Appraising the Impact of Economic Uncertainty to Hotel Industry
After the fall of Lehman Brothers on September 15, 2008, the 2008 Financial Crisis resulted in some of the most aggravated economic disruptions witnessed in the 21st Century. The hotel industry was not spared. As a whole, the American hotel industry experienced a significant negative impact on rate, occupancy, and revenue per each available room beginning from September 15, 2008, and during the 2008 sub-prime lending crisis (Enz, 2011). Although the immediate effects of the financial crisis decreased palpably after approximately four (4) months for which the downturn persisted, occupancy rates fell for the hotel industry. They remained low between 2009 and early 2010 (Enz, 2011). After the ravages of the 2008 Financial Crisis, the hotel industry bounced back admirably and has outperformed industry expectations. However, the inescapable conclusion was that the entire industry was affected by the uncertainty that resulted from the period of economic confusion, uncertainty, and disruption after the collapse of the sub-prime mortgage lending system and the global financial meltdown.
In terms of performance, the hotel industry, like any other, is affected by various economic factors. The performance of the hotel industry is affected by both macroeconomic indices and consumer demand. This situation is because of the complex and multi-layered nature of the hotel segment and the hospitality industry. Hotel industry performance is also affected by the performance of other related sectors, including travel. (Deloitte, 2015) Most importantly, the performance of the hotel industry is affected by consumer trends and the seasonality of demand. Because of this, a demand shock would likely have an unprecedented effect on the hotel industry, and the incidence of the 2008 global financial crisis was no exception.
It is crucial that researchers correctly understand the impact of the various economic shocks that can affect the hospitality industry, and business organizations have in place practical tools to mitigate the consequences of economic uncertainty on their business operations. Parker and Bade have defined a recession as a phase within the economic cycle where the real Gross Domestic Product (GDP) has a negative net value for two consecutive financial quarters. The 2008 recession (known as the ‘Great Recession’) occurred when large financial institutions, which had placed their securities in off‐balance‐sheet entities, became insolvent when the housing bubble that the United States was experiencing at the time burst. (Mizen, 2008 & Acharya, et al., 2008) Placing the very risky securities in off-balance sheet items meant that the banks were not required by law to hold significant capital to buffer against these securities (Acharya et al., 2008). In addition to this state, bank capital regulations had allowed banks to minimize their capital against AAA-rated portions of securitized mortgages. Banks were able to repackage shaky mortgages into mortgage-backed securities and effectively reduced the amount of capital required against the loans the banks issued. (Mizen, 2008 & Acharya, et al. 2008). For the banks, this increased their ability to lend from the same pool of assets, comprising capital, many‐fold. The primary effect of this provision was to concentrate on the possibility that many of the mortgage-holders would default. When the housing bubble popped, banks could not sustain the resulting liability.
A period of uncertainty affects both the demand and supply domains of the economy. For the hotel industry, the uncertainty that resulted from the global financial meltdown was severe. (Enz, 2011) It is clear from the foregoing that economic uncertainty is not suitable for the hotel industry. During the 2008 economic downturn, a considerable proportion of the losses that were suffered by the hotel and tourism industry could be attributed directly or indirectly to the arising economic uncertainty.
Given its unique position in any country’s economy, the hospitality industry is quite vulnerable to economic shocks, events, and disruptions. For the hotel industry, the economic uncertainty resulting from the financial crisis that occurred after the implosion of the U.S. sub-prime mortgage system was extremely destructive. This destruction was more so because the hotel industry is cyclical, and tourist arrivals in various destinations depend on many factors, including economic performance. (Deloitte, 2015) Papatheodorou states that the relationship between the performance of the hotel industry and the incidence of an economic recession or downturn is characterized by total confusion as to the “duration, depth, and implications of the (…) economic crisis”. (Papatheodorou et al., 2010) Further to this is the fact that industry players and consumers are concerned about how such uncertainty is passed through the economic system and particularly into the hotel and tourism industry as economic volatility. This concern makes it difficult to coordinate the actions of the industry players leading to financial losses incurred by the industry. Factoring in the great loss of employment and the collapse of the sub-prime lending system during the crisis, it is not unlikely that the hotel industry, which focuses on leisure and recreation, would suffer a significant hit on revenues and overall demand. Because of the disruptive impact of demand shocks that occur after a financial crisis, such as the 2008 recession, the most significant effect of economic uncertainty is difficult to predict. Often, there will be a lag between the onset of the economic downturn and the effect on the specific industry sector, in this instance, the hotel industry.
It is well established that consumer spending on recreation has a direct link to the Gross Domestic Product (GDP) performance of a nation’s economy during an economic cycle. During a financial crisis, such as the recession of 2008, consumers become sensitive to price changes in products and services that firms offer in the marketplace (Deloitte, 2015). During times of economic hardship, such as an economic downturn, consumers generally tend to consume fewer luxury items, and they begin investing more time in searching for better bargains and want to ensure that they receive the best value for their money. (Ang, Leong & Kotler, 2000) Consumers end up spending more time shopping for deals so that they maximize and attain the best bargains for goods and services purchased. (Ang, Leong & Kotler, 2000) Some consumers may stop spending on recreation altogether. (Shama, 1981) Once the consumer expectation of future income is impaired as inevitably happens during a financial crisis, consumers are less inclined to spend their income on recreational activities. (Deloitte, 2015) Furthermore, the uncertainty as to how long the financial crisis would last also had a massive and negative effect on the performance of the hospitality industry not just in the U.S. but in other international tourist destinations as well. (Spencer, 2008). Ultimately, the uncertainty had a severe effect because of the inability of various players in the hotel industry to predict their sales and make appropriate plans for capital expenditure.
A recession is a very challenging period for any firm in an economy. For those in the hospitality industry, the 2008 financial crises created one of the most difficult periods from both operations and a business investment angle (Deloitte, 2015). The resulting economic uncertainty has a protracted impact on hotel revenues and typically outlasts the economic downturn (Deloitte, 2015). sIn addition, due to the uncertain expectations involved, the capital expenditure planning of hotels is also affected by a financial crisis such as the sub-prime mortgage crisis. Hotels and hospitality businesses should balance their short term concerns to respond effectively to an economic downturn. These concerns include the need for sufficient cash to sustain operations as well as more far looking responses such as changes to product development and placement, pricing, and segmentation.
After the Great Recession, the hotel industry and the hospitality segment (with lodging itself emerging as a leading performer) rebounded in the period post-recession. This impressive performance, however, demands that hoteliers understand the effects and changes that resulted from the 2008 experience and better strategize to ensure that the performance of the industry remains shielded from economic uncertainty. If the hotel industry is to become formidable in the face of unpredictable economic cycles, the industry must embrace the lessons learned from the 2008 downturn and internalizes these lessons as business philosophy. (Corgel & Woodworth, 2012) Having determined that the hotel industry is greatly affected and susceptible to economic shocks and changes in consumer tastes and demand, it is important that hoteliers understand the impact that economic uncertainty has on both the demand and supply sides of the hotel industry. (Deloitte, 2015) Having in mind that economic recessions are inevitable economic cycles, it would best serve the interest of the hotel industry to see hoteliers embrace an understanding of the highly adverse effects of economic uncertainty on the hospitality business.
The impact of the 2007/2008 economic downturn was unprecedented and would have decimated the hotel industry had corrective measures not been taken early in the course of the crisis. It is encouraging to note that the industry recovered well after the shocks from the ensuing uncertainty during the Great Recession.
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