Spa Revenue Management Basics

In principle, spa managers should be able to apply revenue management to spa operations. To do so, however, requires a revision in the way most spas traditionally have viewed sales. Most spa managers track appointments and customer needs, but instead they need to focus specifically on the time element involved in their services. A time-related measure, revenue per available treatment-hour (RevPATH), integrates the price and duration of the treatment as factors in the revenue calculation. Certain elements of current-day spa practice, such as discounting and managing treatment duration, carry the seeds of revenue management, but those are often implemented as tactical measures during particularly slow or busy times. Few spas have established the necessary strategic approach to assemble those tactics into a coherent revenue management strategy. This report establishes a framework for implementing a spa revenue management strategy and sets a practical road map for its execution.

The principles of revenue management that have been extended from the airline industry to hotels and restaurants can also be used by spa operators. To make this work, spa managers must have a measure of time and revenue. Such a measure is revenue per available treatment-hour (RevPATH). This measure integrates a treatment’s price and its duration, rather than simply tracking appointments and customer needs. Revenue management for spas must go beyond simply offering discounts to fill slack times. Rather than taking a tactical approach when business is particularly strong or weak, managers need an integrated approach.

Research in revenue management that we and others have conducted has addressed the theoretical and practical problems facing airlines, hotels, and restaurants, among other industries (Hanks, Noland, and Cross 1992). So far, we have seen little consideration given to the possibilities for revenue management in spas (see Boyd and Bilegan 2003; McGill and van Ryzin 1999; Weatherford and Bodily 1992). The spa business is similar enough to hotel and restaurant operations that a spa should be able to apply revenue-management principles to the mutual benefit of customers and the operator. Indeed, many spas use various revenue management-type practices, but the application has so far been mostly tactical. We propose here that a broad theory of revenue management would permit spa operators to gain the benefits of strategic revenue management that they currently lack.

The worldwide spa industry is estimated to generate nearly US$40 billion per year (Haden 2007). In 2005, the spa industry generated $11 billion in revenue in Canada and the United States. The average annual growth rate is 18 percent in North America, while the growth rate in the Asia-Pacific region is nearly 200 percent. Not surprisingly, spas are considered the fastest-growing sector in the tourism industry (Haden 2007). Spa visits in the United States alone reached more than 130 million per year in 2006, with an annual growth rate of 9 percent (International Spa Association [ISPA] 2006).

With the exception of the large chain hotel and resort spas, the spa industry is thought of being in its developmental stages, quickly growing but with a lack of set global standards. The industry has not seen measures of financial performance or a chart of accounts until recently. In 2003, ISPA, in collaboration with the Association for Hospitality Financial and Technology Professionals, released the first edition of Uniform System of Financial Reporting for Spas, and ISPA compiles industry statistics.

A logical way to measure success in the spa industry is a straightforward approach of analyzing the contribution of different revenue streams, managing expenses, tracking the percentage of retail out of treatment revenue, and managing productivity or utilization of treatment areas and therapists. Taking those revenue measurements into account, in this report we propose a framework for how revenue management can be applied to spas. We review the necessary conditions for revenue management; the strategic levers available to spa operators for revenue management; how they have been applied in traditional revenue-management settings; and how they, along with some tactical tools, can be applied to spas.

A Review of Revenue Management

Revenue management is the practice of allocating the right space to the right customer at the right price at the right time so as to maximize revenue or contribution margin (Smith, Leimkuhler, and Darrow 1992). The determination of “right” in that definition entails achieving the most revenue possible for the spa while at the same time delivering the greatest value or utility to the customer. The issue of maximum utility is particularly important for spas because of their direct contact with the guest through the spa experience. Without the balance of revenue and utility, revenue management-type practices will alienate customers who will feel that the spa has taken advantage of them and has not provided them with the expected service in exchange for their patronage.

In practice, revenue management has meant setting prices according to predicted demand levels so that price-sensitive customers who are willing to purchase at off-peak times can do so at favorable prices, and price-insensitive customers who want to purchase at peak times likewise can do so. The application of revenue management has been most effective when it is applied to operations that have relatively fixed capacity, predictable demand, perishable inventory, an appropriate cost structure, varying customer price sensitivity, and time-variable demand (Kimes 1989; Cross 1997). Those attributes are generally found in some form or another in the spa industry.

Relatively fixed capacity.

Spa capacity can be measured by the number of treatment rooms and the time that those rooms are available (with the added factor of ensuring appropriate staffing). Most spa operators approach optimizing revenue by filling the treatment rooms, but that effort can be limited by demand patterns and the number of therapists available. In many spas, the therapists are specialized, and even if a room is available, the appropriate therapist may not be. In the United States in particular, or where there are limitations on therapist licensing, it might be challenging to fill a room set up for facials, for example, when only body therapists are available.

Spa capacity is generally fixed over the short term, although spas have some flexibility to offer remote treatments, hire more therapists, increase the number of operating hours, change the length of the appointment, or reduce the amount of time between treatments.

Predictable demand.

Spa demand consists of the two distinct market segments. One group is customers living relatively near the spa, and the other segment is visitors to the area. Demand by guest type varies depending on the type of spa. Day spas may approach 100 percent of customers being local residents, while resort or destination spas may see all of their demand from visitors staying at the resort. Unlike many hospitality industry segments, spa appointments are not typically booked far in advance and are mostly made at most a couple of weeks in advance. Many spas make appointments only a day or a few hours in advance, although it is true that resort or destination spas often gain reservations at the time the hotel booking is made. In contrast, spas in urban locations or day spas have a relatively high number of same-day reservations.

One key point about spa demand is that it can be classified by type of user. A leisure day user would typically be available to visit the spa anytime during the day, while corporate users or others on a tight schedule would only be available for set times during the day (e.g., before or after work or for an express treatment during lunch).

That dichotomy creates a revenue-management opportunity. Both forms of demand can be managed, but different strategies are required. Different types of demand constitute an inventory from which managers can select the most profitable mix of customers. To forecast this demand and manage the revenue it generates, a spa operator needs to compile information on the proportions of local and visitor demand and of leisure day and corporate evening or weekend demand. In addition, the revenue manager must record the desired treatment times, how far in advance appointments are booked, and the preferred types and lengths of treatments. Tracking customer-arrival patterns requires an effective reservation system, whether by computer or by hand.

Perishable inventory.

One might think of a spa’s inventory as its rooms and therapists, but instead, spa inventory should be thought of as time–or, in this case, the time during which the spa’s capacity (both rooms and therapists) is available. If the spa is not fully occupied for a period of time, that part of the spa’s inventory perishes. This is the key to the strategic revenue management framework, and it is the element we believe has been missing in most approaches to spa revenue management. Instead of measuring costs or revenue for a given month, spa operators should measure revenue or contribution per available treatment-hour (RevPATH). This measure captures the time factor involved in the spa business. Revenue can come from a variety of sources, including regular and upgraded treatment fees and surcharges for particular rooms or therapists.

Many spa companies evaluate operations based on sales volume. This is equivalent to hotels’ measuring effectiveness by recording occupancy without paying attention to average rate. While a high volume is desirable, volume alone does not provide the information regarding revenue that RevPATH would give.

Appropriate cost structure.

Revenue management works best in industries that have a relatively high fixed cost and a relatively low variable cost. This describes spas, with their sometimes elaborate facilities and essentially fixed labor costs (or at least a fixed labor-cost percentage). Spa sales generally must generate sufficient revenue to cover variable costs and offset at least some fixed costs. Depending upon the spa’s geographic location, labor can be considered either a fixed or a variable cost. For example, as explained by spa analyst Andrew Gibson (personal communication, 2008), in Asia, where most therapists are on salary and labor costs range from less than 20 percent to nearly 60 percent of the treatment price, labor is often treated as a fixed cost. Conversely, in North America, said Gibson, most therapists are paid an amount per treatment and labor is considered a variable cost, although the labor cost is a known percentage. Other variable costs include treatment costs of sales, ranging from virtually nothing (in treatments where no products are used, such as Thai Massage or Shiatsu) up to an average of 15 percent. Thus, spas have some pricing flexibility and can reduce prices during low-demand times.

Since revenue management has more potential in operations with a cost ratio of high fixed costs to low variable costs, it offers more revenue opportunity in spas that treat labor as a fixed cost. This is not to say that revenue management cannot increase revenue in spas that treat labor as a variable cost, but it cannot provide the same level of return. We say this only because, when labor costs are variable and therapists are paid per treatment, the opportunity cost of an unsold treatment time mostly comes from an empty facility and not the cost of paying staff.

Varying customer price sensitivity.

The spa industry, like most other industries, has some customers who are extremely price-sensitive. These customers may be willing to plan for a treatment at a less attractive time or in a less desirable room if they can get a discounted price. Conversely, other customers may be price-insensitive and be more than willing to pay a premium to get their preferred treatment time, treatment room, or therapist. Having raised the issue of discounting, we note its dangers. When deciding to offer lower prices, operators must pay particular attention to the effects that any price adjustments may have on the patronage of regular guests. Not only might price reductions annoy regular guests who have paid full price, but an influx of guests attracted by off-price opportunities may also interfere with regular customers. A spa is a place of sanctuary for most guests and unless care is taken, having a larger (and different) market segment in the spa may adversely affect the traditional spa experience.

Time-variable demand.

Customer demand varies by the time of year, by the week, by the day, and by the time of day. Depending on the type and location of the spa, demand may be higher on weekends, during high season, or during late afternoons and evenings. Each spa’s managers must be able to forecast their operation’s time-related demand so that they can make effective pricing and capacity-allocation decisions to manage the shoulder periods.

In addition, the length of the treatment can vary. Some treatments may last for an hour, others for forty-five minutes, and still others for ninety minutes, depending on the treatment and the customer’s preferences. Beyond that issue, guests can combine treatments in a long visit to the spa, with packages starting at two hours and including half day (three to four hours) and full day (up to six hours).

Spa operators must also be conscious of their definition of treatment time. Often, an hour treatment only lasts fifty minutes, allowing for a ten-minute turnaround of the room between guests. Some guests are quite aware of the treatment duration and are conscious about whether they are getting a fifty-minute treatment or a full sixty minutes.

Measuring Success RevPATH

Focusing on RevPATH has major implications for the way in which a spa is operated and evaluated. Many managers currently measure their spa’s success by tallying the number of customers served; average spent per guest; utilization of therapists and treatment rooms; percentage of retail revenue; revenue per square foot; revenue per treatment; and, in the case of hotel and resort spas, hotel guest capture rate or spa revenue per occupied guest room. While such measures are valuable for many purposes, they do not explicitly reflect the spa’s revenue-production performance. RevPATH, on the other hand, combines information from the average customer expenditure and treatment room use (or occupancy) to provide a measure of the flow of revenue through the system and to indicate how effectively a spa is using its productive capacity. Revenue streams vary by location, business model, and type of spa, but typically a spa will generate 70 to 85 percent of its revenue from treatments (face and body services and others); 5 to 20 percent from retail; and up to 15 percent from other sources, such as fitness, wellness, nutrition, seminars, and workshops.

Because it embraces capacity use and average expenditures, revenue (or contribution) per available treatment-hour is a much better indicator of the revenue generating performance of a spa than are the commonly used measures that we just mentioned. RevPATH indicates the rate at which revenue is generated and captures the trade-off between average expenditure and facility use. If occupancy percentages increase even as the average expenditure decreases, for instance, a spa can still achieve the same RevPATH. Conversely, if a spa can increase the average expenditure, it can maintain a similar RevPATH with a slightly lower facility use. The balance between average rates and facility use depends in part on the type of spa. High-end spas, for instance, may wish keep rates high to ensure low facility occupancy and thus maintain a quiet ambience and relaxed guest experience, as well as use price to signal the spa’s luxury positioning.

RevPATH can be calculated by multiplying the treatment room occupancy by the average treatment-related expenditure per person or by dividing the revenue for the time period in question (e.g., day part, day, or month) by the number of treatment-hours available during that interval. For example, assume that a ten-room resort spa has a 70 percent treatment room occupancy and a $200 average expenditure per person on treatments (excluding retail). Its RevPATH is $140 (calculated by multiplying the 70 percent occupancy by the $200 average expenditure per person). Alternatively, assume that a twenty-room day spa makes $1,600 on Fridays between 6:00 and 7:00 p.m. Its RevPATH would be $80 ($1,600/[20 rooms x 1 hour]). Similarly, if that same twenty-room day spa made $8,000 over a four-hour treatment period, its RevPATH would be $100 ($8,000/ [20 treatments x 4 hours], or $8,000/80 available treatment room-hours).

Exhibit 1 gives a hypothetical illustration of this principle. The four spa operators have the same RevPATH ($72, calculated by multiplying the occupancy percentage by the average expenditure per person), but each achieves it in a different manner. Spa A has a facility use of 40 percent and an average expenditure of $180, while Spa D has a use ratio of 90 percent but an average expenditure of $80. Spa operators B and C also achieved a RevPATH of $72, but with varying facility-use and average-expenditure statistics.

The numbers for Spa A are typical of a high-end spa where the operator prefers to have a lower occupancy so a relaxed ambience can be offered, but must compensate for this lower occupancy by having a higher expenditure per guest. Conversely, Spa D’s numbers are common for a day spa that has a relatively low average expenditure per guest. To compensate for the lower rates, the operator of this spa must achieve a high volume of business. The trade-off between occupancy and average expenditure is a strategic one, and one that must be carefully considered when positioning one’s spa.