HENDERSONVILLE, Tennessee—As we move into the summer travel season, hotels across all industry segments continue to heavily discount rates. This is of increasing concern because during the past four years, most of the growth in revenue per available room has been a function of gains made in room rates. Especially when supply growth is topping 3 percent and demand probably has hit bottom, resistance to RevPAR declines predominately will come from the rate side of the equation. Rate declines seen over the past three months are staggering, with March and April loses almost reaching double digits. Discounting was expected as business and leisure demand declined in the face of worsening economic conditions; however, the magnitude of losses (especially in major metro markets) likely was not expected.
Long term impacts of discounting
So, to hark back to an article I wrote last year, the industry needs to realize the long-term impact of rate discounting. Let’s first introduce a couple of terms that most industries use when talking about rates: nominal rates and real rates.
Inflation is the change in the price of goods and services over a period of time. As prices rise, each dollar buys fewer goods and services. Nominal rates have not been adjusted for inflation. Real rates are inflation-adjusted and provide a more accurate representation of growth across a period of time. We at Smith Travel Research always like to point out that it took six years for rates to recover after the 2001-2002 recession, so perhaps putting that statistic in a graphical representation will help to explain.
As you can see, when we use 2000 as our base year, nominal rates did not match inflation adjusted rates again until 2007 as a result of discounting in 2001-2003. While we as an industry tout an average average daily rate growth rate of 3.5 percent per year over the past 20 years, that is only slightly better than the average rate of inflation, which is in the 3.1 percent range. The result: real rates have grown very little.
Discounting right now
As you can see, real ADR growth has been a give-and-take battle over the past 20 years. In the early 1990s recession, the 1-month moving average reached a low point around 0 percent, while in our last recession we reached -5 percent. With the current trends we are seeing, the industry is poised to see continued loses in terms of nominal rate growth throughout the second and third quarter of 2009. Performance results through the first quarter show an ADR decline of 7.7 percent, and after reviewing data from April and preliminary May statistics, the second quarter likely will end up at a level even or below the first quarter (barring a strong June performance).
While current economic conditions might not seem ripe for maintaining rates, research has shown that discounting does not increase RevPAR performance. A cooperative study between STR and Cornell University in 2004 showed hotels that maintain rates higher than their competitors generally have lower occupancies, but record a higher RevPAR (CHR Reports, 2004). The report showed that hotels in direct competition make more money when they have higher rates and do not try to increase revenues by undercutting the competition, even in economic down times. These hotels might steal market share in the short term, but in most cases they will not gain a higher RevPAR.
Here is where we stand: Rate declines in March and April topped 9 percent, which outpaces the high 7-percent to mid-8-percent declines we experienced following September 2001. Preliminary May numbers released by STR indicate that we likely will see mid-8 percent to 9 percent declines in ADR. With the current recession expected to soften into the third and fourth quarter of 2009, hoteliers should be cognizant of the impact of continued rate loses. The industry has worked hard to recover from the previous recession, but we are in a position now where we could negate much of that progress in a matter of months. As the economy shows signs of stabilization and growth, so should hotel rates.