The hospitality industry in Bermuda has been a prominent subject in the local news lately. The recent foreclosure on the Belmont/Newstead Resort and the “special development order” issued for Tucker’s Point has highlighted the dire predicament that the Bermuda tourism industry faces.According to the UN World Tourism Organisation, international tourism recovered from the economic crisis in 2010 with a surge of 6.7 percent compared to 2009. Although cruise ship passenger arrivals rose in 2010, Bermuda’s hotel industry continues to deflate.Based on the three quarters of reported data for 2010, hotel receipts look to have actually fallen roughly two percent last year.There are a couple “outside the box” reasons for this which I will attempt to touch on briefly:1. International Business has Killed TourismThe success Bermuda has had in its international business segment has not come without some unintended consequences. One of these is pricing pressure.Escalating wages and benefits paid to employees in various exempt industries has perpetuated a wage-price spiral over the years in Bermuda which has only recently begun to reverse.These persistent inflationary pressures have trickled out into other aspects of economy from services to housing.Bermuda’s inflation rate has averaged around 3.3 percent over the past 10 years which is about one percent more per year than the US inflation rate.Unionised workers and other salaried employees have demanded to be paid salaries in line with this higher inflation rate. As a result of wage pressures the hotel industry has a cost basis that is still much too high and uncompetitive internationally.For example, it costs roughly $100 per square foot with a wage rate of $4 per hour to build a hotel in the Dominican Republic. In Bermuda, it can cost a developer about $1,000 per square foot with a wage rate of about $20 per hour.Combine these higher building costs and the higher overall wage costs for service workers in Bermuda and you have a very steep cost basis to overcome. This, of course, means you need to charge $400 to $500 a night to make any money. At these rates you need a five-star hotel to compete in the new leisure world of ultra-competitive pricing.The only way hotels can generate acceptable returns now is by lowering this cost basis and improving service.When the Ernst & Young receivership team looks through Belmont/Newstead it will be interesting to see if the resort can make a decent return after stripping out the financing costs.Deflation in the hotel industry will may make this sector much more competitive and hopefully lead to a new period of growth. Until the cost side of this equation is reset, however, I would suspect continued erosion.2. Bring Out the BulldozersI actually think that one of the biggest problems Bermuda faces in its hospitality is surplus inventory.I know this is somewhat controversial because a lot of people you talk to believe we should be building MORE hotels. Growth, however, doesn’t equal prosperity.The reality is that the hotel industry has been shrinking for over a decade. Tourist air arrivals have actually shrunk even more.The “great recession” may have exasperated a trend that has been in effect for many years. This can be illustrated by simply comparing the drop in air arrivals to the drop of hotel room inventory.Since 2000 air arrivals have fallen roughly 30 percent. Over this same period the hotel room count has fallen by only 18 percent and the bed count by only 13 percent.It could be argued that the hotel industry is still oversupplied for its current level of demand. Adding more hotel inventory at this stage seems very counterproductive given the existing stock cannot generate acceptable returns.I don’t think any of us would believe the solution to the US housing problem is to build a lot more houses? One solution to assist Bermuda in creating a viable hotel resort industry may be to simply reduce local competition bulldoze some properties or convert them to residential units.The current situation in Bermuda exhibits some eerie parallels to what went on in the corporate sector of Japan after its bust you essentially have a litany of walking-wounded resorts that are being artificially sustained under receivership.Clearing this underperforming inventory should help firm up the survivors by lowering competition, which hopefully results in sustainable and competitive prices with associated higher occupancy rates.So the whole debate over the Tucker’s Point SDO is mute, in my opinion. The fact is we don’t need further development of hotel rooms since many of the current hotel rooms at Tucker’s Point are empty.HSBC should write off its loan and the hospitality industry should work to optimise the assets they already have.The only exception to this argument may be that Bermuda develops a “Super Resort” that attracts a new set of customers to the island, such as “Atlantis” in the Bahamas. Or we may want to consider adding gambling but that is a whole other debate.Nathan Kowalski is the chief financial officer at Anchor Investment Management. He holds a Chartered Financial Analyst (CFA) designation and Chartered Accountant (CA) designation.