Establishing Room Rates for Hotels: A Comprehensive Guide by Yvonne Yang - RDM LRJJ

1. Establishing RoomRates Yvonne Yang - RDM LRJJ

2. Contents Tariff construction Positioning price Establish room rates Pricing rooms: Market Condition approach Rule-of-Thumb approach Hubbart Formula approach Yvonne Yang - RDM LRJJ

3. How do hotels set their rates? A determination of: Economic calculation To price & to understand how consumers react to the pricing strategy Marketing decision Positioning Tariff construction Yvonne Yang - RDM LRJJ

4. Tariff construction • What is “Price”? • An amount ($) as an exchange to acquire goods or services • In order to understand: • How much to charge for its accommodation • How to be attractive and competitive with other hotels Yvonne Yang - RDM LRJJ

5. Positioning Your Price • Approaches to Positioning Your Price • Skim - to skim, set your prices higher than the competition does so you can "skim off" the higher-paying customers. If the competition is charging $79, you might set your rates at $89 and $99, in hopes of getting the people who are willing to pay a bit more. • Match - to match, set one rate to match the competition and another rate slightly higher. For instance, if the competition is charging $79, you might also charge $79 for one type of room and have an $89 rate available for a better room or option. Yvonne Yang - RDM LRJJ

6. Positioning Your Price • Surround - to surround, offer one price that's lower than the competition's price and one price that's higher. If the competition is charging $79, offer a $69 rate to attract the bargain-seekers, and offer an $89 rate for a slightly better room or option. • Undercut - to undercut, offer a price that is the same as your competition and a lower one as well. If the competition is charging $79, offer a $79 rate and a $69 in hopes of attracting more customers. • Penetrate - to penetrate, set your rates lower than those of the competition. If the competition is charging $79, offer rates such as $69 and $59 in hopes of getting consumers to try your products. Yvonne Yang - RDM LRJJ

7. Positioning Your Price The table above illustrates the five approaches to positioning your price against the competition's. In this example, the competition is charging $79. Yvonne Yang - RDM LRJJ

8. What about? Season ? Weekday or Weekend? Time of arrival? Inclusive or non inclusive? Per person or per room? Establishing Room Rates • Criteria's influencing room rates: • Size (square meters) • Type of room and bed • Location / View • Grade (Stars *) • Furnishing / Amenities (features) • Level of Service • Type of business • Etc… Yvonne Yang - RDM LRJJ

9. Pricing Rooms • Market condition approach • Rule of thumb approach • Hubbart formula approach Yvonne Yang - RDM LRJJ

10. Market Condition Approach • The simplest and the most commonly used approach • Management looks at comparable hotels in the geographical market and sees what they are charging of the same product (normally 6 to 10 hotels) • These properties are called as “competitive set” • The competition can be based on location, property ratings, property type, brand identification, or other factors Yvonne Yang - RDM LRJJ

11. Market Condition Approach • This could be done by “blind calls” to competing hotels, the following questions will be considered: - Are our rates lower or higher than the competing hotels? • How are our rates affecting our revenue? • What is our occupancy percentage? What are the ones of the competing hotels? • If we increase or decrease our rates, will our total revenue improve? • Have any trends emerged during the past 3 to 6 months? • This also could be done by “industry report”: IBHS Yvonne Yang - RDM LRJJ

12. Market Condition Approach Disadvantages • If the property is new, construction costs will most likely be higher than those of the competition • This approach does not take the value of the property into consideration (newer facilities and amenities) Reality • Rates might also be obtained through price order company such as certified accounting firm • Revenue managers among hotels might have direct discussion with competitors • Rates may also be available from public sources: Internet, GDS, CRS or published rate brochure Yvonne Yang - RDM LRJJ

13. Rule-of-Thumb approach • Set the rate of a room at $1 for each $1000 of construction and furnishings cost per room, assuming a 70% occupancy. • Example: a hotel with the average construction and furnishings cost per room is $125,000, the minimum average room rate would be $125. Yvonne Yang - RDM LRJJ

14. Rule-of-Thumb approach • A well-maintained hotel worth $100,000 per room today may have been constructed at $20,000 per room 40 years ago • The average selling price will be $20 per room • A much higher rate would appear to be appropriate since inflation, increased costs of labor, furnishings and supplies have not been taken into account (CPI) • This approach DOES NOT take inflation into account. • This approach DOES NOT consider other facilities and services (e.g.: F&B, recreation, laundry) Yvonne Yang - RDM LRJJ

15. Rule-of-thumb Approach Average per-room cost for hotel development: SegmentPer-room cost • Budget/Economy $52,800 • Mid-range w/o F&B $85,600 • Mid-range with F&B $103,100 • Full Service $165,900 • Luxury/Resorts $516,300 From Hotel & Motel; Jan. 12, 2012 Yvonne Yang - RDM LRJJ

16. Rule-of-thumb Approach • A hotel costs investors a total of $15,465,000/-, and has 300 rooms. Calculate an ARR with this information • A second hotel costs $9,895,000/- and has 60 rooms. Calculate an ARR • A boutique hotel costs 2,500, 00/- and has 12 rooms. Calculate an ARR Yvonne Yang - RDM LRJJ

17. Hubbart Formula Approach “Bottom-up” approach Method: • Calculate desired profit  • Calculate pre-tax profits • Calculate fixed charges and management fees • Calculate undistributed operating expenses • Estimate non-room operated department profit/loss • Calculate required rooms division income • Determine rooms division revenue  • Calculate average room rate Yvonne Yang - RDM LRJJ

18. Hubbart Formula • Example: • Look at desired Profit • Add all costs • Gives Average Price per Room Return Costs = ARR Yvonne Yang - RDM LRJJ

19. Case 1 Holiday Inn Hotel, a proposed 30-room with a fully equipped restaurant, will cost $750,000 to construct. An estimated additional $50,000 will be invested in the business as working capital. Of the total $800,000 investment, $400,000 is to be secured from the Bank of China at the rate of 10% interest and cash $400,000 provided by the owners. The projected occupancy rate is 80% for the year. The owners desire a 15% annual return on their investment after the hotel pays income taxes of 25%. The estimated undistributed expenses, not including income taxes and interest expense total $480,000. The estimated direct operating expense of the room department are $7 for each room sold. Consider a year to have 365 days. Yvonne Yang - RDM LRJJ

20. Case 1: Holiday Inn Answer Yvonne Yang - RDM LRJJ

21. Case 2 • The proposed Harris Place (a 50 room, room only lodging facility) is to be built in mid-Michigan. Jeremy Harris, the owner is concerned about the ADR, construction costs, borrowing costs, and their impact on future profits. He provides you with the following information. Proposed Costs of the Lodging Facility: • Land - $400,000 • Building - $2,000,000 • Equipment - $1,000.000 Yvonne Yang - RDM LRJJ

22. Case 2 Financing • Equity (desired return on investment (ROI = 15%) $1,000,000 • Debt (8% annual interest rate) $2,400,000 • Income Tax Rate: 40% • Property Taxes: $120,000 per year • Fire Insurance: $30,000 (annual) • Depreciation of Building: 40 year life straight line method, ($50,000 per year) • Depreciation of Equipment: 10 year life, straight line method, ($100,000 per year) • Undistributed Operating Expense: $300,000 annually • Rooms Department Direct Operating Expenses: equal $30,000 annually • Expected Paid Occupancy: 70% • Determine the required ADR to achieve Jeremy Harris’ goal of earning an ROI of 15% Yvonne Yang - RDM LRJJ

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24. Case 3 • Barbara Rope, a wealthy investor, is considering investing $2,000,000 in a 300 room hotel. Debt financing would total $8,000,000. She desires to know the average room rate her hotel will have to charge, given the following alternatives. Yvonne Yang - RDM LRJJ

25. Case 3 Information Yvonne Yang - RDM LRJJ

26. Case 3 Answer Yvonne Yang - RDM LRJJ