The hotel industry is close to peak pricing, if not already there. If we truly are at the top of the cycle, with hotel revenue performance at an all-time high, the industry is in a perfect position to hone its revenue management skills and maximize the situation.
Those of us who have weathered numerous industry cycles know that inevitably there will be a downturn that leads to price wars. Savvy hoteliers, however, can defend themselves using trends to mitigate the need for rate reductions.
Many revenue managers spend an inordinate amount of time focused on opening and closing segments with the brands and online travel agencies, and determining pricing solely on what the competition is charging across the street. Most use relatively sophisticated revenue management software. Yet, I often wonder how many people within the discipline truly understand the basics of how pricing should be established.
Hoteliers also should consider elasticity, a basic economic principle of pricing, as they consider revenue management strategies. For the hospitality industry, pricing elasticity is defined by how the demand for a hotel room changes in response to pricing. For example, if a hotel drops its rates by a percentage and sees a resulting increase in revenue, that demand is considered elastic. Conversely, inelastic demand is not price sensitive. Factors that affect price elasticity include competitor room availability, degree of necessity, income of buyer, stay pattern and day of week, seasonality, “sale” pricing and the price/value perception.
Where to start
So, how does one take advantage of price elasticity?
The first step is setting up “rate fences,” which allow hoteliers to charge different prices to different customers. These can include physical features such as bed size; concierge floor; premium rooms; suites; view; and connecting rooms; to more indirect rate fences, such as loyalty programs; purchaser age; corporate travel; affiliations; length of stay; advanced purchase; nonrefundable; preferred upgrade; online purchase; quantity sold; and weekday versus weekend; among others. Understanding the elasticity of demand and how it affects price and utilizing rate fences effectively can lead to higher revenues.
Next, consider “reference pricing” and how that plays into the “prospect theory.” Reference pricing is simply how a guest determines which rate to choose based on the relationship to other prices available.
For example, let’s say you were choosing between a cup of generic coffee at $2 and the same brand, premium roast for $3. What if we added a super-premium to the menu for $4? In the first instance, most would pick the $2 coffee. In the second example, studies have shown that the $3 coffee gets the nod most often.
Similarly, the way a hotelier lists pricing influences how and what a guest will buy. Reference pricing can come from what guests have paid in the past, pricing set by competitors (especially the rate leader of a competitive set), and related pricing such as the same hotel brand in another location and the way the price is presented. Online travel agencies’ use of strike- through pricing where the “old” price has a line through it and a new lower price is offered is an effective example of reference pricing in action.
Reference pricing begs the question of how to set price points given demand dynamics and related elasticity. Hotel shoppers have different priorities, including those who 1) will pay whatever price is available, 2) will pay what they believe to be a fair price, 3) will pay negotiated prices and 4) will look for the least expensive price.
From these four categories, one can make pricing assumptions based on demand. A revenue manager’s goal should generally be to sell at least 50% of occupied rooms in the high rate categories (rack or corporate rates). High rate pricing should be at least 110% of total transient average daily rate. Optimally, a hotelier would limit discounted rates to 30% or less of occupied rooms at a rate that is no more than a 25% discount to the higher rated category. For preferred rates discounted due to volume, the mix should be no more the 40% of occupied rooms with discounts ranging from 10% to 30% off premium pricing (based on forecasted occupancy levels).
Another way to prevent price slashing is through upselling and upgrades. It is easier to sell something extra to someone who already has made a buying decision than it is to convince a buyer to purchase the more expensive item initially. Here are few strategies for upgrading:
1- Offer upgrades online. There are no pressure sales (like it might be perceived at the front desk), and the guest does not have to make a split second decision.
2- Send upgrade offers through loyalty programs. Most loyalty guests expect a free upgrade. Consider offering the free upgrade as the base level, with two premium upgrades offered above that.
3- Offer a set of upgraded rooms on a tiered system. For example, from $15 to $30 to $45 to $60. Consider extending the offer in an email after the reservation is made.
There are many benefits to upgrading. They help establish the price/value relationship by setting reference prices, can improve guest loyalty and are relatively easy to implement. Ultimately, upgrades give a sense of how guests react to dynamic pricing and provide information pertaining to demand elasticity.
Let’s consider these pricing concepts with respect to online pricing. Online searches and buying are important and becoming more relevant each day. According to several recent surveys, three of four potential guests go to some form of travel site prior to booking, and eight out of 10 guests visit a search site. This means that two-thirds of hotel guests visit both a travel site and a search site prior to booking. Two-thirds of online searches also are reportedly for branded hotels. This means that most travel buyers don’t have a definitive product in mind prior to making a purchasing decision, giving the hotelier the opportunity to influence the decision.
Social media also provides pricing options for hoteliers. Because guests have grown wary of advertisements relying more heavily on reviews, sites such as Facebook, TripAdvisor and Twitter now have major influence on travel decision making. Positive reviews often translate to guests’ willingness to purchase a product and potentially pay a premium for the service or offering. While customers will select a hotel for any variety of reasons, reviews tend to have one of the most striking impacts on purchasing decisions.
Now is the time to audit your revenue management practices and ensure that your property is fully utilizing all the available tools to create consumer buying patterns. The current growth cycle won’t last forever, so maximize the opportunity while you can. In so doing, you will be preparing your company for the eventual downturn.