At root, capitalism is all about making the right investment decisions and getting the right return on your capital employed. In challenging times such as these, we can get lost in concentrating on reducing costs and optimising revenue, and forget the empowering effect of prudent capital investment. All leisure businesses have a cycle of investment which initially creates a good revenue stream; this eventually starts to deliver reducing returns and reinvestment is needed to freshen up the mix. One of the challenges of the current marketplace is that the emphasis on fashion in leisure offerings means that the reinvestment cycle is shortened.
In the ‘old days’ people would consider a 10-year cycle of reinvestment to be reasonable and plan their returns accordingly, however, in today’s market, the ‘must-visit’ hot ticket becomes tired and unloved within two or three years and needs much more rapid refreshment. The challenge is that capital is harder to come by and some businesses are finding reduced revenues mean lower cash generation and less opportunity to plough anything back in.
This means every decision about reinvesting has to be carefully considered.
No more free rides
Time was when it seemed easier, and for some golden years in the latter part of the last century the smaller end of the hospitality business was a little like farming: people invested in freehold property, ran the business to cover the operating costs and took the return on the eventual sale of the property through increased capital value. This escalator to escape is no longer reliably in operation.
The reliance on increases in the capital value of the property is no longer a sensible way of escaping the need to deliver a genuine return on the trading operation. In some ways, this is a healthier business climate but it throws a lot of emphasis on the importance of getting investment decisions shrewdly made.
What’s the objective – what will be the return?
The underlying objective of capital investment has to be focused on either improving revenues or changing the realisable value of the asset. It also has to be affordable and achievable within the market climate.
In the past few years I’ve had to put my money where my mouth is. Rather than just selling strategic marketing services, I’ve actually bought and operate my own property – Howard’s House Hotel in Teffont Evias, Wiltshire.
Over the past four years we’ve spent 10 per cent of our annual revenue on refurbishment and improvements. We’ve completed the bedrooms, upgraded the sitting room, developed an outside dining terrace and upgraded the infrastructure. This has resulted in much improved guest satisfaction and has increased our sales by around 15 per cent. It means that if we didn’t invest any more, we’d make a healthy profit.
However, in the current climate – where at least four of our nearest competitors have closed for good – the investment hasn’t created a sea change in sales. Times are tough and we all have to offer better value.
We now have two projects on the table for consideration and they present quite different investment challenges.
Undoubtedly a good investment
The first is the complete renewal of the last main area of the hotel which is ‘unimproved’ – the dining room. After a lot of heart searching, we’ve committed the capital investment and in the last week of August we completely transformed the dining room, with new furniture, a state of the art environmental lighting system and a lot of new and better quality artwork.
From the beginning of September through to January, we’re filled with shooting parties. I’m happy to say that our bookings for this year are a notch up on last year. This is an international market group, mainly from America, South Africa and Northern Europe and they are very discerning guests. They tend to use the place on an exclusive-use basis, so the dining room is transformed into ‘house party’ format. We believe the impact of the refurbishment will be hugely appreciated by this group and will give them the confidence to keep on coming back and also to ‘tell their friends’.
It’s a capital investment decision which in today’s parlance could be described as a ‘no brainer’. It will consolidate and improve our business from this vital sector.
A tougher judgement call
The second investment decision is more difficult and is more of a gamble. Teffont Evias has just been voted Wiltshire’s best kept village of the year and we have a very active community who strongly want Howard’s House to offer them a club environment.
We have the perfect opportunity to do this, as we have an old coach house on one side of the courtyard which would make a perfect club and event room. Over the past year we’ve gained the necessary planning permission and listed building clearance (including the mandatory bat survey!) and we’re ready to go.
The difficulty we have is that making this decision will mean a capital investment of a sum which is approximately 25 per cent of our annual revenue and in order to justify that, we really need to see our sales increase by a further 10 per cent at least. In the current climate, that’s something of a stretch.
Avoiding the downside
One thing we’ve always been keen to avoid is borrowing. Until now, the operation of the hotel has been financed through the trading account and personal investment. The choice we have is whether to finance the investment in the coach house ourselves or whether to borrow. We’ve decided to take the first option and at the moment we’re discussing with our local community the idea of selling memberships in the club in advance to raise revenue. I suspect we’ll only make the investment when we’re certain we can do so without compromising the existing business.
It’s no accident that throughout the UK economy almost every business is in the process of reducing its borrowings and strengthening its balance sheet. I suspect we’ll go ahead and develop the coach house – but after a lot of heart-searching.
These decisions are all about timing – I’ll let you know how it goes.
