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The Marriott Company has three major lines of business, including lodging, contract services, and restaurants. Lodging operations include 361 hotels, with a total room count of over 100,000. These establishments range from full-service, high-quality hotels and suites to more moderately priced hotels, known as the Fairfield Inn. In 1987, 41% of sales were generated by lodging, along with 51% of profits.
Contract services entail food and service management for health-care and educational institutions and corporations. Airline catering and services are also included by means of Marriott In-Flite Services and host International operations. These generated 46% of sales in 1987 and 33% of profits.
Restaurants include Bob's Big Boy, Roy Rogers, and Hot Shoppes, which resulted in 13% of sales for 1987 and 33% of profits.
Marriott's financial strategy includes four key elements: 1) Manage rather than own hotel assets; 2) Invest in projects that increase shareholder value; 3) optimize the use of debt in the capital structure; 4) Repurchase undervalued shares.
In 1987 Marriott was the developer of more than $1 billion in hotel properties. As such, it was also one of the ten largest commercial real estate developers in the United States. The integrated development process included identifying markets, creating development plans, designing projects, and assessing possible profitability. When properties have been developed, they are then sold to limited partners. Thus, Marriott relinquishes ownership, while at the same time retaining management of the properties as general partner. This is managed under a long-term partnership contract. Management fees usually amounted to 3% of revenues plus 20% of profits. A portion of the partnership's debt was also guaranteed by Marriott.
To enable investments in projects that would increase shareholder value, Marriott uses the discounted cash flow technique to determine which investments would be most likely candidates. The rate is then based on market interest rates, project risk, and risk premium estimates. Cash flow forecasts are based on standard companywide assumptions for consistency across projects. These projects are then audited across their lifespan to determine their viability throughout.
The use of debt in the capital structure is optimized by focusing on the company's ability to service its debt. It is then used as a target for interest coverage rather than a debt-to-equity ration.
When repurchasing undervalued shares, Marriott calculates a warranty equity value for its common shares. Those that were found to fall substantially below the calculated value would then be repurchased. Checks were made by comparing Marriott's stock values against those of other, similar companies. When undervalued stock was then repurchased, the company experienced this as a better use of its capital than owning real estate or investing it in additional stocks.
In general, the goals and strategies of the company therefore focused on increasing its overall value and profits.
When considering the historical patterns of performance for the company, these goals and strategies seem to have worked well. The company showed substantial growth in its sales and profits from its three core businesses.
In 1987, Lodging generated 41% of sales and 51% of profit; contract services provided 46% of sales and 33% of profits; while restaurants provided 13% of sales and 16% of profits. According to the case, one potential pitfall in the company's financial strategy could be the company's divisional hurdle rates. These could substantially affect the company's profitability, since increasing the hurdle rate could decrease the current value of project inflows. The anticipated net value of projects could therefore be affected and the company's growth affected. Should hurdle rates decrease, however, the company's growth would accelerate.
One strategy to handle this is using the hurdle rates to determine incentives for company executives. Incentive compensation is a substantial proportion of total compensation, which could range between 30% and 50% of base pay. Criteria used for the payment of these bonuses include the ability of managers to meet budgets, as well as their job responsibilities and earnings level. Using the hurdle rates to pay these compensatory incentives would make managers sensitive to Marriott's financial strategy and capital market conditions, which might be the optimal way to provide incentives for loyalty and excellence.
Before such decisions are taken, the company might do well to analyze the performance of its specific types of business. The highest profits, for example, have been resulting from the lodging business, followed by contract services, with the restaurant business being at the lowest end of the profit scale. When deciding to invest in further enhancing businesses then, the company might make the decision to focus on the more profitable business, particularly in the light of the division hurdle rate. The restaurant business is then also the most vulnerable to changes in the hurdle rate. When the rate, however, decreases, the restaurant business stands to gain the most ground.
The company's decision for business focus would then be dependent upon the hurdle rate and upon the actual profitability of the business in question. The hurdle rate has historically decreased, meaning that it is likely to continue doing so. This means that the company is likely to continue seeing profits in the future.
The cost of capital opportunity for Marriott is calculated by means of using debt capacity, debt cost, and equity cost that is consistent with the amount of debt. The three divisions of Marriott varied in terms of these calculations. The capital debt for Marriott in general was shown at 60%, its fraction of debt at floating at 40%, its fraction of debt at fixed 60%, and its debt rate premium above Government at 1.3%. For its lodging component, these numbers were at 74%, 50%, 50%, and 1.1% respectively. For contract services, the values were at 40%, 40%, 60%, and 1.4%, respectively. For its restaurants, the numbers were at 42%, 25%, 75%, and 1.8%. It is interesting to note the substantial difference between the restaurant component and the other divisions of the business.
Since there is such a substantial difference between the Fraction of debt at floating and the fraction of debt at fixed for the restaurant component, the decision may be made to pay more attention, financially speaking, to the other components.
In terms of the financial strategies outlined, for example, the company might focus on restaurants when repurchasing undervalued stock, but focus more on the lodging business when investing in projects to increase shareholder value. Contract services are also a good candidate for this, since being at the middle in terms of financial strength, this component has significant room for growth without creating a potential burden for the company.
Action plans should therefore focus on investing in strategies and aims to create profit where substantial growth has been shown. The restaurant component of the business has been showing the lowest growth and profits of all the components. It should therefore be lowest on the list of priorities when planning to increase profit and sales goals. The first priority should be the corporate service business, since it has shown substantial profits, but also demonstrates room for growth.
The nature of the business world today is also such that a company can draw great profit from offering innovative and targeted services. In addition to its current services, Marriott could therefore invest in creating new services for increasing the profit of this division. Executives and managers could then be offered incentives for creating innovative new service ideas that the company can implement.
In addition, the most profitable component, the lodging business should receive second priority when devising ways and means of increasing profit. A good strategy here might be to repurchase undervalued stock, as these values could be highly flexible and it is so closely connected to the real estate business. The company's strategy to manage rather than own the lodging business also seems to be working well.
Although lowest on the priority list in terms of decision-making, this is not to say that the restaurant component should be dismissed from attention. Instead, actions that could be taken here is also to invest in innovation. The food industry is potentially profitable, especially when taking into account the specific regional tastes of a demographic. Marriott might consider expanding its restaurant business towards other areas in order to explore these possibilities. Food themes are an example of investing in strategies that might be useful in this regard.
For contract services, paying incentives for new service creation could impact substantially on operating profit. However, once the new innovation has been implemented and is running, the profit margin is likely to right itself and to grow as the service comes into increasing use.
Lodging is unlikely to show great growth, since there is little innovation in this regard. Operating profit is likely to remain at a relatively stable rate, unless something specific occurs to affect it, such as a sudden recession or unforeseen disaster.
Restaurants have substantial room for growth in terms of location and innovation. Food can be offered to differentiate these restaurants from their competitors. One idea is to add a local and cultural…[continue]
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