International Hotels: Escape the Foreign Exchange Hedging Trap with Rev. Mgmt

It turns out that revenue managers have more in common with foreign exchange (FX) analysts than they might think, except that revenue management carries a lot less risk than does trading in foreign currency markets. Not only that, but hotels (and certain other hospitality firms) act as currency hedgers in the normal course of business. As explained in a new report from the Cornell Center for Hospitality Research, hotels' operational currency hedging occurs as a consequence of the changes in "real" room rates and occupancy that arise from changes in relative currency values.

 

Available at no charge, the study, "Operational Hedging and Exchange Rate Risk: A Cross-Sectional Examination of Canada's Hotel Industry," by Charles Chang and Liya Ma, examined how the profits of 1,032 Canadian hotels fared as the Canadian dollar appreciated against the U.S. dollar in the mid-2000s. As is true in any nation, the experiences of hotels with a large international clientele (and foreign ownership), is different from that of hotels with local customers and local owners.

 

The challenge for international hotels is the effect of foreign exchange rates on profits. Generally, guests pay in the local currency, but the profits are often repatriated in dollars, euros, or yen. The problem occurs when the currency values change to the detriment of the local currency. At once, a hotel is earning "less money." Many companies become involved in foreign exchange hedging to offset the negative effects of currency changes, but that is a potentially expensive strategy that involves expert FX traders.

 

Instead, hotels and other companies that use revenue management to adjust rates effectively gain a foreign currency hedge through their normal operations. Here's how that works. Assume that a particular currency loses value against the U.S. dollar. Two things might happen. First, international travelers who are carrying dollars would find that hotel to be suddenly "less expensive" to patronize, even though the hotel hasn't changed its rates, as stated in the local currency. Because the hotel seems less expensive, more travelers stay at the hotel. Here's where the revenue management system takes over. Because demand is increased, the RM system recommends raising the hotel's rates, again stated in local currency. This doesn't necessarily discourage the international travelers because in dollar terms the hotel's rooms are still effectively a bargain.

 

Changes in RX and RM
The question that Chang and Ma investigated is whether all of those changes in FX and RM end up helping the hotel's "real" profits, hurting profits, or being just a wash. Based on their study of the Canadian hotels, hotels make out better in dollar terms because their revenue per available room is kicked higher by both higher rates and higher occupancy, even after the currency conversion.

 

The entire scenario works in reverse. If the local currency appreciates against the dollar, revenue management can help maintain occupancy by cutting nominal rates in the local currency. Since that currency is worth more, the resulting revenues remain relatively strong. Thus, Chang and Ma conclude that international hotel firms should reconsider expensive and risky FX hedges. Although they considered only the exchange between the Canadian dollar and the U.S. dollar, Chang and Ma note that this analysis has held true for several other nations and currencies, including the United Kingdom, Italy, Australia and South Africa. They concluded, however, that this process does not apply to hotels that do not draw a large international clientele or those that do not have to repatriate profits in a different currency. Likewise, the operational hedge is more effective for large hotels than for small ones.

 

 

RELATED ARTICLES