News for the Hospitality Executive
Revenue Management: Tactical Discounting
By Dr. Gabor Forgacs, March 2010
Discounting in the tactical context is done to maximize revenue generation in the short term. If a hotel believes that downward rate adjustments will provide price incentives for their potential guests to book same-day or same-week room nights, this tactic may help to hold or boost occupancy. However, it must be recognized that selling more room nights at reduced room rates will not necessarily generate higher room revenue. The unknown variable is how much more occupancy will be gained at the reduced rate.
Enz, Canina, and Lommano analyzed data of more than 6,000 hotels regarding the effects of discounting from 2001 to 2003. According to their key findings, hotels can increase market share within their comp set by discounting, but it is done at the cost of declining revenue performance, measured in RevPAR. Hotels that chose to discount their rates by more than 2 percent compared with their comp set’s average achieved lower RevPAR performance than their competitors. There were minor differences identified in the level of price sensitivity (elasticity) between the clienteles of upper-upscale and economy hotels. In 2003, Carvel and Canina concluded from data of 480 hotels in 22 U.S. metropolitan areas covering 1989–2000 that, on average, for every 10 percent decrease in room rates, demand rose by only 1.3 percent. The evidence to date clearly shows that discounting room rates does not improve profitability.
These findings were also consistent with research pointing out that the corporate segment is less likely than the leisure segment to respond to a room rate discount.
Overall, it appears that tactical discounting can accomplish a number of things. It can fill rooms that would have stayed vacant. It can help steal market share from competitors. It can attract mostly leisure travelers, who are more likely to respond to discounts and perceptions of a better deal. It can get the business of brand neutral, price-sensitive customers. But it does all this by diluting RevPAR, as the impact of selling more units at lower rates is usually negative.
Late discounting has led to another noticeable and unfortunate trend. More and more guests with reservations are calling to cancel their rooms one or two days before arrival if last-minute discounts have been offered either on third-party websites or on the hotel’s website for the date they were booked. They cancel the old reservation, then make a new one at the newly available discounted rate. What has become evident was that a significant portion of guests never stops looking for deals, even after they have booked their room nights. Hotels that post discounts for last-minute bookings hoping to sell distressed inventory, may watch already booked business become less profitable when attentive guests discover and switch to the lower rate. This revenue “leakage” may further dilute room revenue.
Despite its often negative impact, the discounting tactic is still frequently used to sell distressed inventory. When a weekly, 3-day or same-day forecast shows fairly disappointing demand, the revenue manager may believe the only way to boost occupancy is to drop rates as a last effort. Demand-based dynamic pricing is applied in order to gauge what price point the market would accept.
Given the drawbacks of discounting, one might reasonably wonder why any revenue manager would ever use it as a tactic. The answer can be complex. Low occupancy has always been considered a reflection of less than satisfactory sales performance. Low occupancy reduces a hotel’s ability to pay its fixed costs as they come due, so owners tend to want some sort of intervention to ensure those costs will be covered from the cash flow generated.
The fact is, that room rates are the variable that managers have the most control over, so it is often their first choice to manipulate it – even though discounting should probably be their last choice. Developing a convincing value proposition by creating more value without discounting is harder work: package development (bundling), better defined differentiation, better websites, product improvements like better service, better mattresses, better shower-heads, better amenities, better breakfast, etc. all require more work, more resources, more creativity and need some ramp-up time to take effect. Owners and asset managers may put pressure on revenue managers to show short-term results, and holding or boosting occupancy through discounting may temporarily assuage owners and get them off the manager’s back.
Another argument is that, although room revenue is likely to fall, the increased occupancy may generate larger revenue increases in the hotel’s other revenue centers. Increasing occupancy also helps maintain the level of employment the hotel needs to uphold service quality and sustain staff morale. Stealing market share can also be a consideration, but this goal presents a serious issue to deal with. Can a hotel retain the stolen clientele? The answer is probably not. The deal-driven bargain hunters always go where the best deals are. There is no protection against a competitor’s steeper discount next time. So even if one day a battle can be won, there is no chance to win a war by using this weaponry. Any price can be undercut by someone more desperate.
There are times when discounting is used for entirely the wrong reasons. After the dramatic events of September 11, the New York hotel market saw a drastic decline in demand. Following the SARS outbreak in the spring of 2003, the bottom of the market fell out in Toronto. In both cases, the steep decline in demand had nothing to do with the pricing level of hotel rooms. Travelers stayed away for a variety of reasons, but high room rates were not one of them. Why would hoteliers expect heavy discounting to fix a problem when room rates were not part of the problem in the first place? If travelers avoid an area because of safety, security, or health concerns, can low rates really persuade them to disregard those concerns? The answer seems obvious. Nonetheless, discounting became so rampant in both cities that it took years for their hotel markets to recover.
By definition, at the day-to-day operational level, hotels tend to take a tactical approach to rate management versus a strategic one. But tactics should never ignore the larger strategy. To avoid confusing the market by saying one thing and doing another, strategy and tactics should be aligned. Unfortunately, many managers use tactics that conflict with the larger strategy. When we see hotel brands that promote service quality as their strategic choice for market positioning start to discount and promote value instead in their day-to-day operations, there is a clear misalignment. Driving attention to discounts will undermine a coveted strategic choice of being a service quality differentiated brand – a market position that takes extended effort to achieve. Consumers should not be confused: brand clarity is vital. If a hotel chooses to be a price or value driven choice, it should support that strategy consistently with its tactics.
All of this does not mean that discounting should be never used. However, managers who consider tactical discounting need to understand the complexity and dangers of this issue.
This is an excerpt from “Revenue Management: Maximizing Revenue in Hospitality Operations,” published by the American Hotel & Lodging Educational Institute (EI). For information or to order, visit www.ahlei.org or call 800-752-4567 or 517-372-8800. Outside the U.S. and Canada, please call 407-999-8100.
Dr. Gabor Forgacs
|Also See:||Strategic Revenue Management / Dr. Gabor Forgacs / February 2010|
|Revenue Management: Dynamic Pricing / Dr. Gabor Forgacs / January 2010|