Room rate pricing...don't wander in the middle of the road
In my earlier articles I said that hotel managers must be able to establish the total fixed and variable costs in the hotel before setting the selling price for each guestroom. Then I touched on the need to fully understand price elasticity, as its impact can stretch occupancy either ways. Then there is the challenge of alternative lodgings that have emerged as a substitute for traditional accommodation. And as I said, 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. Let’s move on now…
Hotel A is a popular city hotel with a room type priced at US$150 having a demand of 100. The profit contribution (PC) from this room type, after deducting the $25 marginal costs (MC) per occupied room, is $12,500. Wishing to further improve PC, a decision to increase the room price is on the cards.
What remains unknown though, is how much demand will fluctuate in response to a given change in the room price? At which threshold will demand begin to slide? None can boast of having neither advance knowledge nor that magic crystal ball to accurately answer these questions. However, there are methods by which one can calculate the manageable limits to price change.
Scenario 1
The management plans to increase room rates. By raising the room rate by 5% to $158, they can achieve the daily PC of $12,500 when 94 rooms are sold (to be precise $12,502). Should they raise the room rate by another 5%, i.e. to $166, they reckon that they can achieve marginally more ($12,549) - when 89 rooms get sold. However, should the market negatively react to the 10% price hike, and should room sales dip to 84 rooms, the hotel is more or less making the same PC than when it sold 100 rooms at $150.
The question the management of Hotel A needs to answer; is whether at the new price-point of $166, would there be continued future demand to enable hotel A to sell a minimum 90 guestrooms?
Scenario 2
Let’s shift situations. The market driven conditions having attracted new entrants to the hotel supply chain alter suddenly, and the equilibrium shifts towards a supply driven environment. Hotel A now faces a situation of having to drop the rate. Reducing the room rate to $136 will generate increased profits if demand rises to 114 rooms or more. If the demand increases to only 112 rooms, the hotel is no better or worse than when it sold 100 at $150. Drop in rooms sold to less than 112 would erode profitability.
Here to, the hotel’s management team will have to answer the question, at the new price of $136, would demand increase to a minimum 114?
A good deal of uncertainty is removed when using the following formula:-
Key: Q2 = No. of rooms to sell, Q1=100, MC = Marginal costs, P1 = Old price, P2= New price proposition
In this manner, the management of Hotel A is not simply relying on that ‘gut feeling’, but using a technique, combined with the manager’s experience in judging potential price change fluctuations, within the context of their particular market conditions.
As some wise person wrote “Wandering in the middle of the road (picking a rate “in the middle” of what you’re seeing in your market), assuming that demand will just land in your lap, is a bad idea for pricing and life in general. Mr. Miyagi taught us this very important lesson in the Karate Kid back in 1984 - words to live by when pricing in the pandemic: “Walk right side, safe. Walk left side, safe. Walk middle … sooner or later you get squish like grape.” – Mr. Miyagi, Karate Kid.
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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