insights (2006-06)

Assaying Convention Center Losses

At first blush, the Knoxville Convention Center would appear to be losing money on nearly every convention that’s held there, which begs the waggish question whether the KCC is somehow making it up in volume.

Explanations of the convention center’s modus operandi get pretty esoteric. So unless you have a penchant for economic analysis this column may be hard to follow. However, since the convention center is draining close to $13 million a year in losses (including upwards of $10 million in debt service) that ultimately come out of the pockets of city taxpayers, I believe it’s worth the effort to try to get a better understanding of what’s going on.

The reasons for the KCC’s apparent losses on its convention bookings start with the fact that sales and marketing expenses alone are eating up about 75 cents of every revenue dollar. The city contracts out convention sales and marketing to the Knoxville Tourism and Sports Corp. Under that contract, KTSC will be entitled to get $750,000 from the city in the fiscal year ending June 30 if projected KCC revenues from convention bookings exceed a base figure of $875,000.

During the first half of the fiscal year, KTSC booked 12 conventions whose projected revenues total $498,475. The KCC’s general manager, Craig Liston, foresees bookings during the second half of the year at least equaling the first half. So let’s assume projected revenues from bookings for the whole year of about $1 million, entitling KTSC to its full $750,000 payment.

The city’s finance director, Chris Kinney, acknowledges that “the marketing cost is very high relative to the revenues derived.” But he insists that, “It’s part of a maturation process of getting to the point where you’ve got the right revenues relative to your expenses.”

Kinney points out that in the subsequent years of a three-year contract, the revenue base that would entitle KTSC to a $750,000 payout rises to $950,000 in FY 2007 and $1.1 million in FY 2008. If there’s a revenue shortfall, KTSC’s entitlement would be adjusted downward, but if revenues exceed the base KTSC would be entitled to a bonus of up to $50,000

What pushes convention bookings into the red for the current fiscal year at least are the other expenses that KCC incurs to earn its revenues. Food and beverage sales typically account for close to 75 percent of these revenues, and even with a high profit margin the cost of these sales runs 42 cents on the revenue dollar. So on $1 million in total revenues; food and beverages costs of $346,000 (42 percent of $750,000) coupled with KTSC’s $750,000 payment pushes just the out-of-pocket cost of convention bookings to $1.1 million. The balance of KCC’s convention revenues is derived from space and equipment rentals that don’t entail much out-of-pocket, or variable, expense.

Fixed costs, including KCC’s full time staff of 54, account for the bulk of KCC’s total annual operating expenses of about $5 million. Local events including consumer shows, banquets and the like account for the bulk of its revenues, and because these revenues far exceed associated variable expenses they stand to hold down the convention center’s operating deficit to about $1.5 million this fiscal year, the same as last.

A classic rule of economics is that it makes sense to continue even a money-losing operation if its revenues exceed variable costs and thus contribute to covering fixed costs. But on the face of it convention bookings don’t presently pass that test.

Kinney acknowledges that, “We could reduce our cash out of pocket in the short term by shutting down our [convention] marketing effort, but what does that do for us in the long term? The convention center is a high fixed cost operation, and to the extent we’re filling it up we have quite a bit of leverage on the upside. So the goals are to increase the revenues overall, improve the mix of business, and over time reduce the marketing expense relative to these revenues.”

The thing that keeps convention bookings from being the money loser they appear to be on the surface is the tax revenue generated by conventioneer spending in Knoxville. According to what the KTSC classifies as industry standard assumptions, convention delegates spend an average of $230 per day.

KTSC also projects that the 12 conventions booked during the first half of the fiscal year 2006 will beget 24,650 delegate days of spending. Under the overly generous assumption that all of this spending is subject to sales tax and all of it takes place in the central business district where the city is entitled to a six percent sales tax keep, then the city would realize $340,170 in sales tax revenues ($230 x 24,650 x .06). Annualized, that’s $680,340 that would go a considerable way toward covering the convention center’s operating deficit.

The city also has a 3.5 percent hotel/motel tax. Applying that to an industry standard $84 per diem for delegate lodging yields an additional $150,000 in annual city revenues. So the convention center may not be as big a loser for the city and its taxpayers as would appear to be the case from looking at convention revenues and expenses alone. And the KTSC may actually be earning most of its keep even before taking into account a 1.57 multiplier that it applies to direct convention spending in calculating total economic impact.