Average Room Rate - Is it a Myth?
By Venkat Rajagopal, Professor, Pacific International Hotel Management School
Sales is the only means of earning profit in any business. Hotel managers are also not an exception to this phenomenon. In accommodation sector it is the sale of rooms that brings more revenue. When sale is the only means of earning profits as in other business, hotel managers also think that sale of room, good occupancy is the only means to improve the bottom line, since room sales compared to any other sales of the hotel provides better departmental income. Hence to earn more revenue by selling more rooms' managers adopt ARR /ADR technique...
Hospitality or Accommodation sectors all over the world like any other business enterprises, attempts to think that a sale is the only means of producing profits. In the hotel sector room sales provides a greater contribution towards fixed expenses and overhead costs compared to the same amount of sale from any other revenue earning areas such as, food and beverage, telecommunications, laundry, shop rentals etc. In order to achieve this desired result of greater contribution there should be a sales mix.
The sales mix of any typical saleable room in a hotel mainly consists of four main elements such as:
- Hotel segments such as, free individual travellers (FIT's), charters, groups, packages, honeymooners, transit pax, airlines crew, corporate travellers, MICE, again categorised as bed only, bed and breakfast, and various other plans.
- Variety of available rooms such as, single, double, standard, suites etc,
- Various bed configuration such as King, Queen, double, twin sharing, extra bed etc.
- Yield management whereby maximising revenues by lowering tariffs to increase sales during periods of low demand and by raising tariffs during periods of high demand.
Conventionally to determine an effective sales mix, room department revenue is calculated and then percentages of the total room revenue are calculated. A performance evaluation of rooms department is determined by average room sale revenue. Hence it is customary for every manager to look at the management report before the operation meeting commences and feel happy about the Average room rate (ARR) or Average daily rate (ADR). Some managers still think that ARR or ADR is the best tool to measure room department ratio. Similarly most commonly, sales and marketing department's effort is also judged by either percentage of room occupancy or daily average room rate that has been achieved. The concept is simple. Let us imagine a hotel with 75 rooms, which sold 21, 500 rooms in a year and earned room revenue of $850,000.
The ARR or ADR is:
850,000/21,500 = $39.53.This exercise in reality is not 100% correct because of the four sales mix as mentioned above, plus a hotel earns room revenue not only from the bookings that has materialised, historically speaking hotels do charge no shows rates for non-guaranteed reservations, as well as for guarantied reservations. Hence the total revenue earned for the day or for the month or for the year is not only from actual number or rooms sold for various segments but also for different kinds of penalty for not showing up. Sometimes the revenue also includes a small commission earned from other hotels by bouncing the guests to other hotels when it is full and no rooms to sell. Average room rate or ADR could be of some meaning if we could express it as a ratio of maximum potential average rate, though by itself this ratio does not provide a complete and meaningful picture.
There are few managers, who prefer to look into paid occupancy percentage, as a quick indicator of performance efficiency. Paid occupancy percentage refers to the percentage of rooms sold in relations to rooms available for sale in the property.
Paid occupancy %
Paid occupancy percentage is paid rooms' occupied/available room The hotel in our case has sold 21, 500 rooms. Rooms available for sale for the year is 75*365=27,375. Paid occupancy % is: 21,500/27,375 =78.53%.
It is worthwhile to note that ARR, ADR or PO% by themselves are not full proof to measure the efficiency. To illustrate this better, a hotel may have room occupancy of 85%, yet it's ARR or ADR may be only $ 45 where as a similar hotel either close by or elsewhere in the same city may have a paid occupancy of 78% and an ARR or ADR of $ 55. It is not difficult to judge which hotel is in an enviable position. Also worthwhile to note is paid occupancy % of 78.53 does not mean that 78.53% of available rooms were sold every day. It simply means there could have been 100% occupancy from Monday to Thursdays and 21.47% on remaining days. Thus it is a wrong notion that paid occupancy % is a key factor of management's success in selling the rooms.
Again, the occupancy percentage does not confirm whether the sales and marketing department has maximised sales revenue because the hotel may be having 100% occupancy but many of the rooms occupied may be paying much less than the rack rate that has been fixed for the room because, it is occupied by different segment of the hotel. In such a situation a manager may want to increase the occupancy at the cost of the room rate at a time when his performance is likely to be assessed.
Should the manager's performance is going to be measured by ARR or ADR, then he may refuse to sell a room below the prescribed rack rate to a guest who is unwilling to pay the rack rate, thereby turning away the potential guest. If we go by the norms that every satisfied guest brings in five (5) new guests to the hotel without any efforts, imagine the potential loss of not only future guests, but also drop in occupancy and room revenue.
If, ARR, ADR, PO% do not indicate the quality of efficiency of the management in selling the product what is it that could reasonably indicate the efficiency? A combination of ARR, ADR plus PO% would reasonably be a better tool to measure the efficiency and success of the management as far as rooms division is concerned. This combination is called Revenue per Available Room or REVPAR. Let us understand this concept by our imaginary hotel which we had discussed earlier.
Revenue per Available Room (REVPAR)
The combination of both paid occupancy % and ARR or ADR is called REVPAR, which in our case is: 78.53% of $35.93 is = $28.21 ARR/ADR is conventional practice of forecasting saleable rooms for the future. This method is very traditional. With the advancement in technology nowadays hotels have eliminated a greater part of guesswork or room rate decision making process for budgeting room occupancy. The process basically involves the number and kind of rooms that should be sold at various room rates.
The managers may try and follow yield management , the objective of which is to maximise hotel rooms revenue by using certain discretion like offering right type of room to the right type of customer who is prepared to pay that price. In practice yield management may present its own problems when being implemented in accommodation sector, unlike airlines because a guest who checks in at a hotel for a couple of nights may want to check out earlier than two nights and similarly a guest who had checked in for the weekend may want to extent the stay by couple of more nights. A good yield management system can be practiced only when the hotel has exhaustive database of its guests, so that the hotel knows the guest's past reservation patterns.
Thus REVPAR is more a reliable tool in measuring the efficiency of the management in selling rooms than ARR or ADR. What one must remember in calculating REVPAR is all the rooms that are out of order, rooms given as complimentary and rooms given to the staff must be deducted from the total inventory of rooms in the property to calculate rooms available for sale, to arrive at reasonably an accurate REVPAR.
Venkatraman Rajagopal known as Venkat is currently a lecturer teaching hospitality and tourism management subjects at Pacific International Hotel Management School in New Plymouth, New Zealand. Mr. Rajagopal holds a degree in Commerce, a Masters in Business Administration and a Masters in International Hospitality Management. With more than 20 years experience in the hospitality industry, Mr. Rajagopal has worked his way up in all departments of the industry, holding senior management positions such as Director of Finance, Director of Food and Beverage and General Manager. Mr. Rajagopal can be contacted at 64 9 8350535 or firstname.lastname@example.org Extended Bio...
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