Demystifying Price Optimization

By Kelly McGuire Vice President, Advanced Analytics, Wyndham Destination Network | July 06, 2014

Most revenue management experts agree that in order to continue to drive revenue and profits in a changing marketplace, the hotel revenue management discipline must evolve from revenue management to price optimization. As hotels make this important shift, it is crucial that executives understand what price optimization is, how it relates to revenue management, and what advantages will be gained from this approach. In this article, I'll briefly describe how pricing in hospitality and travel has evolved over the past few decades, then I'll define price optimization and describe why it is important for hotels to leverage this approach.

A History Lesson: Yield Management in the Airlines

Yield management, as a discipline, started after deregulation in the airline industry, as a method for airlines to control the number of discounted fares they sold. They forecasted demand by fare class and "protected" a certain number of seats for higher paying fares. Fences (rules to qualify for purchase) were created around the discounted fares, such as advanced purchase or Saturday night stay, which discouraged those that would pay a higher fare from booking the lower fares. As this business process evolved, and more discounted fares were developed, mathematicians began to model the problem to find the mathematically optimal protection levels that would maximize revenue. The output was the number of each discounted product to sell in order to maximize revenue. The early systems developed for this purpose were known as yield management systems.

After the carriers began to move towards "hub-and-spoke" itineraries, where a significant percentage of passenger itineraries involved a stop at the carrier's hub, yield management systems needed to account for the large numbers of connecting passengers produced by the hub and spoke approach. This involved managing demand for a specific segment (known as a "leg") of an itinerary when many different kinds of itineraries (all with different values to the airline) also flowed over it, and optimizing the availability of different fares on these connecting itineraries. This is called the "network effect". (In hotels, length of stay creates a similar issue.)

This practice was highly successful for the airlines, generating interest outside of the airline industry. Yield management, or revenue management as it came to be known, was specifically designed for industries that met certain necessary conditions: fixed capacity (only 75 seats on the plane or 300 rooms in the hotel), perishable produce (once the plane takes off, you can't sell the empty seat), time-variable and segment-able demand, advanced reservations (requiring inventory to be "protected" for more valuable business), and low cost of sale. Hotel companies began to adapt the airline methodologies to their business problem, as did some cruise lines, retail, and media companies.

Then Things Changed...

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Eco-Friendly Practices: Corporate Social Responsibility

The hotel industry has undertaken a long-term effort to build more responsible and socially conscious businesses. What began with small efforts to reduce waste - such as paperless checkouts and refillable soap dispensers - has evolved into an international movement toward implementing sustainable development practices. In addition to establishing themselves as good corporate citizens, adopting eco-friendly practices is sound business for hotels. According to a recent report from Deloitte, 95% of business travelers believe the hotel industry should be undertaking “green” initiatives, and Millennials are twice as likely to support brands with strong management of environmental and social issues. Given these conclusions, hotels are continuing to innovate in the areas of environmental sustainability. For example, one leading hotel chain has designed special elevators that collect kinetic energy from the moving lift and in the process, they have reduced their energy consumption by 50%  over conventional elevators. Also, they installed an advanced air conditioning system which employs a magnetic mechanical system that makes them more energy efficient. Other hotels are installing Intelligent Building Systems which monitor and control temperatures in rooms, common areas and swimming pools, as well as ventilation and cold water systems. Some hotels are installing Electric Vehicle charging stations, planting rooftop gardens, implementing stringent recycling programs, and insisting on the use of biodegradable materials. Another trend is the creation of Green Teams within a hotel's operation that are tasked to implement earth-friendly practices and manage budgets for green projects. Some hotels have even gone so far as to curtail or eliminate room service, believing that keeping the kitchen open 24/7 isn't terribly sustainable. The May issue of the Hotel Business Review will document what some hotels are doing to integrate sustainable practices into their operations and how they are benefiting from them.