Chapter 8

1. Chapter 8 Revenue Management for Hotels 1

2. Chapter Outline • Establishing Room Rates • Revenue Management • Non-Room Revenue 2

3. Learning Outcomes • Utilize alternative methods when establishing a hotel’s room rate structure. • Apply revenue management and analysis techniques to the administration of a hotel’s room rate structure. • Recognize the importance to a hotel of properly managing and controlling its non-room revenue. 3

4. Establishing Room Rates • Any serious exploration of hotel room rates and their management must include basic information about room rate economics. • Room rate economics recognizes that, when the supply of hotel rooms is held constant, an increase in demand for those rooms will result in an increase in their selling price. • Conversely, when supply is held constant, a decrease in demand leads to a decreased selling price. 4

5. Establishing Room Rates • Understanding the law of demand is critical because, unlike managers in other industries, hoteliers cannot increase their inventory levels of rooms (supply) in response to increases in demand. • Hotel managers must also understand that their own inventory of rooms is highly perishable. • If a hotel does not sell room 101 on Monday night, it will never again be able to sell that room on that night, and the potential revenue that would be generated from the sale is lost forever. 5

6. Establishing Room Rates • A rack rate is the price at which a hotel sells its rooms when no discounts of any kind are offered to the guests. • In some cases, it makes sense for hoteliers to create special event rates. Sometimes referred to as “super” or “premium” rack, these rates are used when a hotel is assured of very high demand levels (e.g., Mardi Gras in New Orleans and New Year’s Eve in New York City). • Hotels often negotiate special rates for selected guests. In most cases, these negotiated rates will vary by room type. • In addition to rack and negotiated rates, hotels typically offer corporate rates, government rates, and group rates. 6

7. Establishing Room Rates • Some hotels have great success “packaging” the guest rooms they sell with other hotel services or local area attractions. • When a hotel creates a package, the package rate charged must be sufficient to ensure that all costs associated with the package have been considered. • In addition, the use of one or more authorized fade rates, a reduced rate authorized for use when a guest seeking a reservation is hesitant to make the reservation because the price is perceived as too high, can result in even more room rates to be managed. 7

8. Establishing Room Rates • A hotel’s revenue managers can also create discounts at various percentage or dollar levels for each rate type we have examined. • The result is that a hotel, with multiple room types and multiple rate plans, may have literally hundreds of rates types programmed into its property management system. • A property management system (PMS) is a computer system used to manage guest bookings, online reservations, check-in/check-out, and guest purchases of amenities offered by the hotel. 8

9. The Hubbart Room Rate Formula • The Hubbart formula is used to determine what a hotel’s average daily rate (ADR) should be to reach the hotel owner’s financial goals. • The Hubbart formula is a “bottom-up” approach as shown in Figure 8.2. • To illustrate the Hubbart formula, the Blue Lagoon Water Park Resort’s Income Statement is shown in Figure 8.3. • For a detailed analysis of the Hubbart formula, see Go Figure! following Figure 8.3. • For a summary of the Hubbart formula calculations for the Blue Lagoon Water Park Resort, see Figure 8.4. 9

10. 10

11. 11

12. 12

13. 13

14. 14

15. 15

16. 16

17. 17

18. The Hubbart Room Rate Formula • The Hubbart formula is useful because it requires managerial accountants and hoteliers to consider the hotel owner's realistic investment goals and the costs of operating the hotel before determining the room rate. • The formula has been criticized for relying on assumptions about the reasonableness of an owner’s desired ROI and the need to know expenses that are affected by the quality of the hotel’s management. • Another criticism is that the formula requires the room rate to compensate for operating losses incurred by other areas (such as from telecommunications). 18

19. The Hubbart Room Rate Formula • Despite its limitations, the Hubbart formula remains an important way to view the necessity of developing a room rate that: • Provides an adequate return to the hotel’s owner(s) • Recovers the hotel’s non-operating expenses • Considers the hotel’s undistributed operating expenses • Accounts for all the hotel’s non-room operated departments income (or loss) • Results in a definite and justifiable overall ADR goal 19

20. The $1.00 per $1,000 Rule • One alternative way that hoteliers have historically determined room rate is the $1.00 per $1,000 rule. • This rule states that, for every $1,000 invested in a hotel, the property should charge $1.00 in ADR. • The dollar-per-thousand rule is most accurate for hotels that have high occupancies, high ADRs for their area of operation, and are newly built. 20

21. The $1.00 per $1,000 Rule • Despite some limitations, the $1.00 per $1,000 rule does reflect the tendency for hotel buyers to discuss hotel selling prices in terms of a hotel’s cost per key (average cost per room), which is the average purchase price of a hotel’s guestroom expressed in thousands of dollars. • It is important to recognize that the rate computed using the $1.00 per $1,000 rule does not become the hotel’s rack rate. • Instead, it is the overall ADR that the hotel must achieve when its sells all of its various rooms at all of their respective rates. 21

22. Alternative Room Rate Methodologies • Non-traditional, non-cost methods to establish rates: • Competitive Pricing. Charge what the competition charges. • Follow the Leader Pricing. Charge what the dominant hotel in the area charges. • Prestige Pricing. Charge the highest rate in the area and justify it with better product and/or service levels. • Discount Pricing. Reduce rates below that of the likely competitors. 22

23. Web-Influenced Room Rate Methodologies • Today’s hotel room rate structures have been changed, and changed forever, by the advent of the Internet as the most popular method used for selling hotel rooms. • As a result of the Internet, consumers can easily compare prices, but so can a hotel’s major competitors. • While the call-around was standard practice as late as the early 2000s, consider modern hoteliers utilizing one of the many websites similar to http://www.Travelaxe.com and others that allow him/her to easily see other hotels’ rates. 23

24. Web-Influenced Room Rate Methodologies • Guests care very little how much it “costs” a hotel to provide its rooms. • They care about the lodging value they receive. • As a result, a hotel’s rates are heavily influenced by the laws of supply and demand. • A guest can make a hotel reservation at a given rate, and, every day until the date of arrival, can go online to shop for an even lower price for the same room. • If a lower rate were to be found, the guest could re-contact the hotel, cancel the original reservation, and secure the new, lower rate. 24

25. Revenue Management • Revenue management, also called yield management, is a set of techniques and procedures that use hotel specific data to manipulate occupancy, ADR, or both for the purpose of maximizing the revenue yield achieved by a hotel. • Yield is a term used to describe the percentage of total potential revenue that is actually realized. • Revenue managers are responsible for making decisions regarding the pricing and selling of guest rooms in order to maximize yield. 25

26. 26

27. Revenue Management • RevPAR is a combination of ADR and occupancy %. • To increase yield simply means to increase the hotel’s RevPAR. • Therefore, any change (decrease or increase) in either or both of the factors comprising RevPAR will change the yield of the hotel’s revenue. • RevPAR is calculated using the following formula: 27

28. Revenue Management • Revenue management techniques are used during periods of low, as well as high, demand. • Although the actual revenue management techniques used by hoteliers vary by property, in their simplest form, all these techniques are employed to: • Forecast demand • Eliminate discounts in high demand periods • Increase discounts during low demand periods • Implement “Special Event” rates during periods of extremely heavy demand 28

29. Revenue Management • Using information gleaned from the hotel’s historical sales data, revenue management features in a property management system (PMS) can: • Recommend room rates that will optimize the number of rooms sold • Recommend room rates that will optimize sales revenue • Recommend special room restrictions that serve to optimize the total revenue generated by the hotel during a specific time period • Identify special high consumer demand dates that deserve special management attention to pricing 29

30. Revenue Management • In the hotel industry, a competitive set (comp set) consists of those hotels with whom a specific hotel competes and to which it compares its own operating performance. • To fully evaluate RevPAR changes, hoteliers look to the relative performance of their comp set. • They do so to better understand the room rate economics that affected their own property during a specific time period. • To better understand the shortcomings of an over-emphasis on RevPAR, it is important to take a closer look at its two fundamental components, occupancy % and ADR. 30

31. Occupancy Percentage • It might seem that the occupancy percentage for a hotel would be a straightforward calculation. • A room revenue statistics report generated from the Blue Lagoon Water Park Resort’s property management system produced the information needed to calculate their occupancy percentage. 31

32. 32

33. 33

34. ADR • Average daily rate (ADR) is also a critical component of RevPAR. Generally, hotel managers calculate ADR using rooms sold or rooms occupied. • While both of these ADR formulas are commonly used, neither of these may accurately reflect ADR since they reveal different rates. 34

35. 35

36. Net ADR Yield • Despite the slight differences in these two ADR computations, neither is as useful to the hotel’s owners and managers as the computation of the net ADR yield. • Net ADR Yield is the percentage of ADR actually received by a hotel after subtracting the cost of fees and assessments associated with the room’s sale. • Today, most hotel guests already have a room reservation prior to arrival, and the reservation distribution channels (sources of reservations) used to make their reservations will charge the hotel widely varying fees for making them. 36

37. Net ADR Yield • When a guest makes a reservation via the Internet, no less than three reservation-generation fees are typically charged to the hotel, including fees from: • Internet Travel Sites - websites for booking travel to end-users • Global Distribution System (GDS) - system that books and sells rooms for multiple companies • Central Reservation System (CRS) – system used by companies to centrally book reservations 37

38. Net ADR Yield • With increased usage of high priced distribution channels, a room’s selling price (quoted) and the ADR the hotel actually receives can be radically different. • Clearly, it is the ADR after the cost of reservation generation fees that should be most important to hoteliers and their attempts to increase RevPAR. • If net ADR yield is not used, hotel owners and managers run the risk of significantly over inflated RevPARs accompanied by significantly reduced profits as well. 38

39. 39

40. Flow-Through • Flow-through is a measure of the ability of a hotel to convert increased revenue dollars to increased gross operating profit dollars. • Consider the simplified income statements detailing revenue and expenses for January 2010 and for the same month of the prior year for the Blue Lagoon Water Park Resort (see Figure 8.8). • Gross operating profit (GOP) is, in effect, total hotel revenue less those expenses that are considered directly controllable by management. 40

41. 41

42. 42

43. Flow-Through • Flow-through was created by managerial accountants to measure the ability of a hotel to convert increases in revenue directly to increases in GOP. • When flow-through is high (over 50%), it reflects efficiency on the part of management in converting additional revenues into additional profits. • For most hotels, flow-throughs that are less than 50% indicate inefficiency in converting additional revenues into additional profits. 43

44. GOPPAR • Gross operating profit per available room (GOPPAR) is defined as a hotel’s total revenue minus its management’s controllable expenses per available room. • For example, the costs of a hotel’s lawn care services, utility bills, and even food and beverage expenses are considered when computing GOPPAR. • These same expenses are not, of course, considered when computing RevPAR. 44

45. 45

46. GOPPAR • RevPAR indicates the performance of a hotel in terms of rooms inventory sales and marketing, however, it provides no indication of how much money the hotel actually is, or should be, making. • GOPPAR takes into consideration the cost containment and management control of the hotel and must be considered in any effective rooms pricing strategy. • The difficulty is not that RevPAR is a poor measurement, but rather it is the fact that RevPAR should not be the only measurement of a hotel’s revenue manager’s effectiveness. 46

47. Non-Room Revenue • Non-room revenue is important to the managers of both limited service and full-service hotels. • It is common for limited service hotels to generate 5-20% of their total revenue from non-room sources. In full-service hotels, the non-rooms revenue generated may range from 20-50% of total revenue. • Not every hotel will create revenues in every non-room revenue area. 47

48. Non-Room Revenue • Non-room revenue on a hotel’s income statement is attributed to one of the following categories: 48

49. Food and Beverage Revenue • Food and beverage revenues typically make up the largest portion of a hotel’s non-room revenue. • In a properly managed hotel food and beverage (F&B) department, the department head wants to financially support the hotel through sales. • However, this may be more complicated than it first appears. 49

50. Food and Beverage Revenue • For example, in many hotels, complementary breakfast is served to all overnight guests. • The food and beverage department may be reimbursed for the “cost” of providing breakfast, but the actual “sales” value of the breakfast, including a profit, would not likely be transferred. • Another example is a holiday weekend package plan that includes one night’s stay, dinner, and breakfast sold to guests for one price. 50