HOTEL PRICING Hotel Management and Operations

TRADITIONAL APPROACH

The single most important criterion of success in any business, including hotels, is profit. The purpose of this article is to discuss the importance of hotel pricing and its influence on yield or revenue management, especially in terms of profit generation, and because of inherent dangers to the industry worldwide, integrity of the established pricing structure. Historically, price has been determined by the triangular relationship of cost and demand in the context of competition (see Figure below). The actual pricing structure is developed with one of these three components as the deciding factor while the other two play supplementary roles.

The traditional pricing strategy was largely cost-driven. Many hotel operators tended to favor the rule-of-thumb method. This approach, also called the $1 per $1,000 rule, states that hotels should charge approximately $1 per night for every $1,000 of room cost, based on an average 70 percent occupancy. Although popular in its day, the calculation of cost was commonly misunderstood (see Hanson, 1995). Another widely used quantitative method was the Hubbart Formula, developed in the late 1940s as a guideline issued by the American Hotel Association. It focused on computing an average room rate that would cover operational costs and yield a reasonable return on investment (ROI). These quantitative methods are fairly static and therefore suited for a stable economic environment. Qualitative pricing approaches, such as percentage increase of previous-year rates adjusted for inflation, payroll increases, and new cost of supplies, reflect more realistically the projected cost.

Other qualitative techniques are less exact but, by being competition-oriented, they offer more flexibility. The Pied Piper or Follow-the-Leader method uses competition as the basis for rate setting, while the Gouge ’Em approach tries to lure business away from other properties by undercutting their prices. If there is no competition to speak of, Hit or Miss fluctuation of rates tied to profitable occupancy levels could be employed.

Three Forces of Pricing

Three Forces of Pricing

The drawback of competition-driven pricing is its sole focus on rate comparison, ignoring differences in operating expenses and customer- perceived value. An effective approach, therefore, calls for a mix of methods adjusted for different situations .The fundamental question remains: What should be the driving force in formulating a sound pricing strategy? In today’s dynamic business environment, which discards the traditional view that market demand for room rates is largely inelastic, demand orientation seems to provide the best fit.

CURRENT PRICING CRITERIA

When the chain is setting its prices, it starts with comprehensive market research.

Based on the data, the correct price for each marketplace is determined. If there is a major shift in a market, then the prices will adjust for that. However, if there is a major shift in a demand curve, then a shift of price may have no effect. It may actually leave more money on the table. For example, if the airlines go on strike, a significant shift in the demand curve would result. Under such conditions, decreasing the rate by $50, for example, would only result in a $50 loss. If there is an opportunity to go after a new targeted market with a specific offer, enabling the chain to capture a greater market share, then lowering the rate serves its purpose. Generally, however, lowering rates across the board is not the preferred pricing strategy.

PRICING: WHO IS IN CHARGE?

While independently owned properties make their own pricing decisions, in case of a chain it is usually corporate headquarters (HQ) that sets pricing guidelines. Often, individual properties are still responsible for the actual pricing. Because they are held accountable, they must balance corporate guidelines with their autonomy to set their prices. Caroline Shin, member of the revenue management team at Starwood Hotels and Resorts Worldwide, which operates a number of upscale brands, such as Sheraton and W Hotels, stresses the cooperative nature of this relationship. Successful pricing strategies arise from an ongoing interaction of both sides. Corporate HQ provides sophisticated tools and in-depth market analysis that would be beyond reach of individual properties. Property managers, on the other hand, offer their experience and knowledge of regional specifics that may have gone unnoticed by the corporate team.“The people who have been in the property understand the dynamics of that market, and they have developed pricing intuition,” explains Shin. Some experts view intuition as a valuable part of the pricing mechanism, and even managers who are technically savvy check the numbers against their gut feeling.

PRICING: SCIENCE, ART, AND INTUITION

Pricing distribution and revenue management techniques are a mix of science and art. Recent research shows that two-thirds of managers making strategic decisions under pressure and time constraints use a combination of analysis and intuition (Sinclair, 2003). The advent of modern technology, such as yield management software packages, has further strengthened this link. “Even the most sophisticated analytical model for forecasting, may it be for hotel pricing or for thermal dynamics of a nuclear plant, still needs variables based upon assumptions,” says Shin, who used to work as a nuclear engineer. The more business- savvy hotel management becomes and the more they understand the hotel dynamics and the market, the more can be gained from training them how to define their experience based intuition and put it into numbers. In this respect, an interaction between the corporate revenue management team and individual hotels is paramount. “Every time I go out to a property, I learn something new. It only helps me when I build my analytical models to almost translate what they know into numbers,” confirms Shin. The better hotels can do that, the better models they can develop. Nonetheless, inaccurate historical data remains a major limitation.

No model is ever going to be perfect, though. What seems to work best is to teach hotel managers how to use the model and to understand the direction of the pricing decisions they need to make. That is the scientific part. The art piece comes into play when they infuse the model with their knowledge and intuition. Staff training is an important part of this process.“We can’t just have Ph.D.s sitting in one room coming with all these models and we just roll it out. At the same time, we can’t just have people with intuitions run around and set prices,” says Shin.

Revenue management teams must make sure that hotels understand how to employ the models in their daily pricing decisions. When science is applied, the revenue team can go to their experts, ask probing questions, and get solid results. Even though intuition is a part of this process, it is based only on a hypothesis that could have been triggered by a discussion with a customer, knowledge of what is happening in the marketplace, or historic trends. That is why pure intuition is not sufficient. “Managers must have reliable data to support their hunches,” cautions Scott Farrell.

CUSTOMER NEEDS

Customer satisfaction is a crucial part of marketing, pricing, and yield management. Any pricing strategy established by the hotel management must attract customers willing to pay the specified rate. While price is a determinator of the customer profile the hotel is looking for, it is also an indicator of the quality of services and the market segment the hotel is competing in. Therefore, yield management uses information about targeted customers’ purchasing behavior and product sales to develop pricing strategy together with inventory control that delivers products that are better matched to customer needs, create greater demand, and, on that account, produce greater revenues. Lieberman (1993) states that yield management is the process of maximizing profits from the sale of perishable assets, such as hotel rooms, by controlling price and inventory and improving service through systemization. An exact definition of the target market is essential. There is a definite and firm perception in the psyche of the customer, who views the price as the value forthcoming. Therefore, the eventual satisfaction of the customer is the paramount task of the pricing mechanism. This is the make-or-break factor of the entire hotel, especially if the value expected does not match the price.

ROLE OF TECHNOLOGY

While the approach to hotel pricing is still ruled by supply and demand, speed and sophistication of room-rate yield or revenue maximization is now much increased due to two technological factors: yield management software and Internet bookings. Yield management software packages enable hotels to use a higher number of room rate levels, or buckets, and to control inventory for rate availability in real time. Each level may consist of several room rates open under given conditions to yield a maximum profit. Traditionally, hotels used between three and five rate levels; otherwise, the adjustment became too complex for the human brain to work with. The introduction of software removed this barrier, and some hotel chains now use up to ten rate levels. This allows implementation of much narrower ranges for each bucket, thus optimizing price elasticity. This further means the software model recognizes the point at which the same number of bookings can be achieved at a higher rate.

Online monitoring of room inventory in real time facilitates the timing of the adjustment. So far, the biggest limitation is the reliability of historical data. Even in its imperfect form, the system has made a difference. However, hotel managers are fully aware that it takes years to develop brand recognition and quality but just a push of a button to damage or even destroy it, if the pricing is not set up knowledgeably. As the technology becomes more sophisticated, it will eliminate such questionable practices as overbooking, which aims at compensating for last-minute cancellations by taking in more than 100 percent reservations. Besides the question of whether overbooking is ethical and, in some countries, even illegal, better technology would definitely improve the quality of service provided by properties that engage in this practice. Another area where technological advancement had a great impact on hotel pricing is the Internet. Its use as a booking tool has created a new level of pricing transparency and tiered competition. It also penetrated the negotiation of corporate rates.

Many hotels see the effect of the Internet as both good and bad. The good side is that website bookings are growing every day. As more customers become familiar with their favorite hotel websites, hotel companies have started investing heavily in website development and upkeep, which gives them several advantages. First, the cost of online bookings is lower than for bookings made through other distribution channels. Companies do not have to pay commission because the booking is direct, circumventing all intermediaries.

Online booking also provides an opportunity to monitor inventory in real time without reliance on a distributor willing to share and regularly supply data. Last but not least, it generates loyal customers by making them eligible for bonus points, which they cannot earn if they use an Internet intermediary. That is exactly where the flip side of the Internet lies. The intermediaries are getting more powerful and growing significantly in volume. Because most of them show all hotel rates on their website, they make the information accessible to any computer user. One way to meet the challenge of more powerful intermediaries, especially if hotels need to move inventory, is to utilize auctions where the name of the hotel is not disclosed to the customer until the transaction is finalized. Such action, however, calls for extreme caution so that it does not damage a hotel’s reputation or threaten its strategic partnerships. As intermediaries become bigger, rate transparency will increase to the point where it will drive the market, especially when computer literacy and Internet access become the norm.

Moreover, the Internet allows non branded hotels to compete more heavily with the branded hotels because they can now be displayed just as readily. Without significant advertising expense, they can compete on price. For some markets this does not matter, especially when the brand is powerful enough to charge the premium and get the business. In highly competitive markets, however, the competition creates an additional strain for the individual property. Many branded hotels must now compete with other brands through the traditional distribution channels and with non branded hotels on the Internet, which, in principle, lowers hotel rates. A frequently adopted strategy is to invest heavily in website development and customer loyalty programs, assuring excellent website functionality and that customers are rewarded for booking directly through the hotel website rather than through the website of a third party intermediary. Both Fairmont and Starwood, for example, utilize their high-quality loyalty programs in this way.

Internet booking also changed the way corporate accounts are negotiated. Because many companies now require that their employees make business travel arrangements via the corporate website, the placement of a hotel or a brand on this booking tool is of strategic importance. Being listed first in the accommodation section, for example, may bring in a higher volume of business and thus substantiate a lower negotiated rate.

LONG-TERM STRATEGY FOR THE INTERNET

Because hotels cannot expect that Internet distributors will go out of business, they smartly conclude that a partnership with the devil is better than a fight with him. Besides using their own websites, hotel companies are also making sure that the cost of their transactions goes down continuously so they can compete even at lower rates—while maintaining a good relationship with their carefully selected online intermediaries.

There is a large number of distributors to choose from. On one end of the spectrum is, for example, Expedia, which allows participating hotels to control their rates, meaning a hotel can change its rates any time it wants. At the other end are companies, such as Hotel Reservation Network (HRN), that bind hotels contractually to a locked rate that cannot be changed. Some hotel chains do not want to partner with these distributors because they like pricing flexibility and want to make sure their rates yield as much as possible.

Adaptation to new technology has been the biggest component of change for intermediaries as well. Companies that do not have the most current technology working in real time or allowing hotels to yield rates in real time are usually not considered a suitable distribution partner for some chains. On the other hand, companies that invest in real-time technology to yield rates are ideal partners because, as the industry sees it, they work with, not against the industry by permitting hotels to raise or lower rates in real time. “They work with us,” says Caroline Shin. “They give data to us very frequently so that we understand the travel pattern bookings on their website. Then we compare it with what is happening on our website and also what we are getting outside the Internet to make sure that our market mix is set appropriately.” Pricing flexibility, compatibility with the desired hotel image, and protection of its strategic partnerships, together with cost, play important roles in selecting an intermediary.

THE ROLE OF CREATIVITY IN PRICING

Creativity, either of an individual or a team, can and often does lead to innovative pricing ideas. However, its application must be specific, not just directional. It is not enough to state, “We have to do something about our occupancy level.” A pricing campaign must target a number of sold rooms or generated revenue that is required in order to break even or to do better. This specific approach injects efficiency into allocating marketing money to areas where it is most effective and in periods when it is desired. If there is no task direction or overall pricing leadership, the most creative idea may book only ten room nights instead of one hundred. It may generate more customer loyalty, but that is something the hotel may not need at the moment, although it could be an acceptable outcome in a low-season month. Pricing leadership helps team members understand the hotel’s current situation and direct money and creativity to do exactly what is needed. Creativity comes up with the idea, which serves as a vehicle, but spending marketing money the smart way is a matter of experience in innovation, which turns the idea into a successful product. Creativity also plays a large part in employee satisfaction, and it lowers turnover.

In a sluggish economy, some hotels start paying attention not only to profit as the bottom line but also to revenue. This means they monitor closely the accrued cost as well as the generated revenue, thus achieving the maximum yield. Interestingly, contemporary price leadership may take different forms. It could mean, for example, elimination of smoking rooms throughout the property. Many U.S. motels are revamping rooms, ripping off cigarette- damaged furniture and carpets, and designating them as nonsmoking. This saves on maintenance and adds to overall packaging flexibility when the business is hurt by lackluster demand. This tactic means drapes, carpets, bedding, and other furnishings must be replaced less frequently; it also mitigates fire risk and enhances cleanliness and overall safety.

THE ROLE OF HUMAN RESOURCES IN PRICING

Some large chains recognize that pricing is a complex issue and that they need to get better at it. There is a new focus on analyzing the culture of pricing (how it is being done) and how it can be improved. This approach is reflected even in the kinds of people chains are hiring. Although the majority of staff involved in strategic pricing are in the hotel industry and have a background in revenue management, others are in the airline industry and have in depth travel revenue management experience. Some chains have sought access to this experience by hiring from outside the hotel industry. This is to encourage diversification of thinking and new ways of thought—completely out of the box, as the traditional team members are joined by researchers doing a different kind of optimization analysis. The goal could be as radical as trying to manage risk or optimize toward the railroad industry and its scheduling.

On the surface, these tactics have nothing to do with revenue management per se. A lot of experience in optimizing difficult travel, however, can only be gained by bringing in people with different backgrounds in consulting or with in-depth Internet experience. In order to move pricing and revenue management to a different level of thought, a new mix of people is necessary. For this approach to work, adequate training must be in place.

In this respect, basic HR functions, such as hiring and training, have an impact on pricing. What is necessary is not only to train personnel in quantitative core skills but also in strategic thinking. For example, when a hotel does not want to take a specific piece of business, it must ask such questions as: What is the revenue? What is the rate? What am I displacing by this decision? Where do I think this will go? How does it help my RevPAR? Hotel managers must become more analytical so they can use all the new tools now available. When reports are created, team members must be taught how to use them. A lot of training must be provided for corporate executives, general managers, and regional revenue directors as well. They all must be trained to think more strategically and to understand analysis and the reports so they can help their individual properties.

DIVERSIFICATION: THE IMPROVEMENT OF THE PRICING PROCESS

As noted, exclusive hotel industry experience may lead to ossification due to one-sided judgment and the inability to see beyond the familiar. From this perspective, experience is both an asset and a liability. It is human nature to take for granted the way things are done after being in the same environment for a while. Therefore, hotel chains are continuously creating and refining pricing strategies to accommodate not only different market segments but also different situations a hotel may face based on occupancy levels.

Corporate HQ tries to identify these different situations and associated variables. “It is almost like a bag of goods, a bag of pricing strategies that should be tested,” says Caroline Shin. Hotels are given the full menu and encouraged to try a certain strategy if they are in a specific situation. Depending on the region, an individual property may use one set of strategies more than another. In a weak economy, however, the chains have to work harder and be more flexible because the market is overflowing with demand. Adapting step by step, a hotel may apply a different strategy every week. The problem for the corporate office is to identify situations a hotel might be in and seek remedy. For example, if group bookings are low this week but competitors are full, how can the property make up the difference with transient or leisure business? The general manager may ask the corporate team, “What pricing strategies can I use in order to fill my house?” Then he or she may ask, “What else worked before for other hotels, and what may work for me based on my market specifics and market characteristics?” That way he or she can test each strategy using the provided tool and personal experience.

PRICING: SUPPORT AND PROTECT

The corporate pricing structure is also in place to support and protect members of the chain in a number of areas including pricing and partnerships. The corporate office sets guidelines for hotels in terms of pricing structure and the market segments they deal with. Fairmont Hotels and Resorts, for example, focuses on four segments: transient leisure travel, group travel, business travel, and wholesale. The corporate structure provides guidelines about how the segments fit with each other, how they cross over, and where they reside in the overall pricing structure.

This information is necessary because every segment acts differently. Most market segments are dynamic and require frequent rate adjustments. One exception is the wholesale market, where pricing is still largely done the traditional way: A wholesaler provides a net rate, marks it up, and sells it to the general population. There may be a hidden cost, however, if the distribution chain includes an operator acting as a middleman between the wholesaler and the supplier.

When setting up the overall pricing structure, one starts with the retail rate, which is a bucket of premium or best available rates (BAR) charged on the open market. They usually do not carry any restrictions, such as cancellation fees, and they are fully billable. Depending on the level of occupancy, one of these rates is available on any given day when the hotel is not fully booked. It is up to the yield management system to identify which BAR to offer. All other rate types, such as discount rates and pre negotiated rates, are determined in relation to the retail rate. For instance, a corporate rate for a high-volume client will be probably set lower than the BAR rate that is estimated to sell most during the period when the contract is in place. This way the rates are nested within each other in a manner that makes economic sense.

The corporate pricing guidelines follow two main criteria: to maximize revenue and to protect key partnerships. While the hotel sales force negotiates contracts with key partners, such as longstanding corporate accounts or wholesale volume accounts, they make sure to protect these partnerships and provide them value. At the same time, they take every opportunity to maximize revenue. One cannot survive without the other, reiterates Scott Farrell. However, it is up to the hotels themselves, with guidance and additional research, to determine in their marketplace what their pricing structure should look like.

A diversified corporate team, with a mix of people with a hotel industry background and others skilled in optimization modeling, fulfills an additional function. It acts as a risk prevention mechanism, a necessary prerequisite for managing the risk inherent in pricing. Any chain with a wide variety of hotels must make sure the properties are covered in all kinds of situations. One risk containment scenario might be that the chain, in response to a changing demand curve, acquires a type of business that the brand has not catered to traditionally. Caroline Shin explains, “Sheraton did not take on airline crew business because we did not want crew members lingering in the lobby; it affected our brand image. But we thought maybe we could start taking that when our RevPAR index or occupancy slips to a certain point. So we are trying to change the standards of different market segments we are willing to take.”

On the international scale, another risk management plan would be analyzing operational cost and determining whether to close down part of the hotel if market research shows occupancy will not be high enough. When PESTEL (political, economic, sociocultural, technological, environmental, legal) analysis indicates demand will drop precipitously for an extended period (due to political unrest, economic crisis, or health scare, for example), instead of hoping for the best and running a full house with a full staff, the hotel may decide to shut down floors or restaurants and save cost until the market picks up again. Selection of the appropriate strategy will depend on the market specifics and protection of the image. A property may opt to close down several floors over the weekend if it caters mostly to business clientele staying during the week. It would not, however, suspend room service, although unprofitable, if that is considered an integral part of the offered product. In a worst-case scenario, the chain may decide to sell properties in global risk areas when it determines the external circumstances make it difficult to raise occupancy on an ongoing basis.

BETTER UTILIZE YOUR DISTRIBUTION CHANNELS

The Internet creates a new level of transparency as it allows the opportunity to maximize profitability. There is now a multitude of channels to choose from. Understanding the cost of each channel in relation to the value of provided service has an impact on the quality of pricing decisions. Therefore, it is necessary to determine how much revenue bookings through an Internet intermediary generate and whether or not they justify the accrued cost. There is also a tremendous risk involved. As discussed earlier, one of key guidelines of corporate marketing is that partners are protected. Just because there is a new Internet site it does not mean a chain can use it and advertise a lower rate, which would undermine a partnership of many years. In terms of cost, the chain must review its pricing strategy not only by market segment but also by distribution channel. “Several years ago, we would not consider the cost of distribution in our ROI. Today we do,” concedes Scott Farrell.

Another challenge is to keep up with new Internet sites. The chains must reevaluate constantly and prioritize their yield so as to choose which channels to keep or drop. Fairmont Hotels and Resorts, for example, applies the 80–20 rule. They focus on the 20 percent of the online wholesalers that capture more than 80 percent of the business. As Scott Farrell puts it, “Why would I play with the other 10–12 percent? I only have so many hours in a day to manage. I may as well work with the lion’s share.”

QUALITY ABOVE ALL?

Criteria for selecting an online distribution partner vary by price levels as well. Budget and economy properties are driven mostly by financial considerations, while upscale and luxury hotels are more concerned with compatibility. As for chains, they ask two basic questions: (1) How can the partnership increase our brand recognition or a brand reach, and (2) How much is it going to bring us in terms of revenue or profitability? Their choice has to match the brand first, and then it has to drive the revenue. If the brand is equaled with quality, online providers that project a connotation of cheapness will not be considered at all. The quality image refers not only to the hotel asset itself but also to how and where this asset is sold.

Fairmont Hotels and Resorts, as a quality brand on the luxury side, cannot compete on price. The quality of their product and the offering of the experience must be considered by the customer at the price being offered. When their hotels play with price, the corporate office watches closely. Scott Farrell explains, “If our property wanted to shift their rate by $50, I would ask why? Give me the case behind it and tell me what you are going to do to make up the additional $50 you are going to lose. If they come back to me and say they are moving their rate from $300 to $250 while driving a certain volume, I would make them go through the process of determining what incremental volume they will need to make up for the $50 in loss.” In other words, pricing decisions must be driven by ROI, not only a feeling. Feelings and experience may be involved, but properties must present a strong case based on the estimated ROI and what they plan to get out of the proposed strategy. It allows them to go into the pricing change with their eyes open. They also must consider how the competition will respond. A carelessly lowered rate may lead to a price war.

SPEED AND STRATEGY

The speed and immediacy of exposure via the Internet have reshaped how marketing campaigns are conducted. Having eliminated the delay of exposure to marketing collateral material, such as brochures or newspaper advertisements, hotels can conduct targeted discount mini-campaigns on their own websites when the yield management system indicates a drop in occupancy for specific dates. In a similar manner, brand recognition can be enhanced by a carefully orchestrated online auction. The South African hospitality group Protea (2000) was among the first in the industry using this method by offering their prospective guests the opportunity to bid on a limited number of weekend getaways in their properties that needed to boost occupancy. By setting a minimum bidding price, the integrity of the hotel image was protected. Similar auction systems, used to encourage room-night sales during slow periods, are nowadays available in the United States and Canada via several Internet intermediaries.

For chains in particular, a long-term strategy in distribution pricing is paramount. It stipulates the criteria and accepts or rejects short-term adjustments depending on what is happening in the industry, what is new in the technology, and who the new players are. In terms of corporate hierarchy, pricing is formulated and executed on three levels:

  1. strategy,
  2. tactics and execution, and
  3. measurement.

Strategy comes first, followed by tactics meant to support that strategy and their execution. Finally, the achieved outcome is measured against the set benchmarks. If the strategy is sound, it will last longer than the other two steps. Frequently, new tactics must be implemented; these drive the execution and the measurement. This requires a development of proprietary criteria for measurement and their continuous adjustment to changing conditions.

PRICE ELASTICITY

Contrary to the traditional view that hotel rates are, in the long-term, generally inelastic, price elasticity is receiving a lot of attention nowadays thanks to yield management. Its goal is to take advantage of and to cover the entire spectrum of the customers’ ability to purchase. Price elasticity allows hotels to capture customers who do not mind paying the high rate as well as those who are more price conscious. This can be done in a number of ways. By using different room categories, a luxury hotel can have on the same day suites available at $500 and entry-level rooms at $200. Every room rate category has a different value proposition associated with the incremental revenue. If the variance between a standard room and a deluxe room is $75, the latter should provide an adequately greater value to the customer. The result is a clear product differentiation, which can be also achieved by stay restrictions or by the use of fencing. Examples of physical differences, or fences, are room type, view, amenities, and location. Nonphysical fences may mean different customers, transactions, or consumption characteristics. These bear many similarities with airline pricing strategies, which differentiate the product by, for example, cancellation restrictions or last-minute availability of a pre negotiated corporate rate. The result is nested pricing, allowing properties to have a very high rate available on the same day as a rate that is more attractive to the lower-end customer.

NEW AREAS OF PRICING AND YIELD MANAGEMENT

Hotel pricing strategies traditionally have been limited to setting and adjusting room rates and other ongoing activities. In order to survive in the current dynamic, competitive, and even dangerous global environment, hotels and resorts are taking on other types of business, some of which are one-time projects. Organizing shows, festivals, and conferences or undergoing renovations requires a new type of core competency. Therefore, in addition to mastering current pricing strategies, hotel practitioners must acquire project management skills, such as those that are taught and practiced by Project Management Institute (pmi.org). Mastering these skills will make hotel team members capable of maximizing yield from project-type functions the same way as they optimize revenue from room rates.


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