of service in recent visits has not been as good as in previous visits.
- The rooms need redecorating, and the fixtures and fittings need replacing. For example, the beds need new mattresses to improve the level of comfort they provide. Mandarin Co had planned a two-year refurbishment programme beginning in 20X7 of all the rooms in each hotel. However, this programme has been put on hold, due to the current economic conditions, and in order to reduce expenditure.
Required:
Using the information provided, discuss Mandarin Co’s financial and non-financial performance for the year ended 30 June 20X7.
Note: There are 5 marks available for calculations and 15 marks available for discussion.
- MANDARIN CO
| Top tips
At first glance, you may not know where to begin with this question! Look carefully at the scenario and decide on some headings for your answer – for example, revenue, discounts, operating profit. You’ll need to perform some calculations (worth five marks) and then you’ll have something to talk about.
Be sure to explain what your calculations mean for Mandarin Co specifically, to add depth to your answer. Do not forget to comment on non-financial performance indicators.
Easy marks
There are easy marks available throughout this question. |
Performance for year ended 30 June 20X7
Gross room revenue – Mandarin Co’s ‘gross’ room revenue based on standard room rates has increased by 6.6% in 20X7, which reflects the higher occupancy rates (74% v 72%) and the increase in standard room rates ($140 v $135 per night).
However, this gives a rather misleading impression of how well the hotels have performed in the year to 20X7.
Revenue after discounts – Revenue from room sales, adjusted for discounts or rate reductions offered, has actually only increased 1.8%, and that reflects the significant 45% increase in discounts or reductions offered:
20X7 20X6 % change
$000 $000
Standard revenue 111,890 104,976 6.6%
Discounts/reductions 16,783 11,540 45.4%
Room revenue net of discounts 95,107 95,107 1.8%
Faced with the declining number of business customers, and consequently the prospect of lower occupancy rates, managers may have decided to offer lower room rates to try to retain as many of their existing business customers as possible, or to try to attract additional leisure customers.
Although occupancy rates increased by 2.8% (from 72% to 74% which now exceeds the budgeted level), revenue, net of discounts, only increased by 1.8%. This means that revenue per room per night after discounts in 20X7 was lower than in 20X6, despite the standard rate being higher ($140 v $135).
In the context of tough market conditions, the decision to increase the standard room rate for 20X7 appears rather optimistic. Although the hotel managers have managed to achieve occupancy rates higher than budget, they have only managed to do so by reducing room rates.
Additional revenue – One of the potential benefits of increased occupancy rates, even if guests are paying less per room per night, is that they will generate additional revenue from food and drink sales. This appears to be the case because additional revenues have increased by approximately 5%.
Total revenue – In total, revenue (net of discounts) has increased 2.4% in 20X7 v 20X6. Given the tough competitive environment, Mandarin Co could view any increase in revenues as positive. Moreover, provided the revenue achieved from selling the room is greater than the variable cost of providing it, then increasing occupancy levels should increase the hotels’ contribution to profit.
Operating profit – However, despite the increase in revenue, operating profits have fallen by $0.3m (1.3%) between 20X7 and 20X6, due to a sizeable increase in operating costs. There is no detail about Mandarin Co’s operating costs, for example, the split between fixed and variable costs. However, in an increasingly competitive market, cost control is likely to be very important. As such, the $3 million (3.3%) increase in operating costs between 20X6 and 20X7 is potentially a cause for concern, and the reasons for the increase should be investigated further. However, when looking to reduce costs, it will be very important to do so in a way which does not compromise customer satisfaction. More generally, Mandarin Co needs to avoid cutting expenditure in areas which will have a detrimental impact on customer satisfaction ratings, for example, not replacing mattresses even though they are becoming uncomfortable to sleep on.
Operating profit margin – The increase in costs has also led to a fall in operating profit margin from 20.8% to 20.0%. It is perhaps more instructive to look at the margin based on standard room rates per night, thereby reflecting the impact of the discounts offered as well as the increase in costs. On this basis, the margin falls slightly more: from 18.9% to 17.6%.
| |
20X7 |
20X6 |
| |
$000 |
$000 |
| Total revenue |
119,377 |
116,621 |
| Discounts offered |
16,783 |
11,430 |
| Gross revenue |
136,160 |
128,051 |
| Operating profit |
23,915 |
4,242 |
| Operating profit margin |
17.6% |
18.9% |
ROCE – This reduced profitability is also reflected in the company’s return on capital employed which has fallen slightly from 62% ($24.2m/$39.1m) to 60.5% ($23.9m/$39.5m). This suggests that the value which Mandarin Co is generating from its assets is falling. The decline in ROCE could be a particular concern given the relative lack of capital investment in the hotels recently. Capital investment will increase the cost of Mandarin Co’s non-current assets, thereby reducing ROCE for any given level of profit.
Customer satisfaction scores
Although the reduction in profitability should be a concern for Mandarin Co, the reduction in customer satisfaction scores should potentially be seen as a greater cause for concern. The scores suggest that, in the space of one year, Mandarin Co hotels have gone from being in the top 10% of hotels to only just being in the top 25%. This is a significant decline in one year, and one which Mandarin Co cannot afford to continue.
Mandarin Co prides itself on the comfort of its rooms and the level of service it offers its guests. Both of these factors are likely to be important considerations for people when considering whether or not to stay in a Mandarin Co hotel. Therefore, falling customer satisfactions levels could be seen as an indication that fewer existing customers will stay at a Mandarin Co hotel in future – thereby threatening occupancy rates, and prices, in future.
Moreover, the scores suggest that the decision to defer the refurbishment programme is likely to have a detrimental impact on future performance.
