Return to our Home page Search
Click here for the hotel and hospitality news from around the globe Hotel, Travel and Hospitality Articles Videos and in-depth Interviews
CONCIERGE DESK
Read more now
Read more now
Read more now
Short- and Long-term Implications of Discounting Hotel Room Rates.
By Amber Cheung and Mark Brady
Monday, 2nd November 2009
 

When it comes to profits, the benefits of rate discounting for hotels are illusory, and the negative effects are both immediate and far-reaching.

One of the most important decisions facing hotel managers in an economic drought is determining room rates optimal to maintaining occupancy levels and market share. As occupancy levels fall, rates tend to tumble even more quickly in an attempt to overtake them. In the current recession, rate reductions have occurred across nearly all U.S. markets at hotels representing the economy to mid-scale to luxury segments.

Discounting room rates may be a temporary solution to filling some otherwise empty rooms, but the short- and long-term consequences can be severe. The practice of discounting can also have a negative affect on profits: Smith Travel Research predicts that year-over-year revenue per available room (RevPAR) will decrease 17.1% by the end of 2009.1

Market effects

Low room rates do not induce demand. Given a choice between two equal hotels, guests may opt for the one with a lower rate, but hoteliers will not succeed by this tactic in bringing guests to the market in the first place. For example, major demand generators, such as nearby beaches and the Marine Corps Military Base Camp Lejeune, draw demand to Jacksonville, North Carolina—not the falling room rates of area hotels.

Most hotel operators know that lowering rates will not bring demand to the market; however, they can help increase a hotel’s market share.

Despite this, hotel rates are extremely transparent, and competitors are quick to follow suit when one hotel drops its rate. The undercutting continues apace, and following the free fall, the market hasn’t grown and rates are down by double-digit percentages. In the end, hotels that engage in rampant rate cutting suffer from even lower profit margins and returns.

Short-term losses

To illustrate the effects of lowering rates to fill rooms, we’ve provided the following snapshots of typical profit and loss statements for economy, mid-scale, and upscale hotels. The parameters set are for a typical hotel of each type, based on select actual operating histories in 2008.2

Economy Hotels: Assume a 50-room economy hotel commands an average rate of $60 and achieves 55% occupancy. At a typical, well-managed hotel, this would yield a house profit (before fixed expenses) of 37%.

Given the same expenses as a percentage of sales, suppose the rates are reduced to $55 to maintain 55% occupancy; house profits are thereby reduced to 34%, equating to a loss of approximately $2 per occupied room, or $34,000 per year.

By contrast, suppose rates were raised to $65 and occupancy dropped to 49%: profit margins increase to 39%.

Effect of Rate Discounting at an Economy Hotel



Mid-Scale Hotels: Assume a 100-room mid-scale hotel commands an average rate of $115 and achieves 55% occupancy. At a typical, well-managed hotel, this would yield a house profit (before fixed expenses) of 42%.

Given the same expenses as a percentage of sales, suppose the rates are reduced to $105 to maintain 55% occupancy; this move reduces house profits to 39%, equating to a loss of approximately $6.75 per occupied room, or $135,000 per year.

By contrast, suppose rates were raised to $125 and occupancy dropped to 49%: profits margins increase to 43%.

Effect of Rate Discounting at a Mid-Scale Hotel



Upscale Hotels: Assume a 300-room upscale hotel commands an average rate of $165 and achieves 71% occupancy. At a typical, well-managed hotel, this would yield a house profit (before fixed expenses) of 30%.

Given the same expenses as a percentage of sales, suppose the rates are reduced to $140 to maintain 71% occupancy; house profits are reduced to 25%, equating to a loss of approximately $16.50 per occupied room, or $1.2 million per year.

By contrast, suppose rates were raised to $180 and occupancy dropped to 59%: profits margins increase to 32%.

Effect of Rate Discounting at a Upscale Hotel



Long-term effects

It’s a bit harder to demonstrate the business implications of chronic rate reductions in the long term, but these can have the most detrimental effects on the hotel. U.S. Hotel Trends: Yesterday, Today, and Tomorrow, a study developed by HVS, shows that the recession we are facing today is most comparable to the recession in 1980.

Unlike the 2001 recession, hoteliers are now faced with prolonged demand declines and a longer recovery period; HVS studies anticipate that growth of both demand and average rates will not resume until 2011.

However, RevPAR is not expected to return to 2007 (pre-recession) levels until 2013. This recovery period can have a severe effect on hotel performance and sustainability, and discounting rates contributes to its prolongation.

Hotel managers must also consider potential revenue loss during the recovery due to discounting, as the lost revenues compounded year-to-year are likely to have a pronounced negative effect on overall hotel performance.

Conclusion

Discounting rates, even as a stop-gap measure against demand loss in the current economy, can yield negative effects for hotels and the overall market. Nobody wins in the aftermath of a price war.

Discounting rates in order to increase occupancy will induce higher costs on a per-room basis and decrease profit margins. Perhaps the most deleterious effects lie in the long term, and these effects may not warrant consideration as hoteliers struggle with the immediate challenges of their day-to-day operations.

A better solution to discounting is to offer additional value to the customer without sacrificing rates. Such value additions include Internet service (which can cost up to $15 per night), breakfast or all-day coffee service, or a complimentary spa treatment during a weekend stay.

The take-away message is that rate integrity is essential to the profitability of a hotel operation in the short and long term, and it may not be too late for hoteliers to stop the rate hemorrhaging and put their properties in a stronger position to capitalize on an economic recovery.

Notes:

1 Higley, Jeff. Just Call This Rebound the ‘Swoosh Recovery’. Retrieved August 28th 2009, from Hotel News Now Website: www.hotelnewsnow.com/articles.aspx?ArticleId=1800&PageType=Featured&ArticleType=1
2 Representative operating histories for the three U.S. hotel classes were based on data from brand-affiliated hotels of similar size and amenities.

www.hvs.com

Advertise with 4Hoteliers.com ...[Click for More]

~ Important Notice ~
Articles appearing here contain copyright material. They are meant for your personal use and may not be reproduced or redistributed. While 4Hoteliers makes every effort to ensure accuracy, we can not be held responsible for the content nor the views expressed, which may not necessarily be those of either the original author or 4Hoteliers or its agents.

Learn more about DigiJames - in room technology
Advertisment  
 Related Articles  (Click title to read)
Toxic Hospitality Marketing Strategies.
The Good News: Growth Continues in the Online Distribution Channel in Hospitality.
Price Targeting has Become Increasingly Difficult in this Time of Transparency.
Pricing: Going Backwards with Reverse Auctions.
 Latest News  (Click title to read article)
Foreign GDSs gear up for the much-awaited opportunity in China
Tuesday, 2nd September 2014

IHG announces a Holiday Inn Resort for Pagosa Springs, Colorado
Tuesday, 2nd September 2014

2015 Global Travel Price Outlook
Tuesday, 2nd September 2014

New global certification for handling cold-chain pharmaceuticals freight
Tuesday, 2nd September 2014

CWT announces growth in sales volume and transactions during first half of 2014
Tuesday, 2nd September 2014
 Latest Articles  (Click title to read)
Ctrip Asserts Supremacy with its Performance, Gears up for Deeper Penetration
Tuesday, 2nd September 2014

Much Ado about a Review
Tuesday, 2nd September 2014

Accountability: A Dying Concept?
Tuesday, 2nd September 2014

12 Content Ideas for Your Hotel's Blog
Monday, 1st September 2014

Global Update: Who's Where and Doing What - August 2014
Monday, 1st September 2014
 Most Read Articles  (Click title to read)
Global Update: Who's Where and Doing What - June 2014
5 Social Media Trends to Embrace this Year
Global Update: Who's Where and Doing What - May 2014
Top Ten Things Luxury Guests Want!
Millennials Seek More Value from Luxury Hotels
 Useful Links  (Click company to visit)
A-Listings - Exclusive Links Section @ 4Hoteliers
www.4hoteliers.com/4hots_mshw.php?mwi=9

AETHOS Consulting Group ~ Overview and Articles
www.4hoteliers.com/4hots_mshw.php?mwi=72

Book Hotels & Travel
www.hotelscombined.com/?a_aid=105951

Connect with us at LinkedIn
hk.linkedin.com/in/4hoteliers

Customized Hotel & Restaurant Equipment
www.forkandchopstick.com

Digital Innovation Asia
www.digitalinnovationasia.com

Follow us on Twitter!
www.twitter.com/4hoteliers

Hospitality Consultants ~ Lifestyle Concepts
www.lifestyle-concepts.com

Hospitality IT & Technology
www.nonweiler.com

Hotel Opening Processes: Exploring better ways to open new hotels.
www.hotelopeningprocesses.com

ITB 2015 Marketing
www.4hoteliers.com/news/story/9725

Private, luxurious holiday villa in Valbonne
www.villa-valbonne-biot.com/en

Sayang - For True Wine Lovers
www.sayangwines.com

TravelDaily China Travel Distribution Summit
event.traveldaily.cn/23/index_en.aspx

TV4Hoteliers.com - Live Interviews
TV4Hoteliers.com

Wynamics ~ Working the Dynamics of Wine
www.wynamics.com

ZIXI - Your Asian Partner: Advisory - Sourcing - Project Management - Market Entry
zixi.hk


© Copyright 4Hoteliers 2001-2014 ~ unless stated otherwise, all rights reserved.
You can read more about 4Hoteliers and our company here

Use of this web site is subject to our
terms & conditions of service and privacy policy