There is a simple concept in hospitality revenue management which is which is pushing the rates as much as possible during the strong demand period and reduce and fill the hotel during low periods. We all been there and done that but most of the time without any scientific work. As a result, we have experienced fluctuations in rate occupancy parity and on the bottom line. Of course, depending on location, market and competition it varies and this is where revenue management as an art come in to force. I will share a simple formula which allows you to clarify the risks associated with GOP, allowing you a reasonable starting point to make smart pricing decisions.
As the nature of our business Revenue managers often focused on the top-line impacts of revenue decisions which are a kind of game between occupancy and the rate. On the other hand, stakeholders, owners, GMs are more focus to figures further down on the P&L including gross operating profit and net operating income, since performance at this level is most often directly tied to the value of their asset.
I believe it would be beneficial to explain this with an example; you are running Hotel-A and you have identified a need period in early November and you are thinking about doing a promotion to drive incremental business.
You did a promotion last year for the same period and sold 650 room nights at a rate of £170 produced £110,5K. Your property didn’t sell out on any given night last year, and you were reasonably pleased with the results. This year, you would like to do even better, but you are not sure whether you should raise rates to £180 and run the risk of selling fewer rooms or to lower rates to £160 in the hopes of selling even more room nights.
So, how can you assess the risks associated with either course of action?
Important Note: Depending on your hotel occupancy and your outlet structure you definitely gain or lose potential revenue. We will knowingly ignore this and will focus on just room revenue throughout this exercise to keep our example relatively simple. Please feel free to contact me on firstname.lastname@example.org for more detail and tailored assessment for your hotel.
From basic Mathematics and Revenue perspective, the calculation is very straightforward as shown above. Considering that we would like to have the same revenue if you divide this figure by projected rates you can easily find number of rooms required to sell to earn roughly the same revenue as the year prior.
Above you can find YoY differences for rate and room sold in both mathematical terms and percentages;
Opt-1: £110,000 / £160 = 691 691 - 650 = +41 more rooms 691 / 650 -1 = +6.3% Diff
If you reduced the rate £10 (-5.9%) than you need to sell 41 more room vs LY to achieve the same revenue.
Opt-2: £110,000 / £180 = 614 614 – 650 = -36 less rooms 614 / 650 – 1 = -5.6% Diff
If you increase the rate of £10 than 36 rooms less than LY will help you to get the same revenue.
Unfortunately, this does not shed light on the profitability of each possible decision.
This simple pricing formula will help clarify the risks associated with a given pricing decision on GOP—before that pricing decision is implemented. We have to gather a few more figures to assess each scenario appropriately;
Baseline Production: As per our example, we will use last year’s total room sold which is 650 RNs.
% Change in Rate: Last year’s actual rate is £170 and we would like to explore the possibility to choose in between £160 and £180 for this year’s promotion. In this example we selected two option either -£10 (-5.9%) cheaper or £10 (+5.9%) higher than last year’s rate.
Variable Cost of Room: Cost of room as it stated variable and based on different factors such as total number of rooms, labour and room amenity costs and market segment. You can get this figure from your P&L or Finance manager of your property could give you this variable cost figure. During this exercise, I will use an estimated fictitious figure of £50.
Rooms Gross Margin Percent (GM%):
GM% = (ADR – Variable Cost of Room) / ADR
GM% = (£170 - £50) / £170 = 70.6%.
As we get the essential figures, we can now calculate the room quantity risk factor and ultimately determine how many rooms need to be sold to match last year’s results from a GOP point of view. The formula we will use to calculate Room Quality Risk Factor is;
RF% = GM% / (GM% + % Change in Rate) – 1
Opt-1: RF% = 70.6% / (70.6% - 5.9%) – 1 = +9.1%
Opt-2: RF% = 70.6% / (70.6% + 5.9%) – 1 = -7.7%
Lastly, the formula we will use to determine Rooms Required to Sell formula is;
RM = RF% x Rm Sold
Let’s analyse both options with the above figures. This will give you a better indication of the true risks associated with a given pricing move.
Opt-1: If we reduce our rates £10 to £160 and aim to replicate last year’s revenue than the basic calculation shows we need to sell 691 RNs; 41 RNs more than last year. When we apply Risk Factor formula gives us 9.1% x 650 = 59 RNs more than last year. As you could see you need to sell 18 more RNs than originally anticipated to reach years profit figure. This means that the risk factor associated with lowering rates in this case just increased.
Opt-2: If you increase your rates £10 to £180 with the same aim; the basic calculation shows you need to sell 614 RNs which means you will sell -36 fewer than last year. When we apply the formula; -7.7% x 650 = -50 less room nights can be sold in order to make same GOP. This means even if you sell 14 fewer room nights comparing to basic calculation, you could still achieve desired profit level.
This will not resolve all the rate and occupancy problems and there are other factors to consider to make create more revenue or reduce the costs to improve profitability. When you think about the overall picture of your property you need to develop strategies to fine tune business mix.
This simple pricing tool could be extremely useful when you making period basis pricing decisions and can be applied to almost any scenario including;
Seasonal Pricing Levels
Seasonal Promotional Campaigns
Individual Group Enquiries
During annual Conference periods
Corporate rate negotiations
I hope you find this article and formula useful. Please feel free to contact me to get advice, assess your property and help you develop revenue solutions and team trainings. You can reach me either contact tab on https://www.hospitalitycode.com/contact website or via email directly on email@example.com to arrange a private chat.
Please follow me on www.hospitalitycode.com for my articles on various areas of Hospitality business, trends and interpretation methods.