Whenever a recession looms on the horizon, caused by either wars, security issues , terror attacks, a pandemic such as SARS or H1N1 virus, political instability, ….etc sales and marketing begin to decline, market share often shrinks and management raises the inevitable question – by how much do we discount our price points in order to galvanize business?
I believe this is the main question for many hotels if not many countries that might have some reasons as mentioned above (Egypt as example for the time being after the Russian flight crash Oct. 2015 )
So, in this present time and age hotel management and sales directors start the ambiguous game of discounting rates with a highly uncertain outcome, knowing that rate “dropping” is a myopic answer that anybody can do – there is no real skill required?
One of the most important decisions facing revenue managers in such situations is determining room rates optimal to maintaining occupancy levels and market share. As occupancy levels fall, rates tend to tumble even more quickly in an attempt to overtake them, knowing that discounting room rates may be a temporary solution to filling some otherwise empty rooms, but the short- and long-term consequences can be severe, needless to mention the practice of discounting can also have a negative effect on profits.
What is requires is such situations is a more structured and intelligent approach than just reducing the rate. Reducing room rate does (normally) NOT generate more volume per se in low market demand situations. It is a fallacy to think it does, there is no empirical evidence that supports that notion, but unfortunately many hoteliers believe on that.
Revenue managers should concentrate on increasing revenue share through intelligent sales and marketing initiatives. Then management companies will be surprised how much money they lose as sales declines in proportion to reduced ADR. Furthermore, hotels erode hard earned market share, diminish current and future earning potential and ultimately damage the brand’s reputation.
Below are two simple, but realistic scenarios illustrating that discounting rates is not the answer to attract business and generate demand.
let us assume that this is your hotel scenario without any side effect of decline demand.
A hotel with 400 rooms capacity sells 5,000 rooms nights per month (average occupancy of 41 %) for ADR of U$180 generating revenue of U$900,000 (ADR X Room Nights)
Let us assume variable cost is U$ 10 s per occupied room. That leads to a gross profit of U$850,000.
with all of a sudden decline demand happened for a reason or another as mentioned above , tour operators , OTA and corporates are pushing the hotels to offer very discounted rates reach to even 50 % discount .
In many cases hotel management assumes by decreasing rate by over 50% (times are tough) significant volume will be stimulated that will lead to higher revenue and profit.
Long term discounts like 25%-30 or even 50% discounts for 2-3 months leads to a loss of revenue, drop in RevPAR, change in perception of property and the clientele it gets.
There are multiple options to consider before you implement such a discount where the practice of discounting can also have a negative effect on profits.
Here it’s how it happened, hotels looks to the current situation with declined demand, so hotel respond to the discounted calls, with the new strategy the hotel drop the rates and now sells with new promotional rate of US$ 90, In spite of an attractive rate decrease of almost 50%, but the hotel sold 9,000 room nights (average occupancy of 75 %), so we see growth of 4,000 rooms, (an increase of 55%).
This attractive promotion generates sales of U$810,000 (lower by U$80,000 as generated before); subtracting the variable cost of U$ 10 dollars per occupied room leads to a profit of U$ 720,000, compared to U$ 850,000 in the previous model ( Loss of 130,000 US$).
In this models , most of the hoteliers forget to calculate the room cost when making discounting promotions , we can’t ignore the room fixed cost i.e. CRS fees, management company fees, electricity , insurance, manpower , governmental taxes ………etc , if the hotel rooms is empty or occupied those fees have to be paid in all cases , the same calculation goes to the variable costs when the room is occupied includes labor and benefits , Cleaning supplies and amenities, Laundry expense, Utilities and Reservation fees, marketing royalties, and commissions.
However these two models capture in essence of what is flawed with the notion that discounting is the solution to a complex problem. In this case a lower rate attracts more volume (in a real business simulation there is absolutely no guarantee that a lower rate offer assures more volume hence I note it is a very risky endeavor) but generate less revenue and profit. Unfortunately it is also not as simple as these two samples illustrate. There is no “one size fits all” approach as every market reacts differently to price fluctuations and macro decline demand circumstances differ from each nation to another.
Let us take real analyses even to ourselves level by wondering, have you noticed how our shopping culture has changed in the last decade? Maybe it’s because of the economic downturn or maybe it’s just a natural shift that’s been happening, but everyone, and I mean everyone, seems to be slashing their prices.
There are even multi-million dollar businesses that have built their organizations around the concept of discounting. Take Groupon for example. While the person who signs up to receive those daily “deals” might not be thinking of it as a discount, but rather a special package or promotion, in reality, they’re purchasing a product / service at a lower price, making it a discount.
Discounts are all around us, and as consumers, we’ve started to be conditioned to not purchase unless we’re getting a great deal, isn’t what is happening with the Tour operator , travel agent and corporate , look to an individual consumer when calling a hotel, asking for space availability and prices, 95 % of those consumers are asking for better rates and discounting.
The assumption of discounting and consequently stimulating growth works on the premise that a sharp drop in rate is being compensated by an equally strong (or stronger) growth pattern in volume. That assumption is flawed; largely it assumes that a rate drop is the only answer to volume woes. What I believe in it might work as an academic exercise but reality on the ground is far from different. Another reason for that , often overlooked aspect of rate slashing is once a hotel starts cutting rates it is just a question of times before competitors follow suit and the outcome is a dangerous downward spiral that is very difficult to stop; a classic lose-lose scenario unfolds – there are no winners aside from the end consumer.
Lessons to Learn From History
In times of this global business contraction there is very little or no price elasticity. Since hoteliers tend to forget the history, let us take some historical examples around the world, a classic example is the hotel industry in the late 90′s hotels in Bali enjoyed healthy occupancy levels and relatively high ADR’s Bali (exactly the same happened in Egypt 97 with Luxor terrorism attack and other areas ). In the aftermath of the first Bali bomb in October 2002 tourists left the island in throngs. Hoteliers slashed rates by over 50 percent all in anticipation of attracting business. Alas, that strategy did not produce the expected growth. Another examples Hotels in Hong Kong in 2003 at the peak of SARS were showing occupancy levels in single digits. During times of crisis people do not travel irrespective of how cheap a hotel advertises its rate. This was evident in the aftermath of the first gulf war in the early nineties and again after September 11 in 2001. Life is more precious than a cheap vacation in a dangerous holiday destination.
It took Bali almost three years to recover their rates to “pre bomb” levels. Hotels offered rates as low as U$ 50 including breakfast and still people did not travel to the beaches of Bali, in other destination like Sharm El Sheikh – Egypt hotels offering US$ 50 for double room for all-inclusive concept . Something should have been learned from this!, but in countries like Egypt hoteliers and hospitality industry never learned the lesson , with no chance to recover the ‘pre Luxor attack ‘ in terms of ADR and type of cliental .
Discounting Strategy Other effects
Online Effect : When the demand decline starts , this hit everywhere when the hotel start the discount strategy through online travel agencies and through the hotel’s own website), rate plays a role in both where a hotel room appears on an OTA’s listing of available rooms and in how that room is perceived by potential buyers. Posting a rate that allows a hotel’s available rooms to appear within the first few entries displayed on an OTA,
Value of brand: At this point, though, the impact of the rate upon the hotel’s brand must be considered. Associations between price and quality are natural for consumers to make, and perceived quality is a central component to any hotel’s brand image. Therefore, a rate discount negatively affects a hotel’s brand. (This is an oversimplification, of course; many hotels define their brand by bargain prices, and a high rate does not guarantee positive brand development. A correlation does exist, though.)
Dismissing this effect as the trivial fluctuation of image is unsound. Brands have immense value, especially in influencing the purchasing habits of consumers.
Discounting in a demand decline depressed environment does not deliver the desired results. Furthermore, when will our industry learn that reducing rate is neither a panacea nor the short-term solution to a very complex, and partially undiagnosed problem caused by factors beyond our control?
Conventional sales and marketing strategies don’t work in an uncertain, recessionary environment with only limited access to highly fluid and imperfect information. Discounting will always be a controversial and ambiguous subject with an ambivalent outcome at best. Each hotel has its own perfectly rational explanation, and philosophy, to pursue without justification – provided it makes commercial sense and protects all stakeholders. Discounting to grow volume following a decrease assumes one fatal flaw – which the rate is the reason for the volume drop in the first place. More often than not, when we engage in this type of pricing strategy, the core reason for the drop in volume was not due to rate!
When put like this isn’t the answer so simple? We are providing a remedy to a problem that doesn’t exist! We should be attacking the reason for the volume drop with sales and marketing strategies, not applying a medicine that actually misses the crucial point in the first place. The present challenge our industry faces is that of demand generation. We cannot influence demand factors, they are largely beyond our internal control mechanism, in particular in Thailand with all its socio-economic and political problems.
There is no such thing as a blanket approach to rate dropping. It is all managing the details, account by account, segment by segment. It is a tedious and resource consuming endeavour. But done intelligently the rewards are above average.
If you believe that discounting is not the right solution and you are looking for new strategy, follow our next week post about Hotel Revenue Management Contingency Plan for Demand Decline Era .