Profit Optimization: It's Finally Time to Do Something About It
By Ravi Mehrotra President, Founder, Chief Scientist, IDeaS | October 06, 2019
Over the last decade or so, the hotel industry has been murmuring about profit optimization. In the last five to seven years, that murmur has increased to a constant hum and within the last two years that hum has increased to an unavoidable buzz. I compare it to that song or jingle you can't get out of your head.
In this article, we will walk through key components of a paradigm shift in thinking and address the five areas hotel organizations need to focus on to make impactful profit optimization a reality.
To begin, we as hoteliers and hotel technology providers must answer two fundamental questions:
1. Why has profit optimization across a hotel been so hard to accomplish?
2. Why haven't we implemented anything that has truly given us the ability to achieve global profit optimization?
To make profit optimization a reality, we must radically change the paradigm of our thinking. While this may seem simple in principle, in reality, it requires a little more effort.
Breaking Down the Silos
Silos, as defined by Webster's Dictionary, are not just defined as a tower on a farm to store grain. They are also "a system, process, department, etc. that operates in isolation from others." This isolation is not unique to the hotel industry. It is commonplace for many global businesses.
When business leaders decide to create a new organization or department, they tend to think along functional lines and divide it around those functions. The result is the soloing of people within those functions (I am sure we can all think of examples of this between sales, catering and revenue management). Unfortunately, this inherently injects isolated thinking within those departments in the goals they set and the behaviors that drive their day-to-day operating ethos.
The right way to think about organizing for optimization would be similar to organizing a project team. In this case, you would assemble a team of different experts from across key functional areas of the hotel, then align around optimizing toward a single unified goal, such as top-line revenue growth or net-operating profit.
Until recently, hoteliers were optimizing in silos because they weren't able to get the appropriate data, and if they could get the data, it wasn't clean.
Learning from history, the focus of revenue management in the hotel industry has predominantly been on optimizing room revenue from existing demand and great advances have been made in optimizing this area. However, the challenges of data quality, data silos and capabilities made total optimization an unsolvable problem even the largest computers and mathematical models couldn't solve.
This, in turn, forced organizations to optimize in chunks that could be handled individually-rooms, function space, catering, etc.-resulting in management having to look at the impact from one individually optimized area to another, trying to determine each's impact on the other.
Now, a Radical Change in Behavior
Everything I've said so far may seem straight out of Hotel Business 101, but enabling organizations to make decisions for now, while keeping global optimality under consideration, requires a new data and operating model.
The great thing is that the strong movement to above-property data storage, the convergence of hotel tech and a more general acceptance of cloud and software-as-a-service technology provides incredible opportunities for whole-business optimization.
The biggest change in thinking comes down to using technology to enable business practices across all applicable functions that impact guest value and are relevant for your property. This is dramatically different than optimizing rooms, function space, etc. and trying to determine each one's impact on the other.
Let's take an example of selling a room. If the revenue manager were to take away a room, what impact would it have on the rest of the business the guest would generate during their entire stay in the "ecosystem" of the hotel?
If the rooms are in high demand, the opportunity cost is large, and the revenue manager will sell the room at a high price. This is where optimization across all areas is so important.
Consider this example. Let's say our room capacity is 150 rooms. We already know demand for the rooms is high, and we could sell out the rooms at a great price. But we have three revenue areas we need to optimize together to make the most profitable decision, instead of just optimizing the average daily rate at high occupancy.
Here we need to look at revenues and profits from meetings and events space (M&E) and food and beverage (F&B) in addition to rooms. In order to achieve this, we need to determine the demand for rooms from guests who would buy meeting rooms and catering in addition to rooms as well as guests also likely to spend money on F&B in addition to buying rooms and M&E, such as a business person staying at the hotel for meetings who will entertain in the bar after their meetings.
Recall the hotel has a capacity of only 150 rooms. The demand for rooms from guests who will buy just the rooms is 120. The demand for rooms from guests who will buy M&E in addition to rooms is 70. The demand for rooms from guests who will buy F&B in addition to rooms and M&E is 30. The total demand for rooms from all guests is 220.
As the hotel has only 150 rooms, the hotel must turn down the demand for 70 rooms. If we focus only on rooms and ignore revenues and profit from M&E and F&B, we may sell 120 rooms at a high price to guests who buy only rooms, leaving only 30 rooms to accommodate the demand from guests who buy M&E and F&B in addition to rooms.
If you optimize across your business, your system should tell you to allocate 70 rooms for guests who purchase M&E in addition to rooms and 30 rooms for guests who will purchase M&E and F&B in addition to rooms. Only 50 rooms should be sold to guests who do not purchase M&E or F&B. Limiting the rooms-only allocation to 50 rooms for "sleeping only" guests allows you to sell the 100 rooms to guests who buy M&E or F&B in addition to rooms that ultimately offer the best opportunity for profit.
Through this example, you can see that missing the opportunity to optimize across the business can have a tangible total property optimization impact. Now that we have the right data, we can solve the problem, not only by having the teams work together, but by optimizing our decisions across the revenue streams. We not only take into consideration the independent revenue streams impact, but the impact of the interdependency of the revenue stream combination on the total property.
Five Areas to Take Action
Now that we have shifted our thinking, there are very tangible ways to start this change and to help transition your hotel to enable optimization across your major revenue streams and actually achieve total profit optimization.
Profit optimization and whole property optimality can be compared to the pieces of a five-part puzzle of profit: room revenue, ancillary spend, servicing costs, channel costs and other inventory.
This can be a deceiving puzzle because each piece has the ability to stand on its own, but the great thing about it is you can combine the pieces together in many different ways. In doing so, we create a picture that will optimize your hotel.
So, let's break down what you can do to start putting this puzzle together.
1. Room Revenue
Room revenue is the most advanced in the realm of total revenue management. Here it is critical you take into consideration the interdependency of what drives room demand and the demand to other aspects of your hotels, such as selling M&E spaces based upon a minimum group block.
Start with taking stock of the net revenues and profit values from each of your revenue management segments. This will allow you to begin to optimize your business mix by room class, while considering total profit by available demand. This step also enables to you to create overall guest spend hurdles outside of just the room night alone and helps you make a decision on who to give the last room to-a known guest who spends $250 more across the hotel or an infrequent business traveler who will be spending no time on the property.
2. Ancillary Spend
Ancillary spend across the hotel can be one of the trickiest areas to prepare for but can drive an absolute boon for your net operating profit. It can also be a game changer across your total hotel operations in general decision-making, amenities determination, floor design and licensing agreements, to name a few.
The simplest way is to start gathering data across the "ecosystem" of the guests' time on the property. A tried-and-true option is to continue to drive the guest to assign any and all spends to their guest folio. This not only helps you gather the spend patterns but can also help you reduce the credit card processing costs associated with retail, food service, spa services, guest rooms, gift shop and more.
By consolidating this data, you can set ancillary revenue hurdle rates to ensure you take the most profitable business and manage revenue across discrete revenue sources.
3. Managing and Optimizing Channels
The next piece of this puzzle is understanding, managing and optimizing your channels, which has been on the radar of hoteliers for years. The difference between now and then is that we are in an environment where we can take direct action.
The first step is to take action with your data. Here, you need to understand and streamline your channel and source codes. You'll want to reduce or eliminate using channel and source codes interchangeably. This will clean up your data and allow you to separate each booking endpoint while isolating the differences in demand and cost and ultimately enabling you to build better forecasts.
Once you have clean data from which you can isolate your channel costs, you can make the decision to take more or less of the available demand across the various channels on the basis of the cost when taking one additional reservation through that channel. This improves profit performance by controlling costs on a channel-by-channel basis and can help you better negotiate with online travel agencies.
4. Servicing Costs
Profit is a hot topic in the industry, so we can't go without one of the largest areas of cost in a hotel-servicing costs. While this is typically outside of the purview of the revenue management team, in a world of optimizing across silos, servicing costs is an area of tremendous opportunity.
Here, you should take a broad look at the data you assemble on your targeted guest segments, including their spend profile and total propensity for usage of an amenity. The key area to start your investigation is in the non-room revenue hurdles.
Applying that to crucial elements of the guest usage patterns, and creating metrics that will provide visibility across the guest's length of stay, will open up key areas such as house staffing allocation and costs across rooms, restaurant, golf, spa and other spend areas.
5. Other Inventory
The final piece to the profit optimization puzzle is other inventory (e.g., cabanas, chair rentals and excursions). While this type of inventory is more applicable in resorts and casinos, the principles are important to ensure global optimization of revenues and impact to the total guest experience.
The key initial step, outside of transactional data aggregation across the property, is to determine guest segmentation, such as casino player guest versus non-casino player guest. By isolating these segments, you can start to identify the corollary values and metrics to monitor, thus allowing you to measure and manage your non-room-based, guest-spending hurdles.
It's Up to You to Act
Profit optimization may not be a new topic, but the industry practices and data are better now than they have ever been. To take advantage of this "brave new world," you need to be prepared to break down silos, think in radical ways about your guest value and be willing to take strategic action.
More importantly, however, is that now is the time to stop talking about profit optimization and start doing something about it!
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