Mr. Mourier

Revenue Management

Five Revenue Lessons Hotels Can Learn From Wall Street

By Jean Francois Mourier, Founder & CEO, RevPar Guru Inc.

The hotel business, on the surface, seems full of ambiguities. Its central product, the guest experience, is something that is notoriously hard to quantify. The hotel room night is one of the most perishable items in the world as it is absolutely irredeemable if gone unsold. The largest hotels and resorts- like small cities in their complexity- are rife with variables, while the smaller and more streamlined properties are at the mercy of a myriad of external influences. In any given hotel, different departments have varying aims and objectives, which require multiple plans of action to achieve. And every aspect of a hotel’s operations ultimately depends on a consumer’s decision to stay there (or not).

There is another industry that routinely confronts uncertainty through the course of normal operations: the financial industry. The variables associated with the stock market, equity and commodity trading, and financial risk management are arguably greater than those associated with the provision of a night’s lodging, and yet the financial industry’s ascension has been marked by ever-increasing, ever-sophisticated scientific and mathematical processes to predict and govern these variables. Hotels, on the other hand, have traditionally employed ad-hoc strategies to deal with the ambiguity of their business. Yield management in hotels wasn’t even a widespread concept until the late 1980s, whereas it had been a mainstay of financial economic theory since time immemorial.

This disparity exists (or existed) despite the similarities shared by core aspects of the financial industry and the hotel industry. Determining, predicting and influencing the behaviors of rational actors in an equities or commodities market-sellers and investors-is not so different from anticipating and persuading a guest to book a room. Likewise, the appropriate management of perishable inventory- and the mathematical models and formulas that govern the management, insurance and distribution of that inventory is the same whether the inventory consists of hotel rooms, preferred stock, or pork bellies.

This is not to imply that all hotels have systematically ignored or avoided sophisticated methodology designed to optimize the practice of revenue management. Many hotels, most notably the large chains, have devoted significant resources to systems and personnel charged with increasing yield and achieving the most profitable balance between occupancy and average daily rate. But the application of stock market principles to hotel revenue management is uncommon at best. In general, hotels have not embraced the complex algorithms and models that produce tangible results on a daily basis for the financial sector.

Of course, there are many lessons that hoteliers and revenue managers can learn from the stock market and the technology that powers it. We have outlined the top five lessons that every property must incorporate into their revenue management strategies today to ensure that their property is able to withstand the unpredictable future that we, as an industry, are currently faced with.

Lesson #1 – Pricing today, Gone tomorrow?

Historical pricing, one of the most widely used revenue management techniques among hotels, is a process by which the asking rate of a room is set for a particular period of time based on indications from the past. The historical aspect is revealed by the determining factors used to set the rates; when engaging in historical pricing, hotels will look at occupancy and rate from an analogous period- whether last year, last month, or last season- and set a rate for the concurrent period accordingly. Because many hotels operate in cyclical or seasonal markets, or draw a significant percentage of their annual revenues from holidays or recurring events like annual conventions, this pricing methodology had obvious advantages. Because of these factors, history is perhaps the most popular guide to room pricing, as gauged by the number of hotels that utilize historical pricing as their primary pricing strategy. It is also perhaps the most traditional pricing strategy, which can account for its tenaciousness as an ingrained habit. The reasons for this are as straightforward as historical pricing itself: as a strategy, it’s easy to design and implement; the prices that result from that implementation are justifiable; and in general, it’s effective.

Ultimately, though, historical considerations are just one aspect of a comprehensive pricing plan; while representing a solid starting point for basic pricing strategy, historical pricing by itself can leave a hotel vulnerable to damaging swings in occupancy and unexpected declines in RevPAR in part because, if used without other supportive tactics, they do not incorporate the appropriate amount of variables. But even if contingent pricing strategies are utilized alongside historical pricing, it still lacks the adaptability of a stock market principle-based yield management system.

Not convinced? Let’s look at some similarities between the stock market and the hotel market. First, as has already been noted, the hotel room is an extraordinarily perishable product, making it particularly apt for comparison to traditional commodities. Second, the hotel room is a product that reacts to competition, and is subjected to the forces of supply and demand. Room sales are difficult to forecast, just as the prices of equities are, and history makes for an inaccurate barometer. What’s more, the act of selling hotel rooms can influence sales in the immediate future, much as with the stock market. The pace of room sales is as much a factor in influencing the next sale as the original price, or the available inventory. The hotel room is also a relatively uniform product, varying enough between competitors to make distinctions possible, but not enough to allow a hotel to develop an entirely new product line.

Like equities and commodities, rooms can and are sold across multiple channels, in multiple markets, and at any hour of the day.

Lesson #2 – Money Never Sleeps

This lesson is one of the driving forces behind the development of sophisticated revenue management systems. Even traders who don’t idealize the Wall Street ethos know this: the market doesn’t close at 4pm with the Dow; trades continue to be made, on foreign exchanges and in futures and through electronic trading, at offices and on T1 lines around the world. Financial firms work across time zones - they always have - and hotels ought to as well.

This is one of the fundamental drawbacks of relying solely on a revenue management system handled by flesh-and-blood revenue managers: they’re compelled to engage in those silly human behaviors, like sleep.

Revenue managers perform more ‘maintenance’ tasks now than ever before, because the conditions of room sales fluctuate more wildly and more often than ever before. Just to maintain a high occupancy rate and a healthy ADR, a revenue manager must monitor a dizzying array of online sales channels, determine which rate is selling most briskly (or too briskly), reconcile that with in-house reservations and those gleaned from a GDS, adjust that rate, allocate inventory to the channel, and communicate this information across the various operating departments within the hotel. And this must be done every day.

In fact, to maximize RevPAR, this process must be repeated as often as possible, down to the second, all day (and night), every day. And individual hotels tend not to have offices in Hong Kong and London, as JP Morgan might. Even the most capable revenue managers need the right tools to assist them with this process. The pursuit of rate-adjustment perfection is only attainable through technological means, as is done in financial firms. The physical and time-consuming actions of consulting a rate generator (or worse, historical tables), manually manipulating rates in any or all of the online travel agency websites where the hotel might have room inventory available and updating the property management system rob a revenue management team of the opportunity to work on more productive, sales-generating initiatives.

Lesson #3 - Two heads are better than one

Most financial price-setting formulas utilize two decision makers, one correcting and accounting for the other. Sophisticated hotel revenue management programs can do the same thing. A hallmark of these systems is dual programs, a main program and a secondary program. The main program generates rates based on historical data, taking into account page positioning on online sales channels, competitors’ rates, inventory availability and other variables, and implements them across the sales channels. The second program monitors the first program in terms of effectiveness. The first program is based on a complex algorithm that interprets all of the variables mentioned above and produces the rate and allocation it determines will be optimal in terms of RevPAR for the hotel. The second program interprets the results of the first program’s algorithmic process against the actual booking pace, and makes adjustments accordingly.

This process, a mathematical generator coupled with an efficacy-driven monitoring program, is the foundation of every neural network employed by large trading firms. Because the two programs work off of one another, the system as a whole becomes adaptive.

Lesson #4 - Nuts and Bolts

Just as equity traders keep careful track of price fluctuations in the markets, a comprehensive, automated, stock market principle-based revenue management system will employ ‘spiders’ to crawl the hundreds of available OTAs in search of competitors’ rates. Such a system will also monitor the OTAs for page positioning, to determine which rate appears within the top six listings on the first page, or within the top two listings on the second page. A comprehensive, adaptive revenue management system will calculate the nature of the rate that will land in these coveted positions, and adjust the rate it presents accordingly.

Lesson #5 - Black-Scholes and other economic phenomena

Simply having the bandwidth and computing power to monitor various sales channels is only half the job. A comprehensive revenue management system based on stock market principles also needs an algorithm built on economic theory to effectively interpret and generate optimal rates.

One theory is the Black-Scholes model for pricing options. This model states that the value of an option depends on a number of different variables independent of the value of the asset itself, such as time value, volatility, and lognormal distribution, to name a few. In terms of the sale of hotel rooms across multiple sales channels, this is particularly applicable, because, as mentioned, there are several variables that influence booking pace independent of the base rate of the room. The formula takes these variables into account and generates a rate that is most likely to appeal to a particular buyer at a particular period in time, just as the Black-Scholes model determines the value of an option in relation to the value of its underlying asset.

Wall Street or Bust

Clearly, the hotel industry can benefit from the adoption of stock market principles in the area of revenue management. Because of the many similarities between the product sold by hotels and the products traded on various exchanges by financial professionals, many of the same theories and tenets apply. The industry must make some fundamental changes in the perception of its core product, and recognize that as a perishable, uniform item that is subject to the forces of supply and demand and the sale of which is difficult to forecast, rooms are as much like options and commodities as anything else. Once this change in perception occurs, stock market principles will find acceptance among revenue managers, general managers and owners in hotels across the world.

Jean Francois Mourier arrived in South Florida in 2003 after a career in Europe as a trader, financial analyst and director for a number of firms including Merrill Lynch and ING Barings. He joined a small Miami Beach hotel management firm as a financial analyst. he revamped the company’s revenue management methods, with dramatic results. In 2007, along with his colleague Bruno Perez, Mourier founded RevPar Guru to provide the Yield Dynamic Price Engine, an integrated revenue management and pricing solution, to others in the hospitality industry. Mr. Mourier can be contacted at 786-478-3500 or clientservices@revparguru.com Extended Bio...

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