News for the Hospitality Executive
K. Hayes Ph.D., Allisha
A. Miller, and Joshua D. Hayes, MS.
May 16, 2011
Hotels and restaurants are both segments of the hospitality industry. Managers in each of these segments would seem to have a lot in common. Both sell products (rooms, food or beverages) and the best of them emphasize quality customer service as a key means of differentiating themselves from their competitors. When it comes to setting the prices for what they sell, however, they often seem to come from different worlds.A few examples will illustrate the different approaches to pricing our hotel and restaurant guests typically experience.
1. When guests contact a hotel and request a price quote on purchasing ten or more hotel rooms on a single night, their call will no doubt be transferred to the sales department where they will be offered a quantity purchase discount.
If, however, that same guest reserves a table of ten, for the same night, at a nearby table service restaurant no discount will be offered and, in most cases, a mandatory service charge (effectively a price increase) will be added to the guest’s bill.
2. When guests request a room rate quote on a hotel’s busiest night of the week they can expect to check into their rooms at the normal time, and pay a rate premium of 10-100% above the same room’s normal (rack) rate. However, if they go to a popular restaurant on its busiest night of the week they will A; wait a long time for their table, and B. pay the same menu prices they would pay on the restaurant’s slowest night.
3. When guests go online to make a hotel room purchase they will find literally hundreds of third-party intermediaries selling rooms for the same hotel property on both that property’s busiest and slowest nights. The rates to be charged and the fine print conditions of the sale can vary somewhat, but what will not vary is that the hotel itself will receive only a portion of the room’s selling price (in some cases as low as 50% of what the buyer pays for the room).
The same guest going online to make a dinner reservation at a restaurant will get just that… a dinner reservation; and the restaurant will not pay a third-party intermediary a commission anywhere remotely near what their hotel counterparts routinely pay.
4. When guests arrive, with a confirmed reservation (at a hotel they have never stayed at before), and if the hotel is slow that night, the guest will likely be given a room upgrade at no extra charge to encourage them to come back in the future.
If the same guest goes to his or her favorite restaurant (one they frequent at least monthly) on a slow night and orders a ten-ounce sirloin steak, they know there is zero chance they would be offered the option of paying the menu price for the ten-ounce steak but being upgrading (at no charge) to a 14-ounce steak.
If these examples make you wonder about the thought processes driving hotel and restaurant pricing you are not alone. No doubt, when considering hospitality industry pricing, our guests also wonder: “What’s up with that!?”
To better understand why hotel and restaurant pricing philosophy varies so much (and what managers in each of these two major industry segments can learn from each other about pricing) it helps to understand how the typical manager in each segment first learned about pricing themselves.
If you pick up a course catalog from any of the fine hospitality management schools you will find, in the majority of cases, that there is no separate course devoted solely to “Hospitality Pricing.” That’s particularly unfortunate when the impact of effective pricing on business profitability is fully understood. The importance of pricing to business success was posed succinctly by Warren Buffet, the billionaire CEO of Berkshire Hathaway, in a February 2011 interview with Bloomberg news when he stated:
The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10% then you’ve got a terrible business.
Understanding the power of pricing is critical. Effective pricing allows you to capture an audience and maintain a successful business. So, where then do future hospitality managers initially learn about pricing?
Restaurant pricing is most often taught in “accounting” type courses by “accounting” type instructors. Whether the course is called Cost Control, Menu Management, Restaurant Operations, or something similar, practicing restaurant managers will immediately recognize the philosophy, language and formulas they first learned and now use. Thus, if you are a restaurateur reading this article you are no doubt fluent in the restaurant pricing language of portion costs, food cost %, contribution margin, prime costs, costs of premium liquors vs. well liquors and menu engineering. Most importantly, you have been taught the critical role of carefully calculating your costs prior to establishing your prices.
Hoteliers learn about pricing in “marketing” type courses taught by “marketing” type instructors. Whether the course is called Hospitality Marketing, Hospitality Sales, Front Office Management, Revenue Management or something similar, hotel managers will immediately recognize the philosophy, language and formulas they first learned and now use.
If you are an hotelier reading this article you are no doubt fluent in the language of ADR, occupancy %, RevPAR, room type, rate parity and market share. Most importantly, you have been taught the critical nature of balancing room supply and guest demand when determining your room rates.
To point out the in-practice differences in pricing philosophy between hard-core accountants and hard-core marketing professionals is to re-state the obvious to those hotel or restaurant managers who have spent much time in our industry. Nor does it really make any sense to say one approach is right and the other is wrong. It does make sense, however, for students of each approach to learn important lessons from the other.
What follows are three truths hoteliers know about pricing (that most restaurateurs don’t recognize) and three truths restaurateurs know about pricing (that most hoteliers don’t recognize).
All six truths are offered in the spirit of improving customer-centric pricing decisions and ultimately greater hospitality industry profitability. At the very least, they will no doubt stimulate some lively debate. This is so because the authors fully expect some managers will embrace those truths ascribed to their industry as “only-too-obvious” while at the same time outright rejecting as “implausible” those truths known by their industry counterparts.
This article is written for those open-minded managers willing to consider new truths; even when those truths make them question their old beliefs. These are the managers Oscar Wilde was addressing when he stated, “The truth is rarely pure …and never simple!
Restaurateurs’ Truth #1: Bottom-Line Profits Outshine Top Line Sales
Hoteliers measure percentage changes in top line sales (ADR, occupancy %, and RevPAR) regularly and with great precision. The truth, as every restaurateur knows, however, is that sales are not nearly as important as profits.
Food and beverage sales made at discounts significantly below regular menu prices simply for the purpose of increasing revenue volume do not often occur in the restaurant industry. The cost focus of restaurateurs just will not allow them to knowingly sell at or below their costs.
Contrast that reality with the current hotel industry debate over the relative importance of revenue per available room (RevPAR) vs. gross operating profit per available room GOPPAR as a performance metric. The debate exists only because, in the view of some hoteliers, all sales which increase RevPAR (as every room sale regardless of its profitability will do) are good sales. In truth, they are not.
An industry that places a
top line revenue generation, rather than bottom line profits will
make pricing decisions that favor the former over the latter. Some
a.) Sales professionals motivated to apply a “put head in beds at any cost” mentality to their work
b.) Franchisors (whose incomes are primarily driven by top line sales) who promote questionable marketing campaigns and methods used to maximize RevPAR, rather than GOPPAR
c.) Hotel owners deprived of rightful investment returns
Restaurateurs’ Truth #2: Don’t Sacrifice Pricing Potential Due to Diminished Demand.
The economy is slowing. Hotel occupancies in an area are declining. Restaurant volume in the same area is down as well. The hotel industry’s dominant pricing strategy? Drop rates and use the Internet to widely publicize the rate reductions.
The restaurant industry’s dominant pricing strategy? Stand firm on prices.
The restaurant strategy was summed up nicely by Michael Woodhouse President and CEO of Cracker Barrel Old Country Stores. Speaking of his company’s decision not to reduce its prices during the “Great Recession” of 2009-2010 Woodhouse stated, “Once you devalue something, you’re digging a big hole and it’s (tough) to get out of that. We’re not depending on anything happening in the economy, other than the day-to-day business of treating our guests right.” Translation: “Don’t expect to see solidly run restaurants utilizing Groupon on a long-term basis.”
But things are different on the hotel side.
Every serious hotel pricing study ever undertaken shows the futility of lowered room rates in the face of slackened demand. The research consistently shows those hotels that reduce rates the most in periods of reduced demand lose the most. Those who reduce rates the least, profit the most in the long term.
Despite that fact, in the hotel industry the pain of occupancy rate declines is routinely compounded by decisions to reduce rates because room sellers are convinced that lowered ADRs create greater demand for rooms. The truth is lowered room rates do not create higher room demand. They simply create lower rates.
Bruce White, CEO White Lodging Services summed the industry-wide rate reduction problem up nicely in the March 7, 2001 issue of Hotel Business when he stated:
“As an industry, we tend to overreact to the market, particularly in periods of soft demand. We become our own worst enemy.”
Any service industry (e.g.
car rental companies, movie theaters and the like) that significantly
prices during periods of reduced demand will inevitably experience:
a.) A race to the rate bottom; as direct competitors are forced to match the lowered rates
b.) Reduced per-room sale profitability at a time when each profit dollar is precious
c.) A very slow and painful multi-year recover process when the decision is made to increase prices to previous levels
Restaurateurs’ Truth #3: Never…Ever…Let Others Dictate What You Sell
It is somewhat curious that the same hotel industry whose far-sighted leaders banded together in 1989 to create the THISCO switch (in response to escalating GDS access costs) now finds itself struggling to re-gain control of its rooms inventories and pricing practices from third-party internet sites that neither build hotels nor clean rooms.
It is even more curious that many hoteliers offer lower room pricing to online guests than to their own walk-ins. When pressed, these hoteliers would explain that their room rates have to be kept low on the Internet to ensure proper page placement (near the top of the search page list) and that third-party site operators will punish them with poor placement if rooms inventories are restricted or their prices are too high.
The internet should not be used as an excuse to abandon pricing power. Restaurateurs know it is important to make their presence known via the use of advanced technology. The best of them are adept at utilizing Yelp, Facebook, Twitter, MySpace, iPhone apps and all the rest of the available technology tools to increase the ease with which their customers buy directly from them (re-read the last five words in this sentence and you will know what restaurateurs know).
Hotels have been content to pay astonishing amounts to third-party on-line travel agents (OTAs) selling hotel rooms and have, in far too many cases, ceded to these sites ever-increasing control over rooms pricing and inventory. If the hotel industry continues to rely on a distribution model that gives extraordinary power to its third-party distribution partners to set the terms of room sales it will inevitably continue to experience:
a.) The commoditization of its products as the importance of service levels and brands are reduced in guests’ eyes in favor of lowest price
b.) The ability of intermediaries to achieve even greater price and inventory concessions from franchisors and property-level room sellers
c.) Continued lessened tax revenue to support local CVBs and tourism marketing services
Is there another way to go? Can a business actually maintain complete control of what it sells and the price at which it sells it? Note to hoteliers; restaurateurs (and Southwest airlines!) know that they can.
If you think restaurateurs simply “get it” better than do hoteliers when it comes to pricing products, think again. No industry segment has a monopoly on truth. In fact, restaurateurs can learn a great deal about customer-centric pricing from the things their hotel industry counterparts know to be true.
Hoteliers’ Truth # 1: Customers Don’t Care About Costs
Ask restaurateurs why cheeseburgers cost more on their menus than hamburgers and you will likely get a perplexed look, accompanied by the immediate answer that a cheeseburger costs more to produce than a hamburger; thus the higher selling price is clearly appropriate.
Hoteliers know better. They understand that buyers are absolutely unconcerned about a seller’s real costs and that, in especially in the service industries, a cost-based approach to pricing is simply ineffective. That’s because in markets where consumer demand is weak, cost-based pricing leads to higher prices than most customers are willing pay. In markets where demand is high, cost-based pricing leads to lower prices than most customers are willing to pay. If you immediately recognize that this is exactly the opposite of the pricing logic that should be used by sellers in a service industry then you know what hoteliers know.
It is a dangerous assumption to think that businesses can charge more for their goods and services simply because the business has added costs to them. Increased costs do not automatically equate to increases in consumer perceptions of value; a fact recognized by any business owner whose operating costs continually exceed his or her revenues.
An increase in costs cannot automatically dictate an increase in selling price. In fact, the opposite should be true. The fact that beef costs have risen 20% does not mean customers’ willingness to pay higher prices for steaks has risen as well. An appropriate selling price for a product or service must dictate its allowable cost. It is only when selling prices accurately reflect consumer perceptions of value that a business can ascertain the costs it can reasonably incur while still generating the profit levels it requires for long-term sustainability.
Hoteliers’ Truth # 2: The Hospitality Industry Doesn’t Sell…It Rents
Service industries are characterized in part by their inability to increase supply in times of increased demand. Thus, a hotel that consists of 400 rooms simply cannot sell more than 400 rooms in one night, regardless of how many potential guests want to buy a room. A restaurant with 200 seats can only offer that number of seats for sale during its busiest, as well as its slowest, periods of customer demand. Because the supply of what is sold to guests (hotel beds or restaurant seats) is restricted, effectively managing inventory (capacity) well is critical to business success.
Airline executives understand the important relationship between capacity management and revenue and thus they measure their inventory utilization efficiency using PRASM (Passenger Revenue per Available Seat Mile). Hoteliers focus on RevPAR (Revenue Per Available Room) a similar measure that equates the ability of hotel management to optimize the pricing of available room capacity. Yet in the restaurant industry, RevPASH (Revenue Per Available Seat Hour) is a powerful but under-utilized restaurant performance metric. It shouldn’t be. Few restaurateurs regularly monitor RevPASH. They should.
To best understand RevPASH, it is important to recognize that a restaurant has a fixed number of seats, each of which has the potential to generate larger or smaller amounts of revenue based on how many guests are seated per hour, how long each guest remains in the seat, and how much is purchased by each seated guest. Viewed from that perspective, restaurants don’t actually sell steaks; rather they rent seats to people who may buy steaks. An increase in the number of restaurant seats occupied (rented) results in increased revenue. In a right-sized and properly managed operation, greater revenues should yield greater profits.
The effective monitoring and management of RevPASH is designed to increase revenue by focusing on the duration of guests’ dining experiences, as well as the amount they spend while seated. RevPASH monitoring can give restaurateurs a good idea of the speed at which a kitchen produces food and the speed at which guests are seated and served. Because that is true, an understanding of RevPASH is important both for its emphasis on capacity management and its decidedly customer-centric orientation.
When restaurateurs inventory their vacant seating as carefully as they inventory the products in their walk-ins, they will know what hoteliers know.
Hoteliers’ Truth # 3: Differential Pricing is Customer-centric Pricing
What do hair salons have in common with restaurants and hotels? Each has a limited ability to serve their customers in periods of heightened demand. Hair salons are constrained by the number of chairs and hair stylists available at any one time. Hotels have a limited number of rooms. Restaurants have a limited number of seats.
In the hotel industry, hotel revenue managers routinely implement differential pricing strategies. Differential pricing can be defined as the practice of charging different prices to different buyers for the same product or slightly different versions of the same product. The use of differential pricing is widespread in the hotel industry. It is almost unheard of in the restaurant industry where it is typically perceived as inherently “unfair” to guests. It is not.
To illustrate, assume that on alternating Fridays you regularly get your hair cut at your favorite hair salon. Next, assume it is the week-end of your local high school’s Senior prom. During this week, demand for hair salon services is exceptionally strong. In the face of extra-ordinary demand for what it sells, your salon’s owner, like any service provider whose inventory is constrained, would be forced to choose from one of only three revenue management alternatives. These are:
A. Establish one price and then sell to customers on a first come-first served basis until they have exhausted their supply of products.
B. Allocate the limited supply to selected customers who meet established criteria (e.g. they are volume buyers, repeat buyers, they buy at certain times, or they hold other favored buyer status).
C. Raise prices until demand is reduced sufficiently to equal the available supply.
Of course, pricing experts have the option of A, B, or C, as well as that of fashioning a strategy that combines aspects of B and C into a customized approach (because these two strategies are not mutually exclusive).
Now re-read the list of options from the perspective of you; a loyal salon customer. Which seems fair to you? Which seems unfair? Which would you like to see applied to you during your next visit to the salon during a Prom week?
The perception of fairness in pricing is of prime concern to customers. Customer-centric pricing is an approach to pricing that directly addresses customers’ perceptions of value and pricing equity. Hoteliers know that all customers are not created equally; nor do all of your customers expect to be treated equally.
Neither pricing approach A nor C identified above would likely make you feel your hair salon valued your continued business. If the salon used approach “A”, you would likely visit another salon because your wait to get in your favorite salon (remember it is Prom week) would be excessively long. If approach “C” were implemented, you would pay substantially more this week than last week for the same service. Based on your individual customer characteristic (your frequent buyer status) you would, rightfully, expect the “special” treatment, differential pricing, identified in approach “B”.
The individual buyer characteristics (e.g. age, frequency of purchase, timing of purchase, payment method, among many others) used to implement differential pricing strategies help to ensure fairness to customers and to optimize revenues. That’s because only pricing decisions made after fully considering each of your target markets’ individual desire, ability and willingness to pay characteristics will best serve them, and ensure their long-term loyalty to you.
Ultimately, the worth of any product or service can only be equal to the amount informed buyers are willing to pay for it. The actual determination of selling prices in the hospitality industry, however, is a nuanced process and it is highly influenced by the perspective of sellers. Based on the long histories of their industry segments (and despite their often differing perspectives) hoteliers and restaurateurs know much about products, services, customers, and pricing.
It has been said that education is learning what you didn’t even know you didn’t know. When it comes to pricing, hoteliers and restaurateurs already know a lot. They can know even more when they learn from each other.
About this Article: This article is based on information in Revenue Management for the Hospitality Industry by David K. Hayes and Allisha A. Miller. © 2011 John Wiley & Sons, Inc. All rights reserved. To purchase this book or obtain information about bulk sales, please contact [email protected]
About the Authors: Dr. David K. Hayes and Allisha A. Miller operate Panda Professionals Hospitality Management and Training (www.pandapros.com) where they create and deliver innovative and practical educational materials and pricing-related seminars exclusively for those in the hospitality industry. Joshua D. Hayes, MS is a Panda Professionals consulting author
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