Mr. Forgacs

Revenue Management

The Room Rate Conundrum: The Leap From Tactical to Strategic

By Gabor Forgacs, Professor, Special Graduate Faculty, School of Hospitality & Tourism Management, University of Guelph

We all make tactical room rate adjustments on a daily basis. We need higher occupancy, increased cash-flow, plus show the owners how hard we tried. We also must be sure these tactical decisions are in alignment with our strategic objectives. Actually, do we want to compete on room rates at all?

This is a possible scenario: “We decided to aggressively lower our room rates from $179 to $119 because occupancy was dipping under 60%. We offered the price incentive to stimulate demand. The result was discouraging: we gained some occupancy but our REVPAR took a nosedive and our hotel attracted a new clientele that wanted everything free: parking, WiFi access and buffet breakfast. These new guests ordered local take-out instead of eating at our restaurant. They also complained about anything possible, just to force an apology and a discount at checkout. Is this the new normal?”

The above is an imaginary scenario: it never happens at well-run hotels… Right?... Right. However, if it sounds vaguely familiar, read on. This article will deal with the most pertinent questions and will offer some perspective on our challenging times.

Why Can’t We Improve Profits if Lower Room Rates Lead to Higher Occupancy?

It depends on how much we discount and which clientele we attract. Let’s look into the changes both from quantitative and qualitative perspectives.

Quantity of units sold. The simple answer for quantifiable changes in profit: it’s negative. There are two key variables at play: rate and occupancy. It is very 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 lower rates. Our rate may drop, but the cleaning costs don’t. If it would cost us e.g. $18 variable cost (labour + laundry + supplies) per occupied room to clean it, and we were unhappy with 60% occupancy, the numbers reveal that an occupancy of 95.6% would be required just to break even, i.e. generate identical net room revenue, if our average rate is lowered from $179 to $119. Hotel revenue management text books can be consulted to find the simple formula that calculates identical net room revenue at various room rates. In the given scenario: (179-18) / (119-18) multiplied by 60% equals 95.6%. It is up to our revenue manager to consider if that high occupancy is realistic to achieve. The formula is good to run scenarios: if the average room rate would be $129 then 87% occupancy would do, for same net room revenue.

Sound research by Cornell University’s Centre for Hospitality Research had conclusively shown we can expect on average a 1.3% rise in occupancy after each 10% room rate discount. If we can’t improve the financial performance of our business, why would we expect that discounted rates lead to an increase in profit? The financial performance of a hotel will improve only if we are able to gain a significant, double digit jump in occupancy at lower rates.

Quality of the clientele: most of those guests who react for a discounted rate offer are typical bargain hunters. They are not brand-loyal but price-loyal, and they go where the sweetest deals are to be had. They select their hotel at their chosen destination based on room rates. If we lure them away from our competition on occasion, we may boost occupancy by stealing market share. When next time someone more desperate will undercut our rates, we know where these travelers will choose to stay. Unfortunately, there is no protection against undercutting. It can happen any day that a competitor is more aggressive than us. In other words: we can’t build and retain market share and we can’t hope to expand our customer base. The war cannot be won even if win some battles. Yes, we may attract a deal-hunter segment that is neither possible nor worthy retaining. Why are we so desperate to impress and attract these potential guests?

The Easy Way versus the Hard Way

How resource intensive can be changing room rates? Well, it depends on how many mouse clicks are required to change a BAR (Best Available Rate) from $179 to $119. That is the easy way. It is much harder to identify other ways of gaining a competitive advantage. We need to elevate our thinking from tactical level solutions to strategic thinking.

First we need to develop a solid understanding of our target market’s needs, wants and preferences. Then invest time and resources in finding meningful differentiation and communicate it to our guests. CRM (Customer Relationship Management) enters the picture: transactional information, customer history and customer intelligence can be tied together for maximizing the lifetime value of return guests. Bundling may be considered. Product development could start: an additional LCD television screen hidden behind the bathroom mirror? Docking station for iPods? In-room exercise machine set up on request? Introducing a new food service concept? A door lock that can be opened by a smart phone? The industry has a plethora of exciting new solutions to select from. Cost/benefit analysis, strategic decisions are the hard way. Lastly, we have to face the hottest and fastest-paced strategic issue: distribution channel management. Which channel do come the largest volume of our bookings through? Channel costs and booking volume need to be analyzed. Do we need to develop a mobile friendly version of our internet presence? Are we going to harness the potential of the social media? Can we leverage our location to push quick-response digital coupons to potential guests within a perimeter and engage in location-based mobile marketing? There is so much more.

It would be unfair to suggest that discounting room rates is the easy way of boosting occupancy for the lazy manager. It needs to be pointed out however, unlike dropping room rates, the development of sustainable competitive advantages are the result of hard work and they may not produce overnight results. Room rates should be the last thing to touch. We have worked too hard to be in the position of charging e.g. $179 a room night. We have earned market acceptance and had built a clientele. We have an image and a reputation to manage. Should all these be thrown out the window just because we hit some turbulence? What if we discount PPV (pay-per-view) movies and the WiFi access but hold our rate for our core product?

Room rates are too important to play a continuous game of pull/push with. Hotel brands that held their rates and didn’t dilute their rate integrity were the first to lead ADR recovery after market slumps. Coming down with REVPAR is fast. Rebuilding it, after heavy discounting may take years and it will be uphill all the way.

Measure REVPAR or GOPPAR or ADR?

It depends on what we need to learn. Room rate is a crucial component in all measures that are worth tracking and benchmarking. Compering our own REVPAR to past years can reveal top-line performance by indicating how well we have played the hand we were dealt. It is useful to look beyond it and see if REVPAR changes were driven by ADR or occupancy, so we can learn from our own successes or mistakes. A REVPAR penetration index within our own comp set can help us, or interested investors see how well we lived up to our business potential in comparison to our peers.

Many hotels are run by management contract. A REVPAR, however impressive may not be a sufficient measure for the owners because their interest is in bottom-line performance. That is the reason behind the growing popularity of GOPPAR. Cost efficient operators may be identified more accurately through GOPPAR, because REVPAR doesn’t reflect cost containment.

High or Low Rates - Guest Perceptions and Price Sensitivity

Businesses that sell tangible products have a chance to justify price adjustments upward or downward with changes that the buyer can touch and feel. More horsepower or an extra cup holder in a car; more gigabytes of memory for a computer; 15-ounce steak vs. 12 ounces and the customer will understand that fast. What about a room night at a hotel?

What if last week a hotel charged $119 and this week the room rate is $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 watching the same 42” LCD television screen? The guest will certainly understand the changes in supply and demand. But guests also like to know what they are paying for. They comparison-shop with the click of the mouse and are knowledgeable, wired and value conscious. They can tell apart what is low priced and what is cheap, as 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 not always the only value driver in the eye of many hotel guests.

The morale of the room rate conundrum is that if we choose to use our room rates as a strategic weapon, we 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 ones. Destination image problems cannot be cured by room rate discounts. Discounting a mediocre product, than heavily promoting it will successfully tell now the whole world how mediocre it is, even if we can temporarily steal some market share. Driving the guests’ attention to room rates is a questionable strategy. We can do much better in the long run if we resist the temptation of fast and easy downward rate adjustments and try working harder but smarter.

Dr. Gabor Forgacs has twenty years work experience in the hotel industry on two continents including a management position at a Four Seasons hotel in Toronto, Ontario, Canada and the position of president and general manager of a full service hotel in Budapest, Hungary. He teaches at the Ted Rogers School of Hospitality and Tourism Management at Ryerson University, Toronto since 1997. He is teaching Revenue Management for Hospitality & Tourism, The Value of Branding in Lodging, and Property Management Systems. Mr. Forgacs can be contacted at 416-979-5000 x6693 or gforgacs@ryerson.ca Extended Bio...

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