Effective January 1, 2018, several new accounting standards became mandatory for the hospitality industry in the US and the most important of these standards concerns revenue recognition, and more concretely how hotels recognize revenues from online travel agents (OTAs).
The new accounting standards require the entity designated as the principal in the sales transaction to record the revenue on a gross basis. The principal controls the good or service before that good or service is transferred to the customer.
In the current hotel – OTA relationship, the hotel is the principal, since it is the entity responsible for providing accommodations to the guest. The price of the hotel room sold by the OTAs is determined and enforced by the hotel via rate parity clauses in the agreements with the OTAs, so that the OTAs do not take any inventory risks.
These new standards stem from The Financial Accounting Standards Board’s (FASB) revised guidelines for recording revenue. A private, non-profit organization, FASB is the ultimate accounting standard setting institution in the United States. Its primary purpose is to establish and improve generally accepted accounting principles (GAAP) within the United States in the public’s interest.
The FASB’s Accounting Standards Codification (“ASC”) 606 contains these new revenue recognition standards, effective 1 January 2018 for public companies, and no later than 31 December 2019 for all other companies. The new accounting guidelines clarify how revenue should be recognized for goods and services.
Additionally, the American Hotel & Lodging Association’s Financial Management Committee has followed suit and issued guidance on the new revenue recognition standards’ effect on the hotel industry. The Financial Management Committee, too, has provided a modification to the Uniform System of Accounts (USALI) related to gross versus net revenue accounting, incorporating the new revenue recognition standards.
How is OTA revenue being recognized today?
There are two prevailing OTA business models that affect how revenues are being recognized at the present:
Agency/Retail Model: The guest reserves the hotel with the OTA but pays at the hotel. This is the traditional travel agency commission model: the hotel collects the face value of the reservation (room rate + local taxes), recognizes this gross amount as revenue, and pays the OTA a commission, which is recorded as COGS (Cost of Goods Sold). The new standards will not affect this agency model.
Merchant Model: The guest both reserves and pays for hotel accommodations with the OTA. In turn, the OTA deducts its commission from the gross amount collected and pays the hotel the net amount (room rate minus commission). The hotel recognizes this net amount as revenue, and the OTA commission does not get recorded as COGS and in any way in the hotel’s profit and loss (P&L). Currently, recognizing revenue from the OTAs as “net” inevitably lowers ADRs and RevPARs, but the true effect remains “hidden,” since net OTA revenue is bundled with gross revenue (direct and OTA). The new standards call for the “gross” OTA revenue to be recognized in the property P&L and not the net as it is done currently, and the commission collected from the OTAs to be recognized as COGS.
How will the new OTA revenue recognition standards affect the industry?
The new OTA recognition standards will have a negative impact on hotels that are overly reliant on the OTA Merchant Model. This will result in:
- Recognition of higher COGS
- Higher franchise fees under the current franchise agreement model, where fees are calculated as percentage from the gross room revenue
- Higher management fees under the current agreement structures
- Local taxes such as occupancy and room taxes, CVB marketing contributions, etc., which are typically calculated as percentage from the gross room revenue
- Ultimately, lower profitability
All of this will impact properties and lead to an increased recognition of their reliance on OTAs, since all of the OTA commissions (agency/retail and merchant) will be reflected as COGS in the property’s P&L.
Why higher distribution costs are detrimental to any hotel
As one of the main cost drivers for properties, distribution costs have been rising steadily over the last six years. This is due to OTAs increasing market share by over 40%, in comparison to hotel direct bookings (Kalibri Labs). Now, adding the OTA commissions from OTA Merchant Model bookings to the COGS line item in the property P&L will show the true cost of OTA distribution; this will generate a number of issues for managers, leading to difficult conversations with ownership.
With the exception of distribution costs, hoteliers have very little leverage over the six main cost drivers in hotel operations:
- Labor Costs
- Debt Service
- Franchise Fees
- Real Estate Taxes
- Utilities
- Distribution Costs
The importance of these cost drivers varies, and largely depends on the size of the hotel, condition of the physical plant, whether the property is branded or independent, amount of debt, and geographic location. However, distribution costs have been rising at a rapid pace across all properties.
What can hoteliers do to soften the negative P&L impact of the new OTA revenue recognition standards?
The new OTA revenue recognition standards will force hoteliers to finally take OTA distribution costs seriously. There is only one approach to lowering OTA distribution costs: Invest smartly in the property’s direct booking strategy and focus on shifting share from the OTAs to the direct channel.
Across HEBS Digital’s hotel client portfolio, the average direct booking distribution cost is 4.5%, including website cost amortized over 36 months, full-service digital marketing costs (SEM, SEO, online media and retargeting, social media, email marketing, smart data marketing), consulting and strategy services. Compare this to an average OTA commission for independent properties of 18%-25%.
Here are the most important action steps for hoteliers to consider:
1/ Adopt a “Direct is Always Better” Top-Down Strategy
Adopt a company-wide “Direct is Always Better” strategy with the primary goal of generating more direct online bookings and shifting share from the OTAs to the direct channel. Without such a strategy, the property ends up with under-staffed and under-budgeted direct online marketing efforts, bandwidth and focus.
Who at the property “owns” the website and its results and performance? Whose salaries and bonuses are determined by the website’s revenue and ROI? Who is incentivized when the market share needle is moved from OTAs to direct online bookings? Most properties and hotel companies do not have clear responsibilities and incentives assigned to direct online channel production, resulting in a very muddled —but convenient for some—picture of channel contribution, ADRs, and distribution costs.
When the property embraces a “Direct is Always Better” strategy, the on-property team sets a primary goal of generating as many bookings as possible via the direct online channel, by far the most profitable channel today. The team can then work together to seize market share from the OTAs as a united front. A comprehensive strategy should include direct booking share benchmarks and objectives, employee responsibilities, performance compensation tie-ins and bonuses, guest “book direct” value adds, and more.
Educating the property staff that direct guests are the best guests and empowering them to be responsible corporate citizens are key steps to the overall strategy. “The Customer Lifetime Value (CLV) of direct guests is far greater than CLV of guests acquired via OTA,” confirms Michael Harris, VP of Ledgestone Hospitality, LLC. “Direct guests’ average length of stay is greater, net profit is better, therefore CLV is also bound to be greater.”
2/ Start Treating Direct Online Distribution Costs as… Distribution Costs:
Currently, direct online bookings and their distribution costs come from the Sales & Marketing Budget, a line item in the property budget.
Take into consideration Scenario A:
An online travel consumer comes to the hotel website, likes the property location, product and services, but finds a better rate on Expedia and books there. The distribution cost is either not reflected in the P&L at all if this is a merchant booking, or goes under COGS/Travel Agency Commissions in the case of an agency booking. The COGS line item is rarely scrutinized, and has practically no budgetary limitation. On the contrary, any increase in the COGS line item puts a dent into G&A expenses, which limits direct distribution even further. This “unlimited commission potential” allows OTA bookings to grow unrestrained by the property budget, at the expense of direct online bookings.
In Scenario B, this same online travel consumer comes to the hotel website, likes the property location, product and services, likes the rate and its inclusion of a unique value-add, and books there. The distribution cost (the prorated website and digital marketing expense required to engage, bring in and convert this travel consumer) comes out of the Sales & Marketing line item, part of the G&A expenses of the P&L, which is severely restricted and often subject to budget cuts.
Same travel consumer, same booking dates, entirely different treatment of the distribution costs. Note the contradiction: The most cost-effective bookings—from the direct online channel at an average distribution cost (CoS) of 4.5%—are severely restricted by the property’s sales and marketing budget, while the most expensive bookings—from the OTAs, with distribution costs of 18%-25%—are allowed exponential growth.
The Sales & Marketing line item in the property budget for many properties also includes payroll for the sales and marketing staff. Why is that? “Pure” online advertising/marketing expenses necessary for generating direct online bookings should be separate from the payroll for sales and marketing personnel. Likewise, the Revenue Management team payroll should not be included in COGS/Travel Agent Commissions, but rather in the overall Payroll Expenses. Unless the property has a Digital Marketing Manager, fully dedicated to generating revenues via the hotel website and digital marketing, payroll for the sales and marketing staff should be treated as labor costs and made part of the general labor cost line item of the property budget.
If we separate the actual advertising/marketing expenses, the majority of which now go to digital, it is very easy to determine the cost per direct booking (digital advertising/marketing expenses/website bookings) and easily compare this to the OTA distribution cost. Recognizing direct distribution costs as COGS will supplement the property’s ability to adequately fund direct online channel efforts, boost bookings via the property website, and drastically decrease OTA dependency. Lowering overall distribution costs will allow the property to fund payroll and staff empowerment, renovations and product/services improvements, invest in human resources, and add a hefty chunk to the bottom line.
3/ Invest in Direct Booking-Generating Digital Marketing and Technology
Endemic under-investing in direct online booking-generating technology and digital marketing has led to OTAs gaining 40% of the market share over the past five years.
Have you visited your own property website lately? How did you feel about the experience? Have you visited your website via mobile and been frustrated by poor usability and download speeds? Did you know that according to Google, 53% of visits are abandoned if a mobile site takes longer than three seconds to load? When was the last time you ran a multichannel digital marketing campaign for your hotel? Are you engaging your past and future guests via smart data marketing, programmatic advertising and dynamic rate marketing?
To achieve a level of real success and lessen dependence on the OTAs, hoteliers must invest adequately in the correct website and digital technology and marketing techniques to engage past, present, and future guests and drive direct bookings throughout the entire path to purchase.
HEBS Digital has a comprehensive whitepaper on the subject. The Smart Hotelier’s Guide to 2018 Digital Marketing & Technology Budget Planning is available for download and provides hoteliers with a concrete roadmap to jumpstart the property’s direct bookings and guide its digital marketing and distribution strategy throughout the year. With so many moving pieces in a hotel’s digital budget—enhancing the property website, revenue-generating technology, smart data marketing—it’s important to create a strong plan that is realistic and aligned with your business goals.
4/ Adopt an Effective Merchandising Strategy to “Sell on Value” Vs. “Sell on Rate”
The commoditization of the hotel product, in which hotels are forced to compete with the OTAs strictly based on rate, leaves hotels little opportunity to communicate the value of the hotel product to potential guests. The OTAs have mastered the “sell on rate” game, and hoteliers have little chance of winning this battle. To combat this, hoteliers need to re-learn how to “sell on value” as opposed to “sell on rate,” and need to adopt an effective website merchandising strategy.
The direct online channel offers limitless opportunities for the hotelier to present the hotel product and value proposition directly to the online travel consumer. A strong merchandising strategy is centered on communicating the unique features of the property (hotel services, meeting and event space, the latest promotions and special offers, local attractions, and more) and focuses less on the rate alone. A strong website merchandising strategy allows the hotel to showcase merchandising content on the prime real estate of the website—front and center of the visitor’s attention—and personalize relevant content based on the user.
Implementing a strong website merchandising strategy will maximize room bookings and revenue on the property website, generate group leads and RFPs, sell and promote the hotel services (dining, spa, etc.), engage and convert potential customers, and more.
Conclusion
The new accounting standards for OTA revenue recognition call for the “gross” OTA Merchant Model revenue to be recognized and not the “net” as it is done currently, and the merchant commission collected from the OTAs to be recognized as COGS in the property P&L. These new standards will have the biggest impact on hotels that are reliant on the OTA Merchant Model and will result in lower profitability due to higher COGS, higher fees which contractually are calculated as percentage from the gross room revenue: franchise fees, management fees, etc., higher local taxes such as occupancy and room taxes, CVB marketing contributions, etc.
In light of these new OTA revenue recognition accounting standards, lowering distribution costs by increasing direct bookings and shifting share from the OTAs should become the top priority for the hospitality industry in 2018. Direct bookings’ distribution costs average around 4.5% (HEBS Digital client portfolio) versus OTA distribution costs of 18%-25%.
How can hoteliers achieve that?
- By adopting a company-wide “Direct is Always Better” Strategy with the primary goal of generating more direct online bookings and shifting share from the OTAs.
- By recognizing direct distribution costs as COGS in the property P&L – in exactly the same way as OTA commissions, thus helping to adequately fund direct online channel efforts, boost bookings via the property website and reduce OTA dependency.
- By adequately investing in website and digital technology and marketing techniques to engage past, present and future guests and drive direct bookings.
By adopting an effective merchandising strategy to “sell on value” versus “sell on rate,” a strategy centered on communicating the unique features of the property (hotel services, meeting and event space, the latest promotions and special offers, local attractions, and more).
ABOUT HEBS DIGITAL:
Founded in 2001, the firm is headquartered in New York City and has global offices in Las Vegas, Tallinn, Munich, and the Asia-Pacific. Through its Smart Guest Acquisition Suite, including the smartCMS®, Smart Personalization Engine, Smart Data Marketing, and full-service digital consulting and marketing solutions, HEBS Digital helps hoteliers drastically boost direct bookings, lower distribution costs, and increase the lifetime value of guests. Its diverse client portfolio consists of top-tier luxury and boutique hotel chains, independent hotels, resorts and casinos, franchised properties and hotel management companies, convention centers, spas, restaurants, DMO and tourist offices.
Part of NextGuest Technologies, HEBS Digital and Serenata CRM, the most comprehensive Hotel CRM Suite today, are the creators of the hospitality industry’s first Fully-Integrated Guest Engagement & Acquisition Platform.
Contact HEBS Digital’s consultants at 1 (800) 649-5076 (North America), +64 (0) 9 889 8489 (Asia Pacific) or success@hebsdigital.com / www.hebsdigital.com
