Cash Flow As Used In The Price-Cash Flow Ratio 6 Steps to Profitable Hotel Rate Management.

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6 Steps to Profitable Hotel Rate Management.

The OFT (Office of Fair Trading) has announced an investigation into hotel portals for alleged price-fixing. The complaint was launched by the Skoosh portal, accusing hotels and portals of price fixing – I’ve honestly never heard of them until now, so I don’t think it’s a bad publicity stunt! Regardless of the merits or demerits of this case, hotel pricing defies logic and is not good business practice.

Let me put my cards on the table. My hotel pricing experience comes from working with a hotel that I part own and other hotels that we provide marketing consulting services to, so you could argue that I have limited experience with this. However, for many years I have been involved in pricing complex products for global markets with thousands of components, multiple currencies, local price points, etc. Never in my life have I seen so much nonsense presented as science as in the hotel industry.

While we have seen some great results from hotel groups such as Intercontinental Hotels Group (helped by the sale of the property), the average return on invested capital and net profit margins in the industry are simply appalling. Most large hotels focus on occupancy rates, lowering rates due to higher occupancy. More knowledgeable hotels consider RevPAR (Revenue Per Available Room), which takes into account occupancy and revenue generated from available inventory (rooms). Take it any way you want, these are very rough metrics and encourage wrong behavior in first-tier management, all of which lowers ROI (the true measure of profitability in any business).

The hotel industry is its own worst enemy by forcing the traveling public to think “Buy late and get a bargain” and then complain about ROI and lack of ROI. Portals like lastminute.com have become synonymous with cheap travel and have actually entered our everyday language. Now you can get a last minute deal on almost anything.

The hotel industry needs to take a leaf from the airline industry and their pricing and fare management practices. There are many similarities between the two business models:

  1. Seasonality – Hotels and airlines have parallel seasonal ups and downs, with cash flow from famine to feast that leaves the bravest of entrepreneurs scrambling for cover. This seasonality is central to behavior and pricing in both industries, but it manifests itself strangely differently.
  2. Capital intensive – Airlines and hotels are extremely capital hungry with high levels of capital invested in their infrastructure and inventory (aircraft/seats and bedrooms). This makes it all the more imperative to use assets and stocks aggressively and as the old saying goes, “make your capital sweat hard”. For airlines, keeping aircraft ground time to a minimum is critical to the profitable use of capital, and hotels are trying to pursue the same goals by focusing on occupancy.
  3. High fixed cost ratio – In both cases, operating costs consist of mostly fixed costs and small variable costs. Think about it, a plane taking off from an airport has fuel, crew, landing/takeoff space and aircraft rental/financing costs imposed on it, regardless of how many passengers are on board. The same applies to a hotel, because no matter how many rooms are sold, the costs of construction, staff, marketing, etc. the largest part of the total costs, which are all fixed.
  4. External exposure – The Icelandic volcano fiasco of April 2010 was a stark reminder of the vulnerability of both industries to external events completely beyond their control. The same applies to the harsh winter of 2010, strikes by air traffic controllers, ground staff, etc. All this affects both airplanes and hotels.

Airline pricing model

Airlines have steadfastly maintained their basic tenet of the “early discount, late premium” pricing model. As consumers, we have all accepted this basic premise and know that cheap flights are only available if we book early and hesitate at our peril.

However, this simple principle is not a one-dimensional and asynchronous pricing model. Airline fare management tools take seat availability into account. Seats are divided into groups (price classes/groups) which have a certain number of seats at a certain price and are available for sale at predetermined intervals before departure dates. You could say simple, but that’s not the end of the story. The pricing algorithm takes into account ‘Sell Rate’ (number of bookings per given period, eg per hour/per day/per week), ‘Search Rate’ (number of inquiries for a specific flight per day/per week) and available capacity (number of vacancies seats). This decides whether a particular group of seats will be open, closed or enlarged, allowing you to identify price differences when checking a flight over a period of days. Some have gone further and stored 30-day cookies in visitors’ browsers so that they can identify a returning browser and then decide whether to offer the same price as before or increase the price (the lesson “You should have booked earlier” !).

Hotel pricing model

It could be a simple one-liner saying, “Hotels don’t have a pricing policy or logic model,” but then I would be bombarded with emails full of RevPAR, occupancy, average rates, etc. Well, that’s nonsense. Just because an industry has acronyms and measurable metrics doesn’t mean it has a system, understanding or strategy, nor does it mean it’s measuring the right things. Let me illustrate.

Hands up everyone who saw the “Early Booking” offers in January, then the “Action” prices before Easter and the “last minute” deals the week before going on vacation. Then go to TripAdvisor and see all those portals advertising ‘Up to 70% off’. Does this sound like a sell-as-much-at-all-costs strategy or culture? So what happened to Rack Rate?

Add to this a very popular phenomenon of mine, namely the portals, which are supposed to sweep away excess capacity and increase occupancy. They get a big commission (up to 25%) and then get a lower price than the Rack Rate (usually the same deals available on the hotel’s website). So where is the added value of the portal? If they offer the same rate as the hotel website (90% of them do) and take a large portion of the commission, then what happens to the hotel’s RevPAR? Otherwise, if this is supposed to be a clearinghouse for excess capacity, why do they have rooms for sale in January or February for holidays in July or August? Hotels have no way of knowing about excess capacity 6 months before the start of the high season.

Just like airlines measure the utilization of a plane, we can talk about occupancy, but no matter how high that number is, it does not mean that we are making a profit. Benchmarks are useful for benchmarking between two similar companies, but they should not be mistaken for good business practice and treated as the holy grail. Business analysis is not a dogma, but a rational performance analysis that should show us the right direction of our business.

What is the solution?

The solution is simple, just follow the airline industry.

  1. Have a clear understanding of your tipping point. Without it, you can’t make a rational decision, and all the criteria in the world won’t help you make a profit.
  2. Offer your best available rates 6 months before your arrival date and as the dates get closer, increase your price towards the Rack Rate.
  3. Don’t create random discount packages. You shouldn’t compromise just to increase your occupancy or meet these arbitrary and meaningless benchmarks.
  4. You should always consider other goals, such as increasing the average stay, improving a traditionally poor period, etc. Increasing occupancy will be a secondary goal if your packages are well targeted.
  5. Review your bookings, availability and destinations daily, which will then let you know whether to keep the price low or raise it (airline sale price concept).
  6. Under no circumstances offer a late booking discount unless it exceeds your average stay (bet you didn’t keep track of that). Under no circumstances should you offer your best prices to last-minute bargain hunters; you are just reaffirming the habits that the hotel industry would like to introduce.

Finally, keep up your work with the portals. 10% commission or nothing and use them to generate attraction for your hotel from market segments that are out of your reach but that don’t make them more competitive than your rates. Remember you agreed to parity, not “lowest possible rate!”

This strategy worked and we can show that hotels using this strategy increased their occupancy, RevPAR and believe it or not average stay. Most importantly, all the hotels we work with are profitable. You should be right to think; “If that’s all, why are you posting it for free?” You’d be right, because that’s not all! Contact us and see what we can do for your company.

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