The Performance Variance Question
Do you rely on monthly performance variances for your decision making?
Why is it dangerous to rely just on performance variances in your hotel profit and loss statement?
What this post is all about
This post will address these questions while covering the following points and using an eye opening video:
- PNL - The Illusory Cure for all ills
- Removed from operation often
- Quick Fix - decisions based on PNL
- Dangerous dependence on variances
- Cause-Effect & The Symptom Swamp
- The Eye Opening Funnel Principle of Decision Making Video
- Why decisions based on effect and symptoms are flawed badly
- The Way Out
Without further ado, let us dive right in!
Profit and Loss Statement - Illusory Cure for all ills
If you are a hotel operations manager performance analysis is first nature to you.
It is what your job responsibilities cover, it is what your Boss assesses your performance on and it is what your salary increments and bonus hinge on!
In other words, they are critical.
If you are the General Manager of a hotel property, performance analysis is your No 1 priority.
It is what your bosses who are often owners are demanding from you.
Often though, General Managers get distanced (or even consciously distance themselves) from the monthly performance results.
They leave that to their deputies, the Resident or Hotel Managers of the property.
Given this scenario, general managers tend to resort to what I call the Variance Hack!
In short, using performance variances in Profit & Loss Statement numbers to not just assess performance but also to take financial decisions.
This is dangerous, to understate it!
Why is that you ask.
Let me explain.
The Profit and Loss Statement (we will call it PNL from herein) is the performance statement.
The Profit and Loss Statement (we will call it PNL from herein) is the performance statement.
It is indicative of the business results of a month.
It tells you how much revenue you earned, expenses you incurred and the profit you retained in a month.
Did you notice something in that statement?
I said “indicative.”
So, what is the big deal, you are thinking.
Well, here is the big deal.
The PNL is often considered a cure for all ills.
In particular, performance variances hold a special place in this illusory remedy.
Hotel general managers who as we saw earlier are often removed from the operation and hotel performance, tend to use the variance number in the PNL as something written in stone.
In other words, they swear by variances as numbers which they can depend on to take decisions.
And here is where the big deal is.
Variances are merely indicative of a situation.
They certainly are not absolute numbers that can be relied upon entirely.
You are skeptical about that statement!
Let me clarify with an example.
Assume the Rooms department revenue variance is showing a positive number compared to the budget for the month.
You cannot immediately jump to the conclusion that you can use the same decisions you took in that month for future months since the result is a positive variance.
Why not you ask.
The Symptom Cause Confusion
Well, because the variance is just a symptom.
You still do not know what elements caused that positive variance.
And you should not confuse symptom for cause.
Have you heard of the physician who prescribed medicines based on what he merely and visually saw as the patient’s symptoms?
If not, read on. You may well be enlightened.
A physician prescribed fever medicines to a patient based on symptoms he saw - the patient was sweating profusely and his face looked pale.
He never bothered to find out the cause of the symptom.
Why was he sweating so much?
It turned out later that the patient was sweating so much because first, he had walked to the clinic in blistering temperatures outside.
Moreover, he was also prone to sweating a lot.
But despite the symptoms, he did not run temperature or have fever.
The physician had confused his symptom for the cause (fever) and prescribed medicines.
See, how dangerous it can be to jump to conclusions based on symptoms rather than determining cause?
Performance Variances - The Mathematical Angle
Let me give you another powerful reason why variances are dangerous.
And should not be relied upon without further verification.
Consider what the variance is actually showing.
Let us go back to that Room revenue positive variance.
The positive variance is a number which is a result of deducting the actual revenue from budget revenue.
In this case, actual was higher than the budget and hence the positive variance.
But the positive variance itself does not tell you anything.
All it tells you is that one number is higher or lower than the other.
So, what does tell you the real situation you ask.
All in good time.
The Search for Cause in Performance Variances
For you to get to the bottom of things you need to search out the cause for the positive variance.
That means studying both the actual and the budget numbers.
Why both, you ask puzzled.
Because, there are quite a few scenarios that could be the cause.
Here are a few such scenarios:
- The budget might have been grossly understated making the actual number appear higher than normal
- The actual might have been triggered by an abnormal event in the month which will not repeat itself (and hence cannot be relied upon to take similar decisions)
The above are just two scenarios that should be considered.
We have not even begun digging into how actual revenue was contributed to.
How much did occupancy increase?
How much did average rate increase?
It is also quite possible that either the occupancy or the average rate moved in opposite directions and yet produced a positive variance.
The moral of the story is the same: determine the cause and do not look at just the variance.
The moral of the story is the same: determine the cause and do not look at just the variance.
The Cause Effect Symptom Phenomenon
Using the earlier example of the positive room revenue variance, let us now add an additional element to our discussion on cause and symptom.
That is the effect.
You look totally baffled.
Allow me to clear the clouds of doubt.
In the positive variance example (and in any variance situation for that matter) there are three parts:
- Symptom - the positive variance number
- Cause - the reason why there is a positive variance
- Effect - the actual room revenue (which is higher than the budget room revenue causing the positive variance)
In looking at these three parts, the effect and the symptom are the ones that are obvious.
The moment you look at the Rooms department PNL Statement for a month, you can see the actual room revenue (effect) and the positive variance from the budget room revenue (symptom).
The elusive part is the cause.
It requires further analysis.
It is also the part that will shed light on why the positive room revenue variance happened in the first place.
It is only after the why is determined that a decision can be taken using that cause.
A decision cannot be taken on a symptom (variance).
A decision cannot be taken merely with effect too.
The cause is supreme.
The cause validates the effect and the symptom.
Digging into cause is an involved process.
It requires that you:
- First, determine all elements that influence effect
- Second, find out how much each element impacts effect and
- Third, whether the elements can be used in future for decision making
The Funnel Principle of Decision Making
How do we find out cause from a hotel PNL is your next question.
For that, I will urge you to watch the video below dubbed The Funnel Principle of Decision Making.
It sheds light on not just cause effect snd symptom but much more.
It is an entire paradigm for financial analysis and decision making.
WATCH The Funnel Principle of Decision Making Video
Stakeholders and Variances
Is your hotel owner thrilled with your revenue Plus performance variance compared to budget?
Consider this scenario.
Your hotel has a positive variance compared to budget in the month.
However, it is still behind last year actual number.
Your hotel owner is hardly going to be thrilled!
Stakeholders are obsessed with a phenomenon called YOY - Year on Year Growth.
So, remember, YOY is king as far as hotel owners are concerned.
You will learn about another facet in a different blog post.
And that is how hotel owners treat revenue variances versus profit variances.
Taking the bacon home is a saying that is central to owner motivations.
They prefer profit growth to almost anything else.
Strategies You can Apply
Using the phenomenon we just discussed, as a general manager, you can use the following strategies:
- Treat Variances as mere indicators
- Dig into the Cause
- Determine if cause can be replicated in another situation
- Take decisions based on cause
Do you still think you can rely merely on variance numbers?
Why not?
What would you, as a general manager, do differently from your learning?
I would love to hear from you on this blog post.
If you are an aspiring general manager, build The Ultimate 10 Tools in a Hotel General Manager Business Toolkit with the Mastering Hotel Finance Online Course.
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