Making the Move to Dynamic Pricing

22nd Mar 2014

NB: This is an article written By : Vish Bhatia

Dynamic pricing allows hoteliers to price-to-market in order to maximize top-line revenue potential.

 A number of hotels in the United States and overseas have static pricing for each season. This article is primarily for hoteliers who want to move toward implementing an effective dynamic-pricing model that works for their properties.

Dynamic-pricing structures at the brands
Large hotel brands use best available rates, or rate levels, that vary based on demand. Simply put, hoteliers charge higher rates during higher demand periods such as holidays, citywides, or special events, or when demand is expected to come in strong. Rates are thusly adjusted down during low demand periods. The basic economic supply-and-demand model states that in a competitive environment the price of a service or a commodity settles at a level where quantities offered by the supplier “at a current price” matches the consumer demand “at a current price,” thereby creating an economic equilibrium for price and quantity.

There might be certain exceptions to this model, as evidenced with the Veblen effect, which often happens in the case of luxury products, such as luxury cars (Rolls Royce), watches (Rolex), or trophy assets, that have a positive sloping demand curve (i.e., when the price goes up, the demand for the product goes up). This might be true for certain high-end hotels and experiential hospitality products, which might fall in this category. However, generally speaking, hotels tend to follow the normal price-demand correlation, which is that when the price goes up, demand falls.

Dynamic pricing at large hotel brands varies from having best available rates to having rate levels with full pattern length of stay and may be managed using automated revenue management systems. Based on types of hotel, location, market segments and overall demand, yieldable segments as a percentage of market mix at branded hotels could range from 70% to 100%.

Hotels globally have a larger mix of non-yieldable, or static-priced, segments, especially in Asia and countries such as Japan, China and Korea that have brochure programs. This might make the dynamic-pricing model an issue.

How to set an effective dynamic-pricing structure
Dynamic pricing is typically set as cost-based pricing for the lowest level in order for hoteliers to cover their operating costs in off-season, while they charge much higher rates during peak season to generate their profits and return on investment.

Capabilities for implementing a dynamic-pricing structure vary from different property management systems and central reservation systems. Check with your system documentation and system experts as to what options are available before deciding which option to choose.

An illustration of a simple dynamic-pricing model using rate levels (a process available in many property management systems and central reservation systems) follows:

The number of rate levels is based on the demand for a particular product. There is no standard when it comes to the number of rate levels and could range from three rate levels to as many as 10 to 12 rate levels depending on the delta of troughs and peaks as well as the propensity of the consumer to pay varying levels of pricing during different times for the same product.

Dynamic pricing is based upon accurate forecasting. Hoteliers forecast demand and occupancy day by day and set prices based on booking windows. This could be:

Low to high
Hoteliers set prices low and as the reservations on the books increase, the price is increased. A number of revenue management systems are built on this pricing structure that starts at a $0 hurdle rate or bid price and then increases this bid price as reservations pick up until the bid price reaches equilibrium to demand. If the forecasted demand is inaccurate, it is possible to leave money on the table with this pricing structure, especially during high demand periods.

U-shaped pricing or high to low to high
Airlines practice this type of pricing regularly and price their product high further out from the date of departure to protect their inventory being sold at cheaper rates early on, and only rationalize pricing within the booking window, which might, for example, be 45 to 90 days to the date of departure, and then raise the prices within 21-day, 14-day and seven-day booking windows.

High to low
This practice is also called “dumping the rate” and happens typically when the hotelier overestimates demand and drops rate closer to the day of arrival to fill up when demand doesn’t materialize. It is critical to forecast accurately in order to maximize overall revenue potential.

Dynamic pricing can get complicated and messy. Let’s say a hotel creates five rate levels, has 10 room types and five market segments. If you plot rate levels on the x-axis, room types on the y-axis and market segments on the z-axis, the revenue manager will need to manage 5x10x5, or 250, price-point combinations every single day for 365 days in the future. This might create significant pricing issues across channels.

Therefore, it’s important to have a correct pricing structure. An effective method is to create a relative pricing mechanism wherein pricing of the other market segments is derived off the BAR or rate level. For example, the AAA rate might be set 10% off BAR and as the BAR changes so does the AAA rate. This allows hoteliers to maintain rate integrity of market segments across channels.

There are some key questions to ask while setting your rate levels or BAR rate structure:

• Rate level price differentials:  What should be the price-point differentials between rate levels that will drive demand if the hotel drops a rate level? This dollar amount again varies widely based on whether it’s a budget or an upscale property.

• Room type price differential: What is the incremental value between two room types? Does the room type price differential adequately reflect the added value, which could be larger room size, higher floor, added amenities, etc.

• Price value proposition: This is an important consideration for setting price levels, especially as compared to the competition. If the competition moves in $25 increments, then having a $10 increment between rate levels might mean you are leaving money on the table.

Pros and cons of dynamic pricing 
Dynamic pricing allows hoteliers to price-to-market in order to maximize top-line revenue potential. By matching price to demand, hoteliers have a greater opportunity to capture higher profitability business during high demand periods. On the flip side, lower flexible rates during low demand season help generate additional demand that might not have existed before. Although, it is always wise to set a floor price, which should be equal to the lowest “positioning” price that you might be willing to accept for your product.

The challenge of having a dynamic structure is that the revenue managers need to be on top of their game to manage demand as it is very easy to lose control of inventory if forecasting is erroneous. Having a revenue management system minimizes these errors; however, the majority of hotels today do not have a revenue management system as it could be expensive or might not have been budgeted. Payback period of a decent revenue management system is typically less than a year depending on the size of the property. An interesting exercise to conduct is to look at a set of hotels’ past year occupancy and average-daily-rate data to ascertain lost revenue potential to the dollar amount and determine whether having a revenue management system would have mitigated that loss.

With the proliferation of different distribution channels and business models such as Groupon, Living Social and online travel agency flash sales as well as mobile, it is becoming increasingly difficult to maintain rate integrity using the dynamic-pricing model. Other challenges include having non-yieldable segments such as corporate accounts that have last-room availability or group rates that could be higher than the dynamic rate of the day. As a result, revenue managers have to deal with price parity issues on a regular basis.

The greatest advantage of having dynamic or time-based pricing is that it is an agile pricing structure that allows the revenue manager to react quickly to the changing market conditions. At the same time, our industry is ripe for the next paradigm shift in pricing where pricing is customized to the segment of one—the guest. With the growth of big data we could very well see real-time creation of pricing for individual guests tailored to their needs.

Related Resources