Discuss the implications of the operating cost structure on profitability in the hospitality and travel sectors.

Most industries have characteristics or norms which distinguish them from other business sectors. The tourism, hospitality and leisure sector is no different. Hospitality, leisure and travel businesses tend to be quite capital and labour intensive with a high fixed and low variable cost structure. Demand for their products and services tends to fluctuate and they also sell a perishable product / service. Cost structure refers to the proportion of fixed and variable costs within the total operating cost structure of the business. A business with a high proportion of fixed costs to total costs would be said to have a high fixed cost structure, sometimes called high operating gearing. Travel agents, although not capital intensive, would have a high fixed cost operating structure. Outdoor catering firms would have a mainly high variable cost structure.

Operating risk is high where a business suffers from profit volatility and this occurs when profit is sensitive to small changes in key variables. Generally a business will have high operating risk or gearing when its cost structure is predominantly fixed. This is due to the fact that the pressure is on the business to achieve a required sales level to cover fixed costs. A business with a predominantly variable cost structure would have low operating risk or gearing as, should the business not achieve expected sales, the variable costs would not be charged.

Thus the main implications of  the operating cost structure for a travel agency or hotel are.

• These businesses tend to have high fixed costs and high operating risk. Thus the pressure is on to generate adequate sales to cover fixed costs and make a profit.
• These type of businesses are quite revenue sensitive, thus management should focus on maximising the revenue side of the profit and loss account.
• As these business types have few variable costs, it would indicate that they have less latitude in terms of reducing costs, but greater scope to stimulate demand (by reducing prices in off-peak periods) and thus maximise contribution to cover fixed costs. In this regard we see that travel companies, accommodation providers and leisure fitness clubs, during their ‘off-peak season’, stimulate sales demand by reducing the price. As long as the selling price exceeds the variable costs then the sale makes a positive contribution towards fixed costs and profit. It is important to emphasise that this is not about diluting the importance of cost control, but more about diverting resources into marketing and sales.
• Businesses with high fixed cost operating structures tend also to be quite capital intensive (which creates many of the fixed costs such as depreciation, rates, repairs and maintenance). Also, accommodation providers, restaurants and travel companies provide a perishable product (for a hotel, one bed-night lost is lost forever) with fluctuations in demand. Thus in off-peak periods, selling prices can be slashed to ensure a bed-night or air-flight seat makes a positive contribution towards fixed costs instead of a no-sell, zero contribution and a wasted opportunity.