REPORT FROM THE U.S.—Hoteliers have long disputed the age-old question: Does lowering rates increase demand and drive more revenue?
The answer is a matter of price elasticity. If average daily rate is elastic, then lower prices would generate sufficient incremental demand to offset revenue lost through discounts. If ADR is inelastic, then a rate reduction would not generate enough incremental demand to offset the discount.
A recent distribution study published by the Hospitality Sales and Marketing Association International found that rate is largely inelastic—or discounting does not stimulate enough demand to make up for rate reductions.
The net result of lower rates is lower revenue levels, according to “Distribution Channel Analysis,” which was released in January.
Mark V. Lomanno, active board member for newBrandAnalytics and co-author of the report, said lowering rates does not increase demand at either the property or market level.
Understanding demand
At the property level, lowering rates creates a shift in demand rather than an increase, Lomanno said. It causes consumers to change their minds about the property with which they will book.
As for decreasing prices at the market and city level, Lomanno said it does not create new demand that did not exist before. “It’s kind of a net loss for everybody.”
Bjorn Hanson, divisional dean, clinical professor and HVS Chair for the Preston Robert Tisch Center for Hospitality, Tourism and Sports Management at New York University, took the opposite stance, maintains that lowering rates does increase demand.
“The law of economics—as the price decreases, demand increases—holds true for the hospitality industry,” Hanson said.
Hanson said he monitored the dynamic in the hotel industry from 1990 through 2007 by observing and analyzing markets in which hotels experimented with decreasing rates.
He found that lowering rates generating more revenue than would incremental demand growth if rates remained constant.
Yet, hotel demand growth in the United States is very limited, according to the STR and AH&LA report. It averaged 1.6% year-over-year during the last 20 years.
Adam Weissenberg, vice chairman and global leader of the travel, hospitality and leisure segment at Deloitte LLP, agrees with the law of economics from a theoretical standpoint.
Hoteliers are competing for the leisure traveler’s dollars against other life necessities, Weissenberg said. It often gets down to the point where many people choose not to go on vacations because they are too expensive.
Strategic rate lowering
“If you would lower the rates to (US)$1, everyone would jump and get a hotel room,” Weissenberg said. This significant decrease in rates certainly would cause a spike in demand.
On the business side, if company executives decide they are going to keep the travel budget static, but all of a sudden hotel rates drop, they will have more people traveling, he said.
However, this is not the reality in the hotel industry. Prices do not drop down significantly enough to create this kind of demand. Instead, the shift in demand from one property to its competitor with lower rates is actually what occurs, Weissenberg explained.
Once the other hotel drops its rate to match its competitor, the two properties end up in rate wars, which cut existing revenue the consumer was willing to pay in the first place, he said.
It does make sense to lower rates from time to time, newBrandAnalytics’ Lomanno said. However, he believes the industry has gone too far with the practice and is now at a level of discounting beyond what is necessary.
Increasing revenue per available room via price reductions takes a lot of effort and strong analytics to understand, said Chris Anderson, associate professor at the Cornell School of Hotel Administration at Cornell University. Companies often do not take these additional steps.
“The idea is to do it very strategically in the short term when very price-sensitive consumers are in the market,” he said. For example, Anderson said, targeting a price sensitive leisure traveler by only lowering prices for longer stays would be a strategic move.
Anderson said hoteliers also need to make sure they are marketing price reductions effectively. “The last thing you want to do is lower prices and not tell anyone you are doing it. This is a surefire way to dilute profits.
“What one should take away from this is discounting to stimulate demand needs to be a very data-driven, targeted exercise, not a reactionary one,” Anderson said.
