HENDERSONVILLE, Tennessee—During these challenging economic times, it is easy to justify discounting rates to capture as much share as possible in the marketplace. But what are the long-term ramifications of managing for short-term solutions? Here is a specific example of what could happen to a hotel when it starts discounting:
Let’s assume that a 117-room, limited-service hotel has had a 69-percent occupancy and US$95 ADR over the past 12 months. Its distributed operating expenses run US$24 per occupied room and undistributed operating expenses are US$16 per available room. (Operating expense assumptions are based on the 2008 STR HOST Study) Based on these assumptions, this hotel sells 29,466 rooms per year, reports US$2,799,313 in room revenue and captures US$1,408,838 in gross operating profit (equates to a 49.7-percent GOP).
If this hotel decreases its ADR by US$5 in an attempt to maintain a 69-percent occupancy level, its room revenues drop to US$2,651,981 and GOP percentage lowers to 47.6 percent. For comparative purposes, if the hotel tried to maintain the original US$95 ADR and the same room revenue (US$2,651,981), and instead sell fewer rooms, GOP percentage would drop only to 49.0 percent because of the savings in reduced distributed operating expense.
This simple example shows that more money can be brought down to the profitability line by attempting to maintain rate than by trying to maintain historical occupancy levels.
| Decreased ADR | In USD |
| ADR | $90.00 |
| Occupancy | 69% |
| Rooms Available (12 months) | 42,705 |
| Rooms Sold (12 months) | 29,466 |
| Room Revenue | $2,651,981 |
| Distributable Operating Exp/Occ Room | $24 |
| Rooms Sold | 29,466 |
| Distributable Operating Exp (12 months) | $707,195 |
| Undistributable Operating Exp/Avail. Room | $16 |
| Rooms Available | 42,705 |
| Undistributable Operating Expense (12 months) | $683,280 |
| Room Revenue | $2,651,981 |
| - Distributable Operating Expense | ($707,195) |
| - Undistributable Operating Expense | ($683,280) |
| Gross Operating Profit (GOP) | $1,261,506 |
| GOP Percentage* | 47.6% |
| Fewer Rooms Sold | |
| ADR | $95.00 |
| Rooms Available (12 months) | 42,705 |
| Room Revenue | $2,651,981 |
| / ADR | $95.00 |
| Rooms Sold (12 months) | 27,916 |
| Occupancy (Rooms sold / Rooms Available) | 65.4% |
| Distributable Operating Exp/Occ Room | $24 |
| Rooms Sold | 27,916 |
| Distributable Operating Exp (12 months) | $669,974 |
| Undistributable Operating Exp/Available Room | $16 |
| Rooms Available | 42,705 |
| Undistributable Operating Expense (12 months) | $683,280 |
| Room Revenue | $2,651,981 |
| - Distributable Operating Expense | ($669,974) |
| - Undistributable Operating Expense | ($683,280) |
| Gross Operating Profit (GOP) | $1,298,726 |
| GOP Percentage* | 49.0% |
* GOP percentage = Gross Operating Profit / Total Revenue (In this example, we assumed the only revenue was room revenue)
Historically, STR also has seen that deep discounting during challenging economic times does not generate new demand. It may help in stealing an existing demand base that was already planning on going to your market, but during the pricing wars that typically result among competitors, the only real winners are consumers who end up paying less—not the hotels. Right now, when it is difficult to predict how much demand is in a given market, it is not reasonable to expect to hold occupancy levels at the same level as in years past. But keeping a watchful eye on how much (or little) you discount your rates may prove to be the most profitable solution for your hotel.
History lesson
The 2001 recession lasted from March 2001 to November 2001. At the start of that recession, the 12-month moving average ADR for the U.S. hotel industry was US$86.09. As hoteliers discounted pricing as a reaction to the recession and lingering travel post 9/11, the U.S. 12-month moving average ADR bottomed out at US$82.07 (a 4.7-percent decline from the March 2001 moving 12-month ADR) before climbing on a positive growth pattern. Three years and nine months after the start of the 2001 recession, the U.S. 12-month moving average ADR finally matched the US$86.09 rate of March 2001. Although every market behaves differently, our industry’s past pricing behavior has shown that with just less than 5 percent ADR discount, it took almost four years to match rates at the start of a past recession (not including adjustments for inflation).
Granted, the sudden, rapid decline in hotel demand after 9/11 was an unusual situation in the hotel industry, but the point is still valid—it is hard to regain pricing levels after a period of consistent discounting.
With today’s declining overall hotel demand, it is clear that there is less business to keep or steal from competitors, but being mindful of the long-term effects of today’s pricing strategies will help with future profitability opportunities.