Capacity crunch

By Richard N. Velotta

Friday, April 24, 2009 | 2 a.m.

Times are tough in the Las Vegas resort business, and they are about to get a lot tougher.

Hotel room occupancy and rates plummeted last year as the bottom fell out of the demand side of the supply-demand curve. Resort operators are bracing for a big challenge on the supply side as CityCenter and Fontainebleau prepare to open before year’s end, part of a capacity increase of more than 12,000 rooms that threatens to send rates spiraling lower.

Last year’s shake-up on the demand side was dramatic. Although visitation was off 4.4 percent to 44.1 million people in 2008, the average daily room rate plunged 9.8 percent to $119.19 a night. That compares with an average rate of $132.09 in 2007, the all-time high, and $119.66 in 2006.

The Las Vegas Convention and Visitors Authority calculates the average daily room rate based on a monthly survey of hotels and motels. The monthly figures fluctuate through the year because of demand. Typically, the hot summer months and the family-oriented time between Thanksgiving and Christmas are slow periods, a pattern that held true during the past few years.

With room charges, restaurants and entertainment amenities playing an bigger role in a resort’s revenue, the average daily room rate has become crucial.

An average Las Vegas megaresort has about 3,000 rooms. With 365 room nights each year and occupancy levels about 90 percent, every dollar change in room rates represents a potential shift of about $1 million in revenue.

The challenge that lies ahead for Las Vegas is that while visitor volume and average daily room rates are in decline, room capacity is on the verge of a major expansion. Southern Nevada has already added 390 rooms this year with the March opening of M Resort.

By the end of the year room capacity is expected to increase 8 percent to 156,696. Among the 12,563 rooms coming on line are nearly 6,000 at MGM Mirage’s CityCenter — 4,004 at Aria, 1,495 at the condo-hotel Vdara and 400 at the nongaming Mandarin Oriental. Another 3,815 are to open at Fontainebleau at the north end of the Strip. Expansions will account for nearly another 1,000, with 490 new rooms at the Hard Rock and 500 in a new tower at the Golden Nugget.

Las Vegas’ history has been filled with periods of explosive capacity increases, but resorts absorbed the growth and higher room rates as the new resorts generated excitement and a lot of visitors. Visitation growth outweighed capacity increases 20 years ago when Mirage and Excalibur opened, 16 years ago when MGM Grand, Luxor and Treasure Island debuted and a decade ago when the biggest cluster opened: Bellagio, Mandalay Bay, Venetian, Paris Las Vegas and the Aladdin’s remodeling.

But with Nevada and the world grappling with the worst recession since the Great Depression, banking on a visitation boost big enough to overcome the capacity increase isn’t the safest bet.

Alan Feldman, senior vice president of public affairs at MGM Mirage, said the result of the most recent capacity expansion ran counter to historic trends, citing the Palazzo and Encore openings in 2008.

“Even with great products like those, consumers didn’t respond the way they did in the past,” Feldman said. “I can’t remember a time when a new product didn’t drive occupancy and, ultimately, ADR (average daily room rates).”

Jeremy Aguero, principal analyst for Applied Analysis, a Las Vegas-based economic consulting firm, said he expects the issues of capacity and driving higher room rates will be around for at least three years, but he also thinks MGM Mirage may be best equipped to address it.

“The guys at MGM Mirage are smart, and I expect they will sustain market share,” Aguero said. “They are uniquely positioned to provide something for everyone in the market and it has been an advantage to them.”

He was referring to MGM Mirage’s diverse marketing strategy that offers high end resorts such as the upcoming Aria and the Bellagio, to the budget products Circus Circus and Excalibur, and every market in between.

Aguero thinks it’s possible that underperforming properties or portions of hotels would be closed. But he wouldn’t speculate which ones they would be.

There is precedence for such drastic action: During the winter lull Herbst Gaming closed hotel rooms Mondays through Thursdays at Buffalo Bill’s in Primm, and Black Gaming cut capacity by closing rooms at the Oasis in Mesquite.

Would MGM Mirage reduce capacity and close some of its rooms when CityCenter comes on line?

Feldman acknowledged it’s an option, but at this point, not a likely one.

It isn’t a matter of just closing a tower or several floors in one wing of a hotel. There’s much more to the art of yield management or hotel management systems that attempt to maximize room rates and occupancy.

Feldman said finding the right mix in capacity is “like playing multidimensional chess.”

“As to where things are going, it’s not an easy answer,” he said. “It’s a complex organism, this thing we call yield management.”

Many companies in the tourism industry have yield management formulas, which involve optimizing revenue opportunities based on inventory, which has a finite shelf life. For airlines, the value of the product ends as soon as the plane leaves the gate. For hotels, tonight’s hotel room can’t be restocked and sold tomorrow.

The airline industry has cut capacity by grounding some planes and eliminating flights to drive up ticket prices.

Cutting capacity is riskier in the resort industry because other revenue could be affected if rooms are closed.

“We may end up harming our casinos, restaurants and entertainment offerings, which could result in less overall spending per night,” Feldman said. “It’s a pretty involved calculation. Most of our properties are sized in such a way that they work best when near full capacity.”

In addition, closing rooms means laying off employees, a move MGM Mirage doesn’t want to make.

“We want to keep as many workers employed as possible,” Feldman said. “We don’t want to lose people and go through excessive turnover because we’ll need an experienced workforce when things turn around, which invariably they will.”

Bill Lerner, a Las Vegas-based gaming analyst with the newly formed Union Gaming Group, doesn’t expect MGM Mirage to close rooms.

“To take supply out of the market probably doesn’t make sense,” Lerner said. “That’s not how multiproperty operators view the world anyway.”

But he expects CityCenter will cannibalize business from existing resorts, including MGM’s.

The result likely will be a longer period of absorption as demand catches up with capacity and room rates gradually return to 2007 levels. It also means the likelihood of a five- to 10-year hiatus in Strip construction.

Lerner anticipates projects that are under way will be completed, including the Cosmopolitan in 2010. How Boyd Gaming’s uncompleted Echelon plays out is unknown, as that company is leaving its options open and has discussed the possibility of scaling down the project.

Aguero said educating tourists about available bargains is the way to go while Las Vegas weathers the recession.

“We need consumer confidence and consumer spending to rebound,” Aguero said. “What we need to have happen is for the nation as a whole to see some clear and consistent signs of a recovery.”

Educating the public through advertising and marketing may be the best way to deliver the message.

“If you look at San Francisco, Chicago, Los Angeles and New York, we remain a value proposition,” Aguero said. “Las Vegas is in a much better position competitively.”