United States

The five greatest risks to financial security


Part I

In the January 2013 issue of this newsletter, it was stressed that clubs need to consider how robust their business risk assessment methodology is. This month, private clubs are advised to delve deeper dive into an area of risk assessment and management where most perennially struggle. This discussion is centered on what are arguably the five greatest risks to financial security. The first two risks are described in this issue and the remaining three will be expounded on in March.

Five greatest risks:

  1. Incremental budgeting
  2. Not raising dues
  3. Believing depreciation is not a real expense
  4. Managing to metrics rather than with metrics
  5. Going cheap with your internal financial advisors

Incremental budgeting
Simply stated, incremental budgeting was exposed for the lazy sham that it is when the great recession sunk its teeth into the private club industry. Years of bloated, padded budgets that obscured mediocre management and poor boardroom governance were exposed at a blistering pace as club after club found it had to adjust to rapidly declining revenue streams. Suddenly unnecessary expenses that had become institutionalized in some clubs were stripped bare as boards woke from their slumber and challenged management to run clubs like businesses. What about the club management that did everything right and has been affected by the members who have reduced resources due to the recession or, in the case of the Sunbelt retirement community clubs, are outliving their retirement nest egg? Realistically, for some “community” clubs, remaining affordable is important to resell the real estate. There needs to be a balance between member cost and the availability of amenities. To restate a familiar theme, clubs should question whether they are operating in support of their strategic plans and missions. Question whether remaining open seven days and offering all services really a viable option. Incremental budgeting will only accelerate decline in these tricky scenarios.

Zero-based budgeting has become the new norm for numerous clubs and has been a life saver for many. Rather than slapping an arbitrary percentage increase on prior-year numbers, management has challenged those responsible for budget development to justify expenditures, down to the underlying performance drivers, such as number of people needed for a restaurant shift or the number of times the fairways are mowed. Zero-based budgeting actually provides a mechanism for doing the unthinkable in the club world—quantifying quality.

Once strategy has been agreed upon by the board and membership during a thoughtful and deliberate strategic planning process, management can place cost estimates around the operational element of that strategy with zero-based budgeting. To elaborate on this statement, consider a mission statement that refers to a “high quality dining experience.” What does that mean when preparing a budget? The club can agree on how many staff members will serve a certain number of covers. It can cost that staff in terms of payroll dollars and budget accordingly. If the cost is questioned as too high by the board, management can then show the changes it can make in terms of reducing the quality of the dining experience—either by reducing the planned number of staff per cover or by using less experienced and presumably less costly staff.

Of course, the board, not management, is then faced with the dilemma of not fulfilling to the club’s mission statement. Simply put, budgeting without a strategic plan is like sailing after the lights of another ship in the dark of night only to find you have been following the Titanic. Conversely, why invest so much time and resources in strategic planning only to fail to link strategy to operations using a zero-based budget that associates cost to the mission and action plans agreed on by the membership.

For more on this topic, an upcoming issue of eClub News will offer thoughts about the risks associated with not raising dues. For now, it will suffice to say that without a zero-based budget methodology justifying dues increases often becomes merely wishful thinking.

Not raising dues
In the most basic terms, not raising dues is a short term approach to keeping a portion of club membership happy while jeopardizing the economic stability of the club for all. The decision not to raise dues is often based in a fear of a mass exodus of members. However, when that is the case, the club has failed miserably with its member acceptance procedures and has admitted members who could not afford to make the lifestyle investment that the private club life requires.

Too often, private clubs run initiation fee specials to lure individuals to join. The membership admittance questionnaire: “Do you have a bank account and a checkbook? Sign here.” What a disservice this approach is to existing members of any club. Does management stop to think about the credit line being advanced to these new members? How many months will it be before the club cuts off their membership privileges? Sixty days? Ninety days?

Consider how unlikely it is for a company in any industry to grant effectively unlimited credit line to a new customer without rigorous credit checks.

Frequently it is the fear of losing these newest members, those whom, had the club done its financial due diligence, would never have been admitted, that causes boards to freeze dues levels. Again, think outside the club world for a moment. Have prices of goods and services continued to rise despite the recession? While there have been deals to be had, inflation has not gone away.

The inflation rate in the United States was recorded at 1.70 percent in December 2012. The inflation rate in the United States is reported by the Bureau of Labor Statistics. From 1914 until 2012, the United States inflation rate averaged 3.36 percent reaching, an all time high of 23.70 percent in June 1920, and a record low of -15.80 percent in June 1921. In the United States, the most important categories in the unadjusted Consumer Price Index for All Urban Consumers are shelter (31 percent of the total index) and commodities other than food and energy (20 percent). Food accounts for 14 percent of total index and energy for 10 percent. Transportation services constitute around six percent of the measure and medical care services five and a half percent. These statistics support the notion that dues rates have to increase to remain in line with inflation.

Too many club boards have tried to cut their way to success – the proverbial circle of death:

While clubs may have fought hard to expand revenue sources over the last few years, the fact remains that the reliance on dues as a percentage of operating revenue has grown significantly. As in any business, if clubs are to avoid the downward death spiral associated with trying to cut their way to the future, then they must increase their largest revenue source—dues must increase.

Only a zero-based budget can offer a method to justify how much dues should be, and any budget should contemplate macro economic factors that might affect members spending ability. For example, all clubs are concerned about the new healthcare law’s impact on club expenses, but not every club is considering this regulation in regards to its impact on club revenue. Club management should consider how many members have business interests that will be impacted by the healthcare law and whether that will reduce the salaries members earn or the profits they can draw from those businesses.

What about the American Taxpayer Relief Act and the impact of higher tax rates members’ disposable income? Might it be better for clubs to raise annual dues rates at the start of the year to hedge against these economic impacts rather than wait to see decreased use of club amenities and a related decrease in revenue as the year progresses?

Another factor that has seen its influence on dues rates grow over the last few years is the decline in traditional methods of capital funding.

To be continued

Another factor that has seen its influence on dues rates grow over the last few years is the decline in traditional methods of capital funding, but that leads into the third risk which will be discussed in detail next month. Be sure to continue reading for more complete explanations about the remaining three risks in the next issue of eClub News.