A Business strategy report for for the owners of Cairngorm Heights
This report has been prepared for the owners of Cairngorm Heights (CH). It will highlight four issues in particular. First, the manager's proposal to keep the hotel open during the off season period will be analyzed. Secondly, the manager's proposal to build a covered and heated swimming pool will be looked at in detail. Thirdly, an explanation will be given on why capital budgeting techniques that take account of time value of money is favoured. Finally, a note on strategic management accounting and how it differs from traditional management accounting will be included.
2. Proposal to Operate During the Off Season
The manager has proposed to keep the west wing of the hotel open in the off season period, in order to prevent CH from incurring purely losses during that significantly long time of the year. One option given is to implement it with additional promotional expenditure, and the other without.
2.1. Average Incremental Contribution per Occupied Room
If this proposal is realized, the incremental contribution per room for a single room and a double room would be £26.55 and £41.05 respectively. The average contribution per room will be £38.15 (Refer to Appendix 1, Table 1).
2.2. Additional Fixed Costs
Total additional fixed costs would be £62900 (Refer to Appendix 1, Table 2), among them being £8750 of salary for the manager's wife, who will help her husband in handling the front desk and carrying out the work normally done by maids. It is suggested that maids are not required, and reason for this suggestion is as follows. The average number of rooms occupied is 64 rooms per day, as compared to a maximum (with advertising) average number of occupied rooms during the off season amounting to 12 rooms per day  . If during the season CH only needs two maids handle 64 rooms, it should not be too difficult for the manager and his wife to handle the relatively small number of rooms in the off season.
2.3. Breakeven Occupancy Rate
The occupancy rate needed for the proposal to breakeven is 22.34%. The manager expects the average occupancy rate to be 24.24%, which is above the breakeven occupancy rate. As this will lead to a net incremental profit of £5103.33 (Refer to Appendix 2, Section 1), the proposal is viable.
2.4. Breakeven Occupancy Rate (With Advertising)
Should the hotel commit money on promotional expenditure, total fixed cost would increase to £102900. The breakeven occupancy would increase to 36.70%, but the manager guarantees the average occupancy rate to subsequently rise to 40%. This will lead to a net incremental profit of £9253.28 (Refer to Appendix 2, Section 2).
2.5. Recommendations and Justifications
Do promotional expenditure, higher incremental profit
However, amount of additional profit is not that significant compared to the current annual profit. High increase in fixed costs
Hotel doesn't have a restaurant
Linen is rented from a supply house
3. Proposal to Build Swimming Pool
The manager has also proposed for a covered and heated pool to be added to CH. He believes this will increase occupancy by 15% of the total amount of rooms during the off season. Another option is to build an uncovered pool, but it will only be opened for 92 days during the summer, from 15 June to 15 September. This proposal will be analysed using three distinct capital budgeting techniques. First, by determining the Net Present Value (NPV) of total cash flows, which calculates today's value of present and future cash flows. Secondly, by looking at the Payback Period, or the time taken in order to get back the initial investment. Thirdly, by calculating the Accounting Rate of Return (ARR), or the rate of return on investments based on profits.
3.1. Covered Pool
The covered pool will require an initial investment of £100000, and will lead to future net cash inflows of £18060.38 (before tax) annually for 10 years. The NPV of the total cash flows concerning the covered pool has been calculated at £5149.94. The payback period is 5.57 years. The ARR has been established, and it is at a rate of 16.12%. (Refer to Appendix 3)
3.2. Uncovered Pool
Should an uncovered pool be built instead, it will require an initial investment of £60000, and will lead to future net cash inflows of £9794.10 (before tax) annually for 10 years. However, a net deficit of £5149.94 is obtained when all cash flows are discounted using NPV. The payback period is 6.18 years. The ARR has been calculated at being at a rate of 12.65%. (Refer to Appendix 4)
3.2. Recommendations and Justifications
Build COVERED pool
Shorter payback period
Eventually will have to be built, competition
However, must be remembered that Precise estimates are impossible
4. Capital Budgeting and Time Value of Money
5. Strategic Management Accounting
Strategic Management Accounting (SMA) is defined as 'a form of management accounting in which emphasis is placed on information which relates to factors external to the entity, as well as non-financial information and internally generated information'1.
SMA focuses on productivity cost structures, quality and prices relative to competitors. It also emphasises on ways for the company to secure positional advantage in the market, either through cost leadership, differentiation, focus, or a mixture of the three (Porter, 1985). The most efficient cost system can be set up using value chain analysis, a method which searches linkages within the firm, or between the firm and its suppliers or customers, leading to the company reaching a maximum profit in relative to its costs.
5.2. Main Components
SMA comprises of three components:
This is where the firm attempts to achieve competitive advantage, through various methods i.e. price leadership and niche marketing, in order to garner relatively higher profit than the industry average. Two basic determinants of company profitability are degree of competitive rivalry within the industry and the basic profitability of the industry.
Strategic Cost Management
This component focuses on the cost structure of an organization, the distribution of costs among the processes an organisation uses to deliver its products or services, aiming to continually reduce unit costs over the long run. This method uses cost driver analysis i.e. ABC, and target cost management, which relates to maintaining the cost at the predetermined level.
Customer Profitability Analysis
This section discusses the different costs that relate to the different customers. Customer may not react to the same cost level and therefore, they will not contribute to the same profit. Therefore by gaining information on each customer using methods such as the Boston Consulting Group Matrix, a detailed analysis of customers may be derived according to their preference and how much they are willing to pay for a particular service.
5.3. Basic Comparisons with Traditional Management Accounting
Traditional management accounting only focuses on the manufacturing, and neglects the high cost from post-conversion activities. It also fails to access the relative cost positions of competitors and has over-reliance on existing accounting systems. Being a serviced-based business, CH is very susceptible to external factors such as this. Hence it would be unwise to make future planning for the hotel based on internal capabilities alone.
5.4. SMA Applied in Practice
CH can use Competitor Analysis by analysing the strategic intent of other hotels around it and how management can exploit any advantages. If the strategic intent of competitors is unknown, the cost and pricing strategy of the management will remain subjective and unreliable. The Target Cost Management approach can also be implemented by looking at what CH's competitors are charging customers; subsequently the hotel can set its own charges at these prices. Then after deducting a planned profit margin percentage, the amount left would be the maximum cost that CH can incur to achieve its target profit. The hotel can then play around this targeted number when setting its budget, ensuring costs do not exceed the maximum amount possible to incur. CH can also apply Customer Profitability Analysis and sort customers according to their profit and cost group. This may possibly lead to the hotel coming up with various packages to attract people from different sectors of the market.