Calculating Breaking Point in hotel pricing - part 2
Setting price is inevitable in business. The amount you charge matters. Charge too much and you drive customers elsewhere. Charge too little and you may lose money. It’s all about finding that ‘sweet spot’ between charging enough to meet room costs and make some money and charging less than enough to cover costs and lose money.
Hotel pricing is a challenging problem; beside setting different prices for various room categories (standard rooms, deluxe rooms, penthouse suites, etc) and customer categories (tourist versus business guests, group discounts for corporations, governments, etc.), a hotel manager must be able to continuously update and establish a wide range of future prices since most of the hotel’s customers book rooms well in advance of their planned arrival date.
In Part 1 of my previous article carried under the abovementioned title, and, which appeared last week, I wrote about ‘Price Elasticity’ and how important it is to consider the challenges posed by substitutes and the importance of timing, when planning to change hotel room rates.
Let me be clear that I’m not talking here of certain market conditions that also can play a huge role in pricing. If for instance, there is a mega- event taking place in the vicinity and the market can get saturated during that period, price changes (increases) are inevitable and we know how the rate strategy is going to pan out. The issue is when there is a need to raise rates to be profitable or at the very least perform above the red.
Much can be found in economics and business literature about elasticity including several definitions and various methods to calculate it. Unfortunately, even when armed with all this information, most of these narratives lack reliable instruction about how to estimate elasticity for a specific item, to be sold in a given market over a particular futuristic time period. Without this knowledge (or crystal ball), the value of the available information is incomplete.
Hence, the uncertainty on not knowing how the market would respond to a price change pressurizes managers to be somewhat cautious when approaching price changes. In addition, the mystique of the pricing game has given it a ‘black box’ syndrome - revealing what went wrong only after the event! Consequently, managers are compelled to make decisions based on their knowledge of the market, their experience, and judgment and not least of all, guesswork.
Yes, forecasting is another effective strategy to set prices based on what you expect the demand to be. It relies on how well the manager understands the hotel’s occupancy data, revenue, the average room rate and average per room spend in the last few months, in the same period the previous year as well as the demand trends and events held. Even then, there is always that element of uncertainty as to how the market will actually react.
No one can pin-point to perfection or predict in advance, how demand will react in response to a given change in price. However, there are methods to precisely calculate the financially tolerable limits of change fairly accurately. These methods can be applied by managers who are aware of the existing demand patterns and the marginal cost to occupy a room, to determine how much an increase in volume is required in the event of a price reduction, or how far volume can dip, in the case of a price increase, in order for the change to be profitable.
More on calculating breaking point in hotel pricing accurately next week.
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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