3 rd Edition Strategic Management In Tourism

1. CABI TOURISM TEXTS 3rd EditionStrategic Management In Tourism Editedby LUIZ MOUTINHO AND ALFONSO VARGAS SÁNCHEZ COMPLIMENTARY TEACHING MATERIALS

2. CABI TOURISM TEXTS CHAPTER 9 Financial Management in Tourism JAMES M. WILSON AND LUIZ MOUTINHO

3. CABI TOURISM TEXTS LEARNING OBJECTIVES • To develop an understanding of the financial effects of management decisions and policies. • To develop a comprehension of the impact of pricing policies on an organization’s financial performance. • To develop an appreciation of service and product design issues and their relevance to financial performance. • To present a perspective on the financial consequences of alternatives available for promoting an organization’s services and products by developing a basic comprehension of financial statements and their relevance for management decisions. • To show how the marketing mix interacts with financial management and the impact different elements within the mix may have on an organization’s finances.

4. CABI TOURISM TEXTS STRATEGIC MANAGEMENT IN TOURISM A basic understanding of financial management is essential for managers in the tourism industry. Financial management is central to planning, measuring and controlling many activities and managers that understand and can use this information can act on it more effectively. The learning objectives focus on those dimensions of financial management most relevant to a manager’s effectiveness.

5. CABI TOURISM TEXTS STRATEGIES • A key decision is identifying and developing products and services: • new products/services to be introduced, or • old ones to be withdrawn or ‘improved’; • product/service ‘ranges’, ‘lines’ and ‘portfolios’; • product/service positioning vis-à-vis competitors; • branding; and • product/service and facility characteristics. • This investment is made with a view to potential returns from their successful exploitation later. • The supporting marketing research that helps understand markets and their needs is also a form of investment.

6. CABI TOURISM TEXTS STRATEGIC EXAMPLE • New service introduction case • A new service will cost a total of £250,000, it has a 5-year life expectancy and yields sales revenues of £300,000 in the first year increasing by £100,000 annually until the end of the fifth year, with direct costs of 70% of revenues and allocable overheads of £75,000 per annum. Depreciation of new equipment is £20,000 annually with no salvage value at the end • The company pays 40% tax on its profits. • Similar projects in the past have been evaluated using a 15% discount rate. • Is introducing this new service beneficial?

7. CABI TOURISM TEXTS TABLE 9.1 • Time-phased analysis of the impact of introducing the new service.

8. CABI TOURISM TEXTS TABLE 9.2 • Projected discounted cash flows.

9. CABI TOURISM TEXTS Discussion: • A simple analysis of the undiscounted cash flows shows the investment to be attractive, with the income (415) much greater than the investment (250). • But considering that costs are paid ‘up front’ while the income occurs in the future – and could be risky – means that such a simple analysis is too basic. • Discounting to consider both the effect of time, and perhaps to allow a risk adjustment gives a more realistic assessment. • The comparison is now much closer – this consideration of the impact of time and alternative investments that might be made significantly reduces the economic attractiveness of this proposal. • The total discounted income is now reduced to only £256,000 compared with the costs of £250,000 leaving the net present value of only £6000. • So long as the NPV is positive the proposal is considered viable, but there may well be other proposals with higher NPVs to compete with for limited investment capital.

10. CABI TOURISM TEXTS PRICING APPROACHES • Product/service price setting is important for sales volume and profitability. Alternative approaches may be categorized as: • Accounting-based, dominated by cost considerations (‘cost-plus’ pricing). • Economics-based, considering supply and demand issues. • Market-based, considering its customers and competitors. • All pricing policies have financial implications.

11. CABI TOURISM TEXTS MARKET-BASED PRICING EXAMPLES • Examples of market-based pricing are: • ‘reference’ pricing based on competitors’ prices • ‘skimming’ pricing, with an initial high price, that is then reduced • ‘penetration’ pricing, with a low price to build market share • ‘target’ pricing, with product/service designed and priced considering consumer expectations.

12. CABI TOURISM TEXTS BREAKEVEN PRICING EXAMPLE Total costs Total revenue, High price £ Per unit costs Phigh Fixed costs Qhigh Quantity

13. CABI TOURISM TEXTS BREAKEVEN PRICING EXAMPLE Total costs Total revenue, Low price £ Plow Per unit costs Fixed costs Qlow Quantity A lower price means more have to be sold to recover the fixed costs

14. CABI TOURISM TEXTS Yield management • Yield or revenue management has become a valuable tool for effective pricing. It is now common for • Airlines, • Railways, • Hotel chains, • Car rental companies, • to maximize the revenues that their services generate. • This relies on price discrimination: charging different customers different prices for identical goods or services.

15. CABI TOURISM TEXTS Yield management • Objective: charging the right price to the right customer for the right services at the right time. This requires: • 1. Limited capacity. • 2. Limited availability. • 3. Identifiable market segments – Customers willing to pay different prices. • Ideally, an organization would like to charge every customer the maximum price they’d be willing to pay.

16. CABI TOURISM TEXTS Yield management Example An example of price discrimination with ‘peak’ vs. ‘off-peak’ pricing, as commonly seen in airline and hotel pricing. This may help maximize profits as well as shift demand from the peak to the off-peak period to better use the limited capacity.

17. Revenue lost due to lower Price P2 D2 D1 MR2 MR1 CABI TOURISM TEXTS Yield management Example • Weekday Weekend Weekend • Price Using “normal” weekday price Using lower, weekend price P1 D2 Revenue gain due to higher Sales MR2 QA Q1 QB Increased sales to price-sensitive customers.

18. CABI TOURISM TEXTS Yield management Example • The graph on the left shows a normal pricing policy using conventional economic theory and equates its marginal revenue to its marginal cost and charges price P1 to generate a sales volume of Q1. • But if this same price were applied to its weekend demand it would then find more price-sensitive customers (Demand curve D2) would go elsewhere. • A somewhat lower price at P2 could then attract these customers, and the added sales volume at QB generate more revenue than would be lost through the price reduction. • So a lower price at weekends will maximize profits, the weekday travellers would not generally shift to weekends, and vice versa.

19. CABI TOURISM TEXTS Promotions: ADVERTiSING Example Do organizations benefit from advertising expenditure, or not? This issue may be addressed using an accounting perspective. What overall impact does advertising have on increasing revenues relative to the costs involved?

20. CABI TOURISM TEXTS TABLE 9.3 Impact of advertising on increasing revenue

21. CABI TOURISM TEXTS PROMOTIONS: SALES INCENTIVES Example Do organizations benefit from increasing incentives given salespeople, or not? This issue may also be addressed using an accounting perspective. What overall impact do sales incentives have on increasing revenues relative to the costs involved?

22. CABI TOURISM TEXTS TABLE 9.4 Profitability and sales commission rates.

23. CABI TOURISM TEXTS PROMOTIONS: SUMMARY • Promotion costs are paid not from the increase in total revenues but from the increase in gross profits. • This is true for both broadly targeted promotions such as: • advertising • public relations • and more focused, sale-specific promotions like: • price discounts • sales commission.

24. CABI TOURISM TEXTS MARKETINg and ITS FINANCIAL IMPACT • The basic financial statements may reveal the impact of various marketing strategies, policies and practices on the organization. • The Profit and Loss statement shows their effects over a period of time. • The Balance Sheet shows their effect at a specific time. • Both can provide valuable insights into marketing questions: • Where are we now? • What effect have marketing activities had?