Risk Management in Hospitality Industry - Essay Example

RUNNING HEAD: Risk management in the hospitality Risk management RISK MANAGEMENT IN THE HOSPITALITY INDUSTRY Module 6SZ002 Hand in Date: 21/05/2010 Name: NAM IL KIM Tutor: Abstract All business activities involve a variety of risks. Risks are events that may occur during the normal operations, whether they are foreseen or not, and which result in the loss of resources. It is the function of management to adequately analyze the risk scenario and be prepared to face the risks with minimized losses. This is necessary both for the organization itself and for the society in which it operates. Euro Disney, the joint venture between the US parent company Walt Disney and the French government had to face severe and unexpected financial and operational difficulties that can be directly traced to a failure of the management in assessing the risks and planning for reducing them. This experience is of immense help to the management studies and the hospitality industry, particularly in these days of great emphasis on globalization and expanding service industry. Risk management 2 Index Page No. 1. Introduction 3 2. Definitions 4 2.1 Peril 4 2.2 Hazard 5 2.3 Risk management 5 3. Approaches 6 4. Euro Disney 8 5. PESTEL Analysis 9 5.1 Political factors 9 5.2 Economic factors 9 5.3 Social factors 10 5.4 Technological factors 11 5.5 Environmental factors 11 5.6 Legal factors 12 6. Micro analysis of Euro Disney 13 7. Conclusions 15 8. Recommendations 15 References 17 Risk management 3 1. Introduction From the days of human existence as food gatherers to the present day global enterprises, mankind faced risks. It is appropriate to say that risk and enterprise go hand in hand. Fortunately, the science of risk management has also been expanding based on the experiences on one hand, and the compelling laws that define an enterprise’s responsibility in the event of a disaster. Industrial revolution and expanding markets gave rise to increased use of machinery as well as laborers in the production processes, thus multiplying risks. The character and expanse of risks are changing from individuals to communities, from human beings to natural environment, from local areas to global spread and much more. From the relatively simple industrial accidents to the massive disasters such as the nuclear power plants at The Three Mile Islands and the Chernobyl plant, the Bhopal Gas Tragedy, the Exxon-Valdez/BP-Gulf of Mexico oil spills we have witnessed the changing face of enterprise risks. Significant developments in the form of globalization is leading to another kind of risk viz., the financial risk that spreads across the globe in quick time as was witnessed during the Asian crisis of the late 90s and the global meltdown in the past two years. With the emergence of the Internet and information technology, newer kind of risks includes systemic problems, fraud, and privacy issues. The term risk could mean deviating from the normal course of a particular structure, activity or establishment, as the case maybe, which means it is probable that something could happen and this is within a range, which is from 0 to 100 percent probability. In other words, it could happen but it’s not a hundred percent certainty. Vaughan states that, “Risk constitutes a condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or Risk management 4 hoped for” (1997, p. 8, cited in Brewer & Huque, 2004, p. 78). “Thus, business risks can range from economic downturn and adverse market conditions to losses arising from natural calamities or man-made accidents, or as a result of corrupt practices of employees and managers of companies. Each contingency may generate financial losses that undermine businesses in achieving what must, no matter what other objectives are pursued, be regarded as the primary objective – namely maximizing profits” (Brewer & Huque, 2004, p. 78). Risk management involves “… supervision and management of an establishment which can have equipment, structures, and processes that need to be closely monitored in the course of production or operation” (Gallati, 2003, p. 5). Thus, businesses can not completely rule out risks and hence they have to be managed. Businesses such as Walt Disney that combine entertainment with hospitality business are spread over wide geographical areas and hence face greater challenges in managing risk environments under different socio-economic and political situations. In order to do this, they need to understand the various facets of risks, mitigation approaches and choose the best combination, using tools such as PESTEL analysis. This is best illustrated by considering the example of Euro Disney in the following paragraphs. 2. Definitions 2.1 Peril: According to Gallati, terms such as peril, hazard, danger, and jeopardy are used interchangeably with each other and with the term risk and he goes on to indicate that where there is a risk there is the likelihood of a loss occurring (2003, p.11). Perils create the potential Risk management 5 for loss and include floods, fire, hail, and so forth. Peril is a common term to define a danger resulting from a natural phenomenon. (Gallati, 2003, p. 11) 2.2 Hazard: Hazards are conditions that increase the risks of a peril’s occurring (Clardy, 2004, p. 126). A hazard is abstract because it is a condition the increases the likelihood of a loss out of the peril. Organizations devise plans to counter risks. Risk management is treated as a task to be performed by specialist managers. These managers need skills to handle risk management, which goes beyond simple insurance management. In order to mitigate the losses due to risks and hazards, organizations resort to corporate insurance management and this job is given to risk managers (Gallati, 2003, p. 11). 2.3 Risk management (RM): Risk management is the protection of all of a company’s assets, including people, property, productivity, and profits. “Managing risks involves taking care of the safety and security of individuals or organizations”(Saied, 1990, p. 46). This is achieved in a scientific manner using a step-by-step approach, according to Gallati (2003, p.11). The practice of risk management began in the early 1950s. The change in attitude and philosophy and the shift to the risk management philosophy had to await management science, with its emphasis on cost-benefit analysis, expected value and a scientific approach to decision making under uncertainty. The development from insurance management to risk management occurred over a period of time and paralleled the evolution of the academic discipline of risk management. According to Gallati, “Operations research seems to have originated during World War II, when scientists were engaged in solving logistical problems, developing methodologies for deciphering unknown codes, and assisting in other aspects of military operations” (2003, p. 12). Assessing Risk management 6 insurance coverage remains an important part of the risk manager’s job, but it is only one element of the complex RM function. The risk manager first must be able to identify and assess potential risks from many diverse sources. Next, the risk manager must determine the loss exposure associated with the risk. Finally, the manager must select the proper risk-management method and implement that plan. The purpose of risk management is for customer concern (Turnbull, 1999), more earnings for the company (Cary, 2000; Cadbury, 1992) and a well-defined processing of products (Godfrey, 1996). Peter Bernstein (2000, cited in Holt, 2004, p. 253) describes risk management as the analysis of possible harm and losses to the company’s income and assets using laws of probability (statistical measurement; regression to the mean; diversification) and utility theory (value judgments; opportunity cost assessments; games theory). 3. Approaches There are four approaches to managing risk. These are: (1) terminate or avoid, (2) tolerate or assume, (3) transfer or shift to others, and (4) treat or prevent. In the case of the hotel service industry, a combination of all four approaches can be used depending on the situation. For example, if there are diving boards for its swimming pool, the hotel may eliminate such diving boards to avoid accidents. It may also cancel alcohol sales in its restaurants to avoid inebriated clients using diving boards. However, hotel guests expect a certain level of service and facilities which include the bar and swimming pool with diving boards and hence the hotel operators tolerate or assume risks. The solution to this is not to assume a risk unknowingly by adopting the other two approaches that involve transfer of the risk to others and prevention. Risk management 7 Insurance coverage is the primary method of transferring a risk from the business to the insurance company. However with increasing premium costs, insuring against risks has become quite expensive. While many hotel companies have responded to increased premiums by increasing deductible levels, more and more companies are switching to self-insurance. Self-insurance can cut administrative costs, encourage better loss-control programs, permit lower contingency-loss reserves, and offer more flexibility and control in handling claims. “A self-insurance program can also be applied to risks that cannot be commercially insured at acceptable rates” (Saied, 1990, p. 46). In contrast to insurance, businesses prefer to manage risks by prevention and control. For example, losses due to theft may be reduced or even eliminated by employing security guards, entry control and burglar alarm systems. Similarly, smoke detectors and automatic sprinklers can control and reduce losses due to fire accidents, notwithstanding the (relatively less) damage that the sprinkler systems may cause in a hotel environment. In other words, businesses need to operate in a reduced risk environment and an important consideration is the costs associated with different kinds of risks and prevention methods. Thus balancing the installation and operation costs of prevention and control systems with the potential losses in the absence of such systems is the crux of good risk management. Sharing the costs of loss prevention and control responsibilities between private firms and public agencies is a method to reduce costs. In the event of insufficient public security services, businesses have to fill up the gaps by direct employment or through outsourcing security to specialist private firms. Thus, business managers need to decide about resource commitments in the face of considerable uncertainties. An additional complication arises when businesses are Risk management 8 located in an overseas jurisdiction. Brewer & Huque state that, “…performance measures of public agencies can be a source of useful information to business firms when good governance principles underpin the work of the public sector in the host national country. Performance measures outlining service efforts, service accomplishments in the form of ‘outputs’ or ‘outcomes’ and cost-effectiveness indicators are valuable sources of information” (2004, p. 86). 4. EURO DISNEY Euro Disney is a $4.4 billion project that was officially opened in Marne-la-Vallée, twenty miles outside of Paris, on April 12, 1992. It was a joint venture between the French government, private investors, and Walt Disney Corporation. Euro Disney Resort is an integral part of the entire theme park development. Euro Disney planned to control exclusively all the hotel operations as part of the entire park operations. Euro Disney Resort was formed as a subsidiary of Euro Disney to manage the lodging operations. The six resort hotels were designed to provide international visitors with a taste of American culture and natural wonders. “The purpose of developing these themed hotels is to continue the excitement and fantasy when visitors leave the park to return to the hotel” (Yu, 1999, p. 24). The development of the six on-site themed resort hotels demonstrated Euro Disney’s great interest in hotel development and management, and Euro Disney’s desire not to share its theme park’s success with other hotel companies. Risk management 9 5. PESTEL analysis 5.1 Political factors Government policies in Europe are geared towards improving the service sector. This is favorable to the industry, which can be seen in the opening of Euro Disney and support of the French government towards this goal. This is a continuation of the European governments’ efforts to create more broad based economies - for a second renaissance in Europe. In the last 50 years, there has been a major evolution in European society from being manufacturing based to being predominantly service based. Botten & McManus elaborate the reasons for this shift as follows (1999, p.2): 1. As industrial societies become richer, they choose to spend a higher proportion of their incomes on buying services rather than physical goods. 2. It has so far proved very much harder to draw out additional productivity from primary and secondary industries. 3. As countries become wealthy, they are able to ‘export’ their profits in the form of investments in other countries. Evidently, a number of countries have invested in manufacturing in other developing countries. Democratic and political institutions of the Western European region support rule of law and hence are similar in nature to the US or UK, enabling similar approach to risk management. 5.2 Economic factors The economies of the developed nations such as the USA, the UK, and countries of the Western Europe are all post industrialization economies with increasing emphasis on services. This shift Risk management 10 was necessitated for several reasons such as high wage costs, shifting of manufacturing operations to developing countries, need to create employment opportunities to which the service sector contributes significantly and last but not the least, the enhanced time and money spent by prosperous population on leisure and entertainment. There is a general consensus of opinion that services are intangible and therefore invisible and yet, European industrialized nations, such as Belgium, France, Italy, and the UK have reported higher employment figures in their respective service economies (Botten & McManus, 1999, p. 1). Hence hospitality industry combined with entertainment is an attractive investment opportunity in Europe. However, it needs to be recognized that the relative affluence of a particular region plays an important role in assessment of damages in the event of a mishap. 5.3 Social factors The social factors in the hospitality sector are very important. Each nation has its distinctive cultural and social identity and global businesses run the risk of failure on management as well as customer satisfaction if such nuances are not adequately factored into in their operations. For example, Walt Disney is an entertainment organization with its primary mission of providing entertainment and hospitality to the American public and hence is steeped in the American culture. It expanded its operations to Japan first and to France later, both of which are culturally very different from the US. The languages, the social mores and the management styles of these countries are distinctly different. Hire and fire system of employment, for example, is an accepted fact in the US while life time loyalty and employment are encouraged in Japan. In order for a business to gain respect and win customers, it must have a good public image that gels with the societal values. Hence, transnational hospitality companies need to tailor their management Risk management 11 styles to be in line with the host countries. Thus, the risk here is generation of multiplicity of management guidelines, each catering to a particular country or region and this can lead to diluted management effectiveness. 5.4 Technological factors Service industry in general and hospitality industry in particular are highly dependent on technology for enhanced customer satisfaction. If the host country is not geared to the same standards of technological support as the parent company and its country, there is the risk of loss of reputation even for the parent company. Added to this risk are the opportunities that exist for fraud in the use of the Internet and technology enabled services such as financial transactions and violation of privacy. Hospitality industry needs to manage such risks with investments in manpower, systems and procedures. All these will add to the costs and reduce profitability but are unavoidable if the risk is to be managed and limited. 5.6 Environmental factors Euro Disney was the result of studies and consultations within Walt Disney Company. Its executives believed that they had to branch out to other cultures such as the Europe, since its films and merchandise are well patronized by Europeans. Within Europe, they looked for possible sites, and those considered were Costa del Sol in Spain and Paris in France; the latter got the nod of most Disney executives, especially the Board. Business wise, Marne-la- Vallée is strategically located because of its proximity to two international airports – Orly and Roissy-Charles-de-Gaulle. Risk management 12 The Euro Disney development provided jobs and contracts for local suppliers which resulted in a good treatment from the Europeans. It hired thousands of employees, laborers and entertainers. These employees would have to be distributed to the different entertainment areas and sectors, for example 6,000 employees for the Magic Kingdom, 5,200 in hotels and surrounding properties, and others in the reaction and support facilities. This was a big boost to the employment opportunities of the locality since the area was suffering from massive unemployment. Economic benefit therefore was one of the outcomes of the opening of Euro Disney. During its opening, the people enjoyed the same satisfaction as those in the United States and Japan. However, Euro Disney has resorts, hotels, entertainment parks that can cause environmental risks if not properly managed. The construction phase involved large scale operations and generation of waste which is not unusual. Managing public perception along with adequate measures to mitigate environmental hazards is an important element of risk management. 5.6 Legal factors In the UK, the hospitality sector is being aided with laws and statutes that promote the service sector. In Europe, there is a boom in the hospitality sector and laws are favorable to further promote this area of the economy. This is not to say that there are no legal risks for running hospitality businesses in the UK or Europe. They do exist and the framework of legal provisions needs to be evaluated against business risks and operational changes made as appropriate. Euro Disney has nearly eliminated the legal risks by promoting itself as a joint venture between the American parent and the French government. Risk management 13 6. Micro analysis on Euro Disney Euro Disney is a joint venture between Walt Disney Co., USA and the French government to develop an enormous theme park and real estate complex on 4,800 acres of land near Paris. Euro Disney went public in Europe at the equivalent of $11.50 a share, shot up to $21 before settling at lower levels (Kiplinger’s Personal Finance, 1990 issue). Euro Disney employs about 5,700 managerial and service personnel during its normal operation, with different nationalities as part of the work force. Market entry timing coincided with the economic recession in Europe, and many European visitors did not want to spend money on the expensive admission fees and resort accommodations. Euro Disney carries with it the American culture and as such encountered opposition from France’s media and many people who criticized the development as a threat to the French culture. This caused an image problem for the theme park as the development was negatively perceived by many French people. When Euro Disney opened, risks involved a weak franc, bad weather and the cultural gulf between the American experience and the French operations. This coupled with economic downturn in Europe resulted in the lukewarm response from the public in the initial period. Park visitors simply weren’t willing to spend money in the park and the Euro Resort hotels were not attracting buyers. In an effort to keep Euro Disney operating, the Walt Disney Company, which had 49% ownership, invested $179 million additionally. With the influx of capital, the park managed to stay open through March 1994. Meanwhile, beginning in January 1994, negotiations began between Euro Disney, its 60 creditor banks, the Walt Disney Company, and the French government, aimed at restructuring a debt of $3.6 billion. This was followed by “Challenge Risk management 14 1994” – a major overhaul of operations, in the hope of devising a new strategic approach to the park’s marketing campaign and employee staffing (Brett, 2000, p. 101). On the operations front, expectations were not met; millions of visitors to the vast entertainment complex did not materialize; revenues and profits were well below targets. The loss that the company incurred was so big – at first $905 million in September, 1993, grew to $1.03 billion US dollars by December of the same year. These losses were a result of management failure on operational and risk management processes. To better understand and manage the situation, Euro Disney had to replace its American Chairman with a French Chairman who could bridge the cultural gap. Euro Disney then changed some of its earlier strategies in setting up Euro Disney including its entertainment parks, resorts and hotels. Problems in staffing, training, and issues in cultural differences, communication, and other matters were providing a challenge to the new management. In their examination of these problems, the management was quick to pinpoint several strategic and financial miscalculations, leading to excessive and wasteful capital investments that did not support profitability of operations. There were operational lapses that could have been avoided. Staffing in the park was not properly studied or planned. The choosing of a heavy turn-out of guests and customers was an error – they could have chosen Monday as a busy one and Friday a light day, but this was not the case. Another problem concerned the French bus drivers who had a hard time with the parking spaces; the parking area was small for the buses and the drivers were complaining. The 50 rest rooms were not enough for the 2,000 drivers assigned to the park. The computer stations at the hotels also posed a problem. The time the guests would stay at the hotels should be noted. First the guests would enjoy the day at the park, arriving in the morning Risk management 15 and stroll at the park the whole day. Later at night the guests would check in with the hotels and in the morning they would go back to the park. This situation provided a busy day and would surely need computer stations at the hotels because of the checking in and out of guests. (Aswathappa & Dash, 2008, p.107). 7. Conclusion The Walt Disney Company did not correctly assess the many risks in its Europe venture – the Euro Disney. While the PESTEL factors were supportive of the venture, the timing and management of the obvious risks was inadequate resulting in huge losses. The situation could be brought under control only when a reassessment of the major risk namely, the cultural differences were recognized and many operational errors were corrected by improved management. The Euro Disney experience has to be studied and given attention in the planning for recruitment and training of people involved in the entertainment industry. There is a wealth of information and knowledge on pitfalls of business expansion into new regions and risk management. 8. Recommendations Hospitality industry is not confined to one particular location and in order for the business to grow it needs to expand into newer territories. When taking decisions on such expansion plans, it is important to spend sufficient time and effort to identify the risks and provide for eliminating or minimizing them. This is more so when an expansion involves moving into a significantly different cultural set up. Euro Disney experience points out that even in a prosperous country like France, there could be times when people are reluctant to spend much money on entertainment. Hence what appears as a viable business proposition in normal times, could become a nightmare Risk management 16 in different circumstances. That itself is one more risk factor that must be considered along with the more popularly identified risks. Risk management 17 References Aswathappa, K. & Dash, S. (2008). “International human resource management”, Tata McGraw-Hill Publishing Company Limited, New Delhi. Brett, J. M., (2000). “Negotiating across cultures”, San Francisco; Jossey-Bass; “Mickey’s trip to trouble: Unsuccessful theme park could be closed” (1994, February 14, Newsweek, p. 34) in Linda K. Stroh et al. “Organizational behavior: A management challenge”, Lawrence Erlbaum Associates, Inc. New Jersey. Botten, N. & McManus, J.(1999). “Competitive strategies for service organizations”, Macmillan Press Ltd., Hampshire. Brewer, B. & Huque, A. S. (2004). “Performance measures and security risk management: a Hong Kong example”, International Review of Administrative Sciences 2004; 70; 77. DOI: 10.1177/0020852304041232. Diprose, R. et al. (2008). “Governing the future: The paradigm of prudence in political technologies of risk management”, Security Dialogue 2008; 39; 267. DOI: 10.1177/0967010608088778. Gallati, R. (2003). “Risk management and capital adequacy”, McGraw Hill Publishing, Inc., New York. Kiplinger’s Personal Finance, April 1990 issue. “Changing times”, Kiplinger Washington Editors, Inc. Vol. 44, No. 4, p. 24. ISSN 1528-9729. Saied, J. (1990). “Approaches to risk management: Cornell Hotel and Restaurant Administration Quarterly 1990; 31; 45. DOI: 10.1177/001088049003100207. Schutt, H. J., n.d. “Preface: Risk management: concepts and guidance”, Defense Systems Management College, Ft. Belvoir, VA. Yu, L. (1999). “The international hospitality business: management and operations”, The Haworth Press, Inc., Binghamton, NY. Read More