Sagar Sands Hotel: Break-Even, a Monsoon Contract and a Tariff Cut
Sagar Sands is a 60-room hotel. For the coming year it plans an average room rate of ₹4,200 and 68% occupancy, with variable cost of ₹600 per occupied room (laundry, amenities, utilities, commissions). Food and beverage revenue is expected at ₹1.90 crore with variable cost at 62% of sales, and F&B demand comes almost entirely from in-house guests. Annual fixed costs - staff, rent, power, brand fee, insurance - total ₹4.60 crore. The owner wants a profit of ₹2.50 crore. Two proposals are on the table. Proposal A: a tour operator offers 78% occupancy for the 90 monsoon days at ₹2,600 per room less 5% commission; those 90 days currently run at about 35% occupancy at the normal tariff, and the operator's guests would buy nothing extra. Proposal B: cut the room tariff by 5% for the whole year and spend ₹40 lakh on advertising. The finance manager says the hotel is 'already past break-even, so every extra room sold is pure profit'.
1. Compute break-even occupancy and the margin of safety, and assess whether the owner's profit target is achievable at current plans.
Read the worked answer
Room-nights available = 60 × 365 = 21,900. At 68% occupancy, rooms sold = 14,892.
Contribution per occupied room
- Rooms: 4,200 − 600 = ₹3,600
- F&B: (1.90 crore × 38%) / 14,892 = 72.20 lakh / 14,892 ≈ ₹485
- Total ≈ ₹4,085 per occupied room
(Equivalently, total contribution = 5.361 + 0.722 = ₹6.083 crore on revenue of ₹8.155 crore, a PV ratio of about 74.6%.)
Break-even = 4.60 crore / 4,085 = 11,260 room-nights = 51.4% occupancy.
Margin of safety = (14,892 − 11,260) / 14,892 = 24.4%, or ₹1.99 crore of revenue.
Profit at plan = 14,892 × 4,085 − 4.60 crore = 6.083 − 4.60 = ₹1.48 crore, well short of ₹2.50 crore.
Target check. Required contribution = 4.60 + 2.50 = ₹7.10 crore; required rooms = 7.10 crore / 4,085 = 17,381 room-nights = 79.4% occupancy. That is 11.4 points above plan and close to practical capacity. The target is not achievable by tariff or cost tinkering alone; it needs a mix shift (higher F&B attach, premium room categories) or a fixed-cost reduction. The useful message to the owner is that the hotel has a comfortable break-even but a demanding profit plan.
2. Evaluate Proposal A using incremental reasoning. Is the finance manager's 'every extra room is profit' logic valid here?
Read the worked answer
Gross view. Room-nights in the 90 days = 60 × 90 × 78% = 4,212. Net rate = 2,600 × 0.95 = ₹2,470. Contribution per room = 2,470 − 600 = ₹1,870 (no F&B attach). Total = 4,212 × 1,870 = ₹78.8 lakh.
Incremental view - the correct one. Those 90 days already sell 60 × 90 × 35% = 1,890 room-nights at full rate, contributing about 1,890 × 4,085 = ₹77.2 lakh. The operator's block does not add 4,212 rooms; it displaces the 1,890 full-rate rooms and adds only 2,322.
- Gain on 2,322 new rooms: 2,322 × 1,870 = ₹43.4 lakh
- Loss on 1,890 displaced rooms: 1,890 × (4,085 − 1,870) = ₹41.9 lakh
- Net gain ≈ ₹1.5 lakh for the season.
Why the finance manager is wrong. His statement confuses the marginal rule with the decision. It is true that any genuinely incremental room contributes ₹4,085 against fixed costs that are already sunk, so selling below full rate can be rational. But a block booking is not incremental on the rooms it takes from existing guests; the test is contribution after displacement, not contribution on the block. Here the answer is a near-zero gain.
Recommendation. Reject as offered, or renegotiate: at ₹3,200 net the block contribution is 2,600 per room and the net gain becomes 2,322 × 2,600 − 1,890 × 1,485 ≈ ₹32 lakh. Also require a guaranteed room-night commitment, a cut-off date for release of unsold rooms, and no free F&B, so that displacement risk is bounded.
3. Evaluate Proposal B and compare its risk with Proposal A.
Read the worked answer
Cost of the tariff cut. The 5% cut applies to all room revenue, not just new business. Room revenue at plan is 14,892 × 4,200 = ₹6.255 crore, so the cut costs 0.05 × 6.255 = ₹31.3 lakh of contribution - variable cost per room does not fall, so contribution falls rupee for rupee.
Advertising adds ₹40 lakh of fixed cost.
Recovery required = 31.3 + 40.0 = ₹71.3 lakh of extra contribution. At ₹4,085 per occupied room that is 1,745 additional room-nights, or 8.0 points of occupancy (68% to 76%) - and this before any F&B margin from the extra guests, which helps but does not change the order of magnitude.
Judgement. A 5% rate cut is a permanent reduction in yield; the advertising is an annual cost that must be repeated to hold the gain. Price elasticity in a 68%-occupancy market rarely delivers 8 points from a 5% cut, and competitors can match the cut within a season. The plan also raises break-even: new BEP = (4.60 + 0.40) crore / 4,085 = 12,240 room-nights, 55.9% occupancy, so the margin of safety shrinks from 24.4% to about 17.8% even if the volume materialises.
Comparison. Proposal A has a small positive expected value with a bounded loss (it is confined to 90 days and can be renegotiated next season). Proposal B risks a permanent 5% erosion of yield for a speculative volume gain. If the owner must act, A with a renegotiated rate, or a targeted off-season promotion with a stay-restriction, is the lower-risk route; B should be rejected unless market research supports an elasticity well above 1.6.