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HFT 3431

Learn about the relevant costs in pricing decisions, weaknesses of informal pricing methods, common cost methods in pricing rooms and food/beverages, and the concept of integrated pricing. Understand price elasticity of demand and its impact on profitability. Explore various pricing approaches and yield management strategies to optimize revenue in the hospitality industry.

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HFT 3431

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  1. HFT 3431 Chapter 8 Cost Approaches to Pricing

  2. Pricing Questions • Which Costs Are Relevant in the Pricing Decision? • What Is the Common Weakness of Informal Pricing Methods? • What Are Common Cost Methods of Pricing Rooms?

  3. Pricing Questions • What Are Common Methods of Pricing Food and Beverages? • How May Profitability and Popularity Be Considered in Setting Food Prices?

  4. Pricing Questions • Will Departmental Revenue Maximization Result in Revenue Maximization for the Hospitality Firm?

  5. Pricing Questions • What Is Integrated Pricing? • What Is Price Elasticity of Demand?

  6. Price Elasticity of Demand • Measures How Sensitive Demand Is to Changes in Price • Either Elastic or Inelastic

  7. Price Elasticity of Demand • Computed by Dividing % Change in Quantity Demanded by Base Quantity BY % Change in Price by Base Price (Q2 - Q1) / Q1 (P2 - P1) / P1

  8. Price Elasticity of Demand • Assume Hotel Sells 1,000 rooms @ $30 • Changes Price to $33 and sells 950 (950 - 1,000)/1,000 (33 - 30)/30 = - 0.05 / 0.10 = -0.50 Inelastic

  9. Price Elasticity of Demand • If between 1 and -1 Inelastic (Demand Is Insensitive to Price Changes) • An increase in price is offset by a smaller decrease in demand • Normally results in more profits with a price increase • An decrease in price is offset by a smaller increase in demand • Normally results in less profits with a price decrease

  10. Price Elasticity of Demand • If Greater Than 1 or -1 Elastic (Demand Is Sensitive to Price Changes) • An increase in price is offset with a higher decrease in demand • Normally results in less profits with a price increase • An decrease in price is offset with a higher increase in demand • Normally results in more profits with a price decrease (up to a point)

  11. Price Elasticity of Demand • Competition, Uniqueness Affect Elasticity • When Change Prices, Test for Elasticity

  12. Informal Pricing Methods • Competitive • Intuitive • Psychological • Trial and Error • Follow The Leader

  13. Informal Pricing MethodsFour Modifying Factors • Consider First: • Historical Price Changes • Guest Perceptions (Price/value) • Competition • Modify by Rounding

  14. Mark Up Approaches • Ingredient Mark Up • Determine Ingredient Costs • Determine Multiple to Use • Multiply Costs by Multiplier • Adjust Using Qualitative Factors

  15. Multiplier • 1 / Desired Food Cost Percentage • Example 1 / 40% = 2.5

  16. Alternative to Multiplier • Divide Costs By Desired Food Cost Percentage • Example $3.00 Cost / 40% = $7.50 Selling Price

  17. Ingredient Mark Up Approach • If total ingredients cost $1.32 and you have a 40% desired Food Cost • Multiplier = 1/0.4 = 2.5 • Suggested Price = $1.32 * 2.5 = $3.30 • Would suggest rounding to $3.50

  18. Mark Up Approaches • Prime Ingredient Mark Up • Determine Prime Ingredient Cost • Some Versions Add in a Fixed Dollar Amount for Other Ingredients

  19. Mark Up Approaches • Prime Ingredient Mark Up(Continued) • Determine Multiple to Use - Higher Than Mark up (Arbitrary) • Multiply Costs by Multiplier • Adjust Using Qualitative Factors

  20. Prime Ingredient Mark Up Approach • If Prime Ingredients cost $0.59 and you have a Prime Multiplier of 7.8 • Suggested Price = $0.59 * 7.8 = $4.60 • Would suggest rounding to $4.75 • Note, the Prime Multiplier is based on history or industry standards there is not a formula for it. It is usually higher than the ingredient multiplier

  21. Rooms Pricing Traditional Method • $1 Per $1,000 Cost Per Room • Doesn’t Consider Current Value • Doesn’t Consider Other Services • Assumes 70%occupancy • Assumes Profitable Food and Beverage

  22. Rooms Pricing Traditional Method • If $100,000,000 to build a 5,000 room hotel = 100,000,000 / 5,000 = 20,000 per room = 20,000 per room / $1,000 = $20.00 per room rate

  23. Rooms PricingHubbart Formula • “Bottoms Up” • Start With Profit • Determine Pretax Profit

  24. Rooms PricingHubbart Formula • Add in Fixed Charges • Add in Undistributed Operating Costs • Estimate Non Room Income (Loss) • Sum Is Rooms Department Income

  25. Rooms PricingHubbart Formula • Rooms Revenue Equals Rooms Income Plus Rooms Department Costs • ADR = Room Revenue / Rooms to Be Sold • See page 371 for example

  26. ADR to Single and Double Rates • (Singles Sold * Single Rate) + (Doubles Sold * (Single Rate + Price Differential)) = Average Rate * Rooms Sold • Solve for Each Rate

  27. Rate Calculation • Assume 200 room hotel with occupancy of 75% and double occupancy of 40% with ADR or 67.81 (doubles are $10 more than singles • Sell (.75 * 200) 150 rooms per day 90 singles 60 doubles

  28. Rate Calculation • Let X = Single Room Rate • 90x + 60(x + 10) = 67.81 * 150 • 90x + 60x + 600 = 10,171.50 • 150x = 9,571.50 • x = 63.81 Single Rate x + 10 = 73.81 Double Rate

  29. Yield Management Increasing the Rooms Revenue

  30. Yield Management • Take the Guess Work out of Your Rooms Inventory • The Business of Selecting the Most Profitable Reservations • Yield Management Is the Process of maximizing the total revenues, rather than selling more rooms

  31. Why Yield Management ? • Increase Room Revenues • Improve Total Corporate Profitability • Enter New Markets With Strategic Pricing • Identify and Respond More Quickly to Changing Market Trends • Manage Distribution Channels More Effectively

  32. What We Gain Is: • Assume 100 room hotel and you can sell either to business or group: • Business - ADR = $80 • Business books 1 week out, and have 40 business guests already booked and can book 55 more in the next 3 weeks • Group - ADR = $55 • Groups books 3 week out • It is 4/1/02 and a group wants to book 20 rooms for 4/21-11/02

  33. What We Gain Is: • Option 1 Accept the Group Group Rooms 20 * $55.00 = $1,100 Business Rooms 80 * $80 = $6,400 Total $7,500 • Option 2 - Reject the Group Business Rooms 95 * $80 =$7,600 • Since only $100 difference look at the overall revenue that will be generated from each option (ie food and bev)

  34. Menu Engineering A Tool to Increase Food and Beverage Profits

  35. Breaking Out of the Box • Is It Really Important to Sell Each Guest a Selection From Each Part of the Menu? • Is Food Cost Percentage the Best Measurement of Performance?

  36. Breaking Out of the Box • Can We Determine the Exact Labor Cost for Each Item Sold on the Menu? • Should Selling Prices Be Determined on a Consistent Mark-up Basis?

  37. Selling the Entire Menu • Drives up Check Average and That Is Good • Additional Points of Service Reduces Seat Turnover • Waiting Time for Table May Cause Loss of Customer

  38. Selling the Entire Menu • Would You Rather Serve a Dessert at a Cost of $2 for $5 or an Entrée at a Cost of $4 for $10?

  39. Food Cost Percentage • Ratio of Cost of Goods Sold to Sales • Gross Profit Is Sales Minus Cost of Goods Sold • Objective Is to Increase Gross Profit

  40. Food Cost Percentage • Do You Deposit Percentages or Dollars? • Item “A” Costs $4 and Sells for $12 or 33% • Item “B” Costs $8 and Sells for $20 or 40% • Which One Would You Rather Serve (All Other Things Being Equal)?

  41. Labor Cost • Labor Is a Mixed Cost - a Fixed Component and a Variable Component • Customer Demand Is Variable on a Daily Basis • Daily Labor Is Scheduled Based on Forecasts Which Inherently Are Imprecise

  42. Labor Cost • Therefore, Exact Labor Cost Quantification on a Per Item Basis Is Impossible to Compute • Can Rank Labor Cost Per Item (High or Low Relative to the Items in the Mix)

  43. Menu Engineering • Smith and Kasavana • Analyzes Popularity and Contribution Margin • Two by Two Matrix • Classified Items As Stars, Dogs, Puzzles, or Plowhorses

  44. Popularity • Item Is Popular If Individual Item’s Sales Mix Exceeds 70% of the Average Popularity • Average Popularity = (100% / Number of Items) * (70%)

  45. Popularity Example • 10 Items • Average Popularity = (100% / 10) * (70%) = 7% • If Individual Sales Mix Is > 7%, The item has HIGH Popularity • If Individual Sales Mix Is < 7%, The item has LOW Popularity

  46. Contribution Margin • Selling Price Minus Variable Costs or Gross Profit • Compute for Each Item

  47. Weighted Average Contribution Margin Calculation • Compute Individual Contribution Margin • Multiply Item Contribution Margin by Number of Item Sales • Result Is Total Contribution Margin

  48. Weighted Average Contribution Margin Calculation • Divide Total Contribution Margin by Number of Sales • Result Is Weighted Average Contribution Margin

  49. Contribution Margin • Compare Against Weighted Average Contribution Margin for Menu Section Engineered • If Item CM Is > WACM - Label “HIGH” • If Item CM Is < WACM - Label “LOW”

  50. Classifications • Star - High Popularity & High CM • Continue promoting item • Plow Horse - High Popularity & Low CM • Re-price the item to increase CM • Puzzles - High CM & Low Popularity • Promote the item to increase popularity • Dogs - Low CM & Low Popularity • - Drop the item from the menu

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