Calculating Breaking Point in hotel pricing - part 1
As travel restrictions gradually relax and cross border movements open slowly but surely, hotels are beginning to re-open. Some are doing so in-the-blind, whilst others are calculating their Break-Even Point (BEP) to try and establish their cost of operation and to determine the optimum RevPar level needed to re-open. For the majority, operating under a break-even cloud is a start and maximizing profit as done before COVID-19 is been placed for now, on the ‘back burner’.
The uncertainties involved when deciding it’s time to change room rates are many and the impact from any miscalculation can be potentially disastrous. To begin with, one needs to consider how the revised pricing action will affect occupancy, revenue, cash flow and profitability.
Generally there is an accepted consensus among hoteliers that price decreases can stimulate sales (occupancy) and any increase in room rates can likewise strangle sales. The harder to understand part lies, in not knowing to what degree and direction the reaction from the price change will take… until after the fact.
Rise in occupancy alone from a price decrease is irrelevant. It can yet result in the hotel operating below its BEP. Conversely, a price increase, even if it retards occupancy can still float the hotel’s operation above its BEP. That’s because the hotel’s Average Daily Rate (ADR) comes into the equation and plays a dominant role. Even then, there are other external factors to consider – like competitor actions or changes in the economy, which are beyond one’s control, and which can distort or derail the intended effect of a price change.
The commonly known term applied to volume (occupancy) changes linked to price changes is ‘elasticity’, which is a concept that explains the relationship between a product’s (room’s) price and demand for that product (room). Hence, one need’s to fully understand price elasticity before identifying the optimal price point for hotel rooms that will yield the highest absolute revenue on any given night.
Then there is the challenge of alternative lodgings that have emerged as a substitute for traditional accommodation. Say you buy strawberries regularly until one day the price of strawberries rises to become an unaffordable luxury. The likelihood is that you will switch to buying a less expensive substitute and there are several, such as… apples, pears or oranges. Likewise more travelers are now drawn towards the flourishing short-term rental industry, (Airbnb is a good example). The growth of alternate lodging, especially after COVID-19, has become a real substitute for hotel rooms. More substitutes leads to more price elasticity.
Apart from there been substitutes, timing the change in price can also influence price elasticity. Timing is crucial. During the monsoon rains umbrellas can cost more and even if the rain showers are short and intermittent, people want to stay dry – so they will buy! This phenomenon makes the umbrella prices less elastic.
In the last twenty years or so, the emergence of a technologically developed ‘online’ world, has drastically altered people’s travel booking behaviour. They now have the flexibility to book last minute. Consequently, the bookings ‘window’ now, is not only dynamic and fast-paced – it is very short…more so, after COVID-19. Revenue management strategies have got to refocus pricing and room allocation on the shortened purchase time.
Ilzaf Keefahs is a freelance writer who enjoys focusing on hospitality related matters that he is passionate about, and likes to share his views with hoteliers and customers alike. He delves into the heart of hospitality to figure out both customer service and consumer trends that impact the industry.
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