ROOM PRICING METHOD
ROOM PRICING METHOD
Establishing
rack rates for room types, and determining discount categories and special
rates, are some of the revenue manager's major duties. The revenue manager
recommends rack rates to senior hotel management after analyzing forecasted
occupancy and business conditions in the marketplace. Rack rates are usually
determined on a yearly basis (subject to frequent revision review) and are a
major decision factor in the annual hotel budgeting process. Determining
discounted rates is more tactical and is a decision the revenue manager, or
possibly a revenue committee, must make. When determining rack rates or
discounted rates, management should consider such factors as operating
expenses, guest demand, market conditions, inflationary factors, and related
business issues.
1. Market
Condition Approach:
The market condition approach to pricing
rooms involves analyzing the current state of the market and setting room rates
based on supply and demand dynamics. This approach takes into account factors
such as the time of year, local events, competitor pricing, and overall demand
for accommodations in the area. During peak seasons or high-demand periods,
room rates may be higher, while they could be lower during off-peak times when
demand is lower. The goal is to optimize revenue and occupancy by adjusting prices
according to market fluctuations.
how the market condition approach to
pricing rooms works:
Example: A Beachfront Resort
Imagine a beachfront resort located in a
popular vacation destination. This resort has 100 rooms available for guests.
The management team wants to determine the best room rates for the upcoming
summer season using the market condition approach.
1. Market Research:
The first step is to conduct thorough
market research. The management team looks into various factors that can
influence demand for accommodations during the summer season:
- Historical data: They analyze past
years' booking patterns and room rates during the summer season to identify
trends and peak periods.
- Local events: They check the schedule of
local events, such as music festivals, sports tournaments, or conferences,
which can attract additional visitors to the area.
- Competitor analysis: They assess the
room rates of nearby hotels and resorts to understand the pricing strategies of
their competitors.
- Economic indicators: They consider any
economic factors, such as tourism trends, employment rates, or travel
restrictions, that may affect the demand for accommodations.
2. Identify Demand Patterns:
Based on their research, the management
team finds that the summer season sees a significant increase in tourists, with
the highest demand occurring during weekends and certain festival dates. They
also notice that competing hotels in the area tend to raise their room rates
during these peak periods.
3. Pricing Strategy:
With this information, the resort's
management decides on the following pricing strategy for the market condition
approach:
- Peak Periods: During weekends and
festival dates, when demand is high, the resort will set higher room rates to
capitalize on the increased demand and maximize revenue. They might use a
dynamic pricing strategy to adjust rates in real-time based on demand and
occupancy levels.
- Off-Peak Periods: During weekdays and
less busy times, the resort will offer discounted rates or promotional packages
to attract more guests and maintain a healthy occupancy rate.
4. Monitoring and Adjustments:
Throughout the summer season, the
management team closely monitors the occupancy rates, reservation trends, and
competitor pricing. They use this real-time data to make adjustments to their
room rates as needed. For example, if they notice that demand is stronger than
expected during a specific weekday, they might raise the rate for that night to
capitalize on the opportunity. Conversely, if there is a sudden drop in
reservations, they might offer last-minute discounts to fill up the remaining
rooms.
By continuously evaluating market
conditions and adjusting their pricing strategy accordingly, the resort can
optimize its revenue and maximize occupancy, resulting in a successful summer
season. This is the essence of the market condition approach to pricing rooms.
2. Rule-of-Thumb
Approach:
The rule-of-thumb approach sets the rate
of a room at₹1 for each₹1,000 of construction and furnishings cost per room,
assuming a 70 percent occupancy.
how the rule-of-thumb approach might
work:
Example: assume that the average
construction cost
of a hotel room is ₹80,000. Using the ₹1
per₹1,000 approach results in an average selling price of ₹80 per room.
Singles, doubles, suites, and other room types would be priced differently, but
the minimum
average room rate would be ₹80.
the rule-of-thumb approach may offer a
quick and straightforward method for setting room rates, it has several
disadvantages that can limit its effectiveness in certain situations:
Lack of Accuracy:
The rule-of-thumb approach is not based on detailed data or analysis. It relies
on rough estimates and assumptions, which may lead to inaccurate room rates.
Pricing rooms too low or too high can have negative impacts on revenue and
profitability.
Ignores Market Dynamics:
This approach does not take into account market conditions, competitor pricing,
or demand fluctuations. As a result, the room rates may not be aligned with the
current market trends, leading to missed revenue opportunities or potential
revenue loss.
Ignores Variability:
The construction and furnishing costs per room can vary significantly depending
on the location, quality, and size of the property. Applying a fixed ratio to
all rooms may not reflect these differences, leading to inconsistent pricing.
Does Not Consider Operating Costs: The
rule-of-thumb approach solely focuses on construction and furnishing costs,
ignoring other significant operating expenses such as utilities, staff
salaries, maintenance, and marketing. Setting room rates without considering
these costs could result in unsustainable pricing.
No Revenue Management:
Revenue management involves dynamic pricing based on demand and booking
patterns. The rule-of-thumb approach does not account for these factors,
preventing the establishment from optimizing revenue during high-demand
periods.
Potential Underpricing:
Setting rates too low based on a simple formula may lead to underpricing,
leaving money on the table and reducing overall profitability.
Potential Overpricing: Conversely,
if the formula sets rates too high, it may lead to reduced bookings and
occupancy rates, impacting revenue negatively.
Doesn't Consider Seasonality:
The rule-of-thumb approach may not account for seasonal variations in demand,
leading to less competitive pricing during low-demand periods or overly high
rates during peak seasons.
In summary, while the rule-of-thumb
approach may be a quick starting point for setting room rates, it lacks the
precision and sophistication needed for optimal revenue management. It is
essential for hospitality establishments to conduct more in-depth analysis,
consider market dynamics, operating costs, and customer perceptions to arrive
at well-informed and competitive room rates.
Q.
Assuming the construction and furnishing cost per room is ₹100,000, and the
room rate according to the rule-of-thumb approach is ₹1 for each ₹1,000 of
construction and furnishing cost per room.
Calculate the room rate in using the
rule-of-thumb approach.
Hubbart Formula Approach/ bottom-up
approach
Another approach to average room rate
determination is the Hubbart Formula. To determine the average selling price
per room, this approach considers operating costs, desired profits, and
expected number of rooms sold. In other words, this approach starts with
desired profit, adds income taxes, then adds fixed charges and management fees,
followed by operating overhead expenses and direct operating expenses.
The Hubbart Formula is considered a
bottom-up approach to pricing rooms
The Hubbart Formula approach involves
the following eight steps:
1. Calculate the hotel's desired profit by
multiplying the desired rate of return (ROI) by the owners' investment.
2. Calculate pretax profits by dividing
desired profit (Step 1) by 1 minus the hotel's tax rate.
3. Calculate fixed charges and management
fees. This calculation includes estimating depreciation,
interest expense, property taxes,
insurance, amortization, building mortgage, land, rent, and management fees.
4. Calculate undistributed operating
expenses. This calculation includes estimating expenses for the following
categories: administrative and general, information technology, human
resources, transportation, marketing, property operation and maintenance, and
energy costs.
5. Estimate non-room operated department
income or loss—that is, food and beverage department income or loss,
telecommunications department income or loss, and so forth.
6. Calculate the required rooms department
income. The sum of pretax profits (Step 2), fixed charges and management fees
(Step 3), undistributed operating expenses (Step 4), and other operated
department losses less other operated department income (Step 5) equals the
required rooms department income. The Hubbart Formula, in essence, places the
overall financial burden of the hotel on the rooms department.
7. Determine the rooms department revenue.
The required rooms department income (Step 6), plus rooms department direct
expenses of payroll and related expenses, plus other direct operating
expenses, equals the required rooms
department revenue.
8. Calculate the average room rate by
dividing rooms department revenue (Step 7) by the expected number of rooms to
be sold.
An example of the Hubbard Formula
approach to calculate room rates for a hypothetical hotel.
Assumptions:
- The hotel owner desires a 10% return on
investment (ROI) based on their total investment in the hotel.
- The hotel's tax rate is 25%.
- Fixed charges and management fees amount
to $50,000 per month.
- Undistributed operating expenses
(administrative, marketing, etc.) are estimated to be $30,000 per month.
- Non-room operating department income
(e.g., food and beverage department) is $20,000 per month.
- The hotel expects to sell an average of
80 rooms per day.
- Other room department direct expenses
(payroll, etc.) are $15,000 per month.
Step 1: Calculate the hotel's desired
profit:
Desired Profit = (Desired ROI) * (Owner's
Investment)
Desired Profit = 10% * Owner's Investment
Step 2: Calculate pre-tax profits:
Pre-tax Profits = Desired Profit / (1 -
Tax Rate)
Step 3: Calculate total fixed charges and
management fees:
Total Fixed Charges and Management Fees =
Fixed Charges + Management Fees
Step 4: Calculate the required room
department income:
Required Room Department Income = Pre-tax
Profits + Total Fixed Charges and Management Fees + Undistributed Operating
Expenses + Other Department Losses - Non-Room Operating Department Income
Step 5: Determine the rooms department
revenue:
Rooms Department Revenue = Required Room
Department Income + Other Room Department Direct Expenses
Step 6: Calculate the average room rate:
Average Room Rate = Rooms Department
Revenue / Expected Number of Rooms Sold per Day
Example Calculation:
Let's assume the owner's investment is
$1,000,000.
Step 1: Desired Profit = 10% * $1,000,000
= $100,000
Step 2: Pre-tax Profits = $100,000 / (1 -
0.25) = $133,333.33
Step 3: Total Fixed Charges and Management
Fees = $50,000
Step 4: Required Room Department Income =
$133,333.33 + $50,000 + $30,000 + $0 - $20,000 = $193,333.33
Step 5: Rooms Department Revenue =
$193,333.33 + $15,000 = $208,333.33
Step 6: Average Room Rate = $208,333.33 /
80 rooms = $2,604.17 (rounded to the nearest cent)
In this example, the calculated average
room rate using the Hubbard Formula is $2,604.17 per room per night. This rate
considers the hotel's desired ROI, operating costs, and expected room demand,
and aims to generate the desired profit while covering expenses and other
income from non-room departments.