1. COMPLIMENTARY TEACHING MATERIALS
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3rd Edition Strategic Management
In Tourism
Edited by
LUIZ MOUTINHO AND ALFONSO VARGAS SÁNCHEZ
COMPLIMENTARY TEACHING MATERIALS

2. Financial Management in Tourism
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CHAPTER 9
Financial Management in Tourism
JAMES M. WILSON AND LUIZ MOUTINHO

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LEARNING OBJECTIVES
To develop an understanding of the financial effects of management decisions and policies.
To develop a comprehension of the impact of pricing policies on an organization’s financial performance.
To develop an appreciation of service and product design issues and their relevance to financial performance.
To present a perspective on the financial consequences of alternatives available for promoting an organization’s services and products by developing a basic comprehension of financial statements and their relevance for management decisions.
To show how the marketing mix interacts with financial management and the impact different elements within the mix may have on an organization’s finances.

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STRATEGIC MANAGEMENT IN TOURISM
A basic understanding of financial management is essential for managers in the tourism industry.
Financial management is central to planning, measuring and controlling many activities and managers that understand and can use this information can act on it more effectively.
The learning objectives focus on those dimensions of financial management most relevant to a manager’s effectiveness.

5. A key decision is identifying and developing products and services:
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STRATEGIES
A key decision is identifying and developing products and services:
new products/services to be introduced, or
old ones to be withdrawn or ‘improved’;
product/service ‘ranges’, ‘lines’ and ‘portfolios’;
product/service positioning vis-à-vis competitors;
branding; and
product/service and facility characteristics.
This investment is made with a view to potential returns from their successful exploitation later.
The supporting marketing research that helps understand markets and their needs is also a form of investment.

6. New service introduction case
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STRATEGIC EXAMPLE
New service introduction case
A new service will cost a total of £250,000, it has a 5-year life expectancy and yields sales revenues of £300,000 in the first year increasing by £100,000 annually until the end of the fifth year, with direct costs of 70% of revenues and allocable overheads of £75,000 per annum. Depreciation of new equipment is £20,000 annually with no salvage value at the end
The company pays 40% tax on its profits.
Similar projects in the past have been evaluated using a 15% discount rate.
Is introducing this new service beneficial?

7. Financial cost/return (£000)
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TABLE 9.1
New product assessment
Financial cost/return (£000)
Year 1
Year 2
Year 3
Year 4
Year 5
Sales revenues
300
400
500
600
700
Direct costs
180
240
360
420
Gross profit
120
160
200
280
Selling and administrative overheads 75
Depreciation 20
Profit (loss) 25 65
105
145
185
Tax 10 26 42 58 74
Profit (loss) after tax 15 39 63 87
111
Cash 35 59 83
107
131
Time-phased analysis of the impact of introducing the new service.

8. TABLE 9.2 1/(1.15) 1/(1.15)2 1/(1.15)3 1/(1.15)4 1/(1.15)5 0.15 0.870
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TABLE 9.2
Discount factor
1/(1.15)
1/(1.15)2
1/(1.15)3
1/(1.15)4
1/(1.15)5
Discount factor
0.15
0.870
0.756
0.658
0.572
0.497
Cash × discount factor = discounted income (£000)
35 × =
30.5
59 × =
44.6
83 × =
54.6
107 × =
61.2
131 × =
65.1
Total discounted income (£000)
~ 256
(unrounded 255,979)
Cost (£000)
250 
Net benefit (£000) 6 
Projected discounted cash flows.

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Discussion:
A simple analysis of the undiscounted cash flows shows the investment to be attractive, with the income (415) much greater than the investment (250).
But considering that costs are paid ‘up front’ while the income occurs in the future – and could be risky – means that such a simple analysis is too basic.
Discounting to consider both the effect of time, and perhaps to allow a risk adjustment gives a more realistic assessment.
The comparison is now much closer – this consideration of the impact of time and alternative investments that might be made significantly reduces the economic attractiveness of this proposal.
The total discounted income is now reduced to only £256,000 compared with the costs of £250,000 leaving the net present value of only £6000.
So long as the NPV is positive the proposal is considered viable, but there may well be other proposals with higher NPVs to compete with for limited investment capital.

10. Economics-based, considering supply and demand issues.
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PRICING APPROACHES
Product/service price setting is important for sales volume and profitability. Alternative approaches may be categorized as:
Accounting-based, dominated by cost considerations (‘cost-plus’ pricing).
Economics-based, considering supply and demand issues.
Market-based, considering its customers and competitors.
All pricing policies have financial implications.

11. Examples of market-based pricing are:
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MARKET-BASED PRICING EXAMPLES
Examples of market-based pricing are:
‘reference’ pricing based on competitors’ prices
‘skimming’ pricing, with an initial high price, that is then reduced
‘penetration’ pricing, with a low price to build market share
‘target’ pricing, with product/service designed and priced considering consumer expectations.

12. £ Phigh Qhigh BREAKEVEN PRICING EXAMPLE Total costs Total revenue,
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BREAKEVEN PRICING EXAMPLE
Total costs
Total revenue,
High price
Per unit costs
Phigh
Fixed costs
Qhigh
Quantity

13. £ Plow Qlow BREAKEVEN PRICING EXAMPLE Total costs Total revenue,
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BREAKEVEN PRICING EXAMPLE
Total costs
Total revenue,
Low price
Plow
Per unit costs
Fixed costs
Qlow
Quantity
A lower price means more have to be sold to recover the fixed costs

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Yield management
Yield or revenue management has become a valuable tool for effective pricing. It is now common for
Airlines,
Railways,
Hotel chains,
Car rental companies,
to maximize the revenues that their services generate.
This relies on price discrimination: charging different customers different prices for identical goods or services.

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Yield management
Objective: charging the right price to the right customer for the right services at the right time. This requires:
1. Limited capacity.
2. Limited availability.
3. Identifiable market segments – Customers willing to pay different prices.
Ideally, an organization would like to charge every customer the maximum price they’d be willing to pay.

16. Yield management Example
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Yield management Example
An example of price discrimination with ‘peak’ vs. ‘off-peak’ pricing, as commonly seen in airline and hotel pricing.
This may help maximize profits as well as shift demand from the peak to the off-peak period to better use the limited capacity.

17. Yield management Example
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Yield management Example
Weekday Weekend Weekend
Price Using “normal” weekday price Using lower, weekend price P2
Revenue lost due to lower Price D1 D2
MR1
MR2 P1 D2
Revenue gain due to higher Sales
MR2 Q1 QA QB
Increased sales to price-sensitive customers.

18. Yield management Example
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Yield management Example
The graph on the left shows a normal pricing policy using conventional economic theory and equates its marginal revenue to its marginal cost and charges price P1 to generate a sales volume of Q1.
But if this same price were applied to its weekend demand it would then find more price-sensitive customers (Demand curve D2) would go elsewhere.
A somewhat lower price at P2 could then attract these customers, and the added sales volume at QB generate more revenue than would be lost through the price reduction.
So a lower price at weekends will maximize profits, the weekday travellers would not generally shift to weekends, and vice versa.

19. Promotions: ADVERTiSING Example
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Promotions: ADVERTiSING Example
Do organizations benefit from advertising expenditure, or not?
This issue may be addressed using an accounting perspective.
What overall impact does advertising have on increasing revenues relative to the costs involved?

20. Without advertising (£)
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TABLE 9.3
Profit and loss (typical month)
Without advertising (£)
With advertising (£)
Implications
Revenues
100,000
120,000
Advertising increases sales by £20,000
Cost of sales
90,000
108,000
COS increases proportionately.
Note, some promotional activities may involve disproportionate changes – discounting, or higher sales commissions, for example.
Gross profit
10,000
12,000
Fixed costs
General overheads
5,000
The general overheads will not be affected by increased advertising.
Advertising
Cost of advertising
Profit
2,000
 Tax
2,500
1,000
Rate = 50%
 Net profit
Impact of advertising on increasing revenue

21. PROMOTIONS: SALES INCENTIVES Example
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PROMOTIONS: SALES INCENTIVES Example
Do organizations benefit from increasing incentives given salespeople, or not?
This issue may also be addressed using an accounting perspective.
What overall impact do sales incentives have on increasing revenues relative to the costs involved?

22. Salesperson’s commission (£)
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TABLE 9.4
Profit and loss
Salesperson’s basic salary (£)
Salesperson’s commission (£) 5%
10%
20%
Revenues
5,000
12,500
17,500
22,500
COGS (70% of revenues)
3,500
8,750
12,250
15,750
Sales commissions
125
500
1,250
Gross profit
1,500
3,625
4,750
5,500
Fixed costs
Profit
1,000
3,125
4,250
Tax
1,562.5
2,125
2,500
Net profit
Profitability and sales commission rates.

23. This is true for both broadly targeted promotions such as: advertising
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PROMOTIONS: SUMMARY
Promotion costs are paid not from the increase in total revenues but from the increase in gross profits.
This is true for both broadly targeted promotions such as:
advertising
public relations
and more focused, sale-specific promotions like:
price discounts
sales commission.

24. MARKETINg and ITS FINANCIAL IMPACT
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MARKETINg and ITS FINANCIAL IMPACT
The basic financial statements may reveal the impact of various marketing strategies, policies and practices on the organization.
The Profit and Loss statement shows their effects over a period of time.
The Balance Sheet shows their effect at a specific time.
Both can provide valuable insights into marketing questions:
Where are we now?
What effect have marketing activities had?