Many hoteliers contend that discounting room rates is a necessity during tough economic times—and also a strategy to steal market share in good times. With the current global economic slowdown the temptation to drop rates has again surfaced. To prepare owners and operators for how to consider making wise strategic pricing decisions in uncertain times, we conducted a study in which we examined pricing, demand, and revenue per available room dynamics in the U.S. hotel industry for the periods 2001-2003 and 2004-2007.
It is not always clear why competitors drop their prices or why others follow. To explore these pricing dynamics we looked at hotels that price above and below their direct competitors. To ensure that our study captures true competitors, we only look at competitors who had similar revenue performance in the prior year.
In cooperation with The Center for Hospitality Research at Cornell University and Smith Travel Research, we explored the pricing behavior of 67,008 hotels over a seven year period from 2001-2007. In each year we began with a sample of between 11,056 (2001) to 16,369 (2007) hotels. The data were monthly property-level drawn from STRvdatabases.. We aggregated STR’s monthly rooms data to arrive at the annual number of rooms sold, annual number of rooms available and annual rooms revenue for each property and each property’s competitive set for each of the seven year of the study. Properties that had less than 12 months of data were eliminated from the sample.
The key variables of interest in this study are the percentage differences between each hotel and its competitive set of hotels on price, demand, and revenue metrics. The percentage difference in ADR was used as the basis for making comparisons among the pricing strategies of hotels relative to their competitive set. To calculate percentage difference in ADR, the annual ADR of a competitive set was subtracted from the annual ADR of each hotel. This difference was then divided by the annual ADR of the competitive set and multiplied by 100. The result of this calculation is the percentage difference in ADR from that of the competitive set. Occupancy and RevPAR percentage differences were calculated using the same approach.
Pricing strategies and hotel differences
The sample hotels (n=67,008) were grouped into 12 pricing strategies based on their percentage difference in ADR from their competitive set. The price difference categories ranged from 20 percent to 30 percent above and below the competitive set to 0 to 2 percent above and below. After grouping hotels according to their pricing differences, the percentage difference between each hotel and its competitive set on occupancy and RevPAR were calculated and mapped.
The initial analyses examined all hotels during the turbulent years of 2001 through 2003. Exhibit 1 shows the average percentage difference in occupancy and RevPAR performance across hotels that both rose or lowered their ADRs compared to their competition. Overall, for hotels that dropped their price relative to their competitive set, average percentage differences in occupancies rose, but average percentage differences in RevPARs fell. This pattern of gaining occupancy but losing RevPAR when dropping rate compared to the prices of competitors was true for hotels in all three years.
RevPAR and occupancy percentage differences from the competitive set 2001-2003:
As shown in the data table of Exhibit 1, the maximum occupancy advantage over the competitive set was obtained by those hotels that had the lowest comparative ADRs. But the key point is that these low priced hotels reported the lowest comparative RevPARs as well. Clearly the strategy of putting heads in beds was accomplished by dropping relative prices. In 2003, the hotels with prices 20 percent to 30 percent below the competition reported annual RevPARs of 12.0 percent below the competition. In sum, while the goal of increased occupancy was achieved, the consequence for these hotels was substantially lower RevPARs than their competitive set.
Hotels that dropped their relative prices by less than 2 percent experienced both occupancy and RevPAR gains relative to their competitors. In contrast, hotels that raised their relative prices by less than 5 percent experienced both occupancy and RevPAR gains relative to their competitors. Hotels that raised their relative prices more than 5 percent above the competition were punished with lower occupancies, but rewarded with higher relative revenue.
As the industry began to rebound in 2004, it seems likely that pricing behavior would also change. Exhibit 2 shows the percentage differences in RevPAR and occupancy performance across hotels that both lowered or raised their ADRs compared to competitors from 2004 – 2007. Interestingly, the analysis suggests a similar pattern of rising and falling occupancies and RevPARs as was seen in previous years. Hotels that dropped their rates relative to competitors experienced rising percentage differences in occupancies, but their average percentage differences in RevPARs fell compared to their competition. This pattern of gaining occupancy but losing RevPAR when dropping rate compared to the prices of competitors was similar to the pattern found for the 2001-2003 period.
RevPAR and occupancy percentage differences from the competitive set 2004-2007:
Pricing by market segment
Beginning with the luxury hotels in the United States, as shown in Exhibit 3, occupancies decline with rising comparative rate strategies. Hotels that price above the competition lose occupancy, but they have solid RevPAR gains. In contrast, both occupancies and RevPAR rise for upper upscale and upscale hotels that price as much as 10 percent higher than their competitors do. Occupancy decline compared to competitor hotels only after upscale and upper upscale hotels have prices 10 percent to 15 percent above the competition. Regardless of the market segment, all high-end hotels that priced above their competitors experienced higher comparative RevPAR performance. The largest percentage gains in each price category were for hotels in the upscale segment, followed by upper upscale and then luxury. However, luxury hotels that priced 20 percent to 30 percent higher than their competitors had 13.17 percent higher RevPARs.
RevPAR and occupancy percentage differences
for midscale and economy hotels compared to the competitive set 2004-2007:
Upscale and upper upscale hotels that priced within 2 percent above or below their competitive set are quite similar in their RevPAR and occupancy performance. It appears that the modest 2 percent price increases or price reductions relative to the competition are both viable strategies, for hotels in these higher market segments. Luxury hotels fair better by pricing 2 percent to 5 percent above their competitors with occupancy losses (0.49 percent) that are smaller than when pricing a more modest 2 percent above the competition, and RevPAR performance is 3.0 percent above competitors.
Midscale and economy hotels can gain substantial occupancies by lowering their prices relative to the competition. For hotels in this segment that price 20 percent to 30 percent lower than their competitors, dramatic occupancy boosts (16.5 percent) can be obtained, as illustrated in Exhibit 4. It is unfortunate that this market share benefit also yields a substantial RevPAR loss of 11.4 percent lower than other market competitors. Discounting rates relative to economy competitors does not result in better RevPAR than the competition. Economy hotels that price above their competitors lose occupancy, but gain modest RevPAR benefits. In this market segment RevPAR gains are far more modest than in the midscale segments.
RevPAR and occupancy percentage differences
for Luxury, Upper Upscale, and Upscale hotels compared to the competitive set 2004-2007:
Midscale without food and beverage hotels that price above the competition appear to have the most dramatic RevPAR benefits of the lower segmented hotels. In contrast, midscale with food and beverage hotels have the largest RevPAR losses when they price below the competition. Falling occupancies and rising RevPARs are the norm for hotels that price above their competition in midscale and economy segments.
Midscale with food and beverage hotels and economy hotels also lose occupancy when they price just a little (less than 2 percent) below the competition. Only hotels in the midscale without food and beverage get an occupancy boost for modest discounting. The greatest benefits from price discounting should be experienced by economy hotels that pursue this strategy because their customers are considered to be the most price sensitive. Indeed, economy hotels did get the greatest occupancy benefit from pricing below the competition. Nevertheless, even in the economy segment, pricing higher than your competitors by over 5 percent produced RevPAR benefits of about 1.5 percent.
Summary
For the seven-year period, over all of the market segments, the pattern of results reported in this study shows that price discounting leads to increases in occupancy and decreases in RevPAR compared to the competition. When prices rise, occupancies decline, but are more than offset by increases in RevPAR. The dynamics between price and occupancy appear quite stable from segment to segment, but the degree to which higher prices produce dramatic or gradual drops in occupancy does vary by segment. In addition, for 2003 small price increases did not enhance RevPAR for some segments.
After looking at the pricing behavior of over 67,000 hotels within a seven-year time horizon, in bad and good times, and across market segments, we offer a few important observations for operators:
• Offering guests prices that are lower than the competition does lead to higher occupancy percentages for the discounting hotel, but these comparatively lower prices also result in lower RevPAR performance than the competition.
• Hotels that price higher than their competitors have lower occupancies, but higher RevPARs, especially when they price significantly higher than their competitors do. It is also possible that some competitors trade down to lower market segments. This possibility looks to be greatest for luxury and full-service midscale hotels.
• The best way to have higher revenue performance than your competitors is to have higher rates. A hotel should not drop price below the price of its true competitors if it wishes to enjoy a RevPAR premium.
• Very small differences were found across price segments or years in this study. The pattern of results is consistent across segments and years. Whether you face good or bad times, pricing above your direct competitors yields higher rooms revenue while pricing below your competitors does not stimulate sufficient demand to give the needed revenue boost hoped for. Guests of luxury hotels appear to be insensitive to price discounting while customers of economy hotels are quite sensitive to small price increases.
• The results of this study should be comforting and confirming for any hotel operator who has resisted the pressure to drop prices below their competitors. Hotels in direct competition make more money (i.e., rooms revenue) when they have comparatively higher prices, and do not discount to fill rooms. Further, hotels that dropped their prices did capture market share from the competition, but they did not gain higher RevPARs. This may be due to the possibility that stealing share is not the same thing as stimulating new demand.
• While good revenue management is essential, this study suggests there is nothing wrong with holding rates in both good and bad times when your competitors are discounting. For many different market segments, raising price even a small degree above the competition proved advantageous for those hotels. It is our hope that by examining hotels that outperformed their competitive set because they choose not to discount, that we can offer some sound facts to inform those who are puzzling over the discounting debate.