RE-ENGINEERING TOUR PRICES
de Silva Wijeyeratne, G. (2009). Re-engineering tour prices. LMD. August 2009. Page 153. Volume 16, Issue 1. ISSN 1391-135X.
How the concept of daily mark to market (MTM) in financial markets can be applied to tourism.
The purpose of this article is to explain how certain concepts developed in highly developed capital markets in the west, can be applied even to a small company in Asia, operating in tourism. The particular concept I have in mind is an important financial concept, of Marking to Market.
This very simply means establishing the market value of an asset held by a company. This seemingly simple issue is much more complex than it seems as many assets held by companies are thinly traded and there is no easy way of establishing a market price. Auditors all over the world have this issue with almost any company where certain assets are valued at the financial year end. During my ten years of working in the square mile, Mark to Market (MTM) was an issue that confronted me almost every day, in various roles as an auditor, regulator and risk manager.
Before I discuss the application of MTM in tourism, let me explain a little more on its application in the financial sector. Take for example an investment bank. It will hold a mixture of financial and equity instruments. These financial assets will be either be booked into either what is known as the Banking Book or the Trading Book. Assets in the Banking Book are meant to be held over the long term and are not subject to daily revaluations of the ‘position’. On the other hand, assets bought with a view to selling in the short term at a profit need a daily mark to market. For liquid, quoted instruments, obtaining a market valuation is easy. Valuing a thinly traded corporate bond or an Over the Counter (OTC) option requires a number of assumptions. The idea behind the daily MTM is to see the change in value of positions (i.e the tradeable assets) carried by a trading desk.
In the third quarter of 2008, I began to ask my team to regularly re-value the projected profit on tours which had been confirmed. This was because Sterling began to devalue against the Sri Lanka Rupee. For many years, the exchange rate was not a matter of too much concern to Sri Lankan Tour Operators because the Rupee would generally decline in value and the companies saw an exchange rate gain. In 2008 that changed and a quasi Mark to Market of tour profits and losses (P&Ls) became necessary to keep track of changes in projected profits due to exchange rates.
Let me explain the exchange rate issue with tour profits. Imagine a tour’s income is received in USD and is USD 10,000. Lets assume all the costs are in USD and amount to USD 8,000. The net profit is USD 2,000. If the base currency is Sri Lankan Rupees, the exchange rate gain or loss is simply the change in Rupee value of USD 2,000. If the dollar gains against the rupee by 10%, the base currency profit inflates by 10% and vice versa. In practice a tour will have components of cost which are quoted in Rupees and some in USD. As a result, every component needs to be translated into the base currency and the net profit worked out to quantify the impact of exchange rate movements. What is more, the client may be paying in Sterling. This leaves a tour P&L subject to three currencies, although only two of the currencies give rise to exchange rate risk.
Revaluing P&Ls for tours is tedious. For a small specialist subsidiary, a completely computerized system is not feasible on cost and prohibitively expensive to build if each tour is tailor made. As a result the tours were priced on spreadsheets and the individual components on cost and revenue were entered into the accounting general ledger only on completion of the tour. In a sense this mirrored what goes on to this day in even the biggest and sophisticated financial institutions in the world. Trade capture is on the accounting or position keeping systems, but valuation of exotics is often run on home-made software on laptops.
When I suggested that we move to a daily MTM for all tours there was howl of protest from the Tour Operations Team. How could they find the time to win and book business if they spent their time re-valuing tours? I knew it could be done and set about overhauling the business process. The first problem we addressed was that the spreadsheets mirrored the paper flow and each client had a separate spreadsheet in a separate folder. If 300 tours were under discussion (even if only 100 would run) there were 300 spreadsheets. The first step was to ensure that every tour costing by an operations executive was contained within one Microsoft Exel Workbook. Next, we streamlined the lay out and designed a much more intuitive and user friendly template which contained all the components of costs and revenue. We next built a projected P&L for each tour into the template using the various FX rates prevailing at that point. Besides this was a revised P&L which calculated by converting all currencies into a different Rupee value by reading off current FX rates from a ‘FX Rates’ sheet. Every tour P&L was linked into the ‘FX Rates’ sheet so that when new rates were entered every day into this one sheet, every tour P&L re-computed a Mark to Market P&L and compared it with what had been projected with the original rates.
Each of these tours and their projected P&Ls were then summarized in a summary worksheet. Thus it became possible to have a daily revaluation of all of the pending tours. The time taken for the revaluation and summary was just a manner of seconds. By re-engineering the process, we had possibly saved tens or hundreds of man hours of work that was done at each month end. We had much better control and tighter financial projections. The operations team and the finance function now spoke the same language. There are other aspects of my days in the square mile I have been able to introduce to tourism. But these may have to be the subject of another article.