What is Revenue Management?
Why revenue needs to be managed? The answer is obvious: to increase profits. Unfortunately, not all hotel operators understand the importance of managing revenue and paying enough attention to this activity. In most cases, they simply underestimate the ROI associated with it. Many of them are still concentrated on the more conservative approach of managing just the expense side of the operations while ignoring the revenue side.
However, times have changed. Today, dynamic hospitality market presents a high level of uncertainty:
1- How strong will the demand be on any given day in the future?
2- What price expectations will those customers have?
3- What will competitors implement today, tomorrow and every day in the future?
4- How will future events affect revenues (for example, economic situation, changes in gas prices or air fares, construction next door)?
Besides, now customers are equipped with a wide range of tools that help them navigate in the market of hotel rooms and find deals that don’t always contribute to the hotels’ revenue growth (i.e. numerous OTA and aggregator websites, allowing customers to compare room rates, discounted opaque websites, mobile apps, etc.).
Times of “set it and forget it” are long gone. In order to be able to respond to this challenge and not get lost in constantly changing market conditions, every single hotel needs to understand the value of adequate proactive daily Revenue Management.
The main goal of Revenue Management is: to sell the right product to the right customer at the right time and for the right price, with an ultimate goal to maximize the bottom line (the final profit). How to find that right price and the right moment? Read further…
Main indexes used in the Revenue Management science
This is from the first grade of the hotel management class but still, let’s review them:
Percentage of all rental units in the hotel that are occupied at a given time.
Calculated as: Number of occupied rooms/ Number of total available rooms, and expressed as a percentage.
B- ADR (average daily rate)
Average rental income per occupied room in a given time period
Calculated as: Room revenue/ Number of rooms sold, and expressed in monetary units.
Sometimes a hotel’s productivity is evaluated based on one of the indexes mentioned above (more often – occupancy). Unfortunately, this limited analysis doesn’t reflect the complexity of the relationship between these two indexes, and the sales volumes they generate.
Revenue Management introduced a more accurate coefficient of measurement – RevPAR, which combines the two: occupancy and ADR in one statistic:
C- RevPAR (revenue per available room)
Revenue per available room is often used to measure hotel’s productivity and also to compare different properties within a market.
It can be calculated in a few different ways:
= ADR x Occupancy
= Total guest room revenue/ Number of total available rooms/ Number of days in the period
RevPAR allows for obtaining a more accurate and broad picturing of hotel’s performance, and also compare the results with competitors in your market.
It is recommended that a hotel is signed up to receive monthly STAR reports by Smith Travel Research that display the property’s performance comparing to other hotels in the market.
Unfortunately, RevPAR is also not the most accurate index for measuring the effectiveness of your hotel’s Revenue Management activities, regardless of the widely spread opinion in the hotel industry. This statistic does not objectively reflect the performance (and profitability) of your hotel and particular Revenue Management techniques you implement, due to the following:
- It does not take CPOR into account (to be exact, variable costs per occupied room)
- And also doesn’t take into consideration any additional income a hotel may have from other revenue-generating departments (restaurants, meeting space, banquet rooms, casinos, parking, spa, etc.)
There is one more index, more accurate and objective:
D- Adjusted RevPAR (AdjRevPAR)
More detailed description of this metric along with examples and calculations can be found in this article.
The hotel industry’s focus is finally shifting from high-volume bookings to high-profit bookings.
5 easy steps to successful Revenue Management
Now, let’s discuss the 5 basic steps to be performed in order to successfully manage revenue at a midscale or a limited service property. The steps are listed in order of importance (i.e. projected revenue potential). In your daily practice, start with 1 and proceed to the next as you become more comfortable with the routine.
STEP1: Dynamic pricing
Dynamic pricing IS really a big deal in Revenue Management. And every single hotel property needs to implement it. Here’s why.
As we know, effective Revenue Management requires a lot of forecasting. In order to be successful, it is necessary to be able to estimate approximate demand level for every day in the future, at least 365 days ahead, and price your hotel room accordingly.
However, setting your room rates for next year doesn’t mean that these rates should remain the same until that day arrives and the last guest is checked in. One of the biggest advantages of dynamic pricing concept is the ability to adjust to the real demand fluctuations, even if your initial forecast was inaccurate.
So how do I find the right price? The basic concept behind dynamic pricing in Revenue Management is simple: a hotel room should be priced based on supply and demand inter-correlations (equilibrium price).
And the key points to remember are the following:
- Each day should be treated as a separate season
- Prices need to be constantly re-adjusted in accordance with demand fluctuations in your market
In general, room rates should be increased when demand exceeds supply (in order to capitalize on ADR) and lowered when demand is weak (in order to increase occupancy). Proper pricing adjustments (daily or even hourly), which take existing demand into account and can even influence it, are the key to increased profitability. As was already mentioned, it is important to realize that the ultimate goal of any Revenue Manager should not be increasing occupancy, but rather maximizing the profit, the bottom line.
What’s also important is that managers’ pricing decisions have long-term effects. If you quickly sell a significant portion of your inventory at a low price, then of course, your occupancy index will increase. But another opportunity will be missed: that is, for example, to make more money on more profitable clients during the days that are closer to the arrival. And vice versa: holding your price too high, without paying attention to the competitors’ prices and a slowdown in the booking pace – will lead to a situation when a lot of inventory remains unsold. That makes dynamic pricing even more important in your daily hotel operations.
The two major mistakes that hotel managers make when pricing their rooms:
Instead, managers should react to the real demand fluctuations. Closely monitor your booking pace for the next 365 days to assess the strength of demand, or even better – implement an automated RM solution.
Let’s describe a situation when using Occupancy as an indicator for price adjustments can lead to incorrect revenue management decisions.
A manager is reviewing the upcoming Saturday in order to make a pricing decision. Currently, occupancy for that day is at 70%.
Scenario 1: during the last 7 days occupancy for the weekend has been picking up at a steady pace, about 5% a day, with a jump of 10% since yesterday.
Scenario 2: no reservations have been booked for the weekend during the last 7 days, and the hotel received 3 cancellations yesterday, thus the occupancy dropped from 73% to 70%.
We can see that in the 2 cases above, with the occupancy and the number of remaining days being equal, pricing decisions should be opposite. Scenario 1 describes high demand with strong pick up, which allows for a price increase since the current pickup pace indicates early sell out at the current price. Scenario 2 describes a situation when either the demand is weak or the hotel’s room rates are too high. Thus the most logical decision in this case would be to lower the rate to stay competitive.
Again, this confirms that occupancy alone cannot provide enough information for effective Revenue Management decisions.Price adjustments that are based only on occupancy while ignoring other parameters are in many cases incorrect and can lead to significant revenue and profit losses.
Instead, concentrate on your booking pace, which is an indicator of the demand strength. If you anticipate early sell out (demand exceeds supply) – increase the price. If the pace is too slow – lower the rate slightly and see how it affects your production. Constantly review and constantly re-adjust. Sounds like a daunting task but in reality, all you need is half an hour a day to grow your Revenue by 10-20 or even 30% and always be ahead of your competition, if implemented properly.
STEP 2: Setting stay restrictions
In addition to dynamic pricing fluctuations, there are a few other non-pricing methods of increasing revenue and profit. One method is setting stay restrictions and controls, which helps hotels maximize revenue potential through managing shoulder days. The 2 main restrictions used in the hotel industry are:
- Minimum length of stay (MLOS)
A restrictor that requires that a reservation is made only for at least a specified number of consecutive nights. It allows the hotel to develop a relatively even occupancy pattern during high demand periods or special events. It is intended to keep an occupancy peak on one day from reducing occupancy on shoulder dates. MLOS can also be applied with discount rates. For example, guest may have to pay Rack rates for shorter stays but be offered a discount for longer stays.
Closed to arrival (CTA)
A restrictor that does not allow reservations with date of arrival at a specified date. This strategy is used in 2 cases: to limit the number of arrivals on a given day (to release the burden from the front desk, for example, in case of a large group arrival) and in conjunction with MLOS restriction, to achieve even occupancy during peak demand dates that are longer than 1 night. See examples below.
In general, stay restrictions allow hotels to filter less profitable clients during peak demand seasons, thus increasing the resulting room revenue. It is important to note that they should only be used when estimated sales flow is sufficient enough to reach high occupancy without the loss of revenue.
A 4-day conference that fills all hotel rooms in the city and nearby areas. You know for sure that your hotel will sell out, as the demand significantly exceeds supply. If you don’t set any stay restrictions, then 1 or 2 of these 4 days may fill up sooner than the others, thus leaving the shoulder dates unsold. The shoulder dates will be harder to sell, as they now become a product for a different target audience: not the convention attendee who comes to town for a 4-day event and is ready to pay a higher price but for a different buyer who is coming for 1 or 2 nights and has a lower price expectation. However, if stay restrictions are applied in advance, then all days in the chain will be sold evenly and at the same high price (assuming that you’re employing the correct pricing policy and accurately managing demand levels and your booking pace).This will allow for maximizing your revenue and profit.
Please note that in this example, CTA is set along with MLOS, as this is a multiple-night event. Setting only MLOS for all 4 days won’t prevent customers from checking in on any of the 4 days and thus won’t guarantee even occupancy throughout the whole event. In the case when there is only 1 day, for which the booking pace significantly exceeds the shoulder days, a 2 mlos restriction is most often used (i.e. on a Saturday night to assist with increasing occupancy for Friday and Sunday).