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The Room Rate Conundrum: The Leap from Tactical to Strategic
By Dr. Gabor Forgacs
Hoteliers make tactical room-rate adjustments on a daily basis. They're driven by the need for higher occupancy, increased cash-flow, and, in some cases, they want to prove to their owners that they're working hard to be profitable. But, they also need to be sure strategic decisions are in line with their hotel's objectives. And, at the end of the day, they need to ask themselves whether they truly want to compete on room rates at all.
Consider this: a hotelier may decide to aggressively lower room rates from $179 to $119 when occupancy dips below 60 per cent. As a result, they offer a price incentive to stimulate demand, but the results are discouraging. While they gain a few occupancy points, RevPAR takes a nosedive and the hotel attracts a new customer who wants everything free, including parking, Wi-Fi and a buffet breakfast. The new guests order takeout from a local restaurant rather than eating in the hotel's dining room. And they moan about everything, just to force an apology and perhaps get a discount at checkout. Is this the new normal? Thank goodness the scenario is purely imaginary. Or is it? If it sounds vaguely familiar, read on.
Hoteliers need to ask themselves if lower room rates lead to higher occupancy, why don't profits improve? Simply stated, it depends on how much they discount and what clientele they attract. Let's look into the changes both from quantitative and qualitative perspectives.
QUANTITY OF UNITS SOLD
There are two key variables at play: rate and occupancy. It's difficult to increase occupancy enough to generate so much more net-room revenue (rate minus variable costs) that it covers the net-revenue shortfall that results from the lower rates. The room rate may drop, but cleaning costs don't. For example, if there's an $18 variable cost (labour plus laundry plus supplies) to clean an occupied room, and the hotelier is unhappy with 60-per-cent occupancy, the numbers reveal an occupancy of 95.6 per cent would be required to break even, meaning it would generate identical net-room revenue if our average rate is lowered from $179 to $119. Hotel management textbooks can be consulted to find the simple formula that calculates identical net-room revenue at various room rates. In the given scenario: (179-18) divided by (119-18) multiplied by 60 per cent equals 95.6 per cent. It's up to a revenue manager to consider whether high occupancy is realistic to achieve. The formula is good to run scenarios. If the average room rate is $129 then 87-per-cent occupancy would do, for same net-room revenue.
Data from Cornell University's Centre for Hospitality Research conclusively shows hotels can expect on average a 1.3-per-cent rise in occupancy after every 10-per-cent room-rate discount. If you can't improve the financial performance of the business, why would you expect discounted rates to lead to an increase in profit? The financial performance of a hotel will improve only if it's able to gain a significant, double-digit jump in occupancy at slightly lower rates.
QUALITY OF THE CLIENTELE
Guests who respond to a discount rate are bargain hunters. They're not brand-loyal but rather price-loyal, and they go wherever so-called sweet deals are found. They select a hotel at their destination based on room rates. If the hotel can lure them away from the competition on occasion, it may boost occupancy by stealing market share. Next time, when someone more desperate undercuts rates, you'll know where these travellers will choose to stay. Unfortunately, there's no protection against undercutting. It can happen any time a competitor is more aggressive. In other words, hotels can't build and retain marketshare, and they can't hope to expand their customer base. The war cannot be won even if the industry wins a few pricing battles. It's true, the hotel may attract a deal-hunter segment that is neither possible nor worthy of retaining. But the question remains: why is the industry so desperate to impress and attract these potential guests?
THE EASY WAY
How resource intensive can changing room rates be? Well, it depends on how many mouse clicks are required to change a Best Available Rate (BAR) from $179 to $119. That's the easy way. It's much harder to identify other ways of gaining a competitive advantage. Hotel operators need to elevate their thinking from tactical level solutions to strategic thinking.
First, it's important to develop a solid understanding of your target market's needs and preferences. Then you need to invest time and resources to find relevant differentiation and communicate it to your guests. That's where Customer Relationship Management (CRM) comes in. Transactional information, customer history and customer intelligence can be tied together for maximizing the lifetime value of return guests. Docking station for iPods? In-room exercise machines installed on request? Introducing a new foodservice concept? A door lock that can be opened by a smartphone? The industry has a plethora of exciting new solutions to select from a cost/benefit analysis. Strategic decisions are not always easy.
Lastly, we have to tackle the hottest and fastest-paced strategic issue, which is distribution channel management. It is the channel the largest volume of booking comes through. Channel costs and booking volume need to be analyzed. Other questions need to be answered as well. For instance, do you need to create a mobile-friendly version of your website? Are you going to harness the potential of social media? Can you leverage your location to push quick-response digital coupons to potential guests within a perimeter and engage in location-based mobile marketing? It's only the tip of the iceberg.
It would be unfair to suggest that discounting room rates is the easy way of boosting occupancy for the lazy revenue manager. But it needs to be pointed out, unlike dropping room rates, the development of sustainable competitive advantages will be the result of hard work, and they may not produce overnight results. Room rates should be the last item to touch. The industry has worked too hard to be in the position of charging, for instance, $179 a room night. It has earned market acceptance and built a clientele. Hotels have an image and a reputation to manage. Should all these be thrown out because the industry has gone through a turbulent time? What if you discount pay-per-view movies and parking fees but hold your rate for core product?
Room rates are too important to play a continuous game of push and pull. Hotel brands that hold firm on rates and don't dilute their rate integrity are typically the first to lead ADR recovery after a market slump. Reducing RevPAR is fast. Rebuilding it, after heavy discounting may take years and it will be an uphill battle.
REVPAR OR GOPPAR?
It depends on what you need to learn. Room rate is a crucial component in all measures that are worth tracking and benchmarking. Comparing RevPAR to past years can reveal top-line performance by indicating how well hoteliers have played the hand they were dealt. It is useful to look beyond it to see whether RevPAR changes are driven by ADR or occupancy, so hoteliers can learn from their own successes or mistakes. A RevPAR penetration index within your own comp-set can help interested investors see how well the hotel has lived up to its business potential compared to peers.
Many hotels are run by management firms. Regardless how impressive RevPAR is, it may not be a sufficient measure for the owners because their interest lies in bottom-line performance. That's the reason behind the growing popularity of gross operating profit per available room (GOPPAR). Cost-efficient operators truly may be identified more accurately through GOPPAR, because RevPAR doesn't reflect cost containment.
RATES, PERCEPTIONS AND PRICE SENSITIVITY
Price adjustments or tangible products can be justified. If there's more horsepower or an extra cup holder in a car, or a 15-ounce steak compared to a 12-ounce, the customer will understand. So, what about a room night at a hotel?
What if last week a hotel charged $119 super-saver rates and this week the room rate is back to $179? The guest is greeted by the same doorman, checked in by the same GSA, sleeps in the same bed, flips through the same set of channels on the same 42-inch LCD television screen. The guest will certainly understand the changes in supply and demand. But guests like to know what they're paying for. They comparison-shop, they're knowledgeable, wired and these days they're also value-conscious. They can tell the difference between low priced and cheap. They have learned that a low price point may not necessarily be cheap at all. Even a $50 rate may be overpriced if the room is not clean, the TV remote's battery is dead and staff is unwelcoming. Guests may be able and willing to accept a higher price point for value drivers: a prime location, quality service, superb mattress and a clean, safe hotel. Room rates are important, but they're not always the only value driver in the eye of many hotel guests, and therein lies the challenge.
If hoteliers choose to use room rates as a strategic weapon, they can only fight problems that are room-rate related. Cheaper room rates will not make a destination safer or turn tired attractions into world-class venues. Destination image problems cannot be cured by room-rate discounts. Discounting a mediocre product, then heavily promoting it will only tell the entire world how mediocre it is, even if a hotel can temporarily steal some market share. Driving the guest's attention to room rates is a questionable strategy. The industry can do better in the long run if it resists the temptation of fast and easy downward rate adjustments and works harder and smarter.
About Dr. Gabor Forgacs
Dr. Forgacs has twenty years work experience in the hotel industry on two continents. He has taught at the Ted Rogers School of Hospitality and Tourism Management at Ryerson University, Toronto since 1997. He is teaching Revenue Management. Dr. Forgacs has authored a book "Revenue Management. Maximizing Revenue in Hospitality Operations" published by the American Hotel & Lodging Educational Institute (2010). He has published articles in the International Journal of Contemporary Hospitality Management, The Hotelier Magazine (Canada), The Rooms Chronicle (U.S.), The Accommodator (Canada), The Canadian Lodging News and other print magazines. Also published in conference proceedings of the ICHRIE (International Council on Hotel, Restaurant and Institutional Education), plus in online publications e.g. Hotel-Online.com, ehotelier.com, hotelnewsresource.com, 4hoteliers.com, htrends.com, HVS International.com, hsyndicate.org, hotelexutive.com, wiredhotelier.com and other electronic publications. Dr. Forgacs is frequently interviewed and quoted in the Canadian media.
Dr. Gabor Forgacs
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